China Worries Intensify - BMO Harris · 2015-08-14 · China Worries Intensify China Devalues Yuan;...

Douglas Porter, CFA, Chief Economist, BMO Financial Group

August 14, 2015

BMO Capital Markets Economics www.bmocm.com/economics 1-800-613-0205 Please refer to page 15 for important disclosures

China Worries Intensify

China Devalues Yuan; Economy Slowed in July

Oil Prices Touch Post-Recession Low

Cdn Manufacturing Disappoints; Housing Still Solid

U.S. Data Good Enough to Keep Fed on Track for September

Euro Area Q2 Growth a Bit Soft

Feature ArticlePage 7

of 15 Focus — August 14, 2015

Our Thoughts

It’s Descending, It’s Destabilizing, It’s Devaluation!

he good news is that almost no one is talking about Greece any longer. The bad news is that a much bigger and more important economy has rumbled back onto the

headlines, with China’s significant currency adjustment on Tuesday. It’s not every day that I get to quote long-lost cousin Cole Porter (in the title; for those under 80, search “It’s De-lovely”), but the 3% yuan devaluation was clearly the major event this week. There is still plenty of debate on what exactly was the motivation behind the currency adjustment, but we would highlight at least four key considerations by China’s policymakers:

1) The renminbi was arguably the strongest currency in the world on a trade-weighted basis prior to this week’s actions; and, even with the 3% drop this week, it still has seen one of the smallest declines against the US$ in 2015. Just last week, it hit its highest level against the Canadian dollar in 21 years (see chart). In other words, the CNY is still a very strong currency, even with this week’s moderate devaluation.

2) The currency adjustment followed another wave of downbeat Chinese economic data, most notably an 8% y/y slide in July exports early this week, highlighting the downside risks to Q3 GDP growth. And, it follows the stock market turbulence and some very aggressive monetary easing last month.

3) Prior to the move, it certainly looked like the Fed was fully on track to tighten in September, especially after last Friday’s solid jobs data. Thus, the U.S. dollar was poised to rise further, and China simply did not want to be tightly hitched to that wagon.

4) China is aiming to get included in the SDR basket. And just last week, the IMF recommended some currency reforms, which were remarkably similar to what China unleashed on Tuesday.

Many asserted that the last factor was the most important, and the move should be seen as a welcome step in China moving to further financial market liberalization. That may be correct, but the timing of the move was certainly very convenient from the standpoint of the first three considerations. With the currency now more open to market forces, those forces appear poised to put further downward pressure on the renminbi for the near future. However, we suspect that authorities are serious about reinjecting some stability into the exchange rate, and our currency strategists see the CNY topping at just above 6.50 around year-end (less than 2% weaker from today’s level just below 6.40/US$).

In terms of economic impact, the currency adjustment probably says more about the current state of China’s economy rather than carrying huge implications for what’s ahead. If the moderate devaluation stays moderate, it’s not a game-changer for the global growth outlook, since it merely shifts around where the growth will come from. However, at the margin, the uncertainty around China’s move does weigh slightly further on global growth. By taking such a big step, which was bound to raise the hackles of key trading

Douglas Porter, CFA Chief Economist [email protected] 416-359-4887

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Two Sides of the Yuan CoinChart 1

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Yuan/C$

Yuan/US$

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Our Thoughts

partners and to rattle some neighbouring economies (notably Malaysia and Indonesia), China is signaling that other measures just weren’t doing the job in boosting GDP.

The more downbeat assessment on China’s growth, as well as the amped-up volatility in some financial markets, piled on deeply sagging commodity markets. This is the real pressure point for Canada; $42 WTI and huge discounts on Canadian oil pose a clear threat to our forecast of a second-half rebound in growth. While we suspect the five-month string of monthly GDP declines will soon end, the recovery could be more muted than expected with a second shoe dropping in Alberta and across resource sectors.

Curiously, the deeper drop in most commodity prices (save gold, which bounced almost $25 this week to $1114) and the currency volatility did not knock the stuffing out of the Canadian dollar this week. While the Asian currencies were falling across the board, most of the major currencies actually rose against the U.S. dollar this week. European currencies were up between 1%-to-2%—even with a slightly disappointing Q2 GDP print of +0.3% Q/Q and +1.2% y/y for the Euro Area—while the Australian dollar slipped only slightly (-0.5%), and the loonie was up 0.5% to 76.5 cents.

The driving factor behind the modest bounce in the loonie, the euro, and gold, was the fact that the mighty U.S. dollar lost steam amid renewed questions on whether the Fed will hike in September. While the odds of such a move wobbled temporarily on the yuan-led market volatility, they began firming again as markets settled down and U.S. economic data remained solid. While Asian currency weakness is a wild card, unless it morphs into deeper and broader trauma, we believe the Fed remains on track for its first rate hike in nearly a decade next month.

