Sunday, February 21, 2010


  • Philadelphia and Empire manufacturing indexes rise in January, pointing to continued recovery in the country's goods producing sector.
  • Housing starts rise in January and are now 23% below their trough in April of last year.
  • Weekly jobless claims move up and barely budge on a four quarter moving average basis.
  • Headline inflation falls to 2.6% from 2.5% in December. Core inflation falls to 1.6% from 1.8%
  • FOMC minutes discuss exit strategy and reflect an improved assessment of economic and financial conditions.
  • The Canadian Federal Department of Finance announced three changes to mortgage insurance rules that will help to cool the Canadian real estate market.
  • Canadian Resale housing market data over the last three months suggest activity is cooling. Homes sales fell 2.8% in January, the first decline in over a year. However, a lack of supply continued to push upward pressure on prices, and home prices rose 22% from year ago levels.
  • Canadian headline CPI rose 1.9% in January, up from 1.3% in December, the largest increase since November of 2008. The Bank of Canada's core measure of inflation rose to 2.0%.
  • Canadian retail sales rose 0.4% in December. Stripping out price effects, the month's gain was slightly stronger at 0.6%. The gain was broad based with 9 of the 12 components of retail spending increasing in the month, and underscores the strength in the Canadian domestic economy.
Like an athlete coming off an injury, the U.S. economy continued on its path to recovery this week. But, in amongst the relatively positive economic data were hints of risks - cracks in the ice you could say - that one can not lose site of or risk tripping before the finish line. There are three risks that are especially worth paying attention to: employment, housing and exit strategy.

On the job front, regional manufacturing surveys continued to show rising production levels this week and also improvement in employment sub-indexes. Nonetheless, despite early signs of renewed hiring in the manufacturing sector, evidence of broader improvement in employment is harder to come by. In fact, weekly initial jobless claims rose in the second week of February, and on a four-week moving average basis have remained mired above the 450,000 since early January. While census hiring will add significantly to government payrolls over the coming months, private sector hiring is the real number to watch. As we argue in our report, “Consumer Credit & Household Deleveraging,” the supply and demand for credit remains constrained, and sustainable job and income growth are the real key to a recovery in U.S. consumption.
This week also brought us data on U.S. housing starts and on the 800 pound gorilla in the room - delinquency and foreclosure rates. Needless to say, the housing sector has had a disproportionately large impact on the glide path of the U.S. economy. Housing construction is certainly part of this picture. The decline in residential construction investment subtracted close to a full percentage point from U.S. economic growth in the three years up to and including the recession. So, it is a positive sign that after having fallen a truly astonishing 79%, housing starts have since rebounded by 23%. With new housing construction running close to replacement but well below population growth, there is little risk of future inventory problems in new housing. However, such is not the case in the existing market. While the month's supply of unsold homes fell through 2009, “shadow inventory” looms large. Foreclosure data from the Mortgage Broker's Association indicated that in the fourth quarter of 2009, a full 15% of mortgages were either late on their payments or in foreclosure. The foreclosure rate is closely related to the 8.5 million jobs lost over the course of the recession. As long as job growth turns positive, the delinquency rate will fall. Nonetheless, with over half of the currently delinquent mortgages more than ninety days or more behind on their payments, the efforts of policy makers to stem the foreclosure rate will also be important.

Should all of the more than 4 million seriously delinquent loans all hit the market in 2010, home prices would likely fall an additional 15% - that's one big ice rut to skate over.

Finally, in the minutes of the Federal Open Market Committee (FOMC) we heard more on the Federal Reserve's exit strategy. After substantial liquidity and monetary injections, the Fed has now begun the process of unwinding its emergency support for financial markets, announcing in recent statements the closure of auction facilities and final dates for bond purchases. This week the FRB also moved the discount rate from 0.50% to 0.75%. It should be noted that this does not signal a tightening of monetary policy, and the bellwether overnight rate remains unchanged at the range of 0.0% to 0.25%. Rather it simply represents a move away from emergency like conditions and towards more normal conduct of policy.

As we have argued in the past, there is little reason to doubt the Fed's ability to withdraw monetary stimulus, and as the Fed has emphasized, the ability to pay interest on excess reserves enables them to maintain a larger balance sheet without much risk of stoking inflation. The real question is whether they get the timing right. It is a skate's edge between rising inflation and a relapse into recession. Fortunately, inflation numbers continue to soften -caused in no small part by ongoing woes in housing and slack labor markets. As long as inflation remains soft and inflation expectations well contained, the case for keeping rates low “for an extended period of time” will remain strong. We continue to expect the Fed to leave the overnight rate unchanged until the first quarter of 2011.


