Transcript - Global Economic Outlook- Spring 2015

Hello, and welcome to RBC Global Asset Management Economic Update for Spring 2015. I'm thrilled to have Eric Lascelles, Chief Economist at RBC Global Asset Management, with us today to provide context around recent market events. Eric, thank you for joining us. We're thrilled to have you in the studio today.

My pleasure.  

There's been a lot going on in economies around the world, and 2015 is now well under way. Can you give us an idea of what you think are some of the key economy and market developments?

Sure. Happy to. It seems to me that one needs to acknowledge that it hasn't all been good news. We have in fact seen global economic growth slow a little bit as this first exhibit demonstrates. These are Global Purchasing Manager Indices. They've declined for the developed world and emerging markets alike, so a little bit less growth. Frankly, the downside risks are a little bit bigger than they were before, with a particular emphasis on the likes of Russia and Greece and deflation risks, so not a great starting point.

I will say, though, an important caveat is we still think 2015 sees more growth than last year; even if we're looking for a bit less than before, we still think 2016 sees a bit more growth than 2015. So that's a roundabout way of saying the recovery is still intact, if slightly less enthusiastic. The reason we still think this recovery is on is, centrally, that the combination of lower oil prices, lower borrowing costs and lower exchange rates for many countries in the world is a very powerful economic stimulant, and that should be the ticket to faster growth this year.

Let's go back and focus on some of those risks that you talked about for a moment. What do you see as being some of the biggest risks in the environment today?

From a geographic perspective, I think Russia and Greece really are those big risks. Russia, because of its military adventures, because of its somewhat shaky debt situation and because of an economy that's in deep recession – so any number of challenges existing there. It happens to be the case that the Russian government probably has the resources necessary to mop up that extra debt and to weather the economic slowdown, but it's not a happy position to be in, and there is the risk of some spillovers to the rest of the world if it doesn't go smoothly. So, mostly a risk, not a reality, but a very real one.

If we're talking about Greece, now Greece had an election at the beginning of 2015. They elected a far left government which has expressed some scepticism at the reform process and the austerity process that Greece was previously engaging in. That's created some concerns in the market as to whether they might be forced out of the Eurozone. In the end, we think the risk of that is fairly low. We've seen this new political party blink in terms of its negotiations with Europe.

When we look at the sustainability of Greek debt, it's surprisingly good as this next exhibit shows. In fact, what we find is that Greece is spending less as a share of GDP servicing its public debt than Italy is right now, and it's spending less than it did in 2007, before the crisis started, and spending less than it did in 2001 before it even entered the Eurozone. So, there's nothing obviously unsustainable, but, again, there are some very real risks. They're unlikely to transpire – perhaps less likely to transpire than the market fears – but I wouldn't want to suggest they don't exist at all.

Eric, inflation has softened since last quarter. Is it possible that the world could find itself stuck in a deflationary environment?

Well, declining inflation has absolutely been a key theme, and I will confess we have pulled our inflation forecasts down fairly aggressively this quarter in response to that trend. If we look at the consensus forecast out there, as this next exhibit shows, you can see those forecasts for 2015 inflation have also been in pretty steady decline. In fact, the market now thinks that the Eurozone will see lower prices over the next year, as opposed to higher, which is the technical state of deflation.

                                    When we step back, though, and we acknowledge that a big part of the deflationary impulse comes from lower oil prices, which we think probably will rebound, when we acknowledge that a fair chunk in Europe where it's most acute comes from lower food prices, which seems to be mostly a weather issue and therefore inherently temporary, we probably don't see inflation stay this low for long. Yes, it should be low. It's unlikely to revert to truly normal levels for a few more years, but it is still more likely that inflation rises to some extent over the next year than that it falls. And so, as a result, I think this is perhaps another one of those slightly overblown concerns.

Okay. Now, I recall you saying, when we last spoke, that you thought 2015 was going to be a momentous year for monetary policy. How's that prediction faring now?

It has worked out wonderfully, probably more so, frankly, than we anticipated at the time. Central Banks have been busy, indeed, but, boy, have they been busy – in the sense that here we have a Fed in the US priming itself for rate hikes in the not to distant future motivated by a tightening labour market, seemingly not all that concerned by a strong US dollar. The real action, though, is in Europe, so the European Central Bank finally stepping up to the plate delivering massive quantitative easing, so money printing, bond buying. This next exhibit shows that. You can see they target a 1.1 trillion euro increase in their balance sheet over the next year and a half, so massive stimulus there. That then trigged a number of domino effects: so neighbours to Europe like Sweden and Denmark and Switzerland also ended up cutting rates; several commodity players entered the rate-cutting business, and saw the Bank of Canada cut rates – probably not going to see another, but cut rates nonetheless; Australia cutting rates, as well, in that commodity space; and then a large number of emerging market countries also have been cutting rates. China, India, Indonesia, Turkey, really almost all of the major ones, have been doing that as well.

The bad news is, of course, they are cutting rates because they are encountering disappointing growth. That's part of this narrative of less activity versus last quarter. The good news, though, is of course that by cutting rates they are setting themselves up for more growth going forward. Again, we do think we will see more growth going forward with Central Banks being one of several key tools.

The last comment on this would be that the combination of lower inflation and Central Bank rate-cutting and easing has brought bond yields down to extraordinarily low levels.

Now, Eric, as you've talked about risks today, Europe has figured prominently in many of your comments. As an investor, should we stay away from there or are there, in fact, opportunities?

