Mixed Economic Signals and Shifting Monetary Policy
Monday, 24 June, Week 26: The Canadian Dollar has faced a confluence of mixed economic signals and shifting monetary policy over the past five months. While a robust US economy and elevated oil prices have lent support, a softening domestic economy and a dovish shift from the Bank of Canada have exerted downward pressure. The upcoming release of Canadian inflation data for May (25 June) will be pivotal in determining the near-term outlook for the CAD.
Currency
The Canadian Dollar has been influenced by a range of factors over the past five months. In early 2024, the CAD benefitted from a strong US economy, which boosted demand for Canadian exports. Elevated oil prices, driven by geopolitical tensions and supply constraints, also lent support. However, the CAD has come under pressure more recently as the domestic economy has softened.
January - February: The CAD appreciated against the USD as the US economy outperformed expectations and oil prices remained elevated.
March - April: The CAD depreciated as the Canadian economy slowed and the Bank of Canada signalled a potential shift to a more dovish monetary policy stance.
May - June: The CAD has traded in a range as markets weigh the impact of a softening domestic economy against the potential for further interest rate cuts from the Bank of Canada.
Looking ahead, the CAD is likely to be influenced by the following factors over the next five weeks:
Week 26: The release of Canadian inflation data for May (25 June) will be a key event for the CAD. A softer-than-expected inflation reading could reinforce expectations for further interest rate cuts from the Bank of Canada, putting downward pressure on the CAD.
Week 27 - 28: The Bank of Canada's interest rate decision (24 July) will be another key event for the CAD. The Bank is widely expected to cut interest rates by 25bps, but a more aggressive 50bps cut could weigh on the CAD.
Week 29 - 31: The release of Canadian GDP data for the second quarter (30 August) will be an important indicator of the health of the Canadian economy. Stronger-than-expected GDP growth could support the CAD, while weaker growth could weigh on the currency.
Fiscal Policy
Canada's fiscal policy has been focused on supporting economic growth and affordability. Budget 2024, released in March, included a range of measures aimed at building more affordable homes, lowering everyday costs, and boosting innovation and productivity. The budget also included measures to improve tax fairness by asking the wealthiest Canadians to pay their fair share.
The budget is expected to have a modest stimulative impact on the economy in the near term. However, the government's commitment to fiscal responsibility means that the budget is not expected to have a significant impact on the federal debt-to-GDP ratio.
Over the next five weeks, the focus will be on the implementation of the budget measures. The government will need to work with provinces and territories to deliver on its housing plan, and with businesses to implement its clean growth and innovation initiatives.
Economics
The Canadian economy is facing a number of challenges, including elevated inflation, rising interest rates, and a softening housing market. However, the economy also has a number of strengths, including a strong labour market, a diversified economy, and a sound fiscal position.
Economic Growth
Real GDP growth is projected to slow from 1.1% in 2023 to 0.7% in 2024, before rebounding to 1.9% in 2025. The slowdown in 2024 is due to the impact of higher interest rates and a softening housing market. Growth is expected to pick up in 2025 as interest rates decline and the housing market stabilizes.
Labour
The labour market remains strong, with the unemployment rate at 6.1% in March. However, job creation has slowed in recent months, and the unemployment rate is expected to rise to 6.5% by the end of 2024. Wage growth has also slowed, but it remains elevated at around 4%.
Price Changes
CPI inflation is projected to ease to 2.5% in 2024 and to 2.1% in 2025. The decline in inflation is due to the impact of higher interest rates, easing supply chain disruptions, and lower energy prices. However, inflation is expected to remain above the Bank of Canada's 2% target throughout the forecast horizon.
Trade
Canada's trade surplus narrowed to $7.3 billion in April. Exports rose by 2.6%, while imports increased by 1.1%. The trade surplus is expected to remain relatively stable over the next five weeks, as strong US demand for Canadian exports is offset by higher import prices.
Monetary Policy
The Bank of Canada cut its key interest rate by 25bps to 4.75% in its June 2024 meeting. The Bank signalled that more rate cuts are to be delivered should inflation continue to slow as expected. The Bank noted it has stronger confidence that disinflation is converging toward the target of 2%, warranting a less restrictive policy stance.
