Eric Lascelles - Managing Director, Chief Economist and Head of Investment Strategy Research

Hello and welcome to our latest video #MacroMemo. As always, there's plenty to cover in the macrosphere. And so we're going to talk a little bit about the latest iteration of AI, which is consumer agents and what they do and what that means for the economy. We'll talk about AI safety risks. There have been a lot of concerns about AI taking over the world and we can try to vet those for you.

We'll talk a bit about the Fed (U.S. Federal Reserve), which raised rates, and the phenomenon of rising yields more generally, and indeed what that has meant in markets and could mean for markets. And then I'm going to shift and cover far too many topics in probably far too little time. We'll do some quick hits. And so one will be this U.S.-China summit that just concluded.

Another will be the White House promise of $5,000 checks, if the Republicans win the midterms. We'll talk about the Greenland deal between the U.S. and Greenland and Denmark. We'll talk about some Canadian corporate tax cuts and how fairly profound they are. We will also talk Canada's population growth, which, as it turns out, did not shrink over the last year after some revisions.

And lastly, is Canada actually joining the European Union? What is it to be an associate member? And we'll try to flesh that out as well.

So as I said, a lot to cover. Let's jump right in. We'll start with those consumer agents. So this is really we think the next AI iteration. AI has proven to be a really good chat bot and good for research and so on.

It's very good at computer programing, which is profound. Certainly, for the average person, though, it is still more in the realm of a research helper. And so I can say that this latest development is rather significant. It's not a technological breakthrough. It's still the same large language models beneath the surface. But you might say that the chat bots we're familiar with have been given arms and legs, in a sense.

They've been given your passwords and your email and your calendar and perhaps your credit card number. And with that in hand, they can do a lot of things for you. They can read and monitor and even send emails for you and keep track of your calendar and book appointments for restaurants or the doctor or so on.

They can even haggle over your phone bill. They can help you with any number of delegated tasks. And so again, starting to do things instead of saying things might be a way to think about it. And so of course there are winners and losers when you see a technological change like this.

So on the winners’ side, we would say the consumer or households, to the extent that they stand to perhaps save money, save time, get better quality goods. This thing can shop for you as well.

And so some benefits there. Certainly, the tech companies making these models clearly also stand to benefit, whether it's subscription revenue or advertising or otherwise not entirely determined. But there's always a way. And then of course, you can think of maybe retailers who do not have a big brand name but do have a low price or do have a high quality could be sniffed out more easily by these consumer agents that are looking around for deals, perhaps, for someone.

And so there are certainly some companies on that front that might benefit. However, there are potentially fairly substantial losers. And so many businesses, in fact, may lose if these consumer agents are better able to haggle and negotiate down prices and find deals and remove frictions to canceling subscriptions and this sort of thing.

And so the general thinking is that retailers, on average, might be more challenged, especially those that rely a lot on marketing, a brand name, or goodwill, or that sort of thing.

There's also been talk that other sectors, including telecom, media, insurance, banking, travel might also be somewhat vulnerable to the extent that these agents might be able to unbundle services or haggle better, or some variation, or just manage complexity or some variation on that. And so we would say these developments probably positive for the average person, maybe societally positive, possibly stock markets, slightly negative, though to the extent there are some significant losers specifically on the business side.

Okay, onto the other AI topic I promised: safety risks. And so it's fair to say attitudes toward AI have soured somewhat. There, of course, have been worries for some time about jobs, and that's still an outstanding concern and not entirely resolved. But also now more serious worries about AI killing us all or ending the world, or some variation on genuinely existential risk.

And in terms of how I mean that, that's much debated. It could be could be a virus, it could be a nuclear war, it could be quite a number of things. But, you know, real challenges to humankind. And it's not completely trivial. The reason this is coming up is that AI is now capable of self-improvement and so not fully under the control of humans.

Humans don't fully understand how AI works. It is a bit of a black box, truthfully. And there are examples mounting of what's being called coyly ‘misalignment.’ In other words, AI going out and doing things that either it wasn't told to do or was told to do  but shouldn't have done because it's damaging or some variation on that. So lots of hacking essentially right now.

And so it gets back to the question, how likely is it that AI ends the world? Well, incredibly, you know, experts differ on this subject. And the estimates we've found vary from a 99% chance that AI ends the world to less than 1%. So take your pick, I guess, is the answer here. Not to make it a laughing matter.

