The Weekly Bottom Line

HIGHLIGHTS OF THE WEEK

United States

• Europe provided plenty of negative headlines this week. Both Spain and the U.K. confirmed their economies fell back in recession, while the former saw its unemployment rate jump to 24.4%.
• The Dutch government collapsed over a dispute regarding fiscal tightening measures and S&P downgraded Spain's sovereign rating by two notches to BBB+.
• Although unspectacular, things were better in the U.S. First quarter GDP growth came softer than expected. However moderate, a 2.2% q/q annualized economic expansion feels comforting against the European backdrop.

Canada

• Retail trade slid by 0.2% in February as auto sales declined following strong January results.
• Newfoundland and Labrador brought down its budget, marking the end of the provincial budgetary season. Overall, provinces are planning on limiting spending growth to 1.5% in fiscal 2012-13.

UNITED STATES - Q1 GDP, BETTER THAN MOST, BUT STILL UNINSPIRING

This week started on a low note as Monday proved to be quite an eventful day in Europe. The European Union's statistics agency released 2011 fiscal account figures, which offered an unsolicited reminder of the dire fiscal situation most European countries find themselves. In addition, the central bank of Spain released a report confirming the Spanish economy contracted during the first quarter, falling into a technical recession - defined as two consecutive quarters of economic contraction. The resignation of the Dutch prime minister and his cabinet over a dispute concerning the country's budget further dampened market sentiment. And, if this wasn't enough to add to market angst, leading French presidential contender Francois Hollande promised to renegotiate the terms of the European “fiscal compact”.

The United Kingdom joined the fray on Wednesday, when it released first quarter GDP figures showing its economy had also entered a technical recession. But that wasn't all; yesterday credit rating agency Standard and Poor's downgraded Spain's sovereign rating by two notches to triple-B plus. And, keeping up with the somber tone, this morning Spain's national statistics agency reported that one out of four Spaniards willing and able to work, find themselves without a job.

Events in the U.S. were much less dire; the Federal Reserve held its monetary policy meeting, releasing slightly better economic projections. Economic growth for the current year was revised upwards by 0.2 percentage points to a range between 2.4% and 2.9%. In turn, the unemployment rate forecast was lowered to a range of 7.8% to 8.0%, whereas inflation projections were slightly increased. Fed funds rates projections were updated accordingly: the two members whom in January judged the first rate hike should occur in 2016 have brought forward their expectations by at least one year. On the other hand, seven out of the 17 members expect the first rate hike to take place in 2014 and 6 members judged the fed funds rate should be increased by at least 50 basis point by the end of 2013, at the latest. More important perhaps were Chairman Bernanke's remarks regarding the fiscal outlook: he stressed that, if Congress does not act before January 1st to prevent the full pass-through of the automatic spending cuts stipulated in the Budget Control Act, the size of the “fiscal cliff” would be such that no Fed action could offset it.

Bernanke's words echoed this morning after first quarter GDP figures showed a 3% q/q annualized decline in government consumption subtracted 0.6 percentage points from overall economic growth. In spite of that, U.S. GDP grew at a 2.2% quarterly annualized rate, on the back of a 2.9% gain in personal consumption. The latter was the only bright spot of an otherwise uninspiring report, which did nothing to alter our view that economic momentum will remain soft in the second quarter. Nevertheless, one should find some comfort in the fact that the U.S. economy keeps pulling its weight, even if at a modest pace. That is no minor achievement for a summer that is once again shaping up to be dominated by untoward European headlines.

CANADA - PROVINCIAL BUDGETS: A CODA AFTER THE MUSIC ENDS

This week was a quiet one for Canadian economic data releases. Apart from a disappointing retail sales report for February, the biggest announcement came from south of the border, where the Fed maintained its dovish monetary policy message. In a way, this made last week's announcement by the Bank of Canada appear bullish considering that they intend on moving up plans to increase rates even though the Fed is holding firm to its prior view to keep rates exceptionally low until late 2014.

In the provincial public finance area, there were also interesting developments. Newfoundland and Labrador closed off the provincial budget season with a fiscal plan quite in line with expectations. Revenue shortfalls due to reduced oil production and the end of transition payments from the federal government pulled the Province back into deficit. The plan is to get back to balance in FY 2014-15 mainly via spending restraint.

With all of this year's provincial budgets available, now is a good time to take stock of the main fiscal themes across the country. First, restraint is the overall watchword. Provinces are eager to shore up their balances, even Saskatchewan, which is in surplus. The vast majority of the budgets plan on limiting annual spending growth to about 1.5% over the next three years. In some cases, the size of the public service gets reduced, usually through attrition. The notable exception is Alberta, where spending growth is expected to average 3.3% over the three-year period with the province still returning to balance thanks to surging oil royalty revenue.

Second, health care spending remains a priority. All provinces are trying to curb down the growth in their health tab, letting other spending areas bear the brunt of the fiscal squeeze. For instance, B.C. is planning on limiting health spending growth to half its pre-recession pace. However, we believe that considerable cost pressures due to technological change, demographics and other factors will make restraining health costs very challenging.

