Capital Expenditure Remains Weak

Soft business investment has been a consistent challenge for monetary policymakers this year.Fed Chair Janet Yellen noted in June that the decline in capital spending might indicate a desire of firms to expand operations at a slower pace. Indeed, the last four FOMC statement have recorded “soft” business fixed investment.

Capital expenditure (real non-residential fixed investment) has weakened over each of the last three quarters, currently down -1% YoY. One particularly worrying issue is that the recent softness in capex has not just been limited to the weakness in the energy sector but has been broad based.

The current-quarter data on capital spending have been mixed so far. “core” durable goods orders were up 1.5% in July, which falls roughly in line with the July ISM Manufacturing reading which printed a strong 52.6 and 56.9 on new orders. However, last week, data showed that the ISM Manufacturing reading fell back into the contractionary ground in August printing just 49.4. Alongside the headline print, new orders fell back to 49.1, falling 7.8 points from the prior reading which marks the sharpest decline since January 2014.

Business Spending Environment Is Problematic

The environment for business investment is challenging for a few reasons. US election uncertainty is likely to keep any new investment delayed as businesses wait to gauge the fiscal policy of the new administration. Furthermore, despite last quarters inventory unwind, business inventories remain in an elevated state. This means that firms will be less incline to spend on new equipment and expanding production. Finally, it seems that surveys on future capital spending are mixed.

The decline in capital spending suggests that US GDP which is already at lows of 1.1% YoY will struggle to rebound much over the remainder of the year.Given the current situation, it seems unlikely that the Fed will raise in September and will instead at least look for Q3 readings before making a judgement.

Data Flash

The Bank of Canada yesterday kept rates on hold in line with market expectations. The BOC continues to anticipate sturdy economic growth in the second half of the year as the economy shrugs off the second quarter dip. However, the BOC is becoming more concerned with the global growth environment, particularly the US. The bank highlighted weaker than expected 2Q performance and a less certain outlook on US business investment.

Looking at the domestic outlook, the bank noted that 2Q exports were weaker than expected, even in light of the special circumstances that affected the data. These same factors, however, are expected to boost growth in H2. The bank noted that Financial risks remain elevated are rising despite some initial signs of “possible moderation in the Vancouver housing market.”

Looking at inflation, the bank noted that the balance of risks is seen as tilted to the downside though inflation is broadly in line with the bank’s expectations at this time.

In all, the meeting was viewed as broadly Dovish for the Canadian Dollar and the focus on a weak US outlook highlights the fragility of the global economy. Despite listing reasons why growth is expected to improve over the remainder of the year, the BOC noted that Q3 and Q4 growth may fall below their July forecasts for growth of 3.5% and 2.8% in Q3 and Q4 respectively.

Yesterday’s central bank meeting will no doubt bring traders’ attention back to the possibility of a further BOC rate cut this year. However, without any further significant disappointment in exports, the BOC is likely to remain on hold but continue with their Dovish tone at meetings, thus keeping the pressure on the Canadian Dollar.

For now, USDCAD is resting on trend line support from the year to date lows. Whilst this area holds we can expect a rotation backup to test recent highs. A break of the trend line, however, opens up a test of next structural support at 1.2760s.