#MACROMEMO

On our economic radar this week

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Produced by RBC Global Asset Management's Chief Economist Eric Lascelles, the #MacroMemo covers what's on our economic radar for the week.


August 13 - August 17, 2018

Business cycle  |  Consumer outlook  |  Cdn competitiveness  |  Tariffs  |  and more


Business cycle update:

  • Our latest quarterly business-cycle review is now complete, yielding the same broad conclusion as the prior quarter. The U.S. economy is probably in a “late cycle” position (see first chart), arguing the economy has no more than another year or two of growth before the business cycle comes to its natural end.
  • Supporting variables include an absence of economic slack, big job gains, a long run up in equities, a high level of confidence and a few wobbles in the credit space.
  • Of course, not all of the indicators agree. At the extreme, a few go so far as to argue we are still early in the cycle, while a handful make the diametrically opposite claim – that the cycle is going through its death throes right now. Neither is likely.
  • If we are erring in our diagnosis, it is more likely that we are slightly premature as opposed to too late. Supporting this, the second most common interpretation in our model is “mid cycle.” That counterfactual would add a few more years onto the economic expansion.
  • Whereas over the preceding several quarters the cycle was obviously chomping forward – this is to say, more of the inputs were moving forward rather than backward despite an unchanged central tendency – this quarter saw an equal number of inputs inch forward (Inventories, Prices and Credit) and backward (Equity profitability, Equities direction and Volatility).
Business cycle inputs

U.S. consumer can remain buoyant:

  • Despite higher interest rates that may restrain the U.S. consumer, we find that five other factors remain supportive of future robust spending gains (see next graphic).
  • First, job creation remains quite good. True, the latest print was slightly below recent standards, but it was still a positive result and upward revisions largely undermined any criticism. Rock-bottom jobless claims suggest the trend may persist.
  • Second, wage growth has picked up. It falls somewhat short of being “strong”, but it is certainly improved and alternate metrics argue the gains are larger than they first seem when compositional distortions are corrected.
  • Third, consumer confidence is quite high. One might debate whether this promises further spending gains in the future or instead argues there is less room for additional exuberance to come down the pipe, but the bottom line is that consumers are feeling good, and this sentiment is often expressed at the shopping mall.
  • Fourth, household wealth is rising nicely thanks to steady home price gains and (less steady but nevertheless positive) stock market gains. Some fraction of this is usually repurposed into consumer spending.
  • Fifth, by virtue of a mind-blowing revision to the U.S. personal savings rate, suddenly U.S. households have been discovered to be socking away around 7% of their income as savings, more than double the previous estimate. In turn, this means that consumer spending growth can easily outpace personal income growth in the coming years without translating into a problematically low savings rate.
U.S consumer can remain buoyant

Canadian competitiveness woes lessen:

  • We have long fretted about Canadian competitiveness due to a raft of policy decisions made over the past several years in both Canada and the U.S. that have opened up a large competitiveness wedge to Canada’s disadvantage.
  • The bulk of these challenges remain in place, but it is worth tallying up a number of a recent small to middling developments that should help to improve the situation:
    1. The federal government plans to soften the impact of its upcoming carbon tax by increasing the exemption rate for industries competing against global competition.
    2. Various pipelines are inching forward. The Canadian government has famously taken over the Trans Mountain pipeline that will extend west over the Rockies. The proposed new route for the Line 3 oil pipeline from Alberta through to Wisconsin received environmental approval in Wisconsin.
    3. NAFTA prospects appear somewhat improved, as discussed later in this report. This argues that Canada’s tariff barrier with the U.S. may not get much bigger.
    4. Federal Finance Minister Morneau has identified business taxation as a theme to be addressed in the government’s fall fiscal update. How substantial any relief will be is entirely speculative, but something may be coming.
  • Furthermore, the fact that these various changes have occurred argues that the government is indeed pivoting in response to perceived competitive shortcomings. In turn, additional remedies are possible.
  • For all of this good news, Canada’s competitiveness shortfall is still significant and housing risks present another challenge. As such, we feel slightly better about Canadian growth, but remain fundamentally cautious.