We would pause it though, and I think this is a fairly common-sense view. Far more likely than the world ending is that AI does some significant bad thing of real consequence, but well, well short of an existential risk. And that motivates stronger guardrails. Essentially, the AI companies have to snap to attention. Governments get serious about this, and it is constrained or monitored more carefully or something like that.

And that then prevents later truly existential scale disasters. At this juncture, it doesn't seem possible for that kind of scale of problem to emerge. And so for the moment, we're assuming that the pace of AI development does not significantly slow down. We do have, and we have had for some time, a 20% chance scenario in which AI underwhelms.

And embedded within that would be both the risk that AI itself underwhelmed as a technology, but also the chance that governments have to slow it down or restrict it for safety-related reasons. But we would set aside those existential concerns, at least at this juncture.

Okay, on to another key thing, which is really rising yields. Part of that story is the U.S. Federal Reserve, which joined the rate-hiking party, you might say.

They delivered a September rate hike. It was a unanimous decision broadly. Makes sense. Inflation is certainly too high. Economic growth in the U.S. is pretty good. And so that duo would suggest some tightening is appropriate. We are though for the moment on the side of maybe the tightening in the future will be a little bit less than the market is presently budgeting for.

So the market’s got another 325 basis points in rate hikes over the next year. And we think it might be a bit less than that. I guess in terms of justifying that inflation, we believe, could ease a little bit. That's predicated on the war in the Middle East cooling somewhat and so certainly not automatic. But that's part of our forecast.

We view this tightening cycle, importantly, as more of a mid-cycle adjustment than a brand-new tightening cycle. The starting point isn't low. I think that's the point. Often, you get these tightening cycles of many percentage points, but they're starting near zero. This time we're starting for the U.S. near four. And so you don't need to do quite as much work.

And it's fair to say as well that long-term yields are actually doing some of the work for the Fed and for central banks. Those long-term yields have gone up so much that's imposing its own monetary restraint, setting aside whatever is happening at the short end led by central banks. So we would say certainly more tightening ahead, but maybe a bit less than the market thinks.

00:07:24:01 - 00:07:43:05

Now let's leap though to longer-term yields then. And so there has been this steady increase in long-term yields in the U.S. and indeed significantly around the world. The U.S. 10-year yield is now around 5.3%, as I'm recording these words. That's in the realm of the highest in about two decades. And of course, there are some pretty fundamental reasons for that.

Fiscal concerns are generally big deficits, big debt loads. And central banks, as mentioned, are raising rates. And there are some inflation concerns. And there's also been maybe a decline of trust in the U.S. specifically, and even a shift in how reserve managers are allocating their money. And it's not always going to sovereign bonds as much as it used to.

And so of course, all that has implications and higher yields is the first order implication. But it's worth flagging that of course, the risk-free rate, which is what a government borrowing rate is, then determines a lot of other things in the market and in the economy. And so as an example, at these kind of levels, higher yields do lower the price earnings ratio of the stock market.

That's actually what's happened recently. I think it's gone underappreciated because the stock market itself has broadly kept going up because of such incredible earnings growth. But if you look beneath the surface, you'll find that price earnings ratios have actually been falling notably quite consistently with the rising yields. Again it's just the earnings have been so strong that that's been been masked.

Our view is – and so not with any kind of precision – but our view is that these higher yields are becoming attractive. I can't promise this is the peak or tomorrow is the peak, but becoming more attractive at these levels. We are starting to accumulate somewhat more bonds at these levels because of the return potential. And we do think that potentially the bond outlook can get better from here, particularly if yields stop rising.

Perhaps that's an obvious claim. If true, that would also be helpful for stocks, which again, have had their valuations underperform recently as yields have gone up.

Okay. Onto the quick hits section here. I'm just going to blast through some subjects as quickly as I can. So the U.S. and China met recently. Really nothing big happened there. There was previously scheduled for November some tariff exemptions set to expire.

The tariff rate would have gone up by 20 percentage points in both directions between the U.S. and China. That's been delayed two months to January 10th. Still needs to be dealt with, though, so that that is still sort of looming just a little further out into the future. The two countries did promise to lower tariffs on about 30 billion of imports with one another.

That's about 10% of the trade that they do. And so there's some value in that. China says it'll buy more U.S. coal to the extent it’s promising to lower tariffs on U.S. coal. Actually its demand commitment is about where it was before the tariffs came in. So nothing too heroic there but no permanent fix. And again the tariffs are not permanently lower just temporarily lower.

