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by  Eric Lascelles Mar 9, 2021

In this video update, Chief Economist Eric Lascelles reviews how countries are reopening their economies as infection rates fall, especially in emerging markets. Surprisingly, recent data suggests that Canada has not experienced economic decline despite job losses over the past few months. He also reviews Canadian competitiveness and the implications of rising bond yields.

Watch time: 16 minutes 56 seconds

View transcript

Hello, my name is Eric Lascelles.

I’m the Chief Economist for RBC Global Asset Management, and welcome to our latest video MacroMemo and plenty to cover off this week.

We’ll, of course, start as we always do with the latest COVID infection numbers. And indeed, seeing some stabilization after a happy few months of decline. We’ll talk about the odds of a third wave emerging imminently, in fact it might be fairly high. We’ll certainly discuss the reopening of economies that has begun in many jurisdictions, and we’ll also acknowledge the great success of vaccination efforts.

So far, from an economic standpoint, we’re seeing quite good economic news for the most part, and so we’ll celebrate that, and at the same time, acknowledge there has been an increase in bond yields, and of course, some complications and challenges associated with that.

And to conclude, we’ll dig a little bit into Canadian competitiveness. And we’ll also talk a little bit about low-probability, high-impact risks. And I’ll explain that a bit more slightly later.

But let’s jump in where we usually begin. And so global infection numbers for COVID-19, no longer actively falling, and so that’s unfortunate. We had a happy early January to early March and now seemingly bottoming out. On the emerging market side, six of the seven countries with the most infections per capita are actively deteriorating right now, so there is some deterioration in the emerging market space. And similar story in the developed world. We can say Germany’s numbers are rising again, Italy is spiking, actually. Canada no longer improving, not necessarily getting worse, though. And then U.S. improvement continuing, but it slowed to a crawl. So no longer improving to the same extent. In fact, 10 U.S. states are now getting worse, and so we’re seeing a bit of a shift there. But really, the big question is, is this the start of some new trend, and so we’ve been flagging for a little while now the risk that there will be another viral wave happening over the next few months, and I can’t say it’s a certainty. In fact, there are ways that that might be avoided, but it nevertheless seems fairly likely when I look at the evidence.

And so, for instance, you start, of course, with the observation, the trend is seemingly shifting. That’s the starting point. Let’s acknowledge that countries are reopening to some extent their economies, and so that presents a greater opportunity for spread. But really, the main story is one of these new variants. And so these new, more contagious variants from the UK, South Africa, some others as well, they seem to be accelerating. And so what you actually have is the traditional form of the virus retreating quite nicely, but these new variants actively accelerating and increasingly becoming the dominant strain.

And we have some stats for the U.S. and Canada that do suggest these new variants are rising by leaps and bounds, and just straightlining those sorts of numbers, you get them becoming the dominant strain within a matter of weeks, actually. And so ultimately that’s where we are right now, and these new strains don’t seem to be as constricted by the current level of restrictions. And so again, makes sense that we would see the numbers unfortunately rise for a period of time from here.

I should say, there’s no guarantee of that. Seems likely to me. I can’t think of a scientific reason why it wouldn’t happen, but there’s no quite guaranteeing, so South Africa has somehow dodged that outcome. Ireland, Slovakia, Denmark, they’ve seen the variance take over. They haven’t had big spikes, so apparently it can be done. In fact, in Canada, Newfoundland encountered the new variant and seemingly has quelled that outbreak. But nevertheless, it seems as though just looking at the transmission rates and the spread it would be likely to see more cases in many jurisdictions.

Silver lining would be should be less problematic from a hospitalization and fatality perspective, just because so many vulnerable people are being inoculated right now. Similarly, don’t forget, as we look back on the second wave that dominated the fall and the early winter, in the end the economy didn’t do as badly as feared, and simultaneously financial markets actually did just fine, so these views aren’t necessarily even all that relevant for markets, given the market attitude toward prior waves. But still worth watching. The pandemic is at its root, of course, the spread of the virus. And so again, an important subject.

From there, let’s talk about reopenings. And so we’ve seen economic reopenings picking up speed. Countries recognizing they’ve had fewer infections for a few months and choosing to do something about that. Our measure of global stringency has recovered around half of the losses that occurred since September. And so, again, essentially half reopening back to September levels. Good for the economy, certainly in the short run. Bad for virus transmission, unfortunately, and so that’s a risk and this might be a, a premature move. And then in terms of who to watch, well, Texas needs to be watched quite closely. It’s the extreme case of reopening. It’s essentially reopened everything, and so we’ll see how that plays out over the next few weeks and months.

The UK arguably is something like the opposite extreme. And so it’s seen quite a nice improvement in infections and fatalities, but it’s really very minimally reopened, and in fact it said it won’t do much more until June. And so it is, again, the opposite extreme. So we’ll see whether those two jurisdictions look quite different. Any differences will be, I think, quite instructive.

