This week’s note reviews rising Delta variant infections, examines how India managed to beat back the pandemic, and asks what happens next in the U.K. now that the country has eliminated all restrictions at a time when the virus is surging. We then review the latest hot inflation data (and arguments for and against further strength) and highlight several economic trends. To wrap up, we revisit the latest U.S. fiscal stimulus plan, investigate office occupancy data and touch on several items of geopolitical relevance.
Recent news has arguably been more negative than positive. These negatives include:
- COVID-19 infections are now rising again in the significant majority of the world’s countries.
- The U.S. economy may be decelerating.
- Enthusiastic inventory accumulation could contribute to an economic hangover later.
- Inflation is even higher than before.
- A flattening yield curve hints at an advancing business cycle.
There are still important positives, but they are not new developments and so are easy to overlook:
- The economic recovery continues.
- Vaccinations continue at a fairly good pace.
- Vaccines remain extremely useful against the pandemic, including the Delta variant.
Rising COVID infections
The latest COVID-19 wave is now well underway, albeit still well short of the prior peak (see next chart).
COVID-19 emerging markets vs. developed markets infections
As of 07/18/2021. Calculated as the 7-day moving average of daily infections. Source: World Health Organization (WHO), Macrobond, RBC GAM
It is not simply a matter of a few big countries running into trouble, as around 70% of countries are now experiencing a rising infection rate, up from just 30% a few months ago (see next chart).
Countries report rising daily new COVID-19 cases
As of 07/18/2021. Change in cases measured as the 7-day change of 7-day moving average of daily new infections. Source: WHO, Macrobond, RBC GAM
This breadth is also visible within countries. The U.S. rate of daily infections isn’t just rising, but is now rising in all 50 states (see next chart). The change has been abrupt – almost no states were experiencing a rising infection rate just a month ago. Most new U.S. infections are thought to be the Delta variant.
Number of U.S. states with transmission rate above key threshold of one
As of 07/18/2021. Transmission rate calculated as 7-day change of underlying 5-day moving average of new daily cases, smoothed with 7-day moving average. Transmission rate above one suggests increasing new daily cases. Includes Washington, D.C. Source: Haver Analytics, Macrobond, RBC GAM
This isn’t to say that the virus is spreading indiscriminately. On a per capita basis, there are significantly more infections and a faster rate of increase in states with a low vaccination rate like Mississippi than in states with a high vaccination rate like Vermont (see next chart). Nevertheless, even Vermont is now recording a rising infection rate.
COVID-19 infections in high- versus low-vaccination states
As of 07/14/2021. Source: Center of Disease Control (CDC), United States Census Bureau, Macrobond, RBC GAM
Continental Europe is now experiencing a significant increase in its infection rate as well (see next chart). This is particularly consequential because Europe has proven more willing to lock down in response to the virus than the U.S. In turn, there may be economic consequences from this.
COVID-19 cases and deaths in Spain
As of 07/18/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
Canada continues to enjoy a declining infection rate, though the rate of improvement has slowed. It could be that Canada has done enough that it will significantly sidestep the Delta variant wave. This may be true both from a vaccination perspective (now among the world’s leaders, and ahead of the U.S. via every relevant metric) and from a restrictions perspective (with more restrictions in place than most countries – see next chart).
Severity of lockdown in developed market countries
Based on latest data available as of 07/15/2021. Deviation from baseline, normalised to U.S. and smoothed with a 7-day moving average. Source: Google, University of Oxford, Macrobond, RBC GAM
However, while the Canadian experience should be milder than most, we wouldn’t count on the country skipping the next round of rising infections altogether. The latest variant data shows that while the Alpha variant has declined by 83% over the past four weeks, the Delta variant has increased by 40% over the same time period (see subsequent table). In other words, the existing level of vaccination and mobility restrictions has been insufficient to contain the most contagious variant.
Canada and the variants
As of 07/16/2021. Source: Government of Canada, RBC GAM
Among emerging market nations, it is heartening that the South African infection rate has begun to decline (see next chart).
COVID-19 cases and deaths in South Africa
As of 07/18/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
However, much of Southeast Asia is now being walloped, and none more so than Indonesia. The country now officially logs more than 50,000 new infections each day (see next chart).
