North American Outlook
August 18, 2020 | 11:57
Resurgence Risks Recovery
The resurgence of the coronavirus in the U.S. is starting to impede the recovery, implying a downside risk to the outlook should it persist. For now, buoyed by positive data in the early phase of the recovery, we continue to forecast an economic contraction in the range of 5% to 6% this year for the U.S. and Canada, but a sizeable rebound in 2021. Substantial fiscal policy support, rock-bottom interest rates, and improved financial conditions should aid the recovery, though its fate ultimately hinges on the course of the pandemic. |
With the lockdown ending in May, we probably shouldn't be too surprised to see some flare-up in the number of U.S. cases of the coronavirus. As people rushed back to stores, cafes and bars, the virus caught a second wind. But the tripling in the rate of new daily infections since June is alarming, straining hospital capacity in some regions, even as the growth rate has moderated recently. The hope is that increased vigilance and partial restrictions will help suppress the flare-up before it causes more widespread damage to lives and livelihoods. While Canada has kept its infection rate low while moving through various stages of reopenings, it too is seeing some regional increases, as are several other countries (Spain, Japan, Australia) that previously had the outbreak under control. High-frequency data on U.S. retail mobility, credit-card spending, job postings, restaurant dining and other metrics suggest the resurgence in the virus has slowed activity. Consumer confidence has also pulled back. Some states are considering keeping schools closed in the fall, posing challenges for working families. The next few weeks will be a crucial test for the recovery. If restrictions on consumer and business activity are limited to mostly indoor dining, bars, and gyms, then the recovery should move forward, albeit at a slower pace than in the reopening phase. However, if restrictions are applied more broadly and consumer spirits head south, the recovery will be at risk. A vaccine can't come soon enough. More than 20 global efforts are in advanced, large-scale human trials, with a few showing promising results. Still, while infectious disease experts are cautiously optimistic that a safe, effective vaccine might be available by year's end, they also warn there is no guarantee. Buoyed by vaccine hopes, corporate equity and debt markets have staged a remarkable comeback. Technology firms, many thriving from the surge in activity (working, shopping, learning) to the digital world, have driven the NASDAQ to new peaks, while the S&P 500 has erased this year's loss. Corporate credit spreads have unwound more than half of their run-up, compelling central banks to pull back on debt purchases. Improved financial conditions will help the recovery, and Canada will benefit further from a partial rebound in oil prices and rising metal prices, including a recent record for gold. |
Prior to the infection flare-up and renewed restrictions in the U.S., the economic data were roundly beating expections. Many indicators, including manufacturing surveys and retail sales, were actually sporting V-shaped patterns. Canadian housing starts and existing home sales have surpassed pre-virus levels, while U.S. new and pending home sales have soared to multi-decade highs. Besides record-low mortgage rates, home sales were lifted by teleworkers seeking roomier, cheaper living space in the suburbs. However, other indicators, including employment, suggest the economy remains in a deep hole. As of July, Canada had reversed just 55% of 3 million job cuts, while the U.S. unwound an even lesser 42% of 22 million job losses. Unemployment rates, though falling, remain high at 10.9% and 10.2%, respectively. The 18% peak-to-trough decline in Canadian real GDP in March and April was four-times worse than in the Great Recession and erased the entire expansion of the past decade. BMO's Canadian Business Activity Index (compiled from ten monthly indicators) suggests the economy has retraced much of its decline, now down just over 5% to July. However, it could take until late 2021 to climb out of this deep hole, longer than it took after the last recession. On a quarterly basis, U.S. real GDP contracted 32.9% annualized in the second quarter after sliding 5.0% in the first quarter. This was the sharpest pullback since a 10% dive in early 1958, when the nation was also in the grip of a pandemic. Canada's economy likely contracted even more in Q2 after sinking 8.2% in Q1, as investment in the energy sector was pummeled by the earlier plunge in crude prices. Statistics Canada's advance estimate of a 5% rise in June GDP puts the quarter on track for a harrowing 40% annualized contraction. With some U.S. states rolling back reopening plans, we lowered our outlook for its growth in the second half of this year, though we raised our call for the first half of next year in anticipation of a vaccine. Overall, we expect the U.S. and Canadian economies to contract 5.0% and 6.0%, respectively, in 2020, before rebounding 4.0% and 6.0% in 2021. Jobless rates will likely remain elevated, averaging 8.0% next year in Canada and 7.0% in the U.S. Until the outbreak is under control, fiscal and monetary policies are likely to stay expansive. Canada has extended its business wage subsidy program until December and its emergency response benefits to laid-off workers by two months. The U.S. Congress is working on additional support measures (the fifth such bill) to the tune of at least $1 trillion (on top of nearly $3 trillion already in place). The White House is trying to extend a scaled-back version of the supplemental UI benefits that expired in late July. If the benefits are cut back to $300 per week from $600, Q3 annualized GDP growth could take an estimated 6 ppts hit. Central bankers have signaled a willingness to keep the stimulus taps flowing and provide additional support when needed. We expect both the Fed and the Bank of Canada to keep policy rates near zero until at least 2023. Meantime, forward guidance and increased asset purchases could be employed to hold down longer-term rates if yields budge from near record-lows. The Fed is also considering a strategic shift toward average inflation targeting, whereby it will keep rates low until inflation moves modestly above 2% for a period to compensate for past undershooting of the target. Besides the pandemic, the economy will need to contend with brewing U.S./China tensions. Previous plans for Phase Two trade talks have stalled, though China still looks to buy $200 billion of U.S. goods over two years as part of the Phase One deal. The outcome of the November 3 presidential and congressional elections will also have a bearing on the economy. Presumptive Democratic nominee Biden pledges to raise taxes on corporations and high-income households, while also spending more on government-provided health care, education, child care, and climate-change policies. He is likely to take a less strident approach to trade talks than President Trump. A Democratic sweep of Congress could usher in stricter rules for the financial and energy industries. Meantime, a re-elected President Trump would likely continue to focus on tax cuts, deregulation, and trade policies. Regardless of who wins the election, the next President will need to address the soaring budget deficit. Fitch's downgrade of the country's credit outlook to negative (while affirming its AAA rating) is a warning that the government will eventually need to craft a credible path to fiscal sustainability. Canada's fiscal anchor was also set adrift by the pandemic. With the deficit ballooning to $343 billion this year or about 16% of GDP, new Finance Minister Chrystia Freeland will eventually need to outline a post-crisis plan to put the deficit on a more sustainable footing, or risk further credit-rating downgrades beyond Fitch's earlier move. |