TD Economics. The Weekly Bottom Line. Highlights of the Week. May 11, United States. Canada.

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1 TD Economics The Weekly Bottom Line May 11, 2018 Highlights of the Week United States Domestic equity markets shrugged off news that the U.S. administration is pulling out of the current Iran deal while leaving the door open to renegotiation. WTI oil rose for a fifth consecutive week. Rising U.S. gasoline prices helped drive headline inflation to 2.5% y/y, the fastest pace of price growth since February A loss of momentum in underlying inflation in April should help reduce concerns that the Federal Reserve isn t moving fast enough to cool a hot U.S. economy. Canada Crude oil prices hit a 3½ year high this week, with the WTI benchmark hitting US$71 per barrel. While expectations of a U.S. withdrawal from the Iran nuclear agreement have helped to bid up prices recently, the actual impact on the oil market is likely to be limited. Housing starts slowed to 214k in April, while employment was flat. The unemployment rate held at 5.8%, while wage growth came in above 3% for a fourth consecutive month. THIS WEEK IN THE MARKETS Current* Week Ago Stock Market Indexes 52-Week High 52-Week Low S&P S&P/TSX Comp DAX FTSE Nikkei Fixed Income Yields U.S. 10-yr Treasury Canada 10-yr Bond Germany 10-yr Bund UK 10-yr Gilt Japan 10-yr Bond Foreign Exchange Cross Rates C$ (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 11:01 am on Friday. **Oil-WTI, Cushing, Nat. Gas-Henry Hub, LA (Thursday close price), Copper-LME Grade A, Gold-London Gold Bullion; Source: Bloomberg. EQUITIES RALLY TOGETHER WITH OIL, SHRUGGING OFF HEIGHTENED GEOPOLITICAL RISKS Weekly % Change S&P/TSX S&P 500 DAX USD:EUR USD:JPY USD:CAD DXY WTI Federal Reserve (Fed Funds Rate) Bank of Canada (Overnight Rate) European Central Bank (Refi Rate) Bank of England (Repo Rate) Bank of Japan (Overnight Rate) Source: Central Banks Note: Data as of May 11,11:05 AM ET. Sources: Bloomberg, TD Economics GLOBAL OFFICIAL POLICY RATE TARGETS Current Target % 1.25% 0.00% 0.50% -0.10%

2 2 Events this week remind us of how uncertain the world can be at times, and how unpredictable financial markets can be. On Tuesday President Trump announced that his administration will no longer be part of the current Joint Comprehensive Plan of Action (JCPOA). That was a 2015 deal agreed to by the U.S., UK, EU, Germany, France, Russia, and China that lifted sanctions against Iran in return for a promise to pause its nuclear program. Although pulling out of the agreement will have limited direct economic implications for the U.S., the imposition of sanctions on Iran and the threat to do so on those nations that continue to do business with it, is likely to deal a blow to its trade partners (Chart 1). Financial markets were caught somewhat off-guard by the decision, with conflicting news headlines generating gyrations throughout the day. Since a renegotiation of the deal is a possibility, markets shrugged off the news, with domestic equity markets likely to end the week up 2%. WTI oil prices also moved higher this week, holding above US$70 on this and other news of escalating Middle East tensions. U.S. - Upping the Stakes CHART 2: U.S. GAS PRICES RISING IN LOCKSTEP WITH OIL Price growth, Year-on-Year Change % WTI Oil CPI Gasoline Source: Bureau of Labor Statistics via Haver Analytics. Last Observation: April 2018 is usually quite brisk, and this time is no exception (Chart 2). The U.S. CPI report for April saw prices rise 2.5% over the past twelve months, largely owing to a strong upward move in the price of gasoline (+13.4% y/y). Aside from energy, shelter costs continue to tick up, a reflection of tight housing inventories in many U.S. cities that is sending home prices higher. Oil prices have been rising steadily over the past five weeks, with implications for the domestic and global economy. Higher energy prices should help support domestic investment and overall economic activity in oil exporting countries such as Saudi Arabia, Canada, and increasingly the United States. However, consumers will likely feel the pinch from higher energy prices, as the rising price of gas reduces their overall purchasing power. The pass-through to consumers from rising energy prices CHART 1: EU AND CHINA TRADE TO TAKE A SMALL HIT FROM IRAN SANCTIONS 2017 Trade with Iran, $U.S. billions Imports Exports Total Trade U.S. UK* EU China * Data for 2016 Source: U.S. Census Bureau, Eurostat, UK ONS, CBNS via Haver Analytics, TD Economics Abstracting from energy and other volatile prices, underlying price pressures remain fairly subdued despite strong economic activity and tightening labor markets. Core inflation lost some momentum in April, as price growth in core services slowed a touch. Still, core inflation registered a 2.1% gain year-on-year, but that includes a fading base-year effect from the dip in telecommunications prices last year that is acting to prop up inflation. The loss of inflation momentum may help reduce concerns that the Fed isn t moving fast enough to cool off a hot economy. Inflation is likely to hold near the Fed s 2% target for the remainder of the year, with the economy running just hot enough to warrant two more rate hikes this year. That said, downside risks to the domestic and global outlook continue to materialize. Although they have had limited impact thus far, things can quickly escalate. While the Iran sanctions act to elevate the risk of a trade war between the U.S. and its trade partners, all parties appear open to dialogue. Still, this decision adds further pressure on Europe and China to settle trade imbalances with the United States. Fotios Raptis, Senior Economist

