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Economic Insights
August 11, 2015
Avery Shenfeld
(416) 594-7356
[email protected]
Benjamin Tal
(416) 956-3698
[email protected]
Andrew Grantham
(416) 956-3219
[email protected]
Royce Mendes
(416) 594-7354
[email protected]
Nick Exarhos
(416) 956-6527
[email protected]
First, a couple of definitions. It’s a “technical
recession” when somebody else has lost
their job. It’s a “recession” when you’ve lost
your job. Canada hasn’t actually seen net
job losses this year, so we’re not in recession,
but obviously, output has been slipping in
the first half.
South Park fans may want to “Blame
Canada”, but the roots of our troubles lie
abroad. With global growth falling below
3%, the weakest year since the Great
Recession, resource demand couldn’t sustain
lofty raw materials prices. The woes in the
energy sector were amplified by OPEC’s
willingness to pump out more crude. Gold
has been in retreat ever since investors clued
into the fact that quantitative easing would
not bring surging inflation, with bullion still
vulnerable on that front (see pages 3-5).
Canada was inevitably going to have a
lot of its eggs in the commodities basket,
not because governments invested in the
sector, but because the private sector did.
Manufacturing also faltered, but export
data suggest it snapped back to life in
June. Other soft spots, like non-residential
construction and retailing, are capturing the
spill-over from the resource slump in the
affected provinces.
“Monetary
conditions were
also key to how
Canada managed
to stay out of
recession during
some previous
resource price
slumps.”
http://research.cibcwm.
com/res/Eco/EcoResearch.
html
CIBC World Markets Inc.
CIBC
World
Markets
by Avery Shenfeld
•
China has been part of the story of weak
global growth (see pages 6-7), but despite
an equity slide, monetary stimulus efforts
there could show up in better numbers
ahead. Indeed, although aluminum and
wood volumes remained depressed, the
latest month showed year-on-year gains in
Chinese import volumes for iron, copper
and nickel ores as well as crude oil.
Monetary conditions were also key to how
Canada managed to stay out of recession
during some previous resource price slumps
(Chart). The mid-80s oil crash isn’t relevant,
since Canada was barely a net crude exporter
at the time. But Canada avoided an outright
recession during the Asian-crisis resource
slump in the late 1990s and again when
commodities tumbled during the 2001 US
recession, helped by the stimulus to other
exports from a sharp decline in the Canadian
dollar to well below 70 cents US.
The past year’s C$ slide could take a bit
longer to come to full fruition in terms of its
lift to exports and capital spending by nonresource exporters opting to locate here (see
pages 8-11). But GDP growth in Canada will
get a big lift once we move past the steepest
quarterly declines in energy sector capital
spending. Our updated growth forecast still
has only a 1.1% pace for 2015, but as we
move past the deepest part of the dive in
energy sector capital spending, the recession
talk should soon recede.
Resource Prices, the C$, and Recessions
7.0
110
100
6.5
90
6.0
80
5.5
70
5.0
60
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
ECONOMICS
Don’t Blame Canada
BoC Commodity Price Index (Left, Log Scale)
C$ (Right, US-cents)
Source: BoC, C.D. Howe, Bloomberg, CIBC
Canadian recessions highlighted
PO Box 500, 161 Bay Street, Brookfield Place, Toronto, Canada M5J 2S8
Corp
300
Madison
Avenue,
New
York,
NY
10017
•
•
• Bloomberg
(212)
@ CIBC
856-4000,
•(416) 594-7000
(800)
999-6726
CIBC World Markets Inc.
Economic Insights—August 11, 2015
MARKET CALL
• The latest jobs data were one of the last hurdles to cross before a Fed hike in September and it was
cleared with room to spare. What’s surprising, then, is how calmly the bond market further out the
curve has taken the approach to that lift off. Tame inflation and some equity jitters have kept Treasuries
well bid, and we’ve (again!) had to move some of our near-term yield targets a tad lower.
• The Fed’s hikes should put a modest dose of further pressure on the loonie, and US growth will provide
enough reassurance that Canada’s non-energy exports will eventually build on the gains we saw in June.
So while rate hikes from the BoC are more than a year away, the bond market will see some pressure
due to both the pull from Treasuries and a gradual reduction in the odds placed on a further rate cut
in Canada.
• The US dollar will have a final day in the sun as other majors face the music from an initial Fed hike. But
we would use a period of greenback strength in September to start cashing in on long positions in the
USD against European majors. The absence of an October hike, and a more lasting pause by the Fed
after Q1 2016, will divert attention from rate differentials to other fundamentals, with America’s still
sizeable trade gap looming as a USD negative.
