ECONOMIC & FIXED INCOME COMMENT: "TRADE TENSIONS..."
The global economy has been unfolding for the most part as predicted since the first quarter- decelerating growth. The International Monetary Fund (IMF) has revised global growth downward from 3.5% to 3.3% in April for 2019. However, signs of stabilizing growth have arisen. These include:
Global financial conditions easing with expectations of lower policy rates
Both the European Central Bank (ECB) and U.S. Federal Reserve have reiterated their readiness to provide additional monetary stimulus
China’s economic indicators showing positive signs from stimulus measures enacted due to weaker domestic demand and a trade war between the U.S.
Improvement in industrial production, fixed-asset investment and urban jobless rate
Signs of revitalization are appearing in Emerging Asia and Canada
However, there are two major downside risks that could further negatively affect global growth. These include:
Hard BREXIT – impact on Eurozone and United Kingdom
Further escalation of U.S.-China trade war with additional tariffs
The United States had a strong start to the year with Q1 real GDP increasing by 3.1% annualized. Growth is projected to soften in Q2 to 1.9% and is expected to remain close to 2% in the coming quarters due to capacity constraints and tariffs delaying business investment. However, the consumer which accounts for approximately 75% of their economy has remained robust. Solid job gains, the unemployment rate remaining at 50-year lows and soft inflation measures supporting wage growth all provide a solid foundation for strong domestic demand. The U.S. Federal Reserve held the Fed Funds Rate at 2.5% at their latest meeting. The policy statement was more dovish which has reinforced market expectations of a rate cut later this year. This is due to the escalation of international trade concerns. However, the Fed believes the U.S. economy still looks relatively solid.
Turning to Canada, first quarter GDP was 0.4% which was a continuation of the soft economy we saw in the fourth quarter of 2018. However, household consumption and non-resident investment rose more than expected providing a good set up for the second quarter. Q2 is forecasted to be 2% led by the recovery in the oil and gas industry. Furthermore, the Q2 Business Outlook Survey by the Bank of Canada showed a surprising improvement in business sentiment while the strong labour market continues to provide support for the consumer- all positive for the Canadian economy. The Bank of Canada has remained dovish with international trade concerns and is expected to maintain the Bank Rate at 1.75% for the remainder of the year. Given the expectation that the Federal Reserve will be lowering interest rates, and the Bank of Canada maintaining rates, the interest rate differential between Canada and the U.S. will narrow in Canada’s favour. This will provide support for the Canadian Dollar which is currently at $0.7658 at the time of writing. During the second quarter of 2019 bond yields continued their decline that started back in the fourth quarter of 2018. Year to date, the Government of Canada 10-year bond has declined 48 basis points. Shown in the chart; declining interest rates have been a global event.
During the second quarter, the best performers were long term bonds (over 10 years) which generated a return of 4.82%. The best performing sector was long term Corporate bonds returning 5.26%.
Looking forward, we see stable to declining bond yields in the near term. If we continue to receive good news on trade and improving global growth we could see upward pressure on bond yields later in the year.
Keep cash to a minimum
Continue to hold Corporate and Provincial bonds
Maintain a slightly longer duration position relative to the benchmark
Be prepared to shift duration shorter if economic data surprises to the upside