FOMC Minutes and the Revenge of the Strong US$/Weak WTI Nexus

he July 29 FOMC statement was profound in its placement of one new word (“some”) in front of the well-worn forward guidance on the timing of policy rate

lift-off (when the Committee has seen “further improvement in the labor market”). The “some” depicted a more limited amount of labour market data required as evidence. It was noteworthy that the reference to “energy prices appear to have stabilized”, in the context of continued sub-par inflation, was dropped. Although this suggested that the deflationary impact of falling oil prices was back on the Fed’s radar, we judged that this blip paled in comparison to the ones emitted by mounting momentum in housing and labour markets (housing “has shown additional improvement” and job gains were “solid” amid “declining” unemployment). Indeed, this momentum was probably behind Chair Yellen’s assertion (in the recent semi-annual congressional testimony) that “we now think that the economy can not only tolerate but needs higher rates.”

Until the start of this week, we suspected the Minutes were mostly going to be scrutinized for clues on how much the evidentiary bar was lowered. However, in the wake of this week’s currency move by China, the Minutes take on added significance as the market searches for clues on how the FOMC might react to the strong-USD-weak-oil nexus rearing its growth-sapping/disinflationary head again. The Chinese move caused the yuan (along with other Asian currencies) to depreciate against the

Michael Gregory, CFA Deputy Chief Economist [email protected] 416-359-4747

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Our Thoughts

US dollar. It suggested to market participants that Chinese authorities had become more concerned about domestic growth prospects. The latter undermined commodity prices further, with WTI crude hitting a 7-year low under $43/bbl. Treasury yields headed down amid the increased global economic and financial market uncertainty (a.k.a., safe haven flows), lower inflation expectations and betting that a revived strong greenback/weak crude nexus could cause the FOMC to pass on lift-off next month. We judge Fed policy is unlikely to be swayed so easily by a revived nexus, although this week’s events emphasize why the post-lift-off profile for rates is going to be much flatter than anything we’ve experienced before.

Compared to the first dollar-strength/oil-weakness wave (mid-2014 until this March), much of the (negative) growth and (negative) inflation impacts have already happened or are deep in the process of happening. This was factored into June’s “dot plot” which pointed to one-to-two rate hikes this year. Given the already revealed preference not to move in contiguous meetings at tightening’s outset (for fear of fuelling excessive tightening expectations), and only three meetings left this year (during which time 15 of 17 FOMC participants anticipate at least one rate hike), it’s not surprising how many Fed officials have been musing about the September option. And, while the broad trade-weighted U.S. dollar has now moved above its March high and oil prices have moved below their March lows, both moves are not (yet) likely significant enough to stifle these musings—at least not with evident “further improvement in the labor market”.

True, the recent slide in market-based inflation expectations will not be unnoticed by the Fed. But, even if a revived nexus exerts downward pressure on core inflation, the underlying (shorter-term) trend was already pointing up (so has some room to absorb it). In the past six months, core CPI inflation has run at a 2.3% annual rate with core goods prices moving into positive territory (0.4%) for the first time in two years. Meanwhile, wage-driven core services prices are running at a 3.0% annual rate, a near seven-year high for this metric. Clearly, China-prodded U.S. dollar appreciation and oil price weakness matter for the Fed, but not enough yet to take September off the table given that the FOMC really wants to get off the zero lower bound.

U.S. Economy: H2 Starting Off Much Better Than H1

y, my, how quickly an economy can turn from zero to hero. Recall, in late May the BEA reported that U.S. GDP shrank 0.8% (annualized) in the first quarter of

the year. Well, not only was this estimate subsequently revised to show positive growth (in fact, 0.6% wasn’t all that bad considering the many one-off hits that occurred in the quarter), but, based on more recent inventory and spending data, the reported modest rebound of 2.3% in the second quarter also looks to be adjusted considerably higher, possibly a full percentage point to 3.3%.

And the cheerful news doesn’t stop there, as growth looks to remain robust at around 2.8% in the third quarter. Following strong gains in employment, new auto sales and ISM nonmanufacturing in July, industrial production and retail sales also rose sharply (both 0.6%). Manufacturers had their best month this year, and the beleaguered mining sector is even showing signs of stabilizing. Meantime, purchases of housing-related items remain particularly strong, with furniture/furnishings up 6.1% y/y. This reflects

Sal Guatieri Senior Economist [email protected] 416-359-5295

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Our Thoughts

rising home sales, which should continue for some time as more millennials realize that buying a home is cheaper than renting one (rental affordability has never been worse in the past 36 years, according to Zillow). Households aren’t holding back on discretionary purchases, either, with sports/hobby stores pole-vaulting 6.4% and restaurants/bars up a sizzling 9.0%. Excluding food, clothing, energy and housing expenses from personal consumption shows that real discretionary spending rose 4.2% y/y in the first half of the year, actually faster than during the last housing boom. This reflects much-improved confidence, finances and spending power. Personal consumption advanced 3.2% y/y in H1, fully supported by real disposable income growth.

