“It” is the fact that the Canadian dollar is trading near a seven-month low versus the US dollar. The loonie touched an intraday low of USD0.9864 on Tuesday, Feb. 19, its weakest point since a July 25, 2012, close of USD0.9848.
Since reaching a 2012 high of USD1.0326 on Sept. 13 the loonie has depreciated by 4.3 percent versus the buck. The Canadian currency traded as high as USD1.0171 in early 2013 but weakened significantly as January gave way to February and the glow of the last-minute “fiscal cliff” deal in the US wore off, giving way to the potential tarnish of “sequestered” federal budget cuts south of the border.
On Jan. 1, 2013, the US House of Representatives passed the American Taxpayer Relief Act of 2012 (ATRA), which extended certain tax rates, let others expire, and delayed implementation of the automatic spending cuts–widely referred to as “the sequester” or “sequestration”–provided for in the Budget Control Act of 2011 (BCA) for two months.
If not replaced, revised or further delayed, the sequester will happen on March 1, 2013.
ATRA reduced the total amount of the sequestration from USD1.2 trillion over a decade to USD1.176 trillion. Federal spending will be cut by USD85 billion between now and Sept. 30 when the US government’s fiscal year ends. From Oct. 1, 2013, until Sept. 30, 2021, there will be annual cuts of USD109 billion, about 5 percent for non-defense programs and roughly 8 percent for defense programs.
The Pentagon’s base budget would decline to USD491 billion for fiscal 2013, down from USD554 billion for fiscal 2012. This would represent the first cut in defense spending in nearly 20 years. Beginning with fiscal 2014 defense spending will be tied to inflation, which would save about USD500 billion over a decade.
Non-defense cuts would be far and wide, with reductions to: education spending, small business loan guarantees, food safety inspections, mental health block grants, federal law enforcement spending, federal criminal prosecutions, emergency management spending, Internal Revenue Service operations, workplace safety spending and research and development grants from the National Science Foundation, among others.
The USD85 billion in cuts to the fiscal 2013 budget will kick in during the second and third quarters of calendar 2013. The Congressional Budget Office (CBO) estimates that sequestration could result in the loss of 750,000 jobs in 2013. The CBO also forecast a 1.3 percent contraction in US GDP during the six months following its taking effect.
The White House has predicted dire consequences for ordinary Americans, including an increase in homelessness, more criminals going unpunished and long lines at airport screening terminals. At the same time, however, experts on US defense policy have noted that trimming back to a 2007-level Pentagon budget won’t jeopardize national security. A 2007-level budget is still in the neighborhood of USD500 billion.
And USD85 billion represents a small percentage of the overall USD3.6 trillion annual federal budget in the US and an even smaller percentage of the overall US economy. But the US is still Canada’s most important trading partner, and a slowdown even of this scale will undoubtedly weigh on Canada’s exports south of the border.
The CBO in early February estimated that sequestration will slow growth to 1.4 percent and push unemployment up from 7.9 percent to 8 percent by the end of calendar 2013. The CBO also, however, forecast that after coping with federal-spending-cut headwinds the US economy will regain momentum in 2014.
According to its Budget and Economic Outlook for fiscal years 2013 through 2023, released Feb. 5, the CBO expects real growth to return to its potential in 2017. The CBO forecast real GDP to grow at a rate of 1.4 percent in 2013 and 3.4 percent in 2014, with an annual average of 3.6 percent over the 2015-to-2018 period.
Under current law the US budget deficit would fall to USD845 billion this year, the smallest deficit since 2008. This represents 5.3 percent of GDP. “In CBO’s baseline projections, deficits continue to shrink over the next few years, falling to 2.4 percent of GDP by 2015,” the report notes.
“Deficits are projected to increase later in the coming decade, however, because of the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt.”
In addition to hypersensitivity to the potential impact of sequestration, the Canadian dollar is also reacting to the globalization of fears that the housing market in the Great White North is headed for a US-style collapse.
There’s no question a slowdown is underway, but this is largely the result of significant steps taken by policymakers, including new rules for mortgages issued by Canadian Finance Minister Jim Flaherty and jawboning on the threat of rising consumer debt by Bank of Canada Governor Mark Carney.
Canadians have more equity in their homes than did their US counterparts in the years leading up to 2007, and new requirements limit mortgage insurance coverage for loans of 25 years, down from 30. Meanwhile, a 20 percent down payment is and has been the rule, and there is no provision for the deduction of mortgage interest payments from federal tax liability in the Canadian revenue code.
A slowdown is possible. A collapse is unlikely.
Canada is also suffering from a continuing differential between the price of oil produced from its fields versus that pulled from US and other foreign soils. This is the result of a bottleneck at the key Cushing, Oklahoma, hub. But the US Energy Information Administration has solid if unspectacular news on this front as well:
In sum, over the past three years, 815,000 barrels per day (bbl/d) of new pipeline capacity delivering crude oil to Cushing was added. Over the same period, only 400,000 bbl/d of new pipeline take-away capacity was added. During the next two years an additional 1,190,000 bbl/d of pipeline capacity for delivering crude oil from Canada and the midcontinent to Cushing is planned, but this is balanced by 1,150,000 bbl/d of planned pipeline capacity additions to deliver crude oil from Cushing to the Gulf Coast. In addition, about 830,000 bbl/d of new pipeline capacity is planned to move crude oil directly from the Permian Basin to the Gulf Coast, avoiding the congested Midwest. If this capacity is constructed and fully utilized, waterborne imports to the US Gulf Coast, particularly of light sweet crude oil, could drop significantly.
Sufficient capacity to narrow the spread between North American crudes and Brent crude is, in other words, in the pipeline. But it will take a while, perhaps another half decade. The price differential, however, has already narrowed from its greatest level.
Another factor contributing to the acceleration of the loonie’s downtrend since September 2012 is that foreign investors have reduced their holdings of Canadian securities.
Statistics Canada reported this week that in December foreigners reduced their Canadian holdings by CADD1.9 billion, led by the biggest divestment of shares since November 2007 due to cross-border mergers and acquisitions. Foreign holdings of Canadian bonds fell by 0.7 percent, or CAD655 million, the first reduction in six months.
In 2012 foreigners bought CAD83.2 billion worth of Canadian securities, down from CAD97.3 billion in 2011.
The International Monetary Fund (IMF) forecast in its annual report on the country’s economy that Canadian GDP will grow by 1.8 percent in 2013, as the impact of a weak second half of 2012 carried over.
The IMF predicts that GDP growth will accelerate “thanks to the strengthening of the U.S. economy from mid-2013” and reach 2.3 percent in 2014. The Bank of Canada has forecast 2 percent growth for 2013 and 2.7 percent for 2014.
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