Interest Rate Normalization Could Take a Break

Transcription

1 DECEMBER 11, RETAIL RATE FORECASTS Interest Rate Normalization Could Take a Break #1 BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff International worries and concerns that the U.S. economy is slowing are intensifying. ff The latest economic figures are forcing the Bank of Canada to change its rhetoric. ff The loonie is looking for support. ff After a dismal year for investors, 19 is looking brighter. Growth will remain strong in the short term, but international worries are intensifying. Concerns about the global economy are resurfacing, with the euro zone expanding a scant.7% in the third quarter. Fears about the economy also seem to be gaining momentum in the United States, as business investment disappoints and the real estate market appears to be slowing significantly (graph 1). The underpinnings for growth remain solid in the United States, however, with robust consumption and a job market running on all cylinders. GRAPH 1 Home sales slowing in the United States In thousands 7 6 In thousands New single-family homes (left),9 Existing homes (right),7 6,,3,1, Sources: National Association of Realtors, U.S. Census Bureau and Desjardins, Economic Studies,7 The Federal Reserve (Fed) softens its tone as it moves closer to the neutral rate. Recent comments by Fed leaders stressed the fact that federal rates are edging closer to neutral territory, signalling the eventual end of the current monetary tightening cycle. The importance of remaining sensitive to changes in the economic data was also highlighted, while fears about an economy slowing down seem to be strongly affecting market sentiment. Despite these comments, the outlook remains good and we can expect the Fed to move ahead with its anticipated rate hike in December, as well as three additional increases in 19. That said, the Fed may opt to take a quarterly break in its monetary tightening a little earlier than previously anticipated. Canadian growth more at risk as oil prices collapsed and domestic demand wanes. Economic growth in the third quarter was largely supported by a rise in net exports, with domestic demand was flat (graph on page ). This development points to a weaker than expected Canadian economy, especially since the growth in foreign trade is due to a drop in imports, and not an increase in exports. The plunge in oil prices, coupled with the major discount on the price of Western Canadian oil, is also weighing heavily on exporting provinces, prompting Alberta to announce production cuts. These developments could limit economic growth in the short term. François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, Deputy Chief Economist Lorenzo Tessier-Moreau, Economist Hendrix Vachon, Senior Economist Desjardins, Economic Studies: or , ext. 336 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 outlook, have forced the BoC to redirect its message by focusing on the many risks weighing on Canadian growth rather than monetary policy normalization. We now expect the BoC to wait until the spring before it resumes its monetary tightening. GRAPH International trade boosted Canadian growth in Contributions to annualized quarterly change in real GDP 3.9. Change in inventories and residual error 1 Gross fixed capital formation Consumer spending -1 Total - -3 Net exports Q Q1 Q Sources: Statistics Canada and Desjardins, Economic Studies Retail rates should be maintained, despite the drop in bond yields. The return of pessimism to the stock and bond markets has significantly dragged down North American bond yields. Canadian yields have fallen just below their July levels while U.S. yields have reached their September levels. Despite these significant shocks, retail rate cuts seem unlikely in the short term, as most financial institutions are still adjusting to the recent key rate increases. Retail rates should start climbing again in the medium term as monetary normalization carries on. The Bank of Canada (BoC) should hold off on expected rate hikes as its narrative crumbles, weighed down by a succession of bad news. The October Monetary Policy Report referred to an expected boom in business investment and the resilience of the real estate sector as factors that argued in favour of accelerating monetary normalization. Canadian real GDP data for told a much different story, however, with residential and non-residential investment both showing significant declines of.9% and 7.1%, respectively. These data, along with falling oil prices and a deteriorating global TABLE 1 Forecasts: Retail rate DISCOUNT RATE IN % Realized (end of month) June July August Sept. Oct. Nov. Dec. 1, Forecasts End of quarter : Q 19: Q1 19: Q 19: End of year 19 1 TERM SAVINGS1 MORTGAGE RATE PRIME RATE 1 year 3 years years 1 year 3 years years Non-redeemable (annual); NOTE: Forecasts are expressed as ranges. Source: Desjardins, Economic Studies DECEMBER

3 Exchange Rate The Loonie Is Looking for Support Canada s currency has been trending downward since the beginning of October (graph 3). Protectionist threats against the Canadian economy have dwindled considerably since the free trade agreement was concluded at the end of September and signed at the recent G summit. This could have propped up the loonie, but a confluence of other factors led to the opposite. For one, the recent economic data in Canada have been disappointing on the whole. The sharp rise in job creation for November was a rare bright spot. Difficulties in Canada s oil sector returned to the fore due to low oil prices and Alberta s announcement that it would slash production to reduce current stockpiles. Lastly, the Bank of Canada s shift from being bullish in October to rather pessimistic in December also clipped the loonie s wings, by reducing the probability that monetary tightening would continue in the short term. Th Canadian dollar is not the only currency that has struggled of late. The euro dipped below US$1.13 recently, the lowest it has been since summer. Weak investor appetite for risk usually benefits the U.S. dollar (graph ). Some easing was noted against the currencies of emerging nations, however, which are seeming to benefit from the declines in bond yields. Forecasts: In our view, the current pessimism on the financial markets should fade in the months ahead. This would help the loonie gain back some of the ground it has lost since October. A rebound in oil prices could also boost the loonie, but upcoming changes on interest rates should remain unfavourable. Bottom line, the loonie might have trouble rising above US$.77 in the next year. GRAPH 3 The loonie has been losing altitude since the beginning of October Canadian exchange rate US$/C$ JAN. APR. JUL. JAN. APR. JUL. GRAPH The greenback is rising against other currencies, especially those of advanced nations Change in the U.S. dollar since the end of September Turkey Argentina Indonesia Brazil Japan India Australia China Malaysia Taiwan Thailand Switzerland Korea Russia South Africa Euro zone Sweden Canada United Kingdom Norway Mexico 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$/ 19 Q Q1 Q Qf Q1f Qf f Qf f: forecasts DECEMBER 3

