Interest Rate Forecast

Transcription

1 Interest Rate Forecast Economics March The economy is proving resilient and policymakers are responding with sufficient measures to avert a dire outcome. This does not mean the future is without its problems or pitfalls with political elections in several countries and many imbalances affecting the global economy not to mention the ongoing sovereign debt and banking problems in Europe exacerbated by its recession. Global growth will receive a lift from the U.S. and soon from the emerging economies such as China. Low interest rates will prevail for some time but with an upward bias in followed by a central bank policy shift in signaling the beginning of rate normalization. The bond market will be ahead of the central bankers and occasionally too far ahead only to retreat before leading the rate trend higher. Economy A mixed but generally positive economic performance materialized in the past month. Global PMIs indicate rising output in Asian countries but weakness in Europe. Production expanded for the fourth consecutive month in March after stalling in September to November Growth continued in U.S. manufacturing. This growth upswing could be temporary once the rebound due to the flooding in Thailand dissipates and higher inventory restrains production. While global economic growth is at a slower pace than this time last year no fallback into recession is likely in the near term nor is a strong growth resurgence. Moderate growth will be the watchword for and with a few disruptive episodes emanating from Europe. The U.S. is in an election year with a high probability of at least one unfavourable market reaction, and if not then, when a higher debt ceiling is needed in. In Europe, the EU summit in early March provided a solution for the Greek debt crisis including a restructuring of private debt and a second bailout. A new fiscal agreement was reached and it will come into Balance of opinion (%) Global Manufacturing Purchasing Managers Index 30 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: JP Morgan, Markit. Note: Seasonally adjusted. Latest: Mar-12 force in or possibly earlier if sufficient approval is granted. Greece is preparing for elections in May and spring elections in France have the potential to raise market uncertainty. Most recently, the Eurozone approved a combined new lending capacity for the ESM and EFSF. The deal ensures 500 billion of lending capacity beyond the funds already committed is available from the middle of this year. This figure disappointed those who considered a figure closer to 1 trillion as necessary. Markets are looking at Spain and Portugal as the next possible bailout requests. Of these, Spain presents the larger problem since its debt burden is considerably higher and it is much larger economy. Spanish 10-year government bond yields are inching higher once again and with that economy in a deep recession, more problems loom ahead. The Spanish government s new austerity measures may not be sufficient. While a sovereign debt default remains a significant market risk, the state of the Eurozone banking system and credit conditions are more important to the day-to-day functioning of the economy. Total credit granted rose by 1.4% in each of the first two months of the year, mainly to government, while credit to the private sector remained weak and loans to households decreased to 1.2% in February from 1.3% in January. Credit expansion is a function of both demand and supply and both are restraining forces. In addition, European banks need to meet their new higher capital requirements by the end of June. 1

2 Europe s economy is in a mild recession. The Eurozone Manufacturing PMI fell to a three-month low in March and remained in contraction territory. New orders contracted at a faster rate leading to falling output and further job losses. More significantly, there were signs that the manufacturing recession spread to the core countries. Germany s PMI fell below the neutral 50.0 mark for the first time in, while French manufacturing contracted at the sharpest pace since June The recession in Europe is expected to remain mild in and concentrated in the peripheral countries. Most economies, with the exception of Greece and Portugal, are seen growing in and beyond. A weak recovery is widely expected. Fortuitously for the global economy, China is emerging from its economic growth slowdown at the end of China s National Bureau of Statistics released the March Purchasing Managers Index with a 53.1 reading at a one-year high. The Chinese Lunar New Year likely held down activity earlier in the year and the Thailand recovery helped not only Chinese manufacturing but also others in the region and mainly in high-tech and autos. China s Premier announced a lower GDP growth target at 7.5% for, the first time the official target was lowered in eight years. Markets reacted negatively but the PMI readings helped reverse the negative sentiment. Most forecasters put China s growth above the government s target. The consensus average for is 8.4% with a high of 8.7% and a low of 7.9%. For, the consensus average is 8.6%. Chinese policy-makers have considerable room to deliver more policy easing, which is quite likely and consistent with their intended shift to stimulate domestic demand and rely less on exports for growth. Risks from their hot property markets are significant but manageable. The Chinese currency will see further gradual appreciation. The U.S. economy is growing at a respectable pace. The warm winter has boosted some economic data, but the underlying trend is an improving labour market with the key cyclical sectors in uptrends. Economic data will weaken in coming months as the effects of the warm winter fade and higher gasoline prices bite into discretionary income, but the economy s fundamentals are firming in. Balance of opinion (%) China Manufacturing Purchasing Managers Index 35 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: JP Morgan, Markit. Note: Seasonally adjusted. Latest: Mar-12 Dollars per barrel OIL (L) GAS (R) 20 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: U.S. Federal Reserve. U.S. Oil and Gasoline Prices Latest: Mar-12 Dollars per gallon Gasoline prices are approaching $4 per gallon with limited effect on consumer sentiment and spending so far. However, higher gas prices are expected as refinery issues continue. In addition, there is the potential for a disruption from Middle East supplies but this risk premium is already priced into crude oil. Oil price forecasts for WTI range from US$100 to US$105, which is near current levels. The concern is from higher refinery costs and the lagged impact on the economy both of which should become more evident in the summer months. Real consumer spending accelerated so far this year with gains concentrated in autos and other durable goods. Weak income growth and high unemployment are obstacles but recent labour market improvements bode well for larger income gains in. Residential construction is past its cycle low and beginning a sustainable upturn despite low housing prices and considerable foreclosures yet to hit the market Interest Rate Forecast - March 2

