Monthly Economic Letter
The COVID recession: Why this time is different
While it’s still too early for a full post-mortem on the COVID-19 recession, we know the pandemic has produced the worst contraction in Canada during the post-war period. A year of intermittent lockdowns, school closures, telework and other disruptions has had a huge impact on the economy.
This month, we look at key trends during previous recessions to see what distinguishes them from this one, and how the recovery will unfold in the coming months.
A recession doesn't just happen
Canada has experienced five recessions since 1970, and twelve since 1929. In recent times, Canadian recessions have evolved to be less frequent but more severe events, according to the C.D. Howe Institute.
Recessions usually last between three and nine months. The most recent one, in 2008-09, lasted seven months. Typically, recovery periods—the time it takes to return to pre-crisis levels of economic activity—are long because post-recession growth is weak.
Recessions don't just happen because the economy has been growing for a decade. Looking at past business cycles in Canada, recessions have been caused either by aggressive interest rate hikes or by some kind of economic shock, such as an oil crisis.
Dawn after the dark night
After a recession comes recovery. It begins when the economy starts to grow again and ends when it reaches its pre-recession level—from the trough to the old peak.
A typical feature of previous recessions is that the level of economic growth before the crisis was unsustainable. This is often referred to as an overheated economy or a bubble. In a slow-growth context, it is more difficult to return to the level reached before the downturn.
In both the way it started and its anticipated recovery, the COVID recession truly is different—a black swan event.
Before the pandemic hit, growth had already started to slow in Canada and expectations were for a soft landing, not a recession.
Now, indications are the recovery will be much faster than in previous recessions, even though Canada has experienced the worst GDP drop in decades. Three factors explain why we expect the economy to recover more quickly.
1. A mixed impact on production capacity
A decline in economic activity during a typical recession translates into lower investment and job losses. Recessions therefore lead to the destruction of an economy's productive resources. Physical assets often become obsolete, and workers become discouraged after being unemployed for too long.
During this recession, health restrictions have certainly taken on a toll on certain types of assets. Offices are deserted and airplanes are grounded.
However, airplanes won't stay on the ground forever, and people will eventually go back to offices. Additionally, the pandemic has forced entrepreneurs to adopt digital technologies faster than they had anticipated. This could mitigate the impact of the recession on productivity this time around.
Unemployment is still high in Canada (8.2% in February). However, several sectors have recovered lost jobs fairly quickly. Labour shortages are even beginning to emerge in some industries, and immigration restrictions could exacerbate the situation. When health restrictions are lifted and the economy recovers, workers may be in short supply, hindering Canada's economic recovery.
2. The wealth effect of COVID-19
Another unusual aspect of this recession is the wealth effect it has created. In contrast to previous downturns, the balance sheets of companies and households have held up well.
An inability to spend due to lockdowns and government transfers have led to a significant increase in household savings. As the restrictions are lifted, part of this accumulated wealth will be injected back into the economy.
At the same time, government assistance to businesses, such as rent and wage subsidies, has softened the recession’s blow. Since the beginning of the pandemic, there has actually been a downward trend in the number of business bankruptcies. Government transfers should remain in place until the economic situation improves and continue to limit the impact of the recession on businesses.
3. Low interest rates
A massive injection of liquidity into the economy is expected to lead to a generalized increase in prices (inflation) in response to strong demand following the reopening. However, interest rates should remain accommodative for a good period of time.
The Bank of Canada, like other central banks, will likely be cautious about raising rates as it attempts to support solid and sustainable economic growth. While rates will undoubtedly rise one day, central banks have learned from experience that a gradual and controlled increase in rates is what’s called for following a recession.
What it means for your business
Recessions obviously make casualties, but many entrepreneurs have shown great resilience during the COVID crisis. With the recovery now in sight, the economic environment left by this recession is different from earlier Canadian economic downturns.
- Sectors that were struggling with labour shortages before the crisis could quickly find themselves in hot water again when the economy reopens. Think about solutions to mitigate the impact on your business.
- The recession has encouraged business transitions, creating acquisition opportunities. Buying a business can be a good way to fuel your business’s growth.
- Interest rates will remain low. This is an excellent environment to invest in growth projects.
Canadian economy at a glance
Light at the end of the tunnel for the Canadian economy
It appears the Canadian economy will weather the second COVID-19 wave better than initially anticipated. More balanced growth is expected to return as health restrictions ease. Optimism should begin to spread to the sectors most affected by the pandemic to date.
An economy in recovery
It's official, 2020 was the worst year for Canada’s economy (and probably from many other points of view as well). Gross domestic product declined by 5.4% overall compared to 2019.
However, despite a bleak winter struggling with the pandemic, the economy has fared well overall during the second wave of infections. GDP grew by 2.3% in the last quarter of 2020 (9.6% annualized), although many businesses, including retail stores, hadn’t yet been shut down by health restrictions.
The picture will probably be less rosy in the first quarter of 2021. Statistics Canada's preliminary estimates project an increase of about 0.5% in real GDP for January 2021—a period when containment measures were being reinstated across the country. GDP stagnated in December (+0.1%) compared to the previous month, leaving economic growth at about 97% of its pre-pandemic level.