Assuming Q2’s upward revision, annual GDP growth this year could improve slightly to 2.5%. While that’s far from strong, it’s better than potential growth—which might be 2% or less if labour productivity and participation rates do not improve. This means the unemployment rate will likely dip below 5% by year-end, which won’t go unnoticed at the Fed. Growth this year should also step up from the sluggish 2.1% rate of the first five years of the recovery. Considering the strong dollar and soft global demand, as well as the shaky start to the year, that’s not a bad outcome.

Oil Greases Downside Risks for Canada

hina’s devaluation was the headliner for global markets this week, but the more important event for Canada was the continued slide in oil prices. WTI crude oil

prices touched new post-recession lows, while Western Canadian Select (WCS) crude gained that dubious distinction already last week. Note that Canada oil exports are 53.5% WTI, 39.5% WCS and 7% Brent. The slide in oil over the past six weeks has been a precipitous 30%. And, it could get worse as the WCS discount versus WTI tends to peak in the winter, suggesting that even with steady WTI, WCS could fall further. If prices persist around current levels (or lower) that could prompt another round of capital investment cuts among energy firms. That was one of the biggest drags in the first half of the year and suggests there’s some downside risk to our Q4 and 2016 GDP forecasts.

Despite the drop in oil, the outlook for Q3 remains upbeat. The factors we highlighted in Focus two weeks ago haven’t changed. As such, look for the economic data to continue improving over the coming weeks—though the gain in June manufacturing sales was admittedly disappointing. The commodity backdrop will keep markets from getting too optimistic on the outlook and keep some odds of a rate cut priced in. Indeed, the Bank of Canada based its July MPR forecast on US$60 WTI and US$50 WCS (or C$75 and C$63, respectively), pointing to a downgrade in the BoC’s outlook when it reassesses in October (assuming prices stay here).

Bottom Line: The economic backdrop just got a lot tougher for Canada. We’re not calling for another rate cut quite yet, but another leg down in oil could prompt a shift. Even without further weakness in oil, it looks as though underlying growth might be sluggish for some time as the economy transitions toward non-energy export oriented growth. That might be the recipe for an even weaker Canadian dollar. B.A.A.R.

Benjamin Reitzes Senior Economist [email protected] 416-359-5628

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Recap

Jennifer Lee Senior Economist [email protected] 416-359-4092

Good News Bad News

Canada Still on track for positive

growth in June Housing markets in Toronto

and Vancouver remain hot

Conference Board’s Business Confidence Index +19.1 pts to a 4-year high 105.6 (Q2) New House Price Index +0.3% (June) Manufacturing Sales +1.2% (June) Manufacturing New Orders +0.6% (June) Average Home Prices +8.9% y/y (July) MLS Home Price Index +5.9% y/y (July)

Housing Starts -4.6% to 193,032 a.r. (July) Existing Home Sales -0.4% m/m (July)—national market still well balanced

United States Consumer spending has a

solid start to Q3, keeping September rate hike in play, despite China’s devaluation

Core Retail Sales +0.3% (July) Federal Reserve Labor Market Conditions Index +1.1 pts (July)—but slower than prior month Hires Rate +0.1 ppts to 3.7% (June) NFIB Small Business Confidence Index +1.3 pts to 95.4 (July) Mortgage Delinquencies slip to 8-year low 5.3% (Q2) Initial Claims (4 week m.a.) at 42-year low 266,250 (Aug. 8 wk) Business Inventories +0.8% (June) Import Prices -0.9% (July) Producer Prices +0.2% (July) Industrial Production +0.6% (July)

Nonfarm Productivity +1.3% a.r. (Q2 P)—sluggish Budget Deficit grew to $149.2 bln (July) U of M Consumer Sentiment Index 92.9 (August)—down slightly

Japan Minutes from BoJ’s July

meeting show concern about China slowdown and, for a few, more cautious views on inflation

Industrial Production +1.1% (June F) Tertiary Index +0.3% (June) Current Account Surplus ¥558.6 bln (June) Bank Lending ex. Trusts +2.7% y/y (July)

