The Weekly Bottom Line - Jan 16 2009

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TD Economics The Weekly Bottom Line January 16, 2009 HIGHLIGHTS REAL U.S. RETAIL SALES SPEND ING

• U.S. retail sales and prices are falling • Falling commodity prices drive Canadian trade balance lower and U.S. higher

5 month % chg. 8 6 4

Economists are a group of individuals who took their mother’s advice to heart a little too literally to grow up and live in the “Real World.” For an economist, the “Real World,” or real economy, looks at what is going on once we strip out the changes in prices. There is good reason to do this. Imagine the price of every good in the world was suddenly cut in half. Well, if spending was also cut in half, then nothing changed for spending really. The same number of goods still circulated around the economy, only the price tags changed. It was all just a David Copperfield-esque monetary illusion. There are important caveats to this idea that are now being placed center stage in the global economy.

2 0 -2 -4 -6 -8 196 7 1 970 1974 19 77 1 980 198 4 1 987 1990 199 4 1 997 200 0 20 04 2 007

Last plotted December 2008; Source: Haver Analytics

10%, but the prices of those products consumers are buying has fallen by 3.5% over the same period – meaning real consumer spending has fallen by the far less shocking 6.5%. In fact, in the 1980’s recession and the 1974 recession, the real decline in spending had fallen to as low as 7.5% (over a 5-month period). In real terms, the current “death of the U.S. consumer” is not unprecedented. This also leads to another key extension. Outside of changes in prices and changes in spending, it is also important to look at changes in income. If prices are falling faster than consumer spending, then real spending is rising. Equally important, if prices are falling faster than income, then real income is rising, meaning individuals have more purchasing power. Through the first nine months of 2008, the 5-month growth rate of wages was never higher than the 5-month growth in prices. With skyrocketing fuel costs, Americans were quickly losing their purchasing power. However, in October, these two rates were equal, and by November, real wages were growing by 2.4% and could possibly be increasing by over 3.5% when December data becomes available. This is critical because looking at the chart here, real

Will the real U.S. consumer please stand up

Over the last five months of 2008, American consumer spending (nominal) fell 10%. Prior to this, the biggest such decline had been 2.6% during both the 1980s and 1990s recession – when oddly enough the 5-month inflation rate in both cases was also running at 2.4%. This means in each case, the real decline in spending was 5%. So, consumer spending did not keep pace with the 3.2% increase in prices, and it also contracted by an additional 2.6%. The math works in the opposite direction in the current context. The amount of cash consumers have spent has fallen by Recent TD Economics Research January 16, 2009 - U.S. Consumer Price Index January 15, 2009 - Monetary Policy Monitor January 15, 2009 - ECB Interest Rate Decision January 14, 2009 - U.S. Retail Sales January 13, 2009 - Canadian International Trade The Weekly Bottom Line

Recession shading

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January 16, 2009

www.td.com/economics wage growth and real GDP growth move very much handin-hand, raising a possibility for a bounce in U.S. economic growth to kick off 2009 after what was unequivocally an atrocious fourth quarter. The dramatic collapse in gas prices means consumers can spend that much less on gas, and that much more on other purchases. While much will be raised of the year/year rate of headline inflation having fallen in just 0.1% as a sign of a deflationary trap in the U.S., core inflation remains at 1.8%. Inflation will recede further in the months ahead (inflation reflects past economic changes), but the critical area to focus on is the change of spending and wages relative to these prices. Especially in these unusual times of falling prices and nominal values in the United States.

