Economic and Financial Market Outlook: Read My Lips… Monetary Stimulus is Here to Stay September 2013 David Tulk, CFA Chief Canada Macro Strategist.

Economic and Financial Market Outlook: Read My Lips… Monetary Stimulus is Here to Stay

September 2013

David Tulk, CFA

Chief Canada Macro Strategist

Central Banks Using Forward Guidance to Support the Recovery

• Federal Reserve

• fed funds rate: 25bps since Dec 2008

• balance sheet: $3.6 trillion

• tapering expected early 2014

• Bank of England

• base rate: 50bps since March 2009

• asset purchases: £375 billion

• European Central Bank

• refinance rate: 50bps since April 2013

“a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends” 6.5% unemployment rate, 2.5% inflation

“the MPC intends not to raise Bank Rate … at least until the … of the unemployment rate has fallen to a threshold of 7%”

“The Governing Council confirms that it expects the key ECB interest rates to remain at present or lower levels for an extended period of time”

Liquidity Has Been Assured, Relieving Financial Market Stress

3 Month Funding Over OIS (Basis Points)

0

100

200

300

400

2007 2008 2009 2010 2011 2012 2013Source: Bloomberg, TD Securities

United States Europe Canada

LTROs

OMT

Central Bank Stimulus Has Anchored Rates, Helped Risk Assets Perform

US Government Yields and S&P500

0

1

2

3

4

5

6

2008 2009 2010 2011 2012 2013Source: Bloomberg

0

400

800

1200

1600

2000

2 Year Yields (LHS) 5 Year Yields (LHS) 10 Year Yields (LHS) S&P500 (RHS)

Percent Index

QE1 QE2 QE3

US Fiscal Uncertainty and Austerity to Loom Large in 2013 and Beyond

US Fiscal Stimulus & Drag (Percentage Point Impact on Real GDP)

-2

-1

0

1

2

2009 2010 2011 2012 2013 2014 2015* Including ARRA and payroll tax expiration; Source: TD Economics

Forecast

Gradual Healing in the Housing Market is Encouraging…

500

1500

2500

3500

4500

5500

6500

7500

2004 2006 2008 2010 2012

2

4

6

8

10

12

14

16

18

20Months' Supply (RHS)

Sales (LHS)

US Existing Home Sales and Months Supply (Thousands Units, Months)

Source: NAR/Haver Analytics

Tax Credit

… As is the Improvement in the Flow of Credit

Composite Demand for Credit and Bank Lending Standards (Percent Reporting Greater / Tighter)

-80

-40

0

40

80

120

2006 2007 2008 2009 2010 2011 2012

Source: Federal Reserve/Haver Analytics

Demand Lending Standards

Labour Market is on a Very Long Journey to Recovery

-10

-8

-6

-4

-2

0

2

0 10 20 30 40 50 60

1960

1981

1990

2001

Current

US Job Losses by Recession (Millions of Jobs)

Source: BLS/Haver Analytics

Months Following Start of Recession

Census Hiring

Taper ≠Tightening: Cyclical Vulnerability to Keep Policy Very Accommodative

Mortgage Refinance Index & 30-Year Mortgage Rate

1

2

3

4

5

6

7

Jan-11 Aug-11 Mar-12 Sep-12 Apr-13

3.0

3.5

4.0

4.5

5.0

5.5Mortgage Refinance Index (LHS) 30-Year Fixed Rate Mortgage (RHS)

Source: Bloomberg

The US Economy is a Long Way Away from Full Capacity

-8

-6

-4

-2

0

2

4

1991 1994 1997 2000 2003 2006 2009 2012

United StatesCore PCE Inflation Less 2.5%

US Output Gap and Core PCE (Percent)

Source: Federal Reserve/Haver Analytics

US Forecast: Private Fundamentals Versus Public Austerity

US Economic Forecast Overview

2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3

Real GDP

Growth

(Q/Q ann.)

0.1 1.1 1.7 2.4 2.8 2.7 3.2 3.3

Unemployment

Rate (%)7.8 7.7 7.6 7.5 7.4 7.3 7.2 7.0

Federal Funds

Target* (%)0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25

10 Year Yields*

(%)1.75 1.85 2.49 2.60 2.80 3.00 3.15 3.30

* End of period; forecast as at September 2013. Source: Bloomberg, TD Securities

Canadian Recovery Is Running Out of Steam, Waiting for a Rotation in Growth

-12

-9

-6

-3

0

3

6

9

Sep-08 Jun-09 Mar-10 Dec-10 Sep-11 Jun-12 Mar-13

Domestic Demand Including Inventories

Net Exports

Real GDP Growth

Series3

Composition of Canadian Real GDP Growth (Percent)

Source: Statistics Canada/Haver Analytics

Bank of Canada’s Forward-Looking Guidance Speaks First to Stimulus…

“As long as there is significant slack in the Canadian economy, the inflation outlook remains muted, and imbalances in the household sector continue to evolve constructively, the considerable

monetary policy stimulus currently in place will remain appropriate. Over time, as the normalization of these conditions unfolds, a gradual normalization of policy interest rates can also

be expected, consistent with achieving the 2 per cent inflation target”

-4

-2

0

2

2002 2004 2005 2007 2008 2010 2011 2013

Output GapDeviation of Core Inflation From 2.0% Target

Measures of Canadian Capacity (Percent)

Source: Bank of Canada /Haver Analytics

… But the Legacy of ‘Lower for Longer’ Will Need to be Managed

70

90

110

130

150

170

1990 1993 1996 1999 2002 2006 2009 2012

Canada United States

Household Debt to Income Ratio* (Percent of Personal Disposable Income)

* Adusted to US Measure; Source: Statistics Canada, Federal Reserve / Haver Analytics

Tighter Mortgage Regulations Only Have a Limited Impact in Slowing Sales

60

80

100

120

T-3 0 T+3 T+6 T+9 T+12

2008 2010

2011 2012

Sales Activity Following the Announcement of Tighter Mortgage Regulations*

Existing Home Sales:

Source: CREA, TD Securities *Rebased to announcement of new regulations

Months

Before After

Affordability Will Remain in Check Despite Rising Rates

Canadian National Housing Affordability*

0

5

10

15

20

25

30

35

40

3.7% Posted 5.34% 7% Stress Test 2000 to 2007Average

* Assumes a constant home price and income; ** Assumes 25% down on an average home price, 5yr posted rate, 25 year amortization; Source: Bank of Canada, TD Securities

Monthly Mortgage Carrying Cost as a Percentage of Average Family Income**

Degree of Overvaluation in Housing Depends on the Metric

Housing Affordability Metrics: Threshold Carrying Cost Model

20

25

30

35

40

45

50

55

1980 1984 1988 1993 1997 2001 2006 2010

Source: Haver Analytics, CREA, Statistics Canada

30yr Average

Percent of Household PDI

10% Overvalued

Housing Affordability Metrics: Price to Rent

60

80

100

120

140

160

180

200

1980 1984 1988 1993 1997 2001 2006 2010

Source: Haver Analytics, CREA, Statistics Canada

30yr Average

Price-to-Rent ratio, indexed Year 2000=100

62% Overvalued

Canada Forecast: Subdued Growth Waiting for Foreign Support

* End of period; Forecast as at September 2013. Source: Bloomberg, TD Securities

Canada Economic Forecast Overview

2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3

Real GDP Growth

(Q/Q ann.)0.9 2.5 1.6 2.0 2.3 2.4 2.5 2.8

Unemployment Rate

(%)7.2 7.1 7.1 7.1 7.2 7.1 7.1 7.0

Core CPI Inflation

(Y/Y)1.2 1.3 1.3 1.6 1.6 1.7 1.7 1.7

Overnight Rate* (%) 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

10 Year Yields* (%) 1.95 1.87 2.44 2.60 2.75 2.90 3.00 3.25

USDCAD

(CAD per USD)* 1.00 1.02 1.05 FORECAST UNDER REVIEW

The Taper Trade Makes it as Much About USD Strength as CAD Weakness

Currency Performance vs USD (June 18 - 21)

-8 -6 -4 -2 0 2

GBP

CHF

DKK

EUR

CAD

AUD

JPY

NZD

SEK

NOK

CAD Correlations Breakdown in Favour of Macro Fundamentals

-1.0

-0.5

0.0

0.5

1.0

Sep-11 Dec-11 Apr-12 Jul-12 Oct-12 Feb-13 May-13 Aug-13

S&P500WTI2Y Rate Spread

1 Month Rolling CAD Correlations

Source: Bloomberg, TD Securities

Export Mix to Keep Rebound Subdued Amid Slower Domestic Demand

0

2

4

6

8

10

0 10 20 30 40 50 60 70 80 90 100

Composition of Canadian Exports Versus Forecasted Growth (Percent)

Source: Haver Analytics, TD

2013-4 Real GDP Growth Forecast for Trade Partner (2012 Shares)

Share of Canadian Exports

EU (9%)

Japan (2%)

US (74%)Asian NICs (2%)

Rest of the World (6%)

Mexico (1%)

ASEAN-4 (1%)

India (1%)

China (4%)

Market Positioning Far More Cautious on the Strength in CAD

Canadian Dollar Positioning & CAD Forecast

-120

-80

-40

0

40

80

120

160

2007 2008 2008 2009 2010 2011 2012 2013

Source: CFTC/Haver Analytics

0.9

1.0

1.1

1.2

1.3

1.4

Net Non-Commercial (LHS)USDCAD (RHS, inverted)

Forecast

A Sign that Longer-Term Investors are Also Shying Away from Canadian Debt

-8

-4

0

4

8

12

2005 2006 2007 2008 2009 2010 2011 2012 2013

Equities Money Market Bonds

Net Financial Flows into Canada (6 Month Moving Average, Billions CAD)

Source: Statistics Canada / Haver Analytics

Discontinuous Relationship With WTI & WCS Spread Limit CAD Upside

Spread Between WCS and WTI (USD/bbl)

-50

-40

-30

-20

-10

0

May-08 Apr-09 Mar-10 Mar-11 Feb-12 Feb-13Source: Bloomberg

WTI and USD/CAD (2000-2013)

10

40

70

100

130

160

0.9 1.1 1.3 1.5 1.7Source: Bloomberg, TD Securities

You are Here

• Some of the near-term risks in Europe have faded, but very important structural challenges remain unresolved.

• Slow abatement of headwinds in the United States is consistent with a prolonged economic recovery, stimulus withdrawal still far away.

• Canadian growth will remain unbalanced but ultimately requires support from foreign demand. Risk of a US-style housing correction is low and interest in CAD is fading.

• The global economy remains vulnerable to economic and other shocks, ensuring policy stimulus remains in place. Volatility and uncertainty will remain elevated.

The Outlook in a Nutshell

David Tulk, CFA

Chief Canada Macro Strategist

416 – 983 – 0445

[email protected]