U.S. Highlights
- President Trump announced tariffs on steel and aluminium imports to take effect in 15 days. The scope is narrower than initially announced. Mexico and Canada are exempt, and more allies may be excluded once the levies take effect.
- The American economy continues to hum along, with a very solid job report in February. The Fed’s Beige Book also painted a relatively rosy picture, but also one where businesses are starting to pass higher costs onto customers.
- Inflationary pressures are building in the U.S., and import tariffs will increase the force. This presents a challenge for the Fed which will have to incorporate the uncertain impacts of fiscal stimulus, and now tariffs into its forecast.
Canadian Highlights
- Canada avoided (at least temporarily) the U.S. administration’s steel and aluminum tariffs, providing a relief and potentially even a modest boost to the industries.
- The Bank of Canada left the overnight rate unchanged at 1.25% this week, but struck a dovish tone, citing trade uncertainty and the impact of recent housing regulations.
- Canada added 15.4k jobs in February, bringing the unemployment rate to 5.8%. Wage growth ticked down slightly, but remained buoyant at 3.1% year-on-year (from 3.3% in January).
U.S. – All Signs Point to Higher Inflation
Politics overshadowed economics this week as markets awaited Trump’s announcement on steel and aluminum tariffs. When it came on Thursday afternoon the scope was narrower than first thought. Canada and Mexico are exempt from the tariffs as long as negotiations on the North American Free Trade Agreement continue, and other allies may ultimately be exempt once the tariffs are put in place in 15 days. Together Canada and Mexico represent a quarter of American steel imports and 43 percent of aluminum. America’s neighbors may now benefit from the plan as they take market share from other countries slapped with tariffs.
However, trading partners are expected to retaliate, levying tariffs on U.S. exports. Economic studies have shown that the overall costs to the economy from these trade battles outweigh the job gains in the protected sector. Our own estimates for the steel and aluminum tariffs specifically suggest the overall growth impacts in the large U.S. economy would be fairly modest, but that they could raise inflation a couple of tenths of a percentage point.
The President didn’t stop at steel and aluminum. He reiterated his goal to reverse the U.S. trade deficit, and that he may implement a reciprocal or “mirror tax” to help achieve this. He offered few details, but suggested the U.S. would slap the same level of duties on trading partners that U.S. companies face in those countries. These actions will raise prices for many U.S. businesses that use the materials as inputs in manufacturing, and ultimately raise prices for consumers, adding to budding inflation pressures across the economy.
This week’s economic data certainly doesn’t suggest the U.S. needs economic protection. Payrolls grew by an impressive 313k jobs in February. The unemployment rate stayed at its 17-year low of 4.1%, where it has been since October. Hiring has accelerated in recent months, driven by the goods sector, which had stumbled somewhat in the wake of the oil price crash, but is now making up the lost ground. Wage growth cooled slightly, with average hourly earnings up 2.6% versus a year ago, down from 2.8% in January. However, when this volatile series is smoothed, wage gains have been steady at around 2.6% for about a year, and have been outpacing inflation for over three years.
The Fed’s Beige Book also painted a picture of an economy that is humming along. Fed districts universally reported labor market tightness and heightened demand for qualified workers. Several districts reported increasing compensation as a result of the tax cuts that came into effect at the start of the year. The report also suggested that businesses are increasingly passing on increases in input prices. A variety of forces are expected to push inflation higher this year, the only question is how quickly.
The risks that inflation will accelerate faster than the Fed currently expects are mounting. The FOMC’s next announcement is on March 21st, and a hike at the meeting is essentially a lock. We currently expect three 25-basis point moves in 2018, but the risks are skewed to more hikes rather than fewer.
Canada – Canada Avoids Trump’s Tariffs (For Now)
The Bank of Canada surprised no one with its decision to leave interest rates unchanged this week. The policy announcement is usually the main event for economy watchers in Canada, but took second billing to an announcement south of the border on steel and aluminum tariffs. When that decision came down, it was good news for Canada, as it will be exempt from the 25% tariffs on steel and 10% tariffs on aluminum, pending a successful renegotiation of NAFTA.
