Economic Insights - CIBC World Markets
Transcription
Economic Insights - CIBC World Markets
Economic Insights April 29, 2015 ECONOMICS Avery Shenfeld (416) 594-7356 [email protected] Benjamin Tal (416) 956-3698 [email protected] Andrew Grantham (416) 956-3219 [email protected] Not-So-Super Cycle by Avery Shenfeld Even if growth has nearly stalled in the first quarter, Canada is still in the expansion phase of what has already been, for North America at least, a fairly long cyclical upswing. But for a number of reasons, this is shaping up to be a not-so-super cycle for overall growth, and particularly, for commodities tied to global conditions. To our south, the US economy has made much faster progress towards full employment than one might have expected, at least looking at GDP growth. While that sounds like a positive story, it isn’t in terms of what it implies for the American economy’s sustainable growth pace beyond 2015. Nick Exarhos (416) 956-6527 [email protected] It reflects a trend towards weaker growth in the size of the workforce, and slower gains in output per hour, than seen in prior decades, one that is likely to see little improvement over the coming years. For the US, two is the new three in terms of the potential sustainable pace for real GDP growth (see pages 9-11). Canada has similar issues with demographics, but at the national level we’ve been far from the fate of countries like Japan, where the workforce is headed for the retirement home. But what hasn’t been well appreciated is that a significant proportion of the growth we’ve been seeing in the age groups that drive new entrants to the workforce has been driven by nonpermanent residents (see pages 7-8). We will have to ramp up the pace of permanent immigration if Canada isn’t to face a new squeeze on potential growth. Regionally, there are already demographic issues that could hamper some provinces’ ability to grow their way out of existing debt burdens. Indeed, every province east of Ontario has seen a drop in its workingage population in the past year, and in some cases, going back several years. For Canada’s resource sector, slowing potential growth in Europe, China and the US, coupled with pressures from new supply, has made this a less-than-super cycle for commodity prices (see pages 3-6). Supply will, of course, adjust to new pricing realities as the weaker incentives for additional capital spending on new projects take hold, but that’s cold comfort for the firms doing the retrenching in output. To sustain higher prices and allow room for the supply switch to be turned back on, we’ll need the demand lift from somewhat better global growth. For 2016-17, there’s still upside, not in elevating long-term potential growth, but from the boost to demand inherent in getting countries that still have substantial slack, including Europe, China and Japan, back on track. But we’re not likely to return to the 5% global GDP pace that backstopped the best years of this millennium. There’s still going to be a business cycle for resource producers, just one that’s not so super in terms of pricing or demand. http://research.cibcwm. com/res/Eco/EcoResearch. html CIBC World Markets Inc. CIBC World Markets • PO Box 500, 161 Bay Street, Brookfield Place, Toronto, Canada M5J 2S8 Corp 300 Madison Avenue, New York, NY 10017 • • • Bloomberg (212) @ CIBC 856-4000, • (416) 594-7000 (800) 999-6726 CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 MARKET CALL • An anaemic Q1 will likely delay a first Fed hike until July, long enough for upside surprises on Q2 growth indicators and wages to hit the tape. Because equilibrium neutral rates will be lower in this cycle than in the past, the Fed funds rate path will be below the FOMC’s dot projections. • Although it’s come off the boil recently, the US$ will be temporarily re-energized by Chair Yellen lifting off from zero rates. But the FX drag to US exports, a gentler pace to rate hikes, and improving economic results in the Eurozone should see the dollar shed some of its strength further out. • By setting a low bar in the first half of the year in its updated projections on the Canadian economy, the Bank of Canada has reduced the chances that growth disappointments will push it to cut rates once again. The continued pass-through from a weaker C$ onto core inflation, and still-narrow economic slack, will also mean that Governor Poloz will be in position by mid-2016 to take back any easing in policy provided in 2015. • A re-tightening cycle in Canada after 2015 will be executed very slowly with the C$ in mind, as the Bank tries to limit the loonie’s appreciation. The loonie has gathered greater-than-anticipated strength from a wait-and-see approach from