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Posted on: February 03, 2017

FAM to FAM (IO) and GRACE

The Bank of Canada has always sought to accurately estimate and predict Canada’s non-commodity exports (NCX). It has historically used the Foreign Activity measure (FAM) This has historically factored in;

  • US GDP (some elements)
  • Global GDP

In short, this used to work. More recently, foreign demand has changed in nature, as has the level of Canadian competitiveness and our export capacity. As such, the FAM has suggested higher NCX growth than reality for some time. So the BOC has created new methodologies;

  • FAM –IO (updated FAM)
  • GRACE (global real activity for Canadian exports)

FAM-IO has a lower weighting for private US investment, and higher for US government expenditures. Tellingly, the weight of the rest of the world is trebled. GRACE uses the large amount of data available in various international economic indicators.

The BOC is likely very concerned about Canadian competitiveness and both capacity potential and utilization. These issues are both harder to measure, and potentially way more chronic and damaging. They certainly suggest a weaker dollar will not be the panacea for our manufacturing at this time.

Canadian rates news

Another quiet week on the rates front. Gov. Poloz spent some time in Canada’s greatest province to address the business school at the University of Alberta. He stressed the need to recognize that Canada’s monetary policy is independent of the US and that it can diverge when our economic pictures diverge. Despite the fact that both countries GDP was 1.6% in 2016, no one could really argue that this has not been the case over the last 2-3 years and will likely be the case in 2017- he did after all, use the word “uncertainty” in his speech 12 times.

These are confusing and challenging times for Canada. A major concern and puzzle for the BOC is the fact that our currency’s weakness in recent time has not helped close the performance gap through exports in any material fashion.

The loonie's 30% drop in recent years against the US dollar has not significantly impacted inflation or export volumes. Our Central bank is a diligent and curious beast (as it should be) and has updated the ways that it tracks non-commodity exports to which it overlays the loonie for analysis.

The Governor suggested that time lags might be a factor at play here, but the truth is that there has to be concern that competitiveness and export capacity issues are dulling the predicted impact of our weaker dollar. What countries like Greece wouldn’t give to be able to let their currency float weaker as a prime way to trade their way out of harsh times. We have that capacity, but it appears we can’t make it work for us. Until we figure out if and when it will, expect the BOC to be comfortable letting monetary policy diverge with the US (and for that to weigh on our dollar (at the margin).

US rates news

Rates have actually had a stable week again, staying within the tight range that we have seen. It was hoped (for those who like voilatility) that todays Non-Farm Payroll (US Unemployment) report would give us a little more colour and determine the next move. It did not (as yet).

The headline numbers were bearish. More jobs were created than expected, and although the unemployment rate went up, it was only up .1% to 4.8%, so it is still at the Fed’s considered natural rate of unemployment-and this was on the back of an increased participation rate.

People are confident and optimistic. Those that had previously not bothered to look for work because they considered it a thankless task have lifted their mood (either that or they got their credit card bill for the Christmas period and realised they had overdone it on the Hatchimals)and have signed on to look for a new job in 2017.

But, balancing the bearishness was the Average Hourly Earnings number in this report. It was lower than expected, suggesting that a lack of joblessness is not giving rise to wage pressures. A goldilocks scenario – unless you want a pay rise.

So we await yet more news to get us moving. Currently there are 54bps of hikes priced in over the next year, and a 45% chance of some action by June. The latter feels about right to us, the former a little light. If the market rallies and rates move lower in the next week or so, we recommend leaning against such a development.

Currency news

The Canadian dollar had a good January. It strengthened against all its major trading partners. And as the US dollar was talked off its highs (deliberately and otherwise) by the Trump administration, the loonie gained further ground there too. So we sit around 1.30 – thinking about dipping a toe below.

Unless Trump’s NAFTA renegotiations spoil the party (no scheduled date for that firework display yet), it appears the Canadian dollar could be a warm and happy place in 2017 (For the record- I remain uncomfortable getting bullish here, but feel doomsday scenarios are increasingly misplaced).

I am sure this will be of some concern to the BOC, who would like our economy to wear the pants with the elasticated waistband that is a weaker canadian dollar at this time, but they believe in a floating exchange rate so expect no reaction. Our exporters will just have to cut out the carbs, hit the gym and get lean enough to squeeze in to those slim fit pants that appear all the rage this season.

​​

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