Canadian Economic Forecast in Flux Due to Uncertainties Down South
When markets experience a breakout in either direction to test highs or lows, rarely do they just stop on a dime. This is commonly known as “overshooting” in the investment community. This is where long-term holders throw in the towel when all looks hopeless, leading to a short-term burst through major support or resistance. The Canada economy forecast for 2017 will dictate whether the Canadian dollar (CDN) edges closer to such a scenario.
While the CDN is far away from the danger zone now, this scenario is not impossibly far-fetched in a perfect storm of brewing conditions.
Of course, the narrative begins with President Donald Trump and his pro-American agenda. Trump has been working feverishly to live up to his campaign promises of bringing manufacturing back to America. Several multinational companies have answered the call: Carrier Corporation, Ford Motor Company (NYSE:F), General Motors Company (NYSE:GM), and International Business Machines Corp. (NYSE:IBM), to name a few. The market has rallied consistently since the election on optimism that Trump will dismantle government regulations, enact tax reform, and generally legislate pro-growth policies helpful for American business.
A great example is Trump’s recent executive order mandating that, for every new regulation added to the Federal Registry, two existing ones must be eliminated. This is designed to cut red tape and break down barriers to promote a better business environment. The order caps costs of new regulations for the remainder of the fiscal year and creates a budget process for new regulations in the next fiscal year, which begins in October. (Source: “Trump signs executive order to cut two regulations for every new one added,” MarketWatch, January 30, 2017.)
While Trump is fostering pro-growth policies, the Canadian government keeps layering on new taxes. On January 1, 2017, Canada’s most populous province, Ontario, enacted carbon fees totaling $0.43 per liter of gasoline. These fees extend to natural gas consumers, which include many manufacturers, to the tune of five percent to 10% extra. All this is to pay for Premier Kathleen Wynne’s $8.3-billion boogeyman, also known as climate change.
These fees aren’t just a provincial matter. Prime Minister Justin Trudeau has piled on, announcing a national “floor price” on carbon that would require all provinces and territories to have some form of carbon pricing by 2018. This proposal could lift carbon prices from $10.00 per tonne in 2018 to $50.00 per tonne by 2022. (Source: “5 Things to know about Canada’s carbon pricing plans,” Toronto Star, October 3, 2016.)
It’s my hope you’re getting the picture here: while Trump is already following through on slashing regulations and costs for business, Canada is engaging in just the opposite. This is a particularly damaging economic strategy when Canada’s biggest trade partner, America, is actively encouraging manufacturers to return under threat of import taxes. Doesn’t Trudeau realize Big Business might take Trump up on that offer?
NAFTA Renegotiations and U.S. Tax Reform Loom Large
Now that Trump has thrown down the gauntlet by demanding renegotiation of the North American Free Trade Agreement (NAFTA), the impact on Canada’s economy could be acute.
One area of concern is the auto sector. For some context on how important this sector is to the Canadian economy, consider these facts:
- The industry produced vehicles and parts worth $83.0 billion in 2014 (or $227.0 million per day)
- The auto industry directly employs 120,000 people in Canada
- Auto workers’ paychecks contributed $7.3 billion to the Canadian economy in 2014 (or $20.0 million per day)
- The auto industry accounted for $66.0 billion worth of exports in 2014, 13% of the nation’s total
(Source: “What the Auto Industry Means to Canada,” Unifor, August 6, 2015.)
The Canadian auto sector could come under fire under a rejigged NAFTA. Already, the sector had seen a 17-year decline in aggregate output, with no new plants built since the early 1990s. It has struggled under the weight of high labor and electricity costs, low government subsidies, low worker productivity, and now, carbon taxes. The Canadian economy can little afford another dagger, but one is likely coming when NAFTA is reformulated. This upcoming iteration of NAFTA will focus mainly on narrowing the bulging trade deficit with Mexico, but it certainly will not be good for Canadian automakers.
Foreshadowing the changes to come, President Trump threatened German automaker BMW with 35% tariffs on cars made in Mexico and imported into the United States. He’s also dissuaded Ford and General Motors from moving production down south as well. Either way, it’s almost certain some form of cap on auto exports or tariffs will appear in some form or another. This will negatively affect gross domestic product (GDP) in Canada, and possibly lead to an outright automaker exodus to the United States.