Poloz, but a competitive exchange rate will be needed for Canada to regain manufacturing capacity, and give a lift to non-energy exports. INTEREST & FOREIGN EXCHANGE RATES 2015 END OF PERIOD: 2016 28-Apr Jun Sep Dec Mar Jun Sep Dec CDA Overnight target rate 98-Day Treasury Bills 2-Year Gov't Bond 10-Year Gov't Bond 30-Year Gov't Bond 0.75 0.65 0.65 1.51 2.12 0.75 0.65 0.65 1.60 2.20 0.75 0.70 0.70 1.75 2.30 0.75 0.70 0.90 1.90 2.50 0.75 0.80 1.20 2.00 2.60 1.00 1.05 1.40 2.20 2.70 1.25 1.20 1.60 2.60 2.85 1.25 1.20 1.70 2.65 3.05 U.S. Federal Funds Rate 91-Day Treasury Bills 2-Year Gov't Note 10-Year Gov't Note 30-Year Gov't Bond 0.125 0.01 0.56 1.96 2.65 0.125 0.05 0.75 2.30 2.60 0.625 0.55 1.05 2.75 2.90 0.875 0.75 1.35 2.70 3.15 0.875 0.75 1.30 2.70 3.25 0.875 0.75 1.50 2.75 3.50 1.125 0.95 1.55 3.10 3.60 1.375 1.15 1.80 3.30 3.65 Canada - US T-Bill Spread Canada - US 10-Year Bond Spread 0.64 -0.44 0.60 -0.70 0.15 -1.00 -0.05 -0.80 0.05 -0.70 0.30 -0.55 0.25 -0.50 0.05 -0.65 Canada Yield Curve (30-Year — 2-Year) US Yield Curve (30-Year — 2-Year) 1.47 2.09 1.55 1.85 1.60 1.85 1.60 1.80 1.40 1.95 1.30 2.00 1.25 2.05 1.35 1.85 EXCHANGE RATES 0.83 1.20 119 1.10 1.53 0.80 0.95 2.90 15.23 0.79 1.27 123 1.05 1.45 0.73 0.98 3.25 14.75 0.78 1.29 126 1.04 1.46 0.72 1.01 3.15 14.70 0.79 1.26 125 1.08 1.49 0.75 0.99 3.13 14.83 0.81 1.24 123 1.12 1.52 0.77 0.96 3.18 14.53 0.81 1.23 120 1.15 1.55 0.79 0.94 3.22 14.09 0.82 1.22 118 1.18 1.57 0.82 0.92 3.21 13.68 0.81 1.24 116 1.21 1.59 0.85 0.90 3.21 13.27 CADUSD USDCAD USDJPY EURUSD GBPUSD AUDUSD USDCHF USDBRL USDMXN 2 CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Commodities: Looking for the After-Party Nick Exarhos and Andrew Grantham The party’s over, and now we’re dealing with the hangover. A flood of new supply driven by the prior commodity cycle’s investment boom has hit the wall of waning demand in emerging markets, particularly China. And while lower supply will alleviate the pressure placed on some prices (for example, oil), a slow global growth environment going forward will ensure that any afterparty in commodity prices doesn’t live up to the hype of 2007 or even 2011. countries at this stage were still seeing strong population growth, whereas China’s is already slowing and due to ease further going forward (Chart 1, right). The result is that China’s 8% or so average growth in GDP per capita since the global downturn was well above that achieved in the US or France (both around 4.5%), and even South Korea (6.5%), when those economies were at the same stage of maturity. While recent stimulus measures should help manage a “soft landing”, the global economy needs to get used to a slower Chinese growth pace over the coming decade. Global Growth: Failing to Step on the Gas Ever since the end of the recession, forecasters have been waiting for global growth to accelerate. Yet it hasn’t happened, and we remain stuck in the 3½% or so range that we have been in since the early days of the recovery (Table 1). The fallout from the financial crisis meant that growth in many developed countries, in particular Europe, was slow to recover. That has impacted developing countries as well, with many still reliant on Western consumers to buy their exports. Commodities Still Have a Place in Portfolios A lower speed limit on global growth is already restraining prices for many commodities. But that doesn’t mean investors should shy away from that space. The decline in oil prices, for example, has been more a story of excess supply than flailing demand. Meanwhile, a continued recovery in the US housing market should see lumber prices perform well over the coming years. Out of the commodities we cover, oil and lumber are two of our favourite picks for the coming year (Table 2). In addition to greater potential upside in prices, they also provide greater diversification for investors than, for example, metals, which are often highly correlated with each other and the broad commodity space (Chart 2). While there are signs that 2015 will be a better year for the Eurozone and the US, that’s largely because both are among the highest net beneficiaries of lower oil prices. Plenty of spare capacity remains in Europe, allowing it to grow above its long-run “potential” in 2016 as well. But that’s not the case stateside, where we see growth easing to a 2.4% pace next year. For China, somewhat slower growth should be expected given its development stage. Looking historically at when other countries were at a similar level of GDP per capita, the 7% growth rate target Chinese authorities have set for this year doesn’t appear all that elevated (Chart 1, left). There’s one big difference, however. Most other Chart 1 China Slightly Ahead in