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About this podcast

Eric Lascelles, Chief Economist, RBC Global Asset Management, sits down with David Richardson to discuss the pullback in some of the economic risks he’s been concerned about, delving into low interest rates and their good – and potentially dangerous – impact on the global economy.

Transcript

Hello, and welcome to Personally Invested. I’m your host, Dave Richardson. Today we reprise our somewhat almost quarterly update with Chief Economist at RBC Global Asset Management, Eric Lascelles. What’s interesting about this quarter’s update is Eric’s view that we’re starting to see a little bit of a pullback in some of the risks that he’s been concerned about, if you’ve listened to his previous appearances on the podcast. I think you’ll find his comments particularly interesting around interest rates and the impact it’s having right now on the global economy, in a good and potentially dangerous way. Enjoy the podcast.

Eric, welcome back to Personally Invested.

Thank you very much.

It’s, ah, it’s always great to have you here. We’re hoping to try and make this a quarterly update, and maybe one of the first times our schedules have actually lined up so we’re able to do it on the appropriate schedule for this quarter. But we’ll get right into it. We’re starting to see, just over the last few months—well, really over the last two months maybe—some real positive signs starting to drum up in the global economy.

Yeah. I think that’s right. And so, not completely forgetting some of the issues and challenges and risks out there.

Sure.

But you’re bang on in the sense that we do see a few interesting things happening. One central one is just that some of the big downside risks have shrunk. Again, they’re not gone, and I will be that two-handed economist and continue to identify these as very real downside risks, but on a variety of fronts, it seems as though we are in a somewhat better place. And so to give you an example of that, US-China relations have improved to—

Sure.

—a certain extent. I, again, will quibble and argue we are unlikely to get a comprehensive deal out of this, but tariffs that were meant to go on in October didn’t, tariffs that are meant to go on in December probably won’t at this point.

Yes.

And if we cross our fingers and are lucky, we may well see some low-level deal achieved.

So feeling like it’s moving a little bit better.

Yeah.

In the right direction.

And not getting worse, crucially.

Sure.

Because that was the dominant trend for a while, and to the extent that the global economy has already adjusted to some of the bad tariffs that have come on. Arguably, there’s less of that rough adjustment to go, so long as this holds. And so that’s a welcome development, as an example. The business cycle, same kind of story.

Sure.

Still looks pretty late, if I’m being honest. But when we look at those various yield curve measures, inversion of the curve and what that might tell us about the risk of recession, we’ve actually replicated something the New York Fed put together. They only publish monthly which isn’t high frequency enough for antsy people like me, and so we’ve replicated it. We can do it, you know, minutely if we wanted to.

Oh, really.

And, you know, the recession risk spit out by that model was as high as about 43 percent in early September. That was the risk over the subsequent year.

Wow.

That’s now down to about 25 percent. And so again, still higher than usual and still consistent with late cycle, but that’s a materially diminished risk and I think, quite frankly, helps to explain in significant part why we’ve seen markets go up recently. Because that bad, bad risk has shrunk, quite generally.

And the markets are looking ahead, and we might say now that we can look at what the markets were saying, say between October and December of last year when the US stock market dropped 20 percent—that was sort of looking ahead to this year and saying growth is going to be a little bit lower.

Right.

It’s going to slow down. So the market predicted it. Now the market’s almost looking ahead and saying, well, maybe 2020 might be a little bit better.

There are scenarios in which that plays out. Exactly. And of course, let’s not forget about Brexit.

Ahh.

It’s not yet solved, and depending when all this gets published, could yet be radically different than our conversation, but I’m hoping not. That has happened a few times in the past. And so, you know, the Brexit risk, still uncertain. There’s an election now, frankly, getting in the way.

Sure.

And making it a bit more opaque, but you may recall in early September, it looked very conceivable there was going to be a no-deal Brexit on October 31st. We never fully bought into it; we thought it was as much as a 40 percent chance of that worst-case scenario.

Yeah.