The Canadian real estate market was yet again at centre stage this week, as the Department of Finance announced the long anticipated new regulations for government insured mortgages to take affect April 19th. The new rules are as follows: First, mortgage loans will be income-tested against the 5-year posted rate, rather than the current practice of using the 3-year posted rate. Second, mortgage refinancing will be restricted to 90% of the value of the home, down from 95%. Third, buyers of non-owner occupied dwellings will need to provide a 20% down payment. For a more detailed analysis on these new regulations please see TD Economics Report : “Prudential Changes to Canadian Mortgage Insurance Rules”.

In announcing the new regulations, the department of Finance was taking a “proactive” role rather than a reactive stance to ensure “long-term stability” in the Canadian real estate market. It has been our view, and the view of most policy makers, that a bubble has not formed in the Canadian real estate market. And indeed, recent CREA housing market data have shown some signs of cooling. (See TD Economics Report : Signs of Cooling in Canada's Resale housing Market” ) As such, the regulations were introduced with two key objectives. First, by limiting leverage available to investors, the regulation is meant to curb any potential speculation that could occur, given the recent strength in home prices. Second, by limiting the amount of debt that households can take on, the regulations are aimed at preventing some households from getting over extended with debt. During the recession, favourable borrowing conditions in Canada have allowed households to take ad¬vantage of record low interest rates to underpin household spending and investment through the last half of 2009. But the rate of debt accumulation has raised concerns over the state of the household balance sheet, and that households may not be prepared for the future rise in interest rates. We have estimated that given the current level of debt, a return to a neutral monetary policy stance will lift debt service costs to 9.3% of income by 2013- a 20 year high, and up from its current level of 6%. This will have significant implications for the economic outlook. While we have seen an impressive rebound in consumer spending during the first two quarters of the recovery, large debt levels could become an impediment to consumer spending once interest rates start to rise, as households will have to devote a greater share of their income to servicing their debt.

More importantly, the new mortgage rules will allow the Bank of Canada to take their attention away from the housing market, and focus on inflation and broader economic conditions. But, with the housing market off the Bank's radar, a spike in inflation in January has raised concerns that the Bank of Canada should hike rates sooner - a call we think is premature. The Bank of Canada's core measure of inflation spiked to 2% in January, reaching its target a year and a half before expected. Surprisingly, this was not housing related. In fact, the price of housing related goods and services such as mortgage interest costs, and household furnishings and equipment continued to decline on an annual basis. We believe that the spike in inflation will prove to be short-lived, as part of the rise in core inflation was largely due to a base year effect - prices fell significantly in January of 2009. As this effect falls out of the calculation in February, core inflation will likely moderate back below the Bank of Canada's target. However, inflationary pressures also stemmed from a continued spike in the cost of purchasing and leasing of motor vehicles, as auto dealers have begun to rein in incentive purchase programs in the wake of improving economic conditions, as well as a broad based strength in services excluding shelter costs. While these services tend to be less cyclical than other goods, the sharp jump in these prices is still surprising, and may continue to linger. Nonetheless, we continue to believe significant slack that exists in the Canadian economy, in combination with a strong Canadian dollar, will lower core inflation to the range of 1.6-1.8% over 2010. As such, we believe that the recent jump in core inflation should not be a cause for concern for the Bank of Canada, and the Bank will be able to meet its commitment to keep rates low at least until July of 2010.


U.S. Durable Goods Orders - January

  • Release Date: February 25, 2010
  • December Result: total 1.0% M/M; ex-transportation 1.4% M/M
  • TD Forecast: total 1.5% M/M; ex-transportation 1.0% M/M
  • Consensus: total 1.4% M/M; ex-transportation 1.1% M/M
U.S. business investment appears now to be on the upswing, with businesses beginning to replenish their capital stock in anticipation of a recovery in demand for their products. This improved tone in business investment is expected to be reflected in new durable goods orders in January, which we expect to rise by 1.5% M/M following the 1.0% gain the month before. Much of this uptick in new orders is expected to be on account of stronger transportation orders, with total new orders less transportation equipment should advance by a more modest 1.0% M/M. Core capital goods orders should also be higher, reflecting the improved tone of overall business activity. In the coming months, with the economic recovery expected to gather further traction, new durable goods orders should stay in positive territory as U.S. businesses continue to rebuild their depleted capital stock.
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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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