Growth Rates (L), But Without Demographics to Back it Up (R) 10 Avg. Real GDP Growth (% Yr/Yr) 8 Population Index Start Year = 100 125 6 4 Table 1 135 115 2 2.2 2.4 2.9 2.4 EZ -0.4 0.9 1.7 2.0 China 7.7 * at Purchasing Power Parity 7.4 6.8 6.6 85 t+18 US US 1934-53 France 1950-69 Korea 1984-2003 China 2007-26 (F) 95 t+15 3.6 t+12 3.4 t+9 3.3 t+6 3.3 t World* 105 0 Korea 1984-2003 2016F France 1950-69 2015F US 1934-53 2014E China 2007-2014 2013A t+3 Global Growth Not Joining the Party Source: OECD, IMF, CIBC 3 CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Chart 3 Demand Effects Only Partly Responsible (L); US Rig Efficiency Topping Out (R) Drop in WTI Since Jun-14 0 US Rig Effeciency (Weighted Average) -20 0.3 0.0 -30 -0.3 5yr 10yr -40 -0.8 % -50 Est Demand Effect Nov-13 2yr bbl/day Actual Decline Feb-15 0.5 -0.5 300 290 280 270 260 250 240 230 220 210 200 -10 0.8 Nov-14 1.0 Aug-14 1.3 May-14 Correlation to Overall Commodity Complex Feb-14 Chart 2 Source: Bloomberg, CIBC Source: Bloomberg, EIA, CIBC Oil Rout Driven Primarily by Supply wells offline. With the average shale break-even placed at around $70/bbl, rig counts in the US have halved from year-ago levels. The biggest story this year has been the dramatic decline in oil. Though crude hasn’t been alone in feeling the weight of slowing global demand, the principal component that explains the demand side driving cyclical commodities shows that the majority of oil’s decline has been driven off specific supply effects (Chart 3, left). The shale revolution has driven a near-twofold increase in US oil production over the past five years, with America now pumping over 9 mn bbl/day. And though productivity gains, driven in part by producers focusing on the highest yielding oil fields and by technological advances in the hydraulic fracturing process, have buffered the fall in absolute rig counts, improvements on that front appear to have reached their near-term limit. After seeing an upswing as prices initially tumbled in late-summer 2014, average US rig efficiency has flat-lined for the past few months (Chart 3, right). That rapid increase wasn’t matched by a commensurate rise in worldwide demand, which grew by slightly under 3.5% between 2011 and 2014. The dramatic fall in prices, however, has meant that American producers have had to slash investment plans and take more expensive Crude Imbalance to Narrow by H2 US supply will tail off in the coming quarters, and the International Energy Agency estimates that there should be roughly 2 mn bbl/day more in oil demand by the Table 2 Key Commodities Prices 27-Apr 2012 2013 2014 2015 (f) 2016 (f) 2017 (f) Oil (WTI) $/bbl Natural Gas (Henry) $/Mn Btu 57 94 98 93 57 68 75 2.48 2.75 3.73 4.35 2.95 3.50 3.75 Gold* Silver* $/troy oz 1202 1675 1202 1184 1100 1200 1150 $/troy oz 16.38 30.3 19.5 15.7 15.3 17.6 17.4 Iron Ore (62% Fe) $/mt 59 129 136 97 59 63 62 C opper $/lb 2.74 3.62 3.33 3.12 2.75 3.00 3.05 Aluminum $/lb 0.84 0.92 0.84 0.85 0.84 0.89 0.91 Nickel $/lb 5.98 7.97 6.82 7.68 7.95 8.26 9.20 Zinc $/lb 1.02 0.89 0.87 0.98 1.05 1.11 1.11 Lumber** $/'000 bd ft 255 287 345 338 285 335 350 Potash $/tonne 305 459 379 297 310 315 315 * end of period, Source: CIBC **1st CME Futures 4 CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Chart 5 1.5 2500 0.5 2000 0.0 1500 1000 fcst Jan Feb Mar Apr May -1.0 Jan-15 May-14 Sep-13 -2 0 2 4 6 8 10 12 14 16 3000 1.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 YoY, % 2015 Average 2010-2014 $/mmbtu US Prod Growth (Inv., L) Henry Hub Price (R) Source: IEA, CIBC *Note: Assuming OPEC Supply agerages 30.3 mn bbl/d Source: Bloomberg, EIA, CIBC That’s occurring at the same time as Chinese demand, particularly for steel, slows dramatically, dragging prices meaningfully lower (Chart 6, right). Our iron ore forecast matches our expectations for cooler Chinese demand. fourth quarter of this year than there was in the first, balancing the global crude market (Chart 4). That rise in demand will be critical in seeing a sustained recovery in prices, as production will only be idled until we see prices ramp back up to producer break-evens. So there’s likely a longer-term ceiling on prices at around $75/bbl—a level that we forecast on average for 2017 following a slow and uneven recovery this year and next. Copper, and Other Metals, to Face Slower Days Copper faces many of the same demand headwinds plaguing iron, but does benefit from a more diverse set of uses. Furthermore, copper production hasn’t seen the same type of surge experienced by iron ore. Ore grades in Chile—the country responsible for a third of the world’s copper production—are on the decline, and other potential higher quality mine locations are in jurisdictions with