AMERICAN CONSUMER SPENDING AND ASIAN GLOBAL EXPORTS 40 0

25 0

25 0

20 0

20 0

15 0

15 0 10 0

Asian exports

50 0

50 0

70

73

77

81

85

89

93

96

00

04

08

Seasonally adjusted; Last plotted Dec 2008 Data: Haver Analytics

portant is not only how many U.S. dollars they are receiving for their exports, but also how these stack up in their own domestic currencies and against their own changes in inflation. Global deflation imported to Canada

And when it comes to relative price shocks, Canada again appears to be the biggest loser in the current global climate. In Canada, merchandise exports fell by 11% from July-November, but Canada has seen similar sized changes five times over the last decade, so this in itself is not unique. On a real basis, though, Canadian exports have fallen nearly 10% since they peaked in November 2007, and threaten to post the largest decline, as well as the longest lasting decline, since at least the 1974 recession. With this decline driven by the remarkable collapse in commodity prices, not only is demand for Canadian exports falling, but so is the return collected for each shipment of those products, a relative double-whammy for Canada. This means falling corporate profit margins, and likely falling profits outright, for many exporters, which must then filter through into reduced corporate investment and hiring decisions. For the economy, it’s all relative. With the large shocks simultaneously working through the global system – housing bubbles, oil prices skyrocketing and then crashing, credit squeezes – it is unfortunately impossible to say for certain how they will all intermix, and the U.S. is likely not done contracting. But, while there is a global deflation under way, this is not the same thing as being stuck in a deflationary trap. Richard Kelly, Senior Economist 416-982-2559

2 Quarter % chg. 9 7 5 3 1 -1 -3

Real Wages Real GDP

-9 1 959 19 63 1968 1 972 197 7 1981 19 86 1990 1 995 199 9 2004 2 008

Last plotted: Q3 2008 and Q4 2008 for GDP and wages respectively Source: Haver Analytics

The Weekly Bottom Line

30 0

10 0

U.S. REAL WAGES DRIVES REAL GDP

Recession shading

40 0 35 0

U.S. Retail Sales

30 0

Plotting out the level (nominal, not real) of U.S. retail sales and total Asian exports over the last 40 years demonstrates just how unique the current environment is. As we noted, U.S. retail spending has declined before on a nominal basis, but never of the current magnitude in the post-WWII era. Likewise, nominal Asian exports to the rest of the world have also never collapsed by this scale for the last 40 years that we have data. Asian exports fell by 16% (11 months peak to trough) during the 2001 U.S. recession, 10% during the 1997-98 Asian financial crises (over 3 months) , but 27% over the last five months of 2008. This brings up a crucial issue for how this shock is being distributed around the world. All relative price shocks are not created equal. Over the last decade, Asian trade flows and U.S. retail sales have been closely correlated. However, for each of these Asian economies, what is im-

-7

Billion $

35 0

Asia plays follow the leader

-5

Billion $

2

January 16, 2009

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UPCOMING KEY ECONOMIC RELEASES Canadian Manufacturing Shipments - November Release Date: January 20/09 October Result: -0.5% M/M TD Forecast: -3.0% M/M Consensus: -0.5% M/M

CANADIAN MANUFACTURING SHIPMENTS 4

Manufacturing Shipments (left scale)

3

With the Canadian and U.S. economic woes clearly intensifying in the last quarter of 2008, it is not surprising that the wheels on the Canadian manufacturing sector are slowly falling off. Indeed, given the sluggish domestic and foreign demand for manufacturing products, and slumping energy prices, we expect Canadian manufacturing shipments to post its fourth consecutive monthly decline in November, with a rather dramatic 3.0% M/M drop. In real terms, the decline in shipments is likely to be somewhat more modest as much of the fall in the headline number is expected to be on account of price effects. In the coming months, further retrenchment in manufacturing sector activity is expected as the intensifying global economic recession restrains demand for Canadian manufacturing products. Millan Mulraine 416-308-2911

Seasonally Adjusted Ratio

M/M % Change

2

1.38 1.36 1.34

1

1.32

0 1.30 -1 1.28

-2

1.26

-3 Inventory-to-Shipments Ratio (right scale)

