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Weekly Talking Points

May 22, 2020
Remembrance of Things Past Due
Douglas Porter, CFA, Chief Economist,, +1 (416) 359-4887
After three months of almost non-stop newsflow on all things COVID, it’s understandable that there is a widespread thirst to move on to some other topic. Ripped straight from the pages of “be careful what you wish for”, market attention turned this week to rising U.S./China tensions, first on trade and then on Hong Kong. Yet, even with a two-day sag, equities reversed last week’s setbacks, paced by rising hopes for an effective vaccine. While some of Monday’s initial enthusiasm dimmed, stocks managed to hold most of the gains and the S&P 500 is now up 4% from year-ago levels. Elsewhere, financial markets had a see-saw ride, with oil prices pushing above $33, the Canadian dollar nudging up, and Treasury yields rising mildly with a slight steepening move.

Markets also found some support from Fed Chair Powell's latest remarks, where he reinforced the point that policy can still provide further support: “We’re not out of ammunition by a long shot”. And there continues to be impressive willingness among investors to look past extraordinarily tough current economic data to a potential recovery ahead. In a relatively sparse week for U.S. figures, there were no major surprises, as housing starts fell 30% in April to a six-year low, and a variety of surveys pointed to a fledgling recovery in May. To wit, homebuilder sentiment bounced from the lows last month (from 30 to 37), while the Philly Fed climbed from extreme lows to deep lows (-56.6 to -43.1). Initial jobless claims receded only slightly, but the now more important continuing claims rose above 25 million people, adding more evidence that we’re in for another harsh U.S. employment report in two weeks’ time.

The overseas news was mildly encouraging (emphasis on mildly), as Germany and France backed a joint EU Recovery Fund, while Europe’s tentative reopening is leading to a tentative economic turnaround. More or less echoing some of the initial May readings stateside, the Euro Area PMI rose to 39.5 for manufacturers (from 33.4) and to 28.7 for services (from just 12.0). Both figures were a tad better than expected, but they are a long way from a neutral 50 result. Notably, Britain (40.6), Japan (38.4) and the U.S. (39.8) all reported almost identical early readings from their factory PMIs, reinforcing the point that the global economy is all in this fledgling recovery together.

Canada delivered no such updates for May, but there were some key gauges of the hit from the shutdowns. Headline inflation dropped into negative terrain for the first time in more than a decade in April at -0.2% y/y, the first major economy to report an outright fall this cycle. However, a record 40% y/y plunge in gasoline prices dominated, and the major core CPI measures barely nudged lower (ex-energy inflation was an unremarkable 1.6% y/y). A record 10% drop in March retail sales was somewhat dulled by the fact that: a) it was in-line with consensus; b) volumes were down a less brutal 8.2%; c) the flash estimate for April was a not-shocking drop of 15.6% (recall that U.S. sales fell 16.4% that month); and, d) wholesale trade was down just 2.2% in March, supported by the fact that a big chunk of Canadian on-line shopping is captured in that measure, not retail sales.

Looking ahead to next week, the focus in Canada will be on Q2 bank earnings—and, in particular, on estimates of potential loan losses—and Q1/March GDP (on Friday). The reported drop in March sales volumes, of 8.2% for retail and 2.8% for wholesale, give a tantalizing hint that StatsCan’s initial flash estimate for March’s real GDP of a 9% drop (and -10% annualized for Q1) may have been slightly too pessimistic. For instance, U.S. GDP fell “just” 4.8%, Japan dropped 3.4%, while even the U.K. was down a more moderate 7.7% in Q1. And recall that the Bank of England is openly talking about a potential drop of 14% for the U.K. economy this year, more than twice the drop that the consensus is looking for in Canada. While debating about the degree of weakness in March and Q1 may seem almost pointless at this stage, it is important in properly gauging just how deep the hole is that the economy needs to climb out of in the year ahead.

We’ll get a slightly better sense of how that climb is progressing in the early stages of the U.S. reopening next week. Measures of consumer confidence for May and additional regional factory surveys should show a limited bounce. As well, April household spending and income data on Friday will give a more complete measure of the extent of the damage from the shutdown. Of particular interest in that release will be the savings rate, and it is likely to surge further. It jumped above 13% in March, the highest level since 1982, and early indications point to another bulge last month, as spending has fallen much deeper than incomes. Those diverging trends are bound to reverse in the second half of the year, although we suspect a lasting legacy of the pandemic will be a higher savings rate, despite a low-low interest rate environment.

One of the more eyebrow-arching items this week was a comment by BoC Governor Poloz on Thursday on the economic outlook. And I quoteth Reuters: “he felt some of the talk about the damage that could be done by the coronavirus outbreak was “a little too dire” and predicted the bank’s best-case scenario for recovery was still possible.” While not naming names, there was some muttering about financial market types being too downbeat. Following up on a point we made last week, note that our call of a 6% GDP decline this year is actually the least negative among the major forecasters. The latest consensus looks for a setback of closer to 7%, with the most negative private sector projection of a 9% decline, but also a rebound of more than 5% next year (we are right on +6%).

We will only say that, if the Governor considers Bay Street economists to be negative on the outlook, we would politely suggest he take a look down the street in Ottawa. Just this week, CMHC was talking about a potential 9%-to-18% drop in home prices, presumably based on a double-digit drop in real GDP. Even the normally upbeat EDC looks for a hefty 9.4% drop in Canadian GDP this year, a more negative projection than any private sector call. Meantime, the PBO has been basing its so-called “optimistic” budget deficit projections on a scenario with a whopping 12% GDP decline this year. They defend this massive setback as being well within the range of the scenarios set out by… wait for it… the Bank of Canada.
Douglas J. Porter, CFA | Chief Economist | Managing Director, Economic Research