This week’s MacroMemo tackles the usual assortment of infection, vaccination and lockdown developments, before pivoting to several key economic issues. We update our business cycle scorecard across several dimensions. Lastly, we speculate that risk assets may be starting to prefer moderate rather than strong economic data.
The roster of positives and negative developments are fairly mixed. Negatives include:
- The Delta variant remains concerning.
- Infections and hospitalizations are now rising sharply in the United States.
- Vaccines are proving less effective against the Delta variant.
- China is beginning to tighten restrictions again.
- Economies are no longer actively reopening.
- There is some evidence of a decelerating U.S. economy.
- Our forecasts are for below-consensus growth in 2022.
However, there are a number of positives that mount a stiff opposition to those factors:
- The infection rate is now falling sharply (and surprisingly) in prominent countries such as the U.K. and Indonesia.
- Vaccine passports are becoming more popular, and would help to minimize economic damage during future waves.
- While the business cycle is advancing, it is still at a fairly early point.
- There are hints that inflation may be peaking.
- U.S. housing does not appear problematically overheated despite recent strength.
- The Canadian economy continues to rebound.
Mixed Delta messages
The number of new COVID-19 cases around the world has recently stabilized after a period of increase (see next chart). It is a pleasant surprise that this has happened despite the highly contagious Delta variant.
Global COVID-19 cases and deaths
As of 08/08/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
However, it would be premature to declare victory over the Delta variant wave. The level of infection remains elevated. More countries are suffering rising counts than declining ones (see next chart).
Countries reporting rising daily new COVID-19 cases
As of 08/08/2021. Change in cases measured as the 7-day change of 7-day moving average of daily new infections. Source: WHO, Macrobond, RBC GAM
North American deterioration
Among those deteriorating, the U.S. infection rate has increased sharply in recent weeks. Infections now regularly surpass 100,000 new infections per day (see next chart). All states now report rising numbers, though the rate of deterioration depends heavily on the level of vaccination by state (see subsequent chart). Given a relatively low level of vaccination and an aversion to locking down, it seems likely that the latest wave will continue to surge in the U.S. for some time longer. That said, the Delta waves in other countries such as the U.K. and Indonesia have surprised in their brevity, as discussed later.
COVID-19 cases and deaths in the U.S.
As of 08/08/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
COVID-19 infections in high versus low vaccination states
As of 08/06/2021. Source: CDC, United States Census Bureau, Macrobond, RBC GAM
While Canada is somewhat better positioned than the U.S. – with a higher vaccination rate and broadly more cautious rules – it has not escaped the Delta wave altogether. Canadian infections are now rising significantly, albeit off of very low levels (see next chart).
COVID-19 cases and deaths in Canada
As of 08/08/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
New Chinese concerns
China has broadly fared very well during the pandemic. Its top-down structure and highly compliant population position it particularly well to rapidly quash COVID-19 outbreaks. But there have lately been fresh concerns about the Delta variant in China.
It is not so much that the variant is expected to overwhelm the country, but that China has a zero-tolerance approach. While this was admirable when the virus was less contagious, it could prove problematic going forward -- much as concern has grown around a similar approach in Australia that now requires repeated harsh lockdowns every time the virus escapes. It may not be possible to completely contain the Delta variant, resulting in endless lockdowns.
This is of concern from an economic, financial market and commodity price perspective as the Chinese economy is disproportionately important for all of these things. Already, the city of Beijing has cancelled all major events for August. So far, China’s caseload is very low, but the numbers have risen and this is now on the radar of financial markets.
Interestingly and frankly unexpectedly, some prominent countries are now already beginning to enjoy a decline in their Delta variant wave. Indonesia’s daily infection rate has already fallen by around 30% over the past month (see next chart).
COVID-19 cases and deaths in Indonesia
Similarly, the U.K. infection rate has declined after a ferocious Delta-led spike earlier in the summer (see next chart). This is wonderful news, and may well represent the fact that highly social young people are now being vaccinated and the country’s COVID-19 tracing app is highly vigilant.
COVID-19 cases and deaths in the U.K.
However, it may be premature for the U.K. to declare final victory over the Delta variant. The infection rate ceased falling over the past few days, possibly heralding some new trend. The U.K. is still theoretically fairly far from achieving herd immunity, suggesting a tussle remains. It could be that the decline over the past month was merely the unwinding of unusually high levels of social activity during the European football championships. The U.K. fully opened its economy three weeks ago and any resulting increase in infections would only now begin to appear. Some epidemiologists have also expressed concern that the U.K. is no longer testing enough, as evidenced by a high test positivity rate.
