ANALYSIS: How Will Canada Be Impacted by the Global Market Plunge?

A trader works on the floor of the New York Stock Exchange, in New York City on Aug. 5, 2024. (AP Photo/Richard Drew)

The poor performance of foreign stock markets on Monday reflects increasing anxiety about the global economy, which will certainly impact Canada, according to several economists.

“The markets are generally reacting to the idea of a slower U.S. economy, and thus, the impacts you get on the global economy. At the same time, you’ve also had significant drags from a slowing Chinese economy,” said Eric Miller, president and founder of Rideau Potomac Strategy Group.

“The general rule in Canada is when the U.S. does well, Canada tends to do well. And there is a significant amount of concern about the level of public sector indebtedness in Canada.”

Stock markets across the world plummeted on Aug. 5, with the U.S. Dow Jones Industrial Average falling by 2.7 percent as soon as markets opened at 9:30 a.m., while the S&P 500 dropped by 4.1 percent. For the Dow Jones, this was the worst drop since the crash that accompanied the onset of the COVID-19 pandemic back in 2020.

Japan’s Nikkei 225 index fell by around 12 percent the same day, which was its worst drop since the Black Monday crash of 1987. Due to Monday being a holiday, the Canadian TSX was not open.

The plunge came in the aftermath of a U.S. Department of Labour jobs report released last Friday, which showed job growth came in “below expectations” with 114,000 jobs added in July. The report added that an average of 170,000 jobs added per month over the last three months.

Miller said the jobs creation was “still a pretty good performance” although slower than expected.

“When you’ve been in the period of the past years where you’ve seen [200,000] to 250,000 jobs created per month, 114,000 feels like something is going on,” Miller said. “Financial markets are not always good at keeping things in perspective, and they tend to be quite reactive about this type of data and information.”

Another factor is the Bank of Japan’s recent decision to raise its key interest rate to 0.25 percent on July 31, the second increase this year since raising it from -0.1 percent to a range of zero percent to 0.1 percent back in March. The central bank had lowered its key rate below zero in 2016 to try to stimulate the country’s economy. The hike in March ended Japan’s eight-year period of negative rate policy, which impacted traders who had been borrowing the Japanese yen at such low rates.

Miller said this move away from a “zero-bound” monetary policy likely kicked off the plunge.

‘Overreacting’

Livio Di Matteo, a professor of economics at Lakehead University, said the drop in financial markets reflects concerns that the United States may dip into a recession in light of high interest rates and slow recent employment growth.

“Canada has to date been experiencing slow growth and has avoided a recession,” he said. “The impact on Canada may be serious if the U.S. does go into recession, given that they are our major trade partner and take over 70 percent of our exports.”

Miller said it is difficult to draw “firm conclusions” about what will happen with markets until the U.S. Federal Reserve signals whether it will cut interest rates. He said for Canada, uncertainty and potential conflict in the Middle East would also act as a “double-edged sword,” as higher energy prices would benefit oil producers but harm consumers.

“I think it’s just too soon to tell, and what you’re going to see is some efforts on the part of the Treasury Department and others to calm the markets,” he said. “If the U.S. markets calm, Canada will be fundamentally OK in the process.”

Ian Lee, an associate professor at Carleton University’s Sprott School of Business, said global markets are likely “overreacting” to the U.S. jobs report, as the fundamentals of the U.S. economy are still strong. But he said markets were expecting the U.S. Federal Reserve to cut interest rates during its last meeting in July, and if the bank waits too long, it could “tip the U.S. into recession.”

Federal Reserve Chair Jerome Powell previously said the central bank could cut rates in September if the U.S. economy follows its expected path. The Bank of Canada, on the other hand, made two rate cuts in June and July that brought the key rate from 5 to 4.5 percent.

“I think the fundamental [concern] is the U.S. economy, whether it’s going to fall into recession or not. There’s a lot of uncertainty,” Lee said. “The U.S. has been just doing gangbusters since the pandemic. They’ve been outperforming everyone else, outperforming Canada, outperforming Europe, outperforming China. And so it is the elephant in the room.”