Confusion Reigns as U.S. Budget Impasse Drags On

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1 JANUARY 21ST, 2019 ECONOMIC & FINANCIAL OUTLOOK Confusion Reigns as U.S. Budget Impasse Drags On #1 BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff The problems continue to mount in the euro zone. Industrial output plunged in November, and there is little hope of a rebound in real GDP in the fourth quarter on the heels of last summer s disappointing numbers. Germany appears to have just barely avoided a technical recession after real GDP contracted in the third quarter. With fewer than 70 days to go until Britain s official withdrawal from the European Union, the uncertainty surrounding Brexit is growing. The Chinese economy is slowing, but the government announced new measures to prop up growth. ff In the, the federal government shutdown continues to make headlines. The current standoff is the longest, although less than 25% of the administration is affected. The shutdown is increasingly threatening to impact confidence and economic activity. The lack of data is also complicating the economic situation. ff In, economic growth is expected to slow in the fourth quarter of and the first quarter of The harmful effects of the problems in the oil and gas sector will only add to the struggles that some of the components of domestic demand are experiencing. Growth may return to a more sustainable pace starting in the spring of ff In, the unemployment rate reached % in, the lowest in more than years. Economic growth continued at a strong pace in the third quarter, with an annualized increase of %. However, households and businesses were less confident in recent months. As a result, real GDP growth is expected to slow to % this year, followed by % in 2020 after having advanced roughly % in. ff In, the third quarter of ended with real GDP up % (annualized). Furthermore, domestic demand increased %, clearly outpacing the national average (-%). Spared the challenges of the oil and gas sector, s economy should be able to continue to grow faster than the national average during the next few quarters. The opposite is obviously true for, which will bear the full brunt. In, the housing market correction is expected to continue, causing real GDP to grow a little more slowly. MAIN CHANGES ff In light of the latest disappointing data, Euroland economic growth was revised downward for and Global growth was also slightly revised. ff The next round of key interest rate hikes in North America is now expected to begin around mid 2019, given the high degree of uncertainty and the fact that the Federal Reserve and the Bank of have both signalled that they will be patient. CONTENTS Highlights and Main Changes... 1 Risks Inherent in our Scenarios... 2 Financial Forecasts... 3 François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, Deputy Chief Economist Hélène Bégin, Senior Economist Benoit P. Durocher, Senior Economist Francis Généreux, 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 2019, Desjardins Group. All rights reserved.

2 RISKS INHERENT IN OUR SCENARIOS A number of factors could cause a faster and more serious reversal of the economic situation than anticipated. Recent concerns regarding the strength of the global economy negatively impacted the markets, particularly the stock market, and other downward trends could rattle household and business confidence. The escalating protectionism is also intensifying the uncertainty felt around the globe. However, for, the new trade agreement with and Mexico (CUSMA) has significantly reduced the risks. Geopolitical issues continue to weigh on the global economy. Financial imbalances are still a consideration in a number of regions, especially in Europe and in emerging economies like China. Brexit remains unresolved, and the risks associated with a nonnegotiated exit have become more significant. In the, the policies of the Trump administration could see the situation deviate from our scenarios positively or negatively. If it goes on for a long time, the partial shutdown of the federal government could stunt economic growth. Besides the current standoff, the political uncertainty, fed by doubts about the administration s integrity and the partisan divisions within Congress, could also affect the markets. Significant tightening of financial conditions could have a negative impact on the markets. Inflation that is stronger or weaker than forecast would have major consequences, especially for the bond market. The outbreak of a major conflict in the Middle East could drive international oil prices even higher. In, the rise in interest rates is intensifying concerns over high household debt. There are strong signs of an overvaluation in the Toronto and Vancouver real estate markets; Montreal and Ottawa just became overheated, making the market more vulnerable to a potential correction. If they persist, some provinces could feel the effects of the difficulties in the Canadian oil sector more sharply than others. TABLE 1 World GDP growth (adjusted for PPP) and inflation rate WEIGHT* Japan United Kingdom Euro zone Germany France Italy Other countries Australia Emerging and developing economies North Asia China India South Asia Latin America Mexico Brazil Eastern Europe Russia INFLATION RATE IN % Advanced economies REAL GDP GROWTH 4.6 Other countries South Africa 10 World f: forecasts; PPP : Purchasing Power Parities, exchange rate that equates the costs of a broad basket of goods and services across countries; *. Sources: World Bank, Consensus Forecasts and Desjardins, Economic Studies 2

3 FINANCIAL FORECASTS A dark cloud continued to hang over the financial markets in the closing weeks of, causing the stock markets, bond yields and commodities prices to fall once again. Despite being under pressure from President Donald Trump and the financial markets, the Federal Reserve (Fed) announced another key interest rate hike on December 19. Still, it did indicate that it would monitor developments in the global economy and on the financial markets. In addition, the leaders median forecast for the number of key rate increases anticipated was lowered. The pessimism appeared to spill over into 2019, with the ongoing partial shutdown of the U.S. government and the major drop in the ISM manufacturing index. However, the excellent job numbers in the and a clear signal by the chair of the Fed that it will be patient and flexible going forward have boosted investor confidence since January 4. This more upbeat feeling caused markets and the Canadian dollar to rebound. A major reduction in Saudi oil output helped oil prices rise a little as well. The Bank of (BoC) also signalled that it will be patient before it resumes monetary tightening, given that the outlook for growth and inflation has worsened. As a result, we now expect the Fed and the BoC to wait until mid-year before announcing their next hike in key interest rates. The markets, bond yields and oil prices should continue to rise in the coming months. TABLE 2 Summary of the financial forecasts END OF PERIOD IN % (EXCEPT IF INDICATED) Key interest rate Euro zone United Kingdom Q3 Q Federal bonds 2-year 5-year 10-year 30-year 2-year 5-year 10-year 30-year Currency market Canadian dollar (USD/CAD) Canadian dollar (CAD/USD) Euro (EUR/USD) British pound (GBP/USD) Yen (USD/JPY) Stock markets (level and growth)* S&P 500 S&P/TSX Commodities (annual average) WTI oil (US$/barrel) Gold (US$/ounce) 2,507 14,323 Target: 2,800 (+1%) Target: 16,0 (+1%) Target: 2,660 (-%) Target: 15,600 (-%) 65 (52*) 1,270 (1,225*) 59 (65*) 1,245 (1,220*) 59 (48*) 1,210 (1,230*) f: forecasts; WTI: West Texas Intermediate; * End of year. Sources: Datastream and Desjardins, Economic Studies 3

