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What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
The price of oil fell far below zero early last week, with the price of West Texas Intermediate (WTI) falling much more than Brent Crude and going well below zero. Normally, there is a gap between the prices of these two oil benchmarks, but the gap widened beyond anything imaginable. Specifically, the price of WTI fell to about –US$40 per barrel while the price of Brent was US$26 per barrel. You read that correctly. The price of WTI fell 266 percent in one day. On the same day, Brent Crude fell a modest 9 percent, as the market for Brent has not been disrupted by a shortage of storage capacity. So what happened?
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The answer, in part, is that a major futures contract on WTI Crude expired, meaning businesses that purchased crude oil through that contract must take possession of the oil. Yet the glut of oil on the market is so big that there is a shortage of storage capacity. WTI Crude comes out of the ground and goes into storage before being distributed to customers through pipeline. With demand catastrophically low, storage facilities are mostly full. In fact, it is reported that storage capacity will hit 100 percent within the next few weeks. Thus, those taking possession of the oil will attempt to sell it in a market that doesn’t want it. Many investors are evidently willing to pay others to take the oil. What this means is, despite a recent agreement between Russia and the Organization of the Petroleum Exporting Countries (OPEC) to limit production, the decline in demand is so big that it’s overriding the impact of supply on market prices. Moreover, US producers are cutting back production because the low prices imply negative profitability—the number of oil rigs in operation in the United States is down by about a third in the past month. The unprecedented movement of oil prices shook investors and initially led to a sharp decline in equity prices.
Some people made a lot of money on the day that oil went negative. Imagine that you could be paid US$40 per barrel for taking possession of oil and then sell it in the futures market for US$20 per barrel. If you are a trader who has a long-term lease of storage space, you might have done that and made a fortune. Meanwhile, many people lost a lot of money. Those who had engaged in futures contracts that required them to take possession of oil faced enormous difficulties in obtaining storage space. Thus, they chose to pay others to take their oil. After prices dropped to a low of –US$40 per barrel, they later returned to something close to normal. As investors got spooked by this unusual activity, there was a sudden flight to safety, resulting in a sharp drop in the yield on the US Treasury 10-year bond. In addition, there was a flight away from assets perceived as relatively risky. Consequently, while yields on German government bonds fell, yields on Greek and Italian government bonds soared. In Italy’s case, the yield on the 10-year government bond approached the high that had been reached just prior to the announcement of massive bond purchases by the European Central Bank (ECB).
Going forward, it’s likely there will continue to be trouble in the market for WTI Crude given that storage capacity is nearly full. There are more futures contracts coming due. Thus, a repeat of last week’s dramatic drop below zero is possible. Ultimately, there will have to be a substantial further decline in production. The number of rigs in operation in the United States is already down by about a third in the past month. Still, many producers are obligated to fulfil futures contracts, thus mitigating against an early cutback in production.
In addition, there is evidently an expectation that low energy prices will persist. The so-called breakeven rate, which is an excellent proxy for market expectations of overall inflation, has fallen once again. Prior to the coronavirus crisis, the 10-year breakeven rate was around 1.7 percent. Then it fell dramatically, bottoming at 0.5 percent before rebounding after the Federal Reserve announced extraordinary measures. Until two weeks ago, the breakeven rate was around 1.25 percent. By last week, however, it had fallen to 0.94 percent as many investors reassessed their expectations for inflation. Their rapid change of view was driven by the events in the oil market.
Although US threats of military action against Iran led to an increase in oil prices late last week, the massive imbalance in the global oil market persists. The best solution to the problem would be a huge reduction in production, but this is not likely to happen overnight. As for the OPEC-Russia supply reduction agreement, even this will be hard to enforce.
Very low oil prices are often seen as beneficial to consuming nations. This is because lower oil prices imply lower prices of gasoline (petrol) and aviation fuel. But there is not much driving or flying taking place at present. Thus, the lower oil prices are not necessarily going to help consumers in a significant way. On the other hand, lower prices are hurting oil producers and oil-producing states. In the Middle East, some governments are cutting spending and sending migrant workers home. In Russia, the government is cutting spending and there is concern that the country’s rainy day fund could be quickly depleted. Likewise, oil producers in African and Latin American countries, such as Nigeria or Venezuela, face worsening economic prospects and fiscal integrity as oil prices remain historically low. Mexico’s state oil company, Pemex, which is heavily indebted, could face significant financial stress that could give rise to problems for the government. In the United States, oil-producing states like Texas rely heavily on taxation of oil producers to fund the government; so, these states could face a serious shortfall in funding. Finally, persistent low oil prices could result in business failures in the highly indebted energy sector, thus potentially creating a new source of financial market instability.
There is also the issue of what will happen in the longer term. My own expectation is that, in the absence of a vaccine or cure for the virus, economic recovery will likely be gradual, driven in part by concern about a revival of the outbreak. Restrictions on economic activity are already being lifted in some countries, but only gradually and hesitantly. This implies limited growth in the demand for oil. Even after the virus is eventually defeated, there is a possibility that some of the changes in behavior seen during this crisis will be permanently adopted. These could include working from home, reduced business travel, and increased online shopping. All these changes imply reduced demand for oil. Consequently, it’s not clear whether oil demand will return to levels seen in recent history, implying excess supply and downward pressure on prices. If that’s the case, the energy industry could face a disruptive future.
We now have the first meaningful data on economic activity in the second quarter in Europe and the United States. That is, we have the flash (preliminary) purchasing managers’ indices (PMIs) for these locations for April. The PMIs are published by IHS Markit. The numbers indicate that each of these economies experienced a catastrophic decline in economic activity in April. In the United States and Europe, it was the first month in which there was a lockdown for the entire period examined. The result was that activity in both the manufacturing and services sectors declined rapidly. The services sector, which encompasses industries such as transportation, retail, and hospitality, declined at an especially rapid pace. This is because these industries were forced to completely shut down or suffered a nearly complete loss of customers in many locations.
The question now is how quickly activity can be resumed when governments begin to ease economic restrictions. National governments in Europe and some state governments in the United States are starting to either ease restrictions or plan to do so soon. Whenever this happens, there are likely to be some restrictions to enforce social distancing. Even when restrictions are lifted, many businesses and consumers will be reluctant to go back to normal until they are confident that the virus is gone. Until that happens, it’s likely that people will be averse to airplanes; businesses will be reluctant to have employees ride in elevators (lifts); restaurants will have fewer tables set further apart; entertainment venues will have difficulty generating business; and factories will have to enforce social distancing by limiting employee interaction. Thus, it’s easy to imagine that even when recovery begins, it will be stifled by the need to have people avoid other people.
