July-August 2010

¾ On the whole, the world economy has enough momentum at present to absorb the crosswinds of Europe’s fiscal
crises. Though growth is uneven across the major economic regions, we expect global growth of about 4% in 2010.
¾ After the worst recession since the 1930s, oxygen from public stimulus programs has helped the U.S. private-sector
economy gradually get back on its feet. We expect U.S. growth to remain strong over the rest of 2010 and then be
slowed in 2011 by the drag of federal deficit reduction.
¾ Canada’s economic growth is currently the strongest in the G-7. Domestic demand has passed the pre-recession peak
and is now in an expansion phase. At this rate, excess capacity will be absorbed within two or three quarters. The
Canadian expansion is likely to remain strong through the rest of this year and then slow next year in response to U.S.
fiscal austerity.

Change from
Previous Forecast
2009 2010 2011 2010 2011
United States
GDP -2.4% 3.6% 2.4% unch +0.1%
CPI inflation -0.3% 1.7% 2.3% -0.1% -0.1%
Overnight rate* 0.11% 0.25% 2.00% -50bp -50bp
Ten-year bond yield* 3.84% 3.86% 4.33% -12bp +17bp
Canada
GDP -2.6% 3.6% 2.1% +0.1 unch
CPI inflation 0.3% 1.8% 2.4% unch unch
Overnight rate* 0.25% 1.50% 2.75% unch unch
Ten-year bond yield* 3.61% 3.85% 4.10% -10bp -10bp
USD/CAD 0.92 0.97 0.99 +.01 unch
* end of period

ECONOMIC AND STRATEGY GROUP – 514.879.2529

Stéfane Marion, Chief Economist and Strategist
General: National Bank Financial (NBF) is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on Canadian stock exchanges. ♦ The particulars contained herein were obtained from
sources which we believe to be reliable but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or
sell the securities mentioned herein. ♦Canadian Residents: In respect of the distribution of this report in Canada, NBF accepts responsibility for its contents. To make further inquiry related to this report or effect any transaction, Canadian residents
should contact their NBF Investment advisor. ♦ U.S. Residents: NBF Securities (USA) Corp., an affiliate of NBF, accepts responsibility for the contents of this report, subject to any terms set out above. Any U.S. person wishing to effect transactions
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not be reproduced in whole or in part, or further distributed or published or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of
National Bank Financial.
 Monthly ECONOMIC Monitor
World: A multi-track global economy World: LEI growth peaks, GDP growth will continue
Composite leading indicators: World, OECD, BIC countries
On the whole, the world economy has enough 24 % 6-month change
Decelerating, but
momentum at present to absorb the crosswinds of 20 from a higher peak

Europe’s fiscal crises. Though growth is uneven 16

BIC
across the major economic regions, we expect 12
World
8
global growth of about 4% in 2010. OECD
4

The spectacular surge of leading indicators for the 0

OECD and emerging economies as they emerged -4

from recession has given way to less dazzling but still -8

1997-98 Asian crisis and U.S. recessions in gray
-12
high rates of increase, pointing to firm global growth
-16
over the rest of the year. 96 97 98 99 00 01 02 03 04 05 06 07 08 09

NBF Economy & Strategy (data via Datastream)

That said, the acute structural problems of the euro
zone, brought into harsh relief by severe global
recession, have triggered an unprecedented fiscal
crisis and even, for some observers, compromised
the viability of the single-currency area. The fiscal Price of EU sovereign CDSs on the rise again
Sovereign Credit Default Swap (5-year)
crisis is far from over, as attested by risk premiums
260 Basis points
on some sovereign debt. It will probably have the 240
effect of hastening long-needed reforms and thus of 220
200
improving Europe’s medium-term growth prospects. 180
Italy

