Saturday, August 29, 2009

The Weekly Bottom Line


  • The BEA's preliminary estimate of Q2 U.S. real GDP growth came in at -1.0% (annualized). A likely return to positive growth in Q3 makes the 2008-09 recession the longest in the post-war period at 18 months, as well as the deepest with a peak-to-trough decline in real GDP at 3.9%
  • U.S. new home sales rose by 9.6% in July and month's supply fell to 7.5 months (from 8.5 in June). S&P Case-Shiller shows first monthly gain in over three years, rising by 0.8%.
  • U.S. Personal spending data for July show a "cash-for-clunkers" boost. Real PCE up 0.2% (1.6% annualized) on a 1.2% rise in durable goods spending.
  • Canadian retail sales for June advance in both values (1.0% M/M) and volumes (0.4% M/M).
  • Canadian consumer confidence in August rises to highest level in past year.
  • Teranet-National Bank quality-adjusted home price index for June advances for second month (1.5% M/M)
  • Bank of Canada staff speak about monetary policy during the recovery, and markets over-react to Bank statements about the loonie's rise.


With the release of the Bureau of Economic Analysis' preliminary estimate of the second quarter GDP growth and an increasing number of signs that growth will return to positive territory in the third quarter, it is an appropriate time for a "preliminary" post-mortem look at the U.S. Great Recession. The discussion can only be preliminary because the history books are still being written on the medium and long-run ramifications of the financial crises of 2007 and 2008 and subsequent global recession. At this point at least, we can say that the 2008-09 recession in the United States lasted 18 months - from January of 2008 to June 2009 and resulted in a 3.9% reduction in real GDP. While a number of elements of the recession were unique from previous recessions, in terms of its duration and depth this recession was only slightly worse than the 1973-75 recession, which lasted 16 months and saw a peak-to-trough decline in real GDP of 3.2%, and the recession of 1981-82, which also went 16 months and saw real GDP decline by 2.9% peak-to-trough.

The four most dangerous words in investing, according to Sir John Templeton are "this time it's different." You will often hear these words spoken in the formation of an asset bubble. Indeed, the notion that something is different about the current environment that justifies the run up in (take your pick) stock prices to earnings or home prices to income and rents, is what makes identifying an asset bubble ex-ante so hard to do. Unfortunately, it is all too easy to pick and choose some new phenomenon - the unbounded possibilities of the internet or innovations in housing finance, and claim that it justifies the dramatic move away from historical performance, especially when everyone around you is reaping the rewards.

Nonetheless, with the two most recent recessions at least proximately caused by bursting asset bubbles, the notion that central bankers should do more to lean against their formation, has once again picked up steam. This is precisely one of the questions that the newly reappointed Fed Chief Ben Bernanke will face as he heads into his second term. In that regard, the devastating impact of the housing bust challenges the consensus that central bankers goal of economic stability is best met by primarily focusing on low and stable inflation. As was noted at the recent Jackson Hole symposium, "price stability does not guarantee financial stability." Leaning against asset bubbles may in fact require straying from the target path for consumer price inflation for a certain period of time. How to do this while still maintaining the credibility of the central bank remains an open question.

In the next few weeks we will be updating formally our U.S. economic forecast. One of the key pieces of the forecast puzzle is how much near-term spending will be boosted by government stimulus and cash-for-clunkers. Data out this week on personal spending for July (the first month of the quarter) were encouraging. Real personal consumption expenditures (PCE) rose by 0.2% (2.6% annualized) led by a 1.8% rise in durable goods spending. Given the swiftness with which the cash-for-clunkers funds were exhausted, auto sales are likely to give an even larger boost to consumption in August, resulting in a fairly buoyant growth for overall PCE in the quarter. Positive PCE growth in addition to rebounding residential construction and a positive contribution from business inventory investment will likely lead to real GDP growth of something close to 3% (annualized) in the third quarter.

