Interest Rate Forecast

Interest Rate Forecast Economics January Highlights Global growth firms Waiting for Trumponomics Bank of Canada on hold Recent growth momentum in the global economy continued in December and looks to extend into. Inflation rumblings emerged because of higher energy prices. Policy risks from the new U.S. administration remain top of mind and, until clarity materializes, clouds the outlook. The global economy advanced at a faster pace at the end of according to the Global PMI in December. PMI growth in the fourth quarter was the best in more than one year in part due to a lacklustre start to. However, world manufacturing production accelerated the fastest in two-and-a-half years. Service sector activity remained solid. Growth spread to more economies with country PMI data turning in positive performances for the majority in the global survey. The main risk to the global economy are U.S. administration implementing trade protectionist measures with negative growth impacts and financial market disruptions. The consequences of a trade war is a global recession. Policy measures such as tax cuts, more spending, and deregulation would impact the U.S. economy later. A more medium-term risk is the political situation in Europe generated by the rise in populism and its anti EU sentiment. The Dutch and French elections in the first-half of the year is followed by elections in Germany. While none of the populist parties are expected to gain political control, financial market turmoil and euro currency swings are likely. Oil prices remain a source of uncertainty despite the recent OPEC agreement to cut production. Global Purchasing Managers Indexes 50 = no change 58 56 54 52 50 Services Composite Manufacturing 48 2014 2015 Source: JP Morgan and IHS Markit, Bloomberg. Note: Seasonally adjusted. Latest: Nov-16 Oil futures price movements still indicate that the market remains skeptical of the delivery of cuts by OPEC with a settlement price of $56 in 2020. U.S. shale oil production will increase at prices above $50. Higher oil prices have positive and negative impacts on the economy depending on whether it is a net consumer or producer. overall, higher oil prices are considered negative for the global economy. The U.S. economy generated mostly positive data in the past month. December s employment report was below expectations but nonfarm payrolls increased 156,000 while the unemployment rate ticked up to 4.7%. There were upside reports for construction spending, auto sales, inventories, and the trade balance. The ISM manufacturing survey rose for the fourth month in a row in December to its highest level in two years. The non-manufacturing survey held up after recent improvements. The Fed s December rate increase was predicated on an improving U.S. economy with rising wage pressures in a labour market approaching full-employment. Wages are rising at a faster pace and are approaching the pre-recession 4% pace. The official unemployment rate is below 5%, which is often considered a sign the labour market is at full employment. However, a broader measure of unemployment, the U6 rate, is above 9% indicating more slack than would appear. 1