3 3 Canada Oil Prices Up, But Well Above Fundamentals Crude oil prices hit a 3½ year high this week, with the WTI benchmark hitting US$71 per barrel. This helped drive the S&P/TSX up modestly during the week while the loonie edged up to just over 78 US cents. Oil prices have been trending up in recent months, with the push above US$70 per barrel this week triggered by a bullish U.S. storage report, unrest in the Middle East and President Trump s announcement that the U.S. is pulling out of the Iran nuclear deal that Obama signed in 2015, reinstating sanctions. While expectations of a U.S. withdrawal from the agreement have helped to bid up prices recently, the actual impact on the oil market is likely to be limited. It doesn t appear as though the other countries that signed the agreement will follow in the footsteps of the U.S., and the sanctions will take up to 6 months to fully implement. As such, current estimates put the supply disruption in Iran at up to 500,000 barrels per day (about half the likely impact if all other countries were to support the U.S. action). While significant, the OPEC/non-OPEC agreement in effect until the end of this year has left the market with plenty of spare capacity that could be used to meet any shortfall. Indeed, Saudi Arabia who has cut output by more than its agreed upon amount has already indicated that it would respond to any shortage if necessary. That said, Saudi Arabia has also indicated in recent weeks that the global oil market is not as tight as some may believe and that the 5-year average target for inventories which is in sight is not the best metric to use. This is because it has been driven higher over the last few years as a result of the glut in the market. As such, there may US$ per Barrel 20 Dec-14 Dec-15 Dec-16 Dec-17 Source: Haver Analytics, TD Economics CHART 1: OIL PRICES US$ per Barrel CHART 2: WTI-WCS Spread 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Source: Bloomberg, TD Economics not be a need to make up any shortfall from Iran caused by Trump s withdrawal. All told, oil prices have been lifted in no small part by geopolitical risks, and are sitting well above the price that supply and demand fundamentals would suggest. With speculative activity (as measured by non-commercial net long positions on the NYMEX) elevated, non-opec production set to continue rising particularly in the U.S. and the market still amply supplied, the risks for oil prices are tilted to the downside. In Canada, producers are starting to reap more benefit from higher oil prices, with the WTI-WCS spread narrowing to just over US$15 per barrel this week. This is down from the peak of $30 per barrel reached earlier this year and moving close to the $13 per barrel average seen over the last two years. The improvement in oil prices should help the economy on the income side, while other economic indicators remain solid. Data out this week showed housing starts slowed to 214k (annualized) in April, but are sitting at a healthy pace nonetheless. Meanwhile, employment was flat on the month, although full-time positions rose and wage growth held above 3% for a fourth straight month. The Bank of Canada will look favourably upon the steady wage gains, but will still have to take into account a number of uncertainties, both domestic and external. At this point, we expect the next rate hike to come in July. Dina Ignjatovic, Economist

4 4 U.S.: Upcoming Key Economic Releases U.S. Retail Sales - April* Release Date: May 15, 2018 Previous Result: 0.6%, ex-auto 0.2% TD Forecast: 0.0%, ex-auto 0.3% Consensus: 0.4%, ex-auto 0.5% We look for a flat read on retail sales in April, held down by weaker auto sales. We also expect colder temperatures to temper sales, concentrated in the building materials and food services categories, which points to a modest showing in the control group (0.2%). However, given the strong handoff from March, the report would still be consistent with Q2 real consumer spending near 2.5%. U.S. RETAIL AND FOOD SERVICES SALES Month/Month % Change Total Excl. Automotive Dealers May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Source: U.S. Department of Commerce, Haver Analytics, TD Economics. *Forecast by Rates and FX Strategy Group. For further information, contact TDRates&FXCommoditiesResearch@tdsecurities.com

