USD/CAD's rebound from 1.2246 extended higher last week and reached 1.2915. Considering loss of upside momentum in 4 hour MACD and proximity to 1.2919 key resistance, initial bias is neutral this week first. On the downside, below 1.2757 resistance turned support will indicate rejection from 1.2919 resistance. Intraday bias will be turned back to the downside for 1.2614 support first. Nonetheless, firm break of 1.2919 will resume the rise from 1.2061 low and target 1.3065 fibonacci level.

In the bigger picture, current development is reviving the case of medium term reversal after drawing support from 50% retracement of 0.9406 (2011 low) to 1.4689 (2015 high) at 1.2048. Break of 1.2919 will add more credence to this bullish case and target 38.2% retracement of 1.4689 to 1.2061 at 1.3065 first. Break will target 61.8% retracement at 1.3685. However, break of 1.2450 near term support will turn focus back to 1.2061 low instead.

In the longer term picture, 50% retracement of 0.9406 (2011 low) to 1.4689 (2015 high) at 1.2048 remains a key support level to watch. As long as this level holds, we'll treat fall from 1.4689 as a correction and expect another rally through this level. However, sustained break of 1.2048 will turn favors to the case that rise from 0.9056 (2007 low) is a three wave corrective move that's completed at 1.4689. And retest of 0.9056/9406 support zone could be seen in medium to long term.

GBP/JPY's decline from 156.59 resumed last week and reached as low as 144.97. Initial bias remains on the downside this week for 143.51 medium term fibonacci level next. On the upside, above 147.47 minor resistance will turn intraday bias neutral first. But outlook will remain bearish as long as 150.92 resistance holds, in case of recovery.

In the bigger picture, the case for medium term reversal continues to build up. There is bearish divergence condition in daily MACD. 146.96 support was taken out. And GBP/JPY was rejected by 55 month EMA. Break of 38.2% retracement of 122.36 to 156.59 at 143.51 will pave the way to 61.8% retracement at 135.43 and below. This will now be the preferred case as long as 150.92 resistance holds.

In the longer term picture, rejection from 55 month EEMA (now at 154.20) argues that medium term rebound from 122.36 might be completed. And, the corrective structure also carries some bearish implication today. Sustained break of 135.58 key support will likely bring retest of 122.36 low, with prospect of resuming the long term down trend from 195.86 (2015 high).

EUR/JPY's fall from 137.49 medium term top continued last week and reached as low as 129.55. Initial bias remains on the downside this week. Current fall should target 126.61 medium term fibonacci level next. On the upside, above 130.92 minor resistance will indicate temporary bottoming and bring consolidations, before staging another decline.

In the bigger picture, current development argues that rise from 109.03 has completed at 137.49, on bearish divergence condition in weekly MACD. Deeper fall should be seen to 38.2% retracement of 109.03 to 137.49 at 126.61 first. On the upside, break of 137.49 is needed to confirm medium term rise resumption. Otherwise, risk will now stay on the downside even in case of strong rebound.

In the long term picture, at this point, EUR/JPY is staying in long term sideway pattern. established since 2000. Rise from 109.03 is seen as a leg inside the pattern. As long as 124.08 support holds, further rally is in favor in medium to long term through 149.76 high. However, break of 124.08 could extend the fall through 109.03 low instead.

EUR/GBP rose to as high as 0.8950 last week and the break of 0.8928 resistance suggests near term trend reversal. That is, fall from 0.9305 has completed at 0.8686 after hitting 61.8% retracement of 0.8312 to 0.9305. Initial bias stays on the upside this week for 61.8% retracement of 0.9305 to 0.8686 at 0.9069. Firm break there will target retest of 0.9305 high. On the downside, below 0.8877 minor support will turn intraday bias neutral again.

In the bigger picture, there are various ways to interpret price actions from 0.9304 high. But after all, firm break of 0.9304/5 is needed to confirm up trend resumption. Otherwise, range trading will continue with risk of deeper fall. And in that case, EUR/GBP could have a retest on 0.8303. But we'd expect strong support from 0.8116 cluster support (50% retracement of 0.6935 to 0.9304 at 0.8120) to contain downside.

In the long term picture, we're holding on to the view that rise from 0.6935 (2015 low) is resuming the up trend from 0.5680 (2000 low). Hence, after the consolidation from 0.9304 completes, we'd expect another medium term up trend through 0.9799 to 100% projection of 0.5680 to 0.9799 from 0.6935 at 1.1054.

EUR/AUD rose to as high as 1.5919 last week. The solid break of 1.5816 resistance confirmed medium term rise resumption. Initial bias remains on the upside this week for 61.8% projection of 1.5258 to 1.5816 from 1.5626 at 1.5971. Break will target 1.6526. On the downside, below 1.5786 minor support will turn intraday bias neutral. But outlook will remain bullish as long as 1.5626 support holds.

