Sunday, September 20, 2009



  • Both U.S. supply and demand show signs of life in August, as industrial production (+0.8% M/M) and retail sales (+2.7% M/M) advance
  • U.S. core CPI inflation eased to 1.4% in August from 1.5% in July, which should assuage fears of either deflation or rampant inflation
  • U.S. housing starts inched up to nearly 600K units in August. Residential investment will likely add to real GDP growth in Q3 for the first time in nearly four years.
  • Canadian sales of existing homes eased in August but are still up a wowing 18.5% Y/Y.
  • Canadian manufacturing shipments and wholesale sales both rose ahead of market expectations, with inventory pressures abating but still at elevated levels
  • Canadian capacity utilization fell to 67% in Q2/2009 - its lowest recorded level
  • Canadian household net worth improves after three consecutive quarters of decline
  • Canadian headline inflation in August (-0.8%) is negative for a third month and core CPI eases to 1.6%

The U.S. economy is finally starting to emerge from a long and deep recession. It will likely have lasted 20 months, during which nearly 4% of real GDP and over 7 million jobs - or 5% of employment - will have been lost, making it the worst post-WWII recession. On the flipside, a depression, which many had feared, was averted largely because the most synchronous and global recession in modern history lead to a commensurate monetary and fiscal response. Instead we ended up with what has appropriately been dubbed the Great Recession.

In August, consumers finally started dusting themselves off after being caught in the middle of this dust bowl. Retail sales came in significantly better than expected, surging ahead by 2.7% M/M, their strongest monthly pop since January 2006 and well ahead of the 1.9% consensus expectation. Battered consumers took advantage of the “Cash for Clunkers” auto rebate program, which unsurprisingly led to a 10.6% M/M surge in new vehicle sales. Gasoline station sales also rose by a hefty 5.1% M/M. While the bounce in new car sales will help to boost the Q3 growth figures, there will likely be some near-term payback. The impact of the auto rebate program will have vanished by September, and arguably much borrowed from future new vehicle sales in any event. And higher gasoline station sales are nothing to cheer about from a macroeconomic perspective when they solely reflect higher prices at the pump, which was the case in August. More surprising and positive was what was hidden underneath the headline figure. Stripping away auto dealership and gas station sales still left a decent 0.6% AnalyticsM/M gain in all other retail outlets combined.

Are consumers leading the economic recovery? As the largest contributor to GDP, consumer spending is a necessary component of any recovery. But given the financial headwinds households continue to be faced with, we should not expect an outsized contribution to growth coming from consumers. After an expected bounce (2.3% annualized) in Q3 and a hiccup (0.7% annualized) in Q4, consumer spending growth should resume a steadier 2.0-2.5% (annualized) rate in 2010.

The glass half empty view is that this is considerably less than the 3.0% averaged in the 4 years prior to the recession, while the glass half full view is that this is a far cry from stagnation. Both views agree that while water won't risk spilling over, we won't die of thirst either.

There remains a great deal of uncertainty surrounding the speed and shape of recovery, with much near-term activity clouded by temporary fiscal stimulus. Growth has no doubt resumed, but the long-term path of U.S. real GDP has been near-permanently impaired by the financial crisis. Whatever follows should be a healthier, more sustainable path, but taking your deleveraging medicine - reducing debt and/or raising equity - will be painful and not show immediate results. This should make for a long and uneven recovery, with some misfires along the way as firms and households remain fragile to shocks as yet unforeseen.


All signs are that Canada has now turned the corner and will post positive growth in the third quarter. But, despite having come off the bottom, the Canadian economy will not return to potential output at a speedy pace.

This week's release on the National Balance Sheet Account shows that Canada's household sector, whose spending on consumption and housing has resurged remarkably, still must rebuild its assets and slow its borrowing. Despite a record high share of the population nearing retirement, household liabilities continue to rise relative to personal disposable income and the assets-to-liabilities ratio still remains impaired.

A substantial uptick in Canada's leading indicators for August presages a strengthening pace of positive growth in the third quarter. This was the largest increase since April 2002 and exhibits Canada's solid traction. The underlying components improved broadly (8 of the 10 advancing) and August's leading indicators confirm our view for 2% annualized GDP growth for Q3/2009.

Manufacturing shipments for July provided the biggest upside surprise this week, growing at 5.5% M/M - well ahead of market expectations. Improvements were reasonably widespread and particularly owed to gains in auto and aerospace shipments. Wholesale sales experienced similar improvements, with the lift from autos being the major buoy. Inventory-to-shipments (I/S) ratios fell substantially, showing easing pressure on manufacturing and wholesale inventories. However, in manufacturing, the retreat of unfilled orders and stagnation of new orders does not leave much momentum in the pipeline for future shipments, implying that inventory draw-downs will continue before firms are willing to confidently boost production. However, U.S. manufacturing shipments similarly look to have bottomed, and U.S. firms will boost demand from Canadian suppliers once they start to rebuild their inventories. Although U.S. manufacturers' I/S ratios are still elevated against the past decade, much lower I/S ratios for the stateside wholesale and retail sectors foretell of stronger re-stocking effects. As well, a high ratio of unfilled orders-to-shipments and improving indices for purchasing managers' expectations indicate that a U.S. manufacturing revival is in the works.