One thing as the midterms approach – and by the way the U.S. midterm elections are less than a month away now – as they approach, the White House had promised that if the Republicans managed to maintain their majority in the House and the Senate, $5,000 checks for every adult American. It’s quite an attractive proposition, we would just say very unlikely on multiple fronts.

One would just be the polling and the betting markets would say it's very unlikely the Republicans sweep. The House is almost certainly going to the Democrats. The Senate is increasingly likely to as well. So almost certainly the trigger is just not triggered. It would be, though, if you did it, also very problematic. I mean, the deficit is already big.

It would be $1.3 trillion bigger, which would be a problem. It would just be too much economic stimulus. The Fed would have to raise rates more. And I should say even Republican politicians have suggested they are not all onside with this. And so it would have trouble passing. So we're just going to rule that one out just about completely.

So set that aside. What about this Greenland deal? So, of course, notably the U.S. has sought greater control over Greenland over the last couple of years. It did finally recently strike a deal with Denmark and with Greenland. And so it will build two new military bases, for three in total. I will say the changes beyond that are pretty limited.

There had been a treaty in place before. It's not that different, to our eyes, to the new treaty. I will say non-NATO military presences in Greenland are now banned. That was never likely to happen. Neither Greenland nor Denmark wanted it, but nevertheless, I guess that's been made official. Resource investments are only possible from NATO and EU members. In practice, that's more or less what was happening anyways.

The U.S. does not have a privileged position there. Actually, if wanted, Greenland could approve other NATO militaries to have a presence in Greenland as well. So we would say some changes there, but ultimately certainly not a transfer of sovereignty or anything quite like that.

Canadian corporate tax cut: this is a big deal. So essentially far more capital is eligible for this accelerated depreciation provision.

Fifteen percent used to be the story in terms of the fraction of things businesses would invest in, they could depreciate for this tax advantage. Now it's two thirds. So it's a big number, more generous than the U.S. equivalent. The marginal effective tax rate on capital for Canadian businesses has plummeted. That's a good thing. B some metrics it’s now by far the most compelling in the G7.

And so Canada by this metric is now quite business friendly. Also, of course, with ongoing efforts to streamline regulations and encourage infrastructure investment and resource investment, we would say it is becoming quite a more attractive investment destination. And, as we move beyond, at least over the next year, we hope some of these tariff headwinds. We do anticipate there could be a period of pretty good growth for the Canadian economy.

The Canadian population: well, we had been talking about how it was in decline and how rare that was. The latest revision said there was no decline. And so they've revised the numbers. Not as many temporary foreign workers are going home as had previously been assumed. That's its own political issue, of course. But really the main takeaway is part of the reason we were able to justify weak Canadian growth over the last year or so was that, well, there’s no population growth.

But there was a bit of population growth. So it does make all that look a little bit worse, would be the first comment. The second was it had looked previously as though we were going to see a return to normal population growth over the next few years, which should have accelerated the rate of Canadian economic growth.

That will still happen, but it kind of happens more slowly and over a more stretched-out period. So we shouldn't count quite as much, at least based on demographics, on an acceleration of Canadian economic growth in the next few years. We still like the tax story and the regulatory story and so on.

And I'll finish with this, which is just of course, the European Union president talked of Canada becoming an associate member.

And that got some people excited and raised some questions. And so I'll just say that's mostly a symbolic statement. It does reflect some aspirations of integrating like-minded regions further. Do note Canada already has a free trade deal with the European Union. Do note the European Union does not just throw around freedom of movement or these other things quickly or lightly, because it has many different members and many different associations already.

And generally, to get a deeper relationship, you have to give up something too. And so that is usually you need to give up control of some regulations to align with Europe and often contribute to their budget. And so those are probably no goal for Canada right now. And so we would say we don't expect a formal integration in that way.

Instead, there are some specific efforts. So one would be there's an effort to create a digital trade agreement between the two parties. There are efforts to cooperate digitally more on AI issues and so on. There is a joint defense procurement agreement, which is significant. They are making a critical mineral strategy. And I know Canada's aspiring to allow its students to study across European borders and presumably vice versa.

So there's certainly progress by Canada really not joining the European Union in any real sense.

Okay, I'll stop there and say thanks very much for your time. I hope you found this interesting and please tune in again next time.