THE WEEKLY BOTTOM LINE

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1 THE WEEKLY BOTTOM LINE TD Economics HIGHLIGHTS OF THE WEEK United States There was good news and bad news about the U.S. economy this week. Q2 growth disappointed, thanks to a huge drawdown in inventories, which is likely be reversed in the coming quarters. The Fed sounded slightly more optimistic on the risks and the labor market. But global risks abound and the Fed remains firmly in wait and see mode. Oceans apart, the Bank of Japan tapped a bit harder on the monetary accelerator this week, and hinted at more to come. This would add to an expected fiscal stimulus package aimed at helping to lift Japan out of deflation once and for all. Canada The Canadian economy contracted by 0.6% m/m in May, though the headline should be taken lightly. Transitory factors were the main culprit. We expect a bounce back in GDP in the coming months. Business confidence in Canada continues to trend upwards in July, despite a small fallback from the previous month. The government of British Columbia looked to dent affordability concerns amid a potentially overheating housing market, introducing a four pronged plan this week. Most notably, a 15% tax was introduced on foreign individuals and corporations on the purchase of residential property in Metro Vancouver. THIS WEEK In THE markets Current* Week Ago 52-Week High 52-Week Low Stock Market Indexes S&P 500 2,166 2,175 2,175 1,829 S&P/TSX Comp. 14,503 14,601 14,601 11,843 DAX 10,302 10,147 11,636 8,753 FTSE 100 6,712 6,730 6,752 5,537 Nikkei 16,569 16,627 20,809 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 10:50 am on Friday **Oil-WTI, Cushing, Nat. Gas-Henry Hub, LA (Thursday close price), Copper-LME Grade A, Gold-London Gold Bullion; Source: Bloomberg. S&P 500 Dax FT 100 Nikkei 225 US 10Y T-Note USD:EUR USD:JPY USD:GBP USD:CAD USD:MXN USD:CNY Gold WTI Brent WEEKLY MOVES Weekly % change except (*) which denotes change in index Note: Data as of July 29, 12:00 ET. Change from end of prior week. Sources: Bloomberg, TD Economics GLOBaL OFFICIaL policy rate TarGETS Current Target Federal Reserve (Fed Funds Rate) % Bank of Canada (Overnight Rate) 0.50% European Central Bank (Refi Rate) 0.00% Bank of England (Repo Rate) 0.50% Bank of Japan (Overnight Rate) -0.10% Source: Central

