FOREX TRADING

HIGHLIGHTS OF THE WEEK

• In the U.S., consumer prices fell again in May, driving annual inflation 0.2 percentage points down to 2.0%. Core inflation was flat at 0.9%.
• U.S. industrial production surprised on the upside with a 1.2% monthly gain in May. The rate of capacity utilization rose in tandem to 74.7%, landing half-way up its peak-to-trough gap.
• U.S. housing starts fell by a sharp 10% M/M. A contraction in homebuilding was anticipated, but the magnitude was much larger than expected and it highlights the strong headwinds faced by this sector.
• In a speech this week, Bank of Canada (BoC) Governor Mark Carney struck a cautious tone, noting that “no particular path for monetary policy is preordained”. In light of the multitude of risks still clouding the horizon, the BoC remains understandably vague. While it increased the overnight rate to 0.50% on June 1st, and should continue with gradual increases in the months ahead, it is giving itself room to pause the hiking cycle if the recovery wobbles.
• Existing home sales dropped by 9.5% M/M in May. The sales-to-new listings ratio eased from 0.52 to 0.49. In line with this easing in market balance, the seasonally-adjusted average price slipped by 1.0% M/M with Y/Y growth cooling from 12.2% to 8.5%.
• Manufacturing sales and wholesale trade data for April are consistent with a monthly real GDP expansion of 0.3% M/M.

UNITED STATES – A WEEK WITHOUT GAME CHANGERS

There were a few data releases in the U.S. this week, some of them encouraging, others much less so. Although none of them were a game changer, the data did provide a reminder that this will continue to be a slow recovery. Industrial production surprised on the upside in May with a 1.2% monthly gain, which drove the index up 7.6% Y/Y. The rate of capacity utilization rose in tandem to 74.7%, which represents the half-way mark to closing its peak-to-trough gap. This positive performance adds to the momentum gathered by the industrial sector over the last 11 months. Furthermore, consumer prices fell again in May, driving annual inflation 0.2 percentage points down to 2.0%. Core inflation was flat at 0.9%. This was broadly in line with our expectations, as both indicators remained on the downward path that we have been projecting will extend through the end of this year. Although the underlying causes of this decline in inflation are nothing to cheer for – they are rooted in significant amounts of slack across large swaths of the economy – low price pressures allow the Fed to keep the lax monetary setting in place to stimulate domestic demand.

Changing our focus to the less encouraging data releases of the week, housing starts fell by a sharp 10% M/M to 593K units during May. A contraction in new construction was anticipated, but the magnitude was much larger than expected and it highlights the strong headwinds faced by this sector. New housing construction faces a significant challenge from an oversupply of existing inventories and properties already in, or approaching foreclosure, all totaling more than 8 million units. After the temporary boost in demand from the homebuyer’s tax credit, builders are now sharply adjusting supply. A broad improvement in housing remains dependent on the recovery in the labor market and incomes, to take up inventories. Since we think the job market will generate only two million new jobs this year after an 8.4 million deficit created by the recession, homebuilders will continue to face a relatively weak demand for new housing until 2011.

Financial markets appeared to cheer more for the positive domestic news this week, and sentiment was further bolstered by some good news from Europe, such as the agreement to release the results of stress tests being conducted on European banks and two successful bond issuances by Spain. With investors having more appetite to take on risk, European stock markets were up by as much as 7% on the week, the S&P500 and the Dow Jones were 2.5% ahead of last Friday closing and the U.S. dollar had lost ground visà- vis its main trading partners.

Next week, the focus will be the FOMC meeting and the G20 summit to be held in Toronto. On the Fed front, the after-meeting statement will very likely be uneventful. If anything, the information accumulated since the FOMC last met on April 28th has reaffirmed the low inflation / slowing economic upturn outlook which has provided the basis for “exceptionally low levels of the federal funds rate for an extended period”. For cues on the latest changes in the economic perception of FOMC members and their implications for monetary policy, we will likely have to wait for language subtleties in the minutes to be released in mid-July. It will be interesting to see if the renormalization of the Fed’s balance sheet gains some prominence over the other usual topics under discussion.

Regarding the G20 meeting, the focus will be on financial regulation reform. Given the current state of affairs, it is rather doubtful that the summit will conclude with any concrete set of measures being announced. In other words, there will likely be very few specifics to be found beyond the general consensus to introduce better-crafted regulation. European leaders will insist on the idea of imposing levies on banks and a financial-transaction tax, which will be met with resistance from Canada and other countries. Differences will also arise regarding other issues, such as the allimportant accounting standards. The topic more likely to be brokered into agreement will be the extension of deadlines for the implementation of the new Basel III proposals on capital and liquidity requirements. In all, this means that, at best, the summit will reduce only a small fraction of the uncertainty surrounding financial regulation reform.

CANADA – HOME IS WHERE THE SLOWDOWN IS

Economic data out this week reveal a recovery on the cusp of maturity. Gone are the easy, transitory gains of months past when growth from depressed levels was like picking low hanging fruit. While the recession was the result of an external shock, the ongoing slowdown will mostly be a ‘made in Canada’ affair. Early signs of a downshift are emerging from the sectors which were ‘first in’ the downturn, and ‘first out’ in the ensuing recovery.

Take manufacturing and wholesale sales, for which April data was released this week, providing a glimpse into early Q2. Manufacturing has been rebounding since mid-2009. Not quite in a ‘V’ shape, but still recovering gradually. On a 3-month (M/M annualized) trend basis, manufacturing volumes were motoring along at a 15% clip during the 3 months leading up to April. Then, a drop of 1%, the first in 8 months, slashed this trend growth to 7%. While this neither breaks nor improves the manufacturing recovery track, monthly gains are no longer a foregone conclusion. The wholesale trade report was a bit more favourable. While the headline figure slipped by 0.3%, this was owing to a price decline. This partly reflected cheaper imports as the CAD gained 1.8% in April to average 99.5 US cents. Importantly, wholesale volumes advanced by 0.4%. The inventory-to-sales ratio, while ticking up slightly to 1.17, remains favourable. It is lower than pre-recession levels and reveals a prudent management of wholesale inventories where demand is not taken for granted. The combined data so far are consistent with a monthly real GDP expansion of 0.3% M/M in April.

This week’s most convincing evidence of a downshift came from the May existing home market data. Home sales slumped by 9.5% M/M, while new listings dropped by 4.0% M/M. As a result, the sales-to-new listings ratio eased from 0.52 to 0.49. In line with this easing in market balance, the seasonally-adjusted average price slipped by 1% M/M, while actual Y/Y growth cooled from 12.2% to 8.5%. New listings are 20% higher than their low of late 2009, but this was a first pullback in 8 months. One month does not a trend make, yet an easing in new supply is consistent with fewer sales, as the bulk of buyers are not first-timers. A stabilization or contraction in new listings would cushion the market during this down part of the cycle by keeping it balanced, while sales should continue to trend down from record levels. The resale housing market is currently in a goldilocks balanced position, but this may not last. We forecast conditions to gradually start favouring buyers as we transition to the second half of this year. After an über-rebound brought the average resale price 6% past its pre-recession peak in record time (as of April), expect prices to continue retracing their steps – by roughly 7% between Q2 and year-end 2011.

While welcome, the initial ‘V’-shape of the overall economic recovery is now largely in the rear-view mirror. After averaging 5.5% (Q/Q annualized) growth over the previous two quarters, real GDP is on track to expand by about 4% in Q2. This is still above-trend growth, which is to be expected for an economy that remains in recovery mode. The composition of growth in Q2 will be somewhat of a mixed-blessing, coming about the old-fashioned Canadian way: by adding more bodies, with employment set to grow by 3.6%, rather than significantly boosting productivity.

This is in sharp contrast with the U.S. recovery, where employment has barely recovered (only 12%) from the 8.4 million jobs lost, but productivity is surging. In Canada, job losses were much fewer, even after the obvious adjustment for the size of each country’s labour force. Furthermore, three-quarters of Canada’s jobs lost have been recovered. The unfortunate flipside of this tale is that productivity growth is still weak, averaging 1% over the last year while a comparable figure for the U.S. is four times as large. Well aware of these facts, Bank of Canada Governor Mark Carney drummed up the need for the private-sector to engage in more productivity-enhancing investments, echoing our decade long concerns over mediocre Canadian productivity. The loonie’s purchasing power abroad is strong, and the corporate tax environment is as ripe as ever for investment. It’s time to give all those extra bodies the tools (M&E, IT, and training) they need to compete in this ferociously competitive global economy.

U.S.: UPCOMING KEY ECONOMIC RELEASES

FOMC Interest Rate Decision

• Release Date: June 23/10
• Current Rate: 0.00% to 0.25%
• TD Forecast: 0.00% to 0.25%
• Consensus: 0.00% to 0.25%

It is best to think of the upcoming meeting in terms of how the Fed promotes a revival of risk taking rather than the other way around. In April the market was pricing in almost two rate hikes by Feb 2011. The market has since pushed out those two rate hikes to September 2011, shaving off an expected 100bp in Fed tightening next year. How does all this relate to the extended period language? That is as applicable now as it was several months ago. We believed the Fed could eliminate that language at the June or August meeting, even if we argued that it did not change our view that rate hikes would remain deferred until 2011. Given the rise in risk aversion and mounting if not preliminary evidence that economic momentum is leaking, we believe doing so now would be counterproductive.

CANADA: UPCOMING KEY ECONOMIC RELEASES

Canadian CPI – May

• Release Date: June 22/10
• April Result: core 0.3% M/M, 1.9% Y/Y; all-items 0.3% M/M, 1.8% Y/Y
• TD Forecast: core 0.4% M/M, 1.8% Y/Y; all-items 0.2% M/M, 1.3% Y/Y

Canadian consumer prices have been on a divergent path, with core inflation remaining relatively elevated despite the significant amount of slack that continues to exist in the Canadian economy, while headline inflation has been fairly contained on account of weakening energy prices. This pattern should remain largely intact in May, with headline consumer prices expected to rise by 0.2% M/M. In seasonally adjusted terms, headline prices should fall at a dramatic 0.4% M/M pace as a result of the drop in energy prices during the month. Favourable base effects should result in the pace of annual headline inflation falling from 1.8% M/M to 1.3% Y/Y in May, marking the lowest print on this indicator since December. Core consumer inflation should remain relatively elevated, with core prices rising by a sizeable 0.4% M/M on a non-seasonally adjusted basis. Excluding the impact of seasonality, core prices should rise at a more modest 0.2% M/M pace. On an annual basis, core inflation is expected to tick marginally lower to 1.8% Y/Y, from the 1.9% Y/Y. In the months ahead, we expect core inflation to remain elevated on account of the rapid pace of slack absorption, while headline inflation should continue to moderate due to softer commodity prices.

Canadian Retail Sales – April

• Release Date: June 23/10
• March Result: total 2.1% M/M; ex-autos 1.7% M/M
• TD Forecast: total -1.5% M/M; ex-autos -0.5% M/M

After the dramatic turnaround over the past year, Canadian consumer spending is expected to hit a soft patch in April, with retail sales set to decline for only the second time in the past 15 months. During the month, we expect sales to dip by 1.5% M/M, mostly on account of slower car sales and weaker gasoline prices. Canadian sat on their couches to watch the Olympics in February, resulting in the sales spike in March. That should unwind in April. Sales of housing related items are also expected to soften on the month, as a result of weaker home sales. Despite this, sales excluding autos should fall by 0.5% M/M, following the 1.7% M/M surge in March. Real retail sales should be relatively flat, suggesting the personal consumption expenditure is unlikely to be a source of support for economic activity in April. In the coming months, with the positive momentum in the Canadian labour market and economy expected to remain largely in place, consumer spending should continue to be supportive to growth, though it is unlikely to provide the level of support seen in the past few months.

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