While the economies the world over continue to grow, the Trump tariffs could trigger a global trade war. Beata Caranci, Chief Economist, TD Bank Group, talks to Kim Parlee about how the uncertainty around trade tactics could impact the U.S. and Canadian economy. Click here for the economic reports.
You've just come out with your forecast. And it's titled, Priming the Pump, Risks Flooding the Engine. So clever title, we'll start with that. Is that the comment about the global economy, or that more focused on the US economy?
Well, the priming the pump is definitely focused on the US economy. And that refers to specifically the fiscal stimulus coming through. And in terms of the risk, that does embed very specific risks to the US in terms of inflation and monetary policy. But there are global risks as well, also emanating from the US, with regards to some of the tariff and trade actions that we're hearing about more recently, now China potential $30 billion in tariffs being placed on China, following aluminum and steel, soft wood lumber, and the list goes on. So that is certainly embedding a different kind of risk of slowing some of the trade flows that have been so instrumental to creating a synchronicity in the global recovery in the last two years.
Yeah. The synchronicity you talk about in the report is interesting. I mean, everything has been firing and been looking pretty positive. I think we had some pretty strong growth globally, 3.7% in 2017. And you're forecasting that's going to actually even accelerate a little bit into 2018, 2019.
Yeah. It'll get close to kissing 4% on that front. So that's a big deal. We haven't seen these type of growth numbers in about six years. The situation was slightly different six years ago. So what we're seeing now is this synchronicity led by advanced economies. It's not related to a commodity boom or emerging markets. It's really the advanced economies.
So case in point, if you look at the Euro area, all countries in that area, all 17 countries are all expanding simultaneously. The unemployment rates are dropping broadly, even in places that have traditionally struggled like Spain and Greece and Italy. Unemployment rates also dropping across the board there.
So this is a very important element when we look at why we're getting these numbers. We're seeing this revival holding across countries and expanding out. So there's still room to go, especially in Europe in particular, in Japan, and other markets to have stronger growth.
Let's pivot and go to the States now, because, of course, when all this great stuff is happening, when all the advanced economies are doing what they're doing and things look good, of course, then you have central banks. Let's go to the Fed starting to do what they do, which is raise rates at the same time. We'll get to trade wars in a second.
But you also have a great title in here saying Washington Is Buying a Boom. They're spending, obviously, fiscally to get things going. But when you look at the States, it's got to be a fun time to be an economist right now. There's a lot going on.
Depends what you consider fun, yeah. So there is. So if you just think of what we were tracking for US economic growth prior to the tax policy that came in place late last year, and then on top of it, the budget policy that came in in February. Prior to those two initiatives, we were only looking for about 2% growth from the US. That has been revised up to 2.7%, 2.8%, almost 3%, just off of--
That's a big jump.
Yeah, it is. And that's for 2018 and 2019. So that's definitely above what economists would say is their potential growth, which is that 2% mark. And that's anchored down by what your demographics and labor force are doing and productivity growth.
So when you spread that much above your running speed, you continue to eat up capacity. And you get tighter and tighter. So this is why we think the unemployment rate will actually go below 4% towards about 3.7% which would be a 50-year low for the US. This would put the pressure on wages to the upside and likewise, to your point, cause a Fed response, because it's the feed-through and the risks related to inflation that, then, they have to respond to. That is their mandate, to maintain stable inflation.
So is there a concern? I've talked to market watchers over the past little while. And I think I've heard from them, we could see an overreaction from the Fed. We could see them decide, OK, inflation's going to be ticking up too fast. The Fed jumps in. And suddenly, it kills off all that economic growth we're having.
Well, I think that's always a risk, that you have a bit of an over-tightening on the cycle, because they, like us, are trying to gauge what exactly is going to be the degree to which all this fiscal stimulus translates into consumer spending and business investment, like actual activity. And it's hard to judge, because we've never seen this degree of fiscal stimulus at this late stage in the economic cycle.
So whether consumers save more of that money or spend it has more gray area than when you're in a recession and you get fiscal stimulus, you know people are going to spend that with a greater likelihood. So it's possible you get a Fed policy error on this side.
However, we do have a new chairman in place for the cycle. He hasn't indicated anything alarming at this stage. This is a Fed, traditionally, that has been a little bit in a wait and see mode, cautious. So we're only expecting three rate hikes this year and next. The possibility, if you look at the balance of risk, is that we get four instead of three. So that's certainly a possibility.
But they will do like us. They're going to respond in very much real time, looking at the data. And if there's a turn on the negative side in the data, likewise they would pull back. But it's definitely a trial and error exercise.
