Overview Inside... page Interest rate outlook page Economic outlook page Currency outlook page Central bank watch page 8 Financial conditions have improved page 9 Hitting the reset button FINANCIAL MARKETS MONTHLY March, A turbulent start to the year for financial markets extended into February, but negative sentiment reversed mid-month with an encouraging string of US data indicating the economy is on a solid footing to start and unlikely to slip into recession. Oil prices rebounded as several major producers expressed a willingness to limit further production growth, thereby helping to ease disinflationary concerns in some advanced economies. Equity markets managed to recover from losses earlier in the month, with the MSCI world index limiting the February decline to just and continuing to rally in March. Government bond yields have retraced some of their earlier declines, with -year US and Canada yields rising nearly basis points from recent lows while yields on UK and German equivalents increased by less than half that amount. The G meeting in late February disappointed some observers hopes for coordinated fiscal stimulus, although some countries (notably Canada and China) are set to ease fiscal policy on their own this year. Otherwise, monetary policy will continue to be relied on to boost growth and help return inflation to central bank targets. In that regard, the European Central Bank (ECB) responded to deteriorating financial conditions and deflation concerns by cutting the deposit rate further into negative territory, boosting the size and scope of asset purchases, and providing additional liquidity to banks. The Bank of Canada (BoC) and Bank of England (BoE) are likely to hold their stimulative policy rates steady throughout. We forecast both the Reserve Banks of Australia (RBA) and New Zealand (RBNZ) will cut rates further this year. While we continue to expect further rate hikes from the Federal Reserve, the pace of tightening looks like it will be even more gradual than anticipated around the time of December s liftoff. Central bank near-term bias Three-months out, policy rate The BoC issued a neutral policy statement in March, as growth and inflation are evolving as expected. The Bank will update its outlook after the March federal budget, with support from fiscal stimulus expected to make further rate cuts unnecessary. Recent US data have been positive, but the Fed will likely look for further confirmation that recent market volatility has not materially affected the economic outlook before raising rates again. We expect the fed funds rate will be held steady in March with a hike delayed until Q/. The UK economy appears to have lost some momentum to start, and with increasing uncertainty ahead of June s Brexit vote, we expect the BoE will keep monetary policy supportive this year. The ECB exceeded market expectations in March, stepping up stimulus with rate cuts, expanded asset purchases, and liquidity-providing measures. President Draghi indicated rates could be lowered further but any future stimulus will more likely be through unconventional easing. Josh Nye Economist -9-99 josh.nye@rbc.com A solid Q/ GDP report allowed the RBA to remain on the sidelines with an easing bias for now, but we expect weaker data in will bolster the case for rate cuts later this year. The RBNZ acted on its easing bias in March, lowering the cash rate by basis points and continuing to note that further policy easing may be required. We expect one more rate cut before mid-year.
