Inside... Overview...page Interest rate outlook...page Economic outlook...page Currency outlook...page Central bank watch...page 8 Financial market volatility persisted in Q...page 9 FINANCIAL MARKETS MONTHLY Global market jitters persist October, 0 Financial markets remained on edge in September, with stock markets teetering and the MSCI world index losing another.. Yields on government bonds were range bound in the month, reflecting the pickup in investor risk aversion. Economic reports imply above-average growth in most industrialized countries in the third quarter, with the US building further on a very strong second-quarter performance. Inflation readings conversely were dampened by the low level of commodity prices, with oil prices yet to recover significantly after hitting a cycle low in late August. The persistent low level of energy prices pushed the euro area annual inflation rate back into negative territory in August while monthly readings in the US and Canada were similarly weighed down by gasoline prices. Importantly core inflation rates did not shift lower, thereby dulling the effect of the weak headline numbers on concerns that the global economy is headed for a period of deflation. Central banks to remain sidelined for longer Expectations for central bank policy are being shaped by concerns about the global outlook, given the deceleration in China and other emerging market economies, and the flow-through to inflation from the retreat in commodity prices. In the near term, these factors set up policymakers to maintain extraordinary policy support, as highlighted by the US Federal Reserve s decision to maintain the federal funds target band of 0 to 0. in mid- September. We expect this to be echoed by the Bank of Canada at its upcoming meeting on October, and have altered our forecast for the Bank of England (BoE) to stay on the sidelines until mid-0 with the European Central Bank (ECB) likely to extend its quantitative easing programs beyond September 0. Central bank near-term bias Three-months out, policy rate The BoC delivered a fairly neutral policy statement in September, noting that the outlook continues to evolve roughly as expected while the Canadian economy undergoes a complex adjustment. The Fed held off on raising rates in September, citing global financial market volatility and downside risks to the inflation outlook. We continue to expect a rate hike this year, given the strong domestic economy, but see the Fed waiting until December for signs of stability to emerge. Solid wage growth has failed to generate inflationary pressure, and with a later start to Fed tightening and an uncertain global growth outlook, we look for the Bank Rate to be held steady until May 0. Dawn Desjardins Assistant Chief Economist -9-99 dawn.desjardins@rbc.com Josh Nye Economist -9-99 josh.nye@rbc.com Limited price pressure, falling inflation expectations, and tighter financial conditions will likely prompt the ECB to provide further stimulus. We expect a six-month extension of the current asset purchase program (to at least March 0) will be announced in December. The RBA has struck a more positive tone recently, and the bar for further easing appears quite high. We expect additional rate cuts will be required as the Australian economy increasingly encounters external headwinds, although we do not foresee any moves until the H/. The RBNZ made a third consecutive bp rate cut in September. While the Governor did not commit to a cut at the next meeting, we expect the RBNZ will act on its strong easing bias later in October.
Highlights Financial market volatility spikes Stock as markets investors remained worry about under the pressure global while recovery. government bond yields were range-bound. Data reports have erred on the weak side. Central banks are likely to remain on the sidelines to lean However against there any further were many one-off weakening factors in the that global curtailed economy. activity. As Despite these the factors US economy ease, growth growing will at a accelerate. solid clip and the unemployment rate approaching full-employment, The US recession was the Fed held the policy rate deeper than was previously steady in mid-september. reported and GDP output stands 0. pp below its prerecession peak. With the economy growing at an above-potential pace and the amount of underutilized labour diminishing, the Fed is likely to move forward with a rate hike before year-end 0. Lift-off delayed The Federal Reserve made no change to monetary policy at the mid-september meeting. The statement accompanying the decision cited heightened concerns about global developments, both in the world economy and financial markets, that may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term. Furthermore, policymakers indicated that they were widening their scope and will not only monitor near-term inflation developments but will also focus on developments abroad. Our forecast assumes that signs of weakness outside the US and financial market volatility will not have a material effect on the US economy, and we are maintaining our call for the US economy to grow at an abovepotential pace in the second half of 0 and expect the degree of slack in the labour market will continue to diminish. As the data confirm that the US economy s momentum is not being disrupted by recent events, this will allow the Fed to start the process of unwinding monetary policy stimulus with a bps hike likely in December 0 although this will likely be conditional on global financial markets displaying greater stability. Fed ups growth forecast The Fed s Summary of Economic Projections showed an upgrading of the gross domestic product (GDP) growth forecast for 0 and corresponding reduction in the projection for the unemployment rate. The Fed s revised view is for real GDP growth to be between.0 and. in the final quarter of 0 (on a Q/Q basis) and for the unemployment rate to end the year between.0 and.. Our forecast is that the US economy will grow at a quicker. clip in the fourth quarter (Q/Q), backed by consumer spending and housing market activity, and a recovery in business investment. Inflation concerns continue Despite a somewhat more upbeat outlook for growth, the Fed s assessment is that the combination of