We are in a very interesting point in the cycle. The credit crunch is far from over but with credit spreads has improved notably since early September, it seems that the market’s focus is slowly shifting towards the US economy. And this economy is deep in recession.
The non-farm payroll report for October was not pretty. Payroll employment fell by 240,000 during the month—the tenth consecutive decline. The numbers for the previous two months were revised downward by almost 180,000 jobs. Payrolls in private industries plunged 263,000, the largest decline since November 2001. And the unemployment rate surged by 0.4 of a percentage point to 6.5%—which is now above the peak reached in the last cyclical downturn. And part-time employment is now rising by 30% on a year-over-year basis—more or less the rate we have seen at the bottom of the 1982 and 1991 recessions. Overall the economy lost 1.2 million jobs this year, with about half of the decline has taken place in the last three months.
What will it take to get out of this recessionary territory? The market is now pricing in a 50 basis points cut by the Fed. And the market might be getting this cut. But it is important to note that the Fed has more ammunition than simply cutting rates—and in this sense, it is more powerful than its position in previous cycles. More specifically, the recent Troubled Assets Relief Program (TARP—otherwise known as the bailout) granted the Fed the authority to pay interest on reserves held by commercial banks. This means that the Fed can separate its balance sheet from monetary policy and give it more flexibility to provide liquidity to banks without driving the effective fed funds to 0%.
In Canada, the labour market continues to surprise on the upside. But it will not last. Look for a notable slowing in activity in the coming six months, with the unemployment rate rising to close to 7% by mid next year.
House prices in Canada are falling. But looking simply at the headline numbers can be very misleading. At a risk of being a bit technical, we will note that the headline numbers reflect a current weighting for each city, which leads to a significant bias to the overall average price since dramatic changes in the volume of the sales in certain cities can notably influence the national average price. Take Vancouver. The close to 45% year-overyear fall in the number of homes sold in the city and the fact that Vancouver prices are much higher than the national average combined to make it look as though national home prices were falling sharply when, in fact, it was driven by fewer expensive homes being sold in Vancouver, as a fraction of the whole. The result: the national headline number is down by close to 6% (y/y) last month but if properly weighted, house prices fell by only 1%. Yes, prices are falling and they will continue to fall, but the headline numbers exaggerate the real
weakness in the housing market.
