Financial News for the Week of October 9, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

United States

• Fiscal policy (or lack thereof) drove much of the news cycle this week. On the same day the Federal Reserve Chair made the case for more fiscal support, President Trump tweeted that negotiations were being cut off.
• Trump changed his mind later in the week, and talks appear to have restarted. Still a deal will require the support of Senate Republicans, and with just over three weeks until the election, time is running out.

 U.S. - Fiscal Deal or No Deal

It was a raucous week news wise and in financial markets. As it has been for the past several weeks, fiscal policy (or lack thereof) was front and center. Arriving back to the White House early in the week, President Trump tweeted that stimulus talks were being cut off and any fiscal package would have to wait until after election. Later in the week he reversed course, suggesting the possibility of standalone bills on specific measures, such as support for airlines, the Payroll Protection Program or stimulus checks. The latest word is that the administration is now pushing hard for a more comprehensive deal.

Assuming a deal can be done between the Trump administration and the House Democrats, it may still have difficulty passing the Senate. On Friday, Senate Majority Leader, Mitch McConnell expressed his doubts, saying he still thought a deal was unlikely over the next three weeks.

For his part, Federal Reserve Chair Powell made a strong case for additional fiscal support in a speech this week. He noted that despite the rebound seen so far, the economy is still in a precarious state. Any slowing in the pace of recovery at this stage risks triggering “typical recessionary dynamics, as weakness feeds on weakness.” It would also exacerbate inequalities, a tragedy in the Fed chair’s view, “especially in light of our country’s progress on these issues in the years leading up to the pandemic.”

In pressing for additional fiscal supports, the Fed Chair noted that there is little risk of doing too much in the current environment. With interest rates falling to record lows, the cost of servicing the federal debt is shrinking even as the stock grows. While the U.S. budget deficit is hardly on a sustainable path – something the Fed Chair also recognized – it has not been for some time. The time will come for hard decisions on the longstanding mismatch between what the federal government takes in revenue and what it spends. However, the near and present risk of cascading bankruptcies and permanent job losses is clearly much bigger than the risk of a future debt crisis.

Indeed, there is much to laud in the fiscal policy response to date. Looking back on the last several months, the success of monetary and fiscal policy in supporting the recovery is everywhere to be seen in the economic data. The support to household income allowed for a swift recovery in goods consumption and production. Retail sales are now higher than pre-pandemic levels – a forecast few would have had a few months ago. While the recovery in service consumption has lagged, this is due to health crisis itself, which makes it impossible to go back to normal in close-contact businesses like restaurants, gyms, movie theatres.

For what its worth, our economic forecast assumed a modest fiscal deal that allows for another round of relief checks and additional unemployment benefits of $300 per week (half the amount under the CARES Act) to be delivered before the end of the year. This still seems possible – the fireworks this week notwithstanding – but if it does not occur, economic growth could get dangerously close to stall speed in the quarters ahead. Activity could still bounce back, particularly if a vaccine becomes widely available by mid-year, but the downside risks are clearly higher the longer it takes for policy makers to reach an agreement.

James Marple, Senior Economist | 416-982-2557

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare

Financial News for the Week of October 5, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

United States

• Following a four-week losing streak, U.S. financial markets regained some gusto, buoyed by optimism on the prospect of a new stimulus package.
• The labor market continues to mend, albeit at a decelerating pace. The American economy added 661,000 payroll jobs in September, down from 1.5 million in August. Meanwhile, the unemployment rate fell to 7.9%, in part because of a pullback in the labor force participation rate.
• The House passed a $2.2 trillion coronavirus relief bill this week, but it will not pass the Senate. Talks between Speaker Pelosi and Treasury Secretary Mnuchin continue, but a deal has yet to be reached.

U.S. - Healing, but Slowing Labor Market

Following a four-week losing streak, financial markets regained some gusto, buoyed by optimism on the prospect of a new stimulus package. Sentiment soured late in the week however, as news broke that President Trump and the first lady tested positive for COVID-19. Still, the S&P 500 is on track to end the week about 2% above last week’s close (as of writing).

The release of employment data for the month of September was this week’s main economic highlight. The report showed ongoing, albeit decelerating progress in the labor market recovery. Indeed, 661,000 payroll jobs were added last month, down from 1.5 million in August. Overall, 51.5% of non-farm payrolls lost since the pandemic began have been recovered. The unemployment rate fell from 8.4% to 7.9% in September, a welcome improvement, but a markedly slower pace than in previous months. More concerning, the drop was due in large part to a pullback in the labor force participation rate (Chart 1) rather than strength in job growth.