Beyond the third quarter, the longer term factors impacting the U.S. economy - continued deleveraging in the financial and household sectors, weak income growth, and the unwinding of monetary and fiscal stimulus - will make for a slow-go economic recovery. The impact of the U.S. Great Recession will continue to be felt for several years to come.


As economic data reveals the Canadian economy moving into rebound, the focus increasingly turns to how the recovery will unfold and how policy will be managed. The Canadian economy looks to be improving but levels of activity remain low. It is likely that June's GDP, due out Monday, showed a monthly advance - the first since September 2008. Although skewed upwards by gas sales, retail sales data for June were better-than-expected and, stripping away energy prices, the volume of retails sales advanced on the month. As well, the Canadian resale housing market appears on a tentative rebound with the Teranet-National Bank housing index (a quality-adjusted resale index) advancing in June for the second month and showing an improvement in its year-over-year decline.

Looking towards recovery, the Canadian economy still faces significant risks and these are largely external. Friday's report on Canada's current account balance for Q2/2009 (the tally of our net exports and net investment payments abroad) showed a record deficit of $11.2 bn, with our trade balance in goods posting a deficit for the first time since 1976. The era of twin deficits has clearly begun, and much focus will be on how policy-makers navigate these waters.

Two speeches this week from Bank of Canada officials provided insight on how the Bank will manage recovery over the medium- and longer-term. In Mark Carney's Jackson Hole speech on Sunday, the governor floated some balloons around a central bank's appropriate role in macro-prudential oversight. He observed that "the monetary and financial wings of our [central banks] have operated as two solitudes," and tentatively proposed a monetary policy framework that combined "leaning against the wind for financial stability" with price-level targeting (in contrast with the present inflation-targeting regime).

Regarding the Canadian economy beyond the recession, Deputy Governor Tim Lane spoke to the Canadian Association of Business Economists on Tuesday in an annual address. Hungry for juicy morsels on the Bank's view of the loonie, markets latched onto a paragraph flagging the risk from currency appreciation on the nascent economic recovery, pushing the loonie down three-quarters of a cent from noon to close. However, our view is that market participants misinterpreted and over-reacted to the speech. Firstly, the speech simply reiterated the Bank's stance in relation to a rising dollar that it had already articulated in its July Monetary Policy Report (MPR): The Bank observed the risk from a persistent appreciation and added the now standard boiler-plate that the Bank retains "considerable flexibility" in its conduct of policy. Secondly, the Bank only considers the exchange rate as relevant within the context of its price stability mandate. A fundamental-driven appreciation (such as driven by heightened commodity prices) would correspond with a positive shock to aggregate demand and currency appreciation offsets the resultant upward pressure on prices. This implies no need to adjust monetary policy for the appreciation. While the general weakening of the greenback may be placing upward pressure on the loonie, we regard the Canadian dollar's recent appreciation as primarily driven by economic fundamentals - these being rising commodity prices and financial inflows that will be used for new investments.

The bottom-line is that the Bank's commitment to a flexible exchange rate remains firm. Even in the unlikely event that the Bank opted to use "unconventional monetary policy instruments" it would be acting to maintain price stability, not to target a particular exchange rate. As such, the Bank would need to perceive that a currency movement would result in a substantial deterioration of inflation below the lower bound of its baseline forecast. While we regard the Bank's point forecast as optimistic, we believe that even an appreciation to parity would not result in a deterioration below their lower bound.


U.S. ISM Manufacturing Report - August

  • Release Date: September 1/09
  • July Result: 48.9
  • TD Forecast: 51.0
  • Consensus: 50.1

The U.S. manufacturing sector has been hit hard over the course of the recession, though there is evidence to suggest that the siege is beginning to wane. Taking a look at the various regional PMI reports does suggest heightened manufacturing activity within various regions in the U.S. As such, we expect the upward momentum to continue for the eighth consecutive month, which we believe should take the ISM Manufacturing headline index above the 50-threshold for the first time since January 2008. The significance of this is that the production sub-index, which has sat above the 50-threshold for the past two months, should provide further upward support to the headline print. In addition, the new orders sub-index should also move higher, further buoying the headline number. In the coming months, we do expect the ISM headline index to rise further as aggregate demand picks up resulting in a manufacturing sector gradually returning to life.

