Sunday, December 13, 2009

The Weekly Bottom Line

  • U.S. trade deficit narrows in October by 7.6% as nominal goods exports rise 2.6% (imports up 0.4%). The story is even better in real terms with real goods exports up 4.1% and imports flat.
  • U.S. consumers hit the malls and gas stations in November, pushing total retail sales up 1.3%. Ex-auto spending up 1.2%. Core retail sales up 0.6%.
  • But even while spending rebounds, U.S. households appear to be putting less on their credit cards. U.S. consumer credit data fell 3.2% (annualized) in October led by a 7.1% (annualized) fall in revolving credit.
  • The Bank of Canada Bank reiterated its conditional commitment to keep rates at their effective lower bound until mid-2010, with no major changes to their outlook. However, the Bank has become increasingly concerned over the household balance sheet position.
  • Housing starts were flat in November, at 158,500 units. However, the weaker-than-expected performance was largely driven by a 1.7% M/M decline in the volatile multiple units' component. A 3.4% rise in single units is a better sign of the underlying strength in homebuilding.


Signs that the U.S. recovery gained steam in the final quarter of 2009 abounded this week. First, data on retail sales showed that the all important U.S. consumer continued to rebound in November. The U.S. economy is also getting some much needed support from the economic recovery abroad, which along with the falling U.S. dollar, drove up demand for U.S. exports and helped to further narrow the trade deficit in October. Given these and other positive developments, growth in the fourth quarter is likely to come between 3.5% to 4.0% (annualized) - not a bad way to end the year.

Details of the main reports out this week were unambiguously positive for near-term U.S. growth. First on the docket: the trade balance for October. While we must be careful about placing all our eggs in one month of data, the absolute magnitude of the rise in real goods exports in October (+4.1%) following an even larger 4.3% gain in September cannot be discounted. Even if exports were to fall in the final two months of the year, it would take close to a disaster to prevent exports from contributing positively to economic growth in the fourth quarter.
Of course, from the point of view of headline GDP, what matters is net exports (exports minus imports). The sharp drop off in domestic demand through the recession coupled with the decline in global energy prices, had the side-effect of causing a massive improvement in the U.S. trade deficit over the past year. From over $65 billion in June 2008, the U.S. trade deficit has narrowed to under $32 billion - a 49% improvement. Given the improvement in domestic demand over the past several months, we expect imports to rebound further in the remainder of the year, and in the end, net trade will likely be fairly close to neutral for overall growth in the fourth quarter. Nonetheless, given the amount by which the volume of imports fell during the recession (-21% peak-to-trough) compared to a -15% peak-to-trough movement in exports, the fact that net trade is being supported by strong export growth, despite rebounding imports, is a very good sign for the U.S. economy and one that - should it be sustained - would be a very positive development for the economy in the coming year.
On the domestic front, retail sales data for November soundly beat expectations, advancing by 1.3% in November after a 1.1% rise in October. The details of the report were equally strong, suggesting that consumers increased their spending on a broad range of goods in the month. While sales still remain below their peak, they have risen 5% from their low in December. November's results strengthen our forecast that consumer spending is likely to be an important contributor to economic growth in the fourth quarter. While spending on motor-vehicles will likely subtract slightly from growth due to the give back from cash-for-clunkers, total real spending will likely rise by over 2% in the quarter.

Signs of the recovery are getting stronger by the day, but we remain attune to the factors that may suppress the speed of ascent over the next year. One of these is this pace of consumer borrowing. Early this week, data on U.S. consumer credit were released. Consumer credit continued to fall in October (-3.2%), led by a deep drop in revolving consumer credit (-7.1%), which is made up almost entirely of credit card debt. Pressures on consumer lending are coming from both the supply and demand side. While the Federal Reserve's Senior Loan Officer Survey points to fewer banks tightening credit standards to new credit applicants, the number of banks reporting an increase in interest rate spreads on credit cards and higher required minimum down payments continued to rise in the fourth quarter of the year. Moreover, on the demand side, consumer confidence appears to be on the mend, but the drive to pay down credit cards also seems to be gaining momentum. Demand for consumer credit (according to the Senior Loan Officer Survey) remains in the tank and as the consumer credit data show, this is translating into less new credit and more debt repayment. The trend towards paying down debt will be an important factor to watch in the coming year and as fiscal stimulus is wound down, household deleveraging is likely to be one of the limiting factors to the pace of economic growth through 2010.


