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by  Eric Lascelles Mar 7, 2023

What's in this article:

Monthly webcast

Our latest monthly economic webcast is now available: “China revives and so do inflation fears.”

China’s recovery

China has shaken free of its COVID-19 wave and its economy is now accelerating. Real-time measures such as subway traffic in major Chinese cities have soared to the highest level since before the pandemic (see next chart).

Subway traffic soars in major Chinese cities

As of 03/02/2023. Index is the weighted 7-day rolling sum of subway trips in Beijing, Chengdu, Chongqing, Guangzhou, Nanjing, Shanghai, Suzhou, Wuhan, Xi’an and Zhengzhou. Source: Chinese metro agencies, Macrobond, RBC GAM

Similarly, China’s manufacturing purchasing manager indices (PMIs) jolted higher in February, as we had anticipated. The official estimate is now at the highest level in over a decade (see next chart). China’s service-sector equivalent also leapt higher (see subsequent chart).

China’s manufacturing activity rebounds after the end of zero-COVID

As of Feb 2023. Source: Caixin, China Federation of Logistics & Purchasing, S&P Global, Macrobond, RBC GAM

End of zero-COVID policy lifts business activity in China

As of Feb 2023. Source: Caixin, S&P Global, Haver Analytics, Macrobond, RBC GAM

We anticipate robust economic growth for China in 2023 as this recovery plays out. There is genuine pent-up demand to be sated. However, do not assume that China has a full three years’ worth waiting to explode. Apart from travel restrictions, the country was among the most open in the world for much of the pandemic. China only really succumbed in a major way to lockdowns in early 2020, the spring of 2022 and then in the fall and winter of 2022. Significant sums of cash were already deployed during earlier periods of openness (see next chart).

Furthermore, China’s additional savings, while large, only amount to a savings rate that leapt from approximately 30% to an average of 33% in recent years.

Chinese households saved even more during the pandemic

As of Q4 2022. Based on 4-quarter moving average of disposable income and expenditures per capita. Source: CNBS, Macrobond, RBC GAM

China’s additional savings are large, but not especially impressive in the context of what other countries have done (see next chart). If the U.S. seems surprisingly small, that’s because it has already spent its excess savings significantly down. Additionally, much of the money that was saved in China was put into long-term savings accounts which do not permit rapid access.

Excess household savings rise due to pandemic

As of Dec 2022 for U.S., Q3 2022 for Canada, Japan and U.K., Q4 2022 for China and Germany. Cumulative excess savings vs. 2019 average since March 2020. Source: Macrobond, RBC GAM

All of this is to say that China is credibly on track for a significant economic rebound. However, we still only forecast 5.3% growth. Earlier there had been rumours that China would formally target 6% growth, but this proved unfounded. The country recently announced a 5% target.

These figures are nearly double the growth rate from 2022, but less than what would have been deemed normal just before the pandemic. This is due to a combination of factors: a more muted housing market, poor demographics, a desire for state control, and significant frictions with the West. In this environment, China’s ‘new normal’ growth rate -- absent pandemic-rebound tailwinds – is arguably considerably less than it was before. It is perhaps in the realm of 3-4%.

Pandemic update

Barring the arrival of a substantially more deadly COVID-19 variant, the pandemic no longer has much bearing on global economic activity. In December, China became the last major country to abandon strict pandemic restrictions.

The virus continues to circulate, but without the same medical consequences as before. Hospitals are far less pressed than during the repeated pandemic waves of the last three years. Infections are also reported to be sharply lower than before, though the quality of the data is questionable given less testing today. Clearly the newly dominant XBB.1.5 variant (constituting 90% of new U.S. infections as of early March) is the most infectious yet – and among the most contagious viruses in history. Yet it isn’t creating the problems that earlier variants did, presumably due to greater immunity today.

There is no new variant of significance on the horizon. Luckily, China’s massive outbreak at the turn of the year appears not to have churned out a new variant. The CH.1.1 variant, first detected in India last July, has been flagged as a possible candidate. But for now it remains a fairly small share of infections and isn’t significantly increasing its presence.

