Hello, and welcome to our latest video MacroMemo. And I should add, happy new year.

We have quite a lot to share with you. And so we’ll work our way through some fiscal trends and some supply chain updates and inflation updates. But really, the big themes over the holidays season and subjects I think that we need to talk about now as we return to the grind, one would be, of course, Omicron and the spread of COVID, once again. The other would be fairly hawkish Federal Reserve in the U.S. And so let’s start with those two subjects and then work our way on from there.

In terms of Omicron, this latest COVID-19 variant, it certainly is spreading easily and is the most contagious that we have yet seen. And so, right now, we’re logging record-high numbers at the global level in terms of daily infections. In fact, 2 times the prior record of daily global infections, setting records 3 times higher than the prior peak in the developed world. Conversely, emerging-market infections either just getting started or maybe those countries will prove a bit more resistant to the extent they had high levels of natural immunity from prior waves. But bottom line is, emerging markets just starting to go up.

You turn to a place like Canada, the infection rate running about 5 times prior peaks, so, again, this is easily the biggest wave we have seen yet. The U.S. clocking more than a million cases a day, which is easily a record there. And we also strongly suspect that there is more under-counting of infections going on than has been the case at any other point during the pandemic, and we certainly know under-counting has been material at different points in time. There are significant test shortages right now.

We can proxy all of this via the test positivity rate, the fraction of tests that come back positive, and it’s the highest fraction that we’ve seen. So, again, suggesting we’re under-counting to the greatest extent that we’ve seen. So, certainly an enormous wave. It is mapping its way into hospitalizations. And I should start by saying, it seems as though Omicron is less deadly, is less dangerous in general, but not completely benign. And so, we’re seeing hospitalizations go up. Highly varied, though, I would say. We never saw South African hospitalizations get anywhere near prior peaks, though they did go up somewhat. We’ve seen UK hospitalizations rise somewhat, but quite far from their peaks as well.

Conversely, the U.S. and Canada already running at peak hospitalization. You can take some silver lining in the sense that the average person hospitalized is there for less time; generally, less severe outcomes; generally, not having to progress as much to intensive care or ventilators and so on. But nevertheless, a challenge for hospital systems, and that’s why we’re seeing significant restrictions imposed in some jurisdictions.

In terms of when this Omicron wave may peak, well, that’s an open question. I won’t pretend to have all the answers. And I think the more waves we see, the less I feel I fully understand exactly the dynamics at play, if I’m being perfectly honest. But nevertheless, we can say South Africa—which wasn’t quite the first country to get infected but nevertheless, among the first and maybe the best to track the progress of the wave—South African cases are now in very significant retreat. And so we can say, the South African wave really only spent six to eight weeks rising and it’s now a couple of weeks into decline.

We can then pivot to the UK, which was among the next countries to be infected. And we can say the UK wave may be in the realm of peaking. It seems quite likely in London; it may be the case in other parts of the UK. And so, it’s not a bad thesis to start with the assumption that this is an extremely big wave in terms of height, but perhaps quite slender or quite brief in terms of how long it lasts.

That would make sense from a seasonal perspective to the extent we saw, for instance, last year, infections peaking in and around the holiday season and then retreating, generally, through January and February. So that could well be the trend ahead as well.

I will admit, though, it’s hard to disentangle inadequate testing with fewer cases and these sorts of things. We’re watching in particular for a lower positivity rate, for lower hospitalization rates as well, which we haven’t seen too, too much of yet across most of the developed world.

I would say it seems reasonable to expect some improvement going forward, especially in places that locked down aggressively, like Canada. It’s hard to see the infection spreading as quickly when there are far fewer points of contact.

I guess a different question, though, is whether we can keep infections lower to the extent they do decline even after reopening. And I would say I’ve got a little bit of skepticism on that front. Unlike prior waves, you think of the first wave and essentially it was resolved by new technologies, like, hey, let’s wear masks and this sort of thing, and the next wave by essentially vaccinations solving the problems of a year ago. Aren’t as many game-changing solutions that exist right now that can change the equation relative to where we were a couple of months ago.

