QUARTERLY ECONOMIC FORECAST TD Economics U.S. OUTLOOK: OVERCOMING THE HEADWINDS Highlights Five years have passed since the financial crisis that felled the U.S. and global economies. The modest economic growth that has taken place since the Great Recession ended in 2009 has left the unemployment rate elevated and interest rates at historically low levels. Signs that America is ready to escape this slow-growth state have been building over the first half of the year. America s housing market has turned a corner, supporting consumer confidence, repairing household balance sheets and revenues of state and local governments. Tax hikes and spending cuts were the main speed bumps to growth over the first half of this year. Fiscal drag will continue, but the worst of the adjustment appears to be in the rear-view mirror. However, just as this obstacle is cleared, a swift rise in interest rates presents another challenge. Longer-term interest rates have risen a percentage point since early May. The fundamentals supporting economic growth will withstand the impact of rising rates, but it will slow near-term economic momentum. We expect the U.S. economy to grow by 1.6% in 2013, improving to 2.6% in 2014, and 3.1% in 2015. Five years following the financial crisis, the U.S. economy is at a turning point. The housing market has worked off much of the excess supply that led prices to plunge, consumers and businesses have paid off debts and rebuilt their balance sheets, and state and local governments have seen revenues rebound. There is even good news at the Federal level the deficit is the smallest in five years. The improvement in the deficit has not been painless tax hikes and spending cuts have cut into economic growth but, taking the medicine now should mean less pain in the future. All of this sets the stage for faster economic growth in the years ahead. However, stronger economic fundamentals also means withdrawing policy support, and this transition was never guaranteed to go smoothly. Anticipation that the Federal Reserve would eventually end its $85 billion a month asset-purchase program (also known as quantitative easing) has led to a steep rise in interest rates over the last several months. Since early May, longer-term interest rates everything from Treasury yields to mortgage rates to corporate bond yields have risen close to a full percentage point. The Federal Reserve s decision on September 18th to delay tapering asset purchases has not changed this story. The retracement in rates since the meeting has been small relative to the rise. As the Fed itself noted, the increase in borrowing costs will provide a headwind to growth. But, it will not halt it. While the 6 4 2 0-2 -4-6 -8-10 REAL GROSS DOMESTIC PRODUCT Percent change (annualized) Y/Y % chg. (Q4/Q4 % chg) 2013F 1.6% (2.1%) 2014F 2.6% (2.8%) 2015 3.1% (3.3%) 2008 2009 2010 2011 2012 2013 2014F 2015F by TD Economics, September 2013 Source: Bureau of Economic Analysis Craig Alexander, SVP & Chief Economist Beata Caranci, VP & Deputy Chief Economist James Marple, Senior Economist
adjustment came quicker than we anticipated, higher yields have long been embedded in our outlook and reflect in large part the strengthening fundamentals listed above. The bottom line is that economic growth is still expected to accelerate over the next year, but it will be slower than previously anticipated. Relative to our June forecast, real GDP growth is expected to average 0.2 percentage points lower over the next six quarters. The U.S. economy is forecasted to grow by 1.6% in 2013, improving to 2.6% in 2014 and 3.1% in 2015. 