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The 91 most important economic charts to watch in 2018

For the fourth year in a row Maclean’s presents its year-end Chartapalooza, your guide to making sense of the economy in the year ahead


 

Chart Week

Since 2014, when Maclean’s first asked economists, investors, analysts and financial commentators to submit what though would be an important chart Canadians should watch in the year ahead, our annual collection of charts has grown from 35 contributions to nearly 100 this year. Covering everything from interest rates to marijuana, truck sales to the housing market, and all economic points in between, this year’s charts and brief explainers cover all the angles. To make the charts easier to navigate and share this year, we’ve grouped them by general categories. Each category and chart can be linked to, and each chart can be tweeted by clicking or tapping the blue Twitter button.

Which chart do you like best? Want to share your pick for a chart to watch in 2018? Let us know on Twitter using #MacleansChartWeek.

Lastly, thanks to each and every contributor for participating again this year.

Dig in!


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Business

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Business investment in Canada lags the OECD

Charles Lammam, director of fiscal studies, Fraser Institute (@CharlesLammam)

"Despite all the economic news reported lately, there’s been scant coverage of Canada’s lackluster level of business investment. Robust business investment is crucial to Canada’s long-term economic prospects. When businesses invest in the latest technologies and production techniques, and expand operations, they spur economic growth and make workers more productive, enabling those workers to command higher incomes and enjoy better living standards.

But business investment in Canada has been falling. In fact, as noted in a recent study, business investment in Canada has declined a staggering 18 per cent since the third quarter of 2014 (after accounting for inflation). And globally, Canada’s rate of business investment is exceptionally low, ranking second lowest among 17 comparable industrialized countries in annual investment as a percentage of GDP from 2015 to 2017.

The reasons for Canada’s low investment levels are complex. While some factors are beyond the purview of government (such as a drop in commodity prices), policy decisions also matter. On this front, governments—both federal and provincial—in recent years have not helped by pursuing policies that increase uncertainty and the cost of doing business. These policies include higher marginal tax rates on skilled workers and entrepreneurs, increased capital gains taxes, looming payroll tax hikes, increased corporate income taxes, new carbon-pricing schemes and regulations, unstable fiscal frameworks characterized by growing government debt, dramatically higher minimum wages, and increased labour regulations and skyrocketing energy costs.

A change in policy course would help improve Canada’s investment climate and reverse the trend of weak business investment."

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Where are the new businesses?

Kevin Carmichael, financial journalist, (@carmichaelkevin )

"One of Bank of Canada Governor Stephen Poloz’s favourite data points is firm population. Canadians created 144,080 companies in the second quarter, while 133,380 employers disappeared, according to Statistics Canada. That’s not a fast enough net creation of businesses. The average quarterly increase in new entrants since the start of 2001 is about 138,000, but the average number of exits is only about 123,000. Poloz will be inclined to keep interest rates relatively low in 2018 in order to coax more would-be entrepreneur to take the plunge."

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U.S. tax reform will boost U.S. competitiveness

Jack Mintz, professor, Haskayne School of Business and Faculty of Law, University of Calgary (@jackmintz)

"We will have to see whether U.S. tax reform succeeds but certainly the big push is on with breath-taking speed. The House of Representatives passed their bill on November 16th. The Finance Committee has recommended a bill to the Senate on the same day. From what I have been told, the plan is for the Senate to pass legislation perhaps by December 1. Both Congressional bodies would then pass a bill after their reconciliation conference in December perhaps.

As shown in the graph, the U.S. federal-state tax on new investment will plummet by almost a half with the new House and Senate corporate tax provisions. In the rank order of the 34 OECD countries, the U.S. would fall from the 3rd highest to the 14th highest rate, placing it below Canada as the 12th highest rate. Both Canada and the US would be above the simple average OECD effective tax rate on new investment of only 17.3%.

Although there are some differences between the House and Senate bills, they are remarkably similar especially with respect to big-ticket items. Overall, the reform, especially on the business side, will have a significant impact on American competitiveness if the Republicans, desperate for a big win, ultimately adopt the a tax package for 2018."

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How to measure Canada's international success

Paul Boothe, managing director, Trillium Network for Advanced Manufacturing

"While exports of goods and services have been growing recently, sales by Canadian-owned foreign affiliates have grown even faster. We will be interested to see if this a trend, i.e. will foreign affiliate sales exceed exports (as they did in 2015) in the future?

This opens a debate on how we should measure Canada’s international success. Should the focus be on the things we produce within our borders or the things produced by Canadians at home and abroad?"

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Artificial intelligence could lead to a productivity boom

Sal Guatieri, senior economist, BMO Capital Markets

"This chart shows the acceleration in productivity following the widespread use of the internet at the turn of the century. While the rate of increase subsequently slowed, workers are still much more efficient today than two decades ago (just ask any economist no longer waiting around the fax machine). Further, we are possibly on the cusp of another productivity revival if rapidly-advancing AI technology can help humans work faster, more accurately and more creatively."

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Balance is needed between the corporate and household sectors

Toby Sanger, senior economist, Canadian Union of Public Employees (@toby_sanger)

"Lots of attention is given to government deficits, but little to the balances of the other sectors of the economy, including the household and corporate sectors. These became seriously unbalanced from 2000 onwards.

Slow income growth and high housing prices have meant households have run persistently large annual deficits—income less expenses including capital spending—borrowing an average of $50 billion annually since 2002. This has led to disturbingly high household debt ratios. Meanwhile the corporate sector has run large surpluses, thanks to record profits, corporate tax cuts and low rates of business investment.

Corporate surpluses declined in recent years largely because of a levelling off of corporate profits and increased dividend payouts. Now we’re seeing a rebound in corporate profits and surpluses led by the financial sector, but with little increase in business investment and no improvement in household balances.

We’re not going to achieve more sustained and stable growth until we have more balance between the corporate and household sectors. For that we’ll need higher wages and incomes, more affordable housing and increased business investment. Let’s hope 2018 delivers that."

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Mind the gap

Ted Carmichael, founding partner, Ted Carmichael Global Macro

"The Credit Gap is defined as the difference between the credit-to-GDP ratio and its long-term trend. This chart shows Canada's total household plus business credit gap. The gap in the third quarter of 2017 was 17.7 per cent of GDP, slightly below the 17.8 per cent peak reached in 2Q16, which was the largest gap in the 45 years of available history. Previous peaks preceded or coincided with economic recessions in 1981-82, 1990-91, and 2008-09. The Credit Gap is a measure devised by the Bank for International Settlements (BIS), which is the central bank for the world's central banks. According to the BIS, countries with Credit Gaps of greater than 10 per cent of GDP are at risk of a financial crisis. Only China, Hong Kong, Singapore and Canada currently have Credit Gaps exceeding 10 per cent. Large credit gaps usually result from extended periods of low interest rates and/or lax borrowing standards. Canada's gap of 17.8 per cent is considerably higher than the 12.4 per cent that the U.S. credit gap reached in the first quarter of 2008, just at the onset of the Global Financial Crisis. Canadian regulators have been trying to dampen mortgage credit growth, but despite their efforts, total household and business credit has continued to grow faster than GDP. As interest rates continue to rise, does anybody really think that this will end well?"

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Demographics

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The inter-provincial population shift

Jock Finlayson, executive vice president, Business Council of British Columbia (@jockfinlayson )

"Trends in interprovincial migration reflect differences in economic growth rates and job opportunities across the country, as well as the locational choices made by post-secondary students and retirees. The accompanying chart, spanning the years 2012-2016, shows cumulative two-way migration flows between various provincial pairs. The largest two-way movements of people were between B.C. and Alberta and Ontario and Alberta. In both cases, there were sizable flows each way. Of interest, Alberta lost more people to B.C. than it gained from that province over the period, reflecting the steep energy industry downturn that took hold in 2015 and extended into the following year. Almost 40,000 Albertans relocated to Saskatchewan from 2012 to 2016, while approximately 55,000 Saskatchewan residents moved to Alberta. As further evidence of the impact of energy sector slump, the number of Albertans moving to Newfoundland and Labrador almost matched the number going the other way as tens of thousands of oil patch jobs disappeared. Over the last half decade, Ontario experienced a net outflow of people to Western Canada coupled with lower overall in-migration from the rest of Canada. This is a sign of the continuing economic challenges facing regions of Ontario beyond the dynamic Greater Toronto area."

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Demographic crunch time for our fiscal federation

Kevin Milligan, professor of economics, University of British Columbia

"The population share of Canadians age 75 and over drives health spending, and this share is set to increase by 60 per cent by 2032 and double over the next 25 years. Moreover, the growth in the age 75 and over population share will be much faster and stronger in some provinces. These facts will begin to put immense pressure on provincial budgets starting in the life of the next federal Parliament. Can our fiscal federation evolve to manage this challenge?"

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Keeping low-wage workers in the labour force

Tammy Schirle, professor of economics, Wilfrid Laurier University (@tammyschirle)

"With an aging population, policy makers need to tap into under-utilized segments of our potential work force. Policy efforts, such as the proposed expansion of the Working Income Tax Benefit (WITB), could help support the efforts of low-wage workers and strengthen their attachment to the workforce. If successful, we should see the employment rates of many underrepresented low-wage groups rise over time. "

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The 'grey tsunami' represents a bigger threat than the financial crisis

Ian Lee, associate professor, Carleton University's Sprott School of Business

"I testified in late October before HUMA Committee of House of Commons on seniors and health care and housing where I stated Canada and ALL OECD countries are facing a 'grey tsunami' that represents a crisis greater than the 2008 financial crisis per the IMF.

Why such apocalyptic language? Contrary to some pundits, our four pillar pension system is reasonably well structured and sustainable—see peer reviewed article by Chancellor Professor Vijay Jog and Ian Lee, 2016. No, the unsustainability lies in the explosion of seniors as a percentage of the population and the gargantuan increase in average annual health care consumption. These expenditures will fall disproportionately on the provinces per a recent excellent PBO report—and in my view bankrupt the Maritime provinces—necessitating a bailout in the near future (within 10 years) by the Government of Canada.

The grey tsunami will transform EVERYTHING in our society—in ways never experienced before in human history. It will reduce annual economic growth, reduce taxation revenues, transform health care, housing and transportation systems and transform our provincial governments."

