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Worse before it gets better? Canada’s economy struggles in transition
Canadian investors could use a bit of good news in the midst of the market’s miserable start to the new year, but Canada’s troubling economic fortunes may not offer much to cheer about in the weeks ahead.
While the country’s economy still looks poised for slow but steady longer- term growth, it remains under fire from plummeting commodity prices and may get even worse in the near term before getting any better.
“The current markets appear to be more volatile than the fundamentals suggest,” says Aubrey Basdeo, manag- ing director and head of fixed income, BlackRock Canada.
“However, our economy is in transition and it may take three to five years to get through this process. We’re looking for a U- shaped recovery as the Canadian economy slowly works its way back up the curve.”
Tumbling oil and commodity prices continue to sift through the Canadian economy, with no major price recovery in sight. At last count, West Texas Intermediate crude was trading at less than US$ 30 a barrel, its lowest level since 2003.
Basdeo predicts a 20 per cent drop in energy capex in 2016 on the heels of last year’s 40 per cent decline. However, don’t expect manufacturing to fill the GDP void any time soon.
“Canadian manufacturing has the capacity to contribute significantly more to GDP than it does now,” he says.
“The manufacturing capacity that was lost due to a higher- priced Canadian dollar is gone for good. And if we are going to bring that capacity back online, we will have the added burden of competing with the likes of Mexico, China to serve the U.S. market. This goes a long way to explain why, even with a sharp decline in the Canadian dollar and firming U. S. demand, we’ve continued to see disappointing results from that sector.”
A projected U. S. growth rate of 2.5 per cent in 2016 may be the envy of much of the world, but it’s a weak post- recession recovery by historical standards.
“Canada and other countries hoping to see demand from the U. S. or China carry their economies along may be disappointed,” says Basdeo.
Structural factors in developed economies will l i kely keep growth well below their pre- crisis levels for years to come. These include aging populations and public and private sectors deleveraging out of high debt loads. New technologies are displacing labour, suppressing wages and ultimately suppressing domestic consumer spending, which drives two-thirds of the Canadian economy.
“These factors are all suppressing demand,” says Basdeo. “The sustained levels of economic growth the world grew used to pre-crisis might not return. Inflation and corporate profits may well settle into a band well below historical norms until spending by millennials replaces that of retiring baby boomers.”
He also notes that the proposed federal government infrastructure stimulus program will deliver only a “modest jolt” to the economy, but may be revised higher in light of sub-$30 oil prices. In recognition of this, the Bank of Canada, which left its key lending rate unchanged at 0.50 per cent on Wednesday, may be looking to assess the fiscal policy stimulus delivered by the federal budget in March before deciding if further monetary stimulus is appropriate.
“Waiting for fiscal support is the right approach at this moment,” says Basdeo. “It’s unclear whether another rate cut would give a lift to the economy or potentially cause it more harm.”
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