Special Report
July 30, 2021 | 14:57
The Pandemic in the Rear View
Economics
Economics
Highlights
|
Healthy DemandThe past 16 months have been a rollercoaster. But the second-half of the ride is proving to be more comfortable for the auto sector. Light vehicle sales in Canada and the U.S. will likely rise 17% (Chart 1) this year, nearly returning to their pre-pandemic levels. The ability of households and dealers to adapt during the pandemic has been impressive. Light vehicle sales have been particularly strong in the U.S., where through 2021H1, they were slightly above 2019H1. Meanwhile, in Canada, purchases are down 3.9% in the first half of year versus 2019. |
|
What explains the gap? Canada imposed more restrictions during the second and third COVID waves, which made it harder to make in-person purchases. Most U.S. states also reopened earlier than their Canadian counterparts, bringing more pent-up demand forward. Robust fiscal and monetary support have been key drivers of vehicle sales in both countries during the pandemic, but with the U.S. sending out additional stimulus funds to most households in both January and March, it helped to further accelerate demand. The auto sector has also benefited from the unusual pattern of consumer spending over the last 16 months. With many in-person services unavailable because of the pandemic, consumers channeled some of that forgone spending into other parts of the economy, namely durable goods. Those trends have likely started to reverse, particularly in the U.S., but not enough to supplant the strong consumer demand for new vehicles. The biggest drag on sales in 2021 is actually coming from supply, with semiconductor shortages limiting the available inventory. With 2021Q3 likely to mark the turnaround for auto chip shortages, we see sales continuing to recover through the latter half of this year and returning to pre-pandemic levels in both Canada and the United States in 2022. Fundamentals in the sector are poised to remain healthy over the next few years. As fiscal and monetary support fade later this year, the significant stock of savings that has been built up in both countries will help sustain demand for new vehicles. We also see unemployment rates in each country apporaching pre-pandemic levels by late 2022. As more workers return to the labour market that will also broaden the pool of new vehicle buyers, which has shifted to higher income households during the pandemic. Interest rates over the near-term will continue to be supportive for auto lending. The Bank of Canada is likely to start raising policy rates by the end of 2022, with the Federal Reserve following in early 2023. Population growth has been a key driver of Canadian vehicle sales, and conditional on the country achieving its new elevated immigration targets, it will remain a tailwind for the sector. In the U.S., with the current administration signaling that they are more open to immigration, we could see the weakest population growth in the postwar era improve and become less of a drag on future vehicle demand. Elevated household debt in Canada continues to be the biggest fundamental risk to future auto purchases, but rising home and equity prices have provided households with a bigger cushion against future adverse shocks. The biggest risk for sustaining strong consumer demand in the sector over the near-term is the Delta variant. Further restrictions on activity would slow the recovery, but with high rates of vaccination, we don't anticipate broad restrictions being reimposed in Canada to contain future waves of COVID. In the U.S., with more geographic variance in vaccination rates there could be more of a fallout from Delta, particularly in the South, but the appetite for further restrictions is low in those regions. More economic activity is also generated in those states with higher vaccination rates. While the uncertainty around the future impact of COVID-19 remains high, the sudden turnaround of cases in some advanced economies (e.g., U.K., Netherlands) suggests that broad public health restrictions are unlikely to be necessary to curb its spread. Recuperating Supply |
Auto production has seen significant volatility over the last 16 months. The shutdowns last spring saw production grind to a near halt, and while North American production seemed poised to rebound last fall, shortages of microprocessors cut the supply recovery short. There isn't a simple explanation for why the shortages became so acute this year. The U.S. imposing a 25% tariff on semiconductors from China back in 2018, shifted automaker supply chains away from China. The uncertainty around how sudden the rebound in consumer demand would be also led some producers to cancel their chip orders and delay restarting orders until late last year. These factors meant that there were significant challenges in meeting automaker chip orders with fewer suppliers and more demand from other sectors (e.g., electronics, appliances). Additional waves of the virus also contributed to the supply chain disruptions and may further extend them with the renewed risks from the Delta variant. After production fell 19% across the USMCA countries in 2020, in the first half this year it's running well above last year (+27%), but down 22% compared to 2019H1 (Chart 2). |
|
Supply chain issues have been particularly acute for Canadian producers as GM, Ford, and Stellantis have all had to limit or halt production of certain models this year. Canadian auto production through 2021H1 is tracking 40% below 2019 levels and is just barely ahead of 2020H1, which featured a month of zero production. So far, supply in the U.S. has held up better, as it's down 16% compared to 2019H1, but well above 2020H1 levels. |
