Sunday, October 18, 2009



  • Showing a lessened downdraft on U.S. consumer prices, the decline in headline CPI eased to -1.3% in September from -1.5%, and core inflation actually rose to 1.5% from 1.4% in August.
  • U.S. industrial production in September advanced for 3rd month, and utilization rose above 70%, showing some uptake in excess capacity.
  • With August expiry of “cash for clunkers”, U.S. retail sales fell in September but not as greatly as expected by markets.
  • U.S. consumer confidence diminished in September and inflation expectations rose.
  • Statements and minutes from the Federal Reserve conveyed expectation of a sluggish recovery, pointing to a longer wait on interest rate hikes.
  • Greenback weakened on hints of “lower for longer” monetary policy, but recovers somewhat at week's end.
  • Canadian dollar hits 97 US cents on weakness in the greenback and rising commodity prices.
  • Headline inflation in Canada slid to -0.9% Y/Y in September, while core CPI edged down to 1.5%.
  • Canadian manufacturing shipments slid 2.1% M/M in August, but the 3-month trend remains decidedly positive.

Boosting sentiment that the U.S. economy has sustainably turned the corner, this week brought better-than-expected news for retail sales and industrial production in September. However, demand is still being underpinned by fiscal stimulus and ongoing monetary injections. Wages and privately-supported demand must strengthen if recovery is to stand on its own legs. Indeed, with recovery still nascent, September's weakening of consumer confidence coupled with households' increased inflation expectations are not positive harbingers, but U.S. consumers should become more optimistic as the flow of better news continues.

As good news, the specter of deflation looks behind us, with consumer prices advancing in September. Showing abating downward price pressure, core inflation rose to 1.5% Y/Y from 1.4% Y/Y in August. Although the all-important U.S. consumer was spending less in September, the decline was to be expected given the expiry of “cash for clunkers” in August and the drop-off in retail sales actually was less than the market consensus. As well, with industrial production gaining for the third consecutive month, economic slack is starting to narrow, with capacity utilization rising to 70.5% after six months below 70%. Excess capacity certainly persists, with utilization well below its 80% pre-crunch mark, suggesting inflation will not be a problem anytime soon.

While observing the improvements, the Federal Reserve is also being vocal about its anticipation of a sluggish recovery and slow uptake of economic slack. This was the message of Vice Chairman Kohn's speech on Tuesday, as well as the tone of minutes for the Fed's September 23rd rate decision, released on Wednesday. In addition, Governor Tarullo's Senate testimony on Wednesday highlighted that the U.S. financial system is still healing, with smaller, regional banks still reeling and commercial real estate a looming threat to financial stability. Credit growth will be restrained by ongoing deleveraging and recapitalization, representing a check on the pace of recovery.

The Fed clearly intends to take a very measured approach to the eventual withdrawal of monetary stimulus, while also recognizing the competing need to keep inflation expectations well-anchored. This is a careful tight-rope to tread, but policymakers are well aware of that an erroneous early tightening resulted in the 1937 “double dip”. It's clear that the Fed intends to move slowly on Fed Fund hikes and will deploy alternative tightening measures ahead of that move.

Foreign exchange markets have taken heed of Fed signals that interest rates will remain lower for longer. Conspiracy theories of the Fed inflating away the burgeoning federal debt are certainly misplaced: the inflationary and economic consequences would be extreme, notwithstanding that most government debt is at relatively short maturities (45% matures within 1 year), meaning that such a strategy would be self-defeating.

Nonetheless, expecting lower growth and lower interest rates, the greenback has consequently weakened, as more investors regain their risk-appetite and look to better returns in foreign markets. While not seeing a mass exodus, appetite for U.S. debt does look to be waning. In particular, China has oscillated on its U.S. treasury purchases during the summer, and a weakening dollar has been of substantial concern to China, who hold $800 billion in treasuries (representing 23% of foreigner-held U.S. treasuries and 11.5% of all outstanding treasuries). A depreciating dollar puts China between the proverbial “rock and hard place” since any flight from treasuries would impair the value of its holdings further. Despite speculative fervor and calls for a new global reserve currency, the US dollar's primacy is protected in the near-term by the absence of any debt market with comparable liquidity and depth: the Renminbi isn't fully convertible, Euro bonds are divided between many issuers, and no bonds are denominated in the IMF's Special Drawing Rights.

The greenback's weakening is a consequence of, and necessary remedy to, that persisting current account imbalance between the U.S. and the rest of the world, which was one root of the asset bubble and past years' instability. The U.S. ultimately needs to sell more to foreign markets than it buys, and some U.S. depreciation is a step towards that.


The Canadian dollar's push towards parity continued this week, as the loonie soared to over 97 US cents, reaching the highest level seen since August 2008. While the surge stemmed in part from U.S. dollar weakness - evidenced by an appreciation of all major currencies against the greenback - a rally in commodity prices was also a key driver in the loonie's ascent. In fact, since early September, the top performing currencies against the U.S. dollar are mostly commodity backed currencies (see chart). So the rise in gold prices to an all-time high of US$1059, and perhaps even more so, the jump in oil prices to over US$77 per barrel for the first time since last October, also played a key role in propping up the loonie this week.

