By Michael O’Neill

“Somebody gonna get hurt real bad.” Comedian Russell Peters heard that warning from his father throughout his childhood. If his Dad were an economist, he would look at the market’s reaction to recent U.S. economic data and repeat his warning to all Canadians.

Last Friday’s U.S. employment report was the final straw. Global equity indexes were already retreating as traders were unnerved by disappointing tech earnings and Japan’s latest rate hike, which sent USDJPY into freefall. Risk sentiment was already souring but curdled further after Israel terminated two terrorists, one in Lebanon and one in Beirut. The mad mullahs of Tehran were thoroughly embarrassed and promised to respond “decisively and promptly.” When the Bureau of Labor Statistics reported lower-than-expected job gains and revised the June numbers lower, the specter of a U.S. economic hard landing was brought back to life.

The Friday-Monday bloodbath was staunched on Tuesday. Wall Street bounced, Treasury yields recouped some losses, and the U.S. Dollar Index (DXY) rallied.

Overreaction or Croaking Coal Mine Canary?

Did traders overreact to the employment data, or is it something more ominous? The Tuesday/Wednesday price action suggests the former. The S&P 500 rose 1.0% Tuesday and gained another 0.87% by lunchtime on Wednesday. Investors aren’t dancing in the streets yet, but they are tapping their feet to the tune. Pundits and economists are stoking the euphoria, with many dismissing Friday’s NFP report as a “blip.” Chicago Fed President Austan Goolsbee said the Fed won’t react to one piece of data, while Scotiabank’s Capital Markets Chief Economist blames the weak results on distorted pandemic seasonal adjustments.

Reality Intrudes

The reality of the correction suggests something more ominous. Futures traders have priced in a junior-jumbo rate cut of 50 bps at the September 18 meeting, followed by two more 25 bp cuts by January 29, 2025. That wouldn’t happen if the Fed wasn’t spooked.

Equity traders are just as skeptical as the Tuesday/Wednesday market rally looks to be all fizzle and no soda. The S&P 500 has recovered less than half of what it lost, making it tough to dismiss the meltdown as an anomaly. The U.S. 10-year Treasury yield, which plunged on safe-haven demand, is still below Friday’s opening level. Nonfarm payrolls were just one of a series of weak employment reports. The average for weekly jobless claims rose by 2,500 in the week ending July 26. The ISM manufacturing employment index fell to 43.4% in July (June 49.3%), the lowest reading since reaching 42 in 2020, with none of the six big manufacturing sectors expanding. The Job Openings and Labor Turnover Survey (JOLTS) was unchanged in June, but job openings fell by 941,000 over the year. That’s not good news.

Come Sail Away

The Fed’s ability to manage a “soft landing” by tweaking interest rates is over-hyped. Geopolitics plays a large role, as evidenced by the supply-chain disruption caused by the pandemic and Russia’s invasion of Ukraine. Supply chains are still being disrupted by Iran-proxy Yemeni Houthis firing missiles at Red Sea shipping. Marine Traffic (a ship tracking website) estimates that dry bulk carrier traffic through the Suez Canal was down by 79.6% y/y in June. Iraq and Lebanon-based Hezbollah have promised a retaliatory attack on Israel, leading the U.S. to deploy the formidable USS Abraham Lincoln carrier group to the area. If things go pear-shaped, an economic hard landing may be the best outcome.

Canadian Economy Would be Collateral Damage

Canadians should be worried about a U.S. hard landing. America is Canada’s largest and most important trading partner, and if the U.S. economy is suffering, the Canadian economy will be devastated. Canada does not have much in the way of economic diversity to cushion it from a U.S. recession, and recent government policies are exacerbating the situation.

The Canadian government is transitioning from a proven, revenue-generating fossil-fuel-driven economy with massive proven reserves to an unproven, undeveloped green energy economy that requires massive investment. Even worse, the green energy demands on government finances are coming at a time when the country is the most indebted. EV manufacturers like Ford, GM, Honda, and Tesla have all announced plans to reduce, shift, delay, or scrap EV manufacturing, which suggests the Canadian government bet wrong.

Canada is already struggling with a housing and housing affordability crisis, a crumbling healthcare infrastructure, and massive immigration that far exceeds the economy’s ability to create jobs. The Bank of Canada said that Canada has seen no productivity growth in recent years. The problem is exacerbated by the massive public sector job growth, which has increased by 11.3% between February 2020 and June 2023. The private sector, including self-employed, rose just 3.3%.

The fallout from a U.S. hard landing will ensure USDCAD, which has traded above 1.3450 since February 5, continues to trade with a bullish bias and target 1.4000 and higher.

An elephant falling on a beaver sums up the crushing impact of a U.S. economic hard landing on Canada.