COVID-19 cases and deaths in Indonesia
As of 07/18/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM
How to explain India?
One matter not fully resolved is how India managed to pare its infection rate from more than 400,000 new infections per day at its peak to just 40,000 per day now (see next chart). Infections were doubling every few weeks in April, and then suddenly they were halving just as quickly in May.
COVID-19 cases and deaths in India
Partial answers can be found in the fact that India is among the leading emerging market countries for vaccinations, with almost 25% of its population now possessing at least one dose. India has also imposed more social distancing restrictions over the past few months. Public awareness may also now be higher.
However, it is hard to fathom that these developments sufficed by themselves to quell the Delta variant. At a minimum, the level of inoculation is still far too low to be approaching herd immunity by itself.
Instead, we strongly suspect that India has achieved some semblance of herd immunity via natural means. This is to say, enough Indians have now been infected that the virus is finding it more difficult to locate new people to infect. A serological study from April—May found that approximately 60% of the country’s population already possessed antibodies. In some big cities, the figure was a big 75%. This greatly exceeds the fraction of the population that was officially counted as infected, presumably due to asymptomatic infections, limited access to testing or limited access to medical care.
To the extent that the most recent wave was still in full swing when the serological testing was conducted, the level of natural immunity should be even higher today. Add to this the vaccination campaign (though there would be considerable overlap with those possessing natural immunity) and it is entirely possible that India has now achieved the 80% to 85% of the population that needs to be protected to greatly limit the spread of the Delta variant.
Indonesia is evidently not yet at herd immunity – its infection rate is currently spiking. Yet it may not be all that far off. A serological study of Jakarta from March already found that 44% of the population possessed antibodies. Three months have passed and the infection rate has intensified since then. This is not a happy way to achieve herd immunity, but perhaps it will be achieved sooner than commonly imagined for many emerging market countries.
The British experiment
The U.K. is conducting a large-scale and consequential experiment. The country is experiencing a rising number of infections – now nearly 50,000 per day (see next chart) – and yet has opted to remove most remaining restrictions on July 19. Government projections suggest the daily infection rate may well reach 100,000 or more.
COVID-19 cases and deaths in the U.K.
This is an unconventional strategy to say the least, running contrary to the usual approach of imposing more restrictions when infections rise.
The argument behind the new approach goes as follows:
- A large fraction of the U.K. population has now been inoculated, with a particular focus on the most vulnerable people.
- COVID-19 infections should therefore lead to far fewer hospitalizations and deaths than before.
- It is important to get the economy moving again and for people to live more normal lives.
- While herd immunity via vaccination remains elusive, if countries cannot be fully reopened after vaccinations have been administered to a reasonable threshold, when will they ever be reopened? There is no further silver bullet.
- By getting additional infections out of the way now, herd immunity can be achieved at an earlier date. A spike over the fall and winter may thus be avoided, schools will therefore not be inundated with COVID-19 cases and hospitals will have sufficient capacity to handle flu season.
Perhaps the only flaws in the argument are that:
One way or the other, the results of the British experiment will become clear over the next month, and will be gauged on the basis of factors such as the extent to which:
- infections rise
- hospitalizations and fatalities also go up (so far this is only to a limited extent, but these are known to be lagging variables)
- the public engages in additional voluntary social distancing.
Over the medium term, we will then learn whether herd immunity can be achieved via natural means, and whether that immunity is lasting.
These lessons will prove important, as it seems highly likely that the U.S. will follow the same path. It was later to be inundated by the Delta variant, but it has already removed most of its restrictions, meaning it will probably follow a similar path to the U.K. If successful, many other countries could also opt to use the British strategy.
All of this raises an important philosophical question: when is the pandemic over?
- Is it when the last infection is cured? That will probably never happen.
- Is it when the number of infections is low? That requires serious social distancing or the achievement of herd immunity.
- Or is it when few people are dying from the disease? This may well be achieved via vaccination and effective treatment even when the number of infections is considerable.
The U.K. is betting on the latter. To the extent that we accept a flu season every year and the presence of myriad head colds without calling them pandemics, this may be the right conclusion. We must watch the U.K. fatality figures with particular attention.