4 Asset Classes Return After a Dismal Year for Investors, 19 Is Looking Brighter The stock market s troubles continue. Any hopes for a sharp rebound before the end of are starting to dim. The stock market indexes jumped in early and late November, only to tumble sharply soon afterwards. Disappointing international data and plummeting oil prices fuelled investors concerns. Fears about the strength of the global economy gradually won out over concerns about the increase in bond yields. GRAPH More normal volatility, after a very calm ,9,7,,3 The return of volatility is not surprising. The current situation is tough for investors, but we have to keep in mind that periods of wild swings on the markets are not unusual. The S&P s straight-line advance in was the real exception, from a historical standpoint (graph ). As a number of central bank leaders noted recently, the return of more normal volatility on financial markets is a foreseeable consequence of monetary policy normalization.,1 The bond market capitalizes on concerns. The perception of deteriorating economic and inflation outlooks after oil prices collapsed put major downside pressures on bond yields (graph 6). In Canada, the Bank of Canada s more concerned tone, signalling a pause in monetary tightening, also helped drive down bond yields further. Despite the more ambiguous signals from the Federal Reserve, investors have also sharply downgraded their expectations on U.S. key rate hikes. In this environment, Canada s bond market could wrap up with a slightly positive performance for the year overall. GRAPH 6 1,9 1,7 1 S&P (left) 16 VIX index of S&P implicit volatility (right) U.S. and Canadian bond yields have fallen sharply since the beginning of November 1-year federal bond yields United States (left).7 Canada (right) Oil prices seem to be itching to rebound. Following in the footsteps of Canadian oil prices, international oil prices plummeted recently as well. The price of WTI (West Texas Intermediate) oil, which was above US$7 a barrel in early October, tumbled to about US$ as a result. The U.S. administration s decision to temporarily allow certain countries to continue to import Iranian oil contributed to this price drop, which also reflects the negative sentiment on the financial markets. Oil producers reacted to this recent price drop, however. In addition to funding the increase in rail transportation, the government of Alberta announced that provincial producers would slash their output by 8.7%, starting early next year. Internationally, Organization of the Petroleum Exporting Countries (OPEC) also decided to significantly reduce their output to rebalance the market. These decisions confirm our expectations that oil prices will rebound in the next few months. Soaring profits are reassuring. The stock market turmoil continues to contrast with the impressive growth of corporate earnings in North America (graph 7). Companies on the.1.8 AUG. SEP. NOV.. DEC. GRAPH 7 The surge in earnings is a major support for North American indexes Profits for the past 1 months Profits/share 17 1 Profits/share 1, S&P (left) S&P/TSX (right) 1, Sources: I/B/E/S, Datastream and Desjardins, Economic Studies DECEMBER

5 S&P are thus heading for a more than % rise in profits in. Tax reform in the United States no doubt contributed to this excellent outcome, but a sharp uptrend was already being seen last year. Canadian business profits have also been nothing short of spectacular. The price-to-earnings ratio for the last 1 months has fallen sharply in recent months to slightly below its average since 1987 for the S&P and to a very low level for the S&P/TSX (graph 8). Next year should be better for investors. While investor concerns seem exaggerated in our view, we continue to call for a market rebound in the months ahead. The timing of this rebound is highly uncertain, however, and everything suggests will be a year that Canadian investors will want to forget. As discussed in a recent Economic Viewpoint, the attractive valuations on North American indexes point to nearnormal returns in 19, maybe even a little higher in Canada. The bond market appears vulnerable in the short term after the recent drop in yields, but overall we expect to see another year of almost flat returns in 19. GRAPH 8 The price/earnings ratios based on past earnings dropped sharply in recent months Price/earnings ratios Past 1 months 3 S&P S&P/TSX Sources: I/B/E/S, Datastream and Desjardins, Economic Studies TABLE 3 Asset classes percentage return CASH BONDS CANADIAN STOCKS U.S. STOCKS INTERNATIONAL STOCKS EXCHANGE RATE 3-month T-Bill Bond index1 S&P/TSX index S&P index (US$) MSCI EAFE index (US$) C$/US$ (variation in %) f range target: to 1. target:. -1. to 1. target: to. target: 6.. to 1. target: to. target:.3 (US$.7) 3.9 to 7. 19f range target: to. target:. -1. to 1. target: 11.. to 1. target: to 1. target: 8.. to 1. target: -1.9 (US$.77) -6.8 to 3. END OF YEAR IN % (EXCEPT IF INDICATED) f: forecasts; 1 FTSE Canada Universe Bond ; Dividends included; 3 Negative = appreciation, positive = depreciation. DECEMBER