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The federal budget introduced on March 4th will be forgotten within a week. In many ways this budget should be seen as a transitory budget, with no major initiatives. All the difficult decisions were postponed until the 2011 budget.
But what’s very clear at this point is that from a global perspective, the stimulus and bailouts of yesterday will turn into the fiscal tightening of tomorrow. The US might turn out to be the most difficult case. The issue is not only that the US current budget deficit is close to 10% of GDP, but also the composition of the deficit. Note that “pure” expenditure growth (that is program spending) by the government was not very large and this boost was offset by a de-facto spending cuts by state and local governments. So at the end of the day over the past year, we have seen only $40-$50 billion of pure spending—nothing to write home about. The vast majority of “spending” (close to $500 billion) was in the form of transfer to financial institutions, individuals and lower taxes. Note, for example, in US, all the growth in personal income currently is due to transfer payments and lower taxes. Wage income is actually falling. The point here is that when it comes to taxes and transfer payments, it is much more difficult (politically speaking) to cut when compared to pure fiscal spending.
Also remember that in both the US and Canada, the ability to cut the deficit in the 1990s was largely helped by falling interest rates, and in the case of Canada, a very weak dollar. Both factors are not at play in the current situation. Accordingly, look for any improvement in the fiscal situation to be limited.
The practical implication here is that huge budget deficits cannot co-exist with record low interest rates. Something will have to give. And this something must be interest rates. The new global fiscal reality suggests that long-term interest rates will probably rise faster than short-term rates in the coming 2-3 years—leading to a notable steepening in the yield curve.
In this context, Greece will try to sell enough bonds next week to finance the close to $30 billion of debt that is about to mature in April and May. Note that after these two months, the refinancing situation of Greece will improve for a while with much less debt expected to mature in the following months. So they have to go through the next two months before getting a break. At this point it is far from clear that the market will be willing to absorb this amount of Greek debt—so look for some volatility next week.
The US labour market is still unable to create jobs and start reversing the trend that cost no less than 8 million jobs during the recession. But if you look at overall manufacturing activity in the US, you will see a very different picture with an impressive rebound in production activity. In fact, the manufacturing sectors on both sides of the 49th parallel are showing signs of life. But the improvement in the US is not only stronger, but also much more capital-intensive. The practical implication of the more capital-intensive manufacturing rebound south of the border is that despite the strong Canadian dollar, manufacturing employment in Canada will probably rise faster than in the US in the near term. However, given the increased prevalence of better- capitalized and more efficient production facilities stateside, Canadian manufactures will find it even more difficult to compete when the dust settles.
Benjamin Tal
Senior Economist
Budget 2010
Canada’s Budget 2010 aims to take advantage of Canada’s economic recovery and prepare it for the future.
The budget plan has three main broad aims.
- It confirms $19 billion in new federal stimulus under Year 2 of Canada’s Economic Action Plan, to create and maintain jobs complemented by $6 billion from provinces, territories, municipalities and other partners.
- It invests in a limited number of new, targeted initiatives to build jobs and growth for the economy of tomorrow, strengthen Canadian innovation, and make Canada a destination of choice for new business investment.
- Budget 2010 charts a course to bring Canada’s finances back to balance over the medium term and well before any other Group of Seven (G7) country.
The Canadian brand will be based on competitive taxes, renewed infrastructure and skills, a strong head start in clean energy, a tariff advantage, less red tape, and a more prominent voice as a global financial sector leader.
All of these measures will contribute to maintain and sustain Canada’s fiscal health, which according to the Department of Finance is the envy of the world.
As far as the mortgage industry us concerned the 2010 federal budget includes new regulations to standardize mortgage prepayment disclosure and the elimination of the Insured Mortgage Purchase Program (IMPP).
Under the Insured Mortgage Purchase Program, Canada Mortgage and Housing Corporation (CMHC) purchased securities comprised of pools of insured residential mortgages from Canadian financial institutions to provide long-term stable funding to lenders and help them continue lending to Canadian consumers and businesses.
Of the $125 billion available, as of September 21, 2009, $64.2 billion had been disbursed through 16 reverse auctions: $43.3 billion through 10 fixed-rate reverse auctions and $20.9 billion through six floating-rate reverse auctions. 19 different financial institutions participated directly in the program, including banks, non-bank deposit-taking institutions, and life insurance companies.
Some bankers argue that the program should remain in place as a safeguard. However, recent figures suggested that bank interest had dwindled with just $65.9 billion worth of mortgages having been disbursed. Just a few weeks ago the government offered to buy up to $4-billion of mortgages, but banks only sold it $1.4-billion worth. One last purchase is scheduled for March 24.
The government also says that it will introduce legislation setting out a framework for covered bonds, a type of bond that remains on a banks’ balance sheet and can be backed by assets such as mortgages. They are similar to Canada Mortgage Bonds, except for the fact that they remain on the banks’ balance sheets and that they do not carry the government’s guarantee. A number of Canadian banks have already begun issuing covered bonds during the last two years, and have been successful in selling them to investors.
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