Third, most governments refrained from upsetting their respective economic apple carts with major tax measures, perhaps due to concern over today's modest growth environment. On the sales tax side, the most significant revenue measures are (if you will pardon the acronym alphabet soup) the long-planned return to a PST system in B.C. and the adoption of an HST next year in P.E.I.

There were few income tax measures. In the case of Ontario, the largest and most fiscally challenged province, the March 27 budget featured the cancelation of upcoming corporate income tax cuts. However, in order to pass the minority government's budget, some concessions needed to be made to the opposition. These included a new 2% provincial personal income surtax on individuals earning more than $500,000.

This was not the end of the story for Ontario this week. Just a few hours after the modified budget had passed, Standard and Poor's put Ontario on a negative watch and Moody's lowered the province's rating to Aa2. With this latter event, all three major rating agencies (DBRS, S&P and Moody's) have now downgraded the Province since 2009, reflecting concerns over its deficit profile, growing debt burden and deficit reduction efforts.

In spite of this development, the market reaction was muted. Markets viewed the Moody's move as a bit overdue, given that the other agencies had downgraded Ontario in 2009. Case in point, spreads between Ontario and Canada 10-year bonds have actually widened by only 5 basis points since the budget was tabled on March 27th.

In the end, no province is in an optimal fiscal situation, and all are taking important steps in the right direction. While the watchful eye of rating agencies creates some pressure in the provincial capitals, one must keep in mind that compared to other jurisdictions (including many European countries), the fiscal situation of most Canadian provinces is not that bad.

U.S.: UPCOMING KEY ECONOMIC RELEASES

U.S. ISM Manufacturing Index - April

• Release Date: May 1, 2012
• March Result: 53.4
• TD Forecast: 52.5
• Consensus: 53.0

With slowing global and domestic economic activity we expect US manufacturing momentum to moderate in April, with the ISM manufacturing index falling to 52.5 down from 53.4 the month before. The weakening momentum has been largely choreographed in the regional manufacturing counterparts, with the Empire and Philly Fed indices falling sharply during the month. Much of the weakness in the headline number should come from softer new orders activity, with the production and employment sub-indices also expected to give back some of the gains in March.

Despite the dip in the headline index in April, it will mark the third year of uninterrupted growth for the manufacturing sector, which continues to be one of the bright spots for the economic recovery. And with the new orders to inventory spread (a proxy for future production activity) expected to remain in positive territory for the seventh consecutive month, the outlook for the sector remains favorable.

U.S. Nonfarm Payrolls - April

• Release Date: May 4, 2012
• March Result: 120K; unemployment rate 8.2%
• TD Forecast: 185K; unemployment rate 8.2%
• Consensus: 165K; unemployment rate 8.2%

Labour market activity is expected to rebound nicely in April, with the pace of total employment growth accelerating to a respectable 185K pace, up from the very meagre +120K estimated in March. The improvement in labour market performance in April, to take the pace of jobs growth closer to the 6-month trend should take place in spite of the recent rise in the pace of weekly jobless claims in the past month. Private sector employment is also expected to rise at 185K, with public sector employment remaining unchanged during the month. Service sector employment growth should be the key catalyst for the improvement in labour market performance, with decent growth in education, leisure and hospitality, professional services and retail trade activity.

Manufacturing sector employment should advance for the seventh consecutive month, more than offsetting the drop in construction employment during the month. Despite the rebound in employment activity, the unemployment rate should remain unchanged at 8.2%.

CANADA: UPCOMING KEY ECONOMIC RELEASES

Canadian Real GDP - February

• Release Date: April 30, 2012
• January Result: 0.1% M/M
• TD Forecast: 0.1% M/M
• Consensus: 0.2% M/M

The Canadian economy is forecast to eke out a modest +0.1% m/m gain in the month of February. Broadly speaking, February was a soft month in terms of economic activity. The slight increase in hours worked and solid 2.2% m/m gain in wholesale volumes is expected to provide a modest offset to the weakness observed in manufacturing (-0.1%) and retail (-0.6%) volumes. Moreover, a decrease in crude petroleum production owing to unplanned maintenance shutdowns in the month is expected to weigh on GDP output. Helping to offset some of this drag however will be real estate, which saw firm housing resale activity in the month. In this regard, this could be a source of an upside risk to our GDP forecast. Despite the modest gain for industry level real GDP, the Canadian growth profile for Q1 is still shaping up broadly as we expected. Assuming a flat print in the monthly GDP print for March, our forecast would put us on track for our 2.1% quarterly annualized rate of growth for the expenditure-based GDP measure. As a point of comparison, the Bank of Canada expects a gain of 2.5% although if our forecast for monthly GDP is realized, then this will put downside risk to the Bank's forecast. Heading forward, we expect economic activity to have picked up in the subsequent months and will contribute to an above-trend pace of growth this year.