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  1. 1. DECEMBER 3, 2010FEATURE ARTICLE, PAGE 710 Fabulous Factsfor the Festivities• U.S. and Canadian job reports disappoint• Stress in Europe rises, but tempered by ECB peripheral bond purchases• China to shift to a more ‘prudent’ monetary stance; Brazil lifts reserve requirements; Thailand tightens
  2. 2. Our Thoughts Eurozone Debt Crisis Will Continue There is nothing surprising about the Eurozone debt crisis. It was always known that the Eurozone could not function properly unless fiscal policies in each of the member countries were coordinated; but, without giving up domestic sovereignty, that was nearly impossible. A Brief History To address this issue, the European Union members agreed to the Maastricht Treaty in 1993, creating the so-called convergence criteria. Member inflation and interest rates were to be maintained within a fairly tight range, budget deficits were to be no higher than 3% of GDP and debt-to-GDP ratios were to be no higher than 60%. A key objective of EU was the establishment of “social and economic cohesion among the diverse regions and countries of the community.” A Cohesion Fund was created in 1994 to provide less-developed regions with financial aid to comply with the convergence criteria. The Cohesion countries were none other than Greece, Ireland, Portugal and Spain—the very countries under financial distress today.1 Once the two largest countries in the Eurozone, Germany and France, transgressed the hallowed deficit ceiling in 2001 and 2003 without serious disciplinary action by the European Commission, it was clear that the convergence criteria would not be enforced upon the smaller countries. Today Even before the credit crisis and ensuing recession, Greece was in trouble. The actions taken by the EMU and IMF to bail out Greece have bought some time, but the enforced fiscal restraint will deepen Greece’s economic contraction and ultimately force debt restructuring. The notion that investors in Greek bonds will suffer no haircut or restructuring is simply unrealistic. The crisis entered a new phase with the highly predictable financial crisis in Ireland. By guaranteeing their banks’ liabilities in 2008, the Irish government took on the debt of the private sector, debt that was far too large and risky for the government to guarantee. So now we have a sovereign and bank debt crisis in the Eurozone. Details of how the EU would deal with future troubled EU members was uncertain following the Greek bailout, as most EU officials claimed to have created a firewall. Last week’s agreement by European governments to bail out Ireland and set up a permanent rescue fund has left investors cold. Germany and others hoped the market fears would diminish with the creation of a permanent facility, the European Stability Mechanism 1 Eleven Euroland countries were deemed compliant to join the EMU at the beginning (1999): Spain, Portugal, Italy, Belgium, the Netherlands, Luxembourg, France, Germany, Austria, Ireland and Finland. Four Euroland countries remained out of the Union for different reasons: Greece, United Kingdom, Denmark and Sweden. Greece and Sweden were non-compliant and the U.K. and Denmark opted out after domestic referenda were defeated. Greece joined in 2001, having been deemed to meet the convergence criteria. Euro banknotes and coins were introduced in 2002, Slovenia joined in 2007, Cyprus and Malta joined in 2008 and Slovakia joined in 2009.PAGE 2 – FOCUS – DECEMBER 3, 2010
  3. 3. Our Thoughts (ESM), that will replace the temporary European Financial Stability Facility (EFSF)—set up in May following the Greek bailout—when it expires in mid-2013. Investors have good reason to suspect that Ireland’s bailout has not solved the country’s mess. It is very uncertain whether the country’s politicians will be able to impose the fiscal austerity that is required and it could cause huge out-migration and a terrible economic slide, rendering Ireland unable to service its debt. Ireland’s biggest problem is the insolvent banks. They should have allowed the banks’ senior bondholders to take the hit, but the IMF and the EU feared the contagion it would cause for other banks, particularly those in Europe, so now the Irish taxpayers bear the unwieldy burden. The EU says it does not plan to impose haircuts on investors in existing sovereign bonds. However, defaults will not be taboo under the ESM. Standardized and identical ‘collective action clauses’ will be included in the terms and conditions of all new Eurozone government bonds starting in June 2013. This will allow haircuts to become standard in the resolution process of distressed sovereign debt issued after mid-2013. So it makes sense to demand higher yields on some Eurozone governments’ debt. It is questionable whether the funds that have been committed to the EFSF so far will be sufficient to successfully resolve all of the bailouts yet to come. Portugal appears to be next, which