Interpreting recent economic signals in the first quarter of 2019 is challenging. Housing markets in main urban centers are cooling. This is generally interpreted as a good sign and potentially averting a housing bubble. It appears that the new rules on speculation, foreign ownership and increasing mortgage rates have had a positive impact on a heated marketplace. As BDC.ca indicates the cooling will continue, “Research shows it takes between three and five years for changes in central bank interest rates to fully work their way through the economy. When they do, a one percentage point change in interest rates can have a three-to-five percentage point impact on home prices.”
Business Confidence Stabilizes In April
The Canadian economy is in transition. Our partners at NBF Economics remind us, there is a positive outcome. The benefit is that interest rate hikes are not likely in the future as the Bank of Canada Governor Poloz indicates.
“As financial conditions had eased, the Bank believed the current interest rate level to be consistent with its positive economic outlook going forward. If we assumed the Bank’s forecast to be right, Poloz’s view was that the policy rate was more likely to go up than down, though there was “no rush to get back in the saddle in terms of hikes.”
Today is an important day for investors as it will provide a window into the economic outlook for the US economy and future interest rates increases. Our partners at NBF Economics have forecasted that the ‘Fed’ (US Federal Reserve) is seen as likely to take the Fed funds rate higher looking further down the road. NBF economics has projected their base case scenario for the target Fed funds range at year end 2019 remaining at 2.75% to 3.0%. This is more aggressive than what the Fed funds futures market is pricing in at this writing earlier in 2018 (see graph).
A recent CNBC consensus estimates a range to 2.25 to 2.50 percent and to remove language in its post-meeting statement that says it will continue with “gradual” rate increases. This may mean the US economy is slowing and no further rate increases to quell inflation concerns may occur.
As the NAFTA 2.0 trade deal (USMCA) is finalized and the trade uncertainty is resides, it still appears that successive increases in interest rates are already having an impact in key sectors such as housing and autos. Many investors are asking — where are we as it relates to the next steps of economic growth and market expectations?
Canadians, whether borrowers, lenders or savers have been attuned to rising interest rates in 2018. Rates are on the rise and where they go depends upon external forces such as exchange rates with trading partners and equity markets.
The Canadian economy had a solid month with positive employment figures, settlement of the US NAFTA 2.0 (USMC agreement) and the large liquid natural gas (LNG) project announcement. Looking forward, our partners at National Bank Financial (NBF) Economics offer investors insights on pace and and timing of interest rates which include:
The Bank of Canada (BoC), as widely expected, raised the overnight rate 25 bps to 1.75% on October 24, 2018
NBF continues to see the Bank (BoC) taking a long pause at 2.5% bank rate
NBF outlook for 10-year U.S. Treasuries is trading around 3.50% and 10-year Canadas around 3.10%, a year from now in October 2019
NBF sees the Canadian central bank overnight rate at 2.5% and the upper bound of the target fed funds range at 3.0% at year-end 2019
Enjoy a detailed outlook for Canadian, US and Global Fixed Income Markets from our partners at NBF Economics HERE.
Although the Canadian (and U.S.) job and employment numbers announced on Friday July 6th were positive, the trends in each country are contrasting. The Canadian job numbers have not done well in comparison to strong U.S. employment. These differences will create contrasts in our interest rate and economic policies. As our partners at National Bank Financial Economics (NBFE) team states, “Total employment registered its worst start of the year in the current expansion due to the 48K drop in private-sector jobs. Major cities were not immune to the slump. Vancouver is down 45K jobs this year and Toronto has seen a pullback of 24K.”
What to look for in this week’s Bank of Canada meeting?
In Canada, the highlight of the week will be the central bank’s report. “With its three core inflation measures close to two percent, it could be said that the Bank has a green light to proceed with further policy normalization. However, the deterioration of the international trade outlook since the central bank’s last meeting ought to give pause to the BoC.” What direction will interest rates take in Canada?
NBFE surmises that “with the U.S. threatening to instigate a trade war with China, and with NAFTA negotiations stalling, we don’t see conditions as supportive of further monetary policy normalization.”
