Charting Canada's Macroeconomic Course
Sunday, September 1st, Week 35
The Canadian economy continues to show resilience, outperforming expectations and avoiding recession. Despite challenges such as high interest rates, elevated housing costs, and slowing global growth, the labour market remains robust, and the government is committed to fiscal responsibility. However, it's essential for forex traders to understand the interplay of geopolitics, fiscal policy, economic fundamentals, and monetary policy to make informed trading decisions.
Since the last report, the Bank of Canada has cut its policy interest rate, signalling a shift towards a more accommodative monetary policy stance. The Canadian dollar has remained relatively stable against the US dollar, while the unemployment rate held steady in July. The recent release of the Canadian CPI inflation data for July showed continued moderation, supporting the Bank of Canada's decision to ease monetary policy. Forex traders should monitor key economic indicators such as inflation, employment, and GDP growth in the coming weeks and months to assess the impact of these developments on the Canadian economy and currency.
Navigating a Turbulent World
Geopolitical tensions are on the rise globally, with potential flashpoints in the Middle East, Ukraine, and the US-China trade war. The assassinations of senior Hezbollah and Hamas leaders have raised the risk of retaliatory strikes and further escalation in the Middle East, which could impact global market sentiment and oil prices. The ongoing war in Ukraine, with Russia's recent territorial gains, and the escalating US-China trade war also pose significant risks to global markets and could indirectly affect Canada's economy.
In addition to these immediate concerns, several other geopolitical narratives could significantly influence the financial markets in the coming months. These include:
The upcoming US presidential election in November: The outcome of the US presidential election could significantly impact trade relations with Canada, creating either opportunities or challenges for the Canadian economy. A more protectionist administration could lead to renewed trade tensions and uncertainty, adversely affecting Canadian businesses and the overall economy.
The ongoing conflict in Gaza: The ongoing conflict in Gaza, with its potential for escalation and spillover effects, could further destabilise the Middle East and negatively impact global market sentiment.
The rise of populism and nationalism: The rise of populism and nationalism in many countries around the world is leading to increased political polarisation, protectionist trade policies, and a weakening of multilateral institutions, creating a more uncertain and volatile geopolitical environment.
"The global order is undergoing a period of profound transformation, marked by shifting power dynamics, rising nationalism, and a resurgence of great power competition. These trends are creating a more complex and uncertain geopolitical landscape, with significant implications for global security and prosperity." - World Economic Forum, Global Risks Report 2024
The current geopolitical landscape presents both risks and opportunities for Canada. The potential for escalation in the Middle East and the ongoing war in Ukraine could negatively impact global market sentiment and oil prices, indirectly affecting Canada's economy. The escalating US-China trade war also poses a significant risk to Canada's export-oriented economy. However, Canada's strong economic fundamentals, stable political system, and close ties with its allies provide a degree of resilience to these geopolitical challenges.
Canada's Fiscal Policy Amidst Economic Uncertainty
Canada's fiscal policy deftly balances ongoing investments in critical areas such as housing, healthcare, and clean energy while maintaining fiscal sustainability. The government, through Budget 2024, aims to reduce the federal debt-to-GDP ratio and promote fairness across generations, guiding deficits and federal debt downwards. This commitment preserves Canada's AAA credit rating, fostering low borrowing costs and a stable macroeconomic environment. Substantial investments in affordable housing, clean energy, and skills training aim to unlock opportunities for younger Canadians, address long-term structural challenges, and ensure Canada's competitiveness and prosperity. The recent release of second-quarter GDP data, showing a growth rate exceeding market expectations, reinforces Canada's commitment to fiscal responsibility and is likely to bolster the Canadian dollar and attract foreign investment.
Looking ahead, the government's focus will be on implementing the measures outlined in Budget 2024, including the new Canada Carbon Rebate for Small Businesses, the Canada Housing Infrastructure Fund, and investments in clean energy and skills training. The government will also need to navigate the potential impact of the upcoming US presidential election on trade relations with Canada.