In the bigger picture, medium term rise from 1.3624 is still in progress for 1.6587 key resistance. At this point, we'd be cautious on strong resistance from there to limit upside. But decisive break will confirm resumption of long term rise from 1.1602. On the downside, break of 1.5153 support is needed to indicate completion of the medium term rise. Otherwise, outlook will remain bullish in case of pull back.

In the longer term picture, the rise from 1.1602 long term bottom (2012 low) isn't over yet. We'll keep monitoring the development but there is prospect of extending the rise to 61.8% retracement of 2.1127 to 1.1602 at 1.7488 and above. However, sustained trading below 1.3671 should indicate long term reversal and target 1.1602 long term bottom again.

EUR/CHF spent last week inside recently established range and outlook is unchanged. Initial bias remains neutral this week first. Consolidation from 1.1445 could extend further. But outlook will remain bearish as long as 1.1639 resistance holds. Break of 1.1445 will resume the corrective fall from 1.1832 and target 1.1355 cluster support (38.2% retracement of 1.0629 to 1.1832 at 1.1372.) At this point, we'd expect strong support from there to contain downside and bring rebound.

In the bigger picture, a medium term top should be in place at 1.1832 on bearish divergence condition in daily MACD. But there is no indication of long term reversal yet. As long as 1.1198 resistance turned support holds, we'd still expect another rise through prior SNB imposed floor at 1.2000.

The theme of trade wars overwhelmed the global financial markets last week and overshadowed any other topics. It started on news that US President Donald Trump is going to impose tariffs of 25% on steel and 10% on aluminum. Trump then doubled down by tweeting "trade wars are good, and easy to win" on Friday. DOW suffered a wild 1582 pts swing, diving from weekly high at 25800.35 to as low as 24217.76 before closing at 24538.06. Dollar was initially boosted by Fed Chair Jerome Powell's testimony, which raised the chance of four Fed hikes this year. But the greenback gave up after a brief try to reverse its down trends against Euro and Swiss Franc. Sterling was pressured as EU's draft Brexit treaty reminded the markets that there are still huge divergences between UK and EU regarding post Brexit relationship. And UK Prime Minister Theresa May's high profile speech on Friday didn't live up to the expectations and gave no inspirations.

In the currency markets, Yen ended as the strongest one on risk aversion. Euro closely followed as the second. Dollar didn't perform too badly indeed as it end as the third strongest. Meanwhile, Canadian Dollar ended as the weakest one, partly because of ongoing drag in NAFTA renegotiation, and partly because it's the biggest steel importer to the US. Sterling followed as the second weakest while Aussie was the third.

Large volatility in the markets is almost like a guarantee in the coming week. Results of German Social Democrat member's vote on grand coalition will be released on Sunday. Italy election will be held on the same day too. Then, Trump will probably formally announce the tariffs and other countries will have likely come up with counter measures. Then, there will be RBA, BoC, BoJ and ECB rate decision. US will also release non-farm payroll report. We better be prepared for a rough ride.

DOW heading through 23360 and below as medium term correction extends

DOW initially edged higher to 25800.35 last week but reversed from there and dropped sharply to as low as 24217.76. The index then recovered to close at 24538.06. The development now suggests that the corrective pattern from 26616.71 has started the third leg. That is, further fall should be see through 23360.29 in near term to 100% projection of 16616.71 to 23360.29 from 25800.35 at 22543.93.

Nonetheless, the goods news is that for now, it's look like DOW is only corrective the up trend from 15450.56. Therefore, strong support should be seen around above mentioned 22543.93, which is close to 55 week EMA (now at 22817.61), and 38.2% retracement of 15450.56 to 26616.71 at 22351.24, to bring strong, sustainable rebound.

German DAX performing even worse

Outlook of German DAX is much worse as the last week's sharp decline to close at 11913.71 confirmed resumption of fall form 13596.89. Based on current momentum, key support level at 11868.85 will likely be taken out firmly. And DAX would dive to 61.8% retracement of 9214.09 to 13596.89 at 10888.32 before having strong enough support for rebound.

10 year yield takes a breath, but still on course for 3.036

Despite increasing expectation for four Fed hikes this year, 10 year yield didn't extend recent up trend. For now, 2.943 should be a short term top. And TNX will likely gyrate lower as correction, possibly to 55 day EMA (now at 2.690). But we'd expect strong support from 38.2% retracement of 2.033 to 2.943 at 2.595 to bring rebound.

