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Economic Insights
March 3, 2016
Take a Chill Pill
Economics
Avery Shenfeld
(416) 594-7356
[email protected]
Benjamin Tal
(416) 956-3698
[email protected]
Andrew Grantham
(416) 956-3219
[email protected]
Royce Mendes
(416) 594-7354
[email protected]
Nick Exarhos
(416) 956-6527
[email protected]
“text text text”
by Avery Shenfeld
We’ve been steadily downgrading our
Canadian and global growth outlook since
the second half of 2014. But we now find
that market chatter has left us feeling like
rosy-glassed optimists.
The wall of worry isn’t that high in consensus
economic forecasts. Instead, it’s been heard
in the talk on the trading floors of Wall
Street and Bay Street, and whatever street
the Shanghai market sits on, among the
newly cautious FOMC voters, and in the
resulting flight to safety rally in US Treasuries.
Prospects aren’t as bleak as some now fear,
and rates aren’t going negative everywhere.
Emerging market recessions, or in China’s
case, growth disappointments, have been
front and centre in the global economic
slowdown of the past year. And make no
mistake, these are challenging times for
the likes of China, Russia, Brazil and their
regional trading partners. But as investors,
we need to be scanning for signs that the
news ahead might be better rather than
worse, and there are indeed some forces
that might pave the way for at least lessbad news in the EM space (see pages 6-9).
Stateside, only weeks after the Fed hiked in
December, we were being asked to assess
the odds that America’s central bank will
eventually be pushed into negative rates.
Increasingly, the analogy is being drawn to
Japan, which had its own real estate and
financial market shock way back in the early
1990s, from which it ended up being stuck
in a zero rate policy, and now negative policy
rates, for what seems like forever.
We long ago projected that US rates will
track much lower than in past cycles (See
Economic Insights, April 2014). But America
isn’t turning Japanese, not by a long shot (see
pages 3-5). Nor is it sitting with a massive
output gap like the one still festering in
Europe, wounded by the Eurozone’s failure
to use fiscal stimulus during the Great
Recession.
The analogies that the bond market was
relying on to price away almost all rate hikes
in the next two years, and take 10-year rates
below 2%, simply ignore too many of the
facts on the ground. In recent days, we’re
seeing what could be the early signs of a
reversal of that trend.
The market’s assessment of Canada is
rightly one of concern for near-term growth
prospects. Just as fiscal policy differentiated
the Eurozone’s post-recession fate from
that of the US, it will hold the cards for
getting the Canadian economy back in gear.
Monetary policy is a spent force here, given
an indebted household sector and an aging
housing boom.
Look for the federal budget to deliver a larger
fiscal boost than was talked about during
the campaign (see pages 10-11) as a way
to avoid Canada having to turn Japanese in
monetary policy ahead. Take a chill pill, as
things aren’t as bad as you’re hearing on the
street.
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C I B C W o r l d M a r k e t s C o r p • 3 0 0 M a d i s o n A v e n u e , N e w Yo r k , N Y 1 0 0 1 7 • ( 2 1 2 ) 8 5 6 - 4 0 0 0 , ( 8 0 0 ) 9 9 9 - 6 7 2 6
CIBC World Markets Inc.
Economic Insights - March 3, 2016
MARKET CALL
• A larger fiscal stimulus package is likely to be seen as a sufficient boost to keep Canadian policy rates on
hold. But the Bank of Canada’s serious consideration of a cut in January reflected its distaste for having
Canadian yields get pulled up too soon when the Fed is seen as tightening. We see it using forward
guidance to remind markets that BoC rate hikes are much further off, and we’ve slightly trimmed our
path for two-year Canadas as a result.
• So far, Treasuries haven’t reacted much to what we see are nascent signals of a return to a 2%+ inflation
world, and are not yet priced for even two hikes by the Fed this year. That seems misguided, and overly
influenced by developments in countries overseas with much larger output gaps. We’re retaining our call
for a June hike, and upward pressure on Treasury yields.
• The C$ has staged a decent rebound off its weakest levels, helped by dovish Fed talk and a modest
firming in crude oil. The latter could continue, but we expect the Fed to return to the rate hike table
in June, giving the US$ one final day in the sun against other majors. Longer term, while oil might be
supportive, recoveries in the loonie will be limited as the BoC lags sufficiently behind the Fed in rate
normalization in order to retain the lift to exports.
