CANADA: Navigating Choppy Waters - 5 Months of Mixed Signals and a 5-Week Horizon of Uncertainty
Key events will influence Canada's economic outlook. The US jobs report, BoC announcement, and FOMC meeting will provide insights into interest rate decisions, potentially affecting the USD/CAD.
Tuesday, 02 July, Week 27: Canada's economy has faced ups and downs in recent months, with inflation easing but growth falling below expectations. The Bank of Canada has cut interest rates and signalled more cuts if inflation continues to fall. However, challenges remain, such as the US Federal Reserve's hawkish stance and imbalances in the Canadian housing market. This report navigates the interplay of fiscal and monetary policy, economic indicators, and market risks in Canada's macroeconomic landscape, guiding forex traders in these uncertain times.
Fiscal Policy
Fiscal policy, the government's use of spending and taxation, acts as a powerful rudder, steering the economy towards desired outcomes. By adjusting its course through fiscal measures, the government can influence economic growth, inflation, and employment, impacting monetary policy decisions and sending ripples through financial markets.
Over the past five months, Canada's fiscal policy has been characterised by a commitment to investment, with the federal government unveiling an ambitious budget in March aimed at building a more innovative, inclusive, and sustainable economy. This budget, aptly titled "A Fair Future for Indigenous Peoples," outlines significant spending initiatives in areas such as housing, clean energy, and skills development, funded in part by tax increases on capital gains and a new Digital Services Tax. These measures are expected to provide a steady tailwind to economic growth in the near term, potentially offsetting headwinds from higher interest rates and slowing global demand. However, the long-term impact of these policies on debt sustainability and investor confidence remains to be seen.
Several provinces have also released their budgets, with many adding their own sails to catch the wind of economic growth through increased spending on infrastructure, health care, and education. This coordinated fiscal expansion is expected to provide a further boost to economic activity, potentially leading to a tighter labour market and upward pressure on inflation. However, the effectiveness of these measures will depend on the government's ability to navigate the treacherous shoals of rising interest rates and a potentially more hawkish US Federal Reserve.
Economics
Economics, the study of how societies allocate scarce resources, provides the framework for understanding the complex forces that shape economic outcomes. By analysing economic indicators, policymakers can identify potential headwinds and tailwinds, adjust their course through monetary and fiscal measures, and steer the economy towards a safe harbour of sustainable growth and price stability.
Canada's economic performance over the past five months has been marked by a delicate balancing act, with the government seeking to support economic growth while simultaneously taming inflation. The economy has been sailing against a headwind of rising interest rates, which have slowed consumer spending and housing activity. However, strong population growth, fueled by immigration, has provided a countervailing tailwind, boosting demand and potential output. The BoC has responded to these crosscurrents by cautiously adjusting its monetary policy stance, cutting interest rates in May and signalling a willingness to make further adjustments if inflation continues to ease.
Economic Growth:
Q1 2024 GDP: 0.4% growth (quarter-over-quarter), 1.7% growth (annualised).
Advance Retail Sales Indicator: -0.6% projected decline in May.
Ivey PMI: Fell to 52 in May, indicating a tenth consecutive month of growth, but the weakest in the current sequence.
Assessment:
Canada's economic growth has been facing headwinds in recent quarters, with Q1 GDP growth coming in below market expectations. The advance retail sales indicator suggests a further slowdown in May, potentially signalling a weak start to Q2. However, the Ivey PMI remains above 50, indicating continued expansion in the manufacturing sector. The outlook for economic growth remains uncertain, with the BoC projecting a gradual recovery in the second half of the year, supported by easing financial conditions and government spending.
Labour:
Unemployment Rate: Rose to 6.2% in May.
Employment Rate: Declined for the seventh time in eight months.
Wage Growth: Remains elevated at 5.1% year-over-year.
Employment Rate of Returning Students (aged 20-24): 61.0% in May, down 2.9 percentage points from May 2023.
Assessment:
The Canadian labour market has been showing signs of easing, with the unemployment rate rising and the employment rate declining. However, wage growth remains elevated, potentially reflecting a persistent tightness in the labour market. The decline in the employment rate of returning students suggests a more competitive summer job market for young Canadians. The BoC expects the labour market to tighten further as the economy grows, potentially leading to upward pressure on wages and inflation.
Price Changes:
CPI Inflation: Eased to 2.7% in April, before rising to 2.9% in May.
Core Inflation: CPI-median (3.1%) and CPI-trim (3.2%) have also eased, but remain above 2%.
Inflation Expectations: Near-term expectations have moderated, but remain elevated.
Assessment:
Inflation in Canada has been easing, but remains above the BoC's 2% target. Core inflation measures have also declined, but are still above target, suggesting that underlying inflationary pressures persist. The recent uptick in CPI inflation in May, driven by higher gasoline prices and a smaller-than-expected decline in cellular service prices, highlights the uneven nature of the disinflationary trend. The BoC expects inflation to continue easing, reaching 2% in 2025, but acknowledges that upside risks remain, particularly from the housing market and potential wage pressures.
Trade:
Trade Deficit: Narrowed to CAD 1.05 billion in April.
Exports: Increased 2.6% in April, driven by energy products and unwrought gold.
Imports: Rose 1.1% in April, led by motor vehicles and parts.
Assessment:
Canada's trade balance has been volatile in recent months, reflecting fluctuations in global demand and commodity prices. The narrowing of the trade deficit in April was driven by a strong rebound in exports, particularly energy products. However, the outlook for trade remains uncertain, with the BoC projecting moderate export growth in the coming quarters.
Monetary Policy
Monetary policy, the central bank's management of interest rates and money supply, acts as a powerful engine, influencing the speed and direction of the economic ship. By adjusting interest rates, the BoC can stimulate or restrain economic activity, impacting inflation, employment, and financial markets.
Over the past five months, the BoC has been carefully navigating the choppy waters of a slowing economy and elevated inflation. The central bank cut its key interest rate by 25 basis points to 4.75% in May, signalling a willingness to provide further stimulus if inflation continues to ease. This move was prompted by signs of slowing economic growth, easing inflationary pressures, and a desire to support maximum sustainable employment. However, the BoC remains vigilant, acknowledging that upside risks to inflation persist, particularly from the housing market and potential wage pressures.
The BoC's April Monetary Policy Report (MPR) provided a detailed assessment of the Canadian economy, highlighting the easing of inflationary pressures and the expected strengthening of economic growth in the coming quarters. The MPR also noted that the Canadian economy is currently operating with excess supply, which is helping to moderate inflation. However, the BoC expects this excess supply to diminish as the economy grows, potentially leading to renewed inflationary pressures.
The BoC's future policy decisions will be data dependent, with a focus on inflation and economic growth. The central bank is expected to deliver further rate cuts if inflation continues to ease as projected. However, the BoC will be mindful of the potential for a more hawkish US Federal Reserve, which could limit its ability to cut rates aggressively.
Market Risk
Market risk, the potential for losses arising from movements in market prices, can act as a sudden squall, buffeting the economic ship and forcing policymakers to adjust their course. By understanding and managing market risks, investors and policymakers can help to stabilise the economy and financial markets, ensuring a smoother journey towards desired outcomes.
Significant Risk:
US Presidential and Legislative Elections (November 5th, 2024): The outcome will significantly impact USD and global markets, potentially affecting CAD. Uncertainty might initially weaken USD, but a clear outcome and policy direction could strengthen it.
Implementation of US Tariffs on Chinese EVs and Other Strategic Goods (August 1st, 2024): This could escalate trade tensions, weaken CNY, and potentially strengthen USD as a safe-haven asset. However, the impact on USD might be limited if the tariffs negatively affect US businesses and consumers.
China's Third Plenum of the 20th Central Committee (July 15th-18th, 2024): Announcements regarding stimulus measures, trade policies, or structural reforms could significantly impact Asian currencies, particularly CNY. Positive economic signals might strengthen CNY, while negative news or escalating trade tensions could weaken it.
Minor Risk:
US Jobs Report (July 5th, 2024): A strong report could reinforce expectations of a more hawkish Fed, potentially strengthening USD and putting pressure on CAD.
BoC Policy Announcement and MPR (July 24th, 2024): The BoC's policy announcement and Monetary Policy Report will be crucial for CAD. Any signals of a more dovish stance could weaken CAD, while a more hawkish tone might strengthen it.
FOMC Announcement (July 31st, 2024): The Fed's policy announcement will be crucial for USD. A hawkish stance could strengthen USD, while a dovish tone might weaken it.
Conclusion
Canada's macroeconomic outlook remains uncertain, with mixed signals on inflation and economic growth. The BoC is navigating these choppy waters by cautiously adjusting its monetary policy stance, cutting interest rates in May and signalling a willingness to make further adjustments if inflation continues to ease. However, the path ahead is not without its challenges, with potential headwinds from a more aggressive US Federal Reserve and persistent imbalances in the Canadian housing market. Forex traders should closely monitor economic indicators, fiscal and monetary policy developments, and market risks to make informed trading decisions.
Reference:
Bank of Canada
Statistics Canada
Department of Finance Canada
Trading Economics
Ivey Business School
Ipsos
Canada Mortgage and Housing Corporation
Consensus Economics
Bloomberg
The Daily (Statistics Canada)
Monetary Policy Report (Bank of Canada)