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Nov 23, 2021

In this video, Chief Economist Eric Lascelles reviews the economic implications of recent events. Substantial flooding in British Columbia is expected to translate to lower Canadian GDP in November. The COP26 conference yielded ambitious climate pledges from 151 countries. This will impact energy-intensive sectors over the long term. Climate change is also an inflationary pressure - although our long-term outlook is that inflation, while still high, remains transitory.

Watch time: 13 minutes 51 seconds  |   Hover your cursor over the video to see chapter options

View transcript

Hello, and welcome to our latest video MacroMemo.

There’s a lot to cover, as usual. We’ll touch on COVID-19 and some of the adverse trends there. But quickly we’ll move to some new hot-button topics. And so, first and foremost, flooding in Southern British Columbia that may well be quite economically consequential. We’ll talk a little bit about the reappointment of the Fed chair for another four years. We’ll review the COP26 Climate Change meetings and just what was committed to there.

And then we’ll shift on to, I suppose, firmer terrain and talk a little bit about recent economic trends. We’ll talk about high inflation, which persists, alas. And then, a couple quick comments on oil and the outlook for prices there. Some long-run thoughts on inflation. And lastly, just the balance between workers and businesses and the extent to which that might actually be shifting a little bit.

But first, let’s touch on COVID. And so, just briefly, we are continuing to see rising cases globally, but really, what it is, is that emerging-market countries are actually mostly doing fine. It’s developed countries that are truly seeing the increase, as it stands right now. And, in fact, disproportionately Europe, so a lot of European countries seeing big increases, Germany perhaps most of all, now running double its prior peak number of cases per day.

We are now starting to see some government responses. Greece has imposed a vaccine passport, as have some other countries that didn’t previously have them. Austria is locking down, just for the unvaccinated, though. And so the difference with a passport would be you’re also not supposed to go outside or into public spaces. And Austria also planning fines, quite significant, multi-thousand-dollar fines for unvaccinated people. And so new approaches being pursued there to try and reign in this pandemic.

I can say the numbers are going up a little bit in the U.S., but don’t underestimate that. More than 40 states out of 50 are seeing an increase, so there’s some breadth to that. And in Canada, the numbers flat to slightly higher. Quebec and Ontario getting a bit worse; British Columbia, Alberta, Saskatchewan getting a little bit better, as it stands right now.

Let’s talk about British Columbia flooding. And so, these are being called once-in-a-century floods in Southern British Columbia, and unfortunately, at least as this is being recorded, more rain is coming. And that has had any number of consequences; maybe, from an economic standpoint, most consequentially, rail and road transportation into and out of the area have essentially ground to a halt due to a mix of flooding and mudslides.

The Port of Vancouver is now cut off. And just to give you a sense for its importance, it’s responsible for 15 to 20% of all Canadian trade in goods. And so that’s highly consequential and unfortunate because that port had been doing better than most in a supply chain context before this natural disaster.

People are being advised to stay home; there are gasoline shortages and of some staples; damage to infrastructure is considerable and will have to be repaired. And efforts, of course, are underway to fix many of these things. And so there are some workarounds. Trucks can go through the U.S., though not many are, as far as I’ve heard. Trains can go to Prince Rupert but it’s not exactly simple to reroute these sorts of things and the ships on the other end. And so still significant economic damage. There are expectations that we may see rail restored within a week. That would certainly be very helpful. Roads should start to be partially unblocked over the coming days, but complete reopening is likely months away.

And so, as we try to frame this in an economic context, it does look likely that Canadian GDP in November will be down. So a negative print is more likely than not, due to this natural disaster. Q4 GDP likely loses a few percentage points, probably still growth in the fourth quarter but materially less than there would have been. On the aggregate for 2021, we’re talking maybe a quarter percentage point chopped off annual growth, so not a huge blow but, nevertheless, unfortunate.

But I will say for all of that and all of that negative, do keep in mind that when we’re talking about natural disasters, you do then later restore the lost economic output. And so early 2022 might actually see faster growth than usual and, of course, as highways and other things are rebuilt, that could also unleash extra growth and spending as well. So, more strength later but certainly a problem for the moment and quite a struggle to achieve some semblance of normality, and that’s likely still some distance off.

