The Weekly Bottom Line

HIGHLIGHTS

• TARP looks to finally get Congressional approval (and not a moment too soon)
• U.S. economic data confirms recession has begun...
• While Canadian GDP surprises...

It's been said that September 2008 was a long year and it certainly felt like it. The month that changed Wall Street finally ended this week and what a ride it was. Monday started the ball rolling with a vote in the House on the $700 billion Troubled Asset Relief Program (TARP). When the vote failed (somewhat surprisingly) by a margin of 228 to 205, global stock markets plummeted. Markets rebounded on Tuesday on word that a reworked plan would soon make its way to the Senate but the bad economic news kept on coming, pushing confidence (and stock markets) right back down. In recognition that problems in the U.S. are not confined to this side of the Atlantic, four European financial institutions were bailed out by governments and credit spreads across the globe continued to widen.

Bailout blue

The workings in Washington on the Treasury's bailout plan are now into their third week. With both parties' leadership in agreement on the terms of a bailout package, this week it was a matter of getting Congress to sign on. The first attempt in the House failed quite miserably and officials were sent scrambling to re-work the plan in time to get it passed by the Senate. That was accomplished on Wednesday and with sweeteners added to the bill, the House of Representatives voted in favour of it early Friday afternoon.

It couldn't have come a moment too soon. Since Monday, credit spreads have continued their astronomic rise. Short term funding rates to banks, as measured by the London Interbank Lending Rate, rose to 4.33% by Friday morning, pushing the spread over the effective Fed Funds rate more than 200 basis points since the start of September. With funding costs continuing to rise (despite the increased liquidity injections by central banks) the downside risks to real economic growth have increased along with them. Movement on a plan that will bring some semblance of confidence to financial markets is a clear requirement for the move away from the abyss.

It's not just the United States that is in danger. The banking crisis has moved quickly into Europe with governments bailing French-Belgian lender Dexia and governments in the Netherlands, Belgium and Luxembourg stepping in to take control of Fortis. In Ireland and Greece, governments moved to guarantee all bank deposits, a drastic action intended to re-instill confidence in the countries' retail banking systems. The action in Ireland actually served to increase pressure on other European countries, as savers seeking the security of the Irish guarantee moved deposits out of their own banks and into Ireland.

Bad news moves from Wall Street to Main Street

Just in case the wrangling in Washington was not enough to send world markets teetering; the string of very bad economic news throughout the week, provided the knock out punch. Early in the week, U.S. personal income and spending data confirmed that U.S. consumers have thrown in the towel. After declining in each of the last two months, real consumer spending was unchanged in August, pushing the change in the 3-month-moving-average to its lowest point since January of 1991. Personal consumption expenditure is likely to fall by over 2% in the third-quarter and at over 70% of the real U.S. economy; the fall in spending could well be enough to drag overall economic growth into negative territory as well.

Unfortunately, that wasn't the end of the bad news on Main Street America. The S&P/Case-Shiller home price index showed yet another drop in home prices and is now down 16.4% from last year. The fall in home prices has extended to all 20 cities in the index, with the worst performing cities down close to 30% from a year-ago. Outside of the housing sector, the ISM manufacturing index plummeted clear into recessionary territory in September, reaching its lowest level since mid-2001. The drop in the employment sub-index was a harbinger that more bad news is yet to come. Indeed, on Friday, the release of the September payrolls report showed a drop of 159,000 jobs. The U.S. economy has now shed over 730,000 so far this year and at 6.1%, the unemployment rate, sits full 1.1 percentage points above where it started the year. We have not yet seen the full extent of the economic crisis implications and expect the unemployment rate to continue to rise over the course of 2009, before reaching a peak at 7.1%.

North of the border the economic news was better but unfortunately it was also backward looking. While Canadian GDP growth jumped a solid 0.7% in July, led by increases in the energy, manufacturing and wholesale trade sectors, the world is a much different place than it was just two months ago. Since the strong GDP gain came in the first month of the final-half of 2008, it adds some upside risk to our forecast for third-quarter economic growth but with two months yet to come, it's too early to say by how much.

Nonetheless, the state of both the U.S. and world economies has worsened significantly since July and the credit crunch has exploded into a full blown crisis. The impact of these developments on Canada is unambiguous - higher funding costs for financial institutions will hamper the supply of credit to the domestic economy, while slower demand for commodities and manufacturing products will weigh strongly against the export sector. In the mean time enjoy the good news, while it lasts.

UPCOMING KEY ECONOMIC RELEASES

Canadian Housing Starts - September

Release Date: October 8/08
August Result: 211K
TD Forecast: 200K
Consensus: 210K

The Canadian housing market has now entered a period of moderate correction, following on the heels of the blistering pace of activity witnessed in the past few years. And with a sluggish labour market and rising mortgage rates, we expect the slowdown in residential construction activity to continue in September, with housing starts declining to 200K (from 211K in August). Much of the decline during the month will likely come from the volatile multi-units component. In the coming months, we expect residential construction activity to remain roughly within the 190K to 210K range.

Canadian Employment - September

Release Date: October 10/08
August Result: +15.2K; unemployment rate 6.1%
TD Forecast: +15K; unemployment rate 6.1%
Consensus: +12.5K; unemployment rate 6.1%

The Canadian labour market has been soft for some time, with only 87K jobs being created in the first 8 months of this year (compared to 221K jobs added during the corresponding period last year). This trend is likely to continue in September with the Canadian economy expected to add only 15K jobs, with the unemployment rate holding steady at 6.1%. Indeed, with the economic conditions appearing to have soften somewhat and the growing headwinds dampening consumer spending, job creation should remain tepid for some time. Nevertheless, with the 40th Canadian general election around the corner, temporary public sector employment is expect to provide an important offset from the weak labour market fundamentals. This boost, however, is expected to be temporary and should unwind in the coming months.

Canadian International Trade - August

Release Date: October 10/08
July Result: $4.9B
TD Forecast: $4.2B
Consensus: $4.4B

After peaking earlier this year, the global commodity boom has come to an unceremonious end, and in its wake the commodity-driven Canadian export sector will likely take it on the chin. Consequently, we expect the Canadian international trade surplus to deteriorate for the third straight month in August, falling to $4.2B. Given that the export of energy products accounts for over 25% of total Canadian exports, the 16.3% drop in energy prices in August is expected to be the main contributor to the expected 1.0% M/ M drop in exports during the month - which will be the first monthly drop since December last year. The dramatic slowdown in the U.S. economy should also adversely affect exports. On the other hand, imports are expected to rise, but only by a small 0.5% M/M, thus ensuring that the drop in the trade surplus will be measured. Looking ahead, we expect to see further moderation in the trade surplus, though we do not foresee an outright trade deficit.

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.