The merchandise trade deficit narrowed to C$2.5 billion in July

Week in review

Canada – Real GDP shrank an annualized 1.6% in the second quarter of 2016 after expanding an upwardly revised 2.5% the prior quarter. Trade was a major drag on the economy on account of slumping exports (-20% annualized, their worst retreat since the 2009 recession) and rising imports. Domestic demand was restrained by a further decline in business investment, moderation in consumption growth, and weak residential investment growth, all of which offset higher government spending. Poor sales resulted in inventory build-up, which made a significant contribution to growth. In nominal terms, GDP contracted an annualized 0.2%. Monthly GDP data by industry showed output sprang 0.6% (non-annualized) in June, thereby erasing the prior month's drop. There were gains in both the goods sector (+1.6%) and the services sector (+0.2%) in the month.

Exporters were affected by two temporary factors in Q2: Alberta's wildfires interrupted southbound oil shipments and an inventory cull in the United States translated into softer demand for Canadian goods. However, these forces are now dissipating. Oil production is reportedly rising again and there are signs American manufacturers are rebuilding stocks. Consumption, too, is expected to bounce back in Q3. The reasons are twofold: a mounting savings rate and higher household income courtesy of the federal government's enhanced child benefit program, which went into effect in July. We are encouraged also by the increase in government outlays last quarter, which suggests the announced federal fiscal stimulus is already in gear. Consequently, while inventory accumulation could cramp future production, we still expect Canada's real GDP growth to rebound sharply in the third quarter.

The merchandise trade deficit narrowed to C$2.5 billion in July, the best in six months (from a revised C$4 billion deficit the prior month) as nominal exports jumped 3.5% while imports fell 0.1%. Export gains were broad-based, with the exception of energy. But even the latter was up sharply in volume terms, the price decline in the month hurting nominal energy exports. As a result, the energy trade surplus fell slightly to C$2.7 billion. The nonenergy trade deficit narrowed to C$5.2 billion, also the best in six months. In real terms, Canada's exports surged 3.4% in July, while imports fell 1.1%. After registering the biggest quarterly dive since the Great recession, Canada's exports are now bouncing back sharply in the third quarter. Assuming no change in August and September, real exports are tracking gains of over 7% annualized in Q3, while imports are contracting. In other words, trade is set to be a major contributor to Canada's GDP growth in Q3. The improvement should not be surprising because temporary factors that hurt exporters in Q2, e.g. Alberta's wildfires interrupted southbound oil shipments and an inventory cull in the U.S. translated into softer demand for Canadian inputs, are now dissipating. What about investment spending? Real imports of electronics, as well as industrial machinery, fell again in July. That suggests the investment collapse may have extended to Q3. Regardless, based on the overall data, it seems real GDP growth for Canada should be above 3% annualized in Q3 after falling 1.6% annualized last quarter. At this point, our estimate for Q3 Canadian GDP growth is +3.4% annualized.

The current account—the broadest measure of trade—showed the deficit widened by C$3.3 billion to reach C$19.86 billion in Q2 (roughly 4% of GDP), its worst reading since 2010Q3. The trade deficit in goods continued to deteriorate while foreign investment in Canada remained robust in the second quarter.

Separately, labour productivity fell 0.3% unannualized in Q2 as real GDP fell 0.8%, faster than hours worked (-0.5%). Hourly compensation was up 0.4%, while unit labour costs jumped 0.7% unannualized.

United States – Nonfarm payrolls rose 151K in August, much weaker than the 180K expected by consensus.

