Canadian GDP stagnated in 2023

Unemployment rising (along with employment)

Compared with January 2023, several factors inherent to the post-COVID recovery aren’t likely to underpin Canadian growth going forward.

Excess savings

While excess savings continue to boost household consumption in the United States, Canadians have been more reluctant to deploy accumulated cash balances. For instance, the Canadian savings rate remains above prepandemic levels, unlike in the United States. Moreover, BoC calculations show that Canadians increasingly shift personal deposits to term deposits that deliver higher interest rates. With the perception of inflation (7.2% YoY) significantly above realized inflation (3.5%), it’s no surprise that Canadians are using their savings to insulate themselves from price pressures. 

Canadians largely reduced spending and shifted savings to higher-rate accounts (%)

Responses to "What actions are you taking to protect yourself against inflation?"

Households are feeling less confident about their jobs

Responses to "Would you describe your job, at this time, as secure, somewhat secure, somewhat not secure, or not at all secure?"

Pent-up demand

Global supply chain improvement has mostly run its course and satiated pent-up consumer demand; in fact, facing elevated interest rates and inflation, the Canadian consumer has started to pull back on spending. Over the past six months, in volume terms, discretionary spending toward building materials, supply and garden equipment, sporting goods, and other leisure activity shrank while spending on essential items such as health, personal care, and gasoline continued to rise. Regarding services, restaurant sales growth has slowed considerably, a sign of broader economic weakness.

To be clear, the Canadian labour market is still in good shape. Despite gloomy business sentiment, layoffs stayed low and Statistics Canada’s broadest measure of underemployment (which includes discouraged job searchers, people on waiting lists, and involuntary part-time workers) merely normalized to pre-COVID levels. With falling inflation, real wages also recently moved back into positive territory. These factors underpin consumption. 

However, cracks have become more apparent. Job openings are high but are falling quickly, consistent with a lower-than-usual hiring rate; in other words, labour demand is receding. Without forecasting the type of increase in the unemployment rate we’ve seen in past recessions, we nonetheless anticipate that weaker labour demand will eventually translate into outright layoffs, driving up the unemployment rate slightly above 7% in the later half of 2024. Beyond the direct effect from income losses, we believe that the indirect impact to consumption from a weaker sense of job security—which is already happening—will be a key catalyst for slower consumption in 2024. 

Underemployment merely normalized up, real wages are positive  

Mortgage renewals are putting additional pressure on the economy

The BoC recently estimated that only 43% of mortgages that were outstanding when it started raising rates had renewed, as of November 2023; that proportion is expected to grow to 60% by the end of 2024. Of note, refinancing for mortgages with a term of 5 years, the most common type of mortgage in Canada, will accelerate sharply over these 2 years. In contrast to the United States, where most mortgages have fixed rates for 30 years, we believe that the accelerated refinancing schedule in Canada will negatively affect economic growth.

Higher mortgage payments to reduce discretionary spending

Given the extent of the rise in interest rates, Canadians mortgagors will face significantly higher monthly payments after renewal. Applying market-based interest-rate expectations to their model, the BoC estimates that the median mortgage owner will pay an additional $200 and $300 monthly in December 2024 and 2025, respectively, relative to February 2022. Variable rate, fixed payment, and fixed rate with shorter-term mortgage holders would face a steeper increase under that scenario. More payments toward a mortgage leave less available for discretionary spending, which is expected to reduce overall consumption, especially in the context of weaker labour income prospects.

5-year mortgage renewals will accelerate

Proportion of mortgages outstanding in 2022 that have been refinanced

Mortgage payment shock is on the horizon

Simulation of median monthly mortgage payments by type of mortgage, monthly ($)

No widespread default, but a continued slowdown in housing activity

According to a BoC survey, most homeowners estimate that they have some capacity to absorb higher mortgage payments. This is no surprise considering that the Canadian government imposes a stress test on potential mortgagors to ensure they can withstand a higher mortgage rate than the one they contracted, the so-called B-20 rules. Consequently, we don’t expect widespread mortgage defaults under our base-case scenario.  Nonetheless, higher mortgage rates will increasingly pressure housing demand in the context of rising inventories since June 2023; therefore, we anticipate that the first half of 2024 will mark a rare occasion when home prices decline. Weak demand combined with elevated financing rates for builders might also dent residential construction, which has been surprisingly resilient in this cycle, and put additional pressure on GDP.

No major movement in U.S.-Canada yield spreads

U.S.-Canada 2-year bond differential (percentage points)

Canada's core inflation has been stickier than that of the U.S.

Canadian bonds to follow global developments

As laid out above, Canadian financial markets often follow global trends. As such, building on the massive Fed-driven rally, Canadian bonds ended 2023 on a positive note, even outperforming U.S. aggregate bond indexes by a wide margin over the whole year. Given that rate cuts still need to be cemented from a communication perspective and that, in our view, longer-term government bond yields still have some room to decline, we expect Canadian bonds to start the year in positive territory. However, as the Canadian yield curve has already approached neutral levels (which we estimate to be around 3%), lesser potential gains can be obtained from a base interest-rate perspective. Nonetheless, as companies recover from the early-year slowdown described above, credit should remain attractive in general.   

Equities could do better in the second half of the year

With regard to equities, despite gaining about 8% in 2023, Canadian equities underperformed the S&P 500 and MSCI World Indexes for the ninth time in the last 12 years. Out of the largest sectors of the TSX, only energy and information technology overperformed their U.S. counterparts. Barring any major global downside developments, we believe the first part of 2024 should follow the same modestly positive path. Financial institutions might continue to face slowing credit growth and have to increase provisions for credit losses. Energy companies, despite lower energy prices, should continue to perform well. A slightly stronger correlation to global defensive stocks could also cushion Canadian stocks against lower earnings-per-share expectations. Further in the year, as earnings prospects recover along the global economy, we would expect Canadian stocks to benefit from higher commodity prices and very cheap valuations, especially against the United States. 

2023 ended up positive for bonds

Canadian and U.S. aggregate bond performance in 2023

Energy stocks fared better than energy prices