The US Federal Reserve has finally announced the inception of the long-awaited taper of its extraordinary stimulus. The central bank will start to pare its $85 billion per month bond-purchasing program by $10 billion in January.

As we’ve seen since the Fed first announced earlier this year its plan to eventually curtail the third round of its so-called quantitative-easing program, mere knowledge of its intent alone is enough to cause financial markets to tighten, while having broader repercussions in the global economy, including on exchange rates.

Now that the Fed has finally committed to a concrete action, as opposed to simply jawboning, the question for US investors with Canadian equity holdings is what this move portends for the economy of our neighbor to the north.

While Wall Street has reacted unfavorably to the Fed’s previous efforts to remove stimulus from the economy, the long lead time between the announcement of the Fed’s desire to taper and its actual decision to do so seems to have given traders and investors time to adjust accordingly.

More important, the Fed’s decision is yet another sign of a strengthening US economy, since any curtailment was always conditional upon significant improvements in economic data. And at least for now, it appears the market understands the positive implications of the taper.  

Since the US is Canada’s largest trading partner, a resurgent US economy should finally help Canada transition from an economy dependent on consumer demand to the export-driven economy envisioned by the Bank of Canada (BoC). Indeed, in a recent interview with The Wall Street Journal, BoC Governor Stephen Poloz echoed this sentiment by noting that a taper would occur in the context of a strengthening economy and that Canada would be poised to benefit from that as well.

However, Mr. Poloz cautioned that a US economic rebound alone won’t lift Canadian exports across the board as it’s done in the past. That linkage has been undermined by what Mr. Poloz describes as a “wedge,” and he and his fellow central bankers are still puzzling over it.

Part of the problem is the fact that the period since the global downturn has been more akin to a post-war recovery than a typical recovery following a recession. And Canadian exporters, in particular, suffered mightily during the Global Financial Crisis, with many firms going out of business, while the sector as a whole remains in a deep slump.

The relatively strong Canadian dollar was part of the problem as well, since it undermined the competitiveness of the country’s goods in the global marketplace. But after trading above parity with the US dollar for much of 2011 and 2012, the loonie finally dropped below this key threshold in mid-February. And in the wake of the Fed’s announcement, it recently fell to its lowest level since May 2010, near USD0.935.

Of course, the BoC has also made subtle efforts to engineer a decline in the currency by abandoning its upward rate bias, which suggests at least the possibility of a future cut. As we wrote in a recent update, a “phantom rate cut” can sometimes achieve the same end as an actual rate cut.

But even with a stronger US economy and a weakening loonie, Mr. Poloz is worried that there is still “some unexplained weakness in exports.” He surmises that export firms that survived the downturn are understandably scarred from the experience and are, therefore, waiting to see whether the global economy truly gains traction before investing in growth.

Hopefully, those answers will emerge in the coming months. But circumstances seem to finally be aligning for a rebound in the Canadian economy.