SEPTEMBER 3, RETAIL RATE FORECASTS Interest Rates Continue to Climb # BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff North American economic growth rebounded in the spring. ff The Bank of Canada and the Federal Reserve will continue to normalize their monetary policy. ff The Canadian dollar is struggling to benefit from higher key rates. ff In an uncertain climate, the U.S. stock market is shining. The outlook for the U.S. economy remains favourable. News out of the U.S. continues to be very encouraging. Annualized real GDP rose 4.2% in the second quarter of, the strongest growth since summer, as consumer spending bounced back after a break early in the year. A pullback in growth seems inevitable after such a performance, but the very high business and consumer confidence indexes (graph ) suggest that the U.S. economy will continue to deliver solid results in the coming quarters. The Federal Reserve (Fed) will continue its monetary tightening. A further 0.2% increase in key rates appears to be guaranteed at the September 26 meeting. In June, Fed leaders signalled that two more rate hikes were likely in the second half of, an assessment backed by the encouraging economic data released over the past few months. Accelerating inflation and early signs of more robust wage growth are also reasons for continuing monetary tightening. Canada s economy rebounded in the spring, and inflation is becoming more apparent. The latest news in Canada is also generally encouraging. Benefiting from the surge in consumer spending and exports, Canada s GDP jumped 2.9% (annualized) in the spring. After plunging more than 0% in the winter following the introduction of stricter mortgage rules, residential investment advanced slightly in the spring owing to higher renovation spending. Other residential market data appear to confirm that the slower pace seen at the beginning of the year is giving way to a stabilization GRAPH GRAPH 2 U.S. businesses are still in a very positive situation Canada s inflation rose to the upper target ISM indexes Total consumer price index Index 62 Annual variation in % Manufacturing 4.0 Non-manufacturing 60 3. 8 3.0 6 2. 4 2.0 2. 0.0 48 46 Sources: Institute for Supply Management and Desjardins, Economic Studies 0.0 202 Sources: Statistics Canada and Desjardins, Economic Studies François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, Senior Economist Hendrix Vachon, Senior Economist Desjardins, Economic Studies: 4 28 2336 or 866 866 7000, ext. 2336 desjardins.economics@desjardins.com desjardins.com/economics NOTE TO READERS: The letters k, M and B are used in texts and tables to refer to thousands, millions and billions respectively. IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. The data on prices or margins are provided for information purposes and may be modified at any time, based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. The opinions and forecasts contained herein are, unless otherwise indicated, those of the document s authors and do not represent the opinions of any other person or the official position of Desjardins Group. Copyright, Desjardins Group. All rights reserved.
of activity and even somewhat of an upswing, especially in Toronto. Inflation, meanwhile, delivered a surprise in July with a leap to 3%, reaching the top of the Bank of Canada s (BoC) target range (graph 2 on page ). The BoC warns that more rate hikes are to come. Despite the trade tensions with the United States, the BoC announced another increase in its key rates at its July meeting. The target for the overnight rate has tripled since mid to %, which is still very low (graph 3). The BoC signalled that further rate hikes would be needed to achieve the inflation target, as the economy is operating at almost full capacity. However, it will continue to take a gradual approach and closely monitor the economy s reaction to higher interest rates and the North American Free Trade Agreement (NAFTA) negotiations. GRAPH 3 Gradual normalization of monetary policies should continue Key interest rate 6 Desjardins forecasts 4 United States 3 Canada 2 0 2007 2008 2009 202 209 2020 Retail rates are expected to continue rising. International worries have restrained the rise in bond yields in recent months. While there is every indication that the central banks will continue their monetary tightening, a widespread uptrend in interest rates across North America is, however, expected to come back soon. This should prompt financial institutions to continue to gradually raise their retail rates. TABLE Forecasts: Retail rate DISCOUNT RATE IN % Realized (end of month) March April May June July August Sept. 2, Forecasts End of quarter : Q3 : Q4 209: Q 209: Q2 End of year 209 2020 202 TERM SAVINGS MORTGAGE RATE PRIME RATE year 3 years years year 3 years years 3.44 3.44 4. 