Wild ride won't ease until second wave is under control

Year in review: COVID-19 dealt a devastating blow to the Canadian economy, but there are some positive signs on the horizon, says expert

Wild ride won't ease until second wave is under control

It’s been a wild year for the Canadian economy, from a normal start to the substantial impact of the pandemic, followed by a quicker-than-expected recovery. Yet while that recovery is underway, Canada is also currently battling a second wave of the virus, so the full picture is far from clear.

“At the start of the year, the economy was growing. There were late-cycle concerns, but it was an ordinary first few months,” says Eric Lascelles, chief economist at RBC Global Asset Management. “It got highly abnormal, and the pandemic remains the dominant theme, marked by the catastrophic decline in activity in March and April but, since then, by a surprisingly robust rebound. The story has played out better than anyone would have forecasted. There are still challenges with the second wave, but one thing that comes to mind is enthusiasm of the economic recovery that took hold earlier than most expected and clawed back a lot of the losses ahead of schedule.”

Lascelles notes that RBC GAM had anticipated this type of recovery by the end of the summer but instead saw it in June. By the fall, he says the economy had recovered two-thirds of its losses, leading RBC GAM to upgrade its growth forecasts, despite the economy still not being where anyone would have predicted in January.

The shape of the recovery has also been interesting to Lascelles. While many experts rushed to predict its trajectory as V-, U- or K-shaped, Lascelles says there’s not a single letter to describe it.

“It depends on what you focus on – it’s a bit of a U, V, K,” he says. “Some sectors are up, others down; it has been a divergent recovery. You can’t rule out a W as well. Here we are with a second wave, and there is a debate around if we grow through the fall and might there be stagnation or a decline as the second wave plays out. There could be a mini W involved – but even if we get a drop, it would be mild compared to last spring.”

While Canada’s economic recovery was originally aggressive, he says, climbing nine percentage points in two months, it eventually became more gradual. As for the drivers behind the recovery, Lascelles points to the ingenuity of workers, business and governments, along with the reopening of some sectors.

“Initially, our thought process was you probably need to keep most sectors closed until June; then you would have the virus eradicated and could reopen,” he says. “Instead, we saw sectors open, with restrictions becoming less restrictive. It was probably premature and in part why a second wave is happening, but for the moment, we are anticipating stagnation through the fall. We could be in for a slower go the next couple months, but it doesn’t challenge that we are in a multi-year recovery, and it can get going once the second wave is under control.”   

Another interesting aspect of the recovery has been employment, Lascelles says. RBC GAM’s data shows that the job market has rebounded quicker than the economy itself, recovering close to 75% of its losses.

“We should be grateful for that,” he says. “Then I think you can find sectors that are performing notably ahead. Agriculture output is high, and demand for utilities, financial services, public administration, real estate and technology is looking close to normal.”

Lascelles does acknowledge the headwinds that other sectors – including food services, accommodation, arts and entertainment, and recreation – have faced. He says it’s important to look within sectors for more information, pointing to retail as an example – although it looks to be nearly back to normal, there are varying outcomes within the space.

Moving forward, Lascelles says the unprecedented nature of the pandemic means there could be many risks to the economy.

“There were lagged headwinds that we were initially concerned with when fiscal stimulus would come off,” he says. “There was a risk that could put the economy in trouble. It hasn’t happened – government support remained forceful, which set aside that risk. You could fret about long-term public debt issues, but we aren’t getting a steep fiscal cliff. We are aware problems usually occur with a lag – usually you have a recession, then businesses go bankrupt and households are unable to pay mortgages – but if anything, credit analysts have been reducing the expected losses.

“For the moment, [inflation] is tame, which makes sense,” he adds. “Long term, there are some risks related to the inflation mandate in the US, and that is relevant to the world. Central banks have printed a lot of money; debt levels are high, which can create temptations to tolerate inflation. We can also say there is some onshoring of supply chains, which is inherently inflationary, so you could say there should be more inflation over the long run. I think the risks are minimal – we are just talking about transitioning from a decade with unusually low inflation to more normal inflation. Maybe I can see a bit higher but nothing problematic like the 1970s and ’80s.”

Looking forward, Lascelles says much of the outlook for 2021 depends on Canada’s handling of the second wave and avoiding a third (as was seen during the 1918 Spanish flu pandemic), along with the availability of a vaccine and the timeframe to inoculate enough of the population. Only once the virus is tamed can the rest of the recovery occur.