We heard from the Bank of Canada this week, but there were no new developments on monetary policy. The Bank reiterated its conditional commitment to keep rates at their effective lower bound until mid-2010. And in the communiqué, the Bank stated that the risks to the outlook have not changed since their October Monetary Policy report, with the downside risks still being a “protracted global recovery and a strengthening Canadian dollar”. But that's not all the Bank is worried about. We heard from Governor Mark Carney later in the week stating that he Bank has become increasingly worried that the amount of debt that households are taking on could result in financial stress as interest rates start to rise.

Indeed, household debt accumulation has been remarkable given the severity of the recession, and given the moderation in income growth. This is a bit of a conundrum for the Central Bank. On the one hand, they cut interest rates to such low levels to underpin household spending and investment in housing, which in turn has helped lead the economy into recovery. And, indeed, further evidence of housing strength came out this week. Although housing starts were basically flat in November, the response of homebuilders to rising home prices has been surprising, with housing starts up 34% from their trough in April of this year. But on the other hand, the high level of debt taken on by households may pose a challenge to domestic demand as interest rates rise in the future. As shown in the accompanying chart, household debt has been running well above personal income - a development that is unsustainable. As such, we predict that as households curtail their rate of debt accumulation, growth in Canadian consumer spending and residential investment will moderate through 2011-2012.

Meanwhile, the Canadian dollar has gotten a lot of attention as a significant risk to the Canadian economic outlook due to its negative implications on net trade. This might be hard to believe given that as of October, exports rose for four of the last five months, the best performance in over five years - despite a 14% appreciation in the loonie since April. And following three months of record deficits, the merchandise trade balance edged back into positive territory in the month. While this is great news, we don't expect this momentum to last.
Much of the recent strength in exports can be attributed to the U.S. cash for clunkers program supporting Canadian Analyticsexports of motor vehicles, and global restocking. Even though the cash for clunkers program came to an end in September of this year, the strong motor vehicle sales in the U.S. drove inventory levels of autos down significantly, and the inventory-to-sales ratio of these goods stateside fell to an 8-year low in August. The need to replenish these stocks has helped support Canadian exports into October. But, U.S. demand for motor vehicles has since moderated, and the inventory-to-sales ratio has climbed to a five year high indicating that the boon from U.S. demand for autos on Canadian exports may fade.

Meanwhile, exports to Europe, Japan, and other OECD countries have also strengthened significantly in the last five months. Strong growth in industrial production in these countries has driven demand for Canadian commodities. However, the majority of Canadian exports are still U.S. bound. As such, we expect that going forward, growth in Canadian exports will follow the mild recovery we expect to unfold in the United States.
Unlike the Bank of Canada, we put slightly more weight on the downside risks associated with the above risks to the Canadian economy. As such, the Bank's projection for 3.0% growth in 2010 and 3.3% in 2011 is slightly more optimistic than our forecast for growth of 2.7% and 3.0% respectively. We believe that the slower growth path for real GDP will keep the Bank of Canada on the sidelines past its conditional commitment, and the first rate hike will not come until the fourth quarter of 2010.