Machine Orders -7.9% (June) Consumer Confidence -1.4 pts to 6-mth low 40.3 (July) Producer Prices -0.2% (July)

Europe ECB minutes show it is “still

too early” to say that inflation is at a turning point

Greece and creditors near agreement on bailout terms

Brussels backs IMF view on giving Greece debt relief

Euro Area—Consumer Prices +0.2% y/y (July F) Germany—Real GDP +0.4% (Q2 P) U.K.—Average Weekly Earnings ex. Bonus +2.8% y/y (3 mths to June)—steady U.K.—Jobless Claims -4,900 (July) U.K.—Jobless Rate unch at 5.6% (June) U.K.—RICS House Price Balance +4 ppts to 44% (July)

Euro Area—Real GDP +0.3% (Q2 A)—slower than expected and down from Q1 Euro Area—Industrial Production -0.4% (June) Germany—ZEW Survey -4.7 pts to 25.0 (Aug.) France—Real GDP unch (Q2 P) Italy—Real GDP +0.2% (Q2 P)—slower

Other PBoC devalues CNY, but

says the adjustment is “almost completed”

Moody’s cuts Brazil to Baa3

China—New Yuan Loans 1,480 bln (July) China—M2 Growth +13.3% y/y (July) Australia—Westpac Consumer Confidence +7.8% (Aug.) Australia—Wage Price Index +0.6% (Q2)

China—Exports -8.3% y/y, Imports -8.1% y/y (July) China—Producer Prices -5.4% y/y (July) China—Aggregate Yuan Financing 719 bln (July) China—Industrial Production +6.0% y/y; Retail Sales +10.5% y/y; Fixed Asset Investment +11.2% y/y (July)—slowing Australia—Business Confidence -4 pts to 4 (July) Russia—Real GDP -4.6% y/y (Q2 A)

Indications of stronger growth and a move toward price stability are good news for the economy.


Feature

China Worries Intensify Benjamin Reitzes, Senior Economist • [email protected] • 416-359-5628

China unexpectedly devalued the yuan this week sending shockwaves through financial markets. While the 3% move doesn’t seem like a huge amount—and compared to floating currencies, it clearly isn’t, as the C$ and euro are both down about 17% y/y (Chart 1)—it’s the largest one-week depreciation in the yuan since 1994. The move followed another month of weak trade data, with exports slumping 8.3% y/y in July, while imports were down 8.1%. Those figures hardly point to strong domestic and global demand. China’s policy shift spooked financial markets, with global bonds rallying sharply and equities selling off. Uncertainty on China’s growth prospect has intensified.

China’s economic backdrop has been challenging for some time, posing a downside risk for the global economy for more than a year. Real GDP growth has slowed consistently since the pre-recession peak in 2007Q2 (Chart 2). The recession took a big bite out of China’s growth rate, but there are larger factors at play as well. An aging population, due in part to the one-child policy, and the resulting slowdown in labour force growth is limiting potential output. This trend will worsen over the coming decades. According to United Nations population projections, China’s working age population will start shrinking this year (Chart 3). That points to continued deceleration in GDP growth. In addition, the economy is in the midst of a shift away from industry/export-driven growth, to a domestic demand-driven model. While there are some signs that the transition is progressing, policymakers are struggling to ensure that there is sufficient growth to maintain social stability. The services sector is now about 50% of GDP (Chart 4), but that’s still far from the two-thirds share in both the U.S. and Canada. China’s transition still has a long way to go and will probably take decades to complete.

Despite progress transitioning to domestically-driven growth, the economy has not performed well enough to satisfy policymakers, prompting four interest rate cuts since November 2014 and three reserve requirement rate cuts since February. Those actions appeared to put a floor under GDP growth, but the early Q3 figures suggest more needs to be done to achieve the 7% annual growth target. The yuan devaluation came just one day after weak trade data, hinting that the currency move was intended to provide a boost to exports. While that’s certainly possible, and it will help trade prospects, the move could also be a small step toward liberalizing the yuan and opening up the capital account. But the jury is still out.

Another big worry coming out of China this year was the massive swings in the equity market. An index of large cap stocks, the CSI300, surged 150% y/y as of early June before giving back more

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Currencies vs. USD

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Source: China National Bureau of Statistics

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Feature

than one-third of the gain in the space of one month (Chart 5). There were widespread reports of rampant speculation dominating equity trading, with retail investors using significant leverage to juice returns. When a market more than doubles in value in the span of one year, trouble is usually not far behind. The violent selloff in equities was only arrested by heavy-handed government intervention. Policymakers forced some institutional investors to maintain their holdings, provided significant capital to fund purchases, and cracked down on suspicious short sellers among other measures. Equities appear to have stabilized, but risks are likely on the downside.

