DECEMBER 1, RETAIL RATE FORECASTS Rates Will Continue to Go Up in #1 BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff The economic context remains very favourable. ff Interest rates will continue to rise in the coming quarters. ff The Canadian dollar is still being held back by the Bank of Canada s cautious stance. ff More modest returns for asset classes in. The global economic outlook is favourable for. Advanced economies, with the United States and the euro zone leading the pack, have continued to post impressive economic performance in recent months. The labour market also continues to do very well in many countries. While confidence indexes are still very high, everything suggests that global economic growth will remain sustained next year (graph 1). The Federal Reserve (Fed) will continue its monetary tightening. Given the strong performance of the U.S. economy and job market, the Fed now seems poised to raise its key interest rates by.5% at its December 13 meeting. After three increases in, a similar monetary tightening is expected by the Fed in. Fears of economic overheating could even warrant slightly quicker monetary tightening. The persistent weakness in inflation and wages (graph ) should, however, convince Fed leaders to keep the pace of interest rate hikes gradual. Canadian domestic demand is still very strong. After a spectacular surge in the first half of the year, Canadian GDP posted more subdued growth of % in the third quarter of. This slowdown was in line with expectations, but Canadian domestic demand, particularly household consumption, remained very robust (graph 3 on page ). The latest labour market and real estate data also greatly exceeded expectations. GRAPH 1 GRAPH Global economic growth is expected to continue accelerating next year Job creation remains very strong in the United States, but wages are still a bit weak Global real GDP growth According to purchasing power parity In thousands Annual variation in %.5 Desjardins forecasts. 3.5 3. 11 1 13 1 Sources: World Bank, Consensus Forecasts and Desjardins, Economic Studies 19 35 3 5 15 1 5 1 Annual variation in %.9.7.3.1 1.9 Job creation according to the establishment survey (left) Average hourly wage (right) Sources: Bureau of Labor Statistics and Desjardins, Economic Studies François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, Senior Economist Hendrix Vachon, Senior Economist Desjardins, Economic Studies: 51 81 336 or 1 866 866 7, ext. 555336 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.
The uptrend in bond yields should become clearer soon. After surging this summer, Canadian bond yields came down somewhat when the BoC took a more cautious stance in early fall. U.S. yields, however, have increased significantly in recent months, reflecting a favourable economic outlook and the imminent increase in federal funds. Canadian bond yields should resume their upward trend as soon as the BoC signals that it is ready to continue its monetary tightening. GRAPH 3 International trade curbed real Canadian GDP growth in Q3 Contributions to annualized quarterly change in real GDP 8 6 3.7.3 Net exports. Gross fixed capital formation A gradual rise in retail rates is still expected. With the BoC taking a break this fall, borrowers were given some respite after the fairly abrupt rate hikes this summer. However, the most recent economic statistics confirm that Canadians need to be prepared for further retail rate increases in and 19, even though the BoC s exact timing will likely remain difficult to predict. Consumer spending Total - - Change in inventories and residual error Q Q1 Q Q3 Sources: Statistics Canada and Desjardins, Economic Studies The Bank of Canada (BoC) is expected to raise its key interest rates soon. It comes as no surprise that the BoC kept its monetary policy unchanged at its December 6 meeting. A rate hike announcement is, however, expected in the coming months, as, by all indications, the Canadian economy s excess capacity continues to shrink and since the two rate increases this past summer did not appear to have a major impact on Canadian consumer confidence or spending. High household debt also calls for a gradual rise in interest rates. TABLE 1 Forecasts: Retail rate DISCOUNT RATE IN % Realized (end of month) June July August Sept. Oct. Nov. Dec. 11, Forecasts End of quarter : Q : Q1 : Q : Q3 End of year 19 TERM SAVINGS1 MORTGAGE RATE PRIME RATE 1 year 3 years 5 years 1 year 3 years 5 years.75 1. 1..7.95.95 3.1 3.1 3. 3. 3.59 3.7 3.7 3.7.7.7.8.8.85.85 5 5. 3.7 3.7 3.5 3.95 3.9 3.59 3.35 3.85 3.5 3.95 3.55.5 3.6 3.8 3.6.1 3.6.1 3.8.3.89 5.19.8 5.3.9 5. 5.1 5.6.8 1.1.85 1.35.95 1.5 5 1.35 5. 1.5 5 1.5 1.95.5. 3.. 3. 3.5.5 3.95.95 3.95.95 3.75.55.15.95 3.85.65 3.85.65.3 5.1..8 5.15 5.95 5.6 6. 5. 6. 1.3.1 1.85.65 1.6. 1.6...8 5 5 1.85.65.5 3.5 1.85.65 1 Non-redeemable (annual); NOTE: Forecasts are expressed as ranges. Source: Desjardins, Economic Studies DECEMBER
