In this video, Chief Economist Eric Lascelles reviews recent developments around economic trends. He looks at a quickly advancing U.S. business cycle and shares his growth outlook. As inflation heat rises, he notes central banks' hawkish stance and updated views. Finally, he discusses persistent supply chain issues as we head into the holiday season.
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We have much to share as always, and we’ll start with COVID numbers and COVID science and all of that sort of thing before proceeding to the business cycle and where we now stand in what proves to be a rapidly advancing business cycle. We’ll talk about hawkish central banks. We’ll discuss a mini U.S. economic acceleration and then we’ll revisit some really important subjects: supply chains and the problems they’re in, and also high inflation. So that’s the plan for the next little while.
Let’s begin with COVID cases. And so, unfortunately, the numbers are rising again globally. There had been a multi-month period of decline. We were all very pleased about that. And it looks like there’s a bit of a turn now. And so we’re seeing cases rise, on average, around the world. They’ve been high just about throughout in the UK, in terms of their pursuit of a minimal restriction world. But now rising significantly in Europe, rising significantly, in particular, in Germany and the Netherlands and Poland. Russia going up quite a bit as well. And North America doing, broadly, somewhat better in the sense that the U.S. numbers are still much lower than they were a few months ago. But now roughly stable, having been improving until quite recently. And about half of U.S. states are now getting a little bit worse. Canada, I would say, a similar situation, a long improvement. Now maybe stabilizing in a few of the more prominent provinces, including Quebec, and maybe Ontario getting a bit worse again. And so we’re not seeing the active improvement that we had before. And I suppose it’s anyone’s guess exactly why that turn has happened but perhaps some combination of fewer precautions and colder weather and open schools. But maybe also a new sub-variant of the Delta virus or the Delta variant that we will talk about next.
Let’s talk about COVID science. And so we’ll begin with the Delta Plus sub-variant, if we can call it that. Essentially a new version of the Delta virus that is responsible for a very large fraction of the cases in the UK. In fact, it is found mostly in the UK right now, possibly spreading in Europe, possibly explaining the increase in infections in Europe. I do want to emphasize, though, that this is not a new variant on the order of the Alpha or the Delta. And so the Alpha variant was around 50% more contagious than the original virus. The Delta variant was about 50% more contagious than the Alpha virus. This one might be about 10% more contagious. So not to the same extent. Nevertheless, you would think if this proves to be the case, it would gradually spread around the world and make life incrementally a little bit more difficult in terms of restricting the virus. One bit of good news is that it’s not more resistant to vaccines as far as we can tell.
Now there’s plenty of good news to share on the virus science side as well. I can start by saying over half of the world has now received at least one vaccination. So moving quickly on that front. Billions and billions of people have been vaccinated and that certainly is a very good thing. It’s reached poorer countries I think more quickly than many people had initially imagined. I can say there also has been impressive progress on therapeutic pills. And so for those who have already been infected, the only recently infected, there are two or even three new drugs that purport to reduce the incidence of death or serious illness quite considerably. We’re talking about a 50% to 90% reduction in essentially bad outcomes for those who have already gotten sick, which is quite a big deal. And actually, if successful, in theory could take the COVID fatality rate from around 0.3% where it is right now to, in a best case scenario, as little as about 0.03%. And if that were to be achieved—and so lots of ifs and uncertainties—but if that were to be achieved, it would actually put the fatality rate for COVID-19 below that of the flu. Now that wouldn’t mean it would be necessarily less problematic than the flu because it’s much more contagious. You’d still be—you’d be more likely to get it and then less likely to die and so it still would be a serious thing. But nevertheless, a big step forward if that actually holds in the real world.
Let’s pivot from vaccine science and talk about the business cycle now. And we’ve updated our business cycle scorecard. It’s focused on the U.S., but we think the U.S. is a good bellwether indicator for most of the world as we think it’s relevant to almost everyone. And we now identify the business cycle having transitioned from early cycle to mid cycle. I can say the pivot isn’t overly surprising. We were seeing growing evidence of a shift of that sort over the last few quarters, but now it has officially happened. And it is somewhat consequential at least. It confirms to us that the business cycle is indeed advancing quite quickly relative to standard cycles. Maybe it will be a five-year cycle instead of the sort of ten-year cycles we’ve luxuriated in over the last few cycles. The economic growth, or the economy more precisely, tends to be fine when you’re in mid cycle. So now real change between early and mid from that perspective. Usually you do still get several years of economic growth left to come even when you reach mid cycle. But from a risk asset perspective or from a stock market perspective, on average the returns are a little bit less lucrative than they were at the earlier phases of the cycle. And so slightly less exciting gains out of stock markets on average.