"Both of the Bank’s preferred measures of underlying inflation moved to below the 3% threshold in April, and are expected to continue decreasing throughout the year along with the headline CPI." (Bank of Canada, June 2024)
The Bank of Canada's next interest rate decision is scheduled for 24 July. The Bank is widely expected to cut interest rates by another 25bps at this meeting. However, a more aggressive 50bps cut is possible if inflation data for May comes in softer than expected.
Geopolitics and Market Themes
US-China Trade Tensions
Synopsis: Trade tensions between the US and China have escalated in recent months, with both countries imposing tariffs on a range of goods.
Key Developments:
The US has imposed tariffs on Chinese electric vehicles, batteries, and semiconductors.
China has retaliated with tariffs on US vehicles and agricultural products.
Assessment: The trade war is weighing on global economic growth and is creating uncertainty for businesses. The CAD could come under pressure if the trade war escalates further.
Russia-Ukraine War
Synopsis: Russia's invasion of Ukraine has created a humanitarian crisis and has led to a surge in energy and commodity prices.
Key Developments:
Russia has continued its military offensive in Ukraine.
The West has imposed sanctions on Russia.
Assessment: The war is contributing to global inflation and is creating uncertainty for businesses. The CAD could benefit from higher oil prices, but it could also come under pressure if the war escalates further.
Red Sea Shipping Disruptions
Synopsis: Houthi rebels in Yemen have attacked commercial shipping in the Red Sea, raising concerns about supply chain disruptions.
Key Developments:
Several tankers have been attacked in recent months.
Shipping companies are rerouting vessels around the Cape of Good Hope.
Assessment: The attacks are contributing to global supply chain disruptions and are raising shipping costs. The CAD could come under pressure if the attacks continue.
Conclusion
Upward Support
The CAD could come under upward support over the next five weeks if:
The US economy remains strong, boosting demand for Canadian exports.
Oil prices remain elevated.
Canadian inflation data for May comes in stronger than expected, reducing the likelihood of a 50bps rate cut from the Bank of Canada in July.
The release of Canadian inflation data for May (25 June) will be a pivotal event in determining whether the CAD can sustain upward momentum.
Indifference
The CAD could trade in a range over the next five weeks if:
The US economy slows, but not sharply.
Oil prices remain relatively stable.
Canadian inflation data for May comes in in line with expectations.
The Bank of Canada's interest rate decision (24 July) will be a key event in determining whether the CAD can break out of its recent range.
Downside Pressure
The CAD could come under downside pressure over the next five weeks if:
The US economy enters a recession.
Oil prices decline.
Canadian inflation data for May comes in softer than expected, increasing the likelihood of a 50bps rate cut from the Bank of Canada in July.
The release of Canadian GDP data for the second quarter (30 August) will be a pivotal event in determining whether the CAD can avoid further depreciation.
References
Bank of Canada. (2024, April). Monetary Policy Report - April 2024. https://www.bankofcanada.ca/2024/04/mpr-2024-04-10/
Bank of Canada. (2024, June). Press Release - June 5, 2024. https://www.bankofcanada.ca/2024/06/fad-press-release-2024-06-05/
Department of Finance Canada. (2024). Budget 2024. https://www.budget.gc.ca/2024/home-accueil-en.html
Statistics Canada. (2024, May 21). Consumer Price Index, April 2024. https://www150.statcan.gc.ca/n1/daily-quotidien/240521/dq240521a-eng.htm
Statistics Canada. (2024, May 31). Gross Domestic Product, Income and Expenditure, First Quarter 2024. https://www150.statcan.gc.ca/n1/daily-quotidien/240531/dq240531a-eng.htm
Statistics Canada. (2024, May 31). Gross Domestic Product by Industry, March 2024. https://www150.statcan.gc.ca/n1/daily-quotidien/240531/dq240531b-eng.htm
Statistics Canada. (2024, June 6). Canadian International Merchandise Trade, April 2024. https://www150.statcan.gc.ca/n1/daily-quotidien/240606/dq240606a-eng.htm
Statistics Canada. (2024, June 7). Labour Force Survey, May 2024. https://www150.statcan.gc.ca/n1/daily-quotidien/240607/dq240607a-eng.htm
Statistics Canada. (2024, June 21). Retail Trade, April 2024. https://www150.statcan.gc.ca/n1/daily-quotidien/240621/dq240621a-eng.htm
Trading Economics. (2024). Canada. https://tradingeconomics.com/canada