A Few Thoughts on Canada

The Bank of Canada meets Wednesday.  Last month officials acknowledged that growth could be somewhat lower than previously anticipated.  Those fears have likely materialized, and the central bank may shave its growth forecasts for this year and next.  This means that it will take Canada longer to close its output gap.  It not only pushes out the first hike, but it leaves the door ajar for further easing if the economy falters further.   

Canada's overnight lending rate remains at 0.50%, where it has been since July 2015.  During the Great Financial Crisis, the overnight rate had fallen to 0.25%.  While the Canadian economy may need additional stimulus next year, many economists are divided how it will be delivered.  Some see the possibility of a rate cut, while others expect more fiscal support.  

Canada reported its August international securities transactions earlier today.  Foreign investors bought a third more Canadian securities in August over July, raising their net purchases to C$12.743 bln (from C$9.1 bln in July).  Foreign investors showed a strong preference for Canadian bonds; scooping up C$9 bln, mostly in the secondary market.  Corporate bonds, which include government business enterprise bonds accounted for two-thirds foreign purchases.  About C$1.7 bln of provincial debt was bought.  These were mostly new issues denominated in foreign currencies.  

Foreign investors have C$2.6 bln of Canadian equities in August, which represents a slight increase from July.  It is the 12th consecutive month that non-residents bought Canadian shares.  Canada's equities sold off sharply from April 2015 through January 2016 and then rallied 30% off the January lows through the mid-August high.  However, for the past two months, it has been broadly sideways.  

Canadian investors slowed their purchases of foreign assets to C$1.6 bln in August from C$4.6 bln in July.  They were buyers of foreign equities (C$3.3 bln), but sellers of foreign debt( C$1.7 bln).  In the foreign debt space, however, their activity was nuanced.  Canadians sold C$2.3 bln of non-US bonds.  It was the fourth consecutive month of such divestment, during which time they sold C$7.6 bln of non-US bonds.

Canada's free-trade agreement with the EU is in jeopardy.  Negotiations began in 2009 and concluded in August 2014.  The EU ratification process requires unanimity.  The immediate challenge is a region in Belgium (Wallonia), where the local parliament voted against the agreement (Comprehensive Economic and Trade Agreement--CETA).  EU trade ministers are to meet tomorrow to discuss how to move forward.  The EU has already agreed that parts of  CETA can be implemented before all the members approve it.  

The objections are ostensibly about the scope of liberalization and the establishment of courts to settle disputes.  However, the larger issue is that CETA is seen as model and dress rehearsal for the even more controversial trade agreement with the US (TTIP).  Opposition to CETA is not limited to Belgium.  Press reports, for example, suggest that the French government had used various parliamentary maneuvers to get around opposition in Parliament.   The overall challenge in reaching a trade agreement, the lengthy negotiations, and intricate ratification process may also be suggestive of what to expect with the UK. 

The US dollar has edged higher against the Canadian dollar in each of the months in Q3.  It has extended the advance through the first half of October, though barely (0.12%).  Last Thursday, after briefly poking through CAD1.33, the US dollar posted a reversal pattern and closed below the previous day's lows.  There was follow through US dollar selling ahead of the weekend, perhaps encouraged by the disappointing retail sales report.  Before the weekend the US dollar approached CAD1.31 and bounced to almost most CAD1.3185 late in the Asian session before consolidating in Europe and the US between CAD1.3120 and CAD1.3165.  

We see the Canadian dollar as being more sensitive to the short-term interest rate differential with the US than oil prices presently.  The two-year differential has widened from a five bp premium in early-July to almost 27 bp three months later.  It has since pulled back and is near 21 bp today, the lowest since September 22.