ECONOMIC & FIXED INCOME COMMENT - Continued Growth with a lot of Noise on the Side
Global growth is on track for another year of strength with continued synchronized expansion between advanced economies and emerging markets. World GDP is forecasted to grow 3.6-3.8% in 2018. Looking at emerging markets China is expected to post another year of 6.5% GDP growth while India’s economy is on track to average 7.5% through 2019. Within advanced economies we expect Canada, U.S. and European Union to post another year of above potential growth. Canada’s GDP is forecasted to be 2% in 2018. Last year was a very strong year for Canada as GDP came in at 3% however, in the last half of the year GDP slowed to 1.6%. The slowdown has continued into the start of 2018. The United States GDP is forecasted to increase 2.5-3%. It has been revised upward due to the tax cuts announced in December and the surprisingly large addition of fiscal stimulus signed into law on February 9th 2018. Finally, the European Union’s GDP is forecasted at 2.3% (recently revised upward from 2.1%).
Central banks will remain supportive; however they will continue to dial back monetary stimulus as above-potential growth and tightening labour markets have provided support to policymakers in gradually removing ultralow interest rates. On March 21st, the Federal Reserve Board increased their Fed Funds Rate 25 basis points to 1.75%. This was fully anticipated by the market and the Fed remained hawkish in their statement. Specifically, economic outlook has strengthened in recent months and the unemployment rate is anticipated to tick lower and end the year at 3.8%. We expect 2-3 more rate hikes this year bringing the Fed Funds Rate within a range of 2.25-2.5% by year end.
Turning to Canada, the Bank of Canada (BoC) raised the overnight rate 25 basis points to 1.25% in January due to solid growth and strong employment statistics. However, we expect the BoC to be on hold until July. This is primarily due to the ongoing risk of trade protectionism from the United States and the uncertainty surrounding NAFTA negotiations. Although Canada has received exemption from the recent steel and aluminum tariffs until May 1st, there is still a lot to negotiate for the NAFTA agreement to be successful. Furthermore, the BoC will like to see how the market is absorbing the new mortgage lending rules put in place in January 2018. Last year areas of strength were consumer spending on durables and business investment in machinery and equipment. However, tougher mortgage rules and rising interest rates may constrain consumer spending in 2018. Furthermore, business investment could be an area of weakness compared to 2017. The BoC released its Business Outlook Survey on April 9th, which stated that business confidence is high and business capital spending intentions remain high, albeit lower than the previous survey. As a result, we expect the BoC to announce two more rate hikes (July & October) brining the overnight rate to 1.75% by year end.
The European Central Bank (ECB) will continue its accommodative monetary policy to support the economy. Solid economic conditions and strong labour market (unemployment at 8.5% in February) have laid the groundwork to phase out the QE bond purchasing program later this year however; there are no rate hikes foreseen in 2018 as inflation is well contained within the Euro zone.
Finally the U.K’s economy is operating close to full capacity and unemployment is at multi decade lows. Furthermore, wage growth has been increasing and inflation has been running above the Bank of England’s (BoE) 2% target. We expect the BoE to raise their rates by 25 basis points to 0.75% in May and then be on hold until 2019.
With monetary policy tightening, global bond yields will move higher. However, the magnitude is dependent on inflation and global growth maintaining its momentum. Inflationary pressures have varied among the G7 nations. The U.S, Canada and U.K. are leading the pack with pressures firming in these economies. Within Canada, the BoC’s three preferred core measures of inflation edged above the 2% inflation target in February. Furthermore, two out of the three preferred measures are tracking closer to 2.5% annualized paced over the last six months. In the U.S. core inflation remained steady at 1.8% year-over-year in February but has been running closer to 2.5% annualized pace over the last 6 months. In the U.K, inflation data in March surprised economists to the downside at 2.7%; unfortunately it is still well above the BoE’s 2% target.
As inflation data has firmed in many advanced economies, long term interest rates have moved higher. In Canada, 10 year Government of Canada bonds started the year at 2.03% and ended March 31st, at 2.11% while the U.S. 10 year treasuries started the year at 2.4% and ended March 31st, at 2.74%. By year end we anticipate Government of Canada 10 year bonds to trade at 2.7% while the U.S 10 year treasuries are expected to trade at 3.1%.
Source: BMO Capital Markets North American Outlook March 27th, 2018
Risks to the forecast:
Italy’s parliamentary election showed growing support for populist parties in the Euro zone and the ongoing BREXIT talks could impact European growth.
If NAFTA is negated each country would revert to World Trade Organization rules. This could negatively impact Canadian GDP as much as 1% over the next 5 years.
Import tariffs on steel, aluminum and Chinese goods could further increase inflation concerns and impede growth forecasts by disrupting global supply chains and business confidence.
There are concerns surrounding the U.S. budget deficit approaching $1.2 trillion by next year. The U.S. Government will have less ability to address the next downturn both through monetary policy and fiscal policy.