Produced by RBC Global Asset Management's Chief Economist Eric Lascelles, the #MacroMemo covers what's on our economic radar for the week.
Tune in to our latest webcast, titled “Disentangling macro and market crosscurrents”.
Basically, the current economic signals are sufficiently robust to warrant for a rate hike, but a number of risks and headwinds are coming down the pipe that suggest caution. As an alternative, a May rate hike is entirely possible. We budget for two rate hikes over the next 12 months – a little less than the consensus.
o First, many of these U.S. trade practices are undeniably of questionable legality and the rate at which they have been delivered is ratcheting higher.
o Second, the action warns the U.S. that Canada isn’t about to be cowed by threats or protectionist actions. This may instead be an attempt to force the U.S. to pick a fight with someone else. After all, Canada has been the surprise punching bag for U.S. trade policy despite being responsible for precisely 0% of the U.S. trade deficit.
o Third, the action may reflect a growing resignation on the part of the Canadian government that NAFTA is at real risk of being eliminated, in which case it would be very handy to have a case already wending its way through the sluggish WTO system as that is where future trade issues will have to be settled absent NAFTA.
o A NAFTA termination letter does not result in the sudden death of NAFTA – to the contrary, it starts the clock on a six month cooling off period, after which the U.S. could opt to exit from NAFTA. However, there is no obligation to leave at the end of the period. Any such action by the U.S. could just be a bargaining tactic, with a variety of outcomes possible after six months.
o Legal experts are still torn on whether the President has sole discretion for pulling out of NAFTA. Republicans in Congress are broadly against this move, and have considerable leeway to delay or even reverse the practical effects of a NAFTA exit.
o Small technocratic advances were achieved over the fall between negotiators, suggesting no inevitability to NAFTA being torn up from the U.S. perspective.
o Trump’s big tax reform win might reduce his need to deliver another “win” to his base, particularly an economically dubious one that most Americans oppose.
o The longer Trump goes without killing NAFTA, the lower the likelihood that it will be killed. This is true both in the sense that it illustrates he is apparently willing to consider other options and given the complication of the approaching midterm elections.
-Research by Krystyne Manzer
As of December 11, 2017
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:
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