We'd maintain then the region between 3.036 and 3.318 (100% projection of 1.336 to 2.621 from 2.034) is the long term trend defining resistance zone. And TNX should at least have a go at it even if it's going to give up eventually.

Dollar index staying in down trend after failing 91.01 key resistance

For once, Dollar looks like it's finally reversing the down trend as inspired by Fed Chair Jerome Powell's testimony. However, it clearly lacked follow through buying to push it through 91.01 key support turned resistance. For now, it's staying in the down trend from 103.82. And more downside is still in favor to key support at 84.75 (61.8% retracement of 72.69 to 103.82 at 84.58) before having enough support to complete the medium term correction.

Again, firm break of 91.01 will be the first signal of trend reversal and will turn focus back to 95.15 key resistance for confirmation.

EUR/USD Weekly Outlook

EUR/USD dipped 1.2154 last week but drew support from 55 day EMA and rebounded. The failure to sustain below 1.2205 key support didn't confirm trend reversal. Initial bias is neutral this week first. on the upside, above 1.2354 minor resistance will bring retest of 1.2555 high. Firm break there will carry larger bullish implication. On the downside, break of 1.2154 would revive the case of rejection by 1.2516 key fibonacci level and trend reversal. Outlook will be turned bearish for 38.2% retracement of 1.0339 to 1.2555 at 1.1708.

In the bigger picture, key fibonacci level at 38.2% retracement of 1.6039 (2008 high) to 1.0339 (2017 low) at 1.2516 remains intact despite attempts to break. Hence, rise from 1.0339 medium term bottom is still seen as a corrective move for the moment. Rejection from 1.2516 will maintain long term bearish outlook and keep the case for retesting 1.0039 alive. Firm break of 1.1553 support will add more medium term bearishness. However, sustained break of 1.2516 will carry larger bullish implication and target 61.8% retracement of 1.6039 to 1.0339 at 1.3862.

In the long term picture, 1.0339 is seen as an important bottom as the down trend from 1.6039 (2008 high) could have completed. It's still early to decide whether price action from 1.0339 is developing into a corrective or impulsive pattern. Reaction to 38.2% retracement of 1.6039 to 1.0339 at 1.2516 will give important clue to the underlying momentum.

 

Monday, Mar 5, 2018

[php_everywhere instance="1"]

Tuesday, Mar 6, 2018

[php_everywhere instance="2"]

Wednesday, Mar 7, 2018

[php_everywhere instance="3"]

Thursday, Mar 8, 2018

[php_everywhere instance="4"]

Friday, Mar 9, 2018

[php_everywhere instance="5"]

U.S. Review

Soaring Sentiment, but Will the Hard Data Follow?

• U.S. factory sector data released this week showed another divergence between the "hard" and "soft" data. The ISM manufacturing index reached its highest level since 2004, but durable goods orders showed signs of cooling.
• The Consumer Confidence Index climbed to 130.8 in February, touching the highest level since late-2000 despite volatile U.S. equity markets.
• New and pending home sales slipped in January, while strong public construction spending offset some weakness in the private sector.

Soaring Sentiment, but Will the Hard Data Follow?

U.S. factory sector data released this week showed another divergence between the "hard" and "soft" data. On the hard data front, private equipment spending looks to be cooling after increasing at a double-digit pace in the third and fourth quarters of 2017. Durable goods orders fell 3.7 percent in January, with much of the decline concentrated in the volatile nondefense aircraft component. Our preferred gauge of future business investment, orders excluding aircraft and defense, fell 0.2 percent in January on the heels of a 0.6 percent decline in December. The trend in core capital goods orders has weakened noticeably from the impressive run in the fall; core capital goods orders are up at a 3.7 percent three-month average annualized pace, compared to over 18 percent as recently as November (see chart on page 1).

Survey data on U.S. manufacturing, however, continued to reach new heights. The headline print of 60.8 for the ISM manufacturing index was the highest since 2004 and the latest affirmation of broadening business confidence (top chart). The prices paid component of the index continued climbing—signaling building price pressures in the pipeline—and the employment component jumped to 59.7 after a sharp fall to 54.2 in January. As we have written previously, we expect to see the hard data for orders converge with the survey data. In times of such pronounced survey strength, however, the gap between hard and soft data is usually narrowed by business surveys getting reined in, rather than the hard orders data, which feed directly into GDP calculations.

Survey-data released this week also showed consumer confidence soaring. The Conference Board's Consumer Confidence Index climbed to 130.8 in February, touching the highest level since late- 2000. Both the present situation and future expectations indices rose in the month, with more upbeat sentiment about the availability of jobs and expected income growth. February's stock market volatility seemed to have little effect on consumer sentiment. A separate release from the Department of Commerce showed strong disposable income growth in January as the tax cuts began to take effect. Consumption growth started the year off on a bit of a soft note, but rising confidence and solid income growth bode well for consumption growth over the remainder of the year.

