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The Weekly Bottom Line: Stretch That Loonie (You Have To)

U.S. Highlights

  • After some optimism early in the week, financial market sentiment soured as focus shifted back to fears of an escalation in trade tensions, Brexit uncertainty, and a potential economic downturn in 2019.
  • The U.S. consumer remained unbowed in November, with consumer spending now tracking above 3% annualized in Q4. Inflation has cooled in line with oil prices, which should help to support real spending going forward.
  • The FOMC makes its final decision of 2019 next week, and a hike is universally expected. We will be watching closely to see how members’ views have changed about how many hikes will ultimately be required in this cycle.

Canadian Highlights

  • Canadian builders broke ground on a few more homes in November, as starts beat expectations, reaching 216k in November, a 4.4% increase on the month.
  • This week also revealed that Canadians are more stretched than previously thought. Statistics Canada reported the household debt-to-income ratio at 177.5% in Q3, revising the level up markedly on downward revisions to household incomes.
  • TD Economics’ revised quarterly forecast sees real GDP growth slowing from 2.1% this year to 1.8% in 2019 in the face of mounting headwinds, notably oil sector disruptions.

After some optimism early in the week, supported by positive headlines about the lessening of U.S.-China trade tensions, sentiment turned sour to end the week. Markets seem to be channeling Dickens’s curmudgeonly character Ebenezer Scrooge, saying “Bah! Humbug!” to any good news that comes along. Markets are down roughly 10% in the fourth quarter of this year as investors fret about prospects for 2019, focusing on the potential for escalating trade tensions, uncertainty about the path of Brexit, and a potential economic downturn.

Our latest outlook did feature a small downgrade to global growth (Chart 1). However, the selloff in global risk assets in the fourth quarter has been outsized relative to the magnitude of the economic slowdown. The selloff likely reflects the build-up of unresolved global risks, coupled with a delayed adjustment in growth expectations from lofty levels. Taking a step back from the downturn in equity markets, there are few signs that the economic expansion is nearing an end, other than the fact that the expansion is approaching the longest on record. One worry is that negative sentiment can become self-fulfilling (see our Perspective). We remain vigilant in monitoring signals of an impending downturn, such as yield curves, business confidence, risk-assets, and labor market conditions.

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Financial market pessimism certainly hasn’t yet filtered down to the U.S. consumer. The holiday shopping season appears to have gotten off to a good start in November, as retail sales were up more than expected, on top of upward revisions to October. In our latest U.S. Outlook, we also expect the overall economy to moderate towards a sustainable pace in 2019 (Chart 2). This process is already underway in the fourth quarter, where growth is tracking 2.3% after averaging 3.5% through the middle of the year. However, the consumer has more momentum. Today’s retail sales report places expectations for consumer spending in the fourth quarter to 3.5%, from our recently published 2.9%.

The consumer is in pretty good shape. The job market is strong and inflation is contained. Economy-wide growth in wages and salaries has averaged roughly 4% over the past six months. And, headline inflation has cooled in line with lower oil prices. CPI inflation was at 2.2% year-on-year in November’s data. Our forecast is for inflation to remain around that level through 2019. That sets the consumer up for some decent real income gains. Therefore, we expect consumer spending to slow only modestly in 2019, as the windfall from tax cuts fades, but still running at a very healthy 2-2 ½% clip in real terms.

Overall, the U.S. economy is strong, and the Federal Reserve is well justified in raising rates another quarter point at its meeting next Wednesday. The real question is how the FOMC’s views have changed about how much further rates need to rise. Given the fairly benign inflation backdrop recently, we expect the Fed to hike rates more gradually in 2019.

This week saw generally soft performances across major markets, with the S&P/TSX composite index looking to end the week slightly lower. This movement comes in spite of another constructive week for Canadian energy prices, as both Albertan heavy and light benchmarks held onto recent gains.

The reversal of pricing pressures in the wake of government-mandated curtailment plans has been remarkable. In a few short weeks, the Western Canada Select heavy oil benchmark has gone from the doldrums to among the best performing commodities this year. If current pricing holds, this contract is set to end 2018 more than 5% above where it began, making it one of just a few major commodities set to end the year up.

Away from markets, it was a relatively light week in terms of Canadian economic data before next week’s pre-holiday deluge. Housing starts were released early in the week, with Canadian builders breaking ground on 216k new units (Chart 1). This came in ahead of market expectations, and was strong enough to bend the trend measure upwards. Encouragingly, while much of the gain came from the volatile multi-family segment, single-detached starts also rose a healthy 7.8%.

Less encouraging was Statistics Canada’s release of national wealth accounts. We got a preview of what was coming with the Q3 GDP figures, which reported a household saving rate of just 0.9%, revised down by more than two percentage points. This revision came from updated tax data that revealed a much weaker household income story than initially reported. This also means that households are more stretched than previously thought.

In the event, even as borrowing decelerated slightly, the household debt-to-income ratio rose to 177.5%, meaning households owe, on average, $1.78 for every dollar of disposable income. This is roughly four percentage points higher than what had been reported previously, on a like-for-like basis.
Certain to garner much attention, it may be instructive to compare this with where things sat in the U.S. pre-crisis. Once we adjust the data for comparability, we see that not only are debt ratios lower than they were in the U.S. pre-crisis, but the dynamics are different as well, with the Canadian ratio effectively flat over the past two years (Chart 2).

That said, there is no arguing that household debt levels are anything but high, and stretched C