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Canada's advantage: ready-to-work immigrants

Stéfane Marion, chief economist, National Bank of Canada

"It is fairly well-known that Canada’s population growth, which at 1.2 per cent annually is the highest of the mature OECD economies, relies heavily on immigration. What is less well understood is the extent to which we diverge from other countries in the quantity of talent entering our country. The OECD estimates that of the 272,000 people to whom Canada granted permanent resident status in 2015, 170,000 were 'economic category' admissions—people selected for 'their ability to become economically established in Canada'. That is well above the number of economic-category admissions to the U.S.—a country 10 times our size—and similar to the combined intake of the rest of the G7 (France, Germany, Italy, Japan, U.K.)! In other words, 63 per cent of immigrants admitted annually to permanent residence in Canada are ready to join the labour force. For the U.S. the proportion is only 13 per c ent, for Germany a minuscule four per cent. Little wonder that Canada continues to outpace the rest of the OECD in the growth of its prime-age workforce and in household formation."

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Solid population growth is underlying key to strong domestic demand

Arlene Kish, director, IHS Markit Economics

"Population charts can be one of the most boring things to look at, but the recent underlying story is very interesting and very important. Population growth across most of Canada (Newfoundland being the exception in 2017) was robust, especially for non-energy producing provinces. Expanding populations for energy-producing provinces are typically solid when commodity prices rise. So what’s driving super strong growth elsewhere? In a hyphenated word, net-migration! Recently, total net-migration has hit all-time high levels thanks to the relatively open policies implemented by the federal Liberal government. In Ontario, net-migration is estimated to reach the highest level in 15 years in 2017. Plus, immigrants are flocking to picturesque Prince Edward Island, where population growth was the strongest in the nation this year, peaking at 1.7 per cent. Population growth is adding to domestic demand in terms of household expenditures, residential investment and an increase in the demand for services. So while there are many uncertainties outside of Canada’s border that can hinder growth north of the 49th parallel, underlying domestic forces remain in place that would limit any economic weakness, at least in the near term."

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An older population points to slower growth

Jason Kirby, digital editor, Maclean's (@Jason_Kirby)

"Canada's economy has grown at a decent clip this year. But that might be the exception to the rule over the next 10 to 15 years.

This chart combines long-term real (inflation adjusted) growth rates for Canada, drawn from Stephen Gordon's Project Link historical statistics database, and historical and projected population data from Statistics Canada's population pyramid, released in March 2017 and provided upon request. It shows a strong correlation between the number of 15 year olds per 65 year old—which, having stood at 3.5 in the 1960s has recently fallen to less than one 15 year old per 65 year old—and the country's 10-year growth rate. This is a familiar story that we've heard many times over, but it bears repeating. The slow growth we've endured since the Great Recession is also largely due to the realities of a greying workforce that is working, and consuming, less. Regardless of the uptick in growth we've seen of late, this demographic reality suggests that 2018 will bring more lacklustre growth that even the biggest fuelled infrastructure stimulus plan will struggle to overcome."

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Economic Cycle

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Larry MacDonald, economist, MacDonald Consultants (@Larry_MacDonald)

"The chart to watch in 2018 is the U.S. Federal Reserve’s graph of the U.S. yield curve, which is simply the difference between the yields on 10-year and 2-year U.S. government treasury bonds. It has been one of the more reliable signals of the end of global economic expansions—and bull markets in assets like stocks and houses. Whenever the yield on 2-year treasuries rises above the yield on 10-year treasuries and causes the yield curve to go negative, recessions and bear markets usually follow, as highlighted by the 30-year chart above (shaded areas represent recessions). Currently, the yield curve is in a downtrend and at its lowest level since the recession of 2008. If the downtrend continues, the current economic expansion and various bull markets could be at risk. If I were to take a guess, I would say the yield curve does not go negative in 2018 because U.S. inflation is now turning down again according to the leading indicators complied by the Economic Cycle Research Institute. This means the Federal Reserve will likely stop pressuring short-term interest rates higher. We could thus see an extension of the current U.S. and Canadian economic expansion well into 2018. And against this backdrop, North American asset markets may be able to avoid a major setback."

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Is the yield curve sending a false signal of a U.S. recession?

Beata Caranci, chief economist, TD Economics (@TD_Economics)

"A narrowing U.S. Treasury 10-2-year spread can be an early warning sign that the economy is headed for a recession, but can also give false signals. In the current environment, domestic and global quantitative easing (QE), financial regulation, and low inflationary pressures are keeping the spread lower than it would be otherwise. By our estimation, the U.S. Treasury 10-2-year spread conveys a probability of a U.S. recession occurring within the next 12 months to be 20-30 per cent. But, when we adjust for the presence of QE, it reduces that outcome to 5-15 per cent. Yield compression is a normal late cycle phenomenon, and we expect further narrowing in 2018 with still plenty of cushion from current levels. However, yield inversion (the 2-year yield rising above the 10-year) is not a normal phenomenon, and the Fed would likely adjust communication or policy according to the risks it conveys."

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Watching long-term yields

Finn Poschmann, president and CEO, Atlantic Provinces Economic Council

“Most of us are aware that since 2008 the world’s central banks have more than tripled their asset bases. But what has happened more recently? Dominating the trend is a flattening of the U.S. Fed’s balance sheet profile, with plans to shrink it over time. However, even if the Fed has now slowed, stopped, and shifted to reverse, the European central banking system and China’s PBOC have built assets sharply in the past year. Capital markets are open, and financial market arbitrage keeps yield curves pretty correlated. The top line trend, the sum of major central bank asset holdings, will suggest a direction for long term yields. Indeed, the recent expansion has likely driven part of the this year’s recovery in gold prices, and may do so into the next.”

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Markets are questioning whether the good times will continue

Luke Kawa, financial journalist, Bloomberg (@LJKawa)

"Looking at equity markets, you’d be hard-pressed to find signals that investors expect the good times to end any time soon. But when you mosey over to gauges used to infer how many hikes North American central banks will deliver over the next few years, it’s a different story.

Some context: as long as central bankers are tightening policy to help smooth the business cycle, it’s likely they think their respective economies are growing at a pace that’s above potential and will continue to do so absent the enactment of more restrictive monetary policy.

But right now the implied odds for rate hikes from the Bank of Canada and Federal Reserve suggest investors are worried the end of the cycle might come fairly soon. Forward rates and overnight index swaps for Canada and the U.S. are now in a classic reverse mullet formation: long in the front, short in the back—the opposite of my own hairstyle. Traders think both central banks will deliver about two 25 basis point increases in 2018, but aren’t pricing in a full hike in the two years after that. Granted, the U.S. expansion has gone a long while—but there aren’t many visible imbalances in the real economy that seem overdue for a retraction. In Canada, housing-related vulnerabilities loom large, but betting on an inflection point in that segment has proven to be a money-losing exercise in futility to date.

It’s tough to tell exactly what to make of this market dynamic. Perhaps it’s an unwelcome legacy of the financial crisis and ensuing forward guidance from central banks that investors are only willing to bet on hikes once they can start to see the whites of their eyes. Or maybe 2017 will go down as the year investors completely capitulated and learned to love the new normal—because these market-implied odds suggest that neither central bank will manage to raise policy rates to levels close to their estimates of the long-run nominal neutral rate (roughly three percent).

In the year ahead, watch to see whether investors grow more optimistic or pessimistic on the durability of North American business cycles to help guide asset allocation decisions."

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The 7th inning stretch of the economic cycle

David Rosenberg, chief economist, Gluskin Sheff and Associates

"Given that we are coming off the 100th month anniversary of this economic cycle, the third longest ever and almost double what is normal, it is safe to say that we are pretty late in the game. The question is just how late? We did some research looking at an array of market and macro variables, and concluded that we are about 90 per cent through, which means we are somewhere past the 7th inning stretch in baseball parlance but not yet the bottom of the 9th. The high-conviction message here is that we have entered a phase of the cycle to be very mindful of risk, to be bolstering the quality of the portfolio, to be focusing on strong balance sheets, minimal refinancing risk and companies with high earnings visibility and predictability, and with low correlations to GDP."

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Is the Euro zone’s lost decade finally over?

Stephen Gordon, professor of economics, (@stephenfgordon)

"The European economy has struggled to recover from the Great Financial Crisis, but forecasters are now optimistic about the prospects for economic growth in the near and medium term. This would be good news for the Canadian exporters looking to take advantage of the Canada-European Comprehensive Trade Agreement, and for the Canadian economy more generally. Analysts at the Bank of Canada and elsewhere have been counting on Canadian exports to emerge as a source of growth as consumer spending slows."

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A long period of expansion doesn't mean a recession is coming

François Dupuis, chief economist, Desjardins Group

"Never has an expansion cycle lasted beyond 120 months in the United States. This could be the case, however, if the current cycle lasts until 2019. Some may see this as a sign that the next recession is nearing, but using economic cycle length data in an econometric model does not provide a compelling probability estimate. In fact, the length of cycles depends on a wide range of factors, including an accumulation of imbalances or sudden random shocks. Central banks and governments can also have an influence. Policies that are too restrictive can stifle the economy, but this does not appear to be a threat for 2018."

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Energy & Environment

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Resource royalty dependence

Trevor Tombe, assistant professor of economics, University of Calgary (@trevortombe)

"Oil prices have remained stubbornly low. For the resource-rich provinces of Alberta, Saskatchewan, and Newfoundland and Labrador, this is a challenge. Between 2007 and 2014, royalties provided roughly one-quarter of their total government revenues; now, they provide closer to 10 per cent.

How much royalties do they need to balance? That depends on other tax and spending decisions, and each province has made very different choices each with their own political consequences. Saskatchewan’s latest budget raised taxes and restrained spending, reducing the required royalties from 25 per cent of revenue in 2015 to 13 per cent today. They may balance with only 11 per cent by 2019. Newfoundland and Labrador also plans to balance, but over a longer time frame. Meanwhile, Alberta maintains a wait-and-see approach, hoping for higher oil prices. Of all three provinces, Alberta is now the most dependent on oil royalties with the largest gap between where royalties are and where they need to be.

Will this change in 2018? Will Alberta take stronger action in their upcoming budget? Will Saskatchewan voters demand less? With elections soon approaching, the fate of three governments may depend on how 2018 unfolds."

