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Refocus

August 8, 2016

After a busy end to last week from an economic data perspective, the upcoming week will slow considerably in terms of new data releases for investors to digest, though there is still plenty of information for market participants to let marinate in their brains as they try and refocus their thinking on the global macroeconomic environment.

While new easing initiatives and tweaks to current expansionary monetary policy frameworks have been introduced by the Bank of England and the Bank of Japan (albeit to slightly different market fanfare), the speed of divergence in monetary policy between the US and the rest of the developed world has been slower than initially anticipated given the Federal Reserve is having a challenging time continuing with their monetary policy normalization.  The speed bumps the Federal Reserve has encountered (horrendous May employment report, soft Q2 GDP etc…) has not been helped by the cautious nature emitted from the centre of the Fed’s power base, though we expect we are getting close to the point where policy makers in the US look through some of the noise and focus on bigger picture developments.

We had previously highlighted that while the advanced estimate of second-quarter GDP in the US was surprising, it was not yet cause for panic, and that the wash-out in the American buck was potentially more to do with investors jumping the gun as opposed to a distinct change in tone from the Federal Reserve, and the ongoing risk for USD bears is that the FOMC looks through some of the recent noise to focus on what they can control.  Furthermore, while the disappointing GDP figures are worrisome, we did note consumption was almost three times as large as in Q1, and that if consumer spending figures continued to have legs, inventories would need to be rebuilt, resulting in deferred GDP growth being pushed into the third quarter.  Friday’s labour market report helps corroborate the assumption that continued tightening in the labour market will underpin consumer spending patterns, and should give policymakers confidence a strong H2 is waiting in the wings.  The addition of another strong non-farm payrolls number along with positive revisions to June’s report should help the big dollar recoup some of the ground which was lost over the course of July, even if the September FOMC meeting is too close to expect any upward movement in interest rates.  We still favour the prospects of an interest rate hike from the FOMC at the December meeting, and even though we feel the market continues to underprice the potential for this outcome, participants are starting to come around to this notion.  Prior to Friday’s labour market report the chances of an increase in rates stood just below 30%, with interest rate futures now suggesting a 38% probability further monetary policy normalization occurs before the end of 2016.  As such, we would opine there is a good chance the DXY aims to re-test the highs witnessed in July before GDP figures stopped the greenback’s progression in its tracks, though we would highlight election uncertainty in the lead-up to November has the potential to rock the DXY’s boat.

North of the 49th parallel was a different story on Friday, as the loonie ran into a trifecta of data releases which clipped its wings and caused participants to shed exposure to the waterfowl.  Already dealing with a May GDP report in which the economy contracted by 0.6% on a month-over-month basis, it appears that a robust rebound will be hard to come by given export growth in June stagnated, resulting in a larger than expected trade deficit.  Not only was the trade deficit in May negatively revised, but during the second quarter, exports as a whole fell by 4.7%, the largest quarterly decline since 2009.  Also of concern for the Bank of Canada is that exports excluding energy products 0.4% over the month of June, adding further pressure on what has already been a challenging period of rebalancing growth focused towards non-energy exports.  We have previously highlighted the significant strengthening of the Canadian dollar over the first two-quarters of the year happened at such a fast pace it would threaten to choke off the positive green shoots witnessed in the non-energy export sector, though by itself, Friday’s larger than expected trade deficit isn’t cause for significant panic.  However, compounding the negative trade balance data was the fact that the Canadian employment market posted another month of disappointing numbers, which after remaining effectively flat in June, saw the economy shed just over 30k jobs in the month of July.  Things get scarier when you remove the effect of part-time employment, with the full-time labour market losing 40k jobs in June, and then posting another decline of just over 70k in July.  The lack of positive momentum towards rebalancing GDP growth with more emphasis on non-energy exports and business investment hasn’t been an issue for the Canadian economy thus far given consumer spending has been insulating economic growth from a more pronounced downturn; however, the recent struggles in the labour market do pose significant downside risk for consumer spending patterns.  Should consumers feel the need to batten down the hatches and tighten their purse strings given the recent dour data sets, the Bank of Canada runs the risk there will not be a sustained economic rebound in H2 like they had previously predicted.  Though we don’t feel there is an immediate risk a rate cut materializes from the Bank of Canada given the challenges the housing market in specific areas poses to financial stability, we do think there is the potential for dovish commentary from Governor Poloz that steers the loonie lower in the coming months.  That being said, should the government’s macro-prudential policies aimed at cooling the Vancouver housing market show signs of success, it may open the door for Poloz and Co. to ease monetary policy further without endangering what is already an over-leveraged Canadian consumer.

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