The U.S. economy will continue to grow with a tightening labor market putting upward pressure on wage inflation. The Fed will proceed with rate normalization in and. Our expectation is for two rate increases in with an additional hike if wage inflation spills over into consumer price inflation in the context of 2.5% real GDP growth and no major policy disruption. Prospects and risks for look similar to. China ended with some momentum though the two PMI surveys diverged in December with a small decline in the official survey and a notable increase in the private survey. Sample differences are at play, though both measures usually track in tandem. China s policy response provided support to the economy in but these measures are seen fading in. The yuan s depreciation viz USD is aiding the trade sector but speeding up capital outflows causing China to tightened liquidity conditions. The IMF has highlighted rising financial risks in China and urged more measures to contain corporate debt. Japan s economy picked the pace as reflected in the latest business surveys. The manufacturing PMI posted 52.4 in December, up from 51.3 in November and the highest since last December. Overall GDP Growth remains low but is seen to be somewhat faster in due to the lower yen and government stimulus. In Europe, the yearend saw a robust pace of expansion with accelerating output growth in the composite PMI measure led by manufacturing. How much of and how long this momentum will extend remains to be seen. Political uncertainty is probably higher in Europe than in the U.S. given the number of elections this year and the pending U.K. vote to leave the EU. The lower euro and potential for more fiscal stimulus are positives but likely not sufficient to generate more than 2% real GDP growth given other obstacles. Canada s economy also had a good finish to with a better than expected employment report; November had the largest real goods international trade surplus in several years; housing starts were above 200k units in December; and a higher PMI result in December. Per cent change, y/y 4.5 4.0 3.5 3.0 2.5 2.0 1.5 Hourly Wage Tracker, U.S. 1.0 01/01/2009 01/01/2011 01/01/2013 01/01/2015 Source: Atlanta Federal Reserve. Note: 3-month moving average of median wage growth. Latest: Nov-16 Less positive economic data revealed a poor start to fourth quarter GDP with industry GDP contracting in October mainly on manufacturing weakness. Not surprisingly, manufacturing sales were down in October. Inflation is not a concern with consumer price growth slowing in November to 1.2% from its 1.5% in the previous month from weakness in energy prices. The Bank of Canada s core index slipped to 1.5% from October s 1.7% rate. Inflation should not become an issue for the Bank until excess capacity is reduced and the output gap is much smaller. Housing market activity is widely expected to soften in resulting in less new construction and investment, which will pull down overall GDP growth. While December MLS residential sales bounced up from November, the sales downtrend seen since last April remained intact. Tighter federal mortgage insurance rules in effect last mid-october have yet to be fully felt in the market. However, housing markets are local and local demand-supply conditions can partially or entirely offset national influencers. Forecasts of Canada s economy are upgraded slightly due to the expected improvement in the U.S. economy and higher energy prices. Our forecast is a little above consensus because we do not see housing falling as much as other forecasters. Decimal points aside, a modest growth outlook prevails nonetheless. Canada needs a cyclical uplift in exports to push growth above 2.5 % and there is no likely driver in the near term. Higher energy prices could 2

provide such a lift, as well as other resource export sectors. While commodity prices look to have bottomed, it will take time for markets to generate more rapid price gains. Manufacturing exports are another possible driver but with the U.S. new vehicle sales cycle at or near a peak, it is difficult to envision much growth generated from this sector. Service exports such as tourism, TV/film, transportation, and business/professional services are growing and have further room to grow but they constitute less than 20% of Canada s exports. Layer on top of this possible new trade restrictions imposed by the incoming U.S. administration and exports are not seen providing a cyclical lift anytime soon. Economic Forecast - Canada Government 10-year Bond Yield, U.S. and Canada Per cent 2.70 2.50 2.30 2.10 1.90 U.S. Canada 1.70 1.50 1.30 1.10 0.90 10/03/ 11/02/ 12/05/ 01/06/ Source: U.S. Federal Reserve, Bank of Canada. Latest: 1/13/ 2015 Real GDP, % a.r. -1.3 3.5 1.5 2.0 0.9 1.4 2.0 2.1 Unemployment Rate, % 6.9 7.0 6.9 6.8 6.9 7.0 6.8 6.6 Total CPI, % y/y 1.6 1.2 1.7 1.8 1.1 1.5 1.8 1.9 Source: Statistics Canada, Central 1 Credit Union. Shaded (orange) values are forecasts. In Canada, the futures market for three-month Bankers Acceptances is currently pricing in one 25-bps rate increase in March followed by another in early 2019. The consensus view of forecasters is a rate increase in the third quarter of while a few see a rate cut as the next move. The Bank of Canada s economic forecast envisions a notable lift from exports in and with more business investment following. The Bank s forecast update will be released shortly and it will likely pare back its export performance and bump up consumption and housing. The bond market has sold off in recent weeks following the Trump bump with yields down about 20-bps since their mid-december peak. This likely reflects some unwinding of a market overshoot and has been rationalized as waiting for Trump s policy details and for some reality setting in that campaign talk and policy implementation are different, especially with Trump. The U.S. fed funds futures market is pricing in two 25-bps rate increases in and almost another two in. The Fed s latest median projection is three 25-bps rate hikes in, compared with two in the September projections, and another three in. Most forecasters agree and only a few see substantially more or fewer rate changes. Our view is for no rate change in or in 2019. Two per cent growth will not close Canada s output gap until early 2019. Given the number of growth disappointments since 2009 due to various economic, political and environmental events, it is very likely other events negatively affecting the economy will unfold during the next two years. Of course, a scenario of fewer negative events and a better economic performance prompting the Bank to raise its policy rate sooner than expected is possible. The yield curve is seen steepening through and beyond, barring an economic recession or crisis event. This forecast has the spread for the 10-year Government bond and three-month T-bill rate widening to 1.85% in late from about 1.20% currently and from 0.50% in late September. Posted mortgage rates have not moved and are not expected to move for another year or so even though bond yields have risen since last September and some contract mortgage rates were bumped up. The gap between the posted rate and funding costs remains very wide and 3

there is room for this gap to close before the posted rate needs to be adjusted upwards. The new federal mortgage insurance rules are geared off the posted rate so a higher yield structure in should not much impact on qualifying buyers. Helmut Pastrick Chief Economist, Central 1 Credit Union hpastrick@central1.com www.central1.com 604.737.5026 Target Overnight Rate Forecast Meeting Date (Per cent) Dec. 7 (a) 0.50 Jan. 18, 0.50 Mar. 1 0.50 Apr. 12 0.50 May 24 0.50 July 12 0.50 Sep. 6 0.50 Oct. 25 0.50 Dec. 6 0.50 Jan. 0.50 Mar. 0.50 Apr. 0.50 June 0.50 July 0.50 Sep. 0.50 Oct. 0.50 Dec. 0.50 Source: Bank of Canada, Central 1 Credit Union. (a) actual 4

a Interest Rate Forecast Target Overnight Rate 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 Prime Rate 2.70 2.70 2.70 2.70 2.70 2.70 2.70 2.70 2.70 1-mo. T-Bill 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.50 3-mo. T-Bill 0.48 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.55 6-mo. T-Bill 0.53 0.55 0.55 0.55 0.55 0.55 0.55 0.55 0.60 1-year T-Bill 0.58 0.60 0.60 0.60 0.60 0.65 0.65 0.65 0.75 2-year GoC Bond 0.66 0.80 0.85 0.90 0.90 0.95 1.00 1.05 1.15 3-year GoC Bond 0.70 0.85 0.95 1.00 1.05 1.15 1.25 1.35 1.45 5-year GoC Bond 0.90 1.20 1.30 1.35 1.40 1.45 1.50 1.60 1.70 10-year GoC Bond 1.25 1.80 1.90 1.95 2.00 2.05 2.15 2.25 2.35 Source: Bank of Canada, Central 1 Credit Union. Note: Quarterly average based on daily data. a = actual, all others forecast. a Deposit Rate Forecast 1-year GIC 0.74 0.85 0.85 0.85 0.85 0.85 0.85 0.85 0.85 3-year GIC 1.15 1.15 1.15 1.15 1.15 1.15 1.15 1.15 1.15 5-year GIC 1.45 1.40 1.40 1.40 1.40 1.45 1.45 1.45 1.45 Source: Bank of Canada, Central 1 Credit Union. Note: Quarterly average based on weekly data. a = actual, all others forecast. Non-redeemable semi-annual rates from Bank of Canada based on typical rate (mode) at six major banks. a Mortgage Rate Forecast 1-year Mortgage 3.14 3.15 3.15 3.15 3.15 3.15 3.15 3.15 3.15 3-year Mortgage 3.39 3.40 3.45 3.45 3.55 3.55 3.55 3.60 3.60 5-year Mortgage 4.64 4.65 4.65 4.65 4.75 4.80 4.95 4.95 4.95 Source: Bank of Canada, Central 1 Credit Union. Note: Quarterly average based on weekly data. a = actual, all others forecast. Posted fixed term rates from Bank of Canada rates based on typical rate (the mode) at six major banks. 5