FOREX TRADING

HIGHLIGHTS OF THE WEEK

• The U.S. economy scrapped 131K non-farm jobs in July.
• If it continues to create jobs at the speed it has showed since the labor market bottomed in December 2009, it would take roughly seven years to fully absorb the 8.4 million jobs lost to the recession.
• A research paper written by Federal Reserve FOMC member James Bullard reignited the debate on the prospects of further Quantitative Easing.
• Following six months of strong gains, Canadian employment fell by 9,300 in July, and the unemployment rate inched up to 8.0%, from 7.9% in the prior month. The majority of the jobs lost were in full-time positions (-139,000) where almost half the decline was in education services.
• Canadian Building permits rose to 212,000 units in June, up from 208,500 units in May. Despite the slight uptick, building permits are below levels seen at the end of 2009, indicating a continued drop in construction activity.
• This week we got a preview into July’s existing home sales for major Canadian markets – where sales fell well below the record levels from a year ago.

UNITED STATES – JOBS ARE EASING, SO MIGHT THE FED

It was all about jobs and QE this week; not Her Majesty the Queen of England, if you were wondering, but rather Quantitative Easing -the practice of a central bank buying debt securities to boost money supply. We learned today that the US economy scrapped 131K non-farm jobs in July. Most of the decline stemmed from the departure of 143K U.S. census workers. Private sector jobs added 71K on the month, below market expectations. June private sector net hiring was revised significantly downward. The most discouraging aspect of the report is that it confirms, once again, that improvements in the job market will materialize very slowly. If the U.S. economy continues to create jobs at the speed it has showed since the labor market bottomed in December 2009, it would take roughly seven years to fully absorb the 8.4 million jobs lost to the recession. This is way too slow for an economy that needs private demand to fill the void that fading fiscal stimulus will generate in the coming quarters. More so in light of the latest personal income and spending data, which shows U.S. households continue to increase their savings rate.

On the quantitative easing front, a research paper written by Federal Reserve FOMC member James Bullard published last week reignited the debate on the prospects of further QE within the very limited Fed’s realm of policy options. The paper argues that, in the event of a further decline in inflation (which could be triggered by another shock or simply by a more pronounced slowdown in economic growth, or a combination of both), the Fed should resort to a second round of QE. The current stance of policy might prove inadequate and runs the risk of the economy experiencing Japanese-style deflation.

Bullard’s paper and the repercussion it had on the market will very likely force the discussion about QE at the FOMC meeting scheduled for next week. In recent meetings, some members have voiced their concern regarding the balance of costs and benefits of such a policy tool. Buying troubled assets was a critical step to avoid a complete meltdown at the onset of the financial crisis. It provided a backstop for markets which had become completely dysfunctional. On the other hand, the effectiveness of a second round of QE to recharge the slowing recovery is far more controversial. Simply put, in an environment of historically low rates in which borrowers are unwilling to demand credit and lenders reluctant to extend loans, what can more liquidity accomplish? Will it address the underlying lack of confidence that is putting a lid on credit flows?

One could argue that, given the limited arsenal at the Fed’s disposal, it would be worth trying it. Yet again, there are potential costs to further QE, such as long lasting disruptions to the functioning of financial markets, perceptions of sovereign debt monetization, crowding-out of private buyers, and the associated reputational cost for the central bank.

The discussion of this topic will likely reaffirm the perception of a growing divide within the FOMC, between those who stand firmly behind the need for continued monetary stimulus and those, such as Thomas Hoenig, who has been for some time advocating for a change in verbiage in the FOMC statements which would set the stage for a future fed funds rate hike. In all, a change in the policy rate remains off the table during this meeting, but as always, it will be very interesting to scan the after-meeting statement for shifts in language, and later on, to dive into the details of the minutes. We are getting to the point where it would be refreshing to observe at least a slight change in tone in communication that could hint to where the Fed’s collective mind is at on the issue of QE and the future rebalancing of monetary policy.

