TD’s Drake sees Canada surviving

(October 20, 2003) Despite the challenges posed by outbreaks of disease, the blackout and the soaring dollar, the Canadian economy is in pretty good shape, according to Peter Drake, vice-president and deputy chief economist at TD Bank Financial Group.

Drake admits the economy has been hit with some “bad luck” — with the combined effect of B.C. forest fires, mad cow disease and the blackout shaving up to 1.8% off of the GDP growth rate. But he says the fundamentals show Canada is still poised to take advantage of a recovery in the U.S. despite fears that the loonie will become an albatross around the neck of exporters.

“We see the dollar in the mid-seventies, at least for the foreseeable future,” he said. “That’s a good deal higher than it’s been, but it’s not higher than it was for a number of years back in the early 1990’s. I think that is a level that Canadian exporters could adjust to.”

There have been calls for the Bank of Canada to combat the rapid rise in the dollar’s value by slashing interest rates, but so far governor David Dodge has not been willing to go that route.

Drake says it is more likely that as a U.S. recovery strengthens, the U.S. Federal Reserve will raise interest rates by up to 50 basis points, but not before the end of the year. He predicts the Bank of Canada will follow suit.

“At the long end of the market, we’re not expecting [an increase of] more than 60 basis points, probably 130 at the short end,” he says.

Conventional wisdom holds that rising interest rates would stymie the stock market, but Drake says this is not necessarily true.

“To the extent that you do see higher interest rates, that means if you’re a bond buyer, you’d be better to buy it for the coupon, than for the yield,” he says, discounting any potential for capital gains. “So that tends, almost by default, to put us back toward [buying] equity.”

The fly in the ointment remains the reliance on a U.S. recovery. The U.S. economy is out of balance, with consumer spending has remained strong, but business capital investment has remained weak. The consumer accounts for roughly two-thirds of the U.S. economy, so there has been growth, but there is concern that the consumer can only carry the load for so long.

The economy has continued to shed jobs for most of 2003, despite the claim that the recovery is underway.

In Canada, Drake says we have a more balanced economy. Consumers still lead the way, but business investment is not lagging nearly as far behind as in the U.S. There have been only four quarters of negative growth in the past 10, whereas U.S. posted only two positive quarters in the same period.

America’s so-called “jobless recovery” has left investors wary, despite the significant gains made by the markets this year. Drake says investors will likely remain wary until the U.S. appears to be on a stable footing.

“If we see a couple of strong quarters of U.S. growth, I think that would make people believers in a way that they haven’t been up till now,” he says. In the same breath, though, he offers a caveat: “But as an economist, I’m very careful about making short-term market forecasts.”

Filed by Steven Lamb, Advisor.ca, slamb@advisor.ca