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The Weekly Bottom Line: When the Downside Risks Loom Large

U.S. Highlights

  • The U.S. economy expanded at a slower pace than previously reported in the fourth quarter (2.2% vs. 2.6%). This left annual average growth at just below the 3% mark, though Q4/Q4 they were just able to hit that psychological marker.
  • Housing starts declined in February, though the sale of new homes picked up. A recent deceleration in home price growth should support an expected rebound in housing activity in the months ahead.
  • The trade deficit narrowed in January, aided by a decrease in the goods deficit with China – down $5.5B. On this front, trade talks between the two countries made progress as China showed willingness to negotiate on tech-related concerns.

Canadian Highlights

  • The highly-anticipated January GDP report blew away expectations, with the economy expanding at a healthy 0.3% rate to begin the year. What’s more, the breadth of the expansion was impressive, with output higher in 18 of 20 industries.
  • The strong GDP report brightened the mood of financial markets. It sent bond yields and the Canadian dollar higher, narrowing the inversion in the yield curve, and causing investors to pare back their bets on a rate cut this year.
  • Payroll employment expanded by a healthy 71k in January, capping an overall healthy week for Canadian data.

Hang on to your hats folks. With Fed speeches, Brexit votes, and a slew of economic data, this week was exhilarating.

First, on the data front, the American economy expanded by 2.2% (annualized) in 2018Q4, down from the 2.6% rate initially reported (Chart 1). The revision brought annual average growth to 2.9%, though Q4/Q4 growth was 3%. Consumer spending, government expenditure and business investment were all revised lower, while net exports showed a smaller deficit. Corporate profits also stalled in Q4. These data point to a slowing trend and a weaker handoff to 2019. Reinforcing this narrative, personal income and spending kicked off 2019 with tepid gains. PCE inflation was also muted at 1.4% (y/y) overall and 1.8% for core.

Housing data also came in on the disappointing side. Housing starts declined 8.7% in February, giving back most of the gains in January. The turn lower was concentrated in the single family segment. Meanwhile, the pace of new home sales perked up to the best rate in almost a year (4.9%). Additionally, in January, home price growth decelerated to the slowest rate in almost 4 years – 4.3% (y/y) down from 4.6% a month earlier. It also marked 10 consecutive months of slowing growth (Chart 2). Higher mortgage rates earlier in 2018 and the past run-up in home prices dented affordability. However, recent declines in rates, smaller price gains, and rising wages should result in improved activity going forward as housing demand rebounds (see report).

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On the trade front, the trade deficit narrowed sharply in January, from $59.9bn to $51.1bn, implying less of a drag on GDP growth from net trade in 19Q1. The improvement largely reflected shifting trade with China. Fortunately, there appears to be some progress in negotiations. China is offering concessions on technology-related issues, which had been a major sticking point for U.S. negotiators. Trade talks continue in Washington next week.

Across the pond, the Brexit saga continued to unfold, leaving a lingering air of uncertainty. The UK’s Parliament failed to come to a consensus on alternatives to the withdrawal agreement on Wednesday. Out of eight options proposed, not one was able to garner the needed majority. Parliament voted for a third time against the deal today, the day Britain was originally set to leave. Prime Minister May, who offered her resignation in exchange for support, continues to face an uphill battle to consolidate opinion on a deal. Debate on a deal is expected to continue next week.

Lastly, a parade of Fed speakers made the rounds this week. Among them, Chicago Fed President Evans echoed sentiments expressed in last week’s Fed statement – a rate hike for 2019 is likely not in the cards, while his Philadelphia counterpart, Patrick Harker, suggested one hike could be appropriate. All told, policy normalization at the Fed is quite likely nearly complete, as rising global risks leave the U.S. exposed to foreign shocks.

After a steady diet of pessimism had permeated financial markets in recent weeks, the mood was brightened to end this week. The improved sentiment came courtesy of a robust January GDP report, showing that the economy started 2019 on a much stronger footing than analysts had expected. The upside surprise on GDP sent the yield on the 10-year benchmark bond up over 1.6%. The strong print also caused investors to significantly pare back their bets on a rate cut this year.

As of writing, the yield curve remains inverted – the three month yield sits at about 1.67% – but the gap narrowed by 5 basis points relative to where it was on Monday. At this juncture, we remind readers that, as a recession predictor, the yield curve has been fairly reliable for the U.S. economy. However, it is by no means perfect (see report). In Canada its track record is perhaps even less impressive, having sent a false signal a few times (Chart 1). Indeed, when reading the recession tea leaves, investors are better served by examining a range of indicators.

On that front, January employment data from the SEPH released this week sent a decidedly non-recessionary (albeit backward looking) signal. Indeed, payroll employment expanded by a solid 71k in January, the strongest gain since early 2017 and confirming the strength in the more timely LFS data that is used in calculating the unemployment rate. While other aspects of the report were softer, the solid jobs print had marginally positive implications for our Q1 tracking.

Elsewhere on the data front, January international trade data was notably less positive for Q1 growth prospects. The 0.9% gain in export volumes only partially offset December’s drop, and was swamped by the 1.5% rise in imports.

While the SEPH and international trade data whet the appetites of analysts, January’s GDP report was undoubtedly the main course. As noted above, the report blew away expectations, with the economy expanding at a healthy 0.3% pace in January. The breadth of the expansion was impressive, with a full