5 potential warning signs of a Canadian downturn: Don Pittis

Downturns happen. Everyone knows it. And while there were happy signs earlier this year, now, as Bank of Canada governor Stephen Poloz prepares his latest release on interest rates tomorrow, there are growing indications that Canada's Dr. Jekyll economy is showing a little Mr. Hyde.

Here are some symptoms we should watch for.

1. U.S. rate rise

Despite some gloomy U.S. statistics and warnings from the influential investment bank Goldman Sachs to get out of stocks and into cash, the people guiding the U.S. Federal Reserve seem cautiously optimistic. Minutes of a recent Fed meeting released last week showed the U.S. central bank is prepared to raise interest rates in June.

• U.S. Federal Reserve ready to hike rate in June

The fact that the U.S. economy is strong enough to allow Fed chair Janet Yellen to increase rates is broadly good for the North American economy.

While higher rates could hurt the price of existing bonds and knock down stocks in the short term, signs of an increased demand for labour and capital would signal that the U.S. has turned a corner.

For Canadians, however, whose debt loads have hit new heights, higher U.S. interest rates and their inevitable impact on Canadian commercial lending rates could make us feel poorer. 

2. Housing crater?

Higher rates are just what the Canadian real estate sector does not need at this point.

The painful bankruptcy of Canadian home builder Urbancorp and pressure for governments to intervene in what many are calling an affordability crisis have some commentators worried that Canadian real estate is at a peak.

• Metro Vancouver real estate is like a lottery, says study

Despite evidence that real estate is a major driver of jobs and the economy, ominous warnings are easy to dismiss because they have been offered so often. This time, however, we have real evidence that markets outside Vancouver and Toronto have begun to weaken.

And although he wasn't talking about real estate, Poloz had an ominous warning of his own at a Milken Institute conference earlier this month when he said, "There's a crater under every bubble." 

3. Oil and fires

Falling oil and resource prices have already begun to have an impact on real estate. Forest fires in oil-producing areas of Alberta have drawn the world's eye and the shutdown of oilsands production is cutting output by an estimated $70 million per day.

A rise in oil prices from below $30 US a barrel to about $50 would seem good for Canadian producers, but the market is hard to read.

Canada's biggest oil companies may have had pockets deep enough to wait till other world producers were driven out of the market. At $50, the globe's lowest-cost producers may begin gearing up once again, meaning high-cost Canada will have more competition.

And will oil prices stay high? Uncertainty abounds.

4. Failed industrial recovery

Indirectly, resurgent oil prices have had an unhealthy effect on Canada's long-awaited industrial recovery. Poloz has anticipated the manufacturing sector, battered by a high dollar during oil's rise to $100 US a barrel, would recover and begin exporting as the loonie fell.

Despite a strong showing in the automotive sector, new manufacturing capacity has not appeared, and a stronger loonie rising with oil prices is not helping as much as expected.

And while both Poloz and Finance Minister Bill Morneau have expressed their faith in fiscal spending, the jury is still out on whether that will be enough to spur new private sector innovation and investment.

5. Banking retrenchment

Bad debts in the oil sector and shrinking revenue due to competition from online upstarts are among the worries for Canadian banks that report their results this week.

• Big banks react to threat by cutting fees, modernizing

So far the big Canadian banks have kept their edge, partly by paring down staff and withdrawing from troubled foreign markets.

Above all, banks need to lend, and they would likely be thrilled to lend to support the surge in output that Poloz has been predicting. But they need the borrowers. If fiscal spending fails to restart the economy soon, some are predicting Poloz will cut rates later this year. However, the bank governor has warned that the impact of cuts is losing its power.

"What we know for sure is when interest rates are this low, the next move in interest rates has a smaller effect than it had when you were up at two [per cent]," he said at the Milken event. 

Despite some reports to the contrary, Poloz has not ruled out negative interest rates if all else fails, but the bitter side effects of that strategy in Japan may mean that is an elixir even Mr. Hyde may be reluctant to swallow.

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