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May 2020 - Monthly Economic Letter

May 2020
Feature article

The great reboot

After a sudden stop, the economy is headed for a complicated and gradual recovery

Economic upheaval in response to efforts to contain the COVID-19 pandemic came fast: Closures of schools and non-essential businesses, a halt to public events and major changes in the lives of many people.

But while the cessation of activities was rapid, the easing of containment measures will have to be gradual and strategic. Otherwise, we risk going back to square one. This article looks at how other countries are managing their recovery and the latest plans for reopening the Canadian economy.

The battle against COVID-19 in Canada

With the gradual easing of lockdowns, governments will attempt to boost the economy while limiting the increase in new cases of COVID-19 infection.

The progression of infection curves varies between countries and regions with those that have reached a plateau of new infections proceeding with reopening of the economy. For all jurisdictions, it will be important to keep a close eye on the data during reopening because a sharp increase in COVID cases could lead to the reintroduction of containment measures and a delay in the economic recovery.

The growth of new cases peaked in most Asian and European countries between mid-March and mid-April. This was also the case in six Canadian provinces: British Columbia, Saskatchewan, Manitoba, New Brunswick, Prince Edward Island and Newfoundland and Labrador.

The other four Canadian provinces, Quebec, Alberta, Ontario and Nova Scotia, still hadn’t reached peak infection levels. That was also the case in other countries, including the U.S., Mexico and Brazil. Japan was facing a resurgence of infections.

Economies restarting in Asia and Europe

Countries in Asia and Europe faced the crisis before us and thus are a few weeks ahead in their efforts to relax containment measures. The evolution of the situation in these countries will serve as a guide for us in the weeks and months to come.


China was the first to suffer from the spread of the virus but also the first to recover. Masks are now mandatory in public and temperature sensors have been installed at the entrances to stores, factories and restaurants. An app that is mandatory on mobile phones allows for the identification of possible carriers of infection.

While this strict containment model may not be well suited to many other countries, including Canada, it has allowed for a relatively fast recovery in China, including a rebound in manufacturing. Still, Chinese consumers have been slow to resume their spending habits. This apparent drop in consumer confidence could pose a challenge for the recovery if it’s replayed in North America.

Gradual easing in Europe

In Europe, most countries have loosened confinement measures more than in Canada. While approaches differ from country to country, they follow a similar pattern.

In general, manufacturing and construction were the first sectors to reopen, even in the hardest hit countries, such as Italy and Spain.

In retailing, small shops in Germany, Austria and the Czech Republic initially resumed their activities, although with strict health measures in place. Larger shops then gradually reopened their doors. On the other hand, shopping centres remained closed, with the exception of open-air markets.

Although most French people were able to return to work on May 11, bars, restaurants and cafés remained closed. Reopening of these types of establishments was very limited throughout Europe. Austria and Italy are aiming to reopen them in mid-May.

Public gatherings were still mostly banned, but Austria expects them to resume in mid-July, while Denmark and Germany are targeting late summer. The more affected countries will likely wait until autumn.

This gradual easing of restrictions has helped limit infection rates.

A variety of plans across Canada

What’s the situation in Canada? Various governments have begun to announce their plans to ease containment measures. This list is as of May 8 2020.

Alberta, Ontario, Quebec and Nova Scotia—These four provinces were still close to their infection peaks when they made announcements about the gradual resumption of activity.

In Alberta, activity related to agriculture and the oil and gas industry never ceased. Some retailers will be allowed to reopen on May 14 (clothing, furnitures, bookstores). Theatres, recreation centres and gyms will remain closed. Schools will not open before the fall.

In Ontario, the province proposed to restart the economy in three phases, two to four weeks apart. In each phase, more and more sectors will be able to resume operations. However, the initiation of the next stage will require a reduction in the spread of the disease and the province is not ruling out retightening measures, if necessary. The economic sectors affected by this roadmap will be identified in the near future. Ontario schools could reopen in early June.

In Quebec, residential construction and mining activity resumed in April. Retailers with outdoor access reopened on May 4 (May 25 for hard-hit greater Montreal). Some manufacturing companies (by number of employees) and all construction businesses resumed operations on May 11. Various suppliers to these sectors were also able to return to work.

Elementary schools and daycare centres in Quebec were reopened on May 11 (May 25 in greater Montreal, if the situation permits). However, parents were free to decide whether to send their children to school. High schools, colleges and universities will remain closed until September.