Of course, new variants can arrive with minimal warning. Yet it is hard to see how new variants would significantly change this equation unless they become more fatal, requiring greater public precaution.

At the considerable risk of dwelling too much on viruses when there are only a few occasions in modern history when diseases have had a significant effect on the economy, it is nevertheless worth mentioning that the H5N1 avian flu outbreak currently underway is somewhat concerning. Why?

  • The virus has leapt from birds to mink, signaling that mammals are vulnerable to this iteration of the virus.
  • Most such viruses usually operate primarily in the lower respiratory tract and so are not particularly contagious. However, this one breeds in the upper respiratory tract and so could be quite contagious.
  • Past outbreaks of H5N1 that have infected humans yielded a startling case fatality rate of more than 50%. That’s 35 to 400 times more fatal than COVID-19, depending on the variant and the time period. This is distressing, though the true fatality rate for H5N1 was likely significantly lower since most historical cases were presumably too mild to have been identified or reported.

Ukraine war

The Russia-Ukraine war is now more than a year old, having passed its February 24 anniversary. Russia has been on the offensive for the past few months, recapturing a small fraction of the territory that it ceded to Ukraine last fall. Russian shelling has been steadily rising for several months, though it is not higher than last August or September (see next chart).

Russia has increased shelling since late 2022

As of 02/16/2023. Source: Briefings from General Staff of Ukrainian Army, Ragmar Gudmundsson, RBC GAM

Ukraine has been warning of a major new offensive from Russia. It is unclear whether that has already manifested in the form of Russia’s recent advance, or whether it remains to come. The U.S. Secretary of Defense estimated that Russia has already deployed 97% of its army to the Ukraine war, suggesting that Russia is now fighting very near to its maximum capabilities. The country continues to eat through its military hardware at a rapid rate, as its production of new equipment is limited and increasingly stymied by Western sanctions.

On this subject, the U.S. deployed new sanctions on Russia designed to close loopholes that had allowed foreign companies to supply Russia with U.S. technologies. The European Union also tightened the availability of its technologies.

As earlier sanctions have begun to bite, Russian oil revenue has recently fallen quite sharply (see next chart), damaging the fiscal finances of the country and perhaps limiting its future war effort. Russia recently announced a 500,000 barrel per day cut in its production. This was styled as punishment to the West, though it likely also reflects Russia’s declining capacity to produce as it loses access to key Western technologies. Ominously, Russia also retaliated by suspending its participation in a major nuclear arms control treaty with the U.S., though this could be seen as posturing.

Russian oil and gas revenue decreased significantly as a result of lower price and sanctions

As of Feb 2023. Source: Russian Ministry of Finance, Macrobond, RBC GAM

China recently held a summit with Russia. China failed to repeat its pledge of a ‘no limits’ partnership with Russia and seems to be trying to straddle a fragile line between antagonizing Russia and the West. China also issued a 12-point plan for a political settlement between Russia and Ukraine. This is unlikely to gain much traction as it fails to address the key matter of who gets what land. Putin was not receptive to the overture.

Still, China has been a clear beneficiary of Russian sanctions:

  • A rising fraction of Russia’s oil and gas production is now absorbed by China.
  • China supplies a rising share of Russia’s imports. These include dual-use goods that have both civilian and military applications.
  • China’s share of Russian car purchases has risen from 10% before the war to more than 30% today.
  • The yuan is also supplanting the dollar as a key international currency in Russia, serving as the means of payment for 15% of Russian exports versus just 0.5% before the war. Close to 50 Russian financial institutions now offer yuan-based savings accounts. The world’s dollar-centric financial network continues to fracture – another sign of de-globalization at work.

Strong economic data 

Recent economic data was mostly strong. Some of this may have been artificial. For example:

  • Much of the data was for the month of January, which is always subject to unusually large seasonal adjustments and is thus at risk of larger-than-normal distortions.
  • This particular January also happened to be unusually warm in North America, juicing retail sales and possibly employment.
  • Many pension plan recipients received their annual cost of living adjustment in January, enjoying – and presumably partially deploying – the large leap in their benefits that resulted from higher inflation over the past year.