This raises a further matter, which is that the pandemic isn’t ending quite as neatly as many (and we) had once hoped. There isn’t going to be a day when COVID-19 disappears altogether. That was once possible if the virus hadn’t repeatedly mutated into ever-more-contagious forms. Unfortunately, it has.
Countries that have tried to pursue a zero-tolerance strategy, such as Australia, are now stuck in a repeating loop of harsh lockdowns. It is a bit depressing to accept that an additional small risk now exists in the world, even though, rationally, the world is already filled with many similarly sized risks. There is a chance this creates a malaise that limits the economic rebound at some point, though so far the opposite is in evidence: pent-up demand continues to carry the day.
The latest on inflation
Inflation is white hot, actively rising and repeatedly exceeding the consensus forecast. This was the case again with the release of the June print of the U.S. Consumer Price Index (CPI), which notched an extremely high +5.4% year-over-year (YoY) reading. Indeed, most major measures of inflation are now very high (see next chart).
U.S. inflation rising rapidly
As of June 2021. Shaded area represents recession. Source: Bureau of Labor Statistics (BLS), Macrobond, RBC GAM
The monthly rate of increase was actually the greatest yet recorded during the pandemic, with a 0.9% gain from May to June. That’s half a year’s price increase in a single month.
The last time prices rose this aggressively in a single month (June 2008), they then abruptly reversed course that fall, including a single month in which prices fell by a remarkable 1.8% (November 2008). The parallels are imperfect – the prior episode was in part a burst commodity bubble and in part the intensification of a global financial crisis, whereas we do not anticipate a near-term recession today. Nevertheless, we do find a mildly negative correlation between the monthly change in U.S. CPI and the monthly change three months later. So what goes up may eventually come back down. This pattern is even more apparent in the long-term history of inflation. Most spikes are followed by a sharp decline, not just to normal inflation rates but frequently below (see next chart).
U.S. inflation over time
As of April 2021. Shaded area represents recession. Source: BLS, Macrobond, RBC GAM
There is additional evidence in support of a reversal thesis. After all, shipping costs remain an active driver of higher inflation (though, notably, at a decelerating rate recently – see next chart). But there is no reason to think shipping costs will remain permanently higher than before the pandemic once supply chain bottlenecks have been smoothed out. The average shipping container should eventually fall back to something like $2,000 per 40-foot container from around $9,000 today. That implies unusually weak inflationary pressures at a later date. While some experts believe that the shipping backlog won’t be fully resolved until the middle of 2022, this is another way of saying that the cost of shipping should fall by a factor of four to five over the next year!
Shipping costs soared during the pandemic
As of the week ended 07/15/2021. Source: Drewry Supply Chain Advisors, RBC GAM
Similarly, there is no reason to think that used cars will remain a remarkable 45% more expensive than they were before the pandemic. Yes, driving may remain relatively more popular than public transit for a period of time. But it is hard to fathom that level of distortion persisting when the underlying cost of inputs has not changed nearly as drastically.
Lack of breadth
Price increases remain fairly narrowly based. Only a handful of products are experiencing truly outsized price increases. The aforementioned price of a used car rose by a big 10.5% over the past month alone. Gasoline prices rose by 2.5% over the month. Airfare is up by 2.7% and the cost of a hotel rose by 7.9%. Eating out is 0.7% more expensive than the prior month. Fully a third of the inflation over the past few months has come from used car prices alone.
In contrast, median CPI remains at a roughly normal +2.2% YoY. This is well under half the official CPI reading (see next chart). This is to say, while a few items have sharply rising costs, the average product – the product whose price is rising more quickly than half of the basket and less quickly than the other half – still looks pretty normal.
U.S. headline inflation jumps but median inflation remains tame
As of June 2021. Shaded area represents recession. Source: BLS, Federal Reserve Bank of Cleveland, Macrobond, RBC GAM
This confirms that special factors are at work in driving inflation higher, rather than broadly based forces. Specifically, demand preferences and supply capacity has temporarily changed for a number of sectors.
Accordingly, central banks remain insistent in their view that the extra inflation is “transitory.” They have some credibility in their claim given that they employ a large fraction of the world’s inflation experts. It is also notable that the bond market remains calm, with nominal yields actually falling substantially over the past four months. Similarly, market-based inflation expectations are broadly lower over the past few months (see next chart).