New home sales slipped in January, falling 7.8 percent despite market expectations for a 3.5 percent gain. The winter months can have notoriously volatile seasonal adjustment factors for home building, however, and some upward revisions going back to October helped offset some of the January weakness. Pending home sales also exhibited weakness in January. Construction outlay data were a bit better, as private residential spending rose 0.3 percent and 0.6 percent in the single-family space. Public construction in particular exhibited strength: federal outlays surged 14.9 percent in the month after a 12.7 percent jump in December (bottom chart). Q4-2017 saw the fastest growth in the government line of real GDP since Q2-2015. Although seasonality issues could be at work, this recent data is an early sign of continued near-term momentum in this sector.

U.S. Outlook

ISM Non-Manufacturing • Monday

The ISM non-manufacturing index rose 3.9 points last month to reach a new cycle high of 59.9. The index had reached a cycle high previously in the fall due to hurricane-related distortion, but this record-breaking print is being driven by overall firming in the sector. Non-manufacturing new orders rose 8.2 points in January, which was the strongest monthly increase in the series since early 2009. Prices increased in 15 of the 18 industries reported in service firms last month.

While a trend has yet to emerge, price gains will be something to keep an eye on over the first half of the year. Trade data in the index will also hold significance. Last month, export and import activity picked up, above their six-month averages. However, the rise in imports has been stronger than exports, suggesting trade could be a headwind to Q1 GDP growth.

Previous: 59.9 Wells Fargo: 58.8 Consensus: 58.7

Factory Orders • Tuesday

Factory orders closed 2017 with a 1.7 percent increase in December, marking the fifth straight monthly increase, including upwardly revised November data. Core capital goods shipments were up nearly 9 percent on the year and are up 12.1 percent on a three-month annual rate basis. Equipment spending in Q4 grew by an initially reported 11.4 percent; however, the recent strength in core capital goods, in part, reflects the upwardly revised Q4 equipment spending figure to 11.8 percent. Looking forward into Q1, core capital goods orders slipped a bit in December but are still elevated on an annualized rate basis.

There is still a disconnect between euphoric soft data with ISM new orders near record highs, and hard data that has not quite kept pace. If January's factory orders report confirms survey data strength, Q1 business investment and equipment spending could be in for another strong quarter.

Previous: 1.7% Wells Fargo: -1.1% Consensus: -0.5% (Month-over-Month)

Employment • Friday

January's jobs report posted a solid 200,000 job gain with broad strength, with 63 percent of industries adding jobs compared to just 52 percent last year. Average hourly earnings rose 0.3 percent in January and are now up 2.9 percent over the year. Earnings have trended upwards over the past six months, and this caused some concern in the markets, as higher labor costs could squeeze profits and accelerate inflation. Previously, wages had been sluggish due to low productivity and weak inflation.

Labor force participation is an area that needs improvement if we are to achieve sustained 3 percent growth, as it would help drive both productivity and income growth. The labor force participation rate has trended downwards since the turn of the century, and has remained just under 63 percent over the past two years. The unemployment rate held at 4.1 percent in January, and we expect it to continue declining as job growth outpaces labor force growth.

Previous: 200,000 Wells Fargo: 210,000 Consensus: 200,000

Global Review

Economic Recovery Continued in South America in 2017

• Growth was not strong, but was in the right direction for some of the largest economies in South America. The Brazilian economy managed to grow 1.0 percent in 2017 after a 2.1 yearover- year rate in Q4-2017, with the external sector driving growth. Argentina's economy grew 2.8 percent in 2017. China's Manufacturing Disappointed, U.K.'s Did Not
• The official manufacturing PMI for February dropped close to the demarcation point once again, to 50.3 from 51.3 in January, after remaining above 51 for more than a year.
• In the United Kingdom, the manufacturing PMI came in a bit higher than what markets were expecting, at 55.2 versus markets expectations' of 55.0.

Economic Recovery Continued in South America in 2017

Not strong, but in the right direction, should be the call for some of the largest economies in South America. The largest one, which is also the ninth-largest economy in the world, Brazil, finally abandoned a recession that lasted more than two years. Economic growth was not great, and risks are still high for this economy in 2018, but it managed to grow 1.0 percent in 2017 after a 2.1 yearover- year rate in Q4-2017. From the Q4 release, it is clear that although domestic consumption is starting to improve, the economy was driven by the external sector. Real exports of goods and services surged 9.1 percent in the final quarter of the year, year over year, and 5.2 percent for the year as a whole, while real imports of goods and services grew 8.1 percent on a year-earlier basis in Q4-2017 and 5.0 percent for the whole of 2017. Real personal consumption expenditures were up 1.0 percent, while real government expenditures were down 0.6 percent. Growth in real gross fixed investment was negative for the whole of 2017, down 1.8 percent, but it grew 3.8 percent on a year-earlier basis in Q4-2017, clearly showing a recovering trend that will help the prospects for economic growth in 2018 if the political cycle does not add to the uncertainty over the future of the Brazilian economy.

