RETAIL RATE FORECASTS

François Dupuis, Vice-President and Chief Economist Mathieu D’Anjou, Senior Economist • Jimmy Jean, Senior Economist • Hendrix Vachon, Senior Economist

Desjardins, Economic Studies: 514-281-2336 or 1 866-866-7000, ext. 5552336 • desjardins.economics@desjardins.com • desjardins.com/economics

NOTE TO READERS: The letters k, M and B are used in texts and tables to refer to thousands, millions and billions respectively.IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. The data on prices or margins are provided for information purposes and may be modified at any time, based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. The opinions and forecasts contained herein are, unless otherwise indicated, those of the document’s authors and do not represent the opinions of any other person or the official position of Desjardins Group. Copyright © 2017, Desjardins Group. All rights reserved.

Canadian Key Rates May Rise ShortlyHIGHLIGHTS

f Positive signs for the global and Canadian economies.

f The Bank of Canada could initiate monetary firming in the coming months.

f The U.S. dollar suffers from scepticism over future U.S. interest rate hikes.

f Canadian equities have short-term potential.

• Global growth should reach a 6‑year peak in 2017. Overall, economic figures continue to paint a promising picture for the global economy. Confidence and activity indexes remain high in most economies and growth was solid in a number of major economies in the first quarter of 2017. The start of the year was more difficult for the United States, but all signs indicate that growth rebounded in the second quarter. Accelerated international trade is another sign that the global economy is picking up (graph 1).

• The Federal Reserve (Fed) continues to tighten its monetary policy. The Fed announced another 0.25% increase to its key rates at its June 14 meeting. This is the third consecutive quarterly increase to U.S. key interest rates

and the fourth since the start of the monetary firming cycle. U.S. monetary authorities also clearly signaled their intention to begin shedding their bond holdings while continuing to gradually raise their key rates.

• Canada’s economic performance is particularly impressive. The Canadian economy recorded the highest level of growth among G7 countries with an annualized surge of 3.7% in real GDP for the first quarter of 2017 (graph 2). Domestic demand was particularly strong due to major contributions by households and businesses. The relaunch of business investments and the return to an upward trend for Canadian exports are especially encouraging. However, after three consecutive quarters of very strong growth, the

ECONOMIC STUDIES | JUNE 15, 2017

GRAPH 2 Economic growth was particularly strong in Canada

Sources: Datastream and Desjardins, Economic Studies

Real GDP growth in the first quarter of 2017

Quarterly annualized variation in %

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Canada Germany Eurozone

France Italy UnitedStates

Japan UnitedKingdom

GRAPH 1 Accelerated international trade is another sign of increased activity

Sources: CPB - Netherlands Bureau for Economic Policy Analysis and Desjardins, Economic Studies

Volume of international trade – 3-month moving average

Quarterly annualized variation in %

-8-6-4-202468

101214

2014 2015 2016 2017

#1 BEST OVERALLFORECASTER - CANADA

ECONOMIC STUDIES

2JUNE 2017 | RETAIL RATE FORECASTS

Canadian economy should soon resume a slightly more moderate pace of growth.

• The Bank of Canada (BoC) appears to be preparing to raise its key interest rates. Canada’s strong economic growth in the last few quarters has greatly diminished the Canadian economy’s excess capacity. As the labour market also continues to send encouraging signals and household debt remains a concern, the BoC has adopted a more optimistic tone in the last few months. In its last statment, the BoC noted that the adjustment of the Canadian economy to lower oil prices was essentially over. We now expect that the BoC will begin its own monetary firming in October 2017, and we could even see an increase in rates as soon as July.

• The resilience of the bond market may be nearing its end. Despite the positive economic figures and key rate increases by the Fed, bond yields have been slipping since the start of 2017. The lack of strong inflationary pressure and the presence of a certain amount of political uncertainty seem to have buoyed demand for North American bonds. In our opinion, bond yields should resume an upward trend shortly to better reflect the economic situation.

