North American Economic Outlook: Climbing Out of Recession Presentation to the Canadian Association of Movers Paul Ferley (1) 97-731 Assistant Chief Economist paul.ferley@rbc.com November 17, 9 U.S. Economic Outlook: Return of Positive Growth Expected to be Sustained
The U.S. economy is starting to recover from a severe shock that boosted the cost-of-capital 1 U.S real GDP growth 8 - - - -8 97 98 99 1 3 5 7 8 9 Quarter-over-quarter annualized % change Year-over-year % change Source: Bureau of Economics Analysis, RBC Economics Research 3 The rise in defaults on subprime mortgages was the catalyst for this pressure in financial markets 3 U.S. mortgage delinquencies % of mortgages outstanding % 9 5 8 7 15 1 5 5 98 99 1 3 5 7 8 9 Prime (LHS) Subprime (LHS) 3-year fixed rate mortgages Source: MBA, RBC Economics Research
The uncertainty as to who holds U.S. subprime assets had weighed on financial markets though greater stability is starting to emerge 1 15 Level Weekly observation S&P 5 composite index 1 15 Level Monthly observation S&P 5 composite index 1 13 1 11 1 9 8 7 3 5 7 8 9 Source: Bloomberg, RBC Economics Research Basis points Three-month TED spread* 1 13 1 11 1 9 8 7 1998 1999 1 3 5 7 8 9 Source: Bloomberg, RBC Economics Research Basis points 35 3-month TED spread* 3 3 5 Sub-prime 15 Russian crisis & LTCM 1 1 5 9/11 attacks 3 5 7 8 9 *Three-month LIBOR rate minus Three-month T-bill Source: Federal Reserve Board, RBC Economics Research -5 1998 1999 1 3 5 7 8 9 *3-month LIBOR rate - 3-month T-bill Source: Federal Reserve Board, RBC Economics Research 5 The rise in lending cost was more muted in Canada 3 3 8 1 1 8 Basis points Short-term funding spreads 3 month LIBOR vs. OIS Canada U.S U.K. Eurozone Jan 7 Apr 7 Jul 7 Oct 7 Jan 8 Apr 8 Jul 8 Oct 8 Jan 9 Apr 9 Jul 9 Oct 9 Source: Bloomberg, RBC Economics Research
What prompted the improvement in financial markets? 7 Aggressive policy actions by the Administration and Congress: undertook credible stress tests of the banking system committed over a trillion dollars to rid the system of toxic assets the Obama Administration introduced a $787 billion fiscal stimulus package undertook initiatives to stem mortgage delinquencies 8
The Fed has been forcefully cutting interest rates though with rates bordering on %... 7 % U.S. Fed funds rate 5 3 1 1 3 5 7 8 9 Source: Federal Reserve Board, RBC Economics Research 9 the central bank turned increasingly to using its balance sheet Reserves held by the Fed SA, Bil. $ Monetary base Total reserves 1 1 8 1 3 5 7 8 9 Source: Federal Reserve Board, RBC 1
Fed actions were successful in pushing mortgage rates lower % 7. 3-year mortgage rate.5. 5.5 5..5 5 7 8 9 Source: Mortgage Bankers Association, RBC Economics Research 11 Hints of a stabilization in home sales does provide a hopeful sign that housing has troughed 3 59 55 51 7 level Single family homes sold 1 1 1 8 3 39 Existing home sales (LHS) New home sales (RHS) 35 1 3 5 7 8 9 Source: National Association of Realtors, Bureau of Census, RBC Economics Research 1
A steady easing in credit tightening and simulative policy are expected to allow positive growth to be sustained U.S. real GDP Annualized % change, quarter-over-quarter 1 8 - - - -8 Annual growth rates 8 9f 1f 11f. -.5.5 3. 1 3 5 7 8 9 1 11 Source: Bureau of Economic Analysis, RBC Economics Research 13 13 However, the recovery is expected to be the weakest relative to past three cycles 18 1 1 1 1 98 9 9 9 9 U.S. GDP Indexed to past and current recession GDP peak t-8 t-7 t- t-5 t- t-3 t- t-1 peak t+1 t+ t+3 t+ t+5 t+ t+7 t+8 t+9 t+1 Q3-1981 Q3-199 Q-1 Q-8 1
