Monday, March 9, 2009

The Weekly Bottom Line

  • 651,000 jobs lost in February in the U.S.
  • Canada's real GDP shrank by 3.4% in Q4.08
  • With the price (overnight rate) of credit near zero, BoC to directly increase the quantity of credit

According to the latest non-farm payroll establishment survey, the U.S. economy shed a massive 651,000 jobs in February, just slightly less than the (revised) job losses recorded in the prior two months. December and January's job loss figures got revised up a total net 161,000 jobs, resulting in a pace of layoffs that has been quite steady at around 660,000 over these last three months of available data. The bad news: these are very significant employment drops of 0.5% per month. The (relatively) good news: the monthly figures are not getting worse. The pace of layoffs seems to be stabilizing in most sectors, with the exception of retail trade and professional & business services. We would caution that given the trend in previous data revisions, it is much too early to tell if the steepest job losses are behind us.

Car-pocalypse and beyond in the U.S.

Factory payrolls dropped by 168,000, which was less than in the prior two months. But the 'car-pocalypse' rolls on, and job losses were very broadly based. As February U.S. car sales plunged 41% year-over-year, and those of the Detroit 3 (D3) at only half the levels a year prior, excess capacity remains significant and more layoffs are in the data pipeline. Only utilities, education, health, and government services created jobs in February, and a marginal 36,000 at that. Meanwhile, the unemployment rate increased from 7.6% to 8.1%, which brings it to its highest level since December 1983.

Looking back to better gauge where we are in this employment cycle as compared to recession past, the cumulative job loss so far is a whopping 4.4 million. For anyone doubting the severity of this onslaught, this represents a 3.2% drop in employment from its latest peak. This is already larger than the peak-to-trough percentage drops recorded in the last three U.S. recessions of the early 1980s (-3.1%), early 1990s (-1.4%), and 2001 (-2.0%, including the ensuing protracted 'jobless recovery'). You have to go back to 1949 (-5.2%) to see anything of the magnitude expected by the time the current recession ends, which will likely be by the third quarter. With manufacturing and services activity indicators (provided by the ISM) still well below their expansion thresholds, the housing market not showing yet signs of stabilization, and credit markets still in a deep funk, we are clearly not out of the woods. The accompanying chart provides other employment benchmarks for comparison along with our forecast - details to be published late next week in our first Quarterly Economic Forecast (QEF) of 2009. We currently expect the peak-to-trough drop in employment to be in the 5.5%-6.5% range, which represents roughly 8 million jobs.

Car-tastrophe in Canada

Canadian real GDP contracted at a 3.4% annualized rate in the last quarter of 2008, confirming not only that the national economy has entered a recession but that it will be severe. No sole sector was responsible, as economic activity retreated across the board, in particular the bellwether consumer spending (-3.3%) and business investment (-17.6%) components. Only government expenditures grew (+2.8%). Canada's net trade position actually contributed to overall economic growth, but only because imports (-23.3%) fell more than exports (-17.5%), a sign of weak domestic demand (-4.9%). The latter is particularly visible when one looks at the trend in retail sales, particularly durables. Data available for the months that followed December strongly suggest this downtrend in activity will continue into at least the first half of this year. After meagre 0.5% growth in 2008, the Canadian economy will contract by 2.0-2.5% this year. Furthermore, with economic growth of only 1.0-1.5% expected in 2010, the recovery will look more like a snail crawling out of its hole than a race horse crashing out of the gate.

On the face of it, the ongoing contraction in the U.S. (Q4: -6.2%) seems worse than in Canada (Q4: -3.4%), and on many accounts it is, especially on the employment side. But the 'bar' set by the U.S. recession is extremely low, so that is not saying much. Case in point, and offering little consolation, is Canada's 'car-tastrophe', not as severe a decline in sales and employment in the sector as recorded Stateside. February light vehicle sales were 'only' 27.7% lower than a year prior, with D3 nameplate sales down 'only' 37.9%. From Q3-07 to Q4-08, the autos & parts sector has shed a net 16,000 jobs. Just skimming already announced cutbacks, a significant number are still to come.

Furthermore, while falling commodity prices provide the U.S. economy with a net boost in disposable income that can be allocated elsewhere - mostly towards paying down debt and increasing savings nowadays - this wallops aggregate Canadian income. Indeed, we have been emphasizing that real GDP (volumes) has not been telling the whole story of swings in fortunes within the Canadian economy. The terms of trade boost that Canada got on the upswing in commodities had largely been underestimated, and in large part helps explain why it took a full year, and not shorter, after the U.S. fell into recession for Canada to follow suit. As the commodity pendulum swung the other way, nominal GDP came crashing down at an annualized rate of 13.4% in the last quarter, by far the worst performance on record.

Against this backdrop, the Bank of Canada (BoC) lowered its policy rate by a half point to 0.50% as expected. The Bank of England did the exact same thing a few days later, and the European Central Bank also brought its rate down a half point, to 1.50%. The traditional form of monetary policy easing is therefore nearing an end. What next? First off, policy rates are expected to remain at record lows until well into 2010. Central banks are much more likely to first wait for clear evidence that their respective economies are recovering before hiking rates again, whereas they would normally try to preempt such a recovery. With much uncertainty remaining, that cautious approach seems appropriate. In the Canadian case, the language from the decision communiqué clarifies two issues. First, it now looks likely the overnight rate will be reduced further, down to 0.25% on April 21st. We think the BoC will leave it at that on the count of a cost-benefit analysis slightly tilted in favour of holding it just above zero. Second, with Canada's policy rate nearing bottom, the focus has now shifted to quantitative easing (QE). Central banks are not out of ammunition after having lowered the price of credit to near zero. They can directly affect the quantity of credit, hence the name given to such policies whereby a central bank essentially beefs up its balance sheet. In so doing, by taking on assets against liquidity, it is essentially printing money. The question becomes what assets it chooses to purchase to obtain the most impact. We argue in a separate piece (“Revised BoC Outlook: The Nuclear Option”) these purchases would best be directed towards corporate bonds, where credit spreads and issuance have been under the most severe stress. The BoC is expected to unveil the details of its credit easing measures in its April Monetary Policy Report.


