Canada Q3 GDP report -- some positive signs

Statistics Canada reported this morning that real GDP rose at an annualized pace of 1.3 percent in Q3, down from a pace of 3.5 percent in Q2.  The growth rate was in line with analysts' expectations, and it is worth noting that the strong growth rate seen in Q2 marked the only time in the past year that the economy has grown at a pace above 1.5 percent.  For all the surprising strength shown by the labour market for much of this year, the economy is for the most part just edging ahead.

There were positives to be taken from today's report, mainly relating to investment spending.  Housing investment grew at an annualized rate of 3.2 percent, the fastest pace since 2012, with a healthy gain in new housing construction.  Business investment rose at a 2.6 percent pace, with all sub-categories posting gains.  This is somewhat surprising, given the continuing uncertainty over trade and the global growth outlook, and only time will tell if this sort of performance can be maintained.  Household spending advanced at a 0.4 percent pace in the quarter after being virtually unchanged in Q2, while inventory accumulation and -- ominously -- exports subtracted from the overall pace of growth.

It seems likely that growth for the current quarter will be similarly subdued.  Despite regular reports of an imminent deal, trade tensions remain unresolved.  Moreover, the recent week-long rail strike at  CN Rail will weigh on growth. Normally the impact of labour disputes and such is quickly reversed once the strike is over.  In this case, however, the interruption of oil shipments to US refineries can probably not be made up, as the system is basically running at full capacity.  This suggests that export volumes will again be a drag on overall growth in the current quarter.

Today's numbers are largely in line with the Bank of Canada's most recent forecasts, which do not see the economy moving onto a faster growth path until some time in 2020. The Bank's next rate decision is just days away, scheduled for December 4.  Today's data do not change the likelihood that the Bank will keep rates unchanged this time, with a rate cut looking more likely for some time in the first quarter of next year, particularly if global trade tensions persist.     

Off to a bad start

Canada's Federal Election took place in the third week of October.  It took a full month for Prime Minister Justin Trudeau to put together his Cabinet, and when the new team was unveiled this week, it contained an awful lot of familiar faces, particularly in the most senior positions.

Trudeau is taking the same leisurely approach to recalling Parliament. Reportedly he did not want the Commons to reconvene until the new year, but was somehow persuaded to bring the date forward to December 5. Somehow he and his advisers seem to have failed to notice that the union representing train operators at CN, the larger of Canada's national railroads, had set a strike date for this past Monday.  With no deal in place, the strike duly began and is now in its fourth day.

Usually governments allow a threatened strike at either CN or the smaller CP to start, but then quickly legislate the workers back onto the job in order to avoid problems for the national economy. Trudeau's insouciant approach means that can't happen this time, and the damage is rapidly mounting. 

The Province of Quebec is set to run out of propane by the end of the weekend, posing dangers to sectors from health care to agriculture.  Similar problems are emerging in Northern Ontario.  In Alberta and Saskatchewan, oil-by-rail shipments to US refineries have been drastically reduced, deepening the discount at which western Canadian oil already trades against benchmark crudes. Farmers in the same provinces have lost the ability to ship their products just as harvest season is coming to an end, raising the possibility of crops being left to rot in the fields.

The election left Trudeau without a majority in the Commons.  His Liberals were completely shut out in Alberta and Saskatchewan and badly mauled by a resurgent Bloc Quebecois in Quebec. For the first time in decades, national unity is top of mind in political circles. If Trudeau recognizes the need to reach out to those three Provinces, his lack of action regarding the CN strike is a pretty strange way of showing it.

Preparing for the worst

Bank of Canada Senior Deputy Governor Carolyn Wilkins gave an important speech to the International Finance Club of Montreal this morning, titled "Financial Stability in an Uncertain World".  She covered three inter-related topics: Canada's progress in taming vulnerabilities in its financial system;  the  worsening global economic outlook; and the Canadian financial system's ability to handle an economic crisis, if and when one arises. 

As usual,  the key financial vulnerability in the Bank's mind lies in the state of household finances and imbalances in the housing market.  Ms Wilkins noted that the situation has improved in the past couple of years:

"Credit growth has moderated, and income growth has picked up. So the debt-to-income ratio has been stable over the past couple of years. Also, the share of new mortgages going to highly indebted borrowers fell to a low of 13 percent."

Part of the credit for this goes to the Bank itself and other regulators:

"Federal authorities made changes to mortgage-financing rules to ensure that borrowers could handle higher interest rates or lower incomes. British Columbia and Ontario introduced tax measures to reduce demand for housing from non-residents and speculative buyers. And the Bank increased its policy interest rate from 0.5 percent in mid-2017 to 1.75 percent last autumn, where it remains today. We did this to achieve our inflation target, and when borrowing costs rise, credit growth slows."  

Although there are signs of reviving activity in the housing and mortgage markets, the Bank believes that "the regulatory and other measures in place will support the quality of new credit and mitigate the buildup of imbalances in the housing market."

