THE WEEKLY BOTTOM LINE

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1 THE WEEKLY BOTTOM LINE TD Economics HIGHLIGHTS OF THE WEEK United States Market volatility picked up this week after a post-brexit summer slumber, with moves dominated by speculation on whether we ve seen the bottom for longer-term global interest rates. Hawkish statements by Fed presidents were trumped later by governor Lael Brainard s speech, convincing the market that the fed will wait until December for its next rate hike. Mixed U.S. economic data this week was consistent with a cautious, patient Fed. Weaker than expected retail sales and industrial production data for August suggested modestly slower growth in 16H2, while stronger inflation data is consistent with absorption of economic slack. Global economic data show growth picking up in the second half of the year, but financial fragilities remain at the forefront. Speculation about BoJ policy added to the pressure this week, spurring a sell-off in advanced economy bonds. A repeat of the 2013 taper tantrum episode would have serious negative repercussions on the U.S. outlook. Canada Canadian manufacturing shipments rose 0.1% in July, and a healthier 0.6% in volume terms, picking up momentum after a few week months. Canada s housing market may be approaching a soft landing. Vancouver is undergoing a moderate correction, intensified by the new land transfer tax on foreign buyers. The Toronto market continued to accelerate, but is expected to cool by mid Households are once again accumulating debt at twice the pace of income, with the household debt-toincome ratio reaching a new record high of 167%. THIS WEEK In THE MARKETS Current* Week Ago 52-Week High 52-Week Low Stock Market Indexes S&P 500 2,139 2,128 2,190 1,829 S&P/TSX Comp. 14,456 14,540 14,813 11,843 DAX 10,291 10,573 11,382 8,753 FTSE 100 6,732 6,777 6,941 5,537 Nikkei 16,519 16,966 20,012 14,952 Fixed Income Yields U.S. 10-yr Treasury Canada 10-yr Bond Germany 10-yr Bund UK 10-yr Gilt Japan 10-yr Bond Foreign Exchange Cross Rates C$ (USD per CAD) Euro (USD per EUR) Pound (USD per GBP) Yen (JPY per USD) Commodity Spot Prices** Crude Oil ($US/bbl) Natural Gas ($US/MMBtu) Copper ($US/met. tonne) Gold ($US/troy oz.) *as of 11:05 am on Friday **Oil-WTI, Cushing, Nat. Gas-Henry Hub, LA (Thursday close price), Copper-LME Grade A, Gold-London Gold Bullion; Source: Bloomberg. CBOE VIX MARKET VOLATILITY IS BACK FROM ITS SUMMER SLUMBER 3 Global growth concerns Source: CBOE via Haver Analytics, TD Economics. UK referendum This week GLOBAL OFFICIAL policy RATE TARGETS Current Target Federal Reserve (Fed Funds Rate) % Bank of Canada (Overnight Rate) 0.50% European Central Bank (Refi Rate) 0% Bank of England (Repo Rate) 0.25% Bank of Japan (Overnight Rate) -0.10% Source: Central