But there were people saying 50, 60 percent chance of that worst-case scenario. That’s shrunk radically. It’s not quite impossible; there’s still ways you could accidentally get there, but it’s much more likely we end up with the Boris Johnson deal, which is a moderate outcome. If anything, there are risks that could be a—a different parliamentary configuration or a minority government of sorts that could even yield a softer version of Brexit, giving you no guarantees it gets resolved by January 31st, which is the next deadline.

Yeah.

This could well dribble beyond that. But the risk it goes horribly wrong has shrunk nicely.

Yeah. And so you can almost look at Brexit—I don’t want to spend a ton of time on Brexit—but it’s almost as if the potential outcome now is more than likely going to be better than the worst expectation. So you could actually see almost a positive out of where Brexit goes from here.

I agree. Yep. I think that’s very much the case. And so, increasingly, the market is starting to recognize that, of course.

Sure.

But it looks better than it did a few months ago, and there are some upside risks from here. Not upside meaning the economy accelerates wonderfully, but upside meaning the pain is less than people had previously priced it.

Sure. And we’re taping this on November 15th, German market at a 52-week high, for example, in the Euro zone. So there’s some signs of life, ah, in Europe and then perhaps we’ll get to that in more detail as we move along.

Mm-hmm.

But maybe let’s circle back to the US. And we were just talking before, the we started taping about interest rates and how the lower interest rates are having an impact, or you’re starting to see a sign—

Right. Yeah.

—that they’re having an impact, or could.

Absolutely. And so, just as a plug, we should mention, I’ve recently put an economic compass out, primer on low and negative interests that gets into how it is that interest rates can be negative in parts of the world, and why it is general that they are quite low, and how long that might last and so on. So happy to discuss that in general.

Yeah. Yeah.

But to answer your specific question, yeah, I mean let’s acknowledge, even the bond yields have snuck higher recently.

Sure.

On that optimism we just discussed, interest rates are still extraordinarily low. B-bond yields are—and for that matter, policy rates are much lower than they were a year ago. Central banks have been busy, shall we say, in 2019 delivering stimulus. And it’s not just a US phenomenon; it’s China and India and Brazil and Turkey and Australia and New Zealand, and of course, the European Central Bank, with others perhaps in the wings, including Canada. So a lot of policymakers are exerting downward pressure here. And the general principle here is that when interest rates go down, the whole purpose of that is to help the economy.

Yes.

Encourages people to spend more. And, you know, if you tally up all of those actions that have been taken, if you acknowledge the various lags involved it doesn’t always hit right off the top arguably, the first half of next year enjoys one of the best financial conditions impulses —

Yes.

—that we’ve seen since, you know, the immediate-post-crisis period. Now, that could translate into a beautiful acceleration in growth. We’ve got it more as growth-stabilizing.

Okay.

Having been on a two-year down trend because we’re equally aware, some of the protectionist drag hasn’t fully bled through and there is some policy uncertainty. There are other things on the other side of the ledger, but let’s recognize and celebrate that central banks have done quite a bit, and indeed, the economic boost from that is not done, even though the Fed perhaps thinks at this point it’s done cutting. The benefit of those cuts will, you know, yet play out. And if you ask me, I think there’s a fair chance they cut more, for that matter.

Okay. And so if you’re looking around the world right now and you’re a stock investor, what do you think the most significant thing happening in the global economy would—is right now for someone looking at investing in stocks?

Right. I mean I really think it is the evolution of those big macro risks, and of course, that’s something an economist would say.

Sure. Sure.

I’m probably completely missing some crucial some earnings development or technical signal, but, ah, it seems to me that the risks have been the thing that has kept the market down to the extent it hasn’t perhaps advanced as regularly as—

Yeah. Or at the very least, in a range.

—as we might have expected. Yeah. That’s right. Over the last two years—

Yeah.

—it’s been very choppy. Ultimately, we’ve seen some up, but it hasn’t been quite as reliable as people might like. And of course, looking beyond US shores in particular, it hasn’t been as much up as people would like either, I suspect. And so I would say, let’s keep watching those risks, because, you know, if there is a scenario in which the expansion just gets to keep rolling along for several more years, I mean, that would be quite a nice opportunity for risk assets, like stocks, to continue to advance. I tend to be, you know, bearish as a general disposition, and so—

Yeah.

