Monday, July 13, 2009



  • The U.S. trade deficit unexpectedly fell in May due to strong export growth and a contraction in imports.
  • U.S. Treasuries continue to rally as inflation expectations ease.
  • Job losses in Canada slowing but move towards part-time employment reveals greater underlying weakness
  • Housing starts improve for the second straight month, suggesting a floor in the residential construction sector.

Perhaps it is the contrarian nature of economists. It is interesting to note that financial markets have softened up quite noticeably in the last couple of weeks. This is just as the cumulative impact of better-than-expected economic data since March seems to be raising upside risks that real U.S. GDP growth could come in a bit stronger and a bit sooner than expected. The answer seems to lie in the fact that markets might have gotten ahead of themselves this past spring. At the first sign of good news, equities rallied, but now with earnings season upon us, many analysts seem to be questioning whether the earnings expectations embedded in those higher prices can be met given the ongoing economic slack.

In bond markets, too, some of the froth has come off, with 5-year Treasury yields falling 65 basis points since June 18th. In late 2008, yields tumbled as economic concerns led the Fed to slash interest rates, caused oil prices to collapse and the market to slash its inflation expectations even more. If the world as we knew it was about to end, certainly there would be no more inflation? But now, with the Fed funds rate that anchors the yield curve at effectively zero, those changing inflation expectations continue to drive yields on their roller coaster ride. Fears the Fed might make a mistake with quantitative easing drove inflation expectations and yields higher, stoked further by early upbeat economic data and an unsustainable increase in oil prices. But in the last few weeks, inflation concerns, oil prices, and U.S. bond yields have all fallen closer to levels we have been arguing are more in keeping with where we are in this economic recovery.

Future inflation will remain weak and concerns over the Fed's quantitative easing stoking inflation are overdone. The total size of the Fed's balance sheet has remained virtually unchanged since March. Their increasing purchases of Treasuries have been offset by an across-theboard reduction in the need for their other lending facilities. Borrowed reserves from the Fed fell 16.5% in June. Moreover, in spite of those much maligned purchases of Treasuries by the Fed, they hold fewer Treasuries now ($653bn) than they did before this crisis began ($780bn in September 2008). And as a share of their total balance sheet, Treasuries have fallen from almost 90% to less than one-third. So just to return to the status quo, the Fed will still need to buy another $130bn in U.S. government debt, even as it unwinds its various other credit facilities supporting the economy. Those looking for exit strategies have seemingly missed the forest for the trees. Quantitative easing is its own exit strategy.

The ISM non-manufacturing survey for June continued to march higher and is just three points shy of the 50-threshold that denotes growth in the sector. International trade figures for May were even stronger. U.S. real goods exports rose by 1.9% in the month, while real goods imports fell by 2.1%. All told, the data for the second quarter suggests the contraction in real U.S. GDP may not be as large as we previously forecast (-1.7%), and even puts the U.S. within spitting distance of posting a modicum of growth.


The beginning of July represents both the start of the dog days of summer as well as the second half of 2009. It is an ideal time to look back on the performance of the Canadian economy over the first half of the year and to assess what might be in store in the future. Data out this week provided several important details from which to make this assessment.

While the song remains largely the same in terms of the outlook for the year's second half, the tempo has certainly changed - from the presto pace of the first few months, into something more moderato. On the job front, the pace of job losses in Canada has clearly slowed from an annualized pace of 5.5% in the first quarter to a more moderate 1.5% in the second quarter. In the housing market, falling interest rates have supported resurgent home sales and rising housing starts. On the international trade side, the impact of the deep U.S. recession means exporters are still feeling the pain and prospects here continue to depend on better news south of the border.

While we are encouraged by the slower pace of job declines in the second quarter of 2009, details of Canada's job market reveal key sources of underlying weakness that act to temper any newfound optimism. Much like the situation in the United States, the headline job numbers mask a much weaker underlying picture. Overall job losses have slowed, but the economy's poor prospects are showing up in a move away from private-sector full-time work and towards part-time and self-employment. In June, the share of part-time workers in total employment rose to 19.5%, its highest level since 1993. Moreover, the number of people in part time work because of economic conditions has also risen dramatically - up a whopping 50% from a year ago. The rise in part-time work illustrates an even larger level of economic slack in the Canadian economy than is revealed by the 8.6% unemployment rate. Given the slack clearly building in the economy, inflation pressures are likely to continue to diminish over the months ahead.

On the bright side, the continued moderation in inflation enables the Bank of Canada to leave interest rates at their low 0.25% floor. This is an immediate positive for the nearterm Canadian economic outlook. The resurgence in the Canadian housing market may be attributed to improvements in housing affordability as a result of the interest rate environment. Housing starts have risen for the past two months, now sitting at 140,700 annualized units, up from a low of 121,400 in April. While we don't expect any dramatic improvements going forward, monetary policy has helped to put a floor on activity in this sector.

The side of the Canadian economy that the Bank of Canada has virtually no control over is the foreign sector. International trade data out for May painted another dour picture for the state of Canada's exporters. After having fallen for seven of the past nine months, exports declined again in May, driven down by falling demand for energy products and automobiles. While signs of a bottom in U.S. business activity, as revealed in upward movements in the ISM indices, bode well for the prospects of the Canadian export sector, the second half is likely to be characterized at best by a moderato pace of improvement - at least the sign is pointing in the right direction.


