Monthly Economic Letter

September 2021
Feature article

What to expect from the fourth COVID wave

The number of new daily cases of COVID-19 has been increasing in Canada since the beginning of August, signaling that a fourth wave is underway.

This latest wave brings risks for the recovery, but the Canadian economy appears well-positioned to weather the storm. Waves come and go, but they are not the same.

What will the business environment look like this fall? This month, we look at three factors that companies should consider in preparing for the fourth wave.

1. An enviable vaccination rate

The first factor to consider is the vaccination rate. Canada has the highest vaccination rates among G7 countries, with two-thirds of the population fully vaccinated by early September.

The success of the vaccination campaign is clearly reflected in a relatively low number of new cases, but more importantly in a low number of hospitalizations. However, while research shows that vaccinations are strongly protective against infection, vaccinated individuals can still transmit the virus.

That’s why physical distancing, mask wearing and limits on the size of gatherings will remain the preferred measures to counter this new wave.

Most businesses have already adapted to these measures, although new adjustments may be necessary, such as requiring a vaccination passport to visit certain places. All in all, vaccinations should keep closures and economic disruptions to a minimum in the coming weeks.

2. Risks and limitations will persist for some sectors

There is no such thing as zero risk when it comes to the pandemic, but the level of risk differs by industry. While many industries in the goods sector have fully recovered to their pre-pandemic level of activity, service sectors are still struggling.

Each new wave is a sword of Damocles hanging over high-contact sectors. The restaurant, arts and entertainment, and retail industries have been the main victims of previous waves in Canada.

Challenging conditions for service businesses are likely to persist during the fourth wave. Venue capacity will remain limited; business travel is unlikely to pick up this year; and face-to-face events will be more limited.

The tourism industry was still far from full recovery during the summer, but the borders should remain open to fully vaccinated travelers this fall, helping to extend the season. That said, businesses in this sector remain most at risk for new restrictions, depending on the trend in new cases and the emergence of new variants.

3. The international situation weighs on supply chains

While the health situation in Canada is relatively good, businesses are not immune to COVID-related difficulties. As a small, open economy, many Canadian companies source all or part of their supplies from abroad.

The pandemic has created a number of challenges for the goods producing industries and these challenges will continue for several months.

Among these is the price of raw materials. While this has benefitted Canadian exporters, the price of many inputs has skyrocketed as demand for these products has risen sharply and supply has been slow to adjust.

The good news is that industries are beginning to adapt and some prices are coming down to more sustainable levels. This has been the case for lumber producers, in particular.

The pressure on production costs created by high raw material prices should slowly improve in the coming months. However, supply bottlenecks for some products and shortages of freight capacity will take longer to recover.

The reopening of economies around the world has created strong demand for space in shipping containers. However, ports in some countries have been forced to close to contain the spread of the virus. Most recently, in late May, parts of a Chinese region that has one of the most important ports for containerized exports was forced to close. Each port closure results in ships being stuck outside the port, unable to handle the pile of cargo that has accumulated.

At this point, any type of disruption will have a disproportionate effect on transportation costs and delivery times. Companies are already talking about supply problems for the holiday season.

What the fourth wave means for your business

  • Canada's vaccination rate is high compared to other developed countries. The impact of the fourth wave on businesses and the economy is therefore expected to be less significant than previous waves. Health measures are not expected to increase significantly.
  • High-contact service businesses remain the most at risk for new health measures. If your company is in this type of business, consider this risk in your strategic planning.
  • Although the health situation in Canada is encouraging, the pandemic is taking a much heavier toll in many countries. International restrictions are causing shortages and supply problems. Entrepreneurs whose business depends on international trade, whether for imports or exports, should plan accordingly.
Canadian economy at a glance

The economic recovery falters

Most economists had expected the Canadian economy to rebound modestly in the spring as it shook off the effects of the third wave of COVID infections. However, GDP declined at an annualized rate of 1.1% between the first and second quarters, led by a sharp drop in exports and residential investment.

The second quarter ended on a more optimistic note with GDP rising by 0.7% in June after two months of decline. That brought economic activity to 98.5% of the pre-pandemic peak in February 2020.

Exports take a step backwards

The slowdown in the spring reflected continuing turbulence from the pandemic. Canadian exports fell by 4% in the second quarter (15% annualized) compared to the previous quarter. This drop translated into a decline of almost 5 percentage points in GDP growth.

The drop came entirely from the goods sector, as services exports continued to rise. Services account for only about 15% of total Canadian exports, so they were not enough to offset the losses in Canada's two main goods export sectors—energy (-7.9%) and automotive (-14.8%).

Shortages in automotive supply chains (especially semiconductors) have taken a toll on the industry. They forced the closure of automotive plants in Canada this spring. Although production resumed in June for some plants, supply remains an issue and will continue to hold back the industry for several more months. This should result in subpar exports in the next quarter as well.

