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Focus

When Will We Know If Rising Inflation Isn’t Transitory? Reflation: Is That All There Is?

Fed Signals Less Policy Accommodation Coming

The ‘Core’ of the Housing Problem

As the World Turns, Central Banks Turn, Too

June 18, 2021

Feature Article

Our Thoughts

Our Thoughts

Reflation: Is That All There Is?

.

Douglas Porter, CFA,

Chief Economist

[email protected]

Two key, inter-related developments drove markets in an unexpected direction thisweek—mostly into reverse on the inflation trade. First, commodity prices displayedsome clear exhaustion after a blazing sprint over the past year, weighed further byChina's steps to slow resource demand. Second, the Fed reined in the uber-dovishnessat Wednesday’s FOMC meeting, with Jay Powell openly allowing that taper talk hadarrived. This backstopped the U.S. dollar, and sent commodities skidding further,triggering a significant equity market rotation and knocking resource-heavy currenciesoff their pedestal. After testing the $1.20 level at the start of the week, the Canadiandollar promptly sagged almost 3.5% to around $1.245 (80.3 cents) by Friday, staggeredby the one-two punch of the commodity reversal and the Fed’s turn. Similarly, equitiestook a small step back (exception, Nasdaq) after reaching record highs early in theweek.

Even with the pronounced pullback in most commodities, bond yields mostly steppedhigher in a flattening move. Treasuries see-sawed notably after the FOMC, but the netresult was a 12 bp ratchet up in 2-year yields (a big move in that space), about a 1 bprise in 10s, but an 11 bp dip in 30s. The gap between 30s and 2s has shriveled below180 bps, the narrowest since early February and down 50 bps from the peak just threemonths ago. The over-rated dot plot caught some attention, with a slim majority ofmembers now expecting rate hikes to begin in 2023, and some members are alreadyasserting they’ll be pushing for rate hikes as soon as next year (e.g., Bullard). But ChairPowell’s comments on tapering and a flash of concern on the persistence of inflationwere more meaningful, and really drove the back-up in short-term yields. Still, Powellpicked his timing well to turn “hawkish”—in the midst of sagging commodities andrallying bonds—thereby limiting markets to a tiny taper tantrum, lasting all of about30 minutes.

The bigger issue for markets is whether this week spells the end for the furious year-long rally in commodities, or if it is just a pause for breath. After all, it’s not reallysurprising to many that the Fed is preparing to lift its foot slightly off the gas—theprevailing wisdom (i.e., our view) had been that tapering would begin aroundthe turn of the year and rates would begin rising roughly a year later. But fewwere clear on how far and how fast the commodity rally could run. Lumber did its bestimitation of bitcoin, falling roughly 20% in a week to below $1,000, after its historicrally earlier this year. Agricultural prices fell heavily on good prospects for crops,while copper led all metals down with a 7% setback. But—and it’s a very big but—oilfought back at week’s end to around $72 for WTI, while natural gas hung on to the$3.20 level. Energy prices clearly march to their own drummer, but, weighing in atabout half of many major commodity indices, their resiliency looms large.

On balance, we view this pullback as more a pause than the end of the rally forthe commodity complex. While not in the super-cycle camp, we do look for a robustrebound in global growth to support prices for some time yet. In turn, we suspect thatthis is also not the turning point for commodity currencies, and that’s especially thecase for the loonie if oil prices stay anywhere close to current levels.

Still, the sudden swoon in a wide swathe of resource prices has removed thesteam from the inflation debate. And that’s just as CPI readings were beginning to

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Our Thoughts

heat up in many economies. To this point, the fiery CPI increases had mostly been aU.S. story, with the 5.0% y/y headline price in May towering over all other advancedeconomies. Canada posted its biggest rise in a decade in the month but was behindthe leader at 3.6%—and that may well be the high for the year (easy comps almostcertainly point to a big dip next month). Meantime, while inflation has perked up inthe rest of the G10, the rise has been mostly due to base effects and remains mildat 2.1% in Britain, 2.0% in the Eurozone, 1.3% in China, and -0.1% in Japan. Americanexceptionalism indeed.

Calmer commodities and a mindful Fed have tamped down the inflation trade.However, note that the steady grind in oil prices still has the potential to lift headlineinflation further and almost everywhere. Thus, the transitory debate is far fromsettled. The latest forecasts from Fed participants revealed a leap in expectations forthe 2021 inflation rate, but almost no move in ensuing years. Less convinced that therecent upswing is fully transitory, the consensus now expects the U.S. PCE core deflatorto average 2.7% this year and 2.5% in 2022 (BMO is at 3.2% and 3.0%), up from 1.9%and 2.0% just three months ago. The forecasts for Canadian CPI are weirdly similaralmost across the board.

While it won’t change many minds on the transitory debate, the key U.S. data releasein the coming week will be Friday’s personal income and spending report for May,and particularly the PCE inflation reading. After piercing the 3% threshold in the priormonth, the core deflator is expected to post another meaty rise of 0.6% m/m, liftingthe annual pace to a three-decade high of around 3.5%. We would also point out thatthe two-year trend rate for this preferred measure of core inflation would thus pushabove 2.0% (to 2.2% in fact), for the first time since October 2008. A two-year trendof underlying inflation above 2% seems to tick the sustainable box—next task: healingthe labour market, and that looks to be a bigger job.

Arguably one factor keeping a tight lid on long-term bond yields even amid the recentinflation scare is the likelihood that long-term growth prospects have been weakened,not strengthened, by the pandemic. One key building block of said growth prospectsis the size of the labour force, and it’s taken a hit from a sagging participation rate.But even more fundamentally, population growth has softened in both the U.S.(continuing a long-term trend there) and in Canada (abruptly reversing the trendthere).