Of course, even if infections go back up, this may be tolerable so long as hospitalizations (and fatalities) remain low. So far, this has gone according to plan in the U.K. While infections rose sharply since the spring, hospitalizations have only increased moderately (see next chart). We estimate that U.K. hospitalizations are running around five times lower than they would have without vaccines.
United Kingdom hospitalizations
As of 08/06/2021. Source: Macrobond, RBC GAM
Unfortunately, the same cannot be said of the U.S. In Florida, infections have increased sharply, but so have hospitalizations (see next chart). Hospitalizations have seemingly increased even more sharply than during the prior wave.
As of 08/06/2021. Source: Macrobond, RBC GAM
Why might the U.S. be faring so much worse than the U.K. via this metric? The obvious answer is that the U.S. has a lower level of inoculation. However, it is hard to fathom a five-fold difference in the hospitalization rate on the basis of a 50% vaccination rate in the U.S. versus a 58% rate in the U.K. Other reasons could include:
- a shorter gap between the administration of the first and second dose in the U.S. (which appears to provide less protection)
- a higher level of U.S. obesity.
Yet the U.S. primarily used the more effective mRNA vaccines.
The main takeaway is that this U.S. wave is proving significantly more pernicious than the one in the U.K in terms of hospitalization. In turn, the U.S. should theoretically be less willing to tolerate this Delta wave. In practice, however, it is unlikely the U.S. will lock down significantly from here.
Nearly 4.5 billion shots have now been administered globally and this is advancing at a rate of 42.5 million new doses per day. The clip continues to accelerate, with developing countries capturing a rising fraction of the total (see next chart).
Cumulative COVID-19 vaccine doses administered
Based on latest data available as of 07/28/2021. Source: Our World in Data, Macrobond, RBC GAM
Still, developed countries remain the most highly vaccinated overall, with Canada now in second place among examined countries (see next chart).
COVID-19 global vaccination ranking
Based on latest data available as of 08/08/2021. Source: Our World in Data, Macrobond, RBC GAM
Encouraging vaccine demand
Now that vaccine supply is no longer the constraining variable in the developed world, policymakers are looking for ways to get more people over the finish line.
Vaccine passports feature centrally in this effort, with public sentiment becoming considerably more favorable toward them. For example:
- France now has a health pass that permits entry into restaurants, bars, planes and trains.
- Israel had something similar, discontinued it, and is now reintroducing it as cases again mount.
- The U.K. will soon no longer require the vaccinated to isolate when “pinged” by the country’s tracing app, and hopes to introduce a vaccine passport for nightclubs and other large venues for the fall.
- Quebec is now introducing a form of vaccine passport in Canada.
Many more such initiatives seem likely around the world, albeit six months after they would have been most logically introduced. The allure of such programs is not merely that they encourage more people to be vaccinated in the quest for herd immunity, but that entire industries don’t have to be shuttered during future waves as was the practice previously.
At the same time, some employers are becoming more aggressive in their attempts to ensure their employees – and in some cases, customers – are vaccinated. Cruise ships have their own vaccine passport system for guests. Some companies have fired unvaccinated workers. Some jurisdictions, hospitals and school boards are requiring vaccinations for their employees (or stringent testing).
Vaccine manufacturers now report that immunity begins to fade significantly within six months of being inoculated. They propose a third booster shot to remedy this. The hope is not just that recipients receive another six months of protection, but that the third booster might offer longer-lasting protection when combined with the earlier two.
Several countries are already venturing down this path, including Israel, France and Germany. It seems likely that most countries will eventually follow their lead.
However, this creates a conflict, as developing countries are only now getting access to their first round of doses. The World Health Organization has gone so far as to call for a moratorium on booster doses until the rest of the world has been vaccinated. It seems unlikely that wealthy nations will heed this call, and so it may take longer to inoculate the developing world than previously hoped.
Enough time has passed and sufficient studies have been conducted to now have a reasonable sense for how effective vaccines are against the Delta variant.
The efficacy rate of two Pfizer shots against symptomatic infection appears to have fallen from 95% versus the original virus to between 79% and 88% against the Delta variant. Other studies report even lower efficacy rates of between 64% and 69%, but these include asymptomatic infections (unlike the original Pfizer trial).
From a hospitalization standpoint, Pfizer was initially nearly 100% effective against hospitalization. With the Delta variant, this has now seemingly fallen to 93% to 96% effective.
