Global markets were somewhat directionless over the past week, but encouragingly, levels of volatility remained the lowest they have been for some time. Despite the quiet week for the markets, there is much to discuss with respect to Canada. The third wave of the virus remains a near-term headwind. Meanwhile, the Federal Government unveiled its much-anticipated budget, while the Bank of Canada announced a subtle but meaningful shift in its monetary policy. We discuss more below.
We may have seen the first signs of slowing with respect to the virus spread in Canada. The country’s 7-day average rate of new daily infections was near 8600, relatively flat over the past week. The most problematic provinces were Manitoba, Alberta, Nunavut, and Nova Scotia, with the latter being particularly noteworthy given the situation had been relatively stable in the province until recently. Ontario’s infection trends rose, but the pace was noticeably slower. Quebec, BC, and Saskatchewan saw declines. An ongoing slowing and outright decline over the next week may suggest the country has reached a peak in its third wave.
The United States has continued to experience a relatively stable situation, with new infection trends slowing. Elsewhere, the story remains problematic with a number of countries facing very challenging situations. India may be the most noteworthy as it is dealing with severe strain on its health care infrastructure. After having reported a record of more than 210,000 new daily infections a week ago, India surpassed that level with a tally of 330,000 daily infections over the past week.
Canada’s large two-pronged budget
The federal government unveiled its 2021 budget this past week; its first in two years because of the pandemic. There were two broad takeaways.
First, the budget was two-pronged in nature. On the one end, there were extensions to existing pandemic-related programs, and new ones to help businesses and households deal with ongoing pandemic-driven disruptions. On the other side, there was spending to foster more sustainable growth. This includes an ambitious national early learning and childcare program aimed at boosting women’s labour force participation over time, though it will depend on cooperation from the provinces. There were also wide-ranging measures announced covering everything from employment insurance eligibility, to old age security, infrastructure and transit, affordable housing, and climate mitigation. Ultimately, the budget was very much focused on spending – roughly $100 billion over the next three years - in the hopes of spurring higher economic growth.
The fiscal implications are not surprising. The federal government’s debt-to-GDP ratio (debt to income) is going to remain elevated, at nearly 50% for the foreseeable future. This is meaningfully higher than the 30% level seen before the pandemic. The increase in debt may limit the government’s ability to respond to future crises but it isn’t necessarily a problem right now. The low interest rate environment has made the cost of carrying this debt manageable and other governments around the world have faced increases in their debt burdens over the past year, suggesting Canada is not alone.
Bank of Canada starting to “taper”
The Bank of Canada over the past week became the first major central bank in the world to announce a tapering, or slowing, of its weekly purchases of government bonds. The bank, like many others, had embraced this approach since the onset of the pandemic to increase the money supply, foster an environment of low bond yields, and help stabilize the economy.
The environment today has changed meaningfully from the year ago period despite the challenges that remain. Based on a more resilient economy and the improving outlook, the Bank of Canada raised its forecast for economic growth over the next few years, and in particular for 2021. Moreover, it now expects economic slack – productive capacity that is not being used – to be fully absorbed by the first half of next year, and inflation to reach, if not surpass, its 2% target later next year. As a result, the bank no longer feels the need to stimulate as much and it will start to modestly slow its pace of bond purchases beginning immediately. Investors are now shifting their expectations as to when the Bank of Canada will raise interest rates, with many now seeing late 2022 as a likely timeframe, from the prior expectation of 2023.
This week’s decision by the Bank of Canada marks a small and seemingly incremental change. But it is meaningful nonetheless as it suggests that the future direction of monetary policy over the next few years is likely to be less, rather than more, accommodative. In some ways it is a good sign as it indicates we may be moving towards a more normal and healthy economic and operating environment. However, investors will have to undoubtedly think more carefully about how to position their investments and portfolios, because interest rates play such a fundamental role in the valuations of all assets.
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