Canada – Real GDP contracted 0.1% in February

Week in review

Canada – Real GDP contracted 0.1% in February, matching consensus expectations. The small decline came after an unrevised 0.6% increase the prior month. In February, goods producing industries saw output fall 0.6% (after a 0.9% advance the prior month) as small gains for construction were dwarfed by declines in all other categories including a 0.8% dive for manufacturing. Industrial production fell 0.7% as a result. The services sector's output was flat as gains in retailing, finance/insurance, real estate and accommodation/food services offset declines in wholesaling, transport/warehousing, professional services, health, education, and arts/recreation.

February’s soft GDP was in line with expectations. A moderation was always in the cards after January’s outsized gains. But the big picture is positive because it shows a much improved overall outlook. The cheap Canadian dollar’s benefits are clearly visible. Despite the decline in February, factory output remains close to multi-year highs, no doubt benefiting from strong exports (courtesy of the more competitive loonie). The surge in the accommodation/food services category in recent months (including February) is likely linked to tourism, a sector that’s also benefiting from the currency’s earlier slump. It’s also encouraging to see retailing remaining strong as that points to the resilience of Canada’s main engine of growth, i.e. consumers. All told, despite a soft February, there are positive signs for Canada’s economy. Real GDP should still manage to grow at a near 3% pace annualized in Q1 courtesy of a good handoff from last year and January’s output surge.

Average weekly earnings of non-farm payroll employees were $954 in February, up 0.3% from the previous month. Employees worked an average of 32.9 hours per week in February, unchanged compared with the same month a year ago.

United States – GDP growth slowed to just 0.5% annualized in Q1 according to the advance estimate released by the Bureau of Economic Analysis. The major sources of drag on the economy over this period were trade and business inventories, each of which detracted 0.3% from growth. Domestic demand was buoyed by consumption (despite the fact that it decelerated somewhat as the savings rate eked up), government spending and residential investment, but business investment in equipment disappointed again by contributing negatively to growth for a second consecutive quarter.

The U.S. economy is going through a soft patch, having just posted its worst two-quarter sequence since 2012. The meagre 1% average annualized growth over 15Q4-16Q1 supports the Fed’s cautious approach to monetary policy. Consumers took a breather and socked away part of the higher income earned thanks to a strong labour market, lifting the savings rate to 5.2% in Q1, its highest mark in a year. This is a positive for spending later in 2016.

While Q2 should see better growth, we do not expect results to be stellar in any way. For one thing, the handoff from Q1 was rather poor as industrial production and retail spending fell sharply in March. Trade woes, too, are set to continue for much of the year owing to earlier USD appreciation and weak global demand. Domestic demand should again contribute to growth thanks largely to consumers, although not to the same extent as last year. While the higher savings in Q1 will help, a potential moderation in employment creation (in sync with plunging corporate profits) and the fading benefits of low pump prices could converge to cap consumption growth. As for investment spending, it is not clear whether corporations can reverse the downtrend in the wake of sinking profits. In this light, we have lowered our forecast for U.S. GDP growth in 2016 by one tick to 1.9% (or 1.9% Q4/Q4).

The durable goods report showed new orders rose 0.8% in March, well below the 1.9% increase expected by consensus. Transportation posted a 2.9% increase on a surge by military aircrafts, while civilian aircrafts declined 5.7% and vehicles and parts retreated 3.0%. Excluding transportation, orders decreased 0.2%, running counter to consensus expectations for a 0.5% increase. Shipments of durable goods dropped 0.5%, while those of non-defense capital goods ex-aircraft, a proxy for business investment spending, climbed 0.3%. Durable goods orders fell even further short of consensus expectations when the highly volatile transportation category was excluded. Indeed, in March, orders ex-transportation declined for the fourth time in five months. On the business investment front, the report shows that Q4 weakness continued in Q1, with shipments of nondefense capital goods ex-aircraft down a massive 9.6%, their worst quarterly decline since the 2008-2009 recession.

The Conference Board`s consumer confidence index sank 1.9 points to 94.2 in April. The expectations series declined from 83.6 the month before to 79.3, its lowest level since February of last year. The measure of present conditions rose 1.5 points to 116.4.

New-home sales declined 1.5% m/m to an annualized pace of 511K, their third monthly drop. Yet, home sales in Q1 averaged 517K, up 1.5% from 509K the previous quarter. The supply of homes at the current sales rate rose from 5.6 months the prior period to 5.8 months.

In February, the S&P/Case-Shiller index of property values in 20 cities increased 0.7% m/m on a seasonally adjusted basis. Year over year, the index showed a gain of 5.4%, with property values increasing most in Portland (11.9%) and least in Washington, D.C. (1.4%).

Personal income increased 0.4% in March, following a 0.1% gain in the previous month. Personal spending rose 0.1% in the month after a revised 0.2% gain in February. Personal saving as a percentage of disposable personal income was 5.4%, compared to 5.1% in the previously. In the first quarter, real disposable income rose 2.9%. Consumers took a breather lately and the moderation continued in March. Were are not overly concerned as the weakness is not widespread. It’s rather concentrated in motor vehicle & parts spending after strong gains in 2014 and 2015. This month again, incomes are rising at a very decent pace supported by a strong labor market. The price index for personal consumption expenditure increased 0.1% in March, allowing the year-on-year rate to decline to 0.8% from 1.0%. The core PCE deflator increased 0.1%, allowing the year-on-year rate to drop to 1.6%. This is consistent with our view that the Fed would prefer to wait until Q4 for the next rate hike.

The employment cost index rose 0.6% in Q1, following a 0.5% gain in the previous quarter. Wages and salaries grew 0.7% in the first quarter and benefits costs climbed 0.5%. Over the last 12 months, total compensation rose 1.9%, the smallest gain since Q1 2014.

As expected, the Fed left monetary policy unchanged at its April meeting. Though many were hoping the FOMC’s press release would say more about when the Fed might go ahead with further normalization of its monetary policy stance, the Committee remained non-committal in the aim of keeping open the option of hiking rates when conditions permit. It was the third consecutive meeting at which the FOMC took a pass on assessing the balance of risks. The Committee was cautious not to sound too dovish as it clearly sought to leave the door to a June rate hike at least half open despite a soft first quarter. Is a hike possible that soon? U.S. corporate profits and investment spending have been weak. Historically, that has resulted in weaker employment growth, albeit with a lag. Having lowered our forecast for U.S. GDP to1.9% Q4/Q4 in 2016 and given the persistently soft global economic picture and the risks to U.S. growth, we now see the odds tilted toward just one rate hike this year, and late in the year.

World – The Bank of Japan surprised markets with its decision to leave its deposit rate at -0.1% while maintaining its QQE programme unchanged. The Bank justified its inaction by suggesting it needed more time to assess the effects of negative rates since their introduction in January. The BoJ now expects inflation to reach 2.0% towards the end of fiscal 2017. In its previous release, the central bank had forecast hitting this target in the first half of 2017.

In the Euro area, seasonally adjusted GDP rose 0.6% in Q1. Compared with the same quarter of the previous year GDP rose 1.6%. According to the Eurostat flash estimate, annual inflation fell 0.2% in April. Energy prices were down 8.6% y/y. Excluding energy, food, alcohol and tobacco, core inflation rose 0.8% y/y. In March the unemployment rate drop two ticks to 10.2%. This was the lowest rate recorded since August 2011.

•  Download Full Weekly Economic Letter