2024 Canada Economic Outlook: Yielding to Reality
2024 Canada Economic Outlook: Yielding to Reality
Managing Director & Chief Economist
Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Economist at BMO Financial Group and author of the popular…
Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Economist at BMO Financial Group and author of the popular…
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The past year has been complicated for the U.S. and Canadian economies. This time last year many were calling for at least a mild recession in North America in 2023. The good news is we’ve so far managed to avoid that scenario.
But while the U.S. and global economies have beaten expectations, Canada’s economy has struggled to grow, and it appears that it will continue to do so through much of 2024. There are several reasons why. Let’s examine how we got here and the factors that will continue to drive the Canadian economy for the next 12 months.
Listen to our ~16-minute episode
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Global, U.S. Economies
BMO forecasts the global economy to grow by just under 3% this year, which is a little below average. The important factor here is that every major economy has seen at least some growth this year, which is an outcome that wasn't obvious at the start of 2023. We previously expected Great Britain, Europe and Russia to experience a mild downturn this year. Instead, they've all managed to grind out some growth. While we do anticipate a slowdown for the global economy in 2024, it’s well short of what we would consider a full-blown recession.
It's also been a surprisingly good year for the U.S. economy, with growth of a bit more than 2% for the full year,1 which is better than 2022. I dare say that not a single economic forecaster was expecting the U.S. economy to see better growth this year than last. However, we do expect a cooldown, beginning with the current quarter, and we're looking at fairly modest growth of about 1% over the next year.
A lot of the tailwinds that were blowing behind the U.S. economy have now started to ease. Along with the big run-up in long-term interest rates, the conflict in the Middle East and the United Auto Workers strike will likely weigh on U.S. growth over the next year. Nonetheless, we don't foresee any single quarter of negative GDP in the U.S. over the next year.
A Tougher Slog for Canada
For Canada, however, it’s been a tougher go. Although the economy has managed to avoid a recession, it's seeing only very modest growth, which we believe will likely continue before we see some improvement by late 2024. Bottom line, BMO expects the Canadian economy to trail behind the U.S. over the next 18 months.
The main reason mostly comes down to the consumer. Overall, consumer spending this year has held up remarkably well in both Canada and the U.S. in the face of inflation and higher interest rates. In part, that relates to the fact that consumers were sitting on a lot of so-called pandemic savings. During the early stages of the pandemic, the savings rate in both countries reached extraordinary levels.
Another positive factor for the consumer on both sides of the border is the underlying strength in the job market. In the summer of 2022, we had the healthiest, tightest job market in North America that we've ever had during peacetime. Canada's unemployment rate fell below 5%,2 while the U.S. unemployment rate fell into the low-3% range.3 Since then, we’ve seen a bit of fraying around the edges, and unemployment rates have begun to creep up a bit. Historically speaking, however, jobless rates are still quite low.
With both employment and savings rates high, consumers were able to spend on pent-up demand for travel, entertainment and motor vehicles. But the two countries didn’t spend equally. Even now, Canada’s household savings rate is still over 5%.4 While that’s an average rate historically speaking, it’s higher than it was before the pandemic, and higher than the current U.S. savings rate.5 Canada’s record level of household debt diverges from the U.S. Moreover, much of the household debt in the U.S. is locked into 30-year mortgages, so it doesn’t turn over nearly as quickly as it does in Canada.
BMO’s view is that over the next year, some of the support factors for the Canadian consumer (pent-up demand and excess savings) will start to ebb. Meanwhile, the high level of household debt and the run-up in interest rates remain in place. Over the next year, Canadian consumers will likely be squeezed even more, which is why we anticipate the economy will struggle to grow over the next 12 months or so.
Interest Rate Outlook
Inflation has come down from its worst levels in the summer of 2022—a rate we hadn’t seen since the early 1980s—and without a meaningful downturn in the economy. On the flip side, it’s going to be tougher to cut inflation from its current rate of just under 4%6 down to where the Canadian and U.S. central banks would prefer, which is closer to 2%. BMO’s view is that we won’t see inflation fall to a comfortable level until late 2024.