In Nova Scotia, construction activity continued this spring, but non-essential services remain closed. Some outdoor activities have been authorized starting on May 1.

British Columbia, Saskatchewan and Manitoba—Infection rates peaked in these three provinces a few weeks ago when the easing announcements were made.

British Columbia had its first positive cases at the end of January and its infection rate reached a plateau by the end of March. Nevertheless, only essential services were in operation in early May. Starting in mid-May, health services and some retailers could resume their activites if they follow the appropriate precautions.

Saskatchewan unveiled a five-phase restart plan. The first phase involves mainly outdoor activities and the work of health care professionals. The second phase, scheduled for May 19, includes retail stores. The third phase would see restaurants and fitness facilities reopen. Arenas, swimming pools and playgrounds could reopen in phase four. Finally, the last phase would see a lifting of restrictions on the size of public gatherings. There are no dates for the phases and the relaxation of measures will depend on the evolution of virus’s spread.

In Manitoba, the reopening of non-essential businesses will occur in several stages: As of May 4, hair salons were allowed to reopen, as were retail stores that met certain safety standards. Other services could resume at the earliest on 1 June.

New Brunswick, Prince Edward Island and Newfoundland and Labrador—These three Atlantic provinces had reported less than one case per million people in the last week.

New Brunswick residents will move through a four-colour process of gradual reopening: Red, orange, yellow and green. Outdoor activities were first allowed with business reopening to be announced later. The reopening of daycares, offices and restaurants are expected in the coming weeks.

Prince Edward Island reduced its restrictions on May 1. The lobster fishery was scheduled to resume in mid-May. Access to the province remained limited for non-residents.

In Newfoundland and Labrador, with the exception of retail and restaurants, there were no mandatory closures of businesses that maintained adequate sanitary measures. The provincial government was aiming to lift the first restrictions on May 11.

What does it mean for entrepreneurs?

After the lockdowns, many uncertainties remain and the road to recovery could be winding. Entrepreneurs should favour the following strategies.

  1. Health remains a priority. To avoid an outbreak of infections in your company, you will need to put in place measures to ensure the health and safety of your employees. You may have to be creative to meet the required two metres of physical distancing.
  2. Your expectations should be realistic. The recovery could be slow, as evidenced by lacklustre household spending data from China. Some sectors will rebound more strongly than others. Some industries may take years to return to their former pace. See the Canadian outlook section for more information.
  3. Online sales have exploded since mid-March. As consumers develop new habits, make sure you have an attractive transactional website. Your future sales will benefit from it.
  4. If your business isn’t allowed to restart immediately, your industry's experience in Europe and Asia may give you an idea of how long it will take in Canada. In the meantime, keep an eye out for available assistance programs, including from the Government of Canada and BDC.
Canadian economy at a glance

Phasing out of the lockdowns: The ABCs of a gradual recovery

The sharpest economic contraction of our lifetimes will be followed by an uneven recovery

COVID-19 has undoubtedly landed a major blow to our economy. Recently released statistics highlight the magnitude of the shock. As the infection curves appear to be flattening, provinces have begun to announce plans to ease containment measures. This article reviews the most recent data on the Canadian economy and provides a snapshot of what the recovery might look like.

Looking back to a healthy economy

Statistics Canada engaged in an unusual exercise last month. The agency provided an estimate of Canadian GDP in March before releasing its estimate for February.

The purpose of this early projection was to try to provide an initial look at the size of the shock following the lockdowns in mid-March. The diagnosis confirmed the economists’ fears. A reduction of nearly 9% in economic activity for the month and 2.6% for the first quarter as a whole. Statistics Canada will revise its estimate at the end of May.

By contrast, the economic picture had been relatively positive in February. Although the economy wasn’t growing, the situation was mainly due to temporary factors—strikes in Ontario, rail disruptions and a reduction in flights from areas already affected by COVID-19.

Despite these events, the economy had grown by 2.2% over the past year. This was a fairly satisfactory performance given trade tensions in recent years and long duration of the economic expansion to that point.

Measuring the extent of the damage

The state of the economy in February 2020 will serve as a measuring stick for the quarters—or years—to come. It will be the level of economic activity that needs to be reached in order to affirm the crisis is largely behind us.

The dimensions of the crisis that hit the economy in March is beginning to be confirmed. Employment data in March were catastrophic—one million jobs lost and an unemployment rate of 7.8%. But even those figures underplay the magnitude of the shock because they didn’t yet reflect the widespread effects of lockdowns across the country. Indeed, the data for the week of April 12 were even worse. 1,993,800 additional jobs were lost, pushing the unemployment rate to 13%, a peak dating back to 1982.

