#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.


June 18 - June 22, 2018

Central banks  |  Brexit  |  Protectionism  | 


Buoyant central banks:

  • The era of extreme monetary stimulus continues to fade. Some central banks, such as the Fed, have now been journeying along this path in steady fashion for the past several years. Others, such as the Bank of Canada and the Bank of England, are proceeding more fitfully, but are nevertheless still pointing upward: the market highlights a 72% chance of a further hike at the next opportunity in Canada and a 70% chance of a rate hike by year-end in the U.K.
  • Last week, the Fed continued to lead the charge. Not only did it raise the fed funds rate to 1.875% – well beyond an emergency setting – but the message accompanying the decision was mostly hawkish. Growth, inflation and unemployment rate forecasts were all ameliorated. The median of the Fed’s dot plots now points (albeit, barely) to a total of four rate increases for 2018, up from the prior central tendency of three. The verbiage of the message was upgraded in many small ways, and a reference to the policy rate needing to remain before long-run norms was excised. The accompanying press conference hastily emphasized that no sudden acceleration of monetary tightening is afoot, but equally the Fed is clearly not about to stop tightening despite protectionist uncertainty.
  • The European Central Bank has long been among the handful of developed-world central banks still focused on delivering stimulus. Technically, it remains that way, with quantitative easing set to continue through the remainder of 2018. But the central bank last week laid out its plan to gradually wean the European economy off of monetary stimulus. Barring any sudden shock, the ECB plans to taper its bond buying as of September, halt it altogether by the end of the year, and then deliver a first rate hike in the vicinity of September 2019. This signal was delivered earlier than the market (and we) were expecting, lending a hawkish interpretation. But the timing of the first hike – in the fall of 2019 rather than the summer of that year as speculated – largely offset that interpretation. But the main point is that another huge central bank is planning to embark down the tightening path.
  • What about the Bank of Japan? It remains the laggard, motivated to maintain ultra-low interest rates for longer than the rest due to a persistently low inflation rate (and a lot of public debt). But something is brewing even with the BoJ. For instance, the market identifies a 25% chance of a Japanese rate hike by the end of 2018. The Bank of Japan has been buying fewer government bonds than usual, though this has less to do with a strengthening economy and more to do with the fact that the central bank is not being forced to actively defend its +10bps ceiling on the Japanese 10-year yield.

Brexit update:

  • Brexit battles continue to be fought in the U.K., along several overlapping lines:
    • Astonishingly, two years after the Brexit vote, a fierce fundamental battle continues within the Conservative Party over what type of Brexit to pursue: hard or soft. While a fairly soft Brexit appears the odds on bet, nothing is certain given the minority status of the government and the embattled position of the Prime Minister.
    • Members of parliament are currently debating the degree of oversight they will have on the final Brexit deal, versus a more executive-oriented model in which Prime Minister Theresa May has final say. A vote this Wednesday is expected to be very close and will help to determine the relative balance of power.
    • The seemingly small matter of the Northern Irish border continues to be a pivotal issue. If the Irish-Northern Irish border is to remain unencumbered, the U.K. must either agree to a customs union with the EU or impose a border that slices across the U.K. itself (between Northern Ireland and the rest of the U.K). The U.K. has proposed three alternative cheats – a hybrid customs partnership in which the U.K. would collect certain customs on behalf of the EU while remaining a separate entity, “maximum facilitation” in which high-tech solutions would minimize the disruption of an Irish border, or effectively delaying the imposition of a border until a considerably later date. But none seem practical and all have been rejected by the EU.
  • Previously, the “Canadian model” of a standard goods-oriented free-trade agreement with the EU seemed the most likely scenario for the U.K.
  • Now, however, a customs union appears more probable. Not only does it address the Irish border and permit the free flow of goods, but it is supported by the majority of British MPs. It would allow the U.K. to retain control over its budget, immigration and most of its rules. However, the U.K. would likely be unable to negotiate separate trade deals with other countries, and would not enjoy free trade in services. All in all, this is a “softish” outcome, subtracting somewhere between 2 and 5 percentage points from the level of British GDP (see scenarios in graphic, below).


