It’s Off to the Rate Cuts…

Yesterday, the Bank of Canada (BOC) opted to cut rates for the first time since March 2020, lowering its target rate 25bps from 5.00% to 4.75%.? While growth has improved in the Canadian economy, rising 1.7% in the first quarter following a 0.1% gain the quarter prior, inflation remains still elevated.?Headline CPI?rose 2.7% in April, down from the 2.9% annual gain in March. Although, while still noticeably above the bank’s 2% target, at 2.7% this is the lowest annual increase since March 2021.

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This morning, the European Central Bank (ECB) joined the ranks of those initiating an ease in policy, reducing its deposit rate from 4.00% to 3.75%, the first reduction since September 2019. The reduction comes amid sluggish growth and encouraging signs of disinflation.

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The European economy has been sluggish for some time, with two consecutive quarters of negative growth at the end of last year. More recently, however, activity levels have improved, rising 0.3% in Q1 with expectations for an average 0.7% pace throughout the year.?Meanwhile, inflation has slowed markedly in the Eurozone from a peak of 10.6% in October 2022 to 2.4% as of April.

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Back in the U.S., the Fed continues to reiterate a message of “patience.” Market expectations for rate cuts have dropped from as many as six or seven at the start of 2024 to just about two more recently. Like its counterparts abroad, the Fed continues to maintain a policy bias towards easing – eventually?– as this is clearly a Committee desperate to provide relief and continue to perpetuate positive economic conditions.?However, with inflation and growth failing to evolve as expected, “eventually” increasingly appears to be a 2025 event.??

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The domestic economy has lost momentum from an outsized annual growth pace of 2.5% in 2023 to just 1.3% at the start of this year, but growth remains solid as the U.S. economy has avoided a technical recession that plagued much of the developed world. Furthermore, with inflation in the U.S. stabilizing well above 2%, and surprising to the upside January through March, Committee members have been crystal clear that it will take “many”?more months of improving data before a disinflationary trend can be reestablished to justify a reduction in policy rates.??

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On the data front, yesterday, MBA mortgage applications fell 5.2% in the week ending May 3 following a 5.7% decline the week prior. The 30-year mortgage rate, however, rose 2bps to 7.07%, a three-week high.?

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Also yesterday, ADP reported that private-sector employment rose by 152k in May, less than the 175k gain expected and a four-month low.

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Finally, yesterday, the ISM Services Index bounced back into expansionary territory (a reading above 50) from 49.4 to a reading of 53.8 in May. May’s print of 53.8 surpassed the expected gain to 51.0 and marks the highest reading in nine months. In the details of the report, business activity jumped 10.3 points to 61.2, the highest reading since November 2022, supplier deliveries rose from 48.5 to 52.7, and employment ticked up from 45.9 to 47.1, averaging 47.3 over the past six months. Also, new orders rose 1.9 points to 54.1 in May, a two-month high. On the other hand, prices paid fell 1.1 points to 58.1, a two-month low, backlog of orders slipped by 0.3 points to a reading of 50.8, and the change in inventories decreased from 53.7 to 52.1 in May, a two-month low.

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This morning, initial jobless claims rose 8k from 221k to 229k in the week ending June 1, a one-month high. The four-week average, meanwhile, remained at 223k for the second consecutive week. Continuing claims, or the total number of Americans claiming ongoing unemployment, inched up from 1.790M to 1.792M in the week ending May 25.

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Also this morning, the U.S. trade deficit widened in April to the largest since October 2022. The gap in goods and services widened 8.7% to $74.6 billion. According to the median forecast, the deficit was expected to widen to -$76.5b. The value of imports rose 2.4% from $330 billion to $338 billion, the highest since mid-2022, and the value of exports inched up 0.8% from $262 billion to $264 billion in April.?

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Finally, this morning, nonfarm productivity rose 0.2% in the final first-quarter report, down from a 3.5% increase in Q4 and the weakest quarterly pace in a year. Meanwhile, unit labor costs increased 4.0% in the first quarter, the largest gain in a year.

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Tomorrow, the key report of the week – nonfarm payrolls – will be released. After a smaller-than-expected gain of 175k in April, nonfarm payrolls are expected to rise 185k in May, potentially marking a two-month high with the three-month average, however, potentially falling from 242k to 225k.?

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The unemployment rate, meanwhile, is expected remain at 3.9% for the second consecutive month, still well below what the Fed designates as the full unemployment range, and perpetuating the notion of tight labor market conditions.

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Average hourly earnings are expected to rise 0.3% in May following a 0.2% gain in April, and potentially result in a 3.9% increase over the past 12 months, matching the annual gain in April. ?

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Bottom Line: While arguably rebalancing at a gradual pace in the aftermath of the fastest backup in rates in four decades, the expected slowdown in demand and overall impact on the U.S. labor market remains muted. Again, momentum is slowing in many?key categories of economic activity, particularly as younger and lower-income consumers more heavily adjust spending; the readjustment, however, remains less than anticipated. The minimal rise in?the level of layoffs coupled with still-solid demand for new hires limits any certainty of improvement in price pressures or for more dampened conditions for headline growth. This is undermining expectations for a near-term reduction in rates, let alone a necessity?for less restrictive policy.?

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-Lindsey Piegza, Ph.D., Chief Economist