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The return of the bitumen bubble

Andrew Leach, associate professor, University of Alberta’s School of Business (@andrew_leach)

"I chose a bitumen differential chart again this year. We’ve seen multi-year highs in the discount faced by Alberta in the last couple of weeks and, with pipeline constraints here and in the U.S. not likely to abate any time soon, the situation is only going to get worse. This has big implications in Alberta, where the province is increasingly dependent on bitumen royalties which rise and fall with the value of bitumen, which does not always follow the headline price of crude. In fact, since mid-September, Brent crude is up more than CAD$10 per barrel, while the value of bitumen in Alberta has stayed flat. The higher the differential, the greater will be the pressure on the pipeline file and, and with U.S. market discounts to global markets growing again, the importance of a pipeline to tidewater becomes ever more apparent. Even with roaring 6+ per cent GDP real growth projected for Alberta this quarter, a return to the days of the bitumen bubble might spoil the party in Alberta."

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Rising global oil consumption and the Canadian economy

Rob Roach, director of insight, economics and research, ATB Financial (@RobRoachCalgary)

"This rather unassuming line chart depicts the single most important trend affecting Alberta’s economy and Canada’s oil industry. The estimates vary, but most reputable projections show the global consumption of oil increasing over the next few decades. This is the case even when the rapid adoption of electric cars and efforts to curb carbon emissions are taken into account. The line rises because population growth and rising standards of living in the developing world overwhelm the effects of electric cars and current public policies.

There are a lot of factors affecting the fortunes of Canada’s oil patch, from access to Asian markets and U.S. shale production to global demand taking an unexpected and sustained turn downward. However, even in a bad year like 2016, Alberta’s oil and gas extraction sector produced as much real GDP as Ontario’s manufacturing sector. Still, if this line changes, Canada’s economy changes."

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Pan-Canadian carbon pricing and Saskatchewan

Joel Wood, assistant professor of economics, Thompson Rivers University (@JoelWWood)

"With the recent announcement of the Manitoba Government’s carbon tax plan, Saskatchewan remains as the major hold out from the federal government’s desire to have pan-Canadian carbon pricing. The threat of a federally imposed carbon price hangs over the head of the province; whereas, the current provincial government prefers an approach that would focus on subsidizing Carbon Capture and Storage projects rather than the more cost-effective approach of broad based carbon pricing. This reluctance to cooperate with the feds can partly be explained by the fact that Saskatchewan has the highest emissions per capita and the highest emissions intensity (emissions per dollar of Gross Domestic Product) of the Canadian provinces (as of 2015)."

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The global trend towards carbon pricing

Glen Murray, executive director, Pembina Institute.

"The past decade has seen a dramatic increase in the number of regions putting a price on carbon pollution—a tool widely recognized by economists as the most efficient and effective approach to reduce carbon pollution. As of 2017 almost 40 regions, national and subnational, making up half of the global GDP, have implemented a price on carbon. This includes many Canadian provinces, with a federal backstop planned for 2018. With China set to take carbon pricing from regional pilots to national implementation in 2018 this percentage will grow dramatically. Many other jurisdictions, including Brazil and Washington state are considering a form of carbon pricing.

Carbon pricing is a market mechanism that creates an ongoing incentive for businesses and consumers to reduce pollution and spur low carbon innovation. It drives demand for lower carbon products. As programs roll out and pollution becomes more expensive, global demand for high carbon goods like oil, gas and coal will be impacted. And, as carbon pricing becomes more universal, there may be increased pressure in the form of border adjustments on countries that do not put a price on carbon. Looking ahead, the climate agenda will increasingly intersect with trade, competitiveness and long-term growth."

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Welcome to carbon taxes, Canada

Jennifer Winter, assistant professor of economics, School of Public Policy, University of Calgary (@jenwinter_YYC)

"On January 1, 2018, a principle component of the federal Pan Canadian Framework on Clean Growth and Climate Change will come into effect. The result? Carbon pricing on combustion emissions in all provinces and territories. However, there are substantial differences amongst the level and coverage (proportion of emissions priced) of the different carbon pricing plans. Moreover, provinces and territories are still in the process of negotiating equivalencies between their chosen policies (pricing and complementary policies) and the principles of the Pan Canadian Framework. This will have impacts on Canadian households, businesses and competitiveness. The differences in prices will cause friction politically and economically. How governments respond, and how policy changes, makes carbon pricing an important issue to watch in 2018."

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Government Spending

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Ottawa's role in the economy

Livio Di Matteo, professor of economics, Lakehead University

"Over 150 years of intergovernmental relations, the economic balance in the Canadian federation between Ottawa and the provincial-local tier of government has fluctuated. Until World War I, with the exception of the building of the federally subsidized CPR, the federal share of total government spending in Canada was approximately 40 percent. After the peak of over 70 percent reached during World War I, the federal share came down quickly but went up again during the Depression era and soared during World War II reaching over 90 percent. The federal share of spending came down more gradually after World War II—levelling off at almost 50 percent during the 1970s and 1980s before falling once again to about 40 percent during the 1990s. Those who believe that the Canada requires a stronger federal role in national economic management and activity will be disappointed. Those who see a more decentralized Canada as fostering a government economic role that is a better reflection of regional preferences will be happy. Either way, the federal government’s share of total government spending is back where it started out."

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A burden on future taxpayers

Aaron Wudrick, federal director, Canadian Taxpayers Federation (@awudrick)

"This chart is important because rising public debt means a higher tax burden on future taxpayers, especially given an aging population with a shrinking proportion of working-age Canadians. Interest rates are currently at record lows and we are still spending more on public debt interest payments alone than we do on our armed forces. When rates rise, the cost could balloon rapidly, squeezing programs and services."

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What if forecasts for lower federal spending are wrong?

Brian Lee Crowley, managing director, Macdonald-Laurier Institute (@brianleecrowley)

"The principal story out of October's Fall Economic Statement was that the deficit is shrinking, and Ottawa now has more money to spend. But this prevailing narrative belies a deeper review of medium-term trends and the potential risks to federal budget projections.

Federal budget projections anticipate a significant drop in year-over-year spending growth over the medium term with no explanation. The yellow bars represent final figures and the blue ones are projections. Program spending has grown, on average, by 6.3 percent annually since the government took office. It is now projected to grow, on average, by 2.3 percent per year in the final two years of the four-year mandate. Is it likely that Ottawa will essentially halve program spending growth?

There is good reason to be skeptical—especially in light of recent off-cycle spending such as enhancements to child and low-income benefits and social housing, the reprofiling of infrastructure spending, and the usual pre-election spending.

There is a real risk then that the government’s inexplicable drop in program spending fails to materialize. The result could be larger and longer budgetary deficits."

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Will federal direct program spending keep rising?

Kevin Page, president and CEO, Institute of Fiscal Studies and Democracy.

"Federal deficit watchers may wish to keep their eye on direct program spending over the next two years. Direct program spending is program spending less the major transfers to persons (e.g. old age security) and major transfers to other levels of government (e.g., Canada Health Transfer). It represents a little less than half of all program spending but most of the discretionary (non-statutory) spending like operating expenditures and grants and contributions. Prime Minister Trudeau has increased this spending component considerably—about 12 per cent higher relative to Prime Minister Harper’s medium-term projections in Budget 2015, for 2017-18 (i.e. $15.6 billion). Higher direct program spending under the current government has been deficit-financed. Prime Minister Trudeau promises to keep the reign on spending growth over the next few years, but most deficit watchers know that this is often difficult for governments heading into an election.

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Fiscal federalism has left the Feds flush and the Provinces and Territories with empty pockets

Randall Bartlett, chief economist, Institute of Fiscal Studies and Democracy. (@Randall_Bartlet )

"With some provincial elections just around the corner, a lot of hay has been made about the fiscal positions of governments currently running deficits and the credibility of their plans to return to balance (if they exist). The federal and Ontario governments have also been thrown into this mix, with claims being made from some quarters that their fiscal positions are not sustainable. However, this is not entirely true. Indeed, the Institute of Fiscal Studies and Democracy’s recently-published 2017 Fiscal Sustainability Report found that the federal government’s finances are sustainable under most reasonable scenarios. But with big spending planned for defense and the National Housing Strategy not yet baked in, that long-term fiscal room is slowly being chipped away at. And then there is the province of Ontario which, if it can manage to keep spending in line with inflation and population growth, should be able to keep its fiscal house on a sustainable track, albeit just barely. Any spending beyond that (known as enrichment), and the province’s fiscal train could easily go off the rails. Of course, it doesn’t need to be this way. The federal government has plenty of fiscal room to spare, particularly since it handed down its decision nearly a year ago to grow the Canada Health Transfer (CHT) at roughly the rate of nominal GDP growth over the long term. This followed a CHT escalator of 6% annually over the prior decade. And it’s this change in the growth of a major transfer to a pace below the advance in cost drivers like population growth, aging, real income growth, and inflation that shifted fiscal flexibility from the provinces and territories to the federal government. As a result, provincial-territorial budgets have become more constrained, forcing them to find savings while allowing the federal government to live large. But, so it goes in a fiscal federation."

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Canada's government growth engine returns

Scott Cameron, on leave, Parliamentary Budget Officer (@twitscotty)

"Statisticians and economists are still dissecting exactly what drove Canada's unexpected growth spurt over the past year. But at least part of the story is that the brakes are off the public sector.

Here we see evidence of a country-wide fiscal consolidation working against GDP growth over 2012 to 2014, following the financial crisis stimulus years. The tide turned from ebb to flow in 2015, and by 2016 (the most recently released provincial data) government spending had returned to float the economy in every province. This is expected to continue in 2017 and 2018, with the exception of Newfoundland and Labrador and Saskatchewan.

Governments directly spend one in every four dollars on goods and services in Canada (a figure that doesn't capture indirect spending from social benefits to households and grants to the private sector). While the benefits of public spending may be contested, if GDP is the thermometer of economic health it's easy to see why our cheeks are flush again."

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Unanchored federal fiscal policy

Craig Wright, chief economist, RBC Royal Bank

"Every Canadian fiscal plan since the 1990’s has included either an explicit or aspirational goal of returning to budget balance—until now. While our fiscal house is on a much more solid foundation than it was then, there are many reasons to worry about a plan that involves deficits as far as the eye can see. One of the biggest: what it means for Canadian competitiveness. The large spending plans underlying the deficit profile suggests the risks for Canadian taxes are to the upside in the years ahead. We have already seen a move to higher personal taxes at the federal level which, combined with some provincial changes, leaves marginal tax rates on high income earners above 50 per cent in most provinces. The high rates will challenge attracting the best and brightest in the global talent search. Carbon-pricing initiatives have been seen as a revenue opportunity for provinces rather than being revenue neutral. Add in higher corporate taxes and minimum wage increases and the relative competitiveness vis-à-vis the U.S. has eroded—more do to our own initiatives than anything the U.S. has done to date."