INTEREST & FOREIGN EXCHANGE RATES
2015
2016
10-Aug
Sep
Dec
Mar
Jun
Sep
Dec
CDA Overnight target rate
98-Day Treasury Bills
2-Year Gov't Bond
10-Year Gov't Bond
30-Year Gov't Bond
0.50
0.38
0.45
1.46
2.13
0.50
0.40
0.45
1.50
2.20
0.50
0.45
0.55
2.00
2.50
0.50
0.45
0.80
1.95
2.40
0.50
0.45
1.00
2.05
2.55
0.75
0.70
1.20
2.45
2.75
1.00
1.00
1.50
2.55
3.00
U.S. Federal Funds Rate
91-Day Treasury Bills
2-Year Gov't Note
10-Year Gov't Note
30-Year Gov't Bond
0.125
0.07
0.73
2.22
2.89
0.375
0.30
1.00
2.45
3.10
0.625
0.55
1.05
2.85
3.35
0.875
0.75
1.30
2.70
3.25
0.875
0.75
1.40
2.75
3.40
0.875
0.80
1.50
2.95
3.50
1.125
1.00
1.55
3.10
3.60
Canada - US T-Bill Spread
Canada - US 10-Year Bond Spread
0.32
-0.76
0.10
-0.95
-0.10
-0.85
-0.30
-0.75
-0.30
-0.70
-0.10
-0.50
0.00
-0.55
Canada Yield Curve (30-Year — 2-Year)
US Yield Curve (30-Year — 2-Year)
1.67
2.16
1.75
2.10
1.95
2.30
1.60
1.95
1.55
2.00
1.55
2.00
1.50
2.05
EXCHANGE RATES
0.77
1.31
125
1.10
1.55
0.74
0.99
3.47
16.16
0.77
1.30
125
1.05
1.53
0.73
0.99
3.05
15.22
0.75
1.33
125
1.08
1.59
0.72
0.96
3.13
15.65
0.76
1.32
126
1.11
1.61
0.73
0.95
3.18
15.30
0.76
1.31
125
1.14
1.62
0.75
0.93
3.22
15.28
0.77
1.30
124
1.17
1.61
0.77
0.91
3.21
15.28
0.78
1.28
121
1.20
1.60
0.80
0.90
3.21
15.42
END OF PERIOD:
CADUSD
USDCAD
USDJPY
EURUSD
GBPUSD
AUDUSD
USDCHF
USDBRL
USDMXN
2
CIBC World Markets Inc.
Economic Insights—August 11, 2015
Gold: Glittering No More
Andrew Grantham
Times They Are a Changing
Gold has well and truly lost its luster. Having fallen by
another $100 in the last two months, it has now shed
more than $700, or around a third of its value, since
peaking at the height of global uncertainty following the
Great Recession.
Judging whether this change in attitude towards gold will
persist is key in trying to determine if its value could drop
even further. After all, demand for gold is driven almost
exclusively by speculation that the price will rise over time,
or that it will hold its value better than other alternatives.
Figures from the World Gold Council show that in 2014
industrial demand (largely for electronics) accounted for
only around 8% of demand for gold. The price of gold,
therefore, has more in common with that of bitcoins
than other metals. Fears of excess inflation and currency
depreciation, or the absence of tempting alternatives
when interest rates are low, are what previously drove
gold prices higher.
However, as a store of value since the turn of the
millennium, gold is still performing better than others.
An investment in gold made in 2000 has enjoyed a 9%
compound growth rate. Of course, if that investment was
cashed in in 2011, when gold prices peaked, the annual
growth rate would have been much higher. But that 9%
is still much healthier than the gains made by investments
in the S&P 500 Index, or in the US housing market at that
same time (Chart 1).
Perhaps that’s why investors appear to be wondering if
the price of gold is still too good to be true. ETF holdings
of gold fell sharply as the metal started its precipitous
slide in 2012, and have been on a broad downward trend
really ever since (Chart 2, left). Meanwhile, the upturn in
central bank holdings of gold after the 2008/09 recession
appears to be running out of steam (Chart 2, right). And
the difficulties for bullion go further than just waning
demand from investors, with hedge funds moving into a
net short position recently.
However, many of those factors are now fading. Despite
large amounts of monetary stimulus still being enacted
globally, particularly by the ECB and BoJ, inflation remains
very subdued. True, inflation expectations have picked
up and fears of deflation have eased. But for gold to
catch a bid, just a little bit of inflation doesn’t do the
trick. Historically it’s only when inflation gets to extremely
elevated levels, and fears of it staying there or rising faster
are high, that gold really starts to see significant price
jumps (Chart 3). On average, increases in gold price with
US CPI between 2-4% aren’t significantly different from
those seen during periods of outright deflation.