Canada reported this week that its population edged up 0.2% in Q2 to 38.1 million, butthat left the tally up just 0.4% y/y (an increase of 150,000 people)—which just happensto precisely match the estimated U.S. population growth rate in the past year. That isa shadow of the surging pre-pandemic trends in Canada of 1.5% y/y growth (or morethan 575,000 people). A near-50% drop in the number of immigrants and an outrightdrop in non-permanent residents has nearly stalled population growth. While Ottawaaims to crank up immigration in the years ahead to fill in for the near absence in thepast year, the current cool increases would normally put a chill into housing demand aswell as labour supply. Watch this space.

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Our Thoughts

Fed Signals Less Policy Accommodation Coming

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Michael Gregory, CFA,

Deputy Chief [email protected]

Between the taper talk and raised dots, the Fed is setting the stage for lessaccommodative actions. The asset purchase pace could start being pared within acouple of months; the policy rate could start being hiked within a couple of years.Such inaugural, less-accommodative policy signals can often lead to bond marketdislocations; 2013’s infamous ‘taper tantrum’ comes to mind.

However, after initially spiking almost 11 bps to nearly 1.60% on the news, 10-yearTreasury yields rallied back to settle around 1.46%—below where they began. Whileweaker equity markets were a help, along with the perennial support from excessliquidity and capital inflows that seem to intensify at higher yields, the bond marketlikely found some comfort in the fact that, among the 18 policymakers, thereis unanimity in the view that the current inflation spike will be transitory.And, if rate hikes are necessary to ensure that inflation settles at, or moderatelyabove, 2%, rates will remain well below their neutral levels. For market participantsconcerned about persistently faster inflation and the prospect of the Fed taking awaythe proverbial punchbowl, this was a comforting message. Policy appears destinedto become less accommodative but remain meaningfully net accommodativeoverall, at least through 2023.

In the press conference, Chair Powell indicated that it was time for the Committee tostart talking about tapering. The forward guidance on this front was left unchanged,that monthly purchases of at least $80 billion Treasuries and $40 billion MBS wouldcontinue until “substantial further progress” toward the maximum-employment andprice-stability goals has been made. However, given the current pace of progress,the “substantial” criterion is probably going to be satisfied shortly, hence the earlywarning. As mentioned previously, we suspect the staff was charged with briefing theCommittee on tapering options and consequences for the July meeting, which suggeststhat tapering could be officially announced as early as September (to start in October).Our working assumption is that when tapering starts, it will be in $10 billion and $5billion increments for Treasuries and MBS, respectively, each meeting cycle, resulting ina year-long tapering process.

In the Summary of Economic Projections (SEP), the number of participants pencilingin rate hikes nearly doubled from last time. The median forecast for the fed funds ratewas lifted to now reflect two 25 bp rate hikes from none in the March SEP. Amongthe 18 policymakers, 13 penciled in at least one rate rise by the end of 2023, up fromseven in March. And, although the median remained unchanged in 2022, there are nowseven individual forecasts of rate hikes, up from four before. It will now take just twoparticipants changing their call to a rate hike to lift the median for 2022 as well.

Elsewhere, the median real GDP growth forecast was raised to 7.0% Q4/Q4 in 2021(up 0.5 ppts), 3.3% in 2022 and 2.4% in 2023 (up 0.2 ppts). Our own call pulls a bitmore activity into this year at the expense of next year (7.5% and 2.8%, respectively),before cooling to also 2.4% in 2023. The FOMC’s median unemployment rateprojection was lowered just a bit, to 4.5% in 2021Q4, 3.8% in 2022 (down a tenth) and3.5% in 2023. For the record, we judge the jobless rate will end 2023 at 3.4%, below itspre-pandemic level.

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Our Thoughts

The FOMC’s median forecasts for total and core PCE inflation were also raised, notsurprisingly, most meaningfully for 2021. The headline inflation call is 3.4% Q4/Q4in 2021 (up 1.0 ppt), 2.1% in 2022 (up 0.1 ppts) and 2.2% in 2023 (up 0.1 ppts). Coreinflation is 3.0% in 2021 (up 0.8 ppts), 2.1% in 2022 (up 0.1 ppts) and 2.2% in 2023. Wesee inflation settling a little faster than this, with both the headline and core metricsrunning in the 2.3%-to-2.4% range.

The inflation forecast upgrade now seems to satisfy the rate-hike prerequisite formost FOMC participants, which is that “inflation has risen to 2% and is on track tomoderately exceed 2% for some time”. Further, for core inflation in 2022, no individualforecast (among the 18) is above 2.5% and all run in the 2.0%-to-2.3% range for 2023.In other words, there is a high degree of conviction in the transitory narrative. It’sunclear whether the jobless rate projection upgrade mirrors labour market conditionsthat are “consistent with the Committee’s assessments of maximum employment”.This rate-hike prerequisite doesn’t have to be satisfied if the price stability goalis already achieved, but it must be on track to soon be satisfied—the conclusionapparently reached by most participants now.

Bottom Line: The Fed seems to be setting the stage to begin tapering by the end ofthis year, ending quantitative easing by the end of next year, and commencing ratehikes by the end of 2023. In the meantime, even as these events occur, policy will stillbe very accommodative.

The ‘Core’ of the Housing Problem

.

Robert Kavcic,

Senior Economist

[email protected]

Word surfaced this week that one particular company is going to buy up to $1 billionworth of single-detached houses in Canada over the next five years, targeting mid-sized cities, and convert them into rental units. This might seem to be a prettystandard concept, but judging by the national media backlash over the plan, it strucka very sensitive nerve. To be sure, we’re not here to pick sides, but simply to helpunderstand what is behind the issue.