The theme of a stalling labor market recovery was also borne out in the jobless claims data. Indeed, new filings for unemployment benefits have held stubbornly close to the 900,000 per week mark since the end of August, signaling that businesses continue to lay off workers at an elevated rate. While continuing claims have trended lower over the past few weeks, they remain well above pre-crisis levels.

Unfortunately, as the $600/week federal unemployment top-up expired at the end of July, many people saw their income take a big hit in August. In fact, a 52% decline in unemployment benefits resulted in personal income falling by 2.7% month/month in August (Chart 2). While personal spending continued to make up lost ground, advancing by 1.0% on the month, the decline in incomes poses a downside risk to the recovery. What is more, spending on durable goods, which powered the early rebound in consumption, is showing signs of fatigue, while the recovery in services spending is also slowing. The latter is now in jeopardy due to a resurgence in new coronavirus cases.

Similar concerns were echoed in the September ISM Manufacturing report. The Index registered a worse-than-expected 0.6 point retreat to 55.4, pointing to a slower pace of expansion in the manufacturing sector. The details of the report showed a recovery that remains uneven, with a slew of industries continuing to contend with sluggish demand.

On a more positive note, new vehicles sales soared by 7.6% month/month in September to 16.3 million units. Alongside home sales, auto sales are one of the few economic indicators to have exhibited a “V-shaped” recovery and are now within 2.5% of their pre-crisis level from February.

All things considered, the balance of risks to the economic outlook remains tilted to the downside. The absence of a new stimulus package is beginning to take a toll on the recovery. Talks between House Speaker Pelosi and Treasury Secretary Mnuchin continued this week, but a deal has, so far, remained out of reach. Here’s hoping that Democrats and Republicans can close the gap and come to an agreement sooner rather than later.

Johary Razafindratsita, Economist | 416-430-7126

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare

Financial News for the Week of September 25, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

United States

• Major U.S. equity markets edged lower this week, extending their losing streak to four weeks. This came alongside an uptick in new COVID-19 cases and growing evidence that the economic recovery has shifted into lower gear.
• Existing home sales rose by 2.4% to 6.0 million units (annualized) in August – another post-Great Recession record. New single-family home sales did even better, rising 4.8%.
• The labor market is generally still moving in the right direction, but it is doing so at a slower pace. Initial jobless claims rose modestly to 870k last week, extending a flat trend just below 900k. On a more positive note, continuing claims continued to edge lower earlier in the month.

 U.S. - More Evidence of Recovery Shifting into Slower Gear

Major U.S. equity markets continued to edge lower this week, with the S&P 500 down 1.8% from last Friday’s close as at the time of writing. This disappointing performance, which extends the losing streak to four weeks, came alongside a recent uptick in COVID-19 cases and growing evidence that the economic recovery has shifted into lower gear.

On the data front, the housing market – one of the brightest areas of the U.S. the economy – continued to be a source of good news. Existing home sales rose by 2.4% in August to 6.0 million units (annualized), which marked another post-Great Recession record. The improvement spanned both single and multi-family segments and all four Census regions, though gains in the latter were concentrated in Northeast (13.8%). Meanwhile, in part due to a low inventory backdrop, home price growth accelerated sharply into double digit territory, with the median existing home price up over 11% in August relative to a year ago. New single-family home sales were even more impressive, rising 4.8% even after hitting the highest level in nearly 14 years in July. The level of new home sales has only been higher in the frenzied housing market of the mid-2000s that preceded the Great Recession (Chart 1).

As we argued in a recent publication, housing can’t remain divorced from the broader economy forever (see here). While we expect record-low interest rates to continue to support demand as the economy recovers, the acceleration in prices goes in the other direction. Diminished affordability will become a barrier to further increases. At the same time, the end of mortgage forbearance programs could result in more distressed sales in the quarters ahead. Finally, historically low population growth will weigh on demand growth once the initial recovery phase has played out.

Indeed, the jobs recovery is already showing signs of fatigue. After a relatively steady drop in the months prior, initial jobless claims have remained near the 900k mark since the end of August. Last week they rose modestly to 870k, extending the mostly-flat trend. On a more positive note, continuing claims decreased by 167k to a still-elevated 12.6 million for the week ended September 12th (this data is delayed by a week). Meanwhile, the number of people collecting unemployment benefits from ‘all programs’ edged lower, but remained elevated at 26 million at the start of the month.