Meanwhile, Argentina's economy grew 2.8 percent for 2017, according to the monthly economic activity index, after declining 2.2 percent in 2016. While we do not have demand-side numbers yet, we suspect that the recovery in the global economy also contributed to the performance of the Argentine economy in 2017 as it did for the Brazilian economy. Perhaps in the Argentine case, the balance of growth was relatively more even between the external sector and the domestic economy than in the case of Brazil, as the country's construction industry led the way from the supply side in the recovery process.

China's Manufacturing Disappointed, U.K.'s Did Not

In China, the official manufacturing PMI for February dropped close to the demarcation point once again, to 50.3 from 51.3 in January, after remaining above 51 for more than a year. However, the Caixin China manufacturing PMI, which tends to survey foreign firms producing for the export market, saw its index improve slightly, from 51.5 in January to 51.6 in February. The difference between these two indices is probably related to the current state of the global economy versus the Chinese economy, i.e., the global economy has continued to expand, while data suggest that the domestic Chinese economy may be decelerating a bit in Q1-2018. In the United Kingdom, the manufacturing PMI came in a bit higher than what markets were expecting, at 55.2 versus markets expectations of a 55.0 reading, but the index was slightly lower than the 55.3 print recorded in January. All this information, together with the release of a strong February manufacturing PMI for the United States, continues to point to a relatively strong and steady manufacturing sector across the global economy. In some sense, this week's numbers for the manufacturing sector are a sign that global growth has steadied over the past several quarters, which is no small feat.

Global Outlook

Australia GDP • Tuesday

The Australian economy expanded 2.8 percent year over year in Q3, largely driven by a pickup in investment spending and a modest build in inventories. While the business sector expanded in Q3, private consumption was weak, up just 0.1 percent sequentially. However, recent data point to an improving consumer outlook. Monthly retail sales rose on average 2.4 percent year over year in Q4, and the unemployment rate continues to trend lower. The economy is likely poised for further expansion, as consumer spending improves and a tighter labor market should put upward pressure on wages. The Reserve Bank of Australia (RBA) also meets next week on Monday. Slow wage growth, below-target inflation and high levels of household debt have kept the RBA on hold for the past several quarters. However, its latest policy statement cited improving economic conditions. In the midst of slowly increasing inflation, we look for the RBA to raise rates either later this year or in early 2019.

Previous: 2.8% Consensus: 2.5% (Year-over-Year)

Bank of Canada Meeting • Wednesday

The Bank of Canada (BoC) hiked its overnight target lending rate 25 bps to 1.25 percent at its January meeting, largely due to a strong labor market and inflation within the target range. Although economic growth remains solid and inflation is firmly within the BoC's target range of 1-3 percent, we look for the BoC to remain on hold until the second half of this year. The BoC has already tightened its policy rate 75 bps since July 2017, and is likely mindful of how higher rates will affect consumers. Highly-leveraged households are already facing higher mortgage rates, and other debt servicing costs could also increase. The BoC also cited ongoing NAFTA negotiations as a risk to the outlook, as the United States is Canada's largest trading partner. On net, the outlook remains positive for future rate hikes, albeit at a gradual pace. We acknowledge some upside risk to our forecast, should growth pick up or NAFTA negotiations result in a more favorable outcome for Canada.

Previous: 1.25% Wells Fargo: 1.25% Consensus: 1.25%

European Central Bank Meeting • Thursday

Economic growth in the Eurozone is becoming increasingly broadbased; however, sluggish inflation has restrained the European Central Bank (ECB) from implementing a more rapid pace of policy normalization. Core CPI inflation was only 1.0 percent in February, and ECB President Mario Draghi's testimony to the European Parliament this week cited that "inflation has yet to show more convincing signs of a sustained upward adjustment." However, an overall pickup in growth—Q4 real GDP increased 2.7 percent year over year—combined with a tightening labor market, should support slowly increasing inflation in the coming quarters. While we do not expect the ECB to make any policy changes on March 8, we look for the ECB to end its current €30 billion monthly pace of bond purchases by the end of this year. We then look for the ECB to slowly begin to raise rates by first hiking the deposit rate in H1-2019, while leaving the overnight interbank rate and two-week refinancing rate unchanged for the time being.

