Monthly Economic Letter

April 2021

Feature article

It's getting hot out there!

No, we're not talking about the temperature. The housing market has been breaking record after record recently as the COVID-19 pandemic changes the housing preferences of many Canadians. The result: average price increases of 17% across the country and as much as 35% in some centres. How long will the craze continue? Is the price increase rational or is there a real estate bubble in Canada?

Prices rise across the country

If there is one sector that has surprised many observers during this crisis, it is undoubtedly the housing market. Despite a severe recession in 2020, the real estate market has not faltered.

At the beginning of the crisis, the Canada Mortgage and Housing Corporation (CMHC) predicted the average home price would fall by 9 to 18%, compared to pre-pandemic levels. That was a far cry from what actually occurred. By February 2021, the MLS Property Price Index had jumped 17% from the same time the year before.

Recent increases have been widespread, with prices rising between January and February in 39 of the 40 markets covered by the Canadian Real Estate Association (CREA).

The last time the house price index rose this much, the Office of the Superintendent of Financial Institutions (OSFI) stepped in with measures to curb the increase. Tax measures were also imposed to restrict speculative foreign investment in the Vancouver and Toronto markets.

Is there a bubble?

Since the 2008 crisis in the U.S. housing market, speculation about a bubble in Canada has returned from time to time. Some real estate analysts and economists have recently sounded the alarm once again.

A bubble is not simply a rapid increase in prices. It is a rapid increase driven by high demand—demand that is disconnected from fundamentals and unsustainable.

CMHC believes the danger of overheating is increasing across the country, but that the risk of overvaluation of properties, for Canada as a whole, was still moderate in March 2021. However, if the torrid pace of activity in many markets continues, indicators could quickly turn to red. One-third of the metropolitan areas analyzed by CMHC have increased their vulnerability to overvaluation since December.

Housing preferences have changed

The pandemic has changed the housing preferences of many Canadians. Buyers are now looking for larger homes and are willing to move further away from major urban centres.

Many households that had been saving to afford a pied-à-terre in the city have opted instead for the suburbs where they could already afford to buy. So there has been significant increase in demand.

On the supply side, many seniors who had been thinking of moving to a residence probably decided to wait, given high COVID infection rates in these institutions in many provinces.

Favourable economic conditions despite the recession

In times of recession, governments and the Bank of Canada adopt expansionary monetary and fiscal policies to stimulate economic growth and employment.

During the current downturn, the Bank of Canada has lowered its policy rate and purchased assets to reduce interest rates while governments significantly increased transfers to households. Even lockdowns to slow the spread of COVID have indirectly helped maintain the financial health of households by restricting consumption and, thus, supporting savings.

These exceptional measures have supported the financial position of households. As a result, the creditworthiness of mortgage borrowers has remained relatively strong, a completely different situation from what the U.S. experienced in 2008, even though the share of mortgages with a loan-to-income ratio of more than 450% is increasing.

What can we expect?

The arrival of spring heralds the beginning of the hot season for the real estate market. Price increases are expected to continue into 2021 and even part of 2022. Demand will remain strong as employment continues to recover and immigration picks up. (The federal government is looking to admit over 400,000 new permanent residents in 2021, and 1.2 million over the next three years.)

Still, there are headwinds that may dampen the current frenzy slightly. Effective interest rates in the bond market, which is used as a benchmark for mortgage rates, are rising. Even though the Bank of Canada is determined to keep its policy rate low, borrowing rates have shown a disconnect from that rate. It is likely the central bank will be very cautious about raising rates, given the potential impact on housing market and its growing importance to the Canadian economy.

It is not uncommon for assets to become overvalued without a bubble forming. Obviously, if a housing price correction were to occur, it would hurt the economy, even if it does not extend to the damage caused by a bubble bursting.

Still, faced with the threat of increasing speculation and increasing fear among buyers that they are missing out in a hot market, the authorities may intervene again with new fiscal or macroprudential measures to dampen the markets. The Office of the Superintendent of Financial Institutions has just announced that it intends to resume the consultation process on the minimum qualifying rate for uninsured mortgages. In the past, these types of policies have proven to be effective in slowing growth but only in the short term before price increases resumed.

The impact on your business

  • Businesses in the residential sector, construction and furniture will continue to benefit from the residential craze induced by the pandemic.
  • Renovation and new construction materials are in short supply. If you are in this sector, make sure your inventories are ready to meet spring demand.
  • Housing prices will continue to rise, and mortgage rates are quietly climbing. This could leave households with less money to spend elsewhere in the economy.

Canadian economy at a glance

Facing the third wave

Canada hasn’t been able to escape a third wave of the COVID-19 virus, and that means renewed health restrictions in British Columbia, Ontario and Quebec.

Nevertheless, the Canadian economy held up well during the second wave and the new round of restrictions will likely have even less of an impact, thanks to the improving pace of vaccination campaigns across the country. But a full recovery will likely be delayed a bit, yet again, before the economy takes off in earnest later this spring.