Commodity prices were hit hard by the yuan devaluation and resulting worries about China’s economy. WTI oil dropped nearly $2 on Tuesday, approaching the lows ($42) seen early in 2015. Demand worries pile on top of already significant oversupply. And, metals prices have been hit hard as well, with copper, historically a good indicator for global economic growth, touching post-recession lows, and the CRB metals index also at its worst level in nearly five years. This is where this week’s events hit home. Canada, already reeling from the drop in oil prices from over $100 in mid-2014 to about $50 as recently as last month, faces more downside risk if oil continues to tumble. After energy firms cut capital spending sharply in the first half of the year, they were expected to be far less negative the rest of the year, but the renewed drop in oil prices could mean another leg down for investment. That would introduce some downside risk to our Canadian growth forecast that could spill into 2016. An even weaker Canadian dollar would provide some cushion, but as we’ve noted time and again, it can take up to three years for the full benefit to show up. From a U.S. perspective, this week’s yuan move will have little, if any, impact. The Fed will take note of the U.S. dollar’s strength, but, on its own, yuan weakness alone is unlikely to keep them from raising rates in September assuming the U.S. domestic data behave in the interim.

While there is clearly plenty to be concerned about when it comes to China, we remain optimistic that 2015 growth targets will come close to being achieved. Nonetheless, China’s economy will continue to slow in the years ahead, but that is in part due to the inevitable impact of demographics and the fact that GDP tripled in just over a decade. That’s not necessarily a reason to become permanently bearish on commodities, as China’s oil import volumes were still rising at a double-digit rate in July (Chart 6). China also has about $4 trillion in foreign exchange reserves that can cushion some potential problems. And, lastly, China is still a command economy and policymakers can quickly implement stimulus measures if necessary to boost near-term growth—even if it’s a medium-term negative.

Bottom Line: Concerns about China’s economic outlook are well-founded, and this week’s modest yuan devaluation only heightens the uncertainty surrounding the world’s second largest economy.

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Services Sector

Shift to Domestic Demand ProgressingChina (% share of GDP)

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Source: Haver Analytics

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Source: China Customs


Economic Forecast

Economic Forecast Summary for August 14, 2015 BMO Capital Markets Economic Research

2015 2016 AnnualQ1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2014 2015 2016

CANADAReal GDP (q/q % chng : ar) -0.6 -1.0 3.0 2.2 2.3 2.3 2.1 2.1 2.4 1.2 2.2

Consumer Price Index (y/y % chng) 1.1 0.9 1.3 1.7 2.1 2.1 1.9 2.1 1.9 1.2 2.0

Unemployment Rate (percent) 6.7 6.8 6.8 6.8 6.7 6.7 6.6 6.5 6.9 6.8 6.6

Housing Starts (000s : a.r.) 175 193 188 182 178 179 181 183 189 185 180

Current Account Balance ($blns : ar) -69.9 -62.0 -56.5 -51.5 -45.0 -41.3 -38.1 -35.5 -41.5 -60.0 -40.0

Interest Rates (average for the quarter : %)

Overnight Rate 0.75 0.75 0.50 0.50 0.50 0.50 0.75 1.00 1.00 0.65 0.70

3-month Treasury Bill 0.62 0.63 0.41 0.40 0.41 0.41 0.65 0.89 0.91 0.52 0.59

10-year Bond 1.44 1.64 1.60 1.77 1.90 1.98 2.07 2.17 2.23 1.61 2.03

Canada-U.S. InterestRate Spreads (average for the quarter : bps)

90-day 60 61 28 1 -22 -46 -46 -46 88 37 -40

10-year -52 -52 -75 -75 -76 -79 -80 -80 -31 -64 -79

UNITED STATESReal GDP (q/q % chng : ar) 0.6 2.3 2.8 2.7 2.6 2.5 2.4 2.3 2.4 2.3 2.6

Consumer Price Index (y/y % chng) -0.1 0.0 0.3 0.9 2.3 2.2 2.3 2.4 1.6 0.3 2.3

Unemployment Rate (percent) 5.6 5.4 5.2 5.0 4.8 4.7 4.6 4.6 6.2 5.3 4.7

Housing Starts (mlns : a.r.) 0.98 1.14 1.17 1.26 1.31 1.32 1.31 1.29 1.00 1.14 1.31

Current Account Balance ($blns : ar) -453 -405 -374 -366 -389 -411 -432 -448 -390 -400 -420

Interest Rates (average for the quarter : %)

