Sunday, January 16, 2011

The Weekly Bottom Line

United States
* Economic data were sparse early in the week, but equities still
performed well following some successful debt auctions in Europe
* By the week's end, markets turned their attention to a torrent of
data releases including retail sales, industrial production and
* However, the releases offered few major surprises, and the
market's reaction was muted
* The releases did however signal that as some sectors of the
economy - including manufacturing and consumer spending - continue
to press forward, price pressures and Eurozone worries remain an
ever present challenge to the recovery
* The Canadian dollar has showed some renewed strength through the
first two weeks of 2011, rising past parity vis-à-vis the U.S.
dollar, and appreciating against most major currencies.
* The Canadian dollar may lose some steam as early as next week. The
Bank of Canada will likely disappoint markets, which are expecting
a rate hike as early as March. We anticipate the Bank will
continue to communicate that interest rates will remain low for
the immediate future.
* The improvement in Canada's trade deficit to $80 million, from
$1.5 billion in November, and continued strength in commodity
prices will likely keep the Canadian dollar in a firm trading
range of $US 0.95-1.00.

Equities performed well early this week, as euro-jitters were eased at
least temporarily following some successful debt auctions across
Portugal, Spain and Italy. But clearing this hurdle could only lift
markets so far, as it remains clear that Europe's fiscal challenges
will be an ongoing risk to the global economy for the foreseeable

As such, financial markets spent much of the week positioning
themselves for a steady flow of late week data releases which included
international trade on Thursday and a trifecta of retail sales, CPI
and industrial production on Friday. Yet in spite of this torrent of
data, markets opened flat on Friday, as the releases failed to offer
any material changes to the economic outlook. Though it may have
contained few surprises, this week's data reinforced our view of the
complexities that still persist in the U.S. economic recovery that
encompass a mix of upside opportunities alongside struggles.

An obvious upside risk is the ongoing buoyancy in consumer spending.
While December's retail sales report was a little shy of expectations,
the monthly gains were still significant, and combined with strength
in previous months are consistent with Q4 2010 consumption expenditure
growth of roughly 4%. Another bright spot has been the recent revival
in manufacturing. Industrial production figures from this week further
confirmed this trend, as manufacturing output posted another steady
gain of 0.4% in December.

Two forces underpin the renewed momentum in manufacturing. The first
is consumer spending on durables goods (such as autos) and the second
emanates from the export growth, which is poised to provide a
meaningful boost to Q4 GDP growth. However, in the current
environment, exportdriven growth is precarious, as currency volatility
remains an ever present concern with the ongoing challenges in Europe
threatening to quickly and aggressively drive up the value of the
dollar, eroding export competitiveness.

Overall, these ongoing improvements in consumer spending and
manufacturing are welcomed signs, but make no mistake, the U.S.
economy remains far from healthy. Friday's CPI release confirmed that
core consumer price growth continues to trend below 1%. While prices
will gradually accelerate throughout this year, it is clear that
abundant slack remains in the economy.

There is also a budding concern that even as core price growth remains
subdued, rising commodity prices are rearing their ugly head. This
week's Beige Book was peppered with reports of businesses who are
feeling the pinch of rising input prices, coupled with an inability to
raise final product prices because of competition. This will
ultimately squeeze profit margins. Also, rising gas prices are an ever
present concern for American consumers, and with crude oil now sitting
above $90 a barrel, ongoing increases threaten to slow the recovery in
consumer spending.

As recent gains in equity prices show, markets have become
increasingly optimistic about the strength of the U.S. recovery in the
coming year. Indeed, we were among those to upgrade our growth
forecast in December in anticipation of stronger consumer spending,and
manufacturing activity in the year ahead. However, one cannot overlook
the numerous headwinds and challenges, ranging from the Eurozone to
labor and housing markets, which underlie the maturing economic

The Canadian dollar had a good start to the year, breaking past parity
against the U.S. dollar through the first two weeks of 2011, and
appreciating smartly against other major currencies. This has sparked
debate around whether the currency is overvalued at its current level.

Part of the appreciation in the Canadian dollar can be explained by
temporary factors such as the sell-off in the Australian dollar due to
the flooding earlier this week, and news of foreign acquisitions of
Canadian resource players. But, in large part the loonie's strength
reflects upbeat investor sentiment. In our view, markets have priced
in a bit too much optimism into the Canadian dollar, and there are
some downside risks to the currency in the near term.

For one, with Canadian domestic demand moving at a decent clip,
markets have priced in a high probability of a Bank of Canada (BoC)
move as early as March, and the currency has gained some momentum from
the expected widening in Canada-U.S. interest rate spreads. This is
somewhat premature. Hiking on March 1 would require a significant
change in tone from the BoC's last dovish communiqué at the only
decision meeting until then, which is January 18. Given the tight time
frame, markets may have gotten ahead of themselves. The BoC will
likely be more gradual in signaling a change to its monetary policy
stance. With few signs of inflation perking up and recent housing
market data coming in on the soft side, next Tuesday's communiqué is
expected to push back rate hike expectations. In turn, this should
weaken the currency somewhat.

Further, while a relatively successful Portugal bond auction this week
helped to calm investors, Europe is far from out of the woods. There
remains a sizeable risk that Spain may need assistance, that bailout
funds may not be sufficient, and that part of one periphery nation's
debt will suffer a default. Renewed fears over this situation would
result in a flight back to the safety of the U.S. dollar, with the
Canadian dollar struggling to keep up.

That being said, continued strong domestic fundamentals are expected
to limit the downside risks to the currency's value. First, firm
demand and prices for commodities, and the resulting improvement in
Canada's international trade position, are likely to remain key
drivers of the Canadian dollar. As highlighted in TD's Commodity Price
Forecast Update released today, prices for most commodities are likely
to record further, albeit more modest, gains in the year. Continued
robust demand for commodities from emerging markets is expected to
push Canada's merchandise trade balance into positive territory in
relatively short order. Second, the fiscal backdrop in Canada looks
favourable when compared to the fiscal mess in Europe and the
ballooning public debt of many other developed economies, including
the U.S. While putting domestic fiscal houses in order is expected to
be tougher slog than suggested in last year's budgets, deficits have
narrowed and near-term prospects are mostly positive.
On balance, from its current level against the U.S dollar, it appears
there is more downside than upside risk to the Canadian dollar in the
coming weeks. By the same token, we agree that a strong currency is
here to stay, as a number of fundamental drivers are putting a floor
under the currency, suggesting a firm trading range of 0.95-1.00 U.S.
dollars over the next few months.

!! U.S. Housing Starts And Building Permits - December !!
* Release Date: January 19/11
* November Result: Housing Starts 555K;
* Building Permits 530K
* TD Forecast: Housing Starts 560K; Building Permits 540K
* Consensus: Housing Starts 550K; Building Permits 555K
The US housing market recovery continues to struggle to gain
traction as the combination of weak labour market fundamentals and
still tight credit conditions has continued to dampen housing
demand, despite the historically favourable buying conditions. On
the supply side of the ledger, the huge overhang of unsold homes has
remained a key constraining force on prices and has contributed in
no small part to the very slow pace of new residential construction.
Consistent with the NAHB index, which continues to languish in
depressed territory, we expect this pattern to remain largely intact
in December with new residential construction activity rising only
marginally to 560K units. Both multiples and single-family
construction are expected to advance on the month. In the coming
months, we expect the pace of building activity to remain soft given
the weak economic backdrop. Building permits approvals are also
expected to be quite soft, falling to 540K units.

!! Bank Of Canada Interest Rate Decision !!
* Release Date: January 18/11
* Current Rate: 1.00%
* TD Forecast: 1.00%
* Consensus: 1.00%
With the Canadian economy unfolding largely as expected, there has
been little to compel the Bank of Canada into action. Moreover,
several of the risks that the Bank highlighted at the last Fixed
Announcement Date (FAD) have become less pronounced. So it should be
no surprise to find the Bank remaining on the sidelines next week.

The focus will, however, be on the accompanying communiqué. With
the release of the January Monetary Policy Report (MPR) on
Wednesday, the Bank will also have the opportunity to update their
forecasts and provide a lengthier assessment of their outlook for
the global economy. While we anticipate a more constructive 2011
outlook for the United States, the Bank will be appropriately
circumspect about its impact on Canadian growth and inflation. The
persistent strength in the Canadian dollar as well as the impact of
higher commodity prices on inflation in emerging market economies is
expected to be identified as downside risks to the outlook. And
although the revision to growth will introduce a hawkish tilt to the
communiqué, we expect that there are still enough headwinds at play
to compel the Bank to wait until July before taking the overnight
rate to 2.00% by the end of the year.

!! Canadian Manufacturing Shipments - November !!
* Release Date: January 19/11
* October Result: 1.7% M/M
* TD Forecast: 0.2% M/M
* Consensus: n/a
The seesaw pattern that has come to define manufacturing shipments
is expected to be broken in November, as total shipments are
forecast to eke out a 0.2% gain following last month's solid 1.7%
increase. The modest gain in the headline is expected to reflect the
offsetting impact of a pullback in shipments of transportation
equipment (following a solid 4.0% advance in October) with continued
growth in petroleum and coal products. Not surprisingly, the impact
of higher commodity prices is expected to have played a role in this
latter contribution. As such, inflationadjusted manufacturing
shipments could easily fall in the month. In terms of the
contribution to industry-level real GDP growth, the manufacturing
sector is likely to exert a drag in November. For the quarter as a
whole, however, the gain observed in October should help contribute
to an annualized real GDP growth rate of 2.3%.

!! Canadian Retail Sales - November !!
* Release Date: January 21/11
* October Result: total 0.8% M/M; ex-autos 0.9% M/M
* TD Forecast: total 0.5% M/M ; ex-autos 0.5% M/M
* Consensus: n/a
The momentum in consumer spending observed in recent months is
forecast to continue in November, as total retail sales are forecast
to advance by a reasonably healthy 0.5%. While a portion of this
expected increase is due to households getting an early start on
holiday shopping, the bulk of the increase can be attributed to
higher gasoline prices. Auto sales, meanwhile, are forecast to have
remained unchanged in the month, which implies an ex-autos growth
rate of 0.5%. As we observed in October, the impact of gasoline
prices means that real retail sales will remain under pressure. With
spending expected to be restrained by riding levels of household
debt, we anticipate that the consumer will play a smaller role in
supporting economic growth in 2011.

Source: ActionForex.Com

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