"Fiscal policy plays a crucial role in supporting economic growth, promoting social equity, and ensuring long-term fiscal sustainability. Governments must strike a balance between these objectives, carefully considering the short-term and long-term implications of their fiscal policy decisions." - International Monetary Fund, Fiscal Monitor 2024
Canada's fiscal policy is navigating a delicate balancing act between supporting economic growth and maintaining fiscal sustainability. The government's commitment to reducing the federal debt-to-GDP ratio while investing in key areas is positive for the long-term outlook, but the potential for increased spending pressures and the impact of the upcoming US presidential election on trade relations with Canada pose risks to this trajectory.
Canada's Economic Fundamentals
The Canadian economy exhibits conflicting indicators, showcasing both resilience and potential vulnerabilities. While the nation has successfully averted a recession and experienced moderating inflation, challenges such as high interest rates, elevated housing costs, and slowing global growth persist. These factors influence economic activity and impact the value of the Canadian dollar and the outlook for Canadian assets.
Despite these challenges, Canada boasts a robust labor market. Employment levels surpass pre-pandemic numbers, and wage growth has outpaced inflation for over a year. This strength supports consumer spending and bolsters overall economic resilience. The government recognizes the significance of this strong labor market, emphasizing its positive impact on affordability and purchasing power.
Looking ahead, the release of the August employment report and the Ivey PMI on September 6th will be crucial for evaluating the health of the labor market and business confidence. Market participants will closely watch the August CPI inflation data, scheduled for release on September 10th, for signs of continued moderation in inflation. These indicators will provide valuable insights into the direction of the Canadian economy and inform market decisions.
"The Canadian economy is at a crossroads, facing both opportunities and challenges. The nation's strong fundamentals, including its robust labour market and sound fiscal policies, provide a solid foundation for growth. However, the global economic slowdown, high interest rates, and elevated housing costs pose significant risks to the outlook." - OECD Economic Outlook, August 2024
The Canadian economy is currently navigating a complex landscape characterised by both resilience and challenges. The nation's robust labour market and moderating inflation are positive signs, but high interest rates, elevated housing costs, and slowing global growth are weighing on economic activity. The outlook for the mid-term is for a gradual recovery, but a number of risks could derail this trajectory.
The Bank of Canada's Evolving Monetary Policy
The Bank of Canada's monetary policy is currently focused on steering the Canadian economy towards a soft landing, balancing the need to bring inflation back to its 2% target with the imperative of supporting economic growth. This delicate balancing act is being closely watched by market traders, as it will have a significant impact on the value of the Canadian dollar and the outlook for Canadian interest rates. The Bank of Canada has been aggressively raising interest rates since early 2022 to combat inflation, which surged to a multi-decade high of 8.1% in June 2022. These rate hikes have been effective in cooling the economy and bringing inflation down, with the CPI inflation rate falling to 2.5% in July 2024.
However, the Bank of Canada also recognizes the risks of overtightening monetary policy and potentially pushing the economy into a recession. With signs of slowing economic growth and easing inflationary pressures, the Bank of Canada cut its policy interest rate by 25 basis points to 4.5% in its July 24th meeting. Market participants are now anticipating further rate cuts in the coming months, with the Bank of Canada's next policy meeting scheduled for September 4th. The market expects the Bank of Canada to cut rates to 4.25% at this meeting. The Bank of Canada's recent rate cut has had a significant impact on financial markets. The Canadian dollar has weakened against the US dollar, while bond yields have fallen.
Looking ahead, the release of the Bank of Canada's Monetary Policy Report on October 23rd will provide further insights into the Bank's assessment of the economic outlook and its implications for future monetary policy decisions. The Bank of Canada has clearly signalled its intentions, stating that "If inflation continues to ease broadly in line with our forecast, it is reasonable to expect further cuts in our policy interest rate."
