Taking the North American economy’s temperature
BY Martha Porado | January 15, 2019
For those worried the cycle is about the turn, it’s important to consider that there is no established length for a market cycle, said Avery Shenfeld, managing director and chief economist at CIBC, during a panel at a Canadian Investment Review and Benefits Canada Investor Insight Breakfast in Toronto on Jan. 10, 2019.
Indeed, the typical recession sign posts have yet to materialize in full, he said, noting there hasn’t been a major spike in energy prices, as is typically found before a recession. However, central bank activity testing the waters of what the economy can handle is another signal, which has been happening to some degree of late, he said. And finally, while there has been more volatility in financial markets for the past few months, a major collapse, a clear sign of recession, hasn’t happened.
Currently there are “some worrying corners of the financial system,” Shenfeld said pointing to a little more shaky debt in the marketplace than he would like to see and the Chinese economy appears to be slowing down for now.
He also noted a typical recession can be defined by two down quarters in a row, which is more likely to happen coincidentally when normal growth rates for Canada and the U.S. are lower, as they have been for the past few years. There can easily be a couple of technically negative quarters without that being too meaningful, he added. “That is something we’ll be living with in a slower trend economy.”
Bond yields, however, could be another indicator worth watching, said Douglas Porter, chief economist and managing director at BMO Financial Group.
“One of the most reliable signals we have out there is when yield-curves invert. It has actually had an air-tight relationship in the U.S. with predicting downturns,” said Porter. “That’s not the case in Canada. We’ve actually had a number of false positives in Canada in the past decades.”
Porter attributed those false positives to the more volatile interest rate background Canada has had in the past. While, Canada’s yield curve is certainly on the flat side, unless it actually inverts, Porter says he wouldn’t regard it as a true warning signal.
Inflation is another factor to keep an eye on, said Dawn Desjardins, vice-president and deputy chief economist at the Royal Bank of Canada. The full-steam-ahead nature of the U.S. economy will likely make the Fed cautious through the year, she said.
“They have virtually no economic slack that we can determine. Their unemployment rate is, as we know, extraordinarily low and we’re starting to see wage pressure go up there,” said Desjardins.
Back at home, the Bank of Canada’s attitude has been calm, acknowledging some of the challenges facing Canada’s economy, with particular regard to downward pressure on Alberta’s oil industry, she said.
Desjardins noted that even with these challenges, the central bank still has room to raise rates, and she’s looking to see them reach 2.5 per cent in 2020.
However, Shenfeld was not so optimistic. In his view, Canada will not be able to comfortably weather high interest rates. The country’s economic growth hasn’t been quite high enough in the last handful of quarters to withstand much more dampening from the Bank’s rate hikes, he said. “With a 1.25 per cent average interest rate, the Canadian economy was only averaging two per cent growth. So to me, how are we going to live with a three per cent interest rate and still get two per cent growth?”
“We need a lot of things to go right for rates to get hiked twice this year,” added Porter.
As far as how Canadian oil prices will impact that picture, the commodity’s price action is notoriously difficult to predict, said Shenfeld.
However, oil has a tendency to self-correct it’s value to some degree, he said. When oil is rising to a higher price, more drilling takes place, flooding the market, weakening demand. Once the price falls on that weaker demand, the few producers still extracting will eventually lead back to higher demand and the price regains its footing, he said.
While, globally, it is comforting that players within the Organization of Petroleum Exporting Countries are following through with production cuts in a timely manner, an outlook of $60 a barrel isn’t enough for Canada to get to back to the glory days of just a few years ago in 2014, said Shenfeld. “The test comes when we turn the tap back on and see where prices actually settle,” he added.
Canadian oil, specifically, is still suffering from serious transportation issues, said Desjardins. As well, the proportion of the country’s overall capital investment in the sector has dropped dramatically, she added. “From the Canadian economy’s point of view, prices have come down. And the fact that the industry’s contribution has come down means the impact for overall growth, nationally, just isn’t as great as it had been when we moved into the first oil shock of 2014.”
Another major factor to examine for the upcoming year is Canada’s housing market, which notably saw more moderate prices in 2018 than have been the case in several years, noted Porter.
Interest rate hikes and tighter mortgage rules both contributed to a cooling in the sector, said Porter. However, a key contributing factor has been the new provincial policies targeted at curbing higher spending, he said.
“I can’t stress how much the relatively new government in B.C. is committed to improving affordability,” said Porter. “And the way they’re doing that is basically by trying to crush the market, through speculative taxes . . . They are dead serious about bringing down prices, especially in Vancouver.” It is slow going but they are starting to chip away at a crisis, he added.
In Toronto, another hot market of late, prices have slowed in their rise, but may still have room to expand somewhat, said Porter. “A main supporting factor in Ontario and Toronto specifically, is the robust population trends,” he noted.
One corner where prices could drop further in Toronto is with new residential properties, said Shenfeld, noting quite a bit of new stock the market has been waiting for is about to come online, especially in the form of new condominium towers.
It is important to note that, by all measures, the amount Canadians are spending on housing, as a proportion of their overall income is sky high, said Desjardins. “Certainly, as we look through 2019, again not looking for huge price appreciation, but to the extent that the economy is doing as well as it is, if we do see further rate increases, any relief on the affordability side isn’t going to be in view.”