Turning to the international situation, Ms Wilkins focused on the interplay between trade conflicts and financial markets. She noted that the high household debt levels seen in Canada are also seen elsewhere (Australia, Sweden).  She also pointed out that the quality of corporate debt has been declining, with an increasing proportion of that debt being bundled into increasingly complex collateralized debt instruments, an ominous echo of the financial crisis a decade ago. 

The risk the Bank sees is that a perfect storm could be in the offing:

"An increase in uncertainty or bad trade news could be the trigger. This, in turn, could spark a sharp reversal in risk premiums and lead to a drop in prices for assets, including for houses. Creditors would see more defaults, especially from corporations with lower credit ratings. Moreover, if enough investors rushed to adjust their portfolios at the same time, liquidity would dry up, amplifying the effects. All of this would find its way to the banking system, making it harder for business owners and families to borrow and intensifying the downturn."

Turning finally to the resilience of the Canadian financial system, Ms Wilkins presented a generally positive picture:

"Canadian banks are part of a global banking system that is more solid than it was a decade ago. Globally active banks are holding over US$2 trillion more capital than they were at the beginning of 2011, when the phase-in of the post-crisis reforms began. This translates to a 7-percentage point increase in their Tier 1 capital ratio.  The leverage limits and new liquidity regulations also make these banks more resilient."

She noted that a recent IMF-designed stress test showed that the Canadian banking system could even withstand an extreme scenario in which unemployment jumped by six percentage points (effectively doubling the current rate) and house prices fell by 40 percent. 

This was a timely speech, in view of growing fears that the global economy may be set for a downturn, taking the Canadian economy along with it.  It is interesting that Ms Wilkins was the person chosen to deliver this reassurance.  With Governor Stephen Poloz's term ending in the New Year, she appears to have the inside track to take on the top job.  

Meanwhile, across town....

All the attention in Washington DC today is on the start of the House impeachment hearings, which are monopolizing the airwaves, even here in Canada.  Fed Governor Jerome Powell's testimony to the Joint Economic Committee of the Congress will hardly get a look-in, which is a pity, as he has some important things to say.  

The Fed likes what it see in the economy, both currently and for the near future:

The U.S. economy is now in the 11th year of this expansion, and the baseline outlook remains favorable.  

And:

Looking ahead, my colleagues and I see a sustained expansion of economic activity, a strong labor market, and inflation near our symmetric 2 percent objective as most likely. This favorable baseline partly reflects the policy adjustments that we have made to provide support for the economy.

The testimony goes on to note the continuing risks to the US expansion posed by slower growth abroad and (euphemistically, put, this!) "trade developments".  The Fed will be monitoring these risks, but overall, Powell's comments strongly suggest that the mini easing cycle the Fed has undertaken this year is at an end, barring an unforeseen deterioration in the outlook. .  

Powell also has a few more general observations on monetary policy......

....the current low interest rate environment may limit the ability of monetary policy to support the economy.

And on fiscal policy:

.....the federal budget is on an unsustainable path, with high and rising debt: Over time, this outlook could restrain fiscal policymakers' willingness or ability to support economic activity during a downturn.

Neither of these statements is really disputable, but neither will be welcomed by Donald Trump. He has regularly castigated Powell and the FOMC for their failure to reduce interest rates further and faster, and with the election now less than a year away, Trump would not wish to have voters drawing any connection between his ill-advised tax cuts for the wealthy and the soaring budget deficit. On a slow news day, Powell's comments might have triggered a Twitter tirade from the Oval Office, but today, maybe Trump has more important things to think about. 

OK, "OK boomer"

Yours truly was born in early 1950, so I am very definitely a boomer. Unlike many in my age cohort, I am not in the least offended by the ongoing "OK, boomer" meme/putdown. A quick search back through this blog indicates that I have used the term "baby boomer" in at least fifteen posts, almost always to castigate my generation for its avarice and thoughtlessness.  Here's a sample from March 2013:

What a wonderful generation we are!  For years, we've been demanding generous social programmes that we have no intention of paying for, leading governments to pile up debts that future generations will have to pay back.  And now it seems that increasing numbers of us are stiffing our creditors, rather than making any effort to live within our means.
Years ago, I remember hearing, I think from the Chief of one of Canada's First Nations, something to the effect that "the role of government is to represent the future to the present".  Fat chance of that while the baby boomers are in charge. 

There's an old adage that when there's something important to be done, one's choices are either to lead, follow or get out of the way.  I'd respectfully suggest to my fellow boomers that it's time to let younger people lead: we should either follow or get out of the way. A good place to start would be with the passel of geriatrics currently shuffling toward the 2020 US Presidential election -- but I'm not holding my breath, because at my age that's a bit risky.

The GM effect?

Statistics Canada reported this morning that employment fell by 1800 in October -- a figure well within the sampling error for the series -- keeping the unemployment rate at 5.5 percent, just 0.1 percent above its all-time low.  The ever-unreliable analysts' consensus had expected a gain of about 16,000; since the numbers were released,  those self-same analysts have been noting that the pullback comes after very strong reports for August and September, implying that nobody should really have been surprised.

