In recent years, Canada – along with Australia – was touted as an economic safe haven by financial market participants. Canada was seen as relatively insulated from the banking crises in Europe and the US, triggering a bull run for the Canadian dollar. That is no longer the case. The currency has fallen this year to its lowest level against the US dollar since January 2010 amid negative economic data relative to the US. The bearish trend is likely to continue, say analysts.
To begin with, in general terms, says Charles St-Arnaud, senior G10 currency strategist for Nomura Securities in New York, Canada’s growth is expected to remain weak as consumers remain cautious, while weak competiveness is likely to lead to weak export numbers. Indeed, the Bank of Canada itself recently reduced its GDP growth projection for this year to 2.3% from 2.7%, and for 2015 to 2.6% from 2.7%.
Even these new targets, though, might prove to be optimistic, judging from recent data releases. Earlier this week, for example, the country’s merchandise trade deficit widened to C$940 milllion ($879 million) from a C$908 million deficit in October that was itself revised down from a previously reported C$75 million surplus.
This negative number compounded earlier worse-than-expected news that Canada’s Ivey Purchasing Managers Index fell to 46.3 in December on a seasonally adjusted basis, following a November figure of 53.7.
“In fact, the last quarter’s [third-quarter] growth number was supported mainly by consumption, 2.2%, and inventories, 1.2%, while net exports added just 0.2%, meaning the hoped-for rotation of growth away from consumption and towards exports has yet to take hold,” says Robert Lynch, head of G10 FX strategy for HSBC in New York.
The necessity of redirecting the driver for economic growth towards exports and away from domestic consumption is further underlined by the fact that the ratio of Canadian household debt to disposable income has already risen to a record 163% plus, says Jeremy Stretch, head of currency strategy at Canadian Imperial Bank of Commerce in London.
This was driven in large part by increased mortgage borrowing even after policymakers tightened mortgage rules four times, and Bank of Canada governor Stephen Poloz warned that elevated household debt was the biggest domestic threat to the world’s 11th-largest economy. There are signs, though, that residential investment is expected to moderate as weaker housing activity is leading to an increase in unsold inventory, especially in the condo market.
Despite the extremely limited room for consumption-led growth, the scope for fiscal stimulus to the economy has also been stymied for the foreseeable future as, despite a generally good financial situation and low fiscal deficits, both federal and provincial governments have shown little interest in investing in the economy and are actually in contracting mode.
As such, Canadian finance minister Jim Flaherty has warned that weaker revenues will be met by further spending cuts, keeping the target for a balanced budget at 2015.
This weakening exports profile has clearly not been lost on Poloz who, in October last year, dropped the language about the need for future interest rate increases, which had been in place for more than a year, citing greater slack in the economy, while keeping his benchmark rate on overnight loans between commercial banks at 1% for the 25th consecutive meeting.
This apparent talking down of the Canadian dollar to provide a fillip to exports was bolstered just a few days ago as Flaherty underlined that a weaker currency helps a country’s manufacturers and that Poloz had told policymakers that the Canadian dollar could weaken. With bearish forecasts for the CAD extending to the USDCAD1.1000 level this year from some analysts, and up to USDCAD1.1200 in 2015, at least, it is no surprise that the ‘smart’ hedge fund money is still skewed heavily in favour of short Canada positions, according to data from the CME Group, with the ‘real money’ investors also looking at net short positions.
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The central bank was also keen in its October statement that inflation was still trending down, implying that any easing in interest rates would be easily accommodated. At the time, headline CPI had fallen to 0.7% year on year in October from 1.1% year on year in September, notably below the Bank of Canada’s 1% to 3% target band, while core CPI, a good predictor of future headline inflation, fell to 1.2% year on year from 1.3% year on year in September, and has remained subdued between 1% and 1.4% for the past 12 months.
In most previous economic outlooks for Canada, including those from the Bank of Canada, one of the two main drivers of growth in 2013 and 2014 had been expected to be business investment (the other being exports). However, any expected rebound in business investment that was expected as coming from the need for Canadian businesses to renew their stock of capital and improve their competitiveness was held back last year by continued global uncertainty regarding the US economy and continued weak external demand for Canadian goods.
In this context, although the prospects for US growth are considered to be more favourable this year than last according to the market consensus, a recent survey of 29,000 businesses, made by Statistics Canada, shows that investment intentions for 2014 are not expected to rebound meaningfully and suggests continued weakness, which is likely to add to Canadian dollar weakness in the first quarter of this year, at least, concludes Stretch.
