United States
◾ With little in the way of U.S. data out this week, investors turned their attention to the global economy where softer economic data out of China and rising political risks have given pause to investor optimism about the economic recovery.
◾ Data out of China showed a dip in manufacturing activity in January, while rising political tensions in the Ukraine and Turkey and economic turmoil in Argentina also contributed to the selloff in global stock markets. The risk off behaviour benefited U.S. bonds.
◾ Investor attention will return to America next week. Financial markets are looking for guidance on whether the Fed will again reduce the pace of asset purchases as they did in December. We expect another $10 billion reduction in asset purchases, bringing the monthly total to $65 billion.
Canada
◾ The Canadian dollar briefly dipped below US$0.90 for the first time in four years, losing a cent this week.
◾ The Bank of Canada presented a more dovish tone in its interest rate announcement, tying the future movement in interest rates to the evolution of economic data.
◾ This week's inflation report underpinned the Bank's more dovish tone with core inflation running at 1.3% year-over-year in December - well below the Bank of Canada's 2% target.
◾ Black Friday deals helped entice households to go to the mall in November, with real retail sales rising by a stunning 0.8%. However, retail spending was soft for 2013 as a whole.
◾ Modest economic growth, a slow and gradual trek back to 2% inflation and a Bank of Canada sitting on the sidelines until the second half of 2015 will continue to clip the loonie's wings over the next two years.
UNITED STATES - GLOBAL GROWTH FEARS WEIGH ON EQUITY MARKETS
With little in the way of U.S. data out this week, investors turned their attention to the global economy where softer economic data out of China and rising political risks have given pause to investor optimism about the economic recovery. Data out of China showed a dip in manufacturing activity in January, while rising political tensions in the Ukraine and Turkey and economic turmoil in Argentina also contributed to the selloff in global stock markets. The risk off behaviour benefited U.S. bonds. As of writing, the U.S. 10-year Treasury fell to 2.73%, its lowest level since October when yields fell in response to the Fed's surprise non-tapering announcement.
Sentiment in financial markets has been more cautious ever since the disappointing U.S. December jobs report earlier the month. The global economy is relying on the U.S. to support the acceleration in global growth, but this has also led to jitters about the impact of tapering on emerging market economies. This has showed up in a sharp depreciation in exchange rates relative to the U.S. dollar. For some emerging market economies, the fall in their currencies will support exports; however, in others it reflects a lack of faith in basic political institutions and rampant inflation. Argentina is the prime example of the latter, but Turkey is not far behind. For these countries a sharp slowdown in economic growth is likely.
However, we would lean against the tide of sentiment that dislocations due to tapering will stall the global recovery more generally. We have long expected global growth to be driven by faster growth in advanced economies. This story remains broadly in place and was in fact validated this week by positive data on the Eurozone where purchasing managers indexes (PMIs) accelerated, beating market expectations. New orders were particularly encouraging, matching a 30-month record, and signaling further strength in the months ahead. The U.S. economy is also relatively shielded from the slowdown in emerging economies, especially as growth over the next year is expected to be driven by consumer spending and investment.
After a brief sojourn, investor attention will return to America next week. Financial markets are looking for guidance on whether the Fed will again reduce the pace of asset purchases as they did in December. While the December jobs report has led to some speculation that the Fed may hold off on a further reduction in asset purchases, we think the Fed will look past it. Job growth typically follows economic growth and real GDP for the fourth quarter is likely to come in of above 3.0% (following the third quarter's 4.1% outturn).
Moreover, the Fed is likely satisfied with the market reaction to its tapering announcements so far. Bond yields did not react in a knee jerk way to December's tapering announcement and are unlikely to respond negatively to further tapering. If anything, by lowering U.S. rates, the flight to safety behavior of the last week will benefit America's domestic recovery, while the rising U.S. dollar weakens prospects for inflation and gives the Fed more scope to leave short-term rates on hold even longer.
CANADA - LOONIE'S CLIPPED WINGS
All eyes were on the loonie this week as it briefly dipped below US$0.90 for the first time in four years. One year ago today, the Canadian dollar was at parity vis-à-vis the U.S. dollar. It has since embarked on a long and gradual decent. While the Canadian dollar is often coined a petro currency, its performance over the last year cannot be tied exclusively to commodity prices. In fact, with the WTI currently at US $97 per barrel, the price of oil is almost exactly where it was one year ago today. So what's clipped the loonie's wings?
