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On Wednesday, the U.S. Federal Reserve held its March policy meeting. RBC GAM’s Chief Economist Eric Lascelles joins Dave to discuss the highlights – from brighter growth forecasts, to rate hike expectations. [8 minutes, 36 seconds] (Recorded March 19, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson, and I am joined today by the hardest working economist in Canada, Eric Lascelles, Chief Economist at RBC Global Asset Management. Eric, how are you doing today?

I'm doing just fine. Nice to be on again.

Working hard this week, I know, because we had a lot of economic news this week. Perhaps the most important or the one that had an impact on investment markets was the Federal Reserve meeting in the U.S. We had some other central banks announcing things around the world, but a lot of eyes on the Fed always. What did you take away from the Fed's release and what Chairman Powell had to say afterwards and the impact that it's had on markets since?

Right. Well, certainly the focal point for markets really for a number of months now has certainly been Covid-19. But I would say identically, or at the same time, it has also been inflation fears. It has been a focus on rising interest rates, bond yields, I suppose. And so, of course, the Federal Reserve is responsible or at least cares greatly about those two final things: inflation and interest rates. And so, we got this latest Fed decision and really, two different interpretations here. The first one would be that the Fed is committed again to continue with its program of stimulus. Its policy rate was left unchanged. A commitment to leave it unchanged for quite some time; a commitment to continue printing money and buying treasuries and agency mortgage backed securities at the same rate as before, at a minimum. And so, in that sense, no change. The Fed isn't actively withdrawing any kind of stimulus. However, simultaneously, the Fed did upgrade its economic outlook pretty notably. And so, not a surprise. I should say, we've already upgraded ours and we know why people are upgrading. In the U.S. context, you've got this big new fiscal stimulus coming. You have a rapid rate of vaccination ongoing, all of these good things. And so, the Fed upgraded its 2021 growth forecast from 4.2% to 6.5%— we're already in the sixes ourselves, by the way— downgraded the unemployment forecast, upgraded the inflation forecast as well. In fact, core inflation now expected to be 2.2% this year. It was previously thought to be 1.8%. And so, they've done a lot of economic upgrading, but ultimately not to the point of thinking they need to remove stimulus, which is one of the things that markets should be caring about. All that Fed stimulus has been so helpful over the last year or so. Interestingly, you could say maybe the risks are tilting. They could change something in the future. So, for instance, there are now eighteen participants in the Fed meeting; four, now, think rate hikes could start in 2022. So, four of eighteen; a distinct minority, but nevertheless, not zero any longer. Another three thinking rate hikes might be appropriate in 2023. You've got a total of seven thinking rate hikes might be appropriate. And so, you're still in a position where eleven out of eighteen of the Fed participants think no rate hikes till 2024. That's long been the story. But there are other scenarios in which the rates might go up a little bit sooner. I should say, the market assumes they go up somewhat sooner and we assume they go up somewhat sooner. But keep in mind equally that the market, after the global financial crisis, repeatedly bet on rate hikes prematurely and didn't get them, and in the end was proven wrong repeatedly, and yields had to retreat back down. And that could yet be an important theme here. Certainly, the increase in bond yields has been quite significant. Undeniably, there is some reasonable foundation to them. The economic outlook has improved and some Fed participants are talking about rate hikes in the not too distant future, as much as most aren’t. Inflation probably does go up somewhat. In fact, it will go up quite a bit in the next few months and then retreat, we think, but nevertheless it will be somewhat higher over the next few years. And so, there's some legitimacy to it. I would still say it feels to me like the bond yield move is a little aggressive just in the context of where we are, which is still a pandemic, still with high unemployment rates. And if you look at past taper tantrums, when the bond market panicked that central banks were about to start tightening or tightening too much, and those experiences did send yields higher, but quite notably, shortly thereafter, yields retreated most of the way back to where they had started. And so, this was the case in 2013 when then Fed chairman Ben Bernanke was talking about perhaps beginning to remove some of the stimulus. It concerned markets and they eventually pulled that back. And then in late 2015, when the Fed started hiking rates, there was also an expression of concern in the bond market. And in the end the yields actually ended up falling over the next year. I wouldn't say it's obvious here, even as we get closer to a rate hike that might be two years away, I don't think it's obvious to me that yields have to rise steadily toward that. They've already done a lot of heavy work already.

And we were talking just before we started recording about some of the new lockdowns in Europe; Paris locked down for another month, potential for Germany to enforce some lockdowns and some spots in Canada seeing a slight increase in cases as well. If we look at the Bank of Canada and the way they're responding, do you think you see any kind of deviation in terms of their policy away from what's going on in the U.S? How does the Bank of Canada play through this?

I still think the Bank of Canada is on a pretty similar trajectory to the U.S., which is certainly no hikes this year. And conceivably you could get both central banks tightening a little bit toward the end of next year. And that is on my radar screen. I think that would frankly be reasonable given the economic outlook that we've got, but gradually, cautiously, with a neutral rate being really quite low. I'm not convinced neutral rates are higher than about 2%. So even if central banks are tightening, they're not tightening to 5% or even to 4 or 3%. It might be 2% over the span of many years. And I think the Bank of Canada is on a similar trajectory. The Canadian economy is lagging a little bit, but equally, Canada isn't targeting inflation a bit above 2%. So, the Fed might tolerate a little bit more. I think, in the end, they should have a fairly similar trajectory. And the most recent Bank of Canada meeting suggested no greater urgency moving either. And to your comment on the infection numbers rising a little bit, I am budgeting right now for another wave, unfortunately, in a lot of countries. I don't think it will be as problematic as earlier waves from a fatality or a hospitalization perspective because people are being vaccinated, the most vulnerable people are being vaccinated. I think that's quite important. Nevertheless, the variants are clearly spreading. They now represent slightly over half of Ontario cases. It's not too shy, when we look across Canada and indeed even in the U.S., it's a similar story. And we can see the numbers rising in Canada, in Europe and Japan. A lot of places are now grappling with this. Indeed, as you said, some are locking down a bit. If it's any consolation, I would say this: the second wave, the wave that took place last fall into early January— we saw lockdowns then as well— did not do that much economic damage. Far less damage than in the first wave in the spring of 2020. And actually, for instance, the Canadian economy never actually shrank during that second wave. It grew less quickly than it would have, but it never actually shrank. So, as I look ahead and think, well, there's a scenario here in which we see at least a moderate further lockdown over the next month or two, I would say I'm not convinced it stops the economy from growing. It'll recover a bit less quickly, but it doesn't stop it from growing. That's the kind of thing that central banks are thinking about. They don't just have a base case scenario of a happy recovery here. They recognize that there are a few other ways this can go. They've been burned in the past by tightening rates prematurely. So, I think they're going to keep a lot of stimulus on the table, certainly for 2021 and really for the great majority of 2022 as well. And so, again, the bond yield increase? Not unreasonable. As the economy recovers, there's certain good things happening— and as inflation seemingly is set to rise. But this shouldn't be a quick path back to the 3%-10-year yield that prevailed before the pandemic struck. I don't think so. I think that's quite some distance off.

And you've done some terrific work on this over the last year, which is available on the RBC Global Asset Management website. You're also fairly active on social media, and that's where people can go and just see the volumes of work that you've produced over the last year that make you the hardest working economist in Canada. So, Eric, thanks for joining us again and putting up what's going on, in great perspective, particularly in this interest rate environment. Hopefully we'll connect soon.

Thanks so much.


Recorded: March 19, 2021

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