4..4.4.20.4.60 2.2 2.2 2.00 2.0 4.20 4.20 3.9 4.4 3.7 3. 4.0 3.7 4.2 3.80 4. 4.4 4.0 4. 4.0 4. 4.20 4.70.3.6.3.8.40.90.0 6.00.0.3..6.40.90 2.00.30.60 2.0 2.2.8 2.3.4.80 2.30 2.00 2.0 2.0 2.60 2.00 3.00 2.00 3.00.00 2.00 3.9 4.9 3.9 4.9 2.9 3.9 3.8 4.6 3.80 4.60 2.9 3.7 4. 4.9 3.9 4.7 3.30 4.0.0 6.30.0.90 4.70.0 2.3.4 2.2 0.60.40.80 2.60.60 2.40 0.9 2.0 2.90.70 2.0.30 2.0 Non-redeemable (annual); NOTE: Forecasts are expressed as ranges. Source: Desjardins, Economic Studies SEPTEMBER 2
Exchange Rate The Canadian Dollar Is Struggling to Benefit from Higher Key Rates The Canadian dollar started the summer at around US$0.7 and was worth US$0.77 by the end of August. It was buoyed by a number of factors, such as rising oil prices and better Canadian economic data. However, September is proving to be more challenging for the loonie, which fell to roughly US$0.76. This depreciation can be related to the resurgence of fears about U.S. protectionism, particularly the risk of the North American Free Trade Agreement (NAFTA) being scrapped. The Canadian dollar also lost ground against other currencies, including the euro (graph 4). GRAPH 4 The Canadian dollar recently lost ground against the U.S. dollar and the euro US$/C$ /C$ 0.73 0.82 0.7 0.80 0.69 0.78 0.67 0.76 0.6 0.74 0.63 0.72 Many emerging country currencies continue to be very volatile (graph ). Countries with structural difficulties, such as a current account deficit or precarious public finances, are more likely to see their currencies depreciate substantially. Further interest rate increases in the United States is adding to the challenges faced by many countries, as their financial conditions are deteriorating. The threat of protectionism is also a problem, especially for China. OCT. Exchange rate against U.S. dollar (left) 0.6 Exchange rate against euro (right) GRAPH Many emerging country currencies have posted significant declines since the spring Change against the U.S. dollar since mid-april Forecasts: Despite an expected October interest rate hike in Canada, the Canadian dollar might struggle to make significant gains. We even foresee a slight weakening of the loonie against the greenback by next spring due to the anticipated widening of interest rate spreads with the United States. A quick, favourable outcome of trade negotiations between Canada, the United States and Mexico would, however, prompt a more optimistic outlook for the Canadian currency. The volatility observed in many emerging country currencies may drag on, as the structural difficulties highlighted will not disappear quickly. Venezuela Argentina Turkey South Africa Brazil Chile Colombia Russia Hungary Poland India China Indonesia Mexico Malaysia Romania Thailand Taiwan Philippines Egypt -80-70 -60-0 -40-30 -20-0 0 Determinants Short-term Long-term Oil prices Metals prices Interest rate spreads TABLE 2 Forecasts: Currency END OF PERIOD US$/CAN$ CAN$/US$ CAN$/ US$/ US$/ 209 Q3 Q4 Q Q2 Q3f Q4f Qf Q2f Q3f Q4f 0.8020.2470.474.822.347 0.790 79.0.2008.328 0.776.2894.88.2299.4028 0.76.332.332.67.3203 0.7700.2987 6.600.2900 0.7600.38.39.700.3000.600.700.2700.733.800.2800.6000.2000.300 0.7600.38.603.2200.3400 f: forecasts SEPTEMBER 3
Asset Classes Return In an Uncertain Climate, the U.S. Stock Market Is Shining The past few months have been difficult for overseas stock markets. At the end of spring, the main asset classes all posted near-zero returns since the start of. Much changed over the summer as the U.S. stock market surged, but overseas stock markets retreated (graph 6). The past few months have been particularly difficult for emerging countries, with trade tensions and a rising U.S. dollar putting a lot of pressure on countries with structural weaknesses and significant external financing needs. European stock markets have also struggled, as the political situation in Italy is still worrisome and many European banks are deemed at risk in the event of defaults in Turkey. Some international concerns may stay present over the next few months, and we have downgraded our targets for overseas stock markets accordingly. Like corporate earnings, the U.S. stock market surged. Despite international uncertainty, the S&P 00 recently rose above its January level to a new historical