Micro Vs. Macro Factors in Canada

Facts:

Inflation in Canada is just shy of 2% (mid range target)

200,000 new jobs were created in the first 4 months of 2010

Retail sales rose 2.1% (YoY) in March 2010

Very little economic news out of Canada this week

But over the past 30 days:

    Oil prices down 20% from USD 86 to USD 68

    Copper prices down 17% from USD 3.6 to USD3.0

    Canadian dollar down 6% from parity with the USD to 0.94.

The situation in Canada is interesting, insofar as for the first time in over a year, the Canadian dollar is trading near or at its fair value.  It could give a break to (manufacturing) exporters, but many of them have been aggressively hedging their short term US dollar exposure – a reasonable decision, but it means that over the next 6-12 months they will not benefit from a weaker dollar.  That has implication for growth expectation from ¼ of Canada’s economy (manufacturing).  The energy complex and natural resource sector are also hurting both from a drop in price (especially copper which is considered a bell weather), but also a “contagion” of new taxes on resource extraction – Alberta started the ball rolling in 2007, and last week Australia upped the antes!  

For the BoC’ 30% of Canada’s economy became more exposed to external inflation pressures (the proportion of GDP that is made up of imports), because of the recent weakness of the Canadian dollar – however, the BoC doesn’t take into consideration exchange rates when making decisions about monetary policy – although external factors are probably a key component of the BoC’s decision to increase rates on June 1^st.  Like David Rosenberg, I believe that the likelihood if a rate hike is around 40% -- if we hear more rumors of quantitative easing, the BoC’s hands will be tied and no rate hike, in fact if the s/t and m/t vision is of deflation the yield curve will flatten out – it’s the long end that will come in, not the short end that will go out.  

For the BoC one the core sector worries has been the overheating housing market, Both in 2009 and in the first five months of 2010 it has been Canada’s engine of growth – nearly 30% of all jobs created over the first 4 months of 2010 were in housing or related sectors. There now appears to be a slow down in housing market, which nominally could make the BoC more cautious and hold back on raising rates.

The title of this note reflects the decision tree faced by the BoC over the summer.  The rest of the world appears to be imploding, while Canada remains largely steady – it’s easy to forget that over the past 5 months the Canadian equity market has been more or less static, the S&P500 is down about 5% since January 1^st.  China is down 25% and Europe is “off a cliff” due to its troubles.  I mentioned in a previous post that Europe is not a major market for Canadian exports (the UK is about as big as the rest of Europe), but it remains that the budget cuts announced by the British Government (USD 8.6 billion in 2010), Italy (USD 29 billion), and Spain (USD 80 billion), is going to directly impact these countries GDP – it has to, its simply impossible for private enterprise to replace this lost GDP, so for each of the UK, Italy and Spain it represents at least 1% to 2% in GDP reduction, which means that these countries may find themselves in negative territory.  The “second hand smoke” risk to Canada is clear.  All these countries will require fewer things – which means they will need less raw materials, which means that raw material prices will have to fall – as they have over the past few weeks.

As a commentator once said about one of Evil Kenevil’s motorcycle failed stunts – That’s gotta hurt!