For a detailed report on this week’s economic outlook here.
Sometimes disappointing economic news on jobs can be a positive outcome for the inflation watch. Investors seemingly shrugged off the 7,000 Canadian job losses for the May 2018 employment report. This disappointing economic news instead focused headlines away from the decade-low jobless rate of 5.8% and acceleration of wage growth. Indeed, the 3.9% year-on-year increase for average hourly earnings is the highest in nine years. As the chart below indicates, the job market is tightening and with it wage growth since mid 2016 have rose.
Fixed income portfolio allocations continue to evolve under the neutral rate policy of the Bank of Canada (BoC). This approach is to maintain an interest policy rate consistent with full employment, trend growth and stable prices. It is an important concept in order to understand how your fixed income portfolio will be impacted looking forward.
We expect monetary normalization to proceed slowly. It will take an accumulation of good news to prompt policy action. In this regard, the strong headwinds felt by the economy in early Q1, with GDP reported to have contracted 0.1% in January, have left the central bank with room for patience. The BoC now has the luxury of waiting to see how the housing market performs in May and June before updating its economic projections for the July 11 Monetary Policy Report. By then we expect that evidence of a pickup in growth will be widespread enough to prompt a rate hike. We continue to see the overnight rate ending 2018 at 1.75%.
A little inflation measured by the Consumer Price Index (CPI) is not a bad thing. The North American central banks being the Bank of Canada (BoC) and the U.S. Federal Reserve (The Fed) manage monetary policy and set interest rates. Both are targeting to manage inflation. The good news is that the U.S. and Canadian monetary policies are aligned and not competing against each other.
How does the Inflation outlook impact interest rates?
The Canadian April employment numbers that were announced last week saw a “Cooling of employment” literally as a colder-than-usual April may have temporarily hurt hiring in some sectors. But the soft headline number doesn’t necessarily mean Canada’s labour market is struggling. Looking longer-term, the April jobs report does nothing to change our view that the labour market remains tight and will continue to fuel inflation pressures this year. As such National Bank Financial Economics Partners continue to call for a July interest rate hike from the Bank of Canada.
As interest rates rise in a very managed way, our partners at National Bank Financial (NBF) Economics offer a portfolio perspective. What are the impacts of a strong economy amid trade wars and geopolitical shuffling? Recall that Canada, as well as other trading partners have experienced an exceptionally low interest rate environment since 2008.
How do the Central Banks tread water to control inflation, yet facilitate growth? The neutral rate is the policy rate consistent with full employment, trend growth and stable prices. It is an important concept, yet the Bank of Canada (BoC) is having a difficult time defining the range for the future bank rate. NBF Economics expect monetary normalization to proceed slowly. It will take an accumulation of good news to prompt policy action. In this regard, the strong headwinds felt by the economy in early Q1, with GDP reported to have contracted 0.1% in January, have left the central bank with room for patience.
The Bank of Canada (BoC) announces to stay the course on April 18th as the Canadian economy manages mixed signals. As widely expected, the Bank of Canada (BoC) left the overnight rate unchanged at 1.25% today. The central bank acknowledged rising core inflation, saying this is “consistent with an economy operating with little slack”. The central bank sees total inflation averaging 2.3% this year.
Today, BoC Governor Poloz maintained its target for the overnight rate at 1¼%. The Bank Rate is correspondingly 1½% and the deposit rate is 1%. Inflation in Canada is close to 2% as temporary factors that have been weighing on inflation have largely dissipated, as expected. A reminder that these interest levels still remain low with interest rates averaging 5.90% from 1990 to 2018 (Source: Trading Economics).
Based on today’s message, a May rate hike looks unlikely at this point. That said, should the “data-dependent” Bank of Canada see upside economic surprises before the meeting of May 30th, e.g. monthly GDP, wage, employment and inflation, a change of stance remains possible. Recall that while the economy is currently at capacity, the overnight rate remains 175 basis points below the estimated neutral rate of 3%.