The Canadian dollar plummeted more than a full cent after Bank of Canada Governor Stephen Poloz announced a 25-basis-point cut in interest rates. Where the domestic economic outlook is concerned, however, it may not matter – the American consumer will determine the speed and strength of Canada's export-led recovery now that the commodity supercycle has run its course.
There is no doubt that a weaker loonie will help Canadian exports, but history shows that U.S. consumer demand is a much larger factor. For this reason, Tuesday's report on U.S. retail sales, a huge disappointment relative to economist expectations, will likely prove the most important data point this week for the domestic economy – more so than the cut in interest rates – when it's all said and done.
Month over month, sales declined by 0.3 per cent when a gain of 0.3 per cent was expected – a big miss. The theory that a weak first half of 2015 was largely the result of bad weather in the first quarter, and that U.S growth would snap back quickly, is now no longer viable.
The first chart, below – comparing year-over-year growth in the volume of Canadian exports with year-over-year change in U.S. retail spending – illustrates why the U.S. consumer is so important for the domestic economy. For the past decade, the growth of exports has closely tracked changes in American consumer demand.
The last few data points also show the reason for Mr. Poloz's concern about the domestic economy. By weakening the loonie, January's surprise rate cut was expected to spur export growth for Canadian firms. The downward slide in export growth remains a trend in 2015, however, as weaker year-over-year U.S. retail sales growth limits demand.
The lower chart highlights the limitations of a weaker currency as stimulus for export growth. For most of the past 10 years, domestic exports have followed the value of the U.S. dollar – as the greenback rises against the loonie, Canadian goods are more competitive in the U.S. market.
There are, however, long time periods when the rising or falling dollar has had little effect on Canadian exports. During the financial crisis, for example, the U.S. dollar strengthened as global investors sought a safe haven, but domestic exports declined dramatically.
We are in a similar period now. Since the beginning of 2015, the U.S. dollar has climbed against the loonie, but Canadian export growth has fallen dramatically.
Again, the weaker loonie will help exporters. But attractively priced Canadian goods in the U.S. market won't be enough to pull the Canadian economy out of what seems to be a recession, unless the consumer demand reappears.
Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at Inside the Market.