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Canadas commodities- and energy-leveraged economy should benefit from the bailout


Date: Wednesday, September 24, 2008
Author: Investment Executive

Wall Street rescue will hit U.S. with higher inflation, interest rates: CIBC World Markets.

But Canada's commodities- and energy-leveraged economy should benefit from the bailout.

By IE Staff

The US$700-billion rescue of Wall Street by the U.S. government will help avert a meltdown in the world's financial system, but cost Americans down the road in the form of higher inflation and higher interest rates, suggests a new economic forecast from CIBC World Markets Inc.

"While the cost of taking another path will never be known, the cost of the one chosen is clear enough," says Jeff Rubin, chief economist and chief strategist at CIBC World Markets. "Higher deficits can only bring higher taxes and higher inflation can only bring higher interest rates. Both are on their way in the U.S. economy."

Speaking on Tuesday at the CIBC World Markets Eastern Institutional Investors Conference in Montreal, Rubin told the audience that while the U.S. and rest of the Organization for Economic Co-operation and Development are likely to see growth grind to a halt by year-end, global growth should regain momentum in 2009. And while it will fall short of the near-record pace of the last few years, it will put pressure again on commodity and resource prices.

"With fears of a financial system meltdown and growth collapse averted, prices for a range of commodities have already likely seen their lows," says Rubin, who expects global growth to settle at a respectable 3.8% this year and 4.2% in 2009. That pace should quickly push up commodities prices, including oil, which he expects will average at a record-high $150 per barrel over the second half of 2009 as the economic recovery rekindles demand growth.

The result will see U.S. CPI inflation punch through 6% in the latter half of 2009. The last time CPI inflation was that high was in 1990, when the federal funds rate was 7.5% or almost four times what it is today.

The good news for the U.S., says Rubin, is that the gradual easing of mortgage and credit pressures will help stabilize the housing and labour markets by the second quarter of 2009.

Rubin expects that the U.S. Federal Reserve will only be tolerant of inflation until the economic picture brightens. By the second quarter of next year it will begin raising interest rates. "Once started however, they have a long way to go. By yearend they will have hiked the funds rate by 200 basis points, in what is likely to be a protracted and painful adjustment in real interest rates."

Rubin told his Montreal audience that the 2009 picture will be brighter in Canada.

"For the commodity- and particularly energy-leveraged Canadian economy, the U.S. Treasury bailout is unambiguously good news. After all, it won't be Canadian taxpayers that are on the hook, while it will be Canadian resource and energy companies that will benefit from the stability brought to financial markets and the more bullish outlook that shines on world growth.

"The TSX is likely to take a run up to 14,000 before feeling the bite of interest rate hikes later next year. Not having cut rates as much as the Federal Reserve Board, the Bank of Canada will find itself in the enviable position of not having to raise them as much on the way up. The Bank is likely to do no more than half the Fed's 200-point rise while the loonie breaks through parity again on the back of climbing crude prices," says Rubin.

He adds that while Canadian growth will likely stumble during the second half of this year, rising energy prices next year will once again add momentum to both corporate profit growth and income gains throughout the resource-levered Canadian economy. Real output should also grow at a 3% pace by the second half of 2009, halting the rise in the national jobless rate, which is likely to peak at just over 6.5%. But he says inflation, stoked by the same energy price pressures felt south of the border, will likely re-ignite, suggesting the Bank of Canada's work, like that of the Federal Reserve Board, may not yet be done.