Sunday, May 10, 2009

The Weekly Bottom Line


  • Economic data showing signs of improvement.
  • Good news on the job front - Canada creates jobs in April and U.S. losses are slightly better than expected.
  • U.S. stress test results are in, markets react positively.

After a long winter of dismal economic news, markets this week continued to warm up to signs of spring. And while uncertainty remains, the release of the U.S. stress test gave hope that the worst of the shocks to the financial system may be behind us. The rally was also aided by several leading economic indicators continuing to point in the right direction. In Canada, the Canadian job market decided to take a month off from the recession and created a pleasantly surprising 35,900 jobs in April. In the United States, jobs continued to be shed but on the bright side, the pace of declines appears to be slowing.

I'm my own boss now...

After five months of significant losses, April yielded a nice surprise for the Canadian job market - a positive number! 39,500 jobs were created in the month, putting a halt to the upward march of the unemployment rate at 8.0%. Compared to consensus expectations for 50,000 job losses, the result was nothing short of astounding. Nonetheless, while we hate to throw cold water on such good news, the details of the report did not give quite the same cause for celebration. The primary source of the job gains was self-employment, which swelled in ranks by 37,000. Self-employment is actually quite countercyclical and tends to move in the opposite direction of private employment, especially during recessions. In periods of economic weakness, it is not a stretch of the imagination that a fair number of the newly self-employed are those that are making the best out of a lousy situation. Private-sector employment on the other hand, continued to decline in April, falling by 10,400 jobs. Since the start of the recession, Canada has shed 2.9% of its private work-force. While April's gains on the overall job front were a nice surprise, Canada's economy still faces an up hill battle and we have likely not seen the last of the job shedding.

Is that a glimmer of light at the end of the tunnel?

In the U.S. you had to dig a bit deeper to find the good news in the job market. April continued to see job losses, with a net 539,000 shed from non-farm payrolls and the unemployment rate rising to 8.9% from 8.5%. But on the bright side, the pace of job loss declined, which is a nice change. Compared to an average of 680,000 job losses over the past five months, April's number was a considerable improvement. Unfortunately, as the case with Canada, the details were less encouraging and show just how entrenched the economic downturn has become. Once again, job losses were split evenly between the goods producing (-270,000) and services producing sectors (-269,000), even while a jump in government hiring in anticipation of the 2010 Census helped to stem the services sector bleeding. As one of the first indicators of the condition of the U.S. economy in the second quarter of the year - April's job report shows that we still have some way to go before we can declare an end to this recession. But with another data point showing upward movement in the second derivative, the job report does give credence to our forecast for a recovery starting to take shape in the final quarter of 2009. For more on leading indicators of recovery please see our report (U.S. Recovery Has Legs To Stand On).

U.S. housing sector showing signs of life but vital signs still critical...

While data on U.S. employment capped off the week, the week kicked off with data on pending home sales - a leading indicator for U.S. existing home sales. Pending home sales beat expectations, increasing by 3.2% in March. Conditions in the housing market remain ground zero for an economic recovery and even secondary indicators like pending home sales are watched with interest. The dynamic in the housing market will continue to be a tug-ofwar between upstart demand fueled by increased affordability and rising foreclosures stemming from underwater mortgages and worsened economic conditions. This dynamic will likely play out differently throughout the country. In the West, where pending home sales rose 8.5% month-over-month, the worst of the foreclosure crisis appears to be in the rear-view and significant price correction has buoyed new demand. In the Northeast, economic conditions have held up better than in other regions of the country, but the significant glut of supply means prices have a way to go before excess inventories can be drawn down.

In the South, the legacy of poor lending practices will continue to weigh on the market and an increase in homeowners with negative home equity will fuel foreclosures. Finally, in the Midwest, while affordability remains favorable, labour market deterioration and negative equity will continue to be a drag on the market. (For more please see our report U.S. Housing Market - Fishing for the Bottom.)

All stressed out

Perhaps even more than the economic data, the biggest news story out this week was the results of the much anticipated U.S. stress test of financial institutions. Under the stress test, U.S. regulators were attempting to gauge how much capital U.S. banks would need in the case of a worse than expected economic scenario. Under the assumptions of the stress test, U.S. real GDP would decline by 3.3% in 2009 (compared to consensus of -2.0%), followed by a +0.5% growth in 2010 (from +2.1%); the U.S. unemployment rate would rise to 10.3% by 2010 (compared to 8.8%), and home prices would fall 22% in 2009 and 7% in 2010. Once applying these assumptions, regulators found that commercial banks still need to raise a further $75 billion in common capital in order to absorb expected losses.

