Produced by RBC Global Asset Management's Chief Economist Eric Lascelles, the #MacroMemo covers what's on our economic radar for the week.
Substantial Saudi risks:
Chinese financial reforms:
Monthly economic webcast:
A new Fed Chair:
U.S. tax reform update:
U.S. corruption investigations:
o The Fed’s own dot plots from September clearly point to one further rate increase in 2017 in the opinion of Fed participants.
o The market prices in an 83% chance of a December rate hike.
o The U.S. economy remains strong.
Bank of Canada review:
o Data dependency was again emphasized, in line with earlier speeches by Governor Poloz.
o A cautious path forward: the BoC “will be cautious in making further adjustments to the policy rate.”
o Downside risks emphasized in the press conference: “more preoccupied with the downside risks to inflation.”
o The Canadian economy has become more sensitive to interest rates, meaning that less rate hiking is needed to achieve a particular aim.
o High uncertainty was emphasized as a key factor, implicitly motivating the delay of any near term action. The cited risks were of a geopolitical, fiscal and trade policy nature. For our part, we increasingly anticipate a negative outcome to the last of these three variables.
o The strong currency was cited as a reason for inflation’s return to normality to be delayed until the second half of 2018.”
o Inflation measures edged higher, as expected.
o The Canadian output gap is now closed, a quarter ahead of schedule (though, confusingly, the labour market component of this is still a little distance from normal, and inflation normalizes even later – usually these things are all synchronized).
o The Canadian economy grew more quickly than expected in the second quarter and is increasingly broadly based; the Bank’s 2017 and 2018 growth forecasts were upgraded, as was the U.S. growth forecast for 2018 and 2019.
o Oil prices are a little higher than previously assumed (this helps both growth and inflation).
Next Fed Chair:
China Party Congress:
Upcoming BoC decision:
Canadian mortgage rule change:
A few others:
More NAFTA thoughts:
Policy in the week ahead:
Canadian economy slips:
o Flat July GDP
o A somewhat tamer Business Outlook Survey, released earlier this week
o Our declining Canadian Economic Composite (chart below)
o More moderate job creation
o A falling Canadian economic surprise index
o Comments from the Bank of Canada that growth should slow and that the central bank is now data dependent
Monthly economic webcast:
o The Spanish constitution explicitly bars regions from leaving. Catalans voted strongly in favour of Spain’s 1978 constitution which guaranteed a unified country, along with subsequent statues of limited autonomy for the region within a Spanish whole.
o Famously, Spain has managed to retain a hold on the Basque region despite long antagonism that occasionally flared into violence.
o Catalonia is already recognized as an autonomous region, so the discussion may instead be framed around how much additional power Catalans seek.
o Most countries do not want to indirectly encourage the separatist movements within their own borders.
o There are myriad ways of evaluating the legitimacy of a region’s pursuit of sovereignty, mostly framed within the context of whether a region is being mistreated in its prior arrangement:
U.S. capital stock concerns:
o First, when measured on an inflation-adjusted basis, the decline as a % of GDP is not as severe, since the cost of capital goods has tended to rise less quickly than the inflation rate in the broader economy. The capital is still there and no less potent even if it costs less money.
o Second, this capital stock ratio has been declining for decades. It does not reflect some malaise that suddenly materialized with the onset of the crisis. There are broader narratives at work, as discussed shortly.
o Third, when structures are excluded from the capital stock mix – leaving the more high-tech (and offering a higher return on capital) combination of equipment and intellectual property – this subset of the capital stock has been rising sprightly as a % of GDP. In other words, the important stuff like computers and patents is still growing, even if the number of old-fashioned factories and warehouses is shrinking.
o Fourth, while the overall capital stock is shrinking as a % of GDP, the usage of the capital stock has actually accelerated. Capital is “used” as it is consumed – as its value depreciates – and by this metric the U.S. economy is much more capital-intensive than it first appears.
