#MacroMemo January 28 - February 1,2019 | Shutdown | Boomerang effect | Data stew | Central banks | Cdn insolvencies

Feb 04, 2019 | Eric Lascelles


Shutdown on hiatus:

  • The U.S. government shutdown is now over, at least temporarily, after a record-setting 35 days of paralysis.
  • The primary issue is not yet permanently resolved, however. In fact, it is not resolved at all. The announced three-week reprieve is merely meant to allow more time for negotiations. Neither party has changed their stance, though expectations are that the Republicans and President Trump may ultimately be the ones to make concessions on their demand for border funding, given that the public is disproportionately blaming them for the dispute.
  • Estimates vary widely as to the economic damage done by the shutdown. Our figures are toward the high end of the range. Nevertheless, we imagine no more than a 0.25% upfront hit to annual GDP, with some of that subsequently recovered. While idled workers will receive all of their back pay, this does not restore the lack of output by those workers in the meantime.
  • Coincidentally, we had previously budgeted for U.S. public policy to add around 0.2% to the level of 2019 GDP. As such, the shutdown has arguably just eaten through that remaining scrap of stimulus.
  • Until recently, we were concerned that U.S. payrolls might announce a net job loss in January due to the shutdown. This is no longer an issue, in part because the shutdown itself has ended, and in part because Congress passed a law guaranteeing back-pay for affected workers. This resolved the technical definition of whether they were employed in January – they were. Either development would have been enough to avoid having the furloughed workers appear as unemployed.
  • A great deal of economic data was not released during the shutdown. This will be addressed over the coming days, culminating in a Q4 GDP release later in the week (discussed below).

Boomerang effect:

  • Economic weakness hurt financial markets at the end of 2018. The question now is the extent to which that financial market suffering could, in turn, spook the economy.
  • We have been watching confidence metrics for clues. So far, the evidence suggests some damage was done, but that confidence has not collapsed.
  • Of the two U.S. consumer confidence metrics, the U. Michigan version has now fallen to its lowest level since 2016 (though still well above recessionary levels). At the same time, the Conference Board version has fallen, but isn’t even at its lowest level of the past year.
  • For businesses, the ISM Manufacturing index fell sharply from 59 to 54 last month (though it represents a blurry mix of activity and expectations). Meanwhile the National Federation of Independent Business (NFIB) small business confidence measure has fallen to its lowest level in more than a year, but in line with the norm of the prior several years.
  • The National Association of Home Builders (NAHB) metric of homebuilder confidence has fallen sharply and is at its lowest since 2015. But this likely has as much to do with higher borrowing costs and decelerating home sales as stock market volatility.
  • Again, there is no evidence of collapse here. However, they are all down from late-2018 levels, and most of these measures have not yet published a January reading. This leaves open the possibility of a further decline.

Data stew:

  • The Eurozone composite PMI fell again, to just 50.7 in January. This is down from nearly 60 a year ago. For context, 60 is a fabulous level, while 50 is the separator between expansion and contraction. Thus, it has been quite a descent. While we believe it is U.S. growth that should theoretically be pulled down closer to that of the rest of the developed world in 2019, it is undeniable that, so far, the greatest deceleration has occurred elsewhere.
  • The January U.S. ISM Manufacturing report will be published later this week, having already fallen by a large 5 points to 54 in December. The consensus is currently for a roughly unchanged print in January. On the one hand, the stock market has since partially rebounded and the prior drop was unexpectedly large, suggesting room for a partial retracement. On the other hand, global growth is actively slowing and the December reading may not have fully captured the pain of the stock market’s late-December theatrics. We look for a below-consensus reading.
  • The January U.S. payrolls report is expected to come in at +185K net new jobs, substantially down from the +301K generated in December, but still good by any reasonable standard. There is no evidence of significant layoffs occurring, with jobless claims coming in at a rock-bottom 199K last week. Hiring was likely somewhat cooler, though, translating into a sub-200K performance.
  • U.S. Q4 GDP is forecast to rise by 2.6% annualized according to the Bloomberg consensus, and by 2.7% according to the Atlanta Fed nowcast. These are essentially the same number, confirming the notion that U.S. growth is indeed cooling after big +3.4% and +4.2% quarters. A less favourable inventory environment may contribute to the slowdown.
  • Canadian monthly GDP for November is forecast to shrink outright, taking the annual rate of GDP growth down from 2.2% to just 1.6%. All of this is consistent with our leading indicator, which points to decelerating activity, and with our view that headwinds associated with oil, competitiveness and housing are beginning to restrict Canadian growth.

