What’s In Store For 2019?

1). Canada’s economy will continue to under perform the U.S. as growth slows to 1-3/4% in 2019 compared to just over 2% in 2018. For the U.S., where budget deficits have been rising sharply with the 2018 tax cuts, growth this year will hit about 2.4% compared to nearly 3% last year–an over-heated economy to say the least.

2.) Canada’s population growth will lead the G7 by a wide margin. In 2018, Canada’s population was on track to increase 1.4%, the most robust pace in 18 years and double the 0.7% rate for the U.S., which was the G7 country with the next-highest population growth rate. Despite this, spending did not rise —auto sales fell on an annual basis for the first time since 2009, while home sales had their second biggest slide in the past 20 years. Per capita GDP growth in Canada this year will under perform most of the G7.

Strong (net) immigration accounted for almost half (45%) of Canada’s population increase last year. That contribution will only grow since Ottawa has committed to boosting its annual immigration target from 310,000 new permanent residents in 2018 to 331,000 this year (up 6.7%) and to 350,000 by 2021. About two-thirds of 2019’s expansion will come from the immigration programs that target highly skilled workers aimed at addressing labour shortages across Canada.

As well, the number of non-permanent residents reached an all-time high of 166,000 last year accounting for one-third of the growth in the population. This group includes temporary foreign workers, international students and asylum seekers. All three categories soared, reflecting strong demand for skilled labour, Canada’s growing reputation as a desirable place to obtain post-secondary education, and increases in cross-border refugee claimants.

3.) Canadian consumers are tapped out as debt levels remain high, interest rates edging upward and credit is less readily available. Boomers are wary that their homes are worth less than what they were counting on as Canada’s two largest housing markets experienced decade-low sales last year with softer prices especially at the pricier end of the single-family home market. First-time buyers might have more homes to choose from in some markets, but regulators have tightened qualification rules. Foreign buying has slowed owing to foreign purchaser taxes in Toronto and Vancouver and speculation taxes in Vancouver.

4.) The Fed and the Bank of Canada will raise rates in 2019 by more than the market currently expects. Market participants in recent weeks have reduced expectations for rate hikes by both central banks to barely one increase apiece. More likely, both the Fed and the BoC will raise the benchmark overnight rate twice each this year. Even with these actions, monetary policy in both countries will be slightly accommodating with interest rates still below neutral levels.

5.) Even with only modest rate increases in 2019, consumers will be impacted because they are so heavily exposed to debt. Economists at the Royal Bank estimate that the average household faces a $1,000 hit from rate hikes. This would imply that the average household principal and interest payment will increase by 7.6% in 2019.

6.) This effect will be offset by stronger wage growth as labour markets continue to tighten. Labour shortages will finally add to wage growth. The unemployment rate hit a record low in December, yet wage growth had slowed to only 1.5% year-over-year, well below inflation. Over the next decade, more than 270,000 people will retire from the Canadian labour market every year. Immigrants and temporary workers will replace some of these retirees, but not all.

Recent data suggest that the quit rate–the proportion of the labour force that leaves their jobs voluntarily–is rising. This portends higher wage rates going forward.

7.) Rising interest rates will squeeze government spending for the feds and provinces with significant debt loads. Ottawa will spend more on debt payments than any other program except elderly benefits.

8.) Corporate balance sheets will be negatively impacted by higher interest rates as Canadian companies borrowed more heavily than their international counterparts. Canadian companies remain less competitive as their productivity growth has lagged their global competitors. Efforts to improve Canadian competitiveness are in process but have yet to show meaningful results. This has been a secular problem for Canada.

9.) Canada could be caught in the crosshairs of a U.S.-China trade war, but free-trade deals with Europe (CETA) and China (CPTPP) will reap benefits, particularly as the U.S. continues to alienate many of its allies and trading partners. Canada must diversify trade away from the U.S., particularly in the oil sector, which requires massive infrastructure spending. No longer can we count on exports of oil and transportation products to the U.S. to be the mainstay of Canadian global trade.