greater country-specific risk. Natural Gas Upside Capped by Shale Abundance The shale revolution has gained infamy in crude markets, but the horizontal drilling techniques applied to oil extraction took root in the drilling of natural gas. Growth in landlocked US natural gas production has kept a lid on meaningful price appreciation, and recent outcomes could have been worse had it not been for cold weather saving the day for producers, bringing inventory levels slightly below their five-year average (Chart 5, left). Chart 6 Iron Ore Production Continues to Grow (L), While Marginal Consumer Slows (R) Global Iron Ore Production 3400 3200 3000 $/mt 160 140 16 120 12 100 8 2600 4 60 0 40 Feb-15 Aug-14 1800 Feb-14 2000 80 Feb-12 2200 The commodity super-cycle drove massive investments in expanding iron ore production. With companies hoping to capitalize on surging emerging market demand, global production has been on a steady climb (Chart 6, left). YoY, % 2800 2400 Iron Succumbs to Chinese Slowdown Mt 20 Aug-13 That’s certainly been a fillip to prices, though over the longer term, trading in natural gas has been at the mercy of production, where double-digit annual gains haven’t been abnormal (Chart 5, right). Continued strong production trends are reasons we think upside remains modest in Henry Hub prices, though a strong economy in the US should provide a solid base of demand. Feb-13 -0.5 Bcf Jan-13 3500 mn bbl/d Jan-11 US Natural Gas Storage Levels World Oil Market: Supply* minus Demand Aug-12 2.0 May-12 Oil Demand to Catch Up by Q3 Sep-11 Cold Winter Drives Reduction in Storage (L), But Price of US North Am. Nat Gas Driven by Production (R) Chart 4 Chinese Steel Prod (L) Iron Ore Price 62% Fe (R) Source: Bloomberg, US Geological Survey, CIBC 5 CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Chart 7 Chart 8 Metals Driven by Global Industrial Production Output Gold Gaining Greenback Sensitivity 120 % Yr/Yr % Yr/Yr 80 40 Dec-14 0.0 25 20 15 -0.1 10 -0.2 5 0 -80 2000 2002 2004 2006 2008 2010 2012 2014 Feb-15 Mar-15 Apr-15 -0.3 0 -40 Jan-15 -5 -0.4 -10 -0.5 -15 -0.6 CRB Metals Index (L) CPB World Production Volume (R) -0.7 60-day Correlation: Dollar Index and Gold Source: CPB, CRB, CIBC Source: Bloomberg, CIBC end to 2014 and start to 2015 (Chart 9, left). A bottom has likely been signaled by a small increase in firsthalf contracted prices (Chart 9, right), though sluggish demand from Brazil and the US will cap potash’s upside. That should increase the cost of capital for mining projects going forward, creating a more constrained supply picture and seeing copper prices perform slightly better than iron ore. However, neither are likely to reach prior-cycle price peaks in the medium term, since cyclical metals still largely respond to the global industrial production cycle (Chart 7). Though we aren’t bulls on metals in general, supply restrictions, largely driven by the Indonesian export ban, have us favouring a nickel price appreciation. Lumber Prices Underpinned by US Housing The housing market should be a primary beneficiary of a healthier US economy, and a vastly improved labour market more specifically. Improved job prospects among younger demographics in the US should encourage those stuck living with relatives to branch off on their own. And while renting a condo and multiples construction will remain a larger part of the market than in past years, new single-family sales—the primary driver of American lumber demand—have been on a clear uptrend. With interest rate hikes likely coming at a slower pace than in past cycles, the US housing upturn shouldn’t be disrupted and as such we are bullish on lumber in the years ahead. Yellen Hikes to Cap Precious Metal Gains Despite whatever delays have been created by a lacklustre Q1, Fed hikes should be coming sooner rather than later. The US$ should be a prime beneficiary of that move off of zero, allowing the greenback to gain against most other major currencies, including that most ancient median of exchange, gold. And judging from recent correlations, gold has been gaining sensitivity to the greenback’s moves (Chart 8). There’s scope for the dollar to give ground further out, as policy elsewhere normalizes, but higher interest rates increase the opportunity cost of holding non-yielding assets like precious metals. That should limit gold’s upside further out, while weighing only slightly less on silver, given its more diverse set of industrial uses. Chart 9 Heathier Chinese Potash Imports Continue in ‘15 (L), a Reason to Believe in a Price Bottom (R) China Monthly Imports (Mt) 1.0 H1 China Contracted Potash Prices 500 $/mt 0.8 Potash Prices Finding a Bottom 400 0.6 In fertilizer markets, there are some more