*HIGHLIGHTS OF THE WEEK*
United States
* A mixed week in equity markets as analysts parse through earnings
reports. U.S. bond yields push up slightly on positive economic
data.
* Housing demand showing signs of life with existing home sales up
12.3% and month's supply falling to its lowest level since March
2010.
* But, with shadow inventories still looming, housing starts fall to
their lowest level in over a year at 529,000.
* Clearing distressed properties will be key to pulling the housing
market out of its prolonged stump. With rising demand, that could
well happen in 2011, setting the stage for a robust recovery in
2012 and beyond.
Canada
* Bank of Canada holds overnight rate steady at 1.00%.
* Bank cites the impact of an elevated Canadian dollar on the
nation's export sector and high household indebtedness as two key
risks surrounding its outlook in January Monetary Policy Report.
* Introduction of new mortgage lending rules should ease some of the
pressure off of the Bank of Canada to raise interest rates faster
in order to stem unsustainable household debt growth.
* Evidence further solidifies our expectation that Bank will remain
on hold until second half of this year.
After several positive weeks, stock markets gave back some of their
gains this week as a spattering of disappointing earnings reports from
the nations' financial institutions were released. While credit
conditions are showing improvement, one key question with respect to
financials, and indeed the broader economy, is what will become of the
housing market. So, while analysts parsed through earnings reports,
economists were busy parsing through data on existing home sales and
housing starts. In the world of economic releases, this was a housing
week.
Interpreting conditions in the housing market is never an easy task,
but it has been made even more difficult over the last several months
by the impact of temporary tax stimulus. Fortunately, the distorting
impact of the homebuyer's tax credit is now in the rear-view mirror.
We can now say with a higher degree of certainty that with a12.3%
monthly increase in existing home sales in December, that housing
demand is showing some genuine signs of life.
The reappearance of housing demand is a necessary, though not
sufficient condition to resolving the foreclosure crisis and pulling
the housing market out of its prolonged slump. As a measure of how
important the foreclosure issue is to activity in the existing market
- sales of distressed properties accounted for 36% of total home sales
in December, up from 33% in November. The discount at which distressed
properties sell on the market is behind the 0.8% decline in the median
home price in December. Falling home prices are often considered a
negative because of their impact on household wealth, but in the
current situation they too are a necessary condition to clearing the
still hefty supply of seriously delinquent loans from the market (see
below).
Fortunately, the housing market appears closer to the end of this
process than to the beginning. Delinquency rates have fallen
consistently over the past several quarters, driven by the improvement
in the economy and the return to positive job growth. With job growth
expected to pick up speed in 2011, this should put more households in
good standing to make their mortgage payments. The key to housing will
then be clearing through the excess supply at the back end. The faster
this supply can be worked through, the sooner home prices will move
positive and housing construction will respond.
In the book on leading economic indicators one of the most prominently
featured indicators is housing starts. Given the events of the last
three years, they may have to revise this section. Housing starts
continued to fall in December, reaching their lowest level in over a
year at just 529,000 (annualized units). While building permits shot
up, this was due to impending regulation changes in a number of states
(CA, PA, NY) and is likely to fall out of the data over the next few
months.
Despite December's results, in the long run there are reasons to be
optimistic about new housing construction. In particular, with housing
starts falling well below population and trend household growth, the
only thing keeping construction from shooting up is the inventory of
distressed sales. Once that is worked through, housing starts could
double from their currently very low base, over the next several
years. All told, with continued signs of broader economic recovery,
2011 could well be the year that the housing market finally finds a
cure for its hangover, setting the stage for a robust recovery in 2012
and beyond.
For the better part of a year, the Bank of Canada has been between a
rock and a hard place. First, household debt has been rising at an
unsustainable pace, and second, a Loonie flying at parity has been
very rapidly eroding the competitiveness of an already weak export
sector. Unfortunately, the two have opposing implications for monetary
policy. Keeping interest rates too low for too long may incite more
debt-fuelled consumption, but raising interest rates too quickly may
cause additional upward pressure on the Canadian dollar. This is due
to the fact that an increasing gap between Canadian and U.S.
short-term interest rates puts considerable upward pressure on its
value. And with the Federal Funds Rate firm at its 0-0.25% range, this
gap has widened considerably in the past 18 months. The spread on
3-month t-bills has risen from less than 5 bps in July 2009 to about
90 bps currently. Over that same time period, the Loonie has gone from
86 cents to parity. Indeed, this week's release of the Bank of
Canada's January Monetary Policy Report (MPR) highlighted these two
factors as the primary risks surrounding an otherwise balanced
outlook.
Amidst these crosscurrents, the Bank opting to leave the Overnight
Rate unchanged at 1.00% this week provides some indication that the
currency perhaps carries more weight. In the interest rate decision
communiqué, the Bank stated that "the cumulative effects of the
persistent strength in the Canadian dollar and Canada's poor relative
productivity performance are restraining this recovery in net exports
and contributing to a widening of Canada's current account deficit to
a 20-year high." The sector, which has historically been a key source
of growth in past recoveries, has regained less than one-third of its
recessionary losses. Though the Bank cited stronger growth in the
U.S., Euro-area, and emerging economies in the January MPR, Canadian
growth was upgraded only slightly, by 0.1 percentage points in 2011
and 0.2 percentage points in 2012. In other words, their outlook for
the export sector remains hampered by the Loonie.