Three U.S. fiscal items:
o The main thrusts are a corporate tax rate cut from 35% to 20%, the immediate depreciation of capital investment and lower personal tax brackets.
o To help pay for this is a proposal to limit business interest deductibility and to eliminate the ability for individuals to deduct their state and local tax bills from federal taxes owing. These are both enormously consequential proposals. In particular, the first item would incent a substantial change in the structure of American corporations away from a reliance on debt. We are dubious these changes will be made given that lobbyists will be up in arms.
o Although the current plan is for something in the range of a total tax cut worth $2.4T to $5.0T over a decade, the net effect on growth should be no greater than $1.0 to $1.5T once various loopholes are closed.
o At present, we assign a 60% chance to tax cut legislation in 2018, and budget for a 0.5% boost to U.S. GDP growth if implemented.
o In light of recent unfavourable assessments by negotiators and the latest U.S. push for a “buy American” exemption, we upgrade the chance of NAFTA being terminated altogether from 15% to 25%, and assign an overall 40% chance of an economically “bad” NAFTA outcome, versus a 60% chance of a more benign outcome.
o The latest efforts to reform U.S. health care have failed, and with the end of September and thus the U.S. fiscal year it is unlikely that additional serious efforts will be made in the near term.
Other interesting items:
U.S. dollar weakness:
o Historical dollar cycles have gone from a very cheap valuation to a very expensive one – this one has yet to achieve that final destination.
o From a technical perspective, a further leg higher seems fairly likely.
o We believe the Fed may manage to raise rates by more than the market currently envisions. In contrast, some others, such as the Bank of Canada, may be in the opposite position.
o From an economic standpoint, the U.S. is moving along nicely and could benefit from tax cuts that are more likely than the market currently envisions for 2018. If a repatriation holiday is included for overseas corporate profits, the resulting inflows could further boost the dollar.
o While the risk of protectionism might seem a non-trivial fiscal offset to the aforementioned tax cuts – and it is, from a purely GDP perspective – the more important consideration for the dollar is that countries imposing tariffs on their trading partners usually experience a rising exchange rate. This phenomenon represents the FX market recalibrating post-tariff competitiveness levels across nations.
Hawkish Fed recap:
U.S. tax reforms:
Canadian GDP preview:
Seeking Bank of Canada clarity:
Monthly economic webcast:
Hawkish central banks:
German election preview:
Monthly economic webcast:
Bank of Canada raises rates:
Understanding Canada’s stock-GDP disconnect:
Bitcoin as currency:
This report has been provided by RBC Global Asset Management (RBC GAM) for informational purposes only and may not be reproduced, distributed or published without the written consent of RBC Global Asset Management Inc. (RBC GAM Inc.). In Canada, this report is provided by RBC GAM Inc. (including Phillips, Hager & North Investment Management). In the United States, this report is provided by RBC Global Asset Management (U.S.) Inc., a federally registered investment adviser. In Europe and the Middle East, this report is provided by RBC Global Asset Management (UK) Limited, which is authorised and regulated by the UK Financial Conduct Authority. In Asia, this document is provided by RBC Investment Management (Asia) Limited, which is registered with the Securities and Futures Commission (SFC) in Hong Kong.
RBC GAM is the asset management division of Royal Bank of Canada (RBC) which includes RBC GAM Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, the asset management division of RBC Investment Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.
This report has not been reviewed by, and is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the above-listed entities in their respective jurisdictions. Additional information about RBC GAM may be found at www.rbcgam.com.
This report is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. The investment process as described in this report may change over time. The characteristics set forth in this report are intended as a general illustration of some of the criteria considered in selecting securities for client portfolios. Not all investments in a client portfolio will meet such criteria. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.
Any investment and economic outlook information contained in this report has been compiled by RBC GAM from various sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its affiliates assume no responsibility for any errors or omissions.
All opinions and estimates contained in this report constitute RBC GAM's judgment as of the indicated date of the information, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates and market conditions are subject to change.
Return estimates are for illustrative purposes only and are not a prediction of returns. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods. It is not possible to invest directly in an unmanaged index.
A note on forward-looking statements
This report may contain forward-looking statements about future performance, strategies or prospects, and possible future action. The words "may," "could," "should," "would," "suspect," "outlook," "believe," "plan," "anticipate," "estimate," "expect," "intend," "forecast," "objective" and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties about general economic factors, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made. These factors include, but are not limited to, general economic, political and market factors in Canada, the United States and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings and catastrophic events. The above list of important factors that may affect future results is not exhaustive. Before making any investment decisions, we encourage you to consider these and other factors carefully. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility.
® / ™ Trademark(s) of Royal Bank of Canada. Used under licence. © RBC Global Asset Management Inc., 2017