is small enough to be manageable, but if the crisis spreads further, requiring the bailout of Spain, not to mention Italy or Belgium, it would require a far more substantial commitment of resources by the stronger European countries, especially as the fund would shrink by the size of the reneged allotments of the distressed countries. Essentially, the ECB must step up its purchases of troubled countries’ sovereign debt. The central bank has already supported the zone’s troubled banks with its liquidity facilities; and it created a scheme to buy sovereign bonds to calm markets back in May. The hawkish ECB likes neither and has been keen to stop. It still refuses to engage in quantitative easing to support the economy and the Germans continue to suggest that QE would create inflation risks, but the ECB has toned down its rhetoric this week leaving its options open. Trichet is already beginning to engineer a back- door bailout by buying troubled debt. As well, to restore confidence, the EFSF is likely to need a top up of about €140 billion, especially if both Portugal and Spain need a bailout. By most calculations the EFSF, could lend at most €250 billion and still maintain a AAA credit rating. Politically, however, topping up the fund is a non-starter as German anger against contributions to Eurozone bailouts is already red hot. A greater fiscal union is likely the only sustainable solution. The Eurozone countries could issue common bonds, which would lower the borrowing costs of the peripheral countries. Of course, it would raise borrowing costs for Germany and so far Berlin has ruled out Eurobonds and Paris is only lukewarm on the idea. Bottom Line: While Berlin insists that national governments should bear responsibility for their own budgets and tax policy, the bailouts and the rescue fund take the Eurozone closer to an integrated fiscal policy. Right now, there is a huge commitment to the continuation of the Eurozone. While things are tough, they would be much worse if the Eurozone broke up—at least at the moment, that is the sentiment.PAGE 3 – FOCUS – DECEMBER 3, 2010
  4. 4. Our Thoughts Just as it looked like the U.S. growth party was finally starting to warm up, the ever-obnoxious payroll report had to go and fall face first into the punch bowl. The results were not an unmitigated disaster, as private sector employment did rise (albeit by a sluggish 50k), there were upward revisions to the two prior months and hours worked were up. However, DOUGLAS PORTER the overall tone was surprisingly soft, with the household report piling on with a second straight month of reported job losses and a nasty two-tick back-up in the unemployment rate to 9.8%. (The 2.2 percentage point gap between the U.S. and Canadian jobless rate of 7.6% last month was the second widest on record, topped only by a 2.3 point spread in April 1975. And, measured on an apples-to-apples basis, Canada’s rate is now a full 3 percentage points below the U.S.) What made the payroll report an especially bitter tonic was the fact that markets had been treated to a steady stream of upbeat data this week, which hinted heavily that the U.S. economy was gathering some serious momentum. The ISM for manufacturers stayed strong at 56.6, auto sales were up 13% y/y at 12.3 million units, chain stores reported gains of almost 6% y/y, consumer confidence improved markedly, and even the sad-sack housing sector showed a nice 10% pop in pending home sales for the previous month. Adding to the mystery, even other recent job indicators had taken a turn for the better, with the ADP report showing its best gain in three years and jobless claims trends steadily improving. At the risk of pandering to an optimistic bent, one thus has to wonder aloud if the payroll figure is a rogue result. Still, it’s the most detailed report we have on hand for the U.S. economy in November, and it’s not pretty. The smashing of the punchbowl at least made sure that some guests didn’t over imbibe. Bond yields were starting to rollick, with the 10-year Treasury pushing above the 3% threshold for the first time since July at one point this week, while oil seemed to be making a bee-line for the $90 level. The payroll report made quick work of those trends, although yields still finished higher on the week (despite a 10-bp plunge post payrolls) and the CRB still rose 4% this week to almost a two-year high. The upswing in commodities helped propel the TSX to its highest level in more than two years, despite generally disappointing Q4 results from the banks. This week’s Canadian data told a tale of two economies. In Q3, final domestic demand expanded at a 3.8% annual rate, actually up from 3.5% in Q2. Importantly, the economically-critical growth handoff from housing and governments (combined -0.3% in Q3 vs. +2.0% in Q2) to consumers and businesses (4.3% vs. 3.9%) is unfolding. With respect to MICHAEL GREGORY the latter, machinery and equipment outlays increased nearly 29% annualized in Q3, comparable to Q2’s near-33% pace, as the economically-critical productivity drive is also unfolding. These are all favourable developments. We even got news out of Ottawa that already-allocated stimulus funds will continue to flow past their March 2011 expiry until October, so the inevitable contraction in government spending, of the likes not seen since the “hell or high water” days of the mid-1990s, will not occur as abruptly as first believed.PAGE 4 – FOCUS – DECEMBER 3, 2010