In the short term, however, the recovery of the region 160

140
will be braked by fiscal austerity. 120 Belgium
100
The euro zone’s daunting structural problems have 80
France

not snuffed out all cyclical resilience. Manufacturing 60

40 Germany
output, though still far below the pre-recession peak, 20
is growing robustly in its three largest economies. 0
2008M01 2008M07 2009M01 2009M07 2010M01 2010M07
GDP is expected to have picked up substantially in NBF Economy & Strategy (data via Bloomberg)
the second quarter after a very meagre advance in
the first. On balance, euro-zone growth will trail that
of other large economic blocs by a wide margin in
2010.
Chinese exports at a new high
However, the time when Europe accounted for more Exports and imports, seasonally adjusted
than 20% of global GDP is past. Its current weight of 140 $ billion monthly

14% means that its difficulties are more than offset by 130 Exports
China’s record exports
the steep V-shaped recovery of international trade 120
in May show that
and by the strong acceleration of Asian economies. 110 euro-zone troubles are
having a limited impact Imports
100
The GDP of emerging Asia, still the global driver, has
90
now passed the pre-recession peak. Exports are also
80
at all-time highs for China and many other countries 70
of the region. 60

50

40
2005 2006 2007 2008 2009

NBF Economy & Strategy (data via Datastream)

July-August 2010 2
 Monthly ECONOMIC Monitor
Asia, in short, is doing very well despite headwinds
World Economic Outlook from the deleveraging of U.S. consumers and from
the substantial exposure of its export production to
Current Forecast the euro zone. One reason for this showing is that
fiscal and monetary stimulus policies are working.
2009 2010 2011 Another is that Asian domestic demand is assuming
Industrialized Countries -3.3 2.5 2.0 an ever-growing role in the global economy.
(share of world GDP = 50%)
United States -2.4 3.6 2.4 China's main trading partners
(Last 12 months)
Euroland -4.0 1.0 1.6 Exports Imports
Japan -5.1 2.2 1.5 Asia 47.4% 60.0%
Japan 8.0% 12.9%
UK -5.0 1.5 2.0 Hong Kong 13.8% 0.9%
Canada -2.6 3.6 2.1 North America 19.4% 8.6%
Euro zone 19.7% 12.3%
Australia 1.3 3.5 2.1 Latin America 5.1% 6.3%
New Zealand -1.4 2.8 2.5 Oceania 2.1% 4.2%
$ billion $ billion
Asia (excluding Japan) 5.9 8.2 7.0 Asia 616.4 697.6
(share of world GDP = 25%) Japan 103.8 149.3
Hong Kong 179.6 10.2
China 8.7 10.0 8.5 North America 251.8 99.4
Hong Kong -2.7 5.0 3.3 Euro zone 256.8 142.7
Latin America 65.7 73.4
India 7.0 8.0 7.2 Oceania 27.1 48.6
Indonesia 4.5 5.4 4.2 Others 82.8 100.1
Total 1300.5 1161.8
Korea 0.2 5.2 4.0
Malaysia -1.7 5.5 3.8 NBF Economy & Strategy

Philippines 0.9 4.0 3.5

Thailand -2.3 4.0 3.8 The latter dynamic is reflected in forecasts of world
Taiwan -1.9 5.1 4.2 oil demand in 2010. Its growth is expected to be due
Singapore -2.0 8.0 5.0 entirely to non-OECD countries. Demand from OECD
economies is expected to be down slightly from 2009.
Latin America -2.6 4.5 3.1
(share of world GDP = 6%) Oil: Demand rising outside the OECD economies
Growth of global demand – OECD and non-OECD
Mexico -6.5 4.5 2.5
12 %
Brazil -0.2 5.5 3.5 World oil demand is forecast at 86.6 million barrels
10
a day in 2010 (previous peak 86.5 million in 2007) –
Argentina -2.9 4.8 3.0 8 but new demand is not from the OECD countries
Venezuela -3.3 -3.0 1.5 6 Non-OECD
Chile -1.7 4.5 4.0 4

Peru 0.9 5.5 4.2 2

0
Eastern Europe -5.6 3.9 3.3 -2

(share of world GDP = 5%) -4

Russia -7.9 4.5 3.3 -6 OECD

Czech Rep. -4.1 1.5 2.0 -8

1970 1975 1980 1985 1990 1995 2000 2005 2010
Hungary -6.5 0.0 2.2 NBF Economy & Strategy (data via IEA)
Poland 1.7 2.5 2.8
Turkey -5.8 5.0 4.1 On the whole, the global economy has enough
momentum at present to absorb the crosswinds from
World -0.8 4.4 3.6 Europe. World growth will be uneven from region to
Source: NBF Economic Research, Consensus Economics region, but if Europe can keep its credit markets
working we expect global GDP to expand about 4%
in 2010.