2 U.S. plenty to chew on in the dog days of summer Appropriately for the dog days of summer, there was plenty for markets to chew on this week. U.S. economic news was generally mixed. And, a highly anticipated Bank of Japan decision ultimately fell short of market expectations. First, the bad news. The U.S. economy grew at half the pace economists were expecting in Q2, or only 1.2% (annualized). Mitigating the disappointment was a huge drawdown in inventories, which subtracted 1.2 percentage points from growth (see chart), a dynamic unlikely to last in the coming quarters. Without that, growth would have been much closer to the 2%-plus pace that economists were expecting. But, inventories weren t the only source of disappointment business investment was also weaker than expected. Corporate profits have been soft in recent quarters, limiting businesses capacity to spend. Fortunately, the American consumer didn t disappoint. Real consumer spending surged 4.2% in Q2, as Americans spent more of their disposable income. Consumer confidence also remained solid in July, which bodes well for spending going forward. Personal consumption accounts for nearly 70% of the economy, and is expected to do the heavy lifting in the coming quarters, helped along by an improving labor market that is creating jobs and has begun to manifest in wage gains, and supported by low interest rates. As to how long rates will remain low, the FOMC weighed in on the economy earlier this week. It cited improvement in the labor market and described the risks, which were front and center in June, as having diminished. While this is true, there is also little doubt that risks have not disappeared. The statement was slightly more upbeat, and keeps the door open for a hike this year, but hardly laid out a plan for a near-term CHART 1: GROWTH HELD BACK BY INVENTORY DRAWDOWN Contribution to Real GDP Growth, %. Inventory Investment Net Exports Business Investment Personal Consumption + Residential Investment Real GDP Source: Haver Analytics, TD Economics CHART 2: MARKET-BASED INFLATION EXPECTATIONS HAVE REBOUNDED Five-year forward inflation rate, % Five-year five-year forward* 1.0 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Source: EIA/CME, Federal Reserve Board, TD Economics move in the upcoming meetings. In fact, it is likely that bouts of risk aversion that have overtaken global financial markets periodically, and helped stave off Fed hikes previously, could still emerge, dampening business confidence and investment, and keeping the Fed on the sidelines. Having said that, the Fed can t wait forever. The economy is very close to full employment, and the benign inflation back drop that let the Fed remain patient since hiking last December, is showing signs of perking up. The PCE deflator for Q2 was the highest in two years, and marketbased measures of inflation expectations are moving up (see chart). If U.S. inflation accelerates more than we currently expect and signs point to the economy bouncing back from a disappointing first half of the year, there is a good chance the Fed could still hike once in Oceans apart, the Bank of Japan tapped a bit harder on the monetary accelerator this week, and hinted at more to come. This would be in concert with a large fiscal stimulus package. Not strictly speaking the helicopter drop that markets have been aflutter about in recent weeks, but it should produce much the same effect. When fiscal stimulus is funded by increased government debt issuance, the expected increase in interest rates would dampen the desired impact. But a synchronized increase in central bank purchases would help offset that effect. Both central bank messages echoed the theme of Dollars & Sense how rates will remain low to support a global economy hampered by aging populations, lower productivity and credit growth. Leslie Preston, Senior Economist

3 CANADA Transitory factors weigh on Economic growth in may Data released this week continued to paint a pretty dim backdrop for Canadian economic activity during the second quarter, with the economy contracting by 0.6% m/m in May. Still, it is important to note that many of the negative factors that have dragged down growth are transitory in nature including wildfires and disruptions to supply chains. Wildfires in Northern Alberta reduced nonconventional oil & gas activity by 22%, amounting to a 0.5 percentage point drag nearly the entire contraction. The production cuts have stretched into June, but a gradual recovery over the month should see the sectoral activity bounce back. Other transitory effects included a 15% drop in petroleum refineries, as the feedthrough impact of the wildfires reduced the amount of crude oil available for refining. Moreover, durable goods manufacturing also declined in May, partially a result of supply disruptions related to an earthquake in Japan in April impacting transportation equipment manufacturers in particular. Apart from the temporary factors that have dragged down GDP growth, other data appeared more constructive. Canadian business confidence remains firm with 85.8% of businesses expressing their current business situation as satisfactory or good in July. While this was down slightly from the previous month, confidence among Canadian businesses has trended upwards recently, clawing back some of the losses as a result of the collapse in commodity prices. Any weakness in the survey remains concentrated in three sectors: agriculture, natural resources, and transportation. These results aren t surprising given the current CHarT 1: WILdFIrE and EarTHQUaKE disruptions WEIGH On may Gdp GrOWTH Real GDP, Chained (2007) dollars m/m % change Real GDP Oil & Gas Petroleum & coal manufacturing Source: Statistics Canada. Transportation Manufacturing Other Sectors CHarT 2: OIL & GaS LarGEST COnTrIBUTOr TO monthly decline percentage points Other sectors Transportation manufacturing Petroleum & coal manufacturing Oil & gas extraction Real GDP Mar-16 Apr-16 May-16 Source: Statistics Canada, TD Economics backdrop. Agriculture in Canada has suffered a string of bad weather cycles, while the natural resource sector continues to be weighed down by a low price environment. Weakness in these two sectors, and some softness in manufacturing, has contributed to weaker businesses sentiment within the transportation sector. Still, any pessimism is more than offset by robust confidence in construction and finance, insurance and real estate all supported by the resilient housing market. In fact, the housing market appears to be in some cases overheating. To cool it, the government of British Columbia made an announcement this week, introducing a four pronged plan to help improve housing affordability. The most significant of these announcements is a 15% additional land transfer tax for foreign individuals and corporations on the purchase of residential property in the Metro Vancouver area. In addition, the City of Vancouver has been granted the authority to implement and administer a tax on vacant homes. These moves are intended to curb foreign speculation in the Greater Vancouver real estate market, and if successful, are likely to relieve demand and price pressures at the top end of the market. This would result in improving affordability rippling down the price spectrum. The bottom line is that growth in the second quarter is likely to be negative. Much of this is related to several transitory factors that have impinged on growth during the quarter. As these wane, and rebuilding activity starts in fire ravaged Northern Alberta, growth should surpass the 2% mark in the second half of this year. Warren Kirkland, Economist,