  5. 5. Our Thoughts However, overall GDP growth slowed to 1.0% in Q3 from 2.3% in Q2, as a contraction in net exports lopped 3.4 and 3.9 percentage points, respectively, from headline growth (FYI: inventories and statistical discrepancy make up the difference). Such is the legacy of sluggish U.S. sales and a lofty loonie. This legacy was also evident in November’s Labour Force Survey, with manufacturing jobs falling 28,600 (-1.6%). This pulled down the share of factory jobs to a record-low 10.0% of total employment, which is probably poised for single digits. The fact that a net 15,200 jobs were still created in the month is commendable, even if they were the part-time/public-sector variety. Of course, more than manufacturing jobs are affected by sluggish U.S. sales and a lofty loonie, so as the net export drag has intensified, average monthly job growth has slowed from more than 50,000 in the first half of the year to less than 10,000 so far in the second half. In the tug of war between the external and internal economic forces, the former seems to be winning, which is why the Bank of Canada paused in October and why they will continue to pause next week and for the foreseeable future. After another valiant attempt this week, the Canadian dollar couldn’t quite crack the parity barrier, knocked back by either US$ safe-haven buying, Canada’s burgeoning trade deficit or disappointing economic news. Because of trade, the economy nearly stalled in Q3, meaning the Bank of Canada could stay in park for a while. The record merchandise trade gap, SAL GUATIERI which comes despite lofty resource prices (though it would help if natural gas at least made an appearance at the commodities party), largely reflects two things. Firstly, final domestic demand grew twice as fast in Canada as in the U.S. in the past year, largely because Canadians are still racking up debt, while Americans continue to do penance for their credit-party sins. At some point—given how quickly household debt ratios are converging in the two nations—consumer spending patterns will also converge, with Canadians living more within their means and Americans opening their wallets a little wider. Indeed, the recent pickup in U.S. consumer spending will go some way toward curbing the deterioration in Canada’s trade balance—but not all the way. This is because the second main driver of the trade deficit is the strong loonie, up 5% against the greenback this year. The Bank of Canada’s exchange rate equation, as well as competitiveness metrics such as labour productivity (higher and rising faster in the U.S.) and consumer prices (higher and rising faster in Canada), suggest the currency is at least moderately overvalued. Unless Canadian businesses become more productive or find new ways to shave costs and prices, the loonie will probably weaken in the long run. Of course, that doesn’t mean it can’t strengthen before “we are all dead”, so long as capital movements dominate trade flows. Despite the economy’s recent soft patch, it’s still a good bet that the Bank will resume raising rates well before the Fed reverses gears, as the U.S. economy has much greater slack and disinflationary pressure than Canada’s economy. The widening rate spread should draw more capital to Canada, thereby hauling—and holding—the loonie above parity in 2011. A stronger loonie is an inevitable side-effect of the deep scars etched into the U.S. economic landscape by the Great Recession.PAGE 5 – FOCUS – DECEMBER 3, 2010
  6. 6. RecapJennifer Lee, Senior Economist GOOD NEWS BAD NEWS CANADA Employment +15,200 (Nov.)—but details weak Real GDP slowed to +1.0% a.r. (Q3)CANADA Jobless Rate -0.3 ppts to 7.6% (Nov.) Real GDP at Basic Prices -0.1% (Sep.)• No rush for BoC to tighten Auto Sales+13.6% y/y (Nov.) Current Account Deficit widens to a record $70.1 bln a.r. (Q3) Industrial Product Prices +0.5%; Raw Material Prices +1.7% (Oct.) U.S. Private Sector Nonfarm Payrolls +50,000 (Nov.)— Jobless Rate +0.2 ppts to 9.8% (Nov.)UNITED STATES but slowest increase in 10 months S&P Case Shiller House Prices -0.8% (Sep.)• Disappointing nonfarm Conference Board’s Consumer Confidence Index Manufacturing PMI -0.3 pts to 56.6 (Nov.) payrolls offset better-than- +4.2 pts to 54.1 (Nov.) Factory Orders -0.9% (Oct.) expected data seen earlier in Chain-Store Sales +5.8% y/y (Nov.) the week, including strong Initial Claims +26,000 to 436,000 (Nov. 27 wk) Pending Home Sales +10.4% (Oct.) Black Friday/Cyber Monday results Nonmanufacturing ISM +0.7 pts to 55.0 (Nov.)