Highlights. Change from Previous Forecast

Transcription

1 Highlights December 217 While not a blockbuster year, 217 was nonetheless encouraging on many fronts. The world s largest economy, the U.S., seemingly got back its mojo, while export powerhouses such as the Eurozone and Japan are on track to register above-potential growth courtesy of buoyant global trade. Emerging economies too likely grew faster than the prior year thanks to trade but also to stimulative policies. Slightly higher inflation could have some central banks tighten policy somewhat in 218, although that s unlikely to be enough to prevent a repeat of this year s solid growth performance. The U.S. economy has done better than most expected this year. Business investment has sprung back to life thanks to the stabilization of the energy sector and improved confidence amidst a buoyant global economy. Another year of above-potential growth can be expected in 218 thanks in part to tax cuts. The persistence of low inflation will not deter the Federal Reserve which is increasingly concerned about financial stability risks. As such, we continue to believe that the Fed will tighten monetary policy more than what markets are currently expecting. Newly revised GDP data suggest the Canadian economy is in better shape than previously thought. A blistering first half was followed by a more than decent third quarter, putting Canadian output on track to expand 3% in 217, the fastest pace of growth in six years. Our above-consensus call of 2.5% for 218 real GDP growth assumes boosts from upcoming minimum wage hikes and fiscal stimulus in provinces. As such, we still think the Bank of Canada will be forced by strong data to deliver more interest rate hikes next year than what markets are currently expecting. Krishen Rangasamy Change from Previous Forecast United States GDP 2.2% 2.% 2.% unch na CPI inflation 2.1% 2.2% 2.2% +.3 pp na Fed Fund Target Rate* 1.5% 2.% 2.5% unch na Ten-year bond yield* 2.5% 2.9% 3.% -1 bp na Canada GDP 3.% 2.5% 1.5% unch na CPI inflation 1.6% 2.3% 2.1% +.5 pp na Overnight rate* 1.% 2.% 2.25% unch na Ten-year bond yield* 1.97% 2.7% 3.5% -16 bp na * end of period

2 World: Buoyant trade While not a blockbuster year, 217 was nonetheless encouraging on many fronts. The world s largest economy, the U.S., seemingly got back its mojo, while export powerhouses such as the Eurozone and Japan are on track to register above-potential growth courtesy of buoyant global trade. Emerging economies too likely grew faster than the prior year thanks to trade but also to stimulative policies. Slightly higher inflation could have some central banks tighten policy somewhat in 218, although that s unlikely to be enough to prevent a repeat of this year s solid growth performance. It s been a good year for the global economy. World GDP growth for 217 is on track to be the best in six years thanks to an OECD rebound which complemented continued strength in emerging markets. Helped by consensus-topping economic data, particularly in the OECD, the MSCI All-Country stock index has surged to an all-time high, while commodity prices have also risen. Part of the strong economic performance is due to the extension of highly stimulative government policies, but buoyant global trade volumes have also helped. The latter explains why factories are booming in several of the world s major economies. Latest CPB data show world trade volumes soaring to a new record in. It s the third time in the last four quarters that growth in global trade volumes has outpaced that of industrial output. This suggests excess inventories are being absorbed, a positive for world production going forward. And it seems momentum extended to Q based on Markit purchasing managers indices. Early in the fourth quarter, the global PMI was again well above the 5 threshold denoting expansion in both manufacturing and services sectors. Advanced economies such as the U.S., Eurozone, and Japan all saw further increases in manufacturing and services output. The uptick in world trade volumes has helped boost exports, but domestic demand has also strengthened in the Eurozone. So much so that the zone s real GDP is on track to expand roughly 2.3% in 217, the fastest annual pace of growth in 1 years. The eurozone s 2.5% annualized increase in output during was made possible by a sharp acceleration in Germany (+3.3%) but also solid gains in Spain, Cyprus and Finland, while France and Italy only managed sub-2% growth. The jobless rate at the end of was 8.9%, down a full percentage point from the same time last year and the lowest since early 29. The zone s economic revival coincides with the uptick in credit growth. Loans to households are now growing at an annual pace of more than 3%, the biggest increase since 211, while loans to businesses are also expanding at a healthy clip. World: Surging trade volumes bring down inventories % Trade volumes Trade volumes hit a new record in Level (R) q/q change saar (L) NBF Economics and Strategy (data via CPB) 122 index Eurozone: Economic growth strong again in Real GDP 3.5 q/q % chg. saar NBF Economics and Strategy (data via Datastream) Ratio of industrial production to trade volumes allowing some inventories to be absorbed Index = 1 in 28Q Germany TOTAL ex-germany