2 U.S. Volatility returns in September In the lead-up to next week s FOMC meeting, market action this week was dominated not only by speculation of whether the Fed would raise rates, but also concerns that maybe, just maybe, longer-term global interest rates have finally troughed. Markets gyrated the most we ve seen since Brexit this week, driven by rumours of a forthcoming reverse Operation Twist by the Bank of Japan next Tuesday and somewhat contradictory Fed-speak, as hawkish speeches by Presidents Rosengren (Boston) and Lockhart (Atlanta) were countered by a dovish speech by Fed Governor Brainard. The mixed U.S. data flow this week is consistent with a patient Fed. Following strong performance this spring and summer, retail sales growth slowed over the last couple of months, implying a slowdown in spending by U.S. households in the third quarter of this year. And, in alignment with the weak ISM manufacturing print earlier this month, industrial production contracted a little more than expected in August, driven by greater payback in utilities from July strength. On a somewhat more positive note, the pick-up in headline and core CPI this morning suggests that excess capacity continues to be absorbed. One of the largest contributors to core CPI this year has been core services, driven largely by ongoing improvements in the housing market (Chart 1). The global data flow this week was generally positive, confirming that demand is heating up in the second half of this year. UK retail sales for August failed to fully reverse the strength in July, giving further credence to the idea that the UK economy post-brexit is generally evolving in line with the Bank of England s August forecast. Furthermore, CHART 1: NON-ENERGY SERVICES INFLATION DRIVEN BY HOUSE PRICE RECOVERY Average contribution to y/y Total CPI over past three months, % Services less energy services Rent of primary residence Owner's equivalent residences Medical Care Motor vehicle Airline fare services maintenance, repair, insurance Source: Bureau of Labor Statistics via Haver Analytics, TD Economics CHART 2: A TAPER TANTRUM REPEAT COULD HIT U.S. BUSINESS & RES. INVESTMENT HARD Level index, 2016Q2 =100. Household Consumption Business Investment Residential Investment GDP 16Q2 16Q3 16Q4 17Q1 17Q2 17Q3 17Q4 18Q1 18Q2 18Q3 18Q4 Source: TD Economics. Simulation using FRB/US shocks to the term premiums for 5yr, 10yr, and 30yr U.S. government bonds, calibrated to the 2013 taper tantrum, model consistent expectations. Chinese data for August confirm that growth will remain close to 7.0% (annualized q/q) in the third quarter, driven by strength in the services sector. However, underneath this thin veneer of global stability are risks to financial stability that, if realized, could easily spillover and derail the Fed s normalization of monetary policy. These concerns resurfaced once again this this week as the Bank of Japan (BoJ) became the focus of speculation on whether it would act to ease next Tuesday. Rumours of a reverse Twist whereby the BoJ would purchase government bonds on the short-end of the yield curve (assets with <10 years maturity) and reduce or eliminate purchases of assets with longer maturities helped spur a bond market sell-off in advanced economies. While the benefits of this policy shift would likely be limited, the potential risks of generating another term premium shock similar to that of the taper tantrum episode in 2013 cannot be understated. As we show in Chart 2, a shock to U.S. term premiums similar in magnitude to that observed in 2013 would be detrimental to the outlook for the U.S. economy. Business and residential investment would be hardest hit, falling close to 3% and 2.5% respectively below our baseline by the end of Overall, U.S. economic output would be about 1.2% weaker. All told, with signs that excess slack continues to be absorbed in the U.S. economy and global demand is recovering, conditions are ripe for a fed rate hike. However, the risks remain titled to the downside, implying that a cautious Fed will likely defer a rate hike until December. Fotios Raptis, Senior Economist

3 CANADA HOUSING TIDE IS TURNING After stalling earlier this year, the much anticipated recovery in Canadian manufacturing appears to be gathering some steam. Manufacturing sales edged up 0.1% in July, but were up a healthier 0.6% in volume terms. Still, the sector has seen very little growth in 2016 so far and Canada remains reliant on the housing market to prop up economic activity. But, that tide might be turning. This week s housing data showed that the cooling in Vancouver s housing market intensified along with the August 2 nd implementation of the new land transfer tax on foreign buyers. Both existing home sales and average home prices fell nearly 20% from July to August in Greater Vancouver. The average home price is now down 21% from the peak reached in April. Some of August s extreme weakness may unwind in the months ahead as the initial shock from the recently levied tax dissipates. However, we expect the overarching softness to persist through to For one, the crackdown on foreign investment and speculative behaviour is likely to continue well into next year, raising uncertainty and weighing on activity. The city intends to introduce an additional 2% property tax on vacant properties in 2017 while the Canadian Revenue Agency is paying a bit more attention to potential money laundering and fraudulent tax practices among speculators. Additionally, Vancouver s cool down is related to a broader unwinding of excesses that had recently accumulated rapidly. Vancouver and Toronto were two of six markets that CMHC had flagged as having strong evidence of problematic conditions. These markets were vulnerable to a home price correction given their recent red-hot pace of home price growth which was unsustainable Indexed at 2001= AVERAGE EXISTING HOME PRICES Vancouver Toronto Source: Canadian Real Estate Association Y/Y % Chg Consumer Credit Source: Statistics Canada CANADIAN HOUSEHOLD DEBT Mortgage Credit and further accentuated the already present overvaluation. On the other hand, market activity in Toronto (and most major markets across southern Ontario) continued to accelerate into August, with prices up more than 17% from a year ago. Activity and prices may get a further boost from foreigners, with some potentially shifting their focus to Toronto. This should keep prices rising at a double-digit pace for the rest of the year. The market is expected to eventually cool as affordability issues begin to weigh on demand. Still, prices in Toronto should avoid an outright contraction in prices with housing supply more constrained than in Vancouver, only slowing below the pace of inflation by mid Our base case assumes a moderate unwinding in excesses over the medium term, but there are no shortages of risks to that outlook with rising household debt chief among them. According to the recently released National Balance Sheet Accounts, households are once again accumulating debt at nearly twice the pace of income. As such, the debt-to-income ratio reached another record high in Q2, rising to 167% on weak personal income growth and a marked acceleration in mortgage credit growth. The rising debt load has also increased debt service payments in the quarter and while they remain low for now, Canadian households remain vulnerable to any increase in interest rates. The combination of weak housing markets, slow growth and financially vulnerable households will keep the Bank of Canada on the sidelines for the foreseeable future. Diana Petramala, Economist,