3 Recent employment reports are affected by milder than usual winter weather and there is a fair amount of uncertainty by how much. This temporary boost from the weather will eventually unwind in the spring months. The ADP employment survey indicates a lesser gain in March at 209,000 in private employment, following February s revised 230,000 increase. The ISM surveys for March show improvement in manufacturing while services continued to expand but at a slower pace. March vehicle sales dipped to 14.4 million units seasonally adjusted annualized from February but seasonal factors may have inflated February. Unadjusted sales were well above February to their best pace since August Turning to other sectors, capital spending looks to have moderated in response to the expiration of business tax incentives at the end of The Conference Board index of leading indicators rose 0.7% in February for the fifth consecutive monthly gain indicating that growth will continue through the first half of. The ECRI weekly leading index rose to 125.9, for the week ending on March 23, from a revised also signaling further growth. Real GDP for Q1- is tracking between 2.0 to 2.5%. In addition to rising gasoline prices, another threat to growth is government policy or as Fed Chairman Bernanke described a massive fiscal cliff at the end of. Automatic budget tightening is prescribed in current legislation: the 2% Social Security tax cut expires on December 31, along with the provision for extended unemployment benefits; the Bush tax cuts expire on December 31, ; and a large sequester of planned defense and non-defense spending going into effect in early. At about the same time, the debt ceiling will need to be raised again. Real government spending fell 2.1% last year and will likely repeat this year. Some estimate the impact of the fiscal cliff to be as much as 4.5% of GDP while others put it at 3%. Predicting what politicians may or may not do is fraught with considerable uncertainty but avoiding an economic shock should prevail with all the political maneuvering and grandstanding that accompanies such decision-making. Markets will be jostled back and forth. In the meantime, growth will pick up as progresses. A strengthening global economy will boost exports later in the year when the recession in Europe ends. Real GDP increases about 2.5% with consensus at 2.7% in and 3.1% in No forecaster in the survey is predicting a U.S. recession or sees a negative quarter in. Canada s economy edged forward modestly in January but helped by the upward revision to December, Q1- GDP on track for a solid gain. The labour market has underperformed recently but will begin to generate more significant job growth with a stronger U.S. and global economy. The Federal budget offered few surprises and kept the government on a mild austerity course. The spending forecast is slightly contractionary for the economy in and. The housing market is holding up and while March national sales are not yet released, sales data from some individual real estate boards points to a similar seasonally adjusted sales level as in February but with a small downside outcome possible. Housing prices have held up and will show a small gain over February. Canada s housing market is in reasonable shape not requiring a policy intervention to cool or stimulate it. The leading indicator increased for the eighth consecutive month, rising 0.6% in February led by an increase in its financial components, particularly the first rise in the stock market component in nine months. Manufacturing also contributed positively to the strong growth in the overall index. The consensus forecast has moved its expectations slightly higher on better than expected U.S. data and no hard landing for China. Quarterly real GDP raised to 2.2% from 2.0% in Q1- and to 2.1% from 1.7% in Q2-. For, growth is 2.2% from 1.9%. Their outlook for is unchanged at 2.3%. This forecast sees Canada s quarterly growth profile tracking the U.S. higher with growth rising to 2.5% in the first half and 3.0% later in the year. This results in growth at 2.4% in and 2.8% in. The Bank of Canada s outlook for the Canadian economy has marginally improved relative to its January report, according to the Governor. The Bank expects temporary factors to boost first quarter growth above their published 1.8% forecast, but that underlying growth remains around trend estimated at 2.0% annually. A forecast update will come out in mid-april. Interest Rate Forecast - March 3