I want to talk about trade in just a second. But I'm going to just park that for a moment. And I want to focus more on this, putting stimulus into an economy in a bull cycle, essentially, when you're actually seeing things moving. What is the longer-term risk of that? Because you highlight that pretty strongly in your report.
Yeah. So I think one of the concerns we raise is that basically, the US has made a decision to run very large deficits when your unemployment rate is extremely low. That's typically the time you get the exact opposite. You're moving towards balance or surplus, because you don't need to pay as much out in terms of equalizer payments, such as unemployment insurance. And likewise, your tax revenues are going up, because people are employed and they're paying more in terms of income taxes.
Saving for a rainy day.
Yeah. So we're seeing literally the opposite dynamics. And that means, when you hit the next recession, there'll absolutely be a recession in the forecast horizon at some point. We don't know exactly when. But it's likely in the next five years, you'll see a recession. What happens at that stage if you're already running deficits that are going to be about 5% to 6% of GDP?
And right now, you're saying it's around 3 and 1/2 percent?
Yeah. But it's going to be rising because of all these stimulus measures they did. So it's actually going to push into that 5% to 6% range. Now remember, President Obama, at the height of the financial crisis, ran deficits of 10% of GDP. So here we are in a full expansion, going to be close to 6%.
So ultimately, you're putting that burden onto future generations. And so this fiscal stimulus will have to turn into the opposite and be a drag on economic activity down the road.
A drag in a recession?
Yeah. Well, you can do stimulus in the recession. But the minute you come out of it, you're going to have to address that you've now led to much higher debt to GDP numbers. And as a result, you're issuing treasuries to a much greater extent to fund the debt, which does put you more in debt to foreigners, in effect, and the sentiment they have towards treasuries.
So China and Japan are big holders of US treasuries. And if they decide they don't want to hold this debt anymore, that lifts your yields as a reaction to it. So there are certain risks related to it.
You also have to address, how are you going to pay for your future expenditures and your population, such as entitlements, Social Security. These still have not yet been addressed. And you're running large deficits. So there's going to be some hard choices down the road.
They're hoping they can grow their selves out of the debt situation. But that is pretty high hopes.
That's in the next election cycle. But anyway-- OK. Let's talk a bit about trade, because of course, the other piece here that could make things a little more complicated is just what happens with trade. You highlight some different scenarios that could come from the Trump tariffs, as an example, which could lead to more.
The first one, I think you say exemptions that were put in place for Canada and Mexico could be expanded to other economies. NAFTA renegotiation could be unsuccessful, could lead to tariffs imposed on Canada and Mexico. And then finally, an all out trade war.
What is this going to mean for the US economy? And then I want to pivot to what this means for Canada.
Yeah. So for the US economy, they have been benefiting from the trade side through the pass-through of lower prices as a result of it. And then the offset has been that, what was already in decline-- there was already a structural decline in manufacturing from productivity and automation, that that became even, perhaps, more accentuated through some of these free trade agreements that moved activity offshore.
So the notion that you're going to get back jobs in, say, for example, steel and aluminum, which employ, at most, 150,000 people is a tough sell for the tradeoff that you're going to have to pay higher prices. And aluminum and steel feed through broadly, appliances, cars, you name it.
So it will mean that the consumer at the end user will have to pay more. So some of those tax cuts that came through, if you think of the median tax cut going to a household was about $650, $670 a year, that gets clawed back if you're having to pay more for all these other items. So that's one aspect.
The other aspect, as we saw when the aluminum and steel tariffs were initially announced is you saw an incredible amount of market volatility. The markets are not on side with this tactic. It can be destabilizing. It does increase input costs for firms and reduces their profitability and earnings outlook.
So we could get increased volatility from that perspective, and businesses actually being more cautious with investment than going the other way, because you're not certain which way the policy side is going to go.
You're also, to the first point you made earlier, in an economy that's at very high capacity and utilization. So it's not as if you have people just idly sitting by that you can pull into these jobs, whether it's aluminum, steel or elsewhere. So there's actual additional cost pressures that come from trying to recruit and move production up in an already tight market. So all of these speak to higher cost thresholds that will be getting passed through to the US. And then that embeds some inflationary risks.
Right. And the dampening effect, the opposite of what's going on. What is this all going to mean for Canada? When you look at Canada for growth, 3% in 2017. And I think you're looking for 2% in 2018 and 2019. So what is happening here? And does that factor in some pretty big trade risks that are still on the table?