The main takeaway is that while vaccines are somewhat less effective against the latest variant, it is not a precipitous drop. In particular, the risk of serious infection remains sharply lower. Despite this, Pfizer is fine-tuning its recipe, now testing a vaccine that specifically targets the Delta variant.
Whereas developed countries enthusiastically reopened over the first half of 2021, they have now settled into a holding pattern (see next chart).
Severity of lockdown in developed market countries
Based on latest data available as of 07/26/2021. Deviation from baseline, normalised to U.S. and smoothed with a 7-day moving average. Source: Google, University of Oxford, Macrobond, RBC GAM
Even as some countries continue to ease restrictions (such as in the U.K.), individual residents and companies are providing a significant offset, behaving more cautiously as infections rise. In the U.K., the country’s contact-tracing app has sidelined hundreds of thousands of workers, significantly impeding certain sectors including grocery stores, restaurants and trucking.
Many U.S. companies – including major banks and tech companies – have delayed their return-to-office plans from September to 2022 as the Delta variant accelerates. To the extent that offices are increasingly viewed as a place to work together rather than simply a place to work, it seems unlikely that large numbers of office workers will return until it is safe to put a dozen people into a meeting room. This is something that presumably won’t happen until the infection rate is quite low.
In conclusion, with restrictions no longer actively easing, an important tailwind for growth has been lost. This could potentially slow the rate of advance over the second half of the year (though there are still lagged benefits being accrued from earlier easing).
Business cycle inches forward
The burning question as we updated our U.S. business cycle framework was whether the economy had leapfrogged from “Early cycle” to “Mid cycle”. In the end, the answer is that it hasn’t yet made that jump. Our best estimate remains that the economy is still at a relatively early point of the business cycle (see next chart).
U.S. business cycle score
As of 08/06/2021. Calculated via scorecard technique by RBC GAM. Source: RBC GAM
That said, there is clear evidence of incremental forward movement in the cycle (see next table). Relative to a quarter ago, the strength of the “Early cycle” assessment diminished slightly (54% to 53%). The claim on “Start of cycle” fell sharply (11% to 2%). Meanwhile, “Mid cycle” strengthened (22% to 29%), as did “Late cycle” (8% to 13%) and even “End of cycle” (1% to 3%).
U.S. business cycle scorecard
As at 08/06/2021. Darkness of shading indicates the weight given to each input for each phase of the business cycle. Source: RBC GAM
Relatedly, our suite of yield curve models indicate that there is virtually no chance we are in a recession right now. The risk in a year also remains low. However, the yield curve model did acknowledge a slight increase in this risk (see next chart).
Yield curve-based U.S. recession risk ticked up recently
As of June 2021 for NY Fed model, RBC GAM estimates as of 07/29/2021. Probabilities of a recession 12 months ahead estimated using the difference between 10-year and 3-month Treasury yields. Shaded area represents recession. Source: Federal Reserve Bank of New York, Haver Analytics, RBC GAM
The takeaway is that this business cycle isn’t done yet. We certainly concede that it may be shorter than the average cycle to the extent that the recovery has occurred so quickly. But it will likely still be measured on the order of something like five years rather than the recent norm of approximately 10 years.
Will households deploy their savings?
A big debate for forecasters is the extent to which households will spend the excess savings they have accumulated over the pandemic. Whether economic growth over the remainder of this year and into 2022 is good versus spectacular will be determined in significant part by this. There are quite literally trillions of dollars at stake, representing 10.8% of GDP in the U.S., 9.3% in Canada and 8.6% in the U.K. (see next chart).
Considerable excess household savings due to pandemic
As of Mar 2021 for all countries except Japan (Dec 2020). Source: Macrobond, RBC GAM
Counter-intuitively, the substantial consumer spending that has occurred so far across this recovery cannot be characterized as the deployment of these excess savings. Although households are saving less than they were last year, they continue to save more than usual, meaning that they are technically still continuing to add to their excess savings rather than to deploy them (see next chart).
U.S. personal saving rate surge unwinding
As of June 2021. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM
The optimistic interpretation of this is that households have now accumulated an even larger quantity of money that they will eventually release in a torrent, boosting the economic outlook.
However, there is also a pessimistic interpretation. Our own view lands somewhere between the two extremes, but with slightly more sympathy for the cautious view that follows:
- The longer households don’t deploy their excess savings, even as the economy normalizes and restrictions fade, the more it argues that they simply aren’t going to spend this money.