Canada's economic underperformance relative to the U.S. has a lot to do with it. Part of the loonie's strength between 2009 and 2011 largely reflected Canada's relative strength coming out of the most recent recession. Stellar growth in domestic demand, alongside stability in the housing market, made Canada an attractive buy for foreign investors. That tide is slowly turning with household spending moderating over the last two years and the U.S. picking steam. This week's release of retail sales indicated that consumer spending was strong in November as deep Black Friday discounting helped lure households into the mall. But, for 2013 as a whole, the pace of retail spending was the slowest it has been outside of a recession since 1992 (see chart).
A weaker economy warrants a more dovish Bank of Canada. Over the last year, the Bank of Canada removed its tightening bias and has become more and more dovish through each of its announcements. It has done this with its tone and content, rather than explicitly changing interest rates. This week's release was no different. With the pace of household debt at its lowest rate since 2001, the Bank of Canada has moved persistently low inflation to the forefront of key downside economic risks - for good reason. Both headline and core inflation have been below the Bank of Canada's 2% target since April 2012. While core inflation appears to have turned a corner in December, ticking up to 1.3% year-over-year, up from 1.1% the month prior, it's still at a pace that is too low for comfort. The Canadian dollar fell by a full cent this week as markets are now expecting that Canadian interest rates are yet to remain lower for much longer.
The drop in the Canadian dollar over the last year and more recently was not unexpected. Our own forecasts had the loonie dropping below 90 US cents in 2015, which now looks likely to happen this year. Stay tuned for a new Canadian dollar forecast within the next few days. While we do think that the Canadian economy and inflation have hit a turning point - with both expected to pick-up speed in 2014 - we do think that the Canadian dollar has a bit more room to fall. With households scaling back their pace of borrowing and housing set to cool, much of Canada's economic acceleration over the next two years will largely be driven by a stronger U.S. economy. But, the result will be only modest economic growth, a slow and gradual trek back to 2% inflation and a Bank of Canada sitting on the sidelines until the second half of 2015.
◾ With little in the way of U.S. data out this week, investors turned their attention to the global economy where softer economic data out of China and rising political risks have given pause to investor optimism about the economic recovery.
◾ Data out of China showed a dip in manufacturing activity in January, while rising political tensions in the Ukraine and Turkey and economic turmoil in Argentina also contributed to the selloff in global stock markets. The risk off behaviour benefited U.S. bonds.
◾ Investor attention will return to America next week. Financial markets are looking for guidance on whether the Fed will again reduce the pace of asset purchases as they did in December. We expect another $10 billion reduction in asset purchases, bringing the monthly total to $65 billion.
Canada
◾ The Canadian dollar briefly dipped below US$0.90 for the first time in four years, losing a cent this week.
◾ The Bank of Canada presented a more dovish tone in its interest rate announcement, tying the future movement in interest rates to the evolution of economic data.
◾ This week's inflation report underpinned the Bank's more dovish tone with core inflation running at 1.3% year-over-year in December - well below the Bank of Canada's 2% target.
◾ Black Friday deals helped entice households to go to the mall in November, with real retail sales rising by a stunning 0.8%. However, retail spending was soft for 2013 as a whole.
◾ Modest economic growth, a slow and gradual trek back to 2% inflation and a Bank of Canada sitting on the sidelines until the second half of 2015 will continue to clip the loonie's wings over the next two years.
UNITED STATES - GLOBAL GROWTH FEARS WEIGH ON EQUITY MARKETS
With little in the way of U.S. data out this week, investors turned their attention to the global economy where softer economic data out of China and rising political risks have given pause to investor optimism about the economic recovery. Data out of China showed a dip in manufacturing activity in January, while rising political tensions in the Ukraine and Turkey and economic turmoil in Argentina also contributed to the selloff in global stock markets. The risk off behaviour benefited U.S. bonds. As of writing, the U.S. 10-year Treasury fell to 2.73%, its lowest level since October when yields fell in response to the Fed's surprise non-tapering announcement.