And so really, you have to count on seasonal trends becoming more favourable into the spring, and you have to count on essentially rising immunity getting us closer to herd immunity. And immunity certainly is rising quite significantly, I suspect. But is it enough to reduce the natural transmission rate by a factor of 3 relative to mid-December? That’s what you need essentially to get Omicron back under control, and it feels like a little bit of a stretch to me.

So, bottom line is, we’ll watch. The simple technical signals indicate we could be peaking in the not-too-distant future. However, to the extent there isn’t a brand-new vaccine or anything quite as exciting as that to go alongside it, it could be this sticks with us a little longer, essentially until we get closer to herd immunity. So, an open question there.

In terms of the economic implications of Omicron—and this is now getting closer to my natural expertise—well, we think they are going to be significant. And so, likely more damage than the last few waves. We’re seeing tighter rules in some jurisdictions, and so that’s part of the story. But I would say, voluntary social distancing is a big consideration as well. Even in places like the U.S. that haven’t significantly locked down, you’re seeing a big drop in mobility and in activity, so people taking it upon themselves to behave more carefully.

And then, a third variable that hasn’t really been that relevant in prior waves is labour supply. And so this is a just a lot of people are getting sick. That is crimping the supply of labour. And so, there are widespread reports of worker outages and absenteeism. And so, lots of teachers are out sick, and nurses, and flight attendants, and dock workers, and indeed, workers in almost every sector. And we can see the mobility and the stringency data reflecting that.

We think we could see the level of economic output fall by 1 to even 3 percentage points, temporarily, over the span of a couple of months. And that’s a palpable effect, and that’s as big or bigger damage than we saw over the prior several waves. So we do think there’s some real damage here. Mostly maybe from labour supply. And we can start to see some of that in the real-time data, even in the U.S., which, again, hasn’t locked down very much at all.

And so, U.S. office occupancy data has plummeted. And a little bit of that is a Christmas effect, but it’s bigger than the last year’s Christmas effect. And in fact, you see cities like Dallas, which was the most open U.S. city that we’re tracking, it now has a lower office occupancy than it did in the spring of 2020 during the initial wave, which I don’t think anyone would have anticipated. A place like San Francisco, which has been very cautious throughout, is also back to the realm of its spring 2020 office occupancy level. So we’re seeing a significant effect, and that bleeds its way into restaurants and bleeds its way into all sorts of industries that support office workers.

We can see air travel in decline to some extent. Some of that is demand-based. A lot is supply-based, with pilots and flight attendants in short supply. We can even see some of the real-time credit card spending data coming off somewhat too. So I think there is some real damage there. We should brace ourselves for that. It will unwind later. We suspect it’s a few months, not a year story, but it is a real effect that we need to think about.

And maybe no country more affected than China, which is a strange thing to say because China has among the fewest infections in the world, but it also has a zero-tolerance policy toward COVID-19. And it’s not clear that’s a viable approach against Omicron, which is among the most contagious viruses in known human history. And so, we’re seeing China have to lock down entire cities, and they’re locking down multiple cities of more than 10 million people now.

And it’s not clear what the endgame is for them. This is just such a contagious virus, we’re going to see some economic damage from China, and with implications for the world, to the extent that Chinese manufacturers can’t operate normally. Chinese exports then get affected, and again, that affects the rest of the world as well.

And so, I guess, long story short, even as the Chinese government talks about focusing on stability for 2022, which is code for stabilizing growth after a period of deceleration, we’re still pretty comfortable being below consensus on Chinese growth, having a sub-5% growth forecast. We think this COVID wave could, again, do more damage to China than a lot of other places.

