Saturday, May 2, 2009

The Weekly Bottom Line


  • U.S. economy contracts 6.1% in Q1
  • Canadian GDP slides 0.1% in February
  • Chrysler files for bankruptcy

Despite some of these so-called “green shoots” beginning to appear south of the border, the U.S. economy remains deep in the doldrums. Indeed, the first reading of U.S. real GDP for the first quarter indicated that economic activity contracted by a whopping 6.1% Q/Q annualized, which followed the 6.3% Q/Q plunge seen during the fourth quarter of 2008. Based on this estimate, the drop in U.S. real GDP from its peak is now 3.3%, which is the largest drop since 1958. While the weakness during the first quarter stemmed largely from private domestic investments and a draw-down in inventories, consumer spending provided some offset. In fact, consumption expanded for the first time since the second quarter of 2008. But even with some signs of strength, it is difficult to put a positive spin on the outlook for growth in the U.S.

Strength in consumption to be short-lived

Although consumer spending was positive in the first quarter, this is not a trend that we expect to see continue in the near term. The increase in consumption occurred during the first two months of the year - likely due to extended holiday discounting - before resuming the downtrend again in March. This provides a weak handoff for the second quarter, which will be likely exacerbated by a further deterioration in the labour market.

Following the retail sales report released earlier this month, the personal income and spending report out this week provided further evidence of the drop in spending. Personal income was down 0.3% M/M in March, and up by only 0.3% compared to year-ago levels. Personal spending slid 0.2% on the month, as consumers limited themselves to essential services. What's more, the savings rate increased from 4.0% to 4.2% in March, suggesting that consumers are watching their spending habits closely.

With respect to trade, the positive contribution from net exports was not a good news story and highlights the weakness persisting in the domestic economy - with the contraction in imports (-34%) outpacing the slide in exports (- 30%). Given that the global economy is expected to deteriorate further, exports will likely continue to deteriorate and weigh on economic growth in the near term.

Economic weakness to persist

As such, U.S. economic activity in Q2 will likely remain quite sluggish. The ISM manufacturing data out this morning provided us with our first glimpse of Q2 data, and while extending a three-month uptrend in April, remains extremely depressed. At 40.1, it is still well below the 50 threshold, implying that manufacturing activity is still contracting. Given March's weak handoff, the U.S. economy is on track to shrink further in the second quarter, albeit at a much slower pace than the last two quarters.

With first quarter GDP coming in much weaker than expected, all eyes and ears turned to the Federal Reserve's interest rate announcement. While it was expected that the Fed would leave rates unchanged - which it did - the market was more interested in what the Fed had to say. And on that front, there wasn't a whole lot of new information contained in the accompanying communiqué. Making no changes to the existing quantitative easing framework, the Fed stated that it will “continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook”. The Fed also noted that the economic outlook has improved modestly since the last meeting - with signs that the housing market may be stabilizing - however, further job losses, reduced housing wealth and credit constraints will keep economic activity under pressure for some time still.

Canadian economy slides further in February

Switching to Canada, the picture is not much brighter. The Canadian economy contracted by 0.1% M/M in February, with output sitting at its lowest level in over two years. And combined with January's 0.7% contraction, it appears as though the drop in economic activity in Canada during the first quarter was much sharper than originally anticipated. In fact, assuming a flat performance in March, first quarter GDP is on track to slide by a massive 6.4% Q/ Q annualized - which would be the steepest quarterly drop on record. Moreover, with signs that domestic demand is falling quite rapidly and export demand is still extremely weak, economic activity in Canada will likely remain subdued for some time.

History in the making

Given the current economic environment and the various headwinds facing North American consumers, businesses have been hit quite hard. And while several companies have been unable to weather the storm, history was made this week in the auto sector, as Chrysler was the first major U.S. automaker to file for bankruptcy. After obtaining substantial concessions from labour unions and some large creditors, and securing a partnership with Italian automaker Fiat, the inability to come to an agreement with a group of lenders left Chrysler with only one option: Chapter 11 bankruptcy.