encouraging signs regarding Chinese demand. The economic rotation toward the consumer has been a cause of poorer results for cyclical commodities. But a more protein-intensive diet amongst emerging market populations will be a strong source of potash demand going forward. Though the breaking of the producer cartel had smacked prices in recent years, Chinese import shipments saw a strong 300 0.4 200 0.2 100 2013 6 2014 Nov Sep Jul May Mar Jan 0.0 0 2015 Source: Bloomberg, CIBC CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Non-Permanent Residents— A Major Demographic Force by Benjamin Tal Chart 2 Demographic forces don’t explain everything, but they’re important. In Canada, it is common knowledge that immigration accounts for more than three quarters of population growth. What is less known, is the dramatic impact of the meteoric ascent in the number of nonpermanent residents (NPRs) on the nation’s demographic landscape—mainly among young Canadians. From an economic and policy perspective, non-permanent residents in general, and temporary workers in particular, should no longer be seen as marginal and reversible factors aimed at solving temporary mismatches in local job markets. Rather, they should be viewed as an important demographic force capable of influencing and potentially altering the trajectories of macro-economic variables such as housing activity and consumer spending. Young & Non-Permanent NPRs: Age 18-24 250 000s 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 200 150 100 50 NPRs: Age 18-24 2009-2013 Share in population 03 04 05 06 07 08 09 10 11 12 13 0 Share in population growth Source: Statistics Canada, CIC, CIBC Rising Fast The vast majority (95%) of NPRs are below the age of 45, a key econmic demographic in Canada. The number of NPRs in the age group 18-24 has risen strongly (note the acceleration since 2009 in Chart 2, left). While this group represents only 5% of the total number of that age group in the population, it accounted for almost 50% of its growth over the past half-decade (Chart 2, right). At close to 770,000, the number of non-permanent residents (NPRs) in Canada is at a record high. The pace at which this category is growing is also unprecedented. Over the past decade, the total number of NPRs rose by no less than 450,000. The composition of the NPR population is also changing with the share of those with work permits rising from less than 40% to the current 58%. The fact that most of this advance came at the expense of the share of refugees in the NPR pie, suggests more rapid economic contribution from the current stock of NPRs (Chart 1). But even more impressive is the tremendous impact of NPRs on the 25-44 age group. Chart 3 tells the tale. The number of NPRs in that age category has doubled since 2006 and, in fact, accounted for all the growth in that Chart 3 NPRs Accounted for All the Growth in Age 25-44 Since 2006 Chart 1 Non-Permanent Residents (NPRs) in Canada Annual Growth 90 80 70 Distribution (2013) Age 25-44 200 14.4 % 000s record high 60 40 000s 150 150 27.5 % 50 Index 2006=100 Growth: 2006-2013 200 100 100 58.1 % 50 30 50 20 10 0 06 07 08 09 10 11 12 13 Source: Statistics Canada, CIC, CIBC Workers Students Humanitarian 0 Population less NPRs NPRs 06 07 08 09 10 11 12 13 7 0 -50 Population less NPRs NPRs Source: Statistics Canada, CIC, CIBC CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Chart 5 Chart 4 NPRs: A Significant Offset To Weak Demographics in Ontario Contribution of NPR to Population Growth Age 18-44 (2006-2013) 350% 100 300% 000s Ontario 2006-2013 50 250% 0 200% 150% -50 100% -100 50% 0% Population less NPRs NPRs -150 ONT BC CAN Age 18-24 QUE ALTA SASK MAN Source: Statistics Canada, CIC, CIBC Age 25-44 Source: Statistics Canada, CIC, CIBC age group in the population as a whole. If not for the rapid growth of NPRs, the number of that economically important age group in the Canadian population would have fallen. As strong as those numbers are, they actually understate the real tally. The figures presented here are based on Statistics Canada’s projections derived from 2012 actuals, rather than data subsequently released by Citizenship and Immigration Canada (CIC). The total NPR estimate by Statistics Canada is about 2.4%-pts shy of CIC growth in 2013. As for 2014, Statistics Canada’s projection of only a 4.4% growth is also way too weak. Based on preliminary CIC data (14% growth in new permits and 9% in extensions through three quarters of 2014), and the absence of any evidence of a spike in return of work visa holders through this period, it is reasonable to expect an overall 2014 annual increase in NPRs of no less than 8%. Uneven Geographical Distribution The contribution of NPRs is