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Weekly Talking Points

January 17, 2020
Turn Down for What?
Douglas Porter, CFA, Chief Economist,, +1 (416) 359-4887
Almost nothing, apparently. After a stumbling start to 2020 on last week’s Iran tensions, global markets are back on a roll to behold. Juiced by broadly decent economic data, as well as official punctuation marks on trade uncertainty on two fronts, equities cruised to a variety of record highs, with the S&P 500 on track to rise by nearly 2% this week. The venerable Dow is now just a few percentage points shy of the 30,000 level, less than three years after first driving through the 20,000 threshold.

However, while equities are generating almost as much attention as Megxit, we would note that other financial markets are much less raucous. Bond yields have barely budged on net in the past two weeks, most currencies have slipped slightly against the greenback this year, and commodity prices have mostly chilled after an Iran-led splurge out of the gates. In other words, the overall message from the markets is that nothing truly significant has changed for the economic outlook, despite the ongoing equity party.

There’s little doubt, though, that some of the downside risks facing the economy are being dialled down. This week finally brought the Phase One agreement on U.S./China trade—more than three months after the President Trump first crowed about said deal, we might add. We dive into the details and what it might mean for the economy in this week's Focus, but suffice it to say that the deal would give a moderate boost to U.S. growth this year—if China carries through with its pledges. We regard that as a very big “if”. Still, we will allow that the agreement is a bit meatier than expected, and most likely does mean a spell of peace on this front, at least until the November election. After carving into growth globally in 2019, even a long standstill on the trade war is good news.

Just one day after the Phase One deal was officially inked, the long-fought USMCA passed another key hurdle when the U.S. Senate voted 89-10 in favour. (Sidebar: Just one Republican voted against the deal, concerned that it was more protectionist than NAFTA. On the other side of the aisle, Chuck Schumer and four, count ‘em four, erstwhile or current presidential candidates voted Nay. So did both senators from Rhode Island and one from Hawaii, which apparently are not very dependent on trade with Canada or Mexico!) True, the real drama was over when the House voted in favour of the deal last month, but it’s still very good news that this long-standing source of uncertainty—especially for Canada and Mexico—has drawn to a reasonable conclusion. And, again, overall U.S. trade with its USMCA partners totalled $1.22 trillion in the past 12 months, more than double the $571 billion with China over that period.

The concern now is that with these two big trade battles off to the side, the U.S. will train its sights on Europe. While this week's meeting among trade officials was reportedly constructive, there are plenty of red flags that may yet trigger a tougher U.S. stance—proposed digital taxes, a weak euro, a groaning bilateral trade imbalance (now more than half the size of China’s surplus with the U.S.), aircraft subsidies, to name a few. A fragile Euro Area economy would be deeply challenged by an escalation of the simmering trade tiff with America. Note that while China’s GDP growth cooled to 6.1% in 2019 (and 6.0% y/y in Q4), Germany’s big economy slowed to just a tenth of that pace at 0.6% for last year, with the auto-heavy manufacturing sector essentially in recession.

Unlike China, the ECB already has its foot to the floor on monetary policy, and there is still little appetite (and/or room) for fiscal stimulus in much of Europe, leaving policymakers few tools to counter any growth drag from a full-on trade war. And, of course, the EU is also dealing with the added burden of Brexit—with the Withdrawal Agreement now approved, the countdown to the real thing at the end of 2020 begins in earnest.

On the other side of the pond, U.S. economic data were generally favourable this week. Retail sales turned in a respectable result (+0.5% ex autos and gas) in the key December period, a massive contrast from the shocking performance a year ago (when they plunged 2.3% ex autos/gas, the biggest monthly setback in at least three decades—yes, even worse than during the Great Recession). The mild December weather played havoc with some other key indicators, as housing starts surged to their best level in 13 years, while a plunge in utilities output clipped industrial production. Manufacturing output remains down from year-ago levels, a notable victim of the trade war, but sentiment firmed in both the Empire and Philly Fed surveys. Meantime, jobless claims are back to probing multi-decade lows, and inflation remains calm with both headline and core CPI holding just above 2%.

Pulling these strands together, it looks like the U.S. economy will likely revert to trend-like growth of close to 2% after a soft Q1 (on Boeing’s shutdown). It’s tough to see the Fed doing anything in that growth/inflation environment, especially with the election just 291 days away (but who’s counting?). While an on-hold Fed and a world of growth and inflation close to the 2% mark may not sound gripping, it’s a decent backdrop for equities, especially with a calmer trade landscape. In turn, what does the sturdy start for stocks tell us for the rest of the year? Well, despite the much-hyped January effect, over the past 20 years, precisely 10 Januaries have seen the S&P 500 drop, and 10 have seen advances, with a median move of -0.1%. And exactly half of the time, the market has gone in the opposite direction of January’s move in the rest of the year—in other words, the sturdy start tells us nothing.

The latest consensus results reveal that, among major forecasters, we are currently the most bullish on the street for the Canadian economy for 2020, calling for a princely 1.8% GDP growth rate this year. While the differences are far from large, and the consensus is but two ticks below us, it’s a tad rare for us to be on the optimistic end of the scale. And, that “optimism” underpins our call of no rate cuts by the BoC, so it’s worthy of a brief explanation. True, Q4 is going to print next to no growth, but we expect a solid rebound from the special factors that weighed on that quarter (notably the CN strike). As well, we expect the fiscal engines to keep running in Ottawa this year, with program spending set to rise almost 4% even before any new measures are revealed in the 2020 budget. Some clarity on the trade front should also support capex, which has been a longstanding sore spot on the domestic landscape.

And, finally, there is the underlying push from robust population growth and a firming housing market. This week’s December data on home sales and prices shouted strength across much of the country, and certainly a very tight market in many key cities. We would readily allow that relying on housing and fiscal spending is far from a winning long-term strategy for economic success, but it’s probably enough to help the Canadian economy grind out a decent year for growth.
Douglas J. Porter, CFA | Chief Economist | Managing Director, Economic Research