Overview

This week’s #MacroMemo provides a high level summary of the latest virus trends before venturing into a wide range of economic and policy matters. These include a Canadian election preview, negative economic surprises, swooning Asian manufacturers and a U.S. labour market update. We also take a look at where American households are stowing their recent savings, whether to be concerned about the recent decline in Canadian GDP, and the outlook for developed-world central banks. Lastly, we revisit high inflation and discuss the microchip shortage.

Overall, COVID-19 trends have recently become somewhat less worrying, while economic trends have broadly worsened.

Declining COVID-19 infections

Globally, COVID-19 infections and fatalities continue to decline (see next chart).

Global COVID-19 cases and deaths

As of 09/02/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

The improvement was initially restricted to emerging market nations. Now, however, developed countries are again beginning to see some improvement (see next chart).

COVID-19 emerging market vs. developed market infections

As of 09/12/2021. Calculated as the 7-day moving average of daily infections. Source: WHO, Macrobond, RBC GAM

It is notable that the ebb and flow of global infections appears to be following something of a recurring pattern (see light blue bars in the next chart) over the past three waves. New daily infections appear to rise for approximately two months and then fall for approximately two months, before commencing a new cycle.

Global transmission rate hovering around key threshold of one

As of 09/12/2021. Transmission rate calculated as a 7-day change of underlying 7-day moving average smoothed by a 14-day moving average of new daily cases. Source: WHO, Macrobond, RBC GAM

Perhaps the process is as mechanical as it seems, with rising infections prompting greater caution and resulting in a subsequent decline in infections. But we suspect it is mostly coincidental, with the implication that one cannot set one’s watch to the arrival and end of each wave.

The wave last fall was enabled by looser restrictions, colder weather and re-opened schools. Stricter restrictions then pushed back against this at the turn of the year. The more contagious Alpha variant then took over, increasing infections until a sufficient number of people were vaccinated to begin bringing the rate of infection back downward. Finally, the even-more-contagious Delta variant took over this summer, pushing infections higher again. Rising vaccination rates, vaccine mandates and passports, and additional caution by the public now seem to be pulling infections back down again.

In short, several waves would never have happened without the arrival of new virus variants, and earlier waves would have taken longer to resolve without the intervention of vaccines. There is nothing automatic about any of these developments. In turn, there is no guarantee infections continue to fall from here, especially as the weather becomes colder in the northern hemisphere.

The U.K. continues to experience a high and slightly rising rate of infection, but with a tolerable level of hospitalizations such that it continues to opt to remain fully open (see next chart).

COVID-19 cases and hospitalizations in the U.K.

As of 09/12/2021. Source: WHO, Our World in Data, Macrobond, RBC GAM

Nevertheless, the rate of hospitalization continues to rise, meaning that we cannot conclude definitively that the U.K. approach is a success. Somewhat worryingly, Scotland is now encountering very high infections and a rising fatality rate (see next chart). Scotland has been a leading indicator for the U.K. over the past few waves and opened its schools before the U.K. did.

COVID-19 cases and deaths in Scotland

As of 09/09/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

In Canada, the number of infections per day is seemingly flattening out (see next chart). At the provincial level, British Columbia, Ontario and Quebec are all tentatively stabilizing. It remains to be seen whether this can be sustained now that the weather is cooling and schools have reopened.

COVID-19 cases and deaths in Canada

As of 09/12/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

It is encouraging that U.S. infections now appear to be actually rolling over, having been in the process of peaking during our last update (see next chart).

COVID-19 cases and deaths in the U.S.

As of 09/12/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Quite abruptly, the number of U.S. states with a rising number of daily infections has plummeted from virtually all, to fewer than half (see next chart).

Number of U.S. states with transmission rate above key threshold of one

As of 09/13/2021. Transmission rate calculated as 7-day change of underlying 5-day moving average of new daily cases, smoothed with a 7-day moving average. Transmission rate above 1 suggests increasing new daily cases. Includes Washington, D.C.  Source: Haver Analytics, Macrobond, RBC GAM

The improvement is especially marked among states that have struggled the most, such as Florida (see next chart). To the extent that Florida has not formally tightened its restrictions over the past few months, it seems that the average resident is behaving more cautiously and/or the state has achieved a high level of protection via a combination of vaccinations and infections.

