- U.S. stock indices remained supported by the continued flow of favorable earnings releases. Bond yields and the U.S. dollar moved lower through Thursday but that dynamic reversed course with the robust payrolls report.
- The American economy continued to churn out jobs at a robust pace in July with payrolls rising by 209k. At the same time, the unemployment rate fell to a cycle low of 4.3%. Average wages rose a solid 0.3% m/m.
- Improvements in ISM manufacturing and non-manufacturing prices sub-indices, together with a slightly firmer core PCE price index suggest that a turnaround in inflation may be underway.
- Whatever happens over the remainder of the year, 2017 will go down as a very good year for the Canadian economy. In July, the economy created 10.9k jobs and the unemployment rate fell to 6.3%, its lowest level since 2008.
- Even if economic growth is flat and no more jobs are created over the remainder of the year, real GDP will have grown by 2.5% (annual average) in 2017 and the economy will have created 290k jobs - the highest in a decade.
- With household debt levels at record highs, interest rates going up and home prices looking to decelerate further, economic growth is likely to return to a less exciting pace around 1.5% to 2.0% in 2018. This is still close to a trend rate for an economy with an aging population and limited productivity growth.
U.S. - Job Numbers Impress, But Still Waiting on Inflation
It was another good week across most markets. U.S. stock markets remained supported by continued flow of favorable earnings releases, with the DJIA breaching the 22,000 threshold by mid-week. A string of softer data releases through Thursday also led bond yields and the U.S. dollar lower. But that ended Friday morning, when a solid employment report boosted the dollar and inspired a bit of a sell-off in the bond market.
The report was indeed a beauty as the American economy continued to churn out jobs at a robust pace in July, with payrolls rising by 209k, beating market expectations for a 180k print. But there was more. The jobless rate dropped to a cycle low of 4.3%, while broader measures of labor underutilization remained near their pre-recession lows. More workers joined the labor force, with the participation rate recording a small uptick to 62.9%. While average wages failed to accelerate on a year-over-year basis, given the weakness at the beginning of the year, the monthly gain of 0.3% was very strong and marks the fastest pace in ten months. (Chart 1)
Going forward, we expect job gains to slow somewhat. However, the trend should also be accompanied by stronger wage gains. While the relationship between labor market slack and inflation has become more muted in recent years, and is taking longer to materialize, we believe the link still holds. As such, we believe that a pick-up in inflation should materialize before the end of the year, with the stronger data motivating the Fed to take interest rates higher.
A string of other data releases helped provide additional context as far as far as economic momentum heading into the third quarter. Personal spending rose by a meagre 0.1% in June, with the softness providing somewhat of a weak handoff to consumer spending into the third quarter, while personal income was essentially flat on the month. However, much of the slowdown in personal income was related to decreases in personal dividend and interest income, factors that are likely to prove temporary. On the other hand, growth in wages and salaries was a solid 0.4% m/m and looks to be strong in July also given the average hourly wage data. The strengthening in income growth, together with the relatively healthy auto sales figures for July, suggests that consumer will continue driving economic growth in the third quarter, with consumption expected to rise by 2.6%, supporting real GDP growth of 2.8% during the quarter.
The ISM surveys provided mixed signals of the economy. The manufacturing index suggested that the sector continued to expand at a healthy, but slightly slower pace, supported by a rebounding global economy and the lower U.S. dollar. The non-manufacturing index also telegraphed a deceleration in activity, but remained in expansionary territory while most industries continued to report growth. Importantly, both ISM surveys indicated significant increases in their prices sub-indices. Together with a slightly firmer core PCE price index, which was revised up to 1.5% y/y in June this suggests that a turnaround in price pressures could be underway (Chart 2). Should this in fact be the case, we expect further tightening to take place later this year, with the Fed likely to slip in a December hike. Lack of such evidence, on the other hand, will likely stay the Fed's hand as far as the hike, but is unlikely to prevent the Fed from starting the balance sheet unwinding process in the fall.
