Canadian Rate Hikes Begin Quite Suddenly

Transcription

1 SEPTEMBER 4, RETAIL RATE FORECASTS Canadian Rate Hikes Begin Quite Suddenly # BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff Economic growth is strong all around the world. ff The Bank of Canada quickly raises its key rates. ff The Canadian dollar keeps its momentum. ff The summer was far from quiet on the markets! Economic statistics remain encouraging. Growing geopolitical tensions related to North Korea s nuclear program and the difficulties facing the U.S. administration have raised concerns in recent months. In addition, the hurricane season was particularly violent and was recently marked by Harvey and Irma. In spite of all this, the global economy continues to send encouraging signals and most advanced economies posted strong growth in the second quarter of (graph ). The Canadian economy continues to exceed expectations. Far from slowing down, real GDP growth continued to accelerate, reaching 4.5% in the second quarter of. Cumulative growth since the beginning of the year is therefore 4.% (annualized), the kind of performance not seen since. The surge in the Canadian economy continues to be supported by factors such as very strong consumer spending (graph ), which has benefited from the solid performance of the labour market. The rebound in nonresidential investment also continued in the second quarter, thanks to a 7.% increase. The Bank of Canada (BoC) has already raised its key rates twice. The target for the overnight rate doubled in the space of seven weeks, rising to %. Clearly, the strong growth of the Canadian economy since the start of the year convinced the BoC that an extremely accommodating monetary policy was no longer appropriate as excess GRAPH GRAPH Several advanced economies posted strong growth in the spring Canadian consumers increased their spending significantly Real GDP growth in Q Volume of retail sales Quarterly annualized variation in % Annual variation in % Canada U.S. Euro zone Japan Germany France Italy U.K Sources: Statistics Canada and Desjardins, Economic Studies François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, Senior Economist Jimmy Jean, Senior Economist Hendrix Vachon, Senior Economist Desjardins, Economic Studies: or , ext desjardins.economics@desjardins.com desjardins.com/economics NOTE TO READERS: The letters k, M and B are used in texts and tables to refer to thousands, millions and billions respectively. IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. The data on prices or margins are provided for information purposes and may be modified at any time, based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. The opinions and forecasts contained herein are, unless otherwise indicated, those of the document s authors and do not represent the opinions of any other person or the official position of Desjardins Group. Copyright, Desjardins Group. All rights reserved.

2 production capacity now appears to be nearly depleted in Canada. While the Canadian economy appears to be continuing to grow at a fair clip in the third quarter, another rate increase could be ordered in the fall. After that, the BoC should adopt a more gradual pace for its rate increases. GRAPH 3 Several Canadian rates rose sharply Canadian rates Target for the overnight rate 5-year swap rate Several Canadian bond yields now exceed U.S. yields. The decisive moves by the BoC are a stark contrast to the hesitation of other central banks to begin or continue their monetary tightening policies while inflationary pressure remains limited. In particular, investors now have very low expectations of additional rate hikes in the United States, which has kept the U.S. bond yield at close to %... Retail rates will continue to rise. Increases to Canadian key rates have had a major impact on the bond market and on financing costs for financial institutions (graph 3). The impact has been directly felt by variable rate mortgages, but other retail rates have also begun to adjust to the higher rates. The movement in posted rates illustrates just part of the change as financial institutions have increased their promotional rates further. For example, promotional rates on 5 year mortgages appear to have risen some % since the start of summer. The next few quarters should see more increases. 4 TABLE Forecasts: Retail rate DISCOUNT RATE IN % Realized (end of month) March April May June July August Sep. 3, Forecasts End of quarter : Q3 : Q4 8: Q 8: Q End of year 8 9 TERM SAVINGS MORTGAGE RATE PRIME RATE year 3 years 5 years year 3 years 5 years Non-redeemable (annual); NOTE: Forecasts are expressed as ranges. Source: Desjardins, Economic Studies SEPTEMBER

3 Exchange Rate The Canadian Dollar Keeps Its Momentum The Canadian dollar has been on a roll since late April. It has risen from US$.73 to close to US$.83, placing it among the strongest performing currencies at the moment. Unlike what we re used to seeing, oil prices haven t contributed much to these gains. Rather, favourable changes in interest rate spreads have helped the loonie appreciate (graph 4). Rate spreads were still quite high in April, but improvements to the Canadian economy and the start of monetary tightening in Canada were game-changers. GRAPH 4 Narrowing of interest rate spreads had a major impact on the loonie s appreciation US$/C$ Spreads in basis points Several other currencies have posted gains against the U.S. dollar in the last few months (graph 5). The fact that the markets anticipate few interest rate hikes in the United States has penalized the greenback, particularly against currencies where the economy is performing well and monetary tightening appears more likely. For example, the euro rose to over US$. due to the stronger European economy and anticipations of a change in direction of its monetary policy. Nevertheless, the European Central Bank tried to keep the situation contained in September by expressing its concern over the rising euro Canadian exchange rate (left) Spreads between -year rates in Canada and the United States (right) GRAPH 5 The U.S. dollar retreated further against currencies in main advanced and emerging countries Change in the U.S. dollar since May Russia India Korea Indonesia Japan Brazil South Africa United Kingdom Switzerland Turkey Thailand New Zealand China Mexico Australia Denmark Norway Euro zone Sweden Canada Forecasts: The Canadian dollar could appreciate further in the short term if the Canadian economy continues to perform well and the Bank of Canada pursues its monetary tightening. Our year-end target is US$ (C$.8/US$). The loonie could also benefit from a slight rise in oil prices between now and the end of the year. However, we don t expect the Canadian economy to maintain its current pace in 8, which should curb the loonie s momentum. A reinvigorated U.S. dollar also appears likely, as the markets may be caught off-guard by further monetary tightening in the United States Determinants Short-term Long-term Oil prices Metals prices Interest rate spreads TABLE Forecasts: Currency END OF PERIOD US$/CAN$ CAN$/US$ CAN$/ US$/ US$/ 8 Q3 Q4 Q Q Q3f Q4f Qf Qf Q3f Q4f f: forecasts SEPTEMBER 3