"Monetary policy operates with a lag, and the full impact of past interest rate hikes is still working its way through the economy. The Bank of Canada will need to carefully monitor incoming economic data and adjust its policy stance as needed to ensure a soft landing and a sustainable return of inflation to target." - Bank of Canada, Monetary Policy Report, July 2024
The Bank of Canada is navigating a delicate balancing act between controlling inflation and supporting economic growth. The recent rate cut signals a shift towards a more accommodative stance, but the Bank will continue to closely monitor incoming economic data and adjust its policy as needed. The upcoming Monetary Policy Report on October 23rd will provide further insights into the Bank's assessment of the economic outlook and its implications for future monetary policy decisions.
A Path Through Uncertainty
The macroeconomic outlook for Canada is for a gradual recovery over the mid-term, supported by easing interest rates, a robust labour market, and continued government investment in key areas. However, the outlook remains subject to a number of risks, both domestic and global, that could derail this trajectory.
The Bank of Canada's July 24th Monetary Policy Report projects GDP growth of 1.2% in 2024, 2.1% in 2025, and 2.4% in 2026. This growth is expected to be driven by stronger exports, a recovery in household spending, and robust residential investment. The Bank also expects inflation to continue moderating, with CPI inflation forecast to settle sustainably around the 2% target next year. The Bank of Canada states that "Looking ahead, we expect inflation to moderate further, though progress over the next year will likely be uneven."
However, the Bank acknowledges that there are risks to this outlook. Globally, geopolitical uncertainty remains high, and a sharper-than-expected slowdown in the US economy could weigh on Canadian exports and business investment. Domestically, the biggest downside risk is that household spending could be weaker than expected, particularly if labour market conditions deteriorate.
Since the previous report, the Bank of Canada has revised its outlook for population growth upwards, reflecting the continued influx of non-permanent residents. This upward revision to population growth is expected to support economic growth in the near term, but it also poses challenges for the housing market and could contribute to inflationary pressures.
The macroeconomic outlook for Canada is for a gradual recovery over the mid-term, supported by easing interest rates, a robust labour market, and continued government investment in key areas. However, the outlook remains subject to a number of risks, both domestic and global, that could derail this trajectory. Market traders are closely monitoring these developments, as they will have a significant impact on the value of the Canadian dollar and the outlook for Canadian assets.
Key Economic Indicators to Watch
The following economic indicators are key to tracking the macroeconomic outlook for Canada in the upcoming month:
Economic Growth:
Real Gross Domestic Product (GDP): Real GDP is a lagging indicator that measures the total value of goods and services produced in an economy. Canada's GDP is expected to expand by 1.5% in the second quarter of 2024, following a 0.4% increase in the first quarter. The upcoming release of the July GDP data on September 27th will provide further insights into the pace of economic growth.
Business capital investment: Business capital investment is a leading indicator that measures spending by businesses on fixed assets, such as machinery and equipment. Business capital investment is expected to strengthen in the second half of 2024, driven by easing interest rates and the anticipated pickup in economic growth.
Price Changes (Inflation):
Consumer Price Index (CPI): CPI is a lagging indicator that measures the average change in prices paid by urban consumers for a basket of consumer goods and services. Canada's CPI rose 2.5% year over year in July 2024, down from 2.7% in June. The upcoming release of the August CPI data on September 10th will be crucial for assessing the Bank of Canada's future monetary policy decisions.
CPI-common, CPI-median, and CPI-trim: These are core inflation measures that exclude volatile components, such as food and energy prices. The core inflation measures are expected to continue moderating in the coming months, suggesting that underlying inflationary pressures may be easing.
Labour:
Unemployment rate: The unemployment rate is a lagging indicator that measures the percentage of the labour force that is unemployed. Canada's unemployment rate was unchanged at 6.4% in July 2024. The upcoming release of the August unemployment rate data on September 6th will provide further insights into the health of the labour market.
Employment: Employment is a lagging indicator that measures the number of people employed. Employment in Canada fell by a marginal 2,800 in July 2024, following a 1,400 decline in June. The upcoming release of the August employment data on September 6th will provide further insights into the strength of the labour market.