lower oil prices and the additional appreciation in the US dollar will keep the inflation rate lower than previously anticipated in the near term. Thus, it was a combination of concerns about the effect of recent global developments on US growth and the downside risks to the near-term outlook for inflation that resulted in the Fed s rate decision. In her press conference, Chair Yellen highlighted that of the members still expect to raise the fed funds target from the current range of 0 to 0. this year. Additionally, in a speech on September, 0, the Chair acknowledged that she was one of the Federal Open Market Committee (FOMC) participants who anticipate that conditions will warrant the implementation of a rate hike later this year. Data point to another solid increase in GDP the third quarter Following the upward revision to second-quarter real GDP to a.9 annualized increase, reports for July and August point to the economy posting another abovepotential gain in the third quarter. Consumer spending activity ramped up during the two-month period sufficiently to create an upside risk to our forecast for a.8 annualized third-quarter gain. Housing indicators were mixed but overall point to residential construction activity providing a solid lift to growth in the quarter. Indicators of business investment, including the volatile durable goods orders, suggest that capital expenditure accelerated following the pullback in spending due to the retrenchment by the energy industry in the first half of 0. The September non-farm payroll report showed a disappointing,000 increase in employment with gains in the previous two months revised lower. However, the US unemployment rate held at., and indicators of labour market underutilization showed another month of improvement. Wage gains averaged. in the second and third quarters, a modest improvement over the.0 pace of the prior six month period.
Canada s economy back in the saddle Real GDP increased by 0. in July, building on June s revised 0. gain and resulting in the level of GDP regaining almost all the losses recorded from January to May 0. The rise reflected another solid increase in the goods sector due to a sharp recovery in mining, oil, and gas production. The increase in energy production occurred as facilities came back on line after shutdowns and maintenance saw output plunge earlier in 0. Manufacturing output also increased at a strong clip in July and matched June s gain, with the data providing some tentative evidence that strengthening exports fuelled a pickup in manufacturing activity. Service-sector output increased by 0. following June s 0. gain. Growth in July GDP built on the solid increase in June GDP, which represented a marked improvement compared to modestly declining activity in the first five months of 0. These declines resulted in first-quarter GDP dropping by an annualized 0.8 and 0. in the second quarter. While the bounce back in June GDP was not sufficient to prevent the economy posting a decline in the second quarter, the increase and July s gain strongly support our view that quarterly growth returned to the positive column in the third quarter. We are currently monitoring an annualized third-quarter increase of.. This rebound from the weak growth in the first half of 0 largely reflects strengthening exports and consumer spending that more than offset continued declines in energy investment. The Bank of Canada s most recent forecast, released in July, assumed a return to positive growth in the third quarter of. led by strengthening exports. Exports take flight Canadian exports posted such strong gains in June and July that even assuming some modest payback in export growth in August and September, it is likely that exports will post a hefty 9 annualized third-quarter gain. The surge in exports should be paired with a mild rise in imports, pointing to net trade adding about percentage points to annualized third-quarter GDP growth following a 0. percentage point contribution in the second quarter. Importantly, the rise in exports was concentrated in sales of non-commodity goods, including transportation equipment (autos and aerospace), consumer goods, and industrial machinery. The widespread gains provide optimism that Canadian exporters are now capitalizing on strengthening US growth and the weaker Canadian dollar. Highlights Canada s economy showed renewed strength in June and July, setting up for real GDP growth of. in Q/. This improvement in the economy s performance will likely prevent the BoC from taking out more insurance via another rate cut at its upcoming meeting. As concerns about another round of slower growth ease, we expect the Bank to be more comfortable with holding the policy rate at 0. well into 0. Bank of Canada likely to be encouraged by data, hold policy steady The reversal in GDP growth in June and July will be seen as encouraging by the Bank of Canada whose forecast was for a gradual rebound in growth in the third and fourth quarters of 0. On the inflation front, both the headline and core measures are running slightly faster than the Bank projected in July. The core inflation measure averaged. in July and August, thereby holding above the Bank s mid-range target of.0 for more than a year. In August, 0. of the core index posted increases of.0 or more. Some of the increase reflected the weaker Canadian dollar boosting prices of imported goods. Our forecast assumes that the Canadian dollar will weaken further in the absence of a sharp recovery in oil prices and given the divergence in Canada-US short-term interest rate spreads. This additional currency weakness will continue to exert upward pressure on core prices. The Bank estimated in July that the pass-through from the weaker currency added about 0. to 0. percentage points to the core rate, which suggests that the underlying rate in August was between. and., below but still within reach of the.0 target. With the anticipated rebound in economic activity looking increasingly locked in, we expect the Bank will be content to hold the overnight rate at 0. at its upcoming October meeting and expect that the continuation of positive economic growth and the core rate holding above the.0 target will be sufficient for the Bank to remain sidelined for most of 0.