State of Florida

As of 09/10/2021. Hospitalization data before 07/10/2020 from U.S. Department of Health & Human Services (HHS). Source: Centers for Disease Control and Prevention (CDC), HSS, Macrobond, RBC GAM

Behaving more cautiously

Vaccine mandates and passports continue to prove more popular than lockdowns as a means of controlling the latest iteration of the pandemic. The U.S. White House recently ventured further down the vaccine mandate path. In addition to an earlier compulsion for federal employees, all companies with 100+ employees must either vaccinate or test their employees weekly. This edict covers a remarkable 80 million American workers. Furthermore, all U.S. hospitals that receive Medicare or Medicaid funding will also be required to have vaccinated employees.

Elsewhere, Canada’s Alberta recently reinstated a provincial mask mandate. It has also delayed plans to end its program of testing, tracing and isolation, and has introduced a $100 incentive for those getting vaccinated.

Finally, we can surmise that people must be behaving more cautiously of their own volition. There hasn’t been a big change in measures of government restrictiveness, nor has there been a major change in recent mobility data. And yet, presumably in response to the Delta variant, Americans are behaving more cautiously. Anecdotal reports from businesses yield claims of a recent decline in eating out and tourism. Meanwhile, echoing consumer behavior during the initial phase of the pandemic, Procter & Gamble reports surging demand for toilet paper and paper towels. Some people are evidently hunkering down again.

Asian manufacturing hit

Asian manufacturers are weakening, in significant part because the Delta variant is finally hitting a part of the world that had previously managed to dodge earlier waves. The manufacturing purchasing managers’ index for seven Southeast Asian countries has fallen for a third consecutive month, now sitting at just 44.5. This is well below the 50 metric that denotes stable output.

Parts of Southeast Asia are now recovering from the latest viral wave – Indonesia most obviously. However, others such as the Philippines and Vietnam are still suffering record high infections.

China’s Caixin manufacturing index has also now fallen from 50.3 to 49.2. This shift puts it into contraction for the first time since the pandemic recovery began in April 2020. The virus count remains extremely low in China, but its zero-tolerance approach has nevertheless resulted in the temporary shuttering of a number of key factories and ports.

Furthermore, China grapples with an entirely separate issue. The country’s migrant workers never entirely returned to their factories after the initial stage of the pandemic. There were 5 million fewer at the end of 2020 than 2019. Some are worried about getting sick in a city or factory, while others increasingly prefer the service jobs that are sprouting up across the country as it becomes wealthier.

All of this is to say that supply chain disruptions are not merely a function of altered demand preferences on the part of westerners, but also due to more limited supply than usual. This distortion, too, should fade over time, but it is another reason why high inflation probably doesn’t snap back to normal in the near term.

Ebbing growth

Economic activity has decelerated recently. The U.S. Federal Reserve’s Beige Book uncovered slightly slowing growth in July and August. This was likely due to the Delta variant given that the deceleration is mainly in high-touch activities such as dining out, travel and tourism. A secondary drag came from supply shortages in the auto and home sectors.

The Institute for Supply Management (ISM) Services index fell from an excellent 64.1 to a very good 61.7. Our real-time activity index also shows a slower rate of economic progress (see next chart).

U.S. economic activity now rising less eagerly

As of 09/04/2021. Economic Activity Index is the average of 9 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

It is no surprise, then, that economic surprises have now pivoted from extraordinarily positive levels during the early phase of the recovery – when practically every data point exceeded expectations. Data is now outright underperforming the consensus forecast (see next chart).

Global economic surprises plunged into negative territory

As of 09/07/2021. Source: Citigroup, Bloomberg, RBC GAM

In turn, the consensus outlook for near-term GDP growth in the U.S. is now edging lower. Some of the most optimistic forecasters have prominently downgraded their forecasts, especially for the third quarter of 2021. The consensus may have to adjust somewhat lower, as the Atlanta Fed’s highly regarded GDPNow model argues the actual Q3 result may be in the realm of +4%. That’s well below the consensus forecast of about 6.5%.

