David Rosenberg: A Canadian recession is 'all but set in stone'

David and Julia are related.

The Canadian government, like most of its peers, flooded households with extra cash in the early 2020s as the COVID-19 Pandemic wreaked havoc. Even though employee compensation fell 9.2 per cent, a surge in government transfers led to an eight per cent increase in household income in the second half of the year.

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With the government pulling back on fiscal and monetaryStimulus, it will act as a drag on consumer Spending at a time when job creation is stalling and home prices are deflating

The unemployment rate went up to 13.4 per cent by May from 5.6 per cent in January after businesses were forced to shut down and lay off staff. In the fourth quarter of that year, employee compensation fell to the lowest level since the third quarter of 2017). In the second quarter of 2020, the federal government doubled the transfers to the household sector to $609 billion.

If fiscal support had remained at pre-pandemic levels over the past two years, an additional $906 billion would have landed in the hands of households. The government has further to go in order to return to the historical trend.

If the gap between actual income and counterfactual income were to close, government transfers would have to fall by an additional $58 billion, which would translate into a further three per cent hit to household income.

Since we have to account for the downward pressure on organic income from stagnant job creation within the economy, the drag on household income is going to be much greater. Overall employment growth and employee compensation have an 88 per cent correlation. With employment growth contracting in June, July and August, we can expect compensation to follow suit, so this dominant source of household income is set to decline.

A 0.2 per cent drop in employment would translate into a $27 billion hit to compensation and shave off one percentage point from household income. With more employment losses on the horizon, we expect this trend to gain steam.

The combination of the government transfers and the hit to organic income is set to reduce household income by at least 4%. Employment is expected to continue its descent and it doesn't account for the decrease in rental income that lies ahead as property prices erode further

This means that consumption, which accounts for more than half of gross domestic product and has a perfect correlation to household income, is going to take a tumble.

The Canadian recession outcome is all but set in stone if we layer on the negative wealth effect from falling home prices and stock markets.

While the Bank of Canada continued its aggressive rate-hiking path with the 75-basis point increase last week, it will likely be stopped in its tracks as the central bank comes to terms with the fact that the Canadian economic backdrop is weakening rapidly.

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