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Monthly Economic Letter

December 2020

Feature article

Onward and upward: Leaving 2020 behind

21 trends that will shape the 2021 recovery

The year that is drawing to a close has been an uphill battle for many entrepreneurs. Fortunately, 2021 already looks more promising, despite significant remaining challenges. This economic letter presents 21 trends that will have an impact on the economy in the coming year.

The health outlook

1. In the coming months, the trajectory of the economy will depend primarily on how the pandemic evolves. Although the number of new cases of COVID-19 infections is lower in Canada than elsewhere in the world (graph), several provinces are implementing new measures to limit the spread of the virus. In general, the stricter the rules, the more the economy will be affected. We don’t expect a significant improvement in the pandemic before spring.

2. The arrival of a vaccine appears to be near. Several pharmaceutical companies report efficacy rates of more than 90%—a remarkable breakthrough in such a short time. Pending approval of vaccines by health authorities, many questions remain about the logistics of global distribution.

Canada has ordered enough doses to theoretically achieve herd immunity. However, bottlenecks could initially force priority vaccination for certain groups. This would result, for a period of time, in continued health measures and restrictions that should, however, be less severe than at present.

Canada’s economy

3. A projected economic contraction of 5.5% in 2020 will be followed in 2021 by Canadian GDP growth of 4% to 4.5%, depending on vaccine availability. A slowdown in the Canadian economy, observed in the last quarter of 2020, is expected to continue into the first part of the new year.

4. A few sectors did well in 2020, including retail and real estate. Continued government income support for households affected by the pandemic should support consumption. A significant decline in immigration in 2020, combined with tighter mortgage lending conditions, could limit the potential of the real estate sector, particularly in urban centres.

5. Investment will remain low, while entrepreneurs prioritize the improvement of their financial situation. Nevertheless, our research suggests they intend to invest more in technology, particularly to improve their ability to sell online and support remote work.

6. For the sectors most affected by the pandemic, such as accommodation (chart), transportation and food services, the recovery will unfortunately be muted in 2021. Although a vaccine will soon be available, health measures will likely be maintained until herd immunity is reached. It will also take a few years for international tourism to make a full recovery.

7. Forget about U, V, W or L scenarios to illustrate the economic recovery. It is increasingly clear the current recovery is K-shaped: A rapid recovery for some sectors (V), while others continue to suffer the effects of the pandemic (L). Women, youth and immigrants have benefitted less than average from the economic recovery that began in May, according to employment statistics.

8. The health situation will limit the recovery in oil demand for at least the first half of 2021. High inventories limit prospects for price increases. Maintaining current prices will therefore depend on continued OPEC+ cooperation. The new U.S. administration's opposition to the Keystone XL pipeline also represents a risk for Canadian producers. (See the oil article for more details.)

9. The Canadian dollar, which has strengthened since the beginning of the recovery, is expected to remain in a range of US$0.75 to US$0.78 in the absence of significant jolts to the oil market. The anticipated convergence of Canadian and U.S. monetary policies until 2023 should limit the loonie’s volatility against the U.S. dollar.

10. Business survival rates will need to be closely monitored. Our surveys indicate that 87% of Canadian entrepreneurs expect to still be in business a year from now. However, a significant number of businesses remain inactive, and the longer they are shut, the greater their chances of not rebounding.

In August, there were 9% fewer active companies than the average in 2019. The situation has probably deteriorated since then, given the tightening of health measures in several provinces. In response, the federal government is maintaining its assistance programs for businesses. The more businesses that close their doors, the more difficult the economic recovery will be.

The international scene

11. International observers will remain focused on China. Since being the first hit by the virus, China has experienced a V-shaped recovery, making it the only major economy to post GDP growth in 2020 (1.9%). The International Monetary Fund (IMF) expects growth of 8.2% in 2021.

12. Next year will be one of recovery in all advanced economies. The most affected countries in Europe in 2020, including France, Italy and the United Kingdom, are expected by the IMF to grow by more than 5% but still fall short of their pre-pandemic levels of activity.

13. Exports of goods recovered during the summer, reaching 95% of the level reached the previous year, according to the OECD. Nevertheless, protectionist tendencies continue to gain ground. In October, the IMF identified 120 new export restrictions introduced in 2020. This is a trend to watch for Canadian exporters.

14. In the same vein, December 31 will mark the implementation of Brexit. At the time of this writing, an agreement between the British government and the European Union had not yet been signed. The prospects for a hard Brexit remain, with potentially serious economic consequences, including tariffs, tight customs controls and logistical challenges related to the border between Northern Ireland and the Republic of Ireland.

15. On the other hand, new free trade agreements could help counter protectionism. In November, Britain and Canada agreed to respect the terms of the Comprehensive Economic and Trade Agreement, which also remains in force between Canada and the European Union.

