Despite the Uncertainty, Monetary Tightening Is Expected to Continue

Transcription

1 JUNE 1, RETAIL RATE FORECASTS Despite the Uncertainty, Monetary Tightening Is Expected to Continue #1 BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff The latest economic data in North America is encouraging after a slower start to the year. ff The Bank of Canada is expected to raise its key rates in July. ff The U.S. dollar has benefited from European fears. Attention continues to focus on geopolitical concerns. The fears surrounding a trade war ratcheted up a notch recently following the U.S. administration s decision to impose tariffs on European, Canadian and Mexican steel and aluminum. Financial tensions have also appeared among emerging countries and within the euro zone in reaction to the political crisis in Italy. The U.S. economy is sending encouraging signals. After another slightly disappointing start to the year, everything indicates that the U.S. economy will record strong growth in Q. The rise in consumer spending hit full stride in March and April (graph 1). The latest labour market statistics were also GRAPH 1 Real consumption regained strength in the United States at the end of the winter Contributions to real consumption s monthly growth 0.8 Durable goods Non-durable goods Services MAY. JUL. SEP. NOV. Sources: Bureau of Economic Analysis and Desjardins, Economic Studies Total reassuring, and the unemployment rate dipped to 3.8% in May, its lowest level since the late 1960s. The Federal Reserve (Fed) could raise its rates each quarter this year. The U.S. economy s good performance confirms that the Fed will not hesitate to pursue its monetary tightening in June, despite international uncertainty. While the higher prices for gasoline and the goods targeted by the tariffs risk increasing inflationary pressures without significantly slowing short-term growth, key rates could be raised two more times in the second half of. Growth slowed in Canada in Q1, but appears to have improved in the spring. Real GDP in Canada only rose an annualized 1.3% in Q1. This weak performance, however, can be explained in large part by the decline in the trade balance, as well as by a drop in residential investment as a result of the new, restrictive measures implemented at the beginning of the year. Yet, business investment jumped more than 10%, despite the uncertainty weighing on trade relations with the United States. What s more, the recent jump in monthly GDP (graph on page ) and the trade balance signals a rapid rise in growth in Canada as early as Q. The Bank of Canada (BoC) appears ready to act once again. After raising key rates in January, the Canadian monetary authorities opted for the status quo at their last three meetings. The tone of the BoC s statements is, however, increasingly positive, and the central bank is now clearly signalling its intention to go ahead and hike its key rates once François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, 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 GRAPH GRAPH 3 After retreating in January, the economy rebounded in February and March Mortgage rates are climbing Real GDP by industry Rates posted for closed mortgages In 007 $B 1, , ,70 6 1, ,70 1,710 3 Of five years 9 1,760 1,700 Of one year 10 Quarterly averages 1,770 APR. JUL. OCT. 000 Sources: Statistics Canada and Desjardins, Economic Studies again at its meeting on July 11. What comes after July remains unclear, but the continued uncertainty regarding real estate and trade relations could convince it to hold off for six months before tightening once again. Retail rates should continue to rise, albeit more slowly. Despite the uncertainty, the upward trend in both bond yields and the financing costs of Canadian financial institutions continued over recent months. Consequently, the financial institutions announced a significant increase in their mortgage rates (graph 3), causing the rate for a 5 year, closed mortgage to reach its highest level since. Further increases in retail rates are expected, but they should be gradual and fairly limited, as the central banks will want to avoid overly tightening financial conditions. TABLE 1 Forecasts: Retail rate DISCOUNT RATE IN % Realized (end of month) Dec. January February March April May Jun. 11, Forecasts End of quarter : Q : Q3 : Q 019: Q1 End of year TERM SAVINGS1 MORTGAGE RATE PRIME RATE 1 year 3 years 5 years 1 year 3 years 5 years Non-redeemable (annual); NOTE: Forecasts are expressed as ranges. Source: Desjardins, Economic Studies JUNE

3 Exchange Rate The U.S. Dollar Benefited from European Fears The U.S. dollar rose against most currencies in the last two months. The trend was initially supported by the improved outlook for economic growth in the United States and by the surge in bond yields. More recently, the U.S. currency appears to have benefited primarily as a safe haven in the face of renewed uncertainty among emerging countries and in Europe. However, these fears have calmed somewhat since the beginning of June, putting the brakes on the greenback s rapid momentum (graph ). The Canadian dollar has been fairly successful in resisting the strength of the U.S. dollar. As a result, the loonie gained against several currencies, including the euro (graph 5). Higher oil prices helped, although a decrease was recently recorded. The economic data in Canada remains generally good, and the Bank of Canada (BoC) remains fairly optimistic. That being said, Canada s economic outlook continues to be shrouded in uncertainty due, in particular, to the threat of protectionism. The loonie dropped in value after the United States announced taxes on Canadian steel and aluminum. Forecasts: The U.S. dollar has seen several fleeting gains in recent years. This scenario may be well on the way to repeating itself, as fears subside in Europe. And, this does not include the twin deficit (trade and budgetary) problem, which does not favour a strong U.S. dollar. The Canadian dollar should remain relatively unscathed in the short term if the Canadian economy stays the course and the BoC announces an interest rate hike in July. The exchange rate could hover around US$0.79 during the summer. Any changes in the protectionist threat, which may cast a dark shadow over the economic outlook and the Canadian currency, will have to be monitored. GRAPH The U.S. dollar rebound appears to be running out of steam already U.S. dollar effective exchange rate DXY Index DXY: Index based on a basket of currencies including the euro, pound, yen, Canadian dollar, Swiss franc and Swedish krona. GRAPH 5 The Canadian dollar hardly budged against the U.S. dollar, but it rose against the euro US$/C$ /C$ U.S. exchange rate (left) Euro exchange rate (right) 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$/ 019 Q3 Q Q1 Qf Q3f Qf Q1f Qf Q3f Qf f: forecasts JUNE 3

