North American Outlook

June 09, 2020 | 14:43

The Great Reopening

Economist

Director and Senior Economist
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Director and Senior Economist
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Key Summary

The lockdowns have supressed the rate of new infections of COVID-19, though at the cost of an epic downturn in the economy and rise in joblessness

A return to positive job growth in May signals that the recovery has begun, though one that is likely to prove uneven across industries

A faster-than-expected recovery in oil prices brings some much-needed relief to Alberta and other oil-producing regions, as well as to the loonie

The NBER has officially declared that the longest economic expansion in history ended in February, with the downturn beginning in March and, we suspect, ending in April. A return to positive job growth in May signals the recovery is underway after two months of lockdowns to control the outbreak of the coronavirus. Attention now turns to the speed and breadth of the rebound under the threat of a flare-up. Our critical assumption that the restrictions would ease around mid-May was met, with all states and provinces loosening restrictions on non-essential business. We expect a robust recovery to unfold in the second half of the year. However, it could take two years before employment returns to pre-virus levels. Barring a vaccine, the virus' legacy will linger much longer than the pandemic itself.
The lockdowns and social-distancing measures have slowed the growth rate in daily infections to about 1% in the U.S. and Canada from more than 30% in mid-March. However, we are monitoring an upturn in infections in several states, reflecting increased testing and relaxed social distancing rules. More encouraging is that the death rate continues to trend down, and the nation's hot-spot, New York, is seeing a steady decline in hospitalizatons.
The lockdowns took a crushing toll on the economy, unrivaled in the post-war era. Canada's real GDP contracted 8.2% annualized in Q1, only modestly better than StatCan's initial estimate. An 11% decline in April GDP could anchor an epic 40% annualized contraction in Q2. The U.S. economy fared only moderately better than Canada, contracting 5.0% in Q1, with weaker imports and firm government spending cushioning the blow. Spending on autos, clothing, restaurants and accommodation was notably weak. For all of 2020, the Canadian and U.S. economies are expected to shrink by 6% and 5.5%, respectively.
The shutdowns led to job losses unseen in modern times. More than than 21 million Americans and 3 million Canadians were laid off in March and April. However, the easing of restrictions, coupled with incentives from government wage-assistance programs, resulted in a 2.5 million increase in U.S. payrolls and a 290,000 rise in Canadian jobs in May. The former pulled the U.S. jobless rate down to 13.3%, while Canada's rate hit a record-high of 13.7%. Still, the pace of rehiring retraced only one-tenth of the earlier losses, a small step on the long road to recovery for labour markets.

The massive policy response is one reason we are on the less pessimistic end of consensus forecasts. The U.S. government's pandemic response is near $3 trillion, or over 13% of GDP, with more than half in the form of direct payment support. Most of the $650 billion in loans allocated under the Paycheck Protection Program (PPP) for U.S. small businesses is forgivable if workers are retained for eight weeks. The program should minimize insolvencies while assuring that furloughed workers are called back soon. As a result of the PPP, as well as the $1,200 one-time payments to individuals, personal income rose sharply in April, despite more than 20 million layoffs that month. Although the PPP expires on July 31, it stands a reasonable chance of being extended, though some senators question the need for additional support. Canada's federal government pledges direct payments to the tune of $153 billion, or 7% of GDP. This includes income support for individuals that should fully compensate for lost wages in the current quarter. Over 8 million Canadians have applied for the $2,000 monthly payment under the Canada Emergency Response Benefit, eclipsing the 3 million laid off workers in March and April.
Besides employment, most other data, including real-time indicators on consumer spending, business activity and driver mobility, suggest the downturn ended in April and that the recovery began in May. The housing market has made decent headway, with U.S. mortgage applications for purchases fully retracing an earlier plunge. In Canada, May existing home sales in several major cities and housing starts bounced higher, though they remain well below pre-virus levels. It was a similar story for auto sales in both countries.
June data will better capture the speed of the economy's reboot. We still expect a forceful recovery in the second half of the year, paving the way for real GDP to expand 6% in Canada and 5% in the U.S in 2021. A spirited rally in equity markets (with the S&P 500 all but erasing this year's losses) and a sharp narrowing in corporate credit spreads suggest investors anticipate a robust recovery.
Along with the improvement in employment and financial conditions, another welcome development is the reversal in oil prices. After turning negative on April 20, WTI prices have bounced to around $38 a barrel as OPEC+ nations agreed to extend output cuts. While that's still down more than 30% from the 2019 average level and not high enough to spur new investment in the sector, the rebound should support the recovery in oil-producing regions.
The oil rally and diminished safe-haven demand for greenbacks have allowed the Canadian dollar to return to pre-lockdown levels, at around C$1.34/US$. However, even if oil prices average $45 next year, as we expect, the currency will be challenged to make further headway given the highly uncertain economic climate.
Despite the expected strong upturn in growth, it could take until early 2022 before the economy fully climbs out of a deep hole. Even a year from now, industries such as airlines, hotels, restaurants and entertainment venues, which account for almost 5% of GDP, could be operating substantially below pre-virus levels. Large cities relying on public transportation could face a daunting challenge getting people back to work or to live in dense areas.
After unleashing asset purchases and new credit facilities to backstop the economy, the Fed and Bank of Canada are expected to hold policy rates near zero until at least 2022. To return inflation to the 2% target, Fed officials will likely consider capping bond yields through a combination of targeted asset purchases (such as committing to buy Treasuries in unlimited amounts to keep yields at low levels) and forward guidance (such as committing to hold policy rates low for a specified period or until a certain economic goal is reached). The Fed has all but ruled out a shift toward negative interest rates.
Economic risks will remain skewed to the downside until a vaccine or treatment is found. Despite the income-support and forbearance measures in place, many companies won't survive the crisis. While insolvencies among Canadian firms and consumers fell sharply in April, this was due to support measures rather than an underlying improvement in financial health. The greater the number of business failures, the larger the number of permanent job losses, which will undercut spending and slow the expansion.
Longer-term risks to the economy stem from eventual fiscal restraint to rein in massive budget deficits. Canada's budget gap could widen from over 1% of GDP to 10%, the largest since at least the mid-1980s. The U.S. federal deficit is expected to balloon from $1 trillion to almost $4 trillion this year, or an eye-popping 18% of GDP. It's of only limited comfort that record-low interest rates will ease the debt-service burden on governments.
The outcome of the November 3 presidential and congressional elections will have a bearing on the policy response to tackling the deficit. Presumptive Democratic nominee Biden will lean toward tax increases for corporations and upper-income households, while a re-elected President Trump would likely rely on cuts to program spending.