Highlights Financial market volatility spikes Financial as investors conditions worry have about improved the since global mid- recovery. February, with credit spreads coming off recent highs Data and reports equity have markets erred on rallying. the weak side. However there were many Recent hard data have one-off defied the factors softness that in curtailed survey based indicators, activity. pointing to a solid rebound in Q/ GDP. As these factors ease, growth will accelerate. Job growth rebounded strongly in February, but a The US recession was rise in labour force participation kept the unemploy- deeper than was previously reported and GDP output ment rate steady. stands. pp below its prerecession peak. A cautious approach to tightening favours rates being held steady in March as the Fed awaits further confirmation of an improving trend in the data. US growth slowed at the end of last year The second estimate of fourth-quarter gross domestic product (GDP) confirmed the US economy lost some momentum at the end of. While growth in the final quarter was revised upward to. from. in the advance estimate, much of the adjustment reflected weaker imports and stronger inventory investment. Consumer spending was revised slightly lower but still accounted for most of the economy s growth in the fourth quarter as government spending and private investment were both close to flat. Limited support from the rest of the economy and a less robust gain in household spending relative to prior quarters left domestic demand growth at its slowest pace in more than two years albeit to a still respectable.. Net trade was once again a drag on growth in the quarter with a decline in exports outpacing a modest drop in imports. Despite moderation in the fourth quarter, growth for as a whole was a solid., thereby matching s increase. but concerns about broader downturn overblown Unexpected deterioration in the January Institute for Supply Management (ISM) nonmanufacturing index fuelled concern that the fourth quarter s slowdown extended into and raised the possibility that weakness in the energy and export sectors was beginning to spill into the broader economy. However, a string of positive hard data to start has gone against that notion and quelled fears of a US recession. Strong gains in retail sales and personal consumption in January indicated robust consumer demand (fuelled by a strong labour market and low energy prices) while near cycle-high home sales point to a further recovery in the housing market. In January, a solid increase in capital goods orders boosted the outlook for business investment while a strong industrial production report showed some reversal of recent declines in manufacturing activity. These indicators show the US economy started on a solid footing, supporting our forecast for growth to rebound to a. annualized pace in the first quarter. Consumer spending is forecasted to pick up above. in the current quarter while modest growth in business investment, notwithstanding a continued pullback in the energy sector, should add to solid activity in the residential sector. A broad-based improvement in domestic demand is expected to be only partially offset by a further drag from net exports, given strength in the US dollar and subdued demand abroad. Going forward, strong fundamentals are expected to continue to offset pockets of weakness in energy and exportoriented sectors, keeping the US economy growing at a quarterly pace of around. this year. Labour market backdrop continues to improve Employment data have also been encouraging, with robust job growth continuing in early. February s payroll report showed an unexpectedly strong, increase in employment with upward revisions to the prior two months adding another,. The unemployment rate held steady after edging downward to.9 in January (right in the middle of the Fed s estimate of full employment in the longer run) due to an increase in labour force participation while a broader measure of underutilization fell in February. While the payroll report was not all good news average hours worked fell and wage growth slowed after picking up in recent months it is clear that the US economy is continuing to generate jobs at a fast enough pace to further absorb labour market slack. but Fed likely to hold off on March hike Minutes of the January Federal Open Market Committee (FOMC) meeting and comments from Fed officials since have indicated a degree of concern that recent market volatility and tightening in financial conditions have increased downside risks to the economic outlook. While some deterioration in financial conditions has been retraced since mid-february and there is growing evidence of resilience in the domestic economy, the Fed now looks likely to take a more cautious approach to tightening than envisioned in December when the Committee s consensus was for four rate hikes in. We expect the fed funds rate will be held steady at March s meeting, as the Committee awaits further evidence that the US economy has not been significantly affected by market volatility and slowing growth abroad. The Fed will also be looking for data to bolster its confidence that inflation is returning sustainably to its. objective in the medium term. The recent rebound in oil prices should soften some of the downward pres-
