December 11, 2020 | 12:27
Deal or No Deal, for Real
For the first time in months, markets were batted about this week by something other than the virus, vaccine or votes. Instead, looming deadlines for both Brexit trade talks and U.S. fiscal support were the focus of investor minds, interspersed by two blow-out IPOs. On both negotiation fronts, there was a notable absence of progress, posing a real threat of double disappointment versus underlying market expectations. And the net result was a moderately negative tone, halting a near-continuous run-up in markets over the prior five weeks. After hitting a record high above 3,700 on Tuesday, up more than 13% just since the end of October, the S&P 500 stepped back almost 2% this week. In a similar vein, the 10-year Treasury yield peeled back to below 90 bps after seriously flirting with the 1% threshold (or barrier?) last Friday.
Compounding the somewhat downbeat tone to the proceedings was a flash of sour economic news. In a light week for key releases, a big back-up in U.S. initial jobless claims to 853,000 was the first serious sign that the second wave was making an impact on the economy. Markets had become used to a steady diet of better-than-expected data since mid-year, so the rise in claims is notable and potentially a sign that the tide has temporarily turned. Small business sentiment also took a step back last month, though consumer confidence perked up at the start of December perhaps on positive vaccine news (U of M rose to 81.4 from 76.9 in November). Widening restrictions in many states—including California—as well as the rapid rise in virus cases and all related metrics, point directly to some very tough months ahead for the economy. Yet, these darkening clouds are forming at the very moment that Pfizer’s vaccine was first rolled out in the U.K., Canada (next week) and the U.S. (imminently).
How does this complicated and confusing jumble of conflicting forces affect the near-term economic outlook? Well, it just so happens that a variety of forecast surveys was conducted this very week, and the answer is: not much. Consensus calls on 2021 growth and most other key variables have, on balance, barely budged over the past month, even with the vaccine and virus developments. For example, the Blue Chip survey finds that the average view on U.S. GDP growth for this year and next is for -3.5% and +4.0%, respectively. Besides being smack dab on top of our latest call—by accident, not design—the latter figure is precisely unchanged from a month ago. In fact, while 21 forecasters have revised their 2021 call higher in the past month, 20 have trimmed it over the same period, a clear sign of the heavy cross currents at play on the outlook. For the record, we were one of the 7 forecasters who stuck to our guns in the past month (at 4.0%).
But beneath that seemingly placid surface is a lot of churning on the quarterly views, with many busily trimming the near-term outlook while also bumping up the second-half view. For example, we see growth holding up well in Q4 at a 5% clip, mostly thanks to the solid momentum it carried into the quarter. But, with activity cooling notably more recently, as also evidenced by all the real-time indicators, we look for a serious sag in Q1. At this point we are pencilling in a 1% growth rate, before a spring pick-up. A major asterisk to our call, and the consensus, is that most were anticipating some sort of fiscal support, as well as no government shutdown. For example, Blue Chip found that 91% of forecasters are assuming more fiscal support, averaging roughly $1 trln. And, if no such deal is reached, they would cut their growth call by 0.8 percentage points in 2021.
It’s a broadly similar picture in the rest of the advanced world, without the fiscal drama playing out in the background. Consensus Economics finds that the average call on 2021 growth among all the G7 economies has changed very little over the past month, with six seeing revisions of 0.1 ppts or less. Curiously, the U.K. saw the most significant revision, with next year’s growth bumped up 0.6 ppts to 5.3%. Again, this survey was conducted just this week, but was most likely assuming some sort of trade deal with the EU, and not a hard Brexit—which PM Johnson is now loudly warning about. A hard exit would also cause some issues for the EU economy, but the outlook for a 4.7% rebound there next year still seems reasonable, if not even a bit conservative (after a roughly 7% drop this year).
The one G7 economy that saw a (small) downgrade in its 2021 consensus growth outlook over the past month was none other than Canada. The average view for next year is now a 4.7% advance (previously 4.8%), compared with the estimated 5.7% setback this year. Some of that downgrade may simply reflect the weaker-than-expected hand-off from this year—recall that Q3 growth was 7 points below expectations, albeit at a record high of 40.5%. As well, a wave of new restrictions has unfolded over the past month, with Alberta adding on again this week. On the other side, we have also seen another heavy dose of fiscal spending, generally decent recent economic indicators (e.g., last week’s good gain in November jobs), and the vaccine approval just this week. Our view has not changed, and we remain notably above consensus on next year's 5.5% expected growth rate, even with a very challenging backdrop in the weeks ahead.
The Bank of Canada’s language in Wednesday’s Statement apparently saw more positives than negatives from all these various forces. While there was no mention of any change in the official forecast, the tone was mildly upbeat on balance; that was particularly notable amid the rapid run-up in the Canadian dollar in recent weeks. The BoC took a pass on a prime opportunity to talk the loonie back down, likely noting the lack of success by some others on that front (notably the RBA). Accordingly, and with a further rise in oil prices to above $46 acting as a tailwind, the loonie took flight, rising above 78.7 cents (or down to around $1.27/US$) before finally receding somewhat on Friday. Ultimately, we are of the view that consensus is underestimating the potential for Canadian and global growth in the coming year, and are thus constructive on the Canadian dollar. But, at the same time, there’s the ready recognition of serious near-term hurdles—pointedly, U.S. fiscal talks and Brexit—which all markets may first stumble over.
We take a deeper dive into the outlook for the Canadian consumer in this week’s Focus Feature, and a relatively upbeat view on that front is a big reason for our above-consensus call. One unanticipated side effect of the pandemic has been the strengthening of household finances, driven by the overwhelming fiscal response. Largely as a result of a policy-led bump in personal income, household debt to income fell heavily to 170.9% in Q3 from the record 179.0% a year ago. So, yes, while government finances took a tremendous blow this year, the counterpart was an improvement in household balance sheets.
More broadly, Canada’s overall balance sheet managed to strengthen in 2020, and much of that was driven by the remarkable recovery in financial markets this year. An important, but mostly overlooked, economic indicator is Canada’s net international investment position. It emerged this week that Canada’s status as a net creditor strengthened further in Q3 to a record net asset position of $1.17 trln (or just over 52% of GDP). This is a massive turnabout from decades as a big net debtor, which hit its nadir in 1993 when net debt was nearly 50% of GDP. And this steady climb came about even as Canada ran a string of current account deficits in the past decade (which normally boost foreign debt).
How did Canada manage to massively strengthen its overall balance sheet? It’s mostly due to the nature of the assets versus liabilities. Canada has a huge net position in holdings of equities and direct investment (to the tune of $2.3 trln, or roughly the size of GDP), which have mostly thrived in the past decade. Liabilities, meantime, are dominated by fixed income (bonds, money market instruments), with a net debt position of just above $1.1 trln. In turn, the relatively larger international asset position is now translating into a net surplus in investment income this year, for the first time on record.
Fundamentally, this is a powerful long-term positive for the Canadian dollar. While we remain concerned about very real competitiveness challenges, and the world-topping deterioration in the fiscal position, the near-term support factors appear more important than these longer term drags on the currency’s outlook.