ECONOMIC & FIXED INCOME COMMENT - There is Light
Most people would like to say goodbye to 2020 and are excited about the prospects of 2021. The impact of the COVID-19 virus and rollout of vaccines is having a major impact on economic forecasts for 2021. Having said that, economists have tried to add up the data and come up with their best estimates. Clearly, there is a lot of variability in the forecasts due to unknown changes in the behaviour of the virus going forward.
On a global basis, GDP is expected to grow 5.5% in 2021 from -4.0% in 2020. In the U.S., GDP is expected to decline -3.5% in 2020, then recover by growing 4.5% in 2021. The Canadian economy is expected to follow a similar pattern declining -5.7% in 2020 then snapping back 4.8% in 2021. As the vaccines gets wider distribution, economic activity is expected to improve. However, we will be wearing masks and keeping our social distancing into the third quarter of 2021. We need 70-75% of the population to be inoculated before we have herd immunity. Once we have achieved this, our lives will be able to return to “normal”.
The future looks much brighter in the U.S. in 2021.President elect Biden will provide a steady hand on the tiller of the ship of state as compared to the Trump era. One hopes that Donald Trump will slip away from office quietly and allow President Biden the opportunity to get on with his agenda but this may be asking too much from Trump. While dealing with the COVID-19 pandemic is Biden’s top priority, his shift in international policy away from “America first” to engagement with long term allies is significant for global security. Given the recent cyber-attack by the Russians, the U.S. needs all of its friends to help right this wrong.
In Canada, other than the SNC-Lavalin scandal and the WEE scandal, the minority Liberal government is holding together. The massive fiscal stimulus last spring to support both individuals and corporations has played out well for our economy. One silver lining in these support programs is the significant increase in the personal savings rate to over 27% in the second quarter as compared to 1.5% pre-pandemic. The Bank of Montreal estimates that Canadians have $150 billion in savings, approximately 7% of GDP. The pickup of savings in the U.S. is similar. As a result, consumers in both countries are poised to lead economic growth in 2021.
In Canada, consumer spending (particularly for durable goods), residential construction, investment in machinery and equipment as well as exports are expected to lead the economy. The leading sectors of growth in the U.S. are also consumer spending and residential construction.
Associated with the pickup of economy activity is a decline in the unemployment rate in both countries. In the U.S., unemployment is expected to decline to 5.3% by year end 2021 from the November rate of 6.7% (see chart of U.S. Unemployment Rate). Canada’s November unemployment rate was 8.5% and is expected to decline to 7.0% by year end 2021. Further declines in both countries are expected in 2022 compared to 2019 levels.
With the sharp decline in economic activity in the first half of 2020, the recovery in 2021 and 2022 will have higher growth rates compared to 2019 levels. Generally, higher economic growth rates start to push inflation up as the competition for goods and services increase. However, in this instance, the decline in growth in 2020 has created a deflationary gap resulting in a decrease in demand for goods and services. Therefore, economic growth can run higher than normal (closing the deflationary gap) without stimulating inflation too much.
Canadian core inflation is estimated to be 1.7% in the fourth quarter of 2020. It is expected to remain at that level through 2021 then increase slightly in 2022 to 2.1%. In the U.S., core inflation is expected to be 1.4% in the fourth quarter of 2020 then increase to 1.6% by year end 2021 and move higher to 1.8% in 2022. Given that both the Federal Reserve Board in the U.S. and the Bank of Canada use an average of 2% core inflation rate as a long-term target, inflation is picking up a little but remaining well contained.