April 2017 Highlights - Warren Ross · taken lightly. As we’ve seen in recent years, while it’s a ... Euroland 1.7 1.6 1.5 Japan 1.0 1.2 1.0 ... foods, alcoholand tobacco

April 2017

Highlights The global economy seems to have turned the corner based on recent consensus-topping economic data.

But optimism should not breed complacency considering significant risks which may cause a relapse or worse. Mounting trade protectionism, credit and geopolitical risks could indeed derail growth.

While many are suggesting that the failure of Republicans to reform Obamacare will stall U.S. tax reform, we

take the opposing view. Republicans are now under pressure to deliver something substantial before next year’s mid-term elections or risk the wrath of voters. But considering low fiscal multipliers associated with tax cuts for corporations and wealthy individuals, don’t hold your breath for the 4% GDP growth that was promised during the election campaign. A more realistic target for U.S. growth is arguably in the 2-3% range, but under such scenario inflation is unlikely to spin out of control.

In light of a stronger-than-expected handoff from last year and the good start to 2017, we have raised by

three ticks our Canadian GDP growth forecast for this year to 2.2%. Despite an elevated debt load, consumers are showing resilience thanks to a solid labour market, credit availability, and the housing wealth effect. Consumption growth should moderate later this year as employment creation ramps down to a more sustainable pace, but government spending is set to take up the baton as Ottawa increases outlays. Trade should also contribute to growth buoyed by the Comprehensive Economic and Trade Agreement with Europe and improving demand stateside. But the threat of protectionism should not be underestimated given its potential to derail exports and hence growth.

Krishen Rangasamy

514-879-3140

Change fromPrevious Forecast

2016 2017 2018 2017 2018

United States

GDP 1.6% 2.2% 2.4% unch unch

CPI inflation 1.3% 2.3% 2.2% +0.1 pp unch

Fed Fund Target Rate* 0.75% 1.50% 2.25% +25 bp +25 bp

Ten-year bond yield* 2.45% 2.95% 3.30% - 6 bp +1 bp

Canada

GDP 1.4% 2.2% 1.7% +0.3 pp unch

CPI inflation 1.4% 1.8% 2.0% unch unch

Overnight rate* 0.50% 0.50% 1.25% unch unch

Ten-year bond yield* 1.72% 2.22% 2.69% +4 bp +4 bp

* end of period

MONTHLY ECONOMIC MONITOR

2

World: Upside surprises The global economy seems to have turned the corner based on recent consensus-topping economic data. But optimism should not breed complacency considering significant risks which may cause a relapse or worse. Mounting trade protectionism, credit and geopolitical risks could indeed derail growth. After a disappointing 2016, the global economy seems to have turned the corner. We got some hints of improvement towards the end of last year and it now seems momentum extended to the first quarter of 2017 based on consensus-topping economic data in both the OECD and emerging markets. Lifting advanced economies in Q1 were the U.S. which seems to be on a roll with a booming labour market (see U.S. section), but also Japan and the Eurozone. All three major advanced economies had composite purchasing managers indices increasing in Q1 relative to the prior quarter. In Japan, rising exports are stimulating factory activity. Business investment has also ramped up in line with improving corporate profits, while consumption spending has shown resilience thanks to healthy income gains and strong employment. However, the annual inflation rate remains well below the Bank of Japan’s 2% target, meaning the central bank will maintain its loose stance on monetary policy for a while despite improving data elsewhere. In the Eurozone, the European Central Bank’s stimulus seems to be having the desired impacts of stimulating borrowing, with household credit and business loans on the rise. The credit channels seem to be functioning again and this is having a positive effect on the real economy. Production has risen above the pre-recession peak in the eurozone even excluding Germany, i.e. the zone is now in expansion mode. The labour market is improving as a result ─ employment grew more than 1% last year. That’s not to say all is rosy. Changing U.S. trade policy presents threats to the Eurozone, more so considering its growing trade surpluses may raise red flags in the new Washington. There are also major uncertainties on the old continent itself such as Brexit and its aftermath, as well as upcoming elections in France and Germany which could potentially lead to a further slide towards growth-busting protectionist policies. Also, despite improvements in credit growth, the banking sector is not yet out of the woods. The share of non-performing loans remain elevated in places such as Italy and Spain, delaying the timeline for repairing bank balance sheets. The Eurozone sovereign debt problem is also not resolved. Greece’s troubles shouldn’t be taken lightly. As we’ve seen in recent years, while it’s a relatively small economy (less than 2% of the eurozone’s GDP), Greece can punch above its weight when it comes to contributing to economic uncertainty.

-140

-120

-100

-80

-60

-40

-20

0

20

40

60

80

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

World: Economic data surprising on the upsideEconomic surprise index

NBF Economics and Strategy (data via Datastream)

Emerging

OECD

40 42 44 46 48 50 52 54 56 58

Eurozone

U.S.

