World: Monetary policy eases further

- "Global growth will moderate in 2011. Emerging Asia will remain the driver. With inflation on the whole still tame and, especially, with developed economies slowing, the major Asian central banks are probably not being reckless in giving monetary policy a further expansionary turn."
- "With the U.S. economy halfway back to its previous peak, cyclical forces are fading. A fog of uncertainty about next year’s tax rates is modifying the behaviour of households and businesses. The U.S. is entering a slow-growth trap, with real growth unlikely to exceed 2% annualized in the second half of 2010."
- "The Canadian recovery has reached maturity. Real GDP, employment and domestic demand have all passed their pre-recession peaks. On the other hand, U.S. growth is slowing just when Canada has moved from recovery to expansion and the first signs of cooling have appeared in domestic demand growth. We expect Canadian GDP growth to slow from 3%-plus in 2010 to its approximate cruising speed of 2% in 2011."

Bank of Canada cannot go it alone much longer

- "The Bank of Canada (BoC) has just raised its key rate a third time while the central banks of most of the other advanced countries look on from the sidelines."
- "The BoC’s actions are in response to the more vigorous recovery in Canada, which is benefitting from a strong rebound in economic growth in the emerging countries. Moreover, in terms of domestic demand growth, Canada stands in sharp contrast with the United States, where the housing crisis has caused household balance sheets to deteriorate considerably."
- "In light of the respective shocks suffered and present inflation levels, while the BoC proceeds to normalize rates, the Fed should stay put for yet another year."
- "Although exports as a percentage of GDP have fallen drastically since 2000, the fact is that the Canadian economy remains a small open economy whose monetary policy cannot diverge outrageously from that of its principal trade partner."
- "In 2003, the central bank had to backtrack after learning this lesson the hard way. In the period when the yield spread on 2-year government bonds reached 200 bps, the loonie gained US$0.10."
- "In our opinion, the BoC will go ahead with only two more 25-bp hikes seeing how both international trade and residential investment are expected to detract from economic growth in the coming months. Canadian monetary authorities should then mark time before raising rates further until the U.S. economy gets up and running again."

Foreign exchange market once again in hands of Federal Reserve

- "U.S. real GDP data revisions by the Bureau of Economic Analysis this past July 30 put a dent in our growth and monetary policy scenarios."
- "The data revisions, which showed the U.S. economy running at an even lower capacity utilization rate than initially reported, converged with a soft job market to leave the financial markets feeling disenchanted about the possibility of an imminent interest rate hike in the United States."
- "The euro should not trend up in any sustainable fashion over the medium term. However, if macroeconomic policy in the United States takes a more stimulative turn, the greenback is likely to depreciate to some extent. This is why we believe the European currency will in the short term climb a little above its present level without, however, gaining any undue momentum."
- "Moreover, if the Fed sticks with its extremely accommodative monetary policy, a quick flurry of interest rate hikes this side of the border could launch the loonie into orbit. The Bank of Canada will therefore likely adopt a “stop and go” strategy."
- "Against this backdrop, we still see the loonie attaining parity with the greenback, only now at a slightly later date and at a somewhat slower pace."

Fog on the recovery road

- "We continue to think that economic recovery is on track in most of the developed world and that emerging Asia will continue to expand robustly. On the other hand, recent U.S. developments cannot be ignored. Though we trace much of the expected Q3 slowdown in U.S. domestic demand to the unwinding of temporary stimulus, the recovery remains fragile."
- "Fiscal policy is a key source of uncertainty. At this writing the future of the Bush tax cuts, set to expire at the end of this year, is still up in the air. Unfortunately, political dithering in Washington and the resulting lack of clear guidance to investors on this issue means that the road to recovery is now fogged over– all the more so in that this fall’s midterm elections could provide a platform for protectionist rhetoric (not good either stocks or bonds)."
- "Though equity markets are likely to move higher in the coming months, the risk-reward outlook no longer warrants an overweight stance. Until some of the political dust settles, we are raising the cash portion of our model portfolio to 10% and reducing our equity exposure to a neutral 55%. Among the implications of this shift are a redistribution of our equity holdings among global regions and a realignment of our sector allocation to a somewhat more defensive stance."
- "Despite growing uncertainty, there are pluses in the prospects for equities. Double-digit earnings growth over the last few quarters has plumped up corporate treasuries, boosting their reserves of cash and other highly liquid assets. This bodes well for M&A activity down the road."
- "We are revising down our year-end index targets – the S&P/TSX to 12,100 from 12,700 and the S&P 500 to 1120 from 1280. These downgrades follow from our downward revision of real GDP growth and profits for Q3 and Q4. For the U.S. index we have also reduced our earnings multiple. Our EPS targets are now 740 for the S&P/TSX (down 7.5%) and 83 for the S&P 500 (down 2.4%)."

