First interest rate increases forecast for 2013
Troy Media – by Central 1 Credit Union
The economy is proving resilient and policymakers are responding with sufficient measures to avert a dire outcome.
This does not mean the future is without its problems or pitfalls with political elections in several countries and many imbalances affecting the global economy, not to mention the ongoing sovereign debt and banking problems in Europe exacerbated by its recession. Global growth, however, will receive a lift from the U.S. and soon from the emerging economies such as China.
Low interest rates will prevail for some time but with an upward bias in 2012, followed by a central bank policy shift in 2013 signaling the beginning of rate normalization. The bond market will be ahead of the central bankers and occasionally too far ahead, only to retreat before leading the rate trend higher.
A mixed but generally positive economic performance materialized in the past month. Global PMIs (Purchasing Managers Index) indicate rising output in Asian countries but weakness in Europe. Production expanded for the fourth consecutive month in March after stalling in September to November 2011.
Growth continued in U.S. manufacturing. This growth upswing could be temporary once the rebound due to the flooding in Thailand dissipates and higher inventory restrains production.
While global economic growth is at a slower pace than this time last year, no fallback into recession is likely in the near term nor is a strong growth resurgence. Moderate growth will be the watchword for 2012 and 2013 with a few disruptive episodes emanating from Europe.
The U.S. is in an election year, with a high probability of at least one unfavourable market reaction, and if not then, when a higher debt ceiling is needed in 2013.
In Europe, the EU summit in early March provided a solution for the Greek debt crisis, including a restructuring of private debt and a second bailout. A new fiscal agreement was reached and it will come into force in 2013 or possibly earlier if sufficient approval is granted. Greece is preparing for elections in May and spring elections in France have the potential to raise market uncertainty.
Most recently, the Eurozone approved a combined new lending capacity for the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF). The deal ensures that €500 billion of lending capacity beyond the funds already committed is available from the middle of this year. This figure disappointed those who considered a figure closer to €1 trillion as necessary.
Markets are looking at Spain and Portugal forthe next possible bailout requests. Of these, Spain presents the larger problem since its debt burden is considerably higher and it is much larger economy. Spanish 10-year government bond yields are inching higher once again and with that economy in a deep recession. More problems loom ahead. The Spanish government’s new austerity measures may not be sufficient.
While a sovereign debt default remains a significant market risk, the state of the Eurozone banking system and credit conditions are more important to the day-to-day functioning of the economy. Total credit granted rose by 1.4 per cent in each of the first two months of the year, mainly to government, while credit to the private sector remained weak and loans to households decreased to 1.2 per cent in February from 1.3 per cent in January. Credit expansion is a function of both demand and supply and both are restraining forces. In addition, European banks need to meet their new higher capital requirements by the end of June 2012.
Europe’s economy is in a mild recession. The Eurozone Manufacturing PMI fell to a three-month low in March and remained in contraction territory. New orders contracted at a faster rate, leading to falling output and further job losses. More significantly, there were signs that the manufacturing recession spread to the core countries. Germany’s PMI fell below the neutral 50.0 mark for the first time in 2012, while French manufacturing contracted at the sharpest pace since June 2009.
The recession in Europe is expected to remain mild in 2012 and concentrated in the peripheral countries. Most economies, with the exception of Greece and Portugal, are seen to be growing in 2013 and beyond. A weak recovery is widely expected.
Fortuitously for the global economy, China is emerging from its economic growth slowdown at the end of 2011. China’s National Bureau of Statistics released the March Purchasing Managers’ Index with a 53.1 reading at a one-year high. The Chinese Lunar New Year likely held down activity earlier in the year and the Thailand recovery helped not only Chinese manufacturing but also others in the region and mainly in high-tech and autos.
China’s Premier announced a lower GDP growth target at 7.5 per cent for 2012, the first time the official target was lowered in eight years. Markets reacted negatively but the PMI readings helped reverse the negative sentiment.
Most forecasters put China’s growth above the government’s 2012 target. The consensus average for 2012 is 8.4 per cent with a high of 8.7 per cent and a low of 7.9 per cent. For 2013, the consensus average is 8.6 per cent.
Chinese policy-makers have considerable room to deliver more policy easing, which is quite likely and consistent with their intended shift to stimulate domestic demand and rely less on exports for growth. Risks from their hot property markets are significant but manageable. The Chinese currency will see further gradual appreciation.
The U.S. economy is growing at a respectable pace. The warm winter has boosted some economic data, but the underlying trend is an improving labour market with the key cyclical sectors in uptrends. Economic data will weaken in coming months as the effects of the warm winter fade and higher gasoline prices bite into discretionary income, but the economy’s fundamentals are firming in 2012.
Gasoline prices are approaching $4 per gallon with limited effect on consumer sentiment and spending so far. However, higher gas prices are expected as refinery issues continue. In addition, there is the potential for a disruption from Middle East supplies but this risk premium is already priced into crude oil. Oil price forecasts for WTI range from US$100 to US$105, which is near current levels. The concern is from higher refinery costs and the lagged impact on the economy both of which should become more evident in the summer months.
Real consumer spending accelerated so far this year with gains concentrated in autos and other durable goods. Weak income growth and high unemployment are obstacles but recent labour market improvements bode well for larger income gains in 2013.
Residential construction is past its cycle low and beginning a sustainable upturn despite low housing prices and considerable foreclosures yet to hit the market. Recent employment reports are affected by milder than usual winter weather and there is a fair amount of uncertainty by how much. This temporary boost from the weather will eventually unwind in the spring months.
The ADP employment survey indicates a lesser gain in March at 209,000 in private employment, following February’s revised 230,000 increase. The ISM surveys for March show improvement in manufacturing while services continued to expand but at a slower pace.
March vehicle sales dipped to 14.4 million units seasonally adjusted annualized from February but seasonal factors may have inflated February. Unadjusted sales were well above February, reaching their best pace since August 2007.
Turning to other sectors, capital spending looks to have moderated in response to the expiration of business tax incentives at the end of 2011. The Conference Board index of leading indicators rose 0.7 per cent in February for the fifth consecutive monthly gain indicating that growth will continue through the first half of 2012. The ECRI weekly leading index rose to 125.9, for the week ending on March 23, from a revised 125.4 also signaling further growth. Real GDP for Q1-2012 is tracking between 2.0 to 2.5 per cent.
In addition to rising gasoline prices, another threat to growth is government policy or as Fed Chairman Bernanke described “a massive fiscal cliff” at the end of 2012. Automatic budget tightening is prescribed in current legislation: the 2 per cent Social Security tax cut expires on December 31, 2012 along with the provision for extended unemployment benefits; the Bush tax cuts expire on December 31, 2012; and a large sequester of planned defense and non-defense spending going into effect in early 2013.
At about the same time, the debt ceiling will need to be raised again. Real government spending fell 2.1 per cent last year and will likely repeat this year. Some estimate the impact of the fiscal cliff to be as much as 4.5 per cent of GDP while others put it at 3 per cent.
Predicting what politicians may or may not do is fraught with considerable uncertainty but avoiding an economic shock should prevail with all the political manoeuvering and grandstanding that accompanies such decision-making. Markets will be jostled back and forth.
In the meantime, growth will pick up as 2012 progresses. A strengthening global economy will boost exports later in the year when the recession in Europe ends. Real GDP increases about 2.5 per cent with consensus at 2.7 per cent in 2013 and 3.1 per cent in 2014. No forecaster in the survey is predicting a U.S. recession or sees a negative quarter in 2012.
Canada’s economy edged forward modestly in January but helped by the upward revision to December, Q1-2012 GDP is on track for a solid gain. The labour market has underperformed recently but will begin to generate more significant job growth with a stronger U.S. and global economy.
The Federal 2012 budget offered few surprises and kept the government on a mild austerity course. The spending forecast is slightly contractionary for the economy in 2012 and 2013.
The housing market is holding up and, while March national sales are not yet released, sales data from some individual real estate boards points to a similar seasonally-adjusted sales level as in February but with a small downside outcome possible. Housing prices have held up and will show a small gain over February. Canada’s housing market is in reasonable shape not requiring a policy intervention to cool or stimulate it.
The leading indicator increased for the eighth consecutive month, rising 0.6 per cent in February led by an increase in its financial components, particularly the first rise in the stock market component in nine months. Manufacturing also contributed positively to the strong growth in the overall index.
The consensus forecast has moved its expectations slightly higher on better than expected U.S. data and no hard landing for China. Quarterly real GDP has been raised to 2.2 per cent from 2.0 per cent in Q1-2012 and to 2.1 per cent from 1.7 per cent in Q2-2012. For 2012, growth is 2.2 per cent from 1.9 per cent. The outlook for 2013 is unchanged at 2.3 per cent.
This forecast sees Canada’s quarterly growth profile tracking the U.S. higher with growth rising to 2.5 per cent in the first half and 3.0 per cent later in the year. This results in 2012 growth at 2.4 per cent in 2012 and 2.8 per cent in 2013.
The Bank of Canada’s outlook for the Canadian economy has marginally improved relative to its January report, according to the Governor. The Bank expects temporary factors to boost first quarter growth above their published 1.8 per cent forecast, but that underlying growth remains around trend estimated at 2.0 per cent annually. A forecast update will come out in mid-April.
Consumer prices rose 2.6 per cent over the 12 months through February, slightly above January. The Bank of Canada’s core price index rose 0.2 per cent in February, bringing the rate of 12-month core inflation to 2.3 per cent, up from 2.1 per cent in January. Higher energy and food costs will continue to be the main pressures. Over the past four months, the average monthly change has been less than in the previous four months suggesting some deceleration in inflation.
Bond yields and some short-term bill rates rose in the first two weeks of March on better than expected economic news and the Greek debt agreement. Thereafter though, bond yields and rates retreated by about one-half of their rise.
The Bank of Canada kept its policy rate at 1.00 per cent. However some administered market rates displayed unusual behavior during the month. In particular, the five-year GIC rate surged to 2.1 per cent from 1.63 per cent only to fall back to 1.63 per cent in the following week according to the Bank of Canada. The three-year GIC rate fell to 1.13 per cent in early March from 1.40 per cent in late February. Oddly, this put the three-year GIC rate slightly below the one-year GIC rate at 1.15 per cent.
We conducted our own survey of deposit rates and found no such change in either three-year or five-year GIC rates. According to our survey, a typical three-year GIC rate is 1.40 per cent and 2.1 per cent for a 5-year. It is not clear why the Bank’s database contains those figures but a query sent to the Bank may provide some clarity. There was no change in typical posted fixed term mortgage rates in March, though there were some temporary special offers of a five-year term at 2.99 per cent.
The Bank of Canada held overnight rate at 1 per cent at its March 8 meeting. There was no forward guidance to markets regarding the timing of its next rate hike. The Bank emphasized the considerable monetary stimulus and the uncertainty over the global economic outlook and the Canadian economy.
In the U.S., the FOMC did not make any changes either at its March meeting. The minutes to the March 13 FOMC meeting suggested a continuance of its near-zero interest rate policy and guidance of exceptionally low rates until late 2014.
The odds of a QE3 diminished somewhat but remains on the table should conditions deteriorate. The Fed’s guidance on low rates could include a rate increase before late 2014. Moving its target rate up to 0.50 per cent or 0.75 per cent would still be consistent with exceptionally low rates. It will depend on the performance of the economy and its outlook.
Interest rate forecast
A slight change to the interest rate forecast this month with the Bank of Canada’s first rate increase moved up to July 2013. Rate normalization will continue to occur gradually in phases of tightening followed by pauses and more tightening. The futures market for three-month Banker Acceptances is also more optimistic and prices in the first 25 bps increase by March 2013 from December 2013 in late February. Market expectations can move quickly and by a large amount. The consensus forecast puts the overnight target rate at 1.00 per cent at the end of 2012 and 1.50 per cent at the end of 2013.
Interest rate forecast is for an increase by Mar. 2013 while another sees no change into 2014. At least one forecaster sees a 25 bps rate cut in April 2012.