- The prospect of corporate tax cuts led both the Dow Jones Industrial Average and the S&P 500 to record highs this week, with financial stocks outperforming substantially.
- Economic data was supportive, with third quarter real GDP being revised up to 3.3% annualized, as business investment came in stronger than initially thought.
- Incoming Fed Chairman Jerome Powell stated that "conditions are supportive" of a December rate hike, and we expect the Fed to proceed with one, followed by two more in 2018.
- The Canadian economy created a whopping 80k jobs in November, pushing the unemployment rate down to 5.9% - the lowest level in nearly a decade.
- Economic growth came in largely as expected in the third quarter at 1.7% annualized. While this is a marked deceleration from the prior quarter, it signals a return to a more sustainable pace of growth.
- OPEC and its allies agreed to extend production cuts until the end of 2018 - a timeframe the group expects will allow the global oil market to balance.
U.S. - Tax Cuts Just Around The Corner
The prospect of corporate tax cuts made for another strong week in equity markets. Investors flocked to financial shares, leading both the Dow Jones Industrial Average and the S&P 500 to record highs. Financials have posted stellar earnings growth this year and are among the corporations that stand to benefit the most from the proposed tax cuts. Consumer discretionary stocks were also in high demand, following record-breaking estimates of Black Friday and Cyber Monday sales. Treasuries, on the other hand, sold off this week, sending the benchmark ten-year yield above 2.4% on Thursday, the highest level in over a month. These positive developments led the greenback higher initially, but the gains were pared by the end of the week.
Economic data released this week also supported investor sentiment, with third quarter real GDP revised up to an impressive 3.3% as business investment accelerated (even more than previously estimated), with firms ramping up expenditures on equipment notably (Chart 1). This marks the strongest two consecutive quarters of growth for the American economy in three years. Momentum in business investment is expected to continue, with shale oil production likely to be a key contributor. Producers have ramped up activity this year in response to a rising price of WTI crude oil. OPEC's commitment to extend supply cuts through 2018, announced this week, should maintain this momentum. As a result, the upside for the price of crude oil will be limited; we expect the price of WTI crude to sit in the US$50-55 range as the market balances out.
Consumers are also likely to maintain their pivotal role in the economic expansion alongside businesses. Consumer spending slowed in October, after a bump in the prior month as a result of hurricane-damaged vehicle replacement. With continued job growth and accelerating wages, consumer spending should bounce back in the months ahead. On the inflation front, core PCE price growth held steady at 1.4% (year-on-year) in October, with an uptick in the following month looking increasingly likely as industry contacts reported strengthening price pressures in November's Beige Book (Chart 2). Producers across a range of industries including manufacturing and transportation reported passing on increases in input costs to selling prices, ensuring that inflation will turn higher in the near future. Several FOMC voting members also expressed their agreement with this view in speeches this week.
Incoming Fed Chairman Jerome Powell stated that "conditions are supportive" of a December rate hike at his confirmation hearing on Tuesday. Mirroring this view were Yellen and Kaplan in their speeches this week, in contrast to Kashkari who would like to see firmer evidence of inflationary pressures building before proceeding with a hike. At this point, markets are fully pricing in a December hike and we expect the Fed to proceed with one, followed by two more in 2018. Making this scenario increasingly likely is progress on the tax reform front which will require faster monetary policy normalization in order to temper the potential inflationary pressures.
Canada - Employment Stealing the Spotlight
It was a busy morning on the Canadian data front, with third quarter GDP and November employment figures released. The Canadian dollar shot up by more than a cent following the data releases, recouping most of the week's losses. Meanwhile the S&P/TSX remained down on the week on softer oil prices ahead of the OPEC meeting.
The employment report stole the spotlight this week, with a stunning 80k job added in November. This pushed the unemployment rate down to 5.9%, which is the lowest level seen in nearly ten years and a full percentage point below the level at the start of the year. Wage growth accelerated to 2.7% during the month, which is a stark improvement relative to the 0.6% pace in April. All told, there is little doubt that the Canadian economy is operating at full capacity.
On the other hand, economic growth in the third-quarter came in largely in line with expectations, at 1.7% (annualized). This is a marked slowdown from the stellar 4.3% pace recorded in the prior quarter, reflecting a sharp pullback in exports that was only partly offset by continued strength in consumption and an uptick in government investment. On the whole, the deceleration in the third quarter was expected and is consistent with a return to a more sustainable pace.
These reports will not go unnoticed by the Bank of Canada when deciding on interest rates. Strength in the domestic economy, characterized by solid job and wage gains, appears supportive of higher rates, with a rate hike likely in the coming months.
In other news, during the much-anticipated OPEC meeting yesterday, the group plus its non-OPEC allies extended production cuts through the end of 2018, as expected. Expectations for such an extension had been a key driver behind the recent uptick in prices to a 2½ -year high and the group did not disappoint. Yesterday's agreement also included a collective cap for Libya and Nigeria set above their current combined production levels.
Overall the oil market remains abundantly supplied, with inventories sitting well above their 5-year average. That said, inventories have been falling and with the extension of the production cuts, OPEC expects the remainder to be eliminated by the end of next year. Of course, US shale production - which is sitting near a record high - remains the wild card. With prices on the rise, hedging activity has surged, up nearly 150% in the third quarter. This should enable production to continue to rise in 2018 even if prices give back some of their recent gains. In Canada, production is set to grow over the next year as well, as a couple of new projects ramp up.
Overall, prices have likely been bid up too high given market fundamentals, suggesting that some downside could be in store going forward. Ultimately, we expect the WTI benchmark to sit in the US$50-55 per barrel range over the coming year as the market moves back into a more balanced position.
U.S.: Upcoming Key Economic Releases
U.S. Employment - November
Release Date: December 8, 2017
Previous Result: 261k, unemployment Rate 4.1%
TD Forecast: 175k, unemployment Rate 4.2%
Consensus: 198k, unemployment Rate 4.1%
We expect nonfarm payrolls to advance by 175k in November. Data on persons not at work due to bad weather suggest that hurricane impacts should have faded by this month, allowing payrolls to print closer to their current trend in the 150-200k range. Upward revisions to the prior two months are also likely. Meanwhile, labor market indicators (regional Fed surveys and consumer confidence) remained supportive of solid job growth.
We expect the unemployment rate to tick higher to 4.2% from 4.1%, given the outsized decline in labour force participation that has the potential to correct. We also look for a relatively modest 0.2% m/m increase in average hourly earnings, as calendar effects are less favourable this month. Still, that should leave earnings tracking higher on a y/y basis at 2.6% vs 2.4%.
Canada: Upcoming Key Economic Releases
Canadian International Trade - November
Release Date: December 5, 2017
Previous Result: -$3.2bn
TD Forecast: -$2.6bn
TD looks for the merchandise trade deficit to narrow to $2.6bn in October on a rebound in exports, which should be partially offset by rising imports. Exports should see a broad increase due to higher factory prices, which are largely a symptom of CAD weakness, though we will need to wait another month to see a full rebound in vehicle exports. Labour disruptions in auto production were not resolved until mid-month and advance US imports were flat on the month. Exports of energy products are likely to see a nominal gain while a sharp increase in residential construction south of the border should support exports of building materials. Imports should see a more modest increase which will help to narrow the deficit by $600m.