Our summary of recent economic events and what to expect in the weeks ahead.
Canadian Highlights
- The U.S.-Canada trade dispute continued this week. While the latest tariffs will cause pain for affected businesses, it should not materially add to the drag on Canada’s economic growth.
- Canadian household wealth marked its eleventh consecutive quarterly gain, breaching the $19 trillion mark; it should support the recent resilience in consumer spending.
- Next week’s inflation report will show whether higher energy prices are spilling over into broader inflation. Markets are pricing in at least one interest rate hike from the Bank of Canada this year, but we think that looks overdone.
U.S. Highlights
- U.S. Treasury yields approached their post-pandemic high as oil prices briefly surpassed $100/barrel.
- August producer and consumer inflation picked up on the back of higher energy prices, while core inflation pressures also firmed.
- Markets raised the implied probability of a rate hike to roughly 90% ahead of next week’s Federal Reserve meeting.
Canada – Stand Ready for the Right Time
An escalation in the U.S.-Canada trade conflict was the main event in an otherwise quiet week for economic data. Canada’s latest counter-tariffs took effect on September 8 and triggered another round of countermeasures from the U.S. This weighed on Canadian equities, with the S&P/TSX Composite falling mid-week and losing further ground as oil prices moved higher. Canadian government bonds also sold off, with 5- and 10-year yields rising 19 and 13 basis points, respectively. The increase mirrored the selloff in U.S. Treasuries and, more broadly, a global trend of upward pressure on yields.
Washington responded to Canada’s counter-tariffs by banning imports of some products, removing tariffs on a handful of others and introducing new duties elsewhere. Previously applied tariffs on cement, sugar, toilet paper and fishing rods were removed, while new duties were imposed on products including dairy, alcoholic beverages, metal and paper products, and outboard motors. The impact of another threat to remove Canadian firms from U.S. government procurement is less clear, apart from the immediate hit to sentiment and the share prices of Canadian companies doing business in the U.S.
The new trade restrictions and duties should not materially add to our estimated 0.3 percentage point drag on Canadian growth over the next year. Rather, they represent another manifestation of policy uncertainty, which has been a major headwind to business investment. Encouragingly, the second quarter broke a five-quarter streak of contractions, with business investment rebounding at a solid pace (Chart 1). The question is whether that momentum can last. Ottawa has said trade negotiations will resume at “the right time.” But for the investment, the right time may be now. Canada aims to catalyse $1 trillion in investment over the next five years, next week’s investment summit is a step in the right direction.
Meanwhile, a somewhat backward-looking but positive signal came from the second-quarter household wealth report. Canadian household wealth marked its eleventh consecutive quarterly gain, breaching the $19 trillion mark. Moreover, stronger income growth, supported in part by federal measures, pushed the debt-to-income ratio – a measure of household leverage – lower (Chart 2). Similarly, the debt-service ratio fell to its lowest level since Q3 2022, indicating an improved ability to service debt. Together with continued wealth gains, lower leverage has likely contributed to the recent resilience in consumer spending, which we expect to carry into Q3.
Next week’s CPI inflation report will be closely watched for signs of spillover from higher energy prices. We think current market pricing for Bank of Canada rate hikes this year is overdone. Canadian inflation is more contained than in the U.S and has been moving in the right direction, while the renewed trade tension adds downside risk to growth. Moreover, Canadian bond yields have been pulled higher alongside the move in the U.S., raising borrowing costs, which if sustained will be a drag on growth. We expect the combination of these forces will keep the BoC on the sidelines, but we will be watching the inflation report closely.
U.S. – All Eyes Turn to the Fed After Inflation Pressures Firmed in August
The holiday-shortened week proved to be eventful, with U.S. Treasury yields flirting with their post-pandemic peak (Chart 1) and oil prices briefly breaching $100/barrel for the first time in four months. The two developments are partially related, as rising energy costs have bolstered expectations for tighter monetary policy. However, a higher term premium has also played a role, reflecting increased compensation demanded by investors to hold longer-dated U.S. government debt. Against this backdrop, equities struggled, with the S&P 500 down 0.7% on the week as of the time of writing.
Energy prices marched higher throughout the week as tensions between the U.S. and Iran flared up periodically but paused on Friday amid signs of diplomatic efforts between Iran and several Gulf states to reopen the Strait of Hormuz. Many of the factors that helped to contain energy prices through the summer, both domestically and internationally, are no longer providing the same degree of support. As the recent rise in oil prices illustrates, this could leave energy prices more vulnerable to any further escalation in geopolitical tensions.
August’s CPI inflation data released on Friday only captured a modest uptick in energy prices during the month, but it was still sufficient to generate an acceleration in headline inflation. The producer price index rose 0.4% in August, bringing the annual change to 5.4%, as higher energy costs filtered through supply chains. In the six months since the start of the conflict in the Middle East, producer prices have risen by 2.7%, compared with a 2.0% increase in consumer prices. If this gap reflects margin compression, the recent increase in energy prices could generate greater pass-through to consumer prices if sustained.
On the consumer side, headline and core inflation accelerated to 0.4% and 0.3% month-on-month respectively. The energy price driven uptick in headline inflation was expected, but the acceleration in core inflation, which included broad increases in prices for airfares, hotels, and communication services, was an unwelcome surprise. While the three-month annualized change in core prices sat at 2% in August, the acceleration recorded in both goods and services was more concerning (Chart 2).
Taken together, this week’s data paints a complicated picture for next week’s Fed interest rate decision. Inflation pressures have undoubtedly trended higher, which seems likely to continue into September with oil prices up roughly 16% since the end of last month. However, energy prices remain volatile and the near-term acceleration in core inflation is young. Combined with the sustained stability in inflation expectations, next week’s decision is likely to be a close call. Markets appear slightly more confident, with odds for a hike next week jumping from roughly 70% to 90% following the CPI data release. Chair Warsh’s post-meeting press conference and the updated summary of economic projections will be of particular interest, as markets assess the evolution of the Fed’s reaction function in an environment of elevated uncertainty. We will be releasing updated economic and financial forecasts the following day.