far from uniform (Chart 4). The most significant impact is in Ontario, with NPRs playing an enormous role in the growth of the age group 18-44 since 2006. Here the impact is mainly due to the notable decline in the number of permanent Ontarians in the age group 25-44, with NPRs providing a significant offset. In fact, if not for the rise in NPRs, that age group would have experienced a dazzling 120,000 decline since 2006 (Chart 5). The impact on British Columbia is also significant with NPRs accounting for all the growth in that age group. Recent changes to the temporary foreign workers program might lead to a modest impact on the “at risk” pool of workers that is subject to a “certification” of local worker availability, and new limits on permit extensions. This group consists of just over 29,000 of the “lower skilled” who are neither live-in caregivers nor agricultural workers. Even if all these workers lost their eligibility in 2015 (which they will not), this would reduce the stock of valid visa holders by only about 3.7%. We can expect a spike of this subset of lower skilled to receive Permanent Resident Status (there has already been a spike in applications), and in those that obtain temporary visas in other program categories. It is not a coincidence that those two provinces are also the ones to experience long-lasting strong housing market activity. In fact, given the above demographic picture, it is fair to assume that NPRs play an important role in demand for rental units in both provinces—a factor that contributed to the recent boom in the condo market in centres such as Toronto and Vancouver. The impact on Alberta is relatively muted despite the fact that the skill shortage in the province was one of the catalysts behind past changes to the temporary workers program. Atlantic Canada is not represented in the chart due to the fact that its population aged 18-44 actually declined during that period, despite a modest offset from the rise in NPRs. So ...? The numbers are simply too large to ignore. NPRs are a demographic force with significant macro-economic implications. Any future policy action aimed at limiting growth in that category should be supplemented by an offsetting boost to immigration policies. 8 CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Two is the New Three: The US Economic Speed Limit Avery Shenfeld and Andrew Grantham workforce at full employment, and the output per working hour. If past is prologue, recent years have been signaling disappointment ahead on both fronts (Chart 1, right). Equities aren’t a one-year bet, but a play on a multi-year stream of earnings. That makes growth beyond 2015 now relevant, and in the US, it’s the upside limits to growth that will begin to cap performance. By the end of this year, the Fed’s estimate of “full employment”, a 5.05.2% jobless rate, looks to be in sight. If the Fed steers a perfect track from then on, the economy will be on the glide path consistent with staying at full employment, matching what economists call “potential” growth—the speed limit above which inflation would become an issue. The exit of disheartened job seekers from active search slows work force growth in economic downturns. But the participation declines pre-dated the recession, and didn’t reverse despite strong hiring and rising job vacancies. That’s largely because much of the slowdown has been demographically driven; growth in the “prime-age” 25-55 year-old population is easing off. Each year more American baby boomers are reaching age 60 or 65 and opting to retire. Those under 25 are staying in school longer, a trend unlikely to change given the heightened competition for skilled jobs. In decades past, the US could run at 3% or even 3½% real growth at full employment. But the evidence suggests that, in terms of the long-term growth path, two is the new three. True, there’s still the drop we’ve suffered in participation rates for prime-age 25-54 year-olds since 2000 (Chart 2, left). Some of that reflects rising long-term disability. Incarceration rates also account for about a 0.1% slowing in the labour force. That’s a sobering reality that the Bank of Canada has already come to terms with. The US Fed, for its part, has been ratcheting down its estimate for long-term trend growth. Mid-point forecasts from 2011 still set the speed limit at 2.6%, but most recently a more conservative 2.1% has been shown (Chart 1, left). But even that may be a touch too high; last year’s major drop in unemployment amidst only tepid growth suggests that 2014 potential growth was only 1.65%. There would still be former construction workers waiting for homebuilding to recover, or those locked into a negative-equity mortgage that