-4

1.24

-5

1.22 Oct-07

Dec-07

F eb-08

Apr- 08

Jun-08

Aug-08

Oct-08

Source: Statistics Canada

Bank of Canada Interest Rate Decision

BANK OF CANADA OVERNIGHT RATE

Release Date: January 20/09 Current Rate: 1.50% TD Forecast: 1.00% Consensus: 1.00%

6

%

5 4

The economic data in Canada has categorically deteriorated further, and against this backdrop much of the world is in recession, which suggests that the turnaround will be slow. Against a backdrop of a slumping economy, an expected moderation in inflation, weak global growth and a slow pace of credit market repair, the Bank of Canada has a good case to deliver more easing when it meets on January 20. We therefore look for the Bank of Canada to cut rates by 50 basis points, leaving the overnight rate at 1.0%. The communiqué is unlikely to depart significantly from the December statement, though the Bank might scale back their rhetoric on further rate cuts. That said, the tone will remain broadly dovish.

3 2 1 0 Jan. 03

Jan. 04

Jan. 05

Jan. 06

Jan. 07

Jan. 08

A ctual data to Jan 14, 2008; Source: Bank of Canada

Charmaine Buskas 416-982 3297 The Weekly Bottom Line

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January 16, 2009

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Canadian Wholesale Sales - November

CANADIAN WHOLESALE SALE S*

Release Date: January 21/09 October Result: total -1.8% M/M TD Forecast: total -1.5% M/M

M/M % change

Weak consumer spending is becoming a millstone around the neck of Canadian economic activity, and as consumer spending continues to weaken we expect retailers to cut-back on purchases even further as they endeavour to manage the level of their inventories. This will put further downward pressure on wholesale sales. For November, our call is for wholesale trade to post its second consecutive monthly decline, with a further 1.5% M/ M drop. Much of the weakness in the nominal headline number is expected to come from declines in orders for motor vehicles, machinery and equipment, and household and personal products. In real terms, the decline is likely to be more modest as declining prices should play an important role. Looking ahead, as the Canadian economic recession intensifies, we expect wholesale sales to decline even further.

3

3

2

2

1

1

0

0

-1

-1

-2

-2

-3

-3

Total Ex. Motor Vehicles

-4 Oct -07

Dec-07

Feb-08

Apr-08

Jun-08

-4 Aug-08

O ct -08

*Seasonally Adjusted data; Source: Statistics Canada/Haver Analytics

Millan Mulraine 416-308-2911

Canadian Retail Sales - November

CANADIAN RETAIL SALES*

Release Date: January 22/09 October Result: total -0.9%% M/M; ex-autos -1.1% M/M TD Forecast: total -2.0% M/M; ex-autos -1.5% M/M

3

With a domestic economic recession under way, worsening labour market conditions, plunging financial and housing wealth, and tightening lending conditions, Canadian consumers now have their backs against the wall. It is therefore no wonder that consumer confidence is beginning to crack. For November, we expect consumer spending to reflect the growing unease among Canadian households about their economic fortune, with retail sales falling by a dramatic 2.0% M/M. The continued slump in motor vehicle sales and sharp decline in gasoline prices are also expected to drag the headline number lower. As such, sales excluding autos are expected to be slightly better, falling by a more modest 1.5% M/M. Real retail sales is also likely to be weak, though perhaps not as weak

M/M % change

3

2

2

1

1

0

0

-1

-1

Total Ex. Motor Vehicles

-2 Oct-07

Dec-07

Feb-08

Apr-08

-2 Jun-08

Aug-08

O ct-0 8

*Seasonally Adjusted data; Source: Statistics Canada/Haver A nalytics

as the nominal headline number. In the months ahead, we expect Canadian consumers to retrench spending even further as the global economic recession intensifies. Millan Mulraine 416-308-2911

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U.S. Housing Starts - December U.S. HOUSING STARTS

Release Date: January 22/09 November Result: 625K TD Forecast: 600K Consensus: 610K

1,200

Thousands of units*

1,100

The U.S. housing market correction has clearly taken a dramatic turn for the worse in November with housing starts plunging by its largest margin this cycle. And with the U.S. economic recession appearing to have intensified during the last quarter, housing market activity is expected to remain dismal for some time to come. In December, we expect housing starts to plunge a further 4% M/M, with new residential construction falling to a record low of 600K. Both single-unit and multi-unit construction should decline. In the months ahead, we expect new residential construction to moderate even further as the drag from a worsening domestic economy, tighter lending conditions and the massive overhang in inventories continue to temper new building activity.