While good news for the snowbirds heading south for the winter, not everyone in Canada is celebrating. Manufacturers and exporters, particularly in the automotive and forestry sectors, are wincing with each additional cent that the loonie gains. And given that Canada is a very export-oriented country, many are concerned that the elevated currency threatens the economic recovery. Even the Bank of Canada cited the rapid rate of appreciation (27% since hitting a trough in March) as worrisome if the loonie is disconnected from fundamentals.

We continue to believe that currency intervention is not necessary, as many factors suggest that the Canadian dollar is roughly in line with fundamentals. The exceptional buoyancy in the housing market, the solid financial system, and above all, a low level of federal debt relative to the U.S. have all helped to support an elevated currency. In fact, market speculation that the improvement in the domestic economy will prompt the Bank of Canada to follow Australia's lead and hike rates sooner than expected has also given the loonie a little boost.

Meanwhile, on the other side of the equation, broad-based U.S. dollar weakness appears likely to persist for much longer than originally anticipated. Accordingly, we have revised our USD/CAD forecast, and now expect the Canadian dollar to overshoot parity, peaking at 102 US cents in the second quarter of 2010. The upgrade is based on both a further deterioration in the greenback as well as the more solid fundamentals in the Canadian economy. As a result, we expect the loonie to hold up well against other major currencies, including the euro and the British pound. (For further details on our Canadian dollar and other global currency forecasts, please see the October 15th issue of Global Markets, available on our website.)

In addition to a still-soft economy and low inflation as indicated in this morning's report (core CPI edged down to 1.5% in September), our upgraded forecast pours cold water on the notion that the Bank of Canada will hike rates sooner rather than later, as a high currency constrains growth and augurs for lower interest rates. At the same time, while the elevated loonie will be an impediment to the recovery in the Canadian economy and the export sector in particular, a further easing in monetary policy, at this point, is not warranted. We continue to expect the Bank of Canada to remain on hold until the fourth quarter of 2010. Still, we will be watching closely for remarks from the central bank in the communiqué accompanying the interest rate decision on Tuesday and in the Monetary Policy Report to be released on Thursday.


U.S. Housing Starts - September

  • Release Date: October 20/09
  • August Result: 598K
  • TD Forecast: 620K
  • Consensus: 610K

The U.S. housing market is on the cusp of the long awaited recovery, as the combination of an improving economy and support from the various tax incentives continue to bolster the sector, pushing sales and prices up in recent months. This positive momentum in the overall housing market has also been evident in the new homes segment. In September, we expect residential construction activity to broach the 600K barrier for the first time this year, rising to 620K. Both single-unit and multi-family unit construction are expected to advance on the month. The pick-up in construction activity is likely to be driven in part by the rebound in demand for new home - which has risen for 5 consecutive monthly, as homebuyers take advantage of the various fiscal policy incentives, and affordable home prices and mortgage rates. However, in the coming months, we expect the recovery in new homes construction to be gradual as the overhang of unsold homes is worked off.


Canadian Wholesale Sales - August

  • Release Date: October 20/09
  • July Result: 2.8% M/M
  • TD Forecast: -1.0% M/M
  • Consensus: 0.8% M/M

After rising for two consecutive months, Canadian wholesale sales are expected to fall in August with a 1.0% M/M drop. Weak motor vehicle sales are likely to provide the biggest source of drag, while the weakness from this component should be partially offset by increases in the sale of other goods. Real wholesale sales are also likely to be weak. In the months ahead, we expect wholesale sales activity to remain middling at best given only moderate consumer demand.

Bank of Canada Interest Rate Decision

  • Release Date: October 20/09
  • Current Rate: 0.25%
  • TD Forecast: 0.25%
  • Consensus: 0.25%

The coming Bank of Canada rate decision is attracting a great deal of attention, given the temptation to lump Canada in with hawkish commodity players such as Australia and Norway. The resurgence in Canada's housing market adds further credence to this argument. However, we remain very comfortable with the view that the Bank of Canada leaves its target for the overnight unchanged. Canada's distinction is its close trading relationship with the U.S. and the resultant dampening forces emitted by the heroic Canadian dollar. The statement should highlight these issues, upgrading Canada's economic forecast for H2 2009 (though this is old news), referencing housing market strength, but also emphasizing the consequences of the robust currency. Most importantly, the commitment to leave rates unchanged through to mid-2010 should remain, and this will disappoint those looking for a more aggressive Bank of Canada.

Canadian Retail Sales - August

  • Release Date: October 22/09
  • July Result: total -0.6% M/M; ex-autos -0.8% M/M
  • TD Forecast: total 0.5% M/M; ex-autos 0.5% M/M
  • Consensus: total 0.1% M/M; ex-autos 0.5% M/M

The Canadian economy has now pulled itself out of the economic recession, and the recent pick-up in labour market activity is an indication that some positive momentum is beginning to build in the economy. Despite this, consumer spending has remained fairly tepid, as households continue to consolidate their balance sheet. In September, we expect spending to rise by a moderate 0.5% M/M on account of higher gasoline prices and a pick-up in core spending. Excluding autos, sales are expected to also rise by 0.5% M/M. Real retail sales should also rise modestly. Looking ahead, we expect consumer spending growth to be fairly subdued but steady as Canadian households economise on their mall visits in the face of the soft domestic economy.

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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.