Sunday, August 16, 2009



  • The U.S. Federal Reserve stood its ground this week, leaving the level of interest rates unchanged, slowing the pace of asset purchases, and reinforming that "inflation will remain subdued for some time."
  • U.S. retail sales were worse than expected in July, but the cash for clunkers should be felt in August.
  • The U.S. trade deficit worsened to -$27.0bn in June on higher oil prices, with the ex-petroleum deficit improving from -$12.7bn to -$9.8bn.
  • Exports and manufacturing surprised on the upside in June, rising 2.3% and 1.9% respectively. An increase in U.S. import intentions will likely provide a stimulus to export-oriented manufacturers in the third quarter.
  • Housing starts disappointed falling 4.1% in July. But this small set back doesn't derail our belief that a recovery in construction activity is near, as continued strength in the resale home market will likely provide a boost to renovation activity.

It's a bit of an awkward phase in the U.S. economic recovery as it goes through its "tweener" stage. The growing consensus is that some kind of recovery is underway and that the worst has past. However, the friction now is whether it is too early to talk about exit strategies and higher interest rates. Everyone is anxious to put the recession behind us, but it would be dangerous to assume this recovery is more mature than it is. It still requires conducive monetary policy to help support the businesses and consumers that will drive a full-fledged expansion.

There is good news. For the first time in nearly a year, the year-over-year pace of contraction in U.S. industrial production improved from -13.5% in June to -13.0% in July. Our own leading indicator (graph on the front page) suggests that this is a sustainable turning point and that we will continue to see improvement through the end of the year. In fact, the odds are good that U.S. GDP will expand in the third quarter. Business inventories were perhaps cut too much. Auto sales are rebounding from a poor performance in the first half of the year. And with the U.S. lagging the global economic rebound, U.S. exports might be able to do better than expected, as well.

But looking at the retail sales data this week, it is obvious that consumers remain weak. The y/y contraction in retail sales excluding autos continued to worsen to -8.5%. Up to this point, what has supported consumer spending against rising unemployment – now at 9.4% – and falling wages – down 4.7% over their level last year – has been government assistance. In June 2007, government unemployment benefits were $30bn (annualized). As of June 2009, they were $130bn, easing the immediate burden of job losses on families. Other government transfers, though, had been growing at a 9.9% pace as of April, but have since decelerated to just 1.4% as of June. And as this assistance has slowed, U.S. consumer spending has disappointed. In the end, the economic recovery is real but it is only as strong as the people it's made of.

There is still a concern, however, that inflationary fears will derail the recovery and/or force the Federal Reserve's hand. Headline inflation in July was -2.1%. As the chart here shows, much of this was justified by the collapse in oil prices over the last year. Oil prices last July were $133 a barrel, but just $64 this July. A 50% decline in oil prices translated into a big fall in headline inflation. However, oil prices had collapsed to $41 by December of last year, and we think they are likely to average around $65 in the end of 2009. It is the percent change, not the level, of oil prices that matters for inflation. This means headline inflation will be under the pressure of a 50% increase in oil prices in the months ahead. However, while headline inflation is likely to start picking back up, the Federal Reserve likes to focus on core inflation as a better measure of the medium-term trend. If the historical relationship on the second chart here holds, the brunt of the past recession is only now being felt on core inflation, with a risk core inflation comes close to a 0% pace and lingers below a 1% pace in the second half of 2010. The Fed is nowhere close to raising rates as the recovery does not yet have the full support of the people.


Canadians have been waiting patiently for evidence that a recession that has claimed 414,000 jobs has come to an end, and they may have got what they were looking for this week as Canadian exports surprised on the upside in June. Note the second quarter was still a tough quarter for exporters as exports were down a whopping 21% annualized, and net trade likely detracted 4 percentage points from growth in that quarter. The weaker-then-expected trade data has led us to believe that the contraction in that quarter was deeper than originally expected, in the range of 3.0%-4.0%.

However, second quarter GDP is already old news considering we are already half way through the third quarter. If the Bank of Canada is correct in their estimated timing of the end of the recession, the recovery may very well be under way. The first sign that this may in fact be true has been an improvement in global trade flows, led by a surge in U.S. imports in June. Import intentions from the ISM manufacturing survey suggests this upward trend could continue for at least the next three months, providing much needed stimulus to Canadian exports. As such, we believe that exports will finally end their 8-quarter losing streak with a considerable pop in the third quarter. We should caution that exports have fallen to such low levels that even with a large increase, the level of exports will remain significantly below the peak back in 2007. Moreover the gains may be largely centered in energy and industrial goods and materials.

