In her recent speeches at the City Club of Cleveland, Ohio (on 10 July 2015) and at the semiannual testimony before the US Congress (on 15 July 2015), Federal Reserve (Fed) Chair Janet Yellen reiterated that a rate increase—“lift-off” in market parlance — is likely this year, while also stressing yet again that this decision will be data-dependent. According to Yellen, the labour market, one of the two focal points of Fed policy, remains weak as high levels of part-time work and low labour force participation rates persist. A deterioration in these indicators could delay the rate hike, as could any potential weakness in the outlook for inflation. Data released in the week ending 17/07/15 failed to move the needle in either direction. Inflation, the second focal point of Fed policy, showed signs of firming as wholesale prices (PPI) and consumer prices (CPI) rose more than expected in June. However, core personal consumption expenditure (core PCE), the Fed’s preferred inflation gauge, is currently at 1.2%, significantly below the Fed’s long-term target of 2%. This may be further complicated by the recent drop in commodity prices, especially energy prices, which may put downward pressure on inflation prints to be released in the next few months.
The weakness in commodity prices is having a more profound effect on the policy-setting by the Bank of Canada. Like the US economy, the Canadian gross domestic product (GDP) slowed in the first quarter of 2015 after posting a respectable growth in the fourth quarter of 2014. However, several factors make the developments in Canada more worrisome than those in the US;
(i) the Canadian economy is more exposed to the downside risks of commodity prices;
(ii) there is heightened sensitivity to concerns about global economic uncertainty, particular with regards to China;
(iii) as plotted on the chart of the week below, unemployment in Canada has not shown signs of improvement in the last few months.
All of this prompted the Bank of Canada to cut its benchmark overnight rate on 15 July 2015 for the second time this year. The target was reduced by 0.25% to 0.50%, which caused a sell-off in the Canadian dollar, while Canadian bonds outperformed their US counterparts.