But for all of those qualifications, credit should be given where it is due: the numbers were still pretty strong. North American hiring was enthusiastic (though we await the next month’s data in just a few days). U.S. retail sales soared by a remarkable 3% relative to the prior month. Overall personal spending was up by 1.8%. Even after adjusting for inflation, U.S. spending is again rising (see next chart).

U.S. consumer spending remains resilient

As of January 2023. Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS), U.S. Census Bureau, Macrobond, RBC GAM

After a swoon two months earlier, the U.S. Institute for Supply Management (ISM) services index for February remained at a healthy 55 reading for a second month. This suggests that a large swath of the U.S. economy was just fine through the second month of the year. As well, our overall U.S. business composite index is weak but has staged a recent partial recovery (see next chart). Our European composite has done something similar.

U.S. business expectations composite has staged partial recovery

As of January 2023. Principal component analysis using National Federation of Independent Business (NFIB) optimism and business conditions outlook. ISM Manufacturing and Services new orders and the Conference Board CEO Survey expectations for economy. Source: The Conference Board, ISM, NFIB, Macrobond, RBC GAM

A notable exception is that Canada’s December Gross Domestic Product (GDP) was reported down 0.1%. This leaves the fourth quarter merely flat relative to the prior quarter.

But, overall, economic data was more good than bad. The twist is that markets didn’t celebrate this development whatsoever. With economies already broadly overheating and inflation stuttering at a high level (more on that later), central banks are again on high alert. In turn, what’s good is bad: risk assets are inclined to view economic strength as bad news because it requires more monetary tightening and thus greater economic weakness later.

New growth forecasts

As events on the ground continue to change, so too have our growth forecasts. The resilience demonstrated by economic and inflation data in January has prompted us to delay our recession forecast from roughly the middle of 2023 to the second half. This is to say, we now forecast a two-quarter recession for most developed countries spanning the third and fourth quarters of 2023 rather than the second and third quarters. The depth and duration of the assumed recession is essentially unchanged from before, as is the presumed recovery thereafter.

You wouldn’t know any of this by looking at our new annual growth forecasts for 2023 and 2024 (see next table). The 2023 forecast has increased since a later recession means that less of 2023 economic activity is undercut. Conversely, that same lateness means that output is significantly dimmed over the first part of 2024, making that year look bad even though we expect a handsome economic recovery to take hold next year.

Despite what the annual numbers appear to say, we continue to expect a moderately worse recession than the market does, but then a pretty good recovery in 2024. Confusing stuff.

RBC GAM forecast as of 02/22/2023. Change versus prior quarter. RBC GAM vs. consensus calculated as RBC GAM forecast minus Oct 2022 Consensus Economics (CE) forecast. Source: CE, IMF, Macrobond, RBC GAM

Less enthusiastic economic data

Much of the traditional economic data is looking fairly good. Unconventional and real-time metrics, however, are less enthusiastic.

  • The recent U.S. earnings season yielded a subdued sales forecast from Walmart of just 2.5-3% for the coming year. Furthermore, sales are apparently being sustained in part through significant discounting, and in part because higher income shoppers are shifting down market. These are both further indications of economic weakness.
  • Home Depot, a proxy for the housing market, warned that earnings could fall for the first time since the global financial crisis. This is due to the acidic combination of high inflation and elevated mortgage rates. The company forecasts merely flat sales over the next year.
  • In Canada, the country’s real-time business conditions index has stumbled significantly in recent weeks (see next chart). Its recent extreme volatility renders a conclusive verdict elusive, however.

Business conditions in Canada dropped markedly

As of the week of 02/20/2023. Equal-weighted average of Business Conditions Index of Calgary, Edmonton, Montreal, Ottawa-Gatineau, Toronto, Vancouver and Winnipeg. Source: Statistics Canada, Macrobond, RBC GAM

Recession watch

We continue to look for a mild to middling recession for much of the developed world. Let’s revisit some of the evidence for that prediction.

Dubious ‘no landing’ argument

The standard recession debate over the past year has been between a ‘soft landing’ and recession. A soft landing refers to sagging economic growth, but not quite to the point of contraction. We have argued that a recession has about a 70% likelihood, with a soft landing capturing the remaining 30% probability.