Sharp slowdown in residential housing

The residential sector emerged as an important contributor to the recovery in late 2020 and early 2021 with the construction and real estate services industries accounting for about 20% of the economy.

But a slowdown in the resale housing market in recent months put a damper on the most recent GDP data. Residential investment hurt growth by 1.4 percentage points in the second quarter.

Although it declined by 3.3% in Q2, residential investment remains high by historical standards. Residential investment has three components: real estate transactions, construction, and renovation.

The slowdown in residential housing reflects a low supply of homes for resale, which limits transactions. New construction and renovation, the two main components of residential investment, were still up last quarter.

While levels remain high, early indications for the third quarter show that both construction and renovation are slowing. Housing starts were down 3.2% in July from June. Building permit applications also declined during the same period.

Consumption disappoints

According to a Bank of Canada survey, 75% of respondents who accumulated excess savings during the pandemic planned to spend a good portion of it. Despite this positive outlook, household consumption was more sluggish in Q2.

With growth of just 0.2%, consumers appear to have reallocated their budgets from goods to services rather than increasing their overall spending.

Shortages will limit growth

According to Statistics Canada's initial estimates, the economy contracted by 0.4% in July. Since this is only a preliminary estimate, we have little detail to explain such a decline at a time when the Canadian economy was well on its way to reopening. This is also one of the strongest periods for the tourism industry, which has the potential for strong growth considering that it lags behind the recovery of other Canadian industries.

One hypothesis is that shortages are slowing growth. Labour shortages, which business have faced since the economy began reopening, are at an all-time high.

Additionally, delivery difficulties and a mismatch between supply and high demand for certain products may also be dampening the expected consumption boom. Many businesses have been forced to limit their hours of operation or deal with long delivery delays, limiting the potential for household consumption.

Employment continues to grow in August

The Canadian economy added over 90,000 in August. Not surprisingly, the majority of the gains were in the hotel and food services (+74,600) and arts, culture and recreation (+23,900) sectors, which continued to benefit from the easing of health measures and the tourism season. Similarly, most of these jobs were created in Ontario (+53,000) where the reopening accelerated at the end of July.

The impact on your business

  • Despite the uncertainty surrounding the fourth COVID wave, vaccinations and mitigation measures should limit its economic impact in Canada.
  • Demand is still high, but a return to normal seems to have begun. Businesses should remain busy but will have time to breathe a little easier between clients.
  • Labour shortages are back and forcing many companies into difficult decisions, including limiting business hours. The competition for staff is getting fiercer, prepare your job offers accordingly.
U.S. economy at a glance

End of the V-shaped recovery in the United States

U.S. gross domestic product grew by 6.6% in the second quarter. This impressive increase follows a 6.3% growth in the first quarter. However, this torrid pace of growth is not expected to continue in the second half of the year.

Towards more moderate growth

The U.S. economy won the G7 race as the only country to recover 100% of its pre-pandemic GDP level. However, the Delta variant continues to wreak havoc in states with low vaccination rates, industries continue to face supply bottlenecks and transfers to households are ending.

The Delta variant hit American soil in April, sending infection rates soaring. With only 53% of the population fully vaccinated, the economy, which managed to avoid the third wave experienced in Canada last spring, will not be so successful with the fourth.

While severe restrictions seem to be a thing of the past, this new wave appears to have rekindled consumer risk aversion. This is reflected in the consumer confidence indices and the most recent consumer spending data.

Consumption of services, such as restaurants and transportation, may slow further due to a delay in returning to offices given the increased transmission risks.

Other factors that may dampen consumption growth include fading tax stimulus and employment insurance supplements that will temper disposable income growth for the remainder of 2021.

High prices are cooling the real estate market

Similar to Canada, U.S. housing prices surged during the pandemic. However, residential investment took a step back in the last quarter, falling by 11.5%, in a reversal from several months of sustained growth.

Real estate transactions could be down for what's left of 2021. According to the National Association of Realtors' index, pending purchase contracts declined in June and July, which suggests the market is slowing because those contracts typically become sales one to two months later.

Limited supply pushed the price index for new houses up by 18.4% over one year in July.

Problems continue for manufacturers

Challenges faced by the manufacturing sector since the beginning of the recovery have not lessened. High raw material prices are combined with a scarcity of certain intermediate goods and strong competition for freight capacity. The latest U.S. Manufacturing Outlook Survey shows signs of improving conditions despite these ongoing issues.

Supplier lead times decreased in August and fewer products were in short supply—27 compared to 36 in July. Executives even reported reduced pressure on production prices. This relatively good news is offset, however, by the labour shortages affecting the sector.

