FOREX TRADING

HIGHLIGHTS OF THE WEEK

• The U.S. economy created 431K jobs in the month of May. However, the details of the report were disappointing as temporary census hiring dominated the headline figure and only 41K jobs came from the private sector.
• A host of strong data came out earlier in the week, including the ISM manufacturing and non-manufacturing indexes, pending home sales and motor vehicle sales.
• Financial markets remained agitate this week following Friday’s job report and as fears over Europe and North Korea continue to linger in the background.
• This week’s weak job report serves as a stark reminder that in this post recession world, the recovery will not always be even-handed and is full of uncertainty.
• The Canadian economy expanded by a staggering 6.1% Q/Q annualized in the first quarter of the year.
• The Canadian economy added 25,000 jobs in May, although the unemployment rate remained unchanged at 8.1%
• The Bank of Canada increased the overnight rate by 25 basis points to 0.50%, becoming the first G7 nation to hike interest rates since the start of the recession.
• We expect the Bank of Canada to continue its tightening cycle with a series of 25 basis point hikes, reaching 1.50% by the end of this year.

UNITED STATES – FURTHER SIGNS OF A RISK FILLED RECOVERY

This week, economic and financial conditions were very reflective of the nervous optimism that has surrounded our outlook since the recovery started last year. Data points to strong second quarter growth, but an unimpressive jobs report did not send the signal that markets were hoping for – namely that the lagging labor market is fully on board with the recovery. Uncertainty abounds, and financial markets remain agitated after weeks of elevated volatility.

In the build up to Friday’s jobs report, economists were hopeful that a host of strong data releases during the week would translate into a big boost in private sector job creation. The ISM manufacturing and non-manufacturing indexes both showed strength for the month of May and offered sound evidence that Q2 GDP growth would be stronger than Q1. Pending home sales surprised pleasantly to the upside. But it remains to be seen how sales will hold up once they are no longer supported by the recently expired tax credit. Motor vehicle sales also beat out expectations for the month of May. As the business cycle turns, and motor vehicle sales continue to move off their very low levels, this could be a real catalyst for double digit growth in durable goods spending in the second quarter, and likewise, a significant boost to GDP.

Yet despite indications that the economic recovery is on track, private sector job creation in May was disappointing. While the headline non-farms payroll figure showed that 431K new jobs were created, 411K of these were census hires – which are temporary and will act as a drag on employment as the census hiring unwinds over the June/ September period. Only 41K new jobs came from the private sector. Given the strength of recent economic data, it is unclear what it will take for private sector job creation to mirror this trend. Ben Bernanke – chairman of the Federal Reserve – suggested earlier in the week that low levels of credit flowing into small businesses have been dampening progress. Firms with <500 employees represent over 50% of the total job market and are responsible for a disproportionate share of the jobs lost over the recession.

Another concern is that some of the recent market volatility has not shown up in the economic data yet. Last week’s jump in consumer confidence was promising, but somewhat peculiar given the steep corrections in stock prices and the never-ending stream of oil pouring into the Gulf of Mexico.

Equity markets were down on the week by 12pm Friday in reaction to the weaker payrolls data. As well, a number of key market indicators have been on edge all week as concerns over Europe and a potential showdown with an unpredictable North Korea have not been forgotten. The VIX index and Libor-OIS spreads both remain at some of their highest levels since last summer. This was to be expected. As the economy started expanding during the second half of last year, investors regularly noted the multitude of uncertainties surrounding the recovery. Conditions over the past month have vindicated this view, and served as a stark reminder that in this post recession world, the recovery will not always be even-handed and is full of uncertainty.

This week was reminiscent of how economic conditions are likely to progress over the coming year. Data releases should increasingly show signs that the economy is improving. However, this week’s jobs report highlights concerns that have understandably left most economists nervous about the recovery’s underlying strength. As well, the bumps and grinds experienced in financial markets during the past month may become commonplace. When we spoke about the risk-filled recovery in our last quarterly economic forecast, we envisaged weeks just like this one.

CANADA – ROBUST RECOVERY PROMPTS ONSET OF TIGHTENING CYCLE

In Canada, the widely anticipated June 1st fixed announcement date finally arrived this week. And while the probability of a rate hike was thought to be only marginally above 50%, the Bank of Canada (BoC) decided to begin its tightening cycle, and raised the overnight rate by 25 basis points to 0.50%. Tempering expectations of future hikes and leaving itself plenty of room to maneuver, the central bank emphasized the uncertainty surrounding the global economic outlook.

Indeed, the BoC noted that the global recovery, while progressing, is uneven across countries, and that the necessary rebalancing of global growth has yet to take place. Moreover, it stated that the rebound in most advanced nations is still heavily reliant on fiscal and monetary stimulus. But the central bank also pointed out that while the turbulence in Europe presents some downside risks for the global recovery, spillover into Canada has thus far been "limited to a modest fall in commodity prices and some tightening in financial conditions". As such, the recovery in economic activity and inflation in Canada have been unfolding largely as expected.

Real GDP for the first quarter was released a day before the rate decision, and provided strong support for a rate hike. The report revealed that the Canadian economy advanced at a stellar 6.1% Q/Q annualized rate, which comes off the heels of a robust 4.9% pace seen in the fourth quarter of 2009. The largest contributions to growth stemmed from domestic demand, with residential investment up by a whopping 24% and consumer spending up 4%. As well, business investment expanded by 0.9%, following a sharp 9% drop in the quarter prior. This provides a strong handoff for overall growth in the second quarter of the year, which we anticipate will come in around 4%. But going forward, economic activity will likely ease, as the housing market cools and consumer spending moves more in line with income growth. As such, we expect real GDP growth to fall in the 2.5-3.0% range in the second half of 2010 – roughly half that estimated for the first half of the year.