10). Comparable to last year, housing in 2019 will not fuel Canada’s national economy, thanks to macroprudential policy measures and modestly higher interest rates. Housing accounted for a record-high percentage of overall economic growth and job creation until early last year. We are barely off those peak levels now, so any slowdown in housing activity will have a disproportionately large negative impact on the economy–the flip side of its disproportionate expansionary impact over much of the prior decade.

Bottom Line: Sales to new listings have stabilized in Toronto, but continue to decline in Vancouver. Population growth in Vancouver has under performed Toronto’s for two years, while supply, mainly in the high-rise segment, has risen sharply. In consequence, the number of completed and unabsorbed units in Vancouver continues to increase, while that measure is still trending downward in Toronto. The sector of most significant weakness in Toronto will continue to be in the pre-sale low-rise market where there remains considerable excess supply.

Canadian Home Sales Weakened Further in November

These data suggest a double-digit national sales decline in 2018, falling to its lowest level in five years even though the economy is reaching full employment. Next year’s growth in sales and prices will likely be moderated by recent policy changes from different levels of government, in addition to upward pressure on interest rates.

Many had expected a rebound in sales in British Columbia, but so far it has not materialized. The rebound in sales in Ontario last summer has now run its course and activity in Alberta has edged lower. Housing transactions in Quebec, in contrast, were strong.

The number of newly listed homes fell by 3.3% between October and November, with new supply declining in roughly 70% of all local markets.

With new listings having declined by more than sales in November, the national sales-to-new listings ratio tightened slightly to 54.8% compared to 54.2% in October. This measure of market balance has remained close to its long-term average of 53.4% since the beginning of 2018.

Based on a comparison of the sales-to-new listings ratio with the long-term average, about 60% of all local markets were in balanced market territory in November 2018. There were 5.4 months of inventory on a national basis at the end of November 2018. While this remains in line with its long-term average of 5.3 months, the number of months of inventory is well above its long-term average in the Prairie provinces as well as in Newfoundland & Labrador. By contrast, the measure is well below its long-term average in Ontario, New Brunswick and Prince Edward Island. In other provinces, sales and inventory are more balanced.

Home Prices

The Aggregate Composite MLS® Home Price Index (MLS® HPI) was up 2.3% y/y in October 2018, down once again on a month-over-month basis.

Following a well-established pattern, condo apartment units posted the largest year-over-year price gains in November (+6%), followed by townhouse/row units (+4%). By comparison, one-storey single-family homes posted a modest increase (+0.4%) while two-storey single-family home prices held steady (+0.1%).

Trends continue to vary widely among the 17 housing markets tracked by the MLS® HPI. In British Columbia, home price gains have been steadily diminishing on a y/y basis in the Fraser Valley (+4.7%) and Victoria (+7.2%). By contrast, price gains picked up elsewhere on Vancouver Island (+12.6%) and, for the first time in five years, were down (-1.4%) from year-ago levels in the GVA. On a month-over-month basis, prices fell 1.9% in Greater Vancouver in November, the most since 2008, adding to the recent series of price declines in Canada’s most expensive housing market.

Among housing markets tracked by the index in the Greater Golden Horseshoe region, MLS® HPI benchmark home prices were up from year-ago levels in Guelph (+9.3%), the Niagara Region (+7.2%), Hamilton-Burlington (+6.3%), Oakville-Milton (+3.4%) and the GTA (+2.7%). Meanwhile, home prices in Barrie and District remain below year-ago levels (-2.1%).

Across the Prairies, benchmark home prices remained below year-ago levels in Calgary (-2.9%), Edmonton (-1.9%), Regina (-4%) and Saskatoon (-0.3%). Excess supply of listings relative to demand will continue to put downward pressure on prices until economic activity in the region strengthens.

In contrast, home prices rose 6.6% y/y in Ottawa (led by a 7.3% increase in two-storey single-family home prices), 6.2% in Greater Montreal (driven by a 9.4% increase in townhouse/row unit prices) and 4.2% in Greater Moncton (led by an 11.2% increase in townhouse/row unit prices). (Table 1)

The actual (not seasonally adjusted) national average price for homes sold in November 2018 was just over $488,000, down 2.9% from the same month last year.

Sales in Greater Vancouver and the GTA, two of Canada’s most active and expensive markets, bias upward heavily skew the national average price. Excluding these two markets from calculations cuts almost $110,000 from the national average price, trimming it to just over $378,000.

Bottom Line

We are likely in store for a prolonged period of modest housing gains in the Greater Golden Horseshoe, stability or softening in British Columbia and further weakening in the Prairies, Alberta, and Newfoundland & Labrador.

The Canadian housing market has slowed considerably since mid-2017 and is ending the year on a quiet note. Two offsetting forces are impacting housing—strong population growth and rising rates. Sluggish sales and modestly rising prices nationally are likely in store for 2019. While there will still be some significant regional divergences, there is no need for further policy actions to affect demand.

Canadian Jobless Rate Fell To A 42-Year Low in November

Employment increased by a whopping 94,100 in November, led mostly by full-time jobs that were broadly based across industries. This was the largest monthly jobs gain in records dating back to 1976. The unemployment rate fell to 5.6%, also the lowest in the data, from 5.8% in October.

The strength in employment was unexpected as economists forecast a gain of only 10,000. Just this week, the Bank of Canada painted a picture of an economy facing substantial headwinds, warning of turmoil in the oil sector, government ordered oil production cuts in Alberta and a potential U.S.-China trade war. Since Wednesday’s central bank decision to hold rates steady announced in a decidedly pessimistic press release, markets had been pricing in only one rate hike in 2019.

Some analysts pondered whether the rate-hiking cycle is already over after five increases since the middle of 2017. “My bet is the BoC is done, period,” David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., told clients in a report this week.

In a speech on Thursday, Governor Poloz reiterated his view that the Bank will eventually need to bring the current 1.75% policy rate back into “neutral range” of somewhere between 2.5% and 3.5%–noting the environment of low unemployment, inflation close to target and an economy close to full capacity utilization.

The strong November labour force report certainly keeps a January rate hike on the table for now, but only if it is confirmed by strengthening incoming economic indicators and no reversal in the December jobs report.

The Canadian dollar rallied on the news–having dropped appreciably in the previous three days–and market interest rates edged upward for the first time in a week and a half. The five-year government bond yield, an important indicator of five-year fixed mortgage rates edged up three basis points, offsetting a bit of the monthly decline.

Even the oil-producing hub of Alberta showed strength, adding 23,700 jobs on the month and pushing down the unemployment rate by a full percentage point to 6.3%, near its lowest since 2015 (see chart and table below).

The private sector dominated the employment gains last month as more people worked in professional, scientific and technical services; health care and social assistance; construction; business, building and other support services; transportation and warehousing; and agriculture. At the same time, fewer people worked in information, culture and recreation. Employment in construction increased by 15,000, led by gains in British Columbia and tempered by a decline in Newfoundland and Labrador. Year over year, employment was little changed in the industry.

Employment increased for both core-aged women and men (aged 25 to 54), as well as for older people (aged 55 and over)—driven by men.

Jobs in the Cannabis Industry

For the first time, Stats Canada reported cannabis-related jobs. Non-medicinal cannabis became legal in Canada on October 17, 2018. The number of people employed in these jobs in November was 10,400, an increase of 7,500 (+266%) from 12 months earlier. The majority (58%) of cannabis-related employment in November was in the agriculture sector, where workers performed duties such as bud trimming. The rest of the hiring was spread across a number of other industries such as educational services, health care, and retail trade.

More men than women worked in these jobs (79% compared with 21%). The median age was 35 years, younger than the median for workers in non-cannabis-related jobs (40 years). Virtually all of the employees were working full time and had permanent positions. The highest level of cannabis-related employment was in Ontario, an estimated 5,700, representing more than half of the national total. Ontario is the province with the largest concentration of licensed producers.

Wages Weakened

The one negative component of the November labour report was the slowdown in the growth of wages. Annual gains decelerated sharply to 1.7% in November– the slowest growth since July 2017–compared to a 2.2% clip the prior month. Wage gains for permanent workers were 1.5%, also the slowest in more than a year. This compares to 3.1% year-over-year wage growth in the U.S.

U.S. jobs and wages rose by less than forecast in November while the unemployment rate held at the lowest in almost five decades, indicating some moderation in a still-healthy labour market.

Nonfarm payrolls increased by 155,000 after a downwardly revised 237,000 gain in the prior month, a Labor Department report showed Friday. The median estimate in a Bloomberg survey called for an increase of 198,000. Average hourly earnings rose 0.2% from the prior month, compared with forecasts for 0.3%, though wages matched projections on an annual basis, up 3.1% for a second month.

Tariffs began to bite as employment gains at primary and fabricated metals manufacturers edged upward, but people who use those metals like auto and auto parts manufacturers saw job cutbacks.

Christmas hiring did not match last year’s pace as retail jobs rose by 18,000 roughly 10,000 fewer than this time last year, mostly at department stores. These gains were offset in part by job declines at furniture stores, clothing and accessories stores, electronics and appliance stores, and bookstores. This might have had something to do with online shopping uptrends as couriers and messenger jobs increased significantly.

The broader measure of unemployment known are U-6, or the underemployment rate rose to 7.6% from 7.4%. This measure includes part-time workers who want a full-time job and people who are less active in seeking work.

Q3 Canadian GDP Growth Slowed On The Back of Weak Housing and Business Investment

However, while the headline growth of 2.0% was on trend, the details of the report are troubling. The bulk of the growth last quarter came from a contraction in imports–hardly a sign of a robust economy–leaving final domestic demand–which excludes trade–negative for the first time since early 2016. The softness in imports reflected a contraction in refined energy products as well as aircraft and other transportation equipment.

The NAFTA trade battle over the summer took its toll on the economy as households and businesses sharply curtailed their spending. Consumer spending grew at its slowest pace in more than two years, while businesses posted an unexpected drop in investment and trimmed inventories. Consumer spending moderated, as overall household consumption rose just 1.2%, held back by durable goods spending (-2.7%) as Canadians bought fewer vehicles for a third straight quarter.

The biggest surprise in the report was the sharp decline in non-residential business investment (-7.1%). Spending on non-residential structures fell 5.2%, while machinery and equipment spending, which includes computer software and hardware, plunged at a 9.8% annual rate. Business spending was weighed down by softer oil and gas investment.

Though residential investment was expected to decline, the reported 5.9% drop in Q3 was more significant than expected. Despite an uptick in home sales activity, residential investment weakened as both new construction of housing and renovation activity pulled back (see Note below). Investment in new residential construction posted its largest decline since the second quarter of 2009 when the financial crisis was hammering the global economy. The uptick in home sales was reflected in a sharp uptick in ownership transfer costs, which includes real estate commissions, land transfer taxes, legal fees and file review costs (inspection and surveying).

On the income side, compensation of employees rose 2.7% (4.0% on a year-on-year basis), leaving overall wage gains over the quarter at a modest 2.2% year-on-year. The household savings rate rose to 4.0% from an upwardly revised 3.4% in Q1.

Looking at the monthly data for September, there was not much momentum going into the final quarter of this year. Monthly GDP in September declined -0.1% as just half of major industries expanded. It was mainly down in goods production (-0.7%) as oil and gas extraction pulled back, hit in part by maintenance work. Substantial gains in services (+0.2%) were not enough to keep the headline in positive territory.

The projected further weakening in Q4 will be abetted by the transitory downward impact from the recent postal strike. The risks are on the downside for the Bank of Canada’s forecast of 2.3% growth in the final quarter of this year. Currently, it appears that growth in Q4 will be closer to 1% than 2%.

Implications for the Bank of Canada

The headline 2% growth rate was spot on the Bank of Canada’s expectation, but certainly, the Bank will note the weakness in the underlying data. Potentially more important is the deep reduction in the price of oil for Canadian producers already struggling with transportation bottlenecks that have been pummelling the energy sector and depressing growth in Alberta. Cuts in oil production are likely to hit economic activity in the current quarter, with a full recovery not expected until at least mid-2019.

As well, the GM shutdown in Oshawa, Ontario raises concerns about the viability of the Canadian auto industry and adds to the weakness in the economic outlook. The two largest export sectors in Canada are energy and autos, so weakness in these sectors will keep the Bank of Canada on the sidelines in December, notably as consumers may well be tapped out. Markets had been expecting a rate hike in January, but the latest data suggest that the prospects of such a move have dropped significantly.

Notes:

*Housing investment in the GDP accounts is technically called “Gross fixed capital formation in residential structures”. It includes three major elements:

• new residential construction;
• renovations; and
• ownership transfer costs.

New residential construction is the most significant component. Renovations to existing residential structures are the second largest element of housing investment. Ownership transfer costs include all costs associated with the transfer of a residential asset from one owner to another. These costs are as follows:

• real estate commissions;
• land transfer taxes;
• legal costs (fees paid to notaries, surveyors, experts, etc.); and
• file review costs (inspection and surveying).

Canadian Home Sales Weakened In October

Home transactions last month declined in more than half of all local markets, led by Hamilton-Burlington, Montreal and Edmonton. Although activity did improve modestly in many markets, it was offset by a decline in sales elsewhere by a factor of two. On a year-over-year (y/y) basis, sales were down in slightly more than half of all local markets as lower sales in Greater Vancouver and the Fraser Valley more than offset the rise in sales in the Greater Toronto Area (GTA) and Montreal by a wide margin.

New Listings

The number of newly listed homes edged down 1.1% between September and October, led by the GTA, Calgary and Victoria. The decline in new supply among these markets more than offset an increase in new supply in Edmonton and Greater Vancouver.

As for the balance between sales and listings, the national sales-to-new listings ratio in October came in at 54.2% — close to September’s reading of 54.4% and its long-term average of 53.4%. Based on a comparison of the sales-to-new listings ratio with the long-term average, about two-thirds of all local markets were in balanced market territory in October 2018.

There were 5.3 months of unsold inventory on a national basis at the end of October 2018. While this remains in line with its long-term national average, the number of months of inventory is well above its long-term average in the Prairie provinces and in Newfoundland & Labrador, where downward pressure on home prices is likely to continue. By contrast, Ontario and Prince Edward Island are the two provinces where the measure remains more than one standard deviation below its long-term average pointing to stable prices or modest gains. In other provinces, the number of months of inventory is closer to its long-term average and suggests that sales and inventory are well balanced.

Home Prices

The Aggregate Composite MLS® Home Price Index (MLS® HPI) was up 2.3% y/y in October 2018 with similar gains posted in each of the three previous months.

Following a well-established pattern, condo apartment units posted the largest y/y price gains in October (+7.4%), followed by townhouse/row units (+3.9%). By comparison, one-storey single-family homes posted a modest increase (+0.6%) while two-storey single-family home prices held steady.

Trends continue to vary widely among the 17 housing markets tracked by the MLS® HPI. In British Columbia, home price gains have been diminishing on a y/y basis (Greater Vancouver: +1%; Fraser Valley: +6.8%; Victoria +8.5%; elsewhere on Vancouver Island: +11.8%). Vancouver’s market balance is the weakest in almost six years, and prices for both condos and single-detached homes are now falling outright (the former were previously sturdy).

By contrast, MLS® HPI benchmark price comparisons are improving on a y/y basis among housing markets in the Greater Golden Horseshoe (GGH) region of Ontario that are tracked by the index. Home prices were up from year-ago levels in Guelph (+9.3%), Hamilton-Burlington (+6.8%), the Niagara Region (+6.3%), the GTA (+2.6%) and Oakville-Milton (+2.2%). While home prices in Barrie and District remain slightly below year-ago levels (-0.9%), declines there are shrinking; if current price momentum persists, home prices in December are on track to turn positive compared to December 2017.

Across the Prairies, benchmark home prices remained below year-ago levels in Calgary (-2.6%), Edmonton (-2.4%), Regina (-3.6%) and Saskatoon (-0.9%).

Home prices rose by 6.6% y/y in Ottawa (led by a 7.4% increase in two-storey single-family home prices), by 6.3% in Greater Montreal (driven by a 9.8% increase in townhouse/row unit prices) and by 4.2% in Greater Moncton (led by a 12.4% increase in townhouse/row unit prices) (see table below).

Bottom Line

Housing markets continue to adjust to regulatory and government tightening as well as to higher mortgage rates. The speculative frenzy has cooled, and multiple bidding situations are no longer commonplace in Toronto and surrounding areas. The housing markets in the GGH appear to have bottomed. However, prices still look soggy at the higher end of the single-family home market.

The slowdown in housing markets in the Lower Mainland of BC accelerated last month as the sector continues to reverberate from provincial actions to dampen activity, as well as the broader regulatory changes and higher interest rates.

We are likely in store for a prolonged period of modest housing gains in the Greater Golden Horseshoe, stability or softening in British Columbia and further weakening in the Prairies, Albert, and Newfoundland & Labrador.

Montreal and Ottawa remain the areas of relative strength among the biggest cities. Sales dipped in both cities month-over-month in October, but they are both up a solid 11% from a year ago. In Montreal, we’ve seen some evidence that increased foreign buying activity is mixing with strong domestic fundamentals, pushing benchmark prices up 6.3% y/y. Ottawa has been boosted by a wave a federal government spending and hiring, with price growth similarly running at 6.6% y/y, though now softening from its recent high.

The Bank of Canada is expected to continue gradually tightening monetary policy. Residential mortgage credit growth has slowed to a 17-year low and, for the first time in a decade, borrowers will be refinancing 5-year fixed rate mortgages at higher interest rates.

Bank Of Canada Reports Dramatic Drop in Highly Indebted Borrowers

In a separate report, the Bank of Canada announced this week that the quality of new mortgage lending in Canada had improved markedly owing to tighter mortgage qualification rules and higher interest rates, both of which have pushed marginal buyers out of the market. This was Ottawa’s intention all along in its multiple initiatives to dampen the housing market over the past several years.

The share of new mortgages going to highly indebted borrowers–those with loan-to-income ratios of above 450%–dropped to 13% in the second quarter of this year, down from more than 18% last year. Hence, the Bank believes that there is strengthening resiliency in the financial system, aided in part by an improving economy that has prompted five rate increases since the middle of last year.

The Bank of Canada report on the mortgage market found that not only are the number of new mortgage borrowers declining, but the riskiest ones are being weeded out. The number of new uninsured borrowers considered highly-indebted fell by 39% in the second quarter from year-ago levels, with Toronto posting the most significant declines.

The Bank also commented that the tighter regulations have had one side effect–shifting market share away from the country’s six biggest banks to other institutions such as credit unions and private lenders, which they see as a potential new source of risk. The overall riskiness of new mortgages has decreased “because the proportion of risky borrowers has declined across cities,” the report found. “As well, the regional composition has shifted, with a somewhat larger share of new mortgages recently coming from areas outside Toronto and Vancouver.”