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The Weekly Bottom Line: A Risk-Filled Start to the Year

U.S. Highlights

  • It was a relatively light week on economic data. The merchandise trade deficit narrowed in November, suggesting some upside risk to real GDP growth in the fourth quarter. Still, activity in the manufacturing sector continues to come in on the weak side, with the ISM index falling again in December to its lowest level since 2009.
  • The phase one trade deal between China and the U.S. looks to be signed later this month. Details are still scant and time lines around commitments uncertain.
  • News that a U.S. airstrike in Iraq had killed a top Iranian military leader caused oil prices to spike, global stock markets to sell off and bonds to rally on Friday.

Canadian Highlights

  • Financial markets were quiet during the holiday season, but Canadian markets followed their global peers lower today as escalating geopolitical tensions triggered risk-off sentiment.
  • The holiday season also had little in the way of Canadian economic data releases. October’s real GDP print confirmed the view that the Canadian economy is hitting a soft patch in Q4.
  • The Bank of Canada remains in a tough spot, weighing emerging signals of a softening economy against financial stability concerns in its interest rate decisions this year.

U.S. – A Risk-Filled Start to the Year

The first week of the year was relatively light on economic data, but not short on geopolitical developments. Financial markets started the New Year in an optimistic mood, boosted by news that the People’s Bank of China had cut its reserve ratio by 50 basis points. This move injects additional liquidity into China’s banking system in the hopes of supporting growth while also alleviating any potential funding stress for its banks heading into the Lunar New Year holiday.

Alas, this optimism did not last long. Markets were roiled on Friday by news that a U.S. airstrike in Iraq had killed Qassim Suleimani, a top Iranian military leader. Fears of retaliation and further escalation caused oil prices to spike, global stock markets to sell off and bonds to rally, with the 10-year yield falling seven basis points to 1.81% as of writing.

Outside of the torrid developments in the Middle East, the U.S. and China appear to be moving forward on signing ‘phase one’ of their trade deal. Earlier in the week, President Trump announced that he would sign the deal on January 15th. Details of the final deal are expected in the next several days. Early indications are that the text of the deal could remain vague on the exact amount and timing of China’s commitments to purchase additional agricultural and other U.S. goods for fears that specific details could distort markets.

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News on the trade deal came as preliminary data on the merchandise trade deficit showed a narrowing in November of last year, reflecting a rise in exports and a sharp decline in imports. The fall in imports came alongside data showing a smaller build in inventories in the fourth quarter. Still, the net impact was enough to raise tracking estimates for fourth quarter real GDP growth north of 2.0% (annualized).

Elsewhere on the economic front, global manufacturing activity continued to struggle through the end of last year. In the U.S., the ISM manufacturing index fell to 47.2 in December from 48.1 in November. The decline was contrary to the median economist forecast for an increase in the index. The ISM index has now been in contractionary territory for five consecutive months and at its lowest point since the recession in 2009. Manufacturing sectors remain weak the world over. The Markit PMI index in Germany edged lower in December as well. While still above its trough, it remains in contractionary territory where it has been through all of 2019.

The data flow will pick up next week with the release of the ISM non-manufacturing index and December employment data. So far, the troubles in the manufacturing sector have remained contained therein while broader services expansion has remained unharmed and, importantly, has provided enough support to the job market to support ongoing consumer spending. We will be watching for any developments on this front in the jobs data next week, as well as the impact of new (and old) geopolitical flare ups.

Canada – A Tough Balancing Act

Canadian financial markets, like their global peers, were relatively quiet during the holiday season. However, escalating geopolitical tensions overnight triggered risk-off sentiment, sending equities lower and providing a lift to safe haven assets (for instance, gold) today. These heightened tensions also sent the price of global oil benchmarks (Brent, WTO) spiking, but do not appear to be lifting the energy-heavy S&P/TSX equity index.

Domestically, the holiday season offered very few data releases. Business and consumer indicators are reaffirming the ongoing narrative of a notably softening Canadian economy in the fourth quarter.

Last week’s GDP release was the highlight, showcasing that the Canadian economy contracted 0.1% in October. Worse, September’s real GDP data was also revised downwards a tenth of a percentage point. The GM strike and its spillovers were only a small part of the story. Indeed, while 13 of the 20 broad industries were in expansion (Chart 1), 13 of the 18 m