Sentiment in financial markets has been more cautious ever since the disappointing U.S. December jobs report earlier the month. The global economy is relying on the U.S. to support the acceleration in global growth, but this has also led to jitters about the impact of tapering on emerging market economies. This has showed up in a sharp depreciation in exchange rates relative to the U.S. dollar. For some emerging market economies, the fall in their currencies will support exports; however, in others it reflects a lack of faith in basic political institutions and rampant inflation. Argentina is the prime example of the latter, but Turkey is not far behind. For these countries a sharp slowdown in economic growth is likely.
However, we would lean against the tide of sentiment that dislocations due to tapering will stall the global recovery more generally. We have long expected global growth to be driven by faster growth in advanced economies. This story remains broadly in place and was in fact validated this week by positive data on the Eurozone where purchasing managers indexes (PMIs) accelerated, beating market expectations. New orders were particularly encouraging, matching a 30-month record, and signaling further strength in the months ahead. The U.S. economy is also relatively shielded from the slowdown in emerging economies, especially as growth over the next year is expected to be driven by consumer spending and investment.
After a brief sojourn, investor attention will return to America next week. Financial markets are looking for guidance on whether the Fed will again reduce the pace of asset purchases as they did in December. While the December jobs report has led to some speculation that the Fed may hold off on a further reduction in asset purchases, we think the Fed will look past it. Job growth typically follows economic growth and real GDP for the fourth quarter is likely to come in of above 3.0% (following the third quarter's 4.1% outturn).
Moreover, the Fed is likely satisfied with the market reaction to its tapering announcements so far. Bond yields did not react in a knee jerk way to December's tapering announcement and are unlikely to respond negatively to further tapering. If anything, by lowering U.S. rates, the flight to safety behavior of the last week will benefit America's domestic recovery, while the rising U.S. dollar weakens prospects for inflation and gives the Fed more scope to leave short-term rates on hold even longer.
CANADA - LOONIE'S CLIPPED WINGS
All eyes were on the loonie this week as it briefly dipped below US$0.90 for the first time in four years. One year ago today, the Canadian dollar was at parity vis-à-vis the U.S. dollar. It has since embarked on a long and gradual decent. While the Canadian dollar is often coined a petro currency, its performance over the last year cannot be tied exclusively to commodity prices. In fact, with the WTI currently at US $97 per barrel, the price of oil is almost exactly where it was one year ago today. So what's clipped the loonie's wings?
Canada's economic underperformance relative to the U.S. has a lot to do with it. Part of the loonie's strength between 2009 and 2011 largely reflected Canada's relative strength coming out of the most recent recession. Stellar growth in domestic demand, alongside stability in the housing market, made Canada an attractive buy for foreign investors. That tide is slowly turning with household spending moderating over the last two years and the U.S. picking steam. This week's release of retail sales indicated that consumer spending was strong in November as deep Black Friday discounting helped lure households into the mall. But, for 2013 as a whole, the pace of retail spending was the slowest it has been outside of a recession since 1992 (see chart).
A weaker economy warrants a more dovish Bank of Canada. Over the last year, the Bank of Canada removed its tightening bias and has become more and more dovish through each of its announcements. It has done this with its tone and content, rather than explicitly changing interest rates. This week's release was no different. With the pace of household debt at its lowest rate since 2001, the Bank of Canada has moved persistently low inflation to the forefront of key downside economic risks - for good reason. Both headline and core inflation have been below the Bank of Canada's 2% target since April 2012. While core inflation appears to have turned a corner in December, ticking up to 1.3% year-over-year, up from 1.1% the month prior, it's still at a pace that is too low for comfort. The Canadian dollar fell by a full cent this week as markets are now expecting that Canadian interest rates are yet to remain lower for much longer.
The drop in the Canadian dollar over the last year and more recently was not unexpected. Our own forecasts had the loonie dropping below 90 US cents in 2015, which now looks likely to happen this year. Stay tuned for a new Canadian dollar forecast within the next few days. While we do think that the Canadian economy and inflation have hit a turning point - with both expected to pick-up speed in 2014 - we do think that the Canadian dollar has a bit more room to fall. With households scaling back their pace of borrowing and housing set to cool, much of Canada's economic acceleration over the next two years will largely be driven by a stronger U.S. economy. But, the result will be only modest economic growth, a slow and gradual trek back to 2% inflation and a Bank of Canada sitting on the sidelines until the second half of 2015.
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