As for the PMIs, let’s consider what is happening now. PMIs are forward-looking indicators meant to signal the direction of activity in the manufacturing and services sectors. They are based on sub-indices such as output, new orders, export orders, employment, input and output prices, inventories, pipelines, and sentiment. A reading of above 50 indicates growing activity; the higher the number, the faster the growth and vice versa. A number below 50 indicates contracting activity; the lower the number, the faster the decline. Here are the numbers:
Europe’s economy appears to have collapsed in April. For the eurozone, the PMI for manufacturing fell from 44.5 in March to 33.6 in April, the lowest in 134 months. The services PMI fell from a record low of 26.4 in March to a new record low of 11.7 in April. The services PMIs for Germany and France were not quite as bad as the eurozone average, implying that the PMIs were much worse in Spain and Italy where lockdowns were severe. The extent of the decline in services reflects the closure of non-food retail stores, restaurants, and hotels as well as the near complete collapse of air travel. The decline in manufacturing reflects the near collapse of the automotive industry as consumers stayed home rather than visit automotive showrooms. All sub-indices fell sharply including output, new orders, and employment especially. In addition, output prices fell at the most rapid pace in 11 years. Markit commented that the decline in the PMIs in April was consistent with GDP falling at a quarterly rate of 7.5 percent. Going forward, it’s likely there won’t be a significant easing of restrictions until mid-May, in which case economic activity will remain stifled for much of this quarter.
As for the United Kingdom, the PMIs for manufacturing and services both fell to record lows in April. The manufacturing PMI fell from 47.8 in March to 32.9 in April. The services PMI fell from 34.5 in March to 12.9 in April. Markit said that the decline in the PMIs was consistent with GDP falling at a quarterly rate of 7.0 percent. However, Markit commented that “the actual decline in GDP could be even greater, in part because the PMI excludes the vast majority of the self-employed and the retail sector, which have been especially hard-hit by the COVID-19 containment measures.” Moreover, given that the United Kingdom has not yet seen the curve flatten to the degree seen on the continent, it is likely that restrictions on economic activity will remain in place longer, thus delaying the ultimate recovery.
The US economy also experienced a sharp contraction in April. The PMI for manufacturing declined from 48.5 in March to 36.9 in April, the lowest in 133 months. The PMI for services declined from 39.8 in March to 27.0 in April, a record low. The record drop in services activity reflected many of the same factors seen in Europe. These included the closure of stores, restaurants, hotels, and entertainment venues as well as a catastrophic drop in air travel. However, the US services PMI did not fall as much as that of eurozone. The likely reason is there continued to be parts of the United States where there were only limited restrictions on activity. Still, locations in the United States that have had large outbreaks of the virus and have implemented stringent restrictions account for a disproportionate share of economic activity. Markit said it expects that second quarter US GDP will fall at an unprecedented rate. Also, the US government released a report indicating that an additional 4.4 million Americans filed new claims for unemployment insurance last week. Since the crisis began, more than 26 million Americans have lost their jobs. In addition, the government reported that sales of new homes fell sharply in March.
Going forward, there is a political debate in the United States about the speed at which restrictions should be lifted. Almost every public health official says it is too early to do so given that the outbreak has not yet been stifled and that testing/tracing capabilities are not yet in place. If restrictions are lifted soon, there could be a larger outbreak and a delay in economic recovery. On the other hand, if the virus is suppressed by late May, restrictions could be lifted in June and economic recovery could gradually begin in the summer.
As economies around the world undergo lockdowns of varying degrees, supply chains are being disrupted. In relatively poor countries, this has meant disruption of the delivery of food from farmers to cities. For the farmers, it has meant a loss of income. For the urban population, it has meant higher food prices and shortages of key staples. This, in turn, could lead to rising hunger and potential social unrest. The World Food Program expects the number of people in the world facing acute food shortages to double this year. The United Nations says that poor countries in Asia are at greatest risk as are countries that rely heavily on remittances from overseas such as the Philippines and countries in Central America. Meanwhile, food shortages have already led to violent protests in South Africa.
Rich nations worry that food shortages could generate a new surge in migration from poor to rich nations. The agriculture ministers of the G20 nations held a meeting recently to discuss this topic and committed to “guard against any unjustified restrictive measures that could lead to excessive food price volatility in international markets and threaten the food security and nutrition of large proportions of the world population.” In addition, they warned that policies meant to deal with the virus should “be targeted, proportionate, transparent, and temporary, and do not create unnecessary barriers to trade or disruption to global food supply chains.” Yet barriers have risen. Some countries have placed limits on exports and have boosted stockpiles. Lockdowns have deterred farmers from gaining access to urban markets. Restrictions on migration have limited the supply of migrant farm workers in rich countries. Moreover, if the outbreak of the virus worsens, it could have a further negative impact on food distribution.
Many poor countries rely heavily on remittances from overseas workers. Such remittances account for a large share of GDP in some countries and are often the largest source of foreign currency. The World Bank estimates that for countries classified as poor, remittances accounted for 8.9 percent of GDP in 2019. This figure is much higher in some countries. For countries classified as poor or middle income, remittances were the largest source of foreign capital in 2019. Yet, the World Bank says that remittances could fall this year by US$100 billion from 2019. This would be a drop of about 20 percent from the previous year. This decline stems from the economic disruption caused by the coronavirus. Many countries have implemented varying degrees of lockdowns that have resulted in the dismissal of many workers. Moreover, although some governments have provided fiscal support to individuals and households to help them survive the economic storm, often such support is not provided to migrants. Thus, they are left without funds. Plus, given restrictions on travel, some are left in limbo, unable to work but also unable to go home. And, they are certainly unable to send money to their families in their home countries.
Although the World Bank expects a 20 percent decline in remittances this year, it expects an even bigger decrease in the channeling of remittances to Central and Eastern Europe as well as to sub-Saharan Africa. Finally, the World Bank warned that the decline in remittances comes at a time when many poor countries face an even sharper decline in inbound foreign direct investment as well as a decline in portfolio flows of money from abroad. In fact, there has been a surge in capital flight from poor countries as global investors have engaged in a flight to safety. Thus, many of the poorest nations could face a sudden and severe decline in income. This could result in rising unemployment, hunger, and difficulty in servicing foreign debts. It might also fuel a rise in migration to richer countries.
Once the current crisis is truly over, the post-crisis world could look quite different. Below are some possible scenarios about ways in which the world could change, both during the transition to an opening of the economy and after the economy is fully open and the virus is completely gone. These scenarios are purely hypotheses about what could happen. There is, however, no way to know and it is possible that none of this will happen. Still, it is worth taking the time to consider the possibilities.
Many people and businesses will become accustomed to working from home. Businesses will become more virtual and geographically fragmented. More working from home will mean less automotive traffic, less energy consumed, more bits and bytes transmitted, more time spent with families, a greater need for home offices, less need for commercial office space, and less demand for affiliated services. This transition would especially apply to companies in financial services, professional services, as well as the corporate headquarters staff of almost any other type of business.
Many more people will be accustomed to shopping from home, thereby accelerating a process that was already well under way. More online shopping will mean less need for retail property, more need for distribution centers and transportation services, and more bits and bytes transmitted. For store-based retailers, it will intensify the need to create an entertaining experience in order to drive people out of their homes.
Business people will become accustomed to virtual meetings. More Zoom meetings will mean less air traffic, less business demand for hotels, and fewer meals in urban restaurants. Yet this trend might spark greater interest in finding opportunities to interact with real human beings. While more company meetings might take place in cyberspace, there might be greater interest in staging events and off-site brainstorming sessions, if only as a means to get together.
Global businesses might reevaluate their supply chains. For some, they will recognize that their global supply chains were mostly Chinese supply chains. That creates risk if anything unexpected should happen again in China. Therefore, expect more investment in other countries. US companies will likely give more consideration to Mexico. European companies will likely look to Africa and the Middle East. Japanese companies will likely look to Southeast Asia. And Chinese companies will likely also diversify their supply chains.
People will become accustomed to not visiting their doctors. More telemedicine may mean that sick and elderly patients won’t always have to travel to visit a doctor and be exposed to infection. Rather, they will be consulted from home. Perhaps in-home technology found in mobile devices can allow for remote diagnosis. This could reduce the cost and improve the efficiency of health care.
There could be greater public support for stronger social safety nets, especially in the US with respect to health care. Attitudes toward public spending might change—in either direction. On the one hand, if there are no deleterious effects of massive government borrowing (at least in some countries), there might be reduced concern about fiscal probity. On the other hand, debt service challenges for heavily indebted countries in the Eurozone could alter the European Union. It could strengthen the case for integration and cooperation or it could lead to a collapse of the Eurozone. As for monetary policy, the once expected return to normal interest rates will likely be considerably delayed.
There could be greater use of surveillance technology to monitor the spread of the virus, which is well under way in Asia. Meanwhile, these technologies will likely be critical in suppressing the virus until a vaccine or treatment is found. Thus, there will likely be a tug of war between the needs of public health policy and the desire for privacy.
A key issue at this moment is the sustainability of the huge increases in government borrowing. The downturn in global economic activity will likely lead to a loss of tax revenue for most governments. In addition, most of the world’s major economies are boosting government spending in order to protect households and businesses from the downturn, as well as to finance the massive increase in health expenditures. The result will be a big increase in government borrowing and a rise in the debt/GDP ratio. The International Monetary Fund (IMF) says that global net public debt will increase from 69.4 percent of GDP last year to 85.3 percent this year. In the United States, the annual budget deficit will rise from 5.8 percent of GDP last year to 15.4 percent this year. In Europe, deficits will be around 10 percent of GDP. In the United States and Western Europe, most of the increase in debt will likely be funded by bond purchases undertaken by central banks. Why might individuals be worried about the rise of government debt? There are a couple of reasons.
First, ordinarily an increase in government borrowing in competition with the private sector will lead to higher bond yields. That, in turn, could stifle business investment and slow economic growth. However, bond yields are not expected to rise during the downturn. Indeed, they have mostly fallen as many investors have shed risky assets, such as equities, and moved toward safer assets, such as government bonds. Plus, the downturn has meant lower expectations of inflation and weaker private sector demand for credit, both factors that have driven down bond yields. However, when the recovery eventually comes, there could be a surge in credit demand. If this is not adequately offset by a deceleration in planned government borrowing, it could spook investors and lead to higher bond yields. That, at least, is the theory. In practice, this has not happened in the United States and Japan in recent years.
Second, that the movement of bond yields in some countries indicates concern that there could be trouble servicing debts, especially in Eurozone countries that have no control over their own money supplies. There is particular concern about Italy where the IMF estimates that publicly held debt could rise from 123.1 percent of GDP last year to 142.7 percent of GDP this year. That reflects the extreme weakness of the Italian economy in the face of a strict lockdown. Indeed, Italian bond yields have recently risen. That said, the decision by the European Central Bank to provide unlimited purchases of member state government bonds largely assures that countries will be able to finance their debt accumulation. The risk of default is modest. The bigger potential problem is that countries like Italy will need to severely cut expenditures and possibly raise taxes when the crisis ends. If not, it is possible to imagine a scenario in which the Eurozone unwinds.
Third, there is concern about the possibility of much higher inflation, especially as central banks are financing much of the government largesse. Ordinarily, central bank funding of budget deficits leads to a big increase in inflation. Consider the experience of Venezuela, Zimbabwe, or Germany in the early 1920s, all of which had hyperinflation as a result of ruinous deficits. Yet these are not ordinary times. Central-bank action is helping to offset a catastrophic decline in economic activity as well as a huge increase in unemployment. Moreover, central banks are boosting their balance sheets in order to assure credit market activity does not seize up. This is similar to what they did in 2008 ̶09 when they had also dramatically increased the size of their balance sheets. While many critics worried about inflation, the reality was that money supply grew modestly and inflation never came. The same is likely to be true again.
Finally, when the crisis is over, governments will likely have to raise taxes and cut spending in order to reduce their debt/GDP ratios. For rich, aging countries, this will be especially important if they are to address their longer-term demographic problems. In any event, tax increases and spending cuts could hurt economic growth. Yet failure to implement them could hurt investor confidence.
The current situation could be compared to the Great Depression of the 1930s. Yet in some ways, the current crisis is more reminiscent of World War II. That is, nations are facing an implacable enemy that must be defeated. They are throwing a huge amount of resources into the fight, resulting in a massive build-up of debt. Back in 1945, when the war ended, governments were laden with debt. But over time, they paid down that debt. With the exception of the United Kingdom, most of the major countries that fought in the war, both winners and losers, experienced strong economic growth in the aftermath of the war. The debt was not an obstacle to growth. The same might be true once this war is won. Of course, the post-war era was characterized by increased global cooperation and reduced obstacles to the movement of goods and capital. It is not clear if that will be true following the current crisis.
There is now evidence that the crisis has had a negative impact on the US housing market. The government reports that, in March, housing starts fell sharply, down 22.3 percent from February. Starts of multi-unit structures fell 32.1 percent. While there was a sharp decline in all four major regions, the decline in the Northeast was much greater, at 42.5 percent. This likely reflects the fact that the outbreak was, and is, most severe in the New York area. The decline in starts likely reflects builder expectations that demand will weaken in the coming year. Although mortgage rates are historically low, and house prices are likely to decline, unemployment is up massively and is expected to rise further. Consequently, builders are not expecting to be able to easily unload inventories.
Meanwhile, there is growing concern about the ability of Americans to service existing mortgages and other debts. This poses a potential risk to the banking sector, which currently is well-capitalized. Yet Federal Reserve Bank of Minneapolis President Neel Kashkari, who led the Troubled Asset Relief Program (often called TARP) during the Bush Administration, says that banks ought to raise new capital now in anticipation of trouble. He said, “We simply do not know how large the losses will be from this crisis.” He also said that “an extended downturn can easily sap banks’ current equity capital.” Therefore, he suggested that banks ought to issue new shares. He said that failure to do this now means that, should the economic downturn be worse than expected, the Federal government might have to bail out banks much like it did during the global financial crisis in 2008-09.
Last week there were 5.2 million new claims for unemployment insurance, down from 6.6 million in each of the two prior weeks. In the week before that, there were 3.3 million new claims. Prior to this crisis, the highest number of new claims ever filed in a single week was below 700,000. In any event, 22 million Americans have lost their jobs in the last four weeks. This implies that, when the April job market reports come out in early May, it will likely show an unemployment rate of more than 15 percent. This would be, by far, the highest rate since the early 1930s.
Retail sales fell 8.7 percent from February to March, by far the steepest decline on record. Sales were down 6.2 percent from a year earlier. Yet as shocking as the overall number was, the details were especially notable. For the month, sales were down 27.1 percent at automotive dealerships, down 50.5 percent at clothing stores, down 26.8 percent at furniture stores, down 19.7 percent at department stores, and down 26.5 percent at restaurants. In contrast , sales were up a surprisingly modest 3.1 percent at non-store retailers. However, sales were up a staggering 26.9 percent at grocery stores. It is no wonder, then, that supermarkets are struggling to keep up with demand and often have empty shelves. Also, it is important to note that this report is for all of March. Yet we know that most of the state lockdowns took place in the second half of the month, some toward the end of the month. Therefore, it is reasonable to expect that the retail sales numbers for April will likely see a sharp decline once again.
Meanwhile, the US government also reported about the industrial sector of the economy. Industrial production fell 5.4 percent from February to March, the largest monthly decline since January 1946 when the economy was adjusting to the end of the Second World War. The latest decline included a 6.3 percent decline in output by manufacturers and a 3.9 percent decline in utility output. Production of business equipment was down 8.6 percent, boding poorly for business investment. Among the details of the report were the following: for the month, production of automobiles was down 28.0 percent, production of apparel was down 16.5 percent, furniture was down 10.0 percent, and textiles was down 14.1 percent. Production of food and beverages was down only 0.8 percent and production of computers and electronics was down a mere 1.9 percent.
Xu Sitao, Chief Economist, Deloitte China, offers his views on the economic outlook for China.
How much did the economy contract in the first quarter when almost the entire country was subject to lockdown? This has been on the minds of investors and most China watchers since late January. The government has revealed Q1 GDP was down 6.8 percent from a year earlier which, in my view, is quite respectable in light of halted activities in China and other major economies. Total retail sales of consumer goods saw a 19 percent reduction in Q1, with consumer staples and physical merchandise online sales bucking the trend. Q1 fixed asset investment dropped by 16.1 percent, with e-commerce and professional technological services leading the growth and commercial housing sales recovering some ground. Trade volume declined by 6.4 percent in Q1, with exports bearing the brunt (down 11.4 percent YoY), while imports scraped by (down 0.7 percent YoY). The surveyed urban unemployment rate for March was 5.9 percent, down from its record high of 6.2 percent in February. However, both exports and the housing market have weathered the storm. We will come to this point later.
In our recent publications, we have projected a contraction of 7 ̶ 8 percent simply based on economic activities in January and February. However, we also forecasted a flat Q2 and a vigorous recovery in H2 (around 7 ̶ 8 percent). Q1 GDP growth of –6.8 percent has reinforced our long-held view that China's consumer resilience is underpinned by certain structural factors (e.g., high saving rates and low leverages). COVID-19, essentially, has delayed certain economic goals set by policymakers, and yet there are no reasons for China to achieve such goals with potentially risky investment projects powered by too much leverage. So, if H2 growth is around 8 percent or even higher, GDP growth in 2020 is expected to be between 3 ̶ 3.5 percent. One might raise the question as to the apparent discrepancy between our forecasts and the IMF’s downbeat ones that came out on April 14. According to the IMF, most major economies will see outright contractions while China's 2020 growth will be slightly above 1 percent. Our interpretation is that the IMF’s forecasts were based on a potent V-shaped recovery in 2021 following a far sharper global recession in 2020. Various scenarios of recovery have clearly taken into account the impact of policy responses differently. In our view, Beijing still has a few tools in its toolbox. To be specific, interest rates have more room to fall while another 3-4 percent of fiscal deficit/GDP could be expanded in the form of special bond issuance.
Prior to the Q1 economic data releases, the National Bureau of Statistics released data on house prices in 70 cities—prices were up 5.4 percent YoY in March 2020, with prices in Shenzhen seeing an exceptional gain of 9.7 percent YoY. Why did house prices rise during a period of such uncertainty? There are a few reasons:
Shenzhen has benefitted more than other tier 1 cities from its position as a leader in the Greater Bay Area. Beijing is unlikely to purposefully push housing prices higher in light of policymakers’ concerns over bubbles. But if external demand faces greater-than-expected challenges in H2, why not increase domestic demand through somewhat higher consumer leverage in 2020 by targeted easing of restrictions on housing? As most developed countries go for record-high fiscal deficits (around 10 percent of GDP in 2020) in order to stabilize business and employment, China should and could tolerate a much higher deficit/GDP ceiling than 3 percent, which was set a few years ago. That said, China’s strength lies with its swift execution, which could result in an investment surge similar to what happened after the global financial crisis.
Deloitte Canada’s chief economist reports on the latest GDP data for Canada.
Statistics Canada released a preliminary estimate of real GDP growth for March 2020. This is the first time that the statistical agency has provided an advance reading for real GDP. There is normally a two-month lag in the monthly real GDP data. The fact that it provided an early estimate for March shows a commendable effort to provide data as soon as possible during this crisis.
According to the preliminary numbers, the Canadian economy contracted by 9 percent just in the month of March. This is the largest one-month decline ever recorded since the series started in 1961. Given that estimate, we now have an early reading for the first quarter of 2020. According to these numbers, real GDP fell by approximately 10 percent annualized.
However, the data only captures the decline in the first half of the month and we know much of the lockdown and business closures came later in March. Allowing for this, we believe that Canada is on track to record a second-quarter decline in GDP in excess of 50 percent annualized.
The Statistics Canada release also provided an early picture of the impact by industry in March. Not surprisingly, the largest impact was in travel- and tourism-related industries, such as restaurants and accommodation. There were also large declines in retail and entertainment.
In contrast, the health sector, food distribution, and online retailing all experienced growth. The oil and gas sector saw little impact in production volumes in March. However, this is likely to change in April as storage capacity becomes a problem and companies begin to reduce production in response to falling world demand for oil. Although the OPEC+ coalition of major oil producing nations recently announced a major production cut of 9.7 million barrels per day in May and June, it is unlikely to stop the rise in inventories due the depressed state of global demand. Thus, extremely low oil prices can be expected to persist and will lead to continued weakness in the Canadian energy sector.
The other major event last week was the Bank of Canada policy meeting and the release of its April 2020 Monetary Policy Report. As expected, the bank left its policy rate unchanged, but it announced a new provincial and corporate debt purchase plan.
The IMF released a revised global forecast, with the world economy projected to contract by 3 percent in 2020, far worse than in the 2008-09 recession. The IMF is predicting that the Canadian economy will decline fall by 6.2 percent in 2020, with a rebound of 4.2 percent in 2021. Our Deloitte Canadian economic outlook is for a greater decline in 2020, closer to 10 percent. This is based on the most recent economic data that the IMF would not have had when they created their projection.
Around the world, governments are starting to think about how to reopen the economy once the virus is suppressed. It is not a matter of simply pulling a switch that turns on the lights. Rather, it is a matter of deciding on the sequencing of removing barriers to economic activity. Acting too soon risks reigniting the outbreak. As New Jersey Governor Phil Murphy said, we need to avoid “throwing gasoline on the fire.” Meanwhile, acting too late risks allowing many businesses to fail. One way to avert disaster is for governments to invest in boosting testing capabilities. Another is to invest in tracing and surveillance. This is critically important at least until there is a vaccine or cure for the virus. Some governments have been notable for such capabilities including South Korea and Germany. Others are attempting to catch up. In the United States, such efforts are conducted by state and local governments. Testing and tracing, if done well, can enable economies to reopen and stay open should the virus return in the autumn.
Reopening the economy is also a matter of addressing potential bottlenecks that might emerge. After all, part of the policy response to the downturn has been the injection of a massive quantity of cash into households. Much of that money will likely be saved until people are free and able to reengage with their local economies. When that happens, there could be a surge in demand that may not be easily met with sufficient supply. Such bottlenecks could lead to an increase in prices.
However, as any good economist knows, price movements offer a signal to market participants that can drive changes in supply and demand. Currently, much of the infrastructure for distributing goods lies idle. Once suppliers perceive increased demand, they can begin the process of reviving supply. That will mean retailers placing orders, container ships leaving ports, and ground transportation reviving. The risk is that, if companies are financially stressed, this process might be disrupted or delayed. That is why maintaining the fluidity of financial markets is so important. Recent initiatives by central banks and governments have been undertaken with the goal of providing businesses with sufficient funds and credit availability to revive business once demand picks up. The longer the crisis takes place, however, the more difficult this process will likely be.
Michael Wolf, a global economist at Deloitte, examines early evidence of how people and businesses are behaving in China now that restrictions are being eased.
As policymakers around the world are eager to return their economies to normal, evidence is growing that the normalization process will not be a quick one. Since China and several other Asian countries were among the first to face a major outbreak of the virus and have since reemerged from lockdown, we can look at their experience to better understand what might occur in Europe and then North America as those regions bend the curve and eventually remove some restrictions.
However, the experience in China should probably be viewed as a best-case scenario for the West. China’s test and trace policies are more invasive than what Americans or Europeans may tolerate. Residents of China regularly have their temperatures taken and show an app that provides a risk profile based on health and location tracking data.
Even with the extensive test and trace policies in place, China’s economy is still struggling to return to where it was before the epidemic hit. For example, coal consumption during the first five weekdays in April was 14 percent below where it was during the same period a year earlier. Coal consumption may even provide a more optimistic outlook than is warranted. Businesses that have been able to restart are primarily large firms and factories, which tend to require more energy and therefore coal.
The difference between weekday and weekend traffic hints that many in China may be willing to return to work but are being more cautious when it comes to their leisure time. Last week in Shanghai and Beijing, peak weekday street congestion was down nearly 20 percent from 2019 but down more than 80 percent during the weekend. Despite reports of large crowds at tourist destinations for the Qingming festival, which occurred April 4, tourism spending was down an astonishing 80 percent from a year earlier.
The reopening of the economy has come in fits and starts, with officials reportedly opening and then closing some movie theaters, food service operations, and tourist attractions due to fear of contagion. This likely has negative implications for consumer discretionary spending, which helps explain why some smaller businesses and service sectors are having a more difficult time getting back up and running again. Limited access to finance may be hampering these businesses as well.
Even if other countries are willing and able to adopt the same type of test and trace procedures seen in places like China, Singapore, and Hong Kong, it does not guarantee that the virus will remain contained. Indeed, just last week, Singapore, which had done an excellent job of preventing the spread of the virus early on, is now growing increasingly worried about a resurgence and has issued a partial lockdown this week. Similarly, Hong Kong has extended and expanded upon its social distancing policies as well.
Xu Sitao, Chief Economist of Deloitte China, provides his outlook for the nature of the economic recovery in China.
The powerful rally of financial markets (the Dow is up roughly 20 percent from late March) has been bolstered by formidable policy responses led by the US Federal Reserve (another US$2.3 trillion of liquidity injection last week) and investors’ hopes for economic recovery. The key question is whether China would lead the global recovery and, if so, whether such a recovery is sustainable. Without most March data, we can only base our analysis based on high-frequency data (energy consumption, etc.) and the likely impact of policy responses in China. Beijing’s policy responses center on both containment of the virus and the speed of business resumption. Like many other residents of Beijing, checking confirmed COVID-19 cases is no longer my daily ritual. Every few days, I glance at my mobile phone. The pattern has been around 60 cases or fewer a day, but most are imported ones.
In Beijing, traffic jams have resumed, suggesting a continued pick up of business and eased fears. Given Beijing’s unique position and the fact that the annual Two Sessions’ dates have not been announced, it is logical to assume that the speed of business resumption in other major cities is faster than in Beijing. Meanwhile, at the latest Politburo meeting on April 8, President Xi reiterated the importance of preventing imported cases and emphasized the need to prepare for a less favourable external environment in the next few years.
March auto sales were reported at 1.04 million, down 40.4 percent from a year earlier, compared to a reduction of 78.7 percent in February. Sales of luxury vehicles registered a less steep decline of about 20 percent, suggesting the trend of trading up remains intact, a sign of consumers’ unrattled psyche. It is highly likely that the economy will remain sluggish in the second quarter as it takes time for the expanded quantity of credit to flow to areas of the real economy that have been hit the hardest, such as private sector small- and medium-sized enterprises. Therefore, we see more focused monetary easing through cuts in the required reserve ratio in an effort to channel liquidity to smaller companies.
However, the Chinese economy should recover strongly in the second half provided that COVID-19 infection curves in the United States and western Europe flatten by late Q2 (evidence is encouraging in Italy and Spain of late), capacity utilization returns to normal, and a bigger-than-expected stimulus lends a fillip to growth. The Politburo meeting on March 27 carried clear hints of a big stimulus in the works, calling for an increase in the fiscal deficit ceiling; government issuance of special treasury bonds; more issuance of local government special purpose bonds; and lower interest rates. All of this is meant to stabilize and jumpstart the economy. A plethora of related measures have been announced since then, and housing and auto purchase restrictions have been eased.
With policymakers now averse to the type of large, “flood irrigation” stimulus deployed in 2008, we think the fiscal stimulus to be announced shortly could be enough to drive GDP growth of 3 percent for 2020 as a whole, with the deficit/GDP ratio potentially being ratcheted up to 6–8 percent. The composition of the stimulus package should be prudent, comprising new infrastructure investment in 5G, industrial IoT, and data centers; measures to spur household consumption; and targeted credit easing, rather than a no-holds-barred, credit-fuelled investment drive.
As such, our base case is for a substantial acceleration in economic growth in the second half of this year. For China’s neighbours, laboring under a decline in external demand as major developed economies enter recessions induced by the COVID-19 crisis, a recovery in their biggest economic partner will present much-needed support to their economies. Again, our assumption is that major developed countries will lag China’s recovery by around two quarters, barring a resurgent second wave of COVID-19.
Given that we do not expect any near-term recovery in outbound tourism from China, the main positive will likely come from rising Chinese demand for imports from its neighbours. Hong Kong, Taiwan, South Korea, and Singapore could gain from this. That said, Hong Kong’s economy is likely to suffer a large contraction due to its heavy reliance on Mainland tourists (about 40 ̶ 50 million visits a year) who are unlikely to return until autumn even in the best-case scenario, and the HKD peg as it worsens deflation due to the strength of the US dollar. However, Hing Kong’s strong fiscal position will cushion economic hardship as evidenced by its latest stimulus package (almost US$18 billion) that was announced on April 9.
Michela Coppola, Senior Economist at Deloitte’s EMEA Research Center, provides the results of Deloitte’s latest survey of European CFOs.
While there is little doubt that the global economy is heading into a recession, what is unclear is how deep it will be, how long it will last, and how fast the economy will bounce back. An optimistic scenario assumes that the recession, though painful, will be short-lived, giving way to a sharp rise in economic activity in the second half of this year, driven by pent-up demand.
Deloitte’s European CFO Survey—which in March approached nearly 1,000 CFO respondents across 18 countries—provides a more somber view. Almost 80 percent of respondents expect the pandemic to have a negative effect on their company’s revenues well into the autumn. One in three expect a double-digit decline in the next six months. Perhaps unsurprisingly, CFOs in the tourism and travel industry are particularly pessimistic regarding the impact of the pandemic in the short term, whereas financial executives in the life science and health care industry have slightly more positive views, although even in this sector more than 50 percent of respondents expect some decline in their revenues over the next six months.
Longer-term expectations are only slightly more positive. While only 10 percent of respondents foresee a strong decrease in revenues well into next year and almost 30 percent think that revenues will be at the same level as forecast before the outbreak, more than half still expect the negative effects of the pandemic to stretch into 2021. Thus, rather than a quick and sharp rebound, European companies seem to be preparing for a quite gradual recovery in their business, spread over a longer time horizon.
Subdued business expectations mean companies are downgrading their investment and hiring plans. Forty one percent of CFOs plan to reduce their capital expenditures, twice as many as the 20 percent who plan to increase them. Similarly, 38 percent of respondents foresee a decrease in the number of their employees over the next 12 months, against 21 percent expecting an increase. Looking at the data based on when CFOs responded throughout March it is apparent that the outlook deteriorated as the month progressed. Among the CFOs answering the questionnaire in the last week of March, 51 percent reported a likely decrease in the number of employees over the next 12 months.
To steer their companies in these unchartered waters, companies are prioritizing short-term reactive measures, in particular cutting spending. On average, one in 10 executives report that they are prioritizing the establishment of new credit lines, although the number quadrupled during the data collection phase, from 4 percent in the weeks before March 8, to 18 percent among the CFOs who answered the survey after March 22. As the crisis extends over a prolonged period of time, measures to guarantee and facilitate access to credit will become increasingly relevant.
Here you can download the full report and explore the results country by country in interactive graphs.
There are increasing calls for massive support for emerging countries. Former British Prime Minister Gordon Brown led a group of 165 former leaders in writing a letter urging US$200 billion in direct support for poorer countries. Why? Although the viral outbreak in emerging countries has been relatively muted so far, this could quickly change. If it does, the human consequences could be devastating, not only in the emerging nations themselves, but in developed nations if the virus is transmitted from emerging nations to Europe, North America, and North Asia. In their statement, the former leaders note that a study by Imperial College in London estimates that, even under the best conditions, there could be 900,000 COVID-19 deaths in Asia and 300,000 deaths in Africa. Within emerging nations, there are often inadequate health care facilities and infrastructure, and there are also difficulties in implementing social distancing given high population density in big cities and even in people’s homes. Moreover, many emerging nations are now implementing policies meant to stifle human contact. These include shutting businesses and urging people to stay home. As we already know from China, Europe, and North America, such policies can lead to a dramatic decline in economic activity.
Although some emerging nations, such as India and South Africa, are using fiscal and monetary policy to offset the negative economic effects of social distancing, there are considerable limits to financial resources. Also, due to the collapse of demand in developed nations, there has been a sharp decline in commodity prices and in global trade in manufactured goods. This has resulted in a decline in export revenue for emerging nations, thereby exacerbating unemployment and damaging the ability to service foreign currency debts. The decision by many emerging nations to cut interest rates has meant downward pressure on currency values, further hurting debt repayment. Given all this, the global economy faces a significant risk from a weakening of emerging nations. Hence the call for massive support. Already, the World Bank and the International Monetary Fund have committed to increasing assistance to emerging nations. The former leaders hope that developed-country governments will agree to contribute more as well.
Thenumber of people in the world who have been infected by the COVID-19 virus has passed one million, with nearly a quarter of them in the United States. This number will most likely rise further in the weeks ahead. The good news is that the number of reported cases in China has been flat for some time now. This likely reflects the success of the policy of suppressing economic activity, which is now starting to recover. In Western Europe, there is evidence that the curve is also flattening. In Italy, for example, which has seen the worst outbreak in Europe, the number of new cases has been declining, having peaked on March 21. In Spain, there has been a perceptible flattening of the curve as well. In Germany, despite a large number of infections, the number of deaths has been relatively low. In both Spain and Italy, where the governments have imposed some of the most restrictive stay-at-home rules, there are reports of a backlash against government regulation. This suggests that there might be a limit to how long people are willing to accept such restrictions in a democratic society. However, it appears evident that the restrictions are working. If the outbreak peaks later this month, economic restrictions might start to be eased sometime in May. There could be a modest economic recovery in the summer.
In the United States, however, the curve has not yet flattened and the numbers continue to grow rapidly as of this writing. The US outbreak accelerated a few weeks later than that of Europe. The number of states that have restricted activity has suddenly increased. Now that stay-at-home orders cover more than 90 percent of the population, it is possible to imagine that this could end sometime in the next two months. One important question is how long many businesses can endure absent revenue. In some industries, such as hotels and restaurants, revenue has fallen sharply. A large amount of loans and subsidies will not necessarily offset this sufficiently to allow companies to remain in business for very long.
Amid debate about how soon to ease restrictions on economic activity, a new study conducted by the Federal Reserve Bank of New York looks at the experience from the pandemic of 1918–20, often known as the Spanish Influenza. The study finds that the pandemic had a negative economic impact. However, so-called nonpharmaceutical interventions (NPIs), such as closing schools and businesses and ordering people to stay home, ultimately had a positive economic impact during the pandemic a century ago. Specifically, the study reported that “areas that were more severely affected by the 1918 Flu Pandemic saw a sharp and persistent decline in real economic activity. Second, we find that cities that implemented early and extensive NPIs suffered no adverse economic effects over the medium term. On the contrary, cities that intervened earlier and more aggressively experienced a relative increase in real economic activity after the pandemic subsided.” Thus, the study suggests that there is not a tradeoff between suppressing the virus and economic activity. Instead, the act of suppressing the virus ultimately leads to improved economic activity. That is because early efforts to suppress the virus prevent the negative economic impact that stems from a massive outbreak. In a massive outbreak, there is a far greater disruption of both supply and demand in the economy. Moreover, resources are shifted from productive enterprises to caring for the large number of sick.
The Federal Reserve analysis is consistent with what we’ve seen recently in China. There, strict NPIs were implemented relatively early, resulting in a quick suppression of the outbreak. Now, only a month after the worst of the outbreak, economic activity is starting to revive in China. This offers a model for what is likely to happen in Europe and what could happen in the United States, depending on the degree to which such policies are implemented. In the United States, with a fragmented political system, there have been significant NPIs in some states, but not in others. This creates a risk of a severe outbreak in certain parts of the country. In any event, the study found that, in the second wave of the 1918–20 pandemic, which largely happened in the western part of the United States, cities and states were better prepared and undertook NPI policies early, thereby mitigating the outbreak as well as the economic ramifications.
Early last week, IHS Markit released the purchasing managers’ indices (PMIs) for manufacturing in multiple countries. PMIs are forward-looking indicators meant to signal the direction of economic activity. They are based on subindices such as output, new orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number the faster the growth—and vice versa. The performance of the global manufacturing industry surprisingly improved in March, mainly due to a revival of activity in China and Taiwan. Elsewhere in the world, activity declined, although not to a catastrophic degree. Rather, in many locations, activity declined at rates last seen during the global financial crisis in 2008-09. The global manufacturing PMI published by Markit actually improved slightly, rising from 47.1 in February to 47.6 in March. Both numbers were below 50, indicating a significant decline in activity. The decline in February was due to a major disruption of Chinese manufacturing during the worst time of the virus outbreak. The decline in March was largely due to the economic shutdown now under way in Europe and North America.
Late last week, Markit released the PMIs for the broad services industry in multiple countries and the results provide an early sign of the extent of the European and North American downturn in March. The services sector is defined as most nonconstruction and nonmanufacturing economic activities including finance, telecoms, transportation and distribution, retailing and wholesaling, professional and business services, utilities, health care, and education.
The global services PMI fell sharply from 47.1 in February to 37.0 in March. The PMI for consumer-related services fell much more than the PMIs for business services or financial services. That reflects the shutdown of many consumer-facing industries across Europe and North America including restaurants, hotels, retail stores, and entertainment venues. The sharp decline is disproportionately due to weakness in Europe followed by the United States and Japan. The PMIs in Europe fell to a record low. In China, however, the PMI bounced back, but remained well below 50. Here are the details:
The services PMI for the United States fell sharply, more so than the manufacturing PMI. This reflected the damage in consumer-facing industries as well as business travel. It is likely that the numbers will be worse in April given that many states only recently imposed stay-at-home orders. The services PMI for Brazil also fell sharply, even though Brazil has not imposed significant restrictions on activity.
In Europe, services PMIs are all down sharply. In the United Kingdom, the PMI fell to a record low as consumers and businesses refrained from activity. In the eurozone, the decline was even worse, reflecting the fact that government-imposed restrictions have been in place for longer and have been especially severe in some locations. The PMI for Italy was the lowest of any country at 17.4. This indicated a catastrophic decline in services activity. As Markit commented, “the especially steep decline in Italy’s service sector PMI to just 17.4 likely gives a taste of things to come for other countries as closures and lockdowns become more prevalent and more strictly enforced in coming months.” Spain, too, had a severe decline, in line with its strict restrictions. A less severe but nonetheless huge decline took place in Germany.
In Asia, the PMI for China bounced back after having nearly collapsed in February. It has risen from 26.5 in February to 43.0 in March. This means that activity in the services industry continued to decline in March, but at a much slower pace. In Hong Kong, the PMI stabilized at a very low level. In Japan, evidence of a worsening outbreak led the government to impose new controls late in March. The PMI fell sharply. The same was true in Singapore as well as Australia. The numbers are below.
Michael Wolf, a global economist with Deloitte, looks at high frequency data in Europe to understand the impact of the virus outbreak:
As we discussed in a previous note regarding the United States, high frequency data has become increasingly important to better understand the magnitude and inflection points of the current downturn. Similar to the United States, European high frequency data points to a large collapse in economic activity. Retail foot traffic in the UK was down 81.1 percent from a year earlier, while numbers for Italy were slightly worse. Job postings fell by about a third in the United Kingdom and more than a quarter in Italy. In France, postings were down a little more than 20 percent, with the Netherlands close behind. In Germany, the decline was 13.5 percent. Although such declines would be huge under normal circumstances, they may mask the true extent of pain in labor markets as employers leave job postings open despite hiring freezes.
The data also reflects the timing or magnitude of social distancing policies each country put in place. For example, box office sales in most European countries are near zero now, but Italy’s box office neared zero by the weekend of March 7, while Spain followed one week later and the United Kingdom and Germany another week after that. This generally follows the timing for each government social distancing response to its own virus outbreak.
Similarly, electricity consumption between the first and last full weeks in March fell furthest in Italy, which is down 27 percent. Electricity demand in the UK and Spain was down 15 percent and 13 percent respectively, while German electricity consumption fell just 7 percent over the same period. Electricity consumption in France was down 23 percent. However, French electricity demand is more susceptible to changes in the weather making cross-country comparisons less reliable.
Although it is difficult to say for certain how much France’s electricity consumption decline is due to the coronavirus versus weather effects, French policies to prevent further contagion are looking particularly severe, especially when compared to Germany. For example, peak street congestion in Paris was down 90 percent during the last two days in March relative to 2019. That is even higher than the 84 percent decline in Milan. Rome, Madrid, Barcelona, and London have all seen at least 80 percent declines in street congestion over the same period. But in Berlin and Munich, street congestion was down just 58 percent and 68 percent, respectively. Similarly, public transit usage in Paris was down 86 percent March 31, just shy of the declines seen in Rome, Milan, and Madrid. However, in Berlin, usage was down a more moderate 73 percent.
Craig Alexander, chief economist of Deloitte Canada, provides some insights on the latest developments in Canada:
This week, Canadian indicators showed that the economy had little forward momentum before the pandemic went global and infected Canada. The Canadian economy grew by only 0.1 percent in January, and this follows anemic 0.3 percent annualized growth in the fourth quarter of last year. We expect February 2020 will post a small decline, followed by a plunge in real GDP expected in March as a result of the unfolding COVID-19 pandemic. As a result, we forecast a 5 percent annualized contraction in the first quarter of 2020, followed by a greater than 20 percent contraction in the second quarter of 2020.
This contraction can be seen in many ways. Canadian vehicle sales fell by 47 percent in March from their level in February. However, this covers a period before the economic lockdown came into full effect, meaning a further drop will likely occur in April.
A new survey by Restaurant Canada reports that 800,000 food industry workers have lost their jobs since the beginning of March. Seven out of 10 foodservice operators will further cut back on staff hours or lay off more employees if conditions do not improve. Nearly one out of 10 restaurants have already closed permanently and another 18 percent will permanently close within a month if current conditions continue.
The IHS Markit Canada Manufacturing Purchasing Manager’s Index fell to 46.1 in March from 51.8 February. This was a smaller-than-expected decline, but it does signal that the manufacturing sector is contracting.
The Federal government announced that the 75 percent wage subsidy announced last week for small business would apply to all businesses, regardless of size and includes for-profit, nonprofit, and charity organizations that experienced a decline in revenues of 30 percent or more. The aim is to keep workers on payrolls. Wages are the biggest expense that firms have. So, providing the 75 percent wage subsidy to all employers of any size is designed to address some of the balance sheet shock to firms.
Lastly, it is important to stress that the Canadian economy is not only feeling the shock from the pandemic but is also experiencing an oil shock. Lower oil prices hurt Canadian provinces that have large energy sectors, such as Alberta, Newfoundland and Labrador, and Saskatchewan. There are two benchmark prices for Canadian oil producers. Some sell at West Texas Intermediate (WTI) crude oil, while others sell at Western Canada Select prices. WTI started the year at close to US$60 a barrel. In the final days of March, WTI fell to near US$20 a barrel. Worse still, WCS dropped to around US$5 during the middle of this week. But there was some relief at the end of the week, as oil prices rallied by close to US$5 in anticipation of a possible OPEC supply cut announcement next week. Regardless of the fluctuations, the Canadian energy sector is being impacted by the low energy price environment.