The recovery is expected to gather steam as we move through the year.
Governments ease up on lockdowns
The pandemic situation is very different today, and governments are announcing more flexible health measures from coast to coast. These announcements bode well for sectors most heavily impacted by the pandemic, including the restaurant, leisure and tourism industries.
Large vaccine deliveries and a decrease in new cases offer hope for a return to normal for companies, but the situation will remain difficult for many in the short term. The federal government has announced wage and rent subsidies will continue until June 5. More than half of Canadian companies took advantage of emergency measures in the fourth quarter of 2020.
259,000 jobs recovered
In parallel with the reopening of businesses in several regions across Canada, employment growth resumed in February. Nearly 260,000 jobs were recovered. The sectors most affected by health restrictions in January experienced the strongest job increases (+65,000 in accommodation and food services and +122,300 in trades).
Unemployment rate remains high compared to its level before the pandemic hit a year ago. It was 5.7% and now it is 8.2%. Still, there has been progress.
The recovery is increasingly real-estate based
While recent data on the Canadian economy is encouraging, growth is not balanced. This poses a risk to the recovery.
Residential housing investment continued to gain momentum in the fourth quarter of 2020, growing at an annualized rate of 4.3%. The trend is expected to continue in the first quarter of 2021 as the total value of building permits rose 8.2% in January to a record high.
For a robust recovery, Canada needs stronger business investment. The good news is that capital spending on non-residential buildings is expected to increase this year.
In fact, Statistics Canada estimates suggest a full recovery in this type of spending. With projected growth of 7.5% over 2020, the spending would even surpass the level recorded in 2019.
Statistics Canada also expects investment in machinery and equipment to increase by 6.2% in 2021. This increase will not make up for losses in 2020, but should help the recovery.
What does this mean for your business?
- More vaccines will be available in Canada in coming weeks. The number of new cases per day is declining. Governments have begun to relax containment measures across the country, which will support growth in the first half of the year. Make sure your company is ready to meet coming demand.
- Take advantage of the various relief programs in place for businesses.
- The construction sector and related industries such as hardware stores, sawmills, steel producers, etc. will benefit from a real estate and renovation boom.
U.S. economy at a glance
The U.S. economy comes out of hibernation earlier than expected
There’s good news on the economy from south of the border. Americans have gained two months on their immunization campaign schedule, and new federal relief transfers are landing in citizens’ bank accounts.
Vaccination is going well
President Joe Biden announced recently the U.S. would have enough doses by the end of May for all adults to be vaccinated.
Obviously, it will take until after May for all of these doses to actually be administered. However, this is good news for the U.S., which had previously expected to reach this milestone only by the end of July. As well, the number of daily new COVID cases continues to decline, even as the economy reopens.
Federal transfers to the rescue
A $900-billion stimulus package adopted at the end of 2020 supported consumer spending during the beginning of the year. With personal income rising 10% in January compared to December, consumption increased by 2.4%. This represented the first real gain in consumer spending since the second wave of the virus hit the United States.
A new $1.9-trillion stimulus package signed into law by Biden contains several elements that will directly affect the financial balance sheet of households.
The package includes $1,400 in direct payments to individuals, a federal unemployment benefit boost of $300 per week until September 6, and assistance for people having difficulty paying their rent and mortgage during the pandemic.
These measures will pad household savings in the coming months as consumers slowly regain confidence in the economy. This combined with the reopening of businesses in large states such as Texas should continue to support consumption.
The labour market remains the weak link in the U.S. recovery
Consumer confidence, incomes and savings are all showing encouraging signs for a consumption-led recovery. However, employment remains weakened by the pandemic. School and daycare closures, health restrictions and unemployment benefits are all hampering the recovery of the labour market.
Despite the creation of 379,000 new jobs in February and a marginal decline in the unemployment rate by 0.1 percentage point to 6.2%, the U.S. economy is still far from its pre-pandemic employment level. Permanent job losses remain high.
In contrast to other developed countries, including Canada, even if we exclude the hard-hit recreation and hospitality sector, the picture is not much rosier.
Total employment in February was 94% of its pre-pandemic level a year ago. Excluding the recreation and hospitality sector, it was slightly less than 96%. In fact, this sector had the largest increase in employment in February as health restrictions eased across the country.
Employment should continue to grow as the economy reopens, but the recovery of the labour market is still fragile.
Fed support will continue
Until the labour market improves, the U.S. Federal Reserve will continue its quantitative easing and keep its policy rate at its current low level to keep interest rates down, even if the economy shows promising signs.
With nearly 10 million Americans still unemployed in February, Fed Chair Jerome Powell said he would be willing to tolerate somewhat higher levels of inflation before raising rates until the labour market shows a solid and broad-based recovery.
What does this mean for your business?
- With fewer new cases of COVID in the U.S., and the acceleration of vaccination campaigns, Americans can expect the economy to reopen sooner rather than later.