The recovery continued despite the second wave

Canada's GDP increased for a ninth consecutive month in January. Growth reached 0.7%, well above the meagre 0.1% recorded in December. The resilience of the Canadian economy in the face of the second wave was surprising. Recall that in January, several provinces had to tighten health measures, forcing the closure of many businesses. The country lost more than 200,000 jobs during that month.

According to Statistics Canada's preliminary estimates, real GDP increased by about 0.5% in February. Based on this estimate, overall economic activity in Canada was back to 98% of its pre-pandemic level of activity.

Déjà vu as the third wave strikes

Now, the third wave is hitting the country. The larger provinces have announced new health measures that will restrict economic activity for a few days or weeks, depending on the province and industry. However, most businesses and consumers seem to have adapted to the situation.

The Canadian economy will likely prove to be equally if not more resilient this time around as it was during the second wave. The good pace of vaccination campaigns and warmer temperatures should help combat the spread of COVID variants and slow the wave down relatively quickly.

No relief for high-contact industries

Once again, the recovery will take longer for the high-contact sectors. This is in keeping with the K-shaped pattern the recovery has followed so far, with each new wave accentuating the inequalities between industries.

In January, when the second wave of health restrictions were at their peak in several provinces, GDP in the accommodation, food services, arts, entertainment and recreation sector fell for the fifth consecutive month.

Employment recovery mimics GDP recovery

Employment increased significantly in March with the addition of 303,000 jobs across the country. Significant gains were made in the sectors most affected by the pandemic and the lockdowns. Employment increased in retail trade (+95,000), accommodation and food services (+21,000) and information, culture and recreation (+62,000). For the latter sector, this is the first increase since September.

However, the recovery in employment in the high-contact sectors will be short-lived, as some of these gains are expected to disappear in April as restrictions return. Employment responds strongly in these sectors because high human-contact industries are usually labour intensive.

The speed with which employment recovered in March illustrates the dynamics of the recovery: once the restrictions on a sector are lifted, activity and employment pick up fast.

The impact on your business

  • New health measures will slow down the recovery. Each new wave of the virus lengthens the period it will take for the Canadian economy to fully heal.
  • The impact on the economy is expected to be fairly limited this time around, due to the success of the vaccination campaigns in limiting hospitalizations and the ability of households and businesses to adapt to the restrictions.
  • The speed at which employment recovered in March indicates that the recovery will be quick once restrictions get lifted in high-contact sectors. Make sure you have a hiring plan ready for the reopening of the economy.

U.S. economy at a glance

All the lights have turned green

Unlike many developed countries, the third wave does not seem to be hurting the U.S. economy. On the contrary, the indicators are all positive: successful vaccination campaigns, falling rates of new daily COVID cases, higher employment, burgeoning consumer confidence—nothing seems to jeopardize the reopening of the economy for the moment. If the trend continues, growth should reach 6.5% in 2021.

One step ahead

The U.S. economic recovery is clearly outpacing Canada's rebound. The U.S. vaccination campaign was slow to get off the ground, but the prospects for achieving mass immunity are now looking good.

As of early April, nearly one-third of the population had received at least one dose of vaccine, and 17% of the population was fully vaccinated. Every day that passes is a step closer to a full and sustainable reopening of the economy south of the border.

Biden announces more stimulus spending

After passing a $1.9-trillion COVID relief package in mid-March, U.S. President Joe Biden has outlined a $2-trillion, eight-year plan to support longer-term growth through infrastructure investments. The Biden administration estimates this bill would create millions of jobs. The majority of the program will be financed by higher taxes on businesses, completely reversing a 2017 tax cut.

Finally some jobs

U.S. employment posted impressive growth in March with the addition of about 916,000 jobs, by far the best performance since last fall.

The rate at which Americans are vaccinating continues to increase, and with the number of immunized individuals on the rise, comes the reopening of the economy.

As a result, job growth is expected to continue in the coming months. The U.S. is still 8.4 million jobs short of its pre-pandemic level, but those jobs could be recovered fast if the labour market continues to rebound at the pace seen in March.

Optimism is back

Consumer confidence jumped an impressive 20 points in March. The success of vaccination campaigns combined with the arrival of $1,400 stimulus cheques in bank accounts had a lot to do with the brightening of sentiment. The Conference Board's confidence index reached 109.7, the highest level since the pandemic began. This surge suggests that economic growth should strengthen in the coming months. Such renewed optimism is usually reflected in purchases of big-ticket items like homes and cars.

Consumption fell 1.2% in February after rising 3.0% in January. March consumption is expected to post solid gains due to increased income from the U.S. stimulus package and new jobs.

Manufacturers have wind in their sails

Manufacturing activity continued its momentum in March with a 3.9 point gain from February in the Purchasing Managers' Index (PMI), which reached a nearly 40-year high.

The outlook for the sector may even be too strong. Many manufacturers are struggling with production and supply constraints due to the pandemic, and this may limit their ability to meet growing demand.

The closure of the Suez Canal due to a stuck freighter didn’t help what was already a difficult supply situation for manufacturers.