Chart 2
ETF Holdings Continue to Fall (L),
Central Bank Holdings Levelling Off (R)
1100
70
5
60
1050
50
1000
40
Gold
S&P 500
850
Case-Shiller
House Price
Source: Bloomberg, S&P, CIBC
Jul-15
0
Dec-13
1
900
May-12
10
Oct-10
20
2
Mar-09
3
950
Aug-07
30
Jan-06
4
Jan-15
6
Nov-11
7
Central Bank Holdings
(Mill Fin Troy Once)
1150
80
8
0
Known ETF Holdings
(Mill Troy Once)
Sep-08
9
90
Jul-05
Compound Annual Growth
Rates Since 2000 (%)
Mar-99
10
May-02
Average Growth Rates Since 2000
Jan-96
Chart 1
Source: Bloomberg, IMF, CIBC
3
CIBC World Markets Inc.
Economic Insights—August 11, 2015
year. Although during the most recent Fed tightening
cycle (starting in 2004) gold fared fairly well, on average
it has struggled when the US starts raising interest rates
— losing around 8% of its value in the twelve months
following the first hike (Chart 4). A gradual tightening
cycle, which is widely expected this time around, may
limit the impact. But a Federal Reserve moving off zero
interest rates is still far from bullish for gold.
Chart 3
Average Increase in Gold Price at Different Inflation
Rates
20
Average Y/Y Change in Gold Price at
Different Inflation Rates (Since 1976)
16
12
Green Not Gold
8
There may be some respite coming from one factor
that has been a big negative for gold recently — the
resurgence of the US$. As gold is priced in US dollars,
the strength of the greenback has a direct impact on the
quoted value. But it goes beyond that. Prior to its recent
turnaround, the US$ was on a broad downtrend for well
over a decade. And particularly after the US credit rating
downgrade by S&P in 2011, investors were using gold
as a hedge against further US$ depreciation. As such,
looking at long-term correlations, the US$ index has by
far the best relationship with gold (Chart 5, left).
4
0
CPI Above
4%
Between 24% CPI
Between 02% CPI
Below 0%
CPI
Source: BLS, Bloomberg, CIBC
A turning point in monetary policy could add a new
headwind for bullion. While stimulus will continue to
be added in areas such as the Eurozone and Japan,
interest rates are already at or near their bottoms in many
countries. And in a select few, including importantly the
US and UK, rate hikes appear to be just around the corner
with the Fed moving in September and the BoE following
early next year. Soon, gold investors will have to come to
terms with a world in which interest rates can go up as
well as down.
And so the sharp ascent in the greenback recently—
which has seen the US$ index rise by 20% over the past
year—has been a primary depressant on the price of gold.
Note that if gold prices were quoted in the C$ or euros,
they would actually be up slightly compared with a year
ago (Chart 5, right).
The good news for gold investors is that any further
gains in the US$ should be more limited. After years of
undervaluation the US$ is now, if anything, already in
That has historically had big implications for the value
of gold, which itself pays no interest or dividend each
Chart 5
Gold Highly Correlated With US$ (L),
Not Faring Badly in Other Denominations (R)
Chart 4
Gold Price During Fed Tightening Cycles
0.50
Long-Term Correlation
With Gold Price
5
0.40
0.20
90
-5
0.10
Average
DXY
Low (1980)
70
t+11
t+10
t+9
t+8
t+7
t+6
t+5
t+4
t+2
t+1
t
t+3
High (2004)
60
-10
0.00
Risk (VIX)
80
Yr/Yr Change in Gold
Priced in Different
Currencies
0
0.30
100
Inf Exp (5Y
Breakeven)
110
Changes in Gold Price During Fed Hiking
Cycles (Index 100 = Price at First Hike)
US 10Y Yield
120
-15
-20
US$
C$
Eur
Source: Bloomberg, CIBC
Source: Bloomberg, Federal Reserve, CIBC
4
CIBC World Markets Inc.
Economic Insights—August 11, 2015
overvalued territory. That’s evidenced by recent export
and manufacturing production figures, which show a
clear slowdown compared with rates seen earlier in the
recovery. While the greenback could strengthen a little
further when the Fed starts raising interest rates ahead
of other central banks, the weaker trade picture and
expected slowness of the hiking cycle should mean a
much more muted move in the greenback than that seen
since mid-2014.
how it could be viewed in the rest of the world. Given
developments in monetary policy, with the adoption
of inflation targeting over the past couple of decades,
inflation in developed countries has been generally lower
than in the past.