NBC Monthly Equity Monitor Sep2010

World: A soft landing in 2011

- "Europe’s cyclical momentum means that the chances of its dragging down global growth have lessened in recent months. However, a slowdown of the advanced economies next year is likely to bring a soft landing in 2011."
- "The U.S. badly needs more private-sector job growth to reduce its unemployment rate and keep the Fed from moving to additional quantitative easing. BEA revisions of past GDP numbers have reduced our expectation of 2010 growth, but we have revised up our outlook for 2011 in response to a higher savings rate and a less aggressive reversal of fiscal policy."
- "Since rock-bottom interest rates have encouraged Canadians to borrow from the future for spending on housing and consumption, the recent performance of the economy is no guarantee of its future as household dissaving comes to an end. We expect that strong 3.3% growth in 2010 will be followed by a deceleration of consumer spending and GDP in 2011."

NBC Monthly Economic Monitor Sep2010

Unusually uncertain times

- "In recent weeks, economic data have continued to be disappointing. U.S July durable goods orders were much weaker than projected suggesting business investments which have been an important source of growth so far might be running out of steam. It appears evident the U.S. economy will continue to need additional stimulus in order to close the current output gap and reduce the unemployment rate. Therefore, monetary policy can be expected to remain extremely accommodative well into the second half of 2011."
- "With the uncertainty about the U.S. economic outlook having increased in recent weeks, we believe the BoC will want to take a pause before further reducing the level of monetary stimulus. However as we expect the North American economy to avoid the feared double-dip, we still see the Bank raising its target rate from the current 0.75% to 1.50% in 2011."

NBC Monthly Fixed Income Monitor Sep2010

What BEA revisions mean for Fed

- "The Q2 real GDP data published this past July 30 came with a major revision of historical data by the Bureau of Economic Analysis (BEA)."
- "The economic analysts of the world were left slack-jawed by the disappearance of $100 billion from U.S. GDP for 2010Q1. Consumption alone was revised down $134 billion. As a result, instead of being in expansion territory, it turns out consumption is actually only midway up the recovery curve."
- "The labour market must begin creating enough private-sector jobs to bring down the unemployment rate. Otherwise, the Federal Reserve will not be able to tolerate the situation, as it would ultimately constitute a disinflationary environment."
- "On a more positive note, the level of labour productivity in the United States seems to have hit a wall in the short term. For the first time since the start of the recession, the composition of GDP growth has been geared towards employment rather than productivity."
- "This said, as the level of resource utilization in the economy has been pegged back, this implicitly modifies the impact of past monetary easing by the Federal Reserve."
- "If the unemployment rate does not begin to trend down, the Fed will have no choice but to step in once again."

NBC Weekly Economic Letter 20100820

The impact of structural challenges to growth in advanced economies

- "The current debate between the proponents of austerity measures and those who favour additional stimulus is largely irrelevant because most of the socio-economic problems faced by advanced industrial countries are structural rather than cyclical."
- "Increased global competition, de-industrialization and a loss of control over innovation have undermined the ability of advanced industrial economies to sustain "normal" or historical levels of economic growth."
- "We believe a combination of structural long-term debt, deteriorating demographics, a backlash against immigration, spending cuts and stagnating incomes will lead to political gridlock and instability in developed economies, further undermining efforts to deal with slow economic growth."
- "The current global economic and political situation increases the likelihood of protectionism and trade tensions."
- "Economic power and geopolitical power are inextricably linked. We believe the decline in the geopolitical clout of advanced countries will carry negative implications for economic growth. Conversely, economic growth in developing countries will benefit from theirexpanding sphere of influence."
- "Investors have to be mindful of the increasing disconnect between economic growth and market performance at the national level."
- "Investment conclusions: Emerging markets will continue to outperform developed markets; U.S. markets will outperform most other advanced economies; Indian markets will outperform Chinese markets; Latin American investments are favoured over African ones; Commodities will outperform, as will investments geared to global mega-trends."

NBC Global Investment Implications August 2010