Sunday, February 1, 2009

The Weekly Bottom Line


  • U.S. economy contracts 3.8% in Q4
  • Canadian GDP slides 0.7% in November
  • Harper's fiscal stimulus plan to fuel economy

While the U.S. economy has officially been in a recession since December 2007, real GDP managed to expand in the first half of the year. However, the economy took a turn for the worse as 2008 came to a close, with economic growth contacting by a massive 3.8% (annualized) in the fourth quarter - the largest decline in real GDP since 1982 - following a 0.5% decline in the third quarter. While the drop in economic activity was much softer than markets were expecting (-5.5%), details of the report indicate that the losses were indeed quite dreadful. In fact, inventories played a key role in the fourth quarter, adding 1.3 percentage points to the headline figure. Hence, stripping away inventories, real GDP actually contracted by over 5%. Given that the inventory build-up was probably undesired, adjustments to stockpiles will likely work against the GDP figure in the coming quarters, adding to the long list of challenges facing the U.S. economy.

Fed looking to unconventional methods

The ongoing economic deterioration will only ramp up pressure on the U.S. government to take action. After lowering the fed funds target rate to a range of 0-0.25% in December, the Fed had an easy decision to make at its meeting this week - at least with respect to interest rates. In addition to holding rates steady, the Committee reiterated its commitment to keeping rates extremely low for some time. With this traditional monetary policy tool essentially exhausted, the Fed has become open to more unconventional methods, such as expanding its balance sheet. In the accompanying statement on Tuesday, the Fed stated that it is prepared to purchase longer-term treasuries, should conditions warrant. While there was only one dissenter on this decision -Richmond Fed President Lacker preferred to begin buying treasuries immediately - we suspect that it is only a matter of time before the Fed turns to this approach.

Fiscal stimulus plan moving ahead

On the fiscal side, President Obama is working hard to implement another stimulus package. On Thursday, the $819 billion package - which amounts to a whopping 5½ -6% of GDP - was passed by the House, sending it to the Senate for approval. However, of the 244 votes in favour of the bill, not one came from a Republican. This means that it will face a tougher audience in the Senate, where Republicans will be able to have more influence over the measures set out in the package. As it stands, one third of the total package is geared towards tax cuts, and two thirds towards spending, of which a significant share is directed at states to help pay for programs. The Republicans don't feel as though the current plan will actually stimulate the economy, and would instead like to see more tax cuts, less spending and more measures concentrated on fixing the housing market. Accordingly, there could be some delay in passing the final bill.

Canadian economic activity slumps in November

In Canada, economic data continue to come in softer and softer, and the November GDP numbers out this morning were no exception. Following October's 0.1% slide, the Canadian economy contracted by 0.7%, marking the largest monthly slump in activity since August 2003. This was slightly weaker than TD Economics' forecast for a 0.6% contraction, and even further off market expectations for a 0.4% drop. While the wholesale trade (-3.1%), manufacturing (-2.1%) and construction (-1.2%) sectors were hit the hardest, declines were felt across the board with the goods-producing sector sliding 1.3% and the services-producing sector losing 0.4% on the month.

With two months already in the books and high frequency data for December indicating that the Canadian economy only deteriorated further in the closing month, the real GDP performance in the fourth quarter is looking extremely weak. In fact, even assuming a flat reading for December, fourth quarter real GDP is tracking -2.5% to -3.0%, and likely marks the onset of the recession on this side of the border - which comes nearly a full year after the recession in the U.S. officially began. Hence, the Canadian economy ended the year on a much weaker footing than anticipated (we originally forecasted a 1.6% decline in Q4), providing a weaker handoff for 2009. Indeed, barring any type of stimulus, real GDP could fall as low a 2.0% this year.

Fiscal stimulus to boost GDP

However, as promised, the Harper government unveiled a fiscal stimulus plan in the Federal Budget on Tuesday, which will provide some offsetting support for economic activity this year and into 2010. The greatly anticipated plan to fuel the Canadian economy consists of nearly $40 billion in measures over the next two years. New spending - particularly in infrastructure and enhanced training and employment insurance benefits - will account for about three quarters of the total pie, while tax relief measures - through increases in the basic personal amount as well as the top threshold of the first and second personal income tax brackets - will make up the remaining 25%. The string of measures to free up credit availability in the economy also garnered some attention, with the housing and auto sectors among the beneficiaries.

While the government has estimated that the stimulus package will boost real GDP by 1.6% in 2009 and a total of 1.9% by 2010, we feel that this may be somewhat optimistic. Indeed, we suspect that the package will lift economic growth by about 1 percentage point over the next two years combined. As such, we expect Canadian real GDP to contract by 1.4% in 2009, before rebounding to 2.8% in 2010.

