PrefBlog

There’s a bit of cheerful news in the fiscal wasteland:

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the Long-Term Debt rating of the Province of Ontario (Ontario or the Province) at AA (low) and the Short-Term Debt rating at R-1 (middle). DBRS Morningstar also confirmed the Ontario Electricity Financial Corporation’s (OEFC) Long-Term Obligations rating at AA (low) (based on the Province’s rating). Concurrently, DBRS Morningstar changed the trends on all ratings to Positive from Stable.

The Positive trends reflect DBRS Morningstar’s assessment that Ontario’s fiscal management has improved. Despite economic headwinds, DBRS Morningstar has increased confidence that Ontario’s improved fiscal outlook can be sustained. Stronger-than-anticipated revenue growth has been allowed to flow to the bottom line, while increased program spending is, in part, being offset by a lapse in temporary Coronavirus Disease (COVID-19) supports and other one-time measures.

Ontario’s fiscal outlook continues to improve relative to prior expectations. For 2023–24, Ontario forecasts a budget deficit of $1.3 billion, after incorporating a $1.0 billion reserve. Should the reserve be unnecessary, the budget is essentially balanced. The Province then anticipates small surpluses in 2024–25 and 2025–26. On a DBRS Morningstar-adjusted basis, after including capital expenditures (capex) as incurred rather than as amortized and assuming some modest capex underspending, this equates to DBRS Morningstar-adjusted deficits of 1.0% of GDP or less over the forecast horizon.

Ontario’s debt outlook is expected to show steady improvement, provided the economy remains resilient and fiscal targets are met. On a DBRS Morningstar-adjusted basis, the debt-to-GDP ratio is estimated to fall to roughly 37.0% by 2025–26. Despite ongoing economic uncertainty, DBRS Morningstar believes that Ontario’s track record of budgetary outperformance, combined with the ongoing use of conservative assumptions, could lead to an even faster decline in the debt-to-GDP ratio, which supports the Positive trends.

Economic growth is expected to slow in Ontario as global economic conditions deteriorate in response to central bank efforts to raise policy rates and curb inflation. The Province is forecasting real GDP growth of just 0.2% for 2023, which appears conservative in relation to the current private-sector consensus. Real GDP growth is then forecast to rebound to 1.3% in 2024. Recent financial market instability and deteriorating credit conditions present downside risks to the outlook, while the evolving outlook for inflation and interest rates along with global geopolitical tensions present further uncertainty.

RATING DRIVERS
DBRS Morningstar will look to resolve the Positive trends within the next 12 months. Provided the Province continues to demonstrate prudent fiscal discipline and the economic backdrop remains supportive, DBRS Morningstar could upgrade the ratings by one notch. DBRS Morningstar could restore the Stable trends should there be a deterioration in one or more critical rating factors or a material deterioration in financial risk metrics such that DBRS Morningstar has reduced confidence that the debt-to-GDP ratio will remain on a downward trend.

TXPR closed at 534.62, up 0.69% on the day. Volume today was 1.07-million, above the median of the past 21 trading days.

CPD closed at 10.59, down 0.47% on the day. Volume was 90,580, third-highest of the past 21 trading days.

ZPR closed at 8.78, up 0.23% on the day. Volume was 91,020, third-lowest of the past 21 trading days.

Five-year Canada yields roared up to 3.76% today on the back of the BoC policy hike.

PerpetualDiscounts now yield 6.55%, equivalent to 8.52% interest at the standard equivalency factor of 1.3x. Long corporates yielded 5.23% on 2023-5-26 and since then the closing price has changed from 14.82 to 14.78, a decrease of 27bp in price, with a Duration of 12.21 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies an increase in yield of about 2bp since 5/26 to 5.25%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed sharply to about 325bp from the 345bp reported May 31.

TXPR closed at 530.35, up 0.90% on the day. Volume today was 852,710, a little below the median of the past 21 trading days.

CPD closed at 10.64, up 1.53% on the day. Volume was 57,180, fourth-highest of the past 21 trading days.

ZPR closed at 8.71, up 1.16% on the day. Volume was 128,000, below the median of the past 21 trading days.

Five-year Canada yields up to 3.52% today.

Jobs, jobs, jobs!:

U.S. employers added 339,000 jobs on a seasonally adjusted basis, the Labor Department said on Friday, an increase from a revised total of 294,000 in April.

The strong figures emerged from a survey of employers. A separate component of the report, based on a survey of households, yielded a somewhat dissonant picture.

That data showed a rise in the unemployment rate to 3.7 percent, from 3.4 percent, and a decrease of 310,000 in the number of people employed, as participation in the labor force was little changed.

In a sign that the pressure to entice workers with pay increases is easing, wage growth slowed slightly in May, with average hourly earnings increasing 0.3 percent from April, and 4.3 percent over the year.
…
How can job growth accelerate while the unemployment rate rises? The two figures come from different surveys, one of businesses (the source of the monthly payroll figure) and one of households (the source of the unemployment rate). Over time, the two typically tell consistent stories. but they can diverge in any given month.