—if still highlighting that 25 or even 35 percent recession risk. But equally, even with that priced in, that means you’ve got a two-thirds-plus probability that the next year yields further growth. And whether you tack in a muted 5 percent stock market gain or even do something more exciting than that, you know, there is the prospect of further gains, so long as those big, bad downside risks don’t hit us. And it seems like they’re less likely to than before.

Okay. And if I’m a bond investor, a fixed income investor.

Yeah.

What do you think the key economic themes are related to my decisions as a fixed-income investor?

Right. Well, I mean, I’ll just say this one to get it out of the way, which is of course, inflation is always a thought. And I don’t think a particularly realistic concern to the upside right now. As much as economies are tight, as much as protectionism is inflationary, you’ve just got these structural depressants coming from demographics and automation, maybe even some residual globalization effects. And so it doesn’t seem like high inflation is all that likely to be a problem. You know, this is barring an Iranian shock or something like that.

Sure.

But nevertheless, seems unlikely to be a problem. And so that’s good. That’s the way bond investors sometimes lose a lot of money, and so we’re happy when inflation seems to be fairly tame. I think the challenging thing for fixed-income investors is just that low interest rates make sense. And again, that was really one of the central thrusts of that recent report we put out. When you tally up economic growth rates and inflation rates and, you know, what we know about Central Banks and what we know about demographics and quite a number of other things, you ultimately reach the conclusion, it makes sense that interest rates are very low. Unfortunately, models like this don’t have the kind of precision to say that, you know, two-year—2 percent, 10-year yield is good, and a 2.25 or a 1.75, 10-year yield are bad; they’re not that precise. But they say, in general, it makes sense that this is an extended period of unusually low interest rates, and I would tack on the idea that the lower rates are—the longer—rather—rates are low, probably the longer they have to stay low. It’s almost a vicious circle or a—

Sure.

—or maybe a positive circle, depending on who you are in the market, I suppose. But, you know, the reality is, the more borrowers get accustomed to low rates and the more that governments in particular borrow—

Yes.

—at these low rates, the harder it is to emerge from this. And so, you know, the debate once upon a time—or I should say, the view once upon a time was that a neutral or natural policy rate in the US perhaps was 4 or 5 percent. As of a couple of years ago, the view, it was probably more like 3 percent, and now the debate is, is it 3? Or is it actually 2? And so the point is, yields probably stay quite low. That’s not a prediction they have to fall from here. I’m not expecting North American yields to go negative like Europe and Japan; I think there are some special factors going on there that are not shared in Europe, and for that matter—and, you know, you can ask me if you want but don’t get me started on it—I think negative rates have been a mistake, if I’m being perfectly honest. But I would budget for continued low rates, which unfortunately means not a lot of coupons to clip.

Yeah.

Maybe, though, equally means the risk of a capital loss, though, is contained as well.

Well, one of the things just before we do, because I do want to talk about negative rates because your piece is quite interesting that you’ve written. But one of the things that’s also part of your package, and I’m out right now traveling across Canada doing our event program.

Mm-hmm.

And one of the pieces that I touch on, gives the comparison of demographics in Japan—

Right.

—over the last 20, 30 years, with where we are in Europe right now.

Mm-hmm.

And then—and this’ll be our transition into talking about Canada—the demographic advantage—

Right.

—that Canada has. And it’s been a real—it’s been a really well-received piece in the presentation I’m doing. So your thoughts on Japan and Europe, and then we’ll transition over to Canada.

Right. Of course. And—and so—I mean, the term Japanification has been quite a key notion, at least over the last few years. And the concern for many is that, of course, Japan has had a rough ride of it by some standards over the last several decades, and centrally that’s been a story of an aging population and no immigration and these sorts of things. And as a result, though—though with other issues along the way, they have very low interest rates, very low growth rates, very low inflation, very high public debt in particular; not an especially attractive combination. And to some extent, Europe is rhyming a little bit with that.

Yes.

Here they are with negative rates of their own, and indeed, their demographics aren’t as good, and so on. And so we wanted to spend a bit more time on that, and I guess a couple interesting thoughts emerge from that. And so to begin with, Europe isn’t quite Japan. It does bear some resemblances but the demographics are not as poor going forward over the next 20 years as Japan was over the last few decades. And so we should not expect that Europe will experience precisely the same thing. This is—

Sure.

—broadly good, I think. Furthermore, North America finds itself even further removed from that situation. Still fundamentally challenged by aging populations—

Yes.

—and slower population growth and high debt and so on, but not to the same extent. And that was a large reason why we—we’re not convinced North American rates have to go negative. Pivoting around to Japan again, let’s recognize that even Japan arguably is un-Japanifying a little bit. Ah—

Yes.

—that’s a weird thing to claim. But nevertheless Japanese prices are rising right now. Not to a heroic extent but they were stuck in deflation for decades and now they’re managing at least modest inflation. Now you could fully acknowledge, with the help of massive monetary stimulus and—

Yes. Yes.

—will they have to do that forever—lots of questions around that. But Japan has un-Japanified a little bit; inflation’s a bit faster. We think their potential growth rate’s a little bit better than it was. You know, they have made some structural reforms as well. Don’t get me wrong; lots of public debt still lurking and unlikely to be resolved in the near term. But to their credit, they did just raise the sales tax rate, and that’s one of the small steps they might make towards a more sustainable fiscal situation. I should equally add, just in a—in a short-term Japanese outlook perspective Japan now talking some fiscal stimulus, ah, which is part of a broader global theme—

Yeah.

—we’ve been discussing, which is we think there is some more fiscal stimulus.

And you’re seeing some life in the Japanese stock market recently as well.

Well, very much so. That’s right. And, you know, it’s funny. That discussion, not that it’s fully removed from the economy, but a lot of that is just that Japan has had very poor corporate governance, ah, and—and all sorts of things, and the—the system by which companies were allied with one another, all of these things were anticompetitive, essentially. And so, the structural reforms on that side really are key, I think. And so you see more independent directors coming in and more of a push toward having underrepresented groups on the Board of Directors, and just more of a push toward profit maximization, you might say. And so, you know, to my eye, along with just, you know, the global markets feeling better, that’s—that’s the big upside story for Japan and that’s why you can feel okay about investing in a market where the economy is growing at 0.5 percent per year. That’s the story.

Sure.

Circling around, I promised—or you—you at least promised we’d mention Canada in this discussion.

Well, yeah. Because we—although we have obviously have, as you say, similar demographic challenges—

Mm-hmm.

—or we have demographic challenges.

Yeah.

But—

Immigration. Yeah.

—we have immigration working so effectively in Canada.

Seemingly so. That’s right. And so you look at the G-10 nations out there in the world, which country is actually managing the fastest population growth, and the answer is Canada.

Canada.

Ah, Canada’s outpacing the rest. These are not, you know, world champion countries, here; these are all fairly slow growers. But Canada is leading the way, managing more than 1 percent population growth, which you wouldn’t get by yourself if you looked at a fertility rate of, you know, 1.7 or something like that.

Yes.

And you look at an aging population. So immigration is the secret sauce there, and Canada is accepting more as a fraction of our population than many are. Canada’s also doing seemingly a better job of integrating these people, and also, because of points systems and these sorts of things, doing a pretty good job of identifying economically helpful immigrants as well.

You know, immigration, as a bottom line, is good from an economic perspective in almost all cases. But it is really effective when immigrants can come to a country and not just come to the country, but come and thrive and succeed and—and—and find a really great life there. And I think Canada has done a spectacular job on that front. It’s an inclusive society, diverse society, and it’s a real plus for Canada.

And you look at an aging population. So immigration is the secret sauce there, and Canada is accepting more as a fraction of our population than many are. Canada’s also doing seemingly a better job of integrating these people, and also, because of points systems and these sorts of things, doing a pretty good job of identifying economically helpful immigrants as well.

You know, immigration, as a bottom line, is good from an economic perspective in almost all cases. But it is really effective when immigrants can come to a country and not just come to the country, but come and thrive and succeed and—and—and find a really great life there. And I think Canada has done a spectacular job on that front. It’s an inclusive society, diverse society, and it’s a real plus for Canada.