• November jobs report supports Redbook +0.6% (Nov. 27 wk) Fed Chairman Bernanke Chicago PMI +1.9 pts to 62.5 (Nov.) warning of the “obviously very Construction Spending +0.7% (Oct.) severe economic and social Nonfarm Productivity revised up to +2.3% a.r. (Q3) consequences” of long-term unemployment Auto Sales +12.9% y/y (Nov.)JAPAN Capital Spending +5.0% y/y (Q3) JAPAN Retail Sales -1.9% (Oct.) Household Spending -0.4% y/y (Oct.)• Bad start to Q4 Jobless Rate +0.1 ppts to 5.1% (Oct.) Manufacturing PMI +0.1 pts to 47.3 (Nov.) Industrial Production -1.8% (Oct. P) EUROPE Eurozone—Economic Confidence +1.5 pts to Eurozone—Consumer Prices +1.9% y/y (Nov.)EUROPE 105.3 (Nov.) Eurozone—Producer Prices +0.4% (Oct.)• Ireland becomes the 2nd Eurozone—Retail Sales +0.5% (Oct.) Eurozone—Jobless Rate +0.1 ppts to 10.1% (Oct.) member state of the Eurozone Germany—Unemployment -9,000 (Nov.) Italy—Jobless Rate +0.3 ppts to 8.6% (Oct.) to be bailed out Germany—Retail Sales +2.3% (Oct.) U.K.—GfK Consumer Confidence -2 pts to -21 (Nov.)• ECB fails to announce a Italy—Producer Prices -0.2% (Oct.) U.K.—Nationwide House Prices -0.3% (Nov.) massive bond buying program but continues to provide U.K.—Manufacturing PMI +2.6 pts to 58.0 (Nov.) U.K.—Services PMI -0.2 pts to 53.0 (Nov.) support to banking sector U.K.—M4 +0.7% (Oct.) BRICS AUSTRALIA Building Approvals +9.3% (Oct.) Real GDP slows to +0.2% q/q (Q3)AUSTRALIA Trade Surplus widens to A$2.6 bln (Oct.) Retail Sales -1.1% (Oct.)• RBA highly unlikely to move next week China—Manufacturing PMI +0.5 pts to 55.2 (Nov.) China—Services PMI -7.3 pts to 53.2 (Nov.)—BRICS India —Manufacturing PMI +1.2 pts to 58.4; a 9-month low• China signals tighter monetary Services PMI +3.9 pts to 60.1 (Nov.) stance next year India—Real GDP +8.9% y/y (Q3) Indications of stronger growth and a move toward price stability are good news for the economy.PAGE 6 – FOCUS – DECEMBER 3, 2010
  7. 7. Feature 10 Fabulous Facts for the Festivities Douglas Porter, CFA, Deputy Chief Economist We know how stressful this time of year can be. Between buying gifts, attending functions, deciding whether to tip the dog walker, and visiting family, there’s just no free time. On top of all of that, one is expected to be witty, entertaining and cutting edge at all gatherings. In our never-ending goal to make life easier for our customers, here’s a handy list of fun facts that you can deploy at your next party to surprise and impress your friends, assuming of course your friends are easily surprised and impressed by economic and financial data. 1) Canada and the U.S. had almost identical GDP growth rates this year, as they did in 2009 and as they likely will in 2011 (Chart 1). Despite Canada’s fabled stellar economic performance through this cycle, the economy just can’t pull away from the U.S., with Canada growing 2.9% this year and the U.S. by 2.8%, a difference that’s almost rounding error. Trade has been the CHART 1 great equalizer, sapping Canadian GDP by 2.5 percentage GDP GROWTH: THE SAME, BUT DIFFERENT points this year. For bonus points, mention that Germany (q/q % chng : a.r.) and Japan are in a horse race for the fastest G7 economy in Real GDP 2010, both headed for 3.5% GDP growth for the year. 8 Canada 2) Consumer discretionary stocks was the strongest sector in the S&P 500 this year, with a gain of nearly 4 25%. The U.S. consumer, all but written off for dead, U.S. 0 quietly staged a modest comeback this year, with personal consumption growing faster than overall GDP -4 08 09 10 11 in each of the past two quarters and likely to repeat that Canada 0.5 -2.5 2.9 2.4 U.S. 0.0 -2.6 2.8 2.3 trick in 2011. Bonus points for noting that U.S. household forecast debt as a share of income has now been carved to near -8 04 05 06 07 08 09 10 11 Canadian levels, and savings rates are consistently higher in the U.S. than Canada. Who are the spendthrifts now? CHART 2 2010 EQUITY MARKETS 3) Some of the strongest stock markets in the world (y-t-d % chng : as of December 3, 2010) were in peripheral Europe, by which we mean really peripheral (Chart 2). Sure, every one will realize that the Sri Lanka Estonia stock indexes of Greece, Spain and Ireland were Lithuania clobbered this year, but Sweden, Denmark, Ukraine, Denmark Germany Latvia, Estonia and Lithuania saw some of the heftiest Canada gains in the world (the latter two were up by more than S&P 500 60%). While the headlines were dominated this year by Ireland China Europe’s woes, investors still found lots of value in the Italy Continent. Bonus marks for pointing out that the German Spain DAX was the best-performing major market in the world, Greece though it couldn’t quite match the plus-90% gains in Sri -40 -20 0 20 40 60 80 100 Lanka, Bangladesh and Mongolia.PAGE 7 – FOCUS – DECEMBER 3, 2010