On the bright side, the successful negotiations with the unions and Fiat helped the automaker sidestep a liquidation bankruptcy filing, thus allowing the company to maintain its operations. And while Chapter 11 bankruptcy was not the preferred option, under court protection, Chrysler should be able to rid itself of certain obligations and emerge as a smaller and more cost competitive automaker - which in turn should bring it back to profitability.

The Obama Administration has agreed to provide up to US$8 billion in loans to finance the restructuring for an 8% stake in the new entity, while the Canadian and Ontario governments agreed to provide US$2.4 billion (C$3.8 billion) in exchange for a 2% stake in the company and a commitment to keep 20% of total production in Canada. At the present time, there are no plans for Chrysler Canada to file for bankruptcy protection in Canada.

Although Chrysler was able to obtain government support - thereby avoiding liquidation - the automaker is not out of the woods just yet. With the U.S. economy expected to contract for at least another 2 quarters, unemployment likely to rise and credit conditions expected to improve only modestly, it is highly unlikely that we will see any uptick in sales this year. Moreover, the B-word may scare consumers off, despite warranty guarantees from both the American and Canadian governments. Nonetheless, bankruptcy protection gives Chrysler the chance to improve its financial position, and return to viability.


U.S. Nonfarm Payrolls - April

  • Release Date: May 8/09
  • March Result: -663K; unemployment rate 8.5%
  • TD Forecast: -530K; unemployment rate 8.8%
  • Consensus: -610K; unemployment rate 8.9%

The ongoing correction in the U.S. labour market has been particular sharp, as businesses have slashed jobs left, right and center in response to weakening economic conditions and slumping demand for their products. Notwithstanding the weak economic backdrop, the pace of job losses is likely to ease modestly in April as the 2010 Census hiring moves into gear, with well over 100K census workers likely to be added to payrolls during the month. As such, our call is for nonfarm payrolls to fall by a betterthan- expected 530K, bringing the number of net job losses since the turn in labour market conditions to well over 5.5 million. As has been the case in the past, the losses are likely to be evenly spread among the goods-producing and services-producing sectors, with the size of the government payrolls likely to balloon on account of the census hiring. Moreover, with the pace of job destruction continuing to outpace job creation, the unemployment rate should rise even further, climbing to 8.8% in April. Looking ahead, we expect the pace of contraction in U.S payrolls to remain relatively brisk, though further census hiring should partially offset some of the underlying weakness in the labour market.

Canadian Employment - April

  • Release Date: May 8/09
  • March Result: -61.3K; unemployment rate 8.0%
  • TD Forecast: -60.0K; unemployment rate 8.3%
  • Consensus: -50.0K; unemployment rate 8.3%

The Canadian labour market went in a free-fall in November last year as the Canadian economy slipped into its first economic recession since the early 1990s. So far some 350K positions have been eliminated from Canadian payrolls, and there is every indication that the elevated pace of job losses will continue for some time. Indeed, given the ongoing restructuring in the manufacturing sector and the steady flow of layoff announcements from other badly hit industries, we expect a further -60K jobs to be lost in April. This is very close to the recent trend. The bulk of the job losses should come from the goods-producing sector, with the number of job losses in the construction and manufacturing sectors expected to remain high. The services-producing sector should also post significant losses. Moreover, with the weak economy continuing to limit the ability of displaced workers to find new jobs, the unemployment rate is expected to rise to 8.3%. In the months ahead, given the weak economic fundamentals, we expect the negative dynamics in the Canadian labour market to continue and the pace of job losses to remain brisk.

Canadian Housing Starts - April

  • Release Date: May 8/08
  • March Result: 146.5K
  • TD Forecast: 135.0K
  • Consensus: 140.0K

After plunging for six straight months, Canadian housing starts rebounded sharply in March, on account of the 28% M/M gain in the volatile multi-units component. This up-tick, however, is likely to be a one-month wonder as the backdrop for Canadian households and homebuilders continue to sour. Indeed, with the economy remaining weak, worsening labour market conditions damping demand, and tight financial market conditions continuing to stifle access to credit, we expect Canadian homebuilding activity to moderate further. This much has been clear in the continued fall in permit approvals, which have declined every single month since last September. As such, our call is for starts to fall to 135K. Both single-family and multi-family unit construction should post declines. In the months ahead, we expect starts to edge even lower, and remain in these depressed territories for some time.

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.