European Central Bank (ECB) review:

  • Notwithstanding the official end of quantitative easing at the close of 2018, the ECB delivered a dovish message at its meeting last week, acknowledging that “risks have moved to the downside.”
  • Although its growth forecasts are unchanged for the moment, there seems a high probability that these figures will have to be revised down at the next opportunity, particularly given the recent Eurozone PMI reading.
  • There remains much debate around when the ECB will deliver its first rate increase. What was once expected to be an early-fall proposition has now drifted into 2020. The market now prices in slightly less than a 50% chance of a rate increase before the end of 2019, and let us acknowledge that a fraction of such pundits argue for an increase not because the economy needs bridling, but for the opposite reason: because banks struggle in a negative-rate environment.


Fed ahead:

  • As of 2019 and beyond, all Fed meetings are now theoretically “live”, in the sense that all will be accompanied by a press conference. However, there is still a subtle hierarchy to the meetings, with the March/June/September/December confabs still slightly more important by virtue of the official forecast updates that accompany them.
  • For this Wednesday January 30th, no rate increase is likely from the current 2.375% level. In fact, the market has its doubts about any rate increases at all in 2019. We agree that too much was priced in last fall, though possibly the market has now overshot too far in the opposite direction. The Fed would still like to sneak in a rate hike should the opportunity present itself, though it is decreasingly likely that the timing will be in the first half of the year.
  • Potential changes to the accompanying statement could include a tempering of the references to a “strong” economy, and inflation expectations may also be acknowledged as lower than before.
  • With regard to the Fed balance sheet, half a trillion dollars have already been worked off, taking the size from a peak of $4.5T to $4.0T today. While the end point is not crystal clear, the talk is increasingly that $3.5T could constitute a natural floor, as opposed to counterarguments that run as low as $2.5T. Given the current rate of $50B in net maturities per month, the process of quantitative tightening could conceivably be done before 2019 is over. Whereas the pace of rate hikes seems highly flexible as per the needs of the U.S. economy, quantitative tightening is currently envisioned as a more mechanical process.


Canadian consumer bankruptcies:

  • The Canadian economy appears to be slowing. Canadian consumers deserve particular attention as they grapple with higher borrowing costs, high household debt, a relatively low savings rate and recent housing market wobbles.
  • We have taken to watching the household insolvency data for any evidence of distress (see the chart, below).
  • On the surface, at least, all is well given a low (and recently flat) personal bankruptcy rate.
  • However, this masks a second metric – the insolvency proposal rate – which is actively rising, and now nearly three times higher than it was a decade ago (surprisingly, a moment when overall economic distress was itself quite elevated). Over the past year alone, Canada’s insolvency proposal rate has risen by a significant 12%.
  • What to make of this?
  • The declining bankruptcy rate may be partially structural in nature. Before bankruptcy is declared, the debtor and creditors attempt to negotiate a deal to partially repay the owed money. Only when this attempt fails is bankruptcy the natural recourse. It appears that such deals have become increasingly common over time. This in itself is arguably good news, as it avoids the more chaotic bankruptcy outcome.
  • However, the fact that household insolvency proposals continue to rise argues that more Canadians are struggling to service their debt. And the fact that the rate of household loan growth has recently decelerated to its slowest pace in several business cycles would suggest that lenders are well aware of this development.

Canadian household insolvencies

Note: As of Nov 2018. Source: Industry Canada, RBC GAM