All in all, the labor market is generally still moving in the right direction, but it is doing so at a much slower pace. The capricious nature of the health crisis remains a downside risk, with a still-elevated infection spread to continue weighing on the recovery (Chart 2). In the meantime, without additional income supports, spending could take a tumble as the high numbers of unemployed are forced to reduce consumption. With the Fed clearing up its stance (and limitations) on monetary policy last week, the ball is clearly in Congress’ hands. On this front, yesterday it was announced that Treasury Secretary Steven Mnuchin and House Speaker Nancy Pelosi have agreed to restart stimulus talks, in what marks a small positive step in the right direction.

Admir Kolaj, Economist | 416-944-6318

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare

Financial News for the Week of September 18, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

United States

• The Federal Reserve is not likely to increase interest rates until at least end-2023, however, this has not been enough to quench investors’ thirst for more liquidity.
• Retail sales strengthened for the fourth straight month this August, with several categories above or close to pre-pandemic levels of sales. However, the recovery momentum is fading.
• The labor market recovery has slowed with initial claims flattening at elevated levels. Almost 30 million people are still claiming unemployment benefits.

Canada

• Financial markets were mixed this week, with the S&P/TSX flat on the week. Meanwhile, oil markets received a boost from a bullish EIA inventory report and Thursday’s OPEC+ meeting.
• Economic data released this week continued to point to an ongoing recovery. However, improvements are uneven across the sectors. The highlight was the ongoing strength in resale housing markets that left sales 20% above their pre-pandemic levels.
• Meanwhile, soft CPI inflation readings for August (0.1% y/y) once again served as a reminder that slack remains in the
  economy

U.S. – The Recovery Shifts In to Low Gear

U.S. financial markets had a bumpy ride this week. The highs early on were followed by a sharp drop after Chairman Powell failed to quench investors’ thirst for more liquidity. The declines were primarily led by large cap technology stocks, which have so far made major gains during the crisis. As of writing, the S&P 500 is on track to end the week about 0.1% lower compared to last week’s close.

On the economic front, the Federal Reserve indicated that there will be no interest rate increase until at least end-2023. The Fed said that it would not tighten policy until inflation is higher than 2% for “some time”, a move away from its previous policy goal of “maximum employment” and “symmetric 2% inflation”. This announcement makes the Fed’s desire to make up for past inflation underperformance more explicit. However, the Fed continued to remain vague on the period over which it seeks to achieve higher inflation. Despite the dovish stance, markets thought it wasn’t dovish enough. Equities slid, as investors were hoping for the Fed to magnify its QE by announcing the purchase of more government bonds.

In terms of economic data, retail sales strengthened for the fourth straight month in August with many of the major categories being very close to or even above their pre-pandemic level of sales (Chart 1). However, the momentum is fading as sales grew by a meagre 0.6% month-on-month in August, down from 0.9% in July. Cooling pent-up demand and a decline in income for a significant share of the population (due to CARES Act payments being stopped in end-July) may be responsible for this slowdown. However, the strength in retail has been uneven as it masks the continued weakness seen in clothing, restaurants and bars and department stores. It is important to keep in mind that some of the hardest-hit areas, especially high-touch services (recreation, childcare and haircuts etc.) are not included in these data.

Turning to the housing market, starts weakened by 5.1% month-on-month. The decline was primarily driven by the multi-family segment, which fell by 23% on the month, reversing much of the gains seen during the summer. Single-family starts, on the other hand, jumped by 4.1%. Construction for single family homes is continuing at a solid pace on the back of perceived health risks posed by dense living as well as more permanent work from home policies. The housing market is likely to see slower gains in the coming months as economic recovery slows and pandemic-induced uncertainty abounds.

Meanwhile, the labor market recovery has slowed down (Chart 2). Initial jobless claims (860k) were broadly around consensus, down 33k from last week. Continuing claims came in at 12.6 million, beating the consensus (13 million) and down 1 million. Moreover, the number of people collecting unemployment benefits edged higher in late August. At almost 30 million people, the total remains incredibly high. Job growth is expected to be slower through the remainder of the year, with a full labor market recovery not taking months, or quarters, but years.

Sohaib Shahid, Senior Economist | 416-982-2556

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare

Financial News for the Week of September 11, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

• A wide dispersion of forecasts for U.S. growth over the next year reflects high levels of uncertainty around the duration of the health crisis as well as future government supports.
• Assuming a modest fiscal package passes Congress this fall and a vaccine becomes available by the middle of next year, the American economy should recover most of what was lost through the pandemic by the end of 2021.
• Inflation data showed an acceleration in price growth in August. Total CPI was up 1.3% year-on-year in August, continuing its recovery from only 0.1% in May.