4 Asset Classes Return The Summer Was Far from Quiet! A casual glance at the main stock indices since late June would probably lead to the conclusion that it was a calm summer (graph 6). However, this was far from the case. The staredown between North Korea and the United States has led to fears of a military confrontation. In the United States, Donald Trump s difficulties have continued and he has been unable to push forward his agenda. The devastation caused by hurricanes Harvey and Irma might have helped prevent another budget crisis, but the deadline was only postponed by three months. This is in addition to a number of files that Congress will need to settle by the end of the year, which leaves little time for lawmakers to focus on tax reform. As for the central banks, the Federal Reserve (Fed) appears less convinced than earlier this year of the prospect of an eventual increase in inflation. As a result, the markets expect the Fed to carry out no more than one rate hike between now and the end of 8. This is keeping U.S. rates and the U.S. dollar on downward trajectories (graph 7). In Europe, despite the economy s strong performance, the European Central Bank (ECB) is clearly concerned about the surge in the common currency and is looking to buy time before announcing the gradual scale-back of its securities purchase program. Meanwhile, the Bank of Canada (BoC) just announced not one, but two rate hikes in the same quarter, whereas at the start of the year, it hinted at leading its policy in the opposite direction. That s hardly our idea of a relaxing summer! The recent performances of certain stock markets have nonetheless set themselves apart. Equities in emerging countries are having a very good year, after suffering through three difficult ones. The MSCI Emerging Markets Index has posted gains of more than 5% since January. As we mentioned earlier this year, the valuations for the stock markets in emerging countries versus their historic averages have made them more attractive choices, particularly in a context of rebounding growth in these countries. The stock markets in advanced countries have not enjoyed the same momentum in the last few months. European stocks, which had a strong start, have been retreating since May. Nevertheless, when expressed in U.S. dollars, returns for international equity markets remain solid, and we are keeping a target of 6% for these stocks. In the United States, the S&P 5 is still on track for an annual return of approximately 3%. The last few months have been a bit more difficult for stock market gains, but neither have they featured a collapse. Corporate earnings GRAPH 6 Stock markets have given the appearance of calm Stock market indexes since July July 3rd, = JUL. AUG. S&P 5 MSCI Asia Pacific SEP. S&P/TSX MSCI Emerging Markets MSCI Europe Index GRAPH 7 In the United States, the currency and yields tumbled over the summer U.S. -year bond yield and trade-weighted U.S. dollar index (DXY) Index JUL. AUG. 9 SEP. -year yield (left) DXY index (right) GRAPH 8 Policy rates should continue to rise in North America Policy rates Federal Reserve* Bank of Canada Desjardins forecasts 9 * Upper bound for the federal funds rate. SEPTEMBER 4

5 growth slowed down slightly in the second quarter but remained above the recent average. Meanwhile, sales growth has improved in each of the last three quarters. The problem the U.S. stock market is experiencing is that a lot of good news were already priced into valuations, which remain quite high. Meanwhile, the Canadian stock market, which had a bad start to the year, has been unable to break free of its slump. The S&P/TSX is one of the rare indexes in negative territory since January. Energy stocks are doing the most damage to the Canadian stock market index, with a 6% drop in the sub-index since the start of the year. Other major sectors, such as materials, have been unable to sufficiently make up for this weakness, which is surprising, given the strength of metal prices, particularly the precious kind. The persistent weakness of the Canadian stock market is leading us to trim a few points from our target for the year. We now anticipate a return of just 4%. For most asset classes, the last quarter of looks like it will be tumultuous, particularly due to the central banks. An increase in U.S. federal funds rates in December still appears likely, if excess capacity in the labour market continues to be absorbed and low inflation proves to be temporary. In Canada, the powerful performance of the economy and labour market argue for an additional hike in policy rates this year. In Europe, the ECB should also order a gradual lessening of monetary stimulus measures. A situation in which three major central banks normalize their policies will arguably be very unfavourable for bonds. We expect the first year of negative returns for the bond index since 3. For 8, the degree of certainty varies from one bank to another. For example, at this stage, the BoC appears fairly determined to pursue the normalization of its monetary policy, and our forecasts, which bank on a certain amount of economic momentum to be maintained, suggest three rate increases in 8 (graph 8 on page 4). However, for the Fed, although our base scenario assumes a rate hike in December and three more in 8, the picture is much less clear. In addition to the doubts harboured by Fed officials regarding inflation, several influential members of the Fed s Board of Governors have announced they are stepping down, and there is uncertainty as to whether Donald Trump will renew Janet Yellen s mandate in early 8. The situation also appears fragile in the euro zone, where miscommunication of the ECB s intentions could easily stoke violent market reactions, which could have a ripple effect in other geographic areas. TABLE 3 Asset classes percentage return CASH END OF YEAR IN % (EXCEPT IF INDICATED) f range BONDS CANADIAN STOCKS U.S. STOCKS INTERNATIONAL STOCKS EXCHANGE RATE 3-month T-Bill Bond index S&P/TSX index S&P 5 index (US$) MSCI EAFE index (US$) C$/US$ (variation in %) target:.7.65 to target: - -. to target: 4.. to 8. target: 6. to 7. target: to. target: -.4 (US$) -9. to -4.4 FTSE TMX Canada Bond Universe; Dividends included; 3 Negative = appreciation, positive = depreciation; f: forecasts SEPTEMBER 5