Economic and Financial Market Prospects & Risks

Earl Sweet Economic Research BMO Harrisbank Economic and Financial Market Prospects & Risks Canada-U.S. Business Council March 13, 2013

Global economy turning the corner Emerging markets responding to policy stimulus U.S. domestic demand strengthening Euro Area recession to end by 2013:H2 – tepid recovery Euro Area crisis shifting from acute to chronic Jobless rate 11.9% and rising; 26%+ in Spain & Greece Banks hobbled – FI loan growth still negative Some progress in fiscal reforms, but performance gaps are still huge Commodities off peaks, but still relatively high Global Economy

Vague promise by the ECB to do what’s necessary to save the euro have actually worked, for now … Source: Reuters; BMO Economics

… but can’t cure the euro zone disease of wide economic and fiscal performance gaps in a single-currency region Source: Eurostat

Outside of the Euro Area, growth is gaining momentum;exports and industrial production in Asia are strengthening Source: Netherlands Bureau for Economic Policy Analysis

Global economic growth troughed in 2012;moderate pick-up anticipated for next two years Source: IMF; BMO Economics

Commodity prices are being supported by robust growth in emerging markets and, in some cases, supply constraints Source: BMO Economics

U.S. energy revolution Falling reliance on imports ‘Natural gas advantage’ to boost manufacturing Fiscal reconciliation in Washington? Boost to confidence and growth Diverging U.S. and Canadian trends Consumer spending Residential real estate Business investment Interest rates to remain low in both countries through 2014 C$ below parity in 2013; upside risk in 2014 North American Economic Outlook

New drilling technologies are unlocking massive oil and natural gas resources from shale formations … Source: Energy Information Administration, Department of Energy

… significantly reducing net energy import requirements Source: Energy Information Administration, Department of Energy

The U.S. long-term low-price ‘natural gas advantage’ is stimulating investment in gas-intensive heavy industry … Source: Wall Street Journal; BMO Economics

… and displacing coal in power generation Source: Wall Street Journal; BMO Economics

Crude oil production has risen very quickly in Western Canada and North Dakota, faster than pipeline capacity Source: Energy Information Administration, Department of Energy; NEB

WTI to average in the $90-$100 range, balancing a fine line between Mideast supply risk and global demand risk Pipeline & refinery expansions should narrow the Brent-WTI spread and the double discount on Western Canada oil Source: Wall Street Journal; BMO Economics

U.S. economic growth is being constrained by government deleveraging & fiscal uncertainties Source: Department of Finance, Canada; OMB; BMO Economics

U.S. household deleveraging is well advanced;high household debt in Canada is restraining consumers Source: Bank of Canada; Statistics Canada; Federal Reserve; Dept. of Commerce

Net household worth is being bolstered by rising equity and home prices Source: Statistics Canada; U.S. Dept. of Commerce; BMO Economics

U.S. home equity buffer widening as prices climb;Canadian buffer substantial and fairly stable over time Source: Bank of Canada; Statistics Canada; Federal Reserve; Dept. of Commerce

U.S. employment is gaining momentum; jobless rate should be close to 6.5% by year-end 2014 Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics

Canadian employment surpassed its pre-recession peak two years ago; U.S. still a ways to go Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics

It may look like Canadian house prices are in bubble territory … Source: National Association of Realtors: Canadian Real Estate Association

… yet housing markets are balanced in most regions, except in British Columbia where sales/listings is 30% below its long-term average Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics

Canada’s national house prices are not in bubble territory; running 7% above long-term trend; mild correction in 2013 Source: CREA MLS; BMO Economics

Defaults are a driver of major price corrections; Canadian delinquencies are remarkably low, even in times of severe economic stress Negligible sub-prime; no ‘exotic’ mortgages Source: Canadian Bankers Association; Mortgage Bankers Association

Canadian housing starts are correcting from heated 2-year pace; U.S. recovery now gaining steam Source: CMHC; Dept. of Commerce; BMO Economics

U.S. residential construction near record low share of economy; plenty of room as a growth driver Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics

Auto sales at or above normal run-rate in Canada; U.S. sales recovering sharply – delayed replacement cycle Source: Autodata Corporation; Statistics Canada; BMO Economics

Strengthening demand for autos and household furnishings and appliances is boosting manufacturing; robust new orders Source: Institute for Supply Management --Chicago

U.S. corporate finances are in very good shape;profit ratio near record high; plenty of cash on hand Source: Bureau of Economic Analysis

Canada’s corporate finances are also in very good shape;buoyant returns, relatively low debt … Source: Statistics Canada; BMO Economics

… and ample liquidity reduce business susceptibility to external shocks Source: Statistics Canada

Investment in machinery has led the overall economy, although firms have geared down in the face of global risks Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics

U.S. office vacancies easing down from recession peak; cautious development in Canada kept vacancies relatively low during the recession Source: CBRE

Weaker oil sands engineering to hold back non-res. capex in Canada; U.S. on gradual recovery path Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics

Economic growth to accelerate by 2013:H2;stronger performance in 2014 Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics

Core inflation is well behaved, at or below the 2% longer-term target Source: Statistics Canada; Bureau of Labor Statistics; BMO Economics

Given below-target inflation and slow growth, BoC likely on hold until mid-2014; Fed not until mid-2015 Source: Bank of Canada; Federal Reserve Board; BMO Economics

Long-term yields won’t get back to ‘normal’ until late 2016 Source: Bank of Canada; Federal Reserve Board; BMO Economics

The loonie is expected to gain further against the dollar until mid 2015, and subsequently ease as the Fed raises rates Absent global imbalances – equilibrium loonie around US 90 cents Source: Bank of Canada; BMO Economics

Euro crisis spins out of control, causing major disruptions in interbank, other financial markets, and trade/capital flows Still lots that can go wrong Washington political stalemate weakens confidence Diminishing risk; they’re talking to each other Mideast/North Africa political stress sharply raises oil prices Iran, Syria, Iraq Still-high risks in Libya and Egypt Rising terrorism in Nigeria and other parts of North Africa Key risks:What could go wrong to derail recovery?

Economic and Financial Market Prospects & Risks