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Highlights:

• Canada’s nominal merchandise trade deficit narrowed to $1.9 billion in January from $3.1 billion in December -but controlling for the impact of prices, the volume balance was unchanged.
• Export and import volumes both declined 4%.
• About half the drop in export volumes came from lower energy shipments but non-energy exports also remained soft.

Our Take:

The headline trade deficit narrowed to $1.9 billion in January from the $3.1 billion shortfall in December but only because of a big 4.3% drop in imports and a big increase in the price of Canadian energy exports. Nominal exports declined 2.1% but controlling for the impact of prices, volume shipments fell 4.0% — exactly matching the drop in import volumes and implying no change in the ‘real’ trade balance. About half of the drop in export volumes overall came from a 12% plunge in energy shipments. Non-energy exports also declined about 2%, though, and were down 4% from a year ago. Some weakness in imports was expected — particularly in machinery imports which were reportedly boosted in earlier months as companies rushed to import some machinery ahead of new environmental regulations that kicked in in January. The drop in in January was nonetheless larger than we previously assumed.

The monthly trade data is notoriously volatile and revision prone but weakness in non-energy export volumes is also not really new. There is little evidence that Canadian exporters are really tapping significantly into improving global trade flows to-date. That won’t provide much in the way of encouragement to the Bank of Canada which has been counting on growth in external demand as the global economy improves to offset an expected pullback in household spending growth as interest rates rise. To be sure, the data hasn’t all been bad. The overall economy still looks to be operating pretty close to capacity — with separately released productivity accounts data this morning showing maybe a bit more upward wage pressure in Q4 of last year than the Bank of Canada has been expecting. Nonetheless, mixed economic reports recently leave little urgency for the central bank to hike interest rates later this morning after the 25 basis point hike at the last meeting in January.

The Bank of Canada today maintained its target for the overnight rate at 1 1/4 per cent. The Bank Rate is correspondingly 1 1/2 per cent and the deposit rate is 1 per cent.

Global growth remains solid and broad-based. In the United States, new government spending and previously-announced tax cuts are anticipated to boost growth in 2018 and 2019. However, trade policy developments are an important and growing source of uncertainty for the global and Canadian outlooks.

In Canada, the national accounts data show that the economy grew by 3 per cent in 2017, bringing the level of real GDP in line with the projection in the Bank’s January Monetary Policy Report (MPR). In the fourth quarter, GDP growth was slower than expected, largely due to higher imports, while exports made only a partial recovery from their third-quarter decline. The gain in imports mainly reflected stronger business investment, which adds to the economy’s capacity.

Strong housing data in late 2017, and softer data at the beginning of this year, indicate some pulling forward of demand ahead of new mortgage guidelines and other policy measures. It will take some time to fully assess the impact of these, as well as recently announced provincial measures, on housing demand and prices. More broadly, the Bank continues to monitor the economy’s sensitivity to higher interest rates. Notably, household credit growth has decelerated for three consecutive months. The implications of the recent federal budget for the outlook for growth and inflation will be incorporated in the Bank’s April projection.

Inflation is running close to the 2 per cent target and the Bank’s core measures of inflation have edged up, consistent with an economy operating near capacity. Wage growth has firmed, but remains lower than would be typical in an economy with no labour market slack. Inflation is fluctuating because of temporary factors related to gasoline, electricity, and minimum wages.

In this context, Governing Council maintained the target for the overnight rate at 1 1/4 per cent. While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target. Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.

Information note

The next scheduled date for announcing the overnight rate target is April 18, 2018. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR at the same time.

Canada's trade deficit narrowed to $1.9B in January (previously $3.1B). Imports broadly fell 4.3%, largely driven lower by declines in industrial machinery, equipment, and parts, while exports declined 2.1%, due to declines in the export of passenger cars and light trucks. In real or volume terms, exports declined 3.6% while imports fell 3.9%.

Following two consecutive months of strong increases, imports of industrial machinery, equipment and parts fell 11.3% in January. In addition, the import of logging, mining, and construction machinery and equipment fell 40%. According to Statistics Canada, part of the January decline in imports was likely related to new regulations on off-road diesel engine and machine emissions that took effect at the start of January, which likely limited imports to machinery that met the new standards.

After three consecutive monthly gains, exports fell back in January. Despite a sixth consecutive, price-driven advance in exports of energy products (+2.9% m/m), declines in passenger cars and light trucks (-13.1%) and forestry products and building and packaging materials (-6.6%) helped drag down the headline figure. Statistics Canada notes that atypical plant closures in January were responsible for the decline in imports of motor vehicle engines and parts, while the resumption of the collection of import duties by the U.S. Department of Commerce likely contributed to the decline in export of forestry related products.

Canada's merchandise trade surplus with the U.S. narrowed to $3.1B in January (previously $3.6B), owing to exports falling more than imports. Canada's trade deficit with the rest of the world narrowed to $5.0B (previously $6.6B), as imports fell 8.5% while exports rose a touch (+0.4%).

Key Implications

The January trade data was disappointing, with both export and import volumes declining. While the decline in import volumes was expected after a strong performance in prior months, the trend of weak export numbers pours cold water on the notion that the Canadian economy is rotating away from consumption and housing toward investment and trade. Having said that, some of the weakness in exports is due to temporary factors that should reverse in coming months, and given the volatility in the month-to-month trade data, exports could very well strengthen through the first quarter.

Looking ahead, stronger demand from the U.S. and a sub-80 US cent loonie should provide some support for Canadian exports. But, NAFTA renegotiations pose some risk, and new protectionist rhetoric from the U.S. administration concerning steel and aluminum tariffs only serves to further elevate trade uncertainty.

Later this morning the Bank of Canada is scheduled to announce its decision on interest rates. Given the elevated level of policy uncertainty emanating from the U.S. administration and slowing economic momentum in Canada, the Bank is likely to leave its policy rate unchanged.

Daily Pivots: (S1) 1.2347; (P) 1.2384 (R1) 1.2440; More....

Intraday bias in EUR/USD remains on the upside at this point. Rebound from 1.2154 is in progress to retest 1.2555 high. The corrective structure of the fall from 1.2555 to 1.2154 argues that larger rally is not finished. More importantly, firm break of 1.2555 and 1.2516 long term fibonacci level will carry larger bullish implications. On the downside, below 1.2268 minor support will turn bias back to the downside for 1.2154 instead.

In the bigger picture, key fibonacci level at 38.2% retracement of 1.6039 (2008 high) to 1.0339 (2017 low) at 1.2516 remains intact despite attempts to break. Hence, rise from 1.0339 medium term bottom is still seen as a corrective move for the moment. Rejection from 1.2516 will maintain long term bearish outlook and keep the case for retesting 1.0039 alive. Firm break of 1.1553 support will add more medium term bearishness. However, sustained break of 1.2516 will carry larger bullish implication and target 61.8% retracement of 1.6039 to 1.0339 at 1.3862.

Daily Pivots: (S1) 1.3826; (P) 1.3877; (R1) 1.3939; More....

Intraday bias in GBP/USD remains neutral at this point. Decline from 1.4345 is in favor to extend. Below 1.3711 will resume the fall from 1.4345 through 1.3651 resistance turned support. We'll look for strong support from 38.2% retracement of 1.1946 to 1.4345 at 1.3429 to contain downside and bring rebound. This will be the preferred case as long as 1.4144 resistance holds.

In the bigger picture, as long as 1.3038 support holds, medium term outlook in GBP/USD will remains bullish. Rise from 1.1946 is at least correcting the long term down from 2007 high at 2.1161. Further rally would be seen back to 38.2% retracement of 2.1161 (2007 high) to 1.1946 (2016 low) at 1.5466. However, GBP/USD fails to sustain above 55 month EMA (now at 1.4259) so far. Break of 1.3038 support, will suggest that rise from 1.1946 has completed and will turn outlook bearish for retesting this low.

Daily Pivots: (S1) 0.9369; (P) 0.9394; (R1) 0.9429; More...

Intraday bias in USD/CHF remains neutral at this point. On the downside, break of 0.9321 will indicate completion of the rebound from 0.9186. Intraday bias will be turned back to the downside for 0.9186 first. Break will resume larger down trend to 0.9115 projection level. On the upside, break of 0.9490 will revive the case of near term reversal, on bullish convergence condition in 4 hour MACD. In that case, outlook will be turned bullish.

In the bigger picture, fall from 1.0342 is seen as a medium term down trend. Deeper decline should be seen to 100% projection of 1.0342 to 0.9420 from 1.0037 at 0.9115. Break will target 161.8% projection at 0.8545. In any case, sustained trading above 55 day EMA is needed to be the first sign of medium term reversal. Otherwise, outlook will stay bearish even in case of strong rebound.

Daily Pivots: (S1) 105.82; (P) 106.14; (R1) 106.43; More...

USD/JPY recovers mildly in early US session but momentum has been week. It's also kept comfortably below falling 4 hour 55 EMA. Nonetheless, as it's staying above 105.24 temporary low, intraday bias remains neutral first. Again, as long as 107.67 resistance holds, near term outlook will remain bearish. Break of 105.24 will resume larger decline from 118.65 and target 100% projection of 118.65 to 108.12 from 114.73 at 104.20 next. Firm break there will pave the way to 98.97 key support level and below. However, break of 107.67 will indicate short term bottoming, on bullish convergence condition in 4 hour MACD. In such case, stronger rebound would be seen back to 55 day EMA (now at 108.92) first.

In the bigger picture, current development argues that the corrective pattern from 118.65 is extending. The solid break of 61.8% retracement of 98.97 to 118.65 at 106.48 now suggests that the pattern from 125.85 high is possibly extending. Deeper fall could be seen through 98.97 key support (2016 low). This bearish case will now be favored as long as 110.47 resistance holds.

Dollar is trying to regain some ground in early US session after better than expected job data. But momentum of the greenback is so far very week. Dollar suffered some selling on news of White House top economic advisor Gary Cohn's resignation, due to his opposition to President Donald Trump's steel and aluminum tariff initiative. Global stocks are mixed today, with FTSE trading up 0.2% and DAX up 0.6%, following -0.77% decline in Nikkei. But DOW futures point to sharply lower open. Canadian Dollar continues to trade as the weakest one as markets await BoC rate decision.

Released from US, ADP report showed 235k growth in private sector jobs in February, above expectation of 200k. Prior month's figure was revised up from 234k to 244k. Trade deficit widened to USD -56.6b in January. Nonfarm productivity was finalized at 0.0% in Q4, unit labor costs at 2.5%. From Canada, trade deficit narrowed to CAD -1.91b in January. Labor productivity rose 0.2% qoq in Q4.

EU leaders discussing counter measures to US tariffs

Markets' eyes will stay on when and whether Trump would formally sign the order to impose the 25% tariffs on steel and 10% on aluminum. But for today, focus will turn to EU's plans first. EU leaders are discussing possible counter-measures should the tariffs are imposed. European commission tweeted today that "we have made it clear that a move that hurts the EU and puts thousands of European jobs in jeopardy will be met with a firm and proportionate response".

European Commission Vice President Valdis Dombrovskis said he hoped that the US initiative of steel and aluminum tariffs "will not be followed through." But he also warned that " EU is going to react if these one-sided tariffs are going to be imposed by the U.S." While EU is assessing the options of possible against against US, Dombrovskis emphasized that "we will react in a firm and proportionate way within WTO rules." This is inline with the rhetoric of all other EU officials.

It's reported that EU is considering a 25% tit-for-tat tariff on US goods that worth EU 2.8b, should US imposes the steel and aluminum tariffs.

IMF Lagarde: trade war generally finds losers on both sides

IMF Managing Director Christine Lagarde warned that "in a so-called trade war, driven by reciprocal increases of import tariffs, nobody wins, one generally finds losers on both sides." The macroeconomic impact could be serious especially if other countries were to retaliate. And, notably, she pointed to the most affected by US steel and aluminium tariffs, including Canada, Europe and Germany. She also pointed to China as a case that "some countries in the world that do not necessarily respect the World Trade Organization's agreements".

Released from EU, Euroarea E19 Q4 GDP growth was finalized at 0.6% qoq, 2.7% yoy. EU28 Q4 GDP growth was finalized at 0.6% qoq, 2.6% yoy. In Q4, Estonia ranked top with growth at 2.2%, followed by Slovenia at 2.0% and Lithuania at 1.4%. Greece and Croatia were both at bottom with growth at 0.1%, followed by Italy and Latvia at 0.3%.

Also released in European session, Swiss foreign currency reserves rose to CHF 733b in February, up from CHF 732b.

EU draft Brexit negotiation guidelines reject "mutual recognition

European Council President Donald Tusk is putting forward a draft of Brexit negotiation guidelines. The 6-page document was leaked to Politco. A point to note is that the document rules out UK Prime Minister Theresa May's proposal of "mutual recognition" of standards."

It notes that "trade in services … to an extent consistent with the fact that the U.K. will become a third country and the [European] Union and the U.K. will no longer share a common regulatory, supervisor, enforcement and judiciary framework."

Another point is that financial services is not included in the trade agreement. This certainly disappoints Chancellor Philip Hammond who has been pushing to include it.

Also, the "the European Council has to take into account the repeatedly stated positions of the UK, which limit the depth of such a future partnership. Being outside the customs union and the single market will inevitably lead to frictions.

BoJ deputy nominee Wakatabe: Policy should be date dependent, not date-driven

BoJ deputy governor nominee Masazumi Wakatabe appeared in upper house confirmation hearing today. He said that BoJ has "various things" that can be done under the yield curve control framework. In addition, it can " strengthen its existing tool kit," or even "come up with a new policy". Regarding the 2% inflation target, Wakatable emphasized that the policy is should be data-dependent, not date-driven" and not be bounded by a "set timeframe". He also cautioned that the impact of the sales tax hike in fiscal 2019 should be watched closely. Another deputy nominee Masayoshi Amamiya said there is still a distant to the 2% target and BoJ needs to continue with powerful easing.

Released from Japan, leading indicator dropped to 104.8 in January, down from 107.4.

RBA Low: No strong case for a near term hike

RBA Governor Philip Lowe expressed his optimism on the economy and said it's going to be "stronger" in 2018. He pointed to better business conditions "at any time since before the financial crisis." The economy is "moving in the right direction" and it's likely that the next move in interest rates is "up, no down". However, the board does not see a strong case for a near-term adjustment of monetary policy", thanks to slow progress in unemployment and inflation.

Regarding the steel and aluminum tariffs of the US, Lowe slammed it as "highly regrettable and bad policy". He added that "history is very clear here. Protectionism is costly." If it's confined to steel and aluminum tariffs, Lowe believed "it's manageable for the world economy." However, he warned that "this could turn very badly, though, if it escalates."

Australia GDP grew 0.4% qoq in Q4, below expectation of 0.5% qoq and slowed from prior 0.7% qoq. RBA is generally expected to keep rates on hold throughout 2018, except that NAB predicts one hike. Slowing growth figure in Q4 and risk of trade wars would add to the case for RBA to stand pat.

USD/JPY Mid-Day Outlook

Daily Pivots: (S1) 105.82; (P) 106.14; (R1) 106.43; More...

USD/JPY recovers mildly in early US session but momentum has been week. It's also kept comfortably below falling 4 hour 55 EMA. Nonetheless, as it's staying above 105.24 temporary low, intraday bias remains neutral first. Again, as long as 107.67 resistance holds, near term outlook will remain bearish. Break of 105.24 will resume larger decline from 118.65 and target 100% projection of 118.65 to 108.12 from 114.73 at 104.20 next. Firm break there will pave the way to 98.97 key support level and below. However, break of 107.67 will indicate short term bottoming, on bullish convergence condition in 4 hour MACD. In such case, stronger rebound would be seen back to 55 day EMA (now at 108.92) first.

In the bigger picture, current development argues that the corrective pattern from 118.65 is extending. The solid break of 61.8% retracement of 98.97 to 118.65 at 106.48 now suggests that the pattern from 125.85 high is possibly extending. Deeper fall could be seen through 98.97 key support (2016 low). This bearish case will now be favored as long as 110.47 resistance holds.

Economic Indicators Update

USD/JPY slightly higher as ADP job report beat expectation.

ADP Feb: 235k vs exp 200K  vs prior 244k

But it remains to be seen if USD/JPY could sustain gain.

USD/CAD has posted gains in Wednesday session, erasing much of the losses seen on Tuesday. Currently, USD/CAD is trading at 1.2927, up 0.40% on the day. On the release front, today’s key event is ADP nonfarm payrolls, which is expected to drop sharply to 199 thousand. In Canada, the trade deficit is expected to narrow to C$2.5 billion. As well, the Bank of Canada will set the benchmark rate, which is expected to remain pegged at 1.25%.

The Federal Reserve is widely expected to raise rate four times in 2018, but the Bank of Canada will likely be unable to compete with that kind of pace. The BoC is concerned with economic growth, which slowed in the fourth quarter, as well as uncertainty over NAFTA, which could fall apart if the Trump administration makes good on its threat to withdraw if its demands for more favorable treatment for US goods is not met. The Bank is not expected to raise rates before May, and if the Fed outpaces the BoC on the rate front, the Canadian dollar could lose ground to a more attractive US currency.

The Canadian government is seeing red after President Trump has threatened to impose stiff tariffs on Canadian steel imports. Canada is the top exporter of steel to the US, accounting for some 16% of US steel imports. The “tariff tussle” could prove to be a major irritant in US-Canada relations, and has weakened the Canadian dollar, as USD/CAD broke above the 1.30 line on Monday, for the first time since late June. Trump is facing strong opposition to the move from Republican lawmakers, and has held out a carrot to Mexico and Canada – if a new NAFTA deal is reached, both countries would be exempted from the tariffs. Canada’s steel industry is a crucial backbone of the economy, and if the US does slap on the tariffs, it could ignite a trade war with Canada and other US trading partners.