S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

An Optimization Problem With A Tough Paradox

As governments in many countries try to avoid a complete breakdown of the health care system while also bolstering the economic system, containment of the coronavirus pandemic has been the No. 1 priority.

Paradoxically, containment comes at an economic cost and by choice. Just like anywhere else in the world, in Canada also it will cost a recession. How big a recession? It really depends jointly on the path of the virus spread and government response. What we know is that the flattening of the pandemic curve inevitably steepens the macroeconomic recession curve.

The border has been closed for non-essential travel, schools have shut down, and several provinces have declared a state of emergency and ordered the closure of all non-essential workplaces. Assuming the government's implementation of extreme "social distancing" lasts till well into the second quarter, we forecast Canada's real GDP will contract 3.9% in the first half of 2020.

Social Distancing Paralyzes

The recommended extreme social distancing as a way to slow the virus spread, and in turn, alleviate stress on the health care system, has profound negative effects on the Canadian and global economies. The first of these effects has already been seen in a 100% year-on-year decline in restaurant reservations in the Open Table network of restaurants. Layoffs have spiked in industries that rely on foot traffic. Consumer confidence collapsed a record 32 points in March and claims for employment insurance reached an unprecedented 929,000. This points to a massive rise in unemployment that will cause a severe retrenchment in household spending.

Total household spending directly at risk from social distancing (for example, restaurants and leisure, hotels, public transportation, personal care) constitutes 20% of total spending in Canada, which is facing severe pull-back already. We do not expect the beginnings of normalization before mid-May and the rest of the second quarter will also be under the shadow of COVID-19 fear. In such a scenario in our baseline case, we forecast consumer spending to decline 11.3% (annualized) in the second quarter. Spending on durable goods (such as cars, furniture, etc.) will also see steep declines while spending on staple services such as utilities, housing, and medical should hold steady. In all of this, the unemployment rate is sure to spike in the coming weeks, as separation between businesses and workers speeds up.

Considering the collapse in both output and employment in the retail, restaurant, leisure, travel, and hospitality industries, it now looks likely that real GDP will fall by more than 12% annualized in the second quarter, with the unemployment rate quickly (and temporarily) closing into double digits by May.

Unrelenting Sequence Of Hits Ensures A Recession

By recession, we mean at least two quarters of well below-trend growth sufficient to trigger rising unemployment. This is essentially what we see happening in the first and second quarters of 2020.

Although social distancing will take a large chunk out of Canada's GDP growth in March through sometime in the second quarter, there is more to the story in Canada than just that. Plummeting oil prices--which now look to stay near the US$20-US$30 mark for the foreseeable future--have strengthened the chances of an already near-stagnant Canadian economy experiencing two quarters of contraction in the first half of the year.

The handoff of the economy from fourth-quarter 2019 to first-quarter 2020 was already weak to begin with. Weaker business investment, depressed oil activity, and falling exports, on top of rail blockades, severe winter weather in parts of the country, and Ontario teacher strikes will result in a negative 3% annualized contraction in first-quarter GDP.

This will be the first time for back-to-back quarterly contraction in Canada since first- and second-quarters 2015 (the last time energy prices tanked).

Degree Of Dislocation Today Will Dictate Recovery Tomorrow

Extraordinary fiscal and monetary stimulus is necessary to weather the pandemic storm and support recovery, even though it can't fully offset the severity of the recession. Governments and central banks around the world have been throwing everything but the kitchen sink to provide support to credit flows, liquidity, and incomes.

Truth be told, it will take several more weeks to gauge their effectiveness. If dislocation in the labor, products, and financial markets is smaller, the faster the rebound can gain traction and the less economic activity will be permanently lost.

For example, in the labor market, if separation between employer and employees is large and not contained by the design of government fiscal stimulus, it will be that much harder to get a smooth recovery on the back end because matching of employer-employee after separation is a much bumpier process than simply employees returning to work.

If fiscal and monetary policies prove successful, and social distancing tactics gradually ease, the unemployment rate should level off after one-to-two months and quite possibly fall just as fast if workers are called back to work. There will likely be some permanent scarring in that timeframe, but not for the bulk of workers, as long as the duration of the shock remains contained to one or two more months.

And it is not just dislocation at home, but also in the U.S. and other countries that matters. The U.S. is Canada's most important trading partner and we expect that economic weakness in the U.S. this year (negative 1.3%) will contribute to the significant contraction that we forecast in 2020 for Canada. If the U.S. economy finds a firmer footing sooner by reducing the degree of dislocations in its domestic labor, production, and financial markets, it will be less of a headwind to Canadian recovery.

The Big Institutions Aren't Afraid To Bring Out The Bazooka

Monetary policy can work to keep the markets orderly, and this is what we continue to expect from the BoC in our baseline forecast.

Just today, the BoC lowered its target for the overnight rate by 50 basis points to 0.25%. This unscheduled rate decision brings the policy rate to its effective lower bound (as per Governor Poloz's view) and is intended to provide support to the Canadian financial system and the economy during the COVID-19 pandemic. Governor Poloz in his press conference ruled out the possibility of employing negative rates that the Bank thinks are harmful to financial markets. Essentially, this is a signal that any further easing will take the form of increased purchases of government securities, and/or adjustments to other purchase programs to ensure that monetary stimulus is being transmitted fully to all corners of the financial system.

The BoC has also launched two new programs to inject short-term liquidity and begin acquiring Government of Canada securities in the secondary market, beginning with a minimum of C$5 billion per week, across the yield curve. These purchases will be scaled as needed until the economy fully recovers. The Bank will also begin primary and secondary market purchases of commercial paper through the new Commercial Paper Purchase Program to support credit flows and alleviate strains in short-term funding markets.

Today's announcement of asset purchases follows the Bank's purchases in just the past one week, which amounted to a staggering C$27 billion of total asset purchases (Canadian mortgage bonds, provincial government securities, bankers acceptances, and term repo operations). The BoC's previously largest weekly asset expansion totaled less than C$7 billion in October 2008. We expect the BoC will do "whatever it takes" to make sure that dislocation in the financial markets is warded off (similar to the Fed's intention).

This extraordinary monetary stimulus, in tandem with a still-growing number of fiscal measures (C$55 billion in deferred tax payments and C$27 billion in direct cash assistance together with various other federal initiatives already amount to assistance, direct or indirect, closer to 7% of GDP), is an absolute necessity to help offset the worst-case impacts from the pandemic shock on the economy.

Risk To Baseline Forecasts

The risk to our central forecasts is that duration of extreme disruptions in activity lasts longer than what we imagine in our baseline case. A bounce-back implied in the second half in our baseline forecast is at risk from a more prolonged crisis that would exacerbate households' excessive debt burden from a significant income loss. The longer the duration of disruption, the greater the risk that we would revise our forecasts to show a wider bottom U- or even L-shaped trajectory for the economy.

Even with our assumed duration in the baseline, real GDP could still shrink sharply in the second quarter and the unemployment rate could soar higher--twice as much in both cases compared with what is published in the forecast table below.

We do, however, also believe it's a positive sign that China, South Korea, and other Asian nations are seeing a slowing in their outbreaks and that China is showing early signs of potential in its path of getting back to full capacity. These are tough and extraordinary days but they will come to an end. 

View Expanded Table