Yeah. So the trade risks are on the table but not embedded in the forecast.
So that 2% assumes that you do not have a NAFTA withdrawal, otherwise we would expect significant financial market volatility and a lot more uncertainty feeding through on the investment side. So we would be marking down our forecast in the event that occurred.
Funny enough, on the aluminum and steel, because Canada was offered an exemption, our production levels will likely rise as a result of it, because there's going to be a void that needs to be filled. And so Canadian firms--
Short-term good news.
Yeah, from that perspective.
On the trade side, it's possible that we've seen deferred investment levels already happening in Canada. But we're at an interesting point in the cycle for Canada. So the NAFTA rhetoric is not as prominent as you would think is playing out on business investment.
So we've had an upturn in business investment. And it's because, when you look at capacity utilization in Canada across 17 different industries, all but two are well above their historical average. So they are very high in terms of capacity utilization. And we have very low unemployment rates.
And so we may be at a point in the cycle, whether you are confident and whether the NAFTA will be renegotiated or not, you still have to invest or make a decision to not expand your operations and possibly lose market share. So that's probably what's playing out right now in the cycle.
We don't know the counterfactual, how much stronger would investment be in the absence of NAFTA risks. And so maybe that's why we're sitting at about 2% mark instead of 2 and 1/2, if NAFTA wasn't there, that counterfactual. But we actually do have a fairly decent amount of investment happening in Canada in spite of all the risks.
That is some good news, at least some strength. What about, just to kind of tick off a few boxes here, the loonie, you're still saying you think between $0.77 and $0.80?
Mm-hmm, yeah. If you think of what the fair value of the loonie is, it would be about $0.80. We think it could trade at a slight discount because of the NAFTA risks. And again, we do not have, embedded in the forecast, a NAFTA implosion.
And do you think that's probable? We should just get that on the table.
On the NAFTA side?
Hard to say. We're getting a lot of mixed reports in terms of the progress being made on NAFTA. I think it's more likely that the can continues to get kicked down the road, as they try to work out many of the sticky points. They're still apparently a long way off from getting resolution on a number of items. So it's possible we'll be still talking about NAFTA renegotiation in 2019, because we have the US elections coming up in the fall.
And that'll kick it past then?
Yeah. This is probably not where they want to spend their time in terms of media. So we might see this continue to extend as we go forward. So it's possible it's going to be with us for a while yet.
The oil price, I want to talk about that as well. You say in your forecast, really seeing limited upside and oil, around $61 right now. And we're going to come to, obviously, what this means for Canada and out west as well too. But is this just the fact there's a lot of supply that come on quite quickly the States now?
Yeah. This talks about that price elasticity that they have. They're able to respond really quickly in terms of operations to small movements in prices. And then they hedge that price down the road, so that even when the price drops, they're still getting that higher price. And it maintains production at higher levels.
So every time we see WTI rise, you likewise see production come back online. So it does tell you that there is almost this ceiling put in place on prices for where we are right now. And that's why we kind of feel safe by saying somewhere around that $60 mark looks reasonable.
I want to finish off with taking a look at the provinces. And we had some interesting numbers, I'd say, this year. Alberta stands out with some high growth this year, just because not so great growth there before. But this looks kind of, I'd say, just a little ho-hum for all the provinces. Just, there's not a lot going on. But it's in around that 2%. But nobody really, really stands out here.
Yeah. Alberta would be a little bit more. So it was about 4% last year. And that was coming off of that slump. And so they're sitting at around 2 and 1/2% this year. And most other provinces, like BC and Ontario, we've moved those down to closer to that 2% mark. That is a full percentage point markdown from what their 2017 growth prospects were. So I think that's the important element to pay attention to.
There are still good dynamics in these provinces. But there are certainly headwinds building, particularly in the housing market, as we've seen in the data recently. Big unwinds in sales occurring, perhaps some sensitivity to what's happened with higher stress testing under B20. But also BC recently in their budget put through a slew of measures in terms of housing taxes to wealthier homeowners, so those who have $3 million-plus homes to speculators, to those leaving homes vacant. And all these measures are going to put a little bit of a weight on these provinces.
Ontario's working through minimum wage, higher wage costs, also has an elevated housing market responding to these B20 guidelines and past budget measures as well. So it's hard to build a case that these are economies that can stay at that 3% mark, particularly if you think of Ontario. The last four years have been the strongest four years, we've had since the 1990s. So to presume that can continue when you're coming up against these constraints and these pressures is a bit of a leap of faith. So it generally should be moving back towards its trend of about 2%.
Beata, thank you.