Despite all the hand ringing about America’s dire housing market and all of the cheering over Canada’s renewed resource wealth, first quarter real GDP growth actually came in at 1% q/q annualized in the US, but posted a decline of 0.3% in the great white north. This reversal of fortune was all the more surprising considering that during the first three months of the year the US economy shed 247K jobs, while Canada added over 100K new positions. As we approach the end of the second quarter this outcome is still quite puzzling, but there are growing signs that it may have been a temporary blip. As every investor knows, past performance may not be indicative of future results; and based on the ongoing strength of the Canadian labour market and the renewed strength in domestic demand, Canada’s first-quarter slide is unlikely to be repeated in 2008 or 2009. A slowdown in US growth is certainly squeezing Canadian merchandise trade activity, while a historically strong Canadian dollar is putting the squeeze on manufacturers, but as April’s wholesale and retail trade numbers show, a significant amount of first-quarter economic weakness may have been a function of an unusually harsh weather.
After all, the Canadian labour market is still strong and resource rents are flowing into the country at a prodigious pace. In his first speech since the Bank of Canada surprised markets by not lowering its overnight target rate, Governor Carney commented that resource gains may fuel inflation, but they also fuel domestic demand by boosting Canadians’ real income and wealth.
On the other hand, the growth picture in the US continues to be murkier notwithstanding Q1’s growth surprise and the ongoing strength in consumer spending. As this week’s data will highlight, the American real estate market is still in a downward spiral and consumers may only be temporarily buffered by billions of dollars in rebate cheques that began arriving in mail boxes in April and will stop in July. Add to that significant job losses, a deteriorating credit cycle, and the shock of rising energy prices that we believe will have more of an impact in 2009 than in 2008.
As we head into Wednesday’s FOMC rate announcement these are the serious economic risks that policymakers must contend with. Everyone expects the Fed to kick off a tightening cycle before it cuts rates again, but the question is precisely when.
This week saw the market scale back its expectations of a 25-bp rate hike at the Fed’s August meeting on the prompting of unnamed “senior Fed officials”. We believe that this is prudent considering the substantial economic problems that Chairman Bernanke must still manage. However, the Fed will continue to talk tough on inflation, and be ready to act even as the US economy remains sluggish heading into 2009.
