{{r.fundCode}} {{r.fundName}} {{r.series}} {{r.assetClass}}

You are currently viewing the Canadian website. You can change your location here.

Terms and conditions for Canada

Welcome to the new RBC iShares digital experience.

Find all things ETFs here: investment strategies, products, insights and more.

.hero-subtitle{ width: 80%; } .hero-energy-lines { } @media (max-width: 575.98px) { .hero-energy-lines { background-size: 300% auto; } }
by  Eric Lascelles Mar 18, 2019

What's in this article:

  • Webcast
  • Fed
  • Brexit
  • Tariffs
  • Climate change

Webcast:

Fed preview:

  • The Fed decision scheduled for this Wednesday is set to be closely watched, if not quite as obsessively as the meetings in December and January. At that time monetary policy was undergoing a profound pivot away from tightening and toward a more neutral positioning.
  • The Fed is now clearly on hold, and little is likely to change on that front. The fed funds rate is almost guaranteed to remain in the range of 2.25% to 2.50%.
  • That said, this meeting may clarify several other things.
  • First, how substantially will the Fed’s dot plots recede? The market’s best guess is that the median prediction of two 2019 rate hikes will retreat to just one hike. That remains ahead of the market’s own prediction of no rate increases. This seems like a reasonable guess. Presumably, some Fed participants will themselves anticipate no further rate increases, though they are unlikely to represent the majority of the dots.
  • Second, the text was already substantially softened in the prior statement. Any further tempering is likely to be fairly tame, particularly as long as economic data remains mixed rather than purely negative.
  • Third, the Fed is likely to downgrade its growth outlook modestly, given the extent to which global growth has continued to slow since late 2018. For context, our own forecasts were sliced by a quarter point from 2.50% to 2.25% over the past quarter. The inflation outlook may also be trimmed.
  • Fourth, the Fed may provide guidance on how it will conclude its balance sheet reduction operations. The balance sheet has now declined from $4.5T to under $4.0T, and the process is set to conclude at around $3.5T. At the current pace of selling, the process could be complete by the end of 2019. Earlier in the year, the Fed suggested it would convey the details of this trajectory “soon.”
  • Most of these views are broadly in line with the market. Relative to this consensus, we would highlight the risk that the Fed isn’t quite as dovish as the market hopes. This is in part because a central bank grappling with a sub-4% unemployment rate and a recent 20% rally in the stock market may wish to continue highlighting the possibility of a return to monetary tightening. Furthermore, even if the Fed has already worked out how and when it will end quantitative tightening, it might wish to save that canister of rocket fuel for a later meeting when markets could well be in need of a pick-me-up.

Brexit update:

  • Brexit views have, at best, a half-life measured in hours. Frankly, that might be an optimistic claim at the present juncture. A tangle of soon-to-be-resolved political scenarios vie with one another.
  • A vote last Friday managed to substantially reduce the risk of the U.K. crashing haphazardly out of the EU, committing the U.K. to an extension past the official March 29 Brexit deadline. It will be a short extension if parliament manages to approve Prime Minister May’s exit plan, and a longer one if it fails to do so (requiring a return to square one).
  • This doesn’t completely eliminate the hardest of Brexit scenarios given that all 27 EU countries must unanimously approve any Article 50 extension request. But, given favourable EU comments toward an extension, it means the accidental Brexit scenario is unlikely.
  • For a moment, it looked as though there was a halfway decent chance that parliament might approve May’s third effort to vote through her customs union transition deal with the EU. Some hardliners were tempted to support the deal in recognition of the fact that its failure would likely motivate a cross-party effort for an even softer version of Brexit.
  • However, the plan for a vote on Tuesday or Wednesday is now in doubt. Speaker of the British House of Commons has just shocked virtually everyone by rejecting such a vote on the principle that a single parliamentary session may not vote repeatedly on the same matter. Barring a sudden change of heart by the Speaker, a change to the proposed arrangement, or a radical effort to initiate a new parliamentary session on short notice, this would appear to force the U.K. toward a lengthy (potentially multi-year) extension of the Brexit deadline.
  • In this scenario, the U.K. would then likely hold indicative votes to determine which of the many Brexit options is most popular among parliamentarians. Given the variety on offer, none are likely to receive more than 50% support. But the process could help to congeal cross-party support around a softer Brexit outcome.
  • A delayed Brexit also raises the distinct possibility of a second referendum and/or an election. All of these scenarios further nudge the most likely outcome toward a softer version of Brexit, or even no Brexit at all.
  • Thus, we continue to emphasize that while the chaos and the short-term uncertainty has undeniably mounted around Brexit, the odds of a bad outcome have shrunk as the risk of an uncoordinated exit and hard Brexit have both declined.