Previous: 0.00% Wells Fargo: 0.00% Consensus: 0.00%

Point of View

Interest Rate Watch

So, Mr. Powell, How's the New Job?

The new Chairman of the Federal Reserve, Jerome Powell, took the oath of office on February 5, the same day that U.S. stocks went into freefall and the Dow Jones Industrial Average posted it largest singleday point drop on record, falling 1,175 points.

It would certainly be unfair to blame the new Chairman for the selloff, although it certainly made for a memorable first day on the job. This week, financial markets got an opportunity to take the measure of the new Fed Chairman when he headed to Capitol Hill to meet with lawmakers for the semiannual Monetary Policy Report.

The initial financial market reaction to the published policy report was rather muted, but sparks flew on Wall Street later in the day on Tuesday when the Q&A of Mr. Powell was widely interpreted as being at least somewhat more hawkish than the carefully crafted formal report. After stating that, in his personal view, the economy had strengthened since December, Powell added that "we've seen continuing strength in the labor market — we've seen some data that in my case will add some confidence to my view that inflation is moving up to target." Equity markets sold off again on Tuesday as Treasury yields climbed higher.

Later in the week, during Powell's appearance before the Senate Banking Committee on Thursday, financial markets had more or less stabilized… until the President announced his new tariffs on steel and aluminum. The immediate reaction was another steep sell-off in stocks. Another takeaway from the Q&A of the new Fed Chair is that he does not place too much importance on financial market volatility when considering the course for monetary policy. A week like this one feels almost designed to test anyone's nerve.

Another interesting takeaway from Powell's appearances this week centered on whether recent improvements in the labor market would translate into higher inflation. "For wages to go up sustainably, you need higher productivity," Powell argued. We agree. In fact, productivity is the magic elixir to help GDP growth as well, as we discuss in the Topic of the Week on the next page.

Credit Market Insights

Noncurrent Loan Balances Up in Q4

Noncurrent balances for bank loans increased 1.3 percent ($1.5 billion) in the fourth quarter, according to the FDIC Quarterly Banking Profile released Tuesday. This recent uptick marks a departure from trend after six consecutive quarterly declines, which collectively shaved off $26.4 billion in noncurrent loans.

Real estate contributed most of the increase in noncurrent loans. Noncurrent residential mortgages rose 5.2 percent ($2.8 billion) for the first increase since Q3-2012. Residential real estate makes up just under half of all noncurrent loans, so changes in this segment have a large influence on the headline. Noncurrent credit card balances also increased, up 11.5 percent ($1.2 billion), but noncurrent commercial and industrial loans fell 8.5 percent ($1.7 billion).

Bank balance sheets continue to show underlying strength. Total loan balances at banks increased 1.7 percent in Q4, with growth across nearly every category. This kept the noncurrent loan rate at 1.2 percent, the lowest level since Q3-2007 and down from 1.42 percent a year ago. The coverage ratio of loan-loss reserves to noncurrent loan balances declined slightly to 106.3 percent, but has been above 100 percent for the past three quarters.

We expect the Fed to raise rates three times in 2018. This environment may put pressure on borrowers' ability to afford payments. However, bank balance sheets look to be in a position to absorb further modest increases in noncurrent loans at this point.

Topic of the Week

Potential Growth: As Easy As One-Two-Three?

Last summer, we published a report detailing the challenges to achieving 3 percent real economic growth on a sustained basis, and last week's release of the Economic Report of the President offered another opportunity to revisit the outlook for potential growth.

In the short-run, aggregate spending drives economic growth. It is from the demand-side that economists derive the well-known equation C+I+G+NX=GDP. Over the long-run, however, growth is driven by an economy's capacity to produce goods and services. Labor force growth and the growth in the productivity of these workers determine an economy's productive capacity.

The Economic Report of the President showed the assumptions that underpin the Trump administration's 3 percent growth forecast. As illustrated in the top chart, a return to historical growth rates for hours worked and productivity would lift potential growth to 3 percent. The challenge, however, is that today's demographic profile looks vastly different than the previous half-century. The prime-age population in the United States has more or less been flat for the past decade (bottom chart). The administration's own estimates, which include a positive labor response from the tax plan, do not expect labor's contribution to growth to return to the historical average. The prospect of tighter immigration laws represent another potential downside risk to the labor component.

If labor's contribution will be lower in the future than in the past, productivity growth would have to make up the difference. Indeed, the White House projects productivity growth of 2.6 percent per year over the next decade, above the 2.0 percent averaged since 1953 and the 1.2 percent averaged since 2007 (top chart). We concur that productivity growth is likely to rise from its current pace as stronger investment spending drives capital deepening and total factor productivity accelerates from historic lows. We remain skeptical, however, that productivity growth will swing from one extreme to the other, which is what would be needed to sustain 3 percent GDP growth.