UK

GLOBAL

China

Japan

India

Brazil 2017Q12016Q4

World: Economic activity generally improved in Q1Composite purchasing managers index

NBF Economics and Strategy (data via Bloomberg)

Index

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017-4

-2

0

2

4

6

8

10

12

14

16

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Eurozone: Banking sector is improving

y/y % chg.


Loans to non-financial

corporations

Loans to households

MFI loans to households and non-financial corporations

Eurozone bank lending continues to improve …

… although problems persist with regards to bad

loans in some countries

%

Non-performing loans as a share of total loans

Spain

Italy


3

That’s why ECB President Draghi, during his March press conference, maintained a cautious tone. While there was an acknowledgement that risks surrounding the euro area growth outlook have become less pronounced, the ECB made clear risks remain tilted to the downside. President Draghi downplayed the recent uptick in the annual inflation rate, attributing it to food and energy, while highlighting underlying measures of inflation which remain low. Indeed, the annual core inflation rate has been close to 1% for four years in a row. The ECB expects the latter to rise “only gradually over the medium term” hence warranting its decision to continue with quantitative easing for now. Also of concern to President Draghi is the slow pace of structural reforms. Last year, less than 3% of the recommendations put forward by the European Commission ─ such as reforms to tackle labour market rigidities and boost competitiveness ─ were implemented by targeted governments. The lack of reforms coupled with unfavourable demographics, means the Eurozone’s potential GDP growth will remain low. In other words, the zone seems destined to continue growing at a sub-2% annual pace despite extraordinary monetary policy stimulus from the ECB.

World Economic Outlook

Forecast

2016 2017 2018Advanced countries 1.7 1.9 1.9United States 1.6 2.2 2.4Euroland 1.7 1.6 1.5Japan 1.0 1.2 1.0UK 2.0 1.5 1.3Canada 1.4 2.2 1.7Australia 2.4 2.5 2.8New Zealand 2.7 3.2 2.9Hong Kong 1.5 1.6 1.9Korea 2.7 2.5 2.5Taiwan 1.4 1.7 1.9Singapore 1.8 1.6 2.0

Emerging Asia 6.4 6.0 5.9China 6.7 6.5 6.1India 7.1 6.8 7.4Indonesia 5.0 5.2 5.3Malaysia 4.2 4.2 4.4Philippines 6.8 6.4 6.3Thailand 3.2 3.2 3.2

Latin America -1.1 1.5 2.2Mexico 2.3 1.4 2.0Brazil -3.6 0.7 2.3Argentina -2.3 3.0 3.2Venezuela -18.6 -3.1 0.6Colombia 1.5 2.0 2.6

Eastern Europe and CIS 1.2 1.6 1.9Russia -0.5 1.3 1.6Czech Rep. 2.3 2.5 2.6Poland 2.8 3.1 3.1Turkey 2.1 2.2 3.1

Middle East and N. Africa 3.3 2.8 3.3

Sub-Saharan Africa 1.6 3.0 3.8

Advanced economies 1.7 1.9 1.9Emerging economies 4.0 4.3 4.5World 3.0 3.3 3.4

Source: NBF Economics and Strategy

1.54

1.56

1.58

1.60

1.62

1.64

1.66

1.68

1.70

1.72

1.74

1.76

1.78

1.80

1.82

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

Nov 16 Dec 16 Jan 17 Feb 17 Mar 17-0.8

-0.4

0.0

0.4

0.8

1.2

1.6

2.0

2.4

2.8

2012 2013 2014 2015 2016 2017

Eurozone: Core inflation remains mild

y/y % chg.


TOTAL

Core, i.e. excluding energy, foods, alcohol and tobacco

Feb.

Consumer price index Inflation expectations in 5 years for the next five years versus WTI oil price

WTI (R)

Inflation expectations (L)

% US$/barrel

ECB should focus on core inflation …

… and refrain from paying too much attention to measures of inflation

expectations which can be volatile

0

1

2

3

4

5

6

7

8

2014 2015 2016

European Union: Reform efforts have weakened Share of fully addressed country specific recommendations or those where substantial progress has been made

%

NBF Economics and Strategy (data via European Commission)