U.S. Consumer Price Index - November

  • Release Date: December 16/09
  • October Result: core 0.2% M/M, 1.7% Y/Y; all-items 0.3% M/M, -0.2% Y/Y
  • TD Forecast: 0.2% M/M, 1.8% Y/Y; all-items 0.4% M/M, 1.9% Y/Y
  • Consensus: core 0.1% M/M, 1.8% Y/Y; all-items 0.4% M/M, 1.8% Y/Y
With the U.S. economic recovery beginning to gather traction, and the base-effect impact from last year's run-up in commodity prices fully washed out of the CPI data, we expect the U.S. economy to record its first positive headline inflation print since February this year. In November, the headline CPI index is expected to rise 0.4% M/M, on account of higher food and energy prices. On an annual basis, consumer prices are expected to pop to 1.9% Y/Y following the 0.2% Y/Y drop the month before. Core energy price are also expected to be higher, rising by 0.2% M/M, and bringing the annual pace of core consumer price inflation to 1.8% Y/Y from 1.6% Y/Y in October. 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.

U.S. Housing Starts - November

  • Release Date: December 16/09
  • November Result: 529K
  • TD Forecast: 600K
  • Consensus: 574K
With sales of U.S. homes continuing to gather momentum, and the huge overhang of unsold homes dwindling to its lowest level in many months, there are growing signs that the recovery in the U.S. housing market is slowly gaining traction, after suffering a severe multi-year correction in both price and activity. Building activity, however, has been quite slow to respond as homebuilders cautiously await a sustained pick-up in demand, even despite an improving economic outlook. In November, we expect new residential construction to rise to 600K, following the unexpected sharp drop the month before. The pick-up in construction activity is likely to be driven largely by the rebound in the volatile multi-units segment, though single-family construction should also rise. 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.

FOMC Interest Rate Decision

  • Release Date: December 16/09
  • 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 December 16, and markets will undoubtedly look beyond the actual interest rate announcement, and focus instead on the tone and wording of the actual communiqué. In this regard, we expect the economic assessment to remain largely intact, with the Fed reiterating the improving outlook for the U.S. economy, reflecting in part the encouraging tone in the recent economic reports. The inflation outlook should also remain unchanged, with the Committee noting that it expects inflation to remain “subdued”, on account of the “substantial resource slack” and stable longer-term inflation expectations. We also expect the Fed to reaffirm the Committee's commitment to “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.” Further, the Statement should avoid any mention of exit strategies in the communiqué, though, of course, the discussion on this topic will likely continue at the meeting.


Canadian Manufacturing Shipments - October

  • Release Date: December 16/09
  • September Result: 1.4% M/M
  • TD Forecast: 1.0% M/M
  • Consensus: 0.5% M/M
Despite the combination of a strong domestic currency and weak U.S. demand, the Canadian manufacturing sector should enjoy another month of strong gains in October, with shipments expected to rise by a respectable 1.0% M/M, following a similar gain the month before. Much of the boost in activity should come from the sale of petroleum and industrial products, while sales of transportation equipment should also add favourably to the bottom line. In real terms, manufacturing sector activity is also expected to advance on the month, suggesting that the sector will contribute positively to Canadian economic activity in October. 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 products dampen sales.

Canadian CPI - November

  • Release Date: December 17/09
  • October Result: core 0.1% M/M, 1.8% Y/Y; all-items -0.1% M/M, 0.1% Y/Y
  • TD Forecast: core 0.2% M/M, 1.2% Y/Y; all-items 0.5% M/M, 0.9% Y/Y
  • Consensus: core 0.1% M/M, 1.2% Y/Y; all-items 0.3% M/M, 0.8% Y/Y
The brief flirtation with negative inflation in Canada is over, and as the economy recovers, the annual rate of headline consumer price inflation should begin to slowly march higher. In November, we expect higher energy prices, along with the associated higher cost of transportation to push the headline index up 0.5% M/M on both a seasonally-adjusted and nonseasonally adjusted basis. The annual pace of inflation should rise sharply to 0.9% Y/Y, from 0.1% Y/Y in October. Core CPI should also be higher on the month, rising by 0.2% M/M (up 0.1% M/M on a seasonally adjusted basis), though the annual pace of price inflation should plunge to 1.2% Y/Y from 1.8% Y/Y, underscoring the weak economic backdrop. In the months ahead, we expect core inflation to ease further as the weak economic conditions further dampen the inflationary flames.

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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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