Recently, an additional scenario has been bandied about: a ‘no landing’ scenario. The idea is that, given recent economic resilience, maybe the economy can simply keep growing happily without ever sagging, let alone shrinking.

Never say never, however this is an unlikely scenario. Most economies are already overheated, as evidenced by low unemployment rates and high inflation. To continue growing briskly would make this overheating even worse (or, at a minimum, fail to resolve it). In practice, such economic overheating is difficult to sustain for long, usually culminating in a recession that serves to cool things off.

As a result, even if the economy were to exceed expectations and continue to expand quickly over the next few quarters, this would arguably just increase the likelihood of a recession later. Hot inflation would demand tighter monetary policy, and it would all come tumbling down at a later juncture. 

As such, the ‘no landing’ scenario isn’t very likely. Or – to be charitable – it could be argued to represent a temporary deviation from the other two options, but then merges with the recession scenario later.

Updated recession scorecard

We have updated our U.S. recession scorecard, which combines a dozen simple heuristics that have historically predicted recessions (see next table). The idea is to enhance the power of a series of simple recession signals by looking at them in concert.

Recession signals point mostly to ‘yes’ or ‘likely’ in U.S.

As of 02/21/2023. Analysis for U.S. economy. The Duncan leading indicator is the ratio of real durable goods spending and fixed investment to real final demand. Source: RBC GAM

Overall, fully half of the indicators signal ‘yes’ to a coming recession. Another three are ‘likely,’ with two at ‘maybe’ and just one at ‘no.’ We interpret this to mean that a recession is quite probable, though not absolutely certain.

Of note since the last update, the Duncan leading indicator has leapt into the ‘yes’ column by virtue of its continued decline.

Conversely, we downgraded the ‘Oil price spike’ from ‘yes’ to ‘maybe’ because, although oil prices did rise by 50% relative to their prior one-year average – the historical criteria for a coming recession – oil prices have since fallen sufficiently that the conclusion is becoming ambiguous. It is still possible that the earlier oil shock will have a lagged impact on growth, but the argument is weakening.

It is a similar story with the ‘Jobless claims jump’ variable: we downgraded it from ‘yes’ to ‘maybe.’ U.S. initial jobless claims did rise by 75,000 people – which historically is the threshold for an imminent recession. But the increase has subsequently been completely unwound. It still technically counts that the threshold was breached, but labour market weakness can hardly be said to be weighing on the economy at the moment.

Lending standards tighten a lot

Financial institutions are clearly bracing for a period of economic unpleasantness given their sharp tightening of lending standards for business loans. The U.S. tightening has been substantial and is now consistent with past recessions (see next chart). The tightening of credit standards in the Eurozone has not been quite as extreme but is nevertheless notable. It is also loosely consistent with past recessions (see next chart).

U.S. business lending standards tighten for all firms

January 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices. Source: Federal Reserve Board, Macrobond, RBC GAM

Credit standards for corporations in Eurozone area have tightened further

As of Q4 2022. Source: European Central Bank Euro Area Bank Lending Survey, Macrobond, RBC GAM

Struggling states

The number of U.S. states with shrinking economies is currently a substantial 16 out of 50. This is one of the highest readings outside of a recession (see next chart). The metric is more of a coincident indicator than a leading one, but it is surely still notable that so many states are stumbling all at once. The message is admittedly dampened by the fact that the most populous states are still growing. A recession has always appeared when 28 or more out of the 50 states are contracting.

U.S. recession signal: number of states with negative growth

As of December 2022. Average threshold defined as the average number of states that had negative State Coincident Index (SCI) month-over-month growth at the start of each of the six recessions between 1980 and 2020. Source: Federal Reserve Bank of Philadelphia, Federal Reserve Bank of St Louis, Macrobond, RBC GAM

Revisiting ‘stall speed’

We wrote about the idea of a ‘stall speed’ for the economy in January. The idea is that the U.S. economy has historically tumbled into recession shortly after it dips even moderately below a normal rate of growth. At the time, we introduced the idea that the stall speed had declined over time, but only sketched out what the modern day ‘stall speed’ might be.