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Indigenous demographics meets provincial fiscal reality

André Le Dressay, director, Tulo Centre of Indigenous Economics

"This chart is intended to show how two indigenous demographic facts are colliding with a looming Canadian fiscal reality. First, the indigenous population has grown 4.5 times faster than the rest of Canada in the last 10 years. Second, the indigenous labor force has grown 6.9 times faster over the same period. This contrast with the parliamentary budget office’s projection of an unstainable (for most provinces) 124 percentage increase in total provincial deficits over the next 20 years. This means first that the fiscal sustainability of Canada’s future social programs is rather dependent on the future productivity of the indigenous labor force. Second it means that the any increase in federal transfers to indigenous governments to catch up to national service standards is probably not fiscally sustainable given the future fiscal requirements of the provinces. As my colleague Greg Richard said, Canada can soon no longer afford to run the lives of indigenous people. Perhaps 2018 could be the indigenous policy fiscal tipping point for Canada. If this is correct than Canada should support a more jurisdiction based fiscal relationship with indigenous governments characterized by a connection between more independent indigenous fiscal powers and responsibilities. And Canada should shift more responsibilities to indigenous led institutions and governments over education, health, infrastructure, children and other services."

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Households

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Blake Shaffer, PhD candidate, University of Calgary (@bcshaffer)

“Do drivers really respond to prices? The recent removal of tolls on two bridges in B.C. provides an answer. On Sept. 1, 2017, the new B.C. government fulfilled a campaign promise and removed the tolls on the Port Mann and Golden Ears bridges. While data are just starting to trickle in, one month of data strongly suggests they do: traffic counts on the Port Mann increased by 20,000, or 15 per cent from the prior month. Year-over-year, the increase is closer to 21 per cent. Meanwhile, traffic counts on previously un-tolled bridges fell. While more data will provide more precise estimates, one thing is certain: a well-designed mobility pricing strategy can be part of the solution to tackling congestion.”

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Will Canada's debt binge finally end?

Philip Cross, senior fellow, Macdonald-Laurier Institute

"Canadians are addicted to debt. Not just households, although they receive most of the attention, as governments and corporations have contributed to the 100-point surge in our total debt to GDP ratio. Such debt binges rarely end well."

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Will Canada's truck obsession keep on trucking?

Jamie Carson, recovering economist living in Ottawa, (@carsjam33)

"Truck sales are booming in Canada, outselling cars by a 2:1 ratio. Trucks/SUVs have outsold cars every month since October 2009, upending the traditional relationship between the two categories. Why does this bear watching? There are a number of reasons.

First, it provides an important vital sign of the health of the over-extended Canadian consumer. Thanks to the shift to truck/SUV sales, the average unit price of vehicles has been climbing steadily, with unheard of lengthy terms and stories of consumers continuing to make payments on vehicles that they no longer own. With interest rate hikes and carbon taxes looming, and gas prices remaining stubbornly high after the 2017 hurricane season, truck sales are poised to provide an early indication of consumer malaise.

Second, it undercuts the improvements in fuel efficiency, pegged at roughly two per cent per year, which would have been achieved if model preferences had stayed more stable. (You can play around with fuel ratings data for makes, models and years here. Transportation makes up roughly 23 per cent of Canada's emissions, with passenger vehicles accounting for half of that. Achieving Canada's Paris Agreement target of a 30 per cent reduction of emissions from 2005 levels by 2030 is made more difficult with every new light truck that drives off the lot.

There are other social costs too: Added vehicle weight contributing to more wear and tear on our roads, added vehicle girth making parking lots nearly impossible to navigate, and the two-tier safety impact of heavy hemis sharing the road with puny compacts.

Lastly, from a business and trade standpoint, the light truck category is one area where North American automakers more than hold their own. If the car-truck relationship snaps back, they will pay a price."

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Canadian shoppers are rushing online

Frances Donald, senior economist, Manulife Asset Management (@francesdonald)

"In 2017, while Canadian total retail sales grew at a sizeable average seven per cent year-over-year, online retail sales grew almost six times faster at an average 40 per cent year-over-year pace. E-commerce sales are one of Canada’s newest data points, only dating back to January 2016, but it may increasingly become one of the most important. What it shows is a remarkable acceleration in a new form of consumer spending. According to Statistics Canada, online retail sales make up less than three per cent of total Canadian retail sales, but that data point only captures online sales made by Canadian retailers, not the total purchases made by Canadians within Canada and abroad. In reality, Canadian consumers are likely becoming increasingly dependent on both dot-com and dot-ca vendors to satisfy their collective appetite for goods and services. American non-store retail sales, for example, have climbed from four per cent of total retail sales to 11 per cent since 1993. For our Canadian economy, which relies heavily on consumption hungry households, identifying and following our shifting consumer e-spending habits must be an essential strategy moving forward."

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Recreational cannabis is coming

Allan Gregory, professor of economics, Queen's University (@awg_allan)

"As we move into the legalization of cannabis for recreational use, these two graphs will assist in understanding some of the approaching headwinds. The federal government is responsible for the licensing of cannabis (wholesale) and the provinces are responsible for the remainder (retail distribution, safety and security, health and education).

The graph on the left is based on Brad Martin’s public data (August 10, 2017) and shows the average dollar price per gram of dried medical marijuana and the associated average percent of THC for those products with under 10 per cent (Low) and those with more than 10 per cent (High). THC is the psychoactive and is associated with 'highness' in marijuana. So far the discussion in Canada of safety, taxation, and health has mostly ignored the variation of pricing and potency in marijuana. In fact, Health Canada collects no information on price or potency for medical marijuana.

The second graph on the right is the number of licenses of producers by province (many are also licensed for sale) under Access to Cannabis for Medical Purposes Regulations (ACMPR). We clearly do not see a coordinated supply management system in terms of licensing with Quebec having only 2 licenses compared to Ontario’s 43. Not surprisingly, Quebec has the highest average prices. Unless interprovincial trade occurs, we are likely to see bottlenecks and local shortages. The Canadian Free Trade Agreement (CFTA) has yet to be fully worked out but there seems to be an opt-out clause for each province who disagree with the national compromise."

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How much longer can consumers power the economy?

Erik Hertzberg, financial journalist, Bloomberg (@ErikHertzberg)

"How long can Canadians keep spending like this? Recent figures from Statistics Canada show household expenditures now comprise 58 per cent of the country's total output -- the highest proportion in data going back to 1961. The second and third quarters of 2017 combined saw the strongest household spending contributions to growth since just before the 2008-09 recession.

One consequence is less money being put away for a rainy day. Canada's household savings rate has averaged just 3.1 per cent over the last year, the lowest in nearly a decade. With interest rates expected to climb over 2018, economy watchers and policy makers will be closely monitoring how and if Canadians start tightening their belts—and how that affects the economy."

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Housing Market

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Shadow banking our economic future

Martin Pelletier, portfolio manager, TriVest Wealth Counsel Ltd (@MPelletierCIO)

"Canada’s shadow banking sector, which is comprised of those companies that have more flexibility in providing lending arrangements than the banks, has become a key component of our economy. According to the Bank of Canada, shadow-bank lending has grown to represent roughly 40 per cent of the traditional banking sector and over $1.1 trillion in liabilities.

The role of this sector is growing in importance given the move towards tighter mortgage lending requirements being imposed on the Canadian banks. Additionally, it provides a liquidity option for the banks to offload their higher risk mortgages thereby improving their balance sheet positions. Many have considered sub-prime spin-outs but not surprisingly there has been little interest after being tainted from the financial crisis.

All of this is contingent on a rising housing market to substantiate loan-to-value ratios, and a halt to the interest rate hikes by the Bank of Canada. However, there was some serious trouble this past summer among one of the largest lenders in the space but a solution was found at the wire to help stabilise the situation.

We created the following market cap weighted index of publicly listed shadow bank participants compared against the Teranet-National Bank Housing Price Index. Both need to remain very stable in the year ahead otherwise seriously risk impeding our economic growth which appears to have gained some momentum. Compounding matters is the record setting amount of leverage Canadians are currently onboarding, so it wouldn’t surprise us to see our shadow banking sector continue to gain market share and further increasing our country’s exposure to poorer quality debt."

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Will Canada's building boom end in bust?

Brendan LaCerda, economist , Moody's Analytics

"Driven by soaring prices, homebuilding has come to occupy a record share of total economic output in Canada. In 2017, residential investment’s share of Canadian GDP far exceeds the level reached in the United States at the peak of its housing boom. If residential construction were to quickly return to its historical average of 5.9 per cent, the decline would shrink GDP by almost 2 per cent. If construction stopped as a result of sharp house price declines, the erosion of household wealth and consumer confidence would significantly curtail spending and push the economy into recession. Such a scenario can be avoided if policy makers can deflate the housing market slowly and give the fundamentals of household formation and income growth time to catch up."

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Housing affordability in Canada has never been worse

Paul Smetanin, president and CEO, Canadian Centre for Economic Analysis

"Housing affordability has become an increasing problem for a growing number of Canadian households, hampering their ability to borrow, consume and absorb economic shocks. The SCAR index focuses upon the consumption needs of shelter by dividing a household’s Shelter Consumption Costs by its Net Income after Other Necessities. The SCAR Index for Canada broke through the 40 per cent level for the first time ever in 2015, with Nova Scotia and British Columbia at 15 per cent above the national average (for different reasons) and Alberta 21 per cent below. Ontario sits close to the national average and has increased by 11 per cent since 2010, while Quebec has increased by 3 per cent."

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What real estate commissions say about the economic cycle

David Doyle, head of North America strategy and economics research, Macquarie Group

Understanding residential investment is crucial to understanding the economic cycle. Since 1960, its weakness has explained fully two thirds of the decline in real GDP during Canada’s recessions. Digging deeper within residential investment our analysis reveals that the subcomponent that punches most above its weight during these downturns is ownership transfer costs, which is predominantly comprised of real estate commissions. Our chart shows how this key vulnerability for Canada’s outlook soared to nearly 2 per cent in the first quarter of 2017, but has begun to inflect lower in recent quarters, much in the same way it did in the United States in late 2005 and 2006. For Canada in 2018, we anticipate this downward momentum will persist as housing headwinds become more severe, a consequence of i) the BoC's twin rate hikes during 2017, ii) the astonishing rise in the Government of Canada five year yield and associated impact on mortgage rates, and iii) the implementation of OSFI's stress test on uninsured mortgages in January.

