Covid-19 recession to have impact beyond uncertain recovery, experts say

Thanks to strong fiscal and monetary support from government, many Canadians have fared well through the first seven months of the Covid-19 pandemic — but the recovery remains highly uncertain and largely dependent on the path of the virus, experts said Thursday at an investing conference.

Direct and indirect government stimulus accounting for 20% of Canadian GDP has prevented a solvency crisis and delayed a deleveraging phase “that’s characterized every economic cycle in modern history until now,” said Stéfane Marion, chief economist and strategist with National Bank, who was speaking on a panel at the Global Risk Institute’s summit, held virtually on Thursday.

While the collapse in real labour compensation is the highest on record, Marion said, it’s been more than offset by massive government transfers to households, which have resulted in the savings rate rising to 28%. There’s also been a V-shaped recovery in retail sales despite persistent high unemployment.

“This is amazing: in the midst of a recession, the biggest increase in real disposable income in history,” he said, indicating that government supports were perhaps too generous.

Peter Levitt, executive vice-president and treasurer with CIBC, said government support has led to banks accepting significantly more money in deposits than they’re handing out in loans. This has meant banks haven’t had to rely on central bank liquidity.

However, the stability of these deposits remains unknown at this point, Levitt said, speaking on the same panel. The run-up was “extraordinarily fast” and money in chequing accounts essentially has a maturity date of one day, making it risky to put those funds in illiquid assets such as a five-year mortgage.

Levitt said the deposits are “highly dependent” on government support programs that will end at some point, meaning clients could withdraw funds just as quickly.

“It is important to note that measuring credit risk has never been more complex, as it relies on a confluence of factors that have never been seen before,” he said. “The interaction between economic lockdowns, unemployment, government support programs and human behaviour define future credit risk.”

Fortunately, he said, continued strong Canadian bank earnings act as an important shock absorber, and capital levels should be sufficient to withstand losses.

In the summit’s opening keynote, Bank of Canada Governor Tiff Macklem acknowledged that Canada’s big banks’ have “strong capital and liquidity buffers, a diversified asset base and the capacity to generate income.”

Financial institutions have allowed close to 800,000 households to delay payments on mortgages since the onset of the pandemic, in addition to deferrals on lines of credit and credit cards, Macklem said. While deferrals have kept debt payments down, the six-month payment deferral period is ending for most borrowers, making the next few months “crucial.”

Payment resumption “has been going quite well,” Macklem said, with the “vast majority” of mortgage payments resuming.

Beyond the immediate recovery, investors need to be thinking about longer-term global trends that have accelerated during the pandemic, said Jonathan Hausman, managing director and head of global strategic relationships with the Ontario Teachers’ Pension Plan.

Speaking on the panel with Marion and Levitt, Hausman said the pandemic — particularly its lopsided toll on the poor — has made social inequality a leading issue. “That is driving the social agenda that I think will have a big impact on investors, a big impact on our portfolio companies [and] a big impact on our policy going forward,” he said.

Hausman warned that investors should prepare for a sustained period of lower average returns. Growing economic nationalism will fragment markets and cut into corporate profits by interrupting supply chains and ending labour arbitrage. A political focus on inequality will also affect corporate taxes.

“Fixed income is essentially MIA today in terms of a beta return, so that makes portfolio construction really difficult,” he said.

There’s also growing divergence between winners and losers as large government intervention creates idiosyncratic opportunities, he said.

The bad news for Canada is that market fragmentation is particularly harmful to trading nations, and Canada shouldn’t expect trade volumes to return to pre-pandemic levels, he said.

With the massive government spending set to continue, Marion said a fiscal anchor will be required — eventually.

“It’s part of our Canadian culture to have these fiscal anchors,” Marion said, adding that he favours net debt to GDP.

More than one-third of Canada’s debt is held by foreign investors, he said, and they will demand a path to fiscal sustainability. But there’s no blueprint for dealing with a pandemic, Marion said, and he’s willing to give the federal government a few more months of leeway.