Canada’s annualised gross domestic product slipped 0.1% in the first quarter, undershooting market expectations for 1.5%. The print points to a weaker start to the year than forecast and contrasts with the level of growth anticipated by economists.
The miss between the actual outturn and the consensus estimate may feed into near-term assessments of domestic demand and the wider trajectory of economic activity. Attention is likely to turn to whether subsequent data confirm a broader slowdown or reflect a one-off quarterly dip.
Impact On Bank Of Canada Policy And The Canadian Dollar
This surprising economic contraction fundamentally changes the outlook for the Bank of Canada’s policy. We believe the conversation will now shift away from holding rates steady to the timing of the next rate cut. The market was caught off guard, and this data greatly increases the probability of easing monetary policy before the end of the summer.
Given the increased chance of a rate cut, we see significant weakness ahead for the Canadian dollar. The USD/CAD exchange rate has already surged past 1.3800 on the news, a key technical level. We are positioning for further downside in the loonie by purchasing call options on USD/CAD with expirations in July and August.
Investment Strategy Amid Rising Market Volatility
We also anticipate a rally in Canadian government bonds as the market prices in lower interest rates. Yields on the 10-year Government of Canada bond have already dropped 15 basis points this morning. To capitalize on this, we are buying futures contracts on Canadian bonds, expecting their prices to continue to rise as yields fall further.
The Canadian stock market will likely face headwinds from these clear signs of a slowing economy. We are buying put options on the S&P/TSX 60 index to hedge against a potential decline, as recessionary fears could hit cyclical sectors like financials and energy particularly hard. This also provides a way to profit from the almost certain rise in market volatility.
This situation feels similar to the surprise economic data we saw in early 2015, which preceded an unexpected rate-cutting cycle by the Bank of Canada. In that instance, the Canadian dollar weakened considerably over the following six months. We are positioning for a comparable, though perhaps milder, trend to develop through this summer.