Okay. On from there into the vaccination space. And so we are seeing vaccinations continue to accelerate. In fact, more than 300 million shots have now been delivered globally; Israel leading the way. In fact, Israel now has delivered 100 doses per 100 people. And so you might think they’re done, but keep in mind they’re not actually. You need to get two shots per person to be complete. I should say 200 per 100 people isn’t the finish line since children at present can’t be inoculated. You might says Israel two-thirds of the way to the finish line in terms of its vaccination. It’s well ahead of most others, but the UK and U.S. looking pretty good by big, wealthy country standards. The UK up to 34 shots per 100 people and the U.S. up to 26. Europe is 8 to 10, Canada very much lagging at 6 right now, though making considerable progress and very much accelerating in March and probably a big further acceleration in April there.

And I should say expectations, unsurprisingly, have grown more optimistic as well. And so we look at one betting market that asks, when will two-thirds of Americans be inoculated? And in December the answer was around—there was a 25% chance assigned to two-thirds of Americans being inoculated by the middle of the year. That rose to 75% two weeks ago, and we talked about that two weeks ago. That’s now risen to a 95% likelihood. It is very much expected that the distinct majority of Americans will be inoculated now by the middle of the year. And indeed we’re seeing supply rising quite nicely. And so you have Merck, Sanofi, Novartis, these vaccine makers all now contributing in the sense of producing vaccines for the companies that actually had successful vaccine candidates, so just increasing the total supply.

Maybe the one point of concern on the vaccine front, well maybe two. One would just be that the vaccines do seem to be somewhat less effective against some variants, and that is an issue. The other one being vaccine nationalism. And so we did see, for instance, Italy refused to export a shipment of vaccines to Australia, and so using this theoretical power that the European Union possesses, it’s a bit of a scary thought for countries that don’t have their own domestic manufacturing capacity, including Canada. And so that is an issue right now. Uh, Italy did say they did it because Australia was not a country in need; this was meant to go to Australia. And so perhaps it’s a bit of a different situation given that Australia has practically eradicated the virus. But nevertheless, it does show that countries that don’t have their own capacity cannot be completely assured of the supply that is coming in future months.

Let me pivot to the economy for a moment, and so I can say the Canadian economy has done surprisingly well across the last few months. We had assumed the economy would shrink at least a little bit in response to the second wave, and it really just hasn’t. It grew in November. We learned recently the economy grew in December. Indeed it grew 9.6% annualized across the entire fourth quarter. And we’ve just now learned the Canadian economy tentatively at least grew in January. It grew by 0.5%, which is pretty good, and we have leading indicators that suggest February probably increased as well. And so, apparently, there wasn’t even a single month of economic decline for Canada through the second wave. That’s a very pleasant surprise, indeed. Not to say it’s been a painless experience. Canada had two months of job losses, and so was not entirely painless, but nevertheless quite mild. And so we had thought we were pretty clever in arguing it should be much, much less damage than last spring. That was certainly the case. It was even less damage than we’d initially expected. And then the U.S. has been very similar. The U.S. economy also seemingly not really declining in any significant way, and actually we now are seeing some pretty supercharged economic data there as well. January personal income up 10% just in the month versus the prior month. Now you should understand there was fiscal stimulus delivered, big $600 cheques were sent out, and so maybe that changes the equation more than a little bit, but nevertheless looking quite strong. And job creation in February was strong, and indeed the source of the job creation was previously beleaguered sectors, including leisure and hospitality. In fact, that was where the great majority of the jobs were created.

And it’s not over for the U.S. The U.S. now has another fiscal stimulus package planned. And we’d initially thought this would be $1 trillion, then we’d a couple weeks ago thought maybe it’ll be $1.5 trillion. It looks like it’s going to be the full $1.9 trillion that Joe Biden had initially proposed and so it’s a lot of money that will be sloshing around and we’ll have the U.S. economy I think, very much leading the way.

Maybe a bit of an opposite, or compare and contrast. I can say the European economy has not been doing as well. It did clearly shrink in response to the second wave. In fact, we just saw a recent reading of retail sales down 5.9% in January alone versus the prior month, so more damage done on the continent than in North America, it would appear.

I should flag one other thing which is, and we’ve suspected this for some time that we now have the formal data, there were significantly fewer births than normal in 2020 and so this is not a complete shock. It’s normal during recessions to have fewer births. Also, the specifics of the pandemic itself made it difficult for coupling. It made it feel dangerous to even consider having a child. And so it makes sense that we saw fewer children born. But nevertheless, the numbers are quite significant. And so Chinese births were down 15% in 2020 versus the prior year. California was down 10%. Japan was down 9%. Italy was down 22%. These are pretty big numbers. I do think there’ll be some catch-up over the next few years as people who aspire to children will have those children in the end, but there probably will be some small permanent loss. And so a little bit of a wiggle in the demographic numbers going forward, and perhaps a group of schoolchildren in future years that’s just a little bit smaller than the one above them and the year below them. And so a bit of an interesting relic of the pandemic.

Let me talk for a moment about higher interest rates. And so we’ve seen bond yields rise quite significantly over the last few months. And to give you a sense for that, the U.S. 10-year yield has actually more than tripled compared to last August. It’s gone from 0.5% to around 1.6%. And so, those of you who are discerning with numbers will recognize not a big change in an absolute basis, but on a percent basis, that is more than a tripling.

It’s happened really in two stages. And so initially, it was higher inflation expectations and so commodity prices were moving; inflation to some extent normalizing a little bit. And so that was the driver initially. Central banks printing some money, of course, just as an inflation risk, and more fiscal stimulus potentially being inflationary.

But then, more recently, it’s actually been on the real interest rate side of things as opposed to the inflation expectations side, and that’s been a function of growth picking up and economic activity exceeding expectations, as per our prior comments; progress with vaccines; and indeed more fiscal stimulus coming. And so makes sense.

I would argue, though, in the end, I’m not convinced inflation is going to become a big problem. I’m not convinced real rates can go all that much further from here. And actually, we forecast flat to somewhat lower yields over the next year. We think this has been a bit of an overshoot right now. And just fundamentally, from a cyclical perspective, it would make sense that rates stay quite low. We are likely to be in a high-unemployment rate environment for some time, high household savings rates, central banks buying government bonds. All of this argues, cyclically, rates should still be quite low.

And then structurally, meaning long term, it also makes sense that rates stay low. There’s so much public debt out there, rates have to be low to make them manageable. The neutral definition of an interest rate has been steadily declining over the years; it’s quite low now. And so, in the end, I’m not convinced we see rates push a whole lot further here.

And then maybe the remaining question is, does this have consequences for the economy and markets. And so, I don’t think the increase in rates is all that damaging to the economy. A little bit at the margin perhaps, but manageable, we believe. Could cool housing a little bit, though I don’t think a lot. I don’t think it significantly alters the public debt sustainability equation. Most public debt is locked in over a longer period of time. And most of the bonds being renewed right now, being rolled over, are actually being rolled over at a lower rate as opposed to a higher rate.

And similarly, from a financial market perspective, we’ve seen some ripples into the stock market, as an example. But if this doesn’t go much further, I think, again, that subsequent implications are fairly limited.

All right. A word on Canadian competitiveness. And so Canada has lost some competitiveness over the last few decades, so that’s really the subject of this little critique. But I would say not maybe quite as much as people imagine.

And so for instance, Canada has gone from having 66 companies on the Fortune Global 2000 list to having 61 today. That’s over the last 15 years. Canadian productivity was 82% of the U.S. level at the turn of the millennium; it’s 78% today. So there has been some loss, but I would say there have been some extenuating circumstances as well. The Canadian dollar was extremely cheap at the turn of the millennium; that gave extra competitiveness that wasn’t realistically going to be kept. The rise of China and emerging markets is such that most of the spots claimed on that Fortune Global 2000 and displacing Canada, it would be China just entering the global stage as opposed to Canada specifically underperforming other developed countries.

The ascent of technology and technology firms has really uniquely favoured big companies that can especially take advantage of network effects and economies of scale and these sorts of things. And so, again, that’s to the advantage of the U.S. and China, and fundamentally less so for a place like Canada.

And as we look to the future, it’s likely that the U.S. actually undoes a bit of Canada’s competitiveness losses from the last six years. I should say that Canada raised taxes and put tighter environmental rules on and this sort of thing, and now the U.S. is likely to do something fairly similar, and so narrow that business competitiveness gap.

Certainly, there are opportunities out there. Canada doesn’t do a great job of adopting information and communication technologies; does have too much red tape; big, long list. World Economic Forum does a nice job of summarizing them. But Canada also has big, big advantages. And so, strong education, strong health care, high-quality immigration, lots of land, ample resources, clean environment, proximity to the U.S. is a pretty lucky thing in the grand scheme. And so long term we think Canadian competitiveness is pretty good but there is some room for improvement.

And so let me finish now with one last thing, and I do apologize for going so long, but there’s so much to share. And so low-probability, high-impact risks. And so generally these get ignored in favour of what I would describe as medium-probability, medium-impact risks. Like you get a recession once every 10 years; that gets a lot of attention. But the kind of thing that comes along once every 100 years where the huge consequence tends to be ignored, like a pandemic. And so, gosh, there are other examples of this sort of thing. Some of them, quite frankly, sound a bit silly when you say them out loud. But things like pandemics and asteroids and nuclear war and volcanic super-eruptions and other things like that, as I said, they sound rather unlikely, and indeed, they are rather unlikely. But if they were to happen, the consequences would be so great that it’s nevertheless worth having policymakers think about them and maybe even try and do something to prepare for them.

And so as much as they’re unlikely to happen in our lifetime, it would make sense for governments to be pushing in that direction. And indeed, it seems likely that they will. I guess that’s the point. The pandemic has woken policymakers up. They’ve recognized perhaps that they need to pay attention to those low-probability, high-impact risks as well. And so I’m optimistic we will see a little more resources put in that direction as well. And so, a small silver lining from the pandemic.

Okay. I’ll stop there. I guess you stuck with me. Thanks for that. Hope you found some of this interesting, and please consider tuning in again next time.

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


Publication date: March 9, 2021

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