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The Canadian housing cooldown

Sherry Cooper, chief economist, Dominion Lending Centres (@DrSherryCooper)

"The biggest story in late 2017 and 2018 will be the Canadian housing cooldown. Even before the implementation of OSFI’s new rule (B-20), which stress tests uninsured (low loan-to-value) mortgage borrowers at 200 basis points above the contract mortgage rate, housing had already cooled substantially in the GTA and surrounding cities. The new rules are likely to impact at least 10 per cent of potential borrowers. With housing, such a significant contributor to overall economic activity in Canada, growth in 2018 will undoubtedly slow from the roughly three per cent pace in 2017. As the chart shows, single-family housing in Toronto was hardest hit as psychology shifted following the late April introduction of the 15 per cent nonresident buyers’ tax. New listings surged, and sales slowed. Multiple bidding situations all but disappeared, and buyers have become more cautious. Mortgage rates are rising, which will also slow consumer spending, taking another whack out of GDP. The pile-on of both regulatory and fiscal tightening in the housing market might reduce demand, but it does not address the crucial issue of insufficient supply of affordable housing."

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Vancouver-Toronto Déjà vu

Doug Porter, chief economist, BMO Financial Group

"No, you are not seeing double. The Toronto housing market has followed the lead of Vancouver’s market, almost to a T, with a nine-month delay. And, it just so happens that Ontario’s Fair Housing Plan was announced roughly nine months after B.C.’s 15 per cent tax on non-resident home buyers was first announced. Also note that the ultimate peak in price gains in both cities occurred in the very month that the respective provincial measures were announced—July 2016 for Vancouver and April 2017 for Toronto. Heading into 2018, both markets will of course continue to be a dominant concern for policymakers, with many anxious to see how the new OSFI mortgage rule changes and recent rate hikes affect housing more broadly. Notwithstanding the recent rebound in Vancouver’s market, we would look for housing to cool somewhat further amid these new twin dampening impacts."

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Expect B-20 rules to weaken Canadian real estate

Anthony Scilipoti, CEO, Veritas Investment Research

"In January stricter mortgage guidelines known as B-20 will come into force, requiring borrowers not eligible for mortgage insurance to qualify at a rate higher than their contract rate. Veritas expects B-20 rules to reduce the amount of new money entering Canada’s real estate markets and make it more difficult for borrowers to switch lenders. Low-ratio mortgages (i.e. uninsured with more than 20 per cent down) accounted for roughly three quarters of new lending in 2017. Bank of Canada data shows that approximately 19 per cent of borrowers in this category are already stretched financially (loan-income exceeds 450 per cent). Veritas analysis estimates that these borrowers will see a drop in purchasing power of up to 20 per cent under B-20. And with more than 70 per cent of low-ratio borrowing already exceeding 25 year terms, there is little room to stretch amortizations to meet B-20 tests. As a result, Veritas believes the Canadian housing market will weaken significantly in 2018."

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How will the gap between incomes and house prices close?

Hilliard MacBeth, author, When The Bubble Bursts: Surviving the Canadian Real Estate Crash (@hmacbe)

"This chart highlights the shocking degree to which Canadian house prices have outpaced weekly earnings growth and CPI inflation over the last 18 years. For most people housing costs are paid out of income so this divergence is unsustainable.

Here are two different ways to resolve this gap:

One possibility: house prices stay flat at current levels and household earnings grow much faster than inflation, allowing a return to affordability. This is the preferred scenario by the “soft landing” crowd but there is a major flaw. The rapid pace of wage growth would push inflation higher, forcing the Bank of Canada to raise interest rates more aggressively.

A more likely outcome: the housing bubble bursts under the weight of elevated household debt and house prices drop substantially; all the way down to affordable levels. The required correction is greater than 40 per cent so it would be called a 'crash' "

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The link between unaffordability and recessions

Stephen Punwasi, data analyst and co-founder, Better Dwelling (@StephenPunwasi)

"People think high home prices are just an affordability issue, and most don't care. However, the real threat is to the Canadian economy. This chart shows the cost of servicing mortgage debt, in two major economic centres. The grey bars are recessions. You'll notice that when the cost of servicing mortgages goes too high, a recession follows. Currently we're at the third highest point in history.

The reason this happens is simple. The more people pay for shelter, the less they have to spend at restaurants and shops. The lack of spending sends a ripple through employment, and the economy grinds to a halt. This happens until people deleverage, or there's a new economic boom.

This time is also different due to low interest rates. If the economy bucks all odds, and does well—interest rates will increase. If interest rates increase as little as 100 bps, the median Toronto household will need nine per cent more of their gross income to pay that mortgage. We have a rate trap, where all signs point to recession. Avoiding one would be nothing short of a miracle. Governments and portfolio managers are planning for it, you should as well."

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Strong evidence of highly vulnerable conditions

Bob Dugan, chief economist, Canada Mortgage and Housing Corporation

Canada Mortgage and Housing Corporation

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Affordability will be an issue in 2018

Dawn Desjardins, deputy chief economist, RBC Royal Bank

"Even after several rounds of regulatory changes, affordability pressures continue to mount in Canada’s two largest markets—Toronto and Vancouver. The provincial governments’ efforts to cool the housing market saw sales in both Ontario and B.C. slide—at least temporarily. While prices also fell from month-to-month, this was only sufficient to drive annual increases into the high single-digits. The Bank of Canada bumped up interest rates in the summer of 2017 and we look for more hikes to come in 2018. When combined with tougher mortgage qualifying criteria, this tees up for affordability to remain squeezed in many markets. 2018 is likely bring lower home sales as home buyers’ budgets come under pressure with price gains also expected to slow—something  sellers will need to take into account."

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Is more tightening of housing policy on its way?

Helmut Pastrick, chief economist, Central 1 Credit Union

"Housing has received much attention from policymakers lately because of the deteriorating affordability issue and perceived vulnerabilities to the economy and financial system should a recession or shock event occur. The B.C. government’s foreign buyer tax, Vancouver City’s tax on vacant homes, Ontario’s Fair Housing Plan, and federal moves to restrict mortgage credit are primary examples. The Vancouver market reacted negatively to these measures but has recently rebounded due to strong demand fundamentals. Toronto’s market is heading on the same track, though the recent sales upturn is aided by activity brought forward to avoid the upcoming mortgage rate stress test for uninsured mortgages issued by chartered banks. Provincially regulated and private lenders are not subject to federal regulations. Once this latest measure is digested by the market, demand fundamentals will reassert themselves with sales and prices rising again. This begs the question, will more policy measures to cool the housing market be forthcoming? I think the answer leans to the affirmative."

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Home sale prices will be under pressure in 2018

Dave Madani, senior economist, Capital Economics (@CapEconomics)

"The Toronto resale housing market has slowed significantly, judging by the drop in sales relative to listings, and already appeared to be self-correcting before the Bank of Canada decided to raise interest rates twice this year. Those increases in interest rates and tougher bank lending regulations at the start of next year will put considerable downward pressure on average home sale prices throughout 2018."

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Older homeowners are staying put

Benjamin Tal, deputy chief economist, CIBC World Markets

“Don’t expect any notable supply increase from the existing stock of detached houses—the main winner of the current tight housing markets in centres like Vancouver and Toronto. That stock of housing is static and will remain static. There is growing hope that houses sold by older Canadians in that space will work to release the pressure. But as illustrated in this chart, older Canadians are in no rush to sell. In fact, the share of homeowners age 75 and over has risen notably in the past five years. We estimate that over the next decade, that factor will add only 4,000 units a year of extra supply in the resale market—hardly a game changer.”

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Higher mortgage payments are coming

Ben Rabidoux, president, North Cove Advisors Inc. (@BenRabidoux)

"Since the early 90s, Canadian homeowners have seen continuously decreasing monthly mortgage payments at renewal. By our calculation, for every $100,000 borrowed, consumers have seen payments drop on average $91 per month for a standard 5-year fixed rate mortgage at the end of their first term due to prevailing interest rates that have been progressively lower than at origination. With the recent rise in rates, we’re now at the point where the average consumer is seeing monthly payments rise at their first renewal, something we haven’t seen on a sustained basis since the early 90s.

Granted, household disposable income was rising at a 5.2 per cent year-over-year clip as of the second quarter (the highest rate in seven years) but rising indebtedness has meant that the share of disposable income devoted to debt repayment remains 130bps above long-term norms. Canadians don’t have a ton of wiggle room here.

Skeptics have long underestimated the resiliency of the Canadian consumer, but this may finally be the year when they tap the brakes. In addition to rising mortgage payments, house price appreciation is rapidly decelerating nationally according to the MLS house price index. Along with that, new mortgage rules coming into effect in January will see homeowners who wish to refinance have to ‘stress test’ against a higher qualifying rate. This could significantly curtail ‘home equity extraction’, an important driver of household consumption both directly and indirectly by freeing up income through consolidating higher interest consumer debt into lower cost mortgage debt.

This warrants close attention, particularly since household consumption remains near a record share of GDP and has accounted for just under 70 per cent of real growth over the past 5 years."

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Inequality

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What's next for workers' share of the economy?

Armine Yalnizyan, Toronto-based economist, (@ArmineYalnizyan)

“A major source of political concern and discontent, workers’ share of the economy has been falling in most rich nations over the course of a generation, accompanied by growing inequality within that share. Canada’s trendline has bucked the trends since 2006, an intriguing development that recently is less associated with growth in workers’ incomes than a faltering profit share, driven by falling commodity prices. These trends, and the relationship between them, need to be better understood and closely watched in 2018.”

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A new record for CEO pay?