peak. The bull market that began in March 2009 is now the longest in U.S. history, but there is no indication that an impending correction is inevitable. The outstanding performance of the S&P 00 in recent years and the nearly 0% gain since the start of are backed by strong corporate profit growth (graph 7). Analysts latest estimates are calling for earnings growth of around 30% this year. This remarkable performance is partly a reflection of the U.S. tax reform. A pullback in profit growth is now expected in the United States, despite an economic environment that should remain favourable in the coming quarters. We might see a consolidation of the S&P 00 after this summer s gains, but we have raised our target for this index nonetheless. The Canadian stock market may fare better by the end of the year. The past few months have been less favourable for the Canadian stock market, with the S&P/TSX dropping back below its level of the end of. The summer started off well, and the index reached a new peak in mid-july. Dropping metal prices as a result of trade tensions, concerns surrounding emerging nations and the soaring U.S. dollar beleaguered the important materials sector, however, causing it to tumble more than 4% since the recent S&P/TSX peak. The uncertain future of the North American Free Trade Agreement (NAFTA) also continues to weigh negatively on the Canadian stock market. While corporate profits have also been making strong advances in the country, the stagnating S&P/TSX since the beginning of the year has led to a significant decline in its price/earnings ratios (graph 8). We are maintaining our performance target of about 7% for the Canadian stock market for as a whole since the drop GRAPH 6 A sharp divergence in asset classes performances has been observed since late spring Jan. = 00 0 0 00 9 90 8 FEB. MAR. MAY. JUN. U.S. stock market (US$) Emerging stock markets (US$) Canadian bonds AUG. SEP. Overseas advanced stock markets (US$) Canadian stock market GRAPH 7 Strong earnings growth continues in North America Earnings forecast for the next 2 months Earnings/share Earnings/share 7 S&P 00 (left),200 S&P/TSX (right),00 0,000 2 900 00 7 800 202 700 Sources: I/B/E/S, Datastream and Desjardins, Economic Studies GRAPH 8 The Canadian stock market appears attractive Price/earnings ratios* Index S&P 00 30 S&P/TSX 2 20 0 987 990 993 996 999 2002 200 2008 * Based on earnings for the past 2 months. Sources: I/B/E/S, Datastream and Desjardins, Economic Studies SEPTEMBER 4
in metal prices seems exaggerated in the current economic context, as explained in the Commodity Trends published on August 9. Canada U.S. trade negotiations could keep the S&P/TSX volatile in the short run. The bond market appears vulnerable. The FTSE Canada Universe Bond Index is still slightly above its level of the end of. This resilience is quite impressive in a context where economic news remains favourable in North America and where the Federal Reserve and the Bank of Canada continue to raise their key rates. International worries inflated demand for North American long-term bonds, whose yields have remained fairly stable since the end of January (graph 9). The narrowing of the gap between the short-term and long-term yields should not continue for much longer however, and the first signs of wage growth in the United States recently brought back some upward pressure on U.S. bond yields. We are still predicting that a more definitive rise in bond yields in the coming months will result in a slightly negative return for the Canadian bond market for as a whole. GRAPH 9 Long-term bond yields have risen little since the start of the year 0-year U.S. federal bond yields 3.2 3.0 2.8 2.6 2.4 2.2 2.0.8.6.4.2 United States Canada OCT. TABLE 3 Asset classes percentage return CASH END OF YEAR IN % (EXCEPT IF INDICATED) 2007 2008 2009 202 f range BONDS CANADIAN STOCKS U.S. STOCKS INTERNATIONAL STOCKS EXCHANGE RATE 3-month T-Bill Bond index S&P/TSX index2 S&P 00 index (US$)2 MSCI EAFE index (US$)2 C$/US$ (variation in %)3 4. 2.4 0.3 0.6 0.9.0.0 0.9 0.7 3.7 6.4.4 6.7 9.7 3.6 -.2 8.8 3..7 2. 9.8-33.0 3. 7.6-8.7 7.2 3.0 0.6-8.3 2. 9.. -37.0 26.. 2. 6.0 32.4 3.7.4 2.0 2.8.6-43. 32. 8.2 -.7 7.9 23.3-4. -0.4. 2.6-4.4 22. -3.7 -.2 2.3-2.7 7. 9.4 9. -2.9-6.4 target:.40.30 to.4 target: -. -3.0 to.0 target: 7.0 0.0 to 0.0 target:. 6.0 to 6.0 target: 0.0-7.0 to.0 target: 4.6 (US$0.76) 0.6 to 7.4 FTSE Canada Universe Bond Index; 2 Dividends included; 3 Negative = appreciation, positive = depreciation; f: forecasts SEPTEMBER