HIGHLIGHTS
- U.S. Federal Reserve on the march
- Canada changes mortgage insurance rules
- Softer Canadian employment
While the June employment report in Canada was the focus of attention on Friday, the earlier part of the week was dominated by discussions of regulatory reform in the U.S. financial sector. The aim is to help prevent future financial crises by better delineating and redefining the relative roles of the U.S. Treasury, the Fed, and the SEC. Ultimately, this exchange of information between the three entities will lead to a more concerted supervision and regulation of financial players. The current separation of responsibilities did nothing to forestall the subprime mortgage lending crisis, and is viewed by many as dated. Financial markets have evolved rapidly in the last decade, as highlighted by the massive growth in complex over-the-counter derivative products, and regulatory bodies have had a hard time keeping up with developments.
Under my roof
As was evident in his testimony to the U.S. House Committee on Financial Services on Thursday, Fed Chairman Bernanke is eager to push through reforms and more than willing to bolster the responsibilities of the entity he happens to chair. Recent events stand behind him and provide a fair bit of momentum for a stronger and more proactive Fed going forward. Like any good parents, the Fed is willing to help its children along so long as they play by its rules while living under its roof. Investment banks seemed to be the new, neglected kid on the block, and the Fed has taken them in. In helping along what is akin to an adoption application, the Fed announced on Tuesday it would likely keep the primary dealer credit facility open into 2009 “should the current unusual and exigent circumstances continue to prevail”. You don’t threaten to show the door to the adopted kid when he’s just coming to his new home from rehab. The primary dealer credit facility, a makeshift guest room of sorts, was created in March to extend to investment banks loans previously only available to commercial banks. The markets rallied and let out a sigh of relief at the announcement. It’s not so much that the facility was being used much of late – after peak loan extensions of up to $38.1 billion in early April, investment banks have gradually cut back on use of this facility since then, down to only $1.7 billion last week. But it is soothing in an important way, especially in a week during which the solvency of mortgage corporations Fannie & Freddie were questioned. It’s like knowing that the local Dairy Queen drive-through window is still open in September, on the off-chance you get summer-like temperatures. As a result of the nearcollapse of Bear Stearns in March and the Fed’s consequent intervention to secure a buyout from JPMorgan, investment banks know the price to pay for a comfortable place to sleep is that Dad (a.k.a. the Fed) will be looking over their shoulder. The birth parents (a.k.a. the SEC) will no doubt have extended visiting rights and will actively remain involved on the enforcement side. It would only make sense, after all, that a marriage of economists (Fed) and lawyers (SEC) produce better citizens than either could by themselves.
The short life of the 40-year
Credit conditions have no doubt been better in Canada throughout the subprime meltdown episode. This contrast to the U.S. was highlighted by an announcement from the Bank of Canada (BoC) on Tuesday that the $1 billion purchase and resale agreement maturing the next day would not been renewed. In support of this decision, the BoC stated that “conditions in Canadian markets have improved since the end of April, including funding conditions out to three months.”
Nonetheless, regulatory change, very much in light of what has happened in the U.S. mortgage market, was also high on the agenda in Canada this week, where the government announced on Wednesday it would no longer back 40-year amortizations and require a minimum 5% downpayment. In the past two years, no money down loans became insurable and the amortization period has been stretched beyond the conventional 25 years up to 40 years, as a result of greater competition in the mortgage insurance market and in response to eroding affordability. Close to 40% of mortgages originated last year had amortization periods over 25 years. Any purchase involving less than 20% downpayment requires mortgage insurance, which is government-backed. The new rules, which will also require a minimum credit score of 620 and new documentation standards, will take effect on October 15 and will apply only to new mortgages – existing non-conforming loans will be grandfathered. The near-term distortionary impact of this announcement will be to bring forward sales for households on the margins of affordability, while further helping to cool markets after the October deadline. Shortening the amortization period by 5 years would, for the average-priced Canadian home (about $310,000), increase monthly mortgage payments by $55, and is unlikely to have much of an impact on the market. The greater dampening impact on sales will come from the arguably prudent requirement of a 5% minimum downpayment. With households required to have at least some skin in the game, the new rules should reduce the already low systemic risk of rising Canadian mortgage delinquencies.
Canadian employment falls in line
The latest labour force survey confirmed that the weakness observed in Canadian economic growth, with real GDP contracting by an annualized 0.3% in Q1 and only a modest positive growth figure in store for Q2, is now translating into a softer employment picture. The Canadian economy shed 5,000 jobs in June, the first net monthly contraction in employment since December 2007. At the time, however, a 3,000 job loss was held up by incredibly solid bookends of over 40,000 jobs created in the two prior and consecutive months. December proved to be a blip. Now, employment is weak on a trend basis. Three out of the last four months of employment data show full-time employment declining significantly, for an average monthly job loss of 18,000 in this bellwether segment of the labour market. The overall job creation tallies have only been held up due to uncharacteristic gains in part-time employment averaging 27,000 in the last four months. Year-over-year growth in employment slowed to 1.7% in June after holding above or near 2.0% in the previous 12 months. The unemployment rate edge up ever so slightly to 6.2% and remains low, but will no doubt rise further in the coming quarters. So while the overall employment picture remains better in Canada than in the U.S., Canada is by no means shrugging off the U.S. slowdown. The downside risks to economic growth in both countries loom large as central banks stay on hold, hoping that surging energy prices will cause only a temporary spike in inflation.