Highlights The euro area is growing at its strongest annual pace since 0. We expect the first rate hike by the BoE will be held off until May 0. The bar for additional easing by the RBA has been raised, but we continue to expect further accommodation in 0. ECB likely to announce extension of asset purchases in December The second estimate of second-quarter euro area GDP growth was revised upward to 0. from 0. in the flash estimate with a similar 0. percentage point upward revision to firstquarter growth (now 0.). Those gains leave year-over-year growth at. that, while still relatively modest, marks the strongest annual increase in four years. Survey indicators, which have shown limited effect from domestic and global uncertainty, point to a steady pace of growth continuing in line with our forecast for another 0. GDP gain in the third quarter. Improving activity has done little to generate inflationary pressure, with headline inflation dipping back into negative territory at -0. in September while core inflation remained stable at a meager 0.9. We previously expected that reduced deflationary risk would leave the ECB holding monetary policy steady, and our view remains that the latest foray into negative headline inflation will be brief; however, several factors have led us to expect additional stimulus. Financial conditions have tightened in recent months, underlying inflationary pressure remains subdued despite a pickup in growth, inflation expectations have seen a renewed decline with further downward pressure likely as commodity prices continue to weaken, and the global growth outlook remains uncertain. Given these developments and with the Governing Council sounding more dovish at each meeting, we expect the ECB will announce a six-month extension of its current asset purchase program (which the ECB had previously committed to continuing until at least September 0) in December 0. This would allow for additional stimulus without requiring any major changes to the program s current framework. BoE no longer expected to hike this year Recent survey indicators continue to signal solid growth in the UK economy albeit with momentum waning slightly in the third quarter. August s composite purchasing managers index (PMI) reading was the lowest in two years, as activity in the services sector, a large share of the UK economy, expanded at a slightly slower pace than in previous months while the manufacturing index continued to signal only a modest degree of growth. While moderating from strong readings seen earlier in 0, the level of these indices remains roughly consistent with our forecast for third-quarter UK growth to match the second quarter s 0. gain. Solid growth following a slightly soft start to 0 has led to renewed improvement in the labour market, with the official unemployment rate edging downward to a cycle low of. in July. Tighter labour market conditions have kept wages growing at a solid pace (nearly year over year excluding bonuses), although lack of meaningful acceleration in this area has caused limited flow-through to inflationary pressure with overall year-over-year prices flat in August and core inflation at just.0. The BoE has pointed out tentative signs of productivity growth that would limit the inflationary consequences of stronger wage gains. With wage growth potentially providing less inflationary pressure than previously assumed, a delayed start to Fed tightening, and more uncertain global growth outlook, we expect the BoE will take a slightly more cautious approach to normalizing monetary policy. We now look for the Bank Rate to be held steady for the remainder of 0 with the first increase not occurring until May 0. Pushing back expected rate cuts as RBA strikes a positive tone Australia s economic outlook continued to be clouded by familiar themes: weak terms of trade and national income, a slow adjustment from mining to non-mining capex, and an uncertain global economic outlook with particular concern surrounding Chinese growth. These factors prompted us to mark down our GDP growth forecasts by 0. in both 0 and 0. Although the Australian economy continues to tread water, the Reserve Bank of Australia (RBA) has taken a more optimistic tone lately. Governor Stevens downplayed global developments (going against the tide of many other central bankers) and noted that the Australian economy is responding reasonably well to a significant shock. The RBA appears satisfied with recent currency depreciation and performance of the labour market. The unemployment rate, while elevated, has been relatively stable with job growth somewhat stronger than would be expected given subdued activity. The RBA sounded content with the current policy setting, and thus the bar for further easing is quite high. We expect it will take slower employment growth, moderation in demand, and further weakness in key commodity prices for the RBA to cut rates below the current historic low of.0. This remains our base case, although we expect the easing cycle will continue to be drawn out with basis point cuts now forecasted to occur in the first and second quarters of 0.