Okay. Let’s talk U.S. Federal Reserve here. And so, I’ll begin just by saying, central banks in general have been getting more hawkish since last summer. So this is not just a U.S. story, though it includes the U.S., and it’s not a story from the last couple of weeks. So you might imagine that, when you see how much bond yields have gone up recently, it’s been a progressive story since last summer, central banks essentially recognizing they need to start tightening policy. And so the Fed had already begun to taper, to reduce its bond buying, and, in fact, accelerated that rate over the last month or two. In December, the Fed signaled three rate hikes for 2022, which was above the prior expectation.

We then got Fed minutes recently. This is like a transcript of the discussion that took place in mid-December. It comes out with a lag. And it showed, I guess, a greater degree of urgency among Fed participants to do something than previously imagined and talk about quantitative tightening, which means not just buying fewer bonds, but starting to dispose of that bond portfolio, which didn’t happen for years after the bond buying had finished. With the global financial crisis, it looks like it’s an accelerated process.

So, all of this has pushed yields higher. And indeed, the market is now pricing in 3.5 rate hikes for 2022. It, frankly, broadly seems reasonable in the sense that inflation’s above 6%, maybe on its way to 7; unemployment is below 4%. These are metrics that you would struggle to justify a nearly 0% policy rate with, given just how strong the economy has been, and so bond yields have responded by going up.

And we’ve seen it ricochet into other markets. And so the tech sector is down because the tech sector uses discount rates, interest rates, essentially, to value future earnings. We’ve seen value start to outperform growth, linked to banks enjoying a higher rate environment and these sorts of things. We don’t think it’s a policy error.

And I will say this. As much as markets have been choppy in response to this, and as much as we could well get a rate hike in the next three or four or five months—market thinks, conceivably, even as early as March—stocks usually perform pretty well in the year leading up to a first rate hike, and they usually perform okay, fairly well, in the year after a first rate hike, but generally rising as opposed to falling. So by no means does monetary tightening signal the end of a stock market rally or of an economic recovery. In fact, to the contrary, it’s important to raise rates to avoid overheating the economy and having the recovery end prematurely, essentially.

A couple of other quick thematic items here. The first, just to touch on the fiscal front, the U.S. big, multi-trillion-dollar stimulus initiative is dead right now. So one Democratic senator opposed it and that was enough; they did not have the votes that they needed. And so, the White House isn’t done, they’re still making an effort, but it will have to be significantly smaller. It will likely be revenue-neutral, and so that means no net economic stimulus coming from those efforts. And also, a bit of a setback for U.S. climate change initiative since that policy or the programs proposed had been set to address some of the U.S. obligations on that front.

Let’s talk about supply chain issues for a moment. And so I would say a variety of measures still show a lot of stress. And so we’re still seeing a very high cost of shipping; still lots of ships waiting to unload. Those sorts of things are still quite problematic. The New York Fed has a new metric that confirms all of that.

However, it has come to our attention that the ISM manufacturing index shows some improvement from a supply chain perspective. This is an important measure of the Supplier Deliveries Index embedded within that. It just fell sharply, and it’s now its lowest level in 13 months. So we were seeing some evidence of supply chains getting a bit better. I would say, they could yet get a bit worse again, if China runs into Omicron problems, but we would expect some improvement thereafter and across the rest of 2022. And then just to finish, on the inflation front, inflation’s still extremely high. In fact, the U.S. will release a print not long after I record this, and probably we’ll see a 7% CPI number, which we haven’t encountered in many decades. Other countries hitting multi-decade highs as well. Oil prices recently rose, which isn’t all that helpful.

I would still say, we think inflation can retreat somewhat over 2022. We think oil can fall back somewhat later in the year. We think supply chain problems will ease partially over time. And, indeed, when we turn back to that ISM index, we see the Prices paid index within that falling substantially. So companies saying they’re seeing a little less pressure than before; some of the real-time measures we look at as well coming off a little bit.

So I would say, we probably see inflation peaking over the next couple of months. I’d be surprised if it was still rising as of, say, April or so of this year. I think it should be in retreat by then.

Okay. Let’s stop there. Thanks for sticking with me. Hopefully, you found some of those items interesting. And I wish you well with your investing. Thanks so much.