0
Economic and Financial Market
Prospects & Risks
Earl Sweet
Economic Research
BMO Harrisbank
Canada-U.S. Business Council
March 13, 2013
Economics Department
1
Global Economy

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
2
Vague promise by the ECB to do what’s necessary to save
the euro have actually worked, for now …
10-Year Government Bond Yields (%)
16
14
12
10
8
6
4
2
0
08:1
09:1
Spain
Source: Reuters; BMO Economics
10:1
11:01
Italy
12:1
Portugal
13:1
3
… but can’t cure the euro zone disease of wide economic
and fiscal performance gaps in a single-currency region
Unemployment Rates of Largest Euro Zone Nations
(%)
27
Euro way too high
24
21
18
15
Euro just right?
12
9
6
Euro too low
3
0
00:1
02:1
04:1
Germany
Source: Eurostat
06:1
France
08:1
10:1
Italy
12:1
Spain
4
Outside of the Euro Area, growth is gaining momentum;
exports and industrial production in Asia are strengthening
Asian Export & Production Volumes (Excl. Japan)
Annualized % Change over the Past Three Months
50
40
30
20
10
0
-10
-20
-30
-40
08:1
09:1
10:1
Exports
Source: Netherlands Bureau for Economic Policy Analysis
11:1
12:1
Industrial Production
5
Global economic growth troughed in 2012;
moderate pick-up anticipated for next two years
Global Economic Growth (Average % Change)
2010-11
2012
2013
2014
World
4.4
3.1
3.4
3.9
North America
2.6
2.3
2.3
3.2
Euro Area
1.7
-0.5
-0.4
0.9
United Kingdom
1.4
0.2
0.9
1.5
Japan
1.8
1.9
0.7
1.4
China
9.8
7.8
8.1
8.5
Source: IMF; BMO Economics
6
Commodity prices are being supported by robust growth in
emerging markets and, in some cases, supply constraints
BMO Commodity Price Index
Index, 2003=100
350
300
250
200
150
100
50
0
80:1 83:1 86:1 89:1 92:1 95:1 98:1 01:1 04:1 07:1 10:1 13:1
Source: BMO Economics
7
North American Economic Outlook

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
8
New drilling technologies are unlocking massive oil and
natural gas resources from shale formations …
U.S. Energy Revolution
Production of Crude Oil & Natural Gas
10
75
9
70
8
65
7
60
6
55
5
50
4
45
3
40
70
73
76
79
82
85
88
91
Crude Oil (LHS, MMB/D)
Source: Energy Information Administration, Department of Energy
94
97
00
03
06
09
12
Natural Gas (RHS, BCF/D)
9
… significantly reducing net energy import requirements
U.S. Net Imports of Crude Oil and Natural Gas
12
10
8
6
4
2
0
70
73
76
79
82
85
88
Crude Oil (MMB/D)
Source: Energy Information Administration, Department of Energy
91
94
97
00
03
06
09
Natural Gas (BCF/D)
12
10
The U.S. long-term low-price ‘natural gas advantage’ is
stimulating investment in gas-intensive heavy industry …
Natural Gas: US Benchmark Henry Hub
US$ per million British thermal units
14
12
10
8
6
4
2
0
00:1
02:1
Source: Wall Street Journal; BMO Economics
04:1
06:1
08:1
10:1
12:1
14:1
11
… and displacing coal in power generation
Share of Power Generation by Energy Source (%)
50
45
40
35
30
25
20
15
10
5
0
03
04
05
06
07
Natural Gas
Source: Wall Street Journal; BMO Economics
08
09
Coal
10
11
12
12
Crude oil production has risen very quickly in Western
Canada and North Dakota, faster than pipeline capacity
Crude Oil Production
Millions of Barrels Per Day
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2005
2006
2007
2008
Western Canada
2009
2010
2011
North Dakota
Source: Energy Information Administration, Department of Energy; NEB
2012
13
WTI to average in the $90-$100 range, balancing a fine
line between Mideast supply risk and global demand risk
Crude Oil Prices
US$/Barrel
140
120
Brent
100
WTI
80
WCS
60
40
20
0
08:1
09:1
10:1
11:1
12:1
13:1
14:1
Pipeline & refinery expansions should narrow the Brent-WTI
spread and the double discount on Western Canada oil
Source: Wall Street Journal; BMO Economics
14
U.S. economic growth is being constrained
by government deleveraging & fiscal uncertainties
Government Deficit as % of GDP
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
-10
U.S. is where Canada was 20 years ago;
turnaround needs tough decisions,
but is doable
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Canada, Incl. Provinces & Local
Source: Department of Finance, Canada; OMB; BMO Economics
United States
15
U.S. household deleveraging is well advanced;
high household debt in Canada is restraining consumers
Household + Unincorporated Business Liabililties
% of Personal Disposable Income
190
180
170
160
150
140
130
120
110
100
90
80
Canadian ratio 9% below
U.S. pre-recession peak
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Canada
United States
Source: Bank of Canada; Statistics Canada; Federal Reserve; Dept. of Commerce
16
Net household worth is being bolstered by
rising equity and home prices
Household Wealth
$ Trillion, in Domestic Currencies
Housing
Bubble
8
70
7
6
80
Tech
Bubble
60
5
50
4
40
3
30
2
20
1
10
0
0
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Canada - LHS
United States - RHS
Source: Statistics Canada; U.S. Dept. of Commerce; BMO Economics
17
U.S. home equity buffer widening as prices climb;
Canadian buffer substantial and fairly stable over time
Household Residential Equity
% of Value of Residential Property
75
70
65
60
55
50
45
40
35
30
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Canada
United States
Source: Bank of Canada; Statistics Canada; Federal Reserve; Dept. of Commerce
18
U.S. employment is gaining momentum;
jobless rate should be close to 6.5% by year-end 2014
Unemployment Rate (%)
12
11
10
9
8
7
6
5
4
3
2
1
0
00:1
02:1
04:1
Canada
06:1
08:1
10:1
United States
Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics
12:1
Illinois
14:1
19
Canadian employment surpassed its pre-recession peak two
years ago; U.S. still a ways to go
Employment (Millions)
18.3
163
18.0
160
17.7
157
17.4
154
17.1
151
16.8
148
16.5
145
16.2
142
15.9
139
15.6
136
15.3
133
15.0
130
07:1
08:1
09:1
10:1
11:1
Canada (LHS)
Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics
12:1
13:1
14:1
United States (RHS)
20
It may look like Canadian house prices
are in bubble territory …
Average Resale House Prices
Indexes, 2003:Jan = 100
240
220
200
180
160
140
120
100
80
00:1 01:1 02:1 03:1 04:1 05:1 06:1 07:1 08:1 09:1 10:1 11:1 12:1 13:1
Canada
United States
Source: National Association of Realtors: Canadian Real Estate Association
Midwest
21
… yet housing markets are balanced in most regions,
except in British Columbia where sales/listings is 30%
below its long-term average
Sales-to-Listings Ratios
Relative to Long-term Averages
1.5
>1: Sellers' Market
1.4
1.3
1.2
1.1
1.0
0.9
0.8
0.7
<1: Buyers' Market
0.6
0.5
96:1
98:1
00:1
Canada
02:1
04:1
06:1
British Columbia
Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics
08:1
10:1
Ontario
12:1
22
Canada’s national house prices are not in bubble territory;
running 7% above long-term trend; mild correction in 2013
Average Transaction Price for Resale Homes: Canada
$ Thousands, SA
400
7%
Gap
350
300
250
Trend line calculated through 2006:
annual increase of 4.8%, or 1.2% real
200
150
100
Restrained by fiscal
deleveraging in the 1990s
50
0
80:1
84:1
Source: CREA MLS; BMO Economics
88:1
92:1
96:1
00:1
04:1
08:1
12:1
23
Defaults are a driver of major price corrections;
Canadian delinquencies are remarkably low,
even in times of severe economic stress
Mortgages 90+ days in Arrears
% of Total Mortgages
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
Financial
crisis &
recession
Double-digit jobless
and interest rates
1.0
0.5
0.0
90:1
92:1
94:1
96:1
98:1
00:1
Canada
02:1 04:1
06:1
08:1
10:1
United States
Negligible sub-prime; no ‘exotic’ mortgages
Source: Canadian Bankers Association; Mortgage Bankers Association
12:1
24
Canadian housing starts are correcting from heated
2-year pace; U.S. recovery now gaining steam
Housing Starts
Millions of Units
0.25
2.5
0.20
2.0
Demographic
requirements
0.15
1.5
0.10
0.05
1.0
0.5
Supports recovery in lumber
and wood products
0.00
0.0
00:1
02:1
04:1
06:1
Canada -- LHS
Source: CMHC; Dept. of Commerce; BMO Economics
08:1
10:1
12:1
United States -- RHS
14:1
25
U.S. residential construction near record low share of
economy; plenty of room as a growth driver
Residential Construction
% of GDP
8
7
6
5
4
3
2
1
0
90:1
92:1
94:1
96:1
98:1
00:1
Canada
02:1
04:1
06:1
United States
Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics
08:1 10:1
12:1
26