Right. I think that’s right. And, you know, let’s acknowledge, on the flip side of the equation, productivity growth hasn’t been good in Canada. So the, you know, the Canadian economy trundling along here—

Sure.

—thanks largely to population growth and, therefore, employment growth. Because, of course, people who come to the country bring not just their own supply of labour but demand for things—

Yeah.

—and so that’s why unemployment rates don’t rise in countries with faster population growth. It usually balances itself out to some extent. Productivity growth has been the challenge, and that’s not unique to Canada. A lot of countries are experiencing that. The US perhaps has escaped a little bit but other countries still not managing very much. And so we do worry about Canadian competitiveness to some extent, and it’s fair to say we have fallen somewhat down the rankings there.

Yes.

And I wouldn’t say the last election was particularly fought along productivity or competitiveness lines overwhelmingly; there were other items that were front and centre. And so I don’t know that I’m expecting anything radically to change there, but that’s maybe the thing that prevents us from truly accelerating.

And the election itself, ah, in terms of impact on the Canadian economy would be—

It’s—

—fairly limited.

I think so. I mean to begin with, of course, politics are by definition temporary. You know, you’ll get a new leader in four years, or at least a new shot at electing someone in four years or thereabouts. Maybe less, given the minority government. So nothing’s permanent whether you love the outcome or hate it.

YYes.

Really, I see two opposing forces, if you really want to parse this particular government and what’s likely to happen economically. And so, short run, you can argue there are some positive forces here, and—and that would simply be that, you know, a party that plans to run a deficit has been elected; that means more government spending. The minority government, just minority governments in general—this is a global claim, not a Canada-specific claim.

Yeah.

—tend to be fairly expensive, you’re trying to meet multiple parties’ objectives and you’ve got to do it fast—

Yes.

—because you might only be around for a few years. And so could be even a little more growth in the short run. But then medium run, you start to worry a bit about the lack of focus on the productivity, competitiveness side of the file. And of course, you know, this big question in Canada, this case specifically about the energy sector—

Yes.

—and just what is the plan here. Is this a big chunk of the economy that’s going to be allowed to grow? Or to go sideways? Or be forced to wither? And of course, all of those decisions have huge consequences for the broader economy.

Yeah. Okay. So that gives us a nice overview of the global economy. Let’s get into your, ah, your recent paper on why interest rates are so low. And what were you trying to—what was the key message you wanted to deliver out of that work?

I think it was a few things. And so one was, indeed, just does it make sense that rates are low right now. And for some of the reasons I mentioned a moment ago in the growth and inflation and demographic categories, but also because there is arguably still something of a global savings glut out there, and hard as it is to fathom, a shortage of safe assets relative to the amount of people and funds that want to go pick up those safe assets. So it makes sense the rates are low, was one central thrust. Another one was, though, that negative rates, at least in certain markets, probably are sustainable, ah, and this is not $17 trillion worth of fools expecting to find $17 trillion worth of greater fools down the road.

Yes.

These are—I mean central banks hold almost $10 trillion of bonds around the world. And so they are actively depressing yields and they don’t mind that they’re negative. That was the whole purpose in some of these markets. And so they’re going to keep holding it. They’re not going to be shying away from negative interest rates. You’ve got you know, foreign reserve managers who, similarly, they’re just in the business of having a liquid amount of money in a foreign country in case they ever need to defend their currency. Returns are not the purpose of this. And so they’re going to stay in the US and European and Japanese markets and take their licks when it comes to negative rates, but it’s not going to dissuade them, I don’t think. And don’t forget about banks. I mean banks are told, quite rightly, they need to hold reserves. This is a good thing—

Yes.

—from a stability perspective. But they’re told by their governments, maybe somewhat self-servingly, that, guess what, the type of reserve you need to hold is, it’s our own government bonds. And so, ah, you know, a lot of banks essentially have to do this. They’re not going away either. And there’s also some more tricky work in terms of currency hedging and how you can turn negative rates to positive in some specific circumstances. But I guess the conclusion from that was, these are not speculators who are going to abandon that trade tomorrow. Rates probably stay very low if not outright negative in some markets for some time. And so that was another main element of the thrust. In terms of whether it’s a forever thing, we said we hope it’s not forever.