3 World Economic Outlook Eurozone: Credit is growing nicely again Eurozone loans to households and non-financial corporations 3 y/y % chg. Households Forecast Advanced countries United States Euroland Japan UK Canada Australia New Zealand Hong Kong Korea Taiwan Singapore Emerging Asia China India Indonesia Malaysia Philippines Thailand Latin America Mexico Brazil Argentina Venezuela Colombia Eastern Europe and CIS Russia Czech Rep Poland Turkey Middle East and N. Africa Sub-Saharan Africa NBF Economics and Strategy (data via Datastream) Non-financial corporations While the European Central Bank s stimulus seems to be paying off, a major tightening of monetary policy seems premature. The annual core inflation rate (excluding energy, food, alcohol and tobacco) was less than 1% in November, pointing to the persistence of economic slack. The euro s appreciation is making things worse on that front. Recall that last September the ECB lowered its inflation projections, blaming the euro s strength for disinflationary pressures. The central bank s forecast of 1.2% for the 218 inflation rate assumed EURUSD stabilizing at So, if the euro appreciates further from here, another downward revision of the ECB s inflation forecasts may be necessary. Also of concern to the ECB are geopolitical uncertainties which could derail growth and make it even harder for the central bank to hit its inflation target. Anti-EU populists could gain power in Italy following the 218 elections by capitalizing on a soft economy and a youth unemployment rate of more than 35%. Brexit is another problem for the Eurozone considering the significant trade linkages with the UK. All told, ECB policy is likely to remain loose for a while. Eurozone: Relapse of core inflation Consumer price index excluding energy, food, alcohol and tobacco 2.8 y/y % chg Sep. 1. Advanced economies Emerging economies World Source: NBF Economics and Strategy NBF Economics and Strategy (data via Datastream) 3

4 Japan: Trade rebound in Contributions to real GDP % Real GDP Trade Domestic demand Inventories/other 216q1 216q2 216q3 216q 217q1 217q2 217q3 NBF Economics and Strategy (data via Datastream) China: Solid imports point to healthy domestic economy 2,6 US$ bn 2, 2,2 2, 1,8 1,6 1, 1,2 1, Trade surplus, exports and imports, 12-month cumulative Trade surplus Oct. NBF Economics and Strategy (data via Datastream) Exports Imports Trade surplus is shrinking because imports are rising faster than exports 2 y/y % chg. World: Debt has been rising faster than GDP Gross debt % of GDP Import volumes, 12-month average with particular strength for imports of petroleum and iron ore Petroleum Iron Copper Oct. G-2 advanced economies China G-2 emerging markets excluding China Like the eurozone, Japan benefited this year from better global trade. So much so that Japan s 217 GDP growth could end up near 1.5%, its best performance in four years. A strong Q2 was followed by a good third quarter that saw output grow 1.% annualized thanks to solid contributions from trade and inventories which offset an expected pullback from domestic demand after the latter s surge the prior quarter. The labour market is the best in a generation as evidenced by a jobless rate under 3% and the highest job-to-applicants ratio since the mid-197 s. While the improving economy propelled Prime Minister Shinzo Abe to an easy election win last October, there are still major obstacles to sustainable growth. Recall that this year s outperformance was partly due to fiscal and monetary policy stimulus without which growth would have gravitated towards potential (estimated to be below 1%). Meaningful reforms, including measures to increase the labour force amidst an aging population, are necessary to boost the economy s potential and allow for a repeat of this year s economic performance. But given past struggles of politicians with reforms, we remain skeptical about progress on that front. That, coupled with diminished effectiveness of policy stimulus from Tokyo and the Bank of Japan, explain why we expect Japan s growth to slow down towards potential over the next couple of years. China s economy did better than most had expected, with growth this year slated to hit 6.8%. Fiscal stimulus played a role in lifting growth, but consumption spending was also resilient retail spending continued to grow at an annual pace of over 1% on average. Amidst strong domestic demand, imports have been growing faster than even exports, causing China s annual trade surplus to shrink to less than half a trillion dollars. The import surge is also due to demand for commodities including petroleum and iron ore, some of which are likely related to the observed pick-up in the export sector. Indeed, exports are now growing again on a year-on-year basis. It s unclear, however, if export momentum can extend to 218 especially if the recent uptick in the real effective yuan turns into a trend. The central government is seemingly nervous about a potentially less favourable U.S. trade policy, which explains its decision to allow the yuan to appreciate against the USD since Trump s election win. Besides protectionism, Beijing also has an eye on financial stability risks. The debt load is likely to get even heavier given the high credit intensity it now takes about twice as much credit compared to pre-29 to generate an additional unit of GDP in China. Our forecast for China s GDP to grow roughly 6.5% on average in the next couple of years assumes disorderly deleveraging can be avoided NBF Economics and Strategy (data via IMF)