For our part, we already maintain a moderately below-consensus forecast for the next year.

All of this said, it remains clear that the U.S. economy is not just growing but still inching closer to normality over time. The aforementioned Beige Book finds that most businesses remain optimistic about the near-term outlook despite recent hurdles.

Tragic and costly though it was, Hurricane Ida’s direct hit on New Orleans and path of destruction across the U.S. seems unlikely to impose a large economic hit. New Orleans’ levees and pumps held up and the hit to oil output was only temporary.

U.S. employment resilience

The U.S. job market disappointed in August. Just 235,000 jobs were created versus a consensus expectation of 733,000. However, we are not seriously worried about the U.S. job market’s underperformance. Our reasons include:

1. The addition of 235,000 jobs in a month (plus a further +110,000 in net revisions) is well beyond the underlying demographic need, so the unemployed continue to be absorbed back into the workforce. Reflecting this, the unemployment rate fell from 5.4% to 5.2%.
2. The underperformance is clearly in large part the result of the Delta variant given that the leisure and hospitality sector failed to generate any new jobs in August.
3. Weekly initial jobless claims continue to improve handily. They are down to just 310,000 in the latest week (see next chart).

U.S. jobless claims reach pandemic low

As of the week ending 09/04/2021. Shaded area represents recession. Source: Department of Labor, Haver Analytics, RBC GAM

4. It cannot be said that companies have stopped trying to hire workers. Job openings remain at record highs (see next chart). Instead, it is the unemployed who appear to be reluctant to return (though it isn’t all on them – one could argue that companies need to offer higher wages to attract them).

U.S. job openings rate at record high

As of July 2021. Estimates for all private non-farm establishments. Shaded area represents recession. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

Much has been made of a structural decline in the labour force participation rate due to people retiring early during the pandemic. However, that is only a temporary phenomenon, as those people would have retired within a few years anyway. Meanwhile, to the extent that remote working remains viable into the future, one might argue that an entirely new set of people may be attracted into the workforce if they are no longer geographically constrained and are given additional flexibility in the timing of their work.

There has also been a debate about the expiry of a range of U.S. government programs supporting the unemployed. The latest was the September 6 expiry of federal unemployment benefits worth $300 per month.

Optimists assert that this could push additional people back into the workforce, which seems plausible. However, in practice, studies of the earlier expiry of special benefits in some states versus the continuation of those same benefits in other states find that employment doesn’t actually leap higher when these programs expire.

Meanwhile, pessimists argue that the loss of the extra benefits will hurt consumer spending. This also seems plausible. However, in practice, very little of the excess savings accumulated during the pandemic have actually been deployed. At a minimum, one can argue there will be less of a wealth transfer from the government to households.

Liquid household assets

On the subject of the additional wealth accumulated by households, we have generally argued not to expect a sudden flood of spending in the future. After all, households haven’t deployed a penny of it yet, even as previously closed economic sectors have opened.

But we should concede that our conviction in this view has steadily weakened, for two main reasons:

1. Even if households never spend a penny of the additional savings, the simple process of reverting to a more normal savings level can still unleash several percentage points of income into spending.
2. A glance at where households have put their money shows that the greatest growth has been in highly liquid products such as checkable & time deposits and money market funds (see next chart). Sadly, this money has missed out on the massive appreciation of practically every asset, from home prices to the stock market. But it could easily be deployed as spending or into those longer-term assets in the future.

Change in financial assets of U.S. households and non-profit organizations

As of Q2 2021 for personal saving, Q1 2021 for all other measures. Source: Haver Analytics, RBC GAM

Don’t worry about Canada

Canada put up some surprisingly weak economic figures over the past month. Q2 GDP was reported to have shrunk by 1.1% annualized, versus a consensus forecast for a 2.5% gain. Simultaneously, Statistics Canada announced that its preliminary tracking of July suggested a further 0.4% decline during that month.

But all is not as bleak as it seems. The Q2 decline, while technically unexpected, is not completely shocking. It was widely understood that the Canadian economy had shrunk in April and May due to a lockdown at that time. That left only one month of growth. Furthermore, while GDP fell 1.1%, domestic demand actually grew by more than 3% over the quarter. Canadians were still spending. Exports dragged the economy down, and this was in significant part due to an 18.9% decline in auto exports (chip shortages).

