Has the Recent Batch of Positive Data Been a Head Fake or Something More?

With Canadian GDP for Q3 2022 out next week, it seemed like a good opportunity to put some of the latest macro data into context. Specifically, what it means for the economic outlook and what the implications could be for monetary policy.

When you compare our current tracking for Q3 with our forecast from last month External link. This link will open in a new window., the most striking change is the upward revision to real GDP growth. Monthly GDP for August caused us to adjust our growth tracking upward to 1.5% annualized, exactly in line with the Bank of Canada’s quarterly forecast in its October 2022 Monetary Policy Report (MPR) External link. This link will open in a new window.. And over the course of the past month, the Q3 tracking has ground higher still, leaving the economy in excess demand and our estimate of the output gap broadly unchanged. (You can find the details of our Q3 outlook on page 4).

Then along came the October jobs data, which threw our forecast for a loop. Before its release, we were again very much in line with the Bank’s view that real GDP growth was going to come in around 0.5% annualized in Q4 2022. But after it was revealed that the Canadian economy apparently created over 100,000 net new jobs in October, we’ve been forced to adjust our forecast higher. (Keep in mind that the labour supply also increased and wage growth looks to have plateaued, so this jump in jobs isn’t likely to have caused extra inflation on its own.) And it’s not just employment. The outlooks for auto sales, manufacturing, wholesale trade and retail sales all look likely to have moved sharply higher in October. This is in part because of pandemic-era distortions that continue to reverberate through the economy, such as long-delayed deliveries of motor vehicles and tangles in supply chains that continue to unravel. As a result, we currently expect Q4 real GDP growth to come in around 1.2% annualized, a far cry from the Bank of Canada’s outlook back in October. Of course, it’s still early in the quarter, and we could see some of the shine come off with subsequent data releases. But this becomes increasingly less likely with each new data point.

It’s important to recognize that these upside surprises aren’t just a Canadian phenomenon. US real GDP growth in the third quarter came in at 2.6% annualized, roughly double the pace expected by forecasters in mid-October. And as of the last read, the Atlanta Fed External link. This link will open in a new window. was tracking real GDP growth of between 4% and 4.5% for Q4 2022—far from recession territory. This is not only good news for the US. Growth of this magnitude will boost Canadian trade flows and bolster a quarter that already looks bright for Canada.

So where does this leave us? As a result of better-than-expected quarterly growth in the second half of 2022, we’re likely to revise up our annual real GDP growth forecast in our upcoming Economic and Financial Outlook. No doubt other forecasters will be moving their growth outlooks higher as well, including the Bank of Canada. But that doesn’t necessarily make us more optimistic on the outlook. That’s because any upward revision to our outlook for next year comes from what economists call the “handoff,” which is the impact that quarterly growth this year has on the annual rate of growth next year. We don’t expect quarterly growth in 2023 to be any stronger than when we published our October outlook. If anything, it’s likely to be even weaker. The first two quarters of 2023 are still anticipated to see real GDP contract, and Q3 of next year is more likely than ever to experience the same fate. This is because very aggressive monetary tightening in 2022 will hit the economy with a lag, with the slowdown broadening beyond housing and into other segments of the economy. (For more information, see our recent analysis on recession risks External link. This link will open in a new window..)

Taken together, we don’t believe the recent spate of positive data has moved the goalposts for central banks in any material way. Indeed, we suspect this data has largely been a head fake and that the economy is on a downward trajectory. This reaffirms our view that the Bank of Canada has not just pivoted to smaller rate hikes but is getting close to taking a prolonged pause after its December meeting. The same is likely true for the Fed, which we see extending its tightening into early 2023, but then pausing. As Bank of Canada Governor Tiff Macklem said back in October, “This tightening phase will draw to a close. We are getting closer, but we are not there yet.”