North American Outlook
October 05, 2020 | 16:27
Rocky Recovery Stays On Track
While the U.S. recovery was impacted by the summer flare-up in virus infections, it continues to make headway. Meantime, Canada's economy is doing better than expected amid hefty fiscal policy support, but the recent upturn in infections highlights downside risks to the outlook.
We raised our GDP forecast modestly, with smaller declines of 5.6% and 4.0% expected for Canada and the U.S. in 2020, followed by solid rebounds of 6.0% and 4.0% in 2021.
The Fed's shift to average inflation targeting will likely keep policy rates historically low even when the jobless rate falls to low levels. The Bank of Canada is also expected to keep policy rates near zero until 2024.
The economic recovery is proceeding about as well as could have been hoped for several months ago. There is more evidence of a K-shaped recovery, with the various industries following widely different paths. The recovery still has a long way to go and is at the mercy of the virus, with the level of uncertainty ratcheting higher on news of President Trump's illness.
Though leveling off, the still-high rate of U.S. infections is worrisome. Several other countries that previously had their outbreaks under control, including Spain, France and the U.K., are also seeing a jump in cases and are imposing new restrictions on activity. Canada's daily infection rate has turned higher, forcing Quebec and Ontario to apply new restrictions on restaurants and bars (including, a one-month ban on indoor dining in Montreal and Quebec City) and limits on social outings. While the increased precautions will dampen activity, we are not assuming a return to the broad-based shutdowns that sank the economy in the spring.
U.S. GDP contracted less-than-feared in the second quarter, but by a still horrific 31.4% annualized, the worst quarter in the postwar era. Since the shutdowns ended in May, most sectors have rebounded nicely, and payrolls have recovered just over half of the earlier 22 million layoffs. Retail sales are above pre-virus levels, while home sales are at 14-year highs. However, data on retail mobility suggest some slowing in response to new rules on bars and dining and an increase in consumer anxiety. Some industries continue to struggle, including personal care which is still operating 40% below pre-pandemic levels. Still, the overall positive data, notably on consumer spending, has led to an upward revision in our U.S. growth call to 30% annualized in Q3, and we now see a somewhat lesser 4.0% contraction in 2020. While growth will likely downshift to just 1.5% in Q4 on fading support for jobless workers, a brisk 4.0% rebound is still expected in 2021.
Canadian GDP plunged a record 38.7% annualized in Q2, largely as expected. Led by a V-shaped snapback in retail spending, auto sales and housing activity, GDP looks to have retraced three-quarters of its 18% decline during the shutdowns, and is now about 5% below pre-virus levels. We raised our Q3 growth call to 46% annualized and now see a somewhat lesser 5.6% decline in 2020. A 6.0% snapback is still expected in 2021.
Both housing starts and sales have shot above pre-virus levels. Besides record-low mortgage rates and first-time-buying millennials, sales have been propelled by teleworkers seeking roomier and less expensive homes in the suburbs. Earlier hot-spots Ottawa, Montreal and Toronto are picking up where they left off before the pandemic, with August annual price gains all in the double digits and even faster gains across Southwestern Ontario. We still expect growth in home sales and prices to cool in the face of ebbing pent-up demand, high joblessness and a 63% y/y decline in immigration in July. However, calls by some analysts for a major correction now seem widely off base.
Despite the rebound in activity, millions remain out of work. In Canada, only 63% of the 3 million workers let go during the shutdowns have regained employment to August, while the ratio is even lower in the U.S. at 52% (to September) of 22 million layoffs. Unemployment rates, though falling, remain high at 10.2% in Canada and 7.9% in the U.S., and could still average 8.0% and 6.7% next year. A unique feature of this recession is that layoffs are mainly concentrated among lower-paid workers in the hospitality, entertainment and personal care sectors, although wage losses have been more than offset by government income supports (another unique feature). Household disposable income spiked higher in Q2 as government transfer payments were more than twice as large as the aggregate loss of worker compensation.
Buoyed by progress on vaccines—at least nine are in late-stage human trials—equity markets have staged a surprising (albeit narrowly-based) comeback, led by tech firms. Corporate credit spreads have unwound over half of their earlier run-up, compelling central banks to pull back on debt purchases. Improved financial conditions will aid the recovery, and Canada will benefit further from rising energy prices (both oil and natural gas), record lumber prices, and higher metal prices (copper is at a two-year peak and gold recently hit new highs).
Fiscal and monetary policies remain highly expansionary. The income-support measures have more than offset the aggregate loss of wages for laid-off workers in the U.S. and Canada. They, along with loan deferral programs, have kept household default rates low in Canada, though the U.S. mortgage delinquency rate has spiked higher. Canada has extended its wage subsidy program to next summer and worker benefit programs well into next year, while easing eligibility rules for EI. The U.S. Congress is working on a fifth relief bill to the tune of at least $1 trillion on top of nearly $3 trillion already in place, albeit talks have been testy. The White House has extended the supplemental UI benefits, albeit at half the former rate of $600 per week, though funding will run out soon barring an extension. The smaller benefits will slow consumer spending in Q4. We assume Congress will eventually cobble together a "skinny bill" that extends income support to jobless workers and loans (mostly forgivable) to hard-hit industries.
Central banks have signaled a willingness to keep the stimulus taps flowing. The Fed has signed up for average inflation targeting, pledging to allow inflation to move moderately above the 2% target for a period, while refraining from tightening policy on the basis of low unemployment alone. We expect the Fed and the Bank of Canada to keep policy rates near zero until 2024.
The outcome of the November 3 U.S. elections will have broad, albeit unclear, implications for the economy. Biden plans to raise taxes on corporations and high-income earners and increase the minimum wage, while spending more on education, health care and the environment, and expanding immigration. However, a significant shift in taxes would likely require a Democratic sweep of Congress. Meantime, a re-elected President Trump would likely focus on tax cuts, deregulation, and trade policy. Regardless of who wins, the next federal government will need to start filling a deep budget hole. Fitch's downgrade of the country's credit outlook to negative (while affirming its AAA rating) is a warning that lawmakers will eventually need to craft a credible path to fiscal sustainability.
Canada's fiscal anchor was also set adrift by the pandemic. With the deficit ballooning to at least $343 billion this year (16% of GDP), and likely much higher due to expanded EI benefits and the new Canada Recovery Benefit, Finance Minister Chrystia Freeland will need to outline a plan to put the deficit on a sustainable footing, or risk further credit-rating downgrades beyond Fitch's earlier move. Attention now turns to a fall budget, though the recent Throne Speech made it clear that the government will continue to spend heavily to support the recovery and on longer-term initiatives such as climate change.