Political Turmoil Leaves Canadian Economy "Skating on Thin Ice"

According to Bloomberg, the Canadian dollar continued its downward trend, falling below US$0.70 on Tuesday. This marks its weakest level since the onset of the COVID-19 pandemic. The loonie's decline is attributed to Canada's lagging economy and the challenges faced by officials in formulating a response to President-elect Donald Trump's 25% tariff threats. Additionally, Brad Bechtel, Global Head of FX at Jefferies, noted that the GST/HST holiday, alongside the upcoming Christmas season, is expected to contribute to "holiday liquidity." As a result, the currency could potentially weaken in the coming weeks.

The Canadian dollar's decline follows a tumultuous start to the week, marked by the resignation of Finance Minister Chrystia Freeland from Prime Minister Justin Trudeau's cabinet just hours before she was set to deliver the fall economic statement. On Monday, Chrystia Freeland released a letter expressing her opposition to the prime minister's focus on short-term, voter-friendly spending initiatives, such as tax breaks that could further increase the budget deficit.

Currently, Canada's federal budget deficit for the 2023-24 fiscal year stands at an unprecedented $61.9 billion, surpassing the projected figure by $22 billion. Additionally, the total accumulated debt of the Canadian federal government has now reached $1.24 trillion. Despite the looming fiscal challenges, Prime Minister Trudeau is pushing for federal tax cuts on many goods during the Christmas season and plans to distribute rebate cheques of $250 to most citizens. These measures alone are expected to cost the federal budget an additional $6.28 billion, further straining an already stretched fiscal situation.

The Canadian dollar's decline is set against the backdrop of a weakened economy, which remains vulnerable to the 25% tariff threatened by U.S. president-elect Donald Trump. Deutsche Bank strategist Michael Puempel believes that such tariffs are more likely to be implemented amid the current political tensions. Similarly, Jim Caron, chief investment officer of cross-asset solutions at Morgan Stanley Investment Management, noted that the Canadian economy is 'skating on thin ice', deteriorating further under political turmoil. This political climate is adding pressure on the currency, compounded by the Bank of Canada's move to lower borrowing costs, which is expected to widen the interest rate gap between Canada and the U.S.

After Trump's election as President in the U.S., Chrystia Freeland was appointed to lead a cabinet group responsible for developing a strategy in response to U.S. policies. In a Zoom call on Friday, Prime Minister Justin Trudeau informed Freeland that she would be replaced as Finance Minister by Mark Carney, the former governor of the Bank of Canada and Bank of England.

Source: Bloomberg, The Globe And Mail, CBC News