ECONOMIC & FIXED INCOME COMMENT: "A Fed Surprise!"
After enjoying strong global growth in 2017 and the first half of 2018, the expansion we have seen in recent years is losing momentum. The International Monetary Fund (IMF) is forecasting global growth at 3.5% in 2019 and 3.6% in 2020; both forecasts have been revised downward from October; the second downward revision in 3 months.
In advanced economies, the US will lead the pack with growth in 2019 at 2.4%. This represents a slowing of growth from 2018 where the US economy grew at 2.9%. Canada’s economic growth will also slow in 2019 to 1.5% from 1.8% in 2018. The U.K and the EU will also experience slowing growth and possibly a mild recession in 2019. Brexit will continue to have a negative effect on growth in both regions. Finally, emerging markets are also feeling pressure on growth. China’s GDP is expected to soften further in 2019 to a growth rate of 6-6.5%. With weaker growth developing and global inflation remaining well contained, central bank policymakers have been able to pivot away from their tightening bias and move towards patience and data dependency for 2019. As with all forecasts, there are risks that can impact the outlook for 2019. The two major areas of concern include a no resolution with Brexit and the US-China trade negotiations.
With respect to the United States, consumer spending and business investment were the two key sectors contributing to the US economy in 2018 and are expected to continue into 2019 albeit, to a lesser extent. Both a strong labour market and rising wages will help support the US consumer; which accounts for 70% of their GDP. Furthermore, tax policy changes enacted in 2018 will continue to support business investment. Lastly, The Federal Reserve Board’s latest meeting on March 20th, surprised markets with their dovish tone where they explicitly stated no rate hikes for 2019 and possibly 1 in 2020.
Moving to Canada, there are several challenges the Canadian economy will have to overcome. These include weakness in the energy sector through production cuts and market access, softness in the housing market and consumers more sensitive to interest rates due to household debt. On a positive note, investment activity outside the energy sector is expected to remain positive for 2019 as businesses take advantage of the government’s accelerated depreciating allowance. Furthermore, the Canadian dollar is expected to trade within a narrow range (around $0.75US) this year that will help support Canadian exports. Lastly, the Federal Budget for 2019 was just released and it will provide further fiscal stimulus to the economy. The Bank of Canada will likely abandon their tightening bias from 2018 and will remain on the sidelines for much of or all of 2019.
So, what do we take away from all this? Yes, growth momentum has slowed, but it hasn’t stalled. The strong labour markets on both sides of the border, as well as rising wages, will continue to provide support for both economies. Furthermore, the move away from tightening monetary policy will be a key catalyst to renewing investors risk appetite.
During the first quarter of 2019 bond yields continued their decline that started in the fourth quarter of 2018. Bond yields declined approximately 0.35% across the yield curve. The best performers were long term bonds (over 10 years) which generated a return of 6.9%.
The best performing sector during the first quarter were long term Provincial bonds 7.6%. Long term Canada bonds which were the best performing bonds in the fourth quarter generated a 5.2% return in the quarter.
Looking forward, we see stable to declining bond yields in the near term. If we continue to receive good news on oil pipelines, trade and improving global growth we could see upward pressure on bond yields later in the year. We expect bond returns in 2019 will be slightly higher than money market returns.