On one hand, investor ownership of Canadian real estate is not new, even bylarge corporations and real estate investment trusts. StatsCan data, for example, showthat investors own roughly a third of the condo market in Canada’s largest cities.Aside from a brief period where nonresident investment was rising quickly, this hasrarely been an issue. There is also a perpetual call for more rental stock in Canada,especially in the underserved single-detached market. One issue is that the movedoesn’t create new supply, but further bids up the price for an already extremelyscarce resource (detached homes) in the major cities and, more recently, smaller mid-sized cities. At an emotional level, it is a young family versus big corporate money.

Understanding all sides of the argument, the noise around this is the culmination ofmore than a decade of supply- and demand-side forces that, almost by design,predictably got us to where we are today. When Ontario introduced the Places toGrow Act in 2005, it set off down a long road toward single-detached home scarcityaround Canada’s biggest market. To quote, “the Plan’s emphasis on optimizing theuse of the existing urban land supply represents an intensification first approach todevelopment and city building”. Through the 1990s and early-2000s, housing startsfor single- and multi-unit properties ran roughly in line with each other in the TorontoCMA. But, by 2019, while multi-unit starts totaled almost 30,000 units, there were just

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over 4,000 single-detached homes started. Indeed, with most municipalities targetingintensification rates in the 40%-to-60% range, splitting lots, building out brownfieldareas and converting singles to multis, is right in-line with development policy.

The problem is that these measures are seriously holding back the supply curve forsingle-detached houses, and making it steeper, while the demand curve for thosesame houses is shifting out dramatically. Again, this has been entirely predictablegiven prevailing demographics in this country. Specifically, the leading edge of themillennial cohort is now about 40 years old, and there is a distinct bulge in Canada’spopulation pyramid in the 25-to-39 age group. This group is almost 8 million large,and has been growing faster than 2% per year, the strongest since the late-1980s.These are prime home-buying years, and prime family-building years. The thing is, theidea that families want to live in dense, smaller and walkable urban spaces, is a bitof a fairy tale. Young families want space, and they need it at a time before the babyboomers are ready to move on from those coveted properties, and after 15 years ofcrowding out single-detached development. The exodus to smaller markets during thepandemic is a good example of the pressure finding a relief valve, and that now mightbe competing with institutional dollars.

Bottom Line: Fundamentally, the core of our ‘housing problem’ is a major mismatchbetween the type of supply and demand, but it has been an entirely predictableoutcome based on development policy and demographics. This imbalance shouldbe cresting in the next few years, but the pandemic (pulling forward some activity),immigration targets north of 400k people per year, and record-low interest rates havemagnified it.

As the World Turns, Central Banks Turn, Too

.

Jennifer Lee,

Senior Economist

[email protected]

Change is inevitable... that was the message from some central bankers this week:

• Federal Reserve: It stayed on the sidelines, but it is finally (finally!) having thetapering discussion (and we’ve all been ordered by the Fed Chair to retire the “talkabout, talking about” phrase). Then, watch the USD go, even though he warned thatsubstantial further progress was still far off. But acknowledging that the talks are inplace is the first step.

• Brazil: This central bank is way ahead of the pack. For the 3rd time this year, thecentral bank hiked rates, each time by 75 bps. The latest move took the Selic Rateto 4.25%, the highest since before the pandemic hit. But something clearly neededto be done with inflation at 8.1% y/y, far above the 3.75% target. And, the Copomwarned that more hikes are coming, maybe more than 75 bps, at the next meeting.

• Norges Bank: This is one central bank, much like Brazil, that tells it like it is. It hasbeen warning anyone who would listen that a rate hike is coming and that time isapproaching. The official deposit rate has been sitting at a record-low 0.00% sincethe pandemic hit, but it will “most likely be raised in September”.

• Bank of Japan: The BoJ announced it would keep the policy balance rate at-0.1%, the 10-year JGB target at about 0%, and keep the ceiling on ETF purchasesunchanged. What was new, however, was that its COVID support lending programwill be extended for six months, or until March 2022. And, to address climatechange, a new measure was introduced which will fund bank lending to firms that

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Our Thoughts

are addressing environmental issues. The broader message Governor Kuroda gavewas clear: Japan will need continued stimulus, even after the pandemic is over.

In the “change might be coming” camp was the RBA. The Minutes from its Junemeeting gave plenty of positive remarks, but the central bank remained extremelycautious, citing subdued inflation and wage pressures. Plus, a “return to fullemployment” was a priority and in order to do so, “monetary policy would be likelyto need to remain highly accommodative for some time yet.” However, this meetingtook place before the latest jobs report, which saw a whopping 115,200 jobs created,hauling the jobless rate down to 5.1%, the lowest since February 2020, or pre-pandemic times. This may, just may, be enough for the RBA to be less committed tothe 2024 hiking timeline by the next meeting.

Same thing with the BoE. Although no changes are expected when it meets onJune 24, the Fed’s change in tone makes the overwhelmingly dovish BoE a little moreinteresting. However, despite a delayed full reopening of the economy, and the risein the Delta variant, Governor Bailey may, just may, throw a hint of some pulling backof stimulus... not now, but later. After all, the economy has been incredibly resilientthanks to the early and rapid pace of vaccinations. And, as trade deals are being made(Australia), trade uncertainty has settled down, at least for the next five years (withthe USA, not so much with Northern Ireland).

Things are changing.

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Recap

Indications of stronger growth and a move toward price stability are good news for the economy.