The negative tracking for July GDP is harder to understand. Other metrics broadly point to reviving economic activity during the period. A strong 94,000 people joined the workforce during July, for example. We are inclined to look through it.

August economic data has been strong, with another 90,000 jobs gained. The Canadian Markit Manufacturing PMI is up to a strong level. The National Federation of Independent Business (NFIB) survey of small business openness has also been optimistic.

We do budget for some Canadian economic deceleration over the coming months as the Delta variant becomes more visible. But so far the trajectory has actually been better than it seems.

Central banks pivoting

South Korea was the first developed-world central bank to raise rates, though several emerging market central banks preceded it. Other developed nations are pivoting more cautiously.

The U.S. Federal Reserve signaled a few weeks ago that it may well be scaling back its bond buying by the end of this year, though it remains far from outright raising the policy rate.

The European Central Bank (ECB) has announced that it will moderately slow the rate at which it purchases bonds. While this would normally be called “tapering,” it insists that this should be called a recalibration rather than tapering. To the central bank’s credit, it did increase its pace of purchases as recently as March, so it has arguably already been recalibrating for some time. The bond market was unconcerned, with European yields actually falling in response to the announcement.

Meanwhile, the Bank of Canada has already been tapering for some time, having scaled back its pace of bond purchases twice already. Its latest decision revealed no real changes: the central bank continues to expect economic slack to be gone in the second half of 2022, at which point the policy rate may begin to rise. The Bank was unperturbed by the recent bout of GDP weakness, arguing that the economic situation is better than it looks. It will likely taper its bond buying again in October.

Taper tantrum less likely

There is undeniably the risk that financial markets will engage in a taper tantrum as central banks begin to withdraw their extraordinary stimulus over the next year. Yet it is far from a certainty, for several reasons:

• Unlike before the 2013 taper tantrum, central banks have been providing extensive forward guidance. So there shouldn’t be as many surprises.
• Financial markets realize that they overreacted in earlier taper tantrums. Markets quickly reverted to pre-tantrum levels.
• Central banks are moving more gingerly this time. Relative to when stimulus started to be withdrawn in 2013, U.S. inflation is higher, the growth rate is better and unemployment is lower.
• Central banks have also provided a clearer distinction between tapering and rate hikes, which are set to come significantly later in most countries this time.
• Because fiscal deficits are set to be significantly smaller in 2022, bond supply should also be much lower. Even though central banks will be buying fewer bonds, the publicly available supply of government bonds may actually be lower next year than this year.

Inflation still plausibly peaking

A variety of indicators continue to argue that U.S. inflation may have peaked:

• The Personal Consumption Expenditures (PCE) deflator – the Fed’s favourite measure of inflation – rose by 0.4% month-over-month (MoM) in July. That’s down from previous months when growth was as high as 0.6%.
• The ISM Manufacturing and Non-manufacturing Prices Paid indexes have both now declined from their peaks (though they remain high).
• The headlines about the recently released August producer price index focused on the +8.3% year-over-year (YoY) growth rate. But the more salient development was that the monthly change decelerated from two straight monthly increases of +1.0% to +0.7%.
• Real-time inflation metrics remain slightly lower than they were in the spring, though they can’t be said to be actively falling.

But we continue to warn that elevated inflation is not about to vanish altogether. Supply chains remain very much gnarled. Chip shortages are also extensive and potentially long-lived.

Chip shortages

The present crippling shortage of computer chips has contributed to high inflation across a variety of products, none more visibly than passenger vehicles. It is not so much that the chips represent a large fraction of the cost of a car, but rather that the cars simply cannot be made without the chips, and the chips just aren’t available in sufficient supply. This reduces the supply of cars and, inevitably, increases their price far beyond any increase in chip price.

Chip supply initially fell

There is a long history of boom and bust in the chip-making industry, such that when the economy initially cratered in March 2020, plants sharply scaled back their production. It has taken time to recover this production, particularly given that some production has since been disrupted by disease outbreaks.