A Wide Dispersion of Expectations for Recovery

As we head into the final days of summer, it’s a good time to step back and evaluate the prospects for the American economy over the next year. The dispersion of economic growth forecasts has perhaps never been higher. While forecasters all expect a meaningful decline in activity this year, that is due to what’s already been recorded. Meanwhile, forecasts for growth in 2021 in the Blue Chip survey range from over 6% at the high end, to under 2% at the low end. At the high-end, this recovers all the activity lost to the pandemic, while at the low end, it is nothing short of stagnation.

This wide dispersion reflects the unprecedented level of uncertainty around the course of the pandemic, as well as its secondary economic impacts. This can be seen in the wide array of underlying assumptions among forecasters around items key to the outlook. For example: when and if a vaccine becomes available, how effective and permanent it will be, how much future government support will be provided.

We do not claim to have any better insight on these questions than other forecasters, but we have tried to make plausible assumptions to ground our forecast. In the case of the health questions, we assume that a vaccine or effective treatment becomes widely available by the second half of 2020.

Beyond the basic uncertainty around when and if we recover fully from the pandemic, we have little in the way of traditional macro models to gauge how consumers and businesses respond to health crises. This was true on the way down, but also on the way up. We can observe, based on recent data, that after an initial plunge, households have been more than willing to increase spending on durable goods – suggesting little permanent damage to household confidence. Rather, what’s holding back a broader recovery is service-sector areas of the economy where activity is directly impacted by the potential risk of infection. This offers reason to expect a fairly solid bounce back once these fears are allayed.

In the case of government policy, we are equally in the dark. The extraordinary fiscal supports early in the year have divorced measures of overall economic activity from household income. Spending rebounded as it did due to these supports. Congress continues to debate another package, but the chasm between Republicans and Democratic bills is roughly 10 times ($300 billion versus $3 trillion). So, we’re left making assumptions. We assume that Congress does eventually come up with some additional support, but closer to the lower range of outcomes, around $400 billion, split between individual checks and unemployment benefits.

With these assumptions in place, and assuming no major second wave of the virus leads to another round of shutdowns, it is reasonable to expect the American economy to recover much of what was lost to the pandemic over the past year. While growth appears likely to slow after its initial burst on reopening, it should pick up again once a vaccine is available. Importantly, much of the deficit in spending is due to high-income individuals, who should be able to dip into these accumulated saving to support growth once the virus threat has passed. As a result, we expect the level of GDP to regain its pre-recession level by the first quarter of 2022. We will be publishing our full views on the economic outlook next week and hope you will give them a read.

James Marple, Senior Economist | 416-982-2557

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare

Financial News for the Week of September 4, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

• After reaching new highs early in the week, financial markets tumbled, driven by a broad sell-off in technology stocks. The S&P 500 is on track to end the week about 3% below last week’s close.
• The labor market recovery continued as the economy generated 1.4 million jobs in August, and the unemployment rate fell to 8.4%. However, the pace of the recovery has slowed from previous months, a theme that is echoed in other economic data.
• In speeches throughout the week, Fed officials warned about the fragility of the current recovery. They emphasized the importance of additional government help in supporting the recovery going forward.

Labor Market Mending Continues, but Risks Are Mounting

This was a volatile week for U.S. financial markets. Fresh highs early on were followed by a sharp drop, driven by a broad decline in technology stocks and signs of slowing economic momentum. As of writing, the S&P 500 is on track to end the week about 3% below last week’s close.

On the economic front, the main highlight was the release of the August employment data. As largely expected, the American economy continued to churn out jobs last month, albeit at a slower rate than in June and July (Chart 1). Indeed, August saw a total of 1.4 million net new jobs added, down from 1.7 million in July. Overall, nonfarm employment is about 7.6% below where it was in February. The unemployment rate also continued to trend lower, falling to 8.4% in August. While it has come down significantly since the apex of the crisis, it remains high by historical standards.

As unemployment fell, purchases of new vehicles jumped up 3.9% month/month in August (from 12.4% in July), to 15.2 million units. Meanwhile, the recovery in international trade progressed further in July, as exports rose by 8.1% (from 9.6% in June), and imports grew by 10.9% (from 4.6% in June).

In contrast, other data was consistent with a slowdown in momentum. The number of people receiving unemployment benefits - or continuing claims - has ticked up to 29.2 million in all programs in the week ended August 15th. Unlike initial claims, continuing claims have yet to show any meaningful and sustained improvement. Similarly, the latest Fed Beige Book (covering the period up to August 24th) noted that hiring volatility is becoming a recurring issue, particularly in services industries. The report highlighted that as demand remains subdued, temporary furloughs are increasingly being turned into permanent layoffs. That was born out in the August jobs data, where despite a drop in overall unemployment, the number of people “permanently” unemployed (i.e. out of work, but not on a temporary layoff) rose to 7.4 million, outnumbering the temporarily unemployed (6.2 million) for the first time in months.