Good News Bad News

Canada BoC Gov. Macklem sees

economy “making good progress” but warns on strength of loonie

Q2 population growth ticks up

Housing Starts +3.2% to 275,916 a.r. (May) MLS Home Prices +24.4% y/y (May) New Housing Prices +11.3% y/y (May) Global investors bought a net $10.0 bln in Canadian securities (Apr.) New Motor Vehicle Sales +250.9% y/y (Apr.) —base effects

Consumer Prices +3.6% y/y (May)—fastest since 2011 Industrial Product Prices +3.1% (May) Wholesale Trade Volumes -0.2% (Apr.) Manufacturing Sales Volumes -3.3% (Apr.) Manufacturing New Orders -2.5% (Apr.) Existing Home Sales -7.4% (May)—but from extreme levels Mortgage Credit +7.7% y/y (Apr.)—fastest since 2010

United States FOMC on hold but now talking

about tapering; looking at 2023 lift-off…

…yields pull back after initial jump

Industrial Production +0.8% (May)—and Capacity Utilization Rate +0.6 ppts to 75.2% Housing Starts +3.6% to 1.572 mln a.r. (May) Leading Indicator +1.3% (May) Global investors bought a net $93.2 bln in U.S. securities (Apr.)

Retail Sales -1.3% (May)—but prior two months revised up Producer Prices +0.8%; Import Prices +1.1% (May) Building Permits -3.0% to 1.681 mln a.r. (May) NAHB Housing Market Index -2 pts to 81 (June) Empire State Manufacturing Survey -3.3 pts to 57.0; Philly Fed Index -0.2 pts to 62.5 (June) —both ISM-adjusted Initial Jobless Claims +37k to 412k (June 12 wk)

China Beijing faces pressure on

trade from G7 leaders

Retail Sales +25.7% y/y; Industrial Production +17.8% y/y; Fixed Asset Investment +15.4% y/y (Jan.-to-May)—moderating

Japan BoJ on hold

Tokyo’s state of emergency coming to an end

Exports +49.6% y/y; Imports +27.9% y/y (May) Industrial Production revised up to 2.9% (Apr.)

Consumer Prices -0.1% y/y (May)—but core edged up 0.1% y/y Core Machine Orders +0.6% (Apr.)—below expected Tertiary Industry Index -0.7% (Apr.)

Europe EU and U.K. reach truce with

U.S. on Airbus-Boeing trade dispute… for now

U.K. delays reopening as delta cases rise

Norges Bank on hold… signals September hike

Euro Area—Industrial Production +0.8% (Apr.) Euro Area—Labour Costs +1.5% y/y (Q1) U.K.—Employment +113,000 (3 mths to Apr.) U.K.—Average Weekly Earnings (ex. Bonus) +5.6% y/y (3 mths to Apr.) U.K.—Jobless Rate -0.1 ppts to 4.7% (3 mths to Apr.)

Euro Area—Trade Surplus cut to €9.4 bln (Apr.) Euro Area—Core Consumer Prices revised up to +1.0% y/y (May) U.K.—Retail Sales (incl. Fuel) -1.4% (May) U.K.—Consumer Prices jumped 2.1% y/y (May)

Other Central Bank of Brazil hikes

Selic rate 75 bps to 4.25%; more coming

Australia—Employment +115,200; Jobless Rate -0.4 ppts to 5.1% (May) New Zealand—Real GDP +1.6% q/q (Q1)

June 18, 2021 | of 18

Feature

When Will We Know If Rising Inflation Isn’t Transitory?

.

Sal Guatieri,

Senior Economist

[email protected]

In last week’s Feature article, Robert Kavcic asked whether inflation pressures willlinger as pent-up demand clashes with supply shortages and cited several reasons forconcern. Yet, the Fed, and bondholders it seems, expect much of the recent rapid risein U.S. inflation to fade. While we generally concur, we also expect inflation to trendhigher for longer. And even our call might be sanguine, warranting close vigilance ofthe following early-warning signs of inflation persistence.

Topping the list are the monthly consumer price reports.The core CPI and PCE price measures have reboundedfaster than anyone expected, and only partly becauseof a snapback in travel-related charges. After plungingearly in the pandemic and averaging 0.1% gains in thesix months to March, the core CPI spiked 0.9% in Apriland a further 0.7% in May (Chart 1). This ballooned theyearly rate to 3.8%, the fastest since 1992. Part of theincrease reflects low base-year effects, as the 2-yearannualized rate is running a more moderate 2.5%, thoughthis is still the most in 13 years. Several more monthsof 0.3% or larger gains are expected. Then, core priceswill likely simmer down as pent-up demand ebbs andsupply bottlenecks ease, averaging just a bit above 0.2%in the next two years, only moderately faster than thequarter-century norm (0.17%). This would slow the yearlycore rate to 2.7% by late 2022, which, though above pre-pandemic levels, remains in check. However, monthlyprice gains clocking in at 0.3% or more through the fall of2021 would cast serious doubt on the transitory-inflationview. As well, pay particular attention to services prices,which tend to move more slowly than goods prices, assustained upward pressure here would be a concern.

Also worth tracking is the Atlanta Fed’s “sticky” CPIprice index, which includes only items with infrequentprice changes (one clear example would be vendingmachine products). At 2.7% y/y in May, the index hasalready returned to pre-pandemic norms. On a calmernote, the Cleveland Fed’s median CPI remains mild at2.1% y/y after nearing 3% in late 2019, though its closecousin, the trimmed-mean price index, which strips outthe largest-moving items, is running a bit hotter at 2.6%.The record gap between the two hints at more diverseprice increases than is typically the case.

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-0.5

0.0

0.5

1.0

17 18 19 20 21

Core CPI

Prices Popping

United States (y/y % chng)

Chart 1

Sources: BMO Economics, Haver Analytics

Largest 2-month gain in four decades!

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-4

0

4

8

12

73 83 93 03 13

Unit Labour Costs

End of Cheap Labour…

United States (4-qtr m.a. : y/y % chng)

Chart 2


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Feature

Two key forces needed to sustain higher inflation arerising wage growth and rising inflation expectations.Both act in tandem to sustain a wage-price spiral bycausing lasting changes in the behaviour of workers,consumers and businesses. Workers who expect higherinflation will seek pay increases to preserve spendingpower, pushing companies to pass the cost increase toconsumers, perpetuating the cycle.