sure on inflation. March s statement and press conference will likely emphasize the Committee s patience while reiterating the view that further rate hikes will still be warranted, if not at the pace shown in December s dot plot. Given the positive trend in recent data, we continue to expect the Fed will resume hiking rates in the second quarter with a modest pace of tightening leaving the fed funds rate in a. to. range by the end of. Canadian Q/ GDP beat expectations but details fail to impress Canada s economy grew at a.8 annualized pace in the fourth quarter, exceeding both market expectations and the Bank of Canada s projection for zero growth. Details were not encouraging, with much of the increase due to a sizeable addition from net exports that reflected weaker imports rather than stronger sales abroad. Domestic demand contracted by. following meagre gains in the prior two quarters, as business investment again declined at a double-digit pace. Growth in consumer spending was weaker than expected, and residential investment only provided a modest lift. The most encouraging aspect of the GDP report was the. monthly gain in December GDP that also defied expectations for a flat reading. The increase was driven by broad-based growth in services and stronger manufacturing activity. Building on gains in the prior two months, December s GDP provided a solid starting point to the first quarter and a fairly low hurdle for the Bank of Canada s. first-quarter growth forecast. The fourth quarter capped off a lacklustre year for the Canadian economy, with growth of. in representing the slowest pace since the financial crisis. Business investment subtracted a full percentage point from headline GDP, as energy companies slashed spending amid falling oil prices. Consumer spending still managed to grow by nearly with help from low interest rates, low gasoline prices, and a resilient labour market outside of energy-producing provinces. A solid addition from net exports, aided by currency depreciation and strong US growth, provided a welcomed boost to the subdued pace of domestic demand. Signs of rotation in Canada s economy Trade reports for December and January provided encouraging evidence that the long-awaited rotation toward the non-resources sector is underway. December s narrowing in the nominal trade deficit was only dented slightly in January while the balance on a volumes basis continued to improve strongly. Non-energy export volumes were up 8 year over year in January and point to another solid add to growth from net trade in the first quarter this time driven by strong export growth rather than falling imports. That boost from the trade sector is expected to be paired with solid consumer spending, as flagged by robust auto sales in the first two months of. Offset will likely come from another sizeable decline in energy sector investment (expected to fall for as a whole), but the shrinking importance of oil and gas investment in Canada s economy points to a lesser drag than in recent quarters. Overall, we forecast GDP growth to pick up to a. annualized pace in the first quarter, which would provide a much better start to the year than the declines recorded in early. Balanced BoC statement with fiscal help on the horizon Unlike the admittedly close call at the Bank s January meeting, there was little expectation for a rate cut in March. The Bank indeed left the overnight rate unchanged and delivered a balanced policy statement. The domestic economic outlook is evolving largely as expected; non-energy exports are gathering momentum, but low oil prices will continue to weigh on Canadian growth. The Bank noted financial market volatility is abating and prices for oil and other commodities have rebounded recently. Rather than expressing discomfort with the attendant appreciation in the Canadian dollar, which is up 8 against the US dollar since mid-january, the Bank simply indicated that the exchange rate is close to levels assumed in its latest projections. Fiscal measures from the upcoming March federal budget will be incorporated into its April forecasts with implicit upside risk to its current growth projection of. in. Ahead of the budget, our expectation is that fiscal stimulus will provide a modest lift to GDP growth this year and next. Highlights The.8 gain in Q/ GDP capped off a tough year for the Canadian economy, with growth slowing to. in. An unexpectedly strong. gain in December GDP provided a strong starting point for Q/. The recent surge in nonenergy exports is welcomed news for the Bank of Canada. The BoC delivered a relatively neutral policy statement in March and sees risks to the inflation profile as roughly balanced.
