In this week’s The Seven…

• Getting jittery - A tough week for markets
• Just ask Sahm - Is the U.S. economy headed to recession?
• Summer cooldown - Canadian labour market 
• Moving along… the Beveridge Curve 
• Finding egress - TMX impacts showing up in trade data
• Interesting Fact: The ‘carry trade’ and its role in the market mayhem
• Chart of the Week: Claudia Sahm’s recession indicator

Turbulent times

So when it hits, don't forget

As scary as it gets

It's just turbulence

—Pink, “Turbulence”

Deep breaths. The S&P closed yesterday 2.3% below last Thursday; the TSX Composite took almost the same hit at 2.2% below where it was a week earlier. Both are still up this year, but much of the gains were erased.

What happened? Mid last week, the markets seemed somewhat assured that the ‘soft landing’ plan was working. The Fed held dovishly, signaling a cut was in the cards for September. Lower rates would steer the economy to the coveted soft landing. So far so good.

Then the U.S. jobs report on Friday, which wasn’t great, but also not terrible. However, the Sahm rule was triggered, an indicator that has accurately signaled recessions in the past.

The markets remain on edge, waiting for any hint from the data that the economy will be weaker than expected. Tech stocks have corrected, and the carry trade is being unwound (see the Interesting Fact below).

While the markets acted up, the economy didn’t fundamentally change in the last week:  U.S. GDP growth has been solid and the unemployment rate is still relatively low.

But markets are resetting expectations after a decent run, and more than two years after the Fed started raising interest rates. Buckle up. Jittery markets will continue to respond to any signals from the data and central banks. For more, see my Wednesday post.

TMX - Moving Canadian export values

The Trans Mountain Expansion (TMX) came online in May, and we’re starting to see an impact on the production and export numbers.

As we reported Wednesday, Alberta recorded the highest June on record for oil production, up 7.6% y/y. The next day, Statistics Canada reported that Canada swung from a trade deficit to surplus in June.

A major contributor? Oil exports. Canadian crude oil exports leaped 13.3%, mostly due to higher volumes. More exports are finding their way to Asian markets, as reported by Statistics Canada:

“The higher exported volumes were driven in part by higher exports of crude oil to Asian countries. The rise in exports destined to this part of the world reflects increased deliveries of crude oil from Western Canada via the Trans Mountain pipeline, whose expansion was recently completed.”

The Bank of Canada has also talked about this as a key driver of their outlook. From its July Monetary Policy Report: “Export growth is expected to rise to 6.25% on average over the second half of 2024. This increase is led by oil exports, as new capacity is created by the Trans Mountain Expansion pipeline.”

Improved transportation capacity expands exports and is productivity enhancing. Further, when new markets can be reached, Canadian producers receive better pricing over time with lower volatility. This boosts national incomes.

As for our outlook, oil production is one of two major drivers (along with residential activity) pushing our forecast for Alberta real GDP growth ahead of the national average in 2024.

Interesting Fact…What is a carry trade?

It’s an investment strategy, where you borrow in a low interest rate country and invest in a higher interest rate country. If all works out, and you don’t get burned by exchange and interest rate movements, it can be profitable. But it’s risky.

OK, so what? It turns out that a popular “borrow in Yen, invest in U.S. dollars” carry trade was part of the market mayhem this last week. In fact, the Japanese Nikkei index had its worst day since 1987.

The Bank of Japan surprised markets July 31 by raising its policy rate. And after the disappointing U.S. jobs report, markets started pricing in greater rate cuts by the U.S. Fed. This pushed many to unwind their carry trade positions. Some of these effects are coming off, and Japanese markets have bounced off their lows. But it was a contributing factor to the market volatility.

Chart of the Week: The Sahm Rule

Want to become famous? You can try your hand at acting or athletics. Or you could develop a recession indicator.

That’s what noted economist Claudia Sahm did while at the Federal Reserve Bank. It’s a surprisingly simple tool but with remarkable accuracy, indicating every recession since 1970.

Specifically, Sahm’s indicator signals a U.S. recession if the unemployment rate (on a 3-month moving average basis) moves 0.5 percentage points above the low point of the previous 12 months. Aside: The National Bureau of Economic Research tells us much later when the U.S. economy is in a recession based on a variety of metrics.

When the inverted yield curve did not ‘yield’ the predicted recession response, my attention turned to Claudia’s indicator.

Throughout the latest expansion, as the labour market stayed tight, the indicator stayed comfortably below the threshold.

But that changed last Friday, when the threshold was surpassed just slightly.

Claudia Sahm makes the case that while her indicator is a warning sign (and the Fed should start cutting rates), it does not necessarily mean a recession this time around.  History is a guide, but does not always predict the future.

One of the reasons is that the employment dynamics are different, with the recent uptick in unemployment largely due to more people joining the labour force as opposed to job losses.

For interested readers, here is Sahm’s op-ed: My recession rule was meant to be broken.

Answer to the previous trivia question: Known as the Scottish Play, Shakespeare’s Macbeth had its first known performance on August 7, 1606.

Today’s trivia question: Where is the next summer Olympics being held?