The damage to businesses caused by containment measures is also becoming clearer. According to Statistics Canada, almost half (45%) of firms that reduced their workforce laid off at least eight of 10 employees. Accommodation and food services were the hardest hit. Almost 70% of businesses laid of 80% or more of their staff. More than half of businesses in retail, the arts and health care sectors also laid off more than 80% of their workers.

Jobs more favourable to telework were less affected but not immune to disruption. A quarter of the firms in the professional, scientific and technical services sector that laid off workers also reached the 80% threshold.

So why did the unemployment rate only rise to 13%? The reason is that containment is hitting small and medium-sized businesses disproportionately hard because they face greater liquidity challenges. The new unemployed (which we hope will be temporary) come disproportionately from smaller businesses, with no less than 75% of companies either partially or totally reducing their activities since March, according to a BDC survey.

What will the recovery look like

The same BDC survey indicates that 28 per cent of Canadian entrepreneurs believe it will be difficult to return to a normal level of activity in less than a month. Weak demand for products represents the greatest risk.

This may be a well-founded concern. Early data from China show that demand has been slow to recover, despite the lifting of containment measures (see main article). Chinese consumers remain cautious in response to the COVID-19 crisis and the same trend is likely to occur in Canada.

These are four different scenarios for the economic recovery that entrepreneurs face, depending on their sector of activity.

  1. A V-shaped recovery implies a significant rebound that brings activity back to previous peaks relatively quickly. The manufacturing and construction sectors are good candidates for this kind of rebound because they lend themselves well to physical distancing, as evidenced by their recovery in Europe and Asia.
  2. A U-shaped recovery is characterized by slower progress that takes activity more than a year to return to pre-crisis levels. This scenario seems more likely for sectors requiring a return of consumer confidence. Preliminary economic information from China and Europe indicates that this could be the case for the retail and restaurant sectors.
  3. An L-shaped recovery is the worst-case scenario. It indicates a timid rebound and a level of activity below pre-crisis levels for several years. Businesses in the tourism and consumer events industry could unfortunately follow this path.
  4. A resurgence of COVID-19 cases later in 2020 or 2021 may finally cause a W-shaped recovery for most companies. The three major pandemics of the 20th century were characterized by more than one wave of outbreaks.

The scenario we consider most likely for the Canadian economy as a whole is a cross between the V and U forms. The recovery is expected to be slower overall than a V-shape, but with enough industries showing signs of strength to avoid a painful U-shaped scenario.

What does it mean for entrepreneurs?

The recovery will be gradual and uneven. This has important implications for Canadian entrepreneurs.

  1. Your supply chain may recover with a lag. Before you resume operations be sure to contact your suppliers to minimize bottlenecks.
  2. If you consider a V-shaped recovery unlikely for your business, keep a close eye on your cash flow and stay up-to-date on assistance programs offered by the Government of Canada and BDC.
  3. According to our estimates, 55% of customers have increased their online purchases since the beginning of the crisis. These new habits are likely to continue. A quality website will become even more critical to your success in a post-pandemic world.
U.S. economy at a glance

What the U.S. can tell us about the pandemic’s impact on consumers

Our first hints of how consumer spending has been impacted will come from south of the border

New data is giving us a better picture of the impact of the COVID-19 crisis on the economy. Consumer indicators in the United States come out sooner than in Canada, providing an early look at what’s happening in various industries.

Sharpest economic contraction in eleven years

Two weeks of lockdown helped end the longest economic expansion in modern U.S. history. The U.S. economy dropped 4.8% in the first quarter of 2020, according to early estimates by the Bureau of Economic Analysis. This decline is mainly due to a collapse in consumer spending.

The outlook is even gloomier. Economists expect the contraction for the second quarter of 2020 to be the largest since the years following the Second World War—annualized rates of -30% to -40% are currently the consensus. The Congressional Budget Office (CBO) projects a return to growth in the second half of the year but believes a return to pre-recession economic activity levels will wait until 2022 at the earliest.

More devastation in the job market

Every week since mid-March, millions more people in the U.S. have become unemployed. The country has registered 33.5 million claims for unemployment benefits in the last seven weeks. About 23 million people renewed jobless benefits at the end of April—more than three times the peak reached in 2009.

According to the Bureau of Labor Statistics, 20.5 million jobs were cut in April, following the dismal record of 870 thousand lost in March. The unemployment rate increased from 4.4% to 14.7%.