U.S. Highlights

• Markets sold off sharply this week, following a somewhat hawkish assessment of the U.S. economy from the Fed's new chair Jerome Powell and the announcement of steep tariffs on steel and alumimium imports by Donald Trump.
• Despite the market reaction to Powell's comments, there was not much in the data this week to indicate that the economy is overheating. Both headline and core PCE inflation remained unchanged in January, coming in at 1.7% y/y and 1.5% y/y, respectively. Real consumer spending fell by 0.1% on the month. Vehicle sales also weakened in February.
• Both consumption and GDP will start the year on a softer footing but weakness is expected to be short-lived. Tax cuts and tightening labor market will support consumer spending and above-trend growth over the remainder of 2018.

Canadian Highlights

• The marquee event this week was the 2018-19 federal budget, which despite an array of new spending measures, contained little in the way of policies intended to address Canada's newly disadvantaged tax position versus the U.S.
• Real GDP hit 1.7% (annualized) in the fourth quarter, below the Bank of Canada's forecast. The monthly figure edged modestly higher in December, up 0.1%, signaling diminished momentum to end the year and a soft hand-off into 2018.
• A softer-than-expected GDP print coupled with a maintenance-type budget provides the Bank room to be patient on the rate hike front, but data-dependency remains in place.

U.S. - Fears of Trade War Rattle Financial Markets

This was a busy and difficult week for financial markets. Economic data releases were overshadowed by the much anticipated first Congressional testimony by the new Federal Reserve chair Jerome Powell and trade tariff announcement from the White House.

In his speech on Tuesday, Mr. Powell struck an upbeat tone on the U.S. economy and inflation, saying that his "outlook for the economy has strengthened since December." He also highlighted potential upside risks to growth and inflation stemming from fiscal policy and the improved global economic backdrop. Without stating the exact number of rate hikes expected this year, Powell seems to have opened the door to a faster rate of normalization as long as the economic data cooperates. Markets were quick to interpret his comments as hawkish, with equities selling off and bond yields rising. New York Federal Reserve president Bill Dudley added more fuel to the fire by saying that four rate hikes by the Federal Reserve this year would still constitute a "gradual" pace of tightening.

Market losses extended further on Thursday on fears of trade wars following Donald Trump's announcement of a 25% import tariff on steel and 10% on aluminum. While nothing has been signed yet, should these tariffs be introduced, they will lead to higher input prices for many manufacturing and construction industries which rely heavily on steel and aluminum inputs and ultimately result in higher prices for U.S. consumers, thus posing an upside risk to the Fed's inflation outlook. The Fed may look through a one-time change in prices as a result of tariffs, but will be cautious on the impact on inflation expectations and potential economic growth – trade wars are not typically good for productivity growth.

Still, for the time being there is not much in the incoming data to indicate that the economy is overheating. Inflation-wise, both headline and core PCE inflation remained unchanged in January, coming in at 1.7% y/y and 1.5% y/y, respectively. Real consumer spending fell by 0.1% on the month, despite strong gains in real disposable income (+0.6% m/m) on the back of lower taxes. Indicators of housing activity were also soft. Coming on the heels of a decline in existing homes, January sales of new homes and the forward looking pending sales of existing homes also weakened. Ditto for auto sales, which edged down to 17.0 million units in February from 17.1 million in January. All in all, similar to the prior years, both consumption and GDP will start the year on a softer footing.

That being said, the slowdown will likely be short-lived. Some of the weakness in consumption is likely a pullback from the hurricane-induced ramp up at the end of 2017, and some due to "residual seasonality," which has become apparent in recent years. Barring unexpected developments trade-side, tax cuts and a tightening labor market will prop up household income this year, supporting robust consumer spending and above-trend growth over the remainder of 2018.

All in all, the latest data does not change the calculus for the Fed with three rate hikes expected this year, however, the central bank will certainly need to keep a close watch of the economy, given rapidly evolving U.S. public policy.

Canada - Placeholder Federal Budget Caps Busy Week

It was a fairly busy week for Canadian markets, with several key economic reports and a budget to boot. Sentiment has soured during the week, with the TSX lower in recent days, partly on the back of statements by President Trump indicating that he planned to put punitive tariffs on aluminum and steel imports, sparking fears of a trade war. Softer oil prices amid a larger-than-expected inventory build south of the border also weighed on bourses, as did the inaugural testimony to Congress by the newly-minted U.S. Federal Reserve Chair Powell, who struck a bullish tone, signaling that the pace of hikes may be faster than expected. Powell's speech also sent global bond yields higher though the back-up in Canadian bond yields proved temporary, as weak domestic data weighed on them.