though it will be markedly less weak compared to the Depression of the 193s 11 U.S. GDP Indexed to past and current recession GDP peak 15 1 95 9 85 8 75 7 t-8 t-7 t- t-5 t- t-3 t- t-1 peak t+1 t+ t+3 t+ t+5 t+ t+7 t+8 t+9 t+1 199Q3 Q3-1981 Q3-199 Q-1 Q-8 15 The modest recovery will keep unemployment historically high 11 1 9 8 7 5 3 1 % Unemployment rate 1 3 5 7 8 9 1 11 Source: Bureau of Labor Statistics, RBC Economics Research 1
and inflation low 5 3 % change, year-over-year Core All-items U.S. inflation 1-1 - 1 3 5 7 8 9 1 11 Source: Bureau of Labor Statistics, RBC Economics Research 17 that will delay the tightening in monetary policy until late next year 7 % U.S. Fed funds rate 5 3 1 1 3 5 7 8 9 1 11 Source: Federal Reserve Board, RBC Economics Research 18
Canadian Economic Outlook: Pulling Out of Recession Canada has weathered the U.S. downturn helped by an aggressive easing in policy 7 % Bank of Canada overnight rate 5 3 1 1 3 5 7 8 9 Source: Bank of Canada, RBC Economics Research
though the impact of the U.S. recession has been tempered by three additional factors: less upward pressure on the cost of capital commodity prices, though trading lower, remained at historically high levels which helped boost export revenues the Canadian housing market avoided the freefall in activity evident in the U.S. 1 Oil prices remained historically high 1 1 US$/barrel Crude oil price WTI 1 8 1999 1 3 5 7 8 9 1 11 Source: Wall Street Journal, Bloomberg, RBC Economics Research
as demand from emerging markets, though slowing, did not collapse 1 1 8 - - - -8-1 Major emerging economies % change in real GDP 9. 9. 8.5 7.3. 5. 5.1 -.7 8 9 1 3.5 3.3 3. 3.1 1.3-1.1-7.3 China India Brazil Mexico World Source: IMF, RBC Economics Research 3 More prudent mortgage lending in Canada with less involvement in subprime mortgages Percentage of mortgage in arrears % 35 3 5 15 Subprime Canada Prime Canada Subprime U.S. Prime U.S. 1 5 5 7 8 9 Source: Bank of Canada, Mortgage Bankers Association, RBC Economics Research
has limited the extent of declines in residential investment in Canada relative to the U.S. 17 1 7-3 -8-13 -18-3 % change, year-over-year Canada U.S. Residential investments -8 99 1 3 5 7 8 9 1 11 Source: Statistics Canada, Bureau of Economic Analysis, RBC Economics Research 5 However, financial market turmoil has hit household net worth 1 1 1 1 8 - - - -8 Household net worth % change, year-over-year 91 9 93 9 95 9 97 98 99 1 3 5 7 8 9 Source: Statistics Canada, RBC Economics Research
which will keep the recovery in consumer spending subdued despite low interest rates Consumer spending 8 Annualized % change, quarter-over-quarter - - Annual growth rates 8 9f 1f 11f 3. -.1..7 99 1 3 5 7 8 9 1 11 Source: Statistics Canada, RBC Economics Research 7 Stimulative policy and U.S. recovery should allow Canada to return to positive growth by 9Q3 9 7 5 3 Canada's real GDP Annualized % change, quarter-over-quarter Annual growth rates 8 9f 1f 11f. -.5. 3.9 1-1 -3-5 -7 1 3 5 7 8 9 1 11 Source: Statistics Canada, RBC Economics Research 8
The recession in Canada will likely be the mildest of the past three downturns Canada GDP (Indexed to peak) 1 Q3- Q- Q1-7 Q-7 Q3-7 Q-7 Q1-8 Q-8 Q3-8 Q-8 Q1-9 Q-9 Q3-9 Q-9 Q1-1 Q-1 Q3-1 Q-1 1 1 1 1 1 98 98 9 9 9 9 9 9-8 - - - Peak Q-1981 Q1-199 Q3-8 Series are indexed to GDP peaks during past business cycles. 8 9 To help sustain the recovery, interest rates will be held low though start to be raised by the second half of 1 Bank of Canada overnight rate 7 % 5 3 1 1 3 5 7 8 9 1 11 Source: Bank of Canada, RBC Economics Research 3