• Heading for a rise in retail rates. Dropping North American bond yields have enabled retail rates to remain very close to their historic lows for the last few months. However, recent events, particularly the noticeable change in the BoC’s tone, have reinforced our belief that a gradual rise in rates should begin shortly.

DISCOUNT RATE

PRIME RATE

1 year 3 years 5 years 1 year 3 years 5 years

Realized (end of month)Dec. 2016 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50January 2017 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50February 2017 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50March 2017 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50April 2017 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50May 2017 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50June 14, 2017 0.75 2.70 3.14 3.39 4.74 0.85 1.15 1.50

ForecastsEnd of quarter2017: Q2 0.75 2.70 2.89–3.39 3.14–3.64 4.49–4.99 0.60–1.10 0.90–1.40 1.25–1.752017: Q3 0.50–1.00 2.45–2.95 2.89–3.39 3.14–3.64 4.49–4.99 0.60–1.10 0.90–1.40 1.25–1.752017: Q4 0.75–1.25 2.70–3.20 2.99–3.49 3.24–3.74 4.59–5.09 0.70–1.20 1.05–1.55 1.40–1.902018: Q1 0.75–1.25 2.70–3.20 3.09–3.69 3.34–3.84 4.69–5.19 0.80–1.30 1.15–1.65 1.55–2.05End of year2018 1.00–2.00 2.95–3.95 3.35–4.15 3.80–4.60 5.00–5.80 1.00–1.80 1.35–2.15 1.70–2.502019 1.00–2.00 2.95–3.95 3.20–4.00 3.65–4.45 4.85–5.65 0.90–1.70 1.25–2.05 1.55–2.352020 0.75–1.75 2.70–3.70 3.05–3.85 3.35–4.15 4.70–5.50 0.80–1.60 1.15–1.95 1.50–2.30

1 Non-redeemable (annual); NOTE: Forecasts are expressed as ranges.Source: Desjardins, Economic Studies

TABLE 1Forecasts: Retail rate

IN %

MORTGAGE RATE TERM SAVINGS1

3JUNE 2017 | RETAIL RATE FORECASTS

ECONOMIC STUDIES

• The U.S. dollar has fallen against most of the other major currencies since the start of the year (graph 3). This trend seems to go hand-in-hand with a reduction in bond yields and in expectations about monetary firming in the United States. After the rate hikes in June, the markets are hesitant to count on further increases before the end of the year or even next year. Donald Trump’s promises of reforms and tax cuts raised expectations of monetary firming and helped the greenback’s rise in late 2016. It now appears much less certain that these promises will be kept, at least in the short term.

• The Canadian dollar has only appreciated slightly against the U.S. dollar since the start of the year, primarily due to low oil prices (graph 4). However, the more optimistic tone adopted by the Bank of Canada (BoC) has served as a buoy. The loonie recently approached US$0.76 (C$1.32/US$) amid raised expectations regarding monetary firming in Canada. This rise was also facilitated by reduced fears over U.S. protectionism.

• The euro performed well in the last few months, thanks to allayed political fears in Europe and greater optimism on the part of the European Central Bank. The pound sterling took a hit after the poor results for the Conservative Party in the recent elections in the United Kingdom.

• Forecasts: The U.S. dollar should rebound against most currencies in the short term, thanks to adjusted expectations of monetary firming in the United States. Nevertheless, the Canadian dollar may fare better against a new surge of the greenback due to the increasing likelihood that the BoC will soon tighten its monetary policy. The loonie may also benefit from an uptick in oil prices between now and the end of the year.