Arguably, the marquee event on the economic calendar this week was the release of the federal budget for the fiscal year 2018-19. The federal government plans to use an improved fiscal starting position to fund an array of new initiatives. This should inject some modest near-term stimulus into the Canadian economy. However, the government is banking on the notion that on-going economic growth coupled with slower program spending will keep the federal deficit at a manageable 1% of GDP and the leave the debt-to-GDP profile on downward track (Chart 1). Despite some $20 billion in new spending initiatives announced, in many ways the budget felt like a placeholder. Sweeping U.S. tax reforms have eroded Canada's competitiveness on the global stage, leading to calls for a response from the government. However, the budget contained little in the way of measures to address Canada's disadvantaged position, opting for monitoring instead. At this point, it appears that the government is keeping its powder dry ahead of next year's pre-election budget.

While the budget took centre-stage early on, the release of the Q4 GDP figures capped off the week. GDP growth hit 1.7% (annualized) in the fourth quarter, averaging a robust 3.0% during 2017 overall. The quarterly pace represented a slight strengthening from Q3, but was below the Bank of Canada's estimate of 2.5%. Net trade was slightly less of a drag on growth, with exports improving in part due to higher automotive production – previously depressed on maintenance shutdowns and a labour disruption. Consumer spending slowed sharply but nonetheless remained a positive contributor to growth, while residential investment benefitted from higher home sales ahead of the implementation of the B20 guidelines (Chart 2). On a monthly basis, December's gain was a modest 0.1%, as growth was restrained by weak construction, manufacturing, wholesale and retail activity.

All told, economic growth has clearly downshifted from the solid pace observed in the first half of 2017 while December's relatively modest print points to rather soft momentum heading into 2018. This will likely motivate a downgrade to the Bank of Canada's forecast for growth, and affords more patience on the rate hike front.

U.S.: Upcoming Key Economic Releases

U.S. Employment - February

Release Date: March 9, 2018
Previous Result: 200k, unemployment rate: 4.1%
TD Forecast: 175k, unemployment rate: 4.1%
Consensus: 203k, unemployment rate: 4.0%

We expect nonfarm payrolls to advance by a respectable 175k in February, recording a pace slightly below the 6-month average trend. We expect the unemployment rate to stabilize at 4.1% though unrounded figures should show a decline. All eyes are on average hourly earnings following the January upside surprise that left wage growth tracking at 2.9% y/y. With the 12th of the month landing on a Monday, calendar effects are favorable in February for a strong 0.3% m/m print. However, we see scope for disappointment as monthly readings have a high tendency to mean revert, while any wage increases in response to tax reform are likely insignificant in the aggregate. We expect a 0.2% m/m increase, leaving the y/y pace lower at 2.7% vs 2.9%. Downward revisions cannot be excluded as well, which point to further downside risk to the y/y figure.

Canada: Upcoming Key Economic Releases

Canadian International Trade - January

Release Date: March 7, 2018
Previous Result: -$3.2bn
TD Forecast: -$3.0bn
Consensus: N/A

TD looks for the merchandise trade deficit to narrow to $3.0bn in January on higher export and import activity. Energy will provide the driving force behind export growth though we also see upside risks to non-energy exports on a surge in motor vehicle production, which continues to normalize after transitory disruptions. Imports should see a more tepid pace of growth on the slowdown in consumer spending, though aircraft imports should rebound on Boeing deliveries.

Canadian Employment - January

Release Date: March 9, 2018
Previous Result: -88k, unemployment rate: 5.9%
TD Forecast: 2k, unemployment rate: 5.9%
Consensus: N/A

We expect job creation to print at a subdued 2k in February after the January cold shower of -88k. While outsized LFS prints tend to reverse the following month, we think the dismal January report is mostly explained by the impact of the Ontario minimum wage hike and unsustainable gains over the prior three months as LFS outperformed the less timely SEPH measure by roughly 130k in Q4, the largest gap on record. Moreover, we expect the Ontario minimum wage hike to continue weighing on the regional labour market and we could see further job losses in February, concentrated in low-wage industries (accommodation and food services). We do see scope for a reversal in the full/part time split at the national level, which would add a downbeat tone to the headline print. We expect a small rebound in labour force participation after the rate fell 0.3pp in January, though the unemployment rate should hold at 5.9% from an unrounded 5.85% the prior month. Finally, wage growth for permanent employees is expected to slip to 3.0% from 3.3% on base effects and moderating underlying wage pressures.