The benefit of the stress test is that simply by decreasing uncertainty over the health of the banks, the wheels of credit creation may be able to start spinning again. The situation that the Fed and the Treasury are trying to avoid is one in which uncertainty over the viability of the banking system keeps banks from engaging in their primary business - lending to households and businesses. In that sense, increasing transparency should help to avoid a worst-case scenario from playing out. Even so, risks remain on the horizon. The U.S. stress test scenario is not far off our own base case economic forecast. While the economic data does support our forecast for recovery, this too is contingent on banks being confident enough to expand their balance sheets by issuing loans and taking on more risk. If loan losses are worse than expected, the danger is that credit will remain choked off, forestalling an economic recovery and making it harder, once again, for banks to raise the required capital.


Canadian International Trade - March

  • Release Date: May 12/09
  • February Result: $0.1B
  • TD Forecast: $0.5B
  • Consensus: $0.5B

The Canadian merchandise trade balance defied expectations in February and swung to a surplus (albeit a small one) on the account of the double-digit surge in automotive product exports to the U.S. The surge in auto-related demand was the result of U.S. carmakers switching back on some of their production lines that were kept idle during the prior few months. This improvement in the surplus is likely to continue into April as the boost coming from the first monthly rise in commodity prices (particularly the double-digit jump in crude oil prices) in many months is likely to offset the drop in auto-related export demand resulting from the drop in U.S. motor vehicle production during the month. As such, our call is for the Canadian trade balance to eke out another surplus of $0.5B in March. In the months ahead, if the rebound in commodity prices continues, we expect the merchandise trade surplus to improve even further, though additional deficits may only be a hair's breadth away.

U.S. Retail Sales - April

  • Release Date: May 13/09
  • March Result: total -1.2% M/M; ex-autos -0.1% M/M
  • TD Forecast: total 0.3% M/M; ex-autos 0.7% M/M
  • Consensus: total -0.1% M/M; ex-autos 0.0% M/M

With a weak domestic economy and worsening labour market conditions, the backdrop for U.S. households has not been this bad for many years. Yet, the recent tone of consumer spending activity has been surprisingly positive as personal consumption expenditures added favourably in economic activity in Q1 after two consecutive quarterly drops. Rising equity markets and stabilisation in the U.S. financial sector have been important factors in bolstering consumer confidence in recent months, and this rebound in confidence appear to be translating into increase spending. The momentum in consumer spending is likely to continue into April, with retail sales expected to eke out a 0.3% M/M gain. Evidence of this upswing can be seen in the strong same-store sales report, which showed a sizeable 1.9% M/M gain in April, while higher gasoline prices should also inflation the headline number. Moreover, with the headline number expected to be depressed by a drop in car sales, sales excluding autos should rise by a more attractive 0.7% M/M. Looking ahead, it appears possible that the rebound in retail sales could gather traction as the impact of the massive fiscal stimulus and the improvement in sentiment buoy consumer spending

U.S. Consumer Price Index - April

  • Release Date: May 15/09
  • April Result: core 0.2% M/M, 1.8% Y/Y; all-items -0.1% M/M, -0.4% Y/Y
  • TD Forecast: core 0.1% M/M, 1.8% Y/Y; all-items 0.0% M/M, -0.6% Y/Y
  • Consensus: core 0.1% M/M, 1.8% Y/Y; all-items 0.0% M/M, -0.6% Y/Y

The era of U.S. consumer price deflation is now upon us as the ongoing economic recession and deteriorating labour market conditions continue to weaken the bargaining power of retailers and labourer alike, thereby quenching the once raging inflationary flames. Indeed, in spite of the expected rise in energy and food prices during the month, we expect U.S. headline CPI to remain flat in April as other factors are likely to provide a perfect offset these upward pressures. However, due to base effects, the pace of annual consumer price inflation should fall to -0.6% Y/ Y. Core consumer prices are also expected to be soft on the month, rising by only 0.1% M/M (after three consecutive months of 0.2% M/M gains), with the annual pace of core consumer price inflation remaining at 1.8% Y/Y. In the coming months, as the U.S. economy continues to languish in its most intense economic recession since the Great Depression, we expect consumer prices to remain soft and headline consumer price inflation to remain in deflationary territory.

Canadian Manufacturing Shipments - March

  • Release Date: May 15/09
  • February Result: 2.2% M/M
  • TD Forecast: 1.0% M/M
  • Consensus: 1.0% M/M

After six consecutive months of contraction, Canadian manufacturing sector activity snapped back to life in February on the back of the rebound in motor vehicle shipments. This positive tone in manufacturing activity should carry into April, with manufacturing sales expected to advance by a further 1.0% M/M. The key catalyst for the gains is likely to be auto-related shipments, while higher gasoline prices should also bolster shipments of petroleum and coal products. Indeed, with preliminary data pointing to a strong 6% M/M gain in new car sales during the month and Canadian motor vehicle production rising at a double-digit pace, the risk to this call may be to the upside. Real shipments, however, are expected to be weak as some of the gains are likely to be the result of higher prices. In the future, we expect Canadian manufacturing activity to remain soft as the strengthening Canadian dollar and weak U.S. appetite for Canadian products dampens activity in the sector.

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.