July-August 2010 3
 Monthly ECONOMIC Monitor
U.S.: The private sector taking over U.S.: The recovery remains on track
Growth of private-sector wage bill and personal consumption expenditures

After the worst recession since the 1930s, oxygen 12 % q/q annualized

from public stimulus programs has helped the U.S. 10

Consumption
8
private-sector economy gradually get back on its feet. 6
Wage bill

We expect U.S. growth to remain strong over the rest 4

of 2010 and then be slowed in 2011 by the drag of 2

0
federal deficit reduction.
-2

Thought surveys show households slow to regain -4

-6
confidence, consumer spending – much the largest -8
part of the U.S. economy – has topped its pre- -10
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
recession peak after just three quarters of recovery.
NBF Economy & Strategy (data via BLS)
In other words, U.S. consumption is back in the
expansion phase of the cycle.
This has happened despite contractions of consumer
credit and household debt. Employment growth
beginning in the first quarter has accelerated the Private-sector wages and salaries on the rise
aggregate wage bill to its fastest growth since 2007. 16 % q/q annualized

This pace is fuelled partly by a rise in total hours 12

worked and partly by a resumption of growth in 8

private-sector wages and salaries, made possible in 4

part by labour productivity that has been growing very 0

strongly by historical standards. -4

On the production side, manufacturing output stands -8

out. One of the major drivers of the U.S. economy at -12

present is business investment in machinery and -16

equipment. Since the recent recession led U.S. firms -20

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
to cut capital spending to a rate below aggregate NBF Economy & Strategy (data via Global Insight)
depreciation expense, their stock of tangible capital
assets has depreciated for the first time since the
1930s. The resulting pent-up demand for investment,
in combination with surging profits, has pushed this
private-sector component of GDP to double-digit real Inventories up for the first time in Q1
growth rates in the last three quarters. Change in real private inventories (national accounts)
120 $ billion
Despite the recent appreciation of the U.S. dollar, 100
80
+$33.9B
manufacturing output as a whole is likely to continue 60 in Q1
40
climbing, because inventories are still being rebuilt. 20

After several quarters of drawdown, business began 0

-20
restocking only in the first quarter of this year,. With -40
-60
sales growing strongly and inventory-to-sales ratios -80

at historic lows, output must continue expanding if -100

-120
Cumulative $537B drawdown
only to realign inventories with demand. -140 during the recession at
-160 annual rate
-180
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

NBF Economy & Strategy (data via Global Insight)

July-August 2010 4
 Monthly ECONOMIC Monitor
U.S.: Pent-up demand will boost homebuilding U.S. homebuilders are still struggling in the wake of
Quarterly household formation the housing bubble collapse. Home prices have
480 Thousands
stabilized but the housing market is still oversupplied.
440

400
Household formation is One factor that will help rebalance the resale market
back: Q1 rate was the
360 highest in three years and ultimately boost homebuilding is household
320 formation. Households were formed at a newly robust
280
rate in the first quarter and the outlook is improving. A
240

200 return to equilibrium would require the formation

160 about 1.5 million new households over the coming 12
120
to 18 months and provide a corresponding boost to
80

