February 19, 2021 | 14:14
The Vaccination Gap and Its Implications
The Vaccination Gap and Its Implications
Douglas Porter, CFA; Robert Kavcic; Erik Johnson; and, Benjamin Reitzes
The ongoing public health crisis remains the linchpin for a broader economic rebound. In Canada, employment is still down more than 850,000 (or 4.5%) from February 2020 levels, but over 70% of that is comprised by two major sectors: hospitality (hotels & restaurants) and trade (retail & wholesale). Similarly, of the nearly 10 million jobs still missing from the U.S. economy, almost 40% are in leisure and hospitality alone. No amount of additional government stimulus will allow those sectors to fully reopen—the game-changer will be broad COVID-19 vaccination. Wider immunity to COVID-19 will enable consumers to shift back to purchasing in-person services, thereby supercharging economic growth in the second half of the year.
The good news is that both countries are on track to vaccinate at least 70% of their adult (over 18) populations this year. So far, the U.S. is rolling out the vaccine at a much faster pace than Canada, even with this week's announcement by the latter of an impending ramp-up in supplies. There is also the stark reality that a significantly larger share of the U.S. population has been infected with the virus, providing at least some limited immunity. Taking these two strands together, it is expected that the U.S. will reach something akin to herd immunity much sooner than Canada. How much sooner could the U.S. hit that point than Canada? And what are the possible economic or financial implications of such a gap?
Possible Timelines on Herd Immunity
With its daily vaccination rate already above 1.6 million doses, the U.S. is poised to reach potential herd immunity thresholds by the end of the second quarter. Vaccine hesitancy looks to be the biggest obstacle in maintaining the rapid vaccination rate once access expands to the wider population. Meanwhile in Canada, with procurement challenges fading, logistic hurdles will take centre stage. Canada will likely be able to vaccinate at least 70% of adults by September (Ottawa’s target), but it will require a herculean effort to get vaccine doses in arms. Even if we assume that only 50% of the promised shipments arrive on schedule, provinces will have to reach vaccination rates of nearly 350,000 doses per day in the summer months.
We are not virologists, but will adopt the rough assumption that we need a bit above 70% of the adult population to receive the vaccine or have had the virus to hit herd immunity. Here are the underlying assumptions we used:
Bottom Line: Both countries appear poised to hit herd immunity this year with the U.S. looking quite likely even by the middle of the year. Canada’s path relies heavily on Q3 seeing a vaccine bonanza. If logistics slip, so will Canada’s timeline. We have abstracted from the possibility that vaccine effectiveness erodes (because of variants) and the possibility of a third wave later in the winter/spring. Weighing the probabilities of these various scenarios, we suspect that the U.S. will reach something close to herd immunity roughly three months ahead of Canada. Now, let’s consider the implications of that gap.
Economic and Financial Implications
Fundamentally, the gap in vaccine timing means the U.S. will be able to reopen earlier than Canada—not necessarily fully reopened, just less restrained. If Canada lags the U.S. in reaching herd immunity by roughly three months, there will be direct and indirect effects on the economy. One mitigating factor, though, is that the U.S. has not been as fully shut down as Canada to begin with, so there won’t eventually be as big a rebound in activity when herd immunity is achieved.
The most direct impact will be a delayed reopening of various sectors under lockdown as a result of the virus. As of 2020Q3, the remaining shortfall of real output in Canadian industries (excluding mining) not yet back to pre-COVID (2019Q4) levels was roughly 3.6% of total real GDP. In the U.S., that figure was a similar (albeit slightly smaller) 3.4% at that point. While there are certainly moving parts within each industry, and some will come back looking different than they did before the pandemic, herd immunity will presumably be the catalyst for these areas of the economy to reclaim pre-COVID levels of output. A three-month lead on herd immunity would effectively give the U.S. economy a three-month head start on reclaiming this lost output.
Our base case economic forecast assumes a later acceleration of growth in 2021 in Canada, partly because of a slower vaccine rollout. For example, the U.S. economy significantly outperforms in the first half of the year as restrictions have come off earlier, including 8.5% annualized growth in 2021Q2; and 7.5% annualized in 2021Q3. In Canada, growth will lag in the first half, but begin to outperform by 2021Q3 and, especially, in 2021Q4 with prints above 7% annualized in the second half of the year. Overall, we look for U.S. GDP growth to average a strong 6% for 2021, compared with 5% for Canada.
