U.S. Highlights

• U.S.-China trade tensions continued to dominate headlines as both countries dig in for another round of negotiations under more strained circumstances. U.S. tariffs against Mexico appear to also be in the works.
• As trade tensions flare, investors have run for cover, driving up bond prices and sending the yield curve into inversion territory.
• U.S. Q1 growth was revised marginally lower (3.1% vs. 3.2%), and Q2 is projected to be lower still (below 2%). Inflation however managed to edge marginally higher with core PCE at 1.6% year-on-year in April.

Canadian Highlights

• Trade-related risk-off sentiment weighed on Canadian financial markets this week, with the S&P/TSX Composite down more than 1% and WTI oil prices falling more than 5%.
• Statistics Canada’s GDP release confirmed that the Canadian economy hit a soft patch in Q1, with GDP up a modest 0.4% (annualized). Nevertheless, details of the report point to improving momentum heading into Q2.
• The Bank of Canada kept its overnight rate on hold at 1.75%, as expected, with its communication offering a relatively constructive tone on the back of improving domestic data, but weighing the latter against elevated global trade uncertainty.

U.S. – Trade Tensions Still in the Spotlight

U.S.-China trade negotiations hit a major speedbump earlier in the month and there is now a higher probability that talks could face protracted delays. President Trump stated that the U.S. is “not ready to make a deal”, though he still believes the two nations will ultimately reach an agreement.

In other trade news, just as the U.S. and Mexico took steps this week to ratify the USMCA, President Trump threatened to impose a 5% tariff on all Mexican imports starting June 10th. The President wants Mexico to do more to deter illegal migration from Central America. These tariffs, alongside prolonged Chinese negotiations, complicate trade relations even further. The heightened bout of uncertainty is likely to dent already shaky business confidence.

China has responded to U.S. rhetoric with both direct and indirect threats. The country suggested that they too may influence global supply chains through their dominance of “rare earth” exports – a group of 17 minerals used in the production of most modern electronic devices. A ban on exports to the U.S. could disrupt production and affect prices of many products ranging from smartphones to satellites. There are also indications that China may have once again halted purchases of U.S. soybeans after previously resuming purchases as a sign of goodwill during negotiations.

Meanwhile, on the domestic data front, home price appreciation continues to moderate. Data for March showed that home prices grew 3.7% year-on-year, lower than the 3.9% recorded in February (Chart 1). Price growth has been decelerating since April last year, suggesting that even with lower mortgage rates and rising wages, past price growth may have stretched affordability for many potential buyers.

First quarter real GDP growth was revised to 3.1% annualized, relative to 3.2% previously. The slight downgrade reflected lower business and residential investment. Weak performance in these two categories is expected to continue, weighing on growth in Q2 and resulting in a sub 2% outturn. Personal spending in April was also soft at 0.3% month-on-month, even as incomes rose more than expected, coming in at 0.5%. April’s outturn, however, followed strong growth in March, suggesting that personal spending will be a key driver of Q2 growth, even as other components such as investment look to drag on activity.

With concerns of lower growth and heightened trade tensions, investors pushed the yield on 10-yr Treasury notes to the lowest close since September 2017 this week. This caused the yield curve to invert as it dipped below the three-month note (Chart 2). While inversions tend to precede recessions, the phenomenon would need to be sustained and observed among other maturities before the indicator signals an imminent risk and materially affect decisions at the Fed. All said, the reignited trade tensions have skewed the risks to both U.S. and global growth further to the downside – a development which will no doubt receive close monitoring by central bank officials.

Canada – A Soft Q1 with a Dose of Optimism

Lingering trade tensions between the U.S. and China continued to weigh on sentiment this week, impacting both global and Canadian markets. The S&P/TSX Composite followed its global peers lower, dropping more than 1% at the time of writing, whereas (WTI) oil slumped more than 5% on the heels of the aforementioned trade worries and elevated inventories in the U.S. The U.S. threat to impose a 5% tariff on imported Mexican goods dampened sentiment further.

On the data front, Statistics Canada’s GDP release was the highlight of the week. Real GDP grew at 0.4% (annualized) in the first quarter, in line with our tracking and closely in line with the Bank of Canada’s 0.3% forecast. As expected, exports were the culprit (Chart 1), with the 4.1% drop in Q1 subtracting a full 1.3 ppts from GDP, and with net trade exerting an even larger drag due to a strong rebound in imports (+7.7%). Meanwhile, housing continued to be a weak spot, with residential investment falling for a fifth consecutive quarter. Most of the weakness in these two categories was pre-written. Indeed, exports experienced a broad-based decline in February that was led by a sharp slump in oil shipments, whereas data on home resales and residential construction continued to disappoint, with signs of stabilization starting to appear only recently.