4

Like the OECD, emerging markets started 2017 with consensus-topping economic data. India’s purchasing managers indices for the manufacturing and services sectors both returned to expansion mode in Q1 after briefly dipping below 50 the prior quarter when the cash ban was introduced. In China, the purchasing managers indices remained comfortably above 50 in the first quarter for both the manufacturing and services sectors. Exports, which fell in 2015 and 2016, now seem to be stabilizing, giving a boost to the manufacturing sector. Imports also seem to be slowly coming back after falling even faster than exports in the last two years. That said, China’s trade surplus, which fell to about half a trillion dollars last year, has room for further declines considering the still-elevated yuan in real effective terms. China’s domestic demand is finding support from consumers with nominal retail spending growing roughly 10% in Q1 on a year-on-year basis. The apparent recovery in the real estate market may be helping. The number of cities seeing monthly declines in home prices have dwindled in recent months. So much so that the real estate climate index, after treading water for so long, has soared to its highest level in over 5 years. The improvement in the real estate outlook is good news in that it lowers odds of default in a highly-levered economy. But China’s financial system is not out of the woods just yet. Corporations have borrowed heavily with their debt now accounting for a massive 145% of China’s GDP. The corporate debt to earnings ratio has accordingly soared. Credit risks have been enhanced further by the proliferation of shadow banking products. About half of the stock of shadow credit products is reportedly high yield and hence high risk. So, the question is not if but when defaults are going to hit China’s financial system. The threat of a financial crisis in the world’s second largest economy should not be underestimated. The debt problem isn’t isolated to China. According to the Bank of International Settlements’ latest Quarterly Review, US dollar-denominated debt outstanding outside of America at the end of 2016Q3 amounted to a record US$10.5 trillion, or almost 19% of world GDP excluding the U.S. While USD-denominated debt has increased in emerging markets to $3.6 trillion, that pales in comparison to advanced economies (ex-U.S.) where such debt jumped to US$6.9 trillion at the end of Q3 or 25% of GDP of advanced economies excluding the U.S. That’s more than three times the exposure of 20 years ago. The persistence of USD strength is bad news for those borrowers. All told, while the global economy seems to have turned the corner, credit risks have potential to cause a relapse or worse. The threat of increased trade protectionism and political instability in places such as Europe should not be underestimated either.

85

90

95

100

105

110

115

120

125

130

135

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

China: Declining trade surplus

NBF Economics and Strategy (data via Bank of International Settlements, Datastream)

Real effective yuan

Despite last year’s depreciation, real effective

yuan remains high …

100

150

200

250

300

350

400

450

500

550

600

650

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Exports, Imports and Trade balance, 12-month cumulative

… which explains declining trade

surplus

US$ bn US$ bn

Imports (R)

Exports (R)

Trade balance (L)

0

4

8

12

16

20

24

28

32

36

40

44

48

52

56

60

64

68

72

2011 2012 2013 2014 2015 2016 201792

93

94

95

96

97

98

99

100

101

102

103

104

2011 2012 2013 2014 2015 2016 2017

China: Sharp improvement in real estate outlook

Real estate climate index

NBF Economics and Strategy (data via Bloomberg)

Number of cities seeing monthly decrease in price

Existing residentialapartments

New residentialapartments

Sharp improvement in real estate outlook …

… as fewer cities see home price declines

2

3

4

5

6

7

8

9

10

11

10

11

12

13

14

15

16

17

18

19

2000 2002 2004 2006 2008 2010 2012 2014 2016

US$ trillion

NBF Economics and Strategy (data via Bank of International Settlements)

% of GDP (R)

TOTAL (L)

%

World: Record USD-denominated debt USD-denominated debt held outside of the U.S.


5

U.S.: Fed tightens policy While many are suggesting that the failure of Republicans to reform Obamacare will stall U.S. tax reform, we take the opposing view. Republicans are now under pressure to deliver something substantial before next year’s mid-term elections or risk the wrath of voters. But considering low fiscal multipliers associated with tax cuts for corporations and wealthy individuals, don’t hold your breath for the 4% GDP growth that was promised during the election campaign. A more realistic target for U.S. growth is arguably in the 2-3% range, but under such scenario inflation is unlikely to spin out of control. The U.S. economy is on a roll according to latest data. Indices from the Institute for Supply Management for both the manufacturing and non-manufacturing sectors soared to multi-year highs in February. While the non-manufacturing index is the highest since October 2015, its business activity sub-component is the highest in six years, pointing to a strong services sector. In the manufacturing sector, output is reportedly growing at the fastest pace since 2011, buoyed by strong increases for new orders both at home and abroad. The uptick in factory orders reflects higher demand for capital goods, a sign that business investment, which was rather weak last year, is finally bouncing back. The labour market is also booming. While warmer-than-usual weather probably helped boost February’s employment numbers, underlying strength cannot be denied. Indeed, the establishment survey’s consensus-topping 235K increase for February non-farm payrolls included large gains in cyclical sectors such as manufacturing and construction, both of which suggest the U.S. economy is on solid footing. Construction employment even rose by the biggest amount in a decade. And it wasn’t just those sectors because job gains were broad-based as evidenced by the highest private sector diffusion index since 2015. Wages are also growing at a decent pace of 2.8% on a year-on-year basis. The household survey’s increases in employment ─ full-time jobs crossed 125 million for the first time ─ and the participation rate (63% is the highest in a year) were also encouraging. The improving data gave the Fed more confidence that the recent uptick in prices can be sustained, and it accordingly raised interest rates by 25 basis points to 1.00% in March. It’s unclear, however, if inflation pressures can be sustained ─ see our latest Special Report: “How concerned should the Fed be about U.S. inflation?”. For instance, wage growth is likely to remain under control if there is further progress on the participation rate, particularly for the age group 25-54, the most cyclical cohort of the labour market. The latter, which hit a six-year high of 81.7% in February, has plenty of room to increase further as prime-age workers enter the labour force.

