Monday, November 16, 2009

The Weekly Bottom Line

  • The Federal Reserve's Senior Loan Officer Survey shows a significant improvement from a year ago. On the flipside, credit remains tight and demand remains weak for most credit products except prime residential loans.
  • U.S. imports advanced by 5.8% M/M in September, led by aircraft and crude oil purchases abroad. Meanwhile, exports climbed by a lesser 2.9% M/M, also led by aircraft sales. The resulting trade deficit widened to -$36.5 billion from -$30.8 billion a month prior.
  • University of Michigan consumer confidence index for November disappoints, falling for a second month to 66.0 as expectations worsen. Markets were looking for a print of 71.0 near September's 70.6.
  • Canadian dollar up over two cents in the week from 0.93 USD to 0.95.
  • Housing starts continue to rebound, rising to 157,300 units with multiples leading the way.
  • New home prices up for the third straight month, rising 0.5% M/M in September.
  • Canadian merchandise trade deficit shrinks in September on stronger exports to Europe. Exports rise 3.4% M/M in constant dollar terms, while imports fell 0.6% M/M.


As the largest single component of U.S. GDP, consumer spending remains king. We do not expect consumer spending to lead the recovery, but it remains a necessary and key ingredient of the recipe. And just how is the king feeling these days? To gauge sentiment, we turn to the Conference Board (CB) and University of Michigan (UM) indexes. What we find aligns well with our current thinking on the ongoing recovery, highlighting in particular that (1) it will be modest in historical terms, (2) it remains fragile in its initial stages and reliant on fiscal and monetary stimulus, (3) we look for consumer spending growth to be coincident with the overall recovery. Other ingredients of the economic reprise, such as exports and residential investment, will lead the way.

Even though the CB and UM consumer surveys use different samples and questionnaires to gauge consumer mood, they are strongly positively correlated over the long haul - as one would expect. These indexes, particularly their expectation component, as opposed to their current or present conditions component, do a great job as leading indicators heading into a downturn or recession. They tend to slump significantly 3-6 months in advance of officially dated recessions, and correctly flagged the last five recessions, including this most recent one. However, their record on the recovery side is poorer, acting more as coincident than leading indicators.

Nonetheless, a few similarities and differences between them since the beginning of the year are telling. Both have rebounded from the depressed levels seen in February. But, the CB measure had fallen much more dramatically than its UM counterpart. Broadly speaking, the CB questionnaire is more tilted to the employment landscape (e.g. current and expected job availability) while the UM survey elicits more views on current and expected household financial conditions. Financial conditions have improved significantly and most visibly from a household perspective have been led by a robust stock market rally since the low of March 9th. Meanwhile, the labor market remains thoroughly depressed, as evidenced by continued job losses (190,000) and an unemployment rate of 10.2% in October. In light of these differences between both worlds, it comes as less of a surprise that the two indexes would tell a somewhat different tale in the near-term. This week's release of the preliminary UM index confirmed that this dichotomy cannot last. The index fell for a second consecutive month in November to 66.0 from 70.6 in October. While households' view of current conditions deteriorated, most of the downward adjustment came from lower expectations component, which has fallen by 9.8 over the last two months. And even though their impact on consumer activities tends to more transient, a slew of negative non-economic news isn't helping either, from the tragedy at Fort Hood to the headlines over H1N1.

As the labor market gradually improves and equity markets look for earning confirmations of improved valuations, the sentiment reflected in both consumer confidence indexes should converge as in previous recoveries. Their expectation components should settle around values suggesting a slow upward grind in spending. Early signs of what the pace of recovery will look like for private sector activity beyond fiscal stimulus are to be found elsewhere. Punching above their considerably diminished weights will be the homebuilding and export sectors. While the U.S. Treasury holds to the script of favoring a strong U.S. dollar, an effectively weaker currency will help to drive the external sector while helping to heal global imbalances. A recent signal from China's central bank that it may resume a gradual appreciation if its currency, likely sometime next year, should help to ensure the dollar depreciation does not come too much at the expense of floating currencies with which imbalances are not significant.


It's an old refrain in Canada. The Canadian dollar had another strong week this week, rising from 93 cents U.S. last Friday to over 95 cents U.S. by the time of writing. Economic indicators were rather light but drew attention once again to a perennial issue faced by the Bank of Canada - how to manage monetary policy when interest sensitive sectors of the domestic economy are thriving but the Canadian dollar is putting pressure on exports.

