An eventful week of economic news has underlined how the U.S. economy has separated from the pack of global under-achievers, and has all but assured that it will take its lone-wolf act to a new level with an interest-rate increase next week.
But the latest wave of data also reveals cracks in the U.S. success story that renew questions about how long the American economy can go it alone as overseas woes increasingly lap at its shores.
Another month of strong jobs growth (up 211,000 in November, unemployment at an eight-year low) highlighted the continued good health of the U.S. economy, and likely gave the Federal Reserve the last piece of evidence it needs to raise interest rates at its meeting on Wednesday.
That comes at a time when most of its global counterparts are leaning the other way. Just this week, the European Central Bank cut rates and extended its quantitative easing program in the face of a struggling euro zone economy and persistent weak inflation – joining a list of 43 central banks around the world, including Canada, that have reduced interest rates this year. (Canada's employment report on Friday, in contrast to the U.S. numbers, showed that employment sank by 36,000 in November, raising the jobless rate to 7.1 per cent.)
But the latest international trade numbers, also released on Friday, show that the pressures of being the world's dominant growth and monetary-policy outlier are weighing on the U.S. economy. And as the United States sneezes, the Canadian economy, with its close trade ties to the U.S. market, may already be catching the proverbial cold.
The U.S. trade deficit widened to $43.9-billion (U.S.) in October, largely as a result of sliding exports, which fell 1.4 per cent in the month and were down nearly 7 per cent from year-earlier levels. The combination of weak foreign demand and a rising U.S. dollar – pushed up by the relative strength of the U.S. economy and the prospects of Fed interest rate increases – have slammed the brakes on U.S. exports.
Meanwhile, U.S. imports fell for a third consecutive month – suggesting the lack of export growth may be moderating economic activity at home. That surfaced in the trade numbers also released on Friday for Canada, which relies on the U.S. market for about three-quarters of its own exports. Canada's trade deficit ballooned to $2.8-billion (Canadian) in October – and the culprit was a 2.8-per-cent slump in exports to the United States.
Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said the U.S. economy's reliance on exports is small enough – exports are equivalent to just 13 per cent of GDP, compared with 33 per cent in Canada – that its economy can weather weak demand outside its borders fairly well, as long as its job-creation engine is still humming.
"When you're creating jobs at at a pace of 200,000 a month, you can create a lot of domestic demand," he said. He said that, in past instances of sluggish global demand and a soaring U.S. dollar, notably the late 1990s, the U.S. economy proved that "it can do decently, [but] not spectacularly, relying only on domestic growth."
It may be approaching that decent-yet-unspectacular territory. After growing at a torrid 3.9-per-cent annualized clip in the second quarter, U.S. gross domestic product moderated to an estimated 2.1-per-cent pace in the third quarter, and recent forecasts suggest it might not do much better in the fourth quarter.
At the root of the slowing is the export-intensive manufacturing sector. The Institute of Supply Management's manufacturing purchasing managers' index, a closely watched indicator of U.S. factory activity, fell to a post-recession low of 48.6 in November. Any reading below 50 indicates a contraction – implying that U.S. manufacturing output has actually slipped into decline.
The services side – which represents more than three-quarters of the U.S. economy, and is more closely linked to domestic demand than are goods-producing sectors such as manufacturing – has been faring better. But it, too, is beginning to show some fatigue. The ISM's service-sector index slumped in November, although it remained in positive territory.
"It is clear that the non-manufacturing sector is not entirely immune to global headwinds," Toronto-Dominion Bank economist Ksenia Bushmeneva said in a research note. "Slowing activity in manufacturing and energy sectors will weigh on consumer spending in states that are heavily reliant on these industries, ultimately trickling down to service industries …
"From the Fed's standpoint, contraction in the manufacturing sector and moderate slowdown in the services industry are not game changers as far as the rate hike is concerned. But the headwinds that the economy is facing continue to support the case for a very gradual pace of interest rate normalization," Ms. Bushmeneva said.
Whenever he has been asked about the prospect of rising Fed interest rates at a time when Canada's rates are standing still, Bank of Canada Governor Stephen Poloz has said he views this as a positive for Canada – on the grounds that Fed rate hikes would reflect a growing U.S. economy, which translates to stronger demand for Canadian exports. Indeed, the central bank has long viewed this demand recovery as the key to sustaining Canada's own elusive economic resurgence at a time when the oil shock has stifled business investment, and the highly indebted consumer sector has exhausted much of its capacity to drive further economic growth.
But Canadian export volumes have now fallen three months in a row, despite persistent weakness in the Canadian dollar that should, by standard logic, be making Canadian goods increasingly attractive to U.S. buyers. In a research note on Friday, Royal Bank of Canada senior economist Nathan Janzen expressed concern that this trend "could begin to raise questions about the durability of external demand growth."
Part of the problem, Mr. Shenfeld said, is that "there's a portion of Canadian exporters who suffer when the U.S. dollar is strong" – namely, those who are part of the supply chain for U.S. manufactured export goods.
But Morgan Stanley currency strategist Evan Brown argued this week that, even at a 75-cent (U.S.) Canadian dollar, much of the Canadian manufacturing sector still struggles against its increasingly tough global competition.
"The rest of the market may not appreciate just how much competitiveness Canada has lost in manufacturing," Mr. Brown told Bloomberg News.
The Fed's rate increases could help in that regard, adding further downward pressure on the loonie. Morgan Stanley predicted that the Canadian dollar will slide to 69 cents (U.S.) next year, representing another decline of nearly 10 per cent on top of the 20-per-cent slide it has already suffered since the middle of 2014. While that is at the low extreme of private-sector forecasts, it hammers home a common message: The loonie is going to remain under pressure as Fed rates begin to rise while the Bank of Canada stays in neutral for likely at least another year.
"For the time being, it's hard [for the Canadian dollar] to be too cheap," Mr. Shenfeld said.