Average hourly wages: Average hourly wages are a lagging indicator that measures the average hourly earnings of employees. Average hourly wages in Canada increased 5.2% year over year in July 2024, following growth of 5.4% in June. Wage growth is expected to moderate in the coming months as the labour market cools.
Housing:
Housing starts: Housing starts are a leading indicator that measures the number of new residential construction projects that have been started. Housing starts in Canada surged by 16% month over month to 279,500 units in July 2024, the highest since June 2023. The upcoming release of the August housing starts data on September 17th will provide further insights into the strength of the housing market.
New Housing Price Index: The New Housing Price Index is a lagging indicator that measures the average change in prices for new residential properties. The New Housing Price Index in Canada increased 0.2% month over month in July 2024, following a -0.2% decline in June. The upcoming release of the August New Housing Price Index data on September 20th will provide further insights into the evolution of house prices.
Business Confidence:
Ivey Purchasing Managers Index: The Ivey Purchasing Managers Index is a leading indicator that measures the level of business confidence in the manufacturing sector. The Ivey Purchasing Managers Index in Canada eased to 57.6 in July 2024 from 62.5 in June. The upcoming release of the August Ivey PMI data on September 6th will provide further insights into the level of business confidence.
Consumer Sentiment:
Canadian Survey of Consumer Expectations: The Canadian Survey of Consumer Expectations is a leading indicator that measures the level of consumer confidence. Household inflation expectations fell sharply in the second quarter of 2024 after having stalled for close to one year. The upcoming release of the third-quarter consumer confidence data will provide further insights into the level of consumer sentiment.
Trade:
Balance of Trade: The balance of trade is a lagging indicator that measures the difference between a country's exports and imports. Canada recorded a trade surplus of CAD 0.64 billion in June 2024. The upcoming release of the July trade balance data on September 4th will provide further insights into Canada's trade performance.
Conclusion
This report has provided a comprehensive overview of Canada's macroeconomic landscape, highlighting the key drivers and risks shaping the nation's economic trajectory. As a forex trader, understanding these dynamics is crucial for making informed trading decisions and capitalising on emerging opportunities.
The Canadian economy is currently navigating a complex landscape characterised by both resilience and challenges. The nation's robust labour market and moderating inflation are positive signs, but high interest rates, elevated housing costs, and slowing global growth are weighing on economic activity. The outlook for the mid-term is for a gradual recovery, but a number of risks could derail this trajectory.
The Bank of Canada is expected to continue its data-dependent approach to monetary policy, carefully monitoring incoming economic data and adjusting its policy stance as needed. The timing and magnitude of future interest rate cuts will depend on the evolution of inflation, economic growth, and the balance of risks to the outlook. As the Bank of Canada stated in its July 24th press release, "The timing will depend on how we see these opposing forces playing out. In other words, we will be taking our monetary policy decisions one at a time."
Actionable Insights for Forex Traders:
Monitor key economic indicators: Pay close attention to the upcoming releases of key economic indicators, such as CPI inflation, GDP growth, the unemployment rate, and the Ivey PMI, for insights into the health of the Canadian economy and the Bank of Canada's future monetary policy decisions.
Stay informed about geopolitical developments: Monitor geopolitical developments, such as the conflict in Ukraine and the US-China trade war, for their potential impact on global market sentiment and commodity prices, which could indirectly affect the Canadian dollar.
Assess the impact of fiscal policy: Analyse the government's fiscal policy stance and its potential impact on economic growth, inflation, and the Canadian dollar.
Consider the upcoming US presidential election: The outcome of the US presidential election could significantly impact trade relations with Canada, creating either opportunities or challenges for the Canadian economy and the Canadian dollar.
Sources
Bank of Canada
Statistics Canada
Department of Finance Canada
2024 Third-Quarter Forecast
2024 Canadian Federal Budget
S&P Global
Ivey Business School
Trading Economics
Bloomberg
Reuters
Week Ahead report from Newsquawk
Stratfor