Benjamin Tal, Deputy Chief Economist, CIBC and Katherine Judge, Senior Economist, CIBC discuss how labour market dynamics and inflation risks are impacting Bank of Canada policy.
Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets. A podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.
Benjamin Tal: Hello, welcome to Eyes on the Economy. I'm Benjamin Tal, Deputy Chief Economist CIBC with Katherine Judge, Senior Economist with CIBC Economics Department. And we are going to discuss the economy and what makes sense and what doesn't. If the real and ultimate measure of intelligence is what you do when you don't know what to do, then the next few weeks, months and quarters will test the economic IQ of every central banker in the universe. Because they are the first to admit that they have no clue what's happening. We make it up as we go. We all know that this is a very uncertain environment and we have to make sense out of this madness. So we try to put things in perspective and we're going to look at three things today. One is the labor market because 80 % of service inflation is wages. You need to have a narrative about inflation. You must have a narrative about the labor market, especially wages. So we'll talk about how tight the labor market is, the mismatch in the labor market. We'll talk about the fact that the strikes might be inflationary to what extent we should lose sleep over it. And of course, we'll talk about the situation in which many of those servers that we are so relying on, central banks are relying on, are not really telling you the truth because people are not responding to them. So we'll talk about all that, but let's start with the most important one. And that's the labor market, the mismatch in the labor market. How big is it? How significant it is? How inflationary it is. We just published a research piece about that, looking at the mismatch in the labor market. So Katherine, you want to lead the way?
Katherine Judge: Hi, Benjamin. So we looked at the labor market mismatch in Canada. And, when you look at on the surface of the labor market, you can see things have weakened quite a bit. Things have normalized. Job openings per unemployed person is back to normal levels. But if you look beneath the surface and you look within different categories of occupations, you can see ones that are actually performing better than the average in terms of the unemployment rate. So there's actually about 38 % of jobs right now that are showing signs of a labor shortage. And a lot of these are in non -cyclical areas like healthcare, supply chain, logistics, law, government, management positions and trade. So, what we're seeing is that these labour shortages started years and years ago and have only gotten worse and run the risk of continuing over the next few years.
Benjamin Tal: Yes, and that's important because the labor market is now normalizing. It is slowing down. There is no question about the fact that the labor market is weak enough for the Bank of Canada to start cutting interest rates and should continue to cut interest rates, in my opinion, aggressively. We have to realize a few things. First of all, that the unemployment rate at any point in time is a combination of two things. One is the rate of inflow into unemployment, namely becoming unemployed, the other one is staying unemployed, which means how long people stay employed, the duration of unemployment. And both of them are actually rising now, which means that it's more sustainable. So that's one aspect of the labor market that is slowing down. The quiz rate is slowing down and many servers are telling you that vacancy rates are now going down. Now, since the beginning, I never bought this vacancy rate story. I thought it was a bit of a mirage. Why? Because in economics 101, they teach you, that when you have a shortage of something, the relative price of this something will rise. The shortage during COVID was of relatively low paid individuals. So the relative wage was supposed to go up. So we looked bottom 20, bottom 40 of the distribution. It went up, but nothing to write home about, nothing to justify one million vacancies. And when you go to small businesses that employ 80 % of those people and you ask how come you're not raising wages, they say, economists like yourself are telling us, that the recession is coming. We are not going to raise wages five minutes before recession. And I say, you're not going to raise wages five minutes before recession? You don't need this guy. It's very easy to press a button and say, I need five people, show me the money. And the fact that they are not willing to pay means that it's really not real. It's a mirage. And sure enough, we see vacancies now falling. At the rate we haven't seen before, basically below 2019 level. So I'm not counting on vacancies, and that's why we did what Katherine suggested, look at the unemployment rate and look at occupations that show some signs of labor shortage. And close to 40 % of employment is basically showing symptoms of shortage, which of course is inflationary after the cycle is over, after this slowdown is over. It will make the Bank of Canada's life more difficult. And I believe that's one of the reasons why the new neutral rate of interest will be higher than before, the system will be more inflationary due to de-globalization, just in case inventories, and clearly a tighter labor market. Now, this is interesting for the Bank of Canada, but another interesting thing is that, Katherine, you look at the impact of strikes on inflation, should we lose sleep over it?
Katherine Judge: I don't think we should be losing sleep over it. There's been a lot of potential strike action news recently. And we've seen this before. We saw last year there were the BC port strikes, which did seem to have an impact on inflation, but of course, short -lived. Fast forward to today, and the unemployment rate is way higher, which means there's that offset in terms of inflation. You also have, if there were to be disruptions in the transportation of goods or even services, inventories of goods are above pre -pandemic norms. So there does seem to be a bit of a cushion there. So I don't think we should lose sleep. And as far as wage settlements go, unionized wages tend to lag what's being seen in other areas of the labor market and also what's already been seen in the CPI. So, essentially, all these wage adjustments are just catching up to things we've already seen in the rest of the labor market. And you can already see first year adjustments for wage settlements are down sharply to close to 4%. So they're essentially just lagging what we've seen in CPI. So I don't think it is really a big risk. In the near term, there could be a blip in inflation, but certainly over the timeframe that the Bank of Canada targets the medium to longer term structural changes that are underway are a lot more important like the one that we suggested in our paper from the labor market mismatch.