The same is not always true in emerging markets, and
many investors in those countries still view gold as a safe
investment in the face of potentially high inflation and/
or currency depreciation. A key player at the moment is
India, where demand for gold has risen sharply even as
it has crumbled elsewhere (Chart 7, left) and where the
population is forecast to grow sharply in the years ahead
(Chart 7, right).
Where to Now?
So over the coming months and into early 2016, a strong
US$ and rising interest rates could put further downside
pressure on gold prices. How low could it go? Trying to
judge a fair value for something with no intrinsic use is
obviously extremely difficult. A “real” gold price, using
US CPI as a deflator, remains above its long-run average
(Chart 6, left). And a return to that average level would
see the spot price of gold fall to $850, another $250 drop
from current levels (Chart 6, right).
Doomsayers may even argue that the price could
overshoot that level and fall even further. But looking at
how gold is faring as a store of value in the US ignores
A strong US$ and turn in global monetary policy, led by
the Fed, mean that gold has plenty of challenges still to
face in the coming 6-12 months, particularly if inflation
doesn’t accelerate sharply. We were expecting prices
to fall, but they could now dip lower than we were
previously anticipating. We have cut our year-end forecast
for 2015 and 2016 to $1000 and $950 respectively.
Strong demand from areas like India, and expectations
that the US$ will give back some of its gains, should
position gold for a modest recovery come 2017.
Chart 6
Chart 7
Indian Gold Demand Rising (L),
And Population Will Overtake China (R)
800
200
600
100
Feb-15
May-07
Aug-99
Nov-91
Feb-84
May-76
0
400
1.2
5
Latest Price
If "Real"
Price Back
to Avg
1.0
0
0.8
-5
0.6
-10
Forecast
China
India
0.4
India
World
Total
China
2050
300
1.4
10
L/R Avg
1.6
2040
1000
400
Population
(billions)
2030
15
500
1.8
2020
$
% Change in
Consumer Demand
(Q1'15 vs Q1'14)
2010
20
1200
2000
Real Gold Price
(Deflated Using US CPI)
1990
600
1980
“Real” Gold Price Still Above Average (L),
Suggesting Downside Pressure (R)
Source: World Gold Council, UN, CIBC
Source: Bloomberg, CIBC
5
CIBC World Markets Inc.
Economic Insights—August 11, 2015
China’s Irrational Exuberance
Royce Mendes
than 70% since the start of 2014 (Chart 1, left). A nice
gain for any investor.
Alan Greenspan was famously wrong when he judged the
US equity market as “irrationally exuberant”, but the term
fit China’s 2015 first half rally to a tee. Just as China’s
economy was steeply decelerating, the stock market was
doing anything but following suit. Towards mid-year, the
Shanghai Composite Index was almost 150% higher than
it was at the beginning of 2014.
To further put the situation in perspective, the stock
market needs to be viewed in the context of the rest of
the economy. With state-owned companies still playing
a major role, the market capitalization (as a percentage
of GDP) of China’s listed companies is much smaller than
in the US or even here in Canada, suggesting that any
spillover effects will be smaller as well (Chart 1, right). In
addition, firms in China are simply not as reliant on public
equity financing as they are in other parts of the world
and, therefore, overall industry should be less affected by
the recent correction.
The market was being pumped up by investors’ bets on
continued momentum rather than any great optimism
about fundamentals. But, as speculative bubbles often
do, stocks had their Minsky moment and came crashing
back down to earth in July.
In the aftermath of the correction, questions regarding
its effects on the nation’s huge underlying economy
have come to the fore. While the market’s movements
have grabbed headlines, other underlying weaknesses
in China’s economy are likely more important for
policymakers.
Finally, Chinese citizens also hold a much smaller portion
of their financial assets in stocks than do Americans.
Households in China hold only about 15% of their
assets in stocks, while those in the US hold more than
30%. That means that the effects on consumption or
confidence will likely be less than what a similar fall in
stock prices would induce in other regions.
Canada certainly has a vested interest in all of this, given
China’s importance for our exporters. China is not only
our nation’s third largest trading partner, but its economy
is important for the prices of many Canadian commodity
exports.
Stock Prices Not Signaling the End of the World
Given the drama surrounding the Shanghai plunge,
some have been keen to relate daily movements in the
Chinese stock market to moves in other assets, especially
commodities. However, virtually no one made those links
as the stock market surged earlier this year. A chart of the
correlation of copper prices (which have been falling since
before the equity dive and have been trending lower for
years now) and the Chinese stock market shows that the
perceived relationship only began after the equity selloff
began (Chart 2).
