HIGHLIGHTS OF THE WEEK
- Stock markets inched lower this week as odds increase that the promise of regulatory reforms and tax cuts will be delayed.
- Normally falling stocks, dollar, oil, and Treasury yields would suggest concern about the health of the U.S. economy. However, the data this week remained supportive of an expansion in the U.S. and global economies in the first half of this year.
- Later today the U.S. congress will vote on a bill to amend the Affordable Care Act (ACA) that is likely to have market implications. If the bill passes, it moves onto the Senate, but if today’s vote fails, future amendments to the ACA could be in doubt.
- The big-ticket economic attention-grabber this week was the federal government’s 2017 budget. The budget was largely a stay-the-course type, with the federal government accepting larger deficits over the medium-term to push its spending agenda along.
- Budget aside, the economic data this week highlighted that the economy may outperform near-term expectations, with retail sales roaring back from a disappointing December reading. Motor vehicle and parts remain the biggest driver of retail spending, highlighting that consumer confidence remains strong in Canada. Having said that, inflation readings were soft, suggesting the Bank of Canada isn’t likely to move anytime soon.
UNITED STATES – MARKETS TAKE A BREATHER
There was little in the way of data and news this week to move markets. Nevertheless, stock markets inched lower, as it became increasingly apparent that the promise of regulatory reforms and tax cuts is likely to be delayed beyond the summer. Despite the rate hike by the Federal Reserve last week, U.S. Treasuries rallied, with the 10-yr Treasury yield briefly dipping below 2.4% – roughly the going rate in play prior to the Fed jawboning the market in late February. Coinciding with these market moves has been a decline in oil prices and a weaker trade-weighted U.S. dollar.
Normally falling stocks, dollar, oil, and Treasury yields would suggest concern about the health of the U.S. economy. However, this is unlikely the reason behind the market moves this week. In fact, on a year-to-date basis, the S&P 500 is up 5%, and the 10-yr yield is less than 10 basis points from where it was at the end of last year, and about 50 basis points higher than when it was before the November election. Moreover, although oil prices have dipped below $US 50 per barrel, the recent weakness has more to do with rising supply than declining demand.
The only outlier is the trade-weighted dollar, which has dropped by about 2.5-3.5% since the start of the year, depending on which measure is used. But this too is not necessarily a result of a more negative outlook for the U.S. economy, but rather a reflection of stronger global economic growth. For example, growth in Europe is expected to be well in excess of its trend pace again in 2017 for the third consecutive year, and suggests that the next step for the ECB is likely to tighten rather than ease monetary policy. Strong economic activity by its trading partners should support demand for U.S. produced goods and services, although we still are of the view that net trade is likely to be a small drag on U.S. economic activity this year.
The admittedly sparse data this week is broadly consistent with this view. Preliminary survey data for March released this morning suggests that the Eurozone economy likely expanded at a slightly faster pace than in previous months. Conversely, according to the same survey data the U.S. economy likely saw growth slow a touch in March. Moreover, U.S. existing home sales in February dropped 3.7% m/m to 5.48 million units (annualized). Some payback was expected in existing home sales after an unexpectedly strong showing in January despite rising mortgage rates. Although sales declined, home prices rose 7.7% on a yearon- year basis, up from 6.4% y/y growth in the prior month. Home price growth was once again driven by a lack of inventory. While our outlook for the economic fundamentals driving the housing market remains optimistic, a persistent lack of supply could reduce affordability and act as a material headwind to the housing market.
In an environment of elevated policy uncertainty, every data point and every word uttered by policymakers seems to matter more to markets. Later today the U.S. congress will vote on a bill to amend the Affordable Care Act (ACA) that is likely to have market implications. If the bill passes, it moves onto the Senate. However, if today’s vote fails, President Trump has threatened to leave the ACA unchanged, and in so doing reneging on one of his core campaign promises to repeal and replace it.
CANADA – MIND THE BUDGET GAP
‘Tis the season for budgets, and the most anticipated one of them all (the federal Budget) was tabled on Wednesday of this week. The federal government is projecting larger deficits over the medium-term to push its spending agenda along.
The federal government embarked on a pretty aggressive spending plan last year and estimates of the medium-term deficit have been creeping up since. That deficit is expected to reach $28.5 billion in fiscal year (FY) 2017-18, or 1.3% of GDP and is now projected to be between $5 and $7 billion dollars higher per year over the medium-term than expected in Budget 2016. In fact, the government anticipates to still be running a deficit of $18 billion (0.8% of GDP) by 2021.
In large part, the higher deficit projections reflect more cautious economic assumptions. Still, the government opted not to introduce major revenue generating measures to help fill the gap. There were a few small items, such as raising taxes on alcohol and cigarettes, removing the public transit tax credit and applying the GST to Uber rides, but nothing that will substantially move the needle on revenues. Rather, the federal government added a few more investment dollars to its spending plan for hot-topic issues such as parental leave, affordable housing and skills and innovation. Funding for most of the new initiatives introduced in this budget however, has been shuffled out of prior planned projects and will only add a cumulative $4.8 billion to the deficit between fiscal years 2016-17 and 2020-21.
The course of action in this week’s wait-and-see budget may be appropriate. The Canadian economy may prove a bit stronger in the near-term than what has been baked into this budget, which could give just a bit of a nudge to near-term revenues. This week’s retail sales report was yet another sign that the Canadian economy is gathering considerable momentum in 2017. Retail sales were up 2.4% in January, the sharpest monthly gain in almost seven years. More importantly, motor vehicle and parts (+3.8% m/m) drove the gain, highlighting that Canadians are feeling confident in their future employment prospects. TD Economics is forecasting nominal GDP growth of 4.7% in 2017, compared to the federal government’s more cautious estimate of just 4.1%. At the same time, the timing might not be right for restrictive fiscal policy given the extensive risks facing Canada and the global economy.
One of the key risks remains in the government’s longterm interest rate outlook. This week’s soft consumer price report showed that all of the Bank of Canada’s measures of inflation are running below the 2% target, underscoring the view that the central bank will remain on hold at least until next year. However, TD Economics believes that ongoing Federal Reserve hikes could pull up the 10-year Government of Canada bond yield by 30 to 40 basis points in 2017 and 2018 above the Budget 2017 assumptions.
Still, while deficits remain on the horizon, the debt-to- GDP ratio is not expected to breach 30% over the forecast plan. This is quite low from a historical perspective, at half the peak reached in the late 1990’s, leaving some fiscal room to work down the deficit only gradually.