8 6 4 2 0-2 -4 PUBLIC & PRIVATE SPENDING Year-over-year % change Government Private domestic demand No tapering just yet as Fed waits for confirmation of improvement In one of the most anticipated announcements in over a year, the Federal Reserve surprised financial markets last week by deciding not to taper asset purchases. The Fed s statement noted that the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. The Fed s decision in part reflected concern over nearterm fiscal risks and the recent slowdown in job growth, but also the impact of the swift adjustment on interest rates. Alongside the announcement, Federal Open Market Committee members downgraded their forecasts for economic growth over the next year. The decision to delay tapering is less important to the economic outlook than the rise in rates that has taken place in anticipation of it. As early as May, Federal Reserve members began communicating that the improvement in the labor market had warranted a slowing in the pace of asset purchases. This communication had the effect of unwinding FEDERAL RESERVE BALANCE SHEET $U.S. (Trillions) 4.0 Mortgage-backed securities 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Treasury securities Agency securities Liquidity programs & other assets 2007 2008 2009 2010 2011 2012 2013 Source: Federal Reserve Board, TD Economics -6-8 2002 2004 2006 2008 2010 2012 2014 Source: Bureau of Economic Analysis, Haver Analytics. by TD Economics as of September 2013. in relatively short order the impact of quantitative easing on bond yields. Importantly, while bond markets rallied in the initial aftermath of the announcement, the retracement did not offset the magnitude of the sell off over the past four months. While the Fed s concern over near-term downside risks has pushed tapering out a few meetings, the realization that the program will end in the relatively near future means higher interest rates are here to stay. The U.S. 10-year Treasury yield is still 100 basis points higher than it was in May. Where bond market investors appear to have gotten ahead of themselves was in its expectations for when the Federal Reserve would raise its short-term Federal Funds rate. As speculation about tapering reached an apex, futures markets had moved the first expected hike in the Fed funds rate to the final quarter of 2014. Even with our forecast of an improvement in economic growth, conditions are unlikely to warrant an increase in the fed funds rate until the third quarter of 2015. Rising rates will slow, but not halt recovery Economists have long been predicting a rise in bond yields. At its lowest point, in July of last year, the 10-year Treasury bond yielded just 1.40% - the lowest level on record. After taking inflation into account, investors were literally paying the government to hold their money the real return on government bonds was -0.7%. This was not a sustainable situation. For those expecting higher rates, the last few months have been a vindication. But, when it rains it pours. The rise in long-term rates since May was the swiftest adjustment since the mid-1990s. 2
MORTGAGE APPLICATIONS & MORTGAGE RATES MBA mortgage application index* 1,200 1,000 800 600 Mortgage rate; percent 5.25 4.75 4.25 3.75 matters. The spread of capitalization rates over Treasury yields is high relative to history and can absorb some of the impact of higher rates before prices are impacted. In addition, an improving economy will put downward pressure on vacancy rates, and help to pull up rents. While price growth is likely to slow in the sector, a reversal is unlikely forthcoming. All told, the adjustment in rates is will not stop the economic recovery, but it will modestly temper its pace. 400 200 30-year mortgage rate (rhs) Mortgage application index (lhs) 2010 2011 2012 2013 *March 16, 1990=100. Source: Mortgage Bankers