Protectionism pivots toward China:

  • Our central thesis on protectionism is that trade spats are economically tolerable, but trade wars are not.
  • Thankfully, everything the U.S. has done so far fits into the first of these categories. However, it is undeniable that as small tariff builds upon small tariff, the risk of something more problematic mounts.
  • This week has brought virtually no new NAFTA news, but a few developments on the China-U.S. axis. This pivot is unsurprising given that the North Korean summit is now done and so China is no longer needed as a tactical ally.
  • As long threatened, the U.S. is now imposing a 25% tariff on $50 billion in Chinese imports. The first round of these actions will hit $34 billion of Chinese products on July 6. The remaining $16 billion will occur by the early Fall after public consultation. The products targeted appear to be less consumer-oriented than original feared, making the hit less visible to the consumer (but therefore more visible to businesses and investors). The products are disproportionately oriented toward impeding China’s “Made in China 2025” aspirations of excellence in a variety of technological and industrial fields.
  • As widely expected, China is retaliating in tit-for-tat fashion, with its own 25% tariffs on $34 billion in mostly agricultural U.S. products now and then another $16 billion later that will tilt toward U.S. exports such as oil.
  • As widely documented, the economic and inflation damage from these actions are puny, subtracting perhaps 0.1% from GDP and adding no more than 0.1% to the CPI of each nation.
  • The U.S. is now threatening a further 10% tariff on another $200 billion of Chinese imports (double the previous threat, though at a lower tariff rate), and China has suggested it would continue to match the U.S. This would roughly triple the economic and inflation damage.
  • Our feeling is that the U.S.-China trade relationship will likely sour further, though ultimately stop short of a full trade war.

Items of interest:

  • North Korea summit: The U.S.-North Korea summit went well in the sense that both leaders got along and thus the risk of a near-term military conflict is reduced. But this risk was always quite low in our view and the U.S. has arguably conceded too much to North Korea. It is doubtful that North Korea will actually give up its nuclear weapons program. Furthermore, other rogue nations could be emboldened to follow a similar nuclear weapons-oriented path to global clout.
  • OPEC summit: The coming OPEC oil summit this Friday in Vienna is proving a tricky one to predict. The biggest players – Saudi Arabia and Russia – have already begun to increase their oil production and are said to support a formal increase in OPEC production quotas, at least in principle. This makes sense as shortfalls of production elsewhere within OPEC combined with high prices and surging U.S. shale production argue for some tempering of enthusiasm. However, the likes of Iran, Venezuela and Iraq – the very countries struggling with production shortfalls – don’t want the quota to be increased as they are desperate to maximize their short-term government revenue. As such, the final decision is something of a toss-up. Suffice it to say we expect the big players to increase their production to some extent, whether a formal deal is struck or not.
  • CETA trade deal: Italy’s new populist government has threatened to kill the Canada-EU free trade agreement. While the deal is currently operational, its permanent implementation is still subject to ratification by all involved countries. This risk was something we flagged a few years ago, particularly as populism builds. The deal is not central to either party’s economy, but represented a symbolic victory for globalization over protectionism. For the record, we still think it more likely than not that CETA survives.
  • Canadian household debt: Notably, Canada’s household debt-to-disposable income ratio has now fallen to its lowest level in two years and continues to angle slightly downward. This is something given the rising trend that previously dominated for many years. The reversal also makes sense given the recent pull-back in mortgage demand paired with a surge in wages plus robust hiring over the past few years. However, it doesn’t tell the entire story. The cost of servicing all of this debt is actively rising due to higher global interest rates. Thus, the burden and risk isn’t necessarily falling even though the debt ratio is.



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


May 14 - May 18, 2018

Iran sanctions  |  New U.S. weapon  |  Italian politics


May 7 - May 11, 2018

Softer data  |  Stock-bond correlation  |  Week ahead  | 


April 30 - May 4, 2018

Higher Yields  |  IMF  |  Protectionism  |  Fed


April 23 - April 27, 2018

Business cycle  |  History of protectionism  |  China  |  Bank of Canada


April 16 - April 20, 2018

Remembering fiscal  risks  |  A geopolitical update  |  Bank of Canada preview


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