The Canadian Dollar: Rescued from Near 2019 Lows by "Much Better" GDP Growth Number

Image © Pavel Ignatov, Adobe Stock 

- CAD rescued from near 2019 low by strong March GDP figure. 

- But economy still in low gear, and trade threats are now mounting.

- BoC seen on hold, CAD vulnerable, as U.S. trade policies weigh.

The Canadian Dollar was rescued from close to a 2019 low Friday after official data revealed a sharp pickup in economic growth at the end of the first quarter, although the Loonie still faces headwinds over the coming days and weeks due to White House trade policies. 

Canada's economy grew by 0.5% during March, the fastest increase since May 2018, which was above the consensus for a 0.4% expansion and more-than reverses the 0.1% contraction seen in February.

The economy grew at an annualised pace of 0.4% in the first quarter overall, in line with market expectations but above the Bank of Canada (BoC) forecast of 0.3%. That's a low growth rate compared to those seen in Canada as recently as the first half of 2018.

Household spending and business investment were responsible for much of the growth seen last quarter, with the business spending on equipment and machinery increasing by 8.7% during the period. But this was offset to some extent by a 1% fall in exports and a 1.9% increase in imports. 

"The economy has slid past a near stall in the past two quarters, but the details and progress in March suggest that we're going to make up for some of that in Q2. Over the past year, monthly GDP is running at 1.4%, a mediocre performance that we think is a better guide to how we're doing than either the weakness of the past two quarters or the rebound we expect in the next two," says Avery Shenfeld, chief ecoomist at CIBC Capital Markets.

Above: Contributions to Canadian GDP growth. Source: Statistics Canada.

Canada's economy also grew at a meagre annualised pace of 0.4% in the final quarter of 2018 but the BoC said Wednesday that growth should pick up in the second quarter, although it appeared to make any future interest rate rises at least partly contingent on an end to the U.S.-China economic conflict. 

Currency markets care about the GDP data because it reflects rising and falling demand within an economy, which has a direct bearing on consumer price inflation, which is itself important for questions around interest rates. And interest rates themselves are a raison d'être for most moves in exchange rates.

Canadian GDP growth nearly halved in 2018, falling from 3% previously to just 1.8% last year, after an economic slowdown took hold in the second-half. That was the result of a -30% final quarter fall in oil prices and due to concerns over the impact the U.S.-China trade war would have on the global economy.

"While this should in theory be broadly supportive for CAD on the day, the escalating trade wars (ie, Mexico) won’t bode well CAD, one of the key G10 underperformers overnight," says Petr Krpata, a strategist at ING.

The BoC about-turned in April on earlier guidance that suggested it could lift its interest rate as many as four times in 2019. Its guidance now is that rates could go up or down in the next change, making for a 'neutral' stance.

It cited a slowing global economy, weakness in the domestic economy and risks to already-low business confidence given the ongoing 'trade war' between the U.S. and China as well as an absence of progress across the border on ratifying the new North American Free Trade Agreement (USMCA).

Above: USD/CAD rate shown at daily intervals.

The USD/CAD rate was 0.06% higher at 1.3541 following the announcement after paring an earlier rally up to 1.3554, which took the exchange rate close to a 2019 high. The Pound-to-Canadian-Dollar rate was 0.15% lower at 1.7032 after paring overnight gains, and is now down 2.1% for 2019.

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

"The White House announcement puts in doubt passage through Congress of the US‑Mexico‑Canada trade agreement (USMCA)," says Elias Haddad at Commonwealth Bank of Australia. "Still, ahead of the tariff announcement on Mexico, the Trump administration submitted a Statement of Administrative Action that would fast‑track the process to get the USMCA to a vote in the House of Representatives. Canada and Mexico have already brought forward legislation to ratify USMCA this week."

Friday's price action comes after President Trump said that from June 10, a tariff of 5% will be applied to all goods imported into the U.S. from Mexico, citing illegal migration from Mexico into the U.S. as the reason behind the move.

Multiple so-called caravans of migrants have travelled from across South America in the past year, through Mexico and up to the U.S. border where they have attempted to gain legal or illegal entry into the country.

Trump has repeatedly called for Mexico to do more to prevent those 'caravans' from passing through its territory and now appears prepared to use coercive measures like trade tariffs to have the Mexican leadership fall into line.

....at which time the Tariffs will be removed. Details from the White House to follow.

— Donald J. Trump (@realDonaldTrump) May 30, 2019

"This will smell much more like NAFTA 0.0 to the Mexicans. Domestically for Trump it might be a winner, however: no need for a wall, let tariffs do the work! Yet internationally, the message to China is clearly 'We play ultra hardball',” says Michael Every, a strategist at Rabobank. "Does that sound like a US-China trade deal can be done on terms Beijing will agree to? (“No”, is the answer for those economists who still think this all about economics and hence the answer is automatically “Yes”.)"

Thursday's move comes as lawmakers from the U.S., Mexico and Canada step up efforts to ratify the United-States-Mexico-Canada-Agreement (USMCA), which is an updated version of the NAFTA agreement.

Trump campaigned in the 2016 election on a pledge to renegotiate that trade pact and threatened to tear it up if different terms could not be agreed. A deal was struck in October 2018 after more than a year of negotiations, although it's still unratified by all signatories.

Jesus Seade, Mexico's chieft negotiator, said Thursday the country has not yet spoken to the U.S. about the tariff plan but that it will retaliate aggressively if the levies do come into force.

The U.S. is Canada's largest trade partner and any failure to ratify the new agreement could ultimately threaten at least some of that trade as it could mean tariffs are eventually imposed on goods coming from Canada too.

TD Securities once argued that Canada's Dollar could fall by up to 20% if the trade negotiations failed and the NAFTA agreement was subsequently torn up by the White House.

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