47

48

49

50

51

52

53

54

55

56

57

58

59

60

2014 2015 2016 2017

Index

NBF Economics and Strategy (data via Federal Reserve)

Manufacturing

Non-manufacturing

U.S.: Momentum from last year extended to Q1 ISM manufacturing and non-manufacturing indices

Feb.

-12

-8

-4

0

4

8

12

16

20

2012 2013 2014 2015 2016 2017

q/q % chg. saar

*Assuming no change in March and no revisions to prior months NBF Economics and Strategy (data via Datastream)

Shipments of non-defense capital goods

excluding aircrafts

Real business investmentin equipment

U.S.: Business investment is bouncing back Real business investment in equipment versus Shipments of non-defense capital goods excluding aircrafts

Q1 est.*

110

111

112

113

114

115

116

117

118

119

120

121

122

123

124

125

126

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 201780.4

80.6

80.8

81.0

81.2

81.4

81.6

81.8

82.0

82.2

82.4

82.6

82.8

83.0

83.2

83.4

83.6

61.2

61.6

62.0

62.4

62.8

63.2

63.6

64.0

64.4

64.8

65.2

65.6

66.0

66.4

66.8

67.2

67.6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

U.S.: Labour market is booming


millions

Feb.

Full time employment Participation rate

%

Feb.

Total (R)

25-54 age group (L)

Highest since 2011

%


6

The Fed’s optimism is also based on upcoming fiscal stimulus. While the latter should indeed lift U.S. growth, the extent of the boost may not be as good as advertised. The Trump administration reportedly aims to boost defense spending by US$54 billion this year, while seeking compensating cuts in non-defense spending. But fiscal multipliers for defense spending have typically been estimated at less than 1, meaning that such outlays are likely to crowd out private spending, restraining growth as a result. One can only hope compensating cuts to non-defense spending does not include infrastructure whose fiscal multiplier is well above 1 according to the Congressional Budget Office. While many are suggesting that the failure of Republicans to reform Obamacare will stall Tax reform, we take the opposing view. Tax cuts for corporations and the wealthy are much easier to do than health care reform and have broad support among Republicans. More importantly, after their failure on health reform, Republicans are now under pressure to deliver something substantial before next year’s mid-term elections or risk the wrath of voters. But the benefits of such tax policy are unclear ─ the CBO suggests fiscal multipliers are much lower than 1 when there are tax cuts for corporations and wealthy individuals. So, don’t hold your breath for the 4% U.S. GDP growth that was promised during the election campaign. A more realistic target for growth is arguably in the 2-3% range, but under such scenario inflation is unlikely to spin out of control. Could protectionism cause U.S. inflation to rise? A tariff or border adjustment tax on imports would indeed raise the price of imported goods for American consumers. But unless tariffs are raised every year, the impact on annual inflation would be temporary because the annual price increase due to the tariff would vanish after a year. Moreover, the inflation impact would also be restricted considering the share of imports in U.S. personal consumption expenditures is less than 15%. Moreover, a reversal in prices is likely over the longer-term as economic growth, employment and hence inflation is negatively affected. Note that more than 11 million U.S. workers depend directly on exports and hence would be vulnerable to retaliatory measures from trade partners. All told, we doubt the Fed can deliver more than three rate hikes this year (including March’s increase). While the economy seems strong now, that’s not to say it will remain so throughout the year. Note that credit growth is softening, coinciding with tighter monetary policy since last December. Loans and leases were about flat in the first quarter of 2017 as increases for consumer loans were offset by weak commercial and industrial loans, the latter even registering a quarterly drop for the first time since 2010. One can only hope this is just a temporary pullback because if it turns into a downtrend, the ongoing recovery in business investment spending could be derailed.

480

520

560

600

640

680

720

760

800

840

2000 2002 2004 2006 2008 2010 2012 2014 2016

U.S.: How effective is defense spending?