5 U.S.: Factory surge The U.S. economy has done better than most expected this year. Business investment has sprung back to life thanks to the stabilization of the energy sector and improved confidence amidst a buoyant global economy. Another year of above-potential growth can be expected in 218 thanks in part to tax cuts. The persistence of low inflation will not deter the Federal Reserve which is increasingly concerned about financial stability risks. As such, we continue to believe that the Fed will tighten monetary policy more than what markets are currently expecting. While the post-hurricane employment rebound was not as good as expected, the U.S. labour market is far from capitulating. True, October s establishment survey showed just 261K jobs being created (after a dismal 18K increase the prior month) and hourly earnings (just 2.% year-on-year growth) were also very soft. But taking the last two months together, non-farm payrolls grew on average 1K/month, a tally good enough to reduce slack in the labour market according to the Fed s own estimates. Full-time employment is also up 2. million so far this year, the best performance since 26. More importantly perhaps, cyclical sectors such as manufacturing and construction added jobs yet again, while temporary employment hit a record in October, both in absolute terms (3.75 million) and as a share of total employment (2.1%). Those developments are consistent with other data which suggest continued expansion in Q. Confidence is high for both consumers and businesses, and credit continues to flow freely courtesy of still-loose financial conditions. Consumption remained strong according to October retail data which showed resilience in discretionary spending. The real estate market was also doing well in October based on housing starts (12-month high) and home resales (-month high). Industrial production also grew sharply during that month. While part of the surge was due to warmer-than-normal weather which boosted utilities output, much of the gains were driven by the manufacturing sector, the latter on track to register the best quarterly output increase since 21. Part of the factory surge in recent months is due to exports volume exports of non-petroleum goods are near all-time highs but also because of solid domestic demand. Investment in machinery and equipment, which hit a record high in the third quarter, seems to have risen further in Q based on October s durable goods report which showed a ninth consecutive increase in shipments of non-defense capital goods excluding aircrafts. That s good news for the U.S. economy s potential GDP. U.S.: Labour market consistent with continued economic expansion millions % Full-time jobs created in the first 1 months of every year since 26 Biggest increase in full-time employment since NBF Economics and Strategy (data via Datastream) U.S.: Factory output is bouncing back nicely Industrial production q/q % chg. saar Manufacturing Temporary employment s share of total employment Record high of 2.1% in Oct.217 Share of temporary employment at all-time high Shaded areas are recessions TOTAL * Assuming no change in November and December and no revisions to prior months NBF Economics and Strategy (data via Federal Reserve) Q est.* 5