Dissatisfied with the imprecision of that answer, we have since refined our work, identifying a dynamic stall speed that has changed as the ‘normal’ rate of growth declined over the decades (see next chart). This new stall speed has an 80% accuracy rate at identifying coming recessions in advance.

‘Stall speed’ argues against soft landing

As of Q4 2022. Stall speed calculated as a smoothed function of the GDP trend growth rate minus 1.5 ppt. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM

Today, the stall speed is at +0.7% year-over-year real U.S. GDP growth. Actual growth has not yet fallen below that point, but it is close: the fourth quarter of 2022 managed just +0.9% year-over-year (YoY). Our forecasts anticipate that the ‘stall speed’ will be breached in the third quarter of 2023.

Revisiting ‘most anticipated recession’

Three weeks ago, we discussed the idea that this might be the most anticipated recession in history. The implications were debatable, though we leaned slightly toward the interpretation that this makes an actual recession more likely.

We have since identified another indicator that confirms this is the most anticipated recession, at least in recent history (see next chart). Presently, private-sector forecasters assign a mean 32% likelihood that annual GDP growth will be negative over the next year. As an aside, a recession can happen without this tough standard being breached, so the deemed likelihood of a recession is presumably considerably higher.

Probability of a negative GDP growth from private forecasters has risen

As of Q4 2022. Mean probability of private forecasters’ estimates of negative growth in annual average real GDP in the following calendar year. Shaded area represents recession. Source: Federal Reserve Bank of Philadelphia, Haver Analytics, RBC GAM

While there have been several times when economists had greater conviction about GDP declining, none were recorded until after a recession was already underway. In fact, the highest probability assigned when the economy was not yet in a recession was just 22%, in the third quarter of 1990 (and a recession began the next quarter). Thus, the current reading is the highest it has ever been while the economy is still growing. That counts as the most anticipated recession in recent history, though we do need an actual recession to complete the prophecy!

Stuttering inflation

After inflation fell so nicely over the second half of 2022, 2023 has started off with a stutter. The January inflation data for the U.S. failed to significantly improve. In the U.S., the Consumer Price Index (CPI) merely fell from 6.5% to 6.4% YoY. The country’s Personal Consumption Expenditures (PCE) deflator – which the Fed famously prefers – actually rose from 5.3% to 5.4% YoY.

Gasoline prices rose in January, contributing to the increased heat relative to prior months. Service inflation also remained robust (see next chart). The best predictor of service inflation is the heat of the labour market and the broader economy. These will need to cool to fully restore inflation back to balance, and that may require additional effort from central banks.

U.S. goods inflation is falling, services inflation may be stabilizing

As of January 2023. Shaded area represents recession. Source: BLS, Haver Analytics, Macrobond, RBC GAM

But inflation’s recent stutter should not be overstated. Annual CPI declined nicely across a range of countries in January:

  • U.K. CPI fell from 10.5% to 10.1% YoY.
  • Eurozone CPI declined from 9.2% to 8.6% YoY.
  • Canadian CPI fell from 6.3% to 5.9% YoY.

Looking ahead, February inflation is unlikely to fall particularly sharply. The Eurozone flash estimate nevertheless points to a further slight decline from 8.6% to 8.5% YoY. The Cleveland Fed’s U.S. CPI nowcast anticipates a decline from 6.4% to 6.2% YoY, and then to a much lower 5.4% YoY in March. Their model is extremely simple, and in truth the expected March decline is mainly a function of the fact that last March’ massive 1.2% monthly price increase will fall out of the equation at that point. That was the second largest monthly increase of the recent inflation surge, second only to the rise last June.

Turning to metrics of real-time inflation, these continue to argue that inflation pressures are steadily abating, even when the official monthly numbers don’t always corroborate that view (see next chart).

U.S. Daily PriceStats Inflation Index is steadily declining

PriceStats Inflation Index as of 03/03/2023, CPI as of January 2023. Source: State Street Global Markets Research, RBC GAM

More generally, it is unsurprising that the inflation profile has been choppy. It will probably remain that way. There are big forces ebbing and flowing. But these should point more downward than upward, especially as the global economy starts to soften in the coming quarters. We remain content to forecast not just that inflation declines, but that it declines slightly faster than the market is assuming. But a 2% YoY print remains some distance off.

