A look ahead at the Canadian and American economies February 21, 2018

Transcription

1 A look ahead at the Canadian and American economies February, 8 The Stimulus Games United States The economy grew for a th quarter in a row in Q and by a solid.% annual rate. The current expansion ranks as the third longest on record. For all of 7, real GDP rose.%, a major step up from.5% the prior year. There were no weak links in the economic chain. Investment rebounded.7% after dipping in, as firms added much-needed capacity. Consumers spent at a sturdy.7% rate, bolstered by surging wealth, steady job gains and increased borrowing. A weaker dollar and firmer global demand lifted exports.%. Housing markets caught a second wind later in the year as home sales hit decade highs. The ownership rate is now rising for the first time in years as more millennials take the plunge. The biggest hurdle for sales is supply amid a record-low number of listings. Growth likely stayed at.% in Q. Housing starts jumped % in January and the ISM non-manufacturing index hit a -year high. While retail sales, manufacturing and existing home sales faded after a strong fourth quarter, gains in after-tax income will boost consumer spending this month, likely supporting production and housing. Fiscal and monetary policies are pulling the economy in different directions. The former will dominate, however. The biggest tax reforms in three decades are expected to add. ppts to GDP growth this year and. ppts next year, while nearly $ billion of additional federal spending in the Bipartisan Budget Act could add.7 ppts and. ppts, respectively. Some offset will stem from rising imports and higher interest rates. Still, we upped our GDP call to.8% in 8 (from.%) and to.5% in 9 (from.%), on an average annual basis. ECONOMIC RESEARCH economics.bmocapitalmarkets.com Sal Guatieri, Senior Economist sal.guatieri@bmo.com KEY MESSAGES Tax cuts and a surprisingly large dollop of fiscal spending will boost economic growth, at the risk of fanning inflation and interest rates The Fed is expected to raise policy rates every quarter this year, partly to counteract fiscal stimulus Less supportive financial conditions mean s economy won t match last year s gold medal act, though it should still perform well given robust and global demand A wary Bank of will raise rates just two more times this year, even less if NAFTA talks fall apart Firm resource prices should support the C$ against a sagging greenback, though it will be hard pressed to make headway until trade risks fade Coming so late in the cycle, the fiscal boost will complicate the Fed s job of neutralizing monetary policy. While wages and prices remain in check core PCE prices are up.5% y/y and unit labour costs.% underlying pressures are starting to build, and could overwhelm the calming effect of automation, e-commerce and globalization. Average hourly earnings jumped.9% y/y in January, the fastest in eight years. The increase partly stemmed from higher minimum wages, but it s no coincidence that wages are climbing faster in regions with low jobless rates. A somewhat more hawkish group of FOMC voters this year is expected to lift the fed funds rate four times in 8, one more than we thought previously, with the midpoint of the target range ending the year at.8% and next year at A Publication of BMO Capital Markets Economic Research Douglas Porter, CFA, Chief Economist, BMO Financial Group

2 Page of 8 February, 8.88% close to neutral. A March move is all but certain barring a sharp retreat in equities. Treasuries remain under pressure. Apart from higher policy rates, the market will need to digest less demand from the Fed (which is expected to shrink its balance sheet by over $ billion in 8) and more supply from the Treasury (which will need to fund a ballooning budget shortfall). After a brief respite from the short-lived equity correction, the -year Treasury yield has risen one-half percentage point this year to four-year highs of over.9%. We see it climbing to.% by year-end, before reaching.5% in late 9. And, this assumes core PCE inflation drifts only moderately higher to.% next year, allowing the Fed to tread lightly. After cresting at -year highs a year ago, the trade-weighted dollar has fallen 9% to three-year lows and is expected to weaken modestly further this year on a strengthening global economy and rising budget and trade deficits. While s economy was the envy of the G7 nations in 7, much of the credit was due to one-off factors (the oil price recovery, enhanced child-benefit payments and speculative housing demand in Southern Ontario) that juiced GDP in the first half of the year. Growth likely slowed to a more sustainable % pace in the second half of the year (Q data are due March ). Consumers led the way last year, lifting spending nearly %, as the fastest job gains in years masked elevated debts and drove the jobless rate to four-decade lows. However, despite firmer global demand, exports have struggled to gain traction with the currency bouncing notably higher in the past year. Growth is expected to slow from around % last year to.% in 8. While financial conditions remain supportive and resource prices could rise moderately further, higher interest rates and tougher mortgage rules will apply a brake on consumer spending and home sales. Meantime, the ongoing threat of trade protectionism will impede investment. Although stronger demand is helpful, the fact that s non-resource export volumes are little changed in the past decade is a testament to a loss of competitiveness for many companies as they deal with new regulations, rising mandated labour costs and new environmental protections. British Columbia should lead the nation in growth for the third time in four years, supported by a sturdy housing market and shipments to fast-growing Asia. Still, like most provinces, its growth will downshift in 8. The good news is that many regions have