Highlights The mix of policy measures announced by the ECB in March went beyond the easing expected by markets. A loss of momentum evident in UK data prompted us to lower our Q/ GDP forecast to.. Australia s Q/ GDP surprised to the upside, but more timely indicators pointed to less robust activity early this year. The RBNZ s dovish policy statement indicated additional easing could be on the way. ECB announces broad increase in stimulus The second estimate of euro area fourth-quarter GDP confirmed a. non-annualized increase, marking the eleventh consecutive quarter of expansion for the currency bloc as a whole. Survey indicators have edged downward to start, but the softening was not enough to shift our forecast for a. gain in first-quarter GDP. While steady growth and an attendant improvement in labour market conditions will be welcomed by the ECB, tackling disinflation remains the central bank s top priority. Headline inflation fell back into negative territory in February, and market-based measures of inflation compensation have been slow to rebound despite rising oil prices. With lower inflation putting upward pressure on real yields in addition to general tightening in financial conditions so far this year, expectations grew for further stimulus from the ECB. The central bank did not disappoint at its March meeting, easing monetary policy on several fronts. The deposit rate was lowered as expected by basis points, but that was accompanied by a surprise basis point cut in the refi rate. The ECB increased the size of its asset purchase program to 8 billion per month from the billion pace previously and added euro-denominated non-financial corporate bonds to the list of assets eligible for purchase. A new round of targeted longer-term refinancing operations (TLTRO II) will provide additional liquidity at accommodative (and potentially even negative) rates. While broadly expanding stimulus, the measures put an emphasis on bolstering credit markets and banks. ECB President Draghi indicated the policy focus is now shifting toward unconventional measures, and while rates could go lower, any further easing is likely to come through quantitative easing (QE) and lending operations. UK momentum waning as Brexit vote comes into view UK GDP growth was. in the fourth quarter, with activity driven in large part by consumers. A strong labour market and lower energy prices should continue to support consumer spending, but the economy s momentum appears to have weakened in early. The UK s February composite purchasing managers index (PMI) slipped to its lowest level in nearly three years, as both manufacturing and services indices fell below their longer-run averages. With a subdued growth signal from survey indicators, we lowered our first-quarter GDP forecast to.. Uncertainty is set to weigh on the near-term outlook, particularly for investment, ahead of a June vote on Britain s status within the European Union (EU). The Leave campaign got a boost from London Mayor Boris Johnson s support, although polls still generally favour the UK staying in the EU under PM Cameron s renegotiated framework. Brexit uncertainty has added fuel to the downward trend in sterling that began late last year and the currency s trade-weighted index is now negative on a year-over-year basis. While that implies less downward pressure on inflation from import prices, low energy costs and only modest wage growth are likely to keep inflation well below the BoE s target this year. Also taking into account heightened uncertainty and indications that growth has slowed to start, we expect the BoE will remain firmly on the sidelines this year with the Bank Rate unchanged at.. Mixed data allow for RBA patience Australia s fourth-quarter GDP surprised on the upside with a. non-annualized increase that, along with an upward revision to the third quarter, pushed the year-over-year pace of growth to. Beneath the encouraging headline, terms of trade weakness was again evident, with national income little changed in the quarter and below year-ago levels. With the savings rate now at a multi-year low and unemployment expected to remain stubbornly high, there is less scope for consumer spending to continue to prop up growth going forward. Recent data indicated the fourth quarter s momentum has not been carried into, with softening evident in the labour market, wages, capex plans, business conditions, and confidence. The solid pace of growth at the end of allowed the RBA to sit on the sidelines with an easing bias, but we expect weaker domestic data and subdued inflation will prompt additional stimulus. We shifted our forecasted rate cuts to the second half of but continue to expect basis points of easing that will leave the cash rate at. by the end of. RBNZ surprises markets with a rate cut The RBNZ delivered an off-consensus rate cut in March, lowering the cash rate by basis points to.. Slower global growth, lower than expected inflation, falling inflation expectations, and financial market volatility all factored into the decision to ease. The RBNZ firmed its forward guidance that further easing may be required, and we continue to expect another rate cut will leave the cash rate at. by mid-.