Exchange RateThe U.S. Dollar Suffers from Scepticism Over Future U.S. Interest Rate Hikes

WTI : West Texas Intermediate Sources: Datastream and Desjardins, Economic Studies

US$/C$

10

30

50

70

0.65

0.70

0.75

0.80

0.85

2015 2016 2017

Canadian exchange rate (left) Oil prices – WTI (right)

US$/barrel

GRAPH 4 Weak oil prices hurt the Canadian dollar, but the Bank of Canada starts to help the loonie

-12 -10 -8 -6 -4 -2 0 2

MexicoSouth Africa

KoreaRussia

Euro zoneJapan

DenmarkIndia

ThailandSwitzerland

AustraliaSweden

New ZealandUnited Kingdom

NorwayChina

CanadaIndonesia

TurkeyBrazil

GRAPH 3 The U.S. dollar had a difficult first half of the year

Sources: Datastream and Desjardins, Economic Studies

Variation in the U.S. dollar since the start of the year

In %

Q3 Q4 Q1 Q2f Q3f Q4f Q1f Q2f Q3f Q4f

US$/CAN$ 0.7617 0.7445 0.7511 0.7500 0.7600 0.7600 0.7600 0.7700 0.7700 0.7800CAN$/US$ 1.3129 1.3433 1.3313 1.3333 1.3158 1.3158 1.3158 1.2987 1.2987 1.2821CAN$/€ 1.4754 1.4168 1.4239 1.4933 1.4605 1.4342 1.4342 1.4286 1.4416 1.4487US$/€ 1.1238 1.0547 1.0696 1.1200 1.1100 1.0900 1.0900 1.1000 1.1100 1.1300US$/£ 1.2990 1.2357 1.2505 1.2700 1.2600 1.2400 1.2300 1.2400 1.2500 1.2500

f: forecastsSources: Datastream and Desjardins, Economic Studies

TABLE 2Forecasts: Currency

END OF PERIOD

2016 2017 2018

Determinants Short-term Long-term

Oil prices ↗ ↗Metals prices → ↗Interest rate spreads → →

ECONOMIC STUDIES

4JUNE 2017 | RETAIL RATE FORECASTS

• With spring came a number of challenges. In addition to the unpredictable nature of the U.S. administration, investors had to contend with the presidential election in France, a surprise election in the United Kingdom and weak performance by the U.S. economy in the first quarter. Stock markets held up very well given the circumstances (graph 5). France’s rejection of populism reassured investors. The bet lost by British Prime Minister Theresa May did not have a significant negative impact on the stock markets, while some hold out hope for a less severe break with the European Union during Brexit negotiations, which are set to begin shortly. While growth was disappointing in the United States, the job market continued to perform well overall and corporate profits were solid. Growth was also promising in several other developed countries, including in Europe and Canada. With allayed political fears and the improved economic situation, we have upgraded our target returns for international stocks, and now anticipate a 16% gain for the year.

• The recovery in U.S. profits slightly lifted the pressure on valuations. The surge of the S&P 500 observed in the spring was not accompanied by an additional hike in the valuation multiple, while operating profits posted an annual increase of more than 20% in the first quarter, according to figures by Standard & Poor’s. The return to positive territory for energy sector profits was a major determinant, but in most sectors profits rose or were stable over the previous year (graph 6). These trends compensated for lower expectations for economic reform in the United States. It should be pointed out that foreign sales account for some 46% of the revenues of S&P 500 companies. Even without stimulus measures at the national level, an acceleration in global economic growth is beneficial for profits. Furthermore, disenchantment with Donald Trump’s policies was reflected in the U.S. dollar, which erased all the gains it had posted since the election, thereby mitigating a penalizing factor for foreign profits. Given the resilience observed recently and expectations of a rebound for U.S. growth in the second quarter, we have raised our target return for the U.S. stock market to 13%. Our target for the end of the year for the S&P 500 index is 2,475 points.