4 U.S. ISM Manufacturing Index - July* Release Date: August 1, 2016 June Result: 53.2 TD Forecast: 53.4 Consensus: 53.0 U.S.: UPCOMING KEY ECONOMIC RELEASES TD expects manufacturing sector momentum to tick modestly higher in July, with the headline ISM manufacturing index rising to 53.4 from This will mark the third consecutive monthly gain in this indicator, underscoring the relatively upbeat tone in this sector as the US economy continues to move beyond the Q1 soft patch. The modest rise in the headline index will be driven by gains in the production and employment sub-indices, though the new orders sub-index should slip modestly, reflecting a slight deceleration in orders activity as the stronger dollar and global uncertainties temper export demand for US manufacturing goods. The new orders to inventory spread should also decline, foreshadowing some slippage in production momentum going forward, though it is expected to remain firmly in expansionary territory. The buoyant performance in ISm manufacturing IndEX Source: Institute for Supply Management / Haver Analytics manufacturing sector activity, however, should begin petering out in the coming months as the uncertainty surrounding the fallout from the Brexit vote, the US elections and the impact of strong dollar temper global demand for US goods. U.S. Personal Income & Spending - June* Release Date: August 2, 2016 May Result: Income 0.2% m/m; spending 0.4% m/m TD Forecast: Income 0.5% m/m; spending 0.4% m/m Consensus: Income 0.3% m/m; spending 0.3% m/m The dramatic pick-up in employment in June should bolster personal income, which TD expects to advance by a very robust 0.5% m/m. The acceleration in wage income should be bolstered by continued support from rental income. Spending activity is also expected to be fairly robust, advancing a further 0.4% m/m, topping off a strong showing in personal expenditures for Q2. Real spending should also be decent, gaining a further 0.2% m/m, as spending activity underpins the rebound in growth momentum. The inflation picture, however, should remain quite subdued as TD forecasts the PCE deflator to rise by 0.2% m/m while the annual pace of inflation decelerates to 0.8% y/y from 0.9% y/y. Core inflation should also be weak, eking out a 0.1% m/m gain which will keep the annual pace of core inflation unchanged at 1.6% y/y. The benign inflation U.S. personal InCOmE and SpEndInG M/M % Chg. Spending Income -0.2 May-15 Aug-15 Nov-15 Feb-16 May-16 Source: Bureau of Economic Analysis / Haver Analytics. backdrop should linger into the second half of the year as the disinflationary impulse from a stronger dollar dampens inflationary pressures further. 4

