Global growth continues to slow despite relatively buoyant consumer spending and housing activity in many regions. China’s relatively strong output growth remains on a decelerating path.
A number of countries including the U.S., the U.K., and Canada are losing some momentum again. Activity in Japan and the euro zone remains modest, triggering additional easing in the former and the promise of even more in the latter.
Deep recessions persist in Russia, Brazil and Venezuela, aggravating political and social strains. Commodity markets are still under pressure, with crude oil prices plumbing new cycle lows and deflating the performances of producing nations around the world. By most measures, the wind is still coming out of the sails of global trade and bulk shipping.
Measures of risk aversion and financial market volatility have increased, keeping the U.S. dollar firm and pushing longer-term borrowing costs even lower. Equity prices around the world have turned lower, mirroring the synchronized downturn in corporate earnings, and intensifying concerns about Chinese growth and currency prospects.
Sharply lower commodity prices — for energy in particular — are largely responsible for Canada’s slumping economic performance. The country had leveraged its bountiful resources to take advantage of rapidly increasing international demand and higher prices. At its recent peak, the combined resource sectors represented about 10% of Canada’s national output, but the tally jumped to 18% when resource-related activity in manufacturing, construction, and services nation-wide were included. And like virtually all of the globe’s resource-centric nations, the protracted slide in virtually all commodity prices has severely undercut national income, both directly and indirectly through expanded domestic economic linkages.
The lack of adequate pipeline infrastructure, both to the U.S. and to tidewater, has exacerbated the price discount experienced by domestic producers on already-low prices, although the tandem slide in the value of the Canadian dollar has provided some minor relief. Canadian energy export volumes are rising, but the value of energy exports has plunged alongside the collapse in prices. Through the first eleven months of 2015, the value of energy exports averaged $85 billion, a 34% drop from the high-water mark of $129 billion set the year before.
The importance of the energy sector is reflected in the magnitude of the adjustments underway. The $44 billion decrease in energy-related exports was more than the $32 billion increase in exports realized in the combined non-resource sectors which include the transportation, machinery, electronics, and consumer product categories. Although the trade surplus in energy products is estimated to have dropped by a third to about $55 billion, it was still large enough to offset about 42% of the accumulated deficits in virtually all of the non-resource segments. The pervasive weakness in the resource sector — reinforced by the lingering global economic malaise and a more prolonged slump in commodity prices — is fundamentally reshaping the country’s economic landscape to a lower and slower growth trajectory. Recessionary conditions have emerged in the key oil-producing provinces of Alberta, Saskatchewan and Newfoundland & Labrador. Corporate earnings have been slashed by the persistent and large slide in prices, forcing businesses to consolidate operations through extensive employment and investment cutbacks, and mergers and acquisitions. Just two years ago, investment in the large oil & gas sector
amounted to roughly one-third of all business capital spending in Canada.
Currently, capex in the oil & gas industry is expected to contract by about 25% this year on top of the outsized 40% decline witnessed in 2015. The knock-down effects are spilling over to the broader national economy through the reduced demand for manufactured goods and services destined to the resource regions, as well as the fiscal deterioration in the balance sheets of all levels of government. The financial market ramifications are equally as important. The bellwether S&P/TSX stock market index has slid about 17% since its peak last spring, lopping an estimated $375 billion off of corporate valuations, and sending an increasing chill through investor and business confidence.
The value of the Canadian dollar has slumped to a 13-year low of around US$0.71, an added benefit to export earnings but a further cost to imports of machinery & equipment, technology products, consumer goods and fresh produce. Canadian real GDP likely recorded little if any growth in the last three months of 2015, underscoring the resource sector’s outsized impact on the economy’s performance. In view of the continuing economic and financial turbulence, and even lower energy prices, we expect that Canadian output growth will be modest at best in the first half of the year. Even with a turnaround as the year progresses — based upon expectations of stronger U.S. demand, renewed stabilization in commodity markets and increased fiscal stimulus — Canada’s output growth will be hard pressed to average just 1.1% in 2016 — the weakest economic performance among the G7. Commodity prices are expected to remain on the low side.
Oversupply conditions continue to dominate the outlook for most commodity markets, and crude oil in particular, with increasing inflows from Iran and Iraq. There has been a multi-year buildup in the output capabilities of non-OPEC energy producers, led by U.S. shale and Canadian heavy oil producers. Implementing a much different strategy to maintain its ‘swing-role’ status as OPEC’s dominant and low-cost producer, Saudi Arabia has expanded its oil output in a bid to undercut the financial viability of higher-cost producing companies and regions. And there will be little short-term relief with global production getting an added boost from Iran and other Middle Eastern and African countries in need of expanded revenues. Inventories of unsold crude are at a record on land and on the sea in tankers.
Although oil production in the U.S. is being reduced, even larger output cutbacks will be needed to rebalance the oil market. On the flipside, the demand for energy products is rising, led by strengthening in demand from India, China, and the United States. But the inflection point will likely occur later rather than sooner, and will require much stronger global economic growth to lift crude oil prices higher on a more sustained basis. There is always the risk that the myriad of geopolitical risk factors could lift prices, though more than likely they will add to the chronic volatility. Under these circumstances, Canada faces a longer period of underperformance in many of the resource-centric regions in the west and the east. Consumer spending and housing activity across the country will add much less to overall growth in an environment of increasing consumer caution that is being reinforced by moderating employment gains, reduced pent-up demand for big-ticket items because of record home and car ownership rates, and rising household debt burdens.
Nonetheless, expectations of a renewed strengthening in activity in the second half of the year and beyond relies upon two factors. First, the upcoming Federal Budget should provide a progressive and solid boost to output growth by ramping up social- and infrastructure-related expenditures.
And second, an improvement in net exports’ contribution to growth will be supported by an increase in U.S.-destined shipments and a decrease in higher-cost imports. Canadian export-focussed manufacturers and service providers throughout the central provinces and in B.C. are expected to benefit from the relative strength of U.S. domestic demand, the nation’s highly integrated supply chains, and a highly competitive Canada/U.S. exchange rate. U.S. manufacturing output has been steadily losing momentum since mid-2015, with the continuing decline in capital goods orders pointing to further underperformance. Some of the deceleration in U.S. industrial activity has been caused by the slowdown internationally, and the inventory liquidation underway.
But some of the weakness suggests an increasing loss of U.S. market share attributable to the substitution of more competitively priced foreign-made products from Canada and other countries. Over the past year, energy has been Canada’s top performer from a volume perspective, despite the collapse in prices and the value of energy shipments. Relatively solid export volume gains also have been recorded in consumer goods, industrial machinery, forest products, electronic equipment, chemical goods, and aerospace products, with the majority of these categories largely sensitive to the low-flying loonie.
The transition to a stronger growth trajectory in Canada requires a quicker rebalancing in the supply/demand conditions affecting most commodity prices, a faster and more synchronized global upturn in spending led by the U.S., and increased export penetration into the U.S. marketplace aided by a broader competitive revival. Domestically-focused fiscal stimulus will provide a much needed assist, though the competitive implications associated with running larger deficits for longer, if not addressed, could eventually erode the shorter-term benefits. Monetary policy is expected to retain its highly accommodative stance for the foreseeable future, weighing on the value of the Canadian dollar. Underlying inflation pressures are being constrained by unused capacity, notwithstanding the pass-through effects associated with a weaker currency.