Sunday, June 14, 2009



  • Fed's Beige Book confirms anecdotal picture of slowing pace of contraction
  • Announcement of repayment of TARP funds reaffirms stabilization of U.S. financial system
  • U.S. trade deficit widens for 2nd consecutive month, facing accelerating export contraction
  • Bank of Canada's Governor Carney's provides sober view of sluggish recovery as global imbalances are rejigged
  • Canada reverts into trade deficit with steepening decline in exports
  • Crude oil breaches US$72 per barrel but retreats on OPEC's forecast for diminished demand

U.S. data this week continued to support the story of a slowing pace of contraction. The Beige Book, the Fed's anecdotal survey of economic conditions, qualitatively confirmed this picture – even noting some actual improvements in certain districts. Eyes are now turning to the shape of recovery and the appropriate exit strategies. In a speech Wednesday, Richmond Fed President Lackner noted “inflation risks that are quite legitimate” and admitted the danger of not shrinking the Fed balance sheet enough when recovery emerges to stave off the inflation threat. However, the U.S. economy is still losing ground and this week's news on retail sales and international trade show the fragility of the positive “second derivative”.

Thursday's release of retail sales for May showed a welcome 0.5% M/M gain – the first rise in three months – and spending on gasoline and motor vehicles both increased. Nonetheless, sales remain down 9.6% Y/Y and, despite the monthly pop, the 3-month annualized trend still fell 4.0%. Facing high debt levels and rising unemployment, U.S. households are saving more and spending less – a trend that we expect to continue over the coming months. U.S. trade data for April on Thursday showed a second consecutive month of a widening trade deficit. April's saw a steepening in the export contraction from March, with major declines in exports of industrial and capital goods. Imports rose, but this owed to the uplift from higher petroleum prices.

Nonetheless, investor optimism continues to buoy commodities and financial markets. The announcement that ten large U.S. banks would be allowed to repay up to $68 billion in TARP funds was largely expected but, in Treasury Secretary Geithner's words, nonetheless represents “an encouraging sign of financial repair”. Reflecting optimism about global recovery, oil continued its climb this week, breaching $72 per barrel. Oil inventories remain substantial, and, with demand still falling, we believe present prices are running ahead of fundamentals. As equity markets gained this week, bond yields also continued their climb, on the back of decreasing risk aversion and anticipation that inflation pressures from a quicker-than-expected recovery might force the Fed's hand to raise interest rates sooner.

The rapid hike in medium-term yields has raised some concern. Higher yields on treasuries could delay recovery as mortgage rates and corporate borrowing costs follow. Indeed, as 30-year mortgage rates have climbed since mid- May, the pace of new mortgage applications has slowed for three consecutive weeks.

While rising, inflation expectations have remained relatively anchored around 2% – arguably a sustainable longterm target. With expectations now tilted towards heightened inflation, the threat of a persistent deflationary spiral has largely disappeared. However, as we argue in our latest Global Markets publication, markets' near-term inflation fears are overblown as U.S. CPI is still in negative territory and economic slack continues to build.


While markets are anticipating a recovery, indicators of global demand remain weak and we maintain the view that the worldwide rebound will be sluggish. Those global imbalances between developed world spending and emerging market lending remain yet to be unwound. Bank of Canada Governor Carney conveyed a similar view in a sobering speech Thursday. Carney noted the downdraft to global investment demand and consequent diminished potential growth in developed economies. However, he also noted new opportunities as emerging markets shift towards greater consumption.

Canadian markets were buoyed through this week by rising commodity prices, but OPEC's announcement Friday of reduced oil demand reversed some of these gains. The Canadian dollar followed suit, dipping under 90 cents. Canadian fundamentals are arguably better than those in other developed economies (a fact which Prime Minister highlighted in his “economic report card” on Thursday) and the Bank of Canada has not joined the Quantitative Easing club; however, the Loonie's rapid appreciation was in excess of fundamentals. Some easing for the Loonie would provide some albeit-modest relief for Canadian troubled exporters.

Wednesday's report on international trade for April showed a reversion to a $179 million trade deficit and a steepening plummet in exports, highlighting the external pressures on Canada's economy. The faltering U.S. market remains the primary soft-spot for Canada's exports accounting for 90% of Canada's year-over-year export declines.