1,000

900

800

700

600 Nov-07

Jan-08

Mar -08

May-08

Jul-08

Sep-08

N ov-08

*Seasonally adjusted at annual rates; Source: U.S. Census

Millan Mulraine 416-308-2911

Canadian CPI - December CANADIAN CONSUMER PRICE INDEX (CPI)

Release Date: January 23/09 November Result: core 0.7% M/M, 2.4% Y/Y; all-items -0.3% M/M, 2.0% Y/Y TD Forecast: core -0.5% M/M, 2.3% Y/Y; all-items -1.1% M/M, 0.7% Y/Y

3.5

3.5

CPI: All Items

Last month’s inflation report was a bit of a headscratcher, and in our view it was at odds with the growing economic slack evident in the Canadian economy. With the economy appearing to have weakened even further in the latter part of Q4, and energy prices plunging at a double-digit clip in December, we expect consumer prices to ease dramatically. In particular, our call is for the headline consumer price index to fall by its largest margin on record, with a 1.1% M/M drop (both on a seasonally and nonseasonally adjusted basis). The annual rate of price inflation should also fall, declining to 0.7% Y/Y, which will be the lowest print on headline consumer inflation in just over two years. In terms of core inflation, we expect to see last month’s surge in core prices to begin unravelling in December, with the core consumer price index falling by 0.5% M/M (down 0.1% M/M on a seasonally adjusted

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Y/Y % change

3.0

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0 Bank of Canada Core CPI ex. 8 most volatile items & indirect taxes

0.5

0.5

0.0

0.0 Nov-07

Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

Source: Statistics Canada/Haver Analytics

basis), while the pace of annual core inflation should fall to 2.3% Y/Y. In the months ahead, with the Canadian economy expected to decline further, and commodity prices likely to remain soft, Canadian consumer inflation should continue to moderate. Millan Mulraine 416-308-2911 5

January 16, 2009

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RECENT KEY ECONOMIC INDICATORS January 12 - January 16, 2009 Release Date

Economic Indicators

Data for Period

Units

Current

Nov. Nov. Nov.

M/M % chg. $C, blns M/M % chg.

-0.3 1.3 -7.0

-0.4 3.8 -0.9

Nov. Dec. 11-Jan 9-Jan Dec. Dec. Dec. Nov. Dec. Dec. 10-Jan 3-Jan Jan. Dec. Dec. Dec. Dec. Nov. Dec. Dec. Jan.

US$, blns US$, blns Index % change Y/Y % chg. % change % change % change Y/Y % chg. Y/Y % chg. Thousands Thousands Index Index Y/Y % chg. Y/Y % chg. Index US$, blns Y/Y % chg. Percent Index

-40.4 -83.6 -49.0 15.8 -9.3 -2.7 -3.1 -0.7 -0.9 4.3 524 4497 -22.2 -24 0.1 1.8 216.8 56.8 -2.0 73.6 61.9

-57.2 48.3 -49.0 -8.2 -6.7 -1.8 -1.6 -0.6 0.4 4.2 467 4611 -26 -33 1.1 2.0 216.8 286.3 -0.6 75.4 60.1

