What happens to CAD if Canada goes into a recession?

A recession in Canada is a real possibility.  The coronavirus (COVID-19) pandemic and the seventy-three percent plunge in West Texas Intermediate oil prices since September 2018 have knocked the economy for a loop, and the worst is yet to come.

Canada’s Health Minister Patty Hajdu speculated that the COVID-19 outbreak could affect between 30- and 70% of the population.   The Province of Ontario celebrated St Patrick’s Day by declaring a state of emergency. That gave them the power to order restaurants, casinos theaters, and schools to close while banning public gatherings of 50 or more people.   

Small businesses have been crushed.  Retailers are suffering from a lack of shoppers who have been told to stay home and self-isolate.  The Canadian Federation of Businesses said that 40% of businesses reported at 25% drop in sales. The airline and hotel industries have been decimated. 

Ontario also announced a $300 million economic relief plan. 

Other provinces responded in a similar vein as did the federal government.

Prime Minister Justin Trudeau announced a series of stimulus measures to support business and individuals which includes $27 billion in direct aid to Canadians and $55 billion in tax deferrals.

And therein lies the problem.  Where is all the money coming from?  Ontario, which holds the dubious distinction for being the number 1 most indebted sub-sovereign jurisdiction on the planet, is spending another $300 million. Even worse, the Federal government’s budget deficit of $30 billion budget, has exploded to close to $100 billion, thanks to the COVID-19 stimulus plans.

Canada is also suffering from a current account deficit. 

The current account measures the net flow of current transactions, including goods, services, and interest payments in and out of Canada. On February 27, Statistics Canada reported that the current account deficit stood at $45 billion for 2019.  

Economics theory 101 suggests that the “twin deficits,” budget and current account are negative for a currency.  However, the theory is questionable based on the US performance. Nevertheless, Canada is not the US, and the domestic economy was already in a downward spiral before the CVOID-19 outbreak.

The Conference Board of Canada is forecasting real GDP growth at just 0.3% for 2020 due to the coronavirus, the collapse in oil prices, and lingering damage from the rail blockades.  CIBC economists are more pessimistic. They forecast no growth for 2020.   

The risk of a Canadian recession is real.  The economy is vulnerable to weaker than expected global growth, slowing business investment, and a prolonged oil price war.  Slowing consumer spending and higher rising unemployment are other risks.

A Canadian recession will not equate to a sharply weaker Canadian dollar.  FX traders are forward-looking, and recession risks have been front and center for many months.  The Bank of Canada expressed concern about the deteriorating global outlook last October and in January, said that “indicators of the Canadian economy have turned decidedly mixed.” They pointed out that vehicle sales, consumer confidence, and retail sales were weakening.

FX traders took note.  USDCAD drifted upwards in January and February, then soared in March reaching 1.4660 on March 19.  The steep rally was on the back of oil and equities. Saudi Arabia’s oil price war to punish Russia for not cutting production when asked, decimated crude prices in March. The oil price plunge spooked equity traders leading to panic selling on Wall Street and around the world.   Investors, bailing out of foreign assets, including gold, wanted US dollars and sellers became scarce. The financial authorities were caught off-guard and were slow to react. They made amends decisively. The Fed slashed rates by 100 basis points and pumped in $1.5 trillion in additional liquidity, including a new quantitative easing program. On March 20, the G-7 central banks announced additional coordinated liquidity, which should ease the volatility in FX markets.

Those actions suggest that even if Canada slips into a mild recession, the worst may be over USDCAD although it may be choppy in a wide 1.3800-1.4650 range.