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- Canadian freight rail could grind to a halt due to strike action, possibly as early as August 22nd
- A short-term shutdown should have minimal economic impact, though a more prolonged shutdown remains a tail risk.
- The economic effects of any strikes will intensify over time, with risks that a sustained supply shock triggers a resurgence in price pressures.
- Our base case sees a speedy resolution to the dispute, entailing minimal downside for CAD, but a more prolonged stoppage could lead to significant loonie weakness
Unless agreements with unions are reached, Canadian National Railway and Canadian Pacific Kansas City, which together hold a duopoly over freight rail in Canada, are set to indefinitely halt operations simultaneously for the first time, potentially as early as August 22nd.
A short shutdown should have only a minimal impact on the Canadian economy. Some very rough estimates suggest that strike action would weigh on GDP by about 0.1pp per week in the short term, while inflation would see a modest but temporary uptick. Trucking activity would rise but it cannot replace rail shipments, particularly for bulk commodities, though oil is somewhat less sensitive to a rail strike since the opening of the Trans Mountain pipeline. High levels of inventories should also help to temporarily blunt the immediate impact of transport disruptions.
That said, the effects of a shutdown would be highly non-linear. Strike-related business disruption is typically seen as demand delayed rather than purely demand lost – provided that any shutdown is short in length, given that excess capacity in the system can be used to smooth the impact of supply chain disruption. This becomes less true the longer that any strike action lasts. If the disruption were to drag on, then the reduction in supply would have to be met with a reduction in demand and rising prices.
Highlighting the uncertainty around the potential strike action, sell-side desks are split on the potential impact of the shutdown. Some have suggested that the softer growth profile could see more/faster cuts from the BoC. We take the opposite view.
A short shutdown is unlikely to have sufficient impact to trigger a change in monetary policy approach. A longer strike, however, would see inflation risks come to the fore. We see a non-zero risk that the BoC could be forced to hike rates to contain price pressures under such a scenario, even as the economy sees a sharp economic contraction – though the earliest we are likely to see such a move is the policy meeting on October 23rd.
Given the potential negative consequences of a sustained shutdown, our base case favours a swift resolution to the current standoff as most likely. Moreover, we note that the Federal Government has the power to force the union and railway companies into binding arbitration. From an FX perspective, this should mean only a minimal impact on the loonie, provided that a deal is reached in the next fortnight.
That said, both sides have suggested they remain far apart in their negotiations, while the left-leaning New Democratic Party which is currently keeping the government in power, has called on Prime Minister Justin Trudeau to not intervene. This leaves the prospect of a more sustained work stoppage on the table, with the impact set to be felt on a sliding scale.
Worst case scenario, this would see a sharp spike in inflation that forces the BoC to hike rates, even as the economy falls into recession and other central banks are cutting rates. This eventuality would see significant loonie downside. USDCAD breaching the early COVID-19 highs of 1.46 would not be unreasonable under such a scenario.
Author:
Nick Rees, FX Market Analyst