For the Canadian dollar, 2016 has been looking an awful lot like 2015.
Amid prolonged softness in commodity prices, the adverse effects of lower oil prices on the Canadian economy have proved to be more severe and enduring than the nation's central bank anticipated.
The loonie stumbled to a 12-year low relative to the U.S. greenback on Thursday morning in the wake of an abysmal shortened session of trading in China coupled with a fresh leg of weakness in oil and ahead of a speech from Bank of Canada Governor Stephen Poloz.
In "The Return of the Northern Peso"—a note title referencing the Canadian dollar's dog days in the 1990s—TD Senior FX Strategist Mazen Issa asserts that there are still dominoes to fall stemming from the downwards move in the country's terms of trade.
"Canada is progressing through a terms of trade shock as the knock-on effects from the collapse in energy prices continues to resonate," he wrote.
Despite a shock rate cut to kick off 2015, Poloz and the Bank of Canada's Governing Council were optimistic that the nation's economy would weather a period of lower crude prices without too much aggregate damage.
As of April, the Bank was still professing the belief that pain would be short-lived.
"The negative effects of lower oil prices have begun to emerge and seem to be more front-loaded than expected in January," read the Governing Council's Monetary Policy Report. "The Bank’s estimate of real GDP in the first quarter of 2015 has been revised down since the January Report, to essentially no growth, primarily reflecting the pulling forward of the impact of the oil price shock."
However, after a second rate cut in July, monetary policymakers soon started to sing a different, more nuanced tune on the state of the economy.
"Canada’s resource sector continues to adjust to lower prices for oil and other commodities, with some spillover to the rest of the economy," read the September interest rate statement. "These adjustments are complex and are expected to take considerable time."
TD's Issa echoes these sentiments, explaining that the Canadian economy is near the end of the second phase of a three-stage negative sequence in response to the collapse in oil prices:
Broadly speaking, these effects tend to be seen in three stages. The first round is typically marked by the terms of trade shock with a hit to incomes. Capex intentions are typically reduced but a more advanced stage of actual capex reductions begins to unfold in the second round and may also lead to more severe headcount reductions to preserve margins. Households may also liquidate assets at this stage as well. The third round is potentially most severe with a burst of local credit conditions.
The strategist cited tightening credit conditions as evidence that regional economies might be entering into the third stage of the swoon. Moreover, oil companies have to grapple with continued losses on U.S. dollar-denominated debt and the expiration of hedges that helped cushion the blow last year, Issa added.
Meanwhile, the trend annual growth rate of non-energy export volumes, expected to pick up steam in part because of the decline in the currency, slowed significantly over the course of 2015 even once November's better-than-expected trade figures are factored into the equation:
Issa suggests that the nation's non-energy real export gains have been blunted by the widespread currency depreciation relative to the greenback, a structural loss of market share, and the U.S. manufacturing sector's woes, as the supply chain linkages with Canada are vast.
As such, the strategist sees a possibility that the Bank of Canada will have to increase monetary stimulus, perhaps as soon as this month, as the economy waits for greater fiscal spending at the federal level to materialize.
"Though additional cuts may not necessarily be the ideal policy prescription compared to fiscal (which will occur), the Bank may not want to stand idle while conditions deteriorate further," he wrote.
TD anticipates that the Canadian dollar's malaise will continue for three to six months and see U.S. dollar to rise to the mid-1.40s versus the loonie.
"We think the Canadian dollar is vulnerable to acute pressures early this year," concluded Issa.