Manufacturing shipments data this morning confirmed this view as real unfulfilled orders were up 2.8% in June (the first increase in 7 months), which should give a boost to future shipments. However, the inventory- to -sales ratio is still hovering at historical highs. So, even as sales pick up, export-orientated manufacturers may use the opportunity to work down the unintended inventory build up that has occurred over the downturn rather than ramp up production. Even with a sharp recovery in sales in the third quarter, the elevated inventory-to-sales ratio means that Canada will likely continue to see employment losses as firms attempt to cut production costs to make up for past weakness in sales. So far, the manufacturing industry has directly accounted for half of the job cuts over the current recession, and is unlikely to be a major contributor to employment (and production) during the early stages of recovery.

Housing starts got off to a bad start in the third quarter falling 4.4% in July, which ended two months of gains. However we shouldn't put too much weight on one month worth of data, as the series tends to be volatile. In contrast, the continued uptick in building permits paints a much more optimistic picture on residential investment. First, it suggested that housing starts may resume some growth in August. Second, building permits tell a larger picture than just what's going on in new homebuilding—because some (not all) renovations need a building permit. Despite the weakness in new homebuilding, we expect that residential investment will get a boost from renovation activity, which has benefited from the Federal Government's renovation tax credit and the 6-month string of gains in the resale home market. Existing home sales continued to impress in July rising a whopping 18.2% from a year ago levels, pushing home prices up 7.6%. The recent strength in existing home sales will not only act as a stimulus for renovation activity, but keep the momentum in consumer spending rolling as households set out to purchase items such as furniture, household equipment and building material for those homes.

With the Canadian consumer already on the mend in the second quarter, a recovery in construction and exports are the last two pieces needed to fall into place for a Canadian economic recovery. It appears that both of these were on the rise in the third quarter, setting the stage for a sharper improvement in GDP growth in that quarter than we had previously expected.


U.S. Housing Starts - July

  • Release Date: August 18/09
  • June Result: 582K
  • TD Forecast: 615K
  • Consensus: 596K

The last few month have seen some positive movement for the various U.S. housing market indicators, which to us have been suggesting that after 3 full years of housing market activity contraction, the beleaguered sector may be on the mend. This positive tone has also been seen in the new homes market, where sales have risen for the third straight month in June with a respectable 11.0% M/M gain (its biggest gain since December 2000), bringing both the months' supply and the inventory of unsold homes to their lowest levels in many months. The back-to-back uptick in the number of residential construction permits in May and June are also supportive of this view, though the NAHB home builder's housing market index remains at very low levels. With all these things considered, we expect the number of new residential construction to breach the 600K barrier in July, with a rise to 615K. Both single-unit and multi-family unit construction are expect to advance on the month. However, 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 on building activity, we expect starts to remain fairly depressed, relative to historic norms.


Canadian CPI - July

  • Release Date: August 19/09
  • May Result: core 0.0% M/M, 1.9% Y/Y; all-items 0.3% M/M, -0.3% Y/Y
  • TD Forecast: core 0.1% M/M, 1.8% Y/Y; all-items -0.1% M/M, -0.7% Y/Y
  • Consensus: core 0.1% M/M, 1.9% Y/Y; all-items -0.1% M/M, -0.7% Y/Y

Canadian consumer prices appear set to post their biggest annual decline in over half a century in July, on account of the massive economic slack that has developed in the economy and weakening labour market fundamentals. These factors have combined to rob both retailers and workers alike of their pricing powers, thereby placing considerable downward pressure on consume price inflation. During the month, we expect headline inflation to post it first decline since April, with a 0.1% M/M drop on both a seasonally and non-seasonally adjusted basis. On a year-ago basis, price should fall by 0.7% Y/Y, which will be the sharpest pace of consumer price decline since 1953. The Bank of Canada's core consumer price index is also expected to be soft, rising by only 0.1% M/M on both a seasonally and non-seasonally adjusted basis, with the annual pace of core inflation falling remaining unchanged at 1.9% Y/Y. Recent soft U.S. inflation also bolsters this view. In the months ahead, with the Canadian economy likely to remain quite weak, we expect the pace of headline consumer price inflation to remain negative, before eventually moving back into positive territory later this year.

Canadian Wholesale Sales - June

  • Release Date: August 20/09
  • May Result: -0.3% M/M
  • TD Forecast: 0.5% M/M
  • Consensus: -0.1% M/M

Canadian wholesale trade activity has been on a prolonged downward slide, with activity falling for 8 straight months (and in 9 of the last 10 months), as the weakening domestic economy sapped the juice from the financially distressed Canadian households. Slumping global demand for Canadian products has also been a significant drag on activity. However, we expect wholesale sales to rise in June, with a modest 0.5% M/M gain. The advance should be based mostly on the strength in the housing related components. In the months ahead, we expect wholesale sales activity to remain subdued.

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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.