Employment continues to recover... at a snail's pace

While GDP has recovered from the COVID crisis at a rapid pace, the same cannot be said for U.S. employment. The economy is still substantially behind its pre-pandemic level.

Payroll employment rose by only 235,000 in August, following an increase of over 2 million in June and July combined. This leaves the U.S. economy about 5 million jobs short of the last peak in February 2020.

The unemployment rate ended the summer season at 5.2%. The problem with the U.S. labour market is that the participation rate is still well below pre-pandemic levels (61.7% compared to 63.4%). As a result, there were still over 9 million job openings in June.

The impact for your business

  • U.S. consumption should moderate in the second half of the year as some federal support programs end and pandemic uncertainty increases consumer risk aversion which ultimately could reduce Canada’s exports.
  • Now that labour shortages are hitting the U.S., cross-border recruitment will intensify, making it even more difficult for Canadian entrepreneurs to find the workers they need.
  • The housing market is showing signs of easing south of the border, but supply remains below demand. Price increases could continue to discourage future buyers and lead to a decline in demand for building materials.
Oil market update

Will the market come back into balance soon?

In August, the main crude oil benchmarks, Brent and WTI, traded at an average of US$70 per barrel and US$68 per barrel, respectively.

Prices were slightly higher in early September, but the recent upward trend may well reverse in the coming months.

Elsewhere, notably in Asia, the situation is more dire and stricter measures have been reintroduced. While mobility doesn’t seem to be as badly affected as in previous waves, the Delta variant still appears to be hitting demand.

Some of Saudi Arabia's Asian customers have reduced their orders recently. In response, Saudi Arabia cut prices, a sign that competition between producers could intensify as uncertainty increases about future demand.

Some governments are also willing to tap into their strategic reserves. This is another element that could slow crude demand at the end of the year.

OPEC+ comes to a production agreement

Production by members of the Organization of the Petroleum Exporting Countries and its allies (OPEC+) reached its highest level in nearly 18 months in August.

After stormy meetings in early July failed to produce results and created a shockwave of volatility in the oil market, the organization reached an agreement to gradually lift production limits before August.

On September 1, OPEC+ decided to renew the July agreement. That agreement was for an additional 400,000 barrels per day (b/d) to be allowed to come to market each month.

So, after increasing supply by 400,000 b/d in September, another 400,000 b/d will be added in October. The next OPEC+ meeting is scheduled for October 4. According to official documents, the cartel seems to be optimistic about the prospects for higher demand in 2022, despite the rise in COVID-19 cases.

Supply should therefore remain strong in the coming months despite the shutdown of a significant portion of U.S. production following Hurricane Ida in the Gulf of Mexico.

Bottom line

The Delta variant is creating uncertainty about mobility and therefore the direction of oil demand for the end of the year. Despite this uncertainty, production should continue to increase, amid signs of rising competition among suppliers. Increased supply could, therefore, put downward pressure on the price of crude in the months ahead.

Other economic indicators

No change to the monetary policy

The Bank of Canada made no change to the monetary policy in its latest announcement on September 9. The policy rate will remain at 0.25% and the institution will continue the current pace of its asset purchase program at $2 billion per week. Despite the decline in GDP in the second quarter, encouraging labor market data may justify the announcement of a further slowdown in the pace of asset purchases at the October meeting.

The loonie lost some ground over the summer

The Canadian dollar has been revised downward over the summer. After reaching nearly US$0.83 three months ago, the loonie closed August near US$0.79. The resurgence of COVID cases due to the spread of the Delta variant will have rekindled investors' risk aversion and with it the demand for safe havens (read US dollars). Despite the correction in some commodity prices, the terms of trade remain favourable for the Canadian dollar. Until the uncertainty of the fourth wave has dissipated, the CAD should hover around US$0.80.

Businesses remain confident ahead of the 4th wave

Businesses seem to be keeping their spirits up despite the increase in the number of cases of COVID in the country, according to the latest survey from the Canadian Federation of Independent Business. CFIB's business barometer barely dipped in August with an index of 67.1 compared to 69.4 in the previous month.

The fourth wave was probably not the only factor pulling down business optimism in August. Capacity utilization was up, and so was  the number of businesses whose labour shortages are holding back growth. Lack of skilled workers is a major obstacle for nearly 50% of respondents—the highest level since 2009, according to the federation.

Soaring inflation

Inflation in Canada, as measured by the annual change in the consumer price index, rose to 4.1 percent in August. These recent increases are due to the reopening of the economy, bottlenecks in some resources (e.g. semiconductor shortages), gasoline and housing prices increase.

The Bank of Canada recently shifted its focus away from two of the three core inflation measures, the CPI-trim and CPI-median, which both kept increasing since the beginning of the year. The CPI-comm measure, the only measure remaining below 2%, should therefore have a greater weight on the direction that will take the monetary policy going forward.