The uptrend in the labour market has also presented a strong case for a tightening in monetary policy, and this morning’s employment report was no exception. The Canadian economy created nearly 25,000 jobs in May, following the incredible 109,000 positions added in April. What’s more, the bulk of the gains in May came from full-time, private sector employment, suggesting that the underlying fundamentals in the labour market are quite robust. While the unemployment rate remained unchanged at 8.1% in May, due to more people entering the labour force, we expect ongoing job creation to average about 20,000 positions per month going forward, which should be sufficient to bring that rate down to 7.5% by the end of 2011.

The economic data to date is certainly encouraging of a further reduction in monetary stimulus. But while the Bank of Canada has begun the process, there is still a great deal of uncertainty surrounding monetary policy going forward. The tone of the communiqué accompanying the rate decision was quite dovish, and provided no guidance for the timing of future rate hikes. The BoC stated that "given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments", suggesting that future decisions will be heavily influenced by the data and events that take place between now and each decision date. Furthermore, when individual hikes do occur, they are likely to remain of the quarter-point fare rather than anything larger. Nonetheless, given that interest rates are still extremely accommodative, and that the domestic economy continues to charge ahead, we expect the BoC to continue its tightening cycle at a measured pace, with the overnight rate reaching 1.50% by year-end.

U.S.: UPCOMING KEY ECONOMIC RELEASES

U.S. International Trade – April

• Release Date: June 10/10
• March Result: -$40.4B
• TD Forecast: -$42.0B
• Consensus: -$41.0B

The trade deficit is expected to widen modestly in April owing primarily to an up uptick in the imported energy bill and a modest increase in goods imports. The broader trends in trend suggest its contribution to GDP growth has petered out. In 2009 the collapse of domestic demand led to a precipitous drop in imports, a drop magnified by the sharp drop in oil prices. Net export contribution to growth peaked in Q1 2009 and has steadily diminished and is on track to exert a modest drag on growth in Q2. The US economy has traction, jobs are rising, and inventory accumulation has already bounced all of which import growth is poised to outperform exports. Export growth will be further trimmed by weaker demand in Euroland (14% of exports) and the rising USD, both of which have already pushed export growth across the Atlantic below its recent trend. It suggests that the deficit, which troughed at a measly $26 billion in mid 2009, is set to remain elevated over coming months, though some reduction should be expected in the May data as energy prices fell sharply.

U.S. Retail Sales – May

• Release Date: June 11/10
• April Result: total 0.4% M/M; ex-autos 0.4% M/M
• TD Forecast: total 0.1% M/M; ex-autos -0.1% M/M
• Consensus: total 0.2% M/M; ex-autos 0.1% M/M

Retail sales are expected to inch higher in May owing to an increase in auto related sales, but core sales are forecast to decline by 0.1%. It will be the first monthly decline in core sales since last October. Gas prices as well as building materials and hardware will be the primary constraint on sales growth the former owing to seasonal factors that anticipated higher unadjusted prices and the latter due to an unsustainable surge over the prior two months. Building materials and hardware are up over 15% over the past two months driven in large part by the rebound in home sales. On balance, the trend growth in sales activity will appear robust with headline and sales ex autos both rising around 7% y/y. Going forward, base effects will make the current pace difficult to sustain even if the current y/y trajectory has further room to run over the short term. The bounce in sales over the prior quarter was driven exclusively by government transfers and a drawdown in savings. Fundamentals are improving throughout the economy, but household deleveraging, net worth that remains well off the highs, and muted private sector income growth suggest more subdued retail growth rates as we move deeper into the second half of the year.

CANADA: UPCOMING KEY ECONOMIC RELEASES

Canadian Housing Starts – May

• Release Date: June 8/10
• April Result: 200.7K
• TD Forecast: 205.0K
• Consensus: 205.0K

The positive momentum in the Canadian housing market should continue in May, with new homebuilding activity expected to stay at or about the lofty 200K units mark for the 5th consecutive month. In May, we expect the unseasonably warm weather, particularly in the central and eastern provinces and (still) buoyant housing demand to lift residential construction activity to 205.0K units, which will take the level of activity to the high watermark for this cycle. All of this momentum should come from the bounce-back in single family starts, which dropped at a hefty 13% M/M pace in April, while multi-units starts should remain relatively unchanged. In the coming months, with the Canadian economic recovery expected to gain further traction, and still low (though rising) mortgage rates remaining supportive to housing demand, we expect the recovery in Canadian residential construction to remain largely intact. However, a modest correction may occur in the latter part of the year as housing market activity and starts become better aligned with economic fundamentals.

Canadian International Trade – April

• Release Date: June 10/10
• March Result: $0.3B
• TD Forecast: $1.0B
• Consensus: $0.7B

Despite the strengthening domestic currency and robust domestic demand, the Canadian merchandise trade balance has managed to eke out surpluses for 6 consecutive months, going back to October. This positive momentum is expected to stretch into April, though the strong Canadian dollar, which reached its recent peak in April, should partially offset some of the favourable support coming from higher commodity prices. During the month, we expect the combination of strong global demand for Canadian products and higher energy prices to push the merchandise trade surplus up to $1.0B. Exports are expected to rise robustly, while imports should fall. In the months ahead, we expect the trade balance to improve further.

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TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.