6 With the economy on a clear uptrend real GDP growth expected near 2.2% for 217 and to improve further in 218, the Federal Reserve is set to tighten monetary policy further. While a December interest rate hike is now fully priced by markets, the latter are not expecting much of a follow-up over the next two years the fed funds rate is expected to be below 2% by the end of 22, in sharp contrast to the Fed s own view that rates will be closer to 3% by then. This market view has no doubt been shaped by years of disappointing readings on both wage growth and the overall inflation rate which have seemingly eroded trust in the Fed s ability to hit its 2% inflation target. But a reasonable argument could be made that, even considering the low rate of inflation, U.S. monetary policy is currently too loose. Indeed, it s the first time since the 197 s that real interest rates are in negative territory despite a positive output gap according to the Congressional Budget Office economic slack has now been entirely absorbed. As such, we believe the Federal Reserve will tighten monetary policy more than what markets are currently expecting. Chair Yellen and her designated successor Jerome Powell (who takes office in February 218) have both emphasized that the FOMC should continue the process of normalizing monetary policy. Both believe the Fed will hit its inflation target over the medium term. While in the past neither of them seemed particularly concerned about financial stability risks, the latter could become a more pressing issue if asset prices (including housing and the stock market) add to already significant gains in 218 and/or leveraging intensifies. Some Fed members are now even expressing concerns about financial imbalances fearing a sharp reversal in asset prices according to the latest minutes. U.S.: How serious is the auto sub-prime problem? Outstanding auto debt Sub-prime* auto debt as a share of outstanding auto debt 1.3 US$ trillion % TOTAL auto loans 36 Auto finance 1.1 companies Outstanding auto debt at a 3 1. new record, partly due to rising sub-prime loans TOTAL.6 Normal auto loans although the sub-prime problem is less severe than in the past, accounting. 18 for just 23% of outstanding auto debt Sub-prime* auto loans Banks * Sub-prime auto loans are those given to borrowers with a credit score of less than 62 NBF Economics and Strategy (data via New York Fed) Besides creating asset bubbles, excessively loose monetary policy can also encourage risky lending. Thanks in part to sub-prime loans (some of which are now turning into delinquencies), auto debt reached a record in both absolute terms (US$1.2 trillion at the end of ) and relative terms (its share of household debt jumping to 9.%). The good news is that the sub-prime auto debt problem is unlikely to be as devastating to the economy as say the mortgage sub-prime problem which triggered the financial crisis nine years ago sub-prime auto loans represent just 2% of household debt outstanding and do not directly threaten to topple the banking sector, the latter accounting for just 26% of outstanding sub-prime auto debt or only US$7 billion. But the bad news is that lessons learnt from the 28/9 crisis have apparently being forgotten, with an overly accommodative Fed encouraging excessive risk taking. 6