On the other side of the world, the largest free trade agreement has just been signed. The Regional Comprehensive Economic Partnership (RCEP) brings together 15 Asia-Pacific economies, including Australia, China, South Korea and Japan, representing 30% of the world's GDP. This agreement could put pressure on the Biden administration to rejoin the transpacific agreement.

16. Environmental protection is expected to return to the forefront in the coming years. President-elect Joe Biden's desire to see the United States join the Paris Accord on climate change will set the tone. Canada's formal commitment to achieve carbon neutrality (net zero emissions) by 2050 could lead to the implementation of new environmental measures.

17. There will be few noteworthy elections in 2021 with the exception of an October election in Germany, which will mark the end of Angela Merkel's 16 years as Chancellor. An election in Iran could have an impact on geopolitics in the Middle East.

In the United States

18. After a GDP contraction of 3.6% in 2020, the recovery will continue in the United States where the economy is expected to grow by 3% to 3.5% in 2021.

19. Runoff Senate elections in Georgia on January 5 will have a significant impact on Biden's agenda, who officially takes office on January 20. A victory by the two Democrats (considered unlikely at this time) would give control of the Senate to the Democrats. Any other outcome would require compromises with Republicans in the upper house, at least until the midterm elections of 2022.

20. An agreement on the extension of an economic assistance plan will be necessary, otherwise more than 10 million Americans will lose their federally funded unemployment benefits at the end of this year. Failure by Congress to reach an agreement could have a significant impact on consumption in 2021, in addition to the human cost.

BDC and entrepreneurs

21. Finally, the continuing tenacity of entrepreneurs will be necessary as we move into the new year. BDC regularly publishes content aimed at advising and informing our clients on how best to operate during the pandemic and prepare for the recovery. Happy holidays!

Canadian economy at a glance

The economy’s momentum is hurt by the second wave

With growth slowing, deficits will remain high for several years

Canada’s latest economic data paints a picture of a robust economic recovery that is slowing under the weight of a second wave of COVID-19 infections.

Household income, which remained higher than before the crisis, helped support retail sales in the third quarter. Meanwhile, the country’s governments are headed for major deficits over the next few years, according to the federal government's fall economic update.

Record growth in the third quarter

The Canadian economy experienced the fastest growth in its history in the third quarter (July to September). GDP expanded by 40.5% on an annualized basis, according to Statistics Canada. The increase was a rebound from the worst quarter ever recorded (-38.1% annualized).

Despite the strong recovery, third-quarter GDP was still 5.3% below the last quarter of 2019. While the overall economy has lost ground because of the pandemic, there were some bright spots.

Among these was a 4.8% increase in goods consumption, even though household spending dropped 5%. Spending on services—which has been harder hit by the pandemic—was down 12.4% compared to Q4 2019.

Another surprisingly positive area has been real estate investment. It was 10.3% higher than in the fourth quarter of 2019.

On the other hand, business investment was down (-13.5%) from pre-crisis levels. Exports were also 8.7% lower compared to Q4 2019. The latter decline is mainly due to difficulties related to services exports, which dropped by 21.5%. Exports of goods were down 5.5% during the same period.

The momentum of the last few months is probably coming to an end. The tightening of lockdowns across the country is certain to affect the performance of several industries. Preliminary data suggest GDP growth of just 0.2% in October, the weakest since the start of the recovery. This level of growth would bring economic activity to 4% below its previous peak.

Future gains in GDP will be more difficult to achieve. It will probably take until 2022 to return to previous peaks. Our baseline scenario assumes a recovery period of about 27 months. A rapid roll-out of an effective vaccine could subtract a few months from this forecast.

Household income still higher than in the pre-COVID era

Canadians continued to benefit from government assistance programs during the third quarter. Disposable income, which declined slightly compared to the second quarter, was still 8% higher than before the crisis.

Government transfers to households are 41% higher than at the beginning of the year, while employee compensation, thanks to a jobs recovery in recent months, is only 1% behind.

As a result, retail sales are breaking records and the savings rate of Canadians remains high, reaching 14.6% in the third quarter. This bodes well for consumption in the coming months, despite the pandemic.

However, these developments are offset by historic government deficits.

The federal deficit is projected to reach $381.6 billion in fiscal 2020-2021 (17.5% of GDP), the government reported in its fall update on November 30. The deficit could even reach $400 billion if the second wave was to worsen economic conditions.

This historic deficit would be followed by at least five more years of deficits, including next year's projected shortfall of $121.2 billion. The economic statement also set the table for stimulus spending that could reach $100 billion over the next three years.

The federal debt will exceed 50% of GDP for the first time since the late 1990s.