Advanced retail sales data for June, out Tuesday, will provide a better pulse reading on the American consumer and the near-term impact (or lack thereof) of the fiscal stimulus. Total retail sales have been slowing, not collapsing, but keep in mind that the nominal figures (current $) are somewhat artificially being held up by gasoline station sales and the fiscal stimulus. The underlying health of retail spending is weaker than meets the eye. A recession is arguably hiding behind the fiscal stimulus cheques in the U.S., which we will see through in the fourth quarter.
Next week also brings us a BoC rate decision, and we expect it to remain on hold at 3.00% while highlighting inflationary risks to help anchor expectations which are on the rise for obvious reasons. We will be particularly interested in the communiqué and whether it indicates a shift in the BoC’s currently neutral bias. For a detailed preview, turn to our Monetary Policy Monitor publication.
UPCOMING KEY ECONOMIC RELEASES
Bank of Canada Rate Decision
Release Date: July 15/08 Current Rate: 3.00% TD Forecast: 3.00% Consensus: 3.00%
The Bank of Canada is expected to keep rates on hold at 3% this week and this is almost fully priced in by the market. The June 10th decision marked a significant shifting of gears at the Bank when they elected to keep rates steady. The last statement detailed a neutral bias for the future, which will likely keep the Bank of Canada on hold this time around. Inflation in Canada is picking up, but it is not so elevated as to warrant a rate hike anytime soon. Food and energy prices will continue to push headline CPI higher than the current rate of 2.2% Y/Y recorded in May. Commodity prices will figure in quite heavily into the inflation readings going forward and Governor Carney has suggested that the Bank will be keeping close tabs on commodity prices, which according to the Bank’s commodity price index is up 48% Y/Y. However, core CPI still remains below the Bank’s 2% operational target, with a 1.5% Y/Y gain in May. In addition, with some slowing expected in the Canadian economy, the deceleration in demand for goods and services should reduce some of the upward pressure from prices. As such, there is no pressing need for the Bank to make any adjustments to the rate setting just yet, but the next move for the Bank, when it does occur, is more likely to be a rate hike than a rate cut.
U.S. Retail Sales - June
Release Date: July 15/08 April Result: total +1.0% M/M; ex-autos +1.2% M/M TD Forecast: total +0.2% M/M; ex-autos +0.8% M/M Consensus: total +0.3% M/M; ex-autos +0.9% M/M
Following the tax-rebate driven surge in U.S. retail spending in May, retail sales are expected to rise at a more tepid pace of 0.2% M/M. Indeed, despite the deteriorating U.S. housing and labour markets, and rock-bottom consumer confidence, the arrival of the remainder of the stimulus cheques in June and the lagged usage of earlier cheques should go some way in compensating for these unfavourable consumer conditions. And with sales of automobiles in the U.S. declining for the fourth straight month in June, sales excluding autos should rise by a more respectable 0.8% M/M. The outlook beyond June looks to be extremely grim as sales return to more sustainable levels.
U.S. Consumer Price Index - June
Release Date: July 16/08 May Result: core 0.2% M/M, 2.3% Y/Y; all-items 0.6% M/M, 4.2% Y/Y TD Forecast: core 0.2% M/M, 2.3% Y/Y; all-items 0.7% M/M, 4.5% Y/Y Consensus: core 0.2% M/M, 2.3% Y/Y; all-items 0.7% M/M, 4.5% Y/Y
Despite the surge in energy and food prices, and rising inflationary expectation, core consumer price inflation in the U.S. has so far been fairly well behaved, thanks to the sluggish U.S. economy doing its part in tempering the ability of these higher costs being passed on to core consumer goods and services. And we expect this to remain the case in June. As such, core consumer prices should rise by a moderate 0.2% M/M in June, with the annual rate of increase remaining steady at 2.3% Y/Y for the third straight month. All-items CPI, on the other hand, should remain stubbornly high in June with a strong 0.7% M/M gain, bringing the annual inflation rate up to 4.5% Y/Y – which will be its highest level since September 2005.
Canadian Manufacturing Shipments - May
Release Date: July 16/08 April Result: +2.0% M/M TD Forecast: +0.2% M/M Consensus: +0.5% M/M
After an astonishing 2.0% M/M surge in April, Canadian manufacturing shipments should come back down to earth with a more modest 0.2% M/M gain in May. Despite this advance in nominal terms, real shipments should remain unchanged on the month, as the increase in the headline number is likely to come from price gains. Indeed, notwithstanding the recent resurgence in the sector (with both real and nominal shipments increasing in 3 of the past 4 months), the Canadian manufacturing sector will likely struggle in the coming months as the weakness in the U.S. economy and the strength of the Canadian dollar take hold.
U.S. Housing Starts - June
Release Date: July 17/08 April Result: 975K TD Forecast: 960K Consensus: 965K
The U.S. housing sector remains in a state of distress, with little to suggest an imminent turnaround in the sector anytime soon. And given that the inventory of unsold homes remains elevated and the number of building permits authorised continue to plummet, U.S. residential construction activity will no doubt continue to be muted in the coming months. As such, we are calling for a modest decline in U.S. housing starts in June, with new home construction falling to 960K from 975K in May – bringing the number of starts to its lowest level since early 1991.
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
