From Forbes, Canada and their central bank decided to cut interest rates for the 2nd time already in 2015. This is not normal for Canada. They have been one of the only countries that survived the 2008 crisis without too many problems that we experienced here in the United States.
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On July 14, Canada’s central bank cut benchmark interest rates by 25bps for the second time this year, and slashed its growth forecast for 2015. The bank now expects GDP growth to be 1.1% Y/Y this year, down from its 1.9% forecast in April. That could prove to be optimistic because first quarter growth slumped -0.6% Q/Q, and weak economic data in April sets up the distinct possibility of a technical recession. Why is that a problem? Over the last 50 years, Canada has not had two consecutive quarters of negative GDP growth without a recession in the US.
The downward revision clearly reflects weakness in the commodity sector. Plummeting business investment in energy, as well as weaker than expected exports of non-energy commodities have jolted the Canadian economy. Bank of Canada Governor Stephen Poloz expressed his concern over the weak outlook in March saying the falling price of oil was having an “atrocious” effect on the local economy.
The Canadian Dollar (CAD) is now the second-worst performing G-10 currency this year, only New Zealand Dollars have been weaker. And the chart CAD against USD has developed a classic cup and handle formation.
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An interest rate cut is reason enough for the currency to weaken, but there are broader reasons to be bearish CAD. Canada’s bloated housing market might not be a “bubble,” but the central bank’s own calculation shows that home prices nationwide are roughly 20% overvalued. Canadian’s household debt to disposable income ratio is already 166%, making them some of the most overleveraged consumers in the world. It’s fair to ask whether two rate cuts in 2015 are a waste of valuable ammo if and when home prices do start to decline.
Property investors in Alberta are starting to wonder if the downturn is already underway. Calgary’s luxury home market looks to be the epicenter. In June, there were more than 800 Calgary homes for sale worth more than $1 million, and for every 10 new home listings only 2 were sold. Home sales have fallen for six straights months and home prices have been down for five consecutive months. It’s a similar story in Edmonton. Granted, Alberta is home to most of Canada’s oil reserves and activity in cities like Toronto and Vancouver is still strong. But the potential for trouble is real.
Even if home prices gracefully fall to more realistic levels the BoC is unlikely to raise rates anytime soon. With the Fed getting ready to hike rates we’ll see policy divergence between two heavily intertwined economies for the first time in a while. USD/CAD has already moved a lot but it looks like a runaway train that won’t come back anytime soon.