Hello, and welcome to The Download. A special emergency edition of The Download, with chief economist at RBC Global Asset Management, also known as the hardest working economist in Canada, Eric Lascelles. Eric, welcome back.
Thank you so much. Good to be here. Hi, everybody.
Thanks for coming on relatively short notice. A few surprising things this week started with the bank of Canada’s announcement on tapering and interest rates, and then a couple of prints for GDP, one in the U.S., one in Canada, that were a little disappointing. But let's start with the bank of Canada. Was that something that surprised you? And does it change your view of things as we move forward?
Well, let's start with the observation that central banks, as a collective entity, have been surprisingly hawkish over the last few months. They've generally come in with plans either to take away bond buying or to do some rate hiking a bit more than the market had assumed, and certainly a bit more than the central banks had themselves been signaling before. Bank of Canada was in keeping with that trend. That is to say yes, they did come out, and they were fairly hawkish. Everyone fully expected they would stop their bond buying as of now. That was pretty well signaled. They've been incrementally doing that over the last year. I don't think that's a particular shock as much as that's the only thing they've done in terms of physically changing their process for the moment. But they did signal that they are now thinking of rate hikes in the second and third quarter of next year, as opposed to the second half of next year. In the grand scheme, we're talking about, maybe they pulled rate hikes for three months. Let's put this into the proper perspective here. They haven't suggested that a ton of rate hiking is needed. They haven't suggested that the end level suddenly needs to be much higher than people previously thought. They've just pulled forward the timing a little bit, and I guess they've done that— and many central banks have done broadly similar things on the basis, really, of one main development and then maybe one secondary one. The main one is just that inflation remains high and central banks didn't think it would. I think, in fact, much of the market has done a better job than central banks, recognizing that there are a whole lot of things swirling around here, and these inflationary forces aren't seemingly disappearing. Even if you know nothing about the economy, we know, for instance, that an inflation surprise index that we look at is as strong as it's ever been. The winning bet for inflation has been above consensus every single day for the last four to six months, and so, all else equal, you probably want to assume that we're going to keep some of this inflation around at least a little bit further. Central banks, they still use the word transitory, and that's been a hot button word. But they're recognizing transitory isn't like three to six months. It's like a year or maybe a bit longer. They're settling in. They're recognizing the inflation isn't going to go away completely in the near term. They're recognizing maybe something needs to be done about that. So, rate hiking happening a bit sooner, as opposed to later. That's the main story. There is kind of a second narrative just from the bank of Canada here, which is they also talk a lot about supply chain issues, which is quite fair. And, of course, that is a source of some of the extra inflation. But they're also talking about it in the context of, well, the supply chains mean that Canada doesn't get to produce as many things as it would normally be able to because we just can't get our hands on things and there are all these constraints. They're basically saying the potential of the economy is diminished because of that. We're closer to our full capacity just because supply chains are limiting our full capacity. And they're not wrong. Our production capacity is limited in the short run. I tend to not think of that as being, hey, everybody, the great news is we're not in our potential because it's a diminished potential. I tend to think it's a potential that's somewhat delayed, and we're still working on it, and it will take a bit longer to get there. I'm not sure, to my eye, that would be a reason to be raising rates a whole lot sooner, particularly since rate hikes aren't going to fix supply chain problems. The problem is not cheap money that's creating supply chain problems here. It's a bunch of other things. But the bottom line, Bank of Canada is now thinking second or third quarter of next year. Markets have priced in quite a bit at this point. I think I can safely say— though recognizing there are lots of fixed income portfolio managers and they don't always precisely agree with one another— that, with a fair level of confidence, maybe the market price is a bit too much of that. It's not clear to us if we’re going to get three or four rate hikes over the next year. There might be a couple though. I think that's where we are right now, as it pertains to the Bank of Canada, just a greater respect for inflation at this point.
As legendary— you can confirm or deny legendary— long-distance runner from Princeton, you've taken your first victory lap on being ahead of consensus on your inflation forecast and a little bit better than the Bank of Canada. Long distance runner can take a second victory lap on slower growth. And that's what we got out of Canada and the U.S. this week.
Yes, I guess that's right. We have, as you say, Dave, been looking for below consensus growth and above consensus inflation, and we've been getting that. It doesn't greatly please me because I'd like to have wonderful growth, and I'd like to have quite tamed inflation. But nevertheless, I guess the second best outcome is to be right, if not in the ideal position. Yes, that does seem to be the case. U.S. third quarter GDP came out and it was 2% annualized growth, which by the way, before the financial crisis, we would have said was totally normal, totally cool. No problems here. But in a post-crisis world with room to grow quickly, in theory, we like to see more. We're coming off of a quarter that was more like 7 or 8% the quarter before. It does represent quite a deceleration. I have to say it was in the realm of what we assume; we were assuming two point something, but nevertheless, it’s slightly shy of that. It makes sense. The U.S. economy was hit pretty hard by the Delta variant in that third quarter. It was very much August and September. We could see that the numbers were weaker. I should say, this is not quite confirmed, but I think the U.S. is going to accelerate a little bit through October and November, based on what I'm seeing. I think we're going to get somewhat of a better fourth quarter, and we'll unwind a bit of that. But nevertheless, just the low hanging fruit has been picked. We're not going to see growth as fast period going forward. I don't know if we ever get to see 8% growth again. I'm hoping we don't, because it means something really bad probably happened just beforehand. That's where we are. But it's still a recovery. It's just a slower one. And then Canada just got its official August GDP number, and it was 0.4%. Times that by twelve, and actually that's a pretty good-looking number. But there had been expectation of a 0.7%. Another miss, a below consensus outcome and simultaneously, Stats Canada is, I would say wonderfully, though nevertheless, unconventionally, in the business of hinting what the next number will be before they actually publish it. So really, you could say this was a September release, and they said September growth was in the realm of zero, which isn't great. That's a bit of a surprise, even for the below-consensus types like me. I would say we've had a weird string of GDP numbers. You may recall that July didn't grow and credibly April and May were negative way back when, but it's just very choppy. I think they're likely struggling to capture some of these forces. I tend to be more comfortable looking at, frankly, fresher numbers like employment and some of the other things out there, which for the most part say Canada has been moving pretty well, so I don't think the economy suddenly put on the breaks in any horrific way in September. In fact, particularly since they're missing certain things. The reason they didn't used to give us September data so quickly is because they don't have all the results. This is a guess, as it stands right now, and seems to me, some of the times they've guessed a really big number, like a 0.7%, it ended up being a bit less big. Some of the times they've guessed a bad number, it ended up being a bit less bad. I wouldn't be surprised if they managed to eke out a bit of growth. But more importantly, September enjoyed very nice job creation for Canada. How bad really could it have been? Canada is in a slightly different position than the U.S., for instance, in that the Delta variant kind of came later and we saw Atlantic Canada and the Prairies actually tightening their rules a little bit in the last month or so. I do think it makes sense. There's a bit of a deceleration out there in Canada, even maybe if the U.S. is undecelerating or accelerating a little bit. But I don't think to the tune of zeros. I don't think there's a sudden recession here or anything like that. Let's stick with that original thesis, which is, growth is slowing. It’s makes sense, it's below consensus. I don't think the recovery is off by any means. I think for the most part, the stock market and others recognize that. You can see they've generally been reasonably content in recent weeks.
Yes, we just think about it in terms of the pandemic as well. There's been different points along the line that we thought we were getting out of it, that we were past the worst of it, and then boom, we have another variant. Something else happened, and then we're right back in the midst of it. So not surprising that we're seeing choppy economic growth numbers, month to month or quarter to quarter, coming out of a once in a lifetime event, let's hope.
Yes, that's right. By the way, it is amazing how when you go back— I don't know if other people do this, I always shutter what I do—, you go back six months, and what was I saying then? Often it works out okay. As I see, the growth and the inflation trend have largely held up. But sometimes I look back just at the prior month webcast; I thought that one month ago? It's hard to believe. Not only does it say the future is hard to predict with precision, but it also says something about how quickly you forget your prior positions, if that makes sense. Tragically, they have no economic relevance. In January, we booked a winter holiday to a tropical destination, and the vaccines were almost here, and that was going to be the end of the pandemic, and it was going to be neat and tidy. Of course, that was before the Alpha and Delta variants, which have turned this more endemic as opposed to a limited duration pandemic. I have a younger child, so he's not vaccinated yet. That's actually the pinch point. It's not looking quite like that vaccine is going to come through, at least for two of them, plus two weeks by Christmas. Apparently I made a very bad prediction in January when I booked this trip, Dave, because it's looking like we're about to back out of that. Here's an example of my poor forecasting skills.
Well, hey. If you're in the same situation as me, my wife and kids are always on top of anything that I get wrong. Any prediction, any promise I made that I miss out on. So it's kind of par for the course.
I suppose so. In any event, no tan for me this winter, I'm afraid.
Well, they can't see you on the podcast, but you're looking sharp as always. Eric, thanks for this update on a couple of interesting announcements this week.
Absolutely, my pleasure. Have a great day, everybody.