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Canada on Alert: U.S. Election and Rate Cuts Cast Shadows on the Economic Horizon.

Canada on Alert

Bank of Canada Observes U.S. Economic Strength, Expects Spillover Effects on Canada.

A surprisingly resilient U.S. economy will affect Canadian markets and economic performance this year, say economists.

Last week, U.S. GDP rose 3.3% annually in the fourth quarter of 2023, beating expectations. GDP rose 2.5% last year.

Last week, Bank of Canada Governor Tiff Macklem said global growth has slowed less than expected “largely because of the surprising resilience of the U.S. economy.”

James Orlando, director and senior economist at TD, told that solid and healthy consumer spending is driving the U.S. economy, which has “greater staying power” and is expected to affect Canada.

“When the U.S. does well, Canada benefits. He added spillover effects usually manifest as businesses experiencing strong U.S. demand.

Orlando said that such conditions might favor Canadian exporters to the U.S.

He expects Canada’s GDP to show “substantial weakness,” but the U.S. economy should boost growth.

He said, “It’s providing a nice offset for Canada during a time we really need it most.”

Orlando stated that when Canadian and U.S. central banks boosted rates to lower inflation, U.S. growth may decelerate.

U.S. downturn estimates “keep getting pushed further and further out,” and Orlando doubts it will happen.

Divergent consumer patterns

Last week, BMO Capital Markets senior economist Priscilla Thiagamoorthy wrote that U.S. economic performance normally boosts the Canadian economy, but there is a “diverging growth profile” due to distinct consumption trends.

Q4 spending up 2.8% annually as American shoppers flexed their power. Meantime, Canadians are under enormous pressure, she wrote.

She attributed the discrepancy to 30-year fixed-rate mortgages, which have shielded many homeowners from increased interest rates. In her analysis, Thiagamoorthy predicted “muted consumer spending this year” due to rising mortgage renewal rates in Canada.

Thiagamoorthy told that U.S. household balance sheets “are in much better shape compared to here in Canada.”

“Even when you look at the ratio of personal disposable income, it’s still near a record high here in Canada, whereas the U.S. had a major deleveraging after the financial crisis and that continued,” Thiagamoorthy said.

Central bank rate path

The U.S. Federal Reserve will announce its first interest rate decision of the year on Wednesday after the Bank of Canada held its trendsetting rate at 5% last week.

Both central banks are being watched by economists and markets for indications about rate decreases expected this year.

Abbey Xu, an RBC economist, told that the Federal Reserve will decrease interest rates midyear, relieving consumer pressure.

Xu says this might improve Canadian supply and exports to the U.S.

Orlando stated that the Bank of Canada affects shorter-term interest rates the most, while global financial markets affect bond yields beyond five years.

He predicted U.S. bond yields will fall if the Fed lowers interest rates, which will “spill over into global bond yields,” lowering Canadian bond yields.

The US election

Orlando said the outcome of the U.S. presidential election might affect the Canadian economy.

Orlando noted that Democratic President Joe Biden’s global trade and investment programs, including his investments in green technologies, the climate transition, electric vehicles, and semiconductors, are well recognized.

Orlando said Canada’s federal government has matched investments in area affected by those policies.

Orlando said a second Trump term could push the Canadian government to “(reopen) the playbook” from his last term. Trump is a Republican frontrunner.

Orlando noted that a second Trump presidency could affect foreign trade.

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