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Weekly Talking Points

October 4, 2019
Douglas Porter, CFA, Chief Economist,, +1 (416) 359-4887
We interrupt your regularly scheduled programming of political sound and fury, in both the U.S. and Canada, to bring you this message from the economy…. “HELP!”

After about a one-month reprieve, recession whispers were in the air again this week, following a global wave of disappointing September purchasing manager reports. A respectable U.S. employment release stemmed the tide on Friday, but it was still a week of lower stocks, lower oil prices, and lower yields. Notably, Treasuries saw a significant bull steepening move, with 2-year yields tumbling more than 20 bps to levels not seen in more than two years of around 1.4%. After downplaying the odds of a third Fed easing move in recent weeks, market pricing saw a dramatic shift on the latest slate of growth fears—a rate cut for the October 30 meeting is now seen as almost an 80% probability. We have been assuming the Fed would trim rates again by 25 bps at that meeting for some time, and would readily agree with this week’s shift.

The data point that really set the cat among the market pigeons was the U.S. ISM manufacturing report for September, which sank to its lowest level since the 2009 recession at 47.8. While still shy of full-on recession terrain (more like a 43 reading, or lower), it was much weaker than expected, flew in the face of earlier decent regional results, and the details were awful. It didn’t help that it simply echoed a run of global factory PMIs south of the 50 mark—China 49.8, Britain 48.3, and Euro Area 45.7. Now investors have been dealing with the stark reality of a deeply struggling manufacturing sector for much of this year, primarily owing to the trade war, and were soothed by a resilient consumer/services/jobs backdrop. But even services are beginning to show some cracks, with the non-manufacturing PMIs fading fast last month in all regions. Again, the U.S. pullback to 52.6 (from 56.4 in August) may have been the most serious stumble.

We have high regard for the purchasing manager reports, especially the U.S. ISM—it has a long history, it is timely, it is revised only lightly, and it correlates well with GDP growth. But here’s the thing: It is still only flagging a cooldown, not a downturn. And, these are just surveys, which may have caught the maximum angst of firms in the wake of dire trade news through the summer. Most other recent indicators are far from flashing signs of serious stress. Jobless claims are still bouncing around 50-year lows, in sync with September’s 3.5% unemployment rate. Private sector payrolls managed a modest 114,000 gain last month, not far from the six-month trend of 133,000. And, auto sales were a mild pleasant surprise at 17.2 million for September, a touch above the 12-month trend. On balance, we still expect U.S. GDP growth to dip from just over 2.5% in the first half of the year to the 1.5%-to-2.0% range for H2, with Q3 near the upper end of the range, and Q4 closer to the bottom end.

But the clear risks facing the global and U.S. economy can’t be readily dismissed. Right at the top of that long laundry list is the very real threat of a sour turn on the trade front. Investors have been hopeful that next week’s restart of U.S./China trade talks will at least calm the waters, and Larry Kudlow hinted that there could be a positive surprise coming (thereby rendering any good news a non-surprise). Unfortunately, that isn’t the only iron in the trade fire. A WTO ruling in favour of the U.S. on Airbus subsidies prompted an immediate response of tariffs on a gamut of EU goods: Italian cheese, French wine, and Scotch single-malt whisky. (Oh, the humanity! This is really getting serious now.) As well, the USMCA continues to be caught in limbo, a full year after Canada finally reached an agreement with the U.S.—Speaker Pelosi continues to talk up the pact’s prospects, but political realities are quickly shutting its window of opportunity.

The ongoing cloud of uncertainty for the USMCA is no friend for the Canadian economic outlook. After running against the global grain with a powerful rebound in Q2 growth, Canada has rapidly come back to the pack. A flat reading on July GDP was below expectations and trimmed the three-month annualized trend to 1.8%. While the August trade deficit narrowed a bit below $1 billion, it was all due to better oil prices—net exports will at best be neutral for Q3, after turbocharging Q2. And, more recent, September auto sales dipped again from year-ago levels, roughly matching this year’s average 4% y/y drop.

Coupled with the weak ISM releases, Canadian bonds responded to the generally downbeat domestic economic releases with a furious rally of their own this week. Yields fell by 12-16 bps across the curve, and the market even put a possible rate cut back on the radar screen. While the odds of a trim at the October meeting are still barely 20%, a move by December is close to 50/50. There are still two very big hurdles to a BoC cut: 1) Core inflation is basically right on target, unlike the sub-2% pace for the U.S. PCE deflator; and, 2) housing continues to mount a spirited comeback.

We have often opined that the last thing policymakers want to do now is light another fire under Canadian home prices, and thus under household debt. The early results on home sales from the major cities came in uniformly on the strong side, highlighted by big bounce-backs in sales in both Vancouver (46% y/y) and Toronto (22%). A tumble in five-year mortgage rates in the past year, as well as the strongest population growth in decades, helped turn the market around in double-time. Even so, while a rebound in housing raises the bar for rate cuts, we suspect that global growth concerns, sagging energy prices, and ongoing trade uncertainty will eventually prompt the Bank to trim at least once in the months ahead.

At the risk of repeating a point we have made in the past, if the Fed does indeed trim rates again on October 30 and the Bank refrains on the same date—as markets currently expect—Canada will be the proud owner of the highest overnight interest rate in the G10+ (at all of 1.75%). Australia, which historically always had a higher rate than Canada until this year, has long since gone due south, with the RBA trimming another 25 bps this week to just 0.75%. That’s despite the fact that GDP growth and inflation are expected to be remarkably similar for this year between the two economies, and Australia continues to sport a lower jobless rate (5.3% versus 5.7%)… not to mention a modestly better rugby team.

Not surprisingly, in this rate environment, the Canadian dollar has quietly been one of the firmer currencies in 2019. While it wobbled slightly this week on global recession concerns, and is dealing with a trace of election uncertainty, it now ranks as the second strongest currency in the world so far this year, trailing only a touch behind the safe-haven Japanese yen.
Douglas J. Porter, CFA | Chief Economist | Managing Director, Economic Research