That was quite the supersized GDP number Thursday, helping forestall what had seemed like an inevitable corrective phase in the Canadian dollar. The loonie rallied a full penny after the numbers were released, to 80 cents (U.S.) from 79 cents.
The 4.5-per-cent expansion in real GDP at an annual rate not only beat the consensus view of 3.7 per cent, and the Bank of Canada's most recent estimate of 3 per cent, but was the best reading in six years. This came on the heels of three impressive quarters (3.7 per cent in Q1, 2.7 per cent in Q4 and 4.2 per cent in Q3 of last year) which took the year-over-year trend up to a sizzling 3.7 per cent, the most impressive showing in well over a decade.
By way of comparison, U.S. growth is running at a 2.2-per-cent rate, which is the biggest gap in Canada's favour since the third quarter of 2011. The historical odds of Canada ever seeing such a performance gap over our big brother to the south is barely better than one in 30. So no doubt the loonie's position in a higher range from where it was in the spring, when the Home Capital fiasco was touching off recession fears, is totally justified, even if the currency is a tad overvalued now.
I cannot remember the last time I gave any economic report an A+, especially a report like the GDP, which has so many moving pieces that it's always so easy to find at least one mistake. But this one fits the bill. The consumer (4.6 per cent) was robust and, unlike the situation in the U.S., was not supported by a savings rate drawdown – in fact, the savings rate inched up to 4.6 per cent from 4.3 per cent. The bursting of the housing bubble was notable in the 4.7-per-cent annualized contraction in residential investment, but this was more than offset by the 7.1-per-cent increase (annual rate) in business capital spending – this shift toward productivity-enhancing capital expenditure and away from non-productive housing has to bring a smile to the Bank of Canada's collective face. It wasn't just investment, but also exports, as volumes expanded at a 9.6-per-cent annual rate, surpassing import growth of 7.4 per cent. There was very little help from government (0.5 per cent) and inventory accumulation added a grand total of 0.1 per cent to the headline number.
The monthly GDP data for June were equally impressive, rising 0.3 per cent versus the 0.1-per-cent number that was expected. Fully 14 of 20 industries joined in on the expansion, and even without the benefit yet of one month's set of Q3 numbers, the hand-off from June's level is so strong that we have 1.6-per-cent growth (at an annual rate) built into the current quarter. Even modest 0.2-per-cent gains for July, August and September would result in 3.2-per-cent growth for Q3 (versus the BoC's 2-per-cent forecast).
While the GDP deflator did decline due to terms-of-trade effects, it is still up 2.5 per cent from year-ago levels, and nominal GDP growth is up 6.3 per cent, which is the fastest pace in nearly six years. This in turn, along with some favourable base effects, has taken the year-over-year trend in national account pretax profits up a resounding 38.5 per cent over the past year, and here we have a Toronto Stock Exchange that is actually in the red by 50 basis points through the first eight months of 2017. Best economy in the G7 and worst stock market – go figure. We may as well throw those correlations out the window – either that, or the local stock market has a whole lot of catching up to do.
So the economy is firing on all cylinders. What was interesting about the June GDP number was how strong the cyclically sensitive areas of the economy were – retail trade jumped 0.8 per cent, transportation/warehousing spiked 0.6 per cent, durable goods manufacturing was up a solid 0.9 per cent and construction surged 2.0 per cent (helped in part by the end of a construction strike in Quebec). This economy is packing some heat just as the summer draws to a close.
I should add that while Canada is set with weak domestic politics of its own (soak the rich!), uncertain trade relations with the U.S. administration, and a still-large current account deficit, there are some very positive supply-side developments taking place that are telling me that potential GDP growth may be improving. This should have important long-term implications for monetary policy, the currency and the rate of return on assets.
Net immigration inflow to Canada has soared at a 5-per-cent annual rate over the past half-decade, and last year hit new record levels by a long shot at 342,408. As such, the labour force is expanding at a 1.5-per-cent annualized pace; and the business sector is mobilizing employment to full-time (2.4 per cent) from part-time (1.0 per cent) which should help bolster personal income growth going forward. I don't want to get too excited, but productivity growth has improved over the past four quarters to a three-year high of 2.1 per cent from a modest decline this time in 2016. If you add up productivity growth to the growth in labour force gains, then we could well be talking about Canada's growth potential being a lot closer to 2.5 per cent or even 3 per cent from what the central bank for some time had been estimating at 1.5 per cent.
The question for the Bank of Canada is this: Is one more rate hike enough in view of this unrelenting and unexpected momentum? No doubt this is a dilemma given that the futures market has all but given up on any more Fed hikes by year-end, so any moves by the BoC that are not priced in will naturally push the Canadian dollar higher, notwithstanding the technical challenges the loonie has been confronting in recent sessions. Not to mention oil prices at $47 (U.S.) per barrel for West Texas intermediate crude as opposed to $50 per barrel, which is what is needed to warrant an 80-cent dollar – under the proviso that Canada-U.S. front-end yield spreads don't go positive (now at -5 basis points) – which has not happened since May, 2015.
In just three months, Canadian two-year note yields have gone from a discount of 60 basis points to five basis points at the moment (this has exerted a more powerful influence on the Canadian dollar than anything else). But we do have three meetings left this year, and market-based odds are still 40 per cent for a BoC move on Sept. 6 – it was 27 per cent on Wednesday, just under 70 per cent for Oct. 25, and 80 per cent for Dec. 6.
I don't feel enough BoC tightening is priced into the market at the moment based on the cyclical momentum in the economy, and this is the risk to my more recent caution on the Canadian dollar, which I am now willing to temper, albeit slightly. That said, the lofty net long position on the Chicago Mercantile Exchange is still a cause for pause because this fickle crowd will be the first to sell on strength. What's more, the BoC commodity price index is down 2.5 per cent so far in August and is actually 2 per cent below the May level that coincided with the nearby trough in the loonie at the time below 73 cents (U.S.). Western Canadian Select, the domestic crude benchmark, also is down about 0.7 per cent from where it was in early May, near the time the loonie was at the lows. So if the BoC is looking for an "out" from having to do more than one hike given the supersized-growth in the economy, it would point to the resource markets.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.
David Rosenberg