David Macdonald, senior economist, Canadian Centre for Policy Alternatives (@DavidMacCdn)

"Next year, Canadian richest CEOs may well be taking home pre-crisis levels of compensation, thanks mainly to their stock compensation in a booming equity market, which is pushing the income gap between Canada’s top executives and the average worker to new highs. Why should we care? Well first, because CEOs were some of the first people out of the gate criticizing higher minimum wages. Fifteen dollars an hour would lift minimum-wage workers out of poverty for the first time in decades, with large spinoff benefits to the economy at large. If shareholders can afford this year’s CEO pay hike, they should be endorsing higher wages at the bottom as well. Second, the majority of Canada’s biggest publicly traded companies oversee staggering deficits in their employee pension plans, putting the retirements of those workers at risk. In 2016, Canada’s largest companies paid out four times more to shareholders (including corporate executives) than it would have cost to fully fund their pension plans. At the same time, the biggest tax loopholes, particularly for stock options that benefit Canada’s most wealthy, remain open, funnelling billions in tax revenue away from governments that could it to pay for programs all Canadians need, like affordable child care, public infrastructure and improved retirement security programs. CEO pay matters in 2018 for the same reasons it mattered last year and the year before: it is a glaring reminder of the gap that exists in the expectations of those at the top and those at the bottom."

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CPTPP holds promise for Canada

Kirsten Smith, visiting researcher, Asia-Pacific Energy Research Centre (@kirst_nicole)

"Since deciding to proceed with Trans-Pacific Partnership negotiations after withdrawal by the U.S. earlier this year, the remaining 11 countries have reached agreement on the core principles of the trade deal. The modified deal, now named the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), will eliminate 95 per cent of tariffs on goods as well as reduce non-tariff technical barriers.

The chart displays Canada's product merchandise trade for 2016 with CPTPP member countries and does not include services, due to a lack of disaggregated bilateral data, or investment.

According to a 2015 analysis of the original TPP by Global Affairs Canada, new export opportunities are expected to be most significant with Japan, led by exports of animal and wood products. Gains from exports to Australia and Malaysia of machinery, mechanical & electrical products and vehicles & equipment, as well as food and automotive products to Viet Nam are also expected. While import gains are expected to be led by Japan (automotive and chemical products) and Viet Nam (textile and apparel products).

Lastly, It's worth noting that existing tariffs in Canada are relatively lower than most of the other CPTPP member countries and contribute little to federal government revenue. In fiscal 2016/17, customs import duties were only 1.9 per cent of total federal government revenue. Removing trade barriers will not only lower costs to consumers, but also reduce the allocative inefficiency caused by these distortions with limited impact on federal coffers."

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The poorly defined 'Middle Class'

Angella MacEwen, senior economist, Canadian Labour Congress, and Broadbent Policy Fellow (@AMacEwen)

"The federal government talks a great deal about the middle class and those working hard to join it - but sometimes their policy misses the mark because the 'middle class' is such a poorly defined concept. My chart gives a peek into where is the 'middle' - and what's happening to that middle recently. The ratio of median and average wages gives us an insight into wage inequality, which has grown for both men and women, but you can see in the chart that different shocks affect men and women differently.

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Where the rags to riches story is stalled

Miles Corak, professor of economics, University of Ottawa (@MilesCorak)

"An important dimension of equality of opportunity is the chances that children raised in poverty will grow up to become all that they can be, and even to move from 'rags to riches'. An aspiration of upward mobility means that poverty is not a life sentence.

But intergenerational cycles of poverty are much more common than—and put the big brake on—rags to riches movement. This map shows the chances that a child born to a family in the bottom fifth of the income distribution will in turn grow up to be a low income adult. The chances of an intergenerational cycle of low income vary from less than 20 per cent to more than 40 per cent across the 266 municipalities that Statistics Canada calls Census Divisions. Cycles of poverty are least likely in parts of Southwestern Ontario and in Alberta, and most likely in many parts of Manitoba and along the British Columbia coast."

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The education gap between men and women

Linda Nazareth, economist and author, RelentlessEconomics.com (@relentlesseco)

"Nearly one in 1 in 3 young women in Canada now has a Bachelor’s Degree compared to 1 in 5 young men. It is a trend that has been happening for a while, but as of 2016 it was particularly pronounced. Does it matter? In terms of income, men in that age group had a median employment income of $41,630 as compared to women, who made $30,186 so on the face of it, it would appear not. That said, some of that disparity is surely due to young women (some of them mothers) who are choosing to work part-time. As well, 2015 was a not-bad year for the economy (particularly in B.C. and Ontario) so presumably there was work for all that wanted it including in fields like manufacturing and resources that traditionally have paid men well. Going forward though, the gap may be more problematic. In an economy that increasingly pays for knowledge, it would seem that a degree is not a bad thing to get. As well with jobs that require less education increasingly threatened by technology, the fact that young men are less likely to get a tertiary education could well be putting them at a disadvantage. This is no time to be left behind, so 2018 may be a good time to really look at why the educational disparities are happening."

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The starting point in fighting poverty

Jennifer Robson, assistant professor of political management, Carleton University (@JenniferRobson8)

"In the coming months, we should see the Trudeau government’s promised Federal Poverty Reduction Strategy. That Strategy is going to be benchmarked against some current level of poverty that the government aims to reduce. I’ll be watching to see what the government names as a starting benchmark measure of poverty, recognizing there are serious ongoing debates: Do we use an absolute measure or a relative one? Do we look only at income or at other financial resources too? Do we look at financial means or at real consumption outcomes? And, why can’t Canada seem to get our act together to collect and put out timely data? See my chart below to get a sense of some of the different measures of current poverty levels in Canada. Where we want to go depends on where we’re starting from."

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Tax the rich! (But not me, I'm middle class.)

Antoine Genest-Grégoire, Research Associate, Université de Sherbrooke (@agenestgregoire)

"With provincial elections looming, we're going to hear a lot about the middle class in 2018. One of our research papers from 2017 tried to compare the perception of taxpayers about their income class with their real income level. Using a survey and a standardized definition of middle class (75 to 150  per cent of median family-size adjusted income) we found that very few adults consider themselves to have higher-than-middle income, even if that's the case. Most want higher taxes on the rich, but they don’t always realize that they might themselves be part of the better-off."

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Interest Rates

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Monetary policy in Canada is too loose

Krishen Rangasamy, senior economist, National Bank of Canada

"In November Bank of Canada Governor Stephen Poloz reiterated that the central bank will be cautious in making adjustments to the policy rate. Sure, some degree of caution is warranted considering uncertainties brought by NAFTA negotiations and the economy’s enhanced sensitivity to rate hikes. But one has to ask: Does Canada still need negative real interest rates amidst a booming economy? The real overnight rate is currently -0.5 per cent, roughly unchanged from mid-2013 when Stephen Poloz became Governor, even though the output gap has dropped from two per cent four years ago to almost zero today. As this chart shows, one would be hard-pressed to find prior instances outside of a recession with a similar combination of a near-zero output gap and a negative real overnight rate. So, monetary policy is currently too loose and that is likely to raise financial stability risks further via overleveraging and inflated asset prices (including housing)."

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The risk to Canada's imbalanced economy from tighter monetary policy

David Wolf, portfolio manager, Fidelity Investments

“The performance of Canadian equities and the Canadian dollar relative to their U.S. counterparts tends to be highly correlated. This is sensible, given that both reflect Canada’s relative economic prospects, as affected in particular by the global cycle and movements in commodity prices. In 2017, however, the Canadian dollar went up even as Canadian equities lagged. For me, this unusual divergence represents a warning that the tighter monetary conditions that underpinned the stronger Canadian dollar pose significant risk to an imbalanced domestic Canadian economy.”

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Crunch time for an indebted nation

Sébastien Lavoie, chief economist, Laurentian Bank Securities

"The wind is shifting. In 2018, the highly-leveraged Canadian economy will manage the new reality of higher interest rates driven by global and domestic forces. First, with a debt burden significantly higher than a decade ago, households are likely to adjust their consumption habits since more money is dedicated to interest payments of their debt. We will find out to what extent higher rates reduce the ability of households to increase discretionary spending. Second, indebted governments will also feel the squeeze. In the past, rapidly declining interest rates have led to significantly lower-than-expected debt servicing costs, freeing up money for other public spending initiatives. These good times are likely over. Third, the corporate debt load is also higher than before. It remains to be seen to what extent higher financing costs will ramp down investment and hiring intentions of Canadian entrepreneurs."

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The Bank of Canada will be under pressure to raise rates

Mathieu Savary, managing editor, BCA Research (@SavaryMathieu)

"This chart is important because it highlights that the Bank of Canada is not done hiking interest rates, even if the Canadian housing market still constitutes a key hurdle for the BoC. With household debt representing a stunning 170 per cent of disposable income, higher interest rates could go a long way toward causing serious stress for households. In fact, a recent Ipsos survey indicated that 40 per cent of Canadian households would face financial difficulties if rates moved up significantly.

However, the economy is also exhibiting growing inflationary pressures. The BoC estimates that the slack in the economy is more or less fully gone, but the strong link between U.S. and Canadian activity suggests that Canadian growth will remain above trend next year. This means that capacity constraints will only grow ever more binding. Additionally, the mounting difficulties reported by Canadian businesses to find qualified workers point toward a pick up in wages. This picture highlights the upside risk for Canadian inflation. Thus, as inflationary conditions rear their heads, the BoC is likely to rediscover its hawkish verve and increase rates two to three times in 2018. This could well spell the end of the Canadian housing bubble.

The biggest blemish on this picture remains the tenuous NAFTA negotiations. It is true that if NAFTA is discarded, Canada could fall back on the previously existing CUSFTA, which carries very low tariffs for U.S./Canada trade. However, the high degree of uncertainty created by these regulatory changes could incentivize Canadian and U.S. firms to abandon capex projects in Canada and instead expand capacity in the U.S., generating lower aggregrate demand and lower inflation North of the border in the process. This uncertainty most likely explains Governor Poloz’s cautious tone in October."

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Be mindful of higher interest rates in 2018

Craig Alexander, chief economist, Conference Board of Canada (@CraigA_Eco)

"The new Governor of the U.S. Federal Reserve is likely to maintain the path of tightening, with the fed funds rate rising by close to one percentage point. The further rate hikes would be a vote of confidence in the U.S. economy, but will carry risks. Valuations of U.S. stocks are stretched, so the Fed’s actions might trigger a correction in equity prices. Moreover, the U.S. economy is headed into its eighth year of expansion and the labour market is approaching full employment, conditions that can make the economy vulnerable to rising rates. The most likely scenario for the U.S. economy is continued growth, but close monitoring of the risks is essential.

The Bank of Canada is expected to raise rates by roughly the same amount as the Fed. This will reflect diminishing slack in the labour market, upward pressure on wages and a return of inflation to the Bank’s target. Highly indebted Canadian consumers and stretched real estate valuations will have to cope with higher borrowing costs. The level of rates will remain low, making the base case forecast one of continued economic growth. But, one should not be complacent about the risks. One development that could stop the rate hikes would be a collapse in the NAFTA renegotiation, which would bring its own financial event—a sharply weaker Canadian dollar."