5 U.S. Employment - July* Release Date: August 5, 2016 June Result: 287k; unemployment rate 4.9% TD Forecast: 188k; unemployment rate 4.9% Consensus: 180k; unemployment rate 4.8% After the blockbuster 287K employment gain in June, TD expects the pace of job growth to come back down to earth with the economy adding 188K jobs. Despite the slowing in job growth momentum, the 6M average of net payrolls should tick modestly higher to a healthy 175K pace. The job gains should be sprinkled across most sectors, with stronger hiring in the pro-cyclical manufacturing, professional services, construction, retail and transportation sectors underpinning the rise in labor demand. The 177K gain in private sector employment will be boosted by a further 11K rise in public sector employment, owing to stronger government hiring on a regional level. Despite the strong gains in employment, the unemployment rate should remain unchanged at 4.9% on account of rising labor force participation. Wage growth, however, should accelerate to a solid U.S. LaBOr market Thousands of jobs % 350 Net Job Change* (lhs) Unemployment Rate (rhs) 0 Jul-14 Dec-14 May-15 Oct-15 Mar-16 Seasonally-adjusted data; * Change in non-farm payrolls Source: U.S. Deptartment of Labor / Haver Analytics 0.3% m/m pace though the annual pace of average hourly earnings growth should remain unchanged at 2.6%. And with economic growth momentum expecting to drift lower in the coming months, we expect the pace of job growth to also slow towards the 150K mark U.S. International Trade - June* Release Date: August 5, 2016 May Result: -$41.1b TD Forecast: -$43.6b Consensus: -$42.1b The US trade deficit is expected to widen sharply in June mirroring the deterioration seen in the advanced goods trade report, with TD expecting the deficit to rise to $43.6B from $41.1B. Despite the worsening in the trade balance, the overall tone of the report should be encouraging. In particular, import activity (which reflects the tone of domestic demand momentum) is expected to rise at a decent 1.4% m/m pace, marking the third monthly rise in this indicator in the past four months as the economic recovery continues to gain traction. Export activity should advance, rising at a respectable 0.4% m/m pace, pointing some modest improvement in global demand. Despite this, the external sector should remain a modest source of tailwind for the economy going US$, Billions U.S. InTErnaTIOnaL TradE BaLanCE -55 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Source: Census Bureau / Haver Analytics forward as the stronger dollar erodes US competitiveness and the continued unsupportive global economic backdrop. *Forecast by Rates and FX Strategy Group. For further information, contact TDRates&FXCommoditiesResearch@tdsecurities.com 5

6 Canada: UPCOMING KEY ECONOMIC RELEASES Canadian International Trade - June* Release Date: August 5, 2016 May Result: -$3.3b TD Forecast: -$3.0b Consensus: -$2.6b CanadIan InTErnaTIOnaL merchandise TradE Dollars, Billions Canada s trade deficit is expected to have narrowed modestly to $3.0 billion in June. This forecast is premised on stronger exports that will outpace an expected increase in imports. A closer look at the export data should show gains in several of the sectors that fell sharply in May (metal products) though weaker auto imports reported in the US Advance Trade report casts some doubt on the role that Canadian exports played in supporting the observed increase in US production. There is more uncertainty surrounding the performance of the energy sector. Given that a portion of the production shuttered in May amid the wildfires in Northern Alberta was restored, imports of energy may end up dominating exports as inventories are restored. While oil prices were lower in the month, seasonally adjusted Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Source: Statistics Canada / Haver Analytics Exports Imports commodity prices increased, which may end up biasing the nominal figures higher. More generally however, volumes are expected to be weaker than what is implied by the nominal headlines. Canadian Employment - July* Release Date: August 5, 2016 June Result: -0.7k; unemployment rate 6.8% TD Forecast: 5k; unemployment rate 7.0% Consensus: 10k; unemployment rate 6.9% 80 Thousands of jobs CanadIan LaBOUr market* Net Job Change (lhs) % The July Labour Force Survey is forecast to reveal the creation of 5k jobs while the unemployment rate should rebound to 7.0%. The uptick in the unemployment rate is a factor of anemic job growth, a rebound in labour force participation, and the low threshold for a move (unemployment rate was 6.843% at three decimals in June). The full/ part time breakdown will be determined by a crosscurrent of seasonal factors and anticipated reversals working against each other. Historically, July has been a strong month for part time employment due to the supply of youth entering the work force temporarily, however, the gain of nearly 40k part-time jobs last month (a 1.1 standard deviation move) argues for a pullback. On an industry basis, accommodation and food services will likely unwind a portion of the 20k jobs added in June while public administration is also likely Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 *Seasonally Adjusted Source: Statistics Canada / Haver Analytics Unemployment Rate (rhs) to see significant job losses due to the short-term nature of census-related hiring. At the other end of the spectrum we expect to see a bounce in construction employment after the loss of 29k positions last month *Forecast by Rates and FX Strategy Group. For further information, contact TDRates&FXCommoditiesResearch@tdsecurities.com 6

