U.S. orders for durable goods surged by the most on record in July. The increase was exaggerated by an outsized gain in airplanes and airplane parts that won't be sustained. Still, the report was very good news for Canada. The details matter more than the headline.
Central banks have unofficial "dashboards" of indicators that influence their policy decisions. These dashboards have grown rather complex as central bankers attempt to make sense of a confusing landscape. Fed chair Janet Yellen is watching about half a dozen granular labour-market indicators. The Bank of Canada is getting into the weeds on exports.
This spring it released a discussion paper called "Canadian Non-Energy Exports: Past Performance and Future Prospects." The paper – by André Binette, Daniel de Munnik and Émilien Gouin-Bonenfant – is one of the more important works of analysis the central bank has produced in recent memory. It's become fundamental to any discussion about why Canada's exports still haven't recovered from the financial crisis, and made it possible to have a reasonable discussion about how the Bank of Canada should confront the exchange rate.
Mr. Binette and his co-authors divided Canadian non-energy exports into 31 categories, and then chose the U.S. benchmark that best correlates with sales in each of them. They also identified 15 of those categories that likely will lead the export recovery. The companies in those areas – ranging from commercial services, to aircraft parts to fabricated metals – will decide the near-term fate of Canada's economy.
Five of the industries that the Bank of Canada researchers say will lead the recovery – aerospace, industrial machinery, electrical machinery, communications equipment, and computers – were benchmarked against U.S. business investment. In its report on durable goods released Tuesday, the U.S. government reported that shipments of non-defence capital goods increased 1.4 per cent in July after a strong 3-per-cent gain in June. That figure is a proxy for business investment growth and the Commerce Department includes it in its official quarterly tally of how much money companies are spending to expand and to become more productive.
So what does this mean for policy? No discussion about Canadian exports can be had without talking about the exchange rate. The authors of the non-energy-export paper also ran calculations to determine which exporters were most sensitive to changes in the value of the Canadian dollar. Over all, 17 of the 31 categories appear to gain or lose sales based on the exchange rate. More importantly, 10 of the 15 industries expected to lead the export recovery showed sensitivity to the exchange rate. That means the value of the dollar factors more heavily than usual in the Bank of Canada's consideration of what to do with policy over the months ahead.
"In that very basic sense, yes, the exchange rate is more important given where we are in doing our analysis and trying to figure out what is happening next," Mr. Poloz told The Globe and Mail in an interview at the Kansas City Fed's annual symposium in Jackson Hole, Wyo., on the weekend.
Some market participants already assume that Bank of Canada policy is geared to putting downward pressure on the exchange rate. But Mr. Poloz's approach to the currency is much more nuanced than that. Unlike his counterparts at the Reserve Bank of Australia and the Reserve Bank of New Zealand, he refuses to express an opinion on the value of dollar at any given time.
"If your intention was to try to go out and make the exchange rate into some other number than what it is, first of all you'd have to believe really strongly that you knew what it should be, and I don't think we have that," Mr. Poloz said. "Monetary policy is not a very precise thing. You really only can aim at one thing [and] with difficulty. Aiming at other things too, that's a big job. So we just don't do it."
The Bank of Canada, of course, aims at inflation. And it's in this context that the exchange rate becomes a factor. Inflation is affected by growth and growth is affected by exports. Some exports are influenced by the exchange rate and others aren't. As it happens, the ones that are sensitive to the exchange rate also are the ones the central bank is counting on to lead the economy. The value of the currency, therefore, will provide important information about the pace at which that expected revival will occur. "You can't ignore that" the dollar is higher, Mr. Poloz said. "That's a true shock to our models and our understanding of the export outlook, and therefore output, and importantly inflation."
The bottom line is that it's time to stop accusing the Bank of Canada of operating a stealth campaign to weaken the dollar. The central bank's understanding of export dynamics is deeper than it's ever been. It's aware that the exchange rate has an important influence on some exports, and it's also aware that idiosyncratic factors such as seasonality and hedging decisions often make the exchange rate inconsequential. The exchange rate is on the dashboard, but it's not the target.