The pandemic has thrown up many surprises for the Canadian economy, the latest of which is the speed at which oil production has rebounded. Even though global fuel demand remains weak amid ongoing global travel restrictions, the Canada Energy Regulator’s (CER) latest estimates show that domestic production fully recovered in December, with 500,000 barrels per day of extra output compared to what the CER had previously forecast. The impressive turnaround reflects both the rebound in oil prices, with WTI now back near its pre-pandemic level of $60 per barrel, and the fact that Canadian firms have captured market share in the US, where domestic oil production has barely rebounded at all. The swift recovery in Canadian production helps to explain why, despite the tightening of the coronavirus restrictions, the preliminary estimate showed that GDP rose by 0.4% m/m in December. With other commodity prices also rebounding, activity in the natural resources sector will help to drive a modest rise in GDP in the first quarter, even though the coronavirus restrictions were tightened further. The rise in production and the surge in oil exports to the US in January even suggest there are upside risks to both the consensus forecast that GDP will contract by 1.0% annualised in the first quarter and our own more positive forecast for a 1% expansion.
- The pandemic has thrown up many surprises for the Canadian economy, the latest of which is the speed at which oil production has rebounded. Even though global fuel demand remains weak amid ongoing global travel restrictions, the Canada Energy Regulator’s (CER) latest estimates show that domestic production fully recovered in December, with 500,000 barrels per day of extra output compared to what the CER had previously forecast. (See Chart 1.) The impressive turnaround reflects both the rebound in oil prices, with WTI now back near its pre-pandemic level of $60 per barrel, and the fact that Canadian firms have captured market share in the US, where domestic oil production has barely rebounded at all. The swift recovery in Canadian production helps to explain why, despite the tightening of the coronavirus restrictions, the preliminary estimate showed that GDP rose by 0.4% m/m in December. With other commodity prices also rebounding, activity in the natural resources sector will help to drive a modest rise in GDP in the first quarter, even though the coronavirus restrictions were tightened further. The rise in production and the surge in oil exports to the US in January even suggest there are upside risks to both the consensus forecast that GDP will contract by 1.0% annualised in the first quarter and our own more positive forecast for a 1% expansion.
- Output and activity indicators show the oil sector is recovering quickly.
- Consumption indicators show the latest restrictions have dented spending.
- Business indicators suggest housing starts should remain strong.
- External indicators imply exports will be held back by supply-chain disruption.
- Labour market indicators suggest the LFS may be overstating the employment recovery.
- Inflation indicators point to a sharp rise in inflation.
- Financial market indicators show that longer-dated bond yields have jumped.
Chart 1: Canada Energy Regulator: Estimate of Oil Production (million barrels per day)
- There were two positive surprises in the latest GDP data, with GDP increasing by a much stronger-than-expected 0.7% m/m in November and Stats Can revealing that its preliminary estimate points to a 0.4% rise in December, despite the tightening of the coronavirus restrictions. The latest Labour Force Survey also seems to bode well for GDP in January. Although employment fell sharply, hours worked rebounded (2).
- The surprising strength of GDP at the end of 2020 was in large part due to a rapid recovery in oil production. The CER says that production in December fully recovered to its previous peak of 4.9mn barrels per day, or 500,000 more bpd than the CER had expected in November (3). The new estimate implies oil and gas extraction GDP has already returned to pre-pandemic level (4), although the still-low number of oil rigs currently active shows the broader oil sector has not yet fully recovered (5).
- Containment measures are now being gradually eased across the country, but are set to remain in place until early March in the highly-populated Toronto and Peel areas of Ontario where cases remain elevated (6). The easing of restrictions will support activity from February with growth in restaurant visits already rebounding to -60% y/y in recent days, from -83% in January (7).
Chart 2: LFS Hours Worked & GDP % m/m)
Chart 3: CER Oil Production Estimate (mn bpd)
Chart 4: Oil & Gas GDP & CER Production
Chart 5: Oil Rigs and Oil & Gas Support Services GDP
Chart 6: Weekly Coronavirus Infections Per 100,000
Chart 7: Restaurant Visits and Accommodation & Food Services GDP
Sources: OpenTable, Various Official Sources, Refinitiv
- Coronavirus restrictions caused retail sales to fall by 3.4% m/m in December and the preliminary estimate shows sales fell by almost as much again in January (8). The decline in December was mainly due to weak holiday-related spending, with sporting good, hobby & book sales plunging by 23% m/m, clothing sales by 17% m/m, and electronic & appliance sales by 13% m/m (9).
- The weekly RBC card spending tracker showed little improvement in January, but spending should start to recover in February now that the coronavirus restrictions are being eased (10). Indeed, consumer confidence has held up well and would normally be consistent with consumption growth of more than 3% y/y (11).
- The current high rate of household saving also bodes well for a swift rebound in spending as the restrictions are lifted (12). Spending should also be supported by further gains in house prices, with the sales-to-new listing ratio surging to a record high in January and consistent with a further acceleration in house price inflation from 9.6% in January (13).
Chart 8: Retail Sales ($bn)
Chart 9: Retail Sales – November (% m/m)
Chart 10: RBC Card Spending Tracker (100 = 2019 Ave)
Chart 11: Household Saving Rate (% of Disp, Income)
Chart 12: Consumer Confidence & Consumption
Chart 13: Home Sales-to-New Listings & House Prices
- Amid the latest lockdowns, the CFIB Business Barometer has remained relatively low, at a level that would normally be consistent with sustained falls in investment (14). Investment could feasibly rise strongly once the restrictions are lifted, given that firms’ currency and deposit holdings have jumped by 60% since the pandemic (15) and fiscal support has kept corporate profits looking healthy, at least in aggregate (16).
- The rise in currency and deposits has been met by an increase in debt, however, which firms may opt to pay down before they invest. Moreover, the big picture remains that corporate net worth has fallen in the past year (17), which could also weigh on investment prospects.
- New home construction continues to boom, housing starts jumping to over 280,000 annualised in January (18). Activity was supported by the unseasonably warm weather, with starts rising by the most in Quebec and Ontario (19), where temperatures were most notably above seasonal norms. While starts will likely drop back again in February, strong demand for housing suggests they will remain strong.
Chart 14: CFIB Business Confidence & Investment
Chart 15: Non-Financial Corporations’ Currency & Deposit Assets ($bn)
Chart 16: Non-Financial Corporations’ Disposable Income ($bn, annualised)
Chart 17: Contributions to Change in Net Worth Since Q4 2019 ($ bn)
Chart 18: Building Permits & Housing Starts (annualised, 000s)
Chart 19: Housing Starts (000s, annualised)
Source: Refinitiv, Statistics Canada
- The goods trade deficit narrowed to $1.6bn in December, from $3.6bn, as exports rose by 1.5% m/m and imports fell by 2.3%. The rise in exports was primarily due to a 10% m/m jump in energy exports and the fall in imports partly reflected an 8.0% m/m drop in consumer goods imports, which appeared to reflect lower-than-usual spending during the holiday period (21).
- The rise in energy exports was mainly due to higher prices and the further increase in WTI to $60 pb looks consistent with the trade deficit remaining near $1.5bn (22). We were previously concerned that oil export volumes might suffer from depressed travel demand, but Canadian exporters have captured significant market share in the US, with US oil imports from Canada hit a record high in January (23).
- The improvement in oil exports will help to offset disruption in the automotive sector, with semiconductor shortages causing several plants in both the US and Canada to temporarily halt production (24). Meanwhile, the government’s decision to tighten travel restrictions will further dent travel services exports and imports but, as they have already fallen sharply, that will not have much of an effect on overall trade (25).
Chart 20: Goods Exports, Import & Trade Balance ($bn)
Chart 21: Export & Import Values (% m/m, December)
Chart 22: Oil Price & Trade Balance
Chart 23: Canada Oil Exports to US (000 bpd)
Chart 24: US Auto Assemblies & Canada Exports
Chart 25: Travel Services Exports & Imports (% of GDP)
Sources: Refinitiv, Statistics Canada, US EIA, Capital Economics
- The LFS showed employment fell by a larger 213,000 in January, after the 53,000 drop in December, although hours worked nevertheless rose by 0.9% m/m (26). That was because the job losses stemmed from sectors where part-time jobs are common, such as retail trade, whereas employment continued to rise in sectors where full-time positions are the norm, including construction and professional services (27).
