Canadians went to the polls on Monday and gave Liberal Party leader Justin Trudeau enough seats to form a majority government after nearly a decade of control by Conservative Prime Minister Stephen Harper. For Canadian capital markets, however, the change is unlikely to be meaningful.
To be sure, Trudeau’s administration will likely loosen fiscal policy slightly, enough to add approximately 0.5% to real GDP. But not immediately: Most of the fiscal stimulus will not hit the economy until the second half of 2016.
The Bank of Canada (BOC) takes fiscal policy as a given when deciding monetary policy, so officially it will continue to base its economic forecasts on the Conservative party’s last budget. In reality, though, BOC Governor Stephen Poloz will understand there is a small positive fiscal impulse that will likely factor into his risk management approach to setting the overnight interest rate.
At the margin, the looser fiscal policy of the Trudeau government should slightly reduce the probability of another 25 basis point cut in the BOC’s 0.5% policy rate.
While Canada’s election and federal politics make for interesting theater, investors should continue to focus on the key drivers of the Canadian economy and financial markets.
- First and foremost is the price of oil. PIMCO forecasts stability around current prices with $5–$10/barrel of upside price potential. This should slow down the economic contraction in the energy sector.
- Second, the non-energy export recovery should continue as the U.S. recovery continues through 2016.
- Finally, with interest rates near historic lows, we don’t see a slowdown in consumer spending or residential investment, even though Canadian consumers are over-indebted. Bond markets can change fast, however, and we will continue to keep an eye on this critical part of the Canadian economy.
Our baseline forecast for the next 12 months is for real GDP to grow 1.5%–2.0% and the Bank of Canada to keep its policy rate at 0.50%. Still, we expect that Prime Minister Trudeau will see bond yields rise, albeit very modestly, during his tenure.