However, there is more than meets the eye. The recent moderation in
real output growth has led to much weaker price pressures. Core
inflation has fallen from more than 2.0% Y/Y in January 2010, to just
1.4% as of November. And with the Bank's latest forecast indicating
that they do not expect core inflation to return to 2% until the end
of 2012, it is clear that they feel the 1.00% Overnight Rate is also
consistent with their inflation target. Moreover, some of the pressure
from the household indebtedness issue was eased due to the
introduction of new mortgage lending rules by the federal government
this week. Namely, the maximum amortization period for insured
mortgages was lowered by 5 years to 30 years, the amount of home
equity that one is able to take out as a line of credit (HELOC) was
lowered to 85% from 90%, and HELOCs are now no longer insurable. This
shifts the onus of scaling back household debt growth onto the
households themselves and the financial institutions.
So where does this leave the interest rate outlook? The dovish tone of
the communiqué of the interest rate decision, the only marginal
upgrade to Canadian growth, and the new mortgage lending rules all
further solidify our expectation that the Bank will remain on hold
until the second half of this year. We anticipate the Overnight Rate
to rise to 2.00% by year-end and 3.00% by the end of 2012.
!! U.S. FOMC Interest Rate Decision !!
* Release Date: January 26, 2011
* Current Rate: 0.0 0% to 0.25%
* TD Forecast: 0.0 0% to 0.25%
* Consensus: 0.0 0% to 0.25%
The shift in the composition of the FOMC in 2011 to a slightly more
hawkish Committee is unlikely to change the tone and language of the
communiqué accompanying the interest rate decision. We expect the
Fed to reiterate its commitment to keeping rates "exceptionally low
for an extended period" and reaffirming its willingness to "employ
its policy tools as necessary to support the economic recovery and
to help ensure that inflation, over time, is at levels consistent
with its mandate." The statement should also reiterate the Fed's
intention to purchase $600B in longerterm Treasury securities. The
economic assessment should also be essentially unchanged, repeating
its reference to the "economic recovery continuing". The inflation
assessment should remain largely intact, with the Committee
reiterating its concerns about the subdued inflation trends. Where
the difference will lie in the Statement is with the dissention to
the majority decision. Kansas City Fed President Hoenig, who has
dissented at every FOMC decision in 2010 in favor of removing the
"extended period" language and opposed QE2 will no longer be a
voting member of the Committee. However, his dissent is likely to be
taken by Philadelphia Fed President Plosser who has been equally
vocal in his opposition to the current monetary policy stance.
Dallas Fed President Fisher and Minneapolis Fed President
Kocherlakota are also of hawkish persuasion, but they are unlikely
to dissent at this meeting.
!! U.S. Real GDP - Q4/10 !!
* Release Date: January 28, 2011
* Q3 Result: 2.6% Q/Q ann.
* TD Forecast: 3.0% Q/Q ann., Consensus: 3.4% Q/Q ann.
The US economy is beginning to pick-up significant tailwind on
account of the support from accommodative fiscal and monetary
policies. In Q4, we expect the economic recovery to shift up a gear
with GDP growing at a respectable 3.0% Q/Q ann. pace. Strong
consumer spending, which accounts for close to 70% of overall U.S.
economic activity, should be the key driver for the burst in
activity, with personal consumption expenditures expected to grow in
excess of 3.5% Q/Q - its fastest pace since late 2006. Business
investment should also contribute positively to growth, with
spending on M&E investment more than compensating for the drop in
investment spending on non-residential structures. Residential
construction should decline during the quarter, subtracting from
growth. And after being a key driver for the upswing in activity
over the past year, the inventory swing should become a modest net
drag on growth, while government spending should add to GDP this
quarter. If there are any risks to this call, they are to the
upside. In the coming quarters, we expect the pace of economic
activity to accelerate as the recovery shifts into a self-sustaining
mode driven by consumer spending.
!! Canadian CPI - December !!
* Release Date: January 25, 2011
* November Result: core 0.0% M/M; all-items 0.1% M/M
* TD Forecast: core -0.3% M/M; all-items 0.2% M/M
* Consensus: core -0.2% M/M; all-items 0.1% M/M
The divergent trend between Canadian headline and core inflation is
expected to continue in December. Rising prices for energy, food,
and vegetables is forecast to underpin a 0.2% M/M increase in the
non-seasonally adjusted all-items price index. When the seasonal
factors are taken into account, the forecasted rise is far more
pronounced, rising by 0.7%. The increase in the monthly price index
will push headline inflation, measured on a year-over-year basis to
2.6% from the 2.0% observed in November. For the quarter as a whole,
headline inflation is expected to rise by 2.3%, which is what the
Bank of Canada had forecast in their recently released Monetary
Policy Report (MPR).
Core prices, meanwhile, are expected to fall by 0.3% M/M in December.
This forecast is driven almost entirely by the seasonality in the
series, as the seasonally adjusted price index is expected to rise by
0.1%. This modest advance, which matches the 6 month moving average,
is consistent with the large overhand of idled capacity in the
Canadian economy. Measured on a year-ago basis, core inflation is
expected to accelerate just modestly to 1.5% from the 1.4% observed in
the previous quarter. For the quarter as a whole, core inflation is
forecast to be 1.6%, which is also in line with what the Bank of
Canada expects.
With the inflation dynamic unfolding largely as the Bank had expected,
this release is not expected to alter the timing of rate hikes. As was
telegraphed by the generally dovish stance taken by the Bank, we do
not expect the 25 basis point hike to occur before July .
Source: ActionForex.Com
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