Often, that divergence is nothing more than noise. But sometimes, it reflects something real happening in the economy. That’s because the two surveys measure different things: The survey of households, for example, includes gig workers and other people doing nontraditional jobs that aren’t counted in the business survey.

That appears to be what happened last month. In May, “unincorporated self-employment” — which includes gig workers, independent contractors and some small businesses — fell by 369,000, the third straight monthly decrease. Looking just at people working in more traditional jobs, employment rose in both surveys last month.
…
The share of people in their prime working years — 25- to 54-years-old — participating in the labor market reached 83.4 percent in May, a level not seen since 2007.
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Investors have added to bets on the Fed raising interest rates in June. Still, bets remain skewed toward the central bank holding rates at their current level, in a range between 5 percent and 5.25 percent.

And the US debt limit will be out of the headlines for the next two years:

After weeks of political impasse, tense negotiations and mounting economic anxiety, the Senate gave final approval on Thursday night to bipartisan legislation suspending the debt limit and imposing new spending caps, sending it to President Biden and ending the possibility of a calamitous government default.

The approval by the Senate on a 63-to-36 vote brought to a close a political showdown that began brewing as soon as Republicans narrowly won the House in November, promising to use their new majority and the threat of a default to try to extract spending and policy concessions from Mr. Biden.

The Canaccord deal (last mentioned May 8) continues to appear dubious:

Canaccord Genuity Group Inc CF-T -7.03%decrease
management-led consortium said on Friday its $1.13-billion take-private offer may not result in a deal as there was “no reasonable chance” its conditions would be met by the expiry date.

This comes just a month after the management warned of delays in securing regulatory approvals for the offer, first announced in January.

The management has made no final decision on extending the June 13 deadline for the offer, which was opposed by a special committee of independent directors at the Canadian firm in February.

And, for what it’s worth, my faith in the company’s governance also continues to be dubious.

Toronto real estate continues to impress:

Toronto’s housing market recovered further in May, with sales and home prices climbing for the fourth consecutive month, as the shortage of properties for sale fuelled competition among buyers.

The home price index, which excludes the highest valued properties, increased by 1.6 per cent to $1,164,400 from April to May, according to the Toronto Regional Real Estate Board, or TRREB. Adjusting for seasonal influences, the home price index was up 3.2 per cent to $1,139,600.

Sales rose by 5 per cent month over month on a seasonally adjusted basis. And although new listings increased by 10 per cent as more homeowners put their properties on the market, the volume was about 50 per cent below the 10-year average for May.

Sales represented more than 70 per cent of the new listings, the second consecutive month of similar conditions. TRREB’s chief market analyst Jason Mercer said a measurement this high “represents a very tight market supporting strong price growth.” The last time the market was this tight was at the peak of the pandemic’s real estate boom in January of last year.

Pablo Hernández de Cos, Governor of the Bank of Spain, gave a speech titled The European Central Bank’s monetary policy in response to the price stability challenge:

From a monetary policy perspective, it must be borne in mind that this inflation forecast – which, I stress, is compatible with our medium-term price stability target – is based, among other assumptions, on market expectations for our interest rates that envisage the deposit facility rate peaking at around 3.75% in the coming months, holding at that level over the following quarters and only gradually falling from 2024 Q2.

Although no new projections were available in May, the latest data published since the March projections were prepared show, firstly, that economic activity has performed in line with the forecast. Thus, euro area GDP grew 0.1% in Q1 and the partial and essentially qualitative information available for Q2 suggests a slight acceleration. By component, private consumption remained weak, but the labour market continued to prove robust: the unemployment rate stood at historically low levels (6.9% in March, almost 1 pp below the February 2020 rate), although hours worked were still 1.6% below the pre-pandemic level.

Inflation of 7% in April was slightly higher than expected, while financial conditions tightened further – as a result, above all, of an even stronger euro exchange rate – and energy prices were at somewhat lower levels than those incorporated into the March projections.

All this information led us to consider that the medium-term inflation outlook in the March projections essentially remained valid. In this respect, the International Monetary Fund projections published on 18 April forecast a similar GDP and inflation outlook to that of the Eurosystem.

Underlying inflation (i.e. excluding energy and food) fell slightly in April, to 5.6%, but was higher than expected, after reaching a record high of 5.7% in March. Other indicators confirm that underlying price pressures remain strong. First, inflation rates for the underlying inflation components most exposed to higher energy prices,3 which increased by 4.5 pp over the course of 2022 (to 7.2% in December), have continued to rise and stood at 7.7% in April. Second, the price growth of those items most affected by the recovery in demand after the pandemic restrictions were lifted, such as those related to transport and household equipment and maintenance, shows signs of stabilising, albeit at levels that remain high (above 7%).4

In addition, inflation rates for the components related to recreation, food service activities and tourism reached an all-time high of 7.5% in March (7.4% in April). Lastly, inflation rates for the rest of the items, which account for more than 30% of the consumption basket, held at 3.6%5 in April, with the prices of more than half of the items
growing at rates of over 4%.