Assocation, Federal Reserve Board Yields did not rise in the absence of economic fundamentals, so we cannot treat the entire rise in interest rates as a negative shock to the economy. However, the quick adjustment has led to a slowing in near-term momentum in the more interest-rate sensitive sectors of the economy especially housing and commercial real estate. For the housing market, higher mortgage rates swiftly reduced refinancing demand and housing affordability. Fortunately, housing affordability was sitting at a historical high, offering a wide buffer to absorb the higher rates. We estimate that mortgage rates would have to rise to 7.0% before affordability is eroded to its historical average. In the meantime, the basic fundamentals supporting the housing recovery remain intact. The overhang of unsold homes has been worked off, and housing construction is still running well below expected household growth. From their current level of 896k, housing starts are expected to move up to 1.2 million by the end of next year roughly 100k lower than our previous forecast in June. Housing starts will regain some ground in 2015, rising to 1.5 million by the end of the year. For commercial real estate (CRE), the low rate environment of the last several years has been an important contributor to the rebound in CRE prices. However, as prices have risen, capitalization rates the yield on commercial real estate (measured as rental income over purchase cost) have fallen. As risk-free interest rates rise, it puts upward pressure on capitalization rates and downward pressure on CRE prices. 3.25 2.75 However, as in the housing market, the starting point Debt ceiling and policy uncertainty One of the elements cited by Chairman Bernanke in the Federal Reserve s decision not to taper asset purchases was the continued threat of a policy shock from Washington. With the focus on the Federal Reserve s next steps, financial markets appear to have taken a sanguine attitude to the potential for gridlock in Washington. But, the risk has not gone away. On September 30th, the current continuing resolution funding will expire. If the deadline passes, there will be a temporary and partial government shutdown. Soon after, in mid-october, the U.S. Treasury will once again approach the statutory debt limit. Failure to extend funding for the government after September 30th or raise the debt ceiling could result in financial volatility and undermine consumer and business confidence, at least temporarily. Based on past experience, this would lead to sell-offs in equity markets, a higher U.S. dollar and lower Treasury yields. However, it should be stressed that a funding decision will ultimately be reached and the debt limit will be raised. We know the final outcome, but the path to achieve them could be rocky if partisan politics becomes too contentious. 0-2 -4-6 -8-10 -12 % of GDP FEDERAL BUDGET BALANCE 2001 2003 2005 2007 2009 2011 2013 2015 Source: Congressional Budget Office Projection 3
Bottom Line The U.S. economic recovery remains broadly in place. While the transition to higher longer-term interest rates will slow the pace of growth over the next year, it will not halt it. The fundamentals in place supporting higher growth are well entrenched. After years of declining housing construction, the supply overhang has been worked off and a period of catch up to household formation will add to economic growth. This has already shown itself a powerful impetus to growth, offsetting the largest fiscal drag the country has faced since the end of the Second World War. Fortunately, the worst of this drag appears to be in the rear-view mirror. Provided there is a positive outcome to the near-term policy issues in Washington ongoing government funding and raising the statutory debt ceiling economic growth will continue to improve over the next several years. With tapering in tow, the Fed will continue to support the recovery by maintaining its forward language with a firm commitment to low short-term interest rates. The first hike in the Fed funds is likely to come in the second half of 2015, following a year of above-trend job and economic growth that will go a long way to finally healing the damage caused by the Great Recession. 4