Exchange Rate The Canadian Dollar Is Still Being Held Back by the BoC s Cautious Stance The Canadian dollar reacted positively to the latest Canadian economic data, which often beat expectations. However, the Bank of Canada (BoC) maintained a stance deemed to be cautious, and the Canadian dollar was unable to hold on to its gains. It is currently hovering at close to US$.78 (C$1.8/US$). If not for higher oil prices to support it, the value of the Canadian dollar would probably be closer to US$.75, as suggested by the adverse shift in the interest rate spreads between Canada and the United States (graph ). GRAPH The Canadian dollar has stabilized around US$.78 US$/C$ Spreads in basis points.85.8 -.75 -.7 The U.S. dollar momentum slowed in November. The first week of December was better, but overall the U.S. currency is having trouble profiting from rising interest rates in the United States. Other factors are clouding the issue, such as changes in investors appetite for risk. The U.S. dollar appears to be penalized when investors have a stronger taste for risk. The poor performance of the U.S. dollar also seems to be linked to persistently low inflation and the fact that the markets are not expecting a high potential for monetary tightening in the coming years (graph 5). Forecasts: The Canadian dollar should remain close to US$.78 in the short term, but is expected to appreciate slightly in the longer term. There is a greater likelihood of the BoC raising interest rates again in the first quarter of next year, suggesting that the unfavourable trend in interest rate spreads with the United States is drawing to a close. Lower uncertainty about the North American Free Trade Agreement (NAFTA) could help the loonie, but the opposite is also possible. Economic surprises could inject volatility into the currency, in parallel with monetary tightening expectations. -6.65-8 Canadian exchange rate (left) Spreads between -year yields with the United States (right) GRAPH 5 The greenback rebound has lost steam DXY effective exchange rate Index 1 1 1 98 96 9 9 9 Sources: Bloomberg and Desjardins, Economic Studies Determinants Short-term Long-term Oil prices Metals prices Interest rate spreads TABLE Forecasts: Currency END OF PERIOD US$/CAN$ CAN$/US$ CAN$/ US$/ US$/ 19 Q3 Q1f Qf Q3f Q1f Qf Q3f.8 1.7 1.71 1.18 1.317.78 1.81 18 1.18 1.33.78 1.81 1.17 1.3.78 1.81 18 1.18 1.31.79 1.658 63 1.19 1.3.795 79 9 1. 1.3.8 5 1. 1.31.8 1. 1.3.81 1.36 3 1.3.8 1.195 366 1.6 1.33 f: forecasts DECEMBER 3
Asset Classes Return More Modest Returns Are Expected in Stock markets are continuing to perform well. Encouraging developments that are now suggesting that a tax reform will be signed in Washington by the end of the year have driven a number of stock indexes to new historic highs over the past few weeks. However, some uncertainty has emerged in recent days, as lower corporate tax rates might not be taking effect until 19 and reform details might be less favourable than expected for some sectors. Either way, there is no doubt that will have been another milestone year for investors, as stock markets, particularly foreign ones, skyrocketed without leaving the bond market too worse for wear (graph 6). GRAPH 6 Another great year for asset classes, particularly foreign January = 1 1 U.S. stock market Overseas advanced stock markets 13 Emerging stock markets Canadian stock market Canadian bonds 1 11 1 9 The U.S. stock market is not cheap, but it could stay that way. After another year of spectacular growth, it is clear that the U.S. stock market may seem overvalued to some investors. In particular, there has been a leap in the ratio between the total capitalization of the U.S. stock market