CANADA – GLASS STILL FULL

After adding a whopping 308,000 jobs over the first half of 2010, Canadian employment fell for the first time in 6 months in July. The decline comes on the heels of a robust 11-month spell of labour market recovery. And, despite July’s letdown, exactly one year after the bottom in Canadian employment, the Canadian economy had recouped 94% of the jobs lost during the 2008/09 recession. This is a remarkable performance given the stage of the economic recovery and when compared to the United States, where the jobs recovery has been anemic at best.

However, the outlook for Canadian employment is not as rosy. While one month does not make a trend, the deceleration in trend employment gains may be the start of what is expected to be a pronounced moderation in job creation in the second half of this year. In particular, the largest sources of hiring in Canada – small businesses – are likely to scale back the rate at which they have been adding to payrolls. This week, the CFIB’s business outlook survey indicated that small business confidence slipped for a third straight month in July, reaching a 7-month low. Since the CFIB’s index is highly correlated with real GDP growth, these results suggest that after growth cooled to sub 3% in Q2 2010, small businesses are bracing for slower growth in Q3. In line with an anticipated cooling in domestic demand, the industries with the sharpest decline in confidence are those highly tied to domestic spending like retail, construction, hospitality, and professional services. Also tied to concerns over the U.S. recovery, manufacturing confidence weakened in the last three months.

This is consistent with our view that the pace of real GDP growth will cool toward a range of 2.5-2.9% in the second half of this year. Indeed, it is widely believed that the majority of strength in domestic spending, housing in particular, was the result of households bringing forward purchases in the wake of record low interest rates and stimulative fiscal policy measures. Now that short-term interest rates are on the rise, and Canadian consumers appear fatigued, domestic spending is expected to be less supportive to economic growth in the second half of this year. This is evident in the housing market where construction output retraced six months of gains in June, and July existing home sales in major markets fell below the record pace of a year ago.

This suggests that industries that have helped support the labour market recovery like retail, construction, finance, insurance and real estate, and professional services will likely lose steam in the coming quarters. The pace of economic expansion expected in the second half of this year is consistent with average monthly job creation in the range of 15,000-20,000 – about half the average job gains posted in the first half of this year. While we have seen an impressive decline in the unemployment rate from its peak value of 8.7% a year ago to its current rate of 8.0%, the future pace of job creation may not be enough to support any further declines in the unemployment rate in 2010. Indeed, there is a risk that the combination of robust growth in the workingage population, and re-entrance of discouraged workers could put slight upward pressure on the unemployment rate in the coming months. Such upticks in the unemployment rate should not be viewed as a negative sign, but rather a reflection of better employment prospects. We expect the unemployment rate to hover in the range of 8.0-8.2% in the near future.

U.S.: UPCOMING KEY ECONOMIC RELEASES

FOMC Interest Rate Decision

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

There is more than the usual level of anticipation regarding the FOMC meeting next week given the increasing chatter about a potential change in Fed communications, one that would reflect a growing transition away from tightening and toward how to accommodate more easing should that need arise. We do not think the Fed is prepared to deliver what some in the markets are hoping for, namely a more explicit statement regarding the reinvestment of maturing debt and possibly coupon payments into the balance sheet to prevent it from contracting. Instead, we expect the Fed to essentially maintain the status quo and consider what steps to take at a later date to see if the data reject or reinforce the need to provide more accommodation. Bernanke admitted in his Humphrey Hawkins testimony that the Fed had thought less about ways to engineer more accommodation than they had about how best to withdraw existing accommodation. That is changing, but that does not suggest any inclination to side more decisively with more accommodation, at least not yet. Growth is rolling over, but jobs are being created, the ISM’s are holding comfortably above the 50 threshold, commodity prices have been rising since the last meeting, credit spreads narrowing, and market rates falling. Financial conditions are, therefore, marginally more supportive to growth then they were at the last meeting. With the six month annual rate of core inflation rising at a 0.9% annual rate compared to 0.3% in May, evidence of a bottoming out in rental prices and a surge in capital investment spending, there is little reason to presume now is the time for a decisive change in Fed communications.