Defense spending by federal government

US$ bn

NBF Economics and Strategy (data via BEA)

Sequestrationstarts

+9%

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Owyang, Ramey,Zubairy (2013)

Barro/Redlick (2011) Hall (2009)

Estimations of fiscal multiplier on defense spending

8.0

8.4

8.8

9.2

9.6

10.0

10.4

10.8

11.2

11.6

6.2

6.4

6.6

6.8

7.0

7.2

7.4

7.6

7.8

8.0

8.2

8.4

2000 2002 2004 2006 2008 2010 2012 2014

millions

NBF Economics and Strategy (data via International Trade Administration)

Share of non-farmpayrolls (R)

TOTAL (L)

%

U.S.: More than 11 million workers depend directly on exports Jobs supported by exports

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

2011 2012 2013 2014 2015 2016 2017

q/q % chg. saar

NBF Economics and Strategy (data via Federal Reserve)

Commercial and industrial loans

Loans and leases

U.S.: Weakest credit growth in six years Loans and leases

Q1 est.

Consumer loans


7

Canada: Good start to 2017 In light of a stronger-than-expected handoff from last year and the good start to 2017, we have raised by three ticks our Canadian GDP growth forecast for this year to 2.2%. Despite an elevated debt load, consumers are showing resilience thanks to a solid labour market, credit availability, and the housing wealth effect. Consumption growth should moderate later this year as employment creation ramps down to a more sustainable pace, but government spending is set to take up the baton as Ottawa increases outlays. Trade should also contribute to growth buoyed by the Comprehensive Economic and Trade Agreement with Europe and improving demand stateside. But the threat of protectionism should not be underestimated given its potential to derail exports and hence growth. Canada’s economy continues to surprise on the upside providing more evidence it has adjusted to the oil shock. While last year’s GDP growth ended up at a meagre 1.4%, the handoff to 2017 was very good. The fourth quarter’s growth print of 2.6% annualized was well above consensus-expectations as the economy found support from consumption and housing demand courtesy of solid job creation and rising incomes, but also credit availability. Indeed, both mortgage and consumer credit remained strong, the latter even growing in the second half last year at the fastest pace in 5 years. Strength in consumption and housing seems to have extended to early 2017. So much so, that we have raised by three ticks our Canadian GDP growth forecast for this year to 2.2%. Home sales remain robust while retail volumes are on track to grow at a healthy pace again in the first quarter. An elevated household savings rate, the housing wealth effect ─ the Teranet–National Bank Composite House Price Index shows a year-on-year increase of over 12% in Q1 ─, and solid job gains helped boost spending during the quarter. Recall that roughly 64,000 jobs were created in the first two months of 2017, the best start of the year since 2008. It’s also encouraging that fiscal stimulus is starting to flow as evidenced by healthy contributions of government to Q4 growth. Nominal GDP, which grew 2% last year, is expected by consensus to grow at roughly double that pace this year and next. That explains why the 2017 federal budget forecasted revenues will grow about 4% in the next two years. Program expenses are slated to increase about 5% in 2017-2018, resulting in a projected deficit of $28.5 billion for that fiscal year, or roughly 1.4% of GDP. That is expected to be followed by a $27.4 billion deficit in 2018-19 or 1.2% of GDP. The debt-to-GDP ratio is slated to increase slightly to 31.6% in each of the coming two years, ending up a bit below 31% by 2021-22. While that’s not the lowest ratio among AAA-rated sovereigns, it is nonetheless consistent with good long-term fiscal sustainability.

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

2011 2012 2013 2014 2015 20161.00

1.25

1.50

1.75

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

4.00

4.25

4.50

4.75

5.00

2011 2012 2013 2014 2015 2016

Canada: Consumer credit growth on the rise

s/s % chg. saar

NBF Economics and Strategy (data via Statistics Canada)

y/y % chg.

Household credit Consumer credit, by semester

Second half last year sawconsumer credit grow at the fastest pace in 5 years

Residentialmortgage credit

Consumer credit

TOTAL

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

2015q1 2015q2 2015q3 2015q4 2016q1 2016q2 2016q3 2016q4 2017q1

Canada: Consumption spending remains strong Real consumption spending on goods versus Real retail sales

*Assuming no change in February and March and no revisions to prior months NBF Economics and Strategy (data via Statistics Canada)

q/q % chg. saar

est.*

Retail volumes

Real consumption spending on goods (from

national accounts)

-23

-28.5-27.4

-23.4

-21.7

-30

-25

-20

-15

-10

-5

02016-17 2017-18 2018-19 2019-20 2020-21

Budget 2016 Budget 2017

Canada: Budget deficits expected to remain below 1.5% of GDPProjections from Federal Budgets for Canadian budget balance (includes C$3 bn adjustment for risk)

C$ bn

NBF Economics and Strategy (data via Department of Finance)