The firmer U.S. growth this year is on top of a shallower decline in 2020 activity than Canada experienced. Coming into 2021, real output in the U.S. was 2.5% below pre-COVID levels, while Canada was 3.5% below. Those gaps will close as herd immunity approaches, but the head start on vaccinations in the U.S., as well as less stringent containment measures, should allow pre-COVID levels of real GDP to be reached two quarters earlier, in 2021Q2. This comes as more severely impacted sectors are allowed to quickly return closer to (but not all the way in some cases such as travel) peak levels. In nominal terms, Canada could still be facing a $38 billion annualized shortfall from pre-COVID levels of output (or roughly 1.5% shy) at the same time that the U.S. has fully recovered.
An early taste of that potential relative difference was most clearly displayed in the divergence in the January jobs data, where Canadian employment fell a heavy 1.2% in the month, even as U.S. employment rose modestly. As a result, the unemployment rate in Canada was 3.1 percentage points higher than the U.S. level in the month—this compares with a 2 ppt spread over the past five years. Looking ahead, this divergence could even temporarily widen further amid a faster U.S. reopening. Based on the growth assumptions above, we estimate that Canadian employment could be roughly 300,000 jobs below where it would otherwise be if GDP was keeping pace with the U.S. economy. While this doesn't translate directly to the jobless rate, a rough estimate would leave the unemployment rate around 1 percentage point higher than would be the case if Canadian output was tracking U.S. trends.
Fiscal Costs and Financial Stability
Indirect effects could be seen in areas such as fiscal policy, where earlier herd immunity and a move closer to pre-COVID levels of employment will allow government support programs to begin rolling off, and deficits to narrow. In some areas that are being acutely impacted by the pandemic, such as housing, a longer path to immunity will likely prolong current trends—for example, the extreme tight conditions in the single-detached housing market. Counterintuitively, an end to the pandemic could be what ultimately cools the market, rather than what ignites it. And, a three-month delay in immunity means three more months for business bankruptcies to unfold (though many will be inevitable regardless, given the new normal). In commercial real estate, for example, a longer path to immunity could mean more significant scarring to deal with in 2022 and beyond.
Monetary Policy Implications
The Bank of Canada’s latest policy statement reiterated its commitment to holding policy rates steady at 0.25% at least until 2023 to support the ongoing recovery from the pandemic. However, financial markets are at the optimistic end of that timeline and are pricing the first full BoC rate hike in January 2023. That compares with market pricing for the first rate hike by the U.S. Federal Reserve in early 2024. If the U.S. achieves herd immunity roughly a quarter ahead of Canada, there is the potential for markets to push BoC tightening expectations further out and more in line with the Fed. That, in turn, would drive Canadian short-term bond yields down relative to comparable U.S. Treasury yields.
The BoC will need to taper in the spring, simply due to a coming presumed sharp slowdown in bond issuance by Ottawa (expected to fall roughly $100 bln). This will be a mechanical exercise to better align the bond buying with new supply. The next, and more serious, step in the taper process is a bigger question, but could begin to unfold late this year (with the Fed expected to begin tapering early in 2022). Unless Canada is more than a quarter behind on herd immunity, the lag is unlikely to impact the taper timeline.
A more distant timeframe for the start of rate hikes could also put some modest downward pressure on the loonie. However, if the impact of lagged Canadian herd immunity is largely transitory, as we anticipate, the move in the C$ and relative move in yields could be quickly unwound. A potential offset for the loonie is that a much more robust and rapid U.S. recovery will help further propel commodity prices. On balance, we remain comfortable looking for the currency to average just under 80 cents(US) over the next year.
Bottom Line: As it stands now, we don’t believe that there will be a significant long-term or lasting impact of a relatively slower vaccine rollout on the Canadian economy, but the process is still critical to ensure a strong recovery and limit economic scarring. In the meantime, there will be some short-term negative effect on relative jobs, GDP, government finances, and possibly a short-term weight on the Canadian dollar.