Correction To Have Less Effect Than Expected
First and foremost, it should be noted that despite the
significant fall in equity prices, the Shanghai Composite
is still up 13% since the beginning of this year and more
Chart 1
Investors Have Still Made Significant Gains (L),
Market is Relatively Smaller in China (R)
Shanghai
Composite Index
(%)
160
140
120
160
140
Equity Market as a %
of GDP
Moreover, Chinese stock prices have a history of moving
out of sync with underlying fundamentals. Since 2003,
the Shanghai Composite’s price-to-earnings ratios have
swung from 15 to 40 and then back on a few occasions,
whereas a chart of US ratios on the same scale looks
almost like a sideways line (Chart 3, left). Chinese
financial markets are less sophisticated and not fully
open to large international asset managers, which makes
them less efficient at pricing securities. With this in mind,
although the magnitude of recent losses on the stock
market are nothing to scoff at, it’s important to remember
that volatility like this is more normal in China than in
developed markets.
120
100
80
100
60
80
40
60
20
Source: Bloomberg, CIBC
Jul-15
Apr-15
Jan-15
Oct-14
20
Jul-14
-20
Apr-14
40
Jan-14
0
0
China
Canada
US
6
CIBC World Markets Inc.
Economic Insights—August 11, 2015
old habits have lingered from the times of a completely
managed economy, as our analysis suggests that the
direct impacts of equity weakness will not be material.
True, the stock correction could still show up in weaker
confidence, but the bark from the equity market decline
has likely been much bigger than it’s bite.
Chart 2
Copper Prices and Chinese Equities Were Not
Correlated When Stocks Were Increasing
5500
5000
Stock
Market
Peak
30-day Correlation of the
Shanghai Composite and
Copper Prices
1.0
0.5
The focus of both policymakers and markets now needs
to return to the underlying economy. After blocking out
some of the noise created by volatile equity markets, it’s
clear that China’s decelerating growth has played a part
in the ongoing weakness in commodity prices. Moreover,
the dips in trade volumes and manufacturing PMIs earlier
this year still point to GDP growing only about 6.5% in
2015, somewhat below the target set by the government.
4500
0.0
4000
-0.5
3500
3000
Jan-2015
Apr-2015
Shanghai Composite
-1.0
Jul-2015
30-day Correlation
Instead of making their financial markets less efficient by
intervening in the market, policymakers should continue
using their more conventional monetary and fiscal tools
to support demand. Chinese authorities have already
taken steps this year to ease policy, the effects of which
may yet show up in stronger growth. But they still have
room to maneuver, with both high real interest rates and
required reserves leaving scope for additional monetary
easing, and relatively low government debt providing fuel
for fiscal stimulus (Chart 4).
Source: Bloomberg, CIBC
In addition to the poor relationship with backward
looking earnings, the stock market has not been a
good leading indicator of underlying economic growth
(Chart 3, right). During the late 1990’s and early 2000’s
the market’s performance seemed almost inversely
correlated with the economy’s growth. Around the time
of the financial crisis, the relationship between these two
variables seemed to grow stronger. However, the recent
run-up and crash appears to prove that that correlation
was tenuous at best and points to the weak predictive
power of Chinese equities.
Chinese policymakers exacerbated the attention being
paid to the crash by intervening in the market. Perhaps
As policymakers switch their attention away from tilting
against the windmill of the stock market correction
and turn their attention back to supporting underlying
demand, growth should accelerate to about 6.8% again
in 2016. If that also includes an improvement in resourcehungry goods producers, the rebound will be much more
relevant to Canada than the direction of the Chinese
equity market.
Chart 3
Chart 4
Looking Past the Market’s Volatility
Despite Easing in 2015, There is Still Room for More
Monetary and Fiscal Expansion
Chinese Stocks More Likely to Have Large Swings in
PEs (L), Stocks Have Been a Poor Growth Indicator (R)
Price-to-Earnings Ratio
10
60
8
50
6
40
%
Shanghai
S&P 500
Source: Bloomberg, CIBC
5.5
19.0
5.0
2
0
2014
2008
120
Gross Debt to GDP (%)
80
4
1996
0
20.0
19.5
6
0
10
Monetary Policy Tools
100
8
2
20
6.0
10
4
30
14
12
2002
70
4.5
Jan-15
GDP Growth (RHS)
Shanghai Comp. (Log
Scale)
7
May-15
Policy Rate
RRR (RHS)
60
18.5
40
18.0
20
0
China
Canada
US
Source: Bloomberg, IMF, CIBC
CIBC World Markets Inc.