Canadian government to run a deficit

The stimulus package, combined with recessionary effects, will push Canada into a deficit position, estimated at $30-34 billion annually over the next two years. While the government has projected a return to a balanced budget by fiscal 2013-14, it will definitely be challenge to do so. Nonetheless, the federal government's fiscal position remains on solid footing. At 2% of GDP, these planned deficits would be much smaller than the deficits of 4-8% of GDP that occurred during the 1980s and 1990s recessions, and pales in comparison to the 10% of GDP deficit that the U.S. will incur if the new stimulus plan is implemented. For more details on the budget, see TD Economics' The 2009 Federal Budget, available on our website.


U.S. Personal Income & Spending - December

Release Date: February 2/09 November Result: income -0.2% M/M, spending -0.6% M/M; core PCE deflator 0.0% M/M, 1.9% Y/Y TD Forecast: income -0.4% M/M; spending -0.9% M/M; core PCE deflator 0.0% M/M, 1.8% Y/Y Consensus: income -0.3% M/M; spending -0.9% M/M; core PCE deflator 0.0% M/M, 1.7% Y/Y

U.S. consumers have been stretched to the limit, as the worsening labour market conditions and a weak domestic economy continue to pierce holes into consumer confidence. Add to this plunging equity and home prices, and it is no wonder that U.S. consumer spending has fallen like a stone in the past five months. And we expect this retrenchment in spending to continue for some time. Our call is for personal income to fall for the second consecutive month in December, with a dramatic 0.4% M/M drop. Personal consumption expenditures are also expected to be weak, falling a further 0.9% M/M, following the 0.6% M/M drop in November. In terms of inflation, we expect the core PCE deflator to remain flat on the month, brining the rate of annual core inflation to 1.8% Y/Y. Looking ahead, as the prolonged U.S. economic recession gains traction, we expect to see further moderation in both personal income and spending, with personal consumption expenditures expected to remain a key drag on U.S. economic activity.

U.S. ISM Manufacturing Report - January

Release Date: February 2/09 December Result: 32.9 TD Forecast: 31.0 Consensus: 33.0

Despite plunging by a third in the past four months, we believe that the U.S. ISM manufacturing index has further to fall as the worsening U.S. economic recession continues to take a toll on the beleaguered manufacturing sector. In addition to the weak domestic demand, the recent resurgence in the U.S. dollar has also been unhelpful for the sector, strangling whatever international appetite there was for U.S. manufactured products. Regional surveys largely confirm this view. In the end, our call is for the ISM manufacturing index to decline for the sixth straight month, falling to 31.0 in January, from 32.9 in December. In the coming months, with domestic and foreign consumer demand expected to weaken further, the headline ISM index and most of its sub-components should remain well south of the 50-threshold.

U.S. Nonfarm Payrolls - January

Release Date: February 6/09 December Result: -524K; unemployment rate 7.2% TD Forecast: -600K; unemployment rate 7.5% Consensus: -592K; unemployment rate 7.5%

The new calendar year is unlikely to be any more cheery for the U.S. labour market than the past year. In fact, with the U.S. economic recession expected to last well into this year, we expect the pace of job losses to remain brisk this year. Evidence of this has become ever more apparent recently with the slew of job cuts announced by a number of large U.S. corporations in the past few weeks. As such, we expected the U.S. non-farm payrolls to decline by a further 600K in January, bringing the total number of jobs lost since January last year to 3.2M. Moreover, with the weakening economy limiting the job opportunities for displaced workers and new entrants into the labour force, the unemployment rate is expected to spike to 7.5%, which will be the highest rate of unemployment in the U.S. since the early 1990s. In the coming months, we expect U.S. businesses to continue reducing their workforce as they adjust their production levels in the face of slumping demand for their products.

Canadian Employment - January

Release Date: February 6/09 December Result: -20.4K; unemployment rate 6.6% TD Forecast: -40.0K; unemployment rate 7.0% Consensus: -40.0K; unemployment rate 6.8%

The Canadian economy took a dramatic turns for the worse in the last quarter of 2008, and dragged the labour market along for the ride. Indeed, after adding a sizeable 163.3K jobs in the first ten months of the year, the wheels came off the Canadian labour market in the last two months when 83.7K jobs were lost. And we expect the deteriorating in labour market conditions to continue well into this year as Canadian businesses economise on their use of labour services. In January, our call is for the Canadian employment ranks to fall a further 40K, with the unemployment rate rising to 7.0%. The decline in payrolls should be broadly based, with both goods and service producing sectors expected to surrender jobs. In the months ahead, we expect the Canadian labour market to weaken even further as the global and domestic economic recessions and financial crises gather traction.

TD Bank Financial Group

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.