Still, the weak GDP headline masked some encouraging details. Most important amongst these was a strong, 3.4% rebound in final domestic demand (Chart 2), led by household spending (+3.5%). A stronger-than-expected labour market performance partially explains this, with the healthy trend in job gains further confirmed by this week’s payrolls data. At the other end of the spectrum, a long-awaited pick up in business investment was another bright spot, ending a streak of serial disappointments that casted doubt on any potential rotation in economic growth to this category. Wrapping up the data release, a healthy 0.5% print in March’s monthly GDP, which was relatively broad-based across the industries, adds credence to the expectation of improving momentum heading into Q2.

On a separate, yet related note, the Bank of Canada kept its overnight interest rate on hold at 1.75% this week. In its release and the subsequent speech by Senior Deputy Governor Wilkins, the central bank maintained a constructive tone, highlighting some green shoots in the economy, including improving household spending and strong labour markets, while emphasizing that the current level of interest rates is appropriate given the macroeconomic backdrop.

Looking ahead, we expect the Bank of Canada to remain on the sidelines. Recent data has been pointing to improving momentum, but the outlook remains clouded with uncertainty. For instance, one fly in the ointment in today’s report is an inventory build, which together with that in Q4, will likely result in a drag on GDP growth going forward. More importantly, escalating trade tensions are likely the biggest headwind heading into the second half of the year, a risk highlighted by the Bank of Canada this week.

U.S.: Upcoming Key Economic Releases

U.S. ISM Manufacturing Index – May

Release Date: June 3, 2019
Previous: 52.8
TD Forecast: 52.5
Consensus: 53.0

We look for a modest monthly decline in the manufacturing ISM index as we expect trade-related headwinds to remain a major obstacle for recovery in the short-term. The average of the ISM-adjusted regional surveys failed to improve in May and remained unchanged at 53.5, with declines in three out of the six published surveys we track. Based on regional data, a decline in inventories is likely to be a major drag for the index. Moreover, a recent spate of weak growth in core durable goods orders, a downside surprise in the Markit PMI survey, and another below-50 China manufacturing PMI print also boost the odds for a downside surprise in May, in our view.

U.S. Employment – May

Release Date: June 7, 2019
Previous: 263k, unemployment rate: 3.6%
TD Forecast: 190k, unemployment rate: 3.6%
Consensus: 185k, unemployment rate: 3.6%

We look for payrolls to trend lower to 190k in May, following an eye-popping 263k print in the previous month. In particular, we expect job creation in the manufacturing sector to remain subdued, staying in the single-digit range for a fourth consecutive month. Likewise, we anticipate a mean-reversion in employment in the services sector following the 200k+ print in April. We do flag risks to the upside on the back of a larger-than-expected recovery in employment in the retail sector after three notable declines in Feb-April. All in, the household survey should show the unemployment rate remained steady at 3.6%, while wages are expected to rise 0.2% m/m. The latter should bring the annual print down a tenth to 3.1%. However, if the monthly growth rate were to round up to a “soft” 0.3% advance, that would keep wage growth unchanged at 3.2% y/y.

Canada: Upcoming Key Economic Releases

Canadian International Trade – April

Release Date: June 6, 2019
Previous: -$3.2bn
TD Forecast: -$2.9bn
Consensus: -$2.8bn

TD looks for the international trade deficit to narrow modestly to $2.9bn in April on a combination of weaker import activity and stronger energy exports, partially offset by a pullback in non-energy exports. Motor vehicles are the primary culprit to the latter after a major automaker idled production for two weeks in April, and a sharp drop in preliminary US imports suggests a significant impact on auto exports. Energy products will provide a key offset on higher prices alongside further recovery in crude export volumes which bottomed in February. On the other side of the ledge, imports should pare gains after the 2.5% increase in March, led by a pullback in aircraft imports.

Canadian Employment – May

Release Date: June 7, 2019
Previous: 106k, unemployment rate: 5.7%
TD Forecast: -5k, unemployment rate: 5.8%
Consensus: -5k, unemployment rate: 5.7%

TD looks for the labour market to disappoint in May with employment falling by 5k which should push the unemployment rate to 5.8%, while wages should soften to 2.5% y/y on a sizeable base-effect from May 2018. We have previously argued that recent labour market strength is unwarranted by the economic backdrop and last month’s blockbuster print has not changed our view. While we acknowledge that the volatility of the LFS makes it difficult to accurately predict the timing of any pullback, we view the risks as disproportionately skewed towards a soft print and think our forecast could prove conservative should such a pullback occur. Previous examples have shown much larger giveback after periods of strength; for example, net employment fell by over 60k in January 2018 after job growth was reported at 140k over 2017Q4. Any giveback should be led by the goods-producing sector, with manufacturing in the spotlight after adding 10k jobs over March/April as PMIs dipped into contractionary territory. However, segments of the service-producing sector also appear vulnerable with wholesale/retail trade employment rising by 4.8% (annualized) over the last six months.