  8. 8. Feature 4) Silver prices have risen seven-fold against natural gas in the past five years (Chart 3). All the nattering nabobs will be talking about gold this holiday season, but it was silver that really stole the show in 2010, soaring more than 70%. At the back of the pack was natural gas, which sadly for Canada fell more than 20%. This extends a long-standing relative trend. In late 2005, it took less than 1 mmBTU of natural gas to buy 1 ounce of silver—it now takes 7 units of gas to buy that silver. Double bonus rewards for noting that mostly due to the weakness in natural gas prices, the Bank of Canada’s commodity price index actually fell this year (whereas the CRB was up more than 10%). 5) Vancouver saw the biggest increase in home prices among major Canadian cities this year. Tougher mortgage insurance rules, a 13% slide in sales in the city, a 13% rise in new listings this year, the new HST, a feature story in Business Week about how Vancouver was the last housing bubble in the world, a web site comparing million dollar homes in the city to crack houses… none of it mattered when stacked up against shrewd investors CHART 3 from China. The most expensive housing market in the HI-HO SILVER, AWAY FROM GAS country saw average prices gap up another 15% this (ratio) year. At one point, the average detached home in the city Silver / Gas Prices went for more than $1 million. Here on the rest of planet 8 Earth, Canadian home sales were basically flat on the 7 year, with a first-half surge giving way to a second-half 6 drop, while average prices nudged up 6% in 2010. 5 4 6) The US$ was basically flat this year. While many are 3 chattering about the U.S. debasing its currency, and 2 the wild overheated rhetoric of the currency war, the 1 US$ actually rose more than 3% in 2010 on a trade- 0 weighted basis against the major currencies (Chart 4). 00 01 02 03 04 05 06 07 08 09 10 11 Much of this was simply the flip side of a weak euro, but even the broad trade-weighted US$ index was CHART 4 nearly flat, despite strength in many emerging market CURRENCY BORES currencies. Bonus points for noting that the US$ has (as of December 2, 2010) risen over the past three years on a trade-weighted Broad Trade-weighted US$ Feb ’02 2010 basis. Some debasement. % Chng (vs US$) to Present Y-T-D 140 forecast February 27, Japanese Yen 60.5 10.9 2002 Peak 7) The Japanese yen was the strongest currency in the 130 Australian $ 89.2 8.7 world this year. Japan has some of the ugliest Mexican Peso -26.1 6.3 120 March 9, demographics, a massive government debt load, 2009 Canadian $ 60.2 4.9 decades of deflation, a central bank that intervened to 110 Swiss Franc 72.2 4.3 undercut the currency, was the only major economy to Chinese Yuan 24.2 2.5 Trade-weighted US$ -22.7 -1.0 cut interest rates this year and sports bond yields of 100 July 15, 2008 Trough UK Pound 10.2 -3.5 little more than 1%. No worries, buy the yen. The yen 90 Euro 53.0 -7.7 was supported by the fact that gun-shy domestic 00 02 04 06 08 10 savers seem uninterested in investing abroad, limitingPAGE 8 – FOCUS – DECEMBER 3, 2010
  9. 9. Feature capital outflows to a trickle. Meanwhile, China was an CHART 5 active investor in Japanese bonds this year, effectively U.S. BORROWING COSTS: SUB-ZERO making Japan do some of the dollar buying for them. United States (percent) 8) Some U.S. interest rates turned negative this year, 5-year Treasury Yield notably 5- and 7-year TIPS. The plunge in nominal 3.0 Treasury bond yields during the late summer, in 2.5 anticipation of QE2, was accompanied by a slight back- 2.0 Nominal up in inflation expectations. The net result was a deep 1.5 dive in real yields (even Canadian 10-year real return 1.0 bond yields fell to 1% at one stage). While yields edged 0.5 Real higher late in the year, one still has to pay the U.S. 0.0 government for the privilege of holding their inflation- -0.5 protected securities for five years (Chart 5). 09 10 9) Newfoundland did not have the highest unemployment rate in the country, at least for one CHART 6 month this year, for the first time in more than a PASSING THE BATON decade. (PEI’s jobless rate was higher in September.) (mlns : 3-mnth m.a. : a.r.) The easternmost province also boasted the fastest Auto Sales growing economy in the country this year at 4% and 20 was one of only two provinces with a budget surplus China this year. While your friends are still reeling from those factoids, point out that Ontario’s jobless rate is now 15 not only higher than in Quebec, but for a spell it was U.S. higher than both Nova Scotia and New Brunswick. The 10 biggest have-not province also has the biggest budget Crossover deficit, even as a share of GDP, at 3.1%. For bonus points, note that Saskatchewan will have the lowest 5 05 06 07 08 09 10 11 average unemployment rate this year and will post the other budget surplus—they may have lost the Grey Cup, but they’re winning the economic stakes. 10) There were more Buicks sold in China than in the U.S. this year. The fact that China surpassed the U.S. as the world’s largest auto market is so last year’s news (Chart 6). In fact, China now sells more cars than the U.S., Canada and Mexico combined. The most light vehicles ever sold in a single year in the U.S. was 17.3 million in 2000, a level China is on pace to surpass. Not surprisingly, China is now the biggest energy consumer in the world, and is the world’s fifth largest oil producer. And in another measure of how the BRICs now dominate, Russia is again the world’s largest oil producer and Brazil has not only surpassed Venezuela, but will soon be the biggest oil producer in Latin America (ahead of Mexico).PAGE 9 – FOCUS – DECEMBER 3, 2010
