Canada: A Balancing Act Amidst Global Headwinds
Thursday, June 27, Week 26: Canada's economic narrative over the past five months has been one of cautious optimism, marked by moderate growth, a resilient consumer, and a persistent battle against inflation. However, the global economic landscape is shifting, with the US economy showing signs of slowing, geopolitical tensions simmering, and inflationary pressures proving stickier than anticipated. As we navigate the next five weeks, Canada's economy will need to deftly balance domestic strengths against external challenges. This report provides a comprehensive analysis of Canada's macroeconomic landscape, offering insights for forex traders seeking to capitalise on the opportunities and mitigate the risks presented by this dynamic environment.
Fiscal Policy
Canada's fiscal policy stance over the past five months has been characterised by a focus on balancing support for the economy with concerns about rising debt levels. While provincial and federal governments have implemented some measures to stimulate economic activity, such as infrastructure spending and targeted tax relief, they have generally adopted a more cautious approach compared to the early stages of the pandemic recovery.
The federal government, in particular, has shifted its focus towards deficit reduction, albeit at a gradual pace. This reflects concerns about the long-term sustainability of public finances, particularly as interest rates rise. The upcoming federal fiscal update, expected in late July, will provide further insights into the government's fiscal plans for the remainder of the year. However, given the current focus on deficit reduction, it is unlikely that the update will contain major surprises or significant new stimulus measures.
Looking ahead to the next five weeks, fiscal policy is likely to remain a background factor rather than a major driver of economic activity. With provincial elections on the horizon in several key provinces, including Ontario and Quebec, governments may be hesitant to introduce significant new spending initiatives or tax changes that could be perceived as politically motivated. Instead, the focus is likely to be on implementing existing fiscal measures and ensuring that spending remains within budgeted limits.
Economics
Canada's economy has demonstrated resilience in the face of multiple headwinds, including high inflation, rising interest rates, and global economic uncertainty. Consumer spending has been a key pillar of strength, supported by a robust labour market and pent-up demand. However, high inflation and rising interest rates are starting to weigh on consumer confidence and spending patterns.
Business investment has been mixed, with some sectors, such as energy, benefiting from favourable global conditions, while others remain cautious amid economic uncertainty. The energy sector has been a bright spot, driven by high oil and gas prices and increased demand from Europe as it seeks to reduce its reliance on Russian energy. However, other sectors, such as manufacturing and retail, have faced challenges from supply chain disruptions, labour shortages, and softening consumer demand.
Looking ahead to the next five weeks, Canada's economic outlook is for continued moderate growth, but the pace of expansion is likely to slow as headwinds intensify. Consumer spending is expected to remain resilient, but the pace of growth may moderate as inflation and interest rates continue to bite. Business investment is likely to remain cautious, with firms closely monitoring economic developments before committing to significant new investments.
Economic Growth:
GDP Growth: Canada's GDP growth has been uneven in recent quarters. After contracting by 0.5% in Q3 2023, the economy rebounded with growth of 1.0% in Q4 2023 and 2.8% in Q1 2024. However, this volatility suggests that the underlying growth momentum is not particularly strong. The annual GDP growth rate of 1.7% in Q1 2024, while the highest since Q1 2023, fell short of market expectations, indicating that the economy is facing some headwinds.
GDP Growth Annualised: The annualised GDP growth rate followed a similar pattern, accelerating to 1.7% in Q1 2024 but remaining below market forecasts. This measure, which annualizes the quarterly growth rate, provides a clearer picture of the underlying growth trend and suggests that the economy is not expanding as rapidly as many had hoped.
Potential Output Growth: The BoC's estimate of potential output growth, a key indicator of the economy's long-term growth capacity, is currently around 2.5% for 2024. This robust growth is primarily driven by strong immigration, which is boosting the labour force and supporting consumer spending. However, potential output growth is projected to slow to around 1.5% in 2025 and 2026 as population growth moderates and the contribution from immigration diminishes. This highlights the importance of boosting productivity growth to sustain long-term economic expansion.
Labour:
Unemployment Rate: Canada's labour market has been a source of strength in recent months. The unemployment rate has been ticking upwards, reaching 6.2% in May 2024, the highest since October 2021. This increase is partly due to strong population growth, which is expanding the labour force faster than the economy is creating jobs.