Canadian budget preview:

  • Canada’s federal budget is published late on Tuesday.
  • It seems likely to be a stimulative and thus modestly growth-positive budget, for several reasons:
    • This is an election year, meaning that the government will be seeking to please voters.
    • The Liberal government has been happy to run fiscal deficits throughout its tenure, justifying deficits during periods of economic weakness on Keynesian grounds and during periods of economic strength on the basis of enhanced fiscal space.
    • The calculus for the 2018-2019 fiscal year has been significantly better than expected. Through nine of 12 months, the federal government is running an unexpected surplus of $324M, versus an initial forecast for a deficit of $18B. Granted, there are seasonal factors that should claw back many billions of this apparent gap over the final three months. But the point is that in the very short run, the government may be luxuriating in more fiscal capacity than it expected. On the other hand, the Canadian growth forecast has recently been cratering, potentially subtracting from the fiscal capacity in later years.
  • Policy possibilities:
    • The government has already delivered on accelerated depreciation for businesses. This was announced late last year, but will surely be played up again in the budget.
    • Rumoured spending initiatives include: more support for child care, the beginning of a national pharmacare program, measures to enhance the skills of Canadian workers and possible support for seniors in the form of an option to delay RRSP withdrawals.
    • Canadian governments at all levels have mostly been focused on cooling the housing market over the past decade. Now, recent weakness may prompt a partial back-tracking at the federal level. Two rumoured items include: a larger Home Buyer’s Plan limit (it has been frozen at $25K for a decade) and a possible increase in the maximum insured mortgage amortization period from 25 years back up to 30 years.
    • Given recent suffering, the oil sector could conceivably receive a helping hand of some kind.
    • While not especially likely, the CD Howe Institute has advocated in its shadow budget for a doubling of the threshold at which Canada’s top tax bracket begins, from around $210K to $420K. Were the government to deliver tax relief for high income earners, this would be easier for voters to swallow than an explicit reduction in the top tax rate.
    • There has been radio silence on the key issue for investors of the capital gains inclusion rate. We presume the government will not be increasing it: tax hikes are rare during election years; the matter could have been pursued in earlier budgets, but was not; and when the capital gains and corporate income tax rates are tallied together, investors already pay a higher rate on their income than popularly imagined.
  • The Canadian federal government debt-to-GDP ratio is already low and likely to remain on a downward trajectory, with an expanding economy offsetting a rising absolute debt load. While sustainable in theory, in practice the next recession could upset this happy equation.

    -With contribution from Vivien Lee

Canadian budget review:

  • Two macro developments have pleased markets over the past three months: more dovish central banks and improving trade prospects between the U.S. and China.
  • The first of these is entirely real. The second may not be improving quite as much as first hoped.
  • Two weeks ago we happily conveyed word that U.S.-China trade negotiations were proceeding well, potentially with a constructive resolution by the end of this month. However, it now appears that the process has slowed. Instead of March, there is now talk of April or even May or June as the timeline for an agreement. Furthermore, and related to this, some issues are proving harder to resolve than initially hoped.
  • We continue to believe that a U.S-China deal is reasonably likely, but that it may only be superficial, leaving key political and trade frictions unresolved.
  • Furthermore, let us not forget that auto tariffs may yet surface from the murky depths in the coming weeks.
  • All of this is to say that the protectionist issue has not yet been fully resolved – it remains in the “drag” column for 2019 and beyond.