40
homebuilding.
2005 2006 2007 2008 2009 2010
NBF Economy & Strategy (data via Global Insight) Many observers are concerned at this point by signals
of slowing growth from some U.S. leading indicators.
It should be kept in mind that leading indicators often
send false signals in times of economic recovery. The
slope of the U.S. yield curve, a much better indicator
U.S. financial conditions index
of recession, remains distinctly positive. The likelihood
7 1994 = 0
of a U.S. double dip is accordingly low, as the private
6
5
Restrictive sector picks up the baton of growth. Also, euro-zone
4 turmoil has not prompted enough tightening of U.S.
3 financial conditions to cut deeply into growth. Financial
2
conditions remain highly accommodative, with real
1
0
private rates still low. Apart from financial conditions,
-1 the links between the U.S. economy and the euro
Accommodative
-2 zone are too loose to pose a substantial threat.
-3
-4 Despite uncertainty from Europe, U.S. credit markets
-5
88 90 92 94 96 98 00 02 04 06 08
show important positive developments. For the first
NBF Economy & Strategy time since the Lehman Brothers debacle, commercial
and industrial lending has stopped contracting. If this
trend continues, small and medium-sized businesses,
which have so far contributed less to growth than
larger businesses, will be putting their shoulders to
U.S.: Good news in commercial and industrial loans the wheel. This will be a key development, since
Four-week change in C&I loans outstanding at U.S. commercial banks
60 $ billion
restrictive fiscal policy next year is likely to decelerate
50 U.S. growth to the neighbourhood of 2% in 2011, with
40 a cooling effect on global growth.
30
First 4-week increase since
20 Lehman Brothers collapse
10

-10

-20

-30

-40

-50
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10

* Data since March 31, 2010 adjusted down $33B for effect of new accounting rules
NBF Economy & Strategy (Federal Reserve data via Global Insight)

July-August 2010 5
 Monthly ECONOMIC Monitor
Canada: In a class apart Canada: An outstanding performance
Change in real gross domestic income
Canada’s economic growth is currently the strongest 10 % q/q annualized
8
in the G-7. Domestic demand has passed the pre- 6
recession peak and is now in an expansion phase. At 4
2
this rate, excess capacity will be absorbed within two 0

or three quarters. The Canadian expansion is likely to -2

-4
remain strong through the rest of this year and then -6

slow next year in response to U.S. fiscal austerity. -8

-10
-12
Canadian growth has for some time now been the -14

strongest in the G-7. Real domestic demand in -16

-18
particular has been expanding at an annual rate in 99 00 01 02 03 04 05 06 07 08 09

NBF Economy & Strategy (data via Global Insight)

the neighbourhood of 5% over the last three quarters.
Prompt and vigorous responses to the U.S. recession
by governments and the central bank have resulted
in an almost perfect convergence of macroeconomic
policies, greatly stimulating the domestic economy.
A swift Q2 rebound in private-sector employment
Canadian consumer spending, for example, has So far in
8 % q/q, annual rate
recovered in V-shaped style and the housing market Q2: 5.9%
6
has rebounded even more impressively. Home prices 4
are now well above the pre-recession peak, for a 2
substantial boost to the balance sheets of Canadian 0
households relative to their U.S. counterparts. -2

With the domestic economy firing on all cylinders, the -4

-6
turnaround of the Canadian labour market has been Recessions in gray
-8
unambiguous. Over the last three months the private
-10
sector has added no fewer than 194,000 jobs. The 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

economy-wide wage bill is now well above the pre- NBF Economy & Strategy (data via Global Insight)

recession peak.
To these pluses can be added a fairly robust global
recovery, strong growth in international trade and
firmer prices for commodities. Since Canada is a net A tale of two economies
exporter of commodities, its real gross domestic Distance from pre-recession peaks, U.S. and Canada

income has grown over the last two quarters at more 1

% Real GDP Domestic demand Employment
0.4
than 8% annually. The country’s commodity economy 0
will likely continue to benefit from the spectacular -0.4
-1
-0.8
growth of Asian economies. -1.1
-2

On the whole, therefore, the Canadian economy is in -3 -2.5

better shape than the American. At this writing real -4
GDP is less than 0.4% off the previous peak, domestic
-5
demand is already at new highs and employment is U.S. Canada U.S. Canada
-5
U.S. Canada

growing strongly. Canada is farther along in the NBF Economy and Strategy
economic cycle than the United States.