The impact on your business

  • If it becomes law, a massive $2-trillion infrastructure plan south of the border would create significant opportunities for Canadian companies. A resurgence of Buy American sentiment will likely limit Canadian earnings potential, but the tight integration of the two economies will not change.
  • The reopening of the U.S. economy is ahead of the Canadian reopening. Still, Canadian companies will benefit from strong U.S. demand and the difficulties of American companies in meeting it.
  • The competition for materials will accelerate with the reopening of the U.S. economy, so make sure you have enough inventory to meet demand.

Oil market update

Towards an equilibrium price?

Crude oil prices hit a near two-year high in mid-March. Brent climbed to near US$70 a barrel and WTI to around US$65 in the wake of a decision by the Organization of the Petroleum Exporting Countries and their allies (OPEC+) to continue supply restrictions in April.

However, at an April 1 meeting, OPEC+ decided to increase production gradually over the summer, despite a third wave of COVID-19 infections that’s hurting the outlook for near-term oil demand, and a build-up of oil reserves over the past year.

New lockdowns to slow demand

Crude demand exceeded expectations in the first quarter. Improving industrial activity in Europe and the U.S., and frigid temperatures in February, supported global oil demand despite a devastating second COVID wave that damaged mobility and economic activity during the winter.

The third wave is beginning to make itself felt in several developed countries, despite vaccination campaigns that are well underway. The ferocity of the virus variants is causing authorities to tighten health measures, which is slowing the recovery.

As a result, the outlook for oil demand has been revised downward once again, taking crude oil prices with it.

Supply will soon be back on track

The advent of the third wave does not seem to bother OPEC, Russia or its allies. At the April 1 meeting, the organization concluded that the situation allowed for an easing of restrictive quotas as early as May. This decision also reflects stance of the new U.S. administration, which has publicly encouraged Saudi Arabia to keep energy prices affordable.

Under the new agreement, member countries' production will be allowed to increase by 350,000 barrels per day (b/d) in May, an additional 350,000 b/d in June and 400,000 b/d in July.

Saudi Arabia will also eliminate its additional voluntary cuts by adding 250,000 b/d to production in May, 350,000 b/d in June and 400,000 b/d in July. The Kingdom had voluntarily committed to cutting production by 1 million b/d on top of the OPEC+ agreement in order to support prices further.

Inventories remain high

According to the International Energy Agency, oil inventories are still very high, well above the pre-pandemic level. The inventories of OECD countries were more than 110 million barrels higher in January 2021 than in January 2020.

The prospect of weaker demand than initially anticipated and increases in OPEC+ production suggest there will be a build-up of inventories in the second quarter.

Thus, oil supply is not expected to be a problem during the summer, which should keep prices around recent levels.

Bottom line

The third wave of the COVID-19 pandemic is causing several developed countries to partially lockdown, which will slow mobility and the recovery of global economic activity.

As a result, oil demand is expected to slow in the near term. OPEC and its allies have nevertheless agreed to gradually increase production starting in May, despite still high inventories. Prices should not fluctuate too much while the global economy fights this third wave.

Other economic indicators

Change in monetary policy in sight

The next announcement from the Bank of Canada is scheduled for April 21. The Board of Governors is expected to announce a reduction in the pace of its quantitative easing program. The Bank has been buying at least $4 billion a week in government bonds since the fall. The program may even end completely by the end of the year, which will put upward pressure on rates.

The loonie is holding near $0.80

The Canadian dollar has held above US$0.79 for several weeks and even broke the US$0.80 mark for some days in mid-March. The craze for many Canadian commodities, such as wood, continues, which supports demand for the loonie despite the slight correction in crude oil prices. The Canadian dollar should continue to hover around 80 cents U.S. during the month of April notwithstanding the impact of the third wave and the containment measures that are weighing on the country's economic recovery.

Optimism is on the rise among entrepreneurs

According to our most recent Investment Intentions Survey, optimism is growing among Canadian entrepreneurs. The balance of opinion of business owners regarding the Canadian economy has shifted into positive territory for the first time since the start of the pandemic. A positive balance of opinion (+14 in this case) indicates that a greater proportion of respondents expect the economic environment to be positive for their business over the next 12 months. The proportion of businesses that are more optimistic has increased by 15 points since last quarter. Although the survey was conducted before the third wave hit the Canadian economy, the trend in business owners' confidence was on the rise even in the midst on the second wave.

Commodity prices are still high

The Bank of Canada's commodity price index has grown significantly over the past year. Natural resource (commodity) industries account for about 10% of Canada's economy and nearly 50% of exports. Commodity prices soared during the COVID-19 pandemic, and we expect them to continue to do so in 2021 supported by solid demand.

Wood products and lumber benefited from an expanding residential market and growth in home renovations (interior and exterior) fueled by home containment. Fiscal stimulus, a low US dollar and low interest rates helped China's recovery in the spring, which instantly increased demand for industrial metals. Metal and mineral prices were also supported by the growing need for technology equipment resulting from the rise of telework around the world.

These price increases could be a challenge for entrepreneurs who may see their profit margins shrink. The good news is that they will be able to pass on some of this increase to consumers who have seen their incomes and savings increase during the pandemic.