It’s important to separate wage increases arising fromworker shortages and those arising from productivitygrowth. The latter lifts living standards rather thaninflation. Unit labour costs, which account forproductivity changes, are now trending the fastestin nearly four decades (Chart 2). This reflects higherminimum wages in several states, one-time wage hikesby many large retailers, and businesses struggling toattract and retain workers to meet a surge in demand.It’s also necessary to monitor wage metrics that areunaffected by sectoral shifts. Both the Atlanta Fed WageTracker and employment cost index fit the bill andneither is ringing alarm bells (Chart 3). Average hourlyearnings in the payrolls report are affected by sectoralshifts, and it’s somewhat concerning that recent upsidesurprises have occurred despite the strong jobs reboundin lower-paying industries, such as restaurants.

Even with the jobless rate a couple of percentage pointsabove pre-pandemic levels, there is arguably little ifany slack left in the U.S. labour market currently.The rush of pent-up demand has clashed with a dearthof qualified workers due to health and safety concerns,child-care duties, and expanded UI benefits. It will beinteresting to see if hiring quickens this summer as morestates end the emergency UI programs before theirscheduled expiration in September. To track whetherlabour shortages are worsening, you need to lookbeyond the jobless rate to assess how fast jobs arereturning to the economy (the employment rate) andhow fast people are returning to the labour force (theparticipation rate). These two measures of labourdemand and supply have been slow to unwind theirinitial plunge (Chart 4). The flat participation rate sincelast summer also applies to persons of prime working

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1

2

3

4

5

1

2

3

4

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98 03 08 13 18

…But Wages Still Mostly in Check

United States (y/y % chng)

Chart 3

¹ FRB Atlanta Wage Tracker (lhs : wtd. : 3-mth m.a. : y/y % chng);

² (rhs : y/y % chng) Sources: BMO Economics, Haver Analytics

EmploymentCost Index²

WageGrowth¹

.

48

52

56

60

64

68

03 05 07 09 11 13 15 17 19 21

Much Ground to Make Up

United States (s.a. : % of population 16+ years)

Chart 4


Participation Rate

EmploymentRate

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0

4

8

12

16

20

24

00 05 10 15 20

No Shortage of Jobs

United States (mlns)

Chart 5


Job Openings

Unemployed

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Feature

age (25 to 54 years), suggesting it’s not due solely to anincrease in retirement.

Another guide to labour market slack is the ratio ofjob openings to unemployed persons (Chart 5).Before the pandemic, openings exceeded the numberof unemployed people for two years running, and, trueto form, wage growth picked up. Today, the two arenearly identical at around 9.3 million. However, if currenttrends persist—with record-high openings rising fastand the number of jobless persons falling—the wedgebetween the two will surpass 2019 levels, pressuringwages further.

Households, businesses, and investors all have their owninflation crystal ball. The University of Michigan’s surveyshows that consumers’ expectations of inflation in thenext five years have turned moderately higher (Chart6). The Atlanta Fed’s Business Inflation Expectationspoll finds that firms expect costs to rise 2.8% in theyear ahead, the most in at least a decade. This explainswhy the largest share of small firms since 2008 plans toraise selling prices (Chart 7). For investors, a comparisonof yields on regular Treasuries and inflation-protectednotes shows that the 5-year break-even inflation ratesnapped back from pandemic lows to reach 2.7% in mid-May, the most since before the Great Recession (Chart8). While the break-even rate has pulled back recently(despite the steamy price data and oil hitting 2½-yearhighs), the upward trend suggests inflation expectationsare somewhat less anchored to the 2% target thanbefore the pandemic, which largely fits with the Fed’snew average-inflation approach.

Bottom Line: Recent U.S. consumer price reports havebeen ominous, several wage measures are emittingsparks, and some gauges of expected inflation areflashing amber. Price pressures have emerged veryearly in the economic recovery, rather than in the moretypical late innings. This hints at some staying powerif economic growth remains strong. Most likely, moreworkers will need to return to the labour force andinflation expectations will need to stabilize to keepinflation in check. A keen read of the early-warning signscited above could provide a head start toward the exitsshould the transitory-inflation balm go up in smoke.

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2.0

2.5

3.0

3.5

4.0

97 02 07 12 17

Expected Inflation Rate in Next 5 Years

Consumers Expect to Pay More

United States (% : 3-mnth m.a.)

Chart 6

Sources: University of Michigan, BMO Economics, Haver Analytics

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0

10

20

30

40

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84 89 94 99 04 09 14 19

Net % Small Firms Planning to Raise Selling Prices

Just Passing Through

United States (%)

Chart 7

Sources: NFIB, BMO Economics, Haver Analytics

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-1

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5-Year Nominal Treasury Rate minus 5-Year TIPS Rate

Demanding More Inflation Compensation

United States

Chart 8


(% : as of June 17, 2021)

June 18, 2021 | of 18

Economic Forecast

.

