Canadian policy makers have worked hard to flag the potential risks of U.S. protectionism under Donald Trump, with little success.
The U.S. president intends to act quickly on renegotiating the North American Free Trade Agreement. Yet instead of gloom, investors have been pricing in heady days for Canada’s economy: the yield curve has been steepening, stocks rose to record high last week and the country’s currency is up this year. It’s the sort of market behavior you’d expect at the beginning of a rate-hike cycle.
While it’s not clear how concerned Bank of Canada Governor Stephen Poloz is — and Monday’s market tumble may have tempered any worries — the recent strength does potentially pose a risk for monetary policy. Optimistic investors could drive up corporate borrowing costs and the currency, quelling the fragile recovery.
Hinting at a mismatch with markets, Poloz reminded investors earlier this month that “rate cuts remain on the table.” He also said higher Canadian bond yields, driven by rising U.S. yields, aren’t consistent with the country’s economic outlook.
Perhaps markets have been buoyed by the fact Canada has so far averted Trump’s ire. For example, as the U.S. escalated its trade rhetoric against Mexico, the president moved to push forward TransCanada Corp.’s Keystone XL pipeline project, sending the Canadian dollar higher.
Trump has turned his “Sauron evil eye away from us and towards Mexico,” said Mark Chandler, head of fixed-income research at RBC Capital Markets in Toronto. “Even though it’s facetious, I think that’s part of it.”
Poloz gets another chance Tuesday to hammer home any concerns. He’s due to give a lecture, entitled “Models and the art and science of making monetary policy,” at the University of Alberta School of Business in Edmonton, followed by a press conference. Here are some things — positive and negative — that may frame his remarks:
There are some good reasons to be optimistic. The Canadian economy is expected to finally emerge from the oil shock and grow in real terms at or above 2 percent for the first time since 2014 — fast enough to eat into some of the nation’s idle capacity. Nominal GDP growth is seen rising to about 4 percent, considered to be about normal for Canada.
One reason for the growth pickup is that the impact of the oil shock is bottoming out, and there are even some signs of investment in the oil patch.
Another development that could be considered positive: Poloz gave no indication following his Jan. 18 rate announcement that the bank considered cutting interest rates, contrary to the October announcement, when it said such a move was actively discussed. That may be a harbinger of an improving economic outlook.
In fact, the Bank of Canada is more optimistic than the market. Its estimate for 2.1 percent growth in 2017 and 2018 is higher than the 1.9 percent median pace in Bloomberg’s latest survey of economists.
Some other positives include signs of life in U.S. business investment and industrial production, which is a significant driver of U.S. demand for Canadian exports — even though the Bank of Canada has begun to downplay the linkages. For example, non-residential fixed investment in the U.S. increased at a 2.4 percent annualized pace in the fourth quarter, the most in five quarters.
If you are looking for down arrows for Canada’s economy, there are plenty of those too.
While the Bank of Canada usually lists both upside and downside risks to its outlook, the emphasis at its rate announcement this month was arguably on the downside. For example the accompanying statement began: “Uncertainty about the global outlook is undiminished, particularly with respect to policies in the United States.” By comparison, December’s announcement began with a more positive tone: “Economic data suggest that global economic conditions have strengthened, as the Bank anticipated.”
And the bank also noted “material excess capacity” in the economy, a persistent hit to incomes from the oil shock, the drag of a higher Canadian dollar, slowing residential investment, economic divergence with the U.S. and a labor market that has deteriorated.
Even removing the risks associated with Trump, the Bank of Canada’s economic outlook assumes growth will rise from 1.3 percent in 2016 on the strength of sustained consumer spending and a sharp increase in government stimulus. Some see that as overly optimistic.
For one, consumers are already up to their necks in debt, one of the reasons the central bank not long ago anticipated a slowdown in consumer spending.
Second, expectations are high for federal stimulus, with the central bank projecting 0.9 percent contribution to growth from government spending and investment. Those are levels not seen since the 2008-2010 stimulus budgets, when deficits were a lot higher than they are today.
“It’s an odd time to be expecting the Canadian consumer to carry the burden of growth given debt levels that are going on,” said David Watt, chief economist at HSBC Bank Canada.