U.S. ECONOMIC OUTLOOK: Period-Over-Period Annualized Per Cent Change Unless Otherwise Indicated Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F 13F 14F 15F 13F 14F 15F Real GDP 1.1 2.5 2.1 2.6 2.4 2.9 3.1 2.9 3.0 3.4 3.4 3.2 1.6 2.6 3.1 2.1 2.8 3.3 Consumer Expenditure 2.3 1.8 2.1 2.7 2.5 2.8 3.0 2.8 2.7 3.2 3.1 2.9 2.0 2.6 2.9 2.2 2.8 3.0 Durable Goods 5.8 6.1 7.1 4.7 5.8 6.5 6.7 5.8 6.1 6.7 6.2 5.3 7.0 6.0 6.2 5.9 6.2 6.1 Business Investment -4.6 4.4 3.9 7.2 3.5 6.3 5.2 5.5 5.7 6.5 6.2 5.6 2.7 5.2 5.9 2.6 5.1 6.0 Non-Res. Structures -25.7 16.2 2.7 6.5 1.1 4.2 3.3 2.8 2.1 2.4 3.0 3.5 0.3 4.1 2.8-1.4 2.8 2.7 Equipment & IPP* 2.5 1.3 4.3 7.5 4.2 6.9 5.8 6.3 6.8 7.8 7.2 6.2 3.3 5.5 6.8 3.9 5.8 7.0 Residential Construction 12.5 12.9 5.9 9.3 15.2 18.1 18.2 15.6 14.0 16.3 17.2 14.6 12.6 13.7 15.9 10.1 16.8 15.5 Govt. Consumption & Gross Investment -4.2-0.9-1.9-0.9-0.7-0.6-0.5-0.3 0.1 0.2 0.3 0.5-2.3-0.8 0.0-2.0-0.5 0.3 Final Domestic Demand 0.5 1.9 1.7 2.8 2.4 3.0 3.1 3.0 3.0 3.5 3.5 3.2 1.5 2.6 3.2 1.7 2.9 3.3 Exports -1.3 8.6 5.1 3.8 5.7 6.7 7.0 6.4 7.1 7.4 7.2 6.9 2.6 5.8 7.0 4.0 6.5 7.1 Imports 0.6 7.0 0.5 5.5 4.6 5.9 6.2 6.1 6.4 7.3 7.5 7.1 1.4 4.9 6.6 3.4 5.7 7.1 Change in Private Inventories 42.2 62.6 54.7 58.2 56.3 52.2 50.1 50.2 50.4 51.9 55.2 59.6 54.4 52.2 54.3 --- --- Final Sales 0.2 1.9 2.3 2.5 2.5 3.1 3.1 2.9 3.0 3.4 3.3 3.1 1.7 2.6 3.1 1.7 2.9 3.2 International Current Account Balance ($Bn) -438-404 -410-433 -421-399 -384-378 -378-388 -396-401 -421-396 -391 --- --- % of GDP -2.6-2.4-2.4-2.5-2.4-2.3-2.2-2.1-2.1-2.1-2.1-2.1-2.5-2.3-2.1 --- --- Pre-tax Corporate Profits including IVA&CCA -5.1 16.4-1.6 2.6 2.6 3.4 3.6 3.5 4.6 5.1 5.4 5.4 3.4 3.2 4.4 2.8 3.3 5.1 % of GDP 12.2 12.6 12.4 12.4 12.3 12.3 12.2 12.2 12.1 12.1 12.1 12.1 12.4 12.2 12.1 --- --- GDP Deflator (Y/Y) 1.6 1.4 1.3 1.5 1.7 2.0 2.1 2.2 2.2 2.2 2.3 2.3 1.5 2.0 2.2 1.5 2.2 2.3 Nominal GDP 2.8 3.2 3.9 4.5 4.5 5.1 5.3 5.2 5.4 5.8 5.7 5.5 3.2 4.6 5.5 3.6 5.0 5.6 Labor Force -0.2 0.5 0.2 0.8 0.7 0.7 0.8 0.9 0.9 0.9 1.0 1.0 0.4 0.7 0.9 0.3 0.8 1.0 Employment 1.9 1.7 1.3 1.5 1.6 1.7 1.8 1.7 1.7 1.9 1.8 1.7 1.6 1.6 1.7 1.6 1.7 1.8 Change in Empl. ('000s) 645 579 449 511 526 562 599 584 587 641 626 595 2,157 2,146 2,407 2,184 2,272 2,448 Unemployment Rate (%) 7.7 7.6 7.4 7.3 7.1 6.9 6.7 6.6 6.5 6.3 6.2 6.1 7.5 6.8 6.3 --- --- Personal Disp. Income -7.0 3.2 2.6 4.3 4.0 5.1 5.2 5.2 5.2 5.5 5.6 5.6 1.6 4.3 5.3 0.7 4.9 5.5 Pers. Savings Rate (%) 4.1 4.5 4.1 3.9 3.8 3.9 3.9 4.0 4.1 4.1 4.2 4.2 4.1 3.9 4.2 --- --- Cons. Price Index (Y/Y) 1.7 1.4 1.5 1.4 1.6 2.1 2.0 2.2 2.3 2.4 2.4 2.5 1.5 2.0 2.4 1.4 2.2 2.5 Core CPI (Y/Y) 1.9 1.7 1.7 1.8 1.8 1.9 2.0 2.2 2.3 2.4 2.4 2.5 1.8 2.0 2.4 1.8 2.2 2.5 Housing Starts (mns) 0.96 0.87 0.90 0.97 1.02 1.09 1.15 1.21 1.27 1.34 1.41 1.48 0.92 1.12 1.37 --- --- Productivity: Real Output per hour (y/y) 0.0 0.3-0.1 0.7 1.4 1.3 1.5 1.5 1.7 1.8 1.9 2.0 0.2 1.4 1.8 0.7 1.5 2.0 *Intellectual proprty products. F: by TD Economics as at September 2013 2013 2014 2015 Annual Average 4th Qtr/4th Qtr Source: U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, TD Economics 5