Service industries also lost some momentum in August. The ISM Services Index declined by 1.2 points to 56.9, signaling that the pace at which the services sector is expanding is slowing (Chart 2). By contrast, the ISM Manufacturing Index recorded a surprise 1.8-point gain to 56.0. Despite the top-line increase, the details reveal an uneven recovery thus far, with many businesses still holding back on investment and hiring due to elevated uncertainty.

Given the still very high level of unemployment, the moratorium on residential evictions until the end of 2020 issued by the Center for Disease Control and Prevention (CDC) was a welcome development (it applies to individuals earning less than $99,000 per year). With pandemic-related uncertainty remaining elevated, near-term risks to the economy still appear tilted to the downside. As such, continued government support will be essential in limiting financial stress to households and businesses. This was emphasized by Fed officials in speeches throughout the week, noting that additional support will be key in determining the pace of the recovery. Considering stalled negotiations around the next stimulus package in Washington, consumption growth is at risk of tapering off in the coming months. It is going to be a long and bumpy road back to economic normalcy.

Johary Razafindratsita, Economist | 416-430-7126

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare

Financial News for the Week of August 28, 2020

FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

• Federal Reserve Chair Powell unveiled a change in the Fed’s monetary policy strategy, announcing that it will target an inflation rate “that averages 2% over time” (instead of a strict 2% goal), and that it will be concerned with shortfalls of employment from its maximum level (rather than deviations). Taken together, these mean a bias to keeping rates on hold well after economic recovery sets in.
• Personal income and spending data this week showed continued, albeit slowing progress in recovering from the pandemic-induced shock earlier this year. Real personal spending rose 1.6% in July down from 5.7% in June. Total spending is still 4.9% below its pre-recession peak, with the deficit entirely due to spending on services.

Federal Reserve Flips the Script, Targets Average Inflation

It’s not easy being a central banker. The job of the Federal Reserve – to keep the economy and inflation on an even keel with just its power over the monetary printing press – has been made a lot more difficult by the unprecedented global pandemic. While lower interest rates certainly help, as evidenced by the strong rebound in activity in the auto and housing market, there is still a large hole to fill in other areas of spending less sensitive to interest rates. Things like food services and accommodation, healthcare, and recreation services, which together make up 90% of the deficit in spending relative to January of this year, will not return to normal as long as the virus threat remains. Until they do, employment will remain impaired.

It’s not just the health crisis that has complicated the Federal Reserve’s task of achieving maximum employment and price stability (which it interprets as an inflation rate close to 2%). Its traditional policy lever – the fed funds rate – is consistently impaired by the effective lower bound. Once it cuts to near-zero, it must turn to less traditional tools such as large scale asset purchases. At the same time, the relationships between economic variables that it relied on to achieve its mandate appears to have weakened. A hot labor market does not seem to put upward pressure on inflation the way it seemed to in the past.

Faced with challenges to achieving its goals, the Federal Reserve has decided a chance of tack is necessary. Nothing too revolutionary of course, but a recognition that it should be more concerned with employment undershooting its goal than outperforming it. At the same time, having consistently over-predicted the future path of inflation over the past decade, it has come to the view that it should be less concerned about overshooting its 2% objective. So, rather than targeting a forecast of 2% inflation, it will target a rate that includes the recent past – an average inflation target. In other words, if inflation has underperformed, due, for example, to a period of economic weakness, it will not immediately tighten policy even if inflation pushes higher than 2%.

It’s worth unpacking the theory behind this last change. The thinking is that controlling future inflation depends on influencing people’s expectations for it. In order to get inflation up to its (now average) target it has to convince people that its ok being a little behind the curve when it starts to show up. It remains to be seen how effective this can be. Communication will be challenging. People don’t especially like inflation and there will be pressure to tighten policy when the actual rate moves above 2%. The Fed has also not said how much history it is averaging over or how high it will allow inflation to overshoot, simply that it will tolerate it “moderately above 2%.” Will it tighten policy if inflation is at 2.5% or is 3% the more relevant threshold? At the same time, other influences besides expectations may keep downward pressure on price growth. Just because it wants inflation to move above 2% doesn’t mean it will. Just ask the Bank of Japan.

Still, the reaction in markets to the statement has been positive so far. Stock markets rallied on the news. This makes some sense. Taken at face value, the fed funds rate are likely to remain lower for even longer.

James Marple, Senior Economist | 416-982-2557

 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank 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. This 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 the TD Bank 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.

by Connor Hare