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Last week we received the latest U.S. and Canadian employment reports, and both provided us with valuable insight into where our mortgage rates may be headed.
When employment growth is strong and the demand for labour increases, the cost of labour should rise. Because the cost of labour is one of the key drivers of inflation, a strengthening job market would be expected to push average prices higher. If that happens, bond yields normally rise in response and eventually the Bank of Canada (BoC) would raise its overnight rate to maintain price stability and keep inflation under control. Conversely, if employment demand falls, then over time the cost of labour should fall as well, and that would help push inflation, and eventually interest rates, lower.
Here are the highlights from the latest reports:
Non-Farm U.S. Employment – December
- The U.S. economy added 252,000 new jobs in December, which was slightly above the 240,000 new jobs that the consensus was expecting. The U.S. labour department also added an additional 50,000 jobs to its initial estimates for the prior two months.
- The U.S. manufacturing sector had its best month in more than a year, adding 67,000 new jobs. This is good news for the U.S. economy because, as I have said before, manufacturing job growth has a powerful impact on the demand for labour in other parts of an economy.
- Surprisingly, average hourly earnings fell by 0.2%. There is often a lag in the timing of labour market tightening and rising wages because it can take a while for employees to recognize their increased bargaining power. But the experts I read believe that U.S. job growth has been strong enough for long enough that this normal evolution should have begun to unfold. Since this hasn’t happened, falling U.S. labour costs against the current backdrop of steady job growth have become somewhat of a head-scratching anomaly.
- It was also both surprising and significant to see the U.S. participation rate fall from 62.9% to 62.7% in December. (As a reminder, the participation rate measures the percentage of working-age Americans who are either employed or actively looking for work.) There has been an ongoing debate about whether the steady drop in the U.S. participation rate was the result of cyclical or structural factors. If the causes were cyclical, then the U.S. Fed would be justified in adopting accommodative monetary policies to help counteract that momentum and the U.S. economy would be expected to respond to that stimulus. But if the causes proved structural, then the Fed’s ultra-loose monetary policies would be expected to have little or no impact and, worse still, would risk fueling higher-than-expected inflation growth. The participation rate’s continuing failure to rebound in conjunction with the recent improvements in U.S. employment momentum implies that structural changes are to blame.
The Canadian Labour Force Survey – December
- The Canadian economy shed 4,300 jobs in December, following the 10,700 drop we saw in November.
- While the headline was disappointing, full-time employment surged by 53,500 new jobs and this continues an impressive run that saw full-time employment average more than 22,000 new jobs over the second half of 2014. Our economy therefore replaced part-time and self-employed jobs for full-time jobs last month and, on balance, this would be interpreted as a healthy development.
- Unlike in the U.S., our average earnings rose by a robust 0.6% on the month, and that implies that our employment momentum is being driven by cyclical factors that are part of the normal business cycle, as opposed to structural factors, such as an ageing workforce or skills mismatches, which would be less influenced by accommodative BoC monetary policies.
- Manufacturing employment fell by 18,300 jobs, which was the biggest drop in more than two years. Manufacturing job growth provides vital fuel for healthy job growth across our broader employment market, as mentioned in the section above, but this category has even more importance in Canada’s current economic climate because of our waning resource sector momentum.
Given the volatility in the initial employment data, which are often revised in the months that follow, it is important to avoid making too much of one month’s labour report. That said, trends do emerge over time, and these should be given increasing weight if they are further confirmed by ongoing data.
To that end, the U.S. economy continues to produce new jobs at an impressive rate, but it is unusual to see this happening while the participation rate and average wages are falling. The Fed must weigh the threat that lagging-wages pressures will surge to the fore against the threat that raising interest rates too quickly could choke off a domestic recovery that can’t rely on support from beyond its borders.
Meanwhile, the Canadian economy managed to produce relatively healthy job growth last month, but our view of the horizon is less optimistic in the face of sharply lower resources prices, most especially, oil, and our continuing loss of highly desirable manufacturing jobs.
Five-year GoC bond yields fell nine basis points last week, closing at 1.22% on Friday. Lenders are much slower to lower their rates than they are to raise them and, as such, five-year fixed-rate mortgages remain in the 2.79% to 2.89% range, while five-year fixed-rate pre-approvals are offered at 2.99%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range, depending on the terms and conditions that are important to you.
The Bottom Line: The latest U.S. employment data continue an impressive job-growth run for another month and this probably tilts the U.S. Fed a little more towards raising its policy rate sooner rather than later. While the Canadian employment data were also encouraging overall, despite the disappointing headline number, I think the BoC will be much more cautious than the U.S. Fed because recent developments, such as sharply lower resource prices, will have a much more profound impact on our economic momentum.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave