The BoC appears to be in a precarious situation, says a Russell Investments report. With recent economic data suggesting domestic growth is improving, the challenge for the central bank will be to reconcile recent trade-induced exuberance with erratic employment figures.
As a result, the BoC remains hesitantly dovish, or on the side of lower interest rates, requiring clarity on two key issues: full-time employment and household indebtedness.
“The BoC faces a real conundrum,” says to Shailesh Kshatriya, associate director, client investment strategies at Russell Investments Canada Limited. “Notwithstanding recent improvement in exports and steady domestic consumption, the seminal question he needs to answer is: which way to tilt monetary policy – towards the ‘hawks’ or the ‘doves’?”
According to Kshatriya, low interest rates underpin strength in housing as well as continued household indebtedness. The obvious “quick fix” would be to raise the target rate, which in turn would reduce housing affordability. “The danger, admittedly, is the potential collateral damage to business investment. In addition, raising interest rates prematurely could create a macro shock which would threaten a disorderly decline of housing and potentially portend a wider downturn in the economy.”
For these reasons, Kshatriya believes the timing of the BoC’s next move is likely to occur in the second half of 2015, with the central bank staying on hold longer than the U.S. Federal Reserve, which is expected to potentially raise its target rate in mid-2015. “Not surprisingly, the market has already started to price in the potential for this outcome, with the net effect from a currency perspective being a steady depreciation of the Canadian dollar relative to the U.S. dollar.”
A declining Canadian dollar may be the silver lining, as a lower Canadian dollar is sorely needed to bolster a manufacturing sector that has shed thousands of jobs. The flip side is that an ascending U.S. Dollar pressures commodity prices lower. Overall, the strategist believes Canadian growth is entering a phase where it is becoming overly dependent and/or influenced by the U.S. economy.
“This is not a negative as our southern neighbours gather steam,” adds Kshatriya. “Admittedly, it would be more encouraging to see signs of this momentum translating into business investment and full-time hiring. We believe both will be crucial to sustain recent improvements in growth heading into 2015.”
In terms of global equity markets, the third oldest bull market in the past 50 years is wrought with increasing volatility and stretched valuations, yet Russell’s strategists explain why they do not see an imminent turning point. They maintain their core investment strategy views, namely a moderate preference for equities over fixed income, a liking for credit, and a bias against exposure to rising long-term interest rates.
“The equity bull market is approaching its dotage and starting to display signs of unpredictability and irrationality,” says Russell’s global head of investment strategy, Andrew Pease. “Our models and process tell us it’s not about to end just yet, but we expect volatility to increase as we approach the first Fed tightening.”
Based on their forecasting models, the strategists expect a 2.9% real GDP growth in the U.S., and 1% to 1.5% GDP growth in the Eurozone in 2015. They predict that Chinese GDP growth will stabilize to the 7% to 7.5% range into early next year, Japanese GDP will steadily rise, and the healthy GDP figures in Australia will slow, but not dramatically. For the next year, U.S. job gains are forecasted at 225,000 per month and the first Fed tightening is still expected to take place in mid-2015.