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China's rise in Covid cases and the Ukraine war mean global supply chains will remain impaired into the second half of the year and there could be longer-term challenges as governments and companies rethink production networks, the chief economist at Canada’s federal trade bank told MNI.
Those forces may overtake some improvement in the last few weeks in the Shanghai containerized freight index and the Baltic dry index, said Stuart Bergman, who has worked at Export Development Canada since 2003 and last month was promoted from deputy chief economist to interim chief.
Exporters tied to global supply chains will “adapt to stay alive” amid other policy fights around building domestic supplies of strategic resources or protectionism, he said. “Restructuring these complex production systems that are straddled across countries if not continents takes time and money, and may not even yield the most efficient outcomes.”
While the mix of upside inflation risks and slower global growth prospects do not yet amount to a stagflation scenario, Bergman said they put the BOC and Fed in a tough spot when it comes to raising interest rates by 50bps at multiple meetings as some investors expect. Rate decisions will be made on a meeting-by-meeting basis, he said, and “I don’t think there’s anything that’s inevitable” on tightening at any given pace.
“They are having to guide us into a soft landing, and it’s not going to be easy,” he said. Elevated household and corporate debt may also deter central bankers from half-point rate hikes though they remain possible, he said.
DOLLAR WEIGHED DOWN
Other upside risks include households flush with savings built up through the pandemic and ready to spend on re-opened services, he said.
One thing that has shown less upside than in past commodity booms is the Canadian dollar. Its under-performance is likely tied to stronger demand for U.S. dollars as a safe haven and fading signs the BOC will hike rates faster than the Fed, Bergman said.
“It’s more of a response to what’s happening out of the world in terms of demand for risk assets, or safe havens versus risk assets. That’s where you’re seeing the strength of the U.S. dollar versus the Canadian dollar,” he said.
Canada's dollar traded at CAD1.25 per U.S. dollar Wednesday in Toronto, about where it was in January before crude oil prices surged as Russia invaded Ukraine. The currency was below CAD1.10 the last time crude was this high around mid-2014, and in 2013 it was stronger than the greenback.
WEAKENED SHOCK ABSORBER
The Canadian dollar will weaken 2 cents this year and regain that loss in 2023 according to EDC's latest forecast, even it sees West Texas oil almost doubling to USD113 a barrel.
The currency's reduced role as an economic "shock absorber" for an economy tied to commodity exports has implications for the BOC. It means more imported inflation and less pain for domestic manufacturers hurt by past currency surges. EDC estimates a USD10 rise in WTI would usually add 3 cents to Canada's exchange rate and gains for other commodities would also lift the currency.
Increased bets on Fed hikes are a secondary force holding down CAD, Bergman said. Canada's benchmark lending rate will probably average 2.3% next year and the Fed's about 2.2%, EDC predicts. The BOC rate will average 1% this year, Bergman said, in line with market predictions for rates to climb consistently this year from today's 0.5%.
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