- The LFS paints a brighter picture of the labour recovery than the less timely Survey of Payrolls, Employment and Hours (SEPH). The SEPH implies 1.1 mn people were out of work in November compared to February 2020 whereas, even after the recent 266,000 fall, the LFS shows 850,000 more people were jobless (28).
- The LFS may be overestimating the employment recovery because the assumed rate of population growth used to calculate employment has remained much higher than the official estimate (29). That said, this would only explain 150,000 of the difference in employment between the two surveys and it would not alter the unemployment rate, which rose to 9.4% in January. With the coronavirus restrictions now being eased and new job listings rising sharply, we expect the unemployment rate to start falling again (30,31).
Chart 26: Monthly Change in Employment (000s)
Chart 27: Change in Employment (December, 000)
Chart 28: Employment (000s)
Chart 29: Population (% y/y)
Chart 30: Indeed Job Listings (% y/y)
Chart 31: Quarterly Unemployment Rate (%)
Sources: Refinitiv, Indeed, StatsCan
- The 0.4% m/m seasonally-adjusted rise in consumer prices pushed the annual rate of inflation up to a still-subdued 1.0% in January (32). Inflation weakened in several categories, including clothing, food and shelter, with the increase being driven by higher inflation in the transportation, household furnishing & equipment, and recreation, education & reading categories (35).
- The rise in recreation, education & reading inflation was partly a statistical quirk. Travel tours inflation rose to over 30% (34), but this reflected Stats Can’s method of imputing prices where data collection is not possible and, as this effect unwinds, travel tours inflation will drop toward zero in the next two months. That will subtract 0.3%-points from inflation, but the move should be more than offset by a further rise in gasoline inflation due to the recent jump in oil prices and base effects from the fall in prices last year (35).
- There was some confusion around the true rate of core inflation in January after Stats Can announced some downward revisions to the data, but then subsequently reversed those revisions a week later. The non-revised data show CPI-trim and CPI-median returned to 2% in January (36) and firms’ selling price expectations suggest CPI-common will soon follow (37).
Chart 32: Consumer Prices
Chart 33: CPI Inflation (%)
Chart 34: Travel Related Inflation (%)
Chart 35: Oil Prices & Energy CPI (% y/y)
Chart 36: Core Inflation (%)
Chart 37: CFIB Selling Price Exp. & Core Inflation (%)
Sources: Refinitiv, Capital Economics, Bank of Canada
- Longer-dated government bond yields have jumped in the past month, with both the 30 and 10-year yields rising by near 40 bp while the two-year yield has risen by less than 10 bp (38). The move in longer-dated yields has been primarily due to higher real yields. For bonds expiring in 2036, the real return yield has risen by 27 bp over the past month while the inflation breakeven has increased by 13 bp (39).
- The jump in yields partly reflects changing expectations for the policy rate. Overnight index swaps imply the first 25 bp rate hike will now occur at the end of 2022, sooner than the Bank of Canada has recently signalled (40). Market participants expect the Bank to raise rates to a higher level than the Federal Reserve, with the implied policy rate at almost 1.5% by end 2024 compared to little more than 1% in the US (41).
- The shift in interest rate expectations has been driven in part by the further strength of commodity prices, with the WTI oil price rising back to its pre-pandemic level of around $60 (42). Despite the strength of oil and other commodity prices, the TSX has risen by a modest 2.4% in the past month, which means it has marginally underperformed the 2.8% rise in the S&P 500 (43).
Chart 38: Canada Government Bond Yields (%)
Chart 39: Real Return & Inflation Breakeven for Bonds Maturing in 2036 (%)
Chart 40: Policy Rate Implied by OIS (%)
Chart 41: Policy Rate Implied by OIS (%)
Chart 42: Oil Price & Exchange Rate
Chart 43: S&P 500 and S&P TSX (19th Feb. 2020 = 100)
Sources: Refinitiv, Bloomberg, Capital Economics
Stephen Brown, Senior Canada Economist, +1 416 874 0514, firstname.lastname@example.org