INTEREST & FOREIGN EXCHANGE RATES
2016
2017
2-Mar
Jun
Sep
Dec
Mar
Jun
Sep
Dec
CDA Overnight target rate
98-Day Treasury Bills
2-Year Gov't Bond
10-Year Gov't Bond
30-Year Gov't Bond
0.50
0.45
0.54
1.25
2.04
0.50
0.45
0.50
1.35
2.25
0.50
0.45
0.55
1.50
2.30
0.50
0.45
0.70
1.60
2.50
0.50
0.45
0.90
1.95
2.80
0.50
0.45
1.10
2.20
2.85
0.50
0.55
1.10
2.35
2.95
0.75
0.70
1.20
2.35
3.00
U.S.
Federal Funds Rate
91-Day Treasury Bills
2-Year Gov't Note
10-Year Gov't Note
30-Year Gov't Bond
0.375
0.33
0.86
1.86
2.70
0.625
0.55
0.95
2.25
2.85
0.625
0.60
1.00
2.50
2.95
0.875
0.75
1.30
2.60
3.05
0.875
0.75
1.30
2.75
3.10
1.125
1.00
1.40
3.00
3.15
1.375
1.30
1.60
3.10
3.20
1.625
1.50
1.85
3.10
3.30
Canada - US T-Bill Spread
Canada - US 10-Year Bond Spread
0.12
-0.60
-0.10
-0.90
-0.15
-1.00
-0.30
-1.00
-0.30
-0.80
-0.55
-0.80
-0.75
-0.75
-0.80
-0.75
Canada Yield Curve (30-Year — 2-Year)
US Yield Curve (30-Year — 2-Year)
1.51
1.84
1.75
1.90
1.75
1.95
1.80
1.75
1.90
1.80
1.75
1.75
1.85
1.60
1.80
1.45
EXCHANGE RATES
0.74
1.35
114
1.08
1.40
0.72
1.00
3.92
17.91
0.70
1.42
115
1.10
1.43
0.69
1.00
3.95
17.22
0.73
1.37
118
1.12
1.47
0.71
0.98
3.91
16.71
0.74
1.36
120
1.14
1.54
0.74
0.98
3.97
16.46
0.75
1.34
118
1.16
1.55
0.77
0.97
3.48
16.21
0.75
1.33
116
1.18
1.55
0.78
0.97
3.48
15.97
0.76
1.32
122
1.15
1.53
0.77
1.03
3.55
15.73
0.75
1.33
123
1.16
1.57
0.78
1.03
3.45
16.06
END OF PERIOD:
CADUSD
USDCAD
USDJPY
EURUSD
GBPUSD
AUDUSD
USDCHF
USDBRL
USDMXN
2
CIBC World Markets Inc.
Economic Insights - March 3, 2016
Turning Japanese? We Really Think Not
Avery Shenfeld and Andrew Grantham
Demographic Destiny and Real Neutral Rates
Japan is the poster child for what could go wrong after
a real estate and financial crisis. Turning Japanese was
not only an unfortunate 1980 pop song, but is now a
shorthand for being stuck with employment, growth and
inflation all below target, bond yields at nearly zero, and
of late, overnight rates in negative territory.
What all developed economies share today is that, due to
slower growth in the working age population, their trend
growth at full employment is likely to trail historic norms.
That’s relevant to monetary policy because it implies less
pressure for businesses to expand capacity to keep pace
with demand. A lighter track for capital spending at
any given real rate of interest in turn means that central
banks can’t set rates as high once full employment is
reached. Interest rates ultimately have to be low enough
to turn the savings of the household sector back into the
economy in the form if investment spending.
Only weeks after the Federal Reserve took a baby step
towards higher rates, Treasury yields were looking a lot
like those seen earlier in Japan’s story (Chart 1). Prospects
for additional rate hikes were nearly priced out of futures,
and some were even asking if American rates could go
negative. Canada, beset with the drag from low energy
prices, was also being seen at risk of a Japan-style
outcome.
Japan’s story, however, is one of extremes that won’t
be seen in North America for decades to come, if ever.
Fertility rates are low across the developed world, but
Japan added to that with an aversion to immigration
(Chart 2). Europe had shared that, but a wave of refugees
from war and weak economies in the Middle East and
Africa has, at least for now, significantly increased net
immigration.
But Japan’s story is not likely to be universal even if, as we
long ago argued, US and Canadian interest rates follow a
much gentler path in this cycle than we have seen in the
past. Structural factors and poor policy decisions in Tokyo
doomed Japan to its present fate, and these simply aren’t
replicated in the US, or Canada for that matter. The result
is that markets are getting too pessimistic on equities, and
too bulled up on safe-haven government bonds.
Chart 1
Chart 2
North American Bond Yields Following Those of
Japan
4
6
Japan 10Y Bond Yield (%)
Low Immigration A Factor Behind Japan’s
Demographic Malaise
10Y Bond Yield (%)
8
Net Immigration Rate
(per 1000 of Population, Avg of 5 Years to 2013)
5
3
6
4
2
3
4
1
2
US
1
Feb-16
Sep-14
Apr-13
Nov-11
Jun-10
Mar-06
0
Aug-07
Jan-16
Nov-11
Sep-07
Jul-03
May-99
Mar-95
-1
2
Canada
Jan-09
0
Adj.
For
2015
Surge
0
Japan
Source: Bloomberg, CIBC
Euro Area
UK
US
Canada
Source: World Bank, CIBC
3
CIBC World Markets Inc.
Economic Insights - March 3, 2016
Chart 3
Working Age Populations Rising Slower in US,
Cda; But No Japan-Style Plunge
1.2
Chart 4
Large Fiscal Drag in Japan, Not in US
Avg Annual % Change in 25-64 Population
0.4
Drag/Stimulus From Fiscal Policy (%-pts)
US
0.8
0.0
0.4
-0.4
0
-0.8
2005-2015
-0.4
Japan
Fiscal
Drag
-1.2
2015-2025 F
-1.6
-0.8
US
Canada
W.Europe
2015
Japan
2016
Source: UN, CIBC
2017
2018
Source: IMF, CIBC
North America has a longer history of welcoming
newcomers, albeit one that is under question in this year’s
US election season. But current projections have both
the US and Canada still avoiding the worst of Japan’s
demographic time bomb (Chart 3). That should see trend
GDP growth dip a bit below 2% in the coming decade,
but nothing akin to what happened in Japan.
nearly forced to try its hand at negative policy rates, even
knowing that their efficacy would be limited.
The Eurozone has been similarly ham-handed fiscally,
refusing to ease even as the economy has struggled
to close a massive output gap, pushing the ECB into
negative rates of its own. In contrast, the US eased
policy sharply after the recession, and while it was in a
tightening mode in 2015, now has fiscal policy settings
on track to be neutral this year, and stimulative come
2018, barring a post-election rethinking. Canada, of
course, is about to unveil a federal fiscal stimulus effort
that the Bank of Canada specifically cited in its decision
to eschew the next step towards lower rates in January.
Policy Steps and Missteps
Of course, it’s not just that Japan has a tumbling potential
growth rate, it’s that for most of the past couple of
decades, its fallen short of that potential. Unemployment
rates look low, but full employment in the past has been
well below where the jobless rate now sits. That was true
for most of the post-1990 period, and the resulting slack
allowed deflationary forces to take hold.
Inoculated Against Deflation
The errors of the 1990s included a failure to clean up a
banking system calcified by bad debt, a sharp contrast to
what the US did with the TARP program. It took the BoJ a
half-decade to ease its policy rate to 1% after that shock,
and another half decade to undertake QE.
By acting more aggressively to defend against a
persistent, massive overdose of economic slack, both
the US and Canada are much less likely to fall into the
deflation trap that has fed into negative policy rates and
ultra-low bond yields. It’s just that to some extent, the
bond market has not recognized that difference.
More recently, Japan’s missteps have been associated
with a premature turn to fiscal tightening, in this case
in the form of hiking the sales tax, with another due in
2017. The result is that fiscal policy shifts are taking a
roughly 1.2% of GDP bite out of growth, as measured
by the change in the cyclically adjusted budget balance
(Chart 4). Little wonder then that the Bank of Japan felt
Japan’s near-zero nominal 10-year yields assumes that
inflation isn’t coming back in the next decade. That’s
visible in the market for inflation linked bonds, with a
breakeven implied 10-year inflation rate of only 0.2%.
Monetary policy could ultimately get aggressive enough
to make that the wrong call, but its easy to see why
investors could form their current opinion. After all, the
4
CIBC World Markets Inc.
Economic Insights - March 3, 2016
Chart 5
Chart 6
Inflation Expectations Out of Line With History,
Current Core CPI
Japanese Wages Never Recovered (L),
US Pick-up Already Starting (R)
Japan Avg Earnings
(% Yr/Yr)
6
Avg CPI Past 10Y
10Y Breakeven
5.0
4
4.0
Current Core CPI
F'cst
2
1.6
US Avg Hourly Earnings
(% Yr/Yr)
3.0
0
2.0
-2
0.8
1.0
-4
-6
Sep-17
Jan-16
May-14
Jan-11
Jul-15
Jun-10
May-05
US
Apr-00
Canada
Mar-95
Germany
Feb-90
Japan
0.0
Jan-85
0.0
Sep-12
0.4
Sep-07
1.2
May-09
2.0
%
Jan-06
2.4
Source: National Statistics Agencies, Bloomberg, CIBC
Source: SBJ, BLS, CIBC
past decade has already seen a similar near-zero inflation
rate, and current core price hikes remain moribund (Chart
5).
territory, although it could cool given the tumble in
employment in the high-paid energy sector. But that’s not
the trend stateside (Chart 6). US wage gains are off their
lows, and are projected to head higher as the prime-age
employment rate continues to recover.
In contrast, inflation expectations for the US and Canada
are below their past-decade’s average, even though that
historical period included the much greater economic
slack of the great recession. Moreover, current core
CPI inflation readings are still sitting near 2% in both
countries.
Add it all up, and investors are simply overstating the
odds that the Fed will stay on hold, that inflation in the
US will dive, and that bond yields are thereby reasonable
at sub-2% 10-year rates. Even in Canada, fiscal stimulus
could avoid the worst of what beset Tokyo markets.
Japan’s recent past may still be a guide for what lies
ahead for Japan, and even a risk for Europe, but North
America isn’t turning Japanese any time soon.
The low inflation assumed in the JGB market is also in line
with Japan’s near zero wage inflation, a consequence of
imbedded low inflation expectations and ample labour
market slack. Canadian wage growth is still in the 2%
5
CIBC World Markets Inc.
Economic Insights - March 3, 2016
Emerging Markets' Rebalancing Act
Benjamin Tal and Nick Exarhos
With Asiaphobia taking over from Asiaphoria, the impact
of slowing emerging markets on the rest of the world
is currently of crucial importance. As China tries to
rebalance its economy and find the optimal path between
an aggressive reform agenda and an acceptable rate of
GDP growth, there’s a non-trivial risk of an accident.
But to date, the market’s reaction to slowing EMs has
probably been too severe as investors overestimate the
linkage between emerging markets’ weakness and pass
through to developed economies. When the fog clears,
EM differentiation will continue to be a theme, with policy
stimulus and the pull from developed market growth
paying dividends in 2017.
Chart 2
Emerging Market Slowdown: Not Just China
8
%
Slowdown in Emerging Markets Was Broadly-Based
6
Acg 2012-2015
4
2
0
-2
-4
0
EMs Slowing is Old News
2
4
6
8
%
12
Avg 2000-2011
Source: World Bank, CIBC
After being the darlings earlier in the cycle, markets are
now waking up to the realization that emerging markets
can actually slowdown. But the reality is that growth in
emerging markets has been decelerating for almost half
a decade (Chart 1).
EMs Slide, and The Spillover Abroad
With the growing role of emerging markets in the global
economy, asset prices in developed markets have become
particularly sensitive to what happens in EMs.
Although it’s tempting to attribute all of this deceleration
to China’s well-publicized slowdown, essentially all
emerging markets have seen slower growth in the past 4
years relative to the growth they registered in the previous
decade (Chart 2). During that broad-based slowdown,
currencies have softened relative to the greenback and
firms have seen both margins and topline growth come
down.
But what is the impact that of a slowing in emerging
markets on developed economies? The answer lies
primarily in the interplay between two factors. The first
is the income effect, as slower external growth reduces
effective demand in domestic markets. The second is
Chart 1
Chart 3
EMs Have Been Slowing for a Half-Decade
Sizing Up EM Dent To DM Growth
0.0
-0.1
-0.2
-0.3
-0.4
-0.5
6
UK
-0.6
Japan
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Developed Emerging
economies Markets to
to Emerging Developed
economies
markets
Eurozone
0.0
-0.1
-0.1
-0.2
-0.2
-0.3
-0.3
-0.4
-0.4
-0.5
Impact of 1%-point slowing
in Emerging markets
Impact of 1%-point slowing
in GDP
US
10
9
8
7
6
5
4
3
2
1
0
Source: IMF, CIBC
10
Source: IMF, CIBC
CIBC World Markets Inc.
Economic Insights - March 3, 2016
Further complicating the matter, there isn’t a uniform
impact amongst developed market corporates. Corporate
Germany derives close to 10% of sales in emerging
markets, compared to an estimated 2% seen in the US.
Also note that those sales are largely aimed at emerging
markets’ consumers, who are—on the whole—still seeing
an acceleration. That serves to limit the negative impact
on multinationals.
Chart 4
EM Slowdown Lowers DM Growth Track – A Bit
Growth in Advanced Economies
2.5
%
2.0
1.5
1.0
As for financial markets, bank linkages and cross boarder
holding of securities have grown rapidly over the past
decade, but relatively speaking they’re still small. Bank
claims on EM borrowers range from 4% of assets in the
UK, just over 1% in the US and even lower in Japan and
Germany. The EM slowdown matters to the rest of the
world, but the impact appears to have been exaggerated.
0.5
0.0
2011
2012
Actual
2013
2014
2015
Ex impact of slowing EMs
Source: IMF, CIBC Calculations
The Blow To and From Commodities
the substitution effect, driven by weakening foreign
currencies rotating exports away from developed markets.
If the link between emerging market and developed
economies growth is not as strong as perceived by many,
that’s not the case in the commodity space. As illustrated
in Chart 5, commodity exporting countries like Russia and
Venezuela felt a harsher blow recently.
Based on elasticities calculated by the IMF, a 1%-pt
slowing in emerging markets growth will lead to just
over 0.2%-pt softening in developed economies, with
most of the impact seen in the Eurozone and Japan
(Chart 3). The impact of slowing EMs on growth was
noticeable but hardly a game changer (Chart 4). In
fact, a softening in developed economies has a greater
impact on EM growth. Granted, slowing emerging
markets can impact developed economies via other
channels such as the effect on their corporate sector.
Large multinational companies derive sales and profits
from goods manufactured and sold in China and services
provided there as well. The latter’s economic and financial
impact is not well captured by exports.
However, overall oil exporting economies account for only
13% of EMs’ GDP. In fact, the impact of EMs’ growth
on the commodity space was more important, and can
be measured by using specific IMF elasticities. Estimates
suggest that the deceleration in aggregate EM growth
accounted for almost half the decline in commodity prices
since 2011 (Chart 6).
Chart 5
Chart 6
Oil Exporters Hit Harder (L);
But Still Small Slices of EM Pie (R)
Slowing EMs Accounted for Half the Decline in
Commodity Prices
Deceleration in Activity:
Oil Export vs. Non-Oil
Export
0
Contributions to Commodity Price Weakness (%)
-5
13%
0.0
-10
-0.5
-15
-1.0
-20
-1.5
87%
-25
-2.0
-30
-2.5
Oil
exporters
Oil
importers
Source: IMF, CIBC Calculations
Oil Exporting EMs
-35
Rest
EM Slowdown
7
Other Factors
Including Supply
CRB Drop Since 2011
Source: IMF, CIBC Calculations
CIBC World Markets Inc.
Economic Insights - March 3, 2016
The Middle Kingdom vs Rest of EM Universe
Chart 8
China’s Worth-less Investment
China’s economy is destined to slow as it matures. In fact,
recent output from the economy has been somewhat
firmer than what the statistics alone would have
suggested GDP growth should be running at.
Investment Efficiency (Inversed Icor)
Index 2004=100
120
100
But the recent soft patch in Chinese economic indicators
has been cyclical as well as structural. Some of it has even
been policy-induced. The most notable examples of the
former have been failures in reducing financial market
volatility, but there have been other missteps that have
affected the real economy. For example, a reform aimed
at mitigating risks from the shadow banking sector led to
a decline in public investment.
80
60
40
20
0
04
05
06
07
08
09
10
11
Furthermore for EMs as a whole, cheaper resource prices
driven in part by a slowing in the Chinese appetite for
raw materials could see a broader pick up in investment in
other countries. Taking another look at Chart 7 suggests
that most EMs are committing roughly the same amount
of their national output to investment as the developed
market average.
Despite renewed efforts that should see a stabilization
in growth, investment’s share of GDP is still destined
to come down over the medium term. Will that be the
death knell for Chinese growth? We think not. The overall
quality of investment has been on a precipitous decline
(Chart 8), meaning that additional capital flowing to
these projects is having a diminishing impact on overall
growth. Capital committed to these large projects could
actually be crowding out spending that would otherwise
serve as a catalyst for other sectors. A more balanced
Chinese economy will be growing at a slower pace than
seen previously, but will see more sustainable underlying
dynamics.
Given their smaller capital base, and the greater returns
that capital would have in those nations than in more
developed ones, there’s room for most other EMs to ramp
up investment spending, something that planned fiscal
easing in most Asian EMs will target in the year ahead.
Capital expenditures in these other emerging markets will
be funded by FDI that has been crowded out by China
over the last two decades (Chart 9). Furthermore, central
government debt burdens are still modest in Asia leaving
ample room for investment initiatives.
Chart 7
Chart 9
Investment in GDP: China Miles Above Other EMs
EM FDI Inflows Soaked Up By China
FDI Flows (US$ bn, 2014)
Investment Share of GDP (%, 2014)
250
DM Avg
200
60
150
50
China Share of Emerging
Asia FDI (%)
40
100
30
50
20
10
China (incl
Rest of
HK)
Emerging Asia
8
80
70
0
Source: IMF, CIBC
13
Source: IMF, CIBC
Unlike other EMs, growth in China depends heavily on
capital expenditures (Chart 7). Indeed the typical response
function from Chinese policymakers to cyclical slowdowns
is well-known: stimulate borrowing to target investment
in large infrastructure projects. The most pronounced
example was heavy fiscal stimulus program of 2008-9.
50
45
40
35
30
25
20
15
10
5
0
12
0
90 94 98 02 06 10 14
Source: UNCTAD, CIBC
CIBC World Markets Inc.
Economic Insights - March 3, 2016
EM Winners: Separating the Wheat from The Chaff
Chart 11
Some EMs Not Reliant on China
Part of the answer of who will receive these flows, and
which countries are likely to lead emerging market
growth over the medium-term lies with underlying
institutional strength. Averaging the six governance scores
that the Work Bank compiles (Chart 10), reveals that
there is a great disparity amongst emerging markets in
terms of institutional development.
Share of Value Added in Exports Absorbed by China (%)
30
25
20
15
Nations like Poland and Hungary are near the top
of chart, and should also be well positioned to take
advantage of what will be firming Eurozone growth in the
coming year. Others who rank lower aren’t likely to be the
first to attract capital, and are also tied to less constructive
areas of the global economy.
10
5
0
Commodity Focused
China Linked
Other EMs
Source: IMF, CIBC
commodity producers—no surprise for those of us based
in Canada—will be for another anemic year, if a bit less
negative than 2015 proved to be, as firmer demand puts
a bottom in source prices.
Indeed, we can think of separating emerging market
economies between those linked directly to China,
others whose economies are tied to the production of
commodities, and the rest who are tied to other areas
of the global economy, particularly to developed market
growth. For the last group of countries, the IMF’s TIVA
data suggests that less than 10% of the value added in
their exports is destined for the Middle Kingdom (Chart
11).
Emerging markets tied to developed economies, including
Mexico and eastern European nations, are likely to fare
slightly better. Although the budgetary outlook for
emerging markets in Europe points to the government
sector being a drag, they are in a better starting fiscal
position than Latin American EMs and those in the Middle
East and Africa.
2016: The Transition Year for EMs
China will continue pursuing simulative policies, and by
the end of the year there will be greater signs of a firming
in activity. Asian emerging markets as a whole are poised
to see fiscal stimulus play a role in supporting growth
in the year ahead, while low resource prices have given
room on the inflation front that has already seen several
central banks in the region ease rates. The outlook for
Putting it all together, this year should see somewhat
of a repeat of 2015, although the divergence in growth
amongst emerging markets should narrow somewhat.
A more even flow of capital, easier monetary policy, a
modest rebound in resource prices, and momentum in
developed markets should bear fruit in 2017 (Chart 12).
Chart 10
Chart 12
Wide Range of Institutional Strength
Policy Eases in Asia (L), EM Growth Pickup in ‘17 (R)
2.0
Change in Policy Rate from
Year-Ago (%)
Average Governance Score
1.5
0.0
1.0
-0.2
0.5
0.0
-0.4
-0.5
-0.6
-1.0
-1.5
-0.8
Venezuela
Egypt
Russia
China
Argentina
India
Thailand
Colombia
Saudi Arabia
Mexico
Indonesia
Turkey
Brazil
South Africa
Malaysia
Hungary
Poland
Chile
USA
Germany
-2.0
Source: World Bank, CIBC
-1.0
Emerging Market Growth (%)
6.0
5.0
4.0
3.0
2.0
1.0
0.0
9
Source: Bloomberg, IMF, CIBC
CIBC World Markets Inc.
Economic Insights - March 3, 2016
Federal Budget: Turning Prudence On its Head
Royce Mendes and Avery Shenfeld
When setting a federal budget against a backdrop of
anemic growth, low interest rates, and a modest debt
burden, what’s typically seen as prudent is anything
but. A failure to provide adequate stimulus risks seeing
a period of subpar growth leave lasting scars on the
domestic economy. Fortunately, judging by the majority
government’s recent communications, Canada’s March
22nd federal budget won’t make that mistake.
A Deterioration in the Outlook
Chart 1
Canada Has Low Federal Government Debt
Federal Government Debt-to-GDP Ratios (%)
250
200
150
100
Last week Canadians received a sneak peek at the Liberal
government’s economic assumptions for the next few
years. As expected, the outlook presented was anything
but pretty. In line with the street’s forecasts, growth and
inflation projections were slashed.
50
0
Canada
Germany
UK
US
Japan
Source: StatCan, Eurostat, FRED, Japan MIAC, Bloomberg
The revised starting point for the 2016-17 budget deficit
is now $18.4 bn. Of that, only $2.3 bn reflects measures
taken since the Liberals took office, including the tax
cuts for the middle class and the $250 mn stabilization
payment to Alberta.
revenue on the additional GDP growth generated more
than covers the interest payments accruing on the initial
ramp up in debt.
The key variable left to forecast the final deficit is the size
of the stimulus program. The Liberals had campaigned
on $10 bn of stimulus which would roughly translate into
a $30 bn deficit, but we’re betting on something larger
as the outlook for the economy has dimmed since then.
Infrastructure is an appropriate place to spend the lion’s
share of stimulus funds given that it will put people back
to work and, if the projects are chosen wisely, increase
the economy’s productive capacity.
Infrastructure Spending
Recent estimates suggest that Canada’s infrastructure
deficit stands at over $120 bn. Moreover, the share
of infrastructure spending by the federal government
Fiscal Flexibility
The federal government has ample fiscal room to
stimulate. Relative to central governments in other major
economies, Canada’s debt-to-GDP ratio of 30% ranks
among the lowest (Chart 1). But even those countries
with considerably more debt have not come up against
any material borrowing constraints.
Chart 2
Interest as a Percentage of Revenue Falling
45
Interest as a Percentage of Federal Government Revenue
40
35
Moreover, public debt charges as a percentage of federal
revenue have continued to fall (Chart 2). With longterm interest rates at historically low levels, that ratio
should shrink in the years ahead as maturing debt gets
rolled over at lower rates. Indeed, a widely cited paper
by leading economists Larry Summers and Brad DeLong
demonstrated that, under plausible assumptions and
low interest rates, the burden on future generations is
actually reduced by expansionary fiscal policies. The tax
10
30
25
20
15
Forecast
10
5
0
Q1
1981
Q3
1985
Q1
1990
Q3
1994
Q1
1999
Q3
2003
Q1
2008
Q3
2012
Q1
2017
Source: StatCan, CIBC
CIBC World Markets Inc.
Economic Insights - March 3, 2016
relative to that of provincial and local governments has
been falling since the mid-1990s. With provincial debt
already elevated by historical standards (Chart 3), and
their bond spreads widening recently, having Ottawa pick
up more of the tab will both protect credit ratings and
lower the overall cost of borrowing.
of the small business tax rate, thereby providing a little
more cover for the middle income tax cut. Separately,
the government could target tax relief at private capital
investment, an area that is struggling in the wake of the
oil price collapse.
Balance Not Necessary to Improve Fiscal Position
The Liberal’s election platform called for $5 bn in
additional infrastructure spending and roughly $5 bn in
other stimulus during the first two years of the mandate.
However, with the economy underperforming even the
modest outlook that most market participants were
forecasting last fall, we question whether that’s enough
to get the economic engine firing on all cylinders again.
Federal stimulus under that scenario would be barely
more than 0.5% of GDP, arguably too little to do the job,
particularly with some provinces applying fiscal brakes.
Given the weaker outlook, a balanced budget during the
Liberal mandate is no longer in the cards. But that doesn’t
mean Canada’s fiscal position, properly measured, is set
to deteriorate over time. In fact, as growth rebounds,
aided in part by government stimulus, the debt-to-GDP
ratio is expected to fall in spite of the forecasted deficits.
Assuming a $35 bn deficit in 2016-17, a $30 bn deficit
in 2017-18 and $20 bn deficits during the subsequent
eight years, the debt-to-GDP ratio would fall from roughly
30% today to 28% by 2025 if nominal growth averages
four percent. Indeed, it would take 15 years of $100 bn
deficits to see the federal government’s debt-to-GDP
ratio even approach the levels seen during the mid-1990s
(Chart 4).
$20? $30? or Do I Hear $40 bn?
We see a $20 bn stimulus program with a $40 bn
deficit as being more appropriate, but given the political
sensitivities, the government might show something
closer to $35 bn for 2016-17, while perhaps taking on
some further stimulus charged to the outgoing year.
