Given the fear-inducing movements in the financial markets over the past few months — declines coupled with increases in volatility, tumbles in oil prices, as well as Brexit and Trump-related developments — one can understand why consumers and businesses are anticipating a major growth slowdown.
But the authors of Scotiabank’s latest global economic outlook beg to disagree. Citing the positive reversal in equity markets over the past couple of weeks as well as their own recession probability modeling, they argued that investors are over-reacting to minor changes in the outlook.
“From a Canadian perspective, much is being made of the rapid drop in oil prices and the widening of the differential of the price received for Canadian oil late last year,” the Scotiabank economists wrote. They noted that a drop in international oil prices and a shutdown of US refineries, which helped send Canadian oil prices to nearly $15 in November, have since been reversed. An Alberta government order for oil firms to cut production has also contributed to a Canadian price recovery. “This suggests that the impact of the decline in oil prices may not be as sharp for Canada as the Bank of Canada believes,” the analysts said.
As for the fear that the estimated 10% decline in equity markets would weigh on Canadian wealth and consequently spending, the analysts maintained their expectations that financial wealth will gradually rise to levels more consistent with economic fundamentals. “The pickup in equity indices over the last two weeks is a sign that this is already underway,” they said, adding that their research suggests the impact of financial wealth on spending is much smaller in Canada than it is in the US.
The report granted that the negative factors have caused Scotia analysts to shave their growth forecast down to 1.8% in 2019, they saw it only as a soft patch that would yield to 2% in growth in 2020. They pointed to generally positive fundamentals including:
- Monetary policy that remains highly accommodative as real policy rates remain negative and nominal rates below the Bank of Canada’s neutral-rate range of 2.5%-3.5%;
- Population growth is accelerating at a 10-year record pace as immigration rises;
- Employment growth is still strong with job growth accelerating through 2018;
- Canadian household balance sheets are still relatively healthy, given a debt-to-net worth ratio that’s still roughly where it was in 2007; and
- Inflation remains well behaved in Canada, with the bank’s underlying measures of inflation pointing to 1.9% — close to the Bank of Canada’s 2% target
They also acknowledged areas of weakness, such as oil-industry developments that have dragged on growth, declining sales and starts in the housing sector relative to 2017, and moderating business investment compared to the rapid pace set in early 2018.
“There are plenty of risks to the outlook,” the report said. It cited a possible escalation of the US-China trade war as the dominant negative risk, with additional volatility also possibly coming out of political developments shaking the Trump administration in the US.
They also noted positive risks, including a smaller-than-expected impact of oil prices on the Canadian economy, an extended bull run in oil prices, and a sharper-than-anticipated pickup in business investment as reasons for uncertainty wane in the first months of this year.