Auto sales at or above normal run-rate in Canada;
U.S. sales recovering sharply – delayed replacement cycle
Motor Vehicle Sales
Million Units
1.9
19
1.8
18
1.7
17
1.6
16
1.5
15
1.4
14
1.3
13
1.2
12
A large plus for auto parts and
related materials suppliers
1.1
11
1.0
10
0.9
9
00:1
02:1
04:1
06:1
08:1
Canada -- LHS
Source: Autodata Corporation; Statistics Canada; BMO Economics
10:1
12:1
14:1
United States -- RHS
27
Strengthening demand for autos and household furnishings
and appliances is boosting manufacturing; robust new orders
Chicago Manufacturing Index
70
>50: Manufacturing Expanding
65
60
55
50
45
40
35
<50: Manufacturing Contracting
30
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Source: Institute for Supply Management --Chicago
28
U.S. corporate finances are in very good shape;
profit ratio near record high; plenty of cash on hand
Corporate Profits After Tax
% of Corporate Value Added
16
14
12
10
8
6
4
2
0
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Source: Bureau of Economic Analysis
29
Canada’s corporate finances are also in very good shape;
buoyant returns, relatively low debt …
Canadian Non-financial Industry Performance
1.4
18
1.3
15
1.2
12
1.1
9
1.0
6
0.9
3
0.8
0
0.7
-3
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Debt-Equity Ratio (LHS)
Source: Statistics Canada; BMO Economics
Real ROE (%, RHS)
30
… and ample liquidity reduce business susceptibility
to external shocks
Non-financial Industries
Cash and Deposits as % of Total Borrowing
36
33
30
27
24
21
18
15
12
9
6
3
0
90:1 92:1 94:1 96:1 98:1 00:1 02:1 04:1 06:1 08:1 10:1 12:1
Source: Statistics Canada
31
Investment in machinery has led the overall economy,
although firms have geared down in the face of global risks
Business Investment in Equipment
% Change From Year Ago
15
12
9
6
3
0
-3
-6
-9
-12
-15
-18
-21
00
01
02
03
04
05
06
Canada
07
08
09
10
United States
Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics
11
12
13
14
32
U.S. office vacancies easing down from recession peak;
cautious development in Canada kept vacancies relatively
low during the recession
Vacancy Rates: Office Properties (%)
18
16
14
12
10
8
6
4
2
0
98:1
00:1
02:1
04:1
Canada
Source: CBRE
06:1
08:1
United States
10:1
12:1
33
Weaker oil sands engineering to hold back non-res.
capex in Canada; U.S. on gradual recovery path
Business Investment in Non-res. Construction
% Change From Year Ago
15
12
9
6
3
0
-3
-6
-9
-12
-15
-18
-21
00
01
02
03
04
05
Canada
06
07
08
09
10
11
United States
Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics
12
13
14
34
Economic growth to accelerate by 2013:H2;
stronger performance in 2014
Real GDP Growth (%)
4
3
2
1
0
-1
-2
-3
-4
01
02
03
04
05
06
Canada
07
08
09
10
11
United States
Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics
12
13
14
35
Core inflation is well behaved,
at or below the 2% longer-term target
Core Consumer Price Inflation (%)
4.0
3.5
3.0
2.5
2.0
1.5
1.0
Implicit target is 2%
0.5
0.0
93:1
95:1
97:1
99:1
01:1
Canada
03:1
05:1
07:1
09:1
United States
Source: Statistics Canada; Bureau of Labor Statistics; BMO Economics
11:1
13:1
36
Given below-target inflation and slow growth,
BoC likely on hold until mid-2014; Fed not until mid-2015
Central Bank Policy Rates (%)
7
6
5
4
Neutral Range
3
2
1
0
99:1
01:1
03:1
05:1
07:1
Bank of Canada Overnight
Source: Bank of Canada; Federal Reserve Board; BMO Economics
09:1
11:1
13:1
15:1
Fed Funds Target
37
Long-term yields won’t get back to ‘normal’ until late 2016
Government 10-Year Bond Yields
7
6
5
4
3
2
1
0
99:1
01:1
03:1
05:1
Canada
07:1
09:1
11:1
United States
Source: Bank of Canada; Federal Reserve Board; BMO Economics
13:1
15:1
38
The loonie is expected to gain further against the dollar until
mid 2015, and subsequently ease as the Fed raises rates
Canadian Dollar
US$ per Can$
1.10
1.05
1.00
0.95
0.90
0.85
0.80
0.75
0.70
0.65
0.60
99:1
01:1
03:1
05:1
07:1
09:1
11:1
13:1
15:1
Absent global imbalances – equilibrium loonie around US 90 cents
Source: Bank of Canada; BMO Economics
39
Key risks:
What could go wrong to derail recovery?

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