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What happens when the monetary morphine wears off?

Karl Schamotta, director of global product and market strategy, Cambridge Global Payments (@vsualst)

"Tells us that the relationship between market fear and geopolitical uncertainty has become weaker since central banks began administering monetary morphine after the global financial crisis. As policymakers reduce the dosage over the next year, this relationship should reassert itself - and as the withdrawal symptoms hit, market volatility will likely return with it."

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Canada's worrying debt levels

Mike Newton, portfolio manager and director of wealth management, Scotia McLeod (@NewtonGroupSM)

"Over the past decade, Canadian debt has shot up across all three levels (Consumer, Corporate and Government) to the tune of roughly $5.5 trillion from $3 trillion. Canada’s overall debt to GDP has risen 90 percentage points since the financial crisis. It is also notable that the change in the U.S. is negligible.

It could be argued that this is manageable in a lower interest rate world as the cost of servicing these debts has declined by about nine per cent. But the 'set-up' from here is not one that necessarily breeds a high degree of confidence. The risks going forward need to be understood, especially given that rates appear to be nudging up."

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Jobs

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Raising the minimum wage in B.C.

Lindsay Tedds, associate professor and the 2017 Master's in Public administration cohort, School of Public Administration, University of Victoria (@LindsayTedds)

"The B.C. government recently formed the Fair Wages Commission whose task, among other things, is to 'develop recommendations for a pathway forward to raise the minimum wage to $15 an hour….' While economic theory dictates that increases to the minimum wage will cause unemployment and reduced hours, empirical studies as to the observed economic effects of minimum wage increases provide ambiguous results. Combing through the literature suggests two important considerations to minimizing adverse effects of the minimum wage: maintaining the ratio of the minimum wage to average hourly earnings to between 40 to 50 per cent and ensuring that increases to the minimum wage are small, successive, and predictable.

The chart shows the ratio of minimum wage to average hourly earnings in B.C. since 1997. It shows that the ratio has always been in the low part of the 40 to 50 per cent band, or fell even below 40 per cent during minimum wage freezes. The chart also shows that the recent increases in the minimum wage, while bringing the ratio back up to historical levels, were not small. Should the Fair Wages Commission wish to adhere to the two conditions, the minimum wage should rise to $15 no earlier than when average hourly earnings increase to $30 (meaning a ratio of 50 per cent is not exceeded). Assuming average hourly earnings continue their historical course, this sets a predictable path for minimum wage to hit $15 by November 2025. This would translate into annual increases in the minimum wage in the order of 3.8 per cent starting in October 2018, a pace that may be considered too slow for minimum wage advocates. Whether the Fair Wages Commission recommends such a prudent path remains to be seen."

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Wage Gains Have Finally Arrived

Derek Holt, vice president, head, Scotiabank Capital Markets Economics

"By early in the new year, Canadian wages could be rising at the quickest pace in about a decade. This will build upon the trend of solid aggregate income gains in booming job markets. Income growth is a risk mitigant to the effect of higher borrowing costs and concerns over the underlying health of consumer finances.

About three quarters of expected wage growth will occur independently from large increases to legislated minimum wages in provinces like Ontario and Alberta. Baseline wage growth will probably reach the 3% mark which would be toward the fastest over the past decade and similar to wage growth before the aftermath of the plunge in commodity prices. Tightening labour slack, the maturation of the negative commodity shock on wages and strong trend gains in labour productivity growth are the drivers. Then tack on minimum wage hikes that will add another full percentage point to average gains as icing on the cake. Wage growth should stabilize well above the lows hit earlier in 2017. Whether higher minimum wages destroy jobs (ie: Quebec in the 1970s) or result in broadening wage pressures will be a lengthy but globally watched experiment."

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The link between strike activity and inflation

Jordan Brennan, economist, visiting scholar at Harvard Law, Unifor (@JordanPWBrennan)

Economic commentators have been puzzling over North America’s persistently weak inflation. Tightening labour markets, so the theory goes, should lead to higher levels of inflation as employers bid up wages in an effort to attract and retain workers. Given that unemployment rates have been heading south for nearly a decade, where’s the inflation? It turns out there is no necessary relationship between low unemployment (‘labour scarcity’) and accelerating wage growth (‘labour price’).

Strike activity is a type non-market force which gives workers the bargaining power to bid up wages (upper graph). The statistical relationship between strike activity and wage growth is four times stronger than the relationship between unemployment and wage growth. The growth rate of hourly earnings, in turn, may be the most important determinant of the inflation rate (lower graph). Over the past century North America witnessed three major strike waves, with peaks coming shortly after the First and Second World Wars and, in the case of the third strike wave, the mid-1970s. Wage growth and inflation followed a near-identical pattern. Strike activity has been trending downward since the 1970s and is currently at a postwar low. It should come as no surprise, then, that wage growth and inflation have been so modest. If this is true, the only inflation we are likely to see is that of asset values, namely the stock and housing markets, which will exacerbate economic stratification.

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Jobs are no more temporary than they were in the past

Mike Veall, professor, Department of Economics, McMaster University

"While there is a lot of talk about how employment is becoming more temporary, this graph from joint work with Alex Thomson and Arthur Sweetman shows that the average time that the currently employed has been with the same employer has been almost constant at just over 100 months since 1976."

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Lessons from Quebec for Ontario's minimum wage hike

Matthieu Arseneau, senior economist, National Bank of Canada

"Canada has one of the highest employment rates for youth (people aged 15-24) in the advanced world: 57 per cent versus only 41 per cent for the OECD average. According to Statistics Canada, 61 per cent of all minimum wage employees in our country are aged 15 to 24. Youth thus stand to be the most impacted when there are large increases in the minimum wage. Quebec is a case in point. In the mid-1970s, the province opted to raise its minimum wage to 54 per cent of average hourly earnings (AHE) in manufacturing. This ratio proved to be counterproductive as youth employment conditions soon began to deteriorate: the jobless rate in Quebec had surged six percentage points to 19.5 per cent by 1977 while Ontario’s remained near 13 per cent. It was later established that in Quebec’s case, a ratio of minimum-wage-to-AHE of 48 per cent should not be breached in order to maintain optimal employment conditions. As the chart below shows, it is interesting to note that Ontario’s decision to raise its minimum wage to $15/hour by January 2019 will propel the province’s ratio of minimum wage-to-AHE in manufacturing to 55 per cent. Will the outcome in Ontario be different from that in Quebec in the 1970s? Time will tell."

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Canada's positive labour market gap

Dominique Lapointe,, senior analyst, Institute of Fiscal Studies and Democracy. (@Dlap17)

"The state of the Canadian labour market has been a hot topic of discussion in the second half of the 2017, particularly on the back of the first two interest rate hikes since 2010. And the numbers say it all. Over the last twelve months, the unemployment rate went from a near-post-recession high of seven per cent to 6.3 per cent in October. Over the same period, almost 400,000 full-time jobs were created—a 2.7 per cent increase. Beyond the headline numbers, much of the debate revolved around the remaining “slack” in the labour market. The Bank of Canada argued in its latest Monetary Policy Report and, more recently, in a speech by Governor Stephen Poloz that wage growth, and indirectly inflation, has been hindered by labour market slack. The central bank highlights long-term unemployment and falling unit labour costs, among other data, as an indication of significant slack in the labour market. Conversely, the Institute of Fiscal Studies and Democracy (IFSD) is of the view that the labour market gap is generally positive, and that inflationary pressures are impending. For example, wage growth in all age categories has accelerated this year and the youth unemployment rate is near historic lows. Moreover, the IFSD’s estimate of labour turnover in Canada (the ‘Canada JØLTS’) points to a growing gap between the speed over which unemployed people find a job and the speed at which employees become unemployed (see chart). With labour market slack being a key reason the Bank of Canada has cited for keeping monetary policy on hold, these are surely indicators to keep an eye on in 2018."

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Rising job vacancies are pushing up wages

Ted Mallett, chief economist, Canadian Federation of Independent Business (@cfibeconomics)

"Rising job vacancy rates through 2017 are putting upward pressure on wages. For privately owned businesses with vacancies lasting four months or longer, the average planned wage increase is 2.7 per cent, versus 1.8 per cent for those with no persistent unfilled positions. The difference is consistent among all major industries, as well as across other dimensions such as business size, age and region."

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A reminder to ignore the noise of monthly job numbers

Will Dunning, housing market consultant, (@LooseCannonEcon)

"Actually, this isn’t my most important chart. It’s just useful to be reminded of its message once in a while: we live in a world of imperfect information.

Each month, Statistics Canada reports on the employment situation. The reports begin with a sentence like this “Employment increased by 35,000 in October…”. Depending on the number, the mood about the economy can shift, in a range from euphoric to depressed. Those mood shifts can be extreme, as in 2016, when the July report showed a loss of 25,900 but then August showed a gain of 35,500.

Economic reality does not change as rapidly as these numbers suggest. They are generated by a sample survey, and just like political opinion polls they have a margin-of-error. Therefore, Statistics Canada’s opening sentence contains too much confidence about the numbers. I would really like it if they added four words at the start of the monthly releases: “It is estimated that…”.

I started by saying that this chart isn’t important. But, employment is. That’s why it is important to be careful with the words we use."

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What will the Ontario minimum wage hike mean for jobs?

James Marple, senior economist, TD Economics (@marpelino)

"Ontario's job market has performed admirably over the past year, with overall jobs up over 2.5 per cent. Job gains in minimum-wage-sensitive sectors including agriculture, accommodation/food services, retail trade and other services have been even better, a pleasant change from the last several years. However, new minimum wage laws in the province take effect in 2018. The general minimum wage is poised to rise from its current level of $11.40 per hour to $14 on January 1, 2018 and then to $15 in early 2019. This is above or at the median wage in these sectors. There are offsetting effects to increasing the minimum wage. On the one hand it will transfer income from businesses to low-wage workers, but, on the other hand, businesses looking to defray costs may cut back labor hours and increase the use of automation. The experiment will start shortly. Stay tuned."

