China’s slower-than-expected economic growth could continue to affect commodity prices in Canada — a trend that will likely cause a softening of the Canadian dollar, according to BMO Harris Private Banking’s June Market Commentary.
“China, the world’s second-largest economy, started out 2013 with high expectations for a rebound that would take growth levels close to 8% for the year,” said Daniel Theriault, chief investment strategist, BMO Harris Private Banking. “But after four months of disappointing numbers, growth will likely come in at 7.6% or lower. That, in turn, has Canadian commodities on alert.”
Additional highlights from the report include:
‘Abenomics’ takes hold in Japan
Japanese Prime Minister Shinzo Abe is striving to lift Japan (the world’s third-largest economy) out of a decade of deflation. His progressive plan, dubbed ‘Abenomics’, involves wide-ranging fiscal, monetary and structural reform measures that will be deployed assertively and broadly across Japan’s economy.
- Government spending will increase to 2% of GDP, likely raising the fiscal deficit to as high as 11.5% of GDP.
- In an attempt to balance the national budget, small, but consistent, increases are to be made to the consumption tax — from its current 5% to 8% in 2014 and to 10% by 2015.
Read: Hedge your bets on Japan
The report notes that due to Abe’s policies regarding exchange rates the yen has depreciated 28% against the U.S. dollar since 2012, while the Japanese stock market has advanced 63.7% (JPY) over the last year. As a consequence of these new measures, volatility in this market has increased dramatically.
“Japanese exporters are enjoying invigorated revenue growth on the back of the weakness of the yen, yet the European Central Bank is concerned about the possibility of a currency war as other countries impose a similar strategy to devalue their currency,” said Theriault. “The challenge for non-Japanese investors is to gauge whether the equity gains will withstand any future deterioration in the currency.”
U.S. Talks of Scaling Back
The Federal Reserve is now in its third stage of its bond buying program — quantitative easing — and has signaled that it intends to scale back its bond purchases sooner than expected. The current large bond purchases are designed to boost the economy to be strong enough to stand on its own; in May the 10-year Treasury Bonds surged, paying 1.66% (USD) at the beginning of the month and 2.12% at month’s end. The report notes that the Fed’s pull-back strategy will have to be carefully orchestrated to prevent collapse in the U.S. economy.
Read: Bernanke clarifies Fed QE plans
“Such substantial increases in yield, like we saw for the 10-year Treasury Bond, can erode capital,” noted Theriault. “While we expect short rates to remain low for a number of quarters yet, being in cash currently has a negative real return. The best strategy for protecting capital is to hold shorter maturities and higher coupons.”
Bank of Canada welcomes new boss
New Bank of Canada Governor Stephen Poloz has officially taken over the reins from Mark Carney and will likely extend the policy of low interest rates for the near term. In the meantime, Canadian equity markets experienced a modest month in May, with the S&P/TSX providing a total return of 1.77% for the month.
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