Economics December 2015
A continuation of constrained uneven global growth is likely during 2016 and, though a major economic downturn cannot be ruled out, there are no signifi cant economic or fi nancial imbal- ances or signs of overheating. Several economies will receive further monetary easing with some assistance from fi scal policy, which will generate more growth over time. Brighter prospects for 2017 are expected.
The U.S. economy is on a different course than most and its monetary policy setting will affect currency markets. Canada stands to benefi t from a more robust economic neighbor and its largest trading partner, though the low loonie also brings negative impacts and, until exports rise on a sustained basis, its slow-to-moderate growth phase will continue.
Fed embarks on normalization
The most anticipated rate hike in memory fi nally occurred when the Fed raised the fed funds target rate range 25 basis points to 0.25%-0.50%
after more than six years at the zero-bound following the Great Financial Crisis and the fi rst rate increase in nearly ten years. The FOMC statement emphasized gradual in the outlook for policy and was data dependent on economic conditions. This move was overdue and would have occurred earlier, likely in September, had not external developments intervened.
The Fed’s interest rate projections indicated the target rate could be 100 basis points higher by
the end of 2016 and the median estimate for the end of 2017 was 3.3%. Thus, the median projection implies four 25 bps hikes in 2016 and another four in 2017 and the Fed sees rates normalizing in 2018. These rate projections and their economic projections are little changed from three months ago.
The U.S. prime lending rate increased to 3.50%
from 3.25%. This small rate increase is unlikely to have a signifi cant effect on housing, autos, or consumers. The Fed’s future rate path will take into account current economic conditions and future economic prospects such that growth is not constrained until infl ation becomes a prob- lem. While some label this rate move as mon- etary tightening, it is better described as rate normalization off emergency levels. Monetary tightening occurs when a central bank raises rates to bring down infl ation.
With the Fed beginning to normalize interest rates, it does not want to reverse course as has occurred in several countries that raised rates since 2008. Canada, Australia, Japan, and the ECB are some examples where the central bank reversed course. While unforeseen events will happen during the Fed’s normalization phase, and may cause a rate reversal, it will err on the side of caution and pro-growth in the initial stages.
The federal funds futures market currently antici-
Highlights
• Fed normalization begins
• More policy moves in China
• Canada’s uneven economy
• BoC on hold, lower CAD
U.S. Federal Funds Rate
0 1 2 3 4 5 6
Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14
Per cent
Source: U.S. Federal Reserve. Latest: Dec-15
China’s policy moves
China’s central bank cut its benchmark rate six times in 2015 and lowered the reserve require- ment ratio three times. Further monetary and fi scal stimulus moves are likely in 2016. China’s economy is showing some signs of reversing its downward growth momentum in place since 2010. China’s industrial sector improved some- what in November, with both industrial produc- tion and fi xed asset investment showing stronger growth following recent lows in September.
Retail sales were up in November and housing activity rose. It is too early to declare an end to China’s growth slump but past and new stimulus measures will help. Nonetheless, its medium and longer term growth profi le will be much lower than in the prior decade due to various structural forces.
In November, the IMF announced that China’s currency will be included in the Special Drawing Rights basket commencing in October 2016. Its share at 10.9% will be larger than both the Japa- nese Yen and British Pound in the new basket.
Other currencies in the SDR basket are the U.S.
dollar and the Japanese yen. While a debatable decision in the eyes of some on the freely usable criterion, the IMF’s move recognizes China’s large and dominant role in the global economy.
Another currency development was China’s plan to track the yuan relative to a trade-weighted currency basket rather than of a peg to the USD only. It would serve as a reference guide though in reality it could be used to adjust the yuan’s value. The new index includes 13 currencies four implied by the Fed’s median projection. This
forecaster expects two or three 25 bps increases during 2016. The Fed’s interest rate hike signals a stronger U.S. economy and that is positive for Canada. With the Canadian economy on a weaker growth trajectory than the U.S. economy, the Bank of Canada will not be following Fed rate hikes any time soon.
Most recent U.S. economic data December data indicated a loss of growth momentum in the manufacturing and services sector. The season- ally adjusted Markit Flash U.S. Composite PMI Output Index slowed to 53.5 in December, down from 55.9 in November. Manufacturing is feeling the impact of low oil prices through reduced investment demand for plant and machinery and the stronger dollar is affecting exports.
Many service sectors such as transport and busi- ness services are dependent on manufacturing as well.
