By David Rosenberg and Julia Wendling
As the COVID-19 pandemic ramped up in early 2020, leading to widespread lockdowns and a plunge in economic activity, the Canadian government, like virtually all its peers, flooded households with extra cash to supplement cascading income. As a result, even though employee compensation fell 9.2 per cent, a whopping 30.5 per cent surge in government transfers led to overall household income rising by nearly eight per cent from Q4 2019 to Q2 2020.
But with the government now pulling back on fiscal and monetary stimulus amid rising inflation, income is set to falter, and that will act as a drag on consumer spending at a time when job creation is stalling and home prices are deflating.
At the height of the lockdowns in 2020, businesses were forced to shutter their doors and lay off staff en masse, leading to an uptick in the unemployment rate to 13.4 per cent by May from 5.6 per cent in January. It was unsurprising to see employee compensation then crater, falling in Q4 that year to $1.08 trillion (the lowest level since the third quarter of 2017) from $1.19 trillion in 2019. But the federal government stepped in with generous benefits to supplement that loss of income, nearly doubling transfers to the household sector to $609 billion in Q2 2020.
The flood of cash, in turn, led to an additional $906 billion landing in the hands of households than would have otherwise been the case if fiscal support had remained at pre-pandemic levels over the past two years. That stimulus has been substantially cut back since then, but the government still has further to go to revert to the historical trend.
Indeed, should we see the gap between actual income and counterfactual income (household income if government support had remained at the Q4 2019 level) close, government transfers would have to fall by an additional $58 billion, translating into a further three-per-cent hit to household income from the drop-off in federal aid alone.
However, the drag on household income in the coming months is set to be much greater since we also must account for the downward pressure on organic income from stagnating job creation within the economy. It’s crucial to note that overall employment growth and employee compensation, predictably, have an 88-per-cent correlation. And with employment growth contracting in June, July and August (-0.2 per cent month over month in each of those months), we can expect to see compensation follow suit, so this dominant source of household income is set to sharply slow.
Should the quarter have a 0.2 per cent drop in employment, that would translate into roughly a $27-billion hit to compensation, shaving off another one percentage point from overall household income. And with further employment losses on the horizon, we expect this trend of slowing income to gain momentum.
The combination of the pullback in government transfers and the hit to organic income is set to lop off at least four per cent from household income. But remember, this is an extremely conservative estimate because, as noted above, employment is expected to continue its descent and it doesn’t account for the decrease in rental income that lies ahead as property prices erode further.
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All in, this means that consumption — which accounts for more than half of gross domestic product and has a perfect correlation to household income — is set to take a tumble in the coming months — adding further credence to our recession call.
In addition, if we layer on the downside pressure to spending due to the negative wealth effect from falling home prices and reeling equity markets, the Canadian recession outcome is all but set in stone.
While the Bank of Canada continued its aggressive rate-hiking path with the 75-basis point increase last week, it will likely be stopped in its tracks in short order as the central bank comes to terms with the fact that the Canadian economic backdrop is weakening rapidly on a fundamental level.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. Julia Wendling is an economist there. You can sign up for a free, one-month trial on Rosenberg’s website.
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