Nonetheless, various short-term underlying inflation indicators – measured in month-onmonth or quarter-on-quarter terms – have started to ease somewhat. In this respect, nonenergy industrial goods inflation fell from 6.6% in March
to 6.2% in April.

At the same time, wage pressures have continued to increase, with compensation per employee and per hour growing by 5% and 4.3%, respectively, in 2022 Q4 (3.9% and 2.9% in Q3). In any event, this is in line with the March projections.

The current issue of IMF’s F&D magazine is devoted to globalization this week:

Mounting disillusionment with globalization has consequences. Yale’s Pinelopi Goldberg concludes that protectionism would make the world less resilient and more conflict-prone. Dartmouth’s Doug Irwin says history shows industrial policies and subsidies could leave countries worse off. Growing global tensions, notes the IMF’s Michele Ruta, may push regional trade alliances toward less integration and more discrimination. And smaller economies may be sidelined as the world fragments into rival trading blocs. Some will find it advantageous to remain nonaligned, says Oxford’s Ngaire Woods.

But the IMF’s Kristalina Georgieva and the World Trade Organization’s Ngozi Okonjo-Iweala appeal to countries to keep faith in trade as a transformative force that has lifted many millions out of poverty and call for a strengthening of multilateral institutions. Other contributors advocate for a new political consensus to resolve competing demands on the global trading system, taking into account structural changes in the global economy.

Michelle W Bowman, Member of the Board of Governors of the Federal Reserve System, gave a short speech at a Fed Listens event:

In the near term, higher interest rates intended to lower inflation work most directly in the housing market. While we expect lower rents will eventually be reflected in inflation data as new leases make their way into the calculations, the residential real estate market appears to be rebounding, with home prices leveling out recently, which has implications for our fight to lower inflation.

The pandemic abruptly changed the lives of most Americans and their families, and it fed a surge of demand for those who sought larger homes. It ushered in a wave of homebuilding and renovation that was a significant contributing factor for inflation and supply chain challenges. Much of that initial inflation has moderated, but it will be important to understand the long-term effect of the pandemic environment on household formation and housing demand going forward.

Christine Lagarde, President of the European Central Bank, gave a speech titled The Fight Against Inflation:

Underlying inflation refers to the slow-moving part of inflation which, when temporary shocks have faded, will persist into the medium term. Therefore, by looking at underlying inflation, we can be more confident that inflation is on the right path. And it has an important benefit – measures of underlying inflation can be observed in real time.

However, there is no clear evidence that underlying inflation has peaked. To date, all measures monitored by the ECB are still strong. And whether they remain so will depend mainly on the balance between two forces: energy prices and wages.

On the one hand, as energy is an important input into every economic activity, the sharp rise in energy prices last year has fed through to all prices – including those that make up our various measures of underlying inflation.
But energy prices have dropped considerably since then, which should have the opposite effect. HICP energy inflation in Germany fell from 44.2% in September 2022 to 9.4% in April 2023.

This decline in energy costs for both consumers and producers should, in turn, limit firms’ ability to further raise profit margins, which has been a key factor driving recent price pressures in the euro area.

Consumers are less likely to accept disproportionate price rises when they know that firms are saving on their energy bills.

On the other hand, mounting wage pressures are becoming a more important driver of inflation. So far, workers have faced a significant loss from the erosion in overall labour income caused by the energy crisis. In the euro area, real wages at the end of last year were still around 4 percentage points below prepandemic levels.

But labour markets across the euro area are tight and workers have considerable bargaining power, which they are starting to use to recoup these losses. This is especially visible here in Germany, where labour shortages reached historic highs in the second half of last year, leading to strong wage agreements in many sectors. Wage growth in Germany increased from 3.9% in the fourth quarter of last year to 5.1% in the first quarter of this year.

To be clear: a period of catch-up wage growth need not cause unduly persistent inflation over time – if the costs of the energy shock are ultimately shared in a balanced way between firms and workers. But if we start to see what I have called “tit-for-tat” inflation – with both parties trying to offset any real income losses – we could see a negative spiral taking hold.

The ECB cannot allow this to happen. And since profits are ultimately influenced by the business cycle, it is our responsibility to restrict demand enough to prevent such a spiral. That should, in turn, lead to slower margin growth and lower wage demands while reducing pressure in the labour market.

But to gauge whether rates are sufficiently restrictive, we need to know how much traction our policy tightening is having – and is likely to have – on spending in the economy.

That is why policy transmission is the third element we are looking at.