Chances of a Canadian Recession in 2023 or 2024
The Canadian economy is facing a number of headwinds, including rising interest rates, high inflation, and a slowdown in global growth. These factors have led some economists to predict that Canada could enter a recession in the second half of 2023 or 2024.
What is a recession?
A recession is defined as two consecutive quarters of negative economic growth. In other words, a recession is when the economy shrinks for two quarters in a row.
What are the signs of a recession?
According to David Kelly of the Chicago Federal Reserve, the best early warning indicators of a recession are:
There are a number of signs that can indicate that a recession is on the horizon. These include:
Rising non-mortgage consumer credit delinquency
Falling homebuying activity
Long-term interest rates are lower than short-term rates - also known as an inverted yield curve.
What are the causes of a recession?
Recessions are a fundamental component of the economic cycle. The bigger the economic boom, the bigger the likely bust. Society is not a rational artificial intelligence. Investment tends to be carried away by “animal instincts”, which amplify economic fundamentals.
When times are good and a recession seems far away, the public takes on more risk because they believe the likelihood of getting burned is low. However, that risk-taking helps to bring a potential recession nearer. When the recession strikes, people despair and de-risk at a time when risks are relatively low. This re-risking and shifting from spending to saving makes the recession worse.
Overvalued assets, high debt-to-income ratios, inflation, and short-term interest rates fuel a recession. The trigger event that causes the recession to begin could be anything that significantly dents consumer confidence.
During the 2008 financial crisis, the trigger was panic over high-risk mortgage lending. Before that, in 2001, a loss of confidence in the valuations of Internet dotcom companies triggered a stock market sellout.
These trigger events begin a domino effect that would stop if the economy was de-risked. When an economy has overvalued assets and is overleveraged, that first domino ripples into the broader economy.
What are the effects of a recession?
Recessions can have a significant impact on the economy. They can lead to job losses, falling incomes, and declining economic activity. Recessions can also hurt the stock market and housing market.
Are we headed for a recession in Canada?
These things are never certain. However, the risk of a recession has increased in recent months.
Are the conditions considered high-risk?
Canada's household debt is now the highest among major developed economies.
In 2021, before the recent run-up in home values, New Zealand, Canada and Sweden were identified as the world’s frothiest housing markets, based on the key indicators used in the Bloomberg Economics dashboard.
In 2022, Union Bank Suisse (UBS) also identified Vancouver and Toronto as overvalued housing markets with high bubble risk.
Now let’s examine our early warning system.
Rising non-mortgage consumer credit delinquency: According to Equifax, "Increased missed payments on products like credit cards and auto loans are a concern, but pockets of the population have been impacted more than others during this uncertain period."
Falling homebuying activity: On July 14th, the Canadian Real Estate Association (CREA) forecasted that national sales will fall by 6.8 percent in 2023, with most of the impact outside Ontario and British Columbia. Falling purchases are a red flag because we know there is higher demand, and fewer purchases imply that prices have outrun buyers’ incomes, so prices will need to fall to bring long-term supply and demand into equilibrium.
Long-term interest rates are lower than short-term rates: Canada has had an inverted yield curve since November 2022. The delay between yield curve inversions and recessions in the past 50 years has ranged between 8 and 20 months, with an average of 14 months.
A number of economists are forecasting an upcoming recession in Canada, including:
RBC: RBC's chief economist, Craig Wright, says that RBC continues to think the most likely scenario is a ‘mild’ or more material recession in Canada to begin in Fall or Winter of 2023.
TD: TD's chief economist, Beata Caranci, has said, "At present, our economic leading indicator has been flashing yellow for some time, moving sideways over 2023 on the threshold that predicts a significant slowdown in economic momentum, and in some cases, a recession within the next three-to-six months. Basically, it’s right on the bubble.”
CIBC: CIBC's chief economist, Avery Shenfeld, has said, “If the slowdown that central banks are aiming at fails to materialise, that could force yet more rate hikes and risk a harder landing.”
BMO: BMO's senior economist, Robert Kavcic, said on June 9th that “the risk of a downturn remains in place—for later this year.”
Bank of Canada: In March, before the two most recent rate increases, former Bank of Canada Governor Stephen Poloz said, “The risk of a hard landing has definitely gone up, given that so much has already happened, and we're still waiting for the rest of the effects of interest rate rises to work their way through.”
What can be done to prevent a recession?
There are several things that can be done to prevent a recession. These include:
The Bank of Canada could slow the pace of interest rate hikes. They dried this earlier in 2023, but inflation didn’t abate as hoped.
The government could implement fiscal stimulus measures, which would likely stoke inflation, resulting in more interest rate hikes and a recession.
Businesses could invest in new technologies and products. Still, businesses make their own independent choices. Making new investments with the risk of a recession on the horizon is a risky business decision. Ideally, they want to hold onto a financial cushion so that if there is a recession, they come out the other end of it with a viable business, hopefully without the need for layoffs.
Protecting Yourself from a Possible Recession
The risk of a recession in Canada has increased in recent months. However, it is still too early to say whether a recession will occur. The Bank of Canada and the government have several tools that they can use to prevent a recession. However, the global economy is facing many challenges, which could make it difficult to prevent a recession.
What you can do to protect yourself:
Establish an Emergency Fund for Financial Security: An emergency fund is essential for financial stability. By keeping sufficient cash in a dedicated CDIC-insured bank account, you can ensure that your money retains its value even during market turbulence.
Prioritise maintaining your emergency fund and replenishing it promptly. This approach will help you maintain financial security throughout difficult times.Live within your means: Living within your means is key to relatively unscathed economic turbulence. By adopting this habit, you will avoid accumulating debt even when prices for essentials like housing, gas, and food rise. It's important to remember that debt tends to snowball when left unpaid.
Diversify Your Investments: If you don’t have all of your money in one asset type like stock, real estate, or bonds. Typically, investment values change during a recession but not all investment values move in the same direction. , your paper losses should be mitigated, making it less difficult emotionally to ride out the dips in the market. If you own a home and have a savings account, you already have a start: You have some money in real estate and some money in cash.
In particular, try to build a portfolio of investment pairs that aren’t strongly correlated, meaning that when one is up, the other is down, and vice versa (like stocks and bonds). This also means that you should consider asset classes and stocks in businesses unrelated to your primary occupation or income stream.