  10. 10. Economic Forecast 2010 2011 ANNUAL CANADA I II III IV I II III IV 2010 2011 2012 Real GDP (q/q % chng : a.r.) 5.6 2.3 1.0 2.3 2.5 2.7 3.0 2.8 2.9 2.4 2.7 Consumer Price Index (y/y % chng) 1.6 1.4 1.8 2.1 2.0 2.6 2.3 1.5 1.7 2.1 1.9 Unemployment Rate (%) 8.2 8.0 8.0 7.8 7.7 7.6 7.5 7.4 8.0 7.5 7.2 Housing Starts (000s : a.r.) 198 199 192 171 170 179 182 185 190 179 182 Current Account Balance ($blns : a.r.) -36.7 -51.9 -70.1 -69.2 -68.9 -68.4 -67.1 -67.6 -57.0 -68.0 -70.0 Interest Rates (average for the quarter : %) Overnight Rate 0.25 0.33 0.83 1.00 1.00 1.00 1.33 1.83 0.60 1.29 3.06 3-month Treasury Bill 0.19 0.41 0.70 0.94 0.99 1.00 1.33 1.83 0.56 1.29 3.06 10-year Bond 3.47 3.47 3.01 2.96 2.80 2.78 3.15 3.53 3.23 3.06 4.08 Canada/U.S. Interest Rate Spreads (average for the quarter : bps) 90-day 8 26 54 80 84 85 118 168 42 114 175 10-year -25 -2 22 25 25 22 13 3 5 16 -11 UNITED STATES Real GDP (q/q % chng : a.r.) 3.7 1.7 2.5 2.3 2.2 2.4 2.6 2.9 2.8 2.3 3.1 Consumer Price Index (y/y % chng) 2.4 1.8 1.2 1.1 1.0 1.5 1.4 1.2 1.6 1.3 1.5 Unemployment Rate (%) 9.7 9.7 9.6 9.7 9.7 9.6 9.5 9.3 9.7 9.5 8.8 Housing Starts (mlns : a.r.) 0.62 0.60 0.58 0.54 0.60 0.67 0.71 0.74 0.59 0.68 0.85 Current Account Balance ($blns : a.r.) -437 -493 -515 -516 -524 -517 -513 -524 -490 -520 -530 Interest Rates (average for the quarter : %) Fed Funds Target Rate 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 0.13 1.29 3-month Treasury Bill 0.11 0.15 0.15 0.14 0.15 0.15 0.15 0.15 0.14 0.15 1.32 10-year Note 3.72 3.49 2.79 2.72 2.55 2.56 3.03 3.49 3.18 2.91 4.19 EXCHANGE RATES (average for the quarter) US¢/C$ 96.0 97.3 96.3 98.6 99.4 99.9 100.8 102.0 97.1 100.5 101.2 C$/US$ 1.041 1.028 1.039 1.014 1.006 1.001 0.992 0.981 1.030 0.995 0.989 ¥/US$ 91 92 86 82 83 83 84 85 88 84 90 US$/Euro 1.38 1.27 1.29 1.36 1.30 1.26 1.28 1.33 1.33 1.29 1.30 US$/£ 1.56 1.49 1.55 1.58 1.54 1.51 1.53 1.58 1.55 1.54 1.57 Note: Blocked areas represent BMO Capital Markets forecasts Up and down arrows indicate changes to the forecastPAGE 10 – FOCUS – DECEMBER 3, 2010
  11. 11. Key for Next Week CANADA Douglas Porter, CFA, Deputy Chief EconomistBank of Canada Interest For the first time in six months, the upcoming Bank of Canada rate decision holds littleRate Decision suspense. There is no disagreement that the Bank will keep its key overnight lendingTuesday, 9:00 am rate unchanged at 1.0%, as it chose to do in October following a string of three 25 bpFinancial System Review rate hikes in the summer. Accordingly, all eyes will turn to the Statement, and theThursday, 10:30 am Bank’s take on recent developments. Arguing in favour of a relatively near-term return to rate hikes would be the underlying improvement in the U.S. economy, stronger commodity prices (notably oil and copper), and the latest uptick in core inflation to 1.8%. However, weighing in on the “on hold for a while” side would be the roiling turmoil in Europe and the surprisingly soggy Canadian GDP results for Q3 and September. We believe that the Bank can well afford to wait before tightening again, and maintain our view the next rate hike will not be until mid-2011. In a related note, the Bank will also release its semi-annual Financial System Review on Thursday. The main focus on this release will be the Bank’s comments on the state of household finances, an issue on which the BoC has raised some red flags recently. It would also be news if the FSR finds any other major vulnerabilities for the economy beyond Europe, of course.Housing Starts We will see a slew of housing-related indicators next week, which will likely driveWednesday, 8:15 am home the point that housing conditions continue to gradually recede. Housing startsNov. (e) 170,000 a.r. (+1.3%) have dropped heavily in recent months, falling 18% from the April peak of 205,600 Consensus 170,200 a.r. (+1.4%)Oct. 167,900 a.r. (-9.2%) units to October’s 167,900 level. Curiously, building permits have held up much betterNew Housing Price Index in recent months (though they likely sagged as well in October—data due onThursday, 8:30 am Monday), so we look for starts to nudge up to 170,000 units. That’s still well down fromOct. (e) +0.1 % +2.5% y/y the average level of around 190,000 for all of this year.Sep. +0.2% +2.7% y/y New home prices have started edging higher again, but we look for just a 0.1% rise in October. That would trim the annual pace to 2.5%, surprisingly