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Markets

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The loonie still has room to climb

George Pearkes, macro strategist, Bespoke Investment Group (@pearkes)

"The Canadian dollar's 2017 rally was driven by two factors: rising commodity prices and the sudden uptick in economic growth which allowed the BoC to tighten policy. Of those two factors, one (growth) is taking a breather, but the Canadian dollar still looks a bit lower than "fair" value versus the prices of copper, oil, and the spread between government bond yields in the U.S. and Canada. Over the four years ending November of 2016, those three variables explained almost all movement in the Loonie, and they continue to explain USDCAD's movements pretty well over the past year."

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Be fearful when others are greedy

Alexander MacDonald, investment analyst, Cowan Asset Management (@alex_macdonald )

"Modern-day Canadians are an enthusiastic bunch when it comes to debt. And this enthusiasm has not been limited to homeowners with mortgages: investors in the public markets have also been borrowing at a spirited pace. Margin debt allows investors to supplement their available cash when buying securities. This chart shows that Canadian margin debt outstanding tracked the S&P/TSX Composite Index closely until the end of 2012. The correlation makes sense, as investors have shown a historic tendency to be optimistic when the markets are up and pessimistic when the markets are down. Since 2013, however, these two lines have diverged. Time will tell whether or not this means Canadian investors are now overly optimistic about the equity markets. But it does raise concerns about what could happen if the bull market was to come to an end."

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An indicator for Canadian defensive tech stocks

Nick Waddell, founding editor, Cantech Letter (@CantechLetter)

"Over the next year I will watching the chart of ETF First Trust Dow Jones Internet Index Fund closely. Why this U.S.-based ETF? Simple, it has one of the highest exposures of any product to the FAANG stocks (Facebook. Amazon, Apple. Netflix, Google). In fact, to be included in this ETF, a company must derive more than half of its revenue from the internet.

The story of the past couple years in technology investing is the continuing willingness of investors to reward high flying organic growth names and grant them ever-expanding multiples. To be clear, I do not see much in common between the 90's dot-com era companies that imploded and these high-quality names that generate high margin recurring or repeatable business, but there have been some hints that investors may soon be on the hunt for tech stocks with more defensive qualities; issuers that wouldn't give Ben Graham, the father of value investing, an aneurysm.

What does this have to do with Canada? Simple. Save for names like Shopify or, at various times Kinaxis. Canada has very few of this high-flying organic growth names. What we do have is reams of defensive plays. If you see the chart of FDN level off or begin to fall, watch the charts of Canadian stocks such as OpenText, CGI Group, Computer Modelling Group, Evertz Technologies, Enghouse Systems, all of which have stable if unspectactular businesses, and pay a dividend. "

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ETF flows and company stocks

James Price, director of capital markets products, Richardson GMP (@JP_RGMP)

"ETF Structure may be a concern for Canadians and Americans alike. With the help of Connected Wealth we split the first and last quartile of the S&P100 index as to which are most sensitive to inflows and outflows of money, as measured by the size of the flows and the stocks’ individual liquidity.

While the S&P 100 is a U.S. index, this same analysis holds true for the construction of Canadian ETFs.

The chart is the performance of the ETF Sensitive and Less ETF Sensitive indices. The area chart on the bottom panel is total equity ETF holdings. It would appear as ETF assets rise, the performance between ETF Sensitive and Less ETF Sensitive began diverging. While there may be other factors at play, it is not inconceivable that broad flows into ETFs may be inflating some companies more than others. Continued positive ETF inflows may continue to push the ETF Sensitives higher and valuations higher, while a reversal in flows could trigger a stronger sell-off in the more sensitive stocks."

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How much are central banks driving stock markets?

Scott Barlow, market strategist, Globe and Mail (@SBarlow_ROB)

“I picked this chart by Citi credit strategist Matt King as the most important for 2018 in a recent column. It doesn’t look like much at first—the correlation is very high at times but inconsistent over time—but it could help answer the nagging question as to how much the recent equity rallies have depended on central bank monetary stimulus.

The chart compares the three month change in central bank asset purchases with the three month change in the MSCI World Index.

There are two important concepts here. One, Mr. King was among the first to emphasize cross border asset flows. The borderless nature of investment funds means that combined global monetary stimulus is more important than any one individual central bank. The S&P 500 and U.S. Treasuries, for example, are not just affected by the Fed, but also foreign buyers (or sellers) that arise from stimulus in China, Japan and Europe.

Mr. King also believes that global risk assets, including equities, are more affected by changes in the flow of central bank stimulus than the total amount of debt on their balance sheets.

The Federal Reserve is set to wind down their balance sheet and the European Central Bank is reducing asset purchases by 50 per cent. If global equities fall along with this withdrawal of open market activity, it will be a sign markets have been monetary policy-driven, and less a reflection of fundamentals."

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Trade

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Don’t overstate US leverage in the renegotiation of NAFTA

Brett House and Juan Manuel Herrera, deputy chief economist and economist, Scotiabank (@BrettEHouse)

"Since its inception in 1994, the North American Free Trade Agreement (NAFTA) has helped triple the value of trade between Canada, the U.S., and Mexico. Nevertheless, as the years have passed, a progressively smaller share of U.S. imports from Canada and Mexico has taken advantage of the lower tariffs that NAFTA offers. In 1998, around two-thirds of all U.S. non-fuel imports from Canada entered under NAFTA’s tariff preferences; so far in 2017, this figure has fallen to 50 percent. The share is even lower, around 44 percent, if one includes oil, gas, and other energy commodities with zero or near-zero duties that don’t need NAFTA to enter the US. NAFTA has become less critical to North American trade because the 'Most-Favoured Nation' or MFN tariffs that the U.S. would charge in its absence have come down substantially since 1994—and can’t be raised across the board without imperilling U.S. membership in the World Trade Organization (WTO). Consequently, some traders don’t bother going through the due diligence required to qualify for NAFTA preferences: the costs involved aren’t worth the small savings that NAFTA’s lower-duty access would provide. Of course, NAFTA remains extremely important in some sectors, such as vehicle manufacturing, where integrated production processes mean parts cross borders several times on the way to final assembly: about 85 percent of US imports of transportation equipment pass under NAFTA. But overall, Scotiabank Economics projects that if NAFTA were to be interrupted, economic growth rates in Canada would be shaved by only about a third of a percentage point in both 2019 and 2020. Trade with the US remains vital to both Canada and Mexico: the U.S. consumes around 75 and 80 percent of their exports, respectively. Yet, NAFTA plays a gradually decreasing role in these relationships. Canadians need to keep this in mind as efforts to ‘renegotiate and modernize’ the pact continue into 2018."

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Why Trump and U.S. businesses are at odds over NAFTA

Stephen Tapp, deputy chief economist, Export Development Canada (@stephen_tapp )

"President Trump’s objectives for renegotiating NAFTA have put him on a collision course with North American business interests. This chart illustrates a key source of the conflict. Much of U.S. merchandise trade with its NAFTA partners is 'within firm' trade that involves exchanges between related parties (where one party owns at least 10 percent of the other). Trump wants to 'make America great again' by urging companies to produce inside the United States. However, the President’s desire is at odds with the fact that many successful companies with head offices in the U.S. are able to compete globally, precisely because their operations leverage beneficial relationships with firms operating in Canada and Mexico. Indeed, the viability of businesses in many sectors—including services—depends on supply chains that criss-cross the continent, and that need to move inputs seamlessly and predictably across the very U.S. border that Trump is trying to thicken.

In 2018, as the short deadline imposed on NAFTA talks arrives, the voices of businesses wanting to avoid supply chain disruptions will grow louder. Stakeholders in North America and the rest of the world will be watching how these negotiations play out."

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American trade actions are spiking

Avery Shenfeld, chief economist, CIBC Capital Markets

"American business leaders seeking protection from imports know they have a friendly ear in the White House, and are getting more aggressive in filing trade actions. That's why NAFTA is worth trying to save, as it allows Canada to appeal unsound U.S. Commerce Dept. rulings to an impartial panel."

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The NAFTA Constellation: Which Canadian Industries are Most Vulnerable?

Daniel Schwanen and Aaron Jacobs, vice president, research and former researcher, C.D. Howe Institute

"This graph profiles a constellation of Canadian industries, each represented by a circle, highlighting in gold those that are most vulnerable to any disruption of trade between Canada and the US. The left axis is the share of that industry’s jobs directly relying on exports to the US. The right axis is an indicator of the “supply chain integration” of that industry with the US, as measured by US input into exports from Canada to the US. This captures the fact that parts and other inputs may cross the border a number of times prior to a final product being shipped – potentially magnifying the impact of reinstated custom duties on that industry. The size of the circle captures the total number of Canadian jobs directly or indirectly dependent on that industry’s exports to the US. Gold circles represent those vulnerable industries that support 10,000 or more Canadian jobs.

We see that auto manufacturing stands out both in terms of integration with US manufacturing, and the number of Canadian jobs at stake. But other important job-generating goods producing industries in Canada, including chemicals, plastics and rubber products, food manufacturing, aerospace, machinery, semiconductors, electronic equipment, pharmaceuticals, metals, paper products and textiles, are either significantly integrated with US production, highly dependent on the US market for output, or both." (Each bubble can be explored in more detail by clicking here.)

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More China, please

Barry Schwartz, chief investment officer, Baskin Wealth Management (@BarrySchwartzBW)

"Canada’s trade with China continues to grow, but so has the deficit. With the risk of NAFTA failing, Canada needs to move quickly to broaden its trade relationship with Asia and Europe. According to the World Bank, China is going to account for at least 35 per cent of the world’s GDP growth over the next few years. Justin Trudeau should consider making quarterly visits to China!"

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China's AI rise

Danielle Goldfarb, senior fellow, Conference Board of Canada (@DIGoldfarb)

"U.S. tech giants are not the only ones rapidly accelerating their artificial intelligence (AI) investments over the last few years. This chart shows that two of China's universities (and one of Canada's) are in the top 10 sources of most frequently cited AI research papers. This adds to the mounting evidence that China is rapidly climbing up the technology ladder. In 2017, China's government laid out its ambitious plans to keep pace with world-leading AI activities by 2020 and be the world AI leader by 2030.

As NAFTA uncertainty looms, Canada is actively redefining its global economic role. A key part of this is strengthening economic relations with China, including a possible free trade deal. Historically, Canada sold China raw materials and bought cheap Chinese manufactures. As both economies invest in AI and tech, the relationship becomes much more complex. Canada will need to watch these developments in 2018, and develop a sophisticated strategy to tap positively into China’s transformation while mitigating potentially negative economic and social impacts."

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