Climate change update:

  • As we wrote last fall, we lean heavily on the work of recent Economic Nobel Prize winner William Nordhaus when assessing the economic implications of climate change.
  • The damage is non-linear: the initial pain from a rising temperature is slight. It then grows exponentially as the temperature increase pushes further.
  • The world is already around 1 degree warmer than in pre-industrial times, with the implication that the level of global economic output is already a few tenths of a percentage point lower than otherwise.
  • There are huge error bars around where the global temperature will eventually end up. According to the Intergovernmental Panel on Climate Change, with aggressive policy solutions the cumulative increase might be restricted to just +2 degrees Celsius by the year 2100. On the other hand, doing little to alter the current trend would result in something like a 4.25 degree increase.
  • These scenarios have dramatically different economic implications. The former subtracts 0.9% from the level of GDP, while the latter subtracts a big 4.1%.
  • Converted into a flow variable, this amounts to an average of 0.01% and 0.05% less economic growth per year, every year, between now and 2100.
  • While these impact figures may not seem very large, keep in mind that the global economy currently produces a remarkable $85 trillion per year of value. Even conservative projections for global growth of just 2% per year through 2100 (versus nearly 4% growth in recent years) puts the global economy’s annual production by 2100 at an astounding $432 trillion 2018 dollars. In turn, the difference between policy measures that successfully limit the temperature increase versus the continuation of the current policy trajectory is a high-stakes $14 trillion of theoretical lost output in the year 2100 alone, with similar damage done annually thereafter.
  • These large losses argue that environmental mitigation efforts are actually quite cost effective when compared to the alternative.
  • The damage comes from a mix of factors:
    • Higher temperatures and increased incidence of drought hurt certain forms of economic activity, like agriculture.
    • It is costly to adjust to a changing climate, even in lucky regions where new opportunities arise to replace old industries.
    • Climate change appears to bring about a greater incidence of extreme weather events that slow economic growth and damage the capital stock.
  • On this last subject – extreme weather events – academics such as Dr. Friederike Otto of Oxford University have increasingly succeeded in differentiating via statistical techniques between weather events that are the result of climate change versus those occurring by chance.
  • Naturally, the impact of climate change should vary significantly depending on the sector and country. Some controversial research goes so far as to claim that certain (mostly northern) countries could outright benefit.
  • While the aforementioned growth forecasts represent base-case scenarios, risks extend in both directions. It is possible that climate change itself and/or its effect on economic growth may be less than feared. However, it is just as conceivable that the climate change and/or economic impact is worse than anticipated, with little understood “tipping points” potentially making for large negative misses.
  • From an investment perspective, climate change represents both a risk and an opportunity. The risks are clear. Opportunities can arise by successfully anticipating changes to the environment, environmental regulations, social license, and the value of corporate assets (or lack of value, in the case of “stranded assets”). Companies successfully positioned to dodge the worst of climate change or to help mitigate it are particularly well positioned.

Disclosure

This report has been provided by RBC Global Asset Management (RBC GAM) for informational purposes only and may not be reproduced, distributed or published without the written consent of RBC Global Asset Management Inc. (RBC GAM Inc.). In Canada, this report is provided by RBC GAM Inc. (including Phillips, Hager & North Investment Management). In the United States, this report is provided by RBC Global Asset Management (U.S.) Inc., a federally registered investment adviser. In Europe, this report is provided by RBC Global Asset Management (UK) Limited, which is authorised and regulated by the UK Financial Conduct Authority. In Asia, this document is provided by RBC Investment Management (Asia) Limited, which is registered with the Securities and Futures Commission (SFC) in Hong Kong.




RBC GAM is the asset management division of Royal Bank of Canada (RBC) which includes RBC GAM Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Investment Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.



This report has not been reviewed by, and is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the above-listed entities in their respective jurisdictions. Additional information about RBC GAM may be found at www.rbcgam.com. This report is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. The investment process as described in this report may change over time. The characteristics set forth in this report are intended as a general illustration of some of the criteria considered in selecting securities for client portfolios. Not all investments in a client portfolio will meet such criteria. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.



Any investment and economic outlook information contained in this report has been compiled by RBC GAM from various sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its affiliates assume no responsibility for any errors or omissions. All opinions and estimates contained in this report constitute RBC GAM’s judgment as of the indicated date of the information, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates and market conditions are subject to change. Return estimates are for illustrative purposes only and are not a prediction of returns. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods. It is not possible to invest directly in an unmanaged index.




A note on forward-looking statements

This report may contain forward-looking statements about future performance, strategies or prospects, and possible future action. The words “may,” “could,” “should,” “would,” “suspect,” “outlook,” “believe,” “plan,” “anticipate,” “estimate,” “expect,” “intend,” “forecast,” “objective” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties about general economic factors, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement. These factors include, but are not limited to, general economic, political and market factors in Canada, the United States and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings and catastrophic events. The above list of important factors that may affect future results is not exhaustive. Before making any investment decisions, we encourage you to consider these and other factors carefully. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility.