Canadian Federal Budget Commentary
Alex Bellefleur, M.Ec., CFA
Vice President, Chief Economist and Strategist, Mackenzie Multi-Asset Strategies Team
Budgeting Amid an Economic Slowdown and an Upcoming Election
The 2019 Canadian federal budget is taking place amid a notable deceleration in Canadian economic growth. 2017 was a bumper year for Canadian growth, with several indicators in the household or manufacturing sectors reaching unsustainably high levels. In mid-2017, GDP growth reached 4% on an annualized basis, a level which was near the highs of the last 20 years. While it was clear that growth would not remain at those lofty levels, the slowdown experienced in 2018 and so far in 2019 has been more abrupt than anticipated by analysts.
This deterioration in growth momentum is in line with what has been experienced in Europe, the emerging economies and, more recently, the United States. This lull in growth was recently acknowledged by the Bank of Canada, which admitted that the slowdown in late 2018 was “sharper and more broadly based” than expected. As a result, market participants are now considerably more pessimistic on the Canadian economy. The bond market is also pricing in the end of the Bank of Canada’s tightening campaign as well a rising chance of a rate cut by year-end.
In this context, many had expected a federal budget delivering a larger fiscal stimulus than what was tabled by the government. Rather than aiming for broad-based stimulus or spending increases that would have expanded the deficit significantly, the government chose to address targeted, specific issues ahead of a scheduled federal election this coming fall.
The Housing Market
Much of the chatter ahead of the budget centered around measures to help with housing affordability for first-time homebuyers. Indeed, two of the country’s largest housing markets—Toronto and Vancouver—have seen house prices wobble lately, while remaining relatively unaffordable for first-time buyers. According to the Canadian Real Estate Association, sales activity has been decelerating, with existing home sales for February 2019 tumbling to their lowest level since 2012. This suggests that recent macroprudential tightening (such as the B-20 stress test, implemented at the start of 2018) is keeping prospective first-time buyers on the sidelines. From a broader macro perspective, this is somewhat concerning, given the sector’s contribution to growth over the past several years.
One of the budget’s marquee items consists of the new “shared equity mortgages”, which would see Canada Housing and Mortgage Corporation (CMHC) take equity positions of 5% in existing homes or 10% in new homes for qualifying first-time buyers. Buyers with household incomes of as much as $120,000 would be eligible, with mortgages capped at four times income. This measure is likely to rekindle housing demand from first-time homebuyers and to provide a meaningful boost to housing markets outside of Toronto and Vancouver, two markets where the caps will limit the impact. It is encouraging that the shared equity mortgage measure provides an incentive to increase the supply of new homes, as a sole focus on the demand side of the equation would simply push prices higher and would not help affordability. However, we note that this effectively turns CMHC into an equity owner, making it assume house price risk on top of the existing mortgage credit risk it already assumes.
The budget did not roll back some of the macroprudential mortgage regulations that have been put in place in recent years, which is a positive from a financial stability perspective. Instead, it increased the withdrawal limit from registered retirement savings plans from first-time homebuyers to $35,000 from $25,000. While this measure won’t represent a game-changer for Canadian housing over the longer term, it is likely to support the housing market and construction at the margin over a shorter horizon.
No Broad-Based Fiscal Stimulus
Despite the recent economic slowdown described above, the Canadian labor market has so far remained strong, with job creation beating forecasts and re-accelerating recently.
This has implied that growth in tax revenues has been strong for the federal government. For the fiscal year ended March 31, 2019, the government is forecasting that annual revenue growth will be just shy of 7%, which is higher than initially anticipated. This amounts to approximately $6 billion in additional revenue since the 2018 Fall Economic Statement, giving the government some leeway to increase spending on certain items ahead of this year’s federal election. Overall new spending measures are expected to total approximately 0.2% of GDP in the coming year. This does not represent a fiscal jolt that would boost the Canadian economy as we saw, for example, with U.S. tax reform in early 2018. Therefore, we do not expect this to change the narrative when it comes to Canadian growth.
The Longer-Term Fiscal Picture
One question we are often asked is: should investors worry about long-term federal fiscal deficits? Amid relatively strong growth in the past few years and the unemployment rate hovering around 40-year lows, the federal government’s budget balance still has deteriorated by approximately 1% of GDP, moving from a balanced budget to a deficit. This suggests that the deterioration has been structural, not cyclical. When taken in absolute, this means that the Canadian government risks having a reduced margin to maneuver in the next recession, when revenue growth will inevitably fall.
However, when comparing the Canadian situation with other international examples, we note that Canada’s federal fiscal position is in better shape than, for example, that of the United States, where the structural deterioration has been closer to 2% of GDP. From a big picture perspective, Canada remains a high-quality, AAA-rated credit, faring favorably versus other developed market sovereign bond issuers. There is plenty of local and global demand for Government of Canada bonds, so this slight structural fiscal deterioration is unlikely to represent a problem from a financing standpoint.
For the past 20+ years, the federal government’s debt-to-GDP ratio has been in almost constant decline, except for a few years around the financial crisis and recession of 2007-2009. This is a positive development and this year’s budget does not alter this long-term trend. However, it is important to keep in mind that the situation is completely different in the lower levels of government, most notably the provinces. In fact, much of the current spending pressures (e.g. healthcare, education) are strongest at the provincial level, while some of the revenue pressures (e.g. energy royalties) are also most acutely felt at the provincial level. Canada’s fiscal position remains enviable when compared to other developed economies in Europe or even the United States. Yet to international investors considering the country’s overall, general government financial situation, the macro picture is perhaps less rosy than suggested by federal-only debt figures.
Takeaways for Investors
Overall, it would be an exaggeration to state that this budget provides fiscal stimulus that will change the course of the Canadian growth story in the short run. We have noted in recent weeks the increasingly negative tone adopted by many analysts and strategists when it comes to Canadian assets and, more specifically, the Canadian dollar. Mackenzie’s Multi-Asset Strategies Team, on the other hand, has taken a slightly out-of-consensus view, as we currently have a tactical overweight position in the Canadian dollar relative to the basket of developed market currencies. Some analysts had worried that a large expansion of the federal budget deficit would prove to be negative for the Canadian dollar. In our view, this budget does not justify this concern.