Services-producing sectors recorded a 9.7% drop, led by retail trade and transportation. Goods-producing industries saw a 17% decline in output. The economy at the end of April was 18.2% lower than its February level, the month before the COVID-19 measures began.

Nothing like this has ever happened in our lifetimes; we are in uncharted territory, and the virus will determine the future course of the economy. Policymakers in Canada have done a commendable job in cushioning the blow of the lockdown and its lasting impact on the economy. Importantly, Canada has posted a sustained decline in the number of cases owing to the enforced lockdown measures. Canada’s success is in direct contrast to the disastrous surge in COVID cases in roughly 20 US states where the economy opened prematurely, and public health initiatives were grossly mismanaged. It is crucial, however, that we not assume the worst is over and let down our guard. The World Health Organization said yesterday that “the worst was yet to come.” Moreover, the timing of a vaccine is unknown, and Canada remains susceptible to contamination from incoming American truckers, travellers and virus spread if we open too quickly.

Highlights of the economic contraction in April were:

• Air transportation plummeted 93.7%, reflecting the reduced movement of both goods and passengers.
• Accommodation and food services dropped 42.4%, following a 37.1% decline in March. The sector was down a whopping 64% from its level of activity in February.
• Real estate declined 3.5% in April following a 1.2% decline in March. Activity at the offices of real estate agents and brokers plunged 57.2% in April, as home resale activity in nearly all major urban centres came to a standstill.
• Personal and laundry services (provided by hair salons, beauty parlours, funeral homes, dry cleaners, etc.) dropped 39.3%, while private household services offered by maids, cooks, gardeners, etc. fell more than one-third.

The good news is that StatsCan said today that preliminary information indicates an approximate 3.0% increase in real GDP for May. Output across several industrial sectors–including manufacturing, retail and wholesale as well as the public sector (health, education and public administration)–increased in May, as activities gradually resumed in phases in different regions of the country.

Consumer Providing Support 

On a more positive note, the economists at Royal Bank reported yesterday that personal spending had rebounded sharply since early April, judging by debit and credit card purchases (see chart below). Overall card volumes were near year-earlier levels by June 16th, down 2% year-over-year. Reopening across the country spurred spending at clothing stores and on personal services such as haircuts and massages. Early indications suggest online shopping remains popular despite the opening of bricks and mortar stores.

The reopening of the economy, along with federal government income support, has boosted consumer confidence and spending. The Canadian Emergency Response Benefit program (CERB) provides eligible consumers who had stopped working because of COVID $2,000 per four-week period. Trudeau recently extended the CERB from 16 weeks to 20 weeks.

Consumer confidence has climbed for nine straight weeks according to the Bloomberg Nanos Canadian Confidence Index, a weekly composite measure of financial health and economic expectations. The index currently stands at 46. That’s up nearly 10 points from early May and is slowly nearing the 50-point mark, above which views are considered to be net positive.

One unintended problem, however, is that the CERB is becoming a disincentive to work. If a recipient earns more than $1,000 per month, he or she loses the full $2,000 payment. Also, for some, the CERB allotment is more than they earned at their previous job, so they are reluctant to return to work when their businesses open. The stipend is now making it difficult for restaurants, retail stores, cleaning services and trades to get their workers back. The government needs to start winding down direct cash support, but instead, it extended the payments until the end of August.

• Negative interest rates are off the table as they “lead to distortions in the behaviour of financial markets.”
• Therefore, no additional Bank of Canada rate cuts is coming.
• The BoC will continue its securities purchase program to provide liquidity to financial markets.
• In response to questions, he said he expects lasting damage to demand and supply in the economy. He said the recovery will be “long and bumpy” and “slow and gradual”.
• The inflation target of 2% will remain the beacon for BoC policy. Currently, inflation is below target.
• “This recession is a deep one. Women have been particularly hard hit because they work disproportionately in the hard-hit service sector and women are disproportionately caring for children and the elderly”.
• Fiscal support programs lay the foundation for the recovery of particular groups.
• Oil-producing regions are hard hit by the oil price shock. The price of oil has moved up recently to WTI $40, but the pandemic clearly “weakens oil demand”.
• Household debt levels are a concern. Fiscal transfers help and households have reduced their spending. The role of the BoC is to provide the required stimulus to encourage households to spend. The macroprudential measures already in place will discourage highly indebted households from taking on more debt.
• He expects “pretty good growth in jobs and GDP in Q3”. Beyond that is more uncertain as we will need to repair the economy.
• All institutions must speed up actions to deal with climate change, including the BoC. We will need to get a handle on the implications of this for the economy.
• Chartered banks are more conservative in their lending practices since the pandemic hit. The securities-purchase programs are intended to keep credit flowing from the banks. The banks are an important shock absorber during this recession. Conditions in financial markets are much improved since the beginning of the crisis. “Markets have normalized and credit is flowing more freely”.
• Both the government and the BoC have introduced extraordinary programs to deal with this crisis. He said, however, that we could use “additional international assistance and cooperation”.
• Real estate question–How much risk does this sector represent? The Governor commented that different sectors will behave differently Warehouse and fulfillment centre demand is quite strong. Commercial real estate outlook is uncertain– particularly office space and shopping malls. Housing–he commented that “sharp drops in housing activity” has led to “little change in prices” thus far. This will vary by region and type of housing in the future.  
• “The pace of change is accelerating. Societies around the world are having trouble keeping up. The central bank must get ahead of this” and be prepared for the unknowns, be agile and resolute.
• Asked about the potential for a second wave of a pandemic, he said, “The outlook is fraught with uncertainty. The biggest uncertainty is the course of the virus. There will be increases in the number of cases. We need testing and tracing with quick responses locally. We need to determine how to open up safely.”
• When asked for his last word, he said, “We are going to get through this. Canadians are resourceful, business ingenuity is strong, this will be a long slow recovery and there will be setbacks. We have avoided the worst scenario. Not all jobs will come back. The Bank is laser-focused on supporting this recovery and getting Canadians back to work”.

Economic theory and econometric modelling do not provide a specific roadmap. Unlike previous postwar recessions, today’s is not an endogenous shock triggered by huge imbalances.

To be sure, medical considerations should outweigh economic ones. The job of policymakers is to mitigate the financial burdens caused by doing the right things on the medical side.

How do we navigate the coming months? In my opinion, this is a question to be answered first by medical experts. To assess the next steps from an economic policy perspective, the government should explain its view on the likelihood of a vaccine and antivirals over a six-month, one-year and three-year time frame.

A sober assessment of the outlook for Canadian growth suggests that while the second quarter might be the bottom of the cycle, the economy will only crawl back to full employment. Those hardest hit will be those that can least afford unemployment. Small businesses, which account for more than 40% of private-sector jobs, are by now hard hit, and in many cases, might have already received a death blow. Undeniably, some of these lost jobs are gone for good.

The hope is the waves of stimulus doled out by the government, and the Bank of Canada will eventually bolster the economy and spark a revival in hiring.

The risk, though, is that the pandemic is inflicting a “reallocation shock”[1] in which some firms and even entire sectors suffer lasting damage. Lost jobs in these sectors don’t come back, and unemployment remains elevated. Traditional fiscal stimulus does not address this kind of shock.

An estimated 30% of job losses from February to May could be the result of this permanent reallocation shock. The labour market will initially recover swiftly, as we saw in the May data, but then level off with too many people still unemployed.

Workers in the hospitality industry—accommodation and food—are among the most at risk, alongside inessential retail, leisure, travel and education. Most of these people cannot work from home.

In many cases, the pandemic has increased the challenge of bricks and mortar companies facing off against e-commerce platforms such as Amazon, accelerating a pre-crisis trend in which Canadian companies have woefully underperformed.

The unique shock of the virus means governments may need to do more to support businesses and protect workers than they would in a typical recession. This puts the government under pressure to craft policies that help viable cash-strapped firms to survive and displaced workers to navigate to different jobs, but which ideally do not prop up companies that are no longer sustainable.  We have already seen evidence[2] that shows that high COVID-unemployment benefits can encourage layoffs, discourage work and delay productive reallocation.

We need to know the proportion of  Canada’s job losses that come from lockdown and weak demand. Those will diminish quickly in response to stimulus and reopening. The part generated by high unemployment benefits encouraging workers to stay home requires a gradual reduction in income support. The most intractable group of unemployed suffer the permanent fallout of the reallocation shock.

For them, the government should provide the training that gets workers ready for the next phase of the technology revolution.

The pandemic has accelerated structural shifts that will remain. The efficient response to these shifts requires–among other things–widespread enhanced broadband and computer access for all households, reduced government land-use restrictions and occupational licensing restraints, the removal of regulatory barriers to business formation and interprovincial trade restrictions.

These fault lines were there before the virus, but they are now exposed and need a new social contract between government and its citizens.

[2] Ibid, p. 20 “When Equinox had to start furloughing some employees at its chain of upscale fitness clubs, Executive Chairman Harvey Spevak had a surprising message to stakeholders. ‘We believe most will be better off receiving government assistance during our closure’.” This passage is from Thomas and Cutter (2020), who also write: “Equinox joins a number of companies, including Macy’s … and [furniture maker] Steelcase …that are citing the federal government’s beefed-up unemployment benefits as they furlough or lay off staff amid the coronavirus pandemic. The stimulus package is changing the calculus for some employers, which can now cut payroll costs without feeling they are abandoning their employees.”

Transactions were up on a month-over-month (m-o-m) basis across the country. Among Canada’s largest markets, sales rose by 53% in the Greater Toronto Area (GTA), 92.3% in Montreal, 31.5% in Greater Vancouver, 20.5% in the Fraser Valley, 68.7% in Calgary, 46.5% in Edmonton, 45.6% in Winnipeg, 69.4% in Hamilton-Burlington and 30.5% in Ottawa. Not surprisingly, the cities with the smallest gains posted the smallest declines in prior months.

More importantly, anecdotal data suggest that housing activity has been steadily rising from the middle of April until the first week in June.

The number of newly listed homes shot up by a record 69% in May compared to the prior month with gains recorded across the country.

With new listings having recovered by more than sales in May, the national sales-to-new listings ratio fell to 58.8% compared to 63.3% posted in April. While this statistic has moved lower, the bigger picture is that this measure of market balance has been remarkably stable considering the extent to which current economic and social conditions are impacting both buyers and sellers.

There were 5.6 months of inventory on a national basis at the end of May 2020, down from 9 months in April. The temporary jump in this measure recorded in April reflected the fact that sales were expected to fall right away amid lockdowns; whereas, other variables like active listings would be expected to fall at a much slower pace. The CREA report suggests many sellers who already had homes on the market before mid-March may have left the listings up for now but drastically curtailed the extent to which they were showing their homes during the lockdown. With many of those now coming off the market, overall active listings have fallen by about a quarter as of the end of May, bringing them down among the lowest levels on record for that time of the year.

Home Prices

Home prices were little changed in May compared to April across Canada. Of the 19 markets tracked by the MLS Home Price Index (HPI), 18 recorded either m-o-m increases or smaller decreases than in April. Five markets posted price gains in May following a decline in April (see the table below for local details).

In general, since the pandemic crisis began small declines in prices have been posted in British Columbia while declining trends already in place in Alberta have accelerated. With the recent surge in oil prices, however, sales activity has actually improved across the Prairies and price trends have been stabilizing.

Despite the pandemic, home prices in the Greater Golden Horsehoe area around and including Toronto have fallen very little and remain well above year-ago levels.  In Ottawa, Montreal and Moncton, prices have continued to climb, albeit at a slower pace than before.

CMHC has recently forecast that national average sales prices will fall 9%-to-18% in 2020 and not return to yearend-2019 levels until as late as 2022. I continue to believe that this forecast is overly pessimistic. Firstly, average sales prices are highly misleading, especially on a national basis because they vary so much depending on the location of the activity, as well as the types of property sold. 

There is no national housing market. All housing markets are local. A glance at Table 1 above shows a wide variation in regional sales price action, but if anything, trends appear to be converging on moderate positive pressure on prices. Today’s economic recession is like no other. The record stimulus introduced by the Bank of Canada and the federal government will assure that the housing markets will continue to function, even with social-distancing measures in place, and those who enjoy steady employment will proceed in due course with regular housing decisions.

Those who permanently lose their jobs are the real concern. Many of those people will be in the hardest hit and slowest-to-recover sectors of our economy, such as hospitality (accommodation and food), non-essential retail trade, and the leisure industry (arts, entertainment and recreation). Statistics Canada census data for 2016 in the table below, shows that the homeownership rate in these sectors is relatively low. Unfortunately, most of those who will be hardest hit by the pandemic can least afford it. This is an issue that fiscal policy must address, investing in retraining programs and universal income guarantees.

There are private providers of default insurance as well–Genworth Financial Canada and Canada Guaranty. CMHC is the only insurer of mortgages for multi-unit residential properties, including large rental buildings, student housing and nursing and retirement homes. It is the largest provider of mortgage default insurance by far and is also the primary insurer for housing in small and rural communities.

Investment properties are not eligible for mortgage insurance. Because of this, the buyer needs at least a 20% down payment to buy an investment property. Homes costing more than $1 million, as well, are not eligible for mortgage insurance. Typically, the lender chooses the mortgage insurer.

Why is CMHC Tightening Qualifications?

The economics team at CMHC has predicted that owing to the pandemic lock down, home prices will likely fall by 9% to 18% over the next 12 months. They also believe that it will take at least two years for prices to return to pre-pandemic levels. The CMHC forecast for the economy is more pessimistic than many other forecasts, particularly that of the Bank of Canada, which asserted yesterday that the outlook for the economy was better than their April forecast suggested. Moreover, CMHC acknowledges the high degree of uncertainty associated with any forecast at this time. The Crown Corporation highlights the post-shutdown job losses, business closures and the drop in immigration that adversely affect Canadian housing.