- New fiscal stimulus will support consumption in the U.S. Canadian companies that export will be able to benefit from strong spending by U.S. households and other spillover effects from the stimulus package.
- Interest rates in the United States will remain low, which will support residential investment and consumption in particular.
Oil market update
Oil gains momentum on vaccination rollout
A surge of optimism has taken hold of oil markets, sending crude prices to pre-pandemic levels.
The higher prices reflect an increase in demand supported by the deployment of vaccination campaigns around the world. Additionally, supply restrictions by the Organization of the Petroleum Exporting Countries and their allies (OPEC+) have paid off.
Prices should continue to rise in the months ahead but more moderately.
Full recovery in crude oil prices
Oil prices fell sharply at the beginning of the pandemic. Brent was trading at less than US$10 a barrel while WTI even reached a negative price. These were the worst levels ever recorded.
Prices rose rapidly in May following OPEC+ curtailments, reaching a plateau around $40 a barrel, still well below their pre-pandemic levels. In fact, oil prices only began to truly recover from the pandemic in November 2020—once vaccines proved to be effective.
Since then, oil prices have risen sharply (+85% since November) and the price of the main benchmarks, WTI and Brent, have surpassed their pre-pandemic levels.
In the months ahead, the reopening of the global economy, supported by the deployment of vaccination campaigns around the world, should continue to support the recovery in prices.
Towards an increase in supply?
The collapse of global economic activity and oil demand last April led OPEC+ to reduce its production by 9.7 million barrels per day (Mb/d) to support prices. In February, OPEC+ members were still holding back more than 7 Mb/d.
Some observers expected OPEC+ to increase production to take advantage of higher prices, but at its March 4 meeting, the organization decided to maintain restrictions through April. It stressed the situation was still too uncertain to open the floodgates, but added it would reassess the situation at the beginning of April.
Fragile recovery in demand
The momentum in oil markets is expected to continue for some time to come as global economic activity resumes with businesses reopening and individuals moving more freely. The International Monetary Fund revised upwards its forecast for overall GDP growth in its latest report. Stronger growth should be accompanied by increasing demand for oil, especially in the second half of 2021.
However, demand from China (the largest importer of crude oil) could slow later in the year as fiscal stimulus fades. For the time being, growth in Chinese industrial activity continues to recover.
Regardless of what happens in the short term, it should take a few years before producers see demand levels similar to those experienced before the pandemic. This is primarily because air travel will remain limited for some time to come. Air transportation is one of the most oil-intensive industries.
Since vaccines were found to be effective against COVID-19 last fall, oil prices have fully recovered from their historic drop during the first wave of the pandemic.
Renewed optimism and the reopening of economies around the world should continue to support prices in the second quarter. However, a possible slowdown in Chinese demand coupled with future OPEC+ supply increases could temper growth in the coming months.
Other economic indicators
Bank of Canada stays the course
The Bank of Canada is keeping its policy rate to the lower bound (0.25%) and maintaining its quantitative easing program current pace. Despite improvement of the economic outlook since the last announcement in January, the Board of Governors believes that the situation continues to warrant extraordinary support. However, build-up of inflationary pressures and a faster than expected economic recovery may force the bank to revise its quantitative easing program as early as April.
Loonie above $0.80
The Canadian dollar (CAD) fell below $0.70 in March 2020. A year later, it now stands at about $0.80—a 16% increase. The loonie continues to appreciate against the U.S. greenback thanks to strong commodity prices (including oil) and investors' preference for riskier assets (the U.S. dollar being the safest currency). The Canadian dollar is expected to continue to pick-up steam as demand for commodities increases as the global economy recovers.
Business optimism on the rise
The rollout of vaccination campaigns across the country and the easing of health measures from coast to coast are welcomed by the business community. The Canadian Federation of Independent Business (CFIB) Business Barometer's short-term index rose by more than 10 points, while the long-term index rose by almost 4 points.
The short-term index (measuring expectations for the next three months) remains below 50, reaching 42 in February. An index below 50 means that more business leaders expect their company's performance to be weaker in the future.
Obviously, this optimism is not widespread. The sectors most affected by the pandemic to date, including restaurants, accommodations and the arts and entertainment sector, are still recording short-term indices in the 22-23 range.
Borrowing rates on the rise despite accommodative monetary policies
Credit conditions in Canada remain accommodative. The effective interest rate, which is the average rate households pay for new loans, has not moved since early February. It remains around 2.5 per cent.
However, there has been an increase in the average effective rate for Canadian businesses. This rate rose from 2.15% at the end of January to 2.3% in early March. This is an increase of 15 basis points in a few weeks, even though the Bank of Canada remained on the sideline.
This interest rate increase is in fact a collateral effect of the improved economic outlook. Indeed, the market is anticipating a faster recovery of the economy and inflation, which is pushing bond rates higher. Changes in bond yields are reflected in bank rates. For example, Canadian banks use the 5-year bond rate as a benchmark to determine mortgage rates. Thus, effective rates could continue to rise even if the Bank of Canada maintains its accommodative monetary policy.