5 5 Canada: Upcoming Key Economic Releases Canadian Manufacturing Sales - March* Release Date: May 16, 2018 Previous Result: 1.9% m/m TD Forecast: 1.1% m/m Consensus: N/A TD looks for manufacturing sales to rise by 1.1% m/m in March, led by a nominal increase in energy products. Gasoline prices have surged in recent months on speculation over the future of the Iran nuclear deal but with refining capacity utilization near multi-year highs further upside on volumes for energy products will be limited. Outside of energy we expect a fairly muted advance in contrast to the sharp increase in export activity. Auto production has normalized after months of disruptions and early production estimates are little changed on the month. However, manufacturing surveys continue to point to robust conditions and provide little evidence CANADIAN MANUFACTURING SHIPMENTS Month/Month % Change. Manufacturing Shipments (lhs) Inventory-to-Shipments Ratio (rhs) -4.0 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Source: Statistics Canada, Haver Analytics, TD Economics. Seasonally Adjusted Ratio that threatening rhetoric is impacting activity. Our forecast is consistent with real manufacturing sales growth of 0.5%, which would support industry-level growth for the month Canadian Retail Sales - March* Release Date: May 18, 2018 Previous Result: 0.4%, ex-auto: 0.0% TD Forecast: 0.2%, ex-auto: 0.5% Consensus: N/A Month/Month % Change. CANADIAN RETAIL SALES* Retail sales are forecast to rise by a muted 0.2% as a pullback in motor vehicle sales offsets a rebound in ex-autos after a disappointing flat print in March. Cold weather will weigh on auto sales in March along with the shaky housing market, which introduces uncertainty around the durability of wealth effects. Meanwhile, gasoline station sales will make a positive contribution on the sharp rise in the price at the pump, a dynamic that will weigh on real incomes in the months ahead. We expect real retail sales to remain largely unchanged on the month, which would leave volumes down for Q1 after sales cratered into year-end. Thus, the decline is due largely to Total Ex. Motor Vehicles -3.0 Aug-16 Nov-16 Feb-17 May-17 Aug-17 Nov-17 Feb-18 *Seasonally Adjusted Source: Statistics Canada, Haver Analytics, TD Economics. a poor hand-off from Q4 and we would note that retail sales only account for roughly 45% of household spending, allowing some divergence against national accounts data.

6 6 Canadian Consumer Price Index - April* CANADIAN CONSUMER PRICE INDEX (CPI) Release Date: May 18, 2018 Previous Result: 0.3% m/m nsa, 2.3% y/y, Index: TD Forecast: 0.4% m/m nsa, 2.4% y/y, Index: Consensus: N/A 3.0 Year/Year % Change. 2.5 Core CPI Headline CPI We expect headline CPI to rise to 2.4% y/y, reflecting a 0.4% m/m gain, matching the seasonally adjusted increase. Driving the pickup is gasoline prices, which rose over 7% in April, leaving overall energy prices a net positive. After running weak in the prior to two months food prices are expected to rebound, helped by a weaker CAD. Outside of food and energy, we expect price pressures to post a more moderate m/m increase after recording relatively strong gains over the prior three months. A few categories tempering price gains in April are the following: healthcare is due for a correction while recreation/ education should pullback on sporting equipment and travel services. Downward pressures should continue within the housing component of shelter, overpowering the lift from higher mortgage rates. Elsewhere, other oneoffs (internet services hikes, tobacco taxes) along with currency pass-through offer positive Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Source: Statistics Canada, Haver Analytics, TD Economics. offsets, leaving prices up on balance in the exclusionbased core indexes (CPIX and CPIXFE). We expect these indexes, which have been underperforming the BoC core measures, to rise modestly on a y/y basis. Meanwhile, the average of the BoC measures, which stabilized at 2.0% in March, have more limited scope for further gains in our view. Looking ahead, with gasoline prices likely to rise into the summer, we expect headline inflation to continue to firm and peak at 2.7% y/y in June. This trajectory reflects relatively stable core inflation near 2%, reinforcing the view that inflation remains in check. *Forecast by Rates and FX Strategy Group. For further information, contact TDRates&FXCommoditiesResearch@tdsecurities.com