3 Page of 8 February, 8 already achieved full employment, with Quebec s jobless rate recently touching record lows. No single issue is likely to affect more in 8 than the resolution of NAFTA talks. We currently place equal odds on one of three scenarios unfolding: the deal survives with just moderate changes; it is withdrawn by the administration but remains in effect until politicians and businesses resolve the issue in Congress or court; or, it is repealed after six months notice by the government. If the middle zombie scenario unfolds, weaker business confidence and investment will see s economy slow more than expected. If NAFTA is repealed, the three nations will likely revert to WTO trade rules. In this event, Canadian GDP could be as much as % lower over five years, a relatively modest hit for an economy that s expected to grow almost % in this period. A weaker currency and lower interest rates would help cushion the blow. The more trade-intensive industries such as motor vehicles and food processing would be more heavily impacted, as would Ontario s economy. A worse case would be if the ignored WTO rules and imposed punitive tariffs on a wide range of Canadian shipments, in which case the economy could slip into recession. Another concern relates to the housing market s response to the new mortgage rules that took effect January. The Bank of estimates that a higher qualifying rate on uninsured loans could impact up to % of low-ratio borrowers in the Toronto region. Although some buyers will resort to alternative lenders, others will turn to less expensive homes. The new rules risk deepening the correction in Toronto s detached housing segment, where prices have fallen % since the spring and are flat from a year ago. Ontario s Fair Housing Plan (including a 5% tax on non-resident buyers) had a chilling effect on buyer psychology, while unleashing a flood of listings. By contrast, Toronto s condo market remains resilient, with prices still up % in the past year to January amid wafer-thin inventories. More affordable condos and townhouses could even benefit from a shift toward less expensive housing. Unlike Toronto and even higher-priced Vancouver, housing markets in the rest of the country remain affordable and should be little affected by the mortgage rule changes. In fact, house prices in Ottawa and Montreal picked up last year and are expected to lead the nation this year. By contrast, B.C. will need to digest new housing measures announced by the provincial government, including an increase in the size of the foreign buyers tax (to % from 5%) and expansion to areas beyond metro Vancouver, as well as a new speculation tax on nonresident owners. Following a cumulative 75-basis points of rate increases since the summer, the Bank of will raise rates gradually further in

4 Page of 8 February, 8 response to low unemployment and the need to normalize policy. But it will tread lightly given concerns about trade protectionism and the sensitivity of indebted households to higher borrowing costs and tougher mortgage rules. We expect two more rate hikes in 8, with the overnight rate rising from.5% to.75%. Three additional moves next year would bring rates closer to neutral levels at.5%. A generally weak greenback and higher oil prices have allowed the Canadian dollar to appreciate % in the past year to US$.79 (C$.). While NAFTA concerns and a pesky trade gap will dog the currency, it could end the year at four-year highs of C$. (US$.8) if the greenback weakens further and NAFTA talks end with minimal damage to s trade ties. Risks Apart from long-standing concerns about Canadian household debt, the pricey Toronto and Vancouver housing markets, and trade protectionism, several other issues could slow or derail North America s expansion: With the fully-employed economy getting an additional jolt of fiscal stimulus, the dollar weakening and oil prices holding above $ a barrel, the risk of resurging inflation and more aggressive Fed tightening is rising. This combination has triggered nearly every recession in the postwar era. As the budget deficit heads toward $. trillion next year (or more than 5% of GDP), the government will have little fiscal capacity to address the next downturn. A prolonged equity market correction would send the wealth effect spinning in reverse, undercutting consumers. However, if economic fundamentals remain relatively healthy and interest rates rise only slowly, equities should avoid a steep correction given that valuations are not far from historic norms. The inability of the U.K. to re-establish amicable trade relations with the EU in Brexit talks could lead to slower European growth. Other developments that could weaken confidence in the Euro Area include a still-shaky German coalition government, Catalan s independence movement in Spain and a possible rise to power of a euro-skeptic party in Italy s March election. None of these events, however, are likely to derail North America s expansion. While tensions between the and North Korea have eased somewhat, a possible military event remains an ongoing threat.