Let’s talk for a moment about the Fed chair renewal. That is to say the U.S. Federal Reserve had to choose its next chairman—or chairperson, I should say—and Jerome Powell, the incumbent chair, was selected for another four years. There had been some doubt about that, by the way. Markets had increasingly assigned a rising probability that Lael Brainard would instead be appointed. She had been assigned less than a 20% likelihood in September; it was up to around 40% as of quite recently. But the White House ultimately opted to stick with consistency and the status quo.

And the interpretation is that, on the margin, Powell is a bit more hawkish than the alternative, though equally in line with the prior trajectory since he has been in charge for the last four years. My sense is it’s probably the right decision. This is an important time for monetary policy during a pandemic recovery. Not a great time to be changing course in any major way. And, to my eye, the risks are that monetary policy is too stimulative as opposed to not stimulative enough, and so it’s probably best to continue on this path toward incrementally tighter policy. But the good news is, it eliminates a source of uncertainty and that’s been something that markets have broadly embraced.

Recently, the COP26 Climate Change Summit came to an end. And just to summarize some of the key outcomes there. Well, to begin with, 151 countries did announce more aggressive climate change plans and so that was, of course, welcome. Nevertheless, the world is still on track for something like a 2.5-degree temperature increase relative to pre-industrial times, which is more than desired; 1.5 degrees would be the ideal; 2 degrees would be, I guess, tolerable. And unfortunately, 2.5 is the current trajectory. So there was some disappointment that more aggressive commitments were not made.

As it stands right now, to get to that 1.5-degree target would be quite a stretch. You’d need to half emissions by 2030, which would be quite remarkable; half of the emitting cars off the road and this sort of thing. And so, unlikely to get quite there. I have to say in my own mind, I’m assuming we do end up with something like a 2.5-degree temperature increase, and at that kind of level, you can’t rule out nonlinear effects. So there could be some problems that emerge from that. But nevertheless, that’s the most likely trajectory, based on this meeting and prior meetings.

In terms of the economic consequences from that, hard to say with precision. The estimates vary quite radically as it stands right now, but safe to say several percentage points chopped off the level of economic output within the next several decades.

But the bigger implications aren’t top-down GDP. They are certain sectors like fossil fuels get radically affected, like the utility sector, like energy-intensive industries, and so that’s where the focus needs to be. Similarly, we can say it’s a world in which you’d think you’d see more CapEx versus consumption as green initiatives are pursued at the expense of consumer spending. You think you’d see a little more inflation, all else equal, given carbon taxes and that sort of thing. You think you’d see slightly higher interest rates, all else equal, given the need to fund all of that.

Let me emphasize, it’s not a prediction for high inflation—I’ll, in fact, talk about the opposite trend later—but a bit more inflation than you’d otherwise get, all else equal.

A quick nod towards the economy and inflation, which is supposed to be my job and so let’s touch on that for a moment. Economic trends still a very familiar story. A mini acceleration in the U.S. We saw very good retail and industrial production data as an example in the U.S. and a little bit of a deceleration visible in other developed countries.

Looks like Canada is slowing. Looks like UK economy underperforming as well, given fairly high COVID cases there. Japan recorded a negative Q3 GDP print and so a bit of suffering there too. I think those countries can pick up the pace a little bit from here. But nevertheless, less quick growth outside of the U.S. right now.

And then on the inflation front, still very high inflation readings. Do note that we have above-consensus inflation forecast, so this is going according to our forecast, though I can’t say we particularly like it in an absolute sense. You have the U.S. inflation now at 6.2%, which is the highest since 1990. Canada is now clocking in at 4.7; the UK is 4.2; the eurozone is 4.1. All of these are more than twice the 2%-type forecasts that most of these countries aspire to. Really, only Japan is managing to buck the trend with only 0.1% inflation.

I can say as well, the real-time metrics we track suggest there could be further pressure over the next month or two. And so we shouldn’t assume that the inflation heat is immediately going to come off, even though some supply chain issues are getting a little bit less bad. It looks like there are fewer ships waiting to unload in Southern California. The cost of shipping is starting to go down. Some retailers are saying they’re in good shape for the holiday season. So I think we’re seeing some diminishment of intensity of that inflation pressure, but equally, there is still a lot of heat out there.

On the subject of oil. And so, oil prices, I must say, have surprised almost everyone with the extent to which they’ve been so high, despite demand that is still below pre-pandemic norms. But of course, the secret has been that supply has remained even further below pre-pandemic norms. There’s been a slow response to the incentive of high prices.

I would say we still expect oil prices to come off somewhat over the next six months or so. One reason is politicians want that outcome. In fact, we’re seeing strategic petroleum reserves being released in the U.S. and elsewhere, and so that will help to some extent.

I can say that credible forecasts from the International Energy Agency think that oil supply goes up quite a bit by the end of this year and that oil supply will actually outpace demand a little bit in 2022, which is a recipe for lower prices. OPEC is saying they do see evidence that demand is being hurt by those high prices, particularly for EM countries, so there’s a demand response to the high prices as well.

And then the market is quite clear in its own betting. Backwardation is in effect. That means that oil price futures very much expect lower prices down the road. And we can see U.S. production still low right now but starting to revive. And so again, we do expect somewhat lower oil prices; not low, but less high than they are right now.

Okay. Let’s talk about the long-run inflation outlook for a moment. And so, the debate is, will we be in a structurally high inflation position from here. And of course, it’s tempting to reach that conclusion, given that here we are with very high inflation right now, and aging populations generally translate into fewer workers, and dissaving as seniors suspend their savings. And so there’s a superficial argument to say, gee, might we have high inflation.

We actually take the opposite side that we still think long-term inflation will be normal if not a little bit low. Japan is the classic example. The oldest country has the lowest inflation. You can extend that and say Korea, low fertility rate, low inflation. Europe is getting old; tends to have lower inflation than the rest. China getting old; also lower inflation than the rest. And on the flip side, Africa, South America; fast-growing countries are experiencing higher inflation. So all else equal, demographics would seem to argue for less inflation as opposed to more.

Keep in mind as well, from a central bank perspective, it’s hard for central banks to crack low inflation. There’s a limit to how much they can cut rates and escape from low inflation. There’s no problem with dealing with high inflation. Inflation is high, they raise rates, inflation is no longer quite so high. And so, central banks feel pretty confident, if there were a high inflation scenario, they can deal with it, at least over the long run.

And keep in mind as well, there are other deflationary forces out there. We think automation is picking up. We think productivity growth is picking up. A high-debt world is usually associated with low inflation as well.

Don’t get me wrong, climate change is probably going to add to inflation, and as we’ll talk about in a moment, the growing clout of workers also maybe adds a bit to inflation. But the demographic forces and these other factors we think are ultimately likely to be more powerful. And so, we’d still bet on a return to normal inflation, with the risk that it’s even a little bit low.

And let me finish just with some thoughts. Workers versus businesses, essentially. And over the last several decades, it’s pretty clear that businesses and investors have done very well. Workers haven’t done quite as well for several reasons. We’ve seen corporate tax rates come down. We’ve seen firm concentration go up. The supply of labour was abundant, so wage demands were hard to make. Globalization was rising. Automation was rising. All of these things help businesses; didn’t help workers quite so much.

Arguably, we’re starting to see a bit of a shift here. And so, for instance, we saw some pretty radically expanded social safety nets during the pandemic; some of that may stick. Labour shortages are a very real phenomenon right now and also conceivably going forward as baby boomers retire en masse. We’re seeing promises of higher minimum corporate tax rates and the U.S. tax rate also looks likely to rise. There’s a focus on antitrust efforts now. That is to say, looking at big tech companies mostly and bringing them down to size. And we’ve seen minimum wages rise fairly significantly. In fact, the most recent Nobel Prize in economics was precisely for work endorsing that kind of decision.

And so, a shift of sorts is happening. I’m not sure I would predict profit margins fall outright, but I would say, maybe they don’t get to keep rising as they have. Conversely, maybe wages get to go up a little bit more than they have, helping workers. And so that’s a pretty profound change, I think.

And from the perspective of investors, it would remove one of the three main stock market drivers. We’ve seen stocks go up over the last decade on the back of higher margins. We’ve seen stocks go up on the back of higher valuations, and of course, on the back of earnings, which is the classic driver. It’s not clear we’ll get as much help from profit margins going forward. In turn, maybe stock market gains have to be a little bit more muted.

Okay. On that sour note, why don’t I stop here. And hope you found this information useful. Thanks, as always, for tuning in, and I wish you very well in your own investing. Thank you.



For more information, read this week's #MacroMemo.

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Publication date: November 23, 2021



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