Market volatility and trade tensions set the tone April 2018

Canada Outlook Market volatility and trade tensions set the tone April 2018 HSBC Private Wealth This document contains the views of HSBC Global Asset Management and is distributed by HSBC Investment Funds (Canada) Inc., HSBC Private Wealth Services (Canada) Inc., and the HSBC InvestDirect division within HSBC Securities (Canada) Inc., each of which are subsidiaries of HSBC Bank Canada. This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. Outlook for Q2 2018: A balanced expansion with negligible recession risk We still maintain that the risk of recession remains effectively zero. The most important risk comes from the potential for rising inflation to prompt policymakers to raise interest rates more aggressively than expected. We see the US Federal Reserve (Fed) raising rates three or perhaps four times in 2018. It s also important to keep in mind that rising inflation can signal better economic growth. Oil and other key commodities should benefit from price appreciation, which is positive news for Canada s economy. Of course, the economic tensions linked to US President Trump s trade rhetoric are a key variable that we are watching closely. The Brexit talks and economic reforms in China are also major risks that we are monitoring. However, overall, we think the economic environment continues to look positive, albeit with elevated volatility, as we move deeper into 2018. Real GDP forecasts 4.0% 2.0% 2.2% 1.8% 2.8% 2.4% 2.4% 2.0% 1.3% 1.5% 1.0% 1.5% 0.0% Canada US Eurozone Japan UK 2018 2019 HSBC investment strategy highlights: Equities remain favoured over bonds The well-diversified structure of our portfolios reflects our views on capital markets. Currently, we have a neutral position in Canadian and US equities with a slight overweight in international equities. Within fixed income, we continue to prefer corporate bonds. Many good-quality corporate bonds are supported by solid company balance sheets. These corporate bonds also offer higher yields than government bonds. Within the government sector, we still prefer provincial bonds over Government of Canada bonds because of their higher return potential. We have built up a small overweight in cash to allow the flexibility to take advantage of opportunities in the bond market as yields move to potentially more attractive levels. INTERNAL

Q1 in review The bull market runs out of steam in the face of market volatility and trade tensions The first three months of 2018 struck a vastly different tone from the consistently positive sentiment and low volatility of 2017. Stock markets looked set to extend their gains until the last few days of January, when markets began to sell off in the face of rising interest rates. A US report on wage growth pointed to increasing inflation, prompting many investors to fear a more aggressive Fed timetable for raising interest rates. The Fed noted strong labour market conditions and inflationary pressures in its January 31 statement but elected to stand pat on rates. But on March 21, it raised the federal funds rate target range to 1.5%-1.75%. Many analysts had expected the 10-year US Treasury yield to hit 3% by the end of 2018, but anxious investors have pushed it within range of that already. As yields rise, they have the potential to encourage investors to shift from stocks into fixed income. The Bank of Canada raised rates 25 basis points on January 17, bringing the policy interest rate to 1.25%. The Bank cited recent strong data, inflation at close to target levels, and Canada s economy operating roughly at capacity. However, it did point to uncertainty over the North American Free Trade Agreement (NAFTA) clouding the economic data. Citing an economy at capacity and close-to-target inflation, policymakers anticipate higher interest rates over time but will be cautious in considering further adjustments. Future policy decisions continue to be dependent on the economy s sensitivity to interest rates, how close the economy runs to full capacity, wage growth, and inflation. Trade tensions proved to be a concern globally as the Trump administration put tariffs on aluminium and steel. This prompted China to impose tariffs on US food imports in early April, rattling markets. Revelations about privacy breaches at Facebook earlier in the quarter, along with President Trump s attacks on Amazon, also added to general market volatility. Canadian fixed income outperforms equities in Q1 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% -3.00% -4.00% -5.00% -4.52% 3-Month Total Returns 0.10% 1.71% 1.36% 12-Month Total Returns S&P/TSX Composite Index FTSE TMX Canada Universe Bond Index Source: Bloomberg as at March 29, 2018 2 Canada INTERNAL Outlook April