Both volumes and values of exports declined with the largest contractions in exports of M&E, energy and industrial products. The export contraction during Q2/2009 will not be as deep as that in Q1/2009, but real exports will still decline substantially. While rising commodity prices may provide some buoyancy to the tumultuous energy and industrial material exports, the appreciating Canadian dollar will place additional downward pressure on both volumes and values of manufactured exports.

The downward pressures on the Canadian economy remain substantial. Capacity utilization data for the first quarter was released Thursday, showing a record low of 69.3% and highlighting the rapid deterioration of industrial activity. Utilization rates were lowest in the troubled transportation sector (43%) but construction, metal manufacturing and mining have also experienced precipitous cutbacks. With inventory-to-sales ratios still elevated and sales falling, manufacturers will continue to cleave production and draw down current stock. Depressed utilization means less incentive for investment in new machinery and equipment (M&E), which in turn diminishes the outlook for productivity growth. This will weigh down Canada's potential growth going forward.


U.S. Housing Starts - May

  • Release Date: June 16/09
  • April Result: 458K
  • TD Forecast: 500K; Consensus: 480K

The correction in U.S. residential building activity has been particularly sharp, with housing starts declining in 8 of the last 9 months as builders adjust their construction activity in the face of slumping demand and rising unsold inventories. Over the past few months, there has been some evidence suggesting that the U.S. housing sector may be stabilising, and as such we are likely to see some stabilisation in housing starts as well, particularly given the recent upswing in the NAHB confidence index. In May, we expect construction activity to rebound slightly, with starts rising to 500K. Much of the rebound should come from a bounce-back in the volatile multi-units component, which declined by a staggering 46% M/M in April, and is now at its lowest level on record at 90K. Single-unit construction should remain unchanged on the month. In the coming months, with the combination of soft demand (driven in large part by the weak labour market conditions) and the huge overhang of inventory of unsold homes continuing to weigh heavily on building activity, we expect starts to remain in depressed territory, though we are unlikely to see a return of the sharp down-drifts of recent months.

U.S. Consumer Price Index - May

  • Release Date: June 17/09
  • April Result: core 0.3% M/M, 1.9% Y/Y; all-items 0.0% M/M, -0.7% Y/Y
  • TD Forecast: core 0.1% M/M, 1.8% Y/Y; all-items 0.0% M/M, -1.1% Y/Y
  • Consensus: core 0.1% M/M, 1.8% Y/Y; all-items 0.3% M/M, -0.9% Y/Y

Weak labour market conditions and soft consumer demand have continued to place considerable downward pressure on U.S. consumer prices, pushing the rate of headline inflation deeper into negative territory. Indeed, outside of the increases in tobacco prices, which were caused by higher taxes, the decline in consumer prices over the past few months has been fairly broadly based. In May we expect the pattern of softer consumer prices to remain intact, with the headline index expected to stay unchanged for the second straight month, despite the dramatic rise in gasoline prices. Due mostly to base effects, the annual pace of consumer price deflation should accelerate to 1.1% Y/Y, which will be the greatest pace of annual consumer price decline since 1950. Core consumer prices are also expected to be soft on the month, rising by only 0.1% M/M (after three consecutive monthly gains of 0.2% or more). The annual pace of core consumer price inflation should fall to 1.7% Y/Y. In the months ahead, we expect U.S. consumer prices to remain soft and headline consumer price inflation to remain in negative territory, though higher gasoline price will likely limit the pace of this decline.


Canadian Manufacturing Shipments - April

  • Release Date: June 15/09
  • March Result: -2.7% M/M
  • TD Forecast: -2.0% M/M
  • Consensus: -1.8% M/M

The Canadian manufacturing sector has been left exposed by the slumping domestic and U.S. economies, which have resulted in Canadian manufacturing shipments declining in 7 of the last 8 month. The contraction in demand has been felt across the board, with almost all components of the Canadian manufacturing sector contracting. This retrenchment in manufacturing sector activity should continue in April with shipments expected to drop a further 2.0% M/M. Much of the weakness is expected to be on account of lower machinery and equipment sales, while softer petroleum and coal products sales should also be a drag on the headline number. On the other hand, motor vehicle shipments are expected to contribute favourably to the headline number. In real terms, shipments should be quite weak, though perhaps not as soft as the headline number. In the months ahead, we expect Canadian manufacturing activity to weaken even further as the strengthening Canadian dollar and weak U.S. appetite for Canadian goods dampen activity in the sector even more.

