- Financial vulnerabilities in focus
- 2019 ‘fender benders’ not recession
- Less than three months to Brexit and uncertainty reigns
By Halo Financial Team
The highs and the lows in GBPCAD in typical interbank rates from Oct- Dec 2018 came less than 10 days apart. The low of 1.664 came on 3rd October after the US-Mexico-Canada Agreement (USCMA) deal was signed, while the high of 1.724 came on 12th October with low oil prices and hints that a Brexit deal was close, although toward the end of the year, at time of writing, the Pound is nearing that level again.
Financial vulnerabilities in focus
At the end of the year, it is traditional for the Governor of the Bank of Canada to speak about the financial system and for the bank to publish an Economic Progress Report. Bank of Canada Governor, Stephen Poloz, has combined the two and highlighted what has been done to ease financial vulnerabilities in the 10 years since the Global Financial Crisis. In fact, it has taken that long for the Canadian economy to recover – which is longer than expected. A decade of massive monetary stimulus has brought Canada to a critical phase in the economic cycle, Mr Poloz says.
In the last 10 years, extraordinary low interest rates have encouraged borrowing and spending, but they have also raised household debt, which is mostly due to large mortgages. That and imbalances in the housing market, centred on Vancouver and Toronto, has made the financial system more vulnerable to economic shocks. After the bank raised interest rates five times and introduced tougher mortgage rules, borrowing is slowing and the quality of new borrowing is improving. However, dangers remain. “New mortgage borrowing is more sound, and house price growth has decelerated. Nevertheless, the stock of household debt will stay high for years, and house prices remain elevated in certain markets.”
Looking at other financial vulnerabilities, concerns of a global economic slowdown have grown. “The trade tensions between the United States and China are the main risk. It is a two-sided risk: tensions could get worse and affect Canada, or they could improve, which would be good for global growth and our economy.” In addition, recent data on the Canadian economy have been disappointing. The bank has seen
- weaker business investment, but expects it to pick up;
- a slower, but more stable, housing sector; and
- a large drop in the price of oil.
This fall in oil prices will have a major impact on the Canadian economy. Global oil prices have declined due to lower global demand and higher supply (mostly from the United States). Discounts in the price of oil from Western Canada have grown because of transportation bottlenecks, refinery shutdowns and inventory build-ups. More rail and pipeline capacity and output reductions will help in the long term, says the bank. On the other hand, unemployment rate is at a 40-year low and inflation is close to target, consistent with an economy that has been operating close to its capacity.
“Weighing all of these developments, we continue to judge that the policy interest rate will need to rise into a neutral range—somewhere in the neighbourhood of 2.5 to 3.5 percent – in order to achieve the inflation target. The pace at which this process occurs, of course, will remain decidedly data dependent.” The bank is now preparing a new economic forecast ahead of its January 2019 interest rate decision.
“It is already clear that a painful adjustment is developing for Western Canada, and there will be a meaningful impact on the Canadian macroeconomy. That said, given the consolidation that has taken place in the energy sector since 2014, the net effects of lower oil prices on the Canadian economy as a whole, Dollar for Dollar, should be smaller than they were in 2015.”
2019 ‘fender benders’ not recession
Looking ahead, Governor Poloz says rather than sliding into recession in 2019, the Canadian economy is instead at risk of “fender benders”. He told CTV that economic fundamentals are “quite solid”. “The things that we are facing are more like fender benders than big events, but the risk that we are talking about is that all the hard work we have gone through can be hurt by the trade front.” Regarding business optimism over the next year, Mr Poloz says it is important not just to take the most negative reports as gospel.
On the US-China front, he says, “Everyone is talking about the gloom scenario, but we have seen signs in recent weeks that they are making progress behind the scenes and if they do resolve all of that, well that will be a source of brand new lift to the global economy and, I think, then we can see this expansion continue on for quite some time. So, somewhere in between there is more likely to be the truth.” Oil prices have fallen sharply in the last three months, with crude oil values dropping from $76 a barrel to under $50 at time of writing. That said, an announcement that oil production in Alberta will be cut in the New Year lifted the value of Western Canadian Select blend from a low of $14 a barrel to around $30 at time of writing. However, it is still significantly cheaper than US crude oil, which Canadian provincial leaders say is a “crisis” and economic competitiveness must be improved.
Faced with falling oil prices and changes in the auto industry, where Canadian jobs are being lost after the pull-out of General Motors from Oshawa, Ontario, the New Year could bring moderating consumer confidence and less vigorous consumption spending, Mr Poloz says. “We factor that in. We expect that. It doesn’t make it easier. I don’t mean that. But it does mean that other parts of the economy we are expecting to pick up speed.” Given USCMA, firms have more of a green light to expand and increase investment and exports, the bank believes.