U.S. Retail Sales - June

  • Release Date: July 14/09
  • May Result: total 0.5% M/M; ex-autos 0.5% M/M
  • TD Forecast: total 0.2% M/M; ex-autos 0.5% M/M
  • Consensus: total 0.4% M/M; ex-autos 0.5% M/M

Even with the boost in household income from the massive fiscal stimulus package, consumer spending has remained fairly weak, as U.S. households use their windfall income to butress their badly-damaged balance sheets. Indeed, instead of engaging in spending sprees, U.S. consumers appear to have rediscovered their ability to save. Add to this the unusually cool and rainy weather in June, and it is no wonder that retail sales activity has remained weak. For June, we expect retail sales to post a modest 0.2% M/M gain. Most of the gains are likely to come from gasoline sales, on account of the second monthly doubledigit gain in gasoline prices. However, reduced spending activity in other retailing categories should partially offset these gains. Excluding autos, sales should rise by a slightly more profound 0.5% M/M. In the months ahead, with U.S. households continuing to contend with the weakening economy and deteriorating labour market conditions, we expect retail sales to remain fairly subdued.

U.S. Consumer Price Index - June

Release Date: July 15/09

  • May Result: core 0.1% M/M, 1.8% Y/Y; all-items 0.1% M/M, -1.3% Y/Y
  • TD Forecast: core 0.2% M/M, 1.7% Y/Y; all-items 0.6% M/M, -1.3% Y/Y
  • Consensus: core 0.2% M/M, 1.7% Y/Y; all-items 0.6% M/M, -1.3% Y/Y

The combination of a rapidly weakening labour market and soft consumer demand has meant that the pricing power of workers and retailers alike has been greatly compromised. As such, the outlook remains for softer consumer price inflation. For June, we expect consumer prices to rise by a strong 0.6% M/M on account of the big gains in energy prices during the month. Despite this, the annual pace of consumer price inflation should remain unchanged at -1.3% Y/Y, which will be the fourth consecutive month of a negative print in this indicator. Core consumer prices should be somewhat strong on the month, rising by a more modest 0.2% M/M. The annual pace of core consumer price inflation, however, 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.

U.S. Housing Starts - June

  • Release Date: July 17/09
  • May Result: 532K
  • TD Forecast: 500K
  • Consensus: 528K

The recent flow of U.S. housing sector reports has been quite mixed, as the sector searches for the elusive bottom, after three consecutive years of correction. In particular, the NAHB index appears to be heading higher (though it remains well below the 20-thresholds), and the inventory of unsold homes have continued to edge down. The strong advance in starts last month (its second monthly gain since June last year) was also encouraging. However, with most of the gains coming from the volatile multiunits segment, the gains are expected to be short-lived. In fact, our call is for the number of new residential construction to fall to 500K units in June, with the losses coming from the volatile multi-units component, which rose by at the breath-taking pace of 67% M/M the month before. 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 overhang of inventory of unsold homes continuing to weigh heavily on building activity, we expect starts to remain in depressed territory.


Canadian Manufacturing Shipments - May

  • Release Date: July 15/09
  • April Result: -0.1% M/M
  • TD Forecast: -3.0% M/M
  • Consensus: -0.5% M/M

The Canadian manufacturing sector has been left reeling from the combination of softening domestic and U.S. demand, with sales declining in 7 of the last 8 months. Add to this mix the rising Canadian dollar and the retrenchment in automobile production in North America, and stage is set for the performance of this beleaguered sector to go from bad to worse. In May, we expect manufacturing shipments to fall a further 3.0% M/M, bringing the value of Canadian manufacturing sector sales to its lowest level in over 10 years. The key source of weakness is expected to come from lower auto products sales, while weaker petroleum and coal, and machinery and equipment shipments should also be sources of significant drag on the headline number. If there are any risks to this call, they are to the downside. In real terms, shipments should also 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 CPI - June

  • Release Date: July 17/09
  • May Result: core 0.4% M/M, 2.0% Y/Y; all-items 0.7% M/M, 0.1% Y/Y
  • TD Forecast: core -0.1% M/M, 1.8% Y/Y; all-items 0.2% M/M, -0.4% Y/Y
  • Consensus: core 0.0% M/M, 1.9% Y/Y; all-items 0.3% M/M, -0.3% Y/Y

The long-awaited era of Canadian consumer price deflation should be upon us in June, ushering Canada into the club of other developed countries with negative consumer price inflation. During the month, we expect the headline index to rise by 0.2% M/M on both a seasonally and a nonseasonally adjusted basis. Energy prices are expected to be the key factor driving consumer prices higher in June. However, due to base-effects, the annual pace of consumer price inflation is expected to drop to -0.4% 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 be soft, falling by 0.1% M/M on a non-seasonally (but up 0.1% on a seasonally-adjusted basis), with the annual pace of core inflation falling to 1.8% Y/Y, from 2.0% Y/Y in May. In the months ahead, with the Canadian economy likely to remain quite weak, we expect consumer price inflation to ease even further.

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.