4 U.S. Housing Starts - August* Release Date: September 20, 2016 July Result: 121k; Permits: 1144k TD Forecast: 1284k; Permits: 1155k Consensus: 1190k; Permits: 1165k U.S.: UPCOMING KEY ECONOMIC RELEASES Housing starts are expected to retract in August after hitting a near post-recession high in July. TD looks for a 2.2% decline to 1184k annualized units reflecting declines in both single- and multi-family segments. Multi-family housing starts likely retraced in August after following a sharp uptrend that is likely unsustainable. Yet the unabated climb in multi-family permits since March suggests that an underlying trend upward remains in place in the near-term. Single-family starts are also expected to fall as presaged by an unfavorable retreat in permits. Overall August building permits likely posted a moderate 1.0% increase led by a bounce back in single-family permits, pointing to continue growth in single-family construction in the fall. Thousands of units 1,300 1,200 1,100 1, U.S. HOUSInG STARTS* Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 *Seasonally adjusted at annual rates Source: U.S. Census Bureau U.S. FOMC Rate Decision* Release Date: September 21, 2016 July Result: 0.25% to 0.50% TD Forecast: 0.25% to 0.50% Consensus: 0.25% to 0.50% 6 5 % FED FUnDS TARGET RATE Despite the gradual shift in tone from the Fed towards a less dovish stance, we share the consensus expectation that they will remain on the sidelines in September. The policy statement should contain a neutral assessment of risks while the dot plot will indicate another 25bps of tightening in 2016, setting the stage for a hike at the December FOMC. Further out the dot plot, we expect the median dots to shift lower but the number of hikes should remain unchanged. While economic conditions have improved in recent months, as evidenced by further tightening in the labour market and Q3 growth tracking north of 3%, we believe the dovish comments by Governor Brainard and the abrupt weakening in the ISM manufacturing and non-manufacturing PMIs argue for the Fed to hold off for the time being Source: U.S. Federal Reserve Board / Haver Analytics. 4

5 U.S. Existing Home Sales - August* Release Date: September 22, 2016 July Result: 5.39m TD Forecast: 5.42m Consensus: 5.45m Existing home sales are expected to see modest improvement in August after falling 3.2% in July. TD expects a 0.5% increase in August to a 5.42m unit annual rate based on the muted trend in pending home sales contracts over the prior three months, which continue to track below the highs reached in April. Looking ahead, however, we look for further gains in sales of existing homes on the back of low mortgage rates and tightening labor market conditions. Thousands of units 6,000 5,500 5,000 4,500 4,000 3,500 U.S. EXISTInG HOME SALES* 3,000 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 *Seasonally adjusted at annual rates Source: Census Bureau / Haver Analytics, TD Economics. *Forecast by Rates and FX Strategy Group. For further information, contact TDRates&FXCommoditiesResearch@tdsecurities.com 5

6 Canada: UPCOMING KEY ECONOMIC RELEASES Canadian Retail Sales - July* Release Date: September 23, 2016 June Result: -0.1% m/m, ex-auto -0.8% m/m TD Forecast: -0.4% m/m, ex-auto 0.2% m/m Consensus: 0.2% m/m, ex-auto: 0.5% m/m M/M % Chg. CAnADIAn RETAIL SALES* Industry data reporting a drop in auto sales is expected to drive another month of weakness for headline retail sales which are forecast to have fallen by 0.4% m/m in July. Lower prices at the pump are also expected to introduce a headwind to spending at gasoline stations while another soft month for existing home sales likely curtailed related spending. All is not lost, however, as a return to aboveseasonal temperatures across most of the country should help spending in food & beverage establishments and in other seasonal stores rebound. Collectively this will leave retail sales excluding autos higher by a meagre 0.2%. Given an unchanged seasonally adjusted print for headline CPI for the month of July, the anticipated weakness in nominal Total Ex. Motor Vehicles -3.0 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 *Seasonally Adjusted Source: Statistics Canada / Haver Analytics retail sales will flow through to the volumes metric. Softer consumer spending to start Q3 will present a modest offset to what is otherwise shaping up to be a strong quarter as the economy rebounds from the wildfires in Northern Alberta that had imperiled activity in the second quarter. Canadian Consumer Price Index - August* Release Date: September 23, 2016 July Result: -0.2% m/m; Core % m/m TD Forecast: 0.2% m/m; Core % m/m Consensus: 0.1% m/m; Core 0.2% m/m CAnADIAn COnSUMER price InDEX (CpI) Y/Y % Chg. Core CPI Headline CPI August CPI inflation is expected to firm on higher energy prices and a modest pickup in the core components. We look for headline CPI to rise 0.2% m/m, leading the annual inflation rate higher to 1.4% y/y vs 1.3% y/y in July. Gasoline and fuel oil prices likely posted moderate increases while fruit/ vegetable prices are set for a soft rebound following a series of declines. The core index likely rose by 0.2% m/m after a more modest 0.1% gain in July, leaving the core inflation rate stable at 2.1% y/y. Higher imported goods and producer prices along with CAD depreciation in the prior month point to sustained growth in core prices. If realized, the August projection would be consistent with a core inflation rate of 2.1% in Q3, exceeding the Bank of Canada s July MPR projection of %. That said, the August readings offers limited implications to the Bank of Canada outlook in light May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Source: Statistics Canada / Haver Analytics of the Bank s concern over the downside risks stemming from serial disappointment in export growth. *Forecast by Rates and FX Strategy Group. For further information, contact TDRates&FXCommoditiesResearch@tdsecurities.com 6