They also have emphasized the 15% of existing mortgages that are now in deferral and believe there is a risk that 20% of all mortgages could be in arrears when deferrals end. Their stated justification for tightening qualification requirements is “to protect future home buyers and reduce risk“.

What Are These Changes In Underwriting Policies

Effective July 1, the following changes will apply for new applications for homeowner transactional and portfolio mortgage insurance:

• The maximum gross debt service (GDS) ratio drops from 39 to 35
• The maximum total debt service (TDS) ratio drops from 44 to 42
• The minimum credit score rises from 600 to 680 for at least one borrower
• Non-traditional sources of down payment that increase indebtedness will no longer be treated as equity for insurance purposes

CMHC goes on to say that “to further manage the risk to our insurance business, and ultimately taxpayers, during this uncertain time, we have also suspended refinancing for multi-unit mortgage insurance except when the funds are used for repairs or reinvestment in housing. Consultations have begun on the repositioning of our multi-unit mortgage insurance products.”

Here’s What We Know So Far

Anecdotal reports suggest that it is likely that private default insurers will not match CMHC’s lower debt ratios. They might, however, be more selective in their approval processes.

Canadian fiscal and monetary authorities are expending huge sums to keep the economy afloat, cushion the blow of the shutdown, and to make sure ample credit is available. These actions are intended to minimize unnecessary insolvencies. It is, therefore, surprising that a federal Crown Corporation would take these pro-cyclical actions now.

The exact impact of these changes will not be known until more details are available: How the Big Banks will respond with their own prime mortgage underwriting rules; how these new rules will apply to the securitization market; and how far the private default insurers will go along with these new rules.

Suffice it to say that this batters buyer and seller confidence and, all other things equal, has a net negative impact on the near-term housing outlook.  Most importantly, in my view, these changes are unnecessary to protect the prudence of Canada’s home lending practices. Mortgage delinquency rates are meager, and even the Bank of Canada’s forecast is for delinquencies to remain less than 1% of all outstanding mortgages. Moreover, home buyers with jobs who meet former qualifications would undoubtedly have a longer than two-year time horizon when buying their first homes. They were already qualifying at the posted rate that is more than 250 basis points above the contract rate. If anything, the pandemic recession assures that interest rates will remain very low over the next two years.

Today’s Governing Council meeting is Stephen Poloz’s swan song, as the new Governor, Tiff Macklem, takes the helm today. Macklem took part as an observer in the Governing Council’s deliberations and endorsed today’s rate decision and measures announced in the press release, thereby assuring continuity in monetary policy.

The Bank has taken very aggressive action to support liquidity and the full functioning of financial markets by buying short- and long-term securities. The central bank’s balance sheet holdings of securities have grown to about 20% of Canada’s GDP, up from 5% pre-crisis. That’s still well below the levels seen at the US Federal Reserve, the Bank of Japan, and the European Central Bank, which have conducted these quantitative easing operations since the financial crisis more than a decade ago. However, the Bank of Canada’s securities purchases have been extraordinary in relation to the size of our economy.

“Decisive and targeted fiscal actions, combined with lower interest rates, are buffering the impact of the shutdown on disposable income and helping to lay the foundation for economic recovery.” According to the central bank, the Canadian economy appears to have avoided the most severe scenario presented in the Bank’s April Monetary Policy Report (MPR).

The level of real GDP in Q1 was 2.1% below the level in the fourth quarter of 2019. The Bank of Canada is now predicting that real GDP in Q2 will likely post a further decline of 10%-to-20%, as continued shutdowns and sharply lower investment in the energy sector take an additional toll on output. That suggests a peak-to-trough decline of 12% to 22%, instead of the 15% to 30% scenario the central bank had previously been estimating. “The Canadian economy appears to have avoided the most severe scenario,” the Bank of Canada said.

Bottom Line: While the degree of uncertainty remains high, there is evidence that the worst of the economic downturn is behind us. Preliminary data for May suggests that home sales picked up on a month-over-month basis in May in the GTA and GVA, although home sales continued to be down significantly from levels one year ago.

Some people are concerned that the extraordinary stimulus in monetary and fiscal measures in recent months might, in time, be inflationary. Governor Poloz has made it clear that the dire results of the economic shutdown would have been highly deflationary had these actions not been taken. Deflation, coupled with high debt levels, would have triggered a depression. Economic models are ill-equipped to deal with the fallout of the pandemic. Policymakers need to be nimble in responding, and when the economy has recovered sufficiently, they will begin the unwinding of all of this stimulus, which will require an equally deft response on both the fiscal and monetary side.