Weekly Market Insight

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1 Economics Weekly Market Insight May 29, 2015 Economic Update Benjamin Tal The recent announcement by the Finance minister that he will be looking into the possibility of voluntary increases in CPP contributions created a lot of noise. Without getting into the politics of it, it is important to remember why a change to the system is essential. The following are some observations derived from a simulation of pension income. The typical 70-year-old today has enough income to maintain his or her pre-retirement standard of living, taking into account the typical drop in expenses in one s post-working years. Their sources of income are well diversified, drawing on both government programs (CPP/QPP, OAS and GIS), pension plans (RPPs), savings accumulated in RRSPs and other funds. While many Canadians, particularly those now close to 65, are on a path to the retirement of their dreams, the data show that millions of others are headed for a steep decline in living standards in the decades ahead, particularly those who are currently younger and who are in middle-income brackets. Those born during WWII are positioned to maintain virtually all of their pre-retirement consumption patterns: after allowing for the drop in living costs, they have a replacement rate close to 1.0. The leading edge of the baby boom generation (post-ww II, born between ) that followed is only slightly less advantaged. But their children are much less well positioned, given the current trend towards lower savings rates and reduced private pension coverage. On average, the replacement rate of those born in the 1980s, who will retire towards the middle of this century, will be only 0.7, implying a 30% drop in their standard of living. Across income groups, future replacement rates look a bit counterintuitive on the surface. Those in the lowest income decile will, on retirement, replace the greatest share of their pre-retirement consumption. Indeed, they might actually be in a position to improve on their living standards, with the replacement ratio of 1.9. That shouldn t be interpreted as a bountiful retirement, since it s benchmarked relative to their very low pre-retirement status. Still, the system now in place does offer important protection for the lowest economic status households. Similarly, the low replacement ratio for the highest decile is also misleading. Although they have on average the lowest share of their pre-retirement living standards maintained on retirement, in absolute terms they will on average enjoy a very high consumption pattern. Those individuals in the top 10% of income earnings (who today earn roughly more than $100,000 per year in individual income) are excluded in order to avoid making a big deal about percentage drops in living standards to what will still be a reasonably comfortable retirement. /2

2 While all income deciles, on average, are replacing 80% or more of their pre-retirement incomes, averages mask the problem. Within each age cohort and income group lie a substantial number of Canadians headed for trouble. Nearly 60% of Canadians born between and almost half of those born in the late 1960s will end up with a below 80% replacement rate. In contrast, that fate was faced by only a quarter or less of those born during or shortly after WWII. Add it all up, and there are some 5.8 million working age Canadians who will see more than a 20% drop in their living standards upon retirement. That s why the time to act is now. Weekly Market Insight 2

3 Market Snapshot US Current* yesterday* a week ago* a month ago* a year ago* TED SPREAD (bps ) Y - 2Y S PREAD (bps ) Y SWAP SPREAD (bps ) M T-Bill (%) LIBOR 1 MONTH (%) LIBOR 3 MONTH (%) YR BOND (%) YR BOND (%) YR BOND (%) A Rated - 10Y TREAS URY (bps ) B Rated - 10Y TREAS URY (bps ) BB Rated - 10Y TREASURY (bps ) CANADA PRIME - BA SPREAD (bps ) CDOR 3 MONTH (%) CDOR 3 MONTH - 3M T-BILL S PREAD (bps ) Y - 2Y S PREAD (bps ) YR BOND (%) YR BOND (%) YR BOND (%) A Rated - 10Y TREAS URY (bps ) BBB Rated - 10Y TREASURY (bps ) CAN S overeign Agency - 10Y TREAS URY (bps ) C OMMODITIES WTI CRUDE FUTURE (US $ / bbl.) NATURAL GAS (US $ / MMBtu) SILVER (US $ /t oz.) GOLD (US $ / t oz.) WHEAT (US / bu.) SOYBEANS (US / bu.) SUGAR (US / lb.) CORN (US / bu.) FX C$ / US $ US $ / EURO C$/ EURO YEN / US $ US $ / BRITISH POUND SWISS FRANCS / US$ EQUITY MARKETS S&P/TSX COMPOSITE S &P NAS DAQ DOW JONES RUS S ELL DAX FTSE NIKKEI * As of ~11:00 a.m. Toronto time Note: Data is for reference only. Weekly Market Insight 3

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