Canadian Wholesale Sales - April

  • Release Date: June 17/09
  • March Result: -0.6% M/M
  • TD Forecast: -1.0% M/M
  • Consensus: -1.0% M/M

Canadian wholesale sales activity has been badly hit by the ongoing slump in consumer and business spending, as the weakening labour market and deteriorating economic conditions continue to stifle domestic demand. Global demand has also been sluggish. The combination of these factors has resulted in Canadian wholesale sales activity posting its longest slump on record, with sales declining for 6 consecutive months. Moreover, given that the Canadian and U.S. economies continue to languish in the current deep recession, we expect wholesale sales activity to fall a further 1.0% M/M. The weakness is expected to be broadly-based, with slower sales of machinery and equipment, petroleum and coal products expected to be the main factors underpinning the soft headline number. Motor vehicle shipments should add favourably to the headline number. Real wholesale activity is also expected to decline on the month, though at a more modest pace. In the coming months we expect wholesale sales to remain very soft as the weak Canadian economy and ongoing global economic recession dampen demand even further.

Canadian CPI - May

  • Release Date: June 18/09
  • April Result: core 0.1% M/M, 1.8% Y/Y; all-items -0.1% M/M, 0.4% Y/Y
  • TD Forecast: core 0.2% M/M, 1.7% Y/Y; all-items 0.4% M/M, -0.2% Y/Y
  • Consensus: core 0.1% M/M, 1.6% Y/Y; all-items 0.4% M/M, -0.2% Y/Y

After resisting the mounting downward pressure arising from the growing economic slack for months, Canadian consumer price inflation is expected to finally buckle in May and dip its toes into negative territory for the first time in 15 years. Indeed, despite the big bounce in energy prices during the month which should push the headline index up 0.4% M/M (down 0.1% M/M on a seasonallyadjusted basis), headline consumer prices are expected to fall 0.2% Y/Y. This will mark the first time since 1994 that Canadian consumer prices have fallen on a yearly basis. The Bank of Canada's core consumer price index is also expected to edge higher, rising by 0.2% M/M (though up only 0.1% M/M on a seasonally-adjusted basis), with the annual pace of core inflation falling further to 1.7% Y/Y from 1.8% Y/Y in March. In the coming months, with the Canadian economy likely to remain quite weak, we expect consumer price inflation to moderate even further, though higher energy prices may perhaps limit the duration and depth of the consumer price deflation that the Canadian economy will encounter.

Canadian Retail Sales - April

  • Release Date: June 19/09
  • March Result: total 0.3% M/M; ex-autos -0.2% M/M
  • TD Forecast: total 1.0% M/M; ex-autos 1.0% M/M
  • Consensus: total -0.1% M/M; ex-autos -0.1% M/M

Canadian consumers appear to be trickling back to the malls to take advantage of the many bargains that retailers have been making available. Indeed, despite the considerable headwinds that Canadian households continue to face, retail sales have risen in each of the first three months of this year, undoing some of the damage done to retail sales activity in Q4 when consumer spending plunged like a stone. This upward momentum in spending is expected to continue in April, and our call is for total retail sales to rise by a respectable 1.0% M/M. Sales are expected to be boosted by a resurgence in housing-related spending. In particular, sales of furniture, home furnishing and building materials are expected to be quite strong as Canadians take advantage of the incentives provided under the government's fiscal stimulus package. The surge in existing home sales over the past few months should also bolster demand for home furnishing items, while higher gasoline prices should contribute favourably to the headline number. Excluding autos, sales are expected to rise by 1.0% M/M. In the coming months, we expect retail sales to remain somewhat subdued as Canadian consumers economise on their spending in the face of the very difficult economic environment.

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.