7 Canada: Upward revisions Newly revised GDP data suggest the Canadian economy is in better shape than previously thought. A blistering first half was followed by a decent third quarter, putting Canadian output on track to expand 3% in 217, the fastest pace of growth in six years. Our above-consensus call of 2.5% for 218 real GDP growth assumes boosts from upcoming minimum wage hikes and fiscal stimulus in provinces. As such, we still think the Bank of Canada will be forced by strong data to deliver more interest rate hikes next year than what markets are currently expecting. Canada s GDP expanded at an annualized pace of 1.7% in the third quarter of 217 after strong first half. Trade was a drag on growth due to slumping exports, but domestic demand helped power the economy in thanks to gains for consumption, government spending and business investment which more than offset drag from residential construction. Inventories contributed to growth for the third quarter in a row. Consumption found support from solid gains in real disposable incomes but also from a drop in the savings rate from 2.8% to 2.6%. Nominal GDP grew for a seventh consecutive quarter, something that will pad government coffers further. There were also revisions to GDP growth for the last three years. Upgrades to 21 (2.9% instead of 2.6%) and 215 (1.% instead of.9%) were offset by a downgrade to 216 (1.% instead of 1.5%). On net, this was an overall upgrade. And based on the Bank of Canada s measure of potential GDP, which one can derive using the integrated framework estimate of the output gap, there is almost no slack left in the economy. A good handoff from September GDP grew a healthy.2% (unannualized) in that month points to a decent performance in the fourth quarter as well. So much so that Canada s real GDP is on track to expand 3% in 217, the fastest annual pace of growth since 211. The solid economy is reflected in a strong labour market which created an average of 33K jobs/month in the last 12 months, the best performance in a decade. Even better news is that the majority of those jobs were full-time and in the private sector. Ontario, Quebec and British Columbia continue to lead the nation in terms of job creation, while the uptick in Alberta employment confirms the province has overcome the oil shock. Wages and salaries are also growing at the fastest pace in years and it s a matter of time before that translates to a higher annual core inflation rate. And that s even before considering the impact on inflation of upcoming minimum wage hikes in Ontario and Alberta. Canada: Growth softens after first half boom Real and Nominal GDP 8 q/q % chg. saar Nominal GDP Real GDP NBF Economics and Strategy (data via Statistics Canada) Contributions to real GDP Q2 217Q1 GDP 1.7%.3% 3.7% Consumption 2.3% 2.8% 2.1% Business investm..%.8% 1.2% Nonprofit sector.1%.1% -.1% Residential investm. -.1% -.3%.9% Government 1.1%.8%.% Domestic Demand 3.7%.2%.% Exports -3.3% 1.9%.7% Imports.1% -2.1%.2% Trade -3.2% -.2% -3.% Inventories 1.1%.2% 3.1% Stat.discrepancy.2%.1%.1% Canada: Upward revisions allow output gap to shrink further 1,87, 1,86, 1,85, 1,8, 1,83, 1,82, 1,81, 1,8, 1,79, 1,78, 1,77, 1,76, 1,75, 1,7, 1,73, NBF Economics and Strategy (data via Statistics Canada, Bank of Canada) Real GDP Millions of chained 27 dollars Revised data Old data % Output gap (integrated framework) Based on revised data -3. Based on old data Canada: Labour market still in excellent shape Jobs created in the last 12 months according to Labour Force Survey, monthly average thousands Total Private Govt Self Goods Services Full-time Part-time QC ON AB BC Other prov. NBF Economics and Strategy (data via Statistics Canada) 7

8 Modified LMI is essentially consistent with unemployment rate Bank of Canada LMI, NBF LMI, unemployment rate 8.8 % LMI Unemployment rate NBF LMI NBF Economics and Strategy (data from Datastream and Bank of Canada) Canada: Exports of non-energy goods continue to disappoint Real exports of energy, non-energy goods, and services Index=1 in 27Q NBF Economics and Strategy (data via Statistics Canada) Canada: Ontario and BC still in sellers market territory Non-energy goods Energy Services All told, the labour market is in better shape than what the Bank of Canada is describing. To spin its dovish message, the central bank has repeatedly highlighted its Labour Market Indicator (LMI) which is still higher (meaning worse) than it was in 28 and hence points to persistence of slack in the labour market. But that index is highly flawed in our view because it is skewed by two variables notably average hours worked (which has been on a declining trend for years due to demographic changes) and long-term unemployment (even though the share of long-term unemployeds in the active population has fallen). A modified LMI, which adjusts for those deficiencies, shows a much better picture of the labour market, i.e. one that is consistent with the low jobless rate. For more details please see our latest Special Report The Bank of Canada s labour market indicator understates labour market tightness. So why is our central bank relying on such an indicator to support its loose stance on monetary policy? It s no secret that a Poloz-led Bank of Canada has an aversion to an appreciating Canadian dollar. Memories of a USDCAD near 1.2 back in September are still fresh in the minds of members of the Governing Council and the latter have seemingly opted to be very cautious from now on in acknowledging any observed improvement in the economy. The central bank s caution also reflects uncertainties that threaten to derail economic growth. Trade is one such uncertainty not only because of ongoing NAFTA negotiations but also due to lost market share that continues to restrain non-energy goods exports, the latter still below the peak reached a decade ago. Another concern is the economy s enhanced sensitivity to interest rate hikes. Indeed, years of low borrowing costs have led to the creation of a beast household debt has surged to unprecedented levels, house prices have doubled in the last 12 years on a national average basis, and residential investment now accounts for a record 8% of GDP. But the solution to getting the beast under control cannot be to feed it further with low interest rates Teranet-National Bank house price index y/y % chg. Toronto correction now driving down national house price inflation TOTAL Toronto Oct NBF Economics and Strategy (data from Teranet-National Bank, CREA) Active listings to sales, October 217 Number of standard deviations from mean Buyers market Balanced market Sellers market but Ontario and BC real estate still in sellers market CA NL PE NS NB QC ON MB SK AB BC A pragmatic approach combining macro-prudential measures and higher interest rates is required to put Canada s financial system on a more sustainable footing. As we ve seen in BC and Ontario, macro-prudential measures alone have limited effectiveness. Both provinces, which temporarily succeeded in curtailing the pace of price increases via a non-resident speculation tax, are now back in sellers market territory. Fiscal stimulus and minimum wage hikes in some provinces, not yet accounted for in the Bank of Canada s 218 forecast, should boost growth next year. So, while the central bank suggested it would remain in pause mode for a while, strong data may eventually force its hand early next year. 8