I can say that the recession models we look at as part of that exercise are not blinking red or even yellow at this point in time; that they indicate quite clearly that we are not in a recession right now and that recession is fairly unlikely over the next year. I think they say the risk is rising a little bit but not an overly likely outcome.
Let’s talk about central banks. And so we’ve flagged a number of times in the past that central banks have been pretty hawkish over the last few months. They’ve been tilting more toward rate hikes as opposed to rate cuts, and more than the market had perhaps initially envisioned. That theme has continued over the last month or so. We’ve seen more of the same, that is to say central banks becoming even a bit more hawkish. And arguably all of this is in response to what has been very high inflation. And central banks still say it’s transitory. That’s been a key word in recent months. They still think it’s temporary or transitory, but I think their definition of transitory has changed somewhat. And so initially the thinking was well, we’ll have a few months of high inflation. That’s the transitory they were conceiving. Now the thinking is well, it might be a year, maybe it’s even two years of high inflation. Still temporary but a different order of magnitude of temporary, if that makes sense. So that’s prompted central banks to think more about tightening policy.
The Bank of Canada as well, by the way, has argued that supply chain problems, while inflationary of course and bad for economies as well, has also technically put the Canadian economy closer to its potential. In other words, the productive capacity of the economy is down because of supply chain issues. Therefore, the economy is closer to overheating. Therefore, more rate hikes are appropriate. And so that’s a different way of thinking about things. I’m not sure I fully agree with that way of thinking, but nevertheless, that’s on their mind as well. And so they’ve pulled forward their planned rate hikes. The Bank of Canada now says the first hike could be in the realm of the second to third quarter of next year. So not yet but nevertheless, moving along. They had previously said the third or fourth quarter, so they pulled that forward somewhat. And the market is now pricing five rate hikes for Canada for next year. Market is pricing two in the U.S., three in the UK, one for the European Central Bank. And so we do now have rate hikes in play for 2022. It looks pretty likely a number of central banks will deliver on that next year. But I would say, in the end, we think that the market is pricing a little bit too much, particularly for Canada with those five hikes priced in. But maybe a little too much for all of these players. We think it might come a little bit more slowly than they’re assuming. And a big part is just we expect growth to slow fairly significantly over the next year and take some of the pressure off of central banks.
We think we’re seeing a mini economic acceleration in the U.S. right now. And so don’t let me distract from the broader theme, which is we think there’s a multiyear deceleration happening, but within that there’s a shorter-term acceleration after the U.S. was slowed over the summer by the Delta variant. And so we can see some recent evidence to that effect. We can see that payrolls in the U.S. added over half a million jobs in the month of October. That was a big number. We can see that the ISM manufacturing index held at quite a strong 61 reading despite all of those supply chain issues out there. And maybe of greatest relevance, the ISM services index, which picks up the sorts of sectors that would have been limited by COVID and now unlimited by that. We can say that that reached a new all-time record of 66. That’s a big number. Many of the subcomponents hit records as well. That suggests a service sector that is rapidly expanding right now. And I guess reflecting all of that, U.S. GDP was only 2% annualized—grew by 2% annualized in the third quarter. It’s now tracking 8% annualized in the fourth quarter. And so again, not a sustainable thing. You don’t get to grow at 8% for long. But nevertheless, it does reflect sort of mini acceleration that’s taking place and we see that in our real-time economic data as well.
U.S. fiscal story is also I think worth highlighting for a moment which is we’ve been waiting for months and months and months for two big infrastructure packages. And these are meant to be President Biden’s big accomplishments, and they might be the big accomplishments of his term in the sense that if the midterms next year tilt a little bit toward the Republicans, as would normally happen as whoever is elected gets rebuked by the public two years later, that could be the end of significant legislative accomplishments. So these do warrant a fair amount of attention. The bipartisan infrastructure bill is now happening. And so it’s worth half a trillion to a trillion dollars, depending on how you care to measure it. And so that is going through. The big question remains the other, bigger component, which is a partisan component, and it’s still a vote or two shy. They can’t quite convince all of the Democrats to support it. I think they will get there in the not-too-distant future and so that will help to advance the green agenda and various other social initiatives. But I will say from a purely top-down economic perspective, we don’t look for a lot of growth to be spun off from that, just because the money trickles out over a decade and much of it is actually offset by tax hikes, and so it’s less net stimulus than you might think.
Okay. Let’s talk supply chains. So this has been a subject we’ve returned to over and over again and remains, I think, perhaps the most important theme out there, at least one of maybe the two most, along with inflation, which comes next. So the issues on the supply chain are still quite intense. We think perhaps some of them are peaking right now. I can say that shipping costs are a bit less high than they were a few weeks ago. The number of ships at anchor in Southern California, which is a proxy for shipping problems, have also come down a little bit recently. And so perhaps some slight improvement. We do think that, broadly, the supply chain situation becomes a bit less extreme once we’re past Christmas, which of course is peak shopping season, but also past Chinese New Year which is a shopping season in China but also when factories temporarily go on hiatus and allow supply chains to breathe a little bit. And so we think we’ll be less intense within a few months, but nevertheless, some of those issues are likely to persist through much of 2022. It takes times for demand for goods to revert down to normal. Supply chain problems aren’t just one broken or one stressed link in the chain. They are—almost every link in the chain is stressed right now and you have to fix most of those things to really properly resolve the supply chain. And right now it’s ranging from factories in China that are struggling to get enough electricity and to get enough workers. You have factory warehouses that are completely overloaded, can’t hold anything more. Port throughput is overloaded and so just not able to handle the flows. Port warehouses are full. There are insufficient ships. There are insufficient trucks. Ships and trucks are operating below their normal efficiency because everything else is so overloaded. And so again, it’s going to take some time to work through all of these things. So we think a fair number of supply chain problems will nevertheless persist through 2022. We’re assuming most will be fixed by 2023, but even there, it would make sense if there were still some chip shortages because it takes a few years to produce new chip fabrication plants and we think the demand for chips is just going to be structurally higher from here. And also I think it’s going to take some time to sate pent-up demand for vehicles because we’ve seen much more demand for cars than we’ve seen produced in recent quarters, and they will have to catch up on that as well. That may linger into 2023. By the way, Canadian ports not doing quite as badly as in the U.S. The flow was a bit smoother there, though certainly some of the same challenges exist.
And let me finish with some thoughts on inflation here. And so inflation heat is persisting. In fact, U.S. inflation, as I record this, is likely to jump a little higher when they release the latest numbers, in fact from 5.6% to 5.9% year over year is the best guess. And that would be the highest reading since 1990 which is not a good time to be matching inflation prints with. And the inflation has gotten somewhat broader so nine of the ten main inflation buckets are now running above 2%. And so it’s not just chip prices and car prices and gas prices that are doing this. There is some breadth to it at this point in time. And we are above consensus in our inflation forecast. We think some of that does stick around, at least in the short run.
Now over the next year we’re expecting some of those pressures to start to abate. For instance, oil prices we suspect will be lower in a year’s time, and we think some of these supply chain issues will be at least partially resolved in a year’s time. But don’t forget about other second-round effects that could keep inflation from completely normalizing. And so, for instance, the pass-through from higher energy and shipping costs isn’t yet fully in product prices. Many of the products that are going to be more expensive are still on a boat somewhere working their way toward the store. So we haven’t seen the full effect there yet. And we also are working on the assumption that wage growth may—not hit with a lag, because we’re already seeing some pressures in some countries, but nevertheless, may persist for a bit longer even beyond inflation. Workers have a lot of bargaining power right now, unusually, and simultaneously we can say that they’ve been hit by the high inflation. Their real wages have gone up. They’re probably going to be making a strong claim for more wages over the next year. So we think some of those pressures persist. I would still say long term we don’t think inflation’s a big problem. We think in the end it will go back to a very normal reading but for the moment, still very hot and not quite done yet. Okay. I’ll stop there. Thanks very much for your time, as always. I wish you well with your investing and thanks for tuning in.
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