Canada - 2017 Belongs to Canada
Whatever happens over the remainder of the year, 2017 will go down as a very good year for the Canadian economy. Even if economic growth is flat and no more jobs are created, real GDP will have grown by 2.5% (annual average) and the economy will have created 290 thousand jobs - the highest in a decade.
Two phenomena explain the buoyant pace of Canadian growth over the first half of the year. First, a bounce back in energy production after setbacks over the past two years explains about a quarter of the growth. This far exceeds its share in overall economic activity (of around 6.5%).
Second, consumer spending growth has been absolutely gangbusters. Given our tracking for the second quarter, consumer spending over the first half of the year looks to have advanced by over 4%, its fastest pace since 2007. Spending on durable goods - especially autos - led the way, but there was little weakness to point to anywhere.
The Canadian economy may not slow to a halt over the remainder of the year, but is likely to cool some from its fiery pace over the first half. The best metaphor for the rebound in the energy sector is a spring that had been pushed down by the fall in prices and then pushed a bit harder by the Alberta wildfires. It has now bounced back. With the outlook for oil prices relatively stable over the next year, activity is likely see a much steadier pace of growth.
Meanwhile, consumer spending, which has been supported in part by wealth gains from outsized advances in home prices and steady gains in equities through 2016, will not get the same support going forward. The TSX composite index peaked in the first quarter of this year and has lost ground since. And, no surprise to anyone, home price growth has slowed considerably, especially since new regulations have come online in Ontario.
With debt levels at record highs, interest rates going up and home prices looking to decelerate further, there is good reason to expect consumers to rein in spending over the remainder of the year. Reining in spending doesn't have to mean a pullback, as strong job gains have also boosted aggregate incomes, but the days of 4% consumer spending growth are likely behind us.
This likely slowdown in Canadian economic activity has important implications for the Bank of Canada. It raised rates in July largely on the pace of growth observed over the first half of the year. But, with 2017 now halfway to the finish line, the story is the outlook for 2018.
In all likelihood, economic growth will return to a less exciting pace around 1.5% to 2.0%. This is still close to a trend rate for an economy with an aging population and scant productivity growth, but not a rate that is likely to put much upward pressure on inflation. With a smaller growth potential comes a smaller margin of error. Given the continued downside risks to the Canadian economy, any disappointment on this front may be enough to put the Bank of Canada back on the sidelines.
U.S.: Upcoming Key Economic Releases
U.S. Consumer Price Index - July
Release Date: August 11, 2017
Previous Result: 0.0% m/m; core 0.1% m/m
TD Forecast: 0.1% m/m,; core 0.1% m/m
Consensus: 0.2% m/m; core 0.2% m/m
Headline CPI inflation is expected to pick up to 1.7% y/y in July, with prices up 0.1% m/m. Energy prices were likely a small drag on lower gasoline prices while we look for food prices to offset. Outside of food and energy, we expect yet another subpar 0.1% gain in the core, keeping the core inflation rate stable at 1.7% y/y. Risk for a continued drag from wireless services, vehicles and apparel prices suggest that a 0.2% print may be hard to reach this month. If realized, our core inflation projection suggests that transitory factors continue to weigh, offering limited signs that price pressures are regaining steam and potentially spurring greater caution at the Fed with respect to rate normalization.
Canada: Upcoming Key Economic Releases
Canadian Housing Starts - July
Release Date: August 8, 2017
Previous Result: 213k
TD Forecast: 205k
Housing starts are forecast to slow to a 205k pace in July, reversing some of the pickup from the prior month. While we have less conviction without building permits for June, the magnitude of last month's rebound in construction activity seems unwarranted given languishing resale activity. As usual, we expect the more volatile multi-unit component to drive the headline result while single family housing starts should remain stable around 65k. Our forecast for 205k reflects a modest deceleration from the six-month moving average, currently 215k.