4 Asset Classes Return The Outlook for Stock Markets Continues to Be Favourable Financial markets remain hesitant. Some optimism returned in May thanks to, among other things, the publication of encouraging economic data in the United States. While initial indications pointed to a more definite rise on the stock markets and in interest rates, new fears arose among emerging countries and in Europe. Within this context, the returns on the main asset classes have been stuck near zero since the beginning of (graph 6). Tense trade relations are also a significant factor in the ongoing uncertainty, even if the reaction of investors to the latest developments on that front has been limited until now. The outlook seems less favourable for overseas markets. The ongoing monetary tightening in the United States may continue to increase the pressure on bond yield and the U.S. dollar. This risks sustaining the fears among emerging countries, especially among those that have to finance their significant current account deficits using foreign money (graph 7). In Europe, a political crisis in Italy reminded investors of the major financial problems some countries and financial institutions are still facing. While the situation threatens to remain tense between the new, populist Italian government and Brussels and the European Central Bank still seems to want to reduce its bond purchases, volatility on the European markets risks staying high. Given this context, we have reduced our performance targets for overseas stock markets. Growth in corporate profits remains encouraging. Despite the high degree of uncertainty, the businesses that make up the S&P 500 index continue to record outstanding earnings. Benefiting from a boost in both sales and profit margins (graph 8), the S&P 500 reported earnings posted an annual increase of 19% in the first quarter of, representing a new, historical peak. This gain was probably inflated by the tax reform in the United States, but it is part of a very positive trend that began several quarters ago, and nothing indicates that profits will drop any time soon. Therefore, we continue to forecast that the U.S. stock market will rise by almost 10% in, despite the disappointing start to the year. The surge in oil prices helped the Canadian stock market. We have repeatedly mentioned over recent months that the easing of specific concerns regarding the Canadian economy should allow the S&P/TSX to catch up somewhat after a difficult start to the year. Also benefiting from the steep rise in oil prices, the Canadian stock market did indeed better over the last few months, while the gap between the performance of the S&P 500 and the S&P/TSX narrowed GRAPH 6 Asset class returns have been modest since the beginning of Jan. = FEB. APR. U.S. stock market (US$) Emerging stock markets (US$) Canadian bonds MAY. JUN. Overseas advanced stock markets (US$) Canadian stock market GRAPH 7 The value of emerging country currencies has plunged in recent weeks Change against the U.S. dollar since mid-april Venezuela Argentina Mexico Brazil Turkey South Africa Poland Hungary Chile Romania Columbia India Thailand Malaysia China Indonesia Philippines Egypt Russia Vietnam GRAPH 8 Businesses sales growth has remained strong, and their profit margins have set a new record S&P Annual sales growth (left) Profit margins (right) Sources: Standard & Poor s and Desjardins, Economic Studies JUNE

5 from a high of 8% at the beginning of March to less than % in mid-april. The lack of an agreement to renew the North American Free Trade Agreement (NAFTA) and the introduction of tariffs on Canadian steel and aluminum have, however, had a somewhat negative impact on the Canadian stock market in recent weeks. As the uncertainty surrounding trade relations threatens to last until the end of the year, it is no longer clear that the Canadian market will continue to outperform; as such, we are keeping our performance target just under that of the United States for as a whole. It should also be noted that a real ramping-up of protectionist measures on both sides of the border could provoke a greater negative feeling about Canadian assets. Bond yields should continue to trend up. Recent heightened concerns regarding Italy have strongly favoured holders of North American bonds, while the U.S. 10 year yield has suddenly dipped from more than 3.10% to less than.80%. However, this break has proved to be short-lived, and the 10 year yield quickly rebounded to around 3.00%. While the North American central banks will continue to gradually normalize their monetary policy (graph 9), a slight uptrend in bond yields is expected. As a result, we continue to believe that the FTSE TMX Canada Universe Bond Index will end down slightly. Recent events show, nonetheless, that bonds are a useful tool for diversifying a portfolio when negative shocks occur. GRAPH 9 Gradual key rate increases should continue Key rates Federal Reserve* Bank of Canada Desjardins forecasts * Upper limit for the federal funds rate. 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 index1 S&P/TSX index S&P 500 index (US$) MSCI EAFE index (US$) C$/US$ (variation in %) target: 1.35 to 1.60 target: to 1.0 target: to 1.0 target: to 16.0 target: to 10.0 target: 1.9 (US$0.78) -1.9 to FTSE TMX Canada Bond Universe; Dividends included; 3 Negative = appreciation, positive = depreciation; f: forecasts JUNE 5