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The Weekly Bottom Line : 02/02/2013
Domestic data releases dominate the docket this week with markets trading sideways on mixed news through Thursday, before advancing on today's data.
Advance estimate of U.S. fourth-quarter output shows GDP slipping marginally into contraction. But details appear very constructive, as private domestic demand steams ahead.
Payrolls come in a notch below expectations, but revision to previous months solidifies the theme of ongoing job market recovery.
January manufacturing reports lend further credence to the idea that the soft-patch is behind us. U.S. manufacturing ISM gains almost three points, and is away from the precipice. Chinese PMI remains in slight expansion while eurozone PMI indicates the declines in activity may be coming to an end.
Canadian 10-year bond yields touch 2.00%, marking an 8-month high.
TD Economics has pushed back the first Bank of Canada rate hike to the first quarter of 2014.
November GDP surprises markets on the upside, growing by 0.3%.
Small business owners were more optimistic in January, with near-term hiring intentions at a post-recession high.
The week was dominated by several domestic data releases, to help complete the 2012 picture. With U.S. equities already having a phenomenal month - up over 5% as of last Friday - equity markets largely moved sideways though the week, digesting each piece of data as it became available, in anticipation of today's payroll report. Perhaps most surprising was the mid-week advance estimate of fourth-quarter GDP, which came in far below expectations, registering a marginal dip in contrast to a consensus 1% call and our even more muted 0.6% forecast. So is the quarterly contraction a sign of what's to come, having put the U.S. in the not-so-prestigious club of contracting economies - joining the UK and the eurozone. We think not, as the devil appears to be in the details. Unlike the eurozone - already in a double dip - or the UK - which appears to be at a real risk of a triple-dip - the U.S. economy is not likely to fall into a technical recession.
In fact, the decline last quarter can be fully attributed to two of the more volatile components of GDP, federal defense consumption expenditures and change in private non-farm inventories. After posting outsized gains in the third-quarter of the year, these two components corrected sharply in 12Q4 and together accounted for a whopping 2.6 percentage point (pp) whack to the annualized growth rate. This drag taken together with a quarter-point hit from net-exports, overwhelmed the otherwise robust growth in private domestic demand, which actually accelerated to 3.3% to close off the year. In spite of the looming 'fiscal cliff,' business non-residential investment held-up well - contributing 0.8pp to growth - on the back of strong durable goods orders. Residential investment was also solid, growing at its fastest pace in eighteen years. As new construction activity continues to recover - with housing starts expected to reach 1M annualized by year-end - in the context of a healing broader housing market, we see this component as a robust supporter over the medium-term. Consumers too held up their end, and while decelerating into December, personal consumption still managed to add 1.5pp to growth on the back of the strength in durables. This should continue to hold-up well into the next several quarters as pent-up demand for autos and gradually improving employment situation motivates people to visit dealer showrooms.
This brings us to this morning's middling non-farm payrolls report. January payrolls advanced by a tolerable 157k, or a notch below expectations, but markets were buoyed by the upward revisions to the previous three months of data, which boosted the fourth quarter employment by 150k, or a months worth of recent job creation. All the more exciting was the continued advance in construction payrolls, which rose by 28k last month after gaining 70k in the fourth-quarter of last year. We expect this pace to accelerate slightly with construction payrolls expected to add nearly half-million jobs this year, or nearly a quarter of the annual tally. Manufacturing payrolls also advanced, although at a trickle-pace, with only 4k added on the month. However, with January's ISM firming into expansionary territory at 53.1, or an eight-month high, the sector looks to be on the up-and-up after a soft-patch in the second-half of last year. Market sentiment on Friday was also aided by manufacturing reports from China and the eurozone, which were far from stellar but reaffirmed a tone of recovery following last year's slowdown.
Coincidentally, this week's data releases included the two variables which the Federal Reserve has identified as 'thresholds' in guiding the future path of monetary policy. PCE inflation continued to decelerate into December, reaching a year-over-year growth rate of just 1.3% to close off the year. The unemployment rate too strayed further from its 6.5% target threshold quoted by the Fed. This fits well with our view that neither will become a binding constraint anytime soon, and that the easing bias is here to stay at least for sometime yet.
It's no secret that the Canadian economy is closely tied to the U.S. economy, and several financial indicators in Canada tend to move largely in line with their American counterparts. Case in point is bond yields. This week, bond yields in both countries shot up, due largely to increased optimism surrounding global economic conditions. Indeed, following the movements in the U.S. bond market, the Canadian 10-year yield jumped 11 basis points from last Thursday, touching 2.00% for the first time since May. This extends an upward trend that began a couple months ago, marking a 30 basis point increase since early December.
Meanwhile, a more muted increase in shorter-term yields led to a steepening in the yield curve. This was due in part to the more dovish tone from the Bank of Canada last week, which indicated that the removal of stimulus is now less imminent. Indeed, with both inflation and economic growth in the fourth quarter sitting well below what the Bank had forecasted in October, it will be in no rush to tighten monetary policy. As a result, we have revised our Bank of Canada rate call, pushing back the first rate hike to the first quarter of 2014. We now expect two 25 basis point hikes in January and March of next year, followed by a second pair of 25 basis point hikes in the fourth quarter of 2014 and first quarter of 2015. This does not alter our view that the Bank of Canada will raise the overnight rate by 100 basis points while the Federal Reserve remains on hold.
While economic growth has disappointed the Bank of Canada's original estimates, November's GDP report actually surprised market expectations on the upside, with growth of 0.3%. Still, even with a better-than-expected print, the Canadian economy is on track for modest growth of only 1% (annualized) in Q4 thanks to the weak hand-off from Q3. However, this should mark the trough in Canada's cycle, with economic activity expected to pick up thereafter.
Some supporting evidence of this was captured in the CFIB Small Business Barometer, which showed an improvement in business sentiment in January. Nearly half (44%) of all respondents said that the general state of their business is 'good' - the best response recorded since the recession. Moreover, hiring intentions continued to improve, with 27% of businesses planning to increase full-time positions over the next 3-4 months, marking the highest level seen in 4 years. The rise in confidence among businesses certainly bodes well for economic growth going forward, and should continue to improve alongside American businesses once there is more clarity on the fiscal front in the United States.
Also working in Canada's favour this year will be a bounce back in commodities. Economic growth around the world - particularly in China and the U.S. - is expected to pick up during the second half of this year, which will lead to increased demand for commodities, particularly energy, lumber and base metals. In turn, prices are likely to trend up. (For details, see our updated Commodity Price Forecast, available on our website.) Increased demand and prices bode well for Canadian exports, which, after having been quite weak in recent months, are expected to have a better showing in 2013-14. This is consistent with our forecast that business investment and exports will be the key drivers of growth in Canada over the next couple of years.