The Weekly Bottom Line
February 16, 2007
HIGHLIGHTS
U.S. housing correction unfolding, but
consumers still spending
Canada’s trade picture improves
Japanese and European economies fare well in
Q4; central banks set to raise interest rates
U.S. data released this week was plentiful, and
helped give us a better sense of how the economy is
faring. The main concern throughout 2006 has been
the housing market correction and its effects on the
overall economy. Despite recent signs that housing
activity might be stabilizing, it looks as though
the correction hasn’t fully run its course just yet.
January starts dipped 14.3% to an annual pace of 1.4
million, their lowest level in almost ten years. The
onset of colder weather didn’t help, but starts are
unlikely to recover until unsold inventories decline
enough to balance the market. Until then,
residential construction will continue to be a drag
on the economy.
Meanwhile, the latest round of U.S. production data
was consistent with the numbers we’ve been seeing
from the ISM index in the last few months,
reflecting a manufacturing sector that is
struggling. Industrial output was down 0.5% in
January, mostly due to a 0.7% drop in manufacturing
output that was broadly-based, with particular weak
spots in, unsurprisingly, auto production and
machinery. As a result, capacity utilization was
down slightly to 81.2% from 81.8% in December.
A recent dominant theme has also been about how U.S.
consumer spending has so far been largely unaffected
by the housing contraction. The latest retail sales
headline was soft, but the underlying details turned
out to be stronger. Total sales came in flat
month-over-month, but were up 0.5% when excluding
autos and fuel, which removes the impact of changes
in gas prices. Hence consumer spending shows no sign
of letting up yet and retail sales are expected to
keep churning along at an annualized 5% clip in the
first quarter of 2007.
America’s international trade for December reflected
both the on-going adjustments in the manufacturing
sector and the consumer-based strength. For the
first time in 4 months, the U.S. trade deficit
widened, rising by 5.3% from the previous month. An
increase in exports of 0.6% was outstripped by a
2.1% climb in imports. Although the U.S. economy
fared well in the fourth quarter of last year, the
direct contribution of net exports to this upbeat
finale for 2006 was reduced to that of back-bencher
in December after being a contributor from September
to November. The widening deficit in December was
likely a reflection of solid consumer spending in
the last month of the year. However, the
deterioration in the U.S. trade balance is unlikely
to continue in the months ahead, as consumer
spending ratchets down a bit and as global demand
for U.S. exports picks up. Indeed, the latest fourth
quarter figures for Japan and Europe show the
improving economic fortunes abroad. The largest
continental European economies of Germany, France,
Italy and Spain spearheaded Euro-zone growth, which
posted an annualized gain of 3.6% in the fourth
quarter. Meanwhile, Japan’s real GDP shot up by a
stunning 4.8%, pushing up the growth of the economy
to 2.5% in the second half of the year, which is
above the economy’s non-inflationary (i.e.
potential) rate, currently estimated to be no higher
than 2.0%.
Putting all the data together, the Fed’s outlook on
the economy is unlikely to be changed by recent
developments. Fed Chairman Bernanke’s Congressional
testimony this week suggests that rates will remain
on hold in the months ahead. ‘So far, so good’ was
Congress’ assessment of Bernanke’s performance – and
the street agrees – as the U.S. economy is currently
negotiating a soft-landing completely in-line with
the Fed’s goldilocks scenario.
Canada’s trade picture rosier
From the Canadian perspective, the trade picture
became more upbeat at the end of last year. The
trade surplus chalked up a significant increase to
end at $5bn in December. In volume terms, fourth
quarter exports rose by an annualized 5.1%, while
imports slipped lower by 0.5%. This should help
quash dire predictions of fourth quarter real GDP
growth below 1%, as net exports could boost economic
growth by as much as 2 percentage points that will
offset weakness in a number of other areas. However,
on a year-over-year basis the overall trade surplus
was still lower, and we’re not ready to signal a
definitive turnaround for Canadian manufacturing
exports in particular, even if recent performances
are encouraging. Manufacturing shipments did show
some upside, with a broad-based 1.7% increase in
December, but that gain still left shipments 0.6%
lower in 2006 than in 2005.
The widening U.S. trade deficit and the increase in
the Canadian trade surplus lent support to the
Canadian dollar, which remains strong against the
U.S. dollar. In contrast, 2006 saw the Canadian
dollar weaken against a strong Euro, helping
Canadian exporters make some headway into Euro-zone
markets. Although Canada is still heavily reliant on
the U.S. as its major trading partner, there is a
slow diversification towards other markets. In 2006,
Canada recorded double-digit export growth to the
European Union and the emerging economies of Brazil,
India and China. Meanwhile, after a surge in the
1990s spurred by the Free Trade Agreement, the
annual increase in Canadian exports destined for the
U.S. has flattened from 7% in the 90s to less than
2% for 2000-06, which is to be expected after the
static gains from trade liberalization have been
tapped. In other words, the current trend in two-way
trade with the U.S. has reverted back to being
driven by commodity prices, currency valuation and
relative domestic demand in the two countries. As a
small open economy that relies heavily on access to
foreign investment and markets to sustain its
standard of living, Canada benefits from some
diversification of our trading partners,
particularly when driven by comparative advantage
fundamentals. In light of the fact that some
policymakers in Washington will be tempted to tap
into protectionist sentiment, as the winds blow into
the sails of the “get though on China” crowd,
America’s leadership role in promoting free and open
trade could be dampened. Canada should be
well-poised to step-up its role on the international
scene by spearheading bilateral and multilateral
trade liberalization negotiations.
Global interest rates set to increase
While the U.S. Federal Reserve and the Bank of
Canada are sitting pretty in a comfortable interest
rate pause, other major central banks are set for
rate hikes. Recent strong performance of their
respective economies along with clear signals from
the monetary authorities themselves all cement
expectations that the European Central Bank (ECB),
the Bank of England (BOE) and the Bank of Japan
(BOJ) will raise their key target interest rate at
their next meetings. First in line is the BOJ on
Wednesday, which is likely to raise its rate by 25bp
to 0.5%. Following that there are back-to-back
meetings by the BOE and ECB on March 7-8
respectively. Both are expected to raise rates by
25bp as well, although the BOE might wait until the
summer to do so.
R.Paul Chadwick
Manager of Residential Mortgages,
TD Canada Trust
Phone # 905 334 4066
Pager # 1 866 767 5446
Fax # 905 332 1619
email: paul.chadwick@td.com
web: http://www.tdcanadatrust.com/msf/paulchadwick
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