Another major threat to Canada’s economy is Trump’s intention to slash corporate taxes. Trump has repeatedly voiced his intent to slash corporate tax rates to 15%-20%, down from the current level of 35%. The Republican majorities in both the House and Senate are reportedly on board. Should this occur, this would knock the main advantage Canada has in attracting international companies to set up shop in Canada: lower corporate taxes.
Currently, the Canadian corporate tax rate is about 15%, with provincial business taxes in the 11% to 12% range. The American corporate tax rate is 35% federally, with state taxes averaging four percent. Thus, Canada’s corporate tax advantage is roughly about 12% over the U.S.—a huge mitigating factor when you consider that employee contributions, personal taxes, and energy costs are much higher in Canada.
Should the Trump administration undercut Canada on corporate tax rates, the cost of doing business in Canada versus the United States could become completely untenable for Big Business, which again would be incentivized to move down south. In Canada, this would spike the unemployment rate and put economic growth at risk, reducing tax receipts to government coffers.
Low Commodity Prices Here to Stay?
It’s no secret Canada is a resource-based economy. A major factor affecting the value of the Canadian dollar lies within the strength or weakness of world commodity prices. Since Canada exports more commodities than most nations—including the United States—it is more reliant on strong commodity prices to attract international capital inflows. Ultimately, this has downstream effects on foreign investment and positive trade balances, boosting the CAD.
Thus, whether the CAD can avoid a free fall is largely dependent on whether commodity prices hold up or continue to sink in USD terms.
Energy and gas prices hold great relevance in particular. Oil prices have recovered nicely since the beginning of 2016, rising from $29.00 per barrel to about $53.00 per barrel today. During that same period, the CAD/USD strengthened from $0.687 to $0.767 (reaching $0.80 in April 2006 during the oil price recovery). Coincidence? I think not.
A similar tale occurred in natural gas, although the lows were achieved a couple months later. Prices almost tripled off the March 2016 lows, providing added buoyancy to the flagging CAD, which was then trading at 13-year lows.
If low energy prices serve to dampen the strength of the Canadian dollar, the election of Donald Trump could be most unhelpful indeed.
Indeed, less than an hour after the inauguration of U.S. President Donald Trump, the new regime took to the White House web site to outline its energy policy, which focuses on boosting oil and gas production and reviving the coal industry. It also laid bare its plans to scrap the Climate Action Plan, which set limits on the amounts of carbon pollution certain industries can emit.
These actions will serve to dampen hydrocarbon prices, since coal directly competes with oil and gas in electricity generation. These actions will also lower regulations on energy companies operating in the U.S., allowing for more domestic oil and gas exploration and fracking field development. This ultimately will result in more downstream hydrocarbon production and lower or mediating prices overall.
The dynamic of lessening regulations, taxes, and promoting U.S. domestic economic agendas could throw a giant wet blanket on the Canadian economy if similar countermeasures aren’t appropriated.
Canada Economy Forecast for 2017
It’s hardly a foregone conclusion that the Canadian dollar will fall precipitously against the U.S. dollar. Most of the major Canadian banks believe the Canada economy growth rate can chug along at two percent in 2017; hardly robust, but comparable to the country’s U.S. counterparts. Likewise, many analysts are predicting a rather neutral CAD outlook, generally ranging from the low $0.70 range to about $0.80 USD.
But are analysts pricing in the “Trump factor” or just following their economic models configured for normalcy bias?
Admittedly, a confluence of negative factors must all come together for $0.57 CAD/USD to transpire: plummeting oil prices; a deteriorating economy; multiple U.S. interest rate hikes; mass corporate defections down south; and perhaps a popping of the Canadian housing bubble. But stranger things have happened.
Until Prime Minister Trudeau pivots towards pro-growth strategies aimed at boosting the economic potential of Canadian businesses, it’s hard to envision the CAD gaining against the USD in value. It’s more likely the CAD will continue to struggle, fighting the tide much like a salmon does swimming upstream to spawn in the spring.
Only the metaphoric bear waiting upstream to eat the fish in this case is Donald Trump.