Pizza prices

It is a sign of the times that a major Canadian pizza chain – Pizza Pizza – has undertaken a marketing campaign playing off of inflation concerns. In a tongue-in-cheek re-imagining of a mortgage application, the ads allow you to “lock into a 1-year fixed rate” on the price of your pizza. “No matter how bad inflation gets, your pizza price stays the same.” Amusingly, the pre-approval questions include “Do you dislike inflation?”, “Do you have a face?” and “Does your face like eating pizza?”

Humour aside, there are two interesting takeaways from the marketing campaign.

The first is that inflation problems are sufficiently central to the average person’s experience that they can carry a marketing campaign all by themselves. Under normal circumstances, the only people who give much thought to inflation are economists and investors. All else equal, the public’s focus on inflation today may make it harder than normal to tame.

The second takeaway is that the pizza company must be confident that it can hold its input costs fairly constant over the next year so as to avoid taking a bath on its fixed pizza price. This bodes well for consumer-facing food prices of all descriptions over the coming year. It also makes sense given the substantial decline in raw food prices over the past year. The price of wheat, for example, peaked at nearly double the current rate last May, and is continuing to decline. This hasn’t yet shown up in consumer prices, but should over time.

Real rates rise with a lag

It has been much-discussed that central bank rate hikes impact the economy with a long (and frustratingly variable) lag. Rate hikes began at the start of last year, but much of the effect is still in transit.

The fact that inflation is high and will probably fall over the coming year argues for an even stronger than usual lagged effect from rate hikes. This is to say, even after nominal policy rates have reached their peak, their inflation-adjusted effect should continue to mount as inflation declines (see next chart).

Real yields have rebounded but remain negative

As of 02/23/2023. Shaded area represents recession. Source: Bloomberg, Macrobond, RBC GAM

This might amount to another 50 basis points or so of effective tightening if the real yield is defined as the nominal yield minus the breakeven rate in the bond market. And it is a whopping 300-plus basis points of further effective tightening if the real yield is defined as the nominal yield minus the realized annual inflation rate. If the standard 550 basis points or so of monetary tightening don’t induce a recession and tame inflation, you’d think the extra 300 basis points will.

Central bank worries

Central banks are surely disturbed by recent economic and inflation strength, tempting them to deliver more monetary tightening. But we are inclined to think they stick with their prior plans for the moment in the hope that recent strength fades before their hand is forced.

The Bank of Canada seems likely to leave its policy rate unchanged on March 8. There is just a 6% chance assigned of a rate increase. The market does think that the Bank could be forced into another 25 basis point rate increase at some point over the coming year, which seems quite possible.

The European Central Bank still appears to be locked into 50 basis point rate increases, with a move from 2.5% to 3.0% likely on March 16.

The U.S. Federal Reserve delivers its next decision on March 22. A 25 basis point rate increase is most likely, but markets assign a 25% chance that it is instead a 50 basis point increase. A decision need not be made yet given the arrival of U.S. payrolls on March 10 and CPI on March 14.

Finally, the Bank of England appears on track for a 25 basis point rate increase on March 23.

Note that even as markets scramble to adjust their expectations for the terminal policy rate in response to growth and inflation surprises, the size of the anticipated adjustments remains fairly small: no more than about a 25 basis point increase so far. It is far from clear that the economy and inflation will continue to misbehave for long.

Turning to other news, the Bank of Japan’s next Governor, Kazuo Ueda, has been selected. He was a surprise choice, though he is well respected and had a long history at the central bank. Although Ueda was viewed as a dove in decades past, he has behaved pragmatically so far and is expected to gradually exit from Japan’s system of yield curve controls over time – in some ways, a hawkish stance. It is arguably necessary that Japan steps away from its negative and ultra-low interest rates to avoid further distorting the economy. However, the country remains at considerable risk as the process plays out given its enormous public debt load and other fragilities.


Two geopolitical items merit our attention – a Brexit tweak and considerable evidence of ‘friendshoring.’