9 United States Economic Forecast Q/Q (Annual % change)* Gross domestic product (29 $) Consumption Residential construction Business investment 2.3 (.6) Government expenditures 1..8 (.1) (.2) Exports. (.3) Imports Change in inventories (bil. $) Domestic demand Real disposable income Household employment Unemployment rate Inflation Before-tax profits (1.1) (2.1) Federal balance (unified budget, bil. $) (38.) (586.) (666.) (677.) (913.) Current account (bil. $) (3.6) (51.7) (9.) (537.5) (577.5) * or as noted Financial Forecast** Current Q 217 Q 218 Q Q 217 Q1 218 Q Fed Fund Target Rate month Treasury bills Treasury yield curve 2-Year Year Year Year Exchange rates U.S.$/Euro YEN/U.S.$ ** end of period Q1 217 Q Q 217 Q1 218 Q Q 218 actual actual actual forecast forecast forecast forecast forecast Real GDP growth (q/q % chg. saar) CPI (y/y % chg.) CPI ex. food and energy (y/y % chg.) Unemployment rate (%) National Bank Financial Quarterly pattern 9

10 Q/Q (Annual % change)* Gross domestic product (27 $) Consumption Residential construction (.) (1.9) 1.5. (3.) Business investment (11.3) (9.) Government expenditures Exports Imports.7 (1.) Change in inventories (millions $), ,73 5,225,177 12,88 1,51,833 Domestic demand Real disposable income Employment Unemployment rate Inflation Before-tax profits (19.8) (1.9) Current account (bil. $) (71.5) (65.) (67.2) (67.6) (56.) * or as noted Canada Economic Forecast Financial Forecast** Current Q 217 Q 218 Q Q 217 Q1 218 Q Overnight rate month T-Bills Treasury yield curve 2-Year Year Year Year CAD per USD Oil price (WTI), U.S.$ ** end of period Q1 217 Q Q 217 Q1 218 Q Q 218 actual actual actual forecast forecast forecast forecast forecast Real GDP growth (q/q % chg. saar) CPI (y/y % chg.) CPI ex. food and energy (y/y % chg.) Unemployment rate (%) National Bank Financial Quarterly pattern 1

11 Provincial economic forecast f 218f 219f f 218f 219f Real GDP (% growth) Nominal GDP (% growth) Newfoundland & Labrador Prince Edward Island Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Canada Employment (% growth) Unemployment rate (%) Newfoundland & Labrador Prince Edward Island Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Canada Housing starts () Consumer Price Index (% growth) Newfoundland & Labrador Prince Edward Island Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Canada e: estimate f: forecast Historical data from Statistics Canada and CMHC, National Bank of Canada's forecast. 11

12 Economics and Strategy Montreal Office Toronto Office Stéfane Marion Marc Pinsonneault Kyle Dahms Warren Lovely Chief Economist and Strategist Senior Economist Economist MD, Public Sector Research and Strategy Paul-André Pinsonnault Matthieu Arseneau Jocelyn Paquet Senior Fixed Income Economist Senior Economist Economist Krishen Rangasamy Senior Economist Angelo Katsoras Geopolitical Analyst General National Bank Financial (NBF) is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on Canadian stock exchanges. The particulars contained herein were obtained from sources which we believe to be reliable but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. 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