Hello and welcome to The Download. I'm your host, Dave Richardson, and we are here for an important tariff and bond market, Treasury activity episode of The Download. We're here with Eric Lascelles, Canada's hardest-working economist, who is working even harder the last couple of days. Well, I think we say this every time, because there's always just so much stuff going on. It's just absolutely incredible. I can't believe you're able to pull everything together.

Well, you're assuming I am. I was on holiday last week— so shooting down the hardest-working economist idea— but it does speak to how much can happen in a week when you come back after 5 days off and you're saying, oh my goodness, there's all this stuff.

But you weren't really on holiday. You were working with your son. By the way, Eric's son is a fantastic baseball player, and we talked about him from his university because he was getting opportunities with scholarships. I think I underestimate how hard you work, calling you Canada's hardest-working economist— but I underestimated just how talented he is. Why don't you tell your story?

Maybe we all have. We'll see where it all ends because there's a lot of hard work ahead. But yeah, he's enjoyed a lot of success in recent years and went from getting some scholarship offers, which was great, to being on the National Junior Team, which was really exciting, and then getting some draft interest. So that was the adventure of the last year. We were debating the school versus professional baseball option pretty intensively there. And, to make a long story short, he got drafted in July. He is a very low-level minor leaguer, I should emphasize, for the San Diego Padres. And so it was in Phoenix, and last week he got promoted to their A-level team in Lake Elsinore, California, where I think Strange Brew happened. No, that's a different Lake Elsinore brewery, I think. But, it's very early going and it's a real shock to the system to be around other incredible baseball players. A lot of them are 21 and 22 and more, and he's 18. So hanging in there. But his first week in A-ball, he was player of the week. So he started off really well. It's been an exciting start, but we miss him and we do need to figure out a way to get him educated on the side, which is no longer, I guess, priority one. But it's certainly priority 2.

The nice thing is, just knowing you and the way you think about things, he's going to have a nice balance between baseball and education all the way through because he's a smart kid as well.

Hopefully. One of the nice things that you don't hear much about in professional baseball is that when you get drafted, you negotiate a scholarship essentially at the end. And so they will pay effectively for your schooling. So that does exist. It's a matter of finding the time and getting to that. Naively, I had thought, well, he can just do a course on the side at all times. But you underestimate the extent to which you're playing baseball from 8 AM until 5 PM. And then traveling. And so it's a little harder maybe than we budgeