Weekly Market Insight

May 1, 2009
NORTH AMERICAN & INTERNATIONAL ECONOMIC HIGHLIGHTS
Now… don’t get too excited, but there are some encouraging signs from both sides of the border suggesting that we are getting close to the bottom of this recession. In fact, we are already starting to accumulate the ammunition we might need to fuel the recovery.

But before we go to the good news, we have to realize that the drop in first quarter Canadian GDP will eclipse the decline stateside. In fact, the projected 7.3% annualized GDP drop in the quarter will be, by far, the steepest on record, and the speed at which the labour market is degenerating is now matching the darkest
hours of the 1982 recession. Decades from now, economists, not yet born, will point to the first quarter of 2009 as the epitome of weak economic data.

But the news is getting better:
• For the first time in many months, both US and Canadian investors are not adding to their cash positions. In fact, we are starting to see a reversal of this trend—a bullish signal since these mountains of extra cash ($1.1 trillion in the US and close to $90 billion in Canada) will be redeployed.
• With commodity prices stabilizing, the gap between nominal and real GDP in Canada is narrowing back to its long-term average. This means that real economic variables such as real GDP will be much more relevant to corporate profits—eliminating a source of uncertainty and volatility in the market.
• The pace at which house prices in Canada are falling is moderating and at this rate, this housing market correction (from a national perspective) will end up being a mild one—both in absolute and relative terms. In fact, the notable improvement in housing affordability is injecting some life to the mortgage market, encouraging new purchasing and refinancing activities.
• Consumer confidence in both countries is starting to improve, while retail sales are surprisingly on the upside.
• And the money multiplier in the US has leveled off in recent weeks. That is extremely important since it suggests that commercial banks are starting to use some of the money that they have been parking at the Fed for other (more constructive) purposes such as lending. This is reflected in the fact that the Ted
spread (spread between the libor and T-bills rate) narrowed by almost 10 basis points over the past few week, and it is now at its lowest rate since the beginning of the crisis.

While the unemployment rate in Canada is projected to peak over 9%, the main impact of the softening labour market will be on the confidence of Canadians that are still employed. In this sense we are already witnessing a rapid change in saving behavior, with the savings rate rising from less than 2% in late-2007 to 4.7% in Q4-2008, the fastest year-over-year ascent since the mid-1980s.

But that is not atypical for a recessionary period. In the 1980s’ recession, the savings rate shot up to 20%, as declining consumer confidence and fear of layoffs had Canadians taking frugality to the extreme. We estimate that the current recession will see the savings rate rise above 6.5%, translating into a net withdrawal from the economy of about C$26 bn over the next two years.
The rise in the savings rate will be relatively modest, primarily because Canadians are better equipped this time.

With higher quality jobs, a high participation rate, and an extended EI program ensure that households continue to see larger inflows of income compared to prior recessions. Moreover, credit is more accessible now than in earlier recessions, and affordability has improved dramatically, thanks to interest rates at historic lows.

Still, C$26 bn of foregone consumption doesn’t go unnoticed and will evidently weigh on GDP. But due to massive cash injections from all levels of government, that estimated increase in personal saving will be dwarfed by increases in government spending, with C$40 bn of fiscal stimulus coming from the Federal government alone, while provinces will do their part through vast outlays over the same two-year period.

These would push the combined Federal and Provincial budget deficit to about C$53 bn and C$47 bn in 2009/10 and 2010/11 respectively or roughly 3% of GDP, a significant boost to the economy by any measure.

Benjamin Tal
Senior Economist