INTEREST RATE OUTLOOK 2013 2014 2015 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F Fed Funds Target Rate (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50 0.75 3-mth T-Bill Rate (%) 0.07 0.04 0.10 0.20 0.20 0.20 0.20 0.20 0.25 0.50 0.80 1.00 2-yr Govt. Bond Yield (%) 0.25 0.36 0.30 0.40 0.45 0.55 0.70 0.90 1.20 1.50 1.70 2.15 5-yr Govt. Bond Yield (%) 0.77 1.41 1.35 1.55 1.75 1.85 2.00 2.20 2.45 2.60 2.80 3.10 10-yr Govt. Bond Yield (%) 1.87 2.52 2.60 2.80 3.00 3.15 3.30 3.50 3.60 3.60 3.75 3.90 30-yr Govt. Bond Yield (%) 3.10 3.52 3.70 3.85 3.90 4.15 4.40 4.55 4.55 4.55 4.60 4.65 10-yr-2-yr Govt. Spread (%) 1.62 2.16 2.30 2.40 2.55 2.60 2.60 2.60 2.40 2.10 2.05 1.75 f: by TD Economics as at September 2013; All forecasts are for end of period; Source: Bloomberg, TD Economics FOREIGN EXCHANGE OUTLOOK Currency Exchange Rate 2013 2014 2015 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F Canadian dollar CAD per USD 1.02 1.05 1.02 1.04 1.05 1.08 1.09 1.05 1.06 1.06 1.08 1.11 Japanese yen JPY per USD 94 99 100 100 102 102 105 110 110 110 112 115 Euro USD per EUR 1.28 1.30 1.35 1.30 1.27 1.25 1.24 1.22 1.22 1.20 1.20 1.20 U.K. pound USD per GBP 1.52 1.52 1.61 1.59 1.55 1.54 1.53 1.53 1.54 1.52 1.56 1.60 Swiss franc CHF per USD 0.95 0.95 0.91 0.95 0.98 1.02 1.05 1.07 1.07 1.08 1.08 1.08 Australian dollar USD per AUD 1.04 0.92 0.94 0.92 0.88 0.88 0.87 0.87 0.86 0.85 0.85 0.84 NZ dollar USD per NZD 0.84 0.78 0.83 0.83 0.81 0.80 0.78 0.77 0.76 0.74 0.73 0.72 f: by TD Economics as at September 2013; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TD Economics 6
GLOBAL ECONOMIC OUTLOOK Annual per cent change unless otherwise indicated 2012 Share* Real GDP (%) 2012 2013 2014 2015 World 99.8 3.0 2.9 3.5 3.6 North America 22.8 2.3 1.7 2.7 3.1 United States 18.9 2.2 1.6 2.6 3.1 Canada 1.8 1.7 1.7 2.4 2.6 Mexico 2.1 4.0 2.6 3.2 3.3 European Union (EU-27) 19.4-0.5-0.2 1.3 1.4 Euro-zone (EU-16) 13.7-0.5-0.3 1.1 1.3 Germany 3.8 0.9 0.6 1.6 1.4 France 2.7 0.0 0.3 1.0 1.0 Italy 2.2-2.4-1.6 0.6 0.8 United Kingdom 2.8 0.1 1.5 2.5 2.2 EU accession members 2.9-0.7-1.0 1.0 1.5 Asia 38.9 5.2 4.9 4.9 4.9 Japan 5.6 2.0 1.7 1.6 1.4 Asian NIC's 3.9 1.7 2.5 3.2 3.1 Hong Kong 0.4 1.5 3.0 3.2 3.1 Korea 1.9 2.1 2.4 3.0 3.0 Singapore 0.4 1.3 2.1 3.6 3.4 Taiwan 1.1 1.3 2.7 3.4 3.2 Russia 3.0 3.6 2.5 2.7 2.6 Australia & New Zealand 1.3 3.6 2.6 2.9 2.9 Developing Asia 25.1 6.8 6.4 6.3 6.3 ASEAN-4 3.4 6.3 5.2 5.0 4.9 China 14.9 7.8 7.5 7.3 7.2 India 5.6 5.1 4.8 5.0 5.3 Central/South America 6.7 2.6 3.1 3.5 3.5 Argentina 0.9 1.9 2.6 3.1 3.1 Brazil 2.8 0.9 3.0 3.1 3.2 Other Developing 12.0 2.8 3.4 3.8 4.0 *Regional wts. do not sum to 100% because some countries omitted as at September 2013 Source: IMF, TD Economics ECONOMIC INDICATORS FOR THE G-7 AND EUROPE 2012 2013 2014 2015 Real GDP (Annual per cent change) G-7 (42.7%)* 1.4 1.2 2.1 2.3 U.S. 2.2 1.6 2.6 3.1 Japan 2.0 1.7 1.6 1.4 EZ -0.5-0.3 1.1 1.3 Germany 0.9 0.6 1.6 1.4 France 0.0 0.3 1.0 1.0 Italy -2.4-1.6 0.6 0.8 United Kingdom 0.1 1.5 2.5 2.2 Canada 1.7 1.7 2.4 2.6 Consumer Price Index (Annual per cent change) G-7 1.9 1.4 1.8 2.1 U.S. 2.1 1.5 2.0 2.4 Japan 0.0 0.3 1.3 1.4 EZ 2.5 1.4 1.6 2.0 Germany 2.1 1.6 1.7 1.8 France 2.2 1.1 1.7 1.6 Italy 3.3 1.4 1.8 1.9 United Kingdom 2.8 2.7 2.3 2.1 Canada 1.5 1.1 1.6 2.2 Unemployment Rate (Per cent annual averages) U.S. 8.1 7.5 6.8 6.3 Japan 4.4 4.0 3.9 4.0 EZ 11.4 12.0 11.9 11.1 Germany 5.5 5.5 5.6 5.7 France 10.3 10.9 10.8 9.3 Italy 10.7 11.9 12.2 11.2 United Kingdom 7.9 7.6 7.3 7.1 Canada 7.3 7.1 6.9 6.5 *Share of 2012 world gross domestic product (GDP) as at September 2013 Source: National statistics agencies, TD Economics This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. This report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise the TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered. 7