North American Outlook

March 16, 2021 | 12:13

From Herd To Immunity

Economist

Senior Economist and Director
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

Senior Economist and Director
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

Pandemic pain will turn to relief for the economy as the vaccine rollout gains pace and broader immunity is achieved this summer. We have made big upward revisions to our 2021 growth outlook for both Canada and the U.S.

Canada’s economy and currency will get an extra push from higher commodity prices, though the initial slow vaccine distribution puts it at risk of a third wave due to variants.

Even as the economy revs faster, central banks will keep a foot on the gas until the labour market is well on the road to recovery. That should take some steam out of the rapid rise in sovereign yields.

The recent severe wave of the virus has crested, with caseloads falling sharply since January's peak. Restrictions are rolling back, slowly across Canada, more quickly in the U.S., and even fully in some states. Although supply delays slowed Canada’s vaccine program, the arrival of millions of doses and the approval of two new shots will greatly speed things up. Ontario says it could deliver doses to all adults by the first day of summer. Going one better, President Biden wants all willing American adults vaccinated by late May, two months sooner than expected. The ability of vaccines to reduce virus severity should ease strains on the health care system. While more contagious strains risk another wave of cases in the spring, the broader vaccination of high-risk groups will limit the potential for another round of severe constraints on activity.
Economies were surprisingly resilient to the latest round of constraints. This was especially the case in Canada, given more aggressive stay-at-home orders in the two largest provinces. Government support programs and the narrower focus of restrictions on a few sectors explain the economy's resilience. Also, businesses have partly adapted by shifting more sales and work online.
A recovering resource sector and booming housing market helped Canada’s real GDP blast 9.6% higher (annualized) in Q4. Even more surprising in light of tougher restrictions, Statistics Canada estimates that January GDP rose 0.5%, setting the stage for continued growth in Q1 instead of the contraction many had feared. The better data spurred a big revision to our 2021 growth call to 6.0%. This would mark the fastest growth since 1973 and fully reverse last year's losses. Moreover, with households building sufficient excess savings to fuel four-years’ worth of typical consumer spending gains, GDP will likely expand 4.0% in 2022. Improving business sentiment suggests investment spending is also poised to speed up. Meantime, the federal government isn’t about to turn off the spending taps, with up to $100 billion of new spending measures proposed in the fall economic statement.
A modest increase in borrowing costs will have little impact on Canada's housing boom. Existing home sales are at record highs, up 39% in the year to February. With a record-lean 1.8 month inventory, benchmark prices have accelerated 17.3% y/y, nearing the peak of the 2017 frenzy. Unlike then, prices are accelerating right across the country rather than in a few regions. Demand has been driven by millennials and teleworkers, and will get an extra push from the expected rebound of more than one million international migrants in the next three years. The concern now is that escalating prices will fuel speculation and flipping, causing trouble down the road. Even though housing starts are trending at 13-year highs, builders will need to ramp up supply to relieve some of the price pressure. If markets continue to overheat, policymakers could step in with new restraining measures.

Alberta is expected to lead the country with 6.5% growth in 2021 after a similar-sized decline last year. Oil prices have unwound their pandemic losses, as the global economy has partially recovered and OPEC+ nations are committed to restraining supply through April. We moderately raised our WTI price forecast to an average of $60 a barrel in 2021 and $57 in 2022.
The U.S. economy has been no slouch, either, growing 4.1% annualized in Q4 and likely 5.0% in Q1. Generally lighter heath restrictions and a faster vaccine rollout than in Canada, together with bountiful fiscal juice (see below), should fuel 6.5% GDP growth this year and 4.5% next year. The former figure is 2 pts higher than we expected when the year began, and would mark the best year since 1984. Households, flush with savings from rebate cheques and deferred spending, are expected to increase demand at the fastest clip (7%-plus) since 1955. Business investment in machinery and equipment has also powered higher, though commercial structures have lagged due to a less-certain outlook for retail and office segments. Current trends in home sales and price growth are analogous to the mid-2000s’ boom, while construction is at a 15-year peak. While the backup in mortgage rates isn't helpful, the housing market should remain well-supported by strong job growth this year. Meantime, record-low availability of homes will continue to fan prices.
Congress recently passed the $1.9 trillion American Rescue Plan Act that rivals the initial CARES Act at the start of the crisis. We assumed that about 3/4 of the original package would pass, hence the big upgrade to our forecast. The bill, which weighs in at 9% of GDP, includes $1,400 in rebate cheques to most individuals, enhanced child tax credits, a six-month extension of the emergency UI programs and $300 weekly supplement, and substantial aid to state and local governments. And waiting in the bullpen is the President’s American Recovery Plan with its centerpiece of $2 trillion in infrastructure spending, though some funds will be spread over several years and much of the economic punch could be offset by higher taxes for corporations and top-income earners.
Labour markets are taking longer to heal than GDP. Recent data for both countries show payrolls are still more than 6% smaller than before the pandemic. Lower-paid workers have faced the brunt of the losses. While Canada’s household survey posted a big 259,200 bounce in jobs in February that largely retraced the prior two months' losses, the unemployment rate remains high at 8.2% and up from 5.7% a year ago. This survey shows net job losses in the pandemic down a lesser 3.1%, but it doesn't account for fewer multiple-jobs held by one person. U.S. payrolls also came storming back last month as restaurants reopened. Still, the 6.2% jobless rate is well above the half-century low of 3.5% mined a year ago. Speedy employment will drive jobless rates down by year-end, likely to 4.5% in the U.S. and to 7.0% in Canada.
Inflation risks are mounting alongside massive policy stimulus, surging money growth, and rising resource prices. A recent survey of U.S. small firms showed a rising number intend to hike selling prices to cover input costs. However, an expected burst of inflation this spring due to low base effects will likely not be sustained if wages stay subdued due to labour market slack and automation. We expect headline inflation in both countries to trend only moderately above the 2% target in the year ahead.
Due to labour market scarring and low inflation, neither the Fed nor Bank of Canada intend to raise policy rates for some time. However, the stronger growth outlook led us to advance the timing of the initial rate hike to mid-2023 for both banks. Chair Powell has pushed back against speculation of an early QE taper, though he doesn't seem too fussed about the backup in Treasury yields to move in the opposite direction. The Bank of Canada is concerned about "considerable economic slack" and the unpredictable course of the virus. However, it is more likely than the Fed to reduce asset purchases soon due to declining government issuance, a largely technical move. The market consensus sees the Bank lifting rates as early as mid-2022, though we expect a longer pause if inflation stays in check.
The commodities rally and softer greenback have pumped life back into the Canadian dollar, lifting it above 80 cents US (or C$1.25). While we expect the rally in energy and resources to generally lose steam as new supplies emerge, prices should remain high enough to support a further moderate increase in the loonie to 81.3 cents (C$1.23) by late next year.
Two key risks to the economic outlook stem from variants and inflation. So far, vaccines have proven to be effective at reducing the severity of cases even from new strains, though this could change if a more aggressive mutation emerges that's resistant to current shots. As well, as in Europe, Canada's slower vaccine rollout puts it at greater risk of a third wave than the U.S. Italy has returned to lockdown to suppress a recent rise in cases. Meantime, while we aren’t losing sleep over the inflation outlook, the zeal of policymakers to juice this recovery could ultimately spark faster inflation in goods and services instead of just assets. In this event, longer-term interest rates would grind higher, hitting an increasingly indebted economy and governments harder.