Tweaking Brexit

The post-Brexit arrangement around Northern Ireland was proving awkward for all parties. It created an effective customs border between Northern Ireland and Britain . The U.K. and EU have now managed to sandpaper some of the worst frictions away. The changes will help, though Brexit remains a significant net drag on the British economy.

‘Friendshoring’ advancing quickly

Globalization has begun to reverse, driven by a mix of factors that include rising tensions between China and the West, the sanctions applied to Russia, and the revival of industrial policy as a popular tool of economic policymakers.

Among the various implications of this, so-called ‘friendshoring’ is advancing especially quickly. This refers not to shifting production back to one’s home country (that’s ‘onshoring,’ which is also happening to a degree). Instead, a company transfers production from potential adversaries to more ideologically aligned countries. For some companies, it could involve moving production from a country such as China to India, Mexico or the developing nations of Southeast Asia.

To be sure, such pivots take decades to fully play out. Infrastructure must be built, factories constructed, workforces trained, and so on. Most companies shifting out of China are simply moving a fraction of their production. This provides greater resilience in the face of future crises, whether or not the entirety of production eventually pivots away from China.

Many large companies indicate a strong desire to remain involved in China. While India’s future appears bright, the country still faces many logistical headaches in some ways.

Nevertheless, the shift is arguably happening faster than we had initially imagined. Many Western companies simply contract factories in China, allowing them to adjust fairly quickly if desired. China’s competitiveness has already been in serious decline for a decade as wages outpaced productivity gains, leaving China’s labour cost around twice that of India or Vietnam. Now, the U.S. has blocked China’s access to the most sophisticated computer chips, effectively preventing China from participating in certain industries. Meanwhile, India and others are providing generous subsidies.

Whereas less than 5% of Apple’s products are today made outside of China, that share is expected to rise to approximately 25% by 2025. India began making the iPhone 14 in September, whereas in the past its production had been confined to older models. Macbooks will shortly be made in Vietnam. Nearly half of AirPod earphones already are.

When comparing China’s global exports relative to the global exports of the rest of Developing Asia*, China easily outpaced its peers from the turn of the millennium until around 2010. After that, China held onto its gains until around 2016, but has since been losing ground (see next chart).

China is gradually losing share to the rest of Developing Asia* in the global export market

As of Q3 2022. *Developing Asia includes China, India, Vietnam, Thailand, Malaysia, Indonesia, Philippines, Bangladesh, Cambodia & Laos. Source: International Monetary Fund (IMF), Macrobond, RBC GAM

The story is even more extreme when looking at exports into the U.S. (see next chart). Again, China outpaced its developing Asia peers across the 2000s, but then started to bleed export share in the 2010s. This turned into a torrent over the past four years. China has effectively relinquished all of the gains it made dating back to the year 2000.

China is losing the U.S. export market share to the rest of Developing Asia

As of Q3 2022. Developing Asia includes China, India, Vietnam, Thailand, Malaysia, Indonesia, Philippines, Bangladesh, Cambodia & Laos. Source: International Monetary Fund (IMF), Macrobond, RBC GAM

A similar pattern can be seen at a more granular level. Comparing Chinese exports of furniture and footwear to Vietnam, one can see a steady erosion of China’s global market share, and a steady increase of Vietnam’s (see next two charts).

Vietnam capturing rising share of global furniture exports

Source: Gabriel Cortes, CNBC, MDS Transmodel

Vietnam capturing rising share of global footwear exports

Source: Gabriel Cortes, CNBC, MDS Transmodel

To be sure, Vietnam has a long way to go before it replaces China as the world’s furniture and footwear powerhouse. That may not even be possible given the substantial population differential. Furthermore, China is naturally moving up the value chain and so may be organically ceding some of this territory as more lucrative industries become viable.

Still, the point is that the transition in global manufacturing is happening faster than commonly imagined. China can be said to be losing, while there are a number of major winners.

Greatly complicating matters, however, many of the factories being opened in Vietnam and elsewhere are being run by Chinese companies! Thus, Chinese companies are not obviously losing, even as the country’s output and workforce are.

-With contributions from Vivien Lee, Thao Le and Aaron Ma

Interested in more insights from Eric Lascelles and other RBC GAM thought leaders? Read more insights now.


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