Fed Funds Target Rate 0.13 0.13 0.21 0.46 0.71 0.96 1.21 1.46 0.13 0.23 1.08

3-month Treasury Bill 0.02 0.02 0.14 0.39 0.63 0.87 1.11 1.34 0.03 0.14 0.99

10-year Note 1.97 2.17 2.35 2.52 2.67 2.77 2.87 2.97 2.54 2.25 2.82

EXCHANGE RATES (average for the quarter)

US¢/C$ 80.6 81.4 76.9 75.5 76.5 77.5 78.6 79.6 90.6 78.6 78.1

C$/US$ 1.241 1.229 1.301 1.324 1.307 1.290 1.273 1.256 1.105 1.274 1.281

¥/US$ 119 121 124 125 126 127 128 130 106 122 128

US$/Euro 1.13 1.11 1.09 1.08 1.06 1.04 1.02 1.01 1.33 1.10 1.03

US$/£ 1.51 1.53 1.55 1.52 1.50 1.49 1.50 1.51 1.65 1.53 1.50

Blocked areas represent BMO Capital Markets forecastsUp and down arrows indicate changes to the forecast


Key for Next Week

Canada Consumer prices look to rise a modest 0.2% in July, matching the prior month’s increase. That would put annual inflation at 1.4%, as prices fell last July, the fastest pace since December. Gasoline prices were relatively subdued for a change, rising less than 1%, though August is on pace for a hefty 5% drop. More broadly, the key for July is how much pass-through from the weakness in the C$ shows up. Prices generally rise about 0.1% on a seasonal basis in the month, so our call encompasses some impact from the softer loonie. Key sectors to watch include (but are not limited to): travel services, clothing, furniture, and recreational equipment. One other notable item is that Alberta electricity prices climbed materially in July. Core prices are expected to rise 0.1%, with C$ pass-through driving the increase. Our call would boost annual core inflation to 2.4%, which would be the twelfth straight month above the Bank of Canada’s 2% target.

Retail sales are expected to climb 0.3% in June, building on the prior month’s 1% gain. However, the details aren’t expected to be particularly encouraging, with auto sales volumes reportedly down modestly according to an earlier StatsCan report, while underlying sales likely rose only slightly. Higher gasoline prices (3.6% seasonally adjusted) are going to drive a good chunk of the increase in both headline and ex. auto sales. Indeed, goods inflation was 0.6% in June, suggesting we’ll need a big headline gain to eke out a positive reading on volumes. Even with a small gain in underlying sales, the yearly increase will decelerate sharply to around 3%, from the recent above-5% pace. After Q1 retail volumes contracted, Q2 is tracking for growth of 1.5%-to-2% a.r. Assuming a decent gain in wholesale trade, June GDP is on track for a 0.2%-to-0.3% increase, but that won’t be enough to keep Q2 GDP from contracting about 1%—though it does bode well for Q3.

United States After bouncing 10% in June, housing starts likely rose further in July, as New York City condo builders raced to file permits ahead of the possible end of some tax breaks. The steadier single-unit structures are likely to continue trending higher amid supportive fundamentals and the fact they remain well below long-run norms. Homebuilder confidence reached decade highs last month, according to the NAHB.

Steadier gasoline prices, a strong dollar and tame wages likely held inflation close to zero in July and the core rate steady at 1.8% y/y. The core index should rise a minimal 0.1% month-to-month, as prices remain largely subdued, apart from residential rent, tuition, pharmaceuticals, and auto insurance. Still, the risk is likely on the upside, with the core rate running at a faster 2.3% pace in the first half of the year. This suggests the best news on inflation is likely behind us, barring a further surge in the dollar or slump in commodities. The Fed’s favoured inflation guide, core PCE, should drift higher in coming months after holding at 1.3% recently.

Benjamin Reitzes Senior Economist [email protected] 416-359-5628

Consumer Prices Friday, 8:30 am July (e) +0.2% +1.4% y/y (+0.1% sa) Consensus +0.2% +1.4% y/y

June +0.2% +1.0% y/y 8:30 am Core CPI July (e) +0.1% +2.4% y/y Consensus +0.1% +2.5% y/y

June unch +2.3% y/y

Retail Sales Friday, 8:30 am Ex. Autos June (e) +0.3% +0.4% Consensus +0.3% +0.6% May +1.0% +0.9%

Sal Guatieri Senior Economist [email protected] 416-359-5295

Housing Starts Tuesday, 8:30 am July (e) 1.180 mln a.r. (+0.5%) Consensus 1.190 mln a.r. (+1.4%)

June 1.174 mln a.r. (+9.8%)

Consumer Prices Wednesday, 8:30 am July (e) +0.1% +0.1% y/y Consensus +0.2% +0.2% y/y

June +0.3% +0.1% y/y Ex. Food & Energy July (e) +0.1% +1.8% y/y Consensus +0.2% +1.8% y/y

June +0.2% +1.8% y/y


Key for Next Week

See Michael Gregory’s Thought on page 3.