U.S. inflation expectations retreating from recent high
As of 07/16/2021. Source: Bloomberg, RBC GAM
Alternately, and crucially, if central bank money-printing was the central engine of higher inflation, you would expect all of that extra money sloshing around to increase the cost of all products roughly equally. It is the opposite.
Other good news
Commodity prices continue to flatten out and even fall. Lumber prices are now off sharply and oil prices have fallen somewhat as OPEC announces rising output (more on that in a later section). The Chinese government continues to do what it can to limit the advance of commodity prices, if mainly by discouraging further speculation. Resource prices were a key driver of the initial inflation boom, and could be a key source of its end.
Real-time web-based prices are now dimming in North America and possibly peaking in the Eurozone and U.K., suggesting that inflation is unlikely to accelerate further. We are reluctant to guarantee such an outcome given the serial upside surprises from inflation recently, but it is a distinct possibility that the fastest month-over-month price increase has now been set.
Emerging market inflation
Inflation is also rising in emerging markets and these countries tend to be especially exposed to swinging commodity prices due to a greater orientation of their spending basket toward food and energy. Yet the increase is actually much less unusual than in the developed world (see less chart).
Inflation in emerging market countries rising quickly
Based on latest data available as of May 2021. Purchasing Power Parity/PPP-based Gross Domestic Product/GDP-weighted average of Consumer Price Indices (CPIs) of 28 emerging market countries.
U.S. growth slowing
The U.S. economy is arguably now past its period of peak growth. The country’s Purchasing Managers’ Indices (PMIs) have slipped slightly (see next chart). The New York Fed’s weekly economic activity index has also edged a bit lower.
U.S. manufacturing and services sectors lost steam recently
As of June 2021. Source: Institute for Supply Management, Haver Analytics, RBC GAM
To be clear, the latest readings are still consistent with enviable growth, but just less than over the past six months. This makes sense for several reasons:
- U.S. fiscal stimulus has faded for the moment (more on a possible future round shortly).
- The tailwind from reopening may be starting to diminish.
- The Delta variant is rising.
- People are worried about inflation and the Fed tightening policy.
In turn, one might expect the return on risk assets to remain positive on average, but to be more muted than over the past year.
Companies have been keen to build a reservoir of inventories. At this time of year, U.S. companies would normally have acquired 14% of next year’s needed inventories, whereas they have already built to a 32% reading today.
Further, they aren’t obviously stopping their inventory binge. A National Federation of Independent Business (NFIB) survey shows that a record-high fraction of business owners believe their inventory level remains too low. A similarly record-high fraction are planning to increase their inventory levels from here.
Why might companies want such a high level of inventories? We can think of four reasons.
- They may be worried that their input costs will continue to rise, and so are seeking to get ahead of those cost increases.
- Many supply chains remain problematic. Companies need a bigger inventory to ensure a sufficient supply of products for their clients.
- The pandemic has likely given them a greater appreciation for the possibility of some future shock coming along and disrupting their just-in-time inventory system.
- Some businesses are genuinely experiencing a boom in demand.
While all of this is rational, it nevertheless pulls forward demand from next year to this year. That’s nice for 2021, but less good for 2022. We’ve already flagged the possibility of a hangover in 2022 as fiscal stimulus unwinds and pent-up demand presumably eases. There might also be a further drag should companies opt to shrink their inventories next year – with the implication that economic output might undershoot demand for a period of time.
Those inclined to fret may further note that an inventory drawdown is classically associated with the end of the business cycle. However, we are dubious that this is the right conclusion to reach, for the following reasons:
- What we are presently observing is inventory accumulation – a source of strength. Anything beyond that remains speculation.
- The relationship between the inventory cycle and the business cycle, while much discussed, seems fairly flimsy.
- Our own business cycle work argues that there can probably be several additional years of economic expansion before this particular cycle comes to an end. Still, it is reasonable to expect some additional headwinds in 2022.
The Canadian economy is making good on its promise of fast growth as restrictions ease. The restrictions have certainly eased right across the country (see next chart).