Protectionism update:

  • As always, there have been some additional developments on protectionism.
  • The U.S. is continuing with its plan to apply tariffs to another $16B of Chinese imports. The new tariffs will hit on August 23rd. China will retaliate in kind.
  • As the U.S. continues to threaten tariffs on a further $200B (or even $400B) of Chinese imports (at either a 10% or a 25% rate – the first number has been discussed more seriously but the second figure was threatened at least once), China has responded by indicating it would add a tariff to a further $60B in imports from the U.S. Why is this asymmetric to the U.S. plan? Because China simply doesn’t import that much stuff from the U.S. Of course, China could impose a higher tariff on a smaller amount of goods to level the playing field, or deploy various non-tariff measures.
  • South Korea – the one country with which the U.S. had struck a tentative trade deal under the Trump Administration – is threatening not to sign on unless its cars are made exempt from any future auto tariff. Korea had agreed to increase U.S. access to its domestic auto market and to impose a voluntary quota on its steel exports to the U.S. In our view, the issue is probably a moot point – an auto tariff would be so bad for everyone that it is unlikely to be delivered.
  • We are feeling a bit better about the prospect of a NAFTA deal given apparent progress in negotiations between Mexico and the U.S. over the auto sector. While Canada could thereafter find itself in the hot seat for a while, we suspect that any deal will ultimately include all three countries given that the Mexico-U.S. disagreements are much more fundamental than the Canada-U.S. ones. Refer to our updated probability table, next.
  • NAFTA renegotiation scenarios
  • However, at the same time, we now assume that the U.S.-China trade dispute will take at least one further step forward, meaning that the most likely protectionism scenario from a broader U.S. perspective is now “Negative” as opposed to “Slightly negative” (see next chart).
  • U.S trade scenarios for 2018-2019
  • Lastly, we identify a few reasons why the theoretical economic damage from tariffs tends to be smaller than one would normally expect:
    • In the U.S., companies have the right to request an exemption from a new tariff if they are unable to secure the product by some other means. So far, more than half of such requests in the aftermath of the steel tariff have been approved, demonstrating how the effective increase in the tariff rate may be considerably less than a simple calculation would suggest. However, the logistics are an issue: 29,000 requests for “tariff exclusion” were made in response to the steel tariff alone. The U.S. has since implemented several other tariffs. And the Commerce Department has only managed to process 1,317 of the steel requests to date. The one saving grace is that the government is apparently shifting to evaluating requests at the industry level as opposed to the company level.
    • As noted in prior weeklies, governments have been keen to compensate affected industries, transferring some of the suffering away from GDP and toward a higher government debt load.

Other tidbits:

  • More U.S. tax cuts: There have been a few murmurs about additional tax cuts in the U.S.:
    • One element is called “Tax Cuts 2.0”, and mainly involves making various temporary aspects of the first round of Trump tax cuts permanent. Other small tweaks are also proposed. However, this should probably be viewed as a policy position designed to excite the Republican base before an election as opposed to something that is likely to be implemented (especially given polls suggesting the Democrats will pick up the House).
    • A second item is a recent proposal to scrap the capital gains tax on inflation. This is actually a great idea from the perspective of eliminating an economic distortion, but it ultimately seems unlikely given how expensive it would be to deliver, how complicated to administer and given further distortions that would arise unless the tax cut were also extended to interest income.
  • U.S. sanctions on Iran were reintroduced on August 6th. Geopolitical risks are rising.
  • Canadian employment for July was great on the surface with 58K net new jobs and a cycle-low unemployment rate of just 5.8%. Beneath the surface, the number was slightly tarnished by a 28K loss of full-time jobs and softer permanent earnings growth. Still, it was a good report and comes on the heels of several others. The Canadian economy is strong right now.
  • U.S. inflation continues to edge higher. Core inflation is now running at 2.4%, the highest level of the cycle, and continuing a concerted upward push that began in late 2017. Headline inflation was unchanged at a heated 2.9%. We don’t foresee any serious inflation problems arising, but are happy to maintain our above-consensus inflation view for the developed world over the coming year.
  • Stretching back to early August, U.S. payrolls were pretty good though slightly below the consensus forecast, while the twin ISM reports both fell materially. All remain consistent with solid growth, but the argument that the U.S. is defying the economic deceleration occurring in much of the rest of the world seems less credible after the new data.



July 30 - August 3, 2018

Webcast  |  China stimulus  |  Tariffs  |  Savings rate  |  and more


July 23 - July 27, 2018

Tariff roundup  |  White House influence  |  Trump & Russia


July 16 - July 20, 2018

Credit cycle  |  Bank of Canada  |  Canadian housing  |  and more


July 9 - July 13, 2018

Webcast  |  Protectionism  |  China slows  |  Bank of Canada  |  Brexit  |  and more


June 25 - July 6, 2018

Global Investment Outlook  |  Corporate leverage  |  Falling forecasts  |  Tariffs  |  Much more


June 18 - June 22, 2018

Central banks  |  Brexit  |  Protectionism  | 


June 11 - June 15, 2018

Protectionism  |  Deflationary pressures  |  And more…  | 


June 4 - June 8, 2018

Webcast  |  Growth stabilizes  |  Protectionism  |  Round-up


May 28 - June 1, 2018

Financial conditions  |  Canadian housing  |  Trade deals  |  Italian politics


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