Real GDP growth in Q4 2015 is tracking just under two per cent annualized according to the Atlanta Fed’s GDPNOW model and Moody’s Analytics High Frequency GDP model. The median expectation of more than 60 forecasters is 2.0%. Q3 2015 real GDP currently sits at 2.3%
with Q2 2015 at 3.9%.
For all of 2015, real GDP growth looks to come in near 2.2%, slightly slower than 2.4% in 2014.
Most forecasts, including the Fed’s, have growth edging higher to around 2.5% in 2016 and near the same pace in 2017.
The U.S., and to a lesser extent the U.K., are on different monetary paths than many other countries because of differing economic cir- cumstances. Europe’s economy is undergoing a modest expansion and 2015 growth will likely come in around 1.5%, with considerable mon- etary stimulus in place possibly another injection in 2016. Japan is in a similar situation with weak domestic conditions and very accommodative monetary conditions. Japan’s export sector is its main hope for a growth uplift, and without a pickup in China, more domestic policy measures are likely.
20 40 60 80 100 120 140
1980 1985 1990 1995 2000 2005 2010 2015
1997 = 100
Source: U.S. Federal Reserve. Note: 2015 year-to-date average to Nov.
Exchange Rate: U.S. Trade Weighted
Broad Index
election. Overall employment growth is trending less than one per cent in 2015.
Infl ation in Canada came in at 1.4 per cent in November while the Bank of Canada’s core index was 2 per cent higher than one year ago. Low energy prices are pulling down headline infl ation while core infl ation was held up by the currency effect and the exclusion of key energy compo- nents.
Fourth quarter real GDP is tracking lower than the Bank of Canada’s 1.5 per cent real GDP fore- cast. Our forecast is 1.0 per cent with downside risks. For all of 2015, growth will come in close to 1.0 per cent. Next year’s forecast is 1.8 per cent, slightly lower than the Bank’s expectation, though the Bank could trim it lower at its next update in the January 2016 Monetary Policy Report.
Exports and the manufacturing sector need to progress on a more sustained basis in order to lift Canada’s growth above 2.5 per cent. The lower Canadian dollar should strengthen exports but this takes several years and in the meantime volatility looks to continue. Overall, moderate growth and a tighter labor market are expected in 2017.
Rates on hold, lower CAD
The Bank of Canada is expected to remain on hold through 2016 until around mid-2017. How- ever, recent data and oil price declines raise the risk of another rate cut or insurance policy move at the January 20 meeting or possibly at the March 9 meeting. The futures market is pricing with the USD given a 0.264 weight and the euro
0.2139. Last August, the yuan was devalued two per cent relative to the USD, and with more USD appreciation on the horizon, the reference basket gives the authorities plausibility to deny currency manipulation, i.e., additional yuan devaluations which are likely.
Growth in other emerging economies remains slow and broadly based with India the best big emerging economy performer. Brazil and Russia are struggling in deep recessions while South Africa fl irts with recession. The energy and mining downturn has a considerable negative impact on these economies with repercussions around the world.
Slow uneven growth
Turning to Canada, real gross domestic product fell 0.5 per cent in September, mainly the result of declines in mining, quarrying, and oil and gas extraction and, to a lesser extent, manufactur- ing. This came on the heels of three consecutive monthly increases.
Expenditure-based real GDP rose for the fi rst time in two quarters with a 2.3 per cent annual- ized increase in the third quarter, ending the rule-of-thumb recession. Households, residential, and an export rebound were behind the gain while business investment contracted further.
October industry real GDP is expected to post a small gain partly because the temporary produc- tion diffi culties and maintenance shutdowns experienced in September will have passed and the hiring ramp-up for the federal election.
However, manufacturing sales fell in October as did wholesale sales. Ongoing weakness in energy and mining has negative spillovers into manufacturing and other sectors such as busi- ness services.
To no surprise, the household sector is holding up. November housing market data were strong with sales and prices rising. New vehicle sales also performed well.
Employment decreased by 36,000 persons in November following a similar-sized increase in October. Employment in public administration declined by 33,000 in November, offsetting an
-15 -10 -5 0 5 10
Q1-08 Q1-09 Q1-10 Q1-11 Q1-12 Q1-13 Q1-14 Q1-15 Real GDP Final Domestic Demand
Source: Statistics Canada. Note: Expenditure-based GDP. Latest: Q3-2015 Per cent change at annual rate
Canada’s Economic Growth
Target Overnight Rate Forecast Meeting Date (Per cent)
Dec. 2 (a) 0.50
Jan. 20, 2016 0.50
Mar. 9 0.50
Apr. 13 0.50
June 25 0.50
July 13 0.50
Sep. 7 0.50
Oct. 19 0.50
Dec. 7 0.50
Jan. 2017 0.50
Mar. 0.50
Apr. 0.50
June 0.75
July 0.75
Sep. 0.75
(a) actual
In a recent speech, Governor Poloz outlined the use of negative interest rates as one of four unconventional monetary policy measures it would use if faced with a major economic crisis.
The other three are forward guidance, large scale asset purchases (QE) and funding for credit.
Negative interest rates are the last policy option though all four could be used simultaneously should conditions warrant and such conditions would be dire indeed.
There is considerable downside pressure on the Canadian dollar due to the confl uence of low oil and other commodity prices and diverging economic and monetary paths with the U.S. A fall below 70 US cents is possible and increas- ingly likely in the next three to six months. Crude oil prices have not bottomed and the Fed will normalize at least once more before mid-2016.
Helmut Pastrick
Chief Economist, Central 1 Credit Union [email protected]
www.central1.com 604.737.5026
0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00
02/01/2014 02/07/2014 02/01/2015 02/07/2015
U.S dollar per Canadian dollar
Source: Bank of Canada. Latest: Dec. 21, 2015
U.S.-Canada Exchange Rate, Daily
Interest Rate Forecast
Item 2015
Q3a 2015
Q4 2016
Q1 2016
Q2 2016
Q3 2016
Q4 2017
Q1 2017
Q2 2017
Q3
Target Overnight Rate 0.54 0.50 0.50 0.50 0.50 0.50 0.50 0.60 0.75
Prime Rate 2.73 2.70 2.70 2.70 2.70 2.70 2.70 2.80 2.95
1-mo. T-Bill 0.40 0.40 0.40 0.40 0.40 0.45 0.45 0.55 0.70
3-mo. T-Bill 0.42 0.45 0.45 0.45 0.45 0.45 0.50 0.60 0.75
6-mo. T-Bill 0.43 0.45 0.45 0.50 0.50 0.55 0.60 0.65 0.80
1-year T-Bill 0.45 0.50 0.50 0.55 0.55 0.60 0.65 0.75 0.90
2-year GoC Bond 0.44 0.55 0.55 0.60 0.65 0.70 0.70 0.85 1.05
3-year GoC Bond 0.45 0.60 0.60 0.65 0.70 0.75 0.75 0.90 1.10
5-year GoC Bond 0.75 0.85 0.85 0.90 1.00 1.10 1.15 1.35 1.55
10-year GoC Bond 1.48 1.55 1.55 1.60 1.75 1.90 2.00 2.25 2.50
Source: Bank of Canada, Central 1 Credit Union forecasts. Note: Quarterly average based on daily data. a = actual, all others forecast.
Deposit Rate Forecast
Item 2015
Q3a 2015
Q4 2016
Q1 2016
Q2 2016
Q3 2016
Q4 2017
Q1 2017
Q2 2017
Q3
1-year GIC 0.79 0.80 0.80 0.80 0.80 0.80 0.80 0.85 0.95
3-year GIC 1.03 1.00 1.00 1.00 1.00 1.00 1.00 1.05 1.15
5-year GIC 1.49 1.50 1.50 1.50 1.50 1.55 1.55 1.60 1.70
Source: Bank of Canada, Central 1 Credit Union forecasts. Note: Quarterly average based on weekly data. a = actual, all others forecast. Non-redeemable semi-annual rates from Bank of Canada based on typical rate (mode) at six major banks.
Mortgage Rate Forecast
Item 2015
Q3a 2015
Q4 2016
Q1 2016
Q2 2016
Q3 2016
Q4 2017
Q1 2017
Q2 2017
Q3
1-year Mortgage 2.89 3.05 2.95 2.95 2.95 2.95 3.00 3.05 3.10
3-year Mortgage 3.39 3.40 3.40 3.40 3.40 3.45 3.45 3.50 3.60
5-year Mortgage 4.64 4.65 4.65 4.65 4.70 4.70 4.75 4.85 4.90
Source: Bank of Canada, Central 1 Credit Union forecasts. Note: Quarterly average based on weekly data. a = actual, all others forecast. Posted fi xed term rates from Bank of Canada rates based on typical rate (the mode) at six major banks.
