Whether it comes from retreating consumers, stress in the housing sector, limited business investment, or simply a weak global environment, 2024 may present many challenges for the Canadian economy. With elevated interest rates only starting to bite and the United States—Canada’s largest trading partner—appearing to be set for a slowdown, it’s difficult to envision the elements that would propel a significant rebound in economic conditions as we enter 2024. In this light, the relevant question isn’t if there will be a recession but rather how significant the economic slowdown will be and how rapidly conditions can recover thereafter. The answer heavily relies on how quickly and how deeply global central banks, including the Bank of Canada (BoC), ease interest rates this year. For most developed economies, especially Canada, the fact that inflation remains somewhat above 2% further complicates the matter; however, as discussed in our global outlook, we anticipate critical concessions on that front. But before getting into the details of our predictions for Canada and tying those to financial markets, we must first understand where we’re starting from.
The year starts on weak footing
In 2023, we saw the Canadian economy slow significantly. GDP growth slowed from 2.7% year over year (YoY) in January likely to 0.8% in November. Beyond this simple measure, three key elements worry us:
The level of economic activity hasn’t increased since May 2023 and has trended down almost continuously since September 2022 on a per capita basis.
The breadth of economic growth has weakened: Eight out of 20 industries contracted in October 2023 on a YoY basis. The goods-producing industries sensitive to interest rates—notably manufacturing and construction—led the decline.
Paradoxically, employment expanded at the same time that the unemployment rate increased (the latter being up by almost a full percentage point since April). The rapid expansion of the labour force explains this and may leave the unemployment rate more vulnerable to a correction if employment creation falters (as we expect it to).
Canadian GDP stagnated in 2023
Unemployment rising (along with employment)
Source: Statistics Canada, U.S. Bureau of Labor Statistics, Manulife Investment Management, as of January 5, 2024. LHS refers to left-hand side. RHS refers to right-hand side.
Compared with January 2023, several factors inherent to the post-COVID recovery aren’t likely to underpin Canadian growth going forward.
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?"
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.
Labour and housing dynamics may characterize the slowdown
If elevated inflation and higher interest rates shaped economic growth in 2023, we believe that households’ confidence about their work income and the uncertainty related to mortgage renewals will shape 2024.
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
Source: Statistics Canada, Manulife Investment Management, as of January 5, 2024. Data is internally seasonally adjusted. Wages for permanent employees are deflated by Consumer Price Index inflation. It is not possible to invest directly in an index. Underemployment is R8. LHS refers to left-hand side. RHS refers to right-hand side.
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.
The economy bottoming around the middle of the year hinges on central bank easing
In summary, we anticipate a modest contraction in Canada’s real GDP, mainly driven by consumers and without the traditional support provided by housing. Tied to feeble global growth, businesses may also have to face weak demand on the manufacturing front, especially when the U.S. economy finally slows down, which we expect in the first half of 2024. Nonetheless, our outlook incorporates an economic rebound starting in the second half of 2024 that will improve both consumer and housing demand. Still, this scenario relies on lower interest rates easing access to credit and, in Canada’s case, avoiding a harder refinancing scenario.
Since the last BoC interest-rate hike in July 2023, we’ve been expecting the central bank to ease its policy rate in early 2024. Since mid-October, markets have rallied around this notion with a full rate cut now expected by June 2024. Additionally, markets have now integrated the equivalent of four additional cuts in 2024 and two more in 2025, close to our forecasts. However, we interpret the recent drop in Canadian yields as mainly driven by renewed expectations of U.S. Federal Reserve (Fed) easing rather than being a Canadian phenomenon; for instance, U.S.-Canada bond yield differentials stayed in a controlled range while all-in interest rates declined. Moreover, while slower-than-expected core inflation explains some of the U.S. bond rally, core inflation in Canada stayed relatively sticky in late 2023. Expectations for aggressive BoC rate cuts could therefore be subject to a reversal in the near term if the Fed changes course. Nonetheless, we believe that weakening Canadian growth and labour market dynamics will prevail over sticky core inflation for the BoC and, as such, we continue to expect steady policy easing in 2024. In turn, this will support demand in the economy and gradually ease the labour market slack generated early in the year.
No major movement in U.S.-Canada yield spreads
U.S.-Canada 2-year bond differential (percentage points)
Source: U.S. Department of the Treasury, Manulife Investment Management, as of January 5, 2024.
Canada's core inflation has been stickier than that of the U.S.
Source: Federal Reserve Bank of Dallas, Statistics Canada, as of January 5, 2024. Canada core inflation is represented by CPI-trim. U.S. core inflation is represented by the Dallas Federal Reserve U.S. Trimmed Mean PCE. It is not possible to invest directly in an index. Methodology differs slightly between the two measures.
Asset class outlook
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
Source: Bloomberg, Manulife Investment Management, as of January 5, 2024. Canadian aggregate bonds are represented by the Bloomberg Global Aggregate Canada Total Return Index, unhedged USD. U.S. aggregate bonds are represented by the Bloomberg Global Aggregate United States Total Return Index, unhedged USD. It is not possible to invest directly in an index. Performance has been rebased to December 31, 2022 = 100.
Energy stocks fared better than energy prices
Source: Toronto Stock Exchange, S&P Global, MSCI, CME Group, Bank of Canada, Manulife Investment Management, as of January 5, 2024. It is not possible to invest directly in an index. Indexes have been rebased to December 31, 2022 = 100.
A modestly stronger Canadian dollar
Our last word goes to the Canadian dollar. Our model suggests that the most important variable determining the path for the Canadian dollar is the broad trade-weighted U.S. dollar, heavily influenced by the euro, the Mexican peso, the British pound, and the Japanese yen. As such, as expectations of rate cuts are confirmed, a downward trend in the U.S. dollar should continue lifting the Canadian dollar; however, we see limited gains for the loonie in 2024. At current levels, the broad trade-weighted U.S. dollar is already approaching the levels it traded at before large divergence between the United States and other developed markets emerged in late 2021. Relatively weaker Canadian growth could also increase rate differentials with the Fed, limiting its gain when compared against other currencies.
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Dominique provides global macroeconomic and financial market research for the Multi-Asset Solutions Team. Additionally, he develops investment strategies across asset classes and regions. Prior to joining the firm, Dominique was at Laurentian Bank Securities, where he served as a senior economist, and before that, he was a senior analyst with the Institute of Fiscal Studies and Democracy at University of Ottawa. He also worked at BCA Research as a research analyst. Dominique holds the Chartered Financial Analyst designation.
Education: B.S., Economics, Université du Québec à Montréal; M.A., Economics, Queen’s University
Joined the company: 2022
Began career: 2013
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