The gradual reopening of the economy in several states should soon put an end to the hemorrhage, but it will take months before a significant drop in the unemployment rate is observed. The CBO believes the unemployment rate will remain above 10% until 2021.

Business confidence continues to suffer

The Institute for Supply Management’s manufacturing and non-manufacturing indices both plunged and are below the 50 mark, indicating a contraction in economic activity.

The manufacturing index fell from 49.1 to 41.5, the worst score since 2009, while the non-manufacturing index is at 41.8, in contraction territory for the first time in more than a decade.

Several components of both indexes are in freefall. New orders and employment in particular have shown significant declines. These two composite indices would have been even worse if it wasn’t for distortions caused by business shutdowns.

Largest monthly contraction in consumption ever recorded

Consumer confidence also declined in April. The Conference Board index fell to 86.9, the lowest level since June 2014.

How does this loss of confidence translate in the economy? Lockdowns have had two main effects on consumer spending. First, it has made it impossible to buy certain services. Second, the economic uncertainty has encouraged many households to tighten their belts and postpone major purchases.

An analysis of consumption in the most affected product categories provides a guide to which sectors are likely to be most affected in Canada. (Canadian data are released later but are less subject to revision).

Durable goods were the hardest hit in March, down 15%. Vehicles and motor vehicle parts posted the largest decline (-26%), but furniture also fell sharply (-8%).

Non-durable goods increased (+4%), but this was entirely due to higher grocery store purchases of food and beverages (+19%). Sales of clothing and footwear fell almost 30%.

Sales of services fell 9.5%, led mainly by a drop in transportation, recreation, food and accommodation.

It should be noted that most states established containment measures from mid-March onwards and, as a result, April is likely to see an even greater drop in consumption.

What it means for Canada

  1. Significant drops in consumption camouflage growth in online sales. Consumers are turning more to e-commerce.
  2. Demand is down sharply in the durable goods sector. If you are exporting such products to the United States, keep an eye on your inventories.
  3. Different sectors will experience different rates of recovery. If your operations depend on moving merchandise easily across the Canada-U.S. border, you should expect a U-shaped recovery rather than a V-shaped rebound. (See the Canadian section for more information.)
Oil market update

A world awash in oil

Collapse in demand and overflowing stocks had investors paying to be rid of excess oil in April

The price reduction discussed in our last monthly letters continued in April, despite the agreement between OPEC and Russia to slow their production rates.

An unusual event occurred on April 20: Various oil futures contracts traded at negative values, reaching -US$37.63 for WTI and -US$48.38 for WCS. Why were investors willing to pay to dispose of oil? This letter seeks to answer this question.

A matter of supply and demand

As is often the case in understanding economic phenomena, the explanation begins with: It's a matter of supply and demand.

Worldwide, the transport sector accounts for about 70% of oil demand. Lockdowns around the world related to the COVID-19 pandemic have drastically reduced travel and contributed to an unprecedented collapse in oil demand.

The International Energy Agency (IEA) forecasts that global demand in the second quarter of 2020 will fall by 25% from 2019 and is not expected to return to its previous level of 100 million barrels per day (mb/d) until at least next year.

The drop in demand has led refineries to slow their operations to avoid the build-up of large inventories.

An April 12 agreement between Russia, Saudi Arabia and other OPEC+ members to reduce global oil production by about 10% should help bring overall supply to just over 90 mb/d. However, if the current difference between estimated production and projected demand were to materialize, the overproduction of crude oil would still reach 17 mb/d.

Without a further reduction in production, a more gradual increase in demand than projected would have serious consequences for global inventories, which, according to some analyses, are already on the verge of overwhelming storage capacity.

Storage has its limits

The mismatch between oil supply and demand is resulting in an increasingly evident lack of storage capacity. Refineries, tank farms and strategic reserves are running out of space. In this regard, the IEA estimates that the world's maximum operational capacity is somewhere between 5 and 5.7 billion barrels of oil.

The agency estimates the midpoint of this range will be reached during May and could hit its upper limit at the end of June. If its storage estimates are correct, a slower-than-expected recovery in oil demand will contribute to a repeat of last month's events off Southern California.

More than twenty oil tankers were anchored off the ports of Long Beach and Los Angeles during the week of April 20. They were awaiting permission to unload crude oil from Mexico or Alaska for delivery to refineries. The negative prices on April 20 were, therefore, the result of a lack of liquidity on the market for contracts for delivery in May. Investors were simply unable to find takers for their contracts, while the usual buyers of crude oil were not even willing to take a barrel for free. They had to be compensated for the cost of storage, which is increasingly high given that maximum capacities are being reached.

