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Increasing job numbers in the U.S. and Canada are among a string of indicators pointing to a better-than-expected economic recovery. This episode, Chief Economist Eric Lascelles shares his outlook for what’s ahead this spring. Eric also explores the rise in bond yields from an economic perspective – from central bank decisions to inflation concerns. [8 minutes, 16 seconds] (Recorded March 5, 2021)

Transcript

Hello and welcome to The Download. I'm your host, Dave Richardson, and we are doing a bit of a special edition of The Download. Given what we've been seeing happening in the bond market, in the stock market, particularly in the Technology sector, Energy sector. As we've talked about on previous podcasts, particularly with Stu Kedwell, that rotation is seeming to be underway. But we had a jobs report in the U.S., which has markets reacting fairly well today. I wanted to take a bigger picture look at that with the chief economist at RBC Global Asset Management, Eric Lascelles. Eric, welcome.

Thank you very much.

Putting the hardest working economist in Canada to work late on a Friday afternoon! So, Eric, the jobs report and what we've been seeing with the rise in the U.S. 10-year Treasury. How do you piece it all together? And what would you say to people looking at it from an investment perspective?

Right, those are all good questions. And so, this latest U.S. job number; 379,000 new jobs created in February. It's the latest in a string of indicators that have broadly landed better than expected, and at a minimum, consistent with a fairly happy economic recovery during this pandemic. And I can say it's not uniquely a U.S. phenomenon either. In Canada, for instance, we've just been repeatedly pleasantly surprised by the fact that the Canadian economy has been growing. I remember thinking back in the fall as that second wave came along, and as the rules got tighter, we were thinking November GDP probably shrank at least a little bit and then it didn't. And then we thought, well, December probably did. They tightened up even more and then it didn't. We just got some tentative numbers in Canada as well. For January and early January, GDP was off. So we are finding that these economies handled their second or latest wave fairly well. We can see that there is some subsequent economic rebound. Don’t get me started on variants and third waves and that sort of business. There are certainly some risks out there over the next month or two. But nevertheless, it's been a pretty good economic story here. And we're getting a fairly happy recovery. I should say our own economic forecasts are above consensus for 2021. We think this is legitimate. We think this is a year of economic recovery, a year in which vaccines play a very important role. We Canadians are still grumbling a little bit at the rate here, but even that should pick up fairly quickly. And so, all of that's very nice. However, you then need to map that onto that second question of yours, which is what does that meant for interest rates? And certainly it has made risk assets in general fairly happy over the last six months or so, but it's sent bond yields notably higher over the last few months. Indeed, you look back to the extreme lows last spring, and the U.S. 10-year yield was as low as essentially 50 basis points. Now it's sitting essentially a percentage point higher than that at 150 basis points. So that is a significant move and a real fraction of what has happened in the last month or two. And so what is all that about? I will say this; our one-year-out forecast is actually for slightly lower yields than where we are right now. We're not convinced this is a path that needs to continue indefinitely. I guess the way I would put it is I agree with the economic excitement that's reflected in those numbers, but I'm aware of a few other things. One would be that we are now in a much heavier debt environment than we were even a year ago. So what governments and what bond markets can arguably tolerate in terms of the level of yields is probably even lower than it was. And it wasn't exactly high before the pandemic. So I'm aware that may yet weigh on the level of yields. Inflation - certainly fears are rising. Indeed, to some extent, inflation is rising over the next few months in particular. But if we look a little further out, we think it's more likely that inflation remains fairly normal as opposed to truly overheat. So there could be a little bit of a retreat on the inflation expectation side. Then, just don't forget what central banks keep telling us over and over again, that they have no plan to raise rates any time soon. And even as we see certain measures looking increasingly normal, they dig through the data, and continue to argue that even if the unemployment rate looks fairly good, then you dig down and you see quite a gender divide or you see divide between high income workers and low income workers. So they feel like there's maybe more hidden economic slack out there even than the official numbers say. Not to say that higher yields are wrong, I think it makes sense. We've seen a selloff here, but it's not necessarily something that's going to gain further speed from here and end up significantly above current levels. If anything, there's a risk we could see a little bit of an unwind in the months to come.

And as you say, central banks are saying very clearly they're not even thinking about thinking about thinking about thinking about raising rates! So in that environment, we've got to remember, when you look at the longer end of the yield curve, like a 10-year treasury, that that's set by the market and markets notoriously overshoot on both sides. So maybe 50 basis points in hindsight looks like it shot the yield down a little bit too low, and maybe 1.55 to 1.60 right now might be a little bit of an overshoot with respect to optimism?

I think that's a good way of putting it. We'll say this; for people maybe worried that the selloff in rates is going to snuff out the economic recovery, I'm not overwhelmingly concerned about that. And we've been tracking financial conditions, indices, and they're a little less friendly than they were just a month ago. But they're still at near record lows in terms of how helpful they are, or record highs in terms of how helpful they are in terms of the economy. So we think the economy gets to keep moving. We will see shortly what central bankers say over the next few weeks with regard to this selloff. And conceivably, there could be some talking back down. I can't imagine central bankers are overwhelmingly happy that yields have moved up this much at a time when they're still doing a whole lot of quantitative easing. Obviously, they'd be nervous whenever they do actually engage in a tapering, let alone stop buying the bonds. They don't want yields massively higher than they are right now. So, I suspect there could be an effort to talk yields back down or at least to help stabilize them as well, so that could be a factor to consider. Fundamentally, this is likely to be a structurally low interest rate environment. And if anything, it should be a little bit structurally lower than it was before the pandemic came along. And so, again, as much as the economy bouncing here, we're still a few years away from anything approaching normality, we think. And even that new normal from a rate perspective should be somewhat lower than the old normal. We've been tracking the central banks, the Bank of Canada's own definition of what a neutral policy rate is. And, you know, at the turn of the millennium, 5% was the best guess or thereabouts. And I remember doing a paper when I was fairly new into this role, in 2011 or 2012, something like that, and 3.75% was our guess for what the neutral policy rate was. And then the central banks got in on the act as well. And it was recently, a few years ago they were saying, maybe 2.5 or. 2,75% is the neutral rate. And Bank of Canada put out new numbers recently. They said; we think the neutral rate coming out of this might actually be something like 2% or even a little bit below 2%. And recognizing it seems like we spend more time below that neutral definition than above. And so, it is really a low rate environment. Let's not lose sight of that.

Yeah. Living in a house at one point in the early 80s where my parents were paying over 20% for their mortgage rate. It seems incredible. And that's what you've got to put in context. I mean, from a historical perspective, 1.5 or 1.6% is extremely low.

Absolutely. My parents mortgage came due in 1982, which was not a good year for that to happen. And we rented for the next 15 years. That was what happened to us. And so, I remember getting back in and being super excited. It was below 10%! So yeah, it's a different world. Absolutely. And to the extent that we've all gotten used to the low rates and that’s part of the reasons why they have to stay quite low and governments have a lot of debt now. Households have a lot of debt as well. We've seen a housing boom. I'm sure policymakers would like to slow that boom down to some extent, but I don't think they want a bust. And so there is a higher level of sensitivity to rates than there once was as there is this extra debt around.

Super. Well that is a fantastic explanation of what we're seeing, the number today and putting everything in historical context, Eric. No surprise. Another great visit. Thanks for dropping in. And we'll check in with you over the next few weeks to see where things progress. Thanks again.

Thank you.

Disclosure

Recorded: March 5, 2021

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