#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.


January 22 - January 26, 2018

U.S. government shutdown  |  Financial conditions deteriorate  |  Canadian medley  |  Other items


U.S. government shutdown:

  • The U.S. government shutdown has proven to be a short-lived affair, resolving after a mere three days of gridlock. This is in line with the normal experience. Among the 18 shutdowns that have occurred over the past 42 years, the shortest lasted a mere day, and the longest 21 days.
  • Markets were fairly calm throughout – again, in line with the historical experience.
  • The economic impact of the shutdown will be all but invisible to the naked eye, as the rule of thumb is that annualized quarterly GDP sheds just 0.1-0.2% per week of a shutdown, and this episode didn’t even make it to the halfway mark of Week 1.
  • But for all of that good news, the federal budget remains unresolved. The fix put in place merely delays another shutdown until February 8th – just over two weeks from now. Having demonstrated the strength of their conviction to their respective political bases, each side is now more likely to find a solution before the next deadline strikes. However, a second shutdown in short succession is not impossible.
  • The key sticking point remains immigration – finding a solution for the so-called “dreamers”: the children of illegal immigrants who had enjoyed temporary amnesty under President Obama but have a much less certain fate today.
  • The stakes over budget negotiations will rise steadily, as the interim government funding of many programs is at stake, and the risk of hitting the debt ceiling looms in March. We suspect all of these issues will be resolved without too much disruption to markets or the economy given a long record of such achievements in recent years, and as the incentive for good behavior rises as the mid-term elections approach.

Financial conditions deteriorate:

  • One key support for strong economic growth over the past 18 months has been steadily loosening financial conditions. That is to say, bond yields have been low, credit spreads have been narrowing and stock prices have been rising. All of this maps back onto economic growth via the optimism it creates, and via the created wealth that gets spent.
  • It is thus worth noting that financial conditions have arguably taken a small step backward in recent weeks. This is in two ways: via higher bond yields and higher oil prices.
  • Higher bond yields: Government bond yields have risen noticeably in many developed countries. Since last summer, 10-year yields have risen by around 65bps in Canada, 40bps in the U.S. and 20bps in Germany. The underlying reasons are not exactly mysterious: tighter monetary policy, stronger growth and higher inflation. But the increase in rates nevertheless imposes a slight macro drag that didn’t exist last summer.
  • Higher oil prices: The brisk rise in oil prices since last summer (from U.S.$45—$50 to nearly $65) has mixed implications, with some countries benefiting and others losing. But the balance of evidence is fairly clear on the global stage – higher oil prices are a mild drag on global growth. Fortunately, the drag should be quite small this time. The oil price increase is much less exciting than it looks for most countries since a substantial fraction of the move simply reflects a weaker U.S. dollar. Furthermore, one of the surprises of the 2015 oil shock was that low oil prices didn’t provide as much of a boost to growth as initially expected. It stands to reason that the reverse is also true – the global economy may simply be less geared to swings in oil prices.
  • It is worth noting that formal financial conditions indices don’t show much of a tightening. We write this mainly to note that yields and oil prices are seemingly now in play, with the capacity to soften the tailwind that financial conditions have provided, if not to reverse the direction of the wind altogether. Of course, there are other supports for strong global growth, such as good growth momentum, U.S. tax cuts, late-cycle dynamics and fading secular stagnation.

Canadian medley:

  • Higher oil good for Canada? Higher oil prices are – in theory – quite a positive for Canada. However, this particular shift won’t prove much of a windfall. That’s because at the same time as West Texas oil (WTI) prices have increased, the gap between WTI and the lower price that Canadian producers receive (Western Canada Select) has blown wider. In fact, the roughly $15 increase in WTI is perfectly offset by a $15 widening in the WTI-WCS spread. Thus, Canadian producers are receiving about the same price that they did last summer, and possibly worse once currency considerations are factored in.
  • Punching back on trade: As expected, Canada has now filed a complaint under Chapter 19 of NAFTA about U.S. tariffs on softwood lumber and Bombardier airplanes. This comes on the heels of a complaint filed a few weeks ago by Canada with the World Trade Organization on many elements of U.S. trade conduct. Given ongoing NAFTA negotiations, we expect 2018 to be a pivotal year for protectionism.
  • Competing employment surveys: Canada has two employment surveys – the Labour Force Survey (LFS) and the establishment survey (SEPH). The LFS tends to attract the most attention, but occasionally a newspaper or analyst will pick up on a contrarian signal coming from the other survey. As an example, the little-discussed SEPH just reported a loss of 11K jobs in its latest month. It is worth mentioning that the SEPH tends to be around half as volatile as the LFS. Do these facts call into question the otherwise very strong job gains reported by the LFS? Not really. The problem with the SEPH is that is stale and prone to revisions. The latest SEPH data is from October, and could yet be altered by future revisions. In contrast, the LFS already has December data locked down. While a single month of LFS data is a bit less trustworthy due to the greater volatility in the LFS, taking a two-month average reduces the volatility to below that of the SEPH while still offering fresher data. As such, we’ll take the LFS data – smoothed appropriately – every day of the week. Moreover, any difference between the two series tends to be only temporary. As the following chart of year-over-year data confirms, the two trend in the same direction and currently agree that job creation has accelerated to an impressive clip in Canada. We have our concerns about future Canadian growth, but none whatsoever about the present.
  • BoC rate hike: The Bank of Canada delivered a rate hike, as expected, last week. That brings the overnight rate up to 1.25% -- no longer an emergency setting, though still lower than the BoC’s definition of neutral (3.0%). The text of the statement and accompanying report upgraded the global and Canadian growth outlook, acknowledged U.S. tax cuts, noted strengthening core inflation and suggested that no real economic slack remains in the Canadian economy. Does this foreshadow a furious barrage of additional rate hikes to come? Not necessarily – the report also discussed risks from protectionism and housing and suggested only cautious tightening to come. Whereas the market looks for 2.5 further rate hikes in 2018, we anticipate just one more. Naturally, there isn’t much precision to this sort of exercise, but the main deviation is that we look for competitive challenges, a (long-awaited!) housing drag and monetary restraint to impose below-consensus growth on Canada.

Other items:

  • German grand coalition: After interminable months of negotiations and a tentative deal followed by a moment of doubt, it appears that Germany is indeed reverting to its previous political arrangement of a grand coalition between the country’s main centre-right and centre-left parties, all under the guidance of Chancellor Angela Merkel. The list of policy initiatives promised as part of the agreement is reasonably balanced between right- and left-leaning measures, with the main implication that Germany will open its fiscal coffers and deliver more fiscal stimulus.
  • Davos this week: Many themes may yet emerge from the annual Davos summit of politicians and business leaders, but an obvious opportunity is for the U.S. and President Trump to lay out their vision of the world, a year after China’s President Xi stole the show with a pro-globalization message.
  • S. Q4 GDP: U.S. fourth-quarter GDP is about to be released, and seems capable of delivering a third consecutive quarter of 3%-plus annualized growth. The consensus is for 3.0% growth, while the Atlanta Fed’s excellent GDPNow measure gives a nod to 3.4%. If achieved, it will be the first such trifecta since 2004—2005. But the precise number doesn’t matter – the important point is that the U.S. economy is rolling along in impressive fashion.



January 15 - January 19, 2018

Monthly Economic Webcast  |  Protectionism update  |  Brexit status  |  North Korea risks shrink further  |  War and the stock market


January 8 - January 12, 2018

Global Investment Outlook  |  Canadian economy flexes  |  Italian election preview  |  Iranian developments


December 18 - December 22, 2017

Fed more hawkish than it looked  |  Bank of Canada uncertainty  |  U.S. tax reform steams forward  |  Catalonian election


December 11 - December 15, 2017

Chinese credit risks shrink  |  Momentum-based forecasting  |  Price-level targeting redux


November 20 - November 24, 2017

U.S. midterm election preview  |  Low market volatility  |  The meaning of a flatter yield curve


November 13 - November 17, 2017

Substantial Saudi risks  |  Chinese financial reforms  |  Inflation ahead


November 6 - November 10, 2017

Monthly economic webcast  |  A new Fed chair  |  U.S. tax reform update  |  European fracture   |  Macro data


October 30 - November 3, 2017

U.S. corruption investigations  |  Fed preview  |  Bank of Canada review  |  Data run 


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