Canadian Housing Starts - February

Release Date: March 9/09 January Result: 153K TD Forecast: 145K Consensus: 148K

The Canadian housing market correction is well under way, and the retrenchment in building activity and home sales are expected to last for some time as the impact of the ongoing economic recession continues to filter through to the real economy. The clearest indication of further declines in residential starts can be seen in the number of permits approved, and this has declined for six consecutive months. The unusually cold and wintery conditions are also likely to be an important factor adversely affecting building activity. For February, our call is for starts to decline for the sixth consecutive month, falling to 145K from 154K. Both single-family and multi-family units should post declines. And with labour market and domestic economic conditions continuing to weaken, we expect further moderation in residential building activity.

U.S. Retail Sales - February

Release Date: March 12/09 January Result: total 1.0% M/M; ex-autos 0.9% M/M TD Forecast: total 0.1% M/M; ex-autos 0.3% M/M Consensus: total -0.5% M/M; ex-autos -0.2% M/M

With job losses continuing to climb, and plunging equity and home prices poking holes in households' budgets, U.S. consumers continue to have their backs up against the proverbial wall. Yet, retail sales showed some life in January as shoppers emerged from hibernation to take advantage of the bargains that retailers offered to lure them back into their stores. The rebound in January came on the heels of six consecutive monthly declines, and we believe that the positive tone in consumer spending will continue into February as consumers continue to trickle back to the malls. Some evidence of this has been borne out in the same store sales numbers, which showed a 2.0% M/M gain on the month. As such, we expect sales to rise by a modest 0.1% M/M in February. Moreover, with sales of motor vehicles continuing to tank, retail sales excluding autos should post a more reasonable 0.3% M/M rise. Looking ahead, we believe that consumer spending will remain tepid in the near term with a return to negatives likely, before the boost from the stimulus package kicks in.

U.S. International Trade - January

Release Date: March 13/09 December Result: -$39.9B TD Forecast: -$37.0B Consensus: -$38.1B

The U.S. international trade deficit has plunged a staggering $22B (from $62B) in only a few short months, as the dramatic turnaround in crude oil prices and overall U.S. economic weakness continue to dampen the import bill. And even though exports have also fallen over the same period, the unprecedented drop in imports (on account of the decline in energy prices) has more than compensated for declining global demand for U.S. products. This trend is expected to continue in January, and our call is for the deficit to narrow even further, falling to $37B. During the month, we expected imports to fall a further 4.0% M/M, following the 5.5% M/M drop in December, while exports should fall by a more modest 3.0% M/M. In the months ahead, with the worsening U.S. economic conditions continuing to dampen import demand, and crude oil prices likely to remain weak, we expect the U.S. trade balance to narrow even further.

Canadian International Trade - January

Release Date: March 13/09 December Result: -$0.5B TD Forecast: -$0.8B Consensus: -$0.8B

The Canadian economy has been left reeling from the dramatic collapse in global commodity prices and plunging U.S. demand for its manufactured products. In the wake of the unprecedented global economic turmoil, Canadian merchandise trade has nose-dived from a whopping $5.7B surplus to a sobering $0.5B deficit in the space of six short months. For January, we expect the Canadian merchandise trade balance to worsen further, with the deficit rising to $0.8B. Much of the deterioration is expected to come from declining motor vehicle exports, which have fallen flat on its face in the past few months. Weak commodity prices are also expected to be a drag on exports, as the lagged effects of the double-digit declines in the past few months add to the impact of the 2.6% M/M slide in energy prices in January. Imports are also expected to be soft, as weak domestic economic fundamentals dampen demand for imported goods. In the coming months, we expect the trade deficit to widen even further as the intensifying global recession gathers traction.

Canadian Employment - February

Release Date: March 13/09 January Result: -129.0K; unemployment rate 7.2% TD Forecast: -40.0K; unemployment rate 7.3% Consensus: -50.0K; unemployment rate 7.4%

After holding up for the better part of 2008, the Canadian labour market has finally been dealt the same hand that its U.S. counterpart has had to contend with for all of 2008. Indeed, after adding some 163.3K jobs in the early part of the year, the Canadian economy has shed a staggering 212.7K jobs since November, with over half of those job losses occurring in January alone. Moreover, with the economy continuing to weaken, this trend should continue, though the pace of job cuts is unlikely to be at the mindboggling clip recorded in January. In February, we expect a further 40K jobs to be lost as Canadian firms continue to consolidate their workforce in the face of waning demand. The majority of the layoffs are likely to come from the goods-producing sector, with the restructuring in the beleaguered manufacturing sector providing the vast majority of the job losses. The unemployment should inch higher to 7.3%. In the months ahead, we expect the deterioration in Canadian labour market conditions to continue as the ongoing domestic economic recession gathers steam.

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.