Data out this week on Canadian housing starts, new home prices and exports served to illustrate this point once again. It is not an overstatement to say that the Canadian housing market has sustained a roaring recovery since the spring of this year. Whether the indicator is home sales, housing starts or home prices, it is clear that the housing market has moved well into expansionary territory. While still down from their peak levels, housing starts rose to 157,300 units in October, up 33% from their trough in April to their highest level so far this year. The gain in October was due to a significant increase in multiple-unit starts but single-units, which rose strongly in the previous month, managed to hold onto most of their gains. Meanwhile, data on new home prices for September echoed what we've seen in the existing home market - in both cases home prices have come off their floor and are on a clear upward trend. The pace of the resurgence of the housing market has led to concerns about the potential for a Canadian housing bubble.

We have written fairly extensively about the impact that the lower interest rate environment and the past fall in home prices has had on housing affordability (, as well as the risks to monetary policy from the resurgent housing market ( In our view, the swiftness of the economic decline in late 2008, contributed to the fall in home sales and home prices observed in the fall and early winter. However, as the dust settled and the economic environment began to improve in the spring, would-be homebuyers were drawn like magnets to the combination of lower home prices and record low interest rates. As a result, pent-up demand was quickly reabsorbed.

With this pool of pent-up demand largely exhausted and the improved pricing environment bringing more sellers back on the market, conditions in the housing market will begin to move into more balanced position, limiting future price gains. Moreover, as the economic recovery spreads to other sectors of the economy, long-term bond-yields will continue to rise, putting upward pressure on mortgage rates and limiting any further gains in housing affordability. Nonetheless, the fast rebound is illustrative of the key difference between financial conditions and the effectiveness of monetary policy in stimulating demand in Canada and the United States. In Canada, the relatively healthier position of the financial sector has allowed the low interest rate environment to feed through to lending growth as evidenced by the rise in mortgage credit growth in recent months.

As for the other half of the story, data out this week were somewhat encouraging that Canadian exports could see an improvement even with the rising Canadian dollar. Canadian merchandise nominal exports rose 3.5% in September, while imports declined slightly by 0.1%. The story on the real side was similar with real exports up 3.4% and imports declining 0.6%. Interestingly, the source of the strength was not a major improvement with our largest trading partner to the south. Instead it was a rise in exports to countries other than the U.S., which grew a whopping 12.4%. For a country that could afford to rely a little less on the U.S. and diversify its trading partners, this is not a bad thing. Nonetheless, as the chart illustrates, we still have a long way to go. For the quarter as a whole, net exports will still subtract from growth, as merchandise imports rose 44% (annualized) compared to the 20% (annualized) improvement in exports. Going forward, the strength of the Canadian dollar remains a concern, and as the Bank of Canada has noted, is the key factor impeding the speed of the Canadian economic recovery.

The Bank will likely continue to walk the tightrope, maintaining its conditional commitment to keep rates at the floor and talking down the Canadian dollar. Nonetheless, should that continue to prove ineffective, more aggressive policy actions will begin to look more and more attractive.


U.S. Retail Sales - October

  • Release Date: November 16/09
  • September Result: total -1.5% M/M; ex-autos 0.4% M/M
  • TD Forecast: total 1.0% M/M; ex-autos 0.5% M/M
  • Consensus: total 0.9% M/M; ex-autos 0.4% M/M
With the U.S. economic recovery appearing to be slowly gathering traction, there are growing indications that consumer spending is beginning to stabilise. Indeed, with core consumer expenditures (retail sales excluding autos and gas) rising in 3 of the last four months and the various consumer confidence measures sitting well above their basement levels of a few months ago, we expect retail sales in October to post a respectable 1.0% M/M advance, following the 1.5% M/M drop in September. Higher automobile and gasoline sales should be the biggest factor pushing the headline number up, and excluding autos, sales should rise at a slightly more modest pace of 0.5% M/M. In the coming month, with U.S. households continuing to navigate against the stiff headwinds coming from a distressed labour market and a depleted balance sheet, we expect retail sales activity to remain relatively subdued, though the recovery in consumer spending should remain on track.