• For Canada, spring was marked by suspicion. The difficulties facing mortgage lender Home Capital attracted much media attention and led some international investors to adopt a negative bias toward Canadian stocks. Financial securities took a major blow despite the fact that banks presented very solid results in the first quarter. The energy sector also faced major difficulties as a direct consequence of dropping oil prices in the last few months. Production

Asset Classes ReturnCanadian Equities Have Short-Term Potential

GRAPH 6 Most S&P 500 sectors posted increased profits

Sources: Standard & Poor’s and Desjardins, Economic Studies

Operating profits per share

In US$ -5 0 5 10 15 20 25 30

S&P 500Consumer discretionary

Consumer staplesEnergy

FinancialsHealthcareIndustrials

Information technologyMaterials

Telecommunication servicesUtilities Q1 2017

Q1 2016

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Canada U.S. U.K. Australia Germany France Japan

GRAPH 7 Canadian consumption pulls ahead

Sources: Datastream and Desjardins, Economic Studies

Growth in real consumption

Annual variation in %

GRAPH 5 A strong first half of the year for several stock markets

Sources: Datastream and Desjardins, Economic Studies

Stock market indexes

Jan. 2017 = 100

96

100

104

108

112

116

120

JAN. FEB. MAR. APR. MAY. JUN.

MSCI Emerging Markets MSCI Europe S&P/TSX S&P 5002017

5JUNE 2017 | RETAIL RATE FORECASTS

ECONOMIC STUDIES

return of 1.0%, which primarily reflects the gains made in the first half of the year.

by Canadian oil companies was abundant, but the price of Canadian oil has fluctuated between US$35 and US$40 limited profitability. Meanwhile, consumer discretionary and consumer staples posted significant gains. In the first quarter, real consumer spending grew 4.2%, its largest increase in seven years. Canadian consumption has been among the strongest in developed countries (graph 7). Despite the recent difficulties, we are maintaining our target return at 6.5% for the S&P/TSX. In our opinion, the troubles facing Home Capital reflects governance shortcomings rather than the type of risky mortgage practices that led to the decline of the U.S. housing market. In addition, accelerated global demand should help oil prices recover slightly.

• Bonds continued to record gains despite improved global growth and decreased political risks. Investors focused heavily on the inflation outlook. Donald Trump’s promises had helped increase implicit inflation expectations, but lowered hopes for reform caused a certain amount of retracement in the spring. Nevertheless, short-term yields continued to rise, as the Federal Reserve (Fed) tightened its monetary policy for the third time in as many quarters. The Fed continues to signal additional firming this year, including taking steps to shrink its balance sheet. In a surprising change in tone, the Bank of Canada is following in the Fed’s footsteps by suggesting that we could see a hike in the overnight rate sooner than previously anticipated. We have adjusted our forecast for the first hike in Canada’s policy rates to October 2017, which is six months earlier than under our previous scenario. Bonds should post a relatively modest

CASH BONDSCANADIAN

STOCKSU.S. STOCKS

INTERNATIONAL STOCKS

EXCHANGE RATE

3-monthT-Bill Bond index1 S&P/TSX

index2

S&P 500 index (US$)2

MSCI EAFE index (US$)2

C$/US$(variation in %)3

2006 4.0 4.1 17.3 15.8 26.9 0.22007 4.1 3.7 9.8 5.5 11.6 -14.42008 2.4 6.4 -33.0 -37.0 -43.1 22.12009 0.3 5.4 35.1 26.5 32.5 -13.72010 0.6 6.7 17.6 15.1 8.2 -5.22011 0.9 9.7 -8.7 2.1 -11.7 2.32012 1.0 3.6 7.2 16.0 17.9 -2.72013 1.0 -1.2 13.0 32.4 23.3 7.12014 0.9 8.8 10.6 13.7 -4.5 9.42015 0.5 3.5 -8.3 1.4 -0.4 19.12016 0.5 1.7 21.1 12.0 1.5 -2.9

2017f target: 0.6 target: 1.0 target: 6.5 target: 13.0 target: 16.0 target: -2.0 (0.76 $ US)range 0.5 to 0.7 -2.0 to 4.0 2.0 to 10.0 6.0 to 17.0 8.0 to 20.0 -5.8 to 2.0

TABLE 3Asset classes percentage return

END OF YEAR IN %(EXCEPT IF INDICATED)

1 FTSE TMX Canada Bond Universe; 2 Dividends included; 3 Negative = appreciation, positive = depreciation; f: forecastsSources: Datastream and Desjardins, Economic Studies