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dog days of summer

The global and Canadian economies are shifting from a period of acceleration to a period of cruise control, according to top economists and that is certain to create temporary headwinds for carriers looking to aggressively raise rates this year.

The global and Canadian economies are shifting from a period of acceleration to a period of cruise control, according to top economists and that is certain to create temporary headwinds for carriers looking to aggressively raise rates this year.

Both Scotia Bank Group’s senior economist Carlos Gomes, the opening speaker at our annual Profitability Seminar held in partnership with Dan Goodwill & Associates, and Robert Hogue a senior economist with RBC Royal Bank, who spoke at the recent SCL-CITA annual conference, forecast continuing albeit “unspectacular” growth for the economy. Their forecasts were later supported by the data from a powerful new indicator of economic events in this country, the newly unveiled Canadian Manufacturing Purchasing Managers’ Index. The index was launched by Royal Bank of Canada in association with Markit, a global financial information services company, and the Purchasing Management Association of Canada (PMAC).

Gomes attributed the weakening economic numbers to the global after effects from the natural disaster in Japan.

“In March car plants were operating at 100%. Now they’re operating at 50% because of a parts shortage and things will probably stay that way through June before they ramp up again by July or August,” Gomes said. “The soft patch is temporary. Globally most of the key indicators are positive.”

The health of the US market is critically important to Canada since about one third of every Canadian dollar is dependent on trade and the US absorbs three quarters of our exports. UG GDP growth in the first quarter was unspectacular however after a strong close to 2010. But Hogue and Gomes believed the economic trouble will prove fleeting.

“We believe this will be temporary. We are not overly concerned about the slowing of growth in the US in the first quarter,” Hogue said.

Gomes and Hogue expect the Canadian economy to growth at around 3% to 3.2% in 2011.

“I expect Canada to rank #1 among the G7 nations in terms of growth. Relatively speaking we are doing quite well and will do so again next year. But that also has to do with the weak performance of the other G7 nations,” Hogue said.

The RBC PMI, which is based on questionnaire responses from a panel of purchasing or senior executives in more than 400 manufacturing companies in Canada, reflected both the current shift into cruise control and Hogues’ and Gomes’ assertion that it’s nothing to be overly concerned about.  The headline RBC PMI, – a composite indicator designed to provide a single-figure snapshot of the health of the manufacturing sector,  registered 54.8 in May, down from 56.3 in April. It fell again in June, down to 52.8, as the Canadian manufacturing sector’s output and new order growth weakened further during the month. Notably, new export business fell during the latest survey period, with firms attributing the decrease to weak global demand and unfavourable exchange rates.

Nevertheless, the latest readings, although not strong, are still above the 50.0 no-change level that separates growth from contraction and signaled an improvement in overall business conditions for the ninth month running.

The downward trend in the PMI reflected weaker expansion of both output and new orders for Canadian manufacturers. Job creation, which had remained solid  until May, fell to a seven-month low by June.

“The overall index moderated once again in June, with weakness in the Canadian manufacturing sector spread broadly across all of the survey components and across the Canadian regions,” said Craig Wright, Senior Vice President and Chief Economist, RBC. “The moderation is consistent with the trends we are seeing around the globe pointing to a temporary soft patch in the economic recovery.”

 Wright added, however, that the slowdown will be temporary and does not signal that fears of a double dip recession are worth considering, echoing the comments of Hogue and Gomes.

“We are seeing an environment of unevenness and uncertainty…But volatile data is typical of turning points in the economy. I am not shocked by the volatility,” Wright said.

Hogue outlined the following growth drivers for Canadian business for the remainder of 2011:

  • 1. Canadian businesses are generally in good shape and many have money to spend. “There is cash there and it’s ready to be deployed. We think investment in capital will be front and centre,” Hogue said.
  • 2. Borrowing costs are at historically low levels and credit is also more readily available to firms in good financial standing
  • 3. Most of Canadian machinery is imported from the US and prices are now 30% lower than they were back in 2002 thanks to the rise of the Canadian dollar in relation to the US greenback.

“The stars are aligned for growth,” Hogue said.

Both Hogue and Gomes pointed to several indicators within Canada and globally to show there is reason for optimism long term despite the current slowdown.