prevents a move to where the jobs are. But even if we allowed for a rebound in the 25-55 part rate, the labour force would settle at only 0.7% growth (Chart 2, right) due to the ongoing slowdown in working-age population growth. Potential growth can be broken down into two components: the growth in the size of the available Chart 1 Chart 2 Fed “Long-Run” Forecasts Move Down (L); Workforce and Productivity Growth Sluggish (R) Prime-age Participation Down (L); Workforce Growth Still Slow Even if Part-rate Recovers (R) 1.6 85 84 0.8 83 0.4 82 1.5 1% Source: FOMC, CBO, CIBC 0.0 81 01 -0.4 Jan-15 Jan-10 Jan-05 Jan-90 2012 2010 2008 2006 2004 2002 2014 9 Jan-00 80 0% 2000 Date of Forecast Mar'15 Mar'14 Mar'13 Apr'12 Apr'11 Estimate for 2014 Potential GDP 21 2% Forecast 1.2 17 2.0 Workforce Growth (% Yr/Yr) 13 Productivity Workforce 3% 2.5 1.0 Participation Rate (25-54, %, 12mma) 09 86 Potential GDP (% Yr/Yr) 4% 05 FOMC "Long-Term" GDP Forecast (% Yr/Yr, Midpoint) Jan-95 3.0 25 Fewer Workers… 25-54 Part Rate Recovers to 83% Unchanged Part-Rates Source: BLS, CIBC CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 … And Less to Show for Them Chart 4 Capital Stock Not Deepening in this Cycle The other driver of potential GDP—productivity—has also disappointed. Output per hour decelerates in recessions as businesses hold on to key workers to avoid turnover costs, but several years into a recovery, it’s usually back in full bloom. In the US, and across the OECD, this recovery has paled relative to the prior one in output per hour (Chart 3). If that didn’t improve, the non-inflationary speed limit might hold the US economy to as little as 1½% real growth after 2015. So the forces behind this deceleration and their longevity is critical for investors. % Yr/Yr 4 Hours 3 Capital Input 2 1 0 Capital spending can boost labour productivity by providing more or superior equipment to work with. Economists typically focus in on capital deepening, the extent to which the growth in the net capital input exceeds the growth in labour input. On that score, this cycle has been much weaker than those in decades past, with no capital deepening at all (Chart 4). Long-Run Avg 1950-2007 2010-14 Source: BEA, San Francisco Fed, CIBC sufficient to tilt the economy-wide averages. That was the case in the 1990s, owing to the leaps achieved by the information and communications tech (ITC) sector. Real output is measured on a quality-adjusted basis, so producing a new chip that is miles ahead of the prior year’s design shows up as a massive productivity gain. History suggests that the investment cycle isn’t likely to quickly get back on its “normal” track, limiting the pickup in productivity. An IMF study found that investment spending as a percentage of the existing capital stock tends to see deeper troughs and slower rebounds for up to a decade after a financial crisis recession than in other cycles, such as the one tied to the bursting of the tech bubble. If anything, this cycle has already seen a bit more improvement than after those past crises (Chart 5), perhaps helped by aggressive interest rate settings. The result was a big gain in total factor productivity in the ITC industry—the output generated not by adding more labour or capital, but by getting more out of the same inputs. Then, with a lag, there was a second bump in total factor productivity outside the ITC sector, with industries that were intensive in the use of information and communications technology showing the benefit of adopting new systems to their workplace. Other Factors Slowing Productivity Productivity can also be shifted by changes in the industry composition of the economy or technological change. Rapid growth in a highly productive sector can be This wasn’t just a US story. Most countries showed a large, one-time lift to productivity growth in the late- Chart 3 Slower Productivity Growth in US and Across OECD Investment-to-Capital Ratio Not Out of Line with Recovery from Financial Crisis 2.5 Productivity Growth (% Yr/Yr) 1.5 Avg 2010-13 1.0 Avg Financial Crises 1989-95 0.5 1.2 1.0 0.0 0.8 -0.5 0.6 -1.0 0.4 -1.5 0.2 -2.0 0.0 Source: OECD, CIBC 10 t+10 t+9 t+8 Source: IMF, BEA, CIBC t+7 -2.5 OECD Total t+6 UK t+5 EZ t+4 Canada t-1 US 2007-13 t+3 1.4 Avg 2004-07 t+2 1.6 Investment-to-capital ratio (Change vs Pre-recession) t+1 1.8 2.0 t 2.0 Chart 5 Source: IMF, BEA, CIBC CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 Chart 6 Chart 7 ICT Sector a Key to Productivity Growth in Late 90’s and Early 00’s Growth in Aggregate Hours in Typically LowProductivity Sectors 6 Contribution of ICT Capital Deepening to Output Growth (%-pts) Jp 4 2 Chg in Agg. Hours (mn 2014 vs 2006) 0.6 0.4 0.2 -80 2011 2008 2005 2002 1999 