A key lesson learned in the aftermath of the financial
crisis was that overly restrictive budgets can do more
harm than good, if their effects on GDP are great enough.
That’s been the case in the Eurozone, where the dent to
GDP due to tight government purse strings has stymied
progress on debt-to-GDP ratios. Larger deficits will no
doubt attract some harsh words from those who recall
the stresses of the early 1990s. But in today’s context,
they represent the prudent approach to getting Canada
back in gear, and are clearly a superior alternative to the
negative interest rates seen in Europe and Japan.
Beyond infrastructure, funding will likely be aimed at
aboriginal people, veterans and families. An extended
period for EI eligibility and support for low income
households could also be on the table, with the
government studying a “guaranteed annual income”
approach. Support for environmentally friendly
technologies could show up on budget day, as well.
On the tax side, the government might restrict the
ability of incorporated professionals to take advantage
Chart 3
Chart 4
Provinces and Territories Have High Debt Loads
Current
Source: Haver Analytics, StatCan, CIBC
Prior
Peak
2007
Current
11
2028F
2007
2025F
Prior
Peak
0
2022F
0
2019F
0
10
2016F
10
2013
5
Forecast Assuming
Deficits of $35 bn in
2016, $30 bn in 2017
and $20 bn Thereafter
20
2010
20
2007
10
30
2004
30
2001
15
40
1998
40
1995
20
50
1992
50
1989
25
Forecast
Assuming
Deficits of $100
bn each year
60
1986
30
60
Federal Government Accumulated Deficit to GDP
70
1983
70
Federal Government Debtto-GDP Ratio
1980
35
Province and Territory
Debt-to-GDP Ratio
Debt-to-GDP to Fall Even With Expected Deficits
Source: StatCan, CIBC
CIBC World Markets Inc.
Economic Insights - March 3, 2016
ECONOMIC UPDATE
2015A 2016F 2017F
15Q4A
16Q1F
16Q2F
16Q3F
16Q4F
17Q1F
Real GDP Growth (AR)
0.8
1.6
1.2
1.9
2.4
2.7
1.2
1.4
2.3
Real Final Domestic Demand (AR)
-0.6
-0.1
0.8
1.3
1.8
1.7
0.5
0.3
1.5
Household Consumption (AR)
1.0
1.1
1.6
1.3
1.3
1.4
1.9
1.4
1.4
All Items CPI Inflation (Y/Y)
1.3
1.7
1.6
1.5
2.1
2.5
1.1
1.7
2.5
Core CPI Ex Indirect Taxes (Y/Y)
2.0
2.0
1.9
1.8
1.8
1.9
2.2
1.9
2.0
Unemployment Rate (%)
7.1
7.3
7.5
7.4
7.3
7.3
6.9
7.4
7.2
CA NA DA
U.S.
2015A 2016F 2017F
15Q4A
16Q1F
16Q2F
16Q3F
16Q4F
17Q1F
Real GDP Growth (AR)
1.0
2.5
2.6
2.2
2.2
1.7
2.4
2.2
2.1
Real Final Sales (AR)
1.1
2.8
3.0
2.4
2.3
1.8
2.2
2.5
2.2
All Items CPI Inflation (Y/Y)
0.5
1.2
0.8
1.3
2.5
3.0
0.1
1.5
2.9
Core CPI Inflation (Y/Y)
2.0
2.2
2.2
2.3
2.3
2.2
1.8
2.2
2.3
Unemployment Rate (%)
5.0
4.9
4.7
4.6
4.5
4.5
5.3
4.7
4.4
CANADA
The fourth quarter of 2015 was hardly a scorcher, but the 0.8% growth rate was better than the expected flat
outcome. That, combined with a brighter Q1 outlook, is good enough to lift the overall track of GDP growth
for 2016 by one-tick, to 1.4%. Softer oil prices should dampen headline CPI’s annual average this year, while
providing easier base-year comparisons for 2017. Our outlook for the labour market continues to highlight an
even higher unemployment rate ahead.
UNITED STATES
Amidst the financial market turmoil earlier this year, talk of a US recession grew louder and caused traders to
pull back bets on further Fed rate hikes. It’s true that the economic data has seen soft patches, but that overly
sour sentiment underestimates the underlying momentum in the domestic economy. Employers’ demand
for labour remains robust leaving consumers with more spending power, while both wages and the Fed’s
preferred measure of inflation have been trending higher recently. Looking ahead, that strength should allow
the domestic economy to grow by more than 2% in 2016.
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