8

But not all is rosy. Business investment spending remains Canada’s Achilles heel, exerting a drag on the economy for the third year in a row in 2016. And odds are that 2017 won’t be any better in that regard. According to latest data from Statistics Canada, planned capital spending for this year is up just C$1.8 billion (or 0.8%) compared to 2016. And even that is entirely due to public sector investment. Private sector investment is set to fall for a third year in a row. Of note is the investment slump in the mining sector which is expected to dwarf the increase in the oil and gas sector. Private sector investment intentions outside of the resources sector aren’t stellar either with an almost 2% decline expected this year. So why are firms reluctant to invest? Uncertainty about U.S. trade policy is clearly not conducive for investment in Canada. A border tax, as is being considered by Congress, would raise the price Americans pay for Canadian goods, resulting in a decline in demand for Canadian exports. Other measures being considered in the U.S. such as corporate tax cuts, if implemented, would further widen the gap in competitiveness between American and Canadian firms. And of course, any labour cost advantage that Canada has is shrinking with the spread of "right to work" legislation in the U.S. ─ earlier this year Kentucky and Missouri became the 27th and 28th states adopting such legislation. So, for firms that have operations on both sides of the border, it’s becoming harder to justify investing further in Canada. The slumping Canadian dollar is also to blame. True, the loonie’s newfound competitiveness should help lift non-energy exporters ─ we’re indeed seeing signs of recovery in the data. But those benefits are likely to be offset by more expensive imports of machinery and equipment (because of the weak C$) and the loss of market share in the U.S. Recall that despite a weaker currency and a strengthening U.S. economy, non-energy goods exports remain well below the peak reached a decade ago. Excess capacity may also explain the dull investment outlook. Despite recent improvements, the capacity utilization rate remains below the average before the Great recession on 2008-09. While a few sectors such as oil & gas, forestry and manufacturing have relatively elevated utilization rates and hence could warrant new investment, we suspect firms (particularly exporters) will want to wait for more clarity about U.S. trade policy before committing to increase investment outlays. All told, while we expect exports to be the major driver of Canadian growth this year thanks to the Comprehensive Economic and Trade Agreement with Europe and improving demand stateside, the anticipated investment boost from exporters in response to better sales abroad, may take some time and may not be as significant as first thought.

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-2

-1

0

1

2

3


2015 2016

Business investment

Trade

Housing

Consumption

Government

Inventories/Stat.discrep.

Real GDP growth and contributions

Canada: Business investment again a drag on growth in 2016

y/y % chg.

Nominal GDP

Real GDP

Real and Nominal GDP

%

-7.3

-6.4

-4.4

-4.3

-2.6

-1.4

-1.0

0.8

0.8

1.5

1.7

8.0

9.9

-10 -5 0 5 10 15

Retail

Wholesale

Manufacturing

Finance/insurance

Agriculture

Health care

Mining/energy

TOTAL

Utilities

Construction

Transp./warehousing

Real estate

Public administration

40

60

80

100

120

140

160

180

200

220

240

260

280

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Canada: No end in sight to slump in private investment

2017 investment intentions by sector (change from prior year)

Non-residential investment

y/y chg. C$ bn

%


Public

Private

C$ bn

Public

Private

TOTAL

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 60 65 70 75 80 85 90 95

TOTAL

Oil and gas

Construction

Manufacturing

Power

Forestry

Mining

5‐year average before Great recession 2016Q4

Canada: Economy still has excess capacity Capacity utilization rate

%


% 5-year average before Great recession

Q4


9

Q4/Q4(Annual % change)* 2014 2015 2016 2017 2018 2006 2016 2017 2018

Gross domestic product (2009 $) 2.4 2.6 1.6 2.2 2.4 1.9 2.1 2.5Consumption 2.9 3.2 2.7 2.8 2.6 3.0 2.5 2.5Residential construction 3.5 11.7 4.9 3.7 1.8 1.1 4.0 1.5Business investment 6.0 2.1 (0.5) 1.4 1.8 0.0 1.5 2.1Government expenditures (0.9) 1.8 0.8 1.4 2.7 0.2 2.5 2.2Exports 4.3 0.1 0.4 (0.6) (0.3) 1.6 (1.5) 0.5Imports 4.4 4.6 1.1 3.3 1.6 2.5 2.5 1.0Change in inventories (bil. $) 57.7 84.0 21.1 45.0 43.0 46.2 44.2 42.2Domestic demand 2.6 3.1 2.1 2.4 2.5 2.1 2.5 2.4

Real disposable income 3.5 3.5 2.8 2.1 1.7 2.5 1.8 1.7Household employment 1.6 1.7 1.7 1.1 1.2 1.6 1.2 1.2Unemployment rate 6.2 5.3 4.9 4.8 4.6 4.7 4.7 4.5Inflation 1.6 0.1 1.3 2.3 2.2 1.8 2.0 2.5Before-tax profits 5.9 (3.0) 0.1 6.8 4.6 10.0 4.9 4.5Federal balance (unified budget, bil. $) (483.3) (439.0) (588.0) (594.0) (620.0) ... ... ...Current account (bil. $) (392.1) (463.0) (481.2) (474.5) (514.5) ... ... ...

