Macroeconomics

Oh, Canada

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Oh, Canada

Political scandals are all too familiar these days. Even supposedly quiet Canada has seen its share of intrigue. It’s had a drug-using mayor and a Prime Minister who had some offensive photos surface. Now Canadian Conservative leader Andrew Scheer has been accused of hiding something far more shameful: that he is secretly American. Not just a North American, but a United States American. 1 1 Close In Canada, dual citizens can hold political office. On the other side of the border, Ted Cruz didn’t seem to create much controversy for being Canadian. Imagine if Scheer had been from Texas… His response to the charges sounded like what we’ve heard in many other scandals: “Everyone who knows me, or knows my family, knows that my father was born in the United States. I’ve been open with that.” 2 2 Close MSN: “Canada Tory leader slammed over dual US citizenship,” 10/5/2019. It’s surprising that he would admit that even to his closest friends, yet somehow, he is still in contention. Fortunately, while the election is important to Canadian citizens, macro investors have little at stake. While there are some differences in the candidates’ platforms and personal styles, neither of the major candidates presents a threat to Canada’s macroeconomic stability. It’s by no means obvious which candidate or coalition will end up in charge after the election but it seems like it will be equally market-friendly. True populists and socialists don’t seem to have as much influence in Canada as they do in other countries.

If it is a problem for a Canadian politician to hide his American roots, it is an even bigger problem for an investor to think that the Canadian economy and markets are the same as America’s. Much of the financial analysis around Canada has centered on its alleged housing bubble. For almost a decade, strategists have drawn ominous parallels between the U.S. in 2007 and Canada in whatever year it was. They warned that the housing bubble was on the brink of bursting, and that Canada’s economy would be as cold as the winter in Saskatchewan. This analysis was not totally baseless. Winters in Saskatchewan are cold. Also, Canadian housing prices and mortgage borrowing rose sharply after the global financial crisis. 3 3 Close Statistics Canada data shows a 20.7% increase in new housing prices between June 2009 and June 2017, and the Teranet-National Home Price Index shows a 77.4% increase in overall prices (i.e. including existing homes as well). According to Statistics Canada, total mortgage credit outstanding rose by 61% over this window.

The drivers of the Canadian housing boom were well known: low interest rates, moderate growth, and strong interest from international buyers. 4 4 Close In other words, Chinese nationals buying property in Vancouver and Toronto. Wall Street Journal: “Western Cities Want to Slow Flood of Chinese Home Buying. Nothing Works.” 6/6/2018. Many economists thought Canadian housing prices were frothy, but they just kept going up. The conditions started to change a few years ago. In September of 2017, the Bank of Canada raised rates from 0.5% to 0.75%, and by the end of 2018, their target was up to 1.75%. In Canada, mortgage rates tend to be fixed for only a few years, so the interest rate hikes directly affected monthly payments on many existing loans. At the same time, Canadian authorities were instituting macroprudential measures to slow the increases in housing prices. Macroprudential measures refer to regulatory actions designed to affect economic activity and are used as an alternative to monetary policy. In this case, the goal was to make housing more affordable for Canadian citizens without slowing economic activity.

Some of these macroprudential measures targeted international buyers. They included transaction fees and taxes on uninhabited investment properties. 5 5 Close Bloomberg: “The Taxes That Sent Vancouver’s Luxury Housing Market Reeling,” 4/16/2019. Meanwhile, China was putting restrictions on its citizens and corporations to reduce capital outflows as part of its anti-corruption crackdown. China had been one of the largest sources of international buyers of Canadian real estate. 6 6 Close Data gathered by the province of British Columbia in 2016 found that “in Metro Vancouver five per cent of all real estate purchases were made by foreign buyers, almost all of them Chinese nationals.” CBC: “Early data shows foreign nationals buying 5% of Metro Vancouver homes sold,” 7/7/2016. This combination of factors hit activity hard. Canadian new housing price growth slowed and has recently turned negative. The measures were successful.


Source: Statistics Canada, Bloomberg as of 10/10/2019.

If Canada were like the U.S. in 2007, you would expect a serious financial crisis to follow. Banks would collapse, and the economy would fall deep into recession. But if being a hidden American is a problem for Canadian politicians, thinking the Canadian economy now is the same as the U.S. economy was ten years ago is a problem for investors. Instead of crashing, the Canadian stock market made all-time highs in September. In May, the Canadian unemployment rate was at a multi-decade low, and Q2 GDP growth was a healthy 3.7% annualized. 7 7 Close Statistics Canada. The Canadian economy is doing fine.