Economic Insights—August 11, 2015
The Cheaper Loonie’s Lift to Exports:
Waiting Longer for Less
Avery Shenfeld and Nick Exarhos
The Bank of Canada was “puzzled” and so were we.
After a huge drop in the Canadian dollar, and a dive
in exports on weather and other disruptions in the first
quarter, the betting was that non-energy export volumes
would step up in Q2. Instead, despite a huge June, Q2
real export growth was minimal.
at expensive levels in mid-2014. The loonie’s slide that
might help us on trade largely commenced in Q4 2014
and the lion’s share of the benefits are therefore still to
be revealed.
Moreover, while US GDP started to improve in Q2, global
growth was depressed. Even within the US, the factory
sector, to which Canada forms part of the supply chain,
was weakening through May. Exports from Canada’s
more currency-sensitive industries were improving, but
other exports have retreated against the backdrop of an
overall slowing in global trade volumes, and stalling US
manufacturing output (Chart 2). We’re optimistic that
US production and import volumes will return to growth
ahead as the global economy improves in 2016.
Some of that reflected the usual lags and other factors
depressing global trade. But a constellation of structural
changes suggests that even when these have passed, the
trade response to currency depreciation will lack its former
vigour. The result is that, with a need for exports and
related capital spending to supplant housing and debtfinanced consumption as a driver of growth, a weaker
loonie will be here today, and not gone tomorrow, even
if energy prices rebound.
More Lasting Disappointments
Patience, Please
Even so, there are reasons to believe that the roughly
12% boost to export volumes that a 20% depreciation
would normally engender won’t materialize in full this
time around. The sensitivities in the model are driven off
historical linkages to US growth and exchange rates, but
there are headwinds now that were not present in that
historical data.
In part, we were disappointed in Q2 because we were
impatient. Our VAR model linking Canadian exports, the
real exchange rate and US GDP suggests that the peak
impact of a 10% depreciation of the loonie on export
volumes isn’t fully felt until six quarters hence (Chart
1). While the Canadian dollar did start a meaningful
depreciation in 2013, by historical standards, it was still
Chart 1
Chart 2
CIBC Model: Cheaper C$ Lifts Exports
with 2 to 6-quarter Lag
C$ Non-sensitive Exports Slowed by Soft US Production (L), Currency-sensitive Exports Fare Better (R)
3
4
5
6
7
8
C$ Non-Sens. Exp. (Left)
US Mfg Ind. Prod. (Right)
9 10 11 12 13
Source: CIBC VAR model
Jan-15
2
Jun-15
1
Aug-14
0
Oct-13
quarters after shock
Jan-14
0.0
Jul-13
Jul-12
1.0
Jan-13
16
2.0
Mar-14
17
3.0
May-13
4.0
Jul-12
18
5.0
16.5
16.0
15.5
15.0
14.5
14.0
13.5
13.0
12.5
12.0
C$ Sensitive Exports
(C$ bn, 3mo avg)
Dec-12
6.0
Jan-15
7.0
2012=100,
3mo avg
108
107
106
105
104
103
102
101
100
99
98
Jul-14
C$ bn,
3mo avg
19
Impact of 10% Depreciation in Real C$
Exchange Rate
on Export Volumes (%-pts)
Source: Statistics Canada, CPB, CIBC
8
CIBC World Markets Inc.
Economic Insights—August 11, 2015
Chart 3
Cda Auto Production Slipping (L) With Loonie Not
Sliding That Much More Than Peso (R)
Chg in Share of N. American
Auto Assemblies
(2010 to 2015 YTD, %)
4
US Production Farther Away From Canada
Change vs USD
Since October 2013 (%)
0
Share of US Manufacturing
48%
45%
-5
2
43%
-10
40%
-15
-25
USA
Mex
Cda
2014
2012
Source: BEA, CIBC
since 2010. Clearly, years of an overvalued exchange rate
have left lasting damage in terms of our ability to reverse
course as quickly as in some past downturns, where the
plants were still standing. In terms of replacing the lost
capacity, thus far, trends in non-energy capital spending
remain very lacklustre (Chart 4).
For one, the strong Canadian dollar stripped out a lot
of capacity from the manufacturing base. As case in
point, Canada lost 5% off its share of North America
auto assemblies since 2010 (Chart 3, left), a sector
that, including parts, is our second largest export after
oil. Mexico was part of that story. Even if we choose to
measure the change since October 2013, just when the
loonie started its major slide, the peso has essentially
kept pace, so there’s been no easing of the competitive
challenge from America’s other bordering country (Chart
3, right).