July-August 2010 6
 Monthly ECONOMIC Monitor
Monetary policy in Canada: An international perspective The remaining output gap is likely to close within two
GDP vs. previous peak, % Real policy rate, % or three quarters. This is one reason Canada was the
3 2.5 2.0 1.6 1.7 first developed economy to raise its policy rate after
2 1.5
1.0 the recession. The fundamentals indicated that it was
1 0.2
0.5 time to start normalizing rates – Canada’s degree of
0 0.0
-1 -0.4 -0.5 monetary accommodation appeared increasingly
-2 -1.2 -1.0 -0.7 disproportionate to that of other countries. The
-1.5
-3 -1.4
-2.0 removal of accommodation that began June 2 can be
-4 -2.5
-5 % -4.1 -3.0 % -2.7
expected to continue. Pauses along the way seem
-4.7
-6 -5.5 Australia Canada U.S. Euro Japan U.K. unlikely to be required. Though Canadian households
Australia Canada U.S. Euro zone Japan U.K. zone have become more sensitive to rate rises because of
NBF Economy and Strategy their record ratio of total debt to disposable personal
income, the more likely consequence of this state of
affairs is that the central bank will stop tightening at a
lower level than in previous economic cycles.
The strength of the economy will benefit the country’s
Canadian public finances: An enviable position
2011 fiscal deficit as % of GDP public finances. Canada’s fiscal deficit relative to
GDP will be lower next year than that of the other G-7
Ireland -10.8
U.K. -10.3 countries and most euro-zone countries. Foreign
U.S. -8.9 appetite for the Canadian currency is running high,
Japan -8.3
Greece -7.1 whetted by a robust recovery and by Canada’s
Spain -7.0 emergence from the recent recession with its public
France -6.9
Portugal -5.6 finances in considerably better shape than those of
Italy -5.0 many other developed countries.
German -4.5
Hungary -4.3
Canadian growth can be expected to slow next year
Iceland -2.7
Canada % -2.1 as U.S. fiscal austerity crimps demand for Canadian
-12 -10 -8 -6 -4 -2 0 exports. But Canadian domestic demand will probably
NBF Economy and Strategy (data OECD via Datastream) remain strong. Consumer spending and homebuilding
are likely to slow but capital spending on machinery
and equipment has good reason to accelerate briskly,
since strong earnings growth will allow Canadian
companies to meet the challenge of catching up to
The productivity challenge U.S. productivity gains.
Manufacturing output per hour

220 1991 = 100 U.S.

210
200 Yanick Desnoyers
190
Germany Assistant Chief Economist
180
170 Japan
160
150
Canada
140
130
120
110
100
90
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

NBF Economy & Strategy (data via BLS)

July-August 2010 7
 Monthly ECONOMIC Monitor
Canada
Economic Forecast

Q4/Q4
(Annual % change)* 2007 2008 2009 2010 2011 2010 2011

Gross domestic product (2002 $) 2.2 0.5 (2.5) 3.6 2.1 4.2 1.2
Consumption 4.6 2.9 0.4 3.5 2.7 3.1 2.8
Residential construction 2.8 (3.7) (8.2) 12.1 (3.2) 5.7 (5.0)
Business investment 3.3 3.4 (19.9) 0.4 7.3 7.3 6.3
Government expenditures 3.2 4.1 5.1 4.6 2.6 2.5 2.5
Exports 1.2 (4.6) (14.2) 7.3 2.9 6.5 2.0
Imports 5.9 1.2 (13.9) 11.1 5.3 7.5 5.7
Change in inventories (millions $) 12,239 9,011 (2,879) 11,546 16,000 15,000.0 16,000.0
Domestic demand 4.0 2.8 (1.8) 4.0 2.9 3.6 2.7

