Sunday, June 28, 2009

The Weekly Bottom Line


  • Bond yields pulled back, as inflationary fears continue to abate
  • U.S. durable goods for May improved for second consecutive month - especially in core capital goods
  • New home sales fell in May but existing home sales see second month of advance, with months of inventory easing
  • Fed left rates unchanged and stayed silent on "exit strategy", but highlighted disinflation pressures from widening slack and, on Thursday, modified several of its programs
  • Canada's pace of growth for Employment Insurance beneficiaries slowed in April and the number of new claims fell, but job losses appear to have accelerated during May.
  • The retreat in Canadian home prices steepened in May, according to a quality-adjusted measure of real estate vallues
  • S&P/TSX buffeted by dampened expectations for the global economy, following a sobering World Bank report, but index recovers ground by week's end


U.S. economic data continued to show signs of tentative stabilization this week; but, with debate now focusing on the future exit strategy, markets should heed that whatever current buoyancy exists owes strongly to fiscal and monetary intervention. The training wheels, provided by monetary pump priming, ultimately need to come off, and markets have upped pressure on central banks to deliver coherent strategies for withdrawal of monetary stimulus. However, risks of a renewed period of weakness are ignored one's at peril. Prudence requires a careful balance between "not too soon nor too late". With the World Bank's economic outlook on Monday observing significant weakness in emerging markets, markets got some cold water poured on their hopes of a quicker-than-expected global recovery (though, as we point out in a commentary, the estimates are not that different from the IMF's earlier view when calculated with comparable weights).

Happily, with a $104 billion in supply of 2-,5- and 7-year Treasuries this week (a record weekly issuance), the auctions were well-received. Moreover, as inflationary fears have subsided, the resulting fall in bond yields is a positive sign. In congressional testimony, Ben Bernanke further countered inflationary concerns: "The key issue here is can we unwind this money creation and low interest rates in time to head off inflation when the economy begins to recover? We have all the tools we need to do that. We believe we can do that. We will certainly remove that stimulus in time. And we are committed to price stability and we will make sure that it happens."

Walking the tightrope, the Fed's rate decision on Wednesday was a near mirror from its April announcement, holding rates steady and emphasizing its view for near-term disinflation, as growing "resource slack is likely to dampen cost pressure." While still silent on an exit strategy, the statement noted that the Fed is "monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted." Indeed, the Fed's balance sheet shrunk again in the latest week to $2.010 trillion from $2.056 trillion - the lowest level since the Fed ramped up monetary injections in March. With bank access to liquidity having stabilized, Thursday saw some re-tooling of the Fed programs, with some facilities scaled back and others extended, with the aim of easing credit more directly for households and businesses.

In further positive news, U.S. housing markets continued to show signs of bottoming, with existing home sales in May rising for a second consecutive month and the inventory of unsold homes (at the current pace of sales) improving to 9.6 months from 10.1 months in April. Distressed properties constituted 33% of sales, but this is down from 45% in April. While foreclosures continue to weigh on housing markets, the degree of crowding-out may be abating.

The week concluded with an ostensibly improved U.S. report on personal income and outlays for May, which showed a second consecutive month of gains in both disposable income (PDI) and the underlying personal incomes. Nonetheless, with wages still falling, the monthly gain in personal income (+$167 bn at seasonally-adjusted annual rates) owes almost entirely to government transfers (+$163 bn), while PDI was further augmented by a $20 bn reduction in personal taxes. Strengthening PDI also seems to have stimulated some spending, and durable goods spending saw its first monthly advance since January. However, uncertain U.S. households are stowing precautionary cash: savings rates rose from 5.5% in April to 6.9% in May - the third month of heightened savings and the highest savings rate since December 1993.


A Canada Day weekend crisis was adverted in Ontario, as the threat of a liquor store strike led to nothing more than panic buying at most stores across the province. If only avoiding the fallout from the global recession was that easy. Aside from the one-day alcohol shopping spree in Ontario, the global turmoil has taken a large toll on Canadian consumer spending, and even with the worst likely behind us, the data this week proved that consumers still have many challenges to overcome.

A key challenge has been the deteriorating financial situation of Canadian households. The combination of stock market turmoil and declining home prices dragged net worth down in the first quarter of 2009 for a third consecutive quarterly loss. The cumulative loss of $510 billion is the largest three quarter decline on record and was enough to wipe out the prior two years of wealth gains. The good news is that there have been some improvements since the end of the first quarter. Despite a temporary dip below 10,000 earlier this week over concerns about a tepid U.S. recovery, the S&P/TSX index has risen 18% from end of March levels, and 34% from its low. Looking ahead, equities are likely to experience some further volatility in the near future, but mid-single digit gains in corporate profits in 2010 should support higher market values. Nonetheless, it will take years to fully recoup the losses racked up since the stock market's recent peak in 2008.

On the housing front, the Canadian Real Restate Association (CREA) has provided some encouraging signs with existing home prices increasing marginally over the first few months of 2009. However, an alternative measure for tracking home prices, the Teranet home price index (which adjusts for the quality of homes being sold), has contracted at an accelerated pace since October, and in April the index dropped to the lowest level in two years. The disparity between the two measures of real estate values suggests that the rise in existing home prices has been due to greater sales volumes of "higher end" homes, as well as heightened sales in higher priced regions. For the majority of Canadians, home values are continuing to deteriorate.

Consumers will not be gaining any support from the labour market either. We learned this week that the amount of people receiving Employment Insurance in Canada edged up 2.7% in April, while the amount of initial claims fell. This should come as no surprise, as April was the month when the job destruction took a small break. But, the job losses continued in May, and the upcoming labour force report is expected to reveal that the Canadian economy shed a further 35,000 job losses in June bringing the job loss tally to 400,000 for the current recession. TD Economics expects a near 500,000 jobs to be lost before the recession ends, with the unemployment rate reaching a ten-year high of 10%. Even with the support from employment insurance benefits, the tightness in the labour market dragged personal disposable income down 2.3% in the first quarter of 2009, as wages fell for the first time on record. Although the decline in income will end in the coming quarter, the recovery in personal income growth will be subdued.

As the economy heads down the road of recovery, consumers will follow, but cautiously. The damage to the household balance sheet caused by lower asset values and weaker incomes will take time to repair, and, during the period, consumers will continue to scale spending growth and increase savings. We do expect a consumer recovery by the end of the year, but growth will not return to trends witnessed over the last decade.


U.S. ISM Manufacturing Report - June

  • Release Date: July 1/09
  • May Result: 42.8
  • TD Forecast: 46.0; Consensus: 44.0

After struggling under the weight of the ongoing intense global economic recession for close to two years, it appears that the winds are slowly shifting in favour of the U.S. manufacturing sector. Indeed, after reaching a multidecade low of 32.9 in December, the ISM manufacturing sector index has steadily clawed its way back. This upward momentum is expected to gather further steam in June, with the index expected to surge to 46.0. The key factor underpinning this call is the surprisingly strong gains in the new orders component of the index, which has moved above the all-important 50 threshold in May for the first time since November 2007. The new orders to inventory spread, a useful proxy for the future direction of manufacturing sector production, has also risen sharply in May, adding further strength to our call. Further evidence of the recent resuscitation in new orders was also seen in the new durable goods orders report for May, which showed the first monthly back-to-back gains since the middle of last year. Notwithstanding this improvement in June, with the economic backdrop for U.S. goods producers remaining very dire, we expect manufacturing sector activity to remain weak for some time, even though the pace of decline should continue to ease as the headline ISM manufacturing sector index continues its march towards the allimportant 50 threshold.

U.S. Nonfarm Payrolls - June

  • Release Date: July 2/09
  • May Result: -345K; unemployment rate 9.4%
  • TD Forecast: -300K; unemployment rate 9.7%
  • Consensus: -375K; unemployment rate 9.6%

The U.S. labour market remains mired in a prolonged downward spiral, as businesses continue to shed jobs at a high clip in the face of the ongoing intense economic recession. In fact, since January last year, over 6 million jobs have been lost, and there is no indication that the layoffs will end any time soon, even though the pace of job destruction has continue to easing - after peaking at 741K in January. In June, we expect a further 300K jobs to be lost. This will be the fifth consecutive monthly fall-off in the number of jobs being eliminated from the U.S. nonfarm payrolls. Evidence of this improved tone in U.S. labour market conditions can be seen in the weekly jobless claims reports, which have shown both initial and continuing claims falling below their recent peaks. As has been the case in the past, the losses are likely to be split almost evenly among the goods-producing and services-producing sectors. In terms of the unemployment rate, with the pace of job destruction continuing to outpace job creation, the unemployment rate should rise even further, climbing to 9.7%.


Canadian Real GDP - April

  • Release Date: June 30/09
  • March Result: -0.3% M/M
  • TD Forecast: 0.1% M/M
  • Consensus: -0.1% M/M

As a small open economy, with significant exposure to U.S. economic activity through trade and financial sector linkages, the Canadian economy has been dealt a severe blow by the ongoing intense U.S. economic recession. In particular, Canadian economy activity declined for a record eighth straight month in March, taking the value of Canadian economic output back to their November 2006 level. This freefall, however, is likely to be interrupted in April, with the Canadian economy expected to post its first monthly gain since November, with a modest 0.1% M/M advance. Most of the gains are likely to come on account of the modest bounce-back in tourism, manufacturing sector activity and wholesale sales during the month. Retail sales and construction activity should be sources of drag on overall economic activity. Notwithstanding the expected respite in April, the Canadian and global economic fundamentals remain extremely weak, and as such, we fear the downward trajectory in Canadian GDP could return.

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.