I think the latter, so I think there are increasingly opportunities there. Context again is everything. It's not that we expect resoundingly fast growth out of Europe. In fact, we expect what would be considered disappointing growth by US standards. But we nevertheless think European growth will be better than the market expects, and that's the ticket in terms of financial markets in a region outperforming. So, we think Europe is firmly in growth mode; we think their growth can accelerate over the next year to two years. When we look at the reasons why, a lot of it has to do with the European Central Bank, as we've discussed. A fair chunk of it has to do with oil and bond yields and currencies, as we've discussed, as well. But a lot also has to do with credit impulse in Europe. It's shifting in a positive direction. Credit is becoming available. The periphery of Europe is starting to grow.

The core – there's been a lot of concern about the core of Europe. In our mind, the core concerns have always been overblown. So, for instance, concerns of a German recession were never all that realistic. In fact, as this next exhibit shows, to the absolute contrary, confidence in Germany was never particularly low, and is actually now clearly improving.

So, we think we will see somewhat faster growth, and that maps onto markets in the sense that we have above-consensus economic expectations, and we acknowledge that European stocks are unusually cheap by a valuation standard, and so on a currency-hedged basis we have found ourselves shifting some of our assets away from the US and towards the likes of Europe.

Eric, oil prices have stabilized recently, but at very, very low levels. Do you think it's possible we can see oil prices rebound in 2015?

I still stubbornly think we will as oil prices absolutely are very low. They have increased notably from their absolute lows, but they are still fairly low. In terms of why we think oil prices will increase, it really comes down to the fact that at $50 or thereabouts a barrel fully half of global oil production is not viable. So, if you think half of production needs to go away, that's a sustainable price, but half of production doesn't need to go away. In fact, oil supply in the world only exceeds demand by about 2%. To resolve that fairly small mismatch can justify a price in fact significantly higher than where it is right now.

Given what's going on not only with oil prices, but how is Canada holding up in an environment like this?

Canada really is a tug of war right now. Lower oil prices are the negative side of this. It hurts an oil exporter like Canada. But there are a number of positives. The weaker Canadian dollar is a good thing, strong US demand is a good thing, as well, and the Bank of Canada rate cut is a helpful thing, as well. It's not obvious how this plays out. As it turns out, oil seems to be dominating, so in the end it is a net negative for the Canadian economy, but really it has regional implications as much as it has national implications.

As this next exhibit shows, you can see that leading indicators for Alberta and Saskatchewan, say, where the oil is general produced, have seen very sharp declines. Others in Ontario are holding up at least a little bit better, or declining by less. So, big regional divergences, different leaders going forward than what we've seen in the past. Circling back to the likes of Alberta which is the most oil-oriented, will there be a recession? I'm inclined to say no in the sense that I do think oil rebounds fairly quickly, but it's not an impossibility. If we're wrong on the outlook for oil, then Alberta could very easily find itself in recession. From a housing market perspective, we've seen Alberta existing home sales fall fairly sharply but we haven't seen much of a hit to home prices or housing starts, and that's actually consistent with the experience of the last oil correction in 2008-2009.

Just to conclude on Canada, what I would say is, going forward, we have pulled our growth forecasts down a bit in response really to oil more than anything else. We still think okay growth will likely transpire, but a bit less than the market is currently budgeting for. Really, that's been our position for several years in a row at this point in time. We think Canada will be slightly disappointing, but still grows fairly handily.

Finally, Eric, can I just ask you to summarize some of the key points that you've made, not only on your outlook for 2015, but maybe even go beyond that?

Sure, I'd be happy to. I guess the main theme needs to be a bit less growth, a bit more on the risk side. So not a lovely theme, though with the important caveat that even as that downgrade occurs, we still look for more growth this year than last year – just less than previously imagined. If we talk thematically, I think the developed world fundamentally is still normalizing, the US perhaps having achieved that, the UK being very close; the Eurozone maybe being the next region to normalize economically in a good way; emerging markets probably haven't received their due attention in this discussion, but emerging market growth certainly has slowed materially over the past several years. There are countries that likely continue to slow along those lines, like China, but we are seeing what we think is a turn among a significant subset of them, with the likes of India perhaps leading the way higher in terms of more growth.

From a market perspective, we're still overweight stocks and have been for quite some time. Less growth doesn't make us pleased, but at the same time ultra-low bond yields don't give a whole lot of alternatives, and so we still find ourselves overweight stocks and underweight bonds. We think the US dollar remains king in the currency space. We think commodity prices have overshot, so not just an oil story, even if it's most obviously an oil story. We may see commodity prices rise more generally.

And then, something that doesn't get done very often, but we should talk for a moment about the longer term outlook. Longer term, it's undeniable there are some significant challenges out there. Public debt vulnerabilities are one, given how high public debt loads are around the world. Demographics present an obvious challenge. The environment presents another theoretical challenge, as well. They do limit global growth over the long run, but let's not underestimate the reforms that policymakers are increasingly willing to make to engineer faster sustainable growth. I think above all else, let's not underestimate human ingenuity in terms of surmounting some of these obstacles. I still think the future is reasonably bright, even with those obstacles.

Eric, thank you so much for joining us in the studio today. You've been incredibly informative, and I look forward to speaking with you again next quarter.

Thank you.

I also want to thank all of you for joining in today, as well. If you have any further questions on the current investing environment, please speak with an RBC Advisor today. Thank you.