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Market Wire: Canadian Dollar Tumbles as Economy Hits a Brick Wall

The Canadian economy expanded at a much slower-than-expected pace in the second quarter, and began to shrink as higher interest rates hit the housing market and weakened consumer demand last month. Numbers released by Statistics Canada this morning show a 3.3 percent quarter-over-quarter expansion in real gross domestic product, up from a revised 3.1 percent in the first three months of the year.

In the second quarter, businesses accumulated inventories aggressively on the back of strong demand, and investment in fixed assets grew at a 14 percent annualized pace, with the oil and gas sector becoming a relative oasis of strength as energy prices moved higher. Factory activity remained robust on strong global demand for tangible products.

Just as in the US, net imports took a negative toll as a 31 percent annualized jump in imports outpaced an 11 percent increase exports through the quarter. Just as in the US, this is best viewed a technical adjustment, reflecting accounting identities more than underlying fundamentals – although it does illustrate an economy that isn’t matching domestic demand with domestic production.

But residential investment plunged at an annualized 28 percent rate in the quarter as house prices weakened, and growth began to decelerate sharply in the early summer.

Output grew just 0.1 percent in June, and a preliminary estimate pointed to a -0.1 percent contraction in July.

Falling real estate prices are reducing withdrawal limits for the millions of Canadians who use their homes as automated teller machines. Debt levels remain spectacularly high, and carrying costs continue to mount. Consumer spending is beginning to deteriorate, raising the likelihood of a recession beginning before the end of the year.

The Canadian dollar fell sharply on the release, down roughly 0.4 percent as we went to pixels.

Barring a violent rally in crude markets, currency is likely to remain on the defensive, trading with a weaker bias as investors turn more skeptical on the growth outlook. Two- and ten-year yields are now firmly below their US equivalents, limiting the extent to which the loonie can make serious headway.

Implied volatility levels are also pointing to downside risks in the month ahead. September has historically been rough for equity markets and the high-beta currencies that follow them.

Karl Schamotta, Chief Market Strategist

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