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The Weekly Bottom Line: As One Source of Uncertainty Fades, Another Intensifies

U.S. Highlights

  • The American economy grew by 2.1% in Q4 according to the advance estimate. While growth has been steady around 2% for the past three quarters, the headline masks a softening consumer spending trend, alongside declining investment.
  • The recent U.S.-China trade deal should help reduce trade uncertainty and provide a modest boost to exports and business investment over the next year.
  • Just as one source of uncertainty fades, another is intensifying. The new coronavirus is weighing on global growth expectations and investor sentiment. This week the World Health Organization declared the virus a global health emergency, triggering further risk-off moves in financial markets.

Canadian Highlights

  • Risk-off sentiment continued to prevail this week amid coronavirus concerns, bringing down the S&P/TSX Composite, oil prices, and the Canadian dollar.
  • On the data front, November’s real GDP growth came in better-than-expected at 0.1%. That said, our expectations are for a still-tepid Q4 outturn (0.3%).
  • A speech by the Bank of Canada’s Deputy Governor Paul Beaudry highlighted the central bank’s dilemma in balancing its monetary policy decisions against financial stability concerns.

U.S. – As One Source of Uncertainty Fades, Another Intensifies

The advance reading on fourth-quarter GDP showed that U.S. economic growth continued to hover around 2% for the third quarter in a row. This steady profile however, masks softening domestic demand growth. Support from consumer spending waned considerably at the end of the year (Chart 1). This morning’s higher frequency ‘personal income and outlays’ report showed a rollercoaster ride within the quarter, with real spending up a soft 0.1% in December following a 0.3% rebound in the month prior. While government spending also contributed to the headline, private investment was, once again, a major drag. Putting the pieces together, domestic demand grew at only 0.6% (q/q annualized) – the weakest print since late 2015. Net trade was instrumental in lifting up growth, adding 1.5 percentage points to it. Still, instead of a major boost in exports (1.4%), this performance was largely the work of a sharp decline in imports (-8.7%).

Two thousand nineteen is now history. Economic growth on an annual average basis decelerated to 2.3% from 2.9% in 2018. We expect the pace of expansion to slow a bit further this year, but to remain near the 2% mark. Consumer spending has lost momentum, but solid labor market fundamentals suggest that it will remain an integral part of the growth story. At the same time, business investment should not be the drag that it was in 2019. While the U.S.-China trade relationship could still prove a wildcard, the phase one trade deal reduces near-term trade uncertainty and should allow for at least a modest rise in business spending. Furthermore, while there is legitimate doubt about China’s ability to hit the ambitious targets set out in the deal, its commitment to increase imports from the U.S. could also raise U.S. exports relative to the past year.

The aforementioned outlook however, will be increasingly tested. Just as one source of uncertainty is fading, another is intensifying. This week the World Health Organization labelled the coronavirus outbreak a global health emergency. From an economic perspective, measures to contain the virus will act as a drag on China’s economy in the near-term. Some of this activity – namely spending on services that are heightened around the Chinese New Year – will not be made up in future quarters. Still, assuming containment measures are successful, past experience with SARS suggests that the economy will return to normal within two or three quarters.

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Since China makes up close to a fifth of the global economy, the near-term slowdown will weigh on growth. Precisely how big that negative impact will be, will depend on the spread of the virus, the economic reach of impacted areas, as well as market sentiment and the evolution of financial conditions. The outbreak is currently weighing on investor sentiment, with a shift into safe assets (i.e. bonds) continuing this week. The resulting pressure on longer-term yields has