Interest rate outlook, end of period Canada Actuals Q Q Q Q Q Q Q Q Q Q Q Q Overnight............ Three-month..8.......8...8 Two-year..8..8.......9. Five-year..8.8...8...... -year..9.........8. -year.98....8....9... United States Fed funds**............ Three-month...........9. Two-year.....8....9...9 Five-year...........9. -year.9....8....8... -year...8...9.9.....8 United Kingdom Bank rate............ Two-year.........8.9.. -year.8...9........ Eurozone Deposit Rate -. -. -. -. -. -. -. -. -. -. -. -. Two-year -. -. -. -. -. -. -. -. -. -. -. -. -year.8..9.......9.. Australia Cash target rate............ Two-year...8........8. -year....88..8.....9. New Zealand Cash target rate............ Two-year swap.8.9.9.8........ -year swap..89.8.....8....8 Yield curve* Canada 8 9 9 8 8 United States 9 9 9 8 United Kingdom 9 Eurozone 8 9 8 8 9 Australia 8 8 8 8 New Zealand 8 9 9 * Two-year/-year spread in basis points, **Top of basis point range Source: Reuters, RBC Economics Research, end of period Central bank policy rate Current Last United States Fed funds.-..-. December, Canada Overnight rate.. July, United Kingdom Bank rate.. March, 9 Current Last Eurozone Deposit rate -. -. March, Australia Cash rate.. May, New Zealand Cash rate.. March, Source: Bloomberg, Reuters, RBC Economics Research
Economic outlook Growth outlook change, quarter-over-quarter in real GDP Q Q Q Q Q Q Q Q Q Q Q Q F F F Canada* -.9 -...8............ United States*..9.............. United Kingdom.............9..9. Euro Area.............9...8 Australia.9...........8.... New Zealand...9............8. *annualized, **preliminary actual Inflation outlook change, year-over-year Q Q Q Q Q Q Q Q Q Q Q Q F F F Canada..9.............. United States -......9..9........ United Kingdom........8....8.... Eurozone -................ Australia............8.... New Zealand...............8. Source: Statistics Canada, Bureau of Labor Statistics, Bank of England, European Central Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, RBC Economics Research Inflation tracking Inflation Watch Measure Current period Period ago Year ago Three-month trend Six-month trend Canada Bank of Canada core CPI Jan....9 United States Core PCE, Jan.... United Kingdom All-items CPI Jan -.8. -.9. Eurozone All-items CPI Feb -. -. -. -. Australia Trimmed mean CPI Q.. N/A N/A New Zealand All-items CPI Q -.. N/A N/A Seasonally adjusted measurement. Personal consumption expenditures less food and energy price indices. Source: Statistics Canada, US Bureau of Labor Statistics, Bank of England, European Central Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, RBC Economics Research
Currency outlook Level, end of period Actuals Q Q Q Q Q Q Q Q Q Q Q Q Canadian dollar....8......9.. Euro....9........ U.K. pound sterling.8.......8...9. New Zealand dollar..8..8....8.8.8.9. Japanese yen.. 9.9.... 8..... Australian dollar......8......8 Canadian dollar cross-rates Q Q Q Q Q Q Q Q Q Q Q Q EUR/CAD..9.9......... GBP/CAD.88.9...9..9.9.98... NZD/CAD.9.8.8.9.9.8.8..... CAD/JPY 9. 98. 9. 8.8 8. 8. 9. 9. 9. 9. 9. 9. AUD/CAD.9.9.9...9.9.8.8.8.8.8 Rates are expressed in currency units per US dollar and currency units per Canadian dollar, except the euro, UK pound, Australian dollar, and New Zealand dollar, which are expressed in US dollars per currency unit and Canadian dollars per currency unit. Source: Bloomberg, RBC Economics Research RBC Economics outlook compared to the market The following charts track historical exchange rates plus the forward rate (dashed line) compared to the RBC Economics forecast (dotted line) out one year. The cone for the forecast period frames the forward rate with confidence bounds using implied option volatilities as of the date of publication.. Canadian dollar. Euro..........9...8 Mar- Sep- Mar- Sep-.9 Mar- Sep- Mar- Sep- Japanese yen. U.K. pound.8. 9. 8 Mar- Sep- Mar- Sep-. Mar- Sep- Mar- Sep-