The supply shortages have started to impose speed limits on activity in the sector. Over the last few months, sales have struggled to keep pace with elevated consumer demand. U.S. light vehicle inventories fell below their Great Recession lows to under 1.5 mln units in May (Chart 3). The implications can be seen most clearly on prices with new vehicle prices rising 5.3% y/y in the June CPI (Chart 4). With limited inventories of new vehicles pushing more consumers to the used market, prices have soared, hitting 45% y/y in June. Over the near-term, elevated prices could be a drag on sales, but with the excess savings accumulated over the pandemic, households are well-positioned to absorb price increases. Another important factor for used vehicle prices has been the behaviour of fleets. Traditionally, fleets have been net-suppliers of used vehicles. But with buying new models becoming a challenge this year, fleets have instead been turning to the used wholesale market. Early indications are that wholesale prices have started to decline in July from their lofty levels. As fleets pivot back to purchasing new vehicles, that likely will provide further relief to used vehicle prices. It will also help create a soft landing for new vehicle sales as pent-up demand from the retail market fades. Through the first half of the year, fleet purchases in the U.S. were down 40.5% compared to 2019, hinting at there being significant room for the fleet market to recover. Another recent positive development for the sector comes from TSMC indicating that they expect their auto chip shortages to abate in 2021Q3. That will enable producers to ramp up production in the second half of the year and ease the speed limits on sales. It will be no small feat to close the supply gap, as North American producers are short more than 1.6 mln vehicles compared to 2019, and closing that gap would require production to run nearly 20% above normal levels in the second half of this year. Broader shortages of semiconductors are likely to persist into 2022, which highlights that risks to production remain on the downside. |
|
Pandemic Silver LiningsThere have been some bright spots for the auto sector over the last 16 months that suggest the industry is well-positioned coming out of the pandemic. The first of these would be the ability of the sector to adapt. Transitioning more activity online out of necessity accelerated a trend that was already underway prior to COVID-19. During the crisis, that shift helped sustain activity amid public health restrictions, but it also has implications for the future. With more sales originating or transitioning fully online, it provides opportunities for both consumers and dealers to access previously less accessible markets. On the dealer-side, it also provides further opportunities to improve economies of scale. Larger dealer networks will be better positioned to absorb the fixed costs required to sustain a national online presence. The immense fiscal support in Canada and the U.S. during the pandemic will likely prevent a lengthy and sluggish recovery for the sector that we saw after the Great Recession. Retail volumes for auto dealers through the first five months of the year are running more than 20% ahead of the same period in 2019 in the U.S. (Chart 5). The strength of the retail market has been a boon to auto dealers, signaling one of the better years for profits with volumes and prices running high, while incentives have hit 5-year lows. Retail sales haven't been as impressive north of the border, coming in roughly 3% below 2019 levels for auto dealers, but they will likely track upwards with easing supply conditions and more pent-up demand left to absorb. Parts dealers are also seeing increased activity this year with volumes running nearly 13% above 2019 levels in the U.S. and 9% in Canada. Those are healthy volumes that will help the sector recover from a tumultuous 2020. |
|
The re-imagining of the workplace over the last 16 months may provide meaningful benefits to the North American auto market in the years to come. The increased reliance on hybrid work models and the desire for more space has shifted people away from central business districts. That will likely mean increased reliance on personal vehicles for transportation, and we're seeing that reflected in elevated driving activity in both the U.S. and Canada (Chart 6). There is uncertainty over the permanence of work-from-home preferences, but recent survey evidence in the U.S., suggests more than 40% of employees currently working from home would consider changing jobs if it meant maintaining a hybrid work model. That could provide support for higher vehicle use in the future if those trends persist. The Future is ElectricThe last 16 months have reminded us how quickly things can change. The acceleration of the transition to zero-emission vehicles (ZEVs) certainly falls into that category. This year has featured new commitments by governments and producers alike in targeting 2035 as the likely date for new ICE vehicles to be phased out in most markets. But charting the course to reach those goals is harder than announcing them. In 2020, ZEVs made up 3.5% of new vehicle registrations in Canada. That's a far cry from the pace required to hit 100% in 14 years. The largest barriers to adoption include higher upfront costs, a lack of charging infrastructure, and consumer range anxiety. The economics of ZEVs are likely to improve, with larger scale manufacturing and declining battery costs predicted to bring the levelized cost of driving (LCOD), the lifetime capital and operating costs, closer to parity with ICE vehicles by 2030. Policy interventions such as carbon taxes will also nudge the LCOD in favour of ZEVs. But matching the current gas station infrastructure with a similar charging station network will require significant policy initiatives on the part of governments. Building up the necessary transmission lines to make that possible across the U.S. and Canada will also be a major endeavour in the years ahead. Factors can align quickly though, as ZEVs now represent the majority of new vehicle sales in Norway, which has set the most aggressive target for phasing out ICE vehicles. Another hurdle for ZEVs to leap over is the rising share of light trucks over passenger cars in North America. Most ZEVs fall into the latter category, but that represents a smaller fraction of the market today. New models are quickly becoming available, but current regulations for corporate average fuel economy (CAFE) also lessen the incentives for replacing profitable ICE light trucks with electric ones. Since CAFE standards are based on a vehicle's footprint, light trucks are given easier targets to hit than passenger cars, which is one of the reasons why the market has shifted toward larger vehicles over the last decade. One benefit to production, however, will be that increasing ZEV supply in North America may resolve a current issue arising under the USMCA around regional value content (RVC). Canada and Mexico believe that once core parts meet the 75% threshold for RVC, they should be rounded up to 100% in the overall calculation. The U.S. isn't as keen on rounding up and that could see more vehicles facing the 2.5% tariff instead of qualifying under the USMCA. For models that rely on batteries manufactured within the USMCA, the RVC will likely skew higher, and every indication suggests many automakers plan to do so. Bottom Line: Supply shortages will continue to limit sales in the near-term, but will likely abate through the latter half of 2021 allowing sales to sustain their pre-pandemic levels in both Canada and the U.S. |