, end of period Interest rate outlook Actuals Q Q Q Q Q Q Q Q Q Q Q Q Canada Overnight.00.00.00.00 0. 0..00 Three-month 0.90 0.9 0.9 0.9 0. 0.8 0. 0..0 Two-year.0.0..0 0. 0.9 0. 0. 0.8.00.0 Five-year.... 0. 0.8 0.8.00.0..0.00 0-year....9..8...8.00..0 0-year.9.8...98..0....90. United States Fed funds 0. 0. 0. 0. 0. 0. 0. 0..00.0.00 Three-month 0 0. 0. 0.9. Two-year 0. 0. 0.8 0. 0. 0. 0..0.0.0.80. Five-year...8.....80.9...0 0-year.....9..0..0.80.00. 0-year.......8.0.0.0.0. United Kingdom Bank rate 0. 0..00 Two-year 0. 0.8 0.8 0. 0. 0. 0. 0.80 0.9..0.80 0-year..8...8.0..00.0.0..0 Eurozone Refi rate 0. 0. Two-year 0. - -0. -0. -0. -0. - - - -0. -0. 0-year.. 0.9 0. 0.8 0. 0.9 0. 0.8.00.0 Australia Cash target rate.0.0.0.0..00.00.00..0.0.0 Two-year.8.80..9..0.8.80.0.0..00 0-year.08.00.8.8..0..00.0.0.0.0 New Zealand Cash target rate...0.0.0...0.0.0.0.0 Two-year swap.0.90.0...09.9.80.80.00.0.0 0-year swap..00....89.8.00.0.0.0.0 Yield curve Canada 9 0 8 8 9 9 0 0 United States 8 0 9 0 8 0 0 0 0 0 00 United Kingdom 0 8 9 0 0 0 9 80 Eurozone 0 0 00 8 90 9 0 Australia 0 0 8 0 00 80 0 0 0 0 New Zealand 0 9 80 9 0 0 0 0 0 * Two-year/0-year spread in basis points Source: Reuters, RBC Economics Research, end of period Central bank policy rate Current Last United States Fed funds -0..00 December, 008 Canada Overnight rate 0. July, 0 United Kingdom Bank rate.00 March, 009 Current Last Eurozone Refi rate 0. September 0, 0 Australia Cash rate.00. May, 0 New Zealand Cash rate..00 September 0, 0 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 0 0F 0F Canada*.0... -0.8-0.......... United States* -0.9... 0..9..9.0.8.0....0 United Kingdom 0.9 0.9 0. 0.8 0. 0. 0. 0. 0. 0. 0. 0..0.. Euro Area 0. 0. 0. 0. 0. 0. 0. 0. 0. 0. 0. 0. 0.9..8 Australia 0.9 0. 0. 0. 0.9 0. 0.8 0. 0. 0. 0.8 0.9... New Zealand. 0.8 0.9 0.8 0. 0. 0. 0. 0. 0. 0. 0....9 *annualized, ** forecast Inflation outlook change, year-over-year Q Q Q Q Q Q Q Q Q Q Q Q 0 0F 0F Canada....9. 0.9....0.9..0..0 United States...8. -0. 0. 0..0.8.0.. 0..0 United Kingdom... 0.9 0. 0. 0.....9. 0.. Eurozone 0. 0. 0. 0. -0. 0. 0. 0..0 0.8 0.9.0 0. 0..0 Australia.9.0.......9.9.8....8 New Zealand...0 0.8 0. 0. 0. 0. 0.9 0.9... 0.. 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 Aug 0.... United States Core PCE, Aug 0.... United Kingdom All-items CPI Aug 0. 0.8 0. Eurozone All-items CPI Aug -0. 0. 0.8 0. Australia Trimmed mean CPI Q 0.. N/A N/A New Zealand All-items CPI Q 0. 0. 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..0..........0 Euro.8....0....... U.K. pound sterling.....8....9..8.0 New Zealand dollar 0.8 0.88 0.8 0.8 0. 0.8 0. 0. 0.9 0.8 0. Japanese yen 0. 0. 09. 9.8 0.. 9.9 8.0.0 9.0.0.0 Australian dollar 0.9 0.9 0.8 0.8 0. 0. 0.8 0.8 0. 0. 0. Canadian dollar cross-rates Q Q Q Q Q Q Q Q Q Q Q Q EUR/CAD......9.9..... GBP/CAD.8.8.8.8.88.9.0.9...0.0 NZD/CAD 0.9 0.9 0.8 0.9 0.9 0.8 0.8 0.8 0.80 0.8 0. 0. CAD/JPY 9. 9.0 9.9 0. 9. 98.0 9 9. 98. 9.0 9. 9. AUD/CAD.0.0 0.98 0.9 0.9 0.9 0.9 0.9 0.9 0.89 0.88 0.8 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..0 Canadian dollar.0 Euro.0.0.0.0.0.0.0.00.0 0.90.00 0.80 Oct- Apr- Oct- Apr- 0.90 Oct- Apr- Oct- Apr- Japanese yen.00 U.K. pound.80.0 0 9.0 8 Oct- Apr- Oct- Apr-.0 Oct- Apr- Oct- Apr-
Central bank watch Bank of Canada The Canadian economy continued to rebound from a soft start to 0 with July GDP up 0. to build on June s 0. gain. This sets up a return to positive (and likely above-trend) growth in Q/. The BoC s latest policy statement noted continued weakness and an uncertain outlook in the resources sector was being balanced by some signs of policy traction and a pickup in the non-resources economy. Canadian real GDP growth Quarter-over-quarter annualized change 8 - - - -8-0 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Statistics Canada, RBC Economics Research ed values: Canadian overnight rate 0 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Bank