7 release date Economic Indicator/Event data for period Units Current prior Jul 26 S&P/Case-Shiller US Home Price Index May Y/Y % Chg R6 Jul 26 S&P/Case-Shiller US Home Price Index (SA) May M/M % Chg Jul 26 Markit US Services PMI Jul P Index Jul 26 New Home Sales Jun Thsd R5 Jul 26 Consumer Confidence Index Jul Index R6 Jul 27 Capital Goods Orders Non-defense Excl. Aircraft Jun P M/M % Chg R6 Jul 27 Durable Goods Orders Jun P M/M % Chg R5 Jul 27 Pending Home Sales Jun M/M % Chg Jul 27 FOMC Rate Decision Jul 27 % Jul 28 Initial Jobless Claims Jul 23 Thsd R6 Jul 28 Advance Goods Trade Balance Jun USD, Blns R6 Jul 29 Gross Domestic Product (Annualized) Q2 A Q/Q % Chg R6 Jul 29 Personal Consumption Q2 A Q/Q % Chg R5 Jul 29 Core PCE Q2 A Q/Q % Chg R5 Jul 29 Employment Cost Index Q2 Q/Q % Chg Jul 28 CFIB Business Barometer Jul Index Jul 29 Gross Domestic Product May M/M % Chg Jul 29 Industrial Product Price Jun M/M % Chg R5 Jul 27 UK Gross Domestic Product Q2 A Y/Y % Chg Jul 28 JN Jobless Rate Jun % Jul 28 JN Consumer Price Index Jun Y/Y % Chg Jul 28 JN Retail Trade Jun Y/Y % Chg R6 Jul 28 JN BOJ Policy Rate Jul 29 % Jul 29 EZ Unemployment Rate Jun % Jul 29 EZ Core Consumer Price Index Jul A Y/Y % Chg Jul 29 EZ Gross Domestic Product (SA) Q2 A Q/Q % Chg Source: Bloomberg, TD Economics. recent KEy ECOnOmIC IndICaTOrS: JULy 25-29, 2016 United States Canada International 7

8 release date UpCOmInG ECOnOmIC releases and EVEnTS: august 1-5, 2016 Time* Economic Indicator/Event United States data for period Units Consensus Forecast Last period Aug 01 10:00 ISM Manufacturing Jul Index Aug 02 6:15 Fed's Kaplan Speaks in Lecture in Beijing Aug 02 8:30 Personal Income Jun M/M % Chg Aug 02 8:30 Real Personal Spending Jun M/M % Chg Aug 02 8:30 PCE Deflator Jun Y/Y % Chg Aug 02 8:30 PCE Core Jun Y/Y % Chg Aug 02 Wards Total Vehicle Sales Jul Mlns Aug 03 8:15 ADP Employment Change Jul Thsd Aug 03 10:00 ISM Non-Manufacturing Composite Jul Index Aug 04 6:15 Fed's Kaplan Speaks in Shanghai Aug 04 8:30 Initial Jobless Claims Jul 30 Thsd Aug 04 10:00 Factory Orders Jun M/M % Chg Aug 04 10:00 Factory Orders Excluding Transportation Jun M/M % Chg Aug 05 8:30 Trade Balance Jun USD, Blns Aug 05 8:30 Change in Nonfarm Payrolls Jul Thsd Aug 05 8:30 Average Hourly Earnings Jul M/M % Chg Aug 05 8:30 Unemployment Rate Jul % Canada Aug 05 8:30 Net Change in Employment Jul Thsd Aug 05 8:30 International Merchandise Trade Jun CAD, Blns Aug 05 8:30 Unemployment Rate Jul % International Aug 03 5:00 EC Retail Sales Jun Y/Y % Chg Aug 04 7:00 UK Bank of England Bank Rate Aug 04 % * Eastern Standard Time. Source: Bloomberg, TD Economics. 8

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