Nonetheless, as a reminder of the amount of current economic slack, a continuing deterioration in Canada's capacity utilization for Q2/2009 was reported this week, and, at 67% of capacity, this is Canada's lowest recorded utilization (records to 1961). Capacity utilization is highly correlated with the “output gap”, which represents excess supply marked by the difference between actual GDP and potential output. Although the third quarter will see positive growth, we expect a slow uptake in capacity utilization.

With the present excess supply, it was no surprise to see that core inflation (excluding the 8 most volatile elements of the consumer basket) edged downwards in August. Base-year effects in energy prices have plunged the headline inflation into negative territory, but these will diminish during the fall and, as a relative price shock, this does not constitute deflation. However, as the negative output gap persists, core CPI will continue to wane, and we forecast that core inflation will bottom at 0.9% in the first half of 2010.


FOMC Interest Rate Decision

  • Release Date: September 23/09
  • Current Rate: 0.00% to 0.25%
  • TD Forecast: 0.00% to 0.25%
  • Consensus: 0.00% to 0.25%

The Federal Open Market Committee (FOMC) will deliver its next interest rate decision on September 24, and as before, the markets will undoubtedly look beyond the actual interest rate announcement, and focus instead on the tone and wording of the actual communiqué. In terms of the economic and inflation outlook, we expect the Committee to be slightly more upbeat in the statement, reflecting the improved tone in the recent economic reports and the brightening U.S. economic outlook more generally. As such, the statement is likely to note that “economic activity has levelled out” and perhaps mention that some growth is beginning to occur in the economy, contrasting with the last statement which noted simply that “economic activity is leveling out.” The inflation outlook, however, is likely to remain virtually intact. In terms of the Fed's quantitative easing program, we believe that there is a nontrivial risk that the committee may perhaps slowdown the pace of MBS and agency debt purchase programs, akin to what was done to the Treasury purchase program at the last meeting, particularly since the Minutes of the last meeting indicated support among a number of participants for such Bureauaction. Beyond these two modifications, we believe that the statement will likely remain virtually intact, with the Fed avoiding any mention of exit strategies in the communiqué, though the discussion on this topic will likely continue at the meeting. We also expect the statement to reiterate that “the Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

U.S. Durable Goods Orders - August

  • Release Date: September 25/09
  • July Result: total 5.1% M/M; ex-transportation 1.1% M/M
  • TD Forecast: total 1.0% M/M; ex-transportation 0.5% M/M
  • Consensus: total 0.2% M/M; ex-transportation 1.0% M/M

The massive advance in durable goods orders last month was due almost entirely to the unsustainable 29.1% M/M surge in aircraft orders. In August, we expect orders to rise further, this time on account of higher motor vehicle orders. During the month, we expect orders to advance by another 1.0% M/M, driven in large part by increased orders for motor vehicles as car dealers replenish their depleted inventory levels following the wildly popular “cash for clunkers” program, which should more than compensate for the expected drop in aircraft orders. Excluding transportation, orders should rise by 0.5% M/M, suggesting that even though the recent advances in total durable orders have been mostly on account of the volatile transportation components, core durable goods demand continues to be positive as U.S. businesses begin to regain their appetite for capital expenditure. In the months ahead, we expect durable goods order to remain in positive territory.


Canadian Retail Sales - July

  • Release Date: September 22/09
  • June Result: total 1.0% M/M; ex-autos 1.0% M/M
  • TD Forecast: total 1.5% M/M; ex-autos 0.5% M/M
  • Consensus: total 0.5% M/M; ex-autos -0.1% M/M

Despite a soft domestic economy and weak labour market conditions, Canadian consumers have kept the cash tills ringing as total retail sales have risen in five of the last six months this year. This momentum should carry into July, with retail sales expected to rise a further 1.5% M/M, following the 1.0% M/M gain in June. The key catalyst for the advance in July sales should be motor vehicle sales, which we expect to post its biggest monthly gain since January, as car dealers ratcheted up discounts to lure buyers into their showrooms. Higher gasoline prices should also bolster the headline number. Excluding autos, sales are expected to rise by a more moderate 0.5% M/M. Real retail sales should also be reasonably robust, in keeping with the recent trend. Looking ahead, we expect consumer spending growth to be fairly subdued as Canadian households economise on their mall visits in the face of the difficult economic environment.

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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.