Prior

Canada Jan. 12 Jan. 13 Jan. 15

New Housing Price Index International Merchandise Trade New Motor Vehicle Sales

R R

United States Jan. 13 Trade Balance Jan. 13 Monthly Budget Statement Jan. 13 ABC Consumer Confidence Jan. 14 MBA Mortgage Applications Jan. 14 Import Price Index Jan. 14 Advance Retail Sales Jan. 14 Advance Retail Sales Less Auto Jan. 14 Business Inventories Jan. 15 Producer Price Index Jan. 15 Producer Price Index excluding Food and Energy Jan. 15 Initial Jobless Claims Jan. 15 Continuing Claims Jan. 15 Empire Manufacturing Index Jan. 15 Philadelphia Fed Index Jan. 16 CPI Jan. 16 CPI excluding Food and Energy Jan. 16 CPI - Core (SA) Index Jan. 16 TIC Flows Jan. 16 Industrial Production Jan. 16 Capacity Utilization Jan. 16 U. of Michigan Confidence Index Source: Bloomberg, TD Economics

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R

R R R

R R R R

R

January 16, 2009

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UPCOMING NORTH AMERICAN ECONOMIC CALENDAR January 19 - January 23, 2009 Release Date

Economic Indicators

Data for Period

Units

Consensus Forecast

Prior

Canada Jan 19

International Securities Transactions

Nov.

M/M % chg.

1.0

3

Jan. 20

Manufacturing Shipments

Nov.

M/M % chg.

-0.5

-0.5

Jan. 20

Bank of Canada Rate

Jan. 20

Percent

1.00

1.50

Jan. 21

Wholesale Sales

Nov.

M/M % chg.

--

-1.8

Jan. 22

Leading Indicators

Dec.

M/M % chg.

--

-0.7

Jan. 22

Retail Sales

Nov.

M/M % chg.

--

-0.9

Jan. 22

Retail Sales Less Autos

Nov.

M/M % chg.

--

-1.1

Jan. 22

Bank of Canada Monetary Policy Report

Jan. 23

Consumer Price Index (CPI)

Dec.

Y/Y % chg.

--

2.0

Jan. 23

Bank of Canada Core CPI

Dec.

Y/Y % chg.

--

2.4

Jan. 20

ABC Consumer Confidence

Jan. 18

Index

--

-49

Jan. 21

MBA Mortgage Applications

Jan. 16

% change

--

Jan. 21

NAHB Housing Market Index

Jan.

Index

9.0

15.8 9.0

Jan. 22

Housing Starts

Dec.

Thousands

610

625

Jan. 22

Initial Jobless Claims

Jan. 17

Thousands

553

524

Jan. 22

Building Permits

Dec.

Thousands

610

616

Jan. 22

Continuing Claims

Jan. 10

Thousands M/M % chg.

--1.2

4497

Nov.

United States

Jan. 22 House Price Index Source: Bloomberg, TD Economics

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G-7 ECONOMIC RELEASES AND EVENTS Time*

Country

Jan 19

4:45 8:30 18:50

EU-12 Canada Japan

Jan. 20

0:00 1:00 4:30 4:30 4:30 4:30 5:00 5:00 5:00 8:30 9:00 17:00 23:00

Japan Japan U.K. U.K. U.K. U.K. Germany Germany EU-12 Canada Canada U.S. Japan

Consumer Confidence Machine Tool Orders Consumer Price Index (CPI) Core CPI Retail Price Index Retail Price Index excl. Mortgages (RPIX) ZEW Survey - Economic Sentiment ZEW Survey - Current Situation ZEW Survey - Economic Sentiment Manufacturing Shipments Bank of Canada Rate Decision ABC Consumer Confidence Bank of Japan Monetary Policy Meeting

Jan. 21

0:00 0:00 2:00 4:30 4:30 7:00 8:30 13:00 18:50 22:00

Japan Japan Germany U.K. U.K. U.S. Canada U.S. Japan Japan

Leading Index CI Coincident Index CI Producer Prices Bank of England Minutes Jobless Claims Change MBA Mortgage Applications Wholesale Sales NAHB Housing Market Index Merchandise Trade Balance Total Bank of Japan Target Rate