The modest rebound will keep the unemployment rate high 1. 9.5 % Canadian unemployment 9. 8.5 8. 7.5 7..5. Inflation-safe range 5.5 1 3 5 7 8 9 1 11 Source: Statistics Canada, RBC Economics Research 31 This slack in the economy will also keep inflation below target near term. % change, year-over-year Canadian core inflation 3.. BoC inflation target 1.. 9 91 9 93 9 95 9 97 98 99 1 3 5 7 8 9 1 11 Source: Statistics Canada, RBC Economics Research 3
Bond yields eventually rise as markets anticipate that the central bank easing will start to be reversed 9. % Canadian 1-year bond yield 8. 7.. 5.. 3.. 1.. 95 9 97 98 99 1 3 5 7 8 9 1 11 Source: Bank of Canada, RBC Economics Research 33 The Canadian dollar to mirror growing optimism about the global recovery and attendant rise in commodity prices 1.1 Canadian dollar forecast U.S dollar per Canadian dollar 1..9.8.7. 81 83 85 87 89 91 93 95 97 99 1 3 5 7 9 11 Source: Bank of Canada, RBC Economics Research 3
Just as monetary policy will need to tighten so will fiscal policy over the medium term 3 1 Canadian federal government fiscal balance $ billions 19.9 8.. 9.1 1.5 13. 13.8 9. Projection -1 - -3 - -5.8-5. -11. -19. -7. -5 - -7-5. -5.3 /1 /3 /5 /7 8/9 1/11 1/13 1/15 Source: Ministry of Finance, RBC Economics Research 35 Regional Outlook: Ontario feeling the full brunt of the U.S. recession 3
The Ontario economy is currently feeling the full brunt of weak U.S. demand, particularly for autos Mil. Units U.S. auto sales 18 1 1 1 1 8 98 99 1 3 5 7 8 9 Source: BEA, RBC Economics Research 37 with high commodity prices representing high input costs Provincial real GDP growth Annual % change, ranked by 9 growth MAN. 9.1 P.E.I N.S. N.B. SASK. 1 -.1 -. -.8-1.3 QUE. CANADA B.C. ALTA. ONT. -1.9 -.5 -. -.8-3.1 N.& L. -3.5 3....7 3... 3. 3.. - -3 - -1 1 3 5 Sources: Statistics Canada, RBC Economics Research. 38
Alberta is paying the price for the earlier housing market surge New housing price index 1997=1, % change, year-over-year Canada Alberta - 1 3 5 7 8 9 Source: Statistics Canada, RBC Economics Research 39 and weakness in natural gas prices 1 9 8 7 5 3 1 US$/mmbtu Natural gas 95 9 97 98 99 1 3 5 7 8 9 1 11 Source: RBC Economics Research
Similarly, British Columbia is being hurt by weak residential investment as well B.C. residential investment % change, year-over-year 3 1-1 - -3 1 3 5 7 8 9 Source: Statistics Canada, RBC Economics Research 1 The impact of high commodity prices on provincial growth will be more apparent in 1 Provincial real GDP growth Annual % change, ranked by 1 growth SASK. -1.3 B.C. ALTA. -. -.8 MAN..1 N.B. -.8 CANADA -.5 N.S. -. ONT. -3.1 QUE. -1.9 P.E.I -.1 N.& L. -3.5 3. 3. 3. 3..7.... 9. 1 - -3 - -1 1 3 5 Sources: Statistics Canada, RBC Economics Research.
However, job growth across the country will be modest keeping the unemployment rate high east and west Unemployment rate 11 1 9 % Ontario Alberta 8 7 5 3 1 3 5 7 8 9 1 Source: Statistics Canada, RBC Economics Research 3 Provincial housing starts outside of Quebec will recover in 1 but remain below 8 levels 8 7 Provincial housing starts Thousands 8 9 1 5 3 1 Atlantic Quebec Ontario Man/Sask Alberta British Columbia Source: Statistics Canada, RBC Economics Research
Intra-provincial migration will likely revert closer to the 8 pattern with gains largely out West Intra-provincial migration 5 Persons 15 1 5-5 -1-15 - N.& L. P.E.I. N.S. N.B. QUE. ONT. MAN. SASK. ALTA. B.C. Source: Statistics Canada, RBC Economics Research 5 Please visit our website: www.rbc.com/economics
Disclaimer 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. 7