COVID-19 restrictions eased across the country
As of 07/07/2021. Atlantic region includes New Brunswick, Newfoundland and Labrador, Nova Scotia and Prince Edward Island; Prairies region includes Alberta, Manitoba and Saskatchewan. Source: Bank of Canada, RBC GAM
Real-time credit and debit card data in Canada reveals a particular enthusiasm for activities that were previously restricted, much as has been observed in the U.S. For example:
- Travel spending remains well below normal, but has recovered from approximately 80% below normal in May to just 40% below normal in July (see next chart).
- Clothing sales have recently exceeded 2019 norms for the first time.
- Spending on entertainment outside the home has surged from around 15% below 2019 levels in early June to a remarkable 20% above pre-pandemic levels by late June.
Travel spending coming back to life from extremely low levels
As of July 2021. Percent change from 2019 (pre-shock) levels, 7-day rolling average. Travel spending includes: airlines, car rental, travel, travel agencies. Source: RBC Economics, RBC Data and Analytics.
Canadian job creation in June confirms the summer rebound narrative. After sizeable job losses in April and May, June managed to recover the great bulk of the previously lost jobs. Further gains are presumably coming in July and beyond.
This, in turn, has kept the Bank of Canada largely on track. For a second consecutive quarter, the Bank removed C$1 billion of weekly bond buying from its quantitative easing program. Net purchases are seemingly on track to be completed by early 2022. While the policy rate remained unchanged, Bank of Canada projections continue to suggest a second-half of 2022 start for policy rate increases.
The big change in the Bank of Canada’s forecast is that it expects a bit less growth than before in 2021 (though still an impressive +6.0%). The Bank then expects considerably more growth than before for 2022 (now +4.5%). The main impetus for the change is that the Bank now assumes that Canadians will spend about 20% of the $210 billion in excess savings they have accumulated over the pandemic.
Europe’s substantial Recovery Fund (672 billion euros) is now being funded and will shortly start to disburse money to its member states. This is certainly a positive for the European Union (E.U.) economic outlook.
But the amount of money involved in Europe continues to be overshadowed by enormous U.S. initiatives. After two big programs delivered over the past year, the White House desires a further infrastructure-oriented effort worth a remarkable $4 trillion.
We haven’t written about these plans in quite some time. That’s not to say there hasn’t been news, but instead that each day’s news largely supersedes the prior day’s, such that there has been little value in providing detailed analysis since it becomes stale so quickly. But we can’t ignore the efforts altogether, as they provide some sense for what the ultimate package may look like.
The White House wishes to split the $4 trillion roughly equally between hard infrastructure (bridges, roads, etc.) and what it calls “human infrastructure.” By this, it means an expanded child benefit, pre-school funding, family leave, child care subsidies, community college subsidies and climate initiatives, among others. This is an unconventional usage of the term “infrastructure” and would normally simply be called program spending. That said, it is entirely possible that spending on programs such as these will increase productivity and economic output (via a higher labour force participation rate and a higher level of education) in much the same fashion as spending on traditional infrastructure seeks to do.
The White House wants as much of this initiative to be bipartisan as possible. It would be easier to legislate if bipartisan, and less likely to be reversed by the next administration, among other attractions.
However, bipartisan negotiations have only managed to reach an agreement for $579 billion in new hard infrastructure spending.
As such, the White House wishes to implement the remaining $3.5 trillion without Republican support via the reconciliation process.
Is the $4 trillion therefore a done deal? Note quite. The Republicans don’t want to implement the $579 billion bipartisan package if there is also a Democrat-only package. And the Democrats don’t want to implement their reconciliation package until they are sure that the Republicans will support the bipartisan bill. It is something of a deadlock and likely to be negotiated over much of the summer.
If I had to guess, I would say that I wouldn’t be surprised if the bipartisan portion failed, meaning that the Democrats have to ram everything through via the reconciliation process. In turn, because that requires unanimous Democratic Party support in the Senate, it seems likely that the amount of money committed declines somewhat given that some Democrats are more moderate in their fiscal orientation.
While the sums of money are likely to be very large even after any shrinkage, it is important to appreciate that the money will be disbursed over five to eight years. This means it won’t have the same upfront effect as earlier rounds of stimulus. Further, the Democrats wish to pay for some of the plan via tax increases. While these are also likely to be watered down, that will reduce the amount of net stimulus, and particularly limit the positive effect for corporations or financial markets.