and GDP in recent years, getting very close to levels seen during the tech bubble (graph 7). However, this ratio does not take into account strong corporate earnings growth, which jumped roughly % in the case of the S&P 5 in, and extremely low interest rates, which justify higher price/earnings ratios than in the past (graph 8). As the uptrend in interest rates should become clearer, we are expecting decent performance of about 7% for the S&P 5 next year. Profit taking could, however, lead to temporary setbacks. Higher commodity prices are encouraging for the Canadian stock market. After a disappointing first half to, industrial commodity prices have recovered significantly since the summer. The renewed optimism was initially mostly felt in industrial metals, but oil prices also posted strong gains recently, hitting nearly US$6 a barrel. The recent rise in oil prices is buoyed by many factors, including a spike in Middle East tensions, but there is no doubt that signs of acceleration in the global economy is great news for industrial commodities. This more positive sentiment concerning resources led to decent performance on the Canadian stock market in despite a difficult start to the year, and it could help it post slightly stronger performance than foreign indexes in. The bond market could have a more difficult year ahead in. One of the pleasant surprises of is that the Canadian bond market will have posted returns of roughly 3% despite the Canadian economy s excellent performance and the Bank of Canada s two rate hikes. This is mainly due to the fact that, unlike short-term rates, long-term yields have remained very low, which has resulted in a significant JAN. MAR. MAY. JUL. SEP. NOV. GRAPH 7 Relative to the economy, the stock market seems very expensive Ratio between Wilshire 5 and U.S. nominal GDP 15 13 11 9 7 5 3 197 1975 198 1985 199 1995 5 1 GRAPH 8 Stock markets remain attractive compared to the bond market Index 16 1 1 1 8 6 196 15 1 5 197 198 199 1 Inverse of the S&P 5 cyclically adjusted price-to-earnings ratio (left) U.S. 1-year yield (right) Sources: S&P Dow Jones Indices, Datastream and Desjardins, Economic Studies DECEMBER
GRAPH 9 Narrowing spreads between long- and short-term rates favoured the bond market in 3.. 1..5. -year yield 1-year yield Despite a fairly favourable context, returns are expected to be more constrained in. Sustained strong economic growth is good news for stock markets, as it suggests further growth in corporate earnings. Aside from having an adverse effect on the bond market, a clearer rise in interest rates may somewhat limit returns of foreign stock exchanges after the remarkable gains in. The most harmful scenarios for investors would be a dramatic deterioration in the economic outlook or, conversely, a pickup in inflation that would force central banks to sharply accelerate monetary tightening. For the time being, however, there is no sign that the economic situation will be going down that road in. flattening of the yield curve (graph 9). The persistence of low inflation in a number of countries and doubts as to central banks willingness to normalize monetary policy helped curb upward pressure on long-term bond yields. As the temporary factors that drove inflation down should dissipate and the steep drop in excess production capacity should put upward pressure on wages, we are expecting a more widespread rise in North American bond yields in the coming quarters. This should translate into a slightly negative return for the Canadian bond market in. 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 5 index (US$) MSCI EAFE index (US$) C$/US$ (variation in %)3..1..3.6.9 1. 1..9.5.5.1 3.7 6. 5. 6.7 9.7 3.6-1. 8.8 3.5 17.3 9.8-33. 35.1 17.6-8.7 7. 13. 1.6-8.3 1.1 15.8 5.5-37. 6.5 15.1.1 16. 3. 13.7 1. 1. 6.9 11.6-3.1 3 8. -1 17.9 3.3 -.5 -.. -1..1-13.7-5..3 -.7 7.1 9. 19.1 -.9 f range target:.7.65 to.75 target: 3. to 3.8 target: 8. 5. to 11. target:. 17. to 3. target: 19. to 5. target: -.6 (US$.78) -6.9 to -. f range target: to 5 target: - -3.5 to. target: 9.. to 1. target: 7.. to 1. target: 7. -1. to 1. target: -1.9 (US$.795) -6. to.6 END OF YEAR IN % (EXCEPT IF INDICATED) 6 7 8 9 1 11 1 13 1 1 FTSE TMX Canada Bond Universe; Dividends included; 3 Negative = appreciation, positive = depreciation; f: forecasts DECEMBER 5