Ontario Election Flash, June 2018

• The election outcome was consistent with the polls, though PCs and Liberals did better than last polls on June 6 suggested, and NDP did worse. However, each outcome was within the ranges that the CBC poll tracker outlined.
• PCs have a strong mandate to implement their agenda of tax cuts and spending cuts.
• The key constraint on them, as it would have been on any party that won the election, is Ontario’s troubled finances. The budget figures are much worse (considerably larger budget deficits) than the Liberals said they were in their last budget, according to both the Auditor General and the Financial Accountability Officer.
• Basically, the cupboard is bare and all of the parties were going to have to walk back their electoral promises.
• Click the link below for an excellent discussion between Steve Paikin and Don Drummond (ex Dept of Finance, TD Chief Economist; one of the better economists in Canada, in my opinion) on Ontario’s financial state and a discussion of the policy options available.

• Ontario faces a prolonged period of spending restraint where expenditure growth is limited over a number of years, or a much shorter period of slashing and burning. There is also pressure to raise revenues in an environment where taxes are already very high, and where economic growth (and hence revenue growth) will likely be up to a half-point lower than projected over the next several years (due to demographic factors and the increased competitive challenge from the U.S.).
• Ontario needs lower corporate and personal income tax rates to be competitive, but it can’t afford them. The only economically sensible taxes to increase are the HST, sin taxes, carbon tax, or gas taxes. If the PCs take a populist approach and cut gas and beer taxes, the odds of any tax changes to improve competitiveness are low, and the pressure to cut spending will increase.
• The only way Premier-designate Ford can fund all of his tax promises at any time over the next four years would likely involve deep spending cuts or ultra-rosy economic forecasts, or more likely both.
• It will likely take the PCs some time to come to grips with the financial situation (i.e., sometime after its first budget. Recall that was also the case in the first budget by the Chretien government in 1994; it took until the 1995 budget to come to grips with a situation that was more dire than Ontario at the moment). This recognition lag would have been the case for the NDP if it had won the election.
• It is going to be difficult for the PCs politically to have to walk back their promises, just as it would have been for the NDP.
• One issue that came up frequently in discussions with my economist and financial market friends and contacts was that the PCs have good bench strength with lots of potentially solid cabinet ministers, but there are concerns that Doug Ford won’t listen to them or take their advice. This single concern caused many of them to seriously consider voting NDP.
• Ontario bonds are likely to be weak performers in this new environment. If the new government drives forward and ignores the finances so it can deliver on its promises, it will be even more troubling for Ontario’s bonds. Ontario’s credit rating is likely at risk of an additional downgrade.
• A zero weight on Province of Ontario bonds beyond a few months’ duration seems prudent.
• The direction of Ontario’s fiscal policy adds a new element of uncertainty for the Bank of Canada, but this uncertainty pales compared to that related to U.S.-Canada trade. Canadian economists remain very upbeat on Canada’s economy and several of them see the overnight rate doubling from its current 1.25% setting to 2.50% by the end of 2019. Markets are currently pricing in two quarter-point rate hikes in the next 12 months, an outcome that is much more reasonable in my estimation.
• The trade situation with the U.S. remains critically important for Canada, and it is getting worse, not better. I am concerned about this, especially in relation to the Canadian dollar which could end up being much weaker than my base case outlook from the April 2018 Big Picture.

Thank you for reading,