Central bank watch Bank of Canada Canadian GDP grew at a faster than expected.8 annualized pace in Q/. A solid. gain in December GDP provided a good starting point for Q/ when we expect growth will rebound to.. The BoC s March policy statement noted the outlook is evolving as expected and highlighted evidence of a pickup in non-energy exports. The Bank is expected to hold rates steady this year with fiscal policy set to provide a boost to growth. Federal Reserve The second estimate of Q/ US GDP growth was revised upward to., but domestic demand was weaker than previously reported. Recent indicators point to growth rebounding above in Q/. The Fed is likely to take a cautious approach to further rate hikes given recent volatility, but strength in US indicators should put the datadependent Fed back in tightening mode in Q/. European Central Bank Survey indicators for the euro area have moderated to start but remain consistent with our forecast for steady growth to continue with a. non -annualized gain expected in Q/ GDP. An increase in downside risks to the inflation outlook saw the ECB boost its stimulus program in March. The policy focus has shifted to improving credit conditions for corporates and banks, using unconventional measures as the main tool. Bank of England With PMI data signalling less momentum in the UK economy early this year, we have marked down our Q/ growth forecast to. from. previously. Some reversal of currency appreciation will lessen downward pressure on UK prices, but limited wage growth and low energy prices will likely keep inflation well below target this year and leave the BoE on the sidelines until. Australia and New Zealand Recent Australian data have been mixed, but we continue to expect weak income growth, a patchy labour market, and softer domestic demand will prompt the RBA to act on its easing bias in H/. Disappointing spot inflation, falling inflation expectations, and financial market volatility all contributed to the RBNZ lowering the cash rate in March. We expect another bp rate cut in Q/. 8 - - - -8 - Quarter-over-quarter annualized change Canadian real GDP growth 8 9 Source: Statistics Canada, RBC Economics Research 8 - - - -8 - Quarter-over-quarter annualized change U.S. real GDP growth ed values: 8 9 Source: Bureau of Economics Analysis, RBC Economics Research change, quarter-over-quarter.... -. -. -. -. -. -. -....... -. -. -. Eurozone GDP ed values: 8 9 Source: Eurostat, RBC Economics Research U.K. real GDP growth change, quarter-over-quarter.... -. -. -. -. -. Australia and New Zealand GDP growth change, quarter-over-quarter Australia ed values: 8 9 Source: Central Statistical Office, RBC Economics Research New Zealand 8 9 * New Zealand Q GDP is an estimate Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research ed values: Canadian overnight rate 8 9 Source: Bank of Canada, Federal Reserve Board, RBC Economics Research U.S. target rate 8 9 Source: Bank of Canada, Federal Reserve Board, RBC Economics Research ECB Deposit rate - 8 9 Source: ECB, RBC Economics Research U.K. policy rate 8 9 Source: Bank of England, RBC Economics Research Australia and New Zealand inflation change, year-over-year Australia New Zealand 8 9 Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research 8
Financial conditions have improved since-mid February Equity markets in Canada and the US rebounded as oil prices picked up and fears of a US recession were refuted by solid January data. Spreads on Canada and US corporate bonds have declined from recent highs but remain elevated relative to last year s levels. Canada and US equity indices Index Index Canada and US corporate bond spreads basis points Canada BBB corporate bond spread US BBB corporate bond spread 9 Canada S&P/TSX (left axis) US S&P (right axis) 8 Mar/ Apr/ May/ Jun/ Jul/ Aug/ Sep/ Oct/ Nov/ Dec/ Jan/ Feb/ Mar/ Source: TSX, WSJ, RBC Economics Research Mar/ Apr/ May/ Jun/ Jul/ Aug/ Sep/ Oct/ Nov/ Dec/ Jan/ Feb/ Mar/ Source: Bank of Canada, Federal Reserve, RBC Economics Research Government bond yields fell through mid-february as investors rushed into safe assets but yields have picked up from recent lows as market volatility ebbs. A rebound in oil prices has helped boost the Canadian dollar in recent weeks but the Bank of Canada did not sound overly concerned about the strengthening currency. Canada and US -year government bond yields. Canadian dollar and oil prices US$/C$.8 US$/bbl....8... Canada y GC yield US y Treasury yield. Mar/ Apr/ May/ Jun/ Jul/ Aug/ Sep/ Oct/ Nov/ Dec/ Jan/ Feb/ Mar/ Source: Bank of Canada, Federal Reserve, RBC Economics Research. US$/C$ (left axis) WTI oil price (right axis).. Mar/ Apr/ May/ Jun/ Jul/ Aug/ Sep/ Oct/ Nov/ Dec/ Jan/ Feb/ Mar/ Source: EIA, WSJ, RBC Economics Research The material contained in this report is the property of Royal Bank of Canada and may not be reproduced in any way, in whole or in part, without express authorization of the copyright holder in writing. The statements and statistics contained herein have been prepared by RBC Economics Research based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This publication is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities. Registered trademark of Royal Bank of Canada. Royal Bank of Canada. 9