Economics Department

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Economic and Financial Market Prospects

Earl SweetEconomic ResearchBMO Capital Markets

CASF Conference 2015November 18, 2015

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Presentation outline

Global economic performance and risks

Canada’s macroeconomic prospects

Motor Vehicles, Construction, and Oil & Gas

Fabricated Metals & Steel Services

Surface Finishing

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Sub-par global growth since 2011; modest improvement anticipated for 2016, though risks skewed to downside

Source: IMF; BMO Economics

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2009 2010 2011 2012 2013 2014 2015 2016

Global Economic Growth (%)

AdvancedEconomies

EmergingMarkets

Global Economy

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Global risks – good time to play defence

China hard-landing & financial crisis

Emerging-market crisis as U.S. raises rates

Disinflation morphs to outright deflation

Re-ignition of European stresses

Geopolitical stresses intensify (no shortage): Middle East & North Africa Russia/Ukraine China vs. neighbours and U.S. in the South China Sea

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Weak global growth has caused BMO’s Oil & Gas and Base Metals indexes to retreat sharply from 2011 peaks

Source: BMO Economics

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400

05:1 06:1 07:1 08:1 09:1 10:1 11:1 12:1 13:1 14:1 15:1

BMO Commodity Price IndexesIndex, 2003=100

Base Metals Oil & Gas

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Demand and supply responses will re-balance the global oil market, though progress will be slow

Source: Bloomberg; Wall Street Journal; BMO Economics

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40

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120

09:1 10:1 11:1 12:1 13:1 14:1 15:1 16:1

Crude Oil Prices$/Barrel

WTI in US$ WCS in US$

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U.S. production of crude oil has topped out and begun to decline, while consumption is edging upward

Source: U.S. Department of Energy

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91:1 93:1 95:1 97:1 99:1 01:1 03:1 05:1 07:1 09:1 11:1 13:1 15:1

U.S. Oil MarketMillion Barrels per Day

Crude Oil Production (LHS) Oil Product Consumption (RHS)

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While U.S. total crude oil imports are falling sharply, there is rising refinery demand for Canadian heavy oil

Source: U.S. Department of Energy

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85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

U.S. Imports of Crude OilMillion Barrels per Day

From Canada From Rest of World

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Not so for natural gas – U.S. is becoming self sufficient;long-term health of Canadian industry depends on LNG

Source: National Energy Board; U.S. Department of Energy

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05 06 07 08 09 10 11 12 13 14 15

Natural Gas Production & Net Exports: CanadaBillions of Cubic Feet Per Day

Production (LHS) Net Exports

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While natural resource output is steady at about 10% of GDP,its contribution to exports and investment is much higher

Source: Statistics Canada

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Natural Resource Share of the Economy (%)

Output

Exports

Investment

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Business Investment:important driver of demand for metals

Oil & gas industry – down sharply, delayed recovery Pipe Equipment

Commercial construction – momentum waning Rising office vacancies Reality check for U.S. retail entrants

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Oil & gas industry investment has plunged 40% in 2015;continued weak prices in 2016 to limit any recovery

Source: Statistics Canada

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06 07 08 09 10 11 12 13 14 15 est.

Investment: Oil & Gas Extraction$ Billions

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Considerable new office space coming onto market and weak resource industry are boosting vacancy rates

Source: CBRE

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Vacancy Rates (%): Office Properties (All Classes)

Montreal Toronto Calgary Vancouver

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Diverging trends for industry profits:weak oil & gas; steady manufacturing returns

Source: Statistics Canada

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05:1 06:1 07:1 08:1 09:1 10:1 11:1 12:1 13:1 14:1 15:1

Canadian Industry Performance: ROE

Manufacturing Oil & Gas

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Business has slashed capex in response to falling resource cash flows, rising commercial vacancies, and global risks

Source: Statistics Canada; BMO Economics

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Business Investment in Canada% Change From Year Ago

Machinery & Equipment Non-residential Construction

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Household demand:also an important driver of demand for metals

Motor Vehicle OEM & Parts Production Strong North American sales Slipping Canadian share of North American market

Household Durables Near peak demand, some slippage as housing market

cools from its current unsustainable pace

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Canadian household debt ratio is edging upward, but is not egregiously high

Source: Bank of Canada; Statistics Canada; Federal Reserve; Dept. of Commerce; Haver

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100

125

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175

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225

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275

300

325

99:1 01:1 03:1 05:1 07:1 09:1 11:1 13:1 15:1

Household + Unincorporated Business Liabililties% of Personal Disposable Income

Canada U.S. Australia Norway Denmark

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Sharp U.S. household deleveraging 2/3 by default;Canadian ratio still above pre-GFC level low rates

Source: Bank of Canada; Statistics Canada; Federal Reserve; Dept. of Commerce

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97:1 99:1 01:1 03:1 05:1 07:1 09:1 11:1 13:1 15:1

Household Debt as a Per Cent of Net Worth

Canada United States

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Canada’s jobless rate essentially flat near 7% since early 2013; weak resource prices restraining growth …

Source: Statistics Canada; U.S. Dept. of Labor; BMO Economics

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Unemployment Rate (%)

