Resilient and Resurgent Against the Waves: A Canadian Macroeconomic Update

Following a steep decline in real gross domestic product (GDP) in the second quarter of 2020 due to the COVID-19 pandemic, Canada’s real GDP expanded 8.9% in the third quarter of 2020, before rising an additional 2.3% in the fourth quarter to finish the year. Overall, the increase in GDP during the second half of the year illustrates economic reopening efforts and slight growth in employment. As the labour market began to recover and the housing market remained hot, the Canadian economy showed a return to growth in the second half of 2020.

While the economic recovery slowed down in the fourth quarter and has remained subdued thus far in 2021 due to a surge in winter coronavirus cases, there is reason for optimism as the vaccine deployment continues to strengthen in the US, which is a key partner in Canada’s efforts to move past the pandemic.

Labour market slog

• 1 million jobs were gained in the second half of 2020, driven by overall easing pandemic-related restrictions. However, 213,000 jobs were lost in January alone due to winter public health measures.
• As public health measures have increased amid new waves and strains of the virus, 5.4 million Canadians worked from home, up from the previous high of 5.1 million in April. This growth is primarily attributable to shifts in the educational service sector as schools transitioned back to remote learning.
• As employment has decreased in January, the unemployment rate increased for a second straight month to 9.4%. This is still down from 10.9% at the start of the half.
• Sectors with the largest gains in employment in the last half of the year were educational services; professional, scientific and technical services; wholesale and retail trade; and manufacturing. Meanwhile, employment in the business and other support services sector has declined.

Consumption trends

• Household final consumption expenditure fell 5.6% in 2020, driven by spending declines for high-contact activities such as food, beverage and accommodation services; transport; clothing and footwear; healthcare; and miscellaneous goods and services.
• Spending growth occurred for insurance and financial services, communications, furnishings, housing, alcoholic beverages, food, tobacco and nonalcoholic beverages.
• Using credit card spending data from the Royal Bank of Canada (RBC) as a leading indicator for final household consumption expenditure, we can tentatively assume an increase in spending so far in Q1 2021. However, entertainment spending, clothing and apparel and dining show upticks still remaining below pre-pandemic levels.
• Spending has been strongly supported by larger-than-usual government stimulus and income support.

Inflation

• Prices increased 0.6% in 2020, below the target range of 1.0-3.0%.
• So far in 2021, the index is up 1.0% on a YoY basis, exceeding analysts’ expectations. Economists have noted the possibility that inflation reaches or goes above the 3.0% range this spring.
• Regardless, this period of higher inflation is expected to be transitory and is not expected to result in a change to central bank policy or the overnight rate.
• Thus far, price appreciation is strongest for recreation, education and reading products, health and personal care products, housing prices, new passenger vehicles and furnishings.

Building activity

• Total construction spending in Canada increased 26.3% in Q3 2020, before falling 30.0% in Q4 2020.
• Overall, construction activity surpassed pre-pandemic levels in Q3, before falling below the threshold again in Q4.
• With relatively low interest rates, construction spending has rebounded as borrowing costs are low.
• In Ontario, both residential and nonresidential construction activity rebounded significantly in Q3. However, diverging trends came thereafter tracking the broader economy.
• As residential construction activity continued to increase slightly in Q4, nonresidential construction fell again at the end of the year.

Financial markets

• S&P/TSX index produced a price return of 2.2% in 2020, yet a 40.0% return between March 26, 2020 and March 26, 2021.
• Information Technology and Materials posted strong gains in 2020 as e-commerce companies such as Shopify Inc. performed well and gold prices have risen.

Risk ratings

• 2019 risk ratings were close to normally distributed.
• Risk in 2020 was concentrated at the higher end of the scale, with nearly three-quarters of industries having a medium-high or greater level of risk.
• While risk ratings in 2021 have moderated, they remain elevated compared to pre-pandemic levels.
• The risk outlook is expected to improve significantly by 2022, once the economy is fully reopened.

Macro outlook

While the Canadian economy grew during the fourth quarter of 2020, it is clear that the economy will operate below pre-pandemic levels of output until herd immunity is reached. Additionally, the deployment of a coronavirus vaccine will speed up the economic recovery, although Canada depends on outside help for the vaccine.

Since Canada does not manufacture or produce any of the currently available, it is dependent on the efforts of its allies, primarily the US. As a result, the Canadian economic recovery is expected to lag behind the US, which will likely hinder overall business investment and expansion during the first half of 2021.

Regardless, prospects of vaccine deployment and herd immunity have fueled optimism for the Canadian economy. As large swaths of the economy continue to reopen, consumer spending and business investment will begin to recover. Additionally, the lower interest rate environment will continue to aid growth in the residential construction market, while businesses can borrow money at relatively affordable levels.

Sector highlights

• Construction - The Canadian housing market has remained hot, primarily due to a relatively low supply of existing homes. As borrowing costs have remained low via historically low mortgage rates, home prices have continued to tick higher. Nonresidential construction activity has largely diverged from residential construction, as pandemic restrictions limited business activity and are expected to inhibit such activity for an extended period of time.
• Financial and Insurance – Interest rates are expected to remain pinned at the lower bound for several years, posing a threat to industries such as Commercial Banking and Credit Unions that derive a significant portion of their earnings through the net interest spreads between their assets and liabilities.
• Arts, Entertainment and Recreation & Accommodation and Food Services – Activity remains at the mercy of the pandemic. With restrictions on food services not expected to be materially lifted until further in the second quarter and travel remaining meagre due to ongoing border closures, the sectors are expected to continue to lag the broader economy.
• Wholesale Trade & Retail Trade – Government stimulus and income support has enabled recovery in the sectors, though social distancing and capacity restrictions have inhibited activity on the sector despite workarounds such as curbside pick-up and e-commerce.