Canada is Likely to Come Out on Top, but the Risk of Recession Remains Elevated

Canadian Economics

  • Our recession risk tracker for March shows a 95.0 per cent risk that Canada could slip into a recession within the next twelve months.
  • The yield curve remains inverted. At the end of March, the 10-year government bond yield and the three-month treasury yield fell to 2.93 bps and 4.3 bps, respectively. As a result, the term spread declined to –1.37 bps.
  • The national inflation rate fell to 4.3 per cent (year-over-year) in March. With inflation moving in the right direction, The Bank of Canada hit a pause on interest rates once again—leaving the target for the overnight rate untouched at 4.5 per cent.
  • Canada’s labour market performed surprisingly well over the last three months—over 200,000 jobs were added to the labour force in Q1 of 2023, while the unemployment rate remained steady at 5.0 per cent.  
  • Our model puts the odds of a U.S. recession within the next twelve months to be around 86 per cent. The collapse of Silicon Valley Bank and Signature Bank raised recession odds; however, the Federal Reserve successfully stabilized the situation.
  • The slope of the U.S. yield curve fell to –1.37 bps in March, while excess bond premiums declined to –0.19 bps—which means that investor risk appetite in the corporate bond market waned.

Key Insights

The financial sector turmoil in the U.S. was contained and did not impact the Canadian economy, but how it was handled could open the door for future banking crises. The collapse of Silicon Valley Bank led to the second-largest failure of a financial institution in U.S. history. There were fears that financial contagion could ensue. The Federal Reserve stepped in and successfully contained the banking crisis by offering a safety net for both insured and uninsured depositors. The U.S. banking sector remains in good shape, but the actions taken by the Federal Reserve could create a moral hazard problem; investors and commercial banks could take on more speculative investments (perhaps even outside of the regulatory perimeter), which would pose a greater risk for financial markets.

The inverted yield curve indicates that investor sentiment has dampened, and recession risk has intensified. Our recession tracker puts the risk of a recession occurring in Canada within the next twelve months at 95.0 per cent. Just because the risk is high, it doesn’t mean that a recession will happen. This risk assessment gives us an idea of what the markets are saying. In fact, our results are driven by financial data and the Canadian business cycle —which could be approaching a trough over the next several months. A negative term spread usually precedes recessions, but this is not the golden rule—there have been instances where the yield curve inverted, but no recession occurred. Since the 10-year bond yield and 3-month treasury yield differential continued to decline, the recession risk tracker produced a higher probability of recession. 

An economic slowdown is on the horizon, but Canada will likely avoid entering a recession. According to our latest national forecast, the Canadian economy is expected to come to a standstill in 2023 but then recover in early 2024. Consumer confidence slightly improved over the last few months, but overall confidence levels remain in a ‘recessionary range’ comparable to April 2020 and the Great Financial Crisis. We have not yet felt the full impact of previous tightening monetary policies. As a result, we expect that demand for durables will wane throughout the year. However, excess savings and a tight labour market will play a role in the economy’s soft landing.