More broadly, our ability to be good neighbours to US
plants, operating as next-door, just-in-time suppliers,
has been significantly dented by a change in the locus of
American manufacturing. Since 2002, the gravitational
centre of US manufacturing has shifted to the lessunionized, lower-wage south, or states in the southcentral or south-west that can be more readily supplied
from Mexico. That’s come at the expense of the northeast, mid-west, and western states bordering on Canada
(Chart 5).
While a loss of market share to a developing Mexican
manufacturing hub might have been inevitable, the US
itself was picking up plants at the expense of Canada
Chart 4
Ex-energy Capex Still Dropping
How Weak is Weak Enough?
Private Non-Oil&Gas Real Cap-Ex (YoY, %)
Of course, all that took place with dollar-Canada trading
near parity. For FX markets, as well as the Bank of
Canada, the issue is whether the subsequent depreciation
will, with enough of a lag, right the ship for non-energy
exports.
8
6
4
2
0
The last time Canada ran a sustained surplus in nonenergy trade was in the 1999-2004 period. Dollar-Canada
was, back then, trading in the 1.40-1.55 range, with the
loonie more than 10% weaker than it is today (Chart 6).
The current account also moved sharply into the black
-2
-4
-6
2010
South, South Central, South West
Northeast, Midwest, and Western Border States
MXN
Source: Automotive News, Bloomberg, CIBC
10
2008
2006
1998
CAD
2004
38%
-20
-4
2002
-2
2000
0
-6
Chart 5
2010
2011
2012
2013
2014
2015E
Source: Statistics Canada, CIBC
9
CIBC World Markets Inc.
Economic Insights—August 11, 2015
True, Mexican compensation costs are not anywhere
near our levels. But we’re not looking to bring back the
most labour-intensive subset of manufacturing that has
migrated to the Mexicos, Chinas or Vietnams of the
world. There’s much more low-hanging fruit if Canada
can, over an extended period of time, win back some of
the share it ceded to the US during the period of excess
C$ strength.
Chart 6
Non-energy Surpluses Achieved with Weak Loonie
4.0
1.80
3mo avg,
C$ bn
2.0
1.60
1.40
0.0
1.20
-2.0
1.00
-4.0
0.80
Jan-13
Some point to much lower productivity in Canada and
argue that we need to pay a lot less than the US to
make up the difference. That might auger for a 1.50
dollar-Canada level. But aggregate productivity numbers
are difficult to compare. Most studies only cite rates of
growth, since it’s a tricky exercise to measure absolute real
value added per hour across countries.
Sep-14
May-11
Jan-08
Non-Energy Trade Balance (Left)
Sep-09
May-06
Jan-03
Sep-04
May-01
Jan-98
Sep-99
May-96
Jan-93
Sep-94
0.40
May-91
-8.0
Jan-88
0.60
Sep-89
-6.0
USDCAD (Right)
Source: Statistics Canada, Bloomberg, CIBC
More importantly, research at Statistics Canada1 found
that most of Canada’s output per hour disadvantage was
tied to a larger portion of its output coming from smaller,
less productive establishments, and a greater productivity
penalty at small scales in Canada. Many of these smaller
establishments would not be involved in trade. Where
Canada is truly competing with the US for the next
North American-mandated auto assembly, machinery or
metal fabricating plant, the facility itself would be largely
identical if sited on one side of the border or the other,
with similar output per hour.
in that period. But our basket of commodities is still
trading at loftier prices now than it was back then, and
oil volumes are much larger. That’s one chip on the side
of being able to sustain a loonie at somewhat stronger
levels than what we saw in that timeframe.
At least against the US, the evidence suggests that dollarCanada in the 1.30s might be cheap enough to do the
job. Canada’s factories prospered until they lost their
competitive advantage after the currency appreciated
post-recession. But the recent loonie dive has restored
that necessary edge (Chart 7). There are, of course, other
differences, but lower corporate tax rates and natural
gas prices could compensate for higher electricity costs
in some Canadian jurisdictions.
While the proof will be in the pudding, our analysis
suggests that dollar-Canada in the 1.30s should be cheap
enough, over time, to get the job done and allow trade
performance to offer a reasonable contribution to growth,
with, as we’ve noted, a considerable lag. Given those lags,
and the longer-term need to attract new export-centred
investments, the Canadian dollar needs to not only reach
the 1.30-1.35 level, but average in that range for years,
not months.
Chart 7
Cdn Manufacturing Labour Pay Now Lower
24
Hourly Compensation in Mfg
(US$/hr)
Visible and Invisible Hands
40
Some argue that if oil drifts higher, the Canadian dollar
will inevitably ride it to stronger levels. But a combination
of the visible hand of the central bank, and the market’s
invisible hand, could easily offset a return to crude prices
above $70 per barrel.