Economic Forecast Summary for June 18, 2021

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

CANADA

Real GDP (q/q % chng : a.r.) 5.6 0.0 9.5 6.0 4.5 3.0 2.7 2.5 -5.3 6.0 4.5

Consumer Price Index (y/y % chng) 1.4 3.3 3.7 3.8 3.7 3.1 2.6 2.3 0.7 3.1 2.9

Unemployment Rate (percent) 8.4 8.1 7.1 6.7 6.4 6.2 5.8 5.7 9.6 7.5 6.0

Housing Starts (000s : a.r.) 304 266 245 223 223 228 227 223 219 260 225

Current Account Balance ($blns : a.r.) 4.7 11.5 6.0 -0.1 -6.6 -14.1 -21.7 -29.8 -40.1 5.5 -18.0

Interest Rates

Overnight Rate 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50 0.25 0.25

3-month Treasury Bill 0.08 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.44 0.10 0.10

10-year Bond 1.13 1.50 1.50 1.60 1.65 1.70 1.80 1.85 0.75 1.45 1.75

Canada-U.S. Interest Rate Spreads

90-day 3 8 4 4 4 4 4 4 7 5 4

10-year -19 -11 -12 -12 -12 -13 -14 -15 -14 -13 -13

UNITED STATES

Real GDP (q/q % chng : a.r.) 6.4 11.0 8.0 4.5 3.3 2.9 2.6 2.3 -3.5 7.0 4.3

Consumer Price Index (y/y % chng) 1.9 4.6 4.5 4.6 4.4 3.3 2.9 2.8 1.2 3.9 3.3

Unemployment Rate (percent) 6.2 5.8 5.1 4.6 4.2 4.0 3.8 3.6 8.1 5.4 3.9

Housing Starts (mlns : a.r.) 1.60 1.57 1.66 1.67 1.67 1.68 1.69 1.70 1.40 1.62 1.69

Current Account Balance ($blns : a.r.) -817 -877 -910 -935 -958 -979 -995 -1,009 -647 -885 -985

Interest Rates

Fed Funds Target Rate 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.38 0.13 0.13

3-month Treasury Bill 0.05 0.00 0.05 0.05 0.05 0.05 0.05 0.05 0.37 0.05 0.05

10-year Note 1.32 1.60 1.60 1.70 1.80 1.85 1.90 2.00 0.89 1.55 1.90

EXCHANGE RATES

US¢/C$ 79.0 81.7 82.8 83.2 83.6 84.1 84.5 85.0 74.6 81.7 84.3

C$/US$ 1.27 1.22 1.21 1.20 1.20 1.19 1.18 1.18 1.34 1.22 1.19

¥/US$ 106 109 108 107 107 106 106 105 107 108 106

US$/Euro 1.21 1.21 1.22 1.23 1.23 1.24 1.24 1.24 1.14 1.22 1.24

US$/£ 1.38 1.40 1.42 1.44 1.44 1.44 1.43 1.43 1.28 1.41 1.43

Blocked areas mark BMO Capital Markets forecasts; up and down arrows ( ) indicate forecast changes; spreads may differ due to rounding

(average for the quarter : %)

(average for the quarter : bps)

(average for the quarter : %)

(average for the quarter)

2021 2022 Annual

2020 2021 2022

June 18, 2021 | of 18

Key for Next Week

Canada

.

Shelly Kaushik,

Economist

[email protected]

.

Retail SalesWednesday, 8:30 am

Apr. (e) -5.1% -6.0%

Consensus -5.0% -4.5%

Mar. +3.6% +4.3%

Retail sales likely fell in April with more stringent third-wave restrictions in manyparts of the country. StatsCan’s preliminary estimate had sales fall by 5.1% following3.6% growth in March. We are sticking with that estimate given the scale of lockdownsacross the country constraining spending in the month. Autos also posted a decline,though smaller than the headline—so we are expecting sales excluding autos tohave fallen 6.0%. Prices for goods also rose in April, suggesting that sales volumeslikely decreased by more than the headline. Look for a small recovery in the May flashestimate given loosened restrictions in parts of the country.

United States

.

Michael Gregory, CFA,

Deputy Chief [email protected]

.

Priscilla Thiagamoorthy,

Economist

priscilla.thiagamoorthy@

bmo.com

.

Existing Home SalesTuesday, 10:00 am

May (e) 5.71 mln a.r. (-2.4%)

Consensus 5.71 mln a.r. (-2.4%)

Apr. 5.85 mln a.r. (-2.7%)

.

New Home SalesWednesday, 10:00 am

May (e) 881,000 a.r. (+2.1%)

Consensus 875,000 a.r. (+1.4%)

Apr. 863,000 a.r. (-5.9%)

Housing demand continues to cool from the torrid pace through the turn of the year,with the pandemic-motived wave of buying likely crested and sharply higher priceseroding affordability. But, demand should remain warm, with mortgage rates runningin a record-low range, millennials pulling forward home purchase plans that weresupposed to unfold over the next few years, and increased saving helping more would-be buyers cross their down payment thresholds.

Existing home sales should slip 2.4% to 5.71 million (annualized), still slightly abovetheir pre-pandemic perch (February 2020), which was, at the time, the highest level inexactly 13 years. These sales get counted when their contracts close, and at the end ofApril, pending sales (those waiting to close) were down 4.4%. And, in May, averagemortgage applications for purchases also dropped. Meanwhile, (seasonally adjusted)existing homes available for sale had fallen for seven consecutive months–setting newrecord lows each time–before advancing in April as more balanced market conditionsare emerging–but with extremely lean inventories (just over two months’ worth). Thelatter continues to divert demand to the new home segment. Although drifting downfrom November’s record high (90%), the NAHB Housing Market Index is still hoveringabove all readings since before last autumn with more than 80% of homebuilders ingood shape. We look for new home sales to increase 2.1% to 881k (annualized), stillelevated but not quite the near-million mark we started the year at.

.

Durable Goods OrdersThursday, 8:30 am

Nondef. Cap.

Goods ex. Air

May (e) +3.1% +0.6%

Consensus +3.0% +0.7%

Apr. -1.3% +2.2%

After halting an 11-month winning streak in April, durable goods orders look toresume their upward momentum, jumping more than 3% in May. Though Boeingbookings were higher, motor vehicles continue to struggle with the global chipshortage weighing on overall transportation equipment. Ex-aircraft and defense, “core”capital goods orders are expected to advance 0.6% amid sturdy demand for machinery,keeping Q2 business equipment spending on track for an 18% annualized gain.

