North American Outlook
February 02, 2021 | 12:12
Don't Look Back
The best thing about the past year is that it's over, and the year ahead could be one of the best since the start of the century. More fiscal juice should lift the economy over the second-wave hump and the vaccine rollout will speed up the recovery, though labour markets will take longer to heal.
The U.S. and Canadian economies are both expected to rebound 5.0% in 2021 if the pandemic can be brought under control by the summer.
After entering crisis mode last year, the Fed and Bank of Canada will have a much quieter year, nursing policy rates near zero and allaying upward pressure on longer-term rates.
Following the worst year since 1946, the U.S. economy can only do better in 2021: the question is how much better? With the pandemic raging, the new year has come in like a lamb but should go out like a lion as vaccinations pave the return to some form of normalcy.
The latest wave of the coronavirus surpassed the first wave in daily caseloads and fatalities, compelling many states to renew restrictions on indoor dining, gyms and in-person services. While the constraints were a pale imitation of the spring shutdowns—when factories and schools were shuttered—they could stall GDP in the first quarter after a 4% annualized gain to cap last year. Recent data suggest U.S. consumer spending and job growth have downshifted sharply, though manufacturing and housing markets remain resilient. While case counts have crested and restrictions relaxed recently, the spread of more contagious variants risks a return to restrictions in the months ahead.
Providing timely support, a $900 billion stimulus bill (over 4% of GDP) was passed in late December. It extends support programs for millions of unemployed to early spring, forgivable loans to small businesses (by reopening the Paycheck Protection Program), and moratoriums on tenant evictions (to the end of January, though some state programs last longer). Personal income will jump sharply on $600 relief cheques to most individuals and a $300 weekly top-up payment to the unemployed. We also assume that about half of President Biden's $1.9 trillion package of proposals, which includes an extra $1,400 in rebate cheques and an additional $100 in weekly UI benefits, will be passed in the first quarter. This should keep consumer spending and the recovery advancing in the current quarter.
The COVID clouds should begin to part by early spring. The initial rollout of vaccines was slow but is now gaining pace, averaging over one million daily doses. This will gradually lead to an end to restrictions on activity, while slowly unleashing a year’s worth of pent-up demand for travel, indoor dining, and in-person entertainment. The willingness to spend will be matched only by the ability to shop, as a mountain of excess savings—estimated at $1.5 trillion or 10% of personal spending—accumulated during the pandemic. At the same time, record equity values and double-digit increases in house prices are fanning household wealth, providing more financial fuel. Low interest rates are supporting mortgage refinancings and household borrowing. This should drive a 5.5% surge in real consumer spending in 2021. While home sales are likely to recede from 14-year highs, the housing market should stay strong on shifting demand by teleworkers. House prices will keep rising and residential construction should remain aloft amid the tightest resale market on record and a potential upturn in immigration under a Biden presidency. After contracting 3.5% in 2020, the U.S. economy is expected to grow 5.0% in 2021, marking the best year since 1984.
Powered by the need to expand digital platforms for customers and workers, business spending is rebounding and will receive an extra lift in 2021 from rising commercial construction beyond the already-ample requirement for industrial and warehouse space. Multi-family housing in major cities will get some relief from easing pandemic anxiety, allaying recent downward pressure on rents, notably in San Francisco and New York. But don’t expect office construction to return to pre-virus levels, as some permanent shift toward remote work will reduce long-term demand. More office buildings will be re-purposed along multi-channel lines for working, living, and warehousing. Slower to return will be bricks-and-mortar retail, as millions of converts have taken the online route during the pandemic—e-commerce generated 14.3% of U.S. retail sales in the third quarter, up 3 ppts from late 2019.
The unemployment rate is expected to fall from 6.7% in December to 5.2% by year-end. However, nonfarm payrolls are still down 6.5% (9.8 million) since the start of the pandemic, which is slightly worse than at the lowest point of the Great Recession. It could take a couple of years to fully recover the job losses. As a result, wages and inflation should stay muted. The Fed will keep policy rates close to zero for at least two more years, and could tilt its $120 billion in monthly bond purchases (Treasuries and mortgages) toward the longer end to prevent market rates from rising as the recovery gains steam. We expect the 10-year Treasury rate to rise only about 20 bps to 1.25% by year-end.
Canada's economy is showing surprising resiliency in the face of tougher restrictions, with broad strength in resources, manufacturing and housing markets offsetting weakness in a few industries that are most impacted by the pandemic. Real GDP grew a strong 0.7% in November and Statistics Canada sees a decent 0.3% advance in December, resulting in annualized growth of over 7% in the fourth quarter. Unable or unwilling to travel, dine out, or venture out, Canadians are buying more goods, with anything related to homes or recreation flying off the shelves. While the recovery will hit a major speed-bump and stall in Q1 given extended restrictions in Ontario and Quebec, real GDP looks to rebound 5.0% in 2021 after contracting an estimated 5.4% in 2020. Underpinning the recovery will be fiscal stimulus, supportive financial conditions, pent-up demand for services, high household savings, and a recovering U.S. and global economy.
The economy is set to rebound sharply in the spring and summer. Although some services industries will struggle until most of the population is inoculated (likely by late summer), the goods-producing sector will continue to expand. Although record home sales should simmer down, residential construction is expected to stay aloft given the record-low availability of resale properties. Easing travel restrictions and increased federal targets will spur immigration after a 61% y/y plunge in Q3 slashed Canada's population growth to 0.5%, a third of its previous G7-leading pace and the slowest rate since at least 1947. Recent double-digit gains in house prices and record equity markets will support household wealth and spending. The resource sector, including energy, will shift from anchor to propeller amid broadly stronger commodity prices. Lumber prices have more than doubled in the past year, while crop and base metals prices have also risen sharply. Most importantly, Canada led major countries in the fiscal policy response last year and shows no sign of easing up even with the federal government facing a $382 billion deficit in the current fiscal year (or 17% of GDP). While the deficit is projected to decline to $121 billion next fiscal year (starting April 1, 2021), this figure excludes proposed additional spending of up to $100 billion to support the recovery in the next three years.
Stronger growth, however, won't trigger tighter monetary policy. With permanent job losses accounting for a third of the 1.6 million unemployed, the jobless rate will decline slowly, likely ending the year at a still-high 7.0%. As a result, the Bank of Canada is expected to keep policy rates near zero, while continuing to use forward guidance and bond purchases to limit upward pressure on long-term rates. We expect the 10-year bond yield to rise about 40 basis points to 1.1% by year-end.
After firming modestly in a volatile 2020, the Canadian dollar is expected to strengthen moderately to $1.25 (or 80 cents US) by yearend. That figure is still at or below purchasing power parity, limiting the impact of the appreciation on the economic recovery, though it will keep the trade deficit large. The loonie should benefit from firmer resource prices (WTI oil is expected to average $55 next year) as global demand improves and from further weakness in the trade-weighted greenback (which fell 5% in 2020) as safe-haven demand ebbs.
Even as the pain of 2020 fades, the fog of uncertainty will remain thick. Major downside risks include a possible glitch in the vaccine rollout (say due to safety concerns), an even more adverse mutation of the virus, and the unwinding of fiscal stimulus later this year. Inflation risks are also moving back onto the radar, though we believe elevated unemployment this year will keep an expected modest upward trend in check.
Unlike last year, however, there is more upside for the economy. A smoother rollout of vaccines could lead to earlier herd immunity. As well, flush with savings, consumers could “let loose” after spending a year in COVID prison. A Democrat-led Congress could lead to more U.S. fiscal stimulus than we assume. The Brexit agreement is one less concern for financial markets. While the U.K.'s departure from the EU single market implies new trade issues (such as lengthy border checks), the deal will avoid costly tariffs on most goods between the two regions while helping businesses more confidently plan for the future.