The Relatively Strong Canadian Dollar Does Not Allow Canada To Fully Capture The Increase In Commodity Prices

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Summary

Further growth of the Canadian Dollar can jeopardize export opportunities for Canada.

The record trade deficit of Canada indicates a high risk of CAD revaluation.

An increase in unemployment rate indicates insufficiency of the adopted fiscal measures.

On Tuesday, May 3, the U.S. dollar (USD) rebounded from the 11-month low against the Canadian dollar (NYSEARCA:CAD) in line with the fall in oil prices. However, in the past few months, the CAD had strengthened against the USD at a faster pace than desired by Canadian exporters. A significant role in this process is played by rising oil prices. The oil industry makes up one-fifth of Canada's economy.

In our opinion, oil prices may continue to rise up to the next OPEC meeting, which will take place on June 2, 2016. Over the last month, the main factors influencing the rise in oil prices has been the decline in U.S. oil production and oil reserves, as well as the oil sector workers' strike in Kuwait. Also, forest fires in Canada are making a significant impact on oil production, which has already decreased quite palpably. The reduction in oil production in Canada amounted to no less than 645K barrels per day, accounting for nearly 25% of the total production of 2.5 million barrels per day pumped in the Canadian oil sands. The Government of Alberta, where the disaster continues to rage, believes that it will take months to put out the horrendous forest fires.

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(Source: stockcharts.com)

The strengthening Canadian Dollar could go unnoticed by the country's exports. The volume of Canadian exports has been falling for the last two months. The cumulative decline in Canada's exports in February and March was the most serious two-month decline in the country's international trade history since 2009. As a result, in March, the trade deficit of Canada has soared to a record high of CAD 3.41 billion. Even the traditional excess of exports over imports in the Canada-U.S. trade line turned out to be minimal in March. The last time this was observed was in 1993 when the difference between the imports and the exports totaled $1.53 billion.

Further strengthening of the national currency may jeopardize the recovery of the country's export potential, which is considered to be the country's key factor of economic growth.

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(Source: tradingeconomics)

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(Source: tradingeconomics)

The grim picture of the Canadian exports is accompanied with an increase in unemployment due to the sharp decline in energy prices and subsequent large-scale reductions in capital expenditures in the energy sector. The rising trend in unemployment negatively affects Canadian economic growth and requires additional fiscal and monetary interventions.

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(Source: tradingeconomics)

During the last meeting on April 13, 2016, the Bank of Canada left interest rates unchanged at 0.50%. It is also noted that, if there was no fiscal stimulus in the form of infrastructure spending and new tax breaks for households with children over the last five years, the Central Bank would be ready to discuss the possibility of a rate cut. This indicates a possibility of monetary easing in case these fiscal methods do not prove to be effective in the end.

In my opinion, one of the main reasons why the Bank of Canada is anxious to lower the rates further is the level of household debt. After the eight years of near-record low interest rates, the ratio of debt-to-household income reached a record high of 167.6% in January 2016. Although low interest rates make debt servicing easy, the monetary authorities are concerned about the aftermath of such decision.

Conclusion

A significant drop in exports along with rising unemployment demonstrates a feasibility of a rate cut aimed at restoring balance in the Canadian economy. At the same time, the growth of the U.S. economy and the strong U.S. dollar would allow Canadian authorities to postpone the monetary easing because the U.S. is a major trading partner.

The fiscal methods adopted by the Canadian government are likely to be insufficient to achieve the economic growth objectives. The Bank of Canada may decide to choose foreign exchange intervention in order to weaken the national currency instead. Fiscal stimulus programs may be further expanded to drive growth in the country' s economy.

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