Had the tariffs been imposed they would have resulted in a decline in steel and aluminum production and exerted a modest headwind on the Canadian economy – likely enough to shave a tenth of a percentage point off real GDP growth. The impact would have been concentrated in Ontario and Quebec, where most of the steel and aluminum is produced and downstream users of both products are located. However, with the exemption the two regions may benefit from decreased competition from parts of the world hit by tariffs. Still, with NAFTA negotiations showing little evidence of a speedy resolution, uncertainty will continue to hang over Canada’s manufacturing sector.
Turning back to Ottawa, the Bank of Canada’s statement was explicit in its recognition of risks on the external front, noting that net exports were a significant drag on economic growth in the fourth quarter of last year and that “trade policy developments are an important and growing source of uncertainty for the global and Canadian outlooks.” Indeed, the statement overall struck a dovish tone, also referencing the impact of new housing regulations and the economy’s sensitivity to rising rates.
As part of a new communication strategy, Deputy Governor Tim Lane provided more colour on the Bank’s thinking. Lane struck a more positive tone, remarking on domestic strengths and encouraging trends. Still, the overall tone of communication suggests the Bank is in wait and see mode – looking for clarity on the trade front and on how the Canadian economy and heavily indebted households in particular are responding to the three rate hikes it has already enacted over the past year.
Beyond policy, the economic data out this week showed an economy that continues to make steady, if more staid, economic progress. The Canadian economy added 15.4k jobs in February, slightly under the consensus projection for 21k, but in a series as volatile as this one, basically a hit. The increase was enough to pull down the unemployment rate to 5.8% – regaining its pre-recession trough. The tight labor market has been supportive of wage growth, which edged down slightly to 3.1% year-on-year from a robust 3.3% in January.
Evidence that the economy is running up against capacity constraints was also revealed in the capacity utilization data reported this week. Overall industrial capacity utilization hit its highest level in over a decade in the fourth quarter of 2017. The rise was broad-based across industries and came despite healthy growth in business investment in the same quarter. Within manufacturing, capacity utilization hit its highest level since 2000. High utilization should support ongoing investment, providing some offset to the trade uncertainty weighing on the outlook. 
U.S.: Upcoming Key Economic Releases
U.S. Consumer Price Index – February
Release Date: March 13, 2018
Previous Result: 0.5% m/m, 2.1% y/y
TD Forecast: 0.2% m/m, 2.2% y/y
Consensus: 0.2% m/m, 2.2% y/y
We expect headline CPI inflation to accelerate to 2.2% y/y in February, with prices up a seasonally adjusted 0.2% m/m. Energy prices should be a small net positive, led by higher gasoline prices. We also see scope for a stronger pickup in food prices, as presaged by higher import prices. Excluding food and energy, we expect core CPI to print a solid 0.2% m/m increase, moderating from the previous 0.3% print. With imported consumer price inflation still benign, we do not look for the strength in January to be repeated. We also expect some oneoffs from the previous month to correct, such as the apparel category (+1.7% m/m in January).
U.S. Retail Sales – February
Release Date: March 14, 2018
Previous Result: -0.3%, ex-auto 0.0%
TD Forecast: 0.2%, ex-auto 0.3%
Consensus: 0.3%, ex-auto 0.4%
We expect retail sales to rise 0.2% in February, with the control group up 0.3%. Gasoline station receipts and auto sales should have neutral contributions. One downside risk is the late start to the tax refund season, which pushed refunds into March. The modest gains would be consistent with real PCE tracking slightly below 2%.
Canada: Upcoming Key Economic Releases
Canadian Manufacturing Sales – January
Release Date: March 16, 2018
Previous Result: -0.3% nm/m
TD Forecast: -1.0% m/m
Consensus: N/A
January is shaping up to be another slow month for Canadian manufacturers, with headline sales forecast to decline 1.0% m/m. Disruptions to auto production will once again play a part due to shutdowns at an Oshawa plant, which should drive a sharp decline in transportation equipment sales. Meanwhile, the broad decline in exports bodes poorly for factory output as a whole. Energy should provide an offsetting source of strength on higher prices for refined products though we see headwinds to forestry products after the US resumed collecting duties on softwood lumber. Volumes should come in below the headline print due to higher factory prices, driven largely by gasoline, which will come at the detriment to Q1 GDP tracking.
