ECONOMIC & FIXED INCOME COMMENTS - "Green Shoots of Spring..."
Over the 6 months ending January 2017, Canada’s GDP has grown at an average rate of 4%. Examining the most recent data (January 2017) Canada’s GDP grew 0.6% month over month; almost double what economists originally forecasted. We anticipated a sharp pickup in economic growth in the third quarter of 2016 after the very slow growth and the Fort McMurray fires in the first half of 2016 however, the continued strength has been a surprise. For the year as a whole, GDP grew 1.4%.
[endif]--Areas of economic strength in Canada during the first quarter of 2017 were housing starts and manufacturing. Although manufacturing has been a slow growth area over the past few years, there has been a sharp increase as of late (see chart). Housing starts continue to show strength. In March they were 253,720 - a level that hasn’t been seen since before 2007; up 25% year over year. Finally, business spending is on the rebound. After the collapse of the oil price in 2014-2015 business spending on capital goods declined sharply and was a major drag on the economy. However, a recent survey of business spending done by the Bank of Canada has shown a modest increase in spending intentions. Good news for our economy.
Chart: Manufacturing Output
While some economists increased their 2017 forecasts by almost 0.6% due to the recent uptick in growth, we are only increasing our GDP forecast for 2017 from 1.9% to 2.1%. This recognizes the recent good news however; there are several uncertainties ahead with downside risk. A primary concern is the course of U.S economic policy under the Trump administration. There is tremendous uncertainty over trade, taxes and deregulation which potentially could be quite negative for Canada. Other events to keep an eye on include:
European elections- recent polls suggest anti-European Union candidates are gaining acceptance
Crisis averted in the Netherlands. Next up France.
Article 50 Treaty of Lisbon was triggered on March 29th, 2017 by Theresa May.
China’s debt level
It has soared since 2009. Currently accounts for 145% of China’s GDP. /
Although the Bank of Canada is forecasting an increase in GDP growth to 2.6%, we do not expect it to increase the Bank Rate from 0.5% in 2017. Instead, policymakers will remain cautious until there is a clearer picture on the U.S administration’s stance on trade. As a result, this will keep the Canadian bond yield curve lower than if we followed the Federal Reserve’s rate increases. Yes, bond yields will rise but not in a big way. At year end 2017, we expect the Government of Canada 10 Year bonds to be trading in a 2-2.2% range.
Turning to U.S. monetary policy, the Federal Reserve Board increased the Fed Funds Rate by 0.25% to 1.0% on March 15th given the low level of unemployment (4.7%) and solid economic growth. We believe the Fed will continue to increase the Fed Funds Rate at a slow-but-steady pace to 2.25% by year end 2018. This rate is near the long-term inflation target of the Fed (2%) and represents a neutral stance. The Fed hikes are necessary as they are gradually removing the emergency low interest rates that were put in place after the financial crisis. Clearly, the Fed feels the U.S economy is on a sustainable growth path.
One piece of interesting political news was President Trump’s inability to get enough votes in the House of Representatives to pass his healthcare bill. This demonstrates how divided the Republican Party is. Furthermore, it highlights the difficulty President Trump is likely to have passing future bills on some of his key campaign promises. This situation is potentially positive for Canada as bills aimed at our country could be held up for some time.
Looking at the bond market for the quarter, Corporate bonds continued to shine. Mid-term Corporates (5-10 years) returned 2.28%, mid-term Provincials 1.39% and mid-term Government of Canada’s 1.0%. At the short end of the curve (1-5 years) Corporates returned 1.09%, Provincials 0.61% and Government of Canada’s 0.39%. Within the Corporate bond sector, energy (Enbridge) and financials (RBC, TD Bank, etc.) were two of the top performers. Going forward, we will continue to overweight corporate and provincial bonds relative to Government of Canada’s.