Economic developments have disappointed market participants since the Bank of Canada delivered its somewhat hawkish decision a month ago. On the global scene, Germany’s third quarter real GDP edged down 0.2% q/q due in part to lower motor vehicle production. Japan’s real GDP also fell in the third quarter (-1.2% q/q annualized) due to the negative impact of natural disasters on exports and consumer spending. Moreover, both Chinese non-manufacturing and manufacturing most recent PMI readings weakened. Finally, in the latest Federal Reserve Loan Officer Opinion Survey conducted in early October, U.S. banks reported weaker credit demand for commercial, industrial, real estate and mortgage loans, usually considered a reliable leading indicator of the business cycle.
Global economic growth may remain solid but new signs that it is peaking in major economies are making the international context less favourable to the Canadian outlook. Particularly, WTI crude oil prices have weakened significantly over concerns of slower-than-expected global demand. The short-term pain is unambiguously greater for Canadian oil producers selling at a large discount to WTI, due in part to temporary refinery maintenance and legal setbacks in the Trans Mountain and Keystone XL projects. While the refineries are now back on line, pipeline issues won’t be solved until 2020 at the earliest. WCS and WTI are, respectively, trading at about US$20/bbl and US$15/bbl below the assumption used in the October Monetary Policy Report (MPR). We argued in a recent note that improving refinery capacity and crude-by-rail transportation are likely to reduce the large WCS discount. This process has begun as the discount improved from a record US$50 on Oct. 11 to US$39 this morning. Nonetheless, WCS is still trading below US$20/bbl.
Thus, there is no chance to take for BoC officials at the Dec. 5 monetary policy meeting. Canadian real GDP growth could be 0.2%-0.4% lower than the MPR 2019 forecast of 2.0% if WCS prices are to remain at depressed levels for a prolonged period of time and lead to eventual second-round effects on business investment and employment. For reference, the plunge in crude oil prices in 2015 shaved 1.0 full percentage point from Canadian real GDP versus what it would otherwise have been, according to the BoC. The situation is not as dire this time around as much of the Western Canadian oil usually trades near WTI prices, which still remain significantly higher than in 2015. However, because of the pipeline shortage, most Canadian benchmarks are also now being sold at a discount to the Cushing benchmark.
Given these recent developments, markets will pay full attention to Carolyn Wilkins’ speech Tuesday. Referring to the pace of future hikes during the MPR press conference one month ago, she said: “It’s possible the pace could be a bit faster but it’s also possible it could be a bit slower.” There is a chance, in our view, that she puts more emphasis on the latter part of the sentence this time.
Furthermore, we do not expect high-frequency indicators to be released on Friday to be particularly upbeat. We estimate total CPI at 0.0% m/m for the month of October (consensus: +0.1% m/m) and nominal retail sales for the month of September at 0.0% m/m as well (consensus: 0.0% m/m).
Even though Finance Minister Bill Morneau somehow plans to improve Canada’s corporate competitiveness in the fiscal update to be released on Wednesday (by allowing for accelerated depreciation on capital investment), orchestrating a major turnaround in the economic outlook and market sentiment is likely to be out of reach. Unfortunately, a reduction in trade tensions between the U.S. and China seems an unlikely scenario at the G20 meeting to be held in Argentina at the end of November, especially given how the APEC summit ended this weekend. Lastly, Democrats’ takeover of Congress in Washington may lead to a legislative gridlock in 2019 and delays in the ratification of the USMCA as the stimulus provided by deregulation and last year’s tax cuts will begin to fade.