U.S. Nonfarm Payrolls - August

  • Release Date: September 4/09
  • July Result: -247K; unemployment rate 9.4%
  • TD Forecast: -175K; unemployment rate 9.6%
  • Consensus: -225K; unemployment rate 9.5%

The improvement in U.S nonfarm payrolls last month is consistent with the secular downward trend in the pace of monthly job destruction. The monthly improvement is largely predicated on improvements coming from various labour market reports, including regional PMI measures and the weekly initial jobless claims data. As such, we are looking for nonfarm payrolls to ease to -175K in August, compared to the -247K drop reported in July, with a likely even split in the goods-producing and service-producing sectors. In terms of the unemployment rate, improving economic conditions and improving sentiment about the future likely enticed job seekers into the market, which should push the unemployment rate up to 9.6% after a temporary dip last month. Going forward, we fully expect further job destruction in the U.S., though not to the extreme depths we saw at the beginning of the year. In addition, while the pace of job destruction may moderate, the unemployment rate is likely to remain fairly elevated, and has not yet peaked.


Canadian Real GDP - Q2/09

  • Release Date: August 31/09
  • Q1-09 Result: -5.4% Q/Q
  • TD Forecast: -3.3% Q/Q; Consensus: -3.0% Q/Q

This Global recession has been a head spinner for Canadian exports which shrank for a seventh consecutive quarter in the second quarter of 2009, with double digit declines for the last three quarters. As such, the bulk of the second quarter contraction came from a deterioration in net trade, which likely detracted 4 percentage points from economic growth. The sharp drop in sales over the last three quarters has left an inventory over hang as businesses couldn't scale back production fast enough to match the drop in demand. The much needed inventory contraction remains a wild card for the second quarter estimate, as it could detract anywhere from 1-3 percentage points from growth in the second quarter. Meanwhile, the domestic economy seems to have turned a corner. Fiscal stimulus spending has appeared to put a floor under nonresidential construction activity which remained flat in the quarter. Moreover, a steaming hot existing home market may have acted as a stimulus for renovation activity in Canada, Analyticswhich helped buoy residential construction in the wake of continued weakness in new homebuilding. Last but not least, consumer spending has been the rainbow after the economic storm, as recent strength in retail sales suggests that consumer spending posted its first gain in two quarters-- albeit a very modest gain.

Canadian Employment - August

  • Release Date: September 4/09
  • August Result: -44.5K; unemployment rate 8.6%
  • TD Forecast: -10.0K, unemployment rate 8.8%
  • Consensus: -20.0K; unemployment rate 8.8%

Despite the fact that the Canadian economic recession is on its last legs, there continues to be job destruction in the broader economy as businesses consolidate their workforces further to accommodate soft aggregate demand. However, to the degree that the economy has been showing signs of stabilization, we are looking for a modest decline of just 10.0K jobs in August. After the manufacturing sector shed its smallest amount of jobs since June 2008 in July, we expect the Canadian manufacturing sector to continue in this trend, especially as the economy continues to garner positive momentum. Further, the beleaguered accommodation and food services sector should start to moderate, suggesting a softer amount of job losses relative to July. In addition, there should actually be a positive boost coming from the student population, as in all likelihood there were fewer students hired at the beginning of the summer, would translate into fewer firings at the end of the summer, suggesting the seasonal factors should work in the report's favour. In terms of the unemployment rate, job losses continue to materialize while improving economic conditions likely enticed new entrants into the labour force. Taken together, we look for the unemployment rate to rise to 8.8% in August from 8.6% the prior month.

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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.