U.S. Consumer Price Index - October

  • Release Date: November 18/09
  • September Result: core 0.2% M/M, 1.6% Y/Y; all-items 0.2% M/M, -1.3% Y/Y
  • TD Forecast: 0.1% M/M, 1.6% Y/Y; all-items 0.3% M/M, -0.2% Y/Y
  • Consensus: core 0.1% M/M, 1.6% Y/Y; all-items 0.2% M/M, -0.2% Y/Y
With the U.S. economy slowly regaining its footing after the deep economic recession, and the base-effect impact from last year's surge in commodity prices virtually washed out of the CPI data, we expect the U.S. economy to record its last negative headline inflation print in October. During the month, the headline CPI index is expected to rise 0.3% M/M, on account of higher food and energy prices. On an annual basis, however, consumer prices are expected to decline 0.2% Y/Y coming on the heels of the more profound 1.3% Y/Y slide the month before. Core energy price are also expected to be higher, rising by 0.1% M/M and bring the annual pace of core consumer price inflation to 1.6% Y/Y, from 1.5% Y/Y in September. Looking ahead, with the considerable economic slack likely to remain a key factor placing downward pressure on core consumer prices, we expect core inflation to ease in the coming months, though headline inflation should creep back into positive territory by the end of the year.

U.S. Housing Starts - October

  • Release Date: November 18/09
  • September Result: 590K
  • TD Forecast: 620K
  • Consensus: 599K
With sales of both new and existing homes rising in 5 of the last 6 months, and the huge overhang of unsold homes falling to its lowest level in many months, there are growing signs that the U.S. housing market is slowly beginning to regain its mojo after suffering from a multi-year correction in both price and activity. Building activity, however, has been quite slow to respond as builders remain cautious, despite the improving economic outlook. In October, we expect new residential construction to rise above the 600K barrier for the first time this year with a print of 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 largely by the rebound in demand for new homes, as homebuyers take advantage of the first-time homebuyer's tax credit, and affordable home prices and mortgage rates. However, in the coming months, with the economic recovery likely to be relatively modest, we expect the rebound in new homes construction to be gradual as the overhang of unsold homes is slowly worked off.


Canadian Manufacturing Shipments - September

  • Release Date: November 16/09
  • August Result: -2.1% M/M
  • TD Forecast: 3.0% M/M
  • Consensus: 0.4% M/M
Despite the combination of a strong domestic currency and weak U.S. demand, the Canadian manufacturing sector should record a stellar performance in September, with shipments expected to rise by a sharp 3.0% M/M, undoing all of the 2.1% M/M decline in August. Much of the boost in activity should come from the automotive industry, given the whopping 15.8% M/M surge in auto exports during the month, while sales of machinery and equipment should also add favourably to the bottom line. Sales of other manufacturing products, however, should be mixed, and shipments of petroleum products are expected to be weaker, on account of lower crude oil prices. In real terms, manufacturing sector activity is expected to advance on the month, suggesting that the sector will contribute positively to Canadian economic activity during the month. In the months ahead, however, we expect the Canadian manufacturing sector to struggle as the combination of a strong domestic currency and weak global demand for Canadian goods dampen sales

Canadian CPI - October

  • Release Date: November 18/09
  • September Result: core 0.3% M/M, 1.5% Y/Y; all-items 0.0% M/M, -0.9% Y/Y
  • TD Forecast: core 0.0% M/M, 1.7% Y/Y; all-items 0.2% M/M, 0.4% Y/Y
  • Consensus: core 0.0 % M/M, 1.7% Y/Y; all-items 0.1 % M/M, 0.3 % Y/Y
With the base-effects from the run-up in energy prices last year fully washed out from the CPI data, the brief flirtation with negative annual headline consumer price inflation rate in Canada should come to an end in October. During the month, we expect higher energy prices, along with the associated higher cost of transportation, and higher mortage rates to push the headline index up 0.2% M/M (up a very strong 0.7% M/M on a seasonally-adjusted basis) in October. On an annual basis, prices are expected to leave the deflationary territory, rising by 0.4% Y/Y, following the 0.9% Y/Y drop in September. Core CPI should be unchanged on the month (up 0.1% M/M on a seasonally adjusted basis), on account of the weak domestic economy, though the annual pace of price inflation should accelerate to 1.7% Y/Y from 1.5% Y/Y. This acceleration in the core inflation rate, however, is expected to be only transitory, and we expect core inflation to soften in the coming months.

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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.

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