With significant downside risks facing the Canadian growth outlook, investors should be pulling away from risky assets, says BofA Merrill Lynch.
In a new report, the firm says that while Canada did outperform most developed market economies throughout the financial crisis, it doesn’t believe that can continue. “In our view, Canada is bumping up against its growth limits,” it says.
Merrill says that Canada faces several near-term demand-side constraints and longer term supply side constraints, which make it cautious on the outlook for Canada. The near-term demand side constraints include household deleveraging and a strong Canadian dollar. The supply-side constraints include: an export sector that’s dependent on the United States; worsening terms of trade from higher oil prices; and, weak labour productivity.
Additionally, the U.S. is facing “a massive fiscal cliff” at year end, which it says engenders market uncertainty. “The slowdown in the U.S., presents significant downside risks to Canadian growth,” it says.
“As Europe remains in recession and the U.S. slows, Canadian aggregate demand will likely weaken, reopening the output gap,” it notes. “Given our relatively weak economic outlook, we are not expecting a return to full capacity until the second half of 2013, helping keep underlying inflation slightly below the [Bank of Canada] target of 2.0% for most of the next year.”
Ultimately, the report suggests that this weaker growth outlook means investors should be reducing their risk exposure. This means moving away from riskier asset classes, such as equities, and into safer investments, such as Canadian government bonds, it notes.
Additionally, it says that it expects several false alarms of the Bank raising rates over the next year and half before the Bank actually moves, which it believes will create near-term trading opportunities in the short-end of the bond market.