Real disposable income 4.0 3.7 1.2 1.5 2.3 2.2 2.2
Employment 2.3 1.5 (1.6) 1.4 1.3 1.8 1.2
Unemployment rate 6.0 6.2 8.3 8.0 7.7 7.9 7.7
Inflation 2.2 2.4 0.3 1.8 2.4 2.2 2.5
Before-tax profits 1.9 8.0 (32.3) 23.9 8.6 20.6 5.0
Federal balance (Public Acc., bil. $) $9.6 $0.0 ($45.0) ($30.0) ($20.0) .... ....
Current account (bil. $) $12.8 $6.9 ($43.5) ($14.1) $1.5 ($5.0) $2.0

* or as noted

Financial Forecast*

Current
6/18/10 Q3 Q4 Q1/11 Q2 2006* 2010 2011

Overnight rate 0.50 1.00 1.50 2.00 2.50 3.25 1.50 2.75
Prime rate 2.50 3.00 3.25 3.75 4.25 5.00 3.25 4.50
3 month T-Bills 0.58 1.26 1.75 2.23 2.60 3.65 1.75 2.72
Treasury yield curve
2-Year 1.74 1.98 2.29 2.61 2.96 2.29 3.16
5-Year 2.65 2.98 3.29 3.40 3.59 3.29 3.80
10-Year 3.33 3.54 3.85 3.90 3.97 3.85 4.10
30-Year 3.76 3.97 4.17 4.19 4.24 4.17 4.33

Exchange rates*
USD per CAD 0.98 1.00 0.96 0.97 0.99 0.97** 0.99**

National Bank Financial

* end of period
** annual average

July-August 2010 8
 Monthly ECONOMIC Monitor
United States
Economic Forecast

Q4/Q4
(Annual % change)* 2007 2008 2009 2010 2011 2010 2011

Gross domestic product (2005 $) 2.1 0.4 (2.4) 3.6 2.4 3.8 1.6
Consumption 2.6 (0.2) (0.6) 2.5 1.8 2.8 1.5
Residential construction (18.5) (22.9) (20.5) 2.4 10.8 5.6 10.0
Business investment 6.2 1.6 (17.8) 3.9 7.8 8.3 6.2
Government expenditures 1.7 3.1 1.8 1.1 2.2 1.6 2.0
Exports 8.7 5.4 (9.6) 10.4 4.6 7.3 3.0
Imports 2.0 (3.2) (13.9) 10.4 5.6 8.8 4.5
Change in inventories (bil. $) 19.5 (25.9) (108.3) 77.2 56.3 110.0 50.0
Domestic demand 1.7 (0.4) (2.7) 2.3 2.7 3.1 2.3

Real disposable income 2.2 0.5 0.8 1.6 2.3 2.8 1.8
Household employment 1.2 (0.5) (3.8) 0.1 1.9 2.4 1.5
Unemployment rate 4.6 5.8 9.3 9.5 9.2 9.2 9.1
Inflation 2.9 3.8 (0.3) 1.7 2.3 1.2 2.4
Before-tax profits (4.1) (11.8) (3.8) 21.8 5.5 11.8 4.0
Federal balance (unified budget, bil ($161.0) ($459.0) ($1,800.0) ($1,200.0) ($1,100.0) ... ...
Current account (bil. $) ($746.0) ($690.0) ($410.0) ($490.0) ($450.0) ($450.0) ($450.0)
-304
* or as noted

Financial Forecast

Current
6/18/10 Q3 Q4 Q1/11 Q2 2010 2011

Fed Fund Target Rate 0.18 0.25 0.25 0.75 1.25 0.25 2.00
3 month Treasury bills 0.10 0.23 0.49 1.01 1.54 0.49 2.25
Treasury yield curve
2-Year 0.72 1.12 1.39 1.65 1.99 1.39 2.52
5-Year 2.02 2.51 2.76 2.96 3.18 2.76 3.58
10-Year 3.22 3.66 3.86 3.99 4.09 3.86 4.33
30-Year 4.15 4.49 4.61 4.68 4.69 4.61 4.84
Exchange rates*
U.S.$/Euro 1.24 1.25 1.18 1.20 1.21 1.25** 1.21**
YEN/U.S.$ 91 95 98 100 102 94** 102**

National Bank Financial

* end of period
** annual average

July-August 2010 9