Sunday, December 20, 2009

The Weekly Bottom Line

  • Similar to other markets around the globe, speculation in the U.S. this past year revolved around when (and to what extent) the massive monetary stimulus delivered in the prior year would bear fruit.
  • Ultimately, investor confidence and desire for risk taking would return in the first half of 2009, setting the stage for a rebound in economic output in the second half.
  • In 2010, the focal point is likely to shift to the likely monetary policy path of the U.S. Federal Reserve.
  • At this week's FOMC meeting, the Fed left its overnight rate unchanged at 0.00-0.25% and signaled virtually no change despite recent data that suggest a further acceleration in U.S. growth in Q4 2009.
  • With growth in the U.S. economy to decelerate in the quarters ahead, 2010 could mark the second straight year where the Fed Funds rate is left unchanged.
  • The recovery in the Canadian economy is expected to become more pronounced in the fourth quarter, with growth of around 4% annualized.
  • Broad-based growth across both the goods and the services sector can be expected next year, though industries that are more vulnerable to recessions are likely to see a stronger bounce back.
  • Still, several headwinds will persist into 2010, resulting in a more subdued rebound in economic activity than what typically takes place after a recession so deep.


Undeniably, the Fed's decisive action and leadership has been instrumental in bringing the U.S. - and by extension - other economies around the world back from the brink. While actual interest-rate slashing and the unveiling of quantitative easing programs were the story of 2008, market focus in 2009 was more centered on the question of when the massive monetary stimulus would bear fruit. Ultimately, confidence and risk appetite would return with a vengeance in the first half of this year, followed by a resumption of economic growth in the second half. Based on the latest data offerings, U.S. real GDP growth in the world's largest economy is set to accelerate to 4-5% (annualized) in Q4. Furthermore, the November reading on non-farm payrolls provided the clearest evidence yet that the hemorrhaging in the U.S. job market is over. Renewed hiring by U.S. businesses, which have recently become lean and mean, is a necessary condition for a sustained recovery.

As we head into the New Year, speculation on the timing of the Fed's exit from the current period of stimulus promises to be the dominant theme in financial circles in 2010. Still, the most recent Fed musings suggest that we remain a long way off from an actual rate hike. Buzz about imminent Fed hikes is likely to be more of a story for the second half of the year than the first.

Consider this past week's FOMC meeting, which concluded with a decision to leave the official rate unchanged at a range of 0.00-0.25%. The accompanying statement contained few surprises. Unaltered from the previous meeting were the discount rate, the quantitative easing framework and the commitment to keep rates “exceptionally low” for an “extended period”. There was some modest tweaking of the language to acknowledge that the “deterioration in the labor market is abating”, although there remained caution about the outlook for household spending. The Fed reiterated its earlier announcement that the expirations of most liquidity facilities would be maintained until February 1st.

The pace at which the Fed will shift its stance in the months ahead will depend on the pace of recovery in the economy and job markets. In this week's release of the TD Quarterly Economic Forecast, we argue that the pace of U.S. growth will likely decline to roughly one-half its Q4 rate in the first half of 2010 and strengthen only modestly in the second half. With high unemployment expected to remain a challenge, U.S. consumers will have limited capacity to ramp up their spending. And some of the sectors that have been bouncing back from their recessionary lows - such as exports and housing activity - won't be able to sustain their recent rapid clip.

The tepid growth on tap for 2010 points to an ongoing abundance of slack in product and labor markets. Although disinflation pressures appear to have eased of late - as highlighted in the November CPI report out this week - the risks will remain tilted towards lower, rather than higher, consumer price growth in 2010.

In sum, the likely profile of U.S. growth and inflation trends suggest that the first Fed rate hike won't take place at all in 2010. In our view, it will be Q1 2011 before Bernanke et al pull the trigger, which would mark the unusual occurrence of two consecutive years when the official rate has remained unchanged. This is not to say that bond markets won't start to aggressively price in higher rates as the Fed begins to parlay a change in stance. But this is more likely to occur towards the middle of 2010. In the meantime, the yield curve will remain extremely steep. What's more, ongoing negative interest-rate differentials between the U.S. and other countries will also put a lid on how much the U.S. greenback can strengthen in the year ahead. For more details, please refer to TD Securities 2010 Outlook and Trading Themes, available on the TD Economics website.


At the start of this year, the outlook for the Canadian economy was quite gloomy, as it had just entered into the recession. But after contracting by 3.3% peak-to-trough, we have already begun to see budding signs of a recovery. As such, the prospects for 2010 are much brighter.

After posting a tepid - yet positive - 0.4% annualized growth rate in Q3 2009, several indicators are pointing to robust growth in economic activity during the final three months of the year. Strength in the housing market, healthy consumer spending and an uptick in business sentiment will likely lead to a more convincing 4.1% rebound in real GDP growth in Q4. This momentum will carry through into 2010, placing Canada first (along with the United States) among the G-7 nations.

We expect to see broad-based growth across both the goods and the services sectors next year, though industries that are more vulnerable to recessions are likely to see more upside during the recovery phase since these were the areas that were hit hardest on the way down. In fact, we are already seeing evidence of this trend in the manufacturing and construction sectors - both of which are very cyclically sensitive.

While we expect these sectors to be among the top performers in 2010, alongside related services sectors - wholesale trade and finance, real estate and legal services - the picture is not as rosy at it might seem. Despite the pick-up in manufacturing activity, output levels will still fall well short of the heights seen during the first half of the decade, and it could take several years to get back to those levels. Moreover, much of the growth in the factory sector has stemmed from a surge in auto and parts production. And this strength is likely to taper off by mid-year once inventories - which were drawn down by the Cash for Clunkers program in the U.S. - are replenished. Similarly, infrastructure spending and momentum in the housing market is likely to cool by mid-2010, setting the stage for a slowdown in construction activity. So after emerging from the recession on a high note, growth in these sectors is likely to slow as 2010 comes to a close.