Auto companies were particularly aggressive in scaling back their chip orders, such that the supply of auto-specific chips was especially reduced.

As a backdrop, U.S.-China geopolitical frictions have also limited the production of certain Chinese semiconductor manufacturers as they have lost access to certain U.S. technologies.

But then demand surged

However, economic activity began to revive surprisingly quickly in the spring of 2020, wrong-footing chip-makers as demand picked up.

Simultaneously, a few other things happened:

• Demand soared for computers and electronic goods. People suddenly had to video conference for work and school, and spending was redirected from services to goods.
• Car demand ended up rising above normal as people became less comfortable with public transit given the risk of infection in a crowded environment.
• Unrelated to the pandemic, chip demand is structurally rising as the world becomes ever-more techno-centric.

Resolving the mismatch

Experts say it could take a few years to rebalance chip supply and demand.

Some of the mismatch is being resolved as previously idled fabrication plants are brought back online. But technology transitions happen every 1—2 years, such that companies must constantly invest in their existing fabrication plants just to keep them viable. Furthermore, it takes between two and five years to build an entirely new fabrication facility, so supply cannot quickly exceed pre-pandemic levels. While many companies are now investing in their production capacity, the backlog only grows longer in the meantime.

The mismatch has been particularly acute for auto chips, for three reasons. First and second, as previously noted, orders were initially cancelled and yet demand ended up rising. Car companies are now at the back of the order queue. Third, carmakers tend to use less sophisticated chips that are not as profitable for chip fabricators, and so chip-makers further deprioritize them.

Reflecting all of this, chip prices are rising. Taiwan Semiconductor Manufacturing Co. – which by some measures produces more than half of the world’s chips – is raising its prices by 10% to 20%, and will cease offering discounts to its biggest customers.

Canadian election preview

The Canadian election is now less than a week away. Polls reveal a race that initially favoured the Liberals, but that is now essentially tied from a popular-vote perspective between the Liberals and Conservatives.

However, the Liberals enjoy a superior distribution of votes, such that most prediction models continue to anticipate a Liberal minority government:

• The Canadian Broadcasting Corporation (CBC) model predicts 155 Liberal seats versus 118 Conservative ones.
• 338Canada predicts 145 Liberal seats versus 129 Conservative ones.
• A range of betting websites assign odds in the realm of a 75% chance that the Liberals will win the most seats.
• Conversely, the Polly model gives a slight edge to the Conservatives, at 137 seats to 134.

Broad ideas

The two vying parties’ platforms are both expansive, as is often the case during an election campaign. But it seems especially true this time: the number of major proposals is mindboggling.

We posit that this is for a few reasons:

• The pandemic hasn’t yet been resolved, potentially justifying further significant policy measures.
• The big government response to the pandemic has increasingly normalized large policy actions, regardless of the need.
• Interest rates have been so low for so long that no one feels particularly constrained by fiscal finances (though the Conservatives commit to balancing the budget in a distant 10 years). Suffice it to say that no party is campaigning on a “small government” platform.

Simultaneously, it appears that everyone has shifted a step or two to the left along the political spectrum. The Liberals are promising a significant number of new programs that would further expand the government. Not to be outdone, the Conservatives have arguably made the bigger leap leftward (if only to the middle of the political spectrum), now occupying territory only recently vacated by the Liberals. They also envision major new programs.

The Conservatives appear to be taking a page from the U.K. conservative political playbook. They are seeking the support of the labour movement and working class voters, and deprioritizing big business and fiscal prudence.

From a top-down fiscal perspective, the Liberals plan to spend more money – $78 billion of new spending is proposed over the next five years versus $51 billion by the Conservatives. But this difference is arguably overstated as the expected deficit for each party in five years is quite similar: $32 billion for the Liberals and $25 billion for the Conservatives. At the margin, the Liberals plan to be a bit more fiscally expansive, and ring up additional public debt in so doing.

Policy platforms

It is impractical to compare and contrast every one of the hundreds of policy proposals made by each party. Instead, we provide a high level summary of the most economically relevant items.