Canadian market and economic highlights Information technology the only Canadian market sector to finish in positive territory Information technology was the only sector of the S&P/TSX Composite Index to post a positive return in the first quarter, largely driven by strength in Shopify. The sector finished the quarter up 10.2%. Performance was in keeping with US and global markets, which also saw good overall performance despite volatility associated with Facebook and Amazon. The worst-performing Canadian sectors were energy and health care. Upward pressure on interest rates hurt performance in higherdividend yielding sectors like utilities and telecommunications services. Canada s trade deficit grows, pointing to a weak first quarter Canada's merchandise trade deficit totalled $2.7 billion in February, widening from a $1.9 billion deficit in January, according to Statistics Canada. Imports rose 1.9%, mainly due to higher imports of energy products. Exports increased 0.4%, primarily on higher exports of passenger cars and light trucks. The weaker trade picture, along with ongoing uncertainty surrounding NAFTA negotiations with the Trump administration, strengthens the argument for the Bank of Canada to move slowly on interest-rate increases this year. We support this view, despite stronger jobs numbers and signs that inflation pressures may be growing. Canada s unemployment rate was unchanged in March at 5.8%. The Bank of Canada likely sees lower interest rates and the resulting weakness in the Canadian dollar as positive factors for Canada s trade position. The Canadian dollar spent most of the first quarter losing ground to the US dollar. Canada s economy at a glance Economic indicators Latest period Year ago Real GDP January -0.1% m-o-m 2.7% y-o-y Unemployment 1 March 5.8% 6.7% Housing starts (000s) 1 February 229.7 units 210.2 units New motor vehicle sales (000s) January 120.2 vehicles 6.4% y-o-y Retail sales January 0.3% m-o-m 3.6% y-o-y Current account balance 1 Q4 2017 -$16.3 billion -$10.7 billion Consumer Price Index February 0.6% m-o-m 2.2% y-o-y m-o-m = month-over-month change; y-o-y = year-over-year change Note: 1. Levels are shown for the latest period and the same period a year earlier Sources: Statistics Canada and Bloomberg at April 6, 2018 3 Canada INTERNAL Outlook April

2018-02 2017-10 2017-06 2017-02 2016-10 2016-06 2016-02 2015-10 2015-06 2015-02 2014-10 2014-06 2014-02 2013-10 2013-06 2013-02 2012-10 2012-06 2012-02 2011-10 2011-06 2011-02 2010-10 2010-06 2010-02 2009-10 2009-06 2009-02 2008-10 2008-06 2008-02 2007-10 2007-06 2007-02 2006-10 2006-06 2006-02 2005-10 2005-06 2005-02 2004-10 2004-06 2004-02 2003-10 2003-06 2003-02 2002-10 2002-06 2002-02 2001-10 2001-06 2001-02 2000-10 2000-06 2000-02 Spotlight on inflation Why is inflation so low? What happens next? The Phillips curve is a central idea in macroeconomics that shows an inverse relationship between the unemployment rate and inflation in the economy. However, recent experience has raised doubts over the Phillips curve. Despite unemployment grinding lower in most developed market economies, wage growth and underlying inflation have been subdued. This suggests the existence of structural factors contributing to a regime of price stability. A long period of low inflation may have led workers to accept their existing level of wage increases, even in a backdrop of a tightening labour market or temporary price shocks. Workers bargaining power may have been eroded by changes in the nature of work in the 21st century, including greater use of flexible contracts, increased self-employment and declining trade union membership. The rise of globalization since the late 1980s has also created a bigger global marketplace for goods and services, as well as labour. This has reduced the pricing power of firms and workers alike and helped to keep a lid on price pressures. Nevertheless, it is important to note that there is still a tendency for the Phillips curve relationship to hold true, even if it is weak. Therefore, we should expect some cyclical inflation at this point in the global economic cycle. In fact, there is already evidence of building price pressures. The market continues to dismiss this risk, however. With our measure of expected sustainable returns remaining low for developed market government bonds, retaining an underweight positioning in this asset class continues to make sense, in our view. Consumer Price Index (CPI) Percentage change over the past 12 months % 5 4 3 2 1 0-1 Source: The Bank of Canada as at April 6, 2018. CPI is an indicator of changes in consumer prices. It compares the cost over time of a fixed basket of goods and services purchased by consumers. CPI is widely used as an indicator of the change in the general level of consumer prices or the rate of inflation. -2 4 Canada INTERNAL Outlook April

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