close to underlying trends in the existing housing market.Merchandise Trade Balance Canada’s merchandise trade balance has sunk dramatically in recent months, with theFriday, 8:30 am deficit close to a record level in September at $2.5 billion (just $26 million away fromOct. (e) -$2.7 bln July’s all-time high). While exports have essentially moved sideways since the start of Consensus -$2.0 blnSep. -$2.5 bln 2010 (burdened by weak U.S. spending and a strong loonie), imports have continued to flare higher (juiced by solid Canadian spending and a strong loonie). We don’t look for much respite in October. Domestic auto production looks to have dropped again in seasonally adjusted terms, and domestic demand was still rolling. One offset may have been a small upswing in commodity prices, after a three-month slide. Even so, we look for the trade gap to widen to a new record high of $2.7 billion. Trouble? Maybe.PAGE 11 – FOCUS – DECEMBER 3, 2010
  12. 12. Key for Next Week UNITED STATES Sal Guatieri, Senior EconomistTrade Deficit The U.S. trade deficit is expected to narrow for a second straight month (to $43 billion)Friday, 8:30 am in October, reversing a 1½-year long upward trend. While imports should bounce backOct. (e) $43.0 bln from the previous month’s decline, exports likely rose faster on the back of a weaker Consensus $43.8 blnSep. $44.0 bln greenback. After carving nearly two percentage points from Q3 GDP growth, trade should leave a more neutral impression in Q4. The smaller trade deficit will help stabilize the current account shortfall, which likely rose for the fifth straight quarter to $515 billion annualized in Q3, or 3½% of GDP. The latter figure is up from 2.7% in 2009 but down from the record annual shortfall of 6.0% in 2006. Though still in the range of sustainability for external finances, the twin trade and budget deficits will likely remain a source of weakness for the greenback.PAGE 12 – FOCUS – DECEMBER 3, 2010
  13. 13. Financial Markets Update CHANGE FROM: (BASIS POINTS) DEC 3 * NOV 26 WEEK AGO 4 WEEKS AGO DEC. 31/09 Canadian Money Market Call Money 1.00 1.00 0 0 75 Prime Rate 3.00 3.00 0 0 75 U.S. Money Market Fed Funds (effective) 0.25 0.25 0 0 0 Prime Rate 3.25 3.25 0 0 0 3-Month Rates Canada 1.01 1.00 1 9 82 United States 0.14 0.15 -1 3 9 Japan 0.20 0.12 8 9 8 Eurozone 1.03 1.03 0 -2 33 United Kingdom 0.74 0.74 1 0 14 Australia 4.85 4.85 0 -1 83 Bond Markets 2-year Bond Canada 1.64 1.67 -4 16 16 United States 0.48 0.51 -3 11 -66 10-year Bond Canada 3.18 3.11 7 33 -43 United States 2.98 2.87 12 45 -86 Japan 1.21 1.20 1 27 -9 Germany 2.88 2.73 15 46 -51 United Kingdom 3.42 3.35 7 44 -60 Australia 5.47 5.49 -2 22 -18 Risk Indicators VIX 18.3 22.2 -3.9 pts 0.0 pts -3.4 pts TED Spread 16 14 2 -1 -4 Inv. Grade CDS Spread ** 92 96 -3 7 7 High Yield CDS Spread ** 474 518 -44 38 -42 Currencies (% CHANGE) US¢/C$ 99.49 97.91 1.6 -0.5 4.8 C$/US$ 1.005 1.021 — — — ¥/US$ 82.93 84.10 -1.4 2.1 -10.8 US$/Euro 1.3341 1.3242 0.7 -4.9 -6.8 US$/£ 1.567 1.559 0.5 -3.2 -3.1 US¢/A$ 98.58 96.45 2.2 -3.0 9.8 Commodities CRB Futures Index 313.65 301.13 4.2 0.0 10.7 Oil (generic contract) 87.93 83.76 5.0 1.2 10.8 Natural Gas (generic contract) 4.36 4.40 -0.8 10.8 -21.7 Gold (spot price) 1407.50 1363.75 3.2 1.0 28.3 Equities S&P/TSX Composite 13159 12893 2.1 1.8 12.0 S&P 500 1218 1189 2.4 -0.7 9.2 Nasdaq 2576 2535 1.6 -0.1 13.5 Dow Jones Industrial 11345 11092 2.3 -0.9 8.8 Nikkei 10178 10040 1.4 5.7 -3.5 Frankfurt DAX 6944 6849 1.4 2.8 16.6 London FT100 5755 5669 1.5 -2.1 6.3 France CAC40 3748 3729 0.5 -4.3 -4.8 S&P ASX 200 4694 4598 2.1 -2.2 -3.6 * as of 10:30 am ** One day delayPAGE 13 – FOCUS – DECEMBER 3, 2010
  14. 14. DECEMBER 6 – DECEMBER 10 Global Calendar MONDAY DECEMBER 6 TUESDAY DECEMBER 7 WEDNESDAY DECEMBER 8 THURSDAY DECEMBER 9 FRIDAY DECEMBER 10JAPAN Leading Index Current Account Surplus Real GDP Corporate Goods Price Index Oct. P (e) 97.3 Oct. ’10 (e) ¥1.5 trln Q3 F (e) +1.0% +4.1% y/y Nov. (e) +0.1% +1.0% y/y Sep. 98.6 Oct. ’09 ¥1.4 trln Q2 +0.4% +2.7% y/y Oct. +0.2% +0.9% y/y Trade Surplus Machine Tool Orders Consumer Confidence Oct. ’10 (e) ¥954 bln Nov. P Nov. Oct. ’09 ¥937 bln Oct. +71.0% y/y Oct. 41.1 Machine Orders Oct. (e) -0.1% +8.3% y/y Sep. -10.3% +4.2% y/y Bank Lending ex. Trusts Nov. Oct. -2.0% y/yEUROZONE GERMANY GERMANY GERMANY FRANCE Factory Orders Industrial Production Consumer Price Index Industrial Production Oct. (e) +1.9% +18.6% y/y Oct. (e) +1.0% +10.0% y/y Nov. F (e) +0.1% +1.6% y/y Oct. (e) +0.5% +5.5% y/y Sep. -4.0% +14.0% y/y Sep. -0.8% +7.9% y/y Oct. +0.1% +1.3% y/y Sep. +0.1% +5.1% y/y Trade Surplus Manufacturing Production Oct. (e) €15.1 bln Oct. (e) +0.4% +5.1% y/y Sep. €16.8 bln ECB Monthly Report Sep. -0.1% +4.9% y/y FRANCE ITALY Trade Deficit Trade Deficit Non-EU Real GDP Oct. (e) €4.2 bln Oct. (e) £8.1 bln £4.5 bln Q3 F (e) +0.2% +1.0% y/y Sep. €4.7 bln Sep. £8.2 bln £4.6 bln Q2 +0.5% +1.3% y/y Industrial ProductionU.K. Industrial Production Oct. (e) +0.8% +4.5% y/y Oct. (e) +0.3% +3.9% y/y Sep. -2.1% +4.1% y/y Sep. +0.4% +3.8% y/y Bank of England Monetary Policy Meeting (December 8-9) Manufacturing Production Producer Price Index—Output Oct. (e) +0.3% +5.4% y/y Nov. (e) +0.3% +4.0% y/y AUSTRALIA Sep. +0.1% +4.8% y/y Oct. +0.6% +4.0% y/y Employ- Jobless ment Rate Nov. (e) +20,000 5.2%OTHER AUSTRALIA CHINA Oct. +29,700 5.4% New Yuan Loans * CHINA Nov. (e) 500 bln Trade Surplus * Oct. 588 bln Nov. (e) $21.0 bln M2 Money Supply * Reserve Bank of Australia Monetary Oct. $27.2 bln Nov. (e) +19.0% y/y Policy Meeting BRAZIL Oct. +19.3% y/y Real GDP Property Prices * Q3 (e) +6.7% y/y Nov. (e) +8.0% y/y Q2 +8.8% y/y Oct. +8.6% y/y* date approximate