19% of jobs still to be recovered

There was further evidence of slower growth in the latest job numbers. In November, 62,100 net jobs were created in Canada, bringing the total to 2.4 million since May. This corresponds to 81% of the 3 million jobs lost at the beginning of the crisis, which compares favorably to the 56% of jobs recovered in the United States.

The Canadian unemployment rate has gone from 8.9% to 8.5%.

As for GDP, the second wave of infections and resulting partial lockdowns are likely to limit job creation in the coming months, as evidenced by the loss of 23,800 jobs in the accommodation and food services sector.

To date, the level of hours worked in this sector is only 74% of last February. We will probably have to wait until spring before seeing significant job creation here.

What it means for entrepreneurs

  • After record growth in the third quarter, the table is set for a slow year-end. The situation will continue to improve, but at a much slower pace, particularly during the winter months.
  • The next phase of recovery will require mass immunity, which implies an effective roll-out of vaccines. Until then, retail sales and exports will see limited gains.

U.S. economy at a glance

The dawn of a “dark winter”

As the pandemic worsens, economic data are a mixed bag

The United States saw a sharp increase in the number of daily COVID-19 infections in November, including record-breaking totals of about 200,000 on the eve of Thanksgiving. While some economic indicators remain strong, deteriorating employment data reflect a definite slowdown in the economy.

Between the need to control the pandemic and the desire to keep the economy afloat, President-elect Joe Biden has warned Americans that a "dark winter" is upon them.

Nevertheless, the economy showed a certain confidence and resilience. Investors welcomed the appointment of Janet Yellen to Treasury Secretary and appeared to approve of the transition to a new administration that will take over on January 20.

Some favourable developments, but job growth disappoints

There has been some encouraging news in recent weeks. First, estimates of GDP growth for the third quarter remained unchanged at +7.4% (+33.1% annualized). In October, retail sales were up 0.3%, an increase of 5.7% year-over-year. Growth was also strong in housing starts (+4.9%) and sales of durable goods (+1.3%).

However, this momentum did not extend to the labour market in November. Only 245,000 jobs were added, bringing the total job creation to 12.3 million since the beginning of the economic recovery (56% of the 22.2 million jobs lost in the spring). The unemployment rate fell to 6.7%, its lowest level since the beginning of the pandemic.

The slowdown in the labour market had been expected because several states tightened measures to counter the spread of the virus. Layoffs, which remain historically high, have shown no signs of improvement since the end of the summer and were even on the rise for two consecutive weeks in late November.

Emergency measures set to expire

Personal income declined by 1% in October, but remained higher than at the beginning of the year. This monthly decline was due to reduced government transfers to households, which were not offset by higher employee compensation, a result of the slowing labour market.

Government transfers are still 20% higher than their pre-crisis level but are the subject of political discord in Congress.

Emergency unemployment benefits introduced in March are set to expire on December 31, threatening the incomes of some 13 million Americans who are currently receiving these benefits. While some of the unemployed may receive assistance from their state governments, this would apply to a limited number of people.

An agreement on a new stimulus package seems unlikely before Joe Biden takes office on January 20. As a result, assistance to households may be delayed until February.

Confidence in spite of the circumstances

Households were less confident in November, according to the Conference Board’s indicator, which fell from 101.4 to 96.1, a low since August. This result was relatively predictable given the continuing high rates of COVID infection. Still, intentions for durable goods purchases (new cars, appliances, homes) were on the rise.

There was a slight deterioration of confidence among firms in the manufacturing sector, with the ISM index falling from 59.3 to 57.5.

The service sector experienced a similar trend. The ISM index fell from 56.6 to 55.9.

Finally, Janet Yellen has been appointed to the U.S. Treasury, the first woman to serve in this role. The stock market welcomed the news. As the former Federal Reserve Chairman, Yellen is known to be supportive of expansionary fiscal policies.

The impact on Canada

  • The deteriorating pandemic situation, coupled with a weaker labour market, points to challenges for the U.S. economy in the coming months.
  • An agreement in Congress for an economic recovery plan is long overdue. It will probably have to wait until the next administration takes over, which will probably mean assistance won’t reach households until February.
  • These conditions could hurt U.S. consumption and, as a result, dampen demand for Canadian exports.

Oil market update

Vaccine optimism pushes oil prices higher

The second COVID-19 wave has had less of an impact on prices

After a volatile October, oil prices rose steadily in November, reaching levels last seen in March before lockdowns were imposed around the world.

The price of West Texas Intermediate (WTI), the North American benchmark, rose from US$39 to US$46 per barrel. Western Canadian Select (WCS) followed the same trend, with prices increasing from US$28 to US$34.

A two-step recovery in demand

Despite plans to gradually ease lockdowns in France and Germany starting in January, the overall demand trend is not expected to improve in the short term. Europe and North America, which are the source of 40% of international oil demand, will see continued reduced travel, at least until spring.

