HIGHLIGHTS OF THE WEEK
United States
- Despite the upward revision to first-quarter GDP growth, with the second estimate indicating a 1.2% annualized gain on stronger consumption and investment, market reaction was relatively subdued given that the overall story is largely unchanged.
- Although investors are almost fully pricing in a June rate hike, the yield curve flattened this week as longerterm growth prospects became murkier and the Fed communicated that the balance sheet unwinding process would be protracted.
- Strength in consumption should leave the U.S. economy 3.3% larger this quarter, for an average growth of 2.2% during the first half of the year. While this is far from red-hot, it nonetheless is enough to reduce slack and should enable the Fed to continue along its gradual rate hike path.
Canada
- News and data were thin ahead of the BoC’s monetary policy decision this week, but what little there was served to confirm our expectation of strong Canadian economic performance for 17Q1.
- Next week we expect Statistics Canada to report economic growth of about 4.0% (annualized) in the first quarter. This strong expansion is expected to be largely driven by consumer spending and business investment.
- With excess capacity quickly being absorbed, a rate hike by the BoC is likely to happen as early as 18Q2. Combined with firming energy prices, this should help provide a lift to the Canadian dollar. The bid on the Canadian dollar following Wednesday’s monetary policy statement suggests maybe the time has come to buy Canada.
UNITED STATES – FED MINUTES SIGNAL JUNE HIKE
Despite the upward revision to first-quarter GDP growth, with the second estimate indicating a 1.2% annualized gain on stronger consumption and investment, market reaction was relatively subdued given that the overall story is largely unchanged. After another slow start to the year in 2017, economic growth appears to be rebounding this quarter, and should help to further diminish labor market slack.
That narrative was expressed in the minutes of the FOMC meeting released this week, which confirmed that participants are willing to see through the first-quarter weakness, and more robust data should be enough to justify a June rate hike. The minutes suggested some discomfort about softer inflation readings for March and April, with the Fed anticipating the upcoming inflation reports to confirm the one-off nature of the declines. Next week’s payrolls should also help mitigate further concerns should the American economy continue to produce jobs at a healthy clip and wage growth pick-up.
Despite investors almost fully pricing in a June rate hike, the yield curve flattened this week as longer-term growth prospects became murkier and the Fed communicated that the balance sheet unwinding process would be protracted. Trump’s proposed budget released this week featured projections of a drastically reduced debt-to-GDP ratio. But the feasibility of the plan is already being contested given its generous underlying growth assumptions. At the same time, the administration’s efforts to push through health care and tax code reform are being met with significant opposition from Congress, leading bondholders to pare back their longer-term growth forecasts. So far, equity investors have remained upbeat, with stock prices recovering last week’s losses, supported by stellar first quarter corporate earnings.
Oil tumbled this week as OPEC’s extension of production cuts through to Q1 2018 fell short of market expectations. The decision comes amidst a surge in US shale production to its highest level since August 2015, keeping oil inventories elevated and having the potential to undermine OPEC’s agenda. Having said that, we expect that oil will find its footing and will end the year higher as U.S. production growth decelerates and the market rebalances.
Economic data out this week was relatively modest. Sales of new and existing homes pared back in April, after a strong start to the year. Moreover, April’s advanced international goods trade balance widened unexpectedly as the surge in imports outpaced the rise in export volumes. Ultimately, the strength of U.S. demand and a relatively elevated dollar will boost imports and hinder export growth, with offsetting impacts on U.S. manufacturers. Next week’s ISM manufacturing index will likely telegraph continued growth for the sector, albeit at a slightly slower pace.
Next week’s income and spending data will provide information on how consumers and inflation performed during the very important handoff month of April. We expect growth in consumption to accelerate from 0.6% in the first quarter to about 3.4% during Q2. Taken together with some inventory investment, the strength in consumption should leave the U.S. economy 3.3% larger this quarter, for an average growth of 2.2% during the first half of the year. While this is far from red-hot, it nonetheless is enough to reduce slack and should enable the Fed to continue along its gradual rate hike path.
CANADA – BUY CANADA
A relatively quiet and short week, but what little new information there was proved to confirm the expectation for a strong performance by the Canadian economy at the start of this year. Indeed, strong economic momentum is boosting business confidence. The CFIB’s Business Barometer index rose to 66 in May, its best reading in two and a half years and near levels seen prior the 2014 oil price collapse. The boost to small business optimism was fairly broad, although the natural resource sector recorded its third consecutive monthly decline, likely a reflection of sectoral challenges including low prices and softwood lumber tariffs. An early indicator, it is supportive of our view that economic activity is on track to expand at an above 2.0% pace in 17Q2.
Unfortunately, corporate profits have yet to fully mirror the strong performance of the Canadian economy, but should eventually. Although corporate profits of Canadian firms declined 7.4% in 17Q1 relative to the end of 2016, underlying developments were more positive. Excluding a one-off actuarial adjustment in the insurance and related industries from the calculation revealed corporate profits grew 0.5%.
While struggling to regain profitability, the Canadian oil sector continues to show signs of life. Since 2014 the sector has responded to the collapse in oil prices by cutting jobs and investment. As a result, it has been a drag on both provincial and national economic activity. However, the rebound in oil prices appears to have renewed investment interest in Canada’s oil sector. Drilling rig counts are climbing, and cash spending on fixed spending in the sector is resurgent – both signs of a sector in recovery mode.
A recovering oil sector is just one factor driving the above trend economic performance. Next week we expect Statistics Canada to report economic growth of about 4.0% (annualized) in the first quarter. This strong expansion is expected to be largely due to consumer spending and business investment. Household consumption growth appears to reflect labour market improvements, although real wage growth continues to disappoint. Business investment is expected to be driven by an oil sector led expansion in structures.
The above trend pace of economic activity may still have room to run. Excess capacity is apparent in the Canadian economy, as highlighted by the Bank of Canada’s (BoC’s) Monetary Policy decision this week. As universally expected, the BoC kept its policy rate at 0.5%, noting that all three measures of core inflation remain below target and wage growth remains subdued – all signs of economic slack. Notably absent were comments about the financial troubles of Home Capital Group, suggesting some comfort by policymakers that the scope for contagion is limited.
Canada’s strong economic performance thus far has been seemingly ignored by financial markets, as concerns about Canada’s housing market and trade clouded the outlook. With excess capacity quickly being absorbed, a rate hike by the BoC is likely to happen as early as 18Q2. Combined with firming energy prices, this should help provide a lift to the Canadian dollar. The bid on the Canadian dollar following Wednesday’s monetary policy statement suggests maybe the time has come to buy Canada.