- Keep in mind that the excess savings aren’t just money sitting in a wallet or bank account. They also represent money that has been invested in financial markets or as a down-payment on a home. Money deployed in that fashion doesn’t count as being spent since it remains part of the wealth of the household – but neither is it available for discretionary purchases.
- S. households also accrued significant excess household savings during World War II. After the war, families only spent about 20% of those excess savings, and it took a decade for that spending to fully occur. In contrast, some forecasts call for 20% or more of today’s excess savings to be spent over the next year – this may be overly optimistic.
- Even if household savings were unleashed in 2022, much of it would probably be motivated by households filling a financial hole that formed due to the removal of fiscal stimulus. The economy wouldn’t necessarily be significantly ahead via this smoothing effort.
We continue to see evidence of a U.S. economy slowing marginally after a period of outsized economic growth over the first half of 2021. Perhaps most compellingly, our measure of real-time economic activity is no longer rising as it was over the first half of the year (see next chart).
U.S. economic activity continues to revive
As of 07/24/2021. Economic Activity Index is the average of nine high-frequency economic data series measuring the percentage change versus the same period in 2019. Source: Bank of America, Goldman Sachs, OpenTable, Macrobond, RBC GAM
Furthermore, economic surprises are no longer landing as reliably on the positive side of the ledger as over the past year (see next chart).
Global economic surprises sliding lower
As of 07/30/2021. Source: Citigroup, Bloomberg, RBC GAM
Turning to individual data points, the terrain remains mixed. Negative developments include the U.S. second-quarter GDP print which landed at “just” +6.5% annualized, considerably less than the +8.4% consensus expectation. That said, the inventory drawdown that contributed to the miss could well reverse in the subsequent quarter.
The Institute for Supply Management (ISM) Manufacturing Index fell again, from 60.6 to 59.5, with new orders also down. The absolute reading remains very strong. However, there is some evidence that supply chain constraints (and diminishing economic buoyancy) is beginning to weigh on goods-producing sectors, even as the services side of the economy remains strong.
Of course, not every outcome is below the consensus: U.S. Payrolls for July managed an above-consensus 943K job gain. The unemployment rate tumbled from 5.9% to an impressive 5.4%.
U.S. housing normalizes
The U.S. housing market has boomed during the pandemic recovery, eliciting some concern as to its sustainability. We have generally been sanguine about this, with the view that the U.S. housing market is quite some distance from overheating, especially when compared to other markets like Canada.
A further support of this view comes in the form of the fraction of U.S. GDP dedicated to residential investment: the construction of new homes and home renovations. This has only now returned to its historical norm after more than a decade in the wilderness (see next chart).
U.S. residential investment continued to rise during the pandemic
As of Q2 2021. Historical average since 1947. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM
Granted, population growth isn’t what it once was and so perhaps the historical norm isn’t precisely the future norm. But residential investment today looks nothing like the boom of the mid-2000s. It simply doesn’t appear that the economy is allocating an excessive share of its resources toward real estate. In turn, there doesn’t have to be a period of notable weakness later.
Well-behaved consumer credit
Before the pandemic, measures of consumer credit delinquency had been trending steadily higher. This contributed to our view that the business cycle was at a late stage at that time. Then, during the initial phase of the pandemic, these delinquency rates edged higher still, consistent with the usual recessionary experience (see next chart). Since then, these delinquency rates have all reverted to a happy downward trend.
U.S. consumer credit performed better than expected during the pandemic
As of Q2 2021. Percent of balance of 90+ days’ delinquent loans normalized. Shaded area represents recession. Source: FRBNY Consumer Credit Panel/Equifax, Macrobond, RBC GAM
Stylistically, at least, this is all perfectly normal. Nevertheless, there are several important observations to be made about this sequence:
- It is remarkable that the increase in delinquencies was not greater given the magnitude of the recession. Fiscal stimulus directed at unemployed people and business owners presumably helped.
- It is incredible that mortgage delinquencies aren’t just falling, but are now at their lowest level in two business cycles. They were never this low over the decade before the pandemic, nor over the eight years before the global financial crisis.
- Finally, this pattern of declining delinquencies argues that the economic recovery to date isn’t just governments papering over a gaping economic hole with public money – there is something genuine and organic about the revival.
