Recent fears about the Canadian economy are vastly overblown, according to a new report from BMO Capital Markets.

BMO says that while Canada, and the Canadian dollar, will likely lag somewhat in the year ahead, “underperformance does not equal catastrophe.” It expects that the loonie is likely to soften further, and that Canada will grow more slowly than the U.S. both this year and next, but, “we flatly reject the extreme negativity of many recent analyses — which have mooted everything from made-in-Canada recessions, to a Canadian bond bubble, to a housing collapse (the favourite call among the punditocracy), to a deep dive in the loonie.”

Underlying these views, it reports, are worries about the housing market, household debt, commodity prices, the currency, the trade gap, and the risk of deflation, among other concerns. BMO concedes that there is a “kernel of reality” to each of these factors, “and those kernels are all solid arguments for why Canada is likely to underperform the U.S. economy over the medium term,” it says.

However, BMO stresses that the fact remains that the Canadian economy is highly correlated with the U.S. “Through every kind of weather—depression, war, inflation, commodity boom/bust—the correlation between U.S. and Canadian GDP remains consistently around 0.80,” it says. “With exports to the U.S. now equal to 23% of GDP, that reality is not going to change abruptly.”

“Canada remains among the most levered to the fate of the U.S. as any major economy; it is simply inconsistent to be simultaneously bullish on the U.S. outlook and bearish on Canada,” it argues, pointing out that GDP growth, labour markets, inflation and current account deficits are all in similar conditions on both sides of the border. Additionally, household debt/income ratios are converging, it says, and it maintains that Canada’s housing market is now cooling as expected.

“The outlook for Canada counsels caution, not calamity,” it concludes. “While we do look for U.S. growth to outperform
Canada in the medium term—largely due to the opposite paths for housing—we are fundamentally bullish on the U.S., which ultimately is a big positive for Canada. Similarly, while we expect the loonie to soften somewhat further against the U.S. dollar, we look for it to gain ground against most other major currencies over the next 18 months. Woe Canada? More like, Whoa Canada bears.”