While hard to fathom, the U.S. will be just a year away from midterm elections this November. That means that politicians will pivot toward campaign mode shortly thereafter. And then, in the election itself, the incumbent party usually loses some Congressional support. As such, Republicans could control the Senate as of 2023 and further such initiatives would be impossible.
Office occupancy trend
In our last #MacroMemo, we discussed the long-term outlook for working from home. The main takeaway was that, for white collar workers, approximately 40% of work that was previously conducted in the office will probably be conducted from home even after the pandemic is over, versus only around 10% before the pandemic.
For individual companies, the calculus is surprisingly tricky. It was well established before the pandemic that white-collar workers can function at a high level of productivity in the office. It has since been established during the pandemic that white-collar workers can function at a high level of productivity while out of the office. Thus, there isn’t a simple mathematical equation for maximizing productivity vis-à-vis time spent in the office. More will become apparent over time as workers agitate for the greater flexibility offered by working from home and companies seek to maintain their corporate culture and better train new hires.
In the meantime, it is surprising how slowly businesses have brought their employees back to the office so far (see next chart). In the U.S., there was no sudden leap in office occupancy even as restrictions were lifted. Workers are merely trickling back in.
Office occupancy of U.S. metropolitan cities
As of the week ending 07/07/2021. The Barometer represents the weekly office occupancy based on swipes of access controls. Source: Kastle Systems, Bloomberg, RBC GAM
Granted, there is considerable variation in office occupancy by city. Cities in Texas are now approaching 50% of normal occupancy levels, while those on the coasts – San Francisco, New York and San Jose – are still well below 20% of normal occupancy levels. All remain below what is thought to be a likely post-pandemic norm (theoretically around 67% of the pre-pandemic norm).
The takeaway is that, at this rate, it will take months to years for offices to reach their post-pandemic norms in any of these cities. Financial and tech hubs have been particularly slow to recall workers. This matters for businesses that service those office workers, though not necessarily as much for the office-based companies themselves since they have established a high level of productivity regardless of location.
These findings also hint at how other countries that are only now reopening their economies may proceed. There will presumably be something of a jump as September rolls around, vacation season ends and children return to school. But it isn’t realistic to think that offices will snap back to normal on some anointed date. The “pent-up” demand for returning to the office doesn’t appear to be quite the same as the pent-up demand to eat in a restaurant or go on vacation.
Oil and OPEC
After much debate, OPEC has taken two steps to increase its oil production going forward. The first was to permit the United Arab Emirates a higher baseline quota, followed shortly by permission for four other OPEC+ countries to also increase their production.
OPEC had cut production by a large 10 million barrels per day during the initial phase of the pandemic, and has since restored 4.2 million of that decline. The new plan will see a further 2 million barrels per day added by the end of 2021, with the remaining 3.8 million barrels theoretically restored by the end of 2022.
Oil prices have fallen on the news of additional supply. There remains a further risk over the coming months that the U.S. strikes a deal with Iran, permitting a significant increase in Iranian oil production.
From the opposite perspective, given the difficulty of recent negotiations, there had been concerns that OPEC might be fragmenting. That would have been a sharp negative for oil prices, and the avoidance of that outcome has presumably limited the decline in oil prices. From a purely inflation standpoint, lower oil prices are welcome.
The U.S. and China remain at odds from a geopolitical standpoint – a situation we expect to persist for years to come. China recently snubbed the U.S. by refusing to allow a high-ranking U.S. official to meet with their Chinese counterpart. China has also cracked down on the ride-hailing firm Didi after it opted to raise funds in the U.S. market (though one could argue China is simultaneously keen to wield greater control over its tech champions, with the U.S. merely a convenient excuse).
Good tariff news
The past four years saw more tariffs added than removed due to U.S.-China frictions and the culmination of Brexit. As such, it is welcome news that some of those barriers are now starting to decline. The U.K. has signed its first post-Brexit trade deal with Australia, and indicates it aspires to many more such deals.
Meanwhile, the U.S. and Europe have eased their long-standing conflict over the subsidization of Boeing and Airbus. Relevant tariffs are to be lifted for five years, though much remains to be negotiated before a lasting resolution is found.
-With contributions from Vivien Lee and Lucas Hervato