Note that there were essentially no revision to prior months payrolls (-1K). In August, the private sector added 126K jobs with gains in services (+150K) being partially offset by a drop in the goods sector (-24K). The decline in goods sector employment was due to manufacturing, construction and mining registering losses. The private services sector job gains were driven by education/health (+39K), leisure/hospitality (+29K) and business services (+22K). Government added 25K positions. Average hourly earnings rose 0.1% m/m and were up 2.4% y/y (down two ticks from the prior month). The private sector employment diffusion index declined a bit to 58.0 from 62.4. The other US employment report, the household survey (similar methodology to Canada's LFS) showed 97K new jobs being created in August with gains in full-time (+409K) being partially offset by a drop part-time employment (-388K). Both participation rate (62.8%) and jobless rate (4.9%) remained unchanged in August. The US employment reports were weaker than expected. Moreover, hourly earnings decelerated in August and private employment showed its second weakest performance this year. However, we were impressed by the fact that full-time positions showed further massive gains in August. A September move by the FOMC is still possible, but unlikely. We would put odds of rate hike in September at no more than 40%. All things considered, we think the Fed will opt to wait a few more months before the next rate hike to confirm that the deceleration in the labor market is not worsening particularly given that ISM employment sub-indices are in contraction territory. That being said, we must get used to lower payroll employment as the labor market has almost fully recovered from the recent crisis and as demographics provide a headwind. If job creation remains at its current level and financial conditions remains healthy we see a compelling case for another Fed rate hike this year (December).

Trade deficit narrowed to $39.4bn in July from the prior month's revised deficit of $44.7 billion. The improvement in the trade balance was due to rising exports (+1.9%) and falling imports (- 0.8%). In real terms, exports surged 2.9%, while imports were down 1.5%. The trade data was good with gains in real exports. The data is consistent with our view that the U.S. economy is set to set growth north of 3.5% annualized in Q3.

In July, personal income increased 0.4% while personal spending rose 0.3%, both matching consensus expectations. As a result, the savings rate climbed to 5.7%. In real terms, spending rose 0.3% while disposable income was up 0.4%. Consumption in the United States should remain decent in Q3 after registering an impressive performance the prior quarter. The PCE deflator was flat in the month, causing the year-onyear rate to slip one tick to 0.8%. The core PCE deflator was up 0.1%, which kept the annual core rate steady at 1.6%.

In August, consumer confidence firmed up, as reflected in a 4.4-point gain on the Conference Board measure, which reached 101.1, its best reading since September 2015. The present condition index rose 4.2 points to 123, a nine-year high. Although the expectations index also showed improvement by jumping 4.4 points to 86.4, it remained well below its pre-2007 recession long-term average of 95.2.

In June, the S&P CoreLogic Case-Shiller National Home Price Index inched up 0.2% m/m. However, the 20-city index retreated 0.07% on a seasonally adjusted basis, for a third monthly decline in a row. Based on the 20-city index, the annual home price inflation rate edged down to 5.1% from 5.2% a month ago.

In August, the ISM Manufacturing Index fell to 49.4 from 52.6 the prior month. Consensus was expecting a 52.1 print. Both the production and the new-orders sub-indices dropped significantly (from 55.4 to 49.6 and from 56.9 to 49.1, respectively). The fact that the new-orders sub-index dipped back below the 50-point threshold suggests that the manufacturing sector has yet to come to terms with the strong USD. Finally, the prices-paid index slid from 55.0 to 53.0 and the employment sub-index sagged from 49.4 to 48.3.

Factory orders rose 1.9% in July. The largest increase in 9 months followed declines of 1.8% in June and 1.2% in May. Orders for non-defense capital goods excluding aircraft increased 1.5%. Inventories edged up 0.1% in the month and shipments fell 0.2%. The inventories-to-shipments ratio was unchanged at 1.35% in July.

In July, construction spending was flat, disappointing consensus expectations for a 0.5% increase. However, June's growth figure was revised upward significantly from -0.6% to +0.9%. Greater spending in the residential sector (+0.4%) was offset by lower spending in the non-residential sector (-0.3%).

Unit labour cost growth in the second quarter was revised upward significantly from an initial 2.0% to 4.3%. The BEA also announced that wages and salaries grew by $92.6 billion instead of an originally reported $44.2 billion. Real hourly compensation rose at an annual rate of 1.1% in the quarter, revised from a previously reported decline of 1.1%. Nonfarm productivity decreased 0.6% following a one-tick downward revision.

World – In July, Japan's retail sales rose 1.4% m/m. Industrial production was flat from the previous month.

In the euro area, business and consumer surveys showed economic sentiment weakened slightly in August, as the indicator lost 1.1 points to 103.5. The unemployment rate was steady at 10.1% in July. The inflation flash estimate for August indicated that headline inflation (0.2 y/y) failed to accelerate. Core CPI notched down one tick from 0.9% y/y in July to 0.8% y/y in August.

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