Isn't there another explanation?  The most significant job losses in October were in the manufacturing sector in Ontario, which reportedly shed 23,000 positions. The lengthy strike at GM in the United States led to widely-reported shutdowns at GM plants in Oshawa and St Catharines, both in that Province.  Almost all of the company's 7,600 employees in Canada were unemployed at precisely the time of StatsCan's monthly survey.  On the entirely reasonable assumption that parts companies that supply GM were also forced to make temporary layoffs, it's not hard to make the case that the October setback will be largely unwound in the November data, since the GM strike has now ended.

I'm reluctant to be definitive about this because the StatsCan data release makes no mention of it, and none of the media outlets I have been able to check has picked up on it.  However, the corresponding US non-farms payrolls survey for October, released a week ago, provided details of the impact of the GM strike on its data, offering reassurance that the relatively low rise in payrolls was the result of this temporary factor rather than a worsening trend. It would be surprising if the same were not true, albeit to a lesser extent, here in Canada.

The November data should tell us whether I'm right or not, and I will 'fess up or brag accordingly when the data are released in early December.     

Fiscal ideology

It's not surprising that in a country as large and diverse as Canada, economic performance can vary significantly between regions. This has at times led to calls for monetary policy to be applied differently in different parts of the country, which is all but impossible. Fiscal policy is another matter: Canada is the home of so-called "fiscal federalism", by which the Ottawa government tries to ensure relatively equal provision of key services (such as education and health) from cost to coast.

A key element of fiscal federalism is the equalization programme, through which wealthier provinces provide financial assistance to poorer ones. As economic cycles unfold, Provinces can move between being "have" jurisdictions, which contribute to equalization, and "have nots", which receive it. The way resource taxes are structured means that Alberta is always likely to be classified as a "have" Province, while the Atlantic Provinces and, more controversially, Quebec are usually "have nots".

Aside from equalization, each Province manages a large taxation and spending budget of its own, which gives it some power to influence the state of its own economy.  Right now it's interesting to look at how Alberta and Ontario are managing their finances.  It's usually the case that when Alberta is doing particularly well economically, Ontario tends to lag.  High oil prices are great for Alberta, for obvious reasons.  They're not so good for Ontario, which has next to no oil and gas of its own and still depends heavily on auto manufacturing.

For the last couple of years, the Alberta economy has been suffering from low oil prices and a lack of  infrastructure for getting its oil to market. In contrast Ontario has benefited from cheaper energy, not least from the boost provided to household spending power. As a simple illustration, consider that in the twelve months to September Ontario, with a population of just over 12 million, added over 250,000 jobs; Alberta, population 3.5 million, added fewer than 11,000. 

Both Alberta and Ontario currently have right-of-centre Conservative governments, under Jason Kenny in Edmonton and Doug Ford in Toronto.  Let's start with Alberta.  Having failed to introduce a 2019-20 budget for the first half of the fiscal year, Alberta finally tabled one just days after the recent federal election. After noting that the Province contributed $22 billion in equalization payments last year, the Government announced a severe austerity package aimed at converting a budget deficit of   $ 8.7 billion this year to a small surplus by 2022/23. Here is a good summary of what that entails. 

This is the wrong budget at the wrong time.  The Alberta economy is sputtering, for reasons that are largely not the Province's fault.  Spending cuts will only slow the economy further.  As the linked summary notes, Alberta has a low debt burden and the lowest taxation rates in Canada -- it is the only Province with no sales tax of its own.  There was a clear alternative to austerity here: carefully targeted spending to help the economy ride out the current rough patch.  The Kenney government has instead chosen a path that can only make things worse, and when that happens, it will no doubt blame the government in Ottawa, rather than admitting to its own bad judgement.

On Wednesday the Doug Ford government in Ontario tabled its Fall fiscal update.  Ford's bull in a china shop approach to his job has not gone down well with voters.  The Government has already had to backtrack on any number of half-baked ideas, and the budget it tabled back in the Spring was so badly received that Finance Minister Vic Fedeli lost his job.

New Finance Minister Rod Phillips announced that the deficit for the current fiscal year is now projected at $9.0 billion, compared to $10.3 billion forecast by the luckless Fedeli.  Phillips portrayed this as proof that the deficit reduction strategy is working, even though the revised projection is higher than the final figure of $7.4 billion for the last fiscal year. 

The real story here is that despite the Government's strident commitment to spending restraint, it is actually spending more than the previous Liberal government was planning. Any progress in deficit reduction is all thanks to outperformance on the revenue side, attributable to the solid performance of the Provincial economy.  Truth to tell, eighteen months into its mandate the Ford government looks very much like the old-style tax-and-spend Liberal regimes that Ford supposedly despises.   

The Ford government is still planning to eliminate the budget deficit by 2023.  In contrast to Alberta, this does seem to be the right goal for Ontario at this time. The Province has the largest public debt of any non-sovereign jurisdiction in the world, a poisoned chalice that it usurped from California during the term of the previous Liberal government.  The economy is moving ahead steadily, as the employment data quoted above demonstrate, so a cautious move back toward fiscal balance is justified.  It remains to be seen whether Ford would pivot toward stimulus if the economy were to slip into recession. Based on what we see happening in Alberta, that might be too much to hope for.