7 Release Date RECEnT KEY ECOnOMIC InDICATORS: SEpTEMBER 12-16, 2016 Economic Indicator/Event Data for period Units Current prior Sep 13 NFIB Small Business Optimism Aug Index Sep 15 Empire Manufacturing Sep M/M % Chg Sep 15 Initial Jobless Claims Sep 10 Thsd Sep 15 Producer Price Index Excluding Food and Energy Aug M/M % Chg Sep 15 Producer Price Index Final Demand Aug M/M % Chg Sep 15 Retail Sales Advance Aug M/M % Chg R5 Sep 15 Retail Sales Excluding Auto and Gas Aug M/M % Chg Sep 15 Capacity Utilization Aug % Sep 15 Industrial Production Aug M/M % Chg Sep 15 Manufacturing (SIC) Production Aug M/M % Chg R6 Sep 15 Business Inventories Jul M/M % Chg. 0.2 Sep 16 Consumer Price Index Excluding Food and Energy Aug M/M % Chg Sep 16 Consumer Price Index Excluding Food and Energy Aug Y/Y % Chg Sep 16 Consumer Price Index Aug M/M % Chg. 0.2 Sep 16 Consumer Price Index Aug Y/Y % Chg Sep 14 Teranet/National Bank House Price Index Aug Y/Y % Chg Sep 15 Existing Home Sales Aug M/M % Chg Sep 16 Manufacturing Sales Jul M/M % Chg Sep 12 CH Retail Sales Aug Y/Y % Chg Sep 15 EZ Consumer Price Index Aug M/M % Chg Sep 14 UK Unemployment Rate Jul % Sep 15 UK Retail Sales Aug Y/Y % Chg R5 Sep 13 UK Core Consumer Price Index Aug Y/Y % Chg Sep 15 UK Bank of England Bank Rate Sep 15 % Source: Bloomberg, TD Economics. United States Canada International 7

8 Release Date UpCOMInG ECOnOMIC RELEASES AnD EVEnTS: SEpTEMBER 19-23, 2016 Time* Economic Indicator/Event United States Data for period Units Consensus Forecast Last period Sep 19 10:00 NAHB Housing Market Index Sep Index 6 6 Sep 20 8:30 Building Permits Aug Thsd Sep 20 8:30 Housing Starts Aug Thsd Sep 21 14:00 FOMC Rate Decision Sep 21 % Sep 22 8:30 Initial Jobless Claims Sep 17 Thsd - 26 Sep 22 10:00 Existing Home Sales Aug Mlns Sep 23 9:45 Markit US Manufacturing PMI Sep P Index Canada Sep 20 12:35 Bank of Canada's Poloz Speech in Quebec City Sep 21 8:30 Wholesale Trade Sales Jul M/M % Chg Sep 23 8:30 Consumer Price Index Aug M/M % Chg Sep 23 8:30 Consumer Price Index Aug Y/Y % Chg Sep 23 8:30 Core Consumer Price Index Aug M/M % Chg. 0.2 Sep 23 8:30 Core Consumer Price Index Aug Y/Y % Chg. 2.1 Sep 23 8:30 Retail Sales Jul M/M % Chg Sep 23 8:30 Retail Sales Excluding Auto Jul M/M % Chg International Sep 21 JN Bank of Japan Policy Rate Sep 21 % * Eastern Standard Time. Source: Bloomberg, TD Economics. 8

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