The Bank of Canada (BoC) kept its target for the overnight rate at 0.50% yesterday. The tone of the short 421-word statement was more dovish than expected by most market participants. The BoC delivered a late summer reality check, acknowledging the disappointing performance of the non-commodity exports lately:
“second-quarter GDP was pulled down by the Alberta wildfires in May and by a drop in exports that was larger and more broad-based than expected. Exports disappointed even after accounting for weaker business and residential investment in the United States, adjustments in the resource sector, and cutbacks in auto production”.
While the export recovery fizzled last spring and during most of the summer, BoC officials have not completely lost faith that the global recovery will propel the Canadian export sector; otherwise they would have likely opted for a 25bps rate cut today. There is still hope that things will get better for the Canadian economy, thanks to rebuilding efforts in Alberta following the wildfires, increasing federal government stimulus and a sign that exporters regained their mojo in July.
In summary, the BoC stays cautiously optimistic about the economic outlook and leans on the dovish side at the same time. “On balance, risks to the profile for inflation have tilted somewhat to the downside since July”, says the BoC. While we maintain our call that the overnight rate target will stay at 0.50% through 2017, it is easier than before to see than the next move is more likely to be a policy rate cut than a hike. In other words, if the bar was previously set high for cutting the policy rate, it is suddenly less elevated today.
And although it is not specifically mentioned in today’s statement, in our view, any economic, political or financial event that would altered the economic outlook on the downside would likely be sufficient to push the BoC to act and cut rates. In our opinion, the big unknown is still the outcome of the American presidential election and its implications regarding the status of existing trade agreements. The best scenario is one in which the odds of revisiting current free-trade agreements remain low, allowing the non-commodity exports sector to remain a positive driver for future Canadian real GDP growth.
Finally, today’s statement ends with an acknowledgment of the cooling in housing conditions in the Vancouver housing market. While we do not know what the ultimate end game is, last week’s data released by the Real Estate Board of Greater Vancouver indicates that the introduction of the 15% foreign tax on August 2nd is having the intended effect so far: The number of detached homes sold on the resale market plunged by 45% in the month of August 2016 compared to the same period a year ago, providing clear evidence that foreigners have stopped purchasing homes in the Vancouver area. Also, the number of condo transactions fell by 10% on a year-over-year basis, a sign that only a few domestic buyers are delaying their purchases until things settle down. The other good news is that home prices have not declined in August, preventing a broad-based loss of confidence among domestic buyers and existing homeowners from having to absorb a drop in the value of their assets. Yet, market participants will need to monitor the situation closely, as further weakening in housing activity could quash growth expectations in the coming months.
South of the Canada-United States border, our base-case scenario remains for a December rate hike. On the other hand, there are still chances that the Fed finally decides to hike rates at its September meeting. Last Friday’s non-farm payroll numbers remained decent with 151k jobs created, following two consecutive months of strong gains exceeding 270k jobs. The month-over-month job gain of 151k also remains above the 100k pace that the Fed considers sufficient to absorb new labour force participants. Moreover, total labour income continued to grow at a historically high 3.2, in real terms. Also, August is the most revised month and it is typically revised upward in subsequent months. For example, the Bureau of Labor Statistics has revised August payrolls higher in 20 of the last 25 years, by an average of +61k jobs. Based on market expectations, chances for a September rate hike are at 20%, down 16% from where they were trading at prior to the release of a negative reading in the Fed’s Labor Market Conditions Index and weaker-than-expected Employment, ISM Manufacturing and Non-Manufacturing reports in August. The bottom line is that a September rate hike still appears to be the table but December remains the more likely option, in our view.