Less than three months to Brexit and uncertainty reigns
With under three months until Britain leaves the European Union on 29th March and uncertainty still reigns. In fact, the chances of a no- deal scenario have grown, with the UK government already spending an extra £2 billion on preparing for the possibility, which it has acknowledged by admitting in its technical notices that no-deal is no longer an “unlikely” option. At the same time, businesses who trade with the European Union have been warned that they need to prepare for the possibility that no deal will be in place when the UK leaves the EU.
In the last three months, Brexit has seen GBP seesaw against the Canadian Dollar as events twisted and turned. There was initial optimism that a deal would be reached, but after Prime Minister Theresa May’s solution was unveiled at Chequers, serious doubts were expressed by ministers, with some resigning. There was good news when EU leaders approved the terms, but as weeks went by, more British MPs opposed the proposals, mainly because of issues with the idea of an Irish backstop – a last resort to keep an open border. In December, enough Conservative votes were submitted to the 1922 committee to warrant a vote of confidence in the leader. Mrs May won that vote, but with a third of backbenchers voting against her. If there is no Brexit deal, the UK is likely to see major disruption from transport and travel, visas and border access, availability of food and medicines and more. Business costs are likely to increase and the UK’s top five business groups have called on the government to prevent a no- deal scenario. They say, “Businesses have been watching in horror as politicians have focused on factional disputes rather than practical steps that business needs to move forward.
The lack of progress in Westminster means that the risk of a ‘no-deal’ Brexit is rising. Businesses of all sizes are reaching the point of no return, with many now putting in place contingency plans that are a significant drain of time and money. Firms are pausing or diverting investment that should be boosting productivity, innovation, jobs and pay, into stockpiling goods or materials, diverting cross border trade and moving offices, factories and therefore jobs and tax revenues out of the UK. While many companies are actively preparing for a ‘no deal’ scenario, there are also hundreds of thousands who have yet to start – and cannot be expected to be ready in such a short space of time.”
They go on to say the responsibility to find a way forward now rests directly with 650 MPs in Parliament. “Nobody wants to prolong the uncertainty, but everyone must remember that businesses and communities need time to adapt to future changes. As the UK’s leading business groups, we are asking MPs from all parties to return to their constituencies over Christmas and talk to their local business communities. We hope that they will listen and remember that when they return to Parliament, the future course of our economy will be in their hands.”
Theresa May says she intends to make whatever option is reached work. “Let’s be clear about this, under ‘no-deal’ there would be some short- term disruption. It’s our job as the government to make sure we make a success of no-deal, just as we make a success of getting a good deal.” In the week beginning 14th January, MPs are set to vote on the Brexit deal. Meanwhile, opposition MPs are seeking to add an amendment to the finance bill that would only allow a no-deal if members of Parliament voted for it. That will also be decided by MPs, early in 2019.
More to worry about than just Brexit
Issues surrounding Brexit are adding to economic difficulties. In December, there was bad news about the economy, with the current account deficit reaching a two-year high of £26.5 billion or 4.9% of GDP in Quarter 3, 2018. This was up £6.5 billion on the previous three months. At the same time, UK real household disposable income stagnated, according to the Office of National Statistics figures. As a result, households borrowed more and the savings ratio reached its third lowest at 3.8%, down 0.3% on the previous quarter. It was the eighth quarter in a row that households spent more than they earned. Businesses also held back in the light of Brexit with investment down 1.1% quarter-on-quarter to £46.9 billion. In the last year, investment is 1.8% lower. In fact, it has fallen three quarters in a row for the first time in 10 years. But there is some good news. UK Public Sector Net Borrowing fell to £7.2 billion in November 2018, £900 million less than a year earlier. It is the lowest November shortfall since way back in 2004.
What next for Sterling-Canadian Dollar?
Technical guidance for CAD buyers
The Canadian economy and oil price issues are likely to dominate the loonie over the next three months, while Sterling will react to how the UK is exiting Europe and how national services are affected, particularly if no deal is agreed. It could be a long three months for GBP.
The Pound remains in a fairly tight range between 1.66-1.75. 1.72 looks to be a fairly key psychological and technical level, so if the Pound manages to get there, it would be worth taking advantage of the 1.70+ level. In the unlikely event that 1.75 breaks, then we could see a run to post-Brexit highs at 1.80 – this, of course, would be dependent on the Brexit situation altering significantly.
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Technical guidance for CAD sellers
Once again, it would be worth selling at least a portion of your exposure now, as we are just off yearly highs. In terms of targeting better levels, 1.66 and then 1.5950 are the resistance levels, so as we hit those it is an opportunity to sell. If CAD weakens and we head north of 1.72, then there is a risk that CAD would have little resistance stopping it from dropping by as much as 5%; in that instance, sellers should be careful about waiting too long.