During the U.S. housing crisis, the big problem was not the loss of activity in construction but rather its effects on the financial system. The slowdown in housing led to a banking crisis, which brought lending to a halt throughout the economy. While there is a good deal of leverage in the Canadian economy, and there is a large mortgage insurer similar to Fannie Mae, there are some major differences. The slowdown in housing prices in Canada has come most acutely at the high end, where many of the buyers were unlevered. We haven’t yet seen the kind of defaults that plagued the U.S. market nor the massive losses on derivatives. As a result, the banking sector hasn’t been challenged in the way the U.S. was.

Canada has also had some positive external factors. The U.S. economy has held up well, which helps its neighbor to the north, whether anyone there likes to admit it. 8 8 Close So maybe Canada is a little American. Just a little. One of the biggest risks was uncertainty over trade with the U.S., but the USMCA agreement has (mostly) resolved that. 9 9 Close It hasn’t been officially ratified yet, but most businesses seem comfortable with the direction of trade between the U.S. and Canada. While business investment has not recovered sharply with the signing, it has been stable. Canada has also seen a large influx of immigrants, many of whom are skilled workers. 10 10 Close Maybe they’ll get a lot more because of Brexit. This may be partly because of increased restrictions in the U.S. Some economists think that this has helped increase economic growth over the past two years. In addition, oil prices, while not at particularly high levels, are well above where they were in 2016. Canada is a large producer of energy, so its economy is affected by commodity prices.

The outlook for Canada is still solid. The economy should continue to grow, if at a slower pace. Housing may start to weigh more on the economy and we could see some hidden problems in the financial system, but the biggest risks are probably external. If the U.S. economy stagnates or energy prices fall, Canadian growth could suffer. But that doesn’t mean you should confuse it for the United States of America. That won’t get you elected or invested.

What We Are Watching

U.S. Retail Sales (Wednesday)
With global growth concerns increasing and clear weakness in manufacturing, consumer spending is being watched closely for any signs of weakening from its current growth trajectory. Data in recent months has shown consumer spending continuing to support the U.S. expansion. Retail sales grew 4.6% YoY in August 2019, with particularly rapid growth in sales from non-store retailers, which expanded at a 16% YoY pace. 11 11 Close U.S. Census Bureau. Economists are forecasting continued healthy growth in this week’s data covering September retail sales. If the data surprises to the downside, the odds of a rate cut at the October FOMC meeting would likely increase. An upside surprise could help support recent Fed rhetoric that the U.S. economy is still relatively healthy and might reduce the odds of further rate cuts.

European Council Meeting (Thursday and Friday)
The U.K. is still scheduled to leave the E.U. at the end of October, and the lack of an agreement on an orderly transition process has fueled fears of a damaging “No Deal” Brexit. U.K. Prime Minster Boris Johnson has maintained that Brexit must take place as scheduled with or without a deal. However, the U.K. parliament has passed legislation requiring Johnson to request an extension if no agreement is reached by October 19th. This week’s European Council meeting, and the days of intensive talks preceding it, provide an opportunity for the U.K. and the E.U. to make progress towards such an agreement. If these talks yield the outline of a possible deal, an extension may still be required to formalize the details and pass legislation. Nonetheless, such an outcome would likely be seen as a major positive for U.K. economic prospects, boosting the pound and weighing on domestic fixed income. If talks are unproductive, there may be continued volatility in U.K. markets as investors wait to see whether Johnson will comply with the requirement to request an extension, whether the E.U. will grant the extension, and whether a new U.K. election will then be scheduled for later this year.

China GDP, Industrial Production, Retail Sales (Friday)

Following underwhelming performance in July, Chinese activity data continued to weaken in August amid rising trade tensions and decelerating global growth. Retail sales and industrial production fell short of consensus forecasts, as economists expected modest improvements in annual growth rates on the back of recent Chinese government stimulus. Instead, retail sales continued to be weighed down by auto sales, which may have been impacted by new emissions standards. Industrial production also slowed, coming at its lowest growth rate since 2002 with broad-based deceleration across industries. Another metric of activity, fixed asset investment growth, printed near a two-decade low as well. All these metrics bode poorly for the Chinese GDP release next week, with economists penciling in continued deceleration to a new multi-decade low. If activity data for September and GDP data for the third quarter confirm these negative expectations, it could weigh on market sentiment.


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