Inventories: Inventories in the US remain at very low ratios and that will continue to support global trade growth. In fact, global trade levels are already above where they were prior to the recession in 2008. The American Trucking Association’s Tonnage Index correlates well with US industrial growth and has been growing in excess of 5% year over year. Industrial production in China is growing at a 15% clip and Germany’s industrial production is also strong.

“We have recovered what we lost and are at a new high point. That is very important,” Gomes emphasized.

Employment: Hogue believes this is the most important indicator to track right now as job growth is critical to the health of several economic sectors and drives government policies.  The jobs scenario looks much better north of the border where we have actually gained about 100,000 jobs compared to pre-recession levels. In the US, however, where the recession cost the loss of about 8.7 million jobs, only about 20% have been recovered to date. But Hogue believes the corner has been turned.

“It’s not going to be smooth sailing but the job creation machine in the US is going into gear,” Hogue said.

Housing: The Canadian housing market never did collapse like it did in the US and contributed to the softer landing experienced north of the border during the recession. Hogue expects housing starts in Canada to stay in line with demographic fundamentals but for the housing market overall to be slightly weaker than last year. In the US, after such as disastrous fall, the housing market can only improve. Housing affordability is actually now at a record high in the US, according to Gomes.

Canadian dollar: The meteoric rise of the Canadian Loonie has made it difficult for Canadian manufacturers to remain attractive to US buyers and greatly reduced southbound hauls for Canadian carriers. Neither Hogue nor Gomes saw any relief in sight.

“The Canadian dollar will continue to strengthen and by the end of next year it will be at $1.09-$1.10 in comparison to the US dollar,” was Gomes’ prediction. The reason behind the continuing high value of our dollar will be high commodity pricing, which is a net benefit for Canada’s economy albeit a real test for Canadian manufacturers having to deal with both higher energy costs and shrinking exports due to what the high dollar does to the price of their goods in the US market.

Hogue expects the Canadian dollar to remain above parity till mid next year, peaking at $1.06 before falling a few cents below parity.

If either of those predictions proves true it will mean our dollar will be above parity in comparison to the US greenback for the longest period of time since 1976.

“Manufacturers do have the wherewithal to overcome the challenge,” Hogue asserted because they will have time to adjust. “Quickly changing conditions are worse than the dollar staying at parity for a long time.”

Interest rates: Both Hogue and Gomes expect interest rates to rise over the course of the year but for monetary policy to remain “very stimulative.”

“The Bank of Canada will probably start raising rates again during the summer. By next year expect rates to be at about 3% but that level should be considered still stimulative to the economy as long as rates are below 3.5%,” Hogue said.

Gomes was more conservative in his forecast, expecting the Bank of Canada’s rate to go up to 2% next year.

Oil prices: Both Hogue and Gomes felt they had better news about the future of oil prices. Both expected oil prices to settle down but remain elevated, attributing recent spikes to a great deal of “risk premium” associated with geopolitical issues rather than supply and demand fundamentals.

“As those issues resolve, that risk premium will drop,” Hogue said. “I expect crude prices to drop to US $96 per barrel and to hit US $102 per barrel for 2012. The long range forecast is about US $100 per barrel. I am not in the camp of peak oil prices of $150 to $200 per barrel.”

Gomes explained that neither global demand for oil nor inventories support peak oil prices at much higher levels. Global demand is about 90 billion barrels per day and he expects a 2% increase in that. When prices peaked to US $140 per barrel, inventories had declined but the market is not experiencing that kind of inventory decline this time.

“We don’t expect to see a further spike in prices but they’re not likely to come down either,” Gomes said.

Government and household debt ratios: Both Hogue and Gomes said these have the potential to be disruptive to future economic growth, particularly in the US. In Canada the government’s deficit rose significantly during the recession but is still at 4.5% of the nation’s GDP. In the US it has hit an alarming 11% of GDP ratio.

Household indebtness, however, has increased substantially in both countries and Canada is now on par with the US when looking at consumer debt to income ratios.

“That’s worrisome. This is something to track closely but it doesn’t spell imminent disaster,” said Hogue. “It’s still manageable because interest rates are low making it easier to service the debt. If interest rates rise, that would be much harder to do.”

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