It appears that the much-discussed economic headwinds to the Canadian economy are now being felt. Q3 GDP data was released today and significantly disappointed to the downside. Economists had been expecting nearly double the meager 1% reading. At least those economists who don’t frequent this lowly blog.
Even more ‘surprising’ was an outright decline in September GDP reading, which retrenched 0.1%.
From RBC economics:
“While a deceleration was anticipated, the mere 1.0% pace for real output was an eye-opener on just how abruptly the Canadian economy has downshifted.”
Go figure. Funny how a linear approach to economics tends to miss the glaringly obvious. Time to put the textbooks down and perhaps adopt a new approach. Call it ‘common sense economics’.
BMO added an insightful quip:
“Despite a constant refrain about how well the Canadian economy is faring, growth lagged behind the U.S. by a full 1.5 percentage points last quarter and topped only Italy in the G7 growth tables.”
And while we may see some noise around the trend, it should be pretty obvious exactly what that trend is.
You’ll note that the three main drags (highlighted in red) are residential investment, exports, and real disposable income.
The decline in residential investment is no shock given the rapidly falling housing starts data as builders flee the market like rats from a sinking ship. With housing sales near decade lows in most major centres, you can’t blame them there. You’ll note the huge bounce this gave to GDP in Q4 2009 and Q1 2010. This was the Canadian economic miracle! Now that the novelty of extremely cheap credit is wearing thin and demand is sparse, we may finally be hitting the demand gap. Sales data over the next few months and into the Spring will give crucial insight into this. Regardless, I don’t see this trend turning around soon.
We just discussed exports yesterday, so I’ll leave that one for now.
Three potential future issues I see (highlighted in yellow) are the impact of government spending, consumer consumption, and a still low savings rate.
Despite stimulus spending, the impact of government spending is muted as it is being offset by cuts at other levels. With Flaherty warning of tough budgets to come and with the public seemingly starting to embrace austerity and fiscal prudence (right, Rob Ford?), one can’t help but think that this will provide yet another drag on future GDP growth.
Consumer consumption continues to show resilience, though a slowing is all but assured. How could it not when household balance sheets look like this:
Add on to that the reality of flat house prices (best case scenario) or falling home prices (much more likely) and you have the recipe for consumer spending to be choked off.
Remember that every 5% fall in house prices strips $10 billion or one full percentage point off consumer spending, which makes up over 65% of GDP. Simple math tells us then that every 5% fall in home prices strips at least 0.65% off GDP growth, and that’s not counting the spin-off effect of lower residential investment demand.
Finally, while the savings rate has picked up from its all-time lows, it is still well below historical averages. Combining high debt loads with low savings in an era of historically low interest rates is a recipe for household financial shock if interest rates rise marginally or if unemployment begins rising again.
There will be a mean reversion in the savings rate, which should come directly at the expense of consumer spending as real disposable incomes are still moribund. Deleveraging and increased savings are a perfect one-two punch for deflationary pressures on credit-reliant assets like real estate.