A pullback in signed contracts for existing homes in June signals a moderate retreat in resale closings in July from eight-year highs. Still, solid job growth, low interest rates and easier loan standards have laid a sturdy foundation for housing demand that should endure until interest rates climb meaningfully. Median prices rose 7.1% y/y in the first half of the year, more than three times faster than family income (2.1%), though affordability remains healthy in most regions because of low mortgage rates.

FOMC minutes from July meeting Wednesday, 2:00 pm

Existing Home Sales Thursday, 10:00 am July (e) 5.40 mln a.r. (-1.6%) Consensus 5.43 mln a.r. (-1.1%)

June 5.49 mln a.r. (+3.2%)


Financial Markets Update

Aug 14 ¹ Aug 7 Week Ago 4 Weeks Ago Dec. 31, 2014(basis point change)

Canadian Call Money 0.50 0.50 0 0 -50 Money Market Prime Rate 2.70 2.70 0 0 -30

U.S. Money Fed Funds (effective) 0.25 0.25 0 0 0 Market Prime Rate 3.25 3.25 0 0 0

3-Month Canada 0.39 0.39 0 -1 -52 Rates United States 0.09 0.06 3 8 6

Japan 0.00 0.00 0 0 0 Eurozone -0.03 -0.02 0 -1 -10 United Kingdom 0.58 0.59 0 0 2 Australia 2.14 2.15 -1 0 -63

2-Year Bonds Canada 0.42 0.44 -1 0 -59 United States 0.72 0.72 0 6 6

10-Year Bonds Canada 1.41 1.42 0 -15 -38 United States 2.21 2.16 4 -14 3 Japan 0.37 0.41 -4 -5 5 Germany 0.65 0.66 -1 -14 11 United Kingdom 1.88 1.85 3 -20 12 Australia 2.78 2.84 -6 -17 4

Risk VIX 13.5 13.4 0.1 pts 1.6 pts -5.7 pts Indicators TED Spread 23 25 -2 -4 1

Inv. Grade CDS Spread ² 76 76 0 11 10 High Yield CDS Spread ² 380 377 4 41 23

(percent change)Currencies US¢/C$ 76.75 76.16 0.8 -0.4 -10.8

C$/US$ 1.303 1.313 — — — ¥/US$ 124.25 124.24 0.0 0.1 3.7 US$/€ 1.1145 1.0967 1.6 2.9 -7.9 US$/£ 1.565 1.549 1.0 0.3 0.5 US¢/A$ 73.91 74.18 -0.4 0.3 -9.6

Commodities CRB Futures Index 198.35 198.32 0.0 -7.5 -13.7 Oil (generic contract) 42.52 43.87 -3.1 -16.4 -20.2 Natural Gas (generic contract) 2.81 2.80 0.5 -2.1 -2.7 Gold (spot price) 1,120.40 1,094.05 2.4 -1.2 -5.4

Equities S&P/TSX Composite 14,285 14,303 -0.1 -2.4 -2.4 S&P 500 2,086 2,078 0.4 -1.9 1.3 Nasdaq 5,032 5,044 -0.2 -3.4 6.2 Dow Jones Industrial 17,455 17,373 0.5 -3.5 -2.1 Nikkei 20,519 20,725 -1.0 -0.6 17.6 Frankfurt DAX 10,988 11,491 -4.4 -5.9 12.1 London FT100 6,553 6,718 -2.5 -3.3 -0.2 France CAC40 4,957 5,155 -3.8 -3.3 16.0 S&P ASX 200 5,357 5,475 -2.2 -5.5 -1.0

¹ = as of 10:30 am ² = One day delay

Upcoming Policy Meetings | ECB: Sep. 3, Oct. 22, Dec. 3

Global Calendar: August 17 – August 21 Monday August 17 Tuesday August 18 Wednesday August 19 Thursday August 20 Friday August 21

Japa

n Real GDP Q2 P (e) -0.5% +0.2% y/y Q1 +1.0% -1.0% y/y

Trade Deficit July ’15 (e) ¥53 bln July ‘14 ¥967 bln

All Industry Activity Index June (e) +0.4% May -0.5%

Leading Index June F (e) 107.2 May 106.0

Department Store Sales July June +0.4% y/y

Euro

Are

a E U R O A R E A Trade Balance June (e) €23.1 bln May €21.2 bln

G E R M A N Y Producer Price Index July (e) unch -1.3% y/y June -0.1% -1.4% y/y

E U R O A R E A Consumer Confidence Aug. A (e) -6.9 July -7.1

G E R M A N Y GfK Consumer Confidence Sep. (e) 10.1 Aug. 10.1

U.K.