Elsewhere, growth will be more muted as several challenges will persist into next year. Though we expect to see Economicsreal domestic demand advance at a healthy 3% clip in 2010, consumers are likely to remain cautious in their spending habits given the ongoing weakness in the labour market - job creation will improve only gradually and the unemployment rate is likely to remain above 8% throughout the year. Moreover, while deficit-challenged governments are unlikely to upset tentative recoveries by cutting expenditures aggressively next year, the 2010 budgets could begin the process of paring back some stimulus measures that have been helping to prop up spending.

Perhaps the biggest impediment to the recovery in Canada will be the high-flying loonie. Despite falling to 93 US cents this week, the Canadian dollar is likely to remain quite elevated, hovering around parity with the greenback throughout 2010. This will limit Canada's competitiveness in foreign markets and hence, export growth. In addition to an elevated currency, exporters will also be faced with sluggish demand from the U.S. - where the majority of Canadian goods are destined - weighing on export growth even more.

All factors combined, the bounce back in economic activity in 2010 will be much softer than what typically takes place after a recession so deep. But while the recovery may be more subdued this time around, a recovery will nonetheless take place.


U.S. Personal Income & Spending - November

  • Release Date: December 23/09
  • October Result: income 0.2% M/M, spending 0.7% M/M; core PCE deflator 0.2% M/M, 1.4% Y/Y
  • TD Forecast: income 0.6% M/M; spending 0.6% M/M; core PCE deflator 0.1% M/M, 1.6% Y/Y
  • Consensus: income 0.5% M/M; spending 0.7% M/M; core PCE deflator 0.1% M/M, 1.6% Y/Y
The U.S. economic recovery is clearly gathering traction, and there are encouraging signs that the U.S. households are beginning to slowly regain their appetite for spending, buoyed in large part by the improving economic outlook. In November, we expect personal income to rise by its largest margin since May, with a 0.6% M/M surge, boosted in large part by the massive spike in aggregate hours worked. Personal consumption expenditures should also be quite strong on the month, posting its sixth monthly advance in seven months, with a 0.6% M/M gain. Evidence of the strength in personal consumption expenditures has been seen in the corresponding retail sales report, which rose by 1.3% M/M in November, providing an upside risk to this call. On the inflation front, the core PCE deflator is expected to rise by a modest 0.1% M/M, with the annual pace of core PCE inflation rising to 1.6% Y/Y, from 1.4% Y/Y in October. In the coming months, we expect the core PCE deflator to ease as the growing economic slack in the U.S. economy dampens core consumer price pressures.

U.S. Durable Goods Orders - November

  • Release Date: December 24/09
  • October Result: total -0.6% M/M; ex-transportation -1.3% M/M
  • TD Forecast: total 0.5% M/M; ex-transportation 1.5% M/M
  • Consensus: total 0.3% M/M; ex-transportation 1.0% M/M
As the U.S. economic recovery takes shape, we anticipate that durable goods orders will regain some positive momentum in November, with the new orders expected to rise by 0.5% M/M, following the 0.6% M/M drop the month before. Much of the improvement should come from a bounce-back in orders for machinery, who posted a big 8.5% M/M drop in October. Weak aircraft orders should be a source of drag on the headline number during the month, and excluding transportation, orders are expected to rise by a more profound 1.5% M/M. In the coming months, as the economic recovery gathers further traction, we expect orders to stay in positive territory as U.S. businesses replenish their depleted capital stock in anticipation of the pick-up in demand.


Canadian Retail Sales - October

  • Release Date: December 21/09
  • September Result: total 1.0% M/M; ex-autos 1.1% M/M
  • TD Forecast: total 0.6% M/M; ex-autos 0.0% M/M
  • Consensus: total 0.8% M/M; ex-autos 0.5% M/M
Given a fairly robust domestic economy and a booming housing market, Canadian households have kept the cash tills busy in recent months with retail sales activity rising at a 1.0% M/M or better pace in 4 of the last 5 months. Much of this recent upward momentum in spending has come from strong motor vehicle sales, while home furnishing-related expenditures have also provided favourable support. This momentum is expected to continue in October, with strong motor vehicle sales expected to bolster headline retail sales up a further 0.6% M/M. Additional upside support should come from expenditures on housing related items, on account of the buoyancy in Canadian housing market activity. Excluding autos, retail sales are expected to be flat, while real retail sales should be modest. In the months ahead, with Canadian labour market conditions expected to be mixed, consumer spending growth should be stop-and-go, but more often “go”.

Canadian Real GDP - October

  • Release Date: December 23/09
  • September Result: 0.4% M/M
  • TD Forecast: 0.3% M/M
  • Consensus: 0.3% M/M
The Canadian economy is slowly emerging from the deep economic recession, supported in large part by the boom in housing market activity and strong consumer spending. In October, we expect the economy to record its second consecutive monthly advance with a modest 0.3% M/M gain. Strong manufacturing and housing market activity should provide the key support for economic activity during the month, while residential construction should also add favourably to GDP. Overall, we expect both goods-producing and service-producing sectors of the economy to grow. In the coming months, the Canadian economic recovery should remain intact, as the significant monetary and fiscal policy stimulus administered to the Canadian economy gathers traction, though the recovery is likely to be both slow and fragile.

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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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