It was busy day for economic reports abroad. The Eurozone economy shrank by 14 percent annualized in the first three months of the year. Countries hardest hit by the COVID-19 pandemic generally suffered most. For example, the Spanish economy shrank by 19 percent while the Italian economy fell 18 percent during the first quarter of 2020. However, France was a notable outlier, as its health experience was better but it experienced a stunning 21 percent drop in real GDP – the deepest contraction in the common currency area. The German economy fared much better, shrinking by an annualized 8.6 percent. Putting it into context, Statistics Canada is reporting that the economy contracted by 10 percent in the first quarter, with activity not only impacted by the lockdown in March but also dragged down by transitory factors including rail blockades and teacher strikes. While the UK (-7.7 percent) and US (-4.8 percent) economies experienced less decline, this had a lot to do with a later start of the economic lockdowns.
While the first quarter numbers look decidedly dreadful, we expect second quarter readings to be significantly worse. Data on US retail sales in April corroborate this notion. Sales fell 16 percent during the month, disappointing analysts expecting a reading closer to -12 percent. Taken together with the 8.3 percent decrease in March, the level of sales is now about a quarter lower than pre-lockdown. Industrial production figures were also published today, with the aggregate industrial activity down 11 percent in April with manufacturing production falling 14 percent. These numbers portend a dramatically weak second quarter south of the border.
The Canadian economy is likely to contract more in 2020 than the US economy, but our current tracking suggests than the second quarter contraction might be around 40 percent annualized – less than the 50 percent we had previously predicted. This is due to the earlier-than-expected reopening of the economy in parts of the country and the relative resilience of the housing sector during the lockdown.
Housing starts in Canada have remained relatively robust. Although, starts fell from 195 thousand in March to 166 thousand in April as the lockdown was fully implemented, this is still a relatively decent level of construction. Activity was supported by the fact that construction could proceed on homes already under construction. While this normally would require ‘shovels in the ground’, the definition was expanded to include projects for which a permit was issued. The two to three month lag between permitting and construction has effectively created a buffer and supported activity in the sector.
The same cannot be said about the existing home sector, where sales plunged by more than half in April and are about one-third their pre-COVID pace. Declines were broad based, but were particularly stark in central Canada. Ontario also experienced the sharpest decline in average prices, down almost 14 percent in April, as compared to the national drop of nearly 11 percent. However, those looking for deals will be disappointed since the decline was almost entirely related to a lower share of expensive homes selling during the month. The home price index, which excludes the composition effect on sales, ticked down just 0.6 percent in April, and is up 6.4 percent from a year earlier—hardly a discount.
The performance is likely at least partly related to rising mortgage rates. While this seems counterintuitive in light of falling bond yields, banks have been rising mortgage rates in recent weeks to compensate for the costs of deferring payments for existing clients. This notion is corroborated by today’s Senior Loan Officer Survey, which showed mortgage lending conditions tightening significantly, in stark contrast to non-mortgage lending saw an easing of conditions. Interestingly, while non-price conditions were tightened for both categories, it was only mortgage lending that experienced higher interest rates.
I would stress that the lockdown period may not be indicative of what the post-lockdown real estate experience will look like. As the economy reopens, unemployment will be higher and household incomes generally lower. Wage growth is also likely to be weak. On balance, I still expect some degree of residential real estate correction. However, the outlook for commercial real estate is even more negative. There will not only be higher vacancies due to the downturn, but there will also be less demand for commercial real estate as firms continue to use more remote workers and consumers are reluctant to spend time in stores.