5 Page 5 of 8 February, 8 Forecasts CANADA 7 8 ANNUAL I II III IV I II III IV 7 8 Real GDP (q/q % chng : a.r.) Consumer Spending Business Investment (non-residential) Consumer Price Index (y/y % chng) Unemployment Rate (%) Housing Starts (s : a.r.) Current Account Balance ($blns : a.r.) Interest Rates (average for the quarter : %) Overnight Rate month Treasury Bill year Bond / Interest Rate Spreads (average for the quarter : bps) 9-day year UNITED STATES Real GDP (q/q % chng : a.r.) Consumer Spending Business Investment (non-residential) Consumer Price Index (y/y % chng) Unemployment Rate (%) Housing Starts (mlns : a.r.) Current Account Balance ($blns : a.r.) Interest Rates (average for the quarter : %) Fed Funds Target Rate month Treasury Bill year Note EXCHANGE RATES (average for the quarter) US /C$ C$/US$ /US$ US$/Euro US$/ Note: Shaded areas represent BMO Capital Markets s

6 Page of 8 February, 8 VOLATILITY RETURNS United States (as of February, 8) CREDIT SPREADS STILL THIN United States (ppts) Ted Spread VIX Corporate Bond Spreads mnth Eurodollar minus -mnth T-bills (bps) CBOE market volatility index year BoA Merrill Lynch AA Corporate Yield less -year Treasury Yield EQUITIES DIP (indices : as of February, 8) LOONIE STEADY (US : as of February, 8) Equities Canadian Dollar 5 5 S&P 5 (lhs) TSX (rhs) Parity RESOURCE PRICES FIRM Commodity price range since start of 7 OIL PRICES AT THREE-YEAR HIGHS (US$/bbl : as of February 5, 8) Lumber (US$/ sq ft).8 Materials & Foodstuffs (as of February, 8) 5.8 [current] 5.8 Metals & Energy (as of February, 8) Gold 9.85 (US$/oz) WTI Crude Oil Soybeans (US$/bu) 8.78 Wheat (US$/bu) Oil (US$/bbl). Natural Gas. (US$/mmbtu) Corn (US$/bu)..5 Copper (US$/lb).9.8 Apart from natural gas

7 Page 7 of 8 February, 8 US ECONOMY GETS FISCAL LIFT (y/y % change) CONSUMERS SPEND FREELY (y/y % change) Real GDP Real Personal Consumption Expenditures US But Canadian growth has peaked BUSINESS INVESTMENT HEALTHY (y/y % change) HOME PRICES RISING Existing Homes (y/y % change : -month m.a.) Real Non-Residential Business Investment Sales Prices FULLY EMPLOYED (percent) INFLATION BOTTOMS Consumer Price Index (y/y % change) Unemployment Rate United States Headline.9% Headline.% Core.% Core.8%

8 Page 8 of 8 February, Overnight Rate MONETARY POLICIES TIGHTEN (% : as of February, 8).5%.5%.5% Year Bonds LONG-TERM RATES RISE (% : as of February, 8).9%.% - Spread -57 bps.5% (yr. end 9).% (yr. end 8).7%.5% General Disclosure BMO Capital Markets is a trade name used by the BMO Financial Group for the wholesale banking businesses of Bank of Montreal and its subsidiaries BMO Nesbitt Burns Inc., BMO Capital Markets Limited in the U.K. and BMO Capital Markets Corp. in the BMO Nesbitt Burns Inc., BMO Capital Markets Limited and BMO Capital Markets Corp are affiliates. This document is issued and distributed in Hong Kong by Bank of Montreal ( BMO ). BMO is an authorized institution under the Banking Ordinance (Chapter 55 of the Laws of Hong Kong) and a registered institution with the Securities and Futures Commission (CE No. AAK89) under the Securities and Futures Ordinance (Chapter 57 of the Laws of Hong Kong). 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