They weren’t quite crying, but they were definitely sad”

By Michael O’Neill

In 1985, British pop band, Tears for Fears, encouraged fans to “Shout, Shout, let it all out. These are the things I can do without.”  Gray-haired popsters, Powell and Poloz, harmonized the central bank version of that tune on July 10.  Bank of Canada (BoC) Governor Stephen Poloz and Fed Chair Jerome Powell were front and center.  Both provided updated economic outlooks which were eagerly awaited by financial markets

They didn’t quite shout, and they didn’t let it all out either, but they did outline a laundry list of things they could do without.  Trade tensions were at the top.

The BoC wrote “Evidence has been accumulating that ongoing trade tensions are having a material effect on the global economic outlook. President Trump’s trade policies got special attention.  “Trade conflicts between the United States and China, in particular, are curbing manufacturing activity and business investment and pushing down commodity prices.”

In Washington, Jerome Powell blamed “trade concerns for lowering business confidence.” He said “Apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture report heightened concerns over trade developments. Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy. These concerns may have contributed to the drop in business confidence in some recent surveys and may have started to show through to incoming data.” 

Mr Powell didn’t come right out and say that US interest rates were going lower, but he didn’t say anything to dissuade markets from their two rate cut view.  That led to further gains in US equities, soaring commodity prices, and falling US Treasury yields.  Not only is a 0.25% rate cut baked in for July 31 but the odds for a 0.50% cut have increased by 27% since yesterday.

The Fed may be dovish, but that is not the case for the BoC, although they aren’t hawkish either.  Mr Poloz deftly dodged answering a question as to whether the next rate move was up or down.

The BoC left its target for the overnight rated unchanged at 1.75% and modestly raised the 2019 GDP growth forecast to 1.3% from 1.2%.  The BoC said that “Canada’s economy is returning to growth around potential” then warned, “the second quarter growth appears to be stronger than predicted due to some temporary factors, including the reversal of weather-related slowdowns in the first quarter and a surge in oil production.”

Nevertheless, things are looking up for the domestic economy. “The Bank estimates that economic growth over the second and third quarters of 2019 will average close to growth of potential output.”   They expect the contribution to growth from exports is expected to be robust over the second and third quarters.  Higher oil exports are also expected. In addition, increased non-energy commodity exports thanks to the removal of tariffs on steel and aluminum.

Source:  BoC Monetary Policy Review-July 2019

China’s hostility to Canada got special mention.  The BoC’s quarterly Monetary Policy Report (MPR) pointed out that “restrictive trade actions by China against imports of canola and meat produced in Canada are estimated to reduce Canadian exports by about 0.2 percent.”

Trade uncertainty is a huge negative.  The MPR noted that while exports are expected to grow over the next couple of years, we forecast them to be around 1½ percent lower than they would have been without the trade uncertainty.  The BoC modeled the impact of an unfavourable trade outcome against a favourable outcome. The results weren’t pretty. The impact on growth, both globally and in Canada, is much larger in the unfavourable scenario than in the favourable one.

Source: BoC Monetary Policy Report July 2019

For now, the downside risks from a negative US/China trade result are outweighed by the prospects for robust domestic growth in the coming months.

USDCAD traded erratically inside a 1.3065-1.3142 range, during Mr Powell’s testimony and Mr Poloz’s press conference.  However, the combination of broad US dollar weakness and surging crude oil prices renewed the downside pressure. The bearish technical outlook completed the picture.  A decisive break below 1.3040 sets the stage for additional losses to 1.2860 while a break of 1.3240 is required to suggest renewed 1.3040-1.3440 range trading.

The US/China trade dispute is a significant factor in central bank decisions globally.  But really, what does a US/China trade pact accomplish?  Ask Mexico?  Mexico is threatened with tariffs when ever Trump gets his dander up over “illegal immigration.” Ask Iran? Iran signed the Iran Nuclear Treaty, alongside, the UK, Russia, France, China, Germany, and the European Union. Trump unilaterally revoked it.  

“Shout, shout, shout it all out.” The tears for fears of more trade turmoil will permeate global markets as long as “The Donald” occupies the White House.