1996 1993 0.0 1990 Sectors Gaining Hours 3 1 0 -40 Constr Source: IMF, CIBC -1 0 40 80 120 -2 Source: BLS, BEA, CIBC * % chg in GVA minus % chg in aggregate hours worked come from. “Big data”, robotics and 3-D printing will aid some sectors, but there doesn’t appear to be any equivalent to the lift that came from the start of the internet era. 1990s (Chart 6), but then a fading of that glory in recent years. That could be due to a maturing tech sector that makes new equipment or software less revolutionary. R&D spending across the US private sector has picked up in recent years, from which there could be payoffs in terms of the next tech wave. Additions to labour hours could improve for a short while as disenchanted prime-age workers return to active job search, but as we noted, demographic forces will still hold labour force growth to a 0.7% pace. Add it all up, overall potential growth looks to run at no better than 2% or so in the next decade (Chart 8). One final hurdle for labour productivity is that sectors that formerly led the economy-wide gains—manufacturing and information services—have downsized. Total hours worked in these sectors were still lower in 2014 than they were in 2006. All of the sectors that have added labour hours relative to 2006 are those that have trend (post-1998 average) productivity growth of less than 1% (Chart 7). That also implies, however, that the Fed will end up on a surprisingly shallow path for tightening; our earlier research found a positive linkage between potential growth and the neutral rate. Modest growth, but modest rates will be a mixed bag for equities in the cycle ahead. Where to from Here? Chart 8 Looking ahead, while we’re still seeing weakness in capital equipment orders for now, capital spending should pick up over the balance of this cycle with an improvement in economic growth that tightens capacity use, and raises returns on new investment. Base Case for 2% Potential Growth in Coming Decade 4.0% Potential GDP (% Yr/Yr) CIBC Forecasts 3.5% But many of our findings above suggest that we are unlikely to attain anything better than a 1½% pace for output per hour. Post-financial-crisis recoveries have had slower productivity bounces for a decade after the event. Construction employment is likely to be a major source of growth as homebuilding comes back to life, a development that is likely to weigh on a recovery in total economy output per hour given that sector’s lacklustre productivity growth trend. There could be an R&D payoff, but at this point, it’s hard to identify where that would 2% Productivity 3.0% 2.5% 2.0% 1.5% 1% Productivity 1.0% 11 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 0.5% 2024 EZ Manf 2022 0.8 UK 2020 1.0 US 2018 1.2 2016 1.4 Labour Productivity* Info 5 Serv Source: CBO, CIBC Source: CBO, CIBC CIBC WORLD MARKETS INC. Economic Insights—April 29, 2015 ECONOMIC UPDATE CANADA 14Q4A 15Q1F 15Q2F 15Q3F 15Q4F Real GDP Growth (AR) 2.4 0.8 0.6 0.7 2.7 2014A 2.5 2015F 1.7 2016F Real Final Domestic Demand (AR) 1.5 0.3 -0.4 -0.6 1.7 1.6 0.9 1.5 Household Consumption (AR) 2.0 1.5 1.8 1.6 1.8 2.8 2.0 1.6 2.6 All Items CPI Inflation (Y/Y) 1.9 1.1 0.7 0.8 1.4 1.9 1.0 2.2 Core CPI Ex Indirect Taxes (Y/Y) 2.2 2.2 2.2 2.1 2.1 1.8 2.2 2.1 Unemployment Rate (%) 6.7 6.7 7.0 7.0 6.8 6.9 6.9 6.6 U.S. 14Q4A 15Q1F 15Q2F 15Q3F 15Q4F Real GDP Growth (AR) 2.2 0.8 4.2 3.3 2.1 2014A 2.4 2015F 2.9 2016F Real Final Sales (AR) 2.1 0.9 4.3 3.7 2.4 2.3 2.9 2.6 All Items CPI Inflation (Y/Y) 1.2 -0.1 -0.2 0.4 1.7 1.6 0.5 2.6 Core CPI Inflation (Y/Y) 1.7 1.7 1.7 1.9 2.1 1.7 1.9 2.2 Unemployment Rate (%) 5.7 5.6 5.5 5.4 5.3 6.2 5.4 5.2 2.4 CANADA Despite some added volatility in Q1 data due to the unseasonably cold weather, the quarter is still set to notch in a growth pace slightly under 1%. Our full-year real GDP forecasts for 2015/16 are unchanged, though March’s inflation data suggests that underlying price trends are running hotter than anticipated, likely due to there being less slack in the economy than previously estimated. That, and the continued pass-through from the C$, should see core run slightly above 2% this year and next. UNITED STATES The US economy is off to a slow start again in 2015, with Q1 GDP tracking only a 1% pace and indicators for March not showing the sort of pick-up we hoped for in areas such as retail sales and housing construction. However, solid income growth and still-low gasoline prices are supporting the purchasing power of households, and should drive an acceleration in real consumer spending and GDP growth in the quarters ahead. For 2015 as a whole, growth is forecast to come in just below 3%, before decelerating to 2.4% in 2016. 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