Rightmove House Prices Aug. July +0.1% +5.1% y/y

Consumer Price Index July (e) -0.3% unch y/y June unch unch y/y

Core CPI July (e) +0.9% y/y June +0.8% y/y

Producer Price Index—Output July (e) -0.1% -1.5% y/y June unch -1.5% y/y

Retail Sales July (e) +0.4% +4.4% y/y June -0.2% +4.0% y/y

Othe

r A U S T R A L I A

Reserve Bank of Australia Minutes for August 4 Meeting

New Motor Vehicle Sales July June +3.8% +4.0% y/y

M E X I C O Real GDP Q2 (e) +0.5% +2.0% y/y Q1 +0.4% +2.5% y/y

C = consensus D = date approximate R = reopening

North American Calendar: August 17 – August 21 Monday August 17 Tuesday August 18 Wednesday August 19 Thursday August 20 Friday August 21

Cana

da

8:30 am New Motor Vehicle Sales D June (e) +1.0% y/y May +1.0% y/y

8:30 am Int’l Securities Transactions Inflows Outflows

June May -$5.4 bln $5.6 bln

8:30 am Wholesale Trade June (e) +1.5% May -1.0%

2-year bond auction announcement

8:30 am Consumer Price Index July (e) +0.2% +1.4% y/y (+0.1% sa) Consensus +0.2% +1.4% y/y June +0.2% +1.0% y/y

8:30 am Core CPI July (e) +0.1% +2.4% y/y Consensus +0.1% +2.5% y/y June unch +2.3% y/y 8:30 am Retail Sales Ex. Autos June (e) +0.3% +0.4% Consensus +0.3% +0.6% May +1.0% +0.9%

Unite

d St

ates 8:30 am Empire State

Manufacturing Survey Aug. (e) 4.0 Consensus 5.0 July 3.9

10:00 am NAHB Housing Market Index Aug. (e) 61 Consensus 61 July 60

4:00 pm Net TIC Flows Total Long Term

June May $115 bln $93 bln

Fed Speaker: Vice Chair Fischer (10:00 am)

11:00 am 4-week bill auction announcement

11:30 am 13- & 26-week bill auction $48.0 bln

7:45 am Retail Economist-GS Same-Store Sales – Aug. 15th week

8:30 am Housing Starts July (e) 1.180 mln a.r. (+0.5%) Consensus 1.190 mln a.r. (+1.4%) June 1.174 mln a.r. (+9.8%)

8:30 am Building Permits July (e) 1.200 mln a.r. (-10.2%) Consensus 1.230 mln a.r. (-8.0%) June 1.337 mln a.r. (+7.0%)

8:55 am Johnson Redbook Same-Store Sales – Aug. 15th week

11:30 am 52-week bill auction $22.0 bln

11:30 am 4-week bill auction

7:00 am MBA Mortgage Apps Aug. 14 Aug. 7 +0.1%

8:30 am Consumer Prices July (e) +0.1% +0.1% y/y Consensus +0.2% +0.2% y/y June +0.3% +0.1% y/y

8:30 am CPI Ex. Food & Energy July (e) +0.1% +1.8% y/y Consensus +0.2% +1.8% y/y June +0.2% +1.8% y/y 2:00 pm FOMC Minutes from

July 28-29 meeting

Fed Speakers: San Francisco’s Williams (2:45 am);

Minneapolis’ Kocherlakota (8:20 pm)

8:30 am Initial Claims Aug. 15 (e) 272k (-2k) C Aug. 8 274k (+5k)

8:30 am Continuing Claims Aug. 8 Aug. 1 2,273k (+15k)

9:45 am Bloomberg Consumer Comfort Index – Aug 16th week

10:00 am Existing Home Sales July (e) 5.40 mln a.r. (-1.6%) Consensus 5.43 mln a.r. (-1.1%) June 5.49 mln a.r. (+3.2%)

10:00 am Philadelphia Fed Index Aug. (e) 6.0 Consensus 6.8 July 5.7

10:00 am Leading Indicator July (e) +0.2% Consensus +0.2% June +0.6%

11:00 am 13- & 26-week bill, 2-, 5- & 7-year note, 2R-year FRN auction announcements

1:00 pm 5R-year TIPS auction $16.0 bln

9:45 am Markit Flash Manufacturing PMI (Aug.)

Upcoming Policy Meetings | Bank of Canada: Sep. 9, Oct. 21, Dec. 2 | FOMC: Sep. 16-17, Oct. 27-28, Dec. 15-16


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