  15. 15. DECEMBER 6 – DECEMBER 10 North American Calendar MONDAY DECEMBER 6 TUESDAY DECEMBER 7 WEDNESDAY DECEMBER 8 THURSDAY DECEMBER 9 FRIDAY DECEMBER 10CANADA 8:30 am Building Permits Manpower Survey—Net Outlook 8:15 am Housing Starts 8:30 am New Housing Price Index 8:30 am Merchandise Trade Balance Oct. (e) -7.0% Q1 (e) +15% Nov. (e) 170,000 a.r. (+1.3%) Oct. (e) +0.1 % +2.5% y/y Oct. (e) -$2.7 bln Sep. +15.3% Q4 +15% Consensus 170,200 a.r. (+1.4%) Sep. +0.2% +2.7% y/y Consensus -$2.0 bln 10:00 am Ivey Purchasing Managers’ Oct. 167,900 a.r. (-9.2%) Sep. -$2.5 bln 9:00 am BoC Policy Announcement 10:30 am BoC Financial System Index Nov. (e) 55.0 Review Oct. 56.7 10:35 am 3, 6 & 12-month T-bill 12:05 pm 3-year bond auction auction $12.5 bln $3.2 bln (New cash -$2.5 bln) (New cash $3.2 bln) 2-year bond auction announcementUNITED STATES Manpower Survey—Net Outlook 8:30 am Initial Claims 8:30 am Goods & Services Q1 (e) +6% Dec. 4 (e) 425,000 (-11,000) * Trade Deficit Q4 +5% Nov. 27 436,000 (+26,000) Oct. (e) $43.0 bln 8:55 am Redbook 10:00 am Wholesale Inventories Consensus $43.8 bln Dec. 4 Oct. (e) +0.9% * Sep. $44.0 bln Nov. 27 +0.6% Sep. +1.5% 8:30 am Import Prices 3:00 pm Consumer Credit 12:00 pm Flow of Funds–Q3 Nov. (e) +0.8% * Oct. (e) -$1.0 bln * Oct. +0.9% Sep. +$2.1 bln 9:55 am Univ. of Michigan 5:00 pm ABC News Consumer Consumer Sentiment Comfort Index Dec. P (e) 72.0 * Dec. 5 Nov. 71.6 Nov. 28 -45 2:00 pm Budget Deficit Nov. ’10 (e) $130.0 bln * Nov. ’09 $120.3 bln 1:00 pm 30-year note auction 1:00 pm 3 & 6-month T-bill (reopening) $13.0 bln auction $57.0 bln 1:00 pm 3-year note auction (New cash for 10 and 30-year (New cash $1.0 bln) $32.0 bln 1:00 pm 10-year note auction auctions $57.0 bln) Fed to purchase $1.5-2.5 bln of Fed to purchase $6-8 bln of (reopening) $21.0 bln Fed to purchase $7-9 bln of Notes/Bonds (Aug. 2028-Nov. 2040) Notes/Bonds (Dec. 2014-May 2016) Fed to purchase $1-2 bln of TIPS Notes/Bonds (June 2016-Nov. 2017)* consensus ** date approximate Upcoming Policy Meetings Bank of Canada: Jan. 18, Mar. 1, Apr. 12 FOMC: Dec. 14, Jan. 25-26, Mar. 15
  16. 16. The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Bank of Montreal (“BMO”) and its affiliates make every effort to ensure that the contents thereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither BMO nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which may be contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to BMO and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting BMO or its relevant affiliate directly. BMO and/or its affiliates may make a market or deal as principal in the products (including, without limitation, any commodities, securities or other financial instruments) referenced herein. BMO, its affiliates, and/or their respective shareholders, directors, officers and/or employees may from time to time have long or short positions in any such products (including, without limitation, commodities, securities or other financial instruments). BMO Nesbitt Burns Inc. and/or BMO Capital Markets Corp., subsidiaries of BMO, may act as financial advisor and/or underwriter for certain of the corporations mentioned herein and may receive remuneration for same. “BMO Capital Markets” is a trade name used by the Bank of Montreal Investment Banking Group, which includes the wholesale/institutional arms of Bank of Montreal, BMO Nesbitt Burns Inc., BMO Nesbitt Burns Ltée/Ltd., BMO Capital Markets Corp. and Harris N.A., and BMO Capital Markets Limited. TO U.S. RESIDENTS: BMO Capital Markets Corp. and/or BMO Nesbitt Burns Securities Ltd., affiliates of BMO NB, furnish this report to U.S. residents and accept responsibility for the contents herein, except to the extent that it refers to securities of Bank of Montreal. Any U.S. person wishing to effect transactions in any security discussed herein should do so through BMO Capital Markets Corp. and/or BMO Nesbitt Burns Securities Ltd. TO U.K. RESIDENTS: The contents hereof are not directed at investors located in the U.K., other than persons described in Part VI of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. ™ - “BMO (M-bar roundel symbol) Capital Markets” is a trade-mark of Bank of Montreal, used under licence. © Copyright Bank of Montreal.PAGE 16 – FOCUS – DECEMBER 3, 2010