Wage Growth: Wage growth has been a key concern for the BoC, as it can contribute to inflationary pressures. While wage growth has shown some signs of moderation in recent months, it remains elevated, ranging between 3.5% and 4.5%. This is still above the level consistent with the BoC's 2% inflation target, indicating that wage pressures remain a concern. The BoC will be closely monitoring wage growth in the coming months to assess whether it is starting to ease in response to the slowing economy and rising interest rates.
Price Changes:
Inflation Rate: Inflation has been the dominant theme in Canada's economic narrative over the past year. After peaking at 8.1% in June 2022, the annual inflation rate has been gradually easing, but it remains stubbornly high. The inflation rate rose to 2.9% in May 2024, halting the disinflation trend and exceeding market expectations. This suggests that the fight against inflation is far from over and that the BoC will need to remain vigilant in its efforts to bring inflation back to the 2% target.
Core Inflation: Core inflation measures, which exclude volatile food and energy prices, provide a clearer picture of underlying inflationary pressures. While core inflation has also been easing, it remains above the BoC's comfort zone. CPI-trim and CPI-median, the BoC's preferred core inflation measures, are currently around 3.2% and 3.1%, respectively. This indicates that underlying inflationary pressures are still present in the economy and that the BoC will need to see further evidence of easing before it can be confident that inflation is on a sustainable path back to target.
Trade:
Trade Balance: Canada's trade balance has been volatile in recent months, reflecting fluctuations in global commodity prices and shifting demand patterns. In April 2024, Canada reported a trade deficit of CAD 1.05 billion, significantly lower than the CAD 2 billion deficit recorded in March and much lower than market forecasts. This improvement was driven by a 2.6% increase in exports, led by shipments of metal products, aircraft, and farm products. Imports also increased, but at a slower pace of 1.1%.
Current Account: Canada's current account, which measures the country's transactions with the rest of the world, has been in deficit for several years. The current account deficit widened to CAD 5.4 billion in Q1 2024, marking the seventh consecutive deficit. This increase was primarily due to the goods balance shifting from a surplus to a deficit, despite improvements in services, investment income, and transfers balances. The widening current account deficit reflects Canada's reliance on foreign capital to finance its investment and consumption spending.
Monetary Policy
The Bank of Canada has been navigating a delicate balancing act in recent months, attempting to support economic growth while also taming inflation. The central bank has adopted a cautious approach to monetary policy, gradually raising interest rates to cool the economy and bring inflation back to the 2% target.
In June 2024, the BoC cut its key interest rate by 25 bps to 4.75%, marking the first rate cut in four years. This move was widely anticipated by the market, as inflation had shown signs of easing in recent months. However, the BoC signaled that further rate cuts would be data-dependent and contingent on inflation continuing to slow as expected.
The BoC's monetary policy stance for the next five weeks is likely to remain data-dependent. The central bank will be closely monitoring upcoming inflation data, particularly the core inflation measures, to assess whether inflationary pressures are easing as expected. If inflation remains stubbornly high, the BoC may pause its rate-cutting cycle or even consider raising rates again. However, if inflation shows clear signs of returning to the 2% target, the BoC could resume its easing cycle with further rate cuts.
The BoC's Monetary Policy Report, released in April 2024, provides further insights into the central bank's thinking. The report states: "The Bank is equally concerned about inflation rising above or falling below the 2% target." This highlights the central bank's commitment to achieving price stability and its willingness to adjust monetary policy as needed to achieve this goal.
The report also notes that "the Bank will consider a broad range of labour market indicators" in assessing the state of the economy. This suggests that the BoC is not solely focused on the unemployment rate but is also looking at other measures, such as wage growth and job vacancies, to gauge the health of the labor market.
Geopolitics and Market Themes
US Economic Performance:
Synopsis: The US economy, Canada's largest trading partner, has been a key driver of global growth in recent months, but there are growing signs that growth is starting to slow. This slowdown is partly due to the aggressive interest rate hikes by the US Federal Reserve, which are aimed at taming inflation but are also weighing on economic activity.
Key Developments: Recent economic data releases from the US have been mixed, with some indicators, such as consumer spending, remaining strong, while others, such as manufacturing activity, have weakened. The US Federal Reserve has signalled that it is likely to continue raising interest rates until inflation is clearly on a path back to its 2% target.
Market Impact: The US dollar has strengthened against most major currencies, including the Canadian dollar, as investors seek safe-haven assets amid global economic uncertainty. A slowdown in the US economy could have a significant impact on Canada, as it would likely reduce demand for Canadian exports and weigh on economic growth.
Global Inflationary Pressures:
Synopsis: Inflation remains a major concern for policymakers and investors around the world. Supply chain disruptions, high energy prices, and strong consumer demand have all contributed to elevated inflation rates in many countries.
Key Developments: Central banks in many countries, including the US, Canada, and the Eurozone, have raised interest rates to combat inflation. However, inflation has been stickier than expected, raising concerns about the potential for a wage-price spiral, where rising wages lead to higher prices, which in turn lead to further wage increases.
Market Impact: Rising inflation has led to increased volatility in financial markets, as investors are concerned about the impact of higher interest rates on economic growth and corporate profits. Higher inflation also erodes the purchasing power of consumers, which can lead to a slowdown in consumer spending.
Geopolitical Tensions:
Synopsis: The war in Ukraine, escalating tensions in the Middle East, and ongoing trade disputes between the US and China have added to global uncertainty and risk aversion. These geopolitical tensions have had a significant impact on energy markets, supply chains, and investor sentiment.
Key Developments: The war in Ukraine has disrupted energy markets, leading to higher oil and gas prices. The conflict has also disrupted supply chains, as Ukraine and Russia are major exporters of agricultural products and other commodities. Tensions in the Middle East have raised concerns about potential disruptions to oil supplies, as the region is a major oil producer. Ongoing trade disputes between the US and China have also added to global uncertainty, as they have led to tariffs and other trade barriers that have disrupted global trade flows.
Market Impact: Geopolitical tensions have led to increased risk aversion among investors, driving safe-haven flows into the US dollar and other perceived safe assets. These tensions have also contributed to higher volatility in financial markets, as investors react to news and developments related to these conflicts and disputes.
OTHER NEWS
Micron Technology's Weaker Outlook: Micron Technology, a leading US manufacturer of memory chips, beat revenue estimates for the most recent quarter but provided a weaker-than-expected outlook for the current quarter, citing softening demand for its products. This news sent ripples through the technology sector, as it raised concerns about the outlook for global economic growth and the demand for electronic devices. The weaker outlook also highlighted the challenges facing the semiconductor industry, which has been grappling with supply chain disruptions and slowing demand in recent months.
Bolivian Coup Attempt: A brief coup attempt in Bolivia, led by a disgruntled military general, was quickly thwarted by the government. However, the incident highlighted the fragility of political stability in the region and the potential for disruptions to commodity markets. Bolivia is a significant producer of natural gas and other resources, and any political instability in the country could have implications for global commodity prices. The coup attempt also raised concerns about the potential for further political instability in Latin America, a region that has been grappling with economic and social challenges in recent years.
Conclusion
Canada's economy is at a critical juncture, facing a complex mix of domestic and external challenges. While the economy has shown resilience in recent months, the outlook for the next five weeks is for continued moderate growth, but the pace of expansion is likely to slow as headwinds intensify.
For forex traders, the Canadian dollar's outlook remains uncertain. The currency is likely to be sensitive to developments in the US economy, global inflation trends, and geopolitical events. A continuation of the current trends, with moderate Canadian growth, a hawkish Fed, and elevated geopolitical tensions, would likely favor further USD strength against the CAD. However, if inflation shows clear signs of easing in Canada, allowing the BoC to cut rates more aggressively, the CAD could regain some ground against the USD.
Traders should closely monitor upcoming economic data releases from Canada, particularly inflation and GDP growth figures, as well as central bank statements and geopolitical developments, to assess the evolving outlook for the Canadian dollar.
References
Bank of Canada: https://www.bankofcanada.ca/
Statistics Canada: https://www150.statcan.gc.ca/n1/en/home
Trading Economics: https://tradingeconomics.com/
Ivey Business School: https://www.ivey.uwo.ca/
S&P Global: https://www.spglobal.com/
Ipsos: https://www.ipsos.com/en-ca
Department of Finance Canada: https://www.canada.ca/en/department-finance.html
Canada Revenue Agency: https://www.canada.ca/en/revenue-agency.html
IMF: https://www.imf.org/
Bloomberg: https://www.bloomberg.com/
Reuters: https://www.reuters.com/