4 Inflation Consumer prices rose 2.6% over the 12 months through February, slightly above January. The Bank of Canada s core price index rose 0.2% in February, bringing the rate of 12-month core inflation to 2.3%, up from 2.1% in January. Higher energy and food costs will continue to be the main pressures. Over the past four months, the average monthly change has been less than in the previous four months suggesting some deceleration in inflation. Interest rates Bond yields and some short-term bill rates rose in the first two weeks of March on better than expected economic news and the Greek debt agreement. Thereafter though, bond yields and rates retreated by about one-half of their rise. The Bank of Canada kept its policy rate at 1.00% however, some administered market rates displayed unusual behavior during the month. In particular, the 5-year GIC rate surged to 2.1% from 1.63% only to fall back to 1.63% in the following week according to the Bank of Canada. The 3-year GIC rate fell to 1.13% in early March from 1.% in late February. Oddly, this put the 3-year GIC rate slightly below the 1-year GIC rate at 1.15%. Central 1 conducts its own survey of deposit rates and found no such change in either 3-year or 5-year GIC rates. According to our survey, a typical 3-year GIC rate is 1.% and for a 5-year GIC 2.1%. It is not clear why the Bank s database contains those figures but a query sent to the Bank may provide some clarity. There was no change in typical posted fixed term mortgage rates in March, though there were some temporary special offers of a 5-year term at 2.99%. Monetary policy The Bank of Canada held overnight rate at 1% at its March 8 meeting. There was no forward guidance to markets regarding the timing of its next rate hike. The Bank emphasized the considerable monetary stimulus and the uncertainty over the global economic outlook and the Canadian economy. In the U.S., the FOMC did not make any changes either at its March meeting. The minutes to the March 13 FOMC meeting suggested a continuance of its near-zero interest rate policy and guidance of exceptionally low rates until late The odds of a QE3 diminished somewhat but remains on the table should conditions deteriorate. The Fed s guidance on low rates could include a rate increase before late Moving its target rate up to 0.50% or 0.75% would still be consistent with exceptionally low rates. It will depend on the performance of the economy and its outlook. Interest rate forecast A slight change to the rate forecast this month with the Bank of Canada s first rate increase moved up to July. Rate normalization will continue to occur gradually in phases of tightening followed by pauses and more tightening. The futures market for three-month Banker Acceptances is also more optimistic and prices in the first 25 bps increase by March from December in late February. Market expectations can move quickly and by a large amount. The consensus forecast puts the overnight target rate at 1.00% at the end of and 1.50% at the end of. One forecaster expects the first increase by Mar. while another sees no change into At least one forecaster sees a 25 bps rate cut in April. Target Overnight Rate Forecast Meeting Date Rate (%) Mar (a) Apr June July Sept Oct Dec Jan Mar Apr June 1.00 July 1.25 Sept Oct Dec Jan Mar (a) actual Interest Rate Forecast - March 4

5 Q1a Q2 Interest Rate Forecast Q3 Target Overnight Rate Prime Rate mo. T-Bill mo. T-Bill mo. T-Bill year T-Bill year GoC Bond year GoC Bond year GoC Bond year GoC Bond Note: Quarterly average based on daily data. a = actual, all others forecast. Q4 Deposit Rate Forecast 2014 Q1a Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1-year GIC year GIC year GIC Note: Quarterly average based on weekly data. a = actual, all others forecast. Non-redeemable rates. Q1 Q2 Q3 Q Q1 Mortgage Rate Forecast 2014 Q1a Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1-year Mortgage year Mortgage year Mortgage Note: Quarterly average based on weekly data. a = actual, all others forecast. Posted fixed term rates. Helmut Pastrick Chief Economist, Central 1 Credit Union hpastrick@central1.com Interest Rate Forecast - March 5