Federal Reserve update
The latest decision by the U.S. Federal Reserve revealed no major changes to the country’s monetary policy stance or to the economic assessment. Possibly the most notable development was that the Fed argued that the economic outlook is no longer significantly dependent on the path of the virus. In other words, future waves are unlikely to elicit major lockdowns and thus big economic consequences.
The Fed’s next meeting in September could be rather more significant. Not only is it a “major” meeting with an opportunity to update forecasts and fed funds dot plots, but it is a natural opportunity to signal when and how quickly bond purchases may begin to be scaled back. Markets are largely debating whether this happens toward the end of 2021 versus early 2022. Rate hikes themselves are still well over a year away.
A second key monetary question for the fall is whether Chair Powell will be nominated for another term at the helm of the Federal Reserve. Arguing against him, he is a Republican and a Trump appointee. Also, he is not a diverse choice from the perspective of a Biden administration attempting to move the needle on that front.
On the other hand, he has implemented quite dovish policy – usually a politician’s preferred stance. He has pushed the Fed to pay more attention to the environment and inequality. His ouster would add unnecessary uncertainty at a critical moment for the economy. So, it seems slightly more likely that he remains than that he goes.
In contrast to what may be a decelerating U.S. economy, the Canadian economy remains in acceleration mode. Real-time indicators have revived as restrictions fell away over the past few months. The Business Outlook Survey from July found rising sentiment, the highest-ever future sales indicator, the strongest-ever hiring intentions and large capex plans.
While failing to meet lofty expectations, the large addition of 94,000 new Canadian jobs in July surely counts as another example of an accelerating economy. The economy has now more than recovered all of the jobs lost in April and May. Employment now sits merely 1.3% below the pre-pandemic level.
Even as U.S. CPI reached an unfamiliar +5.4% year-over-year (YoY) in June, we believe the peak is near. Inflation should cool somewhat into 2022.
Several recent developments support this assertion:
- Commodity prices recently peaked and have come off slightly.
- The ISM Manufacturing Prices Paid Index has finally declined, from a scorching 92.1 to a still-high 85.7 in July. That is the first significant drop since April 2020. Simultaneously, the Supplier Deliveries Index has now fallen for two consecutive months, indicating that delivery times are finally starting to improve.
- Canadian CPI for June fell from 3.6% YoY to 3.1% YoY. Eurozone consumer prices actually declined by 0.1% in June relative to May. While every country has its own inflation idiosyncrasies, the fact that inflation is peaking in several countries suggests the peak could be near for other nations as well, particularly since much of the inflation heat comes from global forces such as commodity prices, shipping costs, altered demand preferences and chip shortages.
- Related to this, it remains quite interesting that U.S. inflation is so much higher than other countries. Not only is Canadian inflation nearly 2 percentage points below the U.S., but U.K. and Eurozone inflation are both approximately 3 percentage points below the U.S. Yes, the U.S. has a weaker currency and a hotter economy, but the difference is still extreme and probably unsustainable.
Great is bad?
During the initial phase of an economic recovery, good economic growth is good for risk assets like equities, and great economic growth is great. The economic recovery means higher earnings and a greater tolerance for risk. Government bond yields tend to react in a similar fashion: they rise moderately in response to good growth and sharply in respond to great growth, largely because risk aversion is fading. As such, the correlation between the stock market and bond yields tends to be strongly positive during this period.
However, as the recovery progresses, risk assets start to have a more nuanced view about great economic growth. It remains nice for short-term earnings, but also adds a tinge of danger to the extent it hints that the cycle is growing older, that inflation could become problematic and that central banks may have to tighten policy sooner rather than later. As such, the stock market arguably starts to prefer good growth over great growth. Bond yields, meanwhile, continue to rise proportionately to the strength of the economy, particularly as higher inflation and central bank tightening enters the discussion.
All of this is visible in the correlation between U.S. stock market growth and the change in the U.S. 10-year yield (see next chart). This was profoundly positive in the early phase of the pandemic, but the correlation has more recently weakened as the stock market becomes pickier about what kind of growth it desires. Case in point, when the barn-burner U.S. job creation number was released, bond yields rocketed higher but the stock market only increased moderately – the number may well have been too strong for comfort.
U.S. stock-bond correlation over time
As of 07/30/2021. Correlations of daily S&P 500 returns and yield change of 10-year U.S. Treasury bonds. Shaded area represents recession. Source: Haver Analytics, RBC GAM
In short, going forward, risk assets may be walking a tightrope in which they desire good but not great (or bad) economic growth.
-With contributions from Vivien Lee and Lucas Hervato