Canadian Economy Faces Excess Capacity

The Bank of Canada’s most recent decision left investors with more questions than answers as the Central Bank refrained from acting while still warning about the downside risks to the outlook. While conditions in Canada are not necessarily worsening, as rising oil prices combined with fiscal stimulus help root gains in the economy, numerous hazards remain intact heading into the unknowns of a Trump presidency and challenging global backdrop. However, despite the more pessimistic viewpoint touted by policymakers, there are some optimistic developments that should not be ignored.

Apart from the volatility in oil prices which could go in either direction, the most recent IMF World Economic Outlook suggests that Canada is poised to outperform growth in most advanced economies during 2017. Though the renegotiation of NAFTA could be a development that potentially complicates the situation for bilateral trade between the US and Canada, unlike Mexico, Canada is not necessarily viewed as a cheaper destination to move manufacturing operations. Thus, despite the obvious downside risks that could emanate from US policy, Canada may be able to overcome the excess capacity problem while gradually experiencing a wave of policy normalization.

Key Officials Underscore the Risks

While the Bank of Canada’s decision to leave interest rates on hold at 0.50% was largely expected by market participants, economists, and analysts alike, the subsequent remarks from Governor Stephen Poloz took a surprising turn. According to Poloz, the Central Bank is prepared to slash interest rates in the event that the incoming Trump administration builds trade barriers. With the renegotiation of the North American Free Trade Agreement (NAFTA) viewed as a priority by newly appointed Commerce Secretary Wilbur Ross, Canada may face new tariffs on exports to the US which invariably will slow GDP growth. Considering the risk of another downturn in oil prices combined with rising unemployment and weak inflation, a dent in trade relations could be distressing.

The move by Poloz to stress the ability of the Central Bank to accommodate rates further does signal that policymakers are willing to do what it takes to restore inflation to 2.00% while working to fight structural unemployment. Nevertheless, the remarks are evidence that significant spare capacity current exists in the economy. However, the most recent IMF World Economic Outlook paints a markedly different picture. Besides revising higher their growth estimates for 2016, the International Monetary Fund believes that Canada is destined to outperform growth in nearly all G7 nations aside from the US for 2017 and beyond. Although rosier than the Bank of Canada’s own projections, the real kicker is inflation. Unless spare capacity can be wound down, raising inflation back to the 2.00% target will likely prove difficult.

Canadian Dollar Responds to Dovish Characterization

The most visible reaction to the Bank of Canada policy statement and dovish speech from Governor Poloz was the kneejerk move lower in the Canadian dollar. The prospect of additional policy easing in the form of interest rate cuts was enough to dent sentiment, sending USDCAD higher on Wednesday before extending gains on Thursday. Although any momentum in crude oil prices higher may be able to reverse some of the most recent losses in the Canadian dollar, upside may be capped as key global producers outside of the OPEC and non-OPEC production cut deal raise output. With the correlation coefficient implying a looser relationship between the two assets at this point, other fundamental factors are likely to have a more pronounced impact.

Looking more closely at the price action of the last few sessions, the steep gains in USDCAD are running into resistance near the 50-day moving average on the upside. However, should this moving average be crossed to the upside, the next main resistance level to watch sits at 1.3568. This level also forms the basis for a potential horizontal range that has emerged over the last few months with the bottom of the range indicated by support at 1.0335. However, acting as support marginally higher is the 200-day moving average. Considering momentum indicators such as the Stochastic Oscillator are rebounding from oversold territory, there may be further upside in the price action over the coming sessions as USDCAD tests resistance.

What Binary Options Traders Should Watch For

Looking ahead, the next major announcements that could impact the Canadian outlook is Donald Trump’s forthcoming inaugural address. If he opts to outline specific policy points, especially those related to trade, the Canadian dollar might find itself under further pressure. Any announcement of NAFTA renegotiation or the implementation of trade tariffs could also spur a selloff in the currency, sending USDCAD even higher. However, with so many unknowns, it will be incumbent to nail down policy specifics before determining the potential impact on the Canadian economy. With the Bank of Canada stressing the downside risks, any more dovish comments from Central Bank officials may be the development that sends the Loonie plunging medium-term.