-304

* or as noted

Current Q4 2016 Q4 2017 Q4 20183-24-17 Q2 2017 Q3 2017 Q4 2017 Q1 2018 2016 2017 2018

Fed Fund Target Rate 1.00 1.00 1.25 1.50 1.75 0.75 1.50 2.25 3 month Treasury bills 0.77 0.83 1.10 1.33 1.55 0.50 1.33 2.08 Treasury yield curve 2-Year 1.26 1.45 1.59 1.85 2.10 1.20 1.85 2.60 5-Year 1.93 2.10 2.20 2.43 2.65 1.93 2.43 2.96 10-Year 2.40 2.67 2.73 2.95 3.10 2.45 2.95 3.30 30-Year 3.00 3.26 3.29 3.47 3.58 3.06 3.47 3.69 Exchange rates U.S.$/Euro 1.08 1.07 1.05 1.03 1.04 1.05 1.03 1.07 YEN/U.S.$ 111 113 115 117 116 117 117 111

** end of period

Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017actual actual actual actual forecast forecast forecast forecast

Real GDP growth (q/q % chg. saar) 0.8 1.4 3.5 1.9 1.8 2.2 2.3 2.0CPI (y/y % chg.) 1.1 1.1 1.1 1.8 2.7 2.3 2.3 2.0Core CPI (y/y % chg.) 2.2 2.2 2.2 2.2 2.3 2.2 2.2 2.2Unemployment rate (%) 4.9 4.9 4.9 4.7 4.8 4.8 4.8 4.7

National Bank Financial

Quarterly pattern

United StatesEconomic Forecast

Financial Forecast**


10

Q4/Q4(Annual % change)* 2014 2015 2016 2017 2018 2016 2017 2018

Gross domestic product (2007 $) 2.6 0.9 1.4 2.2 1.7 1.9 2.0 1.6Consumption 2.8 1.9 2.2 2.0 1.3 2.4 1.6 1.3Residential construction 2.7 3.8 2.9 0.6 (1.5) 2.4 (0.3) (1.5)Business investment 3.2 (11.5) (8.4) (1.6) 2.6 (7.0) 3.4 1.9Government expenditures 0.0 1.9 1.9 2.6 0.9 2.4 2.5 0.5Exports 5.8 3.4 1.1 3.0 4.0 0.8 4.2 3.6Imports 2.2 0.3 (1.0) 1.3 2.2 (1.3) 4.5 1.7Change in inventories (millions $) 9,392 3,861 -1,038 1,031 1,273 -4,365 1,298 1,539Domestic demand 1.9 0.3 0.9 1.6 1.2 1.2 1.8 1.0

Real disposable income 1.3 3.3 2.9 2.9 1.7 3.1 1.9 1.7Employment 0.6 0.9 0.7 1.3 0.7 1.1 1.0 0.7Unemployment rate 6.9 6.9 7.0 6.7 6.5 6.9 6.6 6.5Inflation 1.9 1.1 1.4 1.8 2.0 1.4 2.0 2.0Before-tax profits 8.2 (19.5) (4.5) 16.3 7.1 12.0 9.5 6.0Current account (bil. $) (48.2) (67.6) (67.7) (69.2) (58.0) .... .... ....

* or as noted

Current Q4 2016 Q4 2017 Q4 20183-24-17 Q2 2017 Q3 2017 Q4 2017 Q1 2018 2016 2017 2018

Overnight rate 0.50 0.50 0.50 0.50 0.75 0.50 0.50 1.25 3 month T-Bills 0.49 0.49 0.49 0.63 0.74 0.46 0.63 1.37 Treasury yield curve 2-Year 0.75 0.90 0.97 1.12 1.32 0.75 1.12 1.98 5-Year 1.13 1.35 1.47 1.62 1.77 1.12 1.62 2.32 10-Year 1.64 2.02 2.14 2.22 2.36 1.72 2.22 2.69 30-Year 2.31 2.63 2.69 2.74 2.83 2.31 2.74 3.07

CAD per USD 1.34 1.35 1.36 1.38 1.36 1.34 1.38 1.34 Oil price (WTI), U.S.$ 47 47 52 55 57 54 55 60

** end of period

Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017actual actual actual actual forecast forecast forecast forecast

Real GDP growth (q/q % chg. saar) 2.7 (1.2) 3.8 2.6 2.6 1.6 1.8 2.0CPI (y/y % chg.) 1.5 1.6 1.2 1.4 1.8 1.7 1.9 2.0Unemployment rate (%) 7.2 6.9 7.0 6.9 6.7 6.7 6.7 6.6