Taxes: The Liberals propose to impose a sizeable tax on the country’s largest insurers and banks, generating an additional $5.3 billion in government revenue over four years. There is also concern that the Liberals might increase the capital gains inclusion rate or further tax high-income earners, though this has not been mentioned in the platform. Conversely, the Conservatives promise a one-time GST tax holiday in December of this year to encourage additional purchases in retail stores.

Immigration: The two parties remain strongly pro-immigration, though with modestly different visions of how to implement certain facets. On trade, the Conservatives propose trade deals and open working arrangements with Australia, New Zealand and the U.K. For their part, the Liberals have been demonstrably in favour of free trade during their tenure and have struck free-trade deals. The differences here are minor.

Employment: On the subject of workers, much is proposed. The Conservatives plan to make the self-employed eligible for employment insurance and further propose a “Super EI” that would increase the generosity of benefits during a recession. They also plan to pay up to 50% of the salary for new hires for six months after the Canada Emergency Subsidy ends. The Conservatives also plan to double the generosity of the Canada Workers Benefit, worth an additional $1,400 for those earning less than $24,573 per year. The Conservatives further propose partially forgivable loans to small businesses in retail, tourism and hospitality. They also plan for a month of heavily subsidized restaurant dining to get the restaurant sector moving again.

In addition to maintaining their existing suite of pandemic worker supports, the Liberals plan to provide wage and rent support for the tourism sector and subsidize cultural events with reduced capacity. The Liberals would also expand eligibility for the Canada Workers Benefit rather than increase its generosity, adding a further million people to its rolls. The Liberals would also increase the guaranteed income supplement for low-income seniors by an average of $42/month, and increase the repayment assistance threshold for those with federal student loans.

Business: The Conservatives have fairly major ideas that depart significantly from past Tory platforms. Large federally regulated companies – including banks, insurers, telecom and airlines – would have to include worker representation on their boards of directors. The party would also update the Canada Labour Code to make it easier for workers to unionize in certain situations.

More in keeping with the party’s pro-market past, the Conservatives would allow international telecommunication companies into Canada, potentially presenting a stiff challenge to the incumbents. The party also pitches a 5% credit on capital investment over the next two years and a 25% tax credit on personal investments into small businesses.

Vaccines: Both parties are pro-vaccine, with plans to get the inoculation rate higher. In general, the Conservatives appear to be more tolerant of unvaccinated individuals as long as they are tested regularly.

Housing: Both parties propose to further limit foreign home ownership. Both propose to build many more homes. The Liberals also propose an anti-flipping tax on homes owned for less than a year, cheaper mortgage insurance and a new tax-sheltered program for saving a down payment.

Other: The differences in health care ultimately appear to be fairly small. For childcare, the Liberal proposal is much more expansive. The two parties’ green policies have converged significantly over the past two years, though the Liberal plan appears the more practical.

Implications

It is hard to speak with much confidence when the outcome of the election is still in substantial doubt. Given the constraints of a likely minority government and the poetry of campaigning versus the prose of governing, many of the proposals won’t actually be implemented.

Nevertheless, if the Liberals are re-elected, they would possess considerable scope for action given that they can expect support for progressive initiatives from the NDP or a number of other parties. Of course, this would also represent an effective continuation of the existing government. It would hardly constitute an upheaval.

On the other hand, a Conservative minority would be somewhat more constrained. The party has fewer natural allies in parliament. But do not underestimate the ability for a minority government to survive and implement policies much as the Harper Conservatives managed to do. Many of the Conservatives’ proposals in this particular campaign should be palatable to the other parties.

Ultimately, the fiscal trajectories are fairly similar for the two parties. While the details differ and we are glossing over a handful of initiatives that could incrementally alter the rate of productivity growth, the overall pace of GDP growth should be fairly similar regardless of which party is elected.

Two further observations are perhaps useful:

1. Elections are not forever – they only grant the ability to govern for a maximum of four years. Should Canada go off course, there are ample opportunities to course correct.
2. Financial markets may be less partisan than commonly imagined. Yes, there is a general preference for a right-leaning government. But this particular right-leaning government proposes a number of things that may be worrisome to business leaders. The U.S. experience over the past five years demonstrates that markets are equally capable of flourishing under right-leaning and left-leaning governments.

-With contributions from Vivien Lee