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Canada is one of the channels transmitting the global economic slowdown to the United States

This topic will be discussed during the Amundi World Investment Forum

Forum AMUNDI.com

 

THE ESSENTIAL

The Canadian economy is suffering from the sharp fall of depreciated commodity prices and the Canadian dollar strongly vs its US counterpart.

The weakening of Canada appears to be clearly one of the transmitting channel of the slowdown of global growth and of the collapse of commodity prices to US growth.

 

PUBLICATION

Canada in bad shape

The sharp fall in commodities prices, particularly the oil price decline that began in the summer of 2014, has hit Canada hard. Oil prices collapsed, mainly due to substantial excess supply but also to the slowdown of the global economy, and are expected to remain low for some time. As oil and gas mining represents approximately 8% of Canada’s GDP and 30% of corporate investment, the decline in oil prices is having a fairly heavy impact at the macroeconomic level in Canada.

The mining and construction sectors have been the two most dynamic sectors of the Canadian economy since the Great Recession of 2008/2009. They are now clearly slowing down. Furthermore, as Stephen Poloz, Governor of the Bank of Canada (BoC) underscored on January 7 (“Life After Liftoff: Divergence and US Monetary Policy Normalization”), the impact of the sharp slowdown in the mining sector is spreading across the entire economy, primarily due to lower consumption spending resulting from worker lay-offs. The services sector, where growth has been much more regular in recent years, has been decelerating since the spring of 2015.

Although the BoC lowered its key interest rates to 0.50% last July, its governor increased his communications efforts in December and January and hinted that the BoC could go further (specifically, Governor Poloz made repeated references to forward guidance, large-scale asset purchases, private sector credit fi nancing and negative interest rates). His remarks caused the Canadian dollar to depreciate further: the USD/CAD exchange rate parity rose from 1.33 in early December to 1.46 by 19 January, the day before the Governing Council meeting, during which the BoC ended up leaving its rates unchanged (despite substantially revised downward forecasts for 2016 growth, from 2% to 1.4%). Maintaining the monetary policy status quo allowed the Canadian dollar to make a modest recovery but it is important to put things back into perspective and remember that the US and Canadian dollar were at parity in early 2013. Furthermore, the fact that the BoC stated that the economy’s excess capacity was expected to increase over the next few quarters could prompt this institution to rethink its monetary policy stance in the coming months, which would weigh signifi cantly on the Canadian dollar.

The falling Canadian dollar is strengthening the US dollar. The Canadian dollar has been the main contributor to the rise of the US dollar’s effective exchange rate since the summer of 2014 ahead of the euro, yen or yuan (see chart 3). The rising dollar is one of the main transmission channels of defl ationary forces. During a speech on 12 November (“The Transmission of Exchange Rate Changes to Output and Inflation”), Vice Fed Chairman Stanley Fischer explicitly linked the repeated delays of the initial Fed fund rate hike to the continued rise of the dollar and to weaker foreign demand. In particular, he drew attention to the fact that a 10% appreciation of the US dollar could result
in a permanent 1-1/2 percentage point decline in GDP after three years due to falling net exports. Moreover, according to these same economic models, a 10% appreciation of the US dollar might temporarily depress core PCE infl ation with the maximum effects being felt two quarters after the appreciation (implying a dip of 0.5 percentage point). Since Mr. Fischer’s speech, the nominal US tradeweighted exchange rate has climbed significantly higher (+5% in effective terms between the beginning of November and end of January) and the outlook for world growth has dimmed. This would contribute to delaying further Fed funds rate hikes or even eliminating them if these trends are further exacerbated.

Weakened by the decline in oil prices, Canada represents a significant source of external economic risk to the United States. It worth keeping in mind that Canada is the United States’ most important economic partner:

  • Canada is by far the leading destination of US exports (19% of US exports of goods compared to 15% for Mexico, 13% for the eurozone and 10% for China).
  • After China, Canada is the second largest country of origin of US imports (15% of the total).
  • In both export and import terms, trade in goods with Canada represents approximately 2% of US GDP.
  • Considering the highly integrated nature of trade between these two countries, the orders of magnitude in value added (goods produced in one country and consumed in another) are substantially lower (according to the OECD, about 70% of the total in 2011), but to that should be added the sheer size of trade in services (nearly one-third of US exports) for which Canada’s share, as a destination, is probably at least as great as that for trade in goods).

Because of the foreign currency impact, there has been a very sharp decline in Canadian GDP measured in USD

  • More than the direct impact of Canada’s growth deceleration, it is the change in the value of the CAD (which has lost much more ground against the dollar than China’s currency) which is likely to put negative pressure on the US economy: using the USD/CAD exchange rate prevailing in late January (1.40), the 1.4% rise in Canadian GDP forecast by the BoC has turned into a more than 7% contraction in terms of annual averages when measured in USD.
  • This considerable order of magnitude is likely to influence both the volume of exports to and imports from Canada (to the detriment of US businesses, given that Canadian suppliers are operating in a large number of sectors on the domestic US market).

The Canadian economic slowdown, and especially the foreign exchange effect, could reduce US GDP by up to 0.2 percentage points in 2016.

  • Considering the acceleration in the decline of the Canadian dollar at the end of 2015, much of the pressure likely to be felt by the US economy is still to come.
  • Although the decline of US exports to Canada in nominal figures is already quite substantial (-13% over 12 months as of the end of December), it is only remotely significant because it is very sensitive to oil prices (the US exports large volumes of petroleum-derived products to Canada).
  • In terms of volume data, we note that even in the absence of detailed figures on trade between the two countries, total Canadian imports and exports nonetheless provide an indication since flows to and from the United States represent the lion’s share (54% and 77% for goods, respectively, in 2014). Imports are already showing a clear deceleration (-1.1% between Q3 2014 and Q3 2015, compared to +2.8% a year earlier), while exports, at least for now, are deriving little benefit from the exchange rate devaluation (+2.4% for the same period vs. +7.7% a year ago).
  • Although accurately predicting the future adjustment to import and export fl ows between the two countries due to changes in the exchange rate is a difficult challenge, an estimation may be attempted based on 1/ the contribution of the Canadian dollar to the higher effective exchange rate of the US dollar (1.1 percentage point during the 2d semester of 2014, 2.5 percentage points in 2015). 2/ the estimate made by the US Federal Reserve of the impact of the rise of the US dollar on US GDP (a 10 percent appreciation in the effective exchange rate of the dollar shaves 1.5 percentage point off GDP growth, cumulated over three years). Combined, these results suggest that the cumulative decline in the Canadian dollar since mid-2014 (as well as the lesser effect of slowing Canadian GDP growth) may shave up to 0.2 percentage points off US GDP growth in 2016 (after shaving off a similar amount in 2015).

The weakening of Canada appears to be clearly one of the transmitting channel of the slowdown of global growth and, even more so, of the collapse of commodity prices to US growth.

 

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Cross Asset of February 2016 in English

Cross Asset de Février 2016 en Français

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Bastien Drut & Tristan Perrier, Strategy and Economic Research at Amundi
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