First, an important disclaimer: We’re not expecting Canada to enter a recession anytime soon. On the contrary, Canada’s economy should do slightly better in 2020 than it did in 2019.
We believe increases in residential investment, more investments in the oil and gas sector and the resolution of trade disputes will drive growth this year. That said, there are risks on the horizon. This article looks at three of the more important risks we are keeping our eye on.
Recessions don’t just happen
Quick reminder: Recessions are said to occur after at least two quarters of negative GDP growth. The graph below plots Canada’s real GDP growth since the early 1980s. As shown, there have been four recessions in Canada since 1981. Each one was triggered by a particular set of circumstances and events.
Specifically, high interest rates plunged the economy into recession in the early 80s. In the 90s, a recession in the U.S., restrictive monetary policy and increases in taxes, triggered a recession on this side of the border. Canada’s two most recent recessions were caused by the sub-prime mortgage crisis and the collapse in crude oil prices in 2015. The point is that recessions don’t just happen, they need a trigger.Enlarge the graphic
The following sections describe potential triggers and risks we are keeping an eye on.
Household debt levels are at historic highs in Canada. The figure below shows how Canada’s debt to income ratio has grown since 2012.
High debt payments mean households have less money to spend on other things and represents a risk should higher interest rates or unemployment force households to cut spending further.Enlarge the graphic
Let’s take a closer look at this risk, turning our attention first to interest rates. With inflation under control (core inflation is hovering around 2%) and the economy doing moderately well, we don’t expect much, if any, movement in the Bank of Canada’s policy rate in 2020.
Further, the job market in most of the country is strong with 35,000 new jobs created in December and 320,000 added during all of 2019. We see no reason to expect a downturn in employment in the near future.
Provided that interest rates don’t increase materially, and the job market doesn’t turn for the worse, we feel the risk from household debt is currently under control.
The future of Canada’s oil and gas sector
Oil prices remain significantly below levels seen in 2014 and earlier. Recently, a leak in the Keystone pipeline and a CN Rail strike kept the price of Canadian crude low.
In the long run, headwinds from lacklustre global oil demand growth, higher U.S. shale oil production and the transition to a low carbon economy are also likely to hurt oil prices. A dowturn in prices because of a fall in global oil demand or a delay in completion or cancellation of a new pipeline would obviously have a significant negative impact—especially in Western Canada.
However, it’s important to note that the oil and gas sector’s contribution to Canada’s economy is significantly lower than in the past. For example, capital investments in oil and gas in Canada are about 44% of what they were in 2014—right before the last oil-related recession.
The fact the sector is now smaller, would lessen the impact of a downturn, especially in regions outside of Canada’s oil producing heartland, making it less likely an oil-related downturn would trigger a Canada-wide recession.
Canada is an open economy so the trigger of our next recession could come from abroad. A recession in the U.S. would quickly have an impact in Canada. So, let’s take a quick look at the state of the U.S. economy.
U.S. economic fundamentals remain strong. Job growth over the last 36 months has resulted in an unemployment rate at a historic low of 3.5%. Further, inflation is under control and consumer spending shows no sign of letting up. The risk from an all-out trade war was mitigated recently by the Phase 1 deal with China. Stock market valuations are high, but price-to-earnings ratios and house price indexes are at reasonable levels compared to historic highs.Enlarge the graphic
The consensus view of economists is for the U.S. economy to generate another solid year with GDP growth of around 2%. (See the US tab of this letter for a more comprehensive assessment).
These factors make it unlikely that issues in the U.S. economy will trigger a recession in Canada.
We’ve looked at three potential triggers of Canada’s next recession: Household debt, a downturn in the oil and gas sector and an external shock from the U.S. The evidence suggests they are unlikely to trigger a recession soon.
Read this article from BDC here