National Bank Financial

CanadaEconomic Forecast

Financial Forecast**

Quarterly pattern


11

Provincial economic forecast

2014 2015 2016e 2017f 2018f 2014 2015 2016e 2017f 2018f

Real GDP (% growth) Nominal GDP (% growth)

Newfoundland & Labrador -1.0 -2.0 1.0 -2.7 2.9 -1.3 -11.5 2.3 3.0 2.9Prince Edward Island 1.5 1.3 1.3 1.2 1.4 3.5 3.9 3.4 3.3 3.9Nova Scotia 0.8 1.0 1.1 1.2 1.1 1.7 2.4 2.2 2.7 3.0New Brunswick -0.1 2.3 0.5 0.8 0.9 1.0 2.9 2.7 2.6 2.8Quebec 1.3 1.2 1.7 1.6 1.3 1.9 2.6 2.9 2.9 3.0Ontario 2.7 2.5 2.6 2.3 2.1 4.7 4.9 4.4 3.8 4.1Manitoba 1.5 2.2 1.5 2.0 1.5 2.5 3.1 1.5 2.7 3.6Saskatchewan 2.4 -1.3 -0.5 1.1 1.5 1.3 -5.7 -5.3 2.8 2.7Alberta 5.0 -3.6 -2.5 2.8 1.6 8.9 -12.5 -4.6 7.9 4.3British Columbia 3.3 3.3 3.1 2.7 2.1 5.2 3.8 4.8 5.2 4.1Canada 2.6 0.9 1.4 2.2 1.7 4.5 0.2 2.0 4.3 3.7

Employment (% growth) Unemployment rate (%)

Newfoundland & Labrador -1.9 -1.0 -1.4 -3.0 -3.9 12.0 12.8 13.5 14.3 16.0Prince Edward Island -0.4 -1.0 -2.3 2.1 0.3 10.5 10.4 10.8 9.8 9.2Nova Scotia -1.1 0.1 -0.4 0.8 0.0 8.9 8.6 8.3 7.8 7.6New Brunswick -0.2 -0.4 -0.1 0.4 0.4 9.9 9.8 9.6 8.8 9.4Quebec -0.1 1.0 0.9 1.4 0.4 7.8 7.6 7.0 6.7 6.4Ontario 0.8 0.7 1.1 1.5 1.0 7.3 6.7 6.6 6.2 6.1Manitoba 0.1 1.5 -0.5 0.7 0.8 5.4 5.6 6.1 6.0 5.9Saskatchewan 1.0 0.6 -0.9 0.7 0.8 3.8 5.0 6.4 6.3 6.1Alberta 2.2 1.2 -1.6 0.4 0.8 4.7 6.0 8.1 8.4 8.0British Columbia 0.6 1.3 3.1 2.4 1.0 6.1 6.2 6.0 5.4 5.6Canada 0.6 0.9 0.7 1.3 0.7 6.9 6.9 7.0 6.7 6.5

Housing starts (000) Consumer Price Index (% growth)Newfoundland & Labrador 2.1 1.7 1.4 1.4 1.3 1.9 0.4 2.7 2.5 2.0Prince Edward Island 0.5 0.6 0.6 0.5 0.4 1.6 -0.6 1.2 1.6 2.0Nova Scotia 3.1 3.8 3.8 3.3 3.1 1.7 0.4 1.2 1.3 1.9New Brunswick 2.3 2.0 1.8 1.7 1.6 1.5 0.5 2.2 2.3 2.0Quebec 38.8 37.9 38.9 35.0 35.0 1.4 1.1 0.7 1.4 1.9Ontario 59.1 70.2 75.0 74.0 60.0 2.2 1.1 1.8 1.8 1.9Manitoba 6.2 5.5 5.3 5.7 5.3 1.8 1.2 1.3 1.7 2.2Saskatchewan 8.3 5.1 4.8 4.7 4.6 2.4 1.6 1.1 1.6 2.1Alberta 40.6 37.3 24.5 24.3 23.7 2.6 1.2 1.1 1.9 2.2British Columbia 28.4 31.4 41.8 35.0 30.0 1.0 1.1 1.9 1.9 2.0Canada 189.3 195.5 197.9 185.6 165.0 1.9 1.1 1.4 1.8 2.0

e: estimate f: forecastHistorical data from Statistics Canada and CMHC, National Bank of Canada's forecast.


Montreal Office

514-879-2529

Stéfane Marion Marc Pinsonneault Kyle Dahms Chief Economist and Strategist Senior Economist Economist [email protected] [email protected] [email protected]

Paul-André Pinsonnault Matthieu Arseneau Senior Fixed Income Economist Senior Economist [email protected] [email protected]

Krishen Rangasamy Angelo Katsoras Senior Economist Geopolitical Analyst [email protected] [email protected]

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