By Michael O’Neill
An ebullient President Trump delivered his third State of the Union address to Congress on February 4. There was no shortage of bombast, hyperbole, schoolyard snubs, and Republican Party calisthenics. The sit, stand, applause, sit routine is the most exercise many GOP members get in a month.
The President claimed credit for an “unprecedented economic boom,” the “creation of 5.3 million new jobs,” and wages “rising at the fastest pace in decades.” He boasted that the US economy is “growing twice as fast” as it was when he took office and that his administration cut “more regulations in a shorter period than any other administration.” He bragged about unleashing a revolution in American energy, saying that America is now the number-one producer of oil and natural gas anywhere in the world.” The audience was shouting USA, USA, except for Democrats, most of whom had turned off their hearing aids. He closed by asking American’s to chose greatness. Geriatrics, Bernie Saunders and Joe Biden thought he was talking about them.
The State of the LOONion is a celebration of mediocrity. The Canadian dollar spent most of 2019 ricocheting in a USDCAD range of 1.3000-1.3500, and barely five weeks into the new year, it is trading just above the mid-point of that range.
Canada had a lot going for it in 2019. The economy added 320,00 jobs of which 283,000 were full-time. Inflation hovered around the Bank of Canada’s (BoC) 2.0% target and housing prices picked up. The US economy grew faster than expected, which was good news for the domestic outlook. Oil prices rallied in the last half of the year, and the outlook was positive.
It wasn’t all sunshine and lollypops. Canadian economic growth turned sluggish in the last quarter of 2019 and is expected to stay that way in the first quarter of 2020. The Bank of Canada blamed weakness in global activity, weak consumption, housing, as well as labour disputes, and adverse weather for the sluggish performance. They also noted that household spending softened late in 2019 and suggested that elevated trade uncertainty may have contributed to cautious behaviour by households.
That sentiment should have changed in 2020. Bank of Canada Governor Stephen Poloz told a Vancouver Board of Trade audience on January 9 that the ratification of the Canada-United States-Mexico Agreement removed one significant source of uncertainty for many Canadian companies. Less than two weeks later, he added that the Phase 1 US-China trade agreement was a positive development. Then things went corona shaped.
Former Prime Minister of Canada Pierre Elliot Trudeau once said about living in the shadow of US influence, “when the Elephant sneezes; everyone catches a cold.” Today he might say, when China sneezes, the world gets coronavirus.”
The Wuhan coronavirus took its first victim on January 9. Since then, 24,562 people have been inflicted, world-wide, and 492, people have died (as of February 5) The global financial market reaction has been mixed. The commodity currency bloc was sold and is still under pressure. US Treasury yields plunged but have clawed back a third of their losses. Meanwhile, global equity indices are well along the road to fully recovering losses from their January peaks.
Oil prices were crushed and haven’t recovered. The 22% oil price plunge from January 7 until February 5 flipped the West Texas Intermediate (WTI) technicals to bearish when prices dropped below the $55.00/barrel level and are targeting the December 2018 low of $42.30/barrel. Oil traders are concerned that the impact of the coronavirus on China’s crude oil demand and the increase in US crude inventories will continue to weigh on prices in the near term.
The coronavirus and the drop in crude prices exacerbated the BoC’s concerns for sluggish growth in the first quarter of 2020. That helps to explain the BoC’s shift from a neutral to dovish monetary policy outlook, on January 22. The Bank left interest rates unchanged but slapped the possibility of an interest rate cut on the table. They were concerned about unexpectantly soft consumer confidence and geopolitical risks.
BoC Senior Deputy Governor Paul Beaudry tried to justify the monetary policy flip-flop on January 30, by putting financial vulnerabilities into the equation. Those vulnerabilities, which include a) balance sheet, b) asset price and c) risk allocation vulnerabilities didn’t appear to be a consideration last October. That’s when the BoC opted against an “insurance cut” despite “uncertainty in the economy. At the time, they thought the risk of igniting an acceleration in house price expectations, and a build-up in debt was too high. Today, it seems that those fears disappear when the effects of “financial vulnerabilities” are entered into their models.
The Canadian dollar is on the defensive, but 2020 is very young. The currency is entering into seasonal uptrend territory as it tends to rally between February and June. The US is Canada’s largest trading partner, by far, and the signing of the USMC Agreement may reignite demand for Canadian exports. The trade deal is already paying benefits. The US Commerce Department is planning to lower softwood lumber duties by August. The trade deal may also give non-energy exports a boost, aided by the relatively soft Canadian dollar.
The State of the LOONion is also a state of inertia as the 2020 USDCAD range may be identical to the 2019 band.