September 03, 2021 | 12:42
7 Key Trends in Canada’s Economy
7 Key Trends in Canada’s Economy
The disappointing drop in Canadian GDP for both Q2 and July prompted us to cut our full-year growth forecast by a full percentage point to 5.0%. While that’s still an impressive tally, it doesn’t quite compensate for last year’s steep 5.3% setback, as supply chain issues and ongoing COVID waves have pushed some of the recovery into 2022—when we see still-sturdy 4.5% growth. While the headline GDP results were important, and dominated conversation around the virtual water cooler, there were many other significant developments churning beneath the surface of the Q2 data. Here are seven of the most important:
1. Excess savings remain enormous: One of the main reasons that Canadian GDP took a step back in Q2—and was one of the few major economies to do so in that period—was the third-wave restrictions seen through much of the country. In turn, real consumer spending nearly stalled (up just 0.2% a.r.), with outlays on both goods and services flagging. With spending constrained yet again by the virus and incomes still churning forward (more on that point later), the personal savings rate actually climbed in the quarter to a meaty 14.2% (Chart 1). That’s up from 13.0% in Q1, almost in line with last year’s lofty average reading and roughly 10 times the pre-pandemic level. This further added to the already groaning hoard of excess savings, which we now peg at roughly $270 billion (or more than 10% of current GDP). We continue to believe that this wall of wealth will ultimately boost spending when restrictions recede.
2. Nominal GDP is on a tear: While real GDP was a clear disappointment in Q2, an underplayed element was that nominal spending quietly remained robust. The 7.9% advance ranks as the second strongest of the past decade (aside from the wildness of the past year). And nominal GDP is now essentially back to its pre-pandemic trend (Chart 2). The bad news is the entire spending gain in the quarter was channeled into higher prices (i.e., inflation), and none into volume increases (i.e., real growth). Real GDP remains roughly 2% below pre-pandemic levels and is now almost 5% below trend (or where it would have been had the economy grown at its potential since the start of 2020). Still, rising nominal GDP carries positives, especially when partially driven by rising export prices, as it powers national income and government revenues. For example, this year’s federal budget assumed a solid 9.3% rise in nominal GDP, and a 6% advance in 2022—instead, we are now looking at a 12.5% surge this year and 7% next, which would leave the level of nominal GDP $100 billion above budget projections in 2022. The revenues that flow from that boost would provide additional fiscal room, for either new initiatives and/or a faster decline in the budget deficit.
3. Income growth is (thus) amazingly robust…: As mentioned, even if volumes aren’t rising, prices and incomes are continuing to forge higher. Last year saw the biggest annual rise in personal disposable income (+10.4%) in four decades—in the midst of a deep recession—mostly thanks to massive government support payments. Adjusting for inflation, last year’s disposable income rise was the fastest in 60 years of records (Chart 3). But, critically, disposable income is now poised to add to those spectacular gains, rising in each of the past two quarters and headed for a full-year pace of more than 3%. Wages & salaries are leading the way as government transfers are ebbing somewhat from last year’s wave. After dropping 1.5% last year, employee compensation has fully recovered recession losses and is now almost back to pre-pandemic trends. Given that employment is still 1.3% below Feb/20 levels, this rebound speaks to the fact that job losses have been overwhelmingly concentrated in lower-wage positions. More broadly, overall real gross domestic income rose at a solid 3.6% annual rate in Q2, even as GDP was falling, with the difference thanks to the rise in our export prices (i.e., as a nation we got wealthier even as we produced slightly less).
4. …as are corporate profits: The national accounts measure of corporate earnings may lag well behind the more timely company reports, but it provides a more complete picture of business financial health. And the latest check-up is very positive indeed. The broad “net operating surplus” edged up further in Q2 to record highs and now stands a lofty 68% above depressed year-ago levels. Strong resource prices, economic recovery, and expense controls have helped support the quick comeback in profits, which are headed for roughly a 40% advance for all of this year. Earnings are now running close to 16% of GDP, which is well above the long-term average of just over 12%, but a tad shy of the record highs during the commodity boom of 2004-08 (Chart 4). This solid comeback is powering up a recovery in business investment, which provided one of the rare positive surprises in the Q2 GDP results (up 12.1% in the quarter).
5. Housing remains extraordinarily large as a share of the economy: In stark contrast to the strength in capital spending, residential construction was a big drag on Q2, falling at a 12.4% annual rate. The entire pullback was due to a slide in sales activity, following the unsustainable moonshot in the first quarter of the year. (New homebuilding and reno activity continued to climb in Q2 and are expected to remain sturdy.) Yet, even with the retreat in overall housing activity last quarter, its share of the economy remains massive (Chart 5). In real, or volume, terms, it dipped to 8.3% of GDP from Q1’s record high 8.6% and remains well above long-run norms (of about 7.0%). This suggests that when housing eventually normalizes (assuming it does), it will ultimately shave about 1 percentage point from real growth—although that process could unfold over years. Things get more interesting when the recent explosion in prices is brought into the mix; in nominal terms, housing has barely budged from its all-time high of over 10% of GDP, fully 4 percentage points above long-run averages. And, we would note that this measure is only the “investment” portion of housing and doesn’t take the “consumption” portion into account (that is rents and imputed rent from home ownership). A more complete measure of housing activity would peg it at closer to 22% of GDP, still far above long-run trends of under 16%.
6. The current account seems to have shifted into surplus (on a semi-permanent basis): Completely overshadowed by the downbeat GDP figures, the balance of payments data the previous day provided a generally good news story. The broadest measure of trade—the current account—managed to stay in surplus in Q2, marking the second quarter of black ink since 2008 (Chart 6). There are lots of moving parts behind this improvement, some of which are clearly temporary (the traditional travel deficit of about $10 billion per year has vanished as Canadians remain virtually locked in their country). Some of the changes could either be a passing pandemic phase, or with us for a while, notably the fast swing in the merchandise trade balance into a moderate surplus. Its fate may well hinge on commodity prices (especially energy), and our assumption is that much of this strength will stick—so we look for trade to remain in the black into next year. But then there are also the more permanent, and less heralded, adjustments which have unfolded in recent years, independent of the pandemic. Importantly, investment income has swung from being a big drag on Canada’s balance of payments into a solid surplus position. This reflects the fact that Canadian investment abroad has been focused on equities while foreign investors have focused on buying our bonds—the combination of a plunge in interest rates and powerful corporate earnings have thus been a big positive for Canada’s investment income and the balance of payments. This shift is a fundamental positive for the medium-term outlook for the Canadian dollar.
7. But FDI outflows remain firmly in place: A less positive aspect of the balance of payments picture for the Canadian dollar outlook is the relentless net outflow of foreign direct investment (FDI). From that standpoint, Q2 was fairly typical, with net outflows rising to $10.2 billion, or almost precisely in line with the quarterly average of the past five years (i.e., a net outflow of about $40 billion per year, or just under 2% of GDP). Investment abroad by Canadian firms is down from the lofty levels of a few years ago but is still running at $75 billion in the past four quarters, while inflows from foreign investment remain mired at a relatively low ebb at just below $50 billion (Chart 7). While the four-quarter net outflow of $25 billion is a bit below the five-year norm, FDI continues to flow outward versus a roughly balanced position prior to the past decade. For the Canadian dollar outlook, this shift roughly counters the impressive turnabout in investment income flows.