June 18, 2021 | of 18

Key for Next Week

.

Personal IncomeFriday, 8:30 am

Personal Personal

Spending Income

May (e) +0.4% -2.5%

Consensus +0.3% -2.8%

Apr. +0.5% -13.1%

Core PCE Price Index

May (e) +0.6% +3.4% y/y

Consensus +0.6% +3.5% y/y

Apr. +0.7% +3.1% y/y

Personal consumption expenditures likely increased 0.4% in May, but -0.1% afteradjusting for inflation, as spending on goods slid for the second consecutive monthafter spiking in March owing to the massive economic impact payments (EIP). (Thenear-10% spending spike was the second largest on record (back to 1959) after lastMay’s 14.3%.) However, this second ‘breather’ was more than offset by another stronggain in outlays on services as more states and local areas relaxed their restrictions. Forexample, in the retail sales report, spending at restaurants and bars was up 1.8%, nowhaving completely recovered its pandemic loss. Meanwhile, personal income probablydecreased 2.5% in May, as EIP slowed to a trickle and unemployment benefits ebbedon the month’s strong growth in payrolls (559k). And, together, they more than offsetthe strong expansion in employee compensation. This income-spending mix will resultin the saving rate dropping 2.5 ppts to 12.4%, a pandemic low but still well above the7½% pre-virus average.

The PCE price index should rise 0.5% in May, lifting the inflation rate to 3.9% y/y from3.6% in April, which is the fastest pace since August 2008 (4.0%). Excluding food andenergy items, the index should increase 0.6% m/m, raising core inflation to 3.4% y/yfrom 3.1% and matching the highest level since December 1991 (3.5%). Both inflationrates were around 1½% in February and, like the CPI, the acceleration reflects bothbase effects (the March-April 2020 plummet in prices) and the rapid return to pre-pandemic pricing. Also, supply shortages and other capacity constraints, amid surgingdemand, are adding to the upward pressure. The Fed still asserts that all this will belargely transitory.

June 18, 2021 | of 18

Financials Markets Update

.

Financial Markets Update for June 18, 2021

Jun 18 ¹ Jun 11 Week Ago 4 Weeks Ago Dec 31, 2020

Canadian Call Money 0.25 0.25 0 0 0

Money Market Prime Rate 2.45 2.45 0 0 0

U.S. Money Fed Funds (effective) 0.25 0.25 0 0 0

Market Prime Rate 3.25 3.25 0 0 0

3-Month Rates Canada 0.12 0.11 1 3 6

United States 0.03 0.02 1 3 -3

Japan -0.10 -0.10 0 1 0

Eurozone -0.54 -0.55 0 0 0

United Kingdom 0.05 0.08 -3 -3 3

Australia 0.02 0.03 -1 -2 0

2-Year Bonds Canada 0.42 0.31 11 9 22

United States 0.26 0.15 11 10 13

10-Year Bonds Canada 1.39 1.37 2 -15 71

United States 1.48 1.45 2 -14 56

Japan 0.05 0.03 2 -3 4

Germany -0.21 -0.27 6 -8 36

United Kingdom 0.76 0.71 6 -7 57

Australia 1.60 1.49 11 -14 63

Risk Indicators VIX 19.6 15.7 4.0 pts -0.5 pts -3.2 pts

Inv. Grade CDS Spread ² 50 49 1 -3 -1

High Yield CDS Spread ² 282 278 4 -13 -12

Currencies US¢/C$ 80.53 82.25 -2.1 -2.8 2.5

C$/US$ 1.242 1.216 — — —

¥/US$ 110.37 109.66 0.6 1.3 6.9

US$/€ 1.1859 1.2109 -2.1 -2.7 -2.9

US$/£ 1.382 1.411 -2.0 -2.3 1.1

US¢/A$ 74.90 77.08 -2.8 -3.1 -2.7

Commodities CRB Futures Index 205.65 212.25 -3.1 2.4 22.6

Oil (generic contract) 72.07 70.91 1.6 13.4 48.5

Natural Gas (generic contract) 3.24 3.30 -1.7 11.5 27.6

Gold (spot price) 1,773.09 1,877.53 -5.6 -5.7 -6.6

Equities S&P/TSX Composite 20,054 20,138 -0.4 2.7 15.0

S&P 500 4,187 4,247 -1.4 0.7 11.5

Nasdaq 14,088 14,069 0.1 4.6 9.3

Dow Jones Industrial 33,366 34,480 -3.2 -2.5 9.0

Nikkei 28,964 28,949 0.1 2.3 5.5

Frankfurt DAX 15,452 15,693 -1.5 0.1 12.6

London FT100 7,036 7,134 -1.4 0.3 8.9

France CAC40 6,573 6,601 -0.4 2.9 18.4

S&P ASX 200 7,369 7,312 0.8 4.8 11.9

¹ = as of 10:30 am ² = One day delay

(percent change)

(basis point change)

June 18, 2021 | of 18

Global Calendar — June 21–June 25

Monday June 21 Tuesday June 22 Wednesday June 23 Thursday June 24 Friday June 25

Japa

n

Department Store Sales May Apr. +167.0% y/y Machine Tool Orders May F (e) +140.7% y/y Apr. +120.8% y/y

Manufacturing PMI June P May 53.0 Services PMI June P May 46.5 Composite PMI June P May 48.8

BoJ Minutes from Apr. 26-27 meeting

Euro

Are

a

E U R O A R E A Consumer Confidence June A (e) -3.3 May -5.1

I T A L Y Industrial Sales Apr. Mar. +1.6% +38.1% y/y

E U R O A R E A Manufacturing PMI June P (e) 62.0 May 63.1 Services PMI June P (e) 58.0 May 55.2 Composite PMI June P (e) 58.7 May 57.1

E U R O A R E A ECB Economic Bulletin

G E R M A N Y ifo Business Climate June (e) 100.6 May 99.2

F R A N C E Business Confidence June (e) 110 May 108

E U R O A R E A M3 Money Supply May (e) +8.5% y/y Apr. +9.2% y/y

G E R M A N Y GfK Consumer Confidence July (e) -4.0 June -7.0

I T A L Y Consumer Confidence June (e) 112.0 May 110.6

U.K.