Storage capacities vary from one continent to another. North American production (WCS, WTI) is more landlocked than that of Brent, which is extracted in the North Sea. As a result, storage capacity is more limited in North America. This is also why the price of Brent has never been negative.

Implications for Canada

The medium-term outlook for the oil sector remains daunting. Global inventories in excess of six billion barrels imply lower prices for longer. Demand will need to exceed supply by a significant amount for inventories to eventually return to a more consistent level below three billion barrels.

The IEA estimates that Canadian oil companies reduced their capital budgets by more than $8 billion between March and mid-April. While a complete shutdown of production would create costly and risky logistical challenges, some companies consider this option preferable to producing at a WCS price below US$10 per barrel.

However, these companies have liquidity needs to pay their employees and meet their financial commitments. The federal government and BDC have announced financial support programs for the sector.

Annex: How did we end up with negative prices

To understand the dynamics that can lead to negative oil prices, we must first explain how natural resources are traded on financial markets, and why a negative price does not mean the local gas station will pay you to fill up.

It’s important to distinguish between a spot market and futures contracts. Buying on the spot market means taking immediate possession of a product. This is the case, for example, when you buy the shares of a listed company.

Natural resources, on the other hand, are generally traded through futures contracts, where holding them on a certain date leads to subsequent delivery. For example, it’s possible to buy a contract for WTI today for delivery in June 2020, February 2021, or any time during the decade.

This means there is always more than one price for a commodity, even if prices do not normally differ significantly. (See January 2, 2020 prices on the chart). For example, for WTI during the infamous April 20, it was the May delivery contract that traded in negative territory. On the same day, the barrel for June delivery was trading at US$20.

The last payment date for delivery in May was April 21. On April 22, the new short-term contract was for delivery in June and was trading for US$14—a 30% decrease from two days earlier.

While short-term prices have declined drastically in recent weeks, contracts for delivery in late 2020 have been less volatile and continued to trade in a narrower range of US$28 to $32. Investors and speculators are therefore relatively optimistic, believing the factors that led to the recent drop in price will subside over the next few months.

Other economic indicators

Bank of Canada: Willing to do whatever it takes

After cumulative reductions of 1.5 percentage points in March, the Bank of Canada's key policy rate is now at 0.25%, which outgoing Governor Stephen Poloz considers the lower limit. This was echoed by new Governor Tiff Macklem, who will take office in June. This makes it unlikely that this rate will change over the next year. However, the central bank's activities are not limited to setting its key interest rate. In the space of one month, from mid-March to mid-April, the Bank of Canada's asset holdings jumped 59% to almost $200 billion (about 10% of GDP). These liquidity injections are aimed at avoiding a credit crunch similar to the one during the 2008-09 financial crisis.

Canadian dollar remains weak

The pandemic and oil prices continue to weigh on the Canadian dollar. Since April, the loonie has been trading at around US$0.71, a slight improvement over March when the currency was testing the $0.70 level. Despite the collapse of oil prices in April, the loonie has thus far shown surprising resilience. However, the dollar is not expected to climb back to its value of recent years of around US$0.75 until the pandemic is deemed under control.

Entrepreneurs a little more confident

The Canadian Federation of Independent Business's SME confidence index jumped more than 15 points in April to 46. The increase was slightly higher for the manufacturing sector, which posted a gain of 19 points to 44. An index below 50 represents a contraction in activity. Our sector analysis predicts a significant rebound (close to a V-shape) in the short term in the manufacturing sector. On the other hand, because of health measures that are likely to be spread out over time, many services will experience a slower U-shaped recovery.

Inflation worth monitoring

Year-over-year inflation dropped to 0.9% in March, driven by the collapse in gasoline prices. The average of the Bank of Canada's three core inflation measures, which exclude some of the most volatile goods and services, remained more stable at 1.8%. The Bank of Canada will keep a watchful eye on domestic price increases, with a target range of 1% to 3%. Some products, particularly those facing shortages such as food, could see a sharp increase in prices in the coming months. Closures of North American beef and pork processing plants, for example, could lead to higher prices for meat. The effects of a lower Canadian dollar could also lead to an increase in the cost of imports. However, these upward pressures will be offset by a sharp decline in demand due to the pandemic.

Key indicators—Canada