4:00 5:00 6:00 8:30 8:30 8:30 8:30 8:30 8:30 8:30 10:00 10:30 18:50

EU-12 EU-12 U.K. Canada Canada Canada U.S. U.S. U.S. U.S. U.S. Canada Japan

ECB Publishes Monthly Report Industrial New Orders CBI Quarterly Industrial New Total Orders Leading Indicators Retail Sales Retail Sales Less Autos Housing Starts Initial Jobless Claims Building Permits Continuing Claims House Price Index Bank of Canada Monetary Policy Report Update All Industry Activity Index

Jan. 18 Nov. Jan. 22 Dec. Nov. Nov. Dec. Jan. 17 Dec. Jan. 10 Nov. Jan. 22 Nov.

0:00 2:45 2:45 3:00 3:00 3:30 3:30 4:00 4:00 4:00 4:30 4:30 7:00 7:00

Japan France France France France Germany Germany EU-12 EU-12 EU-12 U.K. U.K. Canada Canada

Bank of Japan Monthly Report Business Confidence Indicator Production Outlook Indicator Purchasing Managers Index (Manufacturing) Purchasing Managers Index (Services) Purchasing Managers Index (Manufacturing) Purchasing Managers Index (Services) Purchasing Managers Index (Manufacturing) Purchasing Managers Index (Services) Purchasing Managers Index (Composite) GDP Retail Sales Consumer Price Index (CPI) Bank of Canada Core CPI

Jan. 22 Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Q4 Dec. Dec. Dec.

Jan. 22

Jan. 23

Economic Indicator/Event

Data for Period

Date

Units

Consensus Last Period Forecast

European Commission Releases Economic Growth Forecasts Nov. International Securities Transactions Nov. Tertiary Industry Index

M/M % chg. M/M % chg.

1.0 --

2.9 0.4

Dec. Dec. Dec. Dec. Dec. Dec. Jan. Jan. Jan. Nov. Jan. 20 Jan. 18

Index Y/Y % chg. Y/Y % chg. Y/Y % chg. Y/Y % chg. Y/Y % chg. Index Index Index M/M % chg. Percent Index

27.5 -2.6 1.3 0.8 2.4 -43.1 -71.5 -46.0 -0.5 1.00 --

28.7 -71.9 4.1 2.0 3.0 3.9 -45.2 -64.5 -46.1 -0.5 1.50 -49

Nov. Nov. Dec.

Index Index Y/Y % chg.

--4.2

81.5 94.9 5.3

Dec. Jan. 16 Nov. Jan. Dec. Jan. 22

Thousands % change M/M % chg. Index ¥, blns Percent

81.0 --9.0 -278.0 0.10

75.7 15.8 -1.8 9.0 -223.4 0.10

Y/Y % chg.

M/M % chg.

-20.0 ----610 553 610 --1.2

-15.1 --0.7 -0.9 -1.1 625 524 616 4497.0 -1.1

M/M % chg.

-2.2

-0.5

Index Index Index Index Index Index Index Index Index Y/Y % chg. Y/Y % chg. Y/Y % chg. Y/Y % chg.

71.0 -76.0 34.4 40.1 32.0 45.7 33.1 41.5 37.4 -1.4 1.5 ---

73.0 -73.0 34.9 40.6 32.7 46.6 33.9 42.1 38.2 0.3 1.5 2.0 2.4

M/M % chg. M/M % chg. M/M % chg. Thousands Thousands

* Eastern Standard Time; Sources: Bloomberg, TD Economics

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This report is provided by TD Economics for customers of TD Bank Financial Group. It is for information purposes only and may not be appropriate for other purposes. The report does not provide material information about the business and affairs of TD Bank Financial Group and the members of TD Economics are not spokespersons for TD Bank Financial Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise TD Bank Financial Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.

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