Rightmove House Prices June May +1.8%

Manufacturing PMI June P (e) 64.0 May 65.6 Services PMI June P (e) 63.1 May 62.9 Composite PMI June P (e) 63.0 May 62.9

7:00 am ET BoE Monetary Policy Announcement

GfK Consumer Confidence June (e) -7 May -9

Othe

r A U S T R A L I A Retail Sales May P (e) +0.4% Apr. +1.1%

M E X I C O Central Bank of Mexico

Monetary Policy Meeting

D = date approximate Upcoming Policy Meetings | Bank of England: Aug. 5, Sep. 23, Nov. 4 | European Central Bank: July 22, Sep. 9, Oct. 28

June 18, 2021 | of 18

North American Calendar — June 21–June 25

Monday June 21 Tuesday June 22 Wednesday June 23 Thursday June 24 Friday June 25

Cana

da

BoC Buyback: 10-year sector 10:30 am 3-, 6- & 12-month bill auction $21.0 bln (new cash $8.4 bln)

BoC Buyback: 2-year sector

8:30 am Retail Sales Ex. Autos Apr. (e) -5.1% -6.0% Consensus -5.0% -4.5% Mar. +3.6% +4.3% Noon 30-year bond auction

$3.0 bln


8:30 am Survey of Employment, Payrolls, and Hours (Apr.)

8:30 am Wholesale Trade May A Apr. +0.4% 8:30 am Manufacturing Sales May A Apr. -2.1%

2- & 10-year bond auction announcements


Unite

d St

ates

8:30 am Chicago Fed National Activity Index

May (e) 0.75 C Apr. 0.24

Fed Speakers: St. Louis’ Bullard, Dallas’ Kaplan (9:30 am); New York’s

Williams (3:00 pm) 11:30 am 13- & 26-week bill

auctions $111 bln

10:00 am Existing Home Sales May (e) 5.71 mln a.r. (-2.4%) Consensus 5.71 mln a.r. (-2.4%) Apr. 5.85 mln a.r. (-2.7%) 10:00 am Richmond Fed

Manufacturing Index June (e) 18 C May 18 2:00 pm Fed Chair Powell

appears before Congress hearing on the COVID-19 crisis

Fed Speakers: Cleveland’s Mester (10:30 am); San Francisco’s Daly

(11:00 am) 11:00 am 4- & 8-week bill auction

announcements

11:30 am 42-day CMB auction $40 bln

1:00 pm 2-year note auction $60 bln

7:00 am MBA Mortgage Apps June 18 June 11 +4.2% 8:30 am Current Account Deficit Q1 (e) $204.2 bln Consensus $207.0 bln Q4 $188.5 bln 9:45 am Markit PMIs (June P)

10:00 am New Home Sales May (e) 881,000 a.r. (+2.1%) Consensus 875,000 a.r. (+1.4%) Apr. 863,000 a.r. (-5.9%)

Fed Speakers: Governor Bowman (9:00 am); Atlanta’s Bostic (11:00

am); Boston’s Rosengren (4:30 pm) 11:30 am 2R-year FRN auction

$26 bln


8:30 am Initial Claims June 19 (e) 380k (-32k) C June 12 412k (+37k) 8:30 am Continuing Claims June 12 June 5 3,518k (+1k) 8:30 am Real GDP GDP Deflator Q1 T (e) +6.4% a.r. +4.3% a.r. Consensus +6.4% a.r. +4.3% a.r. Q1 S +6.4% a.r. +4.3% a.r. Q4 +4.3% a.r. +2.0% a.r. 8:30 am Real GDP by Industry (Q1)

8:30 am Pre-Tax Corporate Profits Q1 F (e) +12.7% y/y Q1 P +12.7% y/y Q4 -0.7% y/y 8:30 am Goods Trade Deficit May A (e) $87.7 bln C Apr. $85.7 bln 8:30 am Wholesale/Retail

Inventories (May A)

8:30 am Durable Goods Nondef. Cap. Orders Goods ex. Air

May (e) +3.1% +0.6% Consensus +3.0% +0.7% Apr. -1.3% +2.2% 11:00 am KC Fed Manufacturing Activity June (e) 24 May 26 4:30 pm Fed Bank Stress Test results

Fed Speakers: Atlanta’s Bostic, Philadelphia’s Harker (9:30 am); New York’s Williams (11:00 am); St. Louis’ Bullard (1:00 pm)

11:00 am 13- & 26-week bill auction announcements

11:30 am 4- & 8-week bill auctions


8:30 am Personal Personal Spending Income

May (e) +0.4% -2.5% Consensus +0.3% -2.8% Apr. +0.5% -13.1% 8:30 am Core PCE Price Index May (e) +0.6% +3.4% y/y Consensus +0.6% +3.5% y/y Apr. +0.7% +3.1% y/y 10:00 am University of Michigan

Consumer Sentiment June F (e) 86.5 C June P 86.4 May 82.9

Fed Speakers: Cleveland’s Mester (11:35 am); Boston’s Rosengren

(1:00 pm)

C = consensus D = date approximate R = reopening Upcoming Policy Meetings | Bank of Canada: July 14, Sep. 8, Oct. 27 | FOMC: July 27-28, Sep. 21-22, Nov. 2-3

June 18, 2021 | of 18

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