4 TABLE 3 : Major economic indicators QUARTERLY ANNUALIZED VARIATION IN % (EXCEPT IF INDICATED) Real GDP (2012 US$) Personal consumption expenditures Residential construction Business fixed investment Inventory change (US$B) Public expenditures Employment according to establishments (%) Total inflation rate* Core inflation rate* ANNUAL AVERAGE Q ,234 1,263 1,295 1,308 1,318 1,327 1,208 1,269 1,312 1,287 f: forecasts; * Annual change; 1 Annualized basis; 2 Before taxes; 3 Excluding food and energy. Sources: Datastream and Desjardins, Economic Studies TABLE 4 : Major economic indicators 2019 ANNUAL AVERAGE QUARTERLY ANNUALIZED VARIATION IN % (EXCEPT IF INDICATED) Q3 Real GDP (2012 $) Final consumption expenditure [of which:] Household consumption expenditure Governments consumption expenditure Gross fixed capital formation [of which:] Residential structures Non-residential structures Machinery and equipment Intellectual property products Governments gross fixed capital formation Investment in inventories (2012 $B) Employment (%) Total inflation rate* Core inflation rate* f: forecasts; * Annual change; 1 Annualized basis; 2 Before taxes; 3 Excluding food and energy. Sources: Datastream and Desjardins, Economic Studies 4

5 TABLE 5 : Major economic indicators ANNUAL AVERAGE IN % (EXCEPT IF INDICATED) 2016 Real GDP (2012 $) Final consumption expenditure [of which:] Household consumption expenditure Governments consumption expenditure Gross fixed capital formation [of which:] Residential structures Non-residential structures Machinery and equipment Intellectual property products Governments gross fixed capital formation Investment in inventories (2012 $B) Real disposable personal income Weekly earnings Employment (%) Personal saving rate (%) Retail sales Total inflation rate ,688 3,023 4,000 4, f: forecasts; 1 Annualized basis. Sources: Statistics, Institut de la statistique du Québec, Mortgage and Housing Corporation and Desjardins, Economic Studies TABLE 6 : Major economic indicators ANNUAL AVERAGE IN % (EXCEPT IF INDICATED) 2016 Real GDP (2012 $) Final consumption expenditure [of which:] Household consumption expenditure Governments consumption expenditure Gross fixed capital formation [of which:] Residential structures Non-residential structures Machinery and equipment Intellectual property products Governments gross fixed capital formation Investment in inventories (2012 $B) Real disposable personal income Weekly earnings Employment (%) Personal saving rate (%) Retail sales Total inflation rate* ,214 9,329 4,666 4,738 2,050 0,3 7 0, f: forecasts; * Annual change; 1 Annualized basis. Sources: Statistics, 's Ministry of Finance, Mortgage and Housing Corporation and Desjardins, Economic Studies 5

6 TABLE 7 : Major economic indicators by provinces ANNUAL AVERAGE IN % (EXCEPT IF INDICATED) Real GDP growth Employment growth Retail sales growth Total inflation rate Housing starts (thousands of units) f: forecasts Sources: Statistics, Institut de la statistique du Québec, 's Ministry of Finance, Mortgage and Housing Corporation and Desjardins, Economic Studies 6

7 TABLE 8 Medium-term major economic and financial indicators ANNUAL AVERAGE AVERAGES 2021f 2022f 2023f f , , , , , , , , , Employment (var. in %) Employment (thousands) Retail sales (var. in %) Housing starts (thousands of units) Employment (var. in %) Employment (thousands) Retail sales (var. in %) Housing starts (thousands of units) IN % (EXCEPT IF INDICATED) S&P 500 index (var. in %)1 Federal funds rate Prime rate Treasury bills 3-month Federal bonds 10-year Federal bonds 30-year WTI oil (US$/barrel) Gold (US$/ounce) Employment (var. in %) Employment (thousands) Housing starts (thousands of units) S&P/TSX index (var. in %)1 Exchange rate (US$/C$) Overnight funds Prime rate Mortgage rate 1-year Mortgage rate 5-year Treasury bills 3-month Federal bonds 2-year Federal bonds 5-year Federal bonds 10-year Federal bonds 30-year Yield spreads ( ) Treasury bills 3-month Federal bonds 10-year Federal bonds 30-year f: forecasts; WTI : West Texas Intermediate; 1 Variations are based on observation of the end of period. Sources: Datastream, Statistics, Institut de la statistique du Québec, 's Ministry of Finance, Mortgage and Housing Corporation and Desjardins, Economic Studies 7