Yes.

That hope is probably the operative word there. We don’t know for sure.

Sure.

But we’re hoping it’s not forever. We don’t think it inevitably has to be. And in fact, I do have a little bit of a bee in my bonnet. I’m not convinced that negative rates are all that great.

So some of the investors that I’m having conversations with as I’m traveling across the country rights now, ah, they saw the headline around, oh, I can get a negative interest rate mortgage in Denmark.

Right.

That sounds really great.

Right.

But is that a great thing?

Ah, well, I mean it might be great for the person getting it, though I think those are very limited, I should emphasize.

Yes. Yes.

But nevertheless, ah, but the question is, is it great in a broader sense. So, you know, good for borrowers, bad for savers.

Yes.

The question then becomes, is it good or bad on a net basis, and what kind of distortions does it create. And so, the traditional argument is, hey, you know, lower rates discourages saving, encourages spending, boosts growth. I think it’s diminishing returns, though. And I think it’s diminishing returns because there’s at least one other consideration at play here, even before getting to the distortions, and that other consideration is just, at some point, investors are worried they’re not going to hit their investment objective.

Yes.

And so what do you do if suddenly the rate of return is so low, you need to save more. And so suddenly you’re saving more because of lower rates as opposed to less, and you’re starting to undo the whole purpose of the low rates. And since we don’t quite know where those two things intersect and where one dominates the other, but at a minimum, it’s diminishing returns in terms of lower rates. I think everybody knows that. For instance, even in Europe and in Japan and in other markets that have gone negative, they recognize you can go slightly negative, you can go to minus 0.5; you can’t go to minus 5, though. So, you know, we all sort of appreciate there is a limit even though apparently it’s not quite zero. And I just think, you know, different central banks have different views on this. So, you know, Europe and Japan are saying negative works but slightly. US, Canada, and the UK have all said clearly, our research suggests that you don’t want to go negative.

Yes.

You can get close but don’t quite go negative. Sweden, fascinatingly, has gone negative and now they’re saying that was a mistake, we’re going to back to zero. So they’re in the process of going back to zero. So there’s a real debate. My feeling at the end of the day is, it probably would’ve been better not to go negative. I think the distortions that arise—I mean you have companies that are paying invoices early. Normally, you know, you pay that invoice as late as you can. This is a means of sort of profit—

Yes.

—maximization for companies. Companies are paying invoices before they’re due because they don’t want the money. It’s got a negative rate they just—

Yes.

And playing hot potato with money seems like a very weird thing to have happening and perhaps not ultimately desirable. So again, I suspect we may see things stay a little bit negative but they can’t go much more, and I’m hopeful we—we sneak our way out of that over time.

That’s great. We should—we should probably end there, but your piece, Why Interest Rates Are So Low, is available on the RBC Global Asset Management website. I’m sure you’re using social media to—

Mm-hmm.

—to get it out. So people who are on LinkedIn and other forms of social media will be able to find it. And apparently as well, ah, RBC Direct Investing for direct investors will have access to this article as well. And some—apparently some fantastic modelling shots that you’ve—photos that you’ve taken—

Right. Yeah. That’s right.

—all made up. So if you want to see Eric live and in person, all touched up, you can go to the Direct Investing website and see him at his absolute best. And we’ll book a special podcast to discuss Swedish interest rate policy—

Okay.

—as well. That’s something we’ll tee up for our next podcast. So, Eric, thanks again for a, for a great update and we’ll see you next quarter. Hopefully things continue to move in the right direction.

I hope so.

And we’ve got an even lower chance of a recession—

Right.

—and people can make some really good decisions around their investment portfolios.

Absolutely.

Thanks again.

Thank you.

Disclosure

Recorded Nov. 15, 2019

This report has been provided by RBC Global Asset Management Inc. (RBC GAM Inc.) for informational purposes only and may not be reproduced, distributed or published without the written consent of RBC GAM Inc. Additional information about RBC GAM Inc. may be found at www.rbcgam.com. This report is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM Inc. takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. RBC GAM Inc. reserves the right at any time and without notice to change, amend or cease publication of the information.

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