Canada is in the early stages of discovering just how much lower oil prices will adversely affect the domestic economy. Decreased investment in the oil patch, a moderation in consumer spending growth, and government austerity in energy-producing provinces will all serve as a drag on activity. The consensus is that data will indeed weaken in the coming months, but even economists' downwardly revised estimates may prove to be too optimistic.
This week's chart is a near-replication of work done by Richard Cochinos, Head of Americas G-10 foreign exchange strategy at Citigroup Inc. Mr. Cochinos examined the relationship between the change in the price of West Texas Intermediate oil and the extent to which Canadian economic data exceed or come in shy of economists' expectations. (A reading of zero for the Canada economic surprise index on the chart represents data meeting expectations). His analysis suggests we're heading into a stretch in which economic data are set to disappoint.
You'll notice that Citi's Canadian economic surprise index is lagged by three months. This is because it takes time for the negative shock to show up in the data, and because Canadian figures are published with a notable lag.
"It is possible that the crude move was so crazy fast that econometric models fail to capture the insanity and we get even more extreme weakness in the Canadian data than expected," writes another trader at Citi. "There is a lot of pessimism priced in for Canada but things might still be worse than expected!"
Friday's retail sales figures for December missed expectations by a substantial margin, as consumer spending registered its largest one-month decline since April, 2010. In Alberta, retail sales have now fallen for three consecutive months. Evidently, consumers in the province are pocketing gas-related savings, likely due to decreased job security.
Friday's print, coupled with a string of disappointing U.S. data points to open the year (excluding payroll growth), suggests that the Bank of Canada may cut interest rates once again in early March.
Enhanced monetary easing and a stretch of underwhelming economic data have a number of implications for domestic investors.
One would expect the loonie to continue to soften if data consistently come in weak; however, as Citi notes, it's difficult to discern just how much bad news has already been priced in to the Canadian dollar at this point in time.
These developments would also be positive for Canadian bonds, putting downward pressure on yields. Canadians with mortgages coming up for renewal will be able to reap the benefits of ultra-low rates, while savers seeking refuge in sovereign fixed income won't be able to count on a generous return.
Economic weakness should also prompt foreign investors, who sold $13.5-billion in Canadian securities in December, to continue to flee the country, and should be considered a negative for domestically oriented equities. As CIBC World Markets senior economist Peter Buchanan observes, TSX-listed firms with a greater share of their revenues coming from outside Canada have outperformed their peers over the past three months.
