Bank Of Canada Forecasting?

You Decide

There is no doubt that the Bank of Canada has some really smart folks putting together all the data and making their best efforts to get a sense of what may be coming at us in regards to the Canadian economy (i.e. is that light at the end of the tunnel sunshine or a train heading our way!).

In their Monetary Policy Report released yesterday, here is the snapshot:

Numbers in parentheses are from the previous report, which means that for Q1, 2018 they have revised expected growth lower by 1/2% to 2.2% from a previously estimated 2.7%.

Likely a good enough reason for not raising interest rates yesterday. Q2 doesn't look so good either. That being said, they must be expecting some pretty good growth in the second half of 2018 (although they are not giving us more detail) because the total 2018 growth is revised up to 2.1% (from 1.8%), which as a matter of fact, matches the IMF's forecast for Canada (see our High Rock Weekly Video for more on that).

For fun (I know, you are all thinking, Scott, get a life, how is this fun!), have a look at the previous 2 year's April forecasts to get a sense of how these folks have done with their work:

April 2016:

Two years ago, the thoughts on 2018 GDP growth were the same as they are now.

April 2017:

But last year, they revised them lower. Likely because of better than expected 2017 growth and the interest rate increases that followed.

Second to the BOC's forecasting abilities, we can also glean that past interest rate increases have definitely put the brakes on Canada's economy (perhaps among other things as well).

As always, we are more interested in looking behind the headline data to see what risks the BOC is concerned with:

1) Weaker Canadian investment and exports: in other words, does increasing competitiveness from US tax reform lure Canadian firms across the border and weaken the prospects for growth?

2) Sharp tightening of global financial conditions: rising interest rates, especially in the US would impact Canadian bond yields and increase debt servicing factors on a highly leveraged household.

3) A pronounced decline in house prices in over-heated markets: which would dampen residential investment and consumption.

What are the bond markets telling us?

2 year bond yields are close to their highest levels in many years (a function of the BOC's actual and expected interest rate increases).

Longer-term bond yields have moved higher, but at a slower pace than the 2 year.

And the spread between 2 year yields and 30 year yields has narrowed to about a 1/2 % differential. When this relationship narrows to 0 (we call it a flat yield curve), it usually signals a recession will follow shortly thereafter.

Another couple of 1/4% increases by the BOC will hasten a recession. Another reason why the BOC is reluctant at the moment.

Confidence in the economy is paramount to economic growth. In all likelihood, the BOC wants to forecast enough growth to keep businesses and consumers participating, but the risks are out there (high and rising) and the bond markets are telling us that.

We (at High Rock) continue to position our collective portfolios with all that is necessary to protect them from the inherent risks that we see building behind the scenes, so that we can all sleep a little better.