Canada Canada on US Basis United States

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… and a lower rate of labour force drop-outs contribute to the higher Canadian jobless rate

Source: Statistics Canada; U.S. Dept. of Labor

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03:1 05:1 07:1 09:1 11:1 13:1 15:1

Labour Force Participation Rate% of Adult Population in the Labour Force

Canada United States

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A higher percentage of Canada’s adult labour force is employed

Source: Statistics Canada; U.S. Dept. of Labor

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64

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03:1 05:1 07:1 09:1 11:1 13:1 15:1

Employment Rate% of Adult Population Employed

Canada United States

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House prices are running around 12% above trend;mostly in Vancouver and GTA single-family detached

Source: CREA MLS; BMO Economics

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80:1 85:1 90:1 95:1 00:1 05:1 10:1 15:1

Average Price for Resale Homes: Canada$ Thousands, SA

12% Gap

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Potential problem? Building boom three years ago has brought a lot of condos to the GTA market in 2015

Source: CMHC; Statistics Canada; BMO Economics

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97:1 99:1 01:1 03:1 05:1 07:1 09:1 11:1 13:1 15:1

Total New & Unabsorbed Housing Units: TorontoPer Million Persons

L.T. Avg.

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GTA housing pipeline had been correcting toward trend, but has upshifted since mid-year:Risk: rising supply meets slowing demand during 2016-2018

Source: CMHC; Statistics Canada; BMO Economics

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Housing Units Under Construction: TorontoPer Million Persons

Condos Other Total

Trend

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Housing starts in Canada expected to run near demographic requirement; U.S. recovery at measured pace

Source: CMHC; U.S. Census Bureau; BMO Economics

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Housing StartsMillions of Units

Canada -- LHS United States -- RHS

Demographic Requirement

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Mortgage quality still rock solid in Canada despite dire warnings from headline writers

Source: Canadian Bankers Association; U.S. Mortgage Bankers Association

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Mortgages 90+ days in Arrears% of Total Mortgages

Canada Alberta United States

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Equity in Canadian households’ real estate has held remarkably steady near 70% for 25 years

Source: CMHC; U.S. Census Bureau; BMO Economics

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Household Residential Equity% of Value of Residential Property

Canada United States

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North American motor vehicle sales spurred by rising employment and very low borrowing costs

Source: Statistics Canada; Autodata; BMO Economics

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Motor Vehicle Sales Million Units

Canada -- LHS United States -- RHS

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Imports of vehicles and parts have surpassed pre-recession peak by 22%; exports rising, but constrained by capacity

Source: Statistics Canada

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Motor Vehicle and Parts Trade$ Billions, Monthly

Exports Imports

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Challenging markets for the Oil & Gas, Construction, and Transportation Equipment industries are restraining demand for and output of fabricated metals and steel services

Source: Statistics Canada

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Metal Surface Finishing MarketsReal GDP: Billions of 2007 Dollars

Fabricated Metals Steel Service Centres

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Metal coating, heating, & engraving have fallen as a per cent of fabricated metals shipments since 2003 …

Source: Statistics Canada

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Metal Surface Finishing Shipments% of Fabricated Metal Shipments

Long-run Average = 8.4%

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… in part, reflecting a more challenging pricing environment for surface finishers

Source: Statistics Canada

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03:1 04:1 05:1 06:1 07:1 08:1 09:1 10:1 11:1 12:1 13:1 14:1 15:1

Industry Selling PricesIndexes, 2003=100

Metal Surfacing Fabricated Metals

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On the plus side, the lower loonie should act as a tail-wind for the trade-intensive Canadian economy …

Source: Bank of Canada; BMO Economics

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Canadian DollarUS Cents

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… and non-energy exports have already begun to respond

Source: Statistics Canada

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Non-Energy Exports$ Billions

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Another positive: even small steps taken to close the large infrastructure gap would boost economic growth

Source: Statistics Canada; BMO Economics

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Government Real Capital Stock Thousands of 2007 Dollars Per Capita

1971-1994 Trend ExtrapolatedTrend Growth = 1.8%

Infrastructure Deficit = $180b

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Canadian growth to strengthen to 2.1% in 2016, supported by robust U.S. demand and the low loonie

Source: Statistics Canada; Bureau of Economic Analysis; BMO Economics

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Real GDP Growth (%)

Canada United States

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Resource-rich provinces will face challenging conditions; momentum improving in manf-oriented Central Canada

Source: Statistics Canada; BMO Economics

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B.C Alb Sask Man Ont Que Atl

Economic Growth by Province (%)

2014 2015 2016

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Fed expected to go in December;global risks expected to keep BoC on hold until early-2017

Source: Bank of Canada; Federal Reserve Board; BMO Economics

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Monetary Policy Rates (%)

BoC Overnight Fed Funds Target

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Modest policy tightening, overseas QE, and slowing potential growth to restrain the increase in LT yields

Source: Bank of Canada; Federal Reserve Board; BMO Economics

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10-Year GoC/Treasury Rates (%)

GoC 10-Year 10-Year Treasury

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Upside surprises for the industry?

A positive LNG Final Investment Decision Would boost natural gas E&P and pipeline development

Accelerated infrastructure investment

Faster-than-expected recovery in oil prices