As growth decelerates, fortunes change for the Canadian dollar

BY DEB SHAW | 

  • Canadian growth rates continue to trend downwards, dashing hopes for rate hikes
  • Tough math and the poor economic outlook is likely to result in decelerating growth
  • In the longer term, Canadian dollar is likely to stay weak

In the past few quarters, economists have made abundant use of the phrase ‘globally coordinated growth’. The idea is that the world is currently experiencing a unique era, whereby major economies (including the US, Eurozone, Japan, and emerging markets) are experiencing strong growth rates at the same time. Many have pointed to aggressive monetary policy as the likely cause, given that the past few years have seen ‘extraordinary’ central bank policies including quantitative easing and negative interest rates.

Unfortunately, coordinated growth appears to have left Canada behind, as growth in the country looks destined to keep decelerating. While commentary surrounding Canadian GDP growth was euphoric a few months ago, we have been warning that Canadian growth is more likely to decelerate in the latter half of 2017.

 

Hard to get excited about the future of Canadian growth 

Yesterday’s month-over-month GDP figures came in at -0.1% versus expectations of 0.1%. Converting the figures into our preferred year-over-year format, the economy was growing at the rate of 3.5% in August 2017. Looking at annualized growth rates in recent times, one can clearly see that growth peaked in May 2017 and has been falling (in rate-of-change terms) since that time. This is illustrated below:

Down and down: growth keeps decelerating

11-1-2017 CAD growth
Source: Statistics Canada

 

Thanks to government-led spending as a result of the Liberal government’s 10-year $120b stimulus program announced in late 2016, Canadian growth remains very high relative to developed countries. Government spending, consumer spending and business spending have all performed well this year. Looking at the future, the picture is far less rosy as all three sectors look set to slow down.

Firstly, growth rates are likely to decelerate thanks to base effects from 2017. Delivering year-over-year growth in 2018 will be mathematically much tougher, especially as the government’s stimulus program is unlikely to keep growing in scope. Secondly, business spending growth (led by the commodity sector) is set to decelerate as Canada faces new competition in key commodity markets. While the country has historically sold crude oil to the US, the tables have been turned recently. According to figures from the US EIA, Canada is now the top export destination for US crude oil in 2017. Specifically, the country bought an average of 307,000 barrels per day from its northern neighbor in the first half of 2017. Given the high costs of extracting crude oil from Alberta’s tar sands, business investment in the sector is decelerating despite the fact that global crude oil prices are rising. Lastly, there are also questions regarding the health of consumer finances, given the real estate boom in Toronto and Vancouver. As Canadian households are amongst the most indebted in the world (with household debt to income at 167.8%), the future of consumer spending growth looks challenging.  

 

Short-term oversold, but the loonie is likely to keep weakening from here

In our daily update of the Canadian dollar published this morning, we wrote that CAD is starting to look fairly oversold in the short-term charts. While this doesn’t suggest that the Canadian dollar is set to strengthen imminently, it does suggest that the loonie is likely to enjoy a short-term ‘relief rally’ at some point in the near future.

Looking at a longer-term picture on a weekly chart, the Canadian dollar remains far from oversold conditions. Once the currency overcomes resistance in the short-term, we expect the loonie to keep weakening over the next few weeks. Given the weak outlook for Canadian growth and monetary policy, USD/CAD is likely to strengthen to 1.30 and beyond.   

Topics: Canadian dollar

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