Benjamin Tal: That's a very good point. Now, there are other things that the Bank of Canada has to worry about. Of course, we are talking about the mismatch in the labor market. We're talking about strikes, but we're also talking about food inflation. And we have to realize one thing. Food inflation at this point is disinflationary. Yes, we all know that when we go to the supermarket, we are overwhelmed by how expensive food is. You basically have to mortgage your house to buy a banana or something. But from a year -over -year perspective, it's actually decelerating. So it's disinflationary as far as the Bank of Canada is concerned. But here we have to talk about inflation. When we say inflation, what do we have in mind? Do we have in mind CPI, core CPI, CPI -X, CPI -shelter, CPI -trim, CPI -minus -shelter and services? All those forces suggest that the Bank of Canada has many CPIs to focus on. And the way we measure it is very different. Year over year, three months moving average, six months moving average annual rate, three months moving average year over year. So we have a matrix of five by six. Inflationary numbers. So every time and that's extremely important every time starts Canada releases the inflation numbers We have to deal with 30 inflation numbers That's an inflationary buffet. The point that I'm making is the following. If the Bank of Canada want to cut, they can justify by looking at all those numbers and find the relative numbers. And the other way is also the case, if they want to tight, they can actually do the same thing, just justifying, looking at those 30 numbers. There is enough numbers here for everybody. So what I'm telling you, and that's extremely important, the narrative determines the data and not the other way around. The Bank of Canada should continue to cut. And the big question is to what extent. The Bank of Canada will be able to divorce itself from the Fed. We believe that the Bank of Canada will be able to continue to cut interest rates beyond 100 basis points spread with the Fed, but clearly this is a risk to our forecast. We hope that the Fed will start cutting in September, especially following the latest inflation number, but that's a big risk to the forecast. Overall, another factor that will add volatility to the situation is the survey response rate. We have written about it last week. We have a situation in which regardless what survey you look at, especially in the US, the response rate went down dramatically. If it's the payroll employment survey or any other survey, including the CPI. And if you have a lower response rate, clearly you have to revise it all the time in order to get to the real response rates, which means the data will be much more volatile. And that's the risk that is facing. The Bank of Canada and the Fed that are data dependent. This data is not as reliable as it used to be because of reduced significant reduction in response rate. So overall, the picture is very clear. We have a situation in which the Bank of Canada should continue to cut the Fed not very clear that they will cut, but I think they will cut in September. And that will allow the Bank of Canada to continue to easeand they need so because if the Bank of Canada was an AI machine, they would have stopped long time ago.
Katherine Judge: Thanks for that great summary Benjamin of what the bank and the Fed are looking for. thank you to all our listeners, and see you in the next episode.
Outro: Please join us next time on the Eyes on the Economy where we will share our latest perspectives and outlook for the Canadian and US economy.
Disclaimer: The information and data contained herein has been obtained or derived from sources believed to be reliable, without independent verification by CIBC Capital Markets and, to the extent that such information and data is based on sources outside CIBC Capital Markets, we do not represent or warrant that any such information or data is accurate, adequate or complete. Notwithstanding anything to the contrary herein, CIBC World Markets Inc. (and/or any affiliate thereof) shall not assume any responsibility or liability of any nature in connection with any of the contents of this communication. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice. CIBC Capital Markets is a trademark brand name under which different legal entities provide different services under this umbrella brand. Products and/or services offered through CIBC Capital Markets include products and/or services offered by the Canadian Imperial Bank of Commerce and various of its subsidiaries. For more information about these legal entities, and about the products and services offered by CIBC Capital Markets, please visit www.cibccm.com. Speakers on this podcasts are not Research Analysts and this communication is not the product of any CIBC World Markets Inc. Research Department nor should it be construed as a Research Report. Speakers on this podcast do not have any actual, implied or apparent authority to act on behalf of any issuer mentioned. The commentary and opinions expressed herein are solely those of the individual(s), except where the speaker expressly states them to be the opinions of CIBC World Markets Inc. Speakers may provide short-term trading views or ideas on issuers, securities, commodities, currencies or other financial instruments but investors should not expect continuing analysis, views or discussion relating to these instruments discussed herein. Any information provided herein is not intended to represent an adequate basis for investors to make an informed investment decision and is subject to change without notice. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice.