The Weekly Bottom Line
HIGHLIGHTS OF THE WEEK
- A narrowing trade deficit and larger than expected inventory accumulation in February suggests Q1 growth will be closer to 2.5-3.0% than our previous forecast for 1.7%.
- That being said, this does not change our underlying outlook. The higher print on GDP reflects an inventory swing and improved trade balance due to weak imports. In contrast, domestic demand still appears set to post a shallow 2% gain.
- In order for the U.S. economy to generate sustained growth at the 3% level, we will need to see a much healthier job market that is capable of generating widespread growth in real incomes.
- In two survey releases, the Bank of Canada detailed that businesses are more upbeat about their sales' prospects and have more access to credit than they did in December.
- While the week got off to a positive start, the warm and fuzzy afterglow did not endure. The European sovereign debt crisis made its way back onto newspaper headlines, after several weeks of absence. Markets also got a chance to digest the disappointing job report coming out of the U.S., after being closed for the Easter holiday. Amid these series of indicators, markets and investors retreated from both the S&P/TSX composite and the Canadian dollar.
- The weekly ups and downs and recent economic data will be the backdrop for the Bank of Canada when it makes its interest rate call next Tuesday. We expect no change to the overnight rate, but the tone and content of the communiqué will serve as clues as to when interest rates will be raised.
UNITED STATES - STRONGER Q1 GROWTH OVERSTATES ECONOMY'S STRENGTH
Data this week revealed some upside risk to our 1.7% first quarter (Q1) growth forecast. Baring any data surprises in March, Q1 growth is now poised to register a 2.5-3.0% reading. On the surface, this is encouraging and will mark the first time since 2010 that growth has exceeded 2.5% for two consecutive quarters. Unfortunately, stronger Q1 growth does not reflect an improved outlook, and soft underlying demand will lead growth back towards 2% in Q2.
Two factors - international trade and wholesale inventories - account for the change in our Q1 outlook. In February, the trade deficit narrowed to $46.0 billion from $52.5 in January. As a result, net exports are now likely to add to Q1 growth rather than subtract as we'd previously forecast. However, since both imports and exports declined during the month, February was far from a healthy month for the U.S. trade sector. Meanwhile, a stronger than expected 0.9% increase in wholesale inventories during February has added another upside risk to Q1 growth.
Ultimately, trade and inventories are volatile series and cannot alone support 3% growth on a sustained basis. Rather, growth at this pace requires solid underlying domestic demand and steady support from household consumption. Granted, consumer spending has accelerated over the last six months and looks set to grow around 2.4% in Q1, but unfortunately this momentum is unlikely to be sustained during Q2.
The first reason is this year's unseasonably warm winter. According to the National Oceanic and Atmospheric Administration, Q1 temperatures were six degrees (F) above average. This may have prompted some consumers to carry forward their Q2 spending plans. Also, warm weather has provided temporary support to disposable incomes as heating bills stay under wraps. Macroeconomic Advisers estimates that in January and February household spending on utilities was $18.4 billion lower as a result of warm weather, more than offsetting the impact of higher gas prices. Moving into the spring, this income effect will be unwound.
Auto sales are another reason consumer spending momentum will slow moving forward. Since last June, sales have risen by a hefty 2.8 million units annualized, and in February sales exceeded 15 million units for the first time since early 2008. While promising, as the impact of mild winter weather and pent-up demand following last year's supply disruption fade, this pace of growth will slow in Q2 and Q3.
The final and important reason spending momentum will slow is that after tax real incomes have been falling. As a result, a good deal of Q1 spending growth has come from a decline in the savings rate. With aggregate household wealth still $8 trillion shy of its pre-recession peak, a falling savings rate cannot sustain consumer spending forever. Eventually, for consumer spending to accelerate to a pace that can support economic growth of 3% or more, we will need to see a stronger take-up in labor market slack to drive widespread growth in real wages.
Ultimately, while this week's inventory and trade data may push Q1 growth as high as 3% for a second quarter running, the underbelly of the U.S. economy remains too soft to support this pace of growth.
CANADA - INTEREST RATE DECISIONS TO GRAB MORE ATTENTION
Given the weekly events, it appears that business psyches and confidence levels here in Canada are no longer stuck in neutral. Last Thursday, the economy churned out 82,300 net new jobs, the seventh largest monthly tally posted in forty six years. The data release was positive all round, with strength noted across sectors, industries and in most provinces. In two survey releases, the Bank of Canada (BoC) detailed that firms are more upbeat about their sales' prospects, have more access to credit, and are experiencing fewer capacity constraints than just four months ago. The good news did not end there - housing starts in March clocked in their fastest annualized pace since the onset of the recession. Low interest rates and unseasonably warm weather were the driving forces behind the robust homebuilding performance. However, we would be remiss if we said that all data releases this week were positive in nature - Canada's international trade surplus narrowed to $292 million in February, much lower than the $1.9 billion figure posted the month prior.
Amid these series of generally positive news and economic indicators, the next couple of interest rate decisions are poised to get more attention than usual. Even next week's call (where most forecasters, including ourselves, expect no change to the overnight rate) will get more airtime. The piqued interest in monetary policy surrounds the timing of rate hikes. The overwhelming consensus is that there will be no change to interest rates for at least another year. However, the tone of the communiqué and accompanying statement attached to the decision could bring forward expectations to earlier in 2013 or perhaps even late 2012.
In recent public statements, BoC Governor Carney has referenced the improved economic climate. This view will be alluded to in the interest rate decision communiqué, but cemented in further detail in next week's Monetary Policy Report. We expect to see an improved economic outlook and more inflation than was forecast in the January version of this publication. The sources of the upgrade should be generally in line with the changes made in our own March forecast. There are now dampened risks of global financial market contagion coming out of Europe, resulting in a shallower recession than last forecast. We are also seeing better economic and employment numbers emerge from our neighbour to the south, evidenced by more than 212K net new jobs created in the first quarter of this year and the recent downward trend being recorded in unemployment insurance claims. Moving over to inflation here in Canada, the profile ought to be stronger given the persistence of higher energy prices relative to the forecast prepared in January.
The bigger wildcard in the upcoming communiqué will be the degree of emphasis on risks to the outlook. Case in point, while European developments have generally improved in recent months, worries about Spain and Italy are once again making front page newspaper headlines, after weeks of absence. In addition, while the U.S. outlook looks to be gaining steam, the disappointing job numbers for March point to some ongoing vulnerability and the headwinds serve as obstacles for a smooth sailing recovery. Risks are not solely international in nature either. Domestic risks surrounding housing overvaluation and household indebtedness persist and in response, Governor Carney has warned that in addition to regulation changes, higher interest rates are another potential tool to help curb further increases.
While confidence levels are perking up, they can also deflate at a moment's notice. We saw this nicely demonstrated with the S&P/TSX composite and Canadian dollar retreating after the European developments this week. With the constant push and pull of good news and bad, there will be considerable interest in how the central bank overlays the improved economic backdrop with a global economic recovery still filled with downside risks. In our view, the balance of risks has been shifting toward the Canadian central bank moving earlier to raise rates than the prevailing consensus forecast of mid-2013. Based on how the Bank messages its views next week, this perception will either be reinforced or snuffed out.
U.S.: UPCOMING KEY ECONOMIC RELEASES
U.S. Retail Sales - March
- Release Date: April 16, 2012
- February Result: Retail Sales 1.1% M/M; ex-autos & gas 0.6% M/M
- TD Forecast: Retail Sales 0.0% M/M; ex-autos & gas 0.4% M/M
- Consensus: Retail Sales 0.4% M/M; ex-autos & gas 0.5% M/M
Higher electronics sales activity should dull the impact of the sharp drop in auto sales in March, with the headline index remaining flat in March. Excluding auto sales, however, spending is expected to boast a respectable 0.3% m/m gain, driven mostly by the boost to activity from the launch of the new iPad product, which should more than compensate for the weakness in other components. Core retail sales should also be quite decent, gaining 0.4% m/m, building on the strong rebound during the first two months of the year, underscoring that consumer spending activity will remain a source of support for economic activity during the quarter. In the coming months, we expect the pace of consumer spending activity to moderate, particularly given some evidence of slowing labour market momentum.
U.S. Industrial Production and Capacity Utilization - March
- Release Date: April 17, 2012
- February Result: Industrial Production 0.0% M/M; Capacity Utilization 78.7%
- TD Forecast: Industrial Production 0.3% M/M; Capacity Utilization 78.6%
- Consensus: Industrial Production 0.3% M/M; Capacity Utilization 78.6%
Weaker motor vehicle production should push overall manufacturing sector activity modestly lower in March, marking only the second drop in this component in the past year. Utility production and mining activity, however, should rise, partially reversing the weakness of the past two months and more than compensating for weaker manufacturing sector activity. During the month, we expect the pace of overall industrial production to post a 0.3% m/m bounce in March, following the flat print the month before. Capacity utilisation, however, should moderate for the second straight month, falling to 78.6% from 78.7% the month before.
CANADA: UPCOMING KEY ECONOMIC RELEASES
Canadian Manufacturing Shipments - February
- Release Date: April 17, 2012
- January Result: -0.9% M/M
- TD Forecast: -1.5% M/M
- Consensus: 0.1% M/M
Manufacturing sales are expected to have declined for a second consecutive month, falling by 1.5% in February. There are several forces at play that point to weak manufacturing sales. Most notably, weaker merchandise exports in February—in particular auto and energy exports—should exert the biggest drag on manufacturing sales. In the past, both of these components have tracked manufacturing sales closely, although energy is prone to the occasional head fake. That said, weakness in energy exports is likely to be reflected in the manufacturing data given the production disruptions reported in Alberta. Taking these developments in tandem with softer US demand during the month and a light order book suggest a downside risk to manufacturing sales above and beyond the support afforded by higher producer prices. In volume terms, sales are expected to remain negative and should weigh on the industry-level GDP print on the month.
Bank of Canada Interest Rate Decision
- Release Date: April 17, 2012
- Current Rate: 1.00%
- TD Forecast: 1.00%
- Consensus: 1.00%
At the March Fixed Announcement Date (FAD), the Bank of Canada adopted a more constructive tone in describing the economic outlook both at home and abroad. This view was reiterated by the Governor in recent public comments and will be crystallized in the updated economic forecasts presented in the April edition of the Monetary Policy Report (MPR). But in a laborious global recovery plagued by false starts and lurking vulnerability, the incremental approach to monetary policy will keep the Bank firmly on hold next week with no change in the forwardlooking language hinting at when the next rate will occur.
Canadian CPI - March
- Release Date: April 20, 2012
- February Result: CPI 0.4% M/M; Core CPI 0.4% M/M
- TD Forecast: CPI 0.5% M/M; Core CPI 0.4% M/M
- Consensus: CPI 0.5% M/M; Core CPI 0.3% M/M
For a second consecutive month, higher commodity prices and a pronounced seasonal adjustment factor will contribute to a strong increase in the all-items CPI price index, forecast to rise by 0.5% in March. After taking into account the seasonality, the underlying monthly increase should be somewhat more subdued at 0.2%. On a year-ago basis, headline inflation is expected to slow markedly from 2.6% to 2.1% due to a 2011 base year effect combining both a spike in energy prices following the Japanese earthquake and the rise of geopolitical tensions in the Middle East and North Africa and the largest monthly gain (5.6%) in clothing prices since 1991.This data release will complete the first quarter, where we expect headline inflation to have increased by 2.4%. While this is stronger than the 2.2% the Bank of Canada forecast in the January Monetary Policy Report (MPR), the Bank will have the opportunity to update its forecast with the release of the April MPR on Wednesday.
The seasonal impact on the core price index will be less pronounced than on the headline, with the non-seasonally adjusted series forecast to increase by 0.4% as compared to a 0.3% increase in the seasonally adjusted series. The continued momentum in core prices reflects a forecasted increase in auto prices and higher clothing prices, as unseasonably warm weather likely accelerated the introduction of new clothing lines. On a year-ago basis, the base year effect will be limited to clothing prices, limiting the magnitude of the forecasted decline in core CPI inflation, which is expected to move from 2.3% to 2.0%. For Q1 as a whole, we expect core CPI to have increased by 2.1% which is in line with what the Bank of Canada expected in January.