Toronto • Bank of Canada Governor Stephen Poloz has a feeble job market and Federal Reserve Chairwoman Janet Yellen to thank for delivering the weaker currency he’s counting on for growth.
Canada’s currency traded at almost a three-month low last week after a government report showed the economy created a paltry 200 jobs in July and the labor force shrank by 35,400. Poloz, who hasn’t said specifically he wants a weaker currency, reiterated last month exports must pick up for the economy to fully recover. A weaker Canadian dollar would hasten that shift by making the nation’s products cheaper for foreign buyers.
The United States added 209,000 jobs last month, highlighting the outperformance of the world’s largest economy relative to Canada’s and spurring bets Yellen will raise interest rates more aggressively than Bank of Canada policymakers. The Canadian dollar, nicknamed the loonie for the image of the waterfowl on the C$1 coin, will probably continue to weaken as the economies diverge, strategists say.
"The Fed will sort of do the Bank of Canada’s work for them in terms of getting the Canadian dollar lower," Steven Englander, the head of Group of 10 currency strategy at Citigroup in New York, said in a phone interview. "The Fed is likely to begin tightening before the Bank of Canada."
That likelihood is driving the yield spread between U.S. and Canada government five-year bonds to the widest since 2009. After peaking at 24 basis points July 30, the yield advantage of U.S. compared with Canadian five-year notes narrowed to 12 basis points, or 0.12 percentage point, as conflicts in Ukraine and Iraq boosted the haven appeal of U.S. government debt.
The spread will widen out again, drawing funds across the border, Englander said, adding that given the correlation over the past three years between the five-year spread and the Canadian dollar, the trend suggests the loonie will weaken to C$1.15 per U.S. dollar, a level it hasn’t seen since July 2009.
The U.S.’s July employment report marked the sixth straight month that payrolls have increased by more than 200,000 positions. The pace of job growth in the U.S. has been about four times faster than its northern neighbor since the start of the year.
"I’m sure the Fed goes into their meetings with a bit of a spring in their step nowadays, and the Bank of Canada probably goes in with some long faces," said David Watt, chief economist at the Canadian unit of HSBC Holdings, by phone from Toronto.
For Watt, the silver lining is if the Fed raises interest rates first, it will cause the Canadian dollar to fall.
"The Bank of Canada wants to see a Canadian dollar that helps support non-natural-resource exports, and we haven’t seen that yet," Watt said. HSBC sees the currency falling to C$1.15 per U.S. dollar by the third quarter this year.
The currency will bottom out in the second quarter of 2015 at C$1.13 per U.S. dollar, according to the median forecast of strategists surveyed by Bloomberg.
Poloz is relying on an increase in exports to lead a recovery that has been driven mostly by consumer spending since the 2008-2009 recession. The governor has said a weaker currency will help.
Statistics Canada said Aug. 8 the workforce participation rate fell to 65.9 percent, the lowest level since October 2001. The shrinking labor force was the main factor in the unemployment rate’s decline to 7 percent from 7.1 percent. Economists predicted a 20,000-job increase and a 7.1 percent unemployment rate, according to median forecasts in a Bloomberg economist survey.
Employment has been stuck at about 17.8 million this year, ending a burst of hiring that led Canada out of a recession in 2009 faster than other Group of Seven countries. The Bank of Canada last month cited weaker participation in the workforce as a sign of idle capacity in the world’s 11th-largest economy.
"It’s an awkward straddling of two different engines of growth," David Tulk, chief macro strategist at Toronto-Dominion Bank’s TD Securities unit in Toronto, said by phone from Toronto. "It does for the time feel uncomfortable because a big part of Canada is cooling and waiting for this smaller part to make up for lost time."
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