An even bigger issue is the relentless rise we’ve seen in long-term interest rates globally. Yields for both the U.S. 10-year Treasury7 and the Canada 10-year government bond8 have reached levels that we haven’t seen since 2007, which threatens both government finances and the near-term outlook. Simply put, when it comes to interest rates, we’re looking at “higher for longer.”
Our view is that both central banks have done enough in terms of interest rate hikes. They might raise rates one more time, but we’re almost at the top of the mountain. The other side of the coin is that we’re going to be in a higher rate environment for a while until the central banks feel comfortable enough with inflation. We expect the Bank of Canada and the U.S. Federal Reserve to keep interest rates near current levels until the second half of 2024. Even then, we expect interest rates to come down the staircase very slowly rather than an elevator ride down.
The more interesting question is where are interest rates going to settle on the other side? Will we come all the way back down to the extremely low rates we saw in the decade before the pandemic? Or will we settle close to current levels? Probably somewhere in between.
The Bank of Canada’s overnight interest rate currently stands at 5%.9 BMO expects those rates to eventually settle into a range of about 2.5% to 3%. That’s higher than anything we saw in the decade before the pandemic, but it’s considerably lower than where we are today. Nonetheless, inflation will have to fall closer to the Bank of Canada’s target before we can realistically talk about interest rate cuts.
Shifting Odds
BMO has slightly adjusted our odds on the three broad scenarios for the Canadian economy: a so-called soft landing where we avoid any kind of a downturn; a middle ground where we see a mild pullback in the economy; and a hard landing where we go into a full recession. It’s the middle ground that’s become a bit less likely. Long-term interest rates have spiked higher and there’s been an increase in geopolitical risks. Those factors, unfortunately, increase the risk of a hard landing. The good news is that as inflation has come down considerably, so the odds of a soft landing increases, too.
1 Gross Domestic Product, bea.gov
2 Canada Unemployment Rate, YCHARTS
3 US Unemployment Rate, YCHARTS
4 Canada Household Saving Rate, Trading Economics
5 Personal Saving Rate, bea.gov
6 Canada’s inflation rate slows to 3.8%, cbc.ca
7 10-year Treasury yield breaks above 4.9% for the first time since 2007, cnbc
8 Selected bond yields, Bank of Canada
9 Daily Digest, Bank of Canada
Fall Forum Pre-Record
October 24, 2023
Doug Porter:
Well, thanks very much, Steven, and hello, everyone. Thanks for joining us today. As Steven mentioned, I'm basically going to spend about the next 15 minutes or so laying out where we see the broad economy going, over the next year, year and a half. It's been quite a complicated environment, to be frank, over the past year. If you stand back, about a year ago or so, we and many others were calling for at least a mild recession in North America this year. And frankly, it hasn't happened. And I think, to start off, that's good news. And part of the reason why we've managed to avoid a recession is inflation has come down from the very worst levels that we saw back in the summer of 2022. Recall, at that point, U.S. inflation was above 9%, Canadian inflation was above 8%, numbers that we hadn't seen since the early 1980s. And in both cases, inflation has been cut in half since then, without a meaningful downturn in the economy. And I think that is good news.
Doug Porter:
The less-great news is, it's going to be tougher to get inflation from around its 4% level now, back down to where the central banks want to see it, and that's closer to 2%. We think that's probably not going to be reached until late next year, before we've really got inflation down to a more comfortable level. And as part of that view that it's taking inflation a little bit longer to get back down to where central banks want to see it, we've seen long-term interest rates really sprint higher in the last couple months. Now, in the past week or so, there's been some relief on that front, partly because of a flight to safety in the wake of the Mideast conflict. But I think the bigger issue is, if you look at that chart on the right-hand side, just the relentless rise we've seen in long-term interest rates around the world. Now, this happens to be the U.S. 10-year government bond I'm looking at. It's reached levels that we haven't seen since 2007. It's certainly not the only one. Here in Canada, we've seen the 10-year government bond yield get up to around 4% or so. And again, that's the highest we've seen in 16 years. And to some extent, that does threaten both government finances and, to some extent, the near-term outlook. And the simple phrase there is that we are looking at higher for longer on interest rates.
Doug Porter:
So let's take a look at what this means for the broader economy. And I'm going to start very big-picture. If we can move to the next slide here, we're going to look at the global economy to start with. As I said at the outset, we have not seen a full-fledged downturn. Yes, it's been a below-average year for the global economy. If you look at that table in the bottom right hand, you can see we've got the world economy growing by a little bit less than 3% this year. Keep in mind, that's after inflation or real economic growth. To most of us, that would seem like a pretty good number, something close to 3%, but it is below average. A more normal year for the global economy would be about 3.25% to 3.5%, so we're a little bit below average. But I think the other important point here is, if you go down that bar chart, you can see that every single economy has seen at least some growth this year. And that wasn't obvious at the start of the year. If we think back to the start of 2023, we thought Britain, Europe, and yes, Russia were probably looking at at least a mild downturn this year. And instead, they've all managed to grind out some growth. I know there's also been a lot of focus on China, certainly. But even with some disappointment there, the reality is, the Chinese economy is looking at about 5% growth this year.
Doug Porter:
Now looking out into 2024, we do see some further slowdown. We see another below-average year for the global economy in 2024. But, again, that's well short of what we would consider to be a full-blown recession for the global economy. So, essentially, what we're saying is, it's going to feel like the economy is swimming upstream. Globally, a below-average year, but not bad and not a full-fledged downturn. So that's the very big picture. If we can go to the next slide, we can focus on what we're looking at here in North America specifically. Now, for the U.S. economy, I have to say, it's been a surprisingly good year for the U.S. economy. In fact, I would just point out that we're looking at growth of a bit more than 2% this year in the U.S. That's actually better than what we saw last year. And I daresay that not a single economic forecaster was expecting the U.S. economy to see better growth this year than it saw in 2022. However, we do expect things to cool down. We actually believe it'll start to cool down this very quarter, and we're looking at fairly modest growth over the next year. A lot of the tailwinds that were blowing behind the U.S. economy have now started to lessen. Of course, we're dealing with the conflict in the Middle East. We're dealing with that big run-up in long-term interest rates that I discussed earlier. We've got an autoworker strike in the U.S. All these things will weigh on U.S. growth over the next year. But importantly, we're not calling for a full-on downturn in the U.S. economy. In fact, we don't see any single quarter of negative GDP in the U.S. over the next year. For Canada, it has definitely been a tougher go. Even though the economy has managed to avoid a recession this year, it's seeing only very modest growth. And we think that's likely to be the story over the next year. In fact, we think the Canadian economy will struggle to grow at all over the next year. We do see some improvement by late 2024, but you can see we do have the Canadian economy trailing behind that, the U.S., basically over the next 18 months or so.
Doug Porter:
If we go to the next chart, the reason for this difference between Canada and the U.S. mostly comes down to the consumer. Now, I would say that overall, consumer spending this year has held up remarkably well in the face of the many issues that the consumer has dealt with, whether it's very high inflation globally or the big run-up in interest rates. I think it's remarkable how the consumer in both Canada and the U.S. have held up. And a lot of it goes back to the fact that in both countries, consumers were sitting on a lot of so-called pandemic savings. The savings rate reached extraordinary levels in the last few years, during the early stages of the pandemic. But even now, Canada's household savings rate is still close to 5%. So the typical household is saving about 5% out of income. Historically speaking, that's about an average savings rate, but it's higher than it was before the pandemic. And if we look at even a conservative measure of household savings, excess savings in Canada, there's still more than $200 billion. That's a lot of money.
Doug Porter:
Now, coupled with that, we also believe that there is quite a bit of pent-up demand for things like travel and entertainment. Look at the price of Taylor Swift tickets and how much demand there is for it, just to give you an idea of how much pent-up demand there is for entertainment. But above and beyond that, there was also a lot of pent-up demand for motor vehicles. When you think about how tough it was to buy a car or truck in recent years, because suppliers just couldn't keep up with the demand because of the chip shortage globally. Now, that's slowly but surely being worked out. The supply chain is getting back closer to normal. But we still believe that there is quite a bit of pent-up demand for motor vehicles. So that's the good news for consumers, is they, in both Canada and the U.S., they were sitting on a lot of savings and they had a lot of pent-up demand for travel, entertainment, and motor vehicles. The last good news is the right-hand chart here -- record levels of household debt in Canada. And this is really where Canada and the U.S. separate. It's not the situation in the U.S. Their household debt levels are actually not particularly high at all. So they're not feeling the same kind of pressure from the run-up in interest rates that we're seeing here in Canada. And on top of that, a lot of U.S. debt is locked in to 30-year mortgages, so it just doesn't turn over nearly as quickly as it does in Canada. And we think that over the next year, some of the support factors for the consumer that I spoke about -- the pent-up demand and the excess savings -- are probably largely tapped out or will start to ebb. And meanwhile, the negative, the level of household debt and the run-up in interest rates, is still there. And so we think that over the next year, the consumer will be increasingly squeezed in Canada. And that's why we see the economy really struggling to grow over the next 12 months or so.
Doug Porter:
Now, I will point out that the reality is, there is no average household in Canada. Everyone is facing a different situation, and all that record level of household debt I just talked about is actually concentrated in only about 40% of households. Roughly speaking, only about 40% of households account for the lion's share of the Canadian debt. And it's those 40% of households that will really face the squeeze over the next year. Meanwhile, there's another 40% of households that account for the lion's share of that excess savings that I talked about. And they, arguably, are even benefiting from the rise in interest rates that we've seen. And so you're looking at a very different story for two different groups of consumers. And by the way, there's another 20% who have very little in the way of debt and very little in the way of savings. And they haven't been that terribly affected one way or the other by this rise in interest rates. Now, another positive factor for the consumer on both sides of the border, if we turn to the next chart now, is just the underlying strength in the job market. And it's tough to describe just how healthy the job market has been. In fact, I would assert that in the summer of 2022, we had the healthiest, tightest job market, in North America, that we've ever had during peacetime. I mean, we have seen lower unemployment rates perhaps during World War II and maybe the Korean War. But if you looked at where we were in last summer, this was as robust a job market as we had ever seen. Canada's unemployment rate got below 5%, the U.S. unemployment rate got down in the low 3s. Well, since then, we have seen a little bit of a fraying around the edges, a little bit of a weakening, in the North American job market in the past year or so. And we have seen those unemployment rates start to creep higher. Historically speaking, these are still very, very low jobless rates. In Canada, it's about 5.5%. The U.S., it's a little bit less than 4%. Again, historically speaking, those are very low rates. But they have started to creep up a little bit.
Doug Porter:
Now, just looking at the unemployment rates alone doesn't give you the full picture of just how strong the job market was. Above and beyond that, we had millions of vacant jobs. In Canada, we had over a million open jobs at its peak. In the U.S., we had way more than 10 million open jobs. Now, in both cases, job vacancies have started to come down a little bit. And that's being also reflected in some softening in the job market. As you see, we do see the unemployment rate rising over the next year. But if we turn to the next chart, if we look at the number of vacant jobs as a share of the labor force -- and this is called the job openings rate -- it reached extreme levels in the summer of 2022. And that's a very good early indicator for wage pressures. So if there's a lot of open jobs, it reflects a very tight job market. It shows a really strong demand for workers. And, yes, wages do tend to go up in that kind of environment. Well, in the past year, that job opening rate has started to come down. Historically, again, it's still very high. It suggests that the job market is still really strong, but we are starting to look for a bit of calming of wage pressures. And ultimately, we think this will take a bit of steam out of inflation over the next 18 months. But it's going to be a slow process for sure, because, as I said, those job openings are still fairly plentiful. And overall, even though the job market has started to soften a little bit, again, historically, it's quite tight.
Doug Porter:
Now, what does this mean for the interest-rate outlook? If we turn to the next chart, I started off, at the outset, by saying a very important development has been this run-up in bond yields. Some of that is just the view that the central banks are going to keep their interest rates higher for longer. Now, there's quite a bit of debate whether the Bank of Canada and the Federal Reserve will need to raise interest rates one more time or not. And frankly, the markets are ebbing and flowing on that view, almost by the week. Our official view is that both the Federal Reserve and the Bank of Canada have done enough, and they've done a lot in the last 18 months. As I said, it's quite possible they might raise interest rates one more time. But I think the key message here is that we're basically almost at the top of the mountain. But the other side of the coin here is, we're going to be here for a while. We're unlikely to see those interest rates start backing down anytime soon. We suspect that the Bank of Canada and the Fed are likely to keep interest rates at around these current levels, probably until the second half of 2024, before they feel comfortable with the inflation outlook to start bringing down interest rates. And at that point, we also expect interest rates to only come down the staircase very slowly. We're not looking for an elevator ride down, like we saw during past cycles, when interest rates plunged -- back in 2007, 2008, or during the pandemic in 2020. We're not looking for a really quick ride down the elevator on the other side of this. We think it's going to be a very slow process. Now, maybe the most interesting question is not whether the bank will raise rates one more time or not, or exactly when they're going to start cutting interest rates. Maybe the more interesting question is, "Well, where are interest rates going to settle when we're on the other side of this inflation episode?" Like, "Where are we going to be two or three years from now? Are we going to get all the way back down to the kind of extreme lows on interest rates that we saw in the decade before the pandemic? Are we going to settle around close to current levels when we're on the other side of this?" Well, I think the truth is probably somewhere in between. So, in other words, interest rates are likely to eventually come down a fair bit, but we don't think they're going to get back down to the kind of levels that we saw in the 10 years before the pandemic. So, if we just look at, say, for instance, the Bank of Canada's overnight interest rate, the policy rate that they can control directly, right now, it's 5%. Our best guess is that when we get on the other side of this, when we're through this inflation episode, those interest rates are likely to settle into a range of about 2.5% to 3%. So roughly 2 to 2.5 percentage points below where we are today. Again, that's actually higher than anything we saw in the decade before the pandemic, but it is considerably lower than we are today. But we have to get inflation back down close to the Bank of Canada's target before we can realistically talk about interest-rate cuts.
Doug Porter:
So, if we go to the next chart, well, what does this mean for the Canadian dollar? The Canadian dollar, it's been bobbing around. It's been on a bit of a weaker ebb recently. But if you look at it over a longer period of time, it's actually been relatively stable at around 75 cents or so, or a little bit lower, as we speak now. Our view is, actually this is not too far from what we would consider to be its long-term fair value. Our best guess on fair value for the Canadian dollar is somewhere between 75 to 77 cents. So we're a little bit below that, but not that far. Now, the key point of this chart is, there used to be a very close relationship between the Canadian dollar and oil prices. It used to be, they used to almost move hand-in-hand. That relationship began weakening about five to six years ago. And the past year, it's really gone almost completely astray. In other words, over the summer, what we saw was oil prices actually taking a big step up. They went from under $70 a barrel to around $90 a barrel. And meanwhile, during that, the Canadian dollar actually weakened. It didn't strengthen. Now, there's a lot of different reasons why this old relationship is broken up. But the key point is, the big driver for the Canadian dollar is the U.S. dollar itself. So, in other words, when the U.S. dollar is strong, we're generally tied with other currencies and weak against the U.S. dollar. And that's really been the story of the last couple years.
Doug Porter:
Now, looking out into 2024, we expect the U.S. dollar to lose some altitude. And on the flip side of that, we think the Canadian dollar will generally move back towards what we consider to be fair value over the next year.
Doug Porter:
Now, just to wrap up, if we turn to my final chart, just to put this all into one nice and neat nutshell, frankly, there isn't an easy way to put this into a nice, easy, tied up with a nice easy bow, because it is a very complicated economic backdrop that we're looking at. We like to consider three broad scenarios for the economy: the so-called soft landing, where we avoid any kind of a downturn; a middle ground, where we see a mild pullback in the economy; and a so-called hard landing, where we go into a full recession. And if you look at the bottom, you can see that we've slightly changed our odds on these different scenarios. Generally speaking, though, I think the key message here is, it's actually that middle ground that's become a little less likely, because of events that we've seen in the last six months or so. The good news, as I said at the outset, is inflation has come down. That does increase the odds of a soft landing. But the less-good news, we've also seen those long-term interest rates sprint higher. We've seen a lot of geopolitical risk. And unfortunately, that's raised the risk of a so-called hard landing. Our best guess, and what I'll leave you with today, is, we're likely to see what we would call the mild contraction in Canada over the next year -- not quite rising to the level of recession, but definitely the economy struggling to grow.
Doug Porter:
That's it for my part of the presentation. Again, thanks for joining us. Thank you.