7 7 Release Data for Economic Indicator/Event Date Period Units Current Prior United States May 08 NFIB Small Business Optimism Apr Index May 09 Producer Price Index Final Demand Apr M/M % Chg May 09 Producer Price Index Ex Food and Energy Apr M/M % Chg May 09 Wholesale Trade Sales Mar M/M % Chg May 10 Consumer Price Index Apr M/M % Chg May 10 Consumer Price Index Ex Food and Energy Apr M/M % Chg May 10 Consumer Price Index Apr Y/Y % Chg May 10 Initial Jobless Claims May 05 Thsd May 10 Consumer Price Index Ex Food and Energy Apr Y/Y % Chg May 10 Real Avg Hourly Earning Apr Y/Y % Chg May 11 Import Price Index ex Petroleum Apr M/M % Chg May 11 Export Price Index Apr M/M % Chg May 11 Export Price Index Apr Y/Y % Chg Canada May 08 Housing Starts Apr Thsd May 11 Net Change in Employment Apr Thsd May 11 Unemployment Rate Apr % May 11 Hourly Earnings Permanent Employees Apr Y/Y % Chg International May 07 EZ Markit Eurozone Retail PMI Apr Index May 09 CH Consumer Price Index Apr Y/Y % Chg May 10 UK Manufacturing Production Mar Y/Y % Chg May 10 UK Bank of England Bank Rate May 10 % Source: Bloomberg, TD Economics. RECENT KEY ECONOMIC INDICATORS: MAY 7-11, 2018

8 8 Release Data for Consensus Time* Economic Indicator/Event Units Date Period Forecast Last Period United States May 14 Mortgage Delinquencies 1Q Q/Q % Chg May 14 2:45 Fed's Loretta Mester Speaks in Paris, France May 14 9:40 Fed's James Bullard Speaks at The CoinDesk's Consenus in New York May 15 8:30 Retail Sales Ex Auto and Gas Apr M/M % Chg May 15 8:30 Retail Sales Advance Apr M/M % Chg May 15 8:30 Empire Manufacturing May Index May 15 10:00 NAHB Housing Market Index May Index May 15 10:00 Business Inventories Mar M/M % Chg May 15 13:10 Fed's John Williams Speaks at The Economic Club of Minnesota in Minneapolis May 16 8:30 Building Permits Apr Thsd May 16 8:30 Housing Starts Apr Thsd May 16 8:30 Fed's Raphael Bostic Speaks in August, Georgia May 16 9:15 Manufacturing (SIC) Production Apr M/M % Chg May 16 9:15 Industrial Production Apr M/M % Chg May 16 9:15 Capacity Utilization Apr % May 16 18:30 Fed's James Bullard Speaks at The Homer Jones Memorial Lectute in St.Louis, Missouri May 17 8:30 Initial Jobless Claims May 12 Thsd - - May 17 10:45 Fed's Neel Kashari Speaks in a Moderated Q&A in Minnesota May 18 3:00 Fed's Loretta Mester Speaks in Frankfurt, Germany Canada May 14 8:30 Teranet/National Bank HPI Apr Y/Y % Chg May 15 9:00 Existing Home Sales Apr M/M % Chg May 16 8:30 Manufacturing Sales Mar M/M % Chg May 16 12:15 BoC's Lawrence Schembri Speaks at the Ottawa Economic Association in Ottawa, ON - May 18 8:30 Consumer Price Index Core - Trim Apr Y/Y % Chg May 18 8:30 Consumer Price Index Core - Median Apr Y/Y % Chg May 18 8:30 Consumer Price Index Core - Common Apr Y/Y % Chg May 18 8:30 Consumer Price Index Apr Y/Y % Chg May 18 8:30 Consumer Price Index NSA Apr M/M % Chg May 18 8:30 Retail Sales Ex Auto Mar M/M % Chg May 18 8:30 Retail Sales Mar M/M % Chg International May 14 22:00 CH Retail Sales Apr Y/Y % Chg May 15 4:30 UK ILO Unemployment Rate 3Mths Mar % May 15 5:00 EZ Gross Domestic Product SA 1Q P Y/Y % Chg May 16 5:00 EZ Consumer Price Index Apr F Y/Y % Chg May 17 19:30 JN Natl Consumer Price Index Apr Y/Y % Chg * Eastern Standard Time. Source: Bloomberg, TD Economics. UPCOMING ECONOMIC RELEASES AND EVENTS: MAY 14-18, 2018

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