It’s therefore the longer-term outlook that has allowed oil prices to gain ground. Vaccines under development by Pfizer/BioNTech and Moderna are particularly promising, with efficacy rates of over 90% to date.

A rapid distribution of vaccines could lead to the easing of containment measures before next fall with a resumption of more normal travel patterns to follow, although more telework has likely become a permanent feature of the economy.

International tourism is unlikely to return to its previous highs for several years. For example, Australian airline Qantas plans to require proof of immunity from COVID-19 from its international customers. Qantas’s CEO expects this practice to be adopted by the industry as a whole. These kinds of barriers could delay a return to normal for the many industries that depend on tourism.

In short, the IEA expects oil demand to grow from 91.3 million barrels per day (mb/d) to 97.1 in 2021. A return to 100 mb/d would be reached only in 2022.

Producers will need to remain disciplined

Despite disputes among some OPEC+ members, the group managed to adjust production to the slowdown in demand during the first wave of COVID-19 infections. However, stagnant demand in the coming quarters may test the patience of OPEC+ members.

After significant overproduction in the first half of 2020, the IEA forecasts that demand should nevertheless outpace production in the last few months of the year and lead to a reduction in inventories, which remained high in September at nearly 3.2 billion barrels.

The current reduction of 7.7 mb/d of OPEC+ production will be very gradually tapered into early 2021, given the current level of uncertainty in demand. This outlook has contributed to the momentum in crude oil prices in recent weeks.

According to IEA estimates, if these cuts had not been renewed, production would have been maintained at about 95 mb/d in 2021. This level would be lower than projected demand and therefore sufficient to reduce inventories accumulated in the first two quarters of 2020.

The impact on Canada

The current momentum is promising for Canadian producers.

The prospect of a return to near-normal in the second half of 2021 bodes well for the oil sector. The schedule for large-scale vaccine distribution will have an impact on prices.

Current prices are encouraging a resumption of drilling activity in oil-producing provinces. As a result, Canadian production is expected to return to 2019 peaks as early as next year, according to the IEA. 

However, the longer-term outlook remains uncertain and investment in the sector will be more limited—potentially extending the time to a full recovery of the Alberta economy. The transition to renewable energy and a gradual shift to more fuel-efficient and electric cars will also eat into demand for crude over the long term.

Other economic indicators

The Bank of Canada remains cautious

Caution remains the order of the day as the Canadian economy faces many challenges over the next few years, Bank of Canada Governor Tiff Macklem warned in a statement to the House of Commons Standing Committee on Finance on November 26.

Among other developments, business investment is expected to remain moderate in the coming months, before rebounding, Macklem noted. This is confirmed by BDC surveys of entrepreneur investment intentions. They indicate that, with exception of investments in technology, entrepreneurs are cautious about spending in the midst of a second wave of the COVID-19 pandemic. Getting their finances in order is taking precedence.

Macklem also expects the exceptional level of monetary stimulus to continue as long as the economy remains below potential, which likely means until 2023. This also applies to the bank’s quantitative easing program.

The Canadian dollar reaches US$0.78

The Canadian dollar has averaged around US$0.77 in recent weeks and even reached US$0.78 in early December.

Although the momentum observed in the oil market has played a role in this appreciation, it’s mainly a depreciation of the U.S. dollar against many international currencies that explains the loonie's relative strength.

Entrepreneurs remain optimistic despite second wave

In November, CFIB's Business Barometer rose for the first time since July, gaining 2.4 points to 55.7. An indicator above 50 indicates entrepreneurs expect the business environment to improve over the next 12 months.

However, the decline of CFIB’s short-term indicator (next three months) to 35.2 suggests that entrepreneurs are focused on a deterioration in the economy caused by the second wave. In short, entrepreneurs appear to be realistic about the economic difficulties of the coming months, but believe the economy will regain strength in the longer term.

All sectors were in expansionary territory (more than 50), with the exception of the accommodation and food services sector (48.6). The capacity utilization rate remained stable at 70.6%. It has changed little since August, and reflects an expected slowdown in GDP in the fourth quarter.

Price increases are accelerating

The annual rate of inflation rose from 0.5% to 0.7% in October, the fastest pace since the beginning of the pandemic. Core inflation, which excludes the goods and services with the most volatile prices, also reached its fastest pace since February, at 1.8%.

The weak economy weighed on the prices of gasoline (-12.4% year-over-year) and clothing and footwear (-4.0%). Inflation rose from 1.6% to 2.3% in October for food, but was stable in the remaining sectors.

Although many companies reported cost increases due to paying for health measures, persistent weakness in demand prevented many from passing the bill on to consumers in the form of price hikes. Government household assistance programs continue to support consumption and limit downward pressure on prices.

The Bank of Canada expects inflation to reach its 2% target only in 2023.

Key indicators—Canada

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