of Canada, Federal Reserve Board, RBC Economics Research Federal Reserve The third estimate of US Q/ GDP growth was revised upward to.9 from. in the second estimate, and the economy appears to have maintained solid momentum in Q/ with above-trend growth likely to continue. We expect sufficient evidence of reduced financial market volatility and signs of stability in commodity prices and inflation will result in a December rate hike after the Fed elected to delay liftoff in September. European Central Bank The euro area economy likely continued to grow at a 0. pace in Q/, as domestic and global uncertainty has done little to hamper the recovery with low oil prices providing a lift. Tighter financial conditions should prompt a response from the dovish ECB, and we look for a six-month extension of the current asset purchase program to be announced in December. U.S. real GDP growth Quarter-over-quarter annualized change 8 - - - -8-0 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Bureau of Economics Analysis, RBC Economics Research ed values: Eurozone GDP change, quarter-over-quarter..0 0. -0. -.0 -. -.0 -. -.0 -. 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Eurostat, RBC Economics Research ed values: U.S. target rate 0 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Bank of Canada, Federal Reserve Board, RBC Economics Research ECB refi rate 0 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: ECB, RBC Economics Research Bank of England While recent PMI surveys have moderated relative to earlier strong readings, we expect solid growth in the UK economy will continue with a 0. Q/ GDP gain matching Q s pace. The BoE is likely to take a cautious approach to tightening, given global uncertainty and a delayed lift-off from the Fed. We now expect the first Bank Rate hike will be held off until May 0. Australia and New Zealand The RBA appears reluctant to ease further despite numerous headwinds facing the Australian economy. We expect the case for rate cuts will build next year with further easing likely in H/. The RBNZ slashed its growth forecasts and expects inflation will continue to run below target. With a strong easing bias in place, we expect a fourth consecutive rate cut later in October will bring the cash rate back down to an historic low of.. U.K. real GDP growth change, quarter-over-quarter..0 0. -0. -.0 -. -.0 -. 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Central Statistical Office, RBC Economics Research ed values: Australia and New Zealand GDP growth change, quarter-over-quarter..0..0 0. -0. Australia -.0 New Zealand -. 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research U.K. policy rate 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Bank of England, RBC Economics Research Australia and New Zealand inflation change, year-over-year Australia New Zealand 0 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Australian Bureau of Statistics, Statistics New Zealand, RBC Economics Research 8
Financial markets volatility persisted in Q Global stock markets were pressured lower in Q/...as financial market volatility saw investors become more risk averse. MSCI World Stock Index Index value 000 800 00 00 Market Volatility Index (VIX) Index 0 0 0 00 000 0 0 0 0 Source: Bloomberg, RBC Economics Research 0 0 0 0 0 Source: Wall Street Journal, RBC Economics Research Government bond yields were range bound....as central banks stood back to assess the effect of recent global developments. 0-Year Bond Yields.0. Canada UK U.S. Euro Area Policy rates: International, eop.0.0 Canada U.S. U.K..0.0 Euro Area..0.0.0.0 0..0 Jan-0 Feb-0 Mar-0 Apr-0 May-0 Jun-0 Jul-0 Aug-0 Sep-0 000 00 00 00 00 00 00 00 008 009 00 0 0 0 0 0 0 Source: Federal Reserve Board, Bank of Canada, Reuters, RBC Economics Research Source: FRB, BoC, ECB, BoE, 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