The urgency to find common ground

Recent headlines on Canada’s economy have been rather mixed. One of the brighter spots continues to be employment, where job growth has been strong and wage growth is running above inflation. General strength on this front should put a floor under consumption growth, mitigating pressure from elevated household debt and modestly higher interest rates.

However, the rebalancing from consumption to investment and exports that policy makers at the Bank of Canada have been looking for has yet to emerge. Overall, the Canadian economy has slowed considerably since mid-2018. While slower growth in the housing sector was to be expected following changing mortgage rules, business fixed investment also decelerated sharply and exports have failed to pick up consistently.

Economic growth could be slower this year

With that, the BoC revised expected economic growth down from 1.7 to 1.2% for 2019, and it estimates that the Canadian economy now operates modestly below potential. Market expectations for short-term interest rates have trended somewhat lower since last fall, and shorter-term Canada Treasury rates now sit modestly below the BoC’s overnight policy rate. For now, the bank remains on the fence regarding future rate hikes while it watches incoming data, expecting a pick-up in activity in the second half of this year.

Some of the recent headwinds are coming from a broader global economic slowdown, following a period of rising interest rates and ongoing uncertainty around trade policies, among other regional factors. More recently, global financial conditions have eased, and oil prices have recovered from their fall toward the end of 2018. This is helpful, but some domestic issues remain.

Of note is the regional imbalance observed across a number of areas, where oil-intensive regions generally face higher spare capacity, slower wage growth and muted investment intentions. Clearly, monetary policy can do little to address imbalances across regions and sectors, so unless we see a broader slowdown in economic activity across Canada, it seems unlikely that we’ll get monetary policy support in this regard.

Canada: leading oil supplier to the U.S.

The good news is that demand for Canadian oil in the U.S. continues to be supported as American refineries often mix their growing production of “light” shale oil with “heavier” oil produced in Canada, to enhance operational efficiency. This, along with declining supply from fellow heavy-oil- exporting countries, Mexico and Venezuela, have resulted in Canada accounting for 50% of all U.S. crude imports in 2018.

However, oil sands pipeline infrastructure has been at capacity for a while, causing mandatory production cuts and the need to turn to rail. Capacity constraints will persist until two delayed pipeline projects (Keystone XL and Enbridge Line 3) are completed. Once, or perhaps, if finished, an estimated additional 20% of current exports could be added.

For now, considerable uncertainty around the future legal and regulatory framework for the energy sector remain, evidenced for example by the heated debate over a proposed new environmental impact assessment system (Bill C69) which is currently awaiting Senate approval. It forms part of broader, federal policy focus on sustainability to help meet Canada’s commitment to reduce greenhouse gas emissions under the Paris Agreement.   

Squaring the circle between sustainably and development will take a concerted effort and appears to shape up as an important issue for the October federal election. For now, ongoing developments in the energy sector, both conventional and renewable, bear 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., 2019. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.