Poloz: hawkish in the face of modest growth
Sadiq S. Adatia, Chief Investment Officer
The Bank of Canada hasn’t raised its key overnight interest rate since 2018. Since then, the economic drag triggered by the U.S./China tariff war has erased about $700-billion worth of trade from the global economy. In response, central banks worldwide, including the U.S. Federal Reserve, have cut interest rates multiple times to bolster their economies. But BoC Governor Stephen Poloz has stood apart by not lowering rates. Now as we enter 2020, Poloz is hoping that the Canadian economy will gather steam and is holding to his hawkish stance. And at its meeting on January 22, while acknowledging that the economy is slowing, the bank held its key rate at 1.75%.
In defending his decision to remain on the sidelines while others cut key interest rates, Poloz has been able to point to strong job growth, with 360,000 jobs created in the first 10 months 2019 –bringing the unemployment rate down to a record low at 5.6%.
Poloz will have to continue to balance his hawkish stance on interest rates against a number of risks to the economy, both at home and abroad. For one, Canadian household spending generates nearly 58% of the country’s GDP. However, Canadian consumers, weighed down by high personal debt loads, have little room to increase spending (Chart1). Indeed, for every dollar of disposable income Canadians have, they owe almost $1.72 – the highest ratio in the G7 (Chart2).
Consumer spending and retail sales have also been falling. Adding to individual borrowing costs by raising interest rates at this time could accelerate that trend. Conversely, lowering rates could add to the debt binge Canadians have been on, with consumers falling deeper into the red.
Chart 1: Consumption and retail sales are falling
Source: Statistics Canada. Data as of October 31, 2019
If Poloz stays on hold, the economy could also soften further. To that end, the economy (despite strong job numbers) has already been slowing. In fact, in 2019, nearly 90% of all the countries in the world experienced lower growth than in 2018. Canada was not immune, with output declining from 1.9% in 2018 to an expected 1.5% in 2019. The consensus view suggests that economic growth could improve slightly to 1.7% in 2020 and 2021. However, the bank, citing slower global growth,reduced its projection to 1.6%.
Higher interest rates would also back into the real estate market, which accounts for almost 13% of economic activity – near its highest level ever. The housing market had been softening, in part, weighed down by the introduction of mortgage stress tests, which kept many consumers out of the market. Given the risks to the economy we remain roughly neutral on Canadian equities. Still, we anticipate that higher real estate prices could raise confidence, allowing consumers to still spend (despite their high debt levels) as their wealth increases.
Chart 2: Savings fall while household debt rises
Source: Statistics Canada. Data as of September 30, 2019
If the economy does improve without lowering rates, Poloz’s strategy to stay the course at a time when monetary policy has been easing worldwide may pay off. Indeed, he has stated that he believes the global economy is stabilizing, with growth expected to edge higher. We now believe (barring a sharp economic slowdown) that the BoC will remain on hold until later in 2020.
In terms of the Canadian dollar, if the BoC stays on hold we expect it to be range bound between US$0.73 and US$0.78 in 2020.
As noted, economic growth has been slowing globally with the International Monetary Fund expecting it to come in at around 2.9% for 2019 and 3.3% in 2020. The decline is largely attributed to the U.S./China trade war.
However, with Brexit now progressing and Phase One of the U.S./China trade pact in place, it has improved the economic outlook. And while we believe clarity on both issues will lead to increased business and investor confidence, it remains to be seen whether it could boost the economy significantly.
As well, global trade issues are far from being resolved. In fact, the next round of negotiations between China and the U.S. may be far more difficult. For now, the majority of tariffs remain in place, and issues around market access remain. As well, negotiations could drag on beyond November’s presidential election and again increase economic uncertainty.
The question surrounding tariffs is not only limited to the U.S. and China. For instance, China is the largest export market for German built cars. And China recently threatened Germany with unspecified sanctions if it bans Huawei, China’s technology giant. Clearly, as we head deeper into 2020 there are risks. Whether Poloz can hold to his stand-pat strategy is something we’ll be watching closely.
This commentary contains information in summary form for your convenience, published by Sun Life Global Investments (Canada) Inc. Although this commentary has been prepared from sources believed to be reliable, Sun Life Global Investments (Canada) Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of Sun Life Global Investments (Canada) Inc. Please note, any future or forward looking statements contained in this commentary are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this commentary.
© Sun Life Global Investments (Canada) Inc., 2020. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.