35
22
20
30
18
25
with USDCAD
@ 1.30
20
16
14
12
The invisible market hand comes from an oft-neglected
force—the current account. Note that Canada was still
running a large, 3% of GDP current account deficit in
2010-2013, despite oil running as high as $100+/bbl
15
USA
'13
'11
'08
'06
'04
'01
'99
'97
10
Cda (in US$)
'97
'99
'01
'03
'05
'07
'09
'11
'13
'15E
26
Average Hourly
Earnings Mfg (US$/hr)
USA
Cda (in US$)
Source: BLS, Statistics Canada, CIBC
10
CIBC World Markets Inc.
Economic Insights—August 11, 2015
and other cyclical commodities riding high (Chart 8).
That would have weighed on the C$ on its own, if not
countered by capital inflows seeking Canada’s higherthan-US short yields and AAA-rated debt. The visible
hand needed to stem such flows is the Bank of Canada’s,
which can stand pat until US short rates rise above those
in Canada.
Chart 8
Despite Sky-high Commodity Prices, Current Account
was in the Red Post-crisis
4.5
900
3.0
800
700
1.5
600
0.0
500
-1.5
400
300
-3.0
200
-4.5
-6.0
1981
Ultimately, we’ll only pin down where the C$ needs to
be longer term as we track the economic response to
the weakness we’ve already seen. The available data
suggests that a modest further depreciation might be
sufficient, but FX markets often overshoot, leaving the
C$ vulnerable during a period in which our exports will
still underwhelm for a while yet.
100
1989
1997
2005
2013
0
Current Account (% of GDP, L)
BoC Commodity Price Index (Jan-72=100, R)
Baldwin, J., D. Leung and L. Rispoli. "Canada-United States Labour
Productivity Gap Across Firm Size Classes." Statistics Canada, 2014
1
Source: Statistics Canada, Bank of Canada, CIBC
11
CIBC World Markets Inc.
Economic Insights—August 11, 2015
ECONOMIC UPDATE
2014A 2015F 2016F
15Q1A
15Q2F
15Q3F
15Q4F
16Q1F
Real GDP Growth (AR)
-0.6
-0.8
2.3
2.1
2.6
2.4
1.1
2.2
Real Final Domestic Demand (AR)
-1.6
0.8
1.4
1.1
1.5
1.6
0.8
1.4
Household Consumption (AR)
0.4
2.9
2.6
1.6
1.6
2.7
2.1
1.7
All Items CPI Inflation (Y/Y)
1.1
0.9
1.2
1.8
2.8
1.9
1.2
2.3
Core CPI Ex Indirect Taxes (Y/Y)
2.2
2.2
2.2
2.2
2.2
1.8
2.2
2.1
Unemployment Rate (%)
6.7
6.8
6.9
6.9
6.8
6.9
6.8
6.7
CANADA
U.S.
15Q1A
15Q2A
15Q3F
15Q4F
16Q1F
Real GDP Growth (AR)
0.6
2.3
3.3
2.5
1.5
2014A 2015F 2016F
2.4
2.4
2.3
Real Final Sales (AR)
-0.2
2.4
3.8
3.0
2.2
2.4
2.2
2.6
All Items CPI Inflation (Y/Y)
-0.1
0.0
0.2
1.3
2.4
1.6
0.3
2.3
Core CPI Inflation (Y/Y)
1.7
1.8
1.9
2.0
2.1
1.7
1.8
2.1
Unemployment Rate (%)
5.6
5.4
5.3
5.2
5.1
6.2
5.4
5.0
CANADA
Another miss on monthly GDP for May has Q2 tracking -0.8%. And as a result of a generally slower first half,
real output is only likely to grow by 1.1% this year. Furthermore, because it appears that the cheaper loonie’s
lift to real exports will take longer to materialize, real growth in 2016 is now likely to come in under what we
had previously expected at 2.2%. A softer profile for growth next year has us making slightly less progress on
the unemployment rate. Our core CPI outlook is a bit firmer given our recent downgrade for the average level
of the C$ next year, but headline inflation will be contained in the near-term by the recent oil retreat.
UNITED STATES
The US economy picked up some steam in the second quarter, and Q1 GDP was revised up, but growth during
the first half of the year was still on average only near 1½%. A pick up in housing activity is already seeing
stronger growth in residential investment, but should also feed through to higher consumer spending in the
upcoming quarters. The outlook for headline CPI has softened again following the renewed downdraft in oil
prices seen recently.
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