Juggling Dynamite

Worried about tariff-inspired inflation, the US Federal Reserve has held its overnight target rate steady at 4.25 to 4.5% since December, and markets have walked back easing expectations to just two 25 basis point cuts by year-end.

At the same time, businesses are warning that constantly shifting trade policies are hindering their ability to plan for the future, resulting in hiring and investment freezes. See WSJ, The US economy is headed toward an uncomfortable summer:

The U.S. labour market has been in an uneasy equilibrium, where companies aren’t hiring but are reluctant to fire workers they hired three or four years ago. Like a beach ball that shoots skyward after being held underwater, joblessness can quickly jump once companies decide demand is too soft to keep those workers.

Despite the official unemployment rate still being relatively low at 4.24%, it increased in May for the 4th consecutive month, marking the highest level since October 2021. If 625,000 Americans had not given up and left the job market, the official unemployment rate would be 4.6% and already above the Fed’s peak projection of 4.4% this year.

As Rosenberg Research pointed out yesterday, Friday’s NFP US jobs estimate of +139k in May came amidst downward revisions to the prior three months, totalling -187k. In other words, benchmarked off where we were at the turn of the year, surveyed employment has contracted in 2025.

Cumulative downward revisions from January to April from the first new job estimate to last revisions, have totaled -219k or around -50k per month: “this is the same pattern of downward revisions we had in the fall of 2007, just ahead of the Great Recession, because the thing about downward revisions to the payroll data over multiple months is this: it is a leading indicator for turning points in the cycle”.

With US Federal debt at 125% of GDP, the Treasury market is currently fixated on what appears to be unbridled deficit spending plans. Federal interest expense has doubled from $508 billion in the third quarter of 2020 to $1.114 trillion in the first quarter of 2025 (shown below since 1947).

The US federal government has $10 trillion in refinancing needs over the next year alone, and as Apollo Chief Economist Torsten Slok points out, Rapidly Growing Treasury Supply Crowds Out Other Types of Credit Growth:

Over the past 12 months, roughly half of all fixed income product coming to the market has been Treasuries.

This is not healthy. Half of credit issued in the economy should not be going to the government.

The consequence is that investors need to allocate more and more dollars to finance the government rather than financing growth in the economy through loans to firms and consumers.

The bottom line is that if the level of government debt were significantly lower, more dollars would be available for consumers to buy new cars and new houses, and for companies to build new factories.

The US 10-year Treasury yield, at 4.5%, is back at the same level as early February 2025, May 2024, the fall of 2023, and July 2007, before that; US mortgage interest rates have risen along for the ride.

Not surprisingly, US consumer debt delinquencies have also been rising, raising concerns that deteriorating financial conditions will lead to a more pronounced slowdown in consumer spending.

For the housing market, the spring sales season has been a bust. The US market has nearly 500,000 more sellers than buyers, according to the real estate brokerage Redfin. That is the largest gap since its tally began in 2013 (chart below).

“The market has been at rock bottom for the last 2½ years and there was some hope that we’d get a little bit of a turnaround this year. And it’s just actually been worse than expected,” said Redfin economist Chen Zhao.

For its part, the stock market is still swinging for the fences, with Canada’s TSX near all-time highs and the S&P 5oo having recovered 20% from its April lows, even as earnings estimates have shrank for this year and next.

Wall Street has convinced itself and all who will listen that growth trends in the real economy are irrelevant to asset prices. But if valuations and economies don’t matter, why employ legions of economists, financial analysts, and investment ‘advisers’? The business model, of course, is to urge buyers at all costs and beg for government bailouts when inevitable implosions happen. Individuals are recurring collateral damage; it’s wise to be wary.

Canada’s unemployment rate has climbed to 7% from 6.2% a year ago, and up 210 basis points from 4.9% in June 2022 (chart below via The DailyShot). Excluding the pandemic, this is the highest unemployment rate since 2016 (Statscan report here). A 180-basis-point increase in the jobless rate over two years has historically been a reliable indicator of a recession.
The broadest form of unemployment, the R-8 measure that includes all forms of idle labour (officially unemployed as well as discouraged workers who have stopped looking, the waiting group expecting to start a job soon, and those involuntarily part-time) has risen to 9.2% from 8.4% a year ago and 7.2% two years ago. The unemployment rate for workers aged 15 to 22 in Canada was 20.1 % as of May, up from a June 2022 low of 9.2 %.

The Bank of Canada and other key economic forecasters anticipate that unemployment will continue to rise into 2026.

Lest we underestimate the degree of rate shock unfolding here, the Bank of Canada (following the US Fed’s lead) held its policy rate at an unprecedented/reckless 0.25% from early 2009 through 2010 and sub-1% through mid-2017. After finally increasing to 1.75% by early 2019, it was slashed back to 0.25% in early March 2020 and remained there through April 2022, before tightening to 5% by July 2023.

In addition to unprecedented monetary stimulus from 2009 through 2023, Canadians received record government subsidies in the form of handouts and deferred debt payments—the private sector borrowed to the hilt, driving self-destructive household consumption and a world-famous real estate bubble.

Now, not surprisingly, tariffs, inflated prices, higher interest rates and deflating property values are all weighing on the Canadian economy. Domestic consumption was practically absent in the first quarter, and the advance estimate of April GDP was not encouraging.

Has the Bank of Canada learned a lesson from the train wreck of near-zero rate policies? Or are we headed back near the zero-bound as the housing-sensitive economy continues to tumble? I fear the latter–especially once the stock market begins to plunge and casualties are screaming for rescue. Still, as with tightening cycles, easing efforts are no quick fix.

We have not seen a credit and real estate contraction like this one since 2006-10, the early 1990s and the early 1980s. Most people have no clue how deep and prolonged such downturns tend to be, but we’re about to have a crash course. The segment below is worthwhile.

David Rosenberg, Founder & President, Rosenberg Research, talks about the Bank of Canada’s decision to hold interest rates and says there is a good chance the economy is slipping into recession. Here is a direct video link.

Since June 2024, interest rates have trended down from a two-decade high, yet remain above the historically low levels seen during the pandemic.

Approximately 1.2 million Canadian mortgages will renew in 2025, a vast majority (85%) of which were secured when the Bank of Canada’s key lending rate was at or below 1% compared with 2.75% today. From the 1.5% to 3% range in 2020-21, Canadian fixed mortgage rates are currently in the 4.2% to 4.55% range (6.09% to 6.99% in the United States).

A recent Royal LePage survey reveals that 57% of Canadian homeowners with mortgages set to renew in 2025 anticipate an increase in their monthly payments. Among these individuals, 81% expect this rise to impose financial strain on their households, with 34% describing the strain as significant.

This financial pressure is prompting many to adjust their spending habits. Specifically, 60% plan to reduce or eliminate discretionary spending, 43% intend to cut back on travel, 36% will decrease their savings or investments, and 34% aim to reduce spending on essentials like gas and groceries. Additionally, 23% are considering obtaining a second job or finding another source of income.

Already, payments that are 90 days+ late have risen to 1 in 22 mortgages nationally.  The number of serious delinquencies increased by 72% year over year in Ontario and by 38% in BC.

All of this makes Canadians less able to absorb price increases inspired by tariffs. While the Bank of Canada is concerned about the inflationary impacts, declining demand from retrenching consumers is a reliable disinflationary force.