U.S. CPI – July

• Release Date: August 13/10
• June Result: core 0.2% M/M; all-items -0.1% M/M
• TD Forecast: core 0.0% M/M; all-items 0.2% M/M
• Consensus: core 0.1% M/M; all-items 0.2% M/M

Inflation data for July is expected to provide a double edged sword with rising headline inflation offset by ongoing disinflation in core prices. Headline prices are forecast to rise by 0.2%, driven primarily by favorable seasonals in energy prices which are expected to rise 2.0% on the month. Core prices should remain broadly unchanged at 0.0% (0.03% rounded down), despite a third consecutive monthly gain in owners equivalent rent. Core commodities should post a modest decline on the month owing to weakness in apparel prices and a likely dip in used car prices which have surged by 16% y/y. Overall core commodities will be rising at only a 0.7% rate y/y, well off its recent peak of 3% y/y as recently as January of this year. In July, lodging prices which have jumped at an unsustainable 14% annual rate since January will offset the putative rise in rents from OER and rent of residence leaving shelter costs down for the first time in five months. Core services, while modestly up on the month, will be rising at a new cycle low of 0.9% y/y. Overall, The composite change in core inflation will leave prices rising at the slowest rate in over 50 years keeping fears of ongoing price compression fresh among policy makers and bond investors alike.

U.S. Retail Sales – July

• Release Date: August 13/10
• June Result: -0.5% M/M; ex-autos -0.1% M/M
• TD Forecast: 0.9% M/M; ex-autos 0.3% M/M
• Consensus: 0.4% M/M; ex-autos 0.3% M/M

Retail sales are expected to post their first gain in three months rising by 0.9% on a combination of strong auto sales and firmer gasoline sales. The 0.3% monthly gain in sales ex autos will be the best since April and follows two consecutive monthly declines. These core sales will get a bounce from gasoline prices, an easing in the pace of weakness in building materials, furniture sales, and a rebound in sporting goods. Nevertheless, the trend weakness in sales will remain in place with the level of sales activity still lower than it was earlier in the year. The six month annual rate will dip to -2.4% in July, well off the recent highs of 10.4% in the six months leading up to February. It does suggest that consumption will get a nice bounce out of the gates for Q3 providing a nice fillip for real consumption which will struggle to rise above 1.5% in Q3. The weak consumption and higher savings pattern will persist for the foreseeable future and without some evidence of stronger job growth, consumer spending will continue to retreat as a percent of GDP. After hitting a high of 71.5% of GDP in Q1 2009, that share is set to fall to 69% by the end of 2011.

CANADA: UPCOMING KEY ECONOMIC RELEASES

Canadian Housing Starts – July

• Release Date: August 10/10
• June Result: 192.8K
• TD Forecast: 178K
• Consensus: 183K

The July release of housing starts will provide a first glimpse of the Canadian housing market in the postharmonized sales tax (HST) era. Given the lag between construction and sales, the support to starts from builders looking to beat the tax is well in the rear view mirror. What we have seen since is a reflection of the headwinds that have arrested a once buoyant housing market. Over the last three months, starts have marked a steady decline, and are expected to have fallen further in July to an annualized level of 178K. Single unit starts are expected to hold onto their gains made in June following the outsized decline in May while the ever-volatile multiples component is forecast to fall further. The moderation in starts is consistent with the steady erosion in building permits over the last three months. Looking further into the third quarter, the impact of the HST is forecast to take a bigger bite out housing construction, with a forecasted decline in the level of starts to 167K units.

Canadian International Trade – June

• Release Date: August 11/10
• May Result: -$0.5B
• TD Forecast: -$0.8B
• Consensus: N/A

Canada’s merchandise trade balance is expected to fall further into a deficit position in June. At a forecasted level of -$0.8B, this will be the largest deficit since September of last year. On a trade-weighted basis, the Canadian dollar was flat on the month, leaving fluctuations in demand as the main drivers of exports and imports. Part of the outsized increase in auto exports in May is expected to be reversed, which when combined with the observed weakness in shipments of US durable goods, is forecast to cause exports to fall by 3.0% M/M. Higher commodity prices should provide some support to exports. Meanwhile, the gradual deceleration in domestic demand is forecast to contribute to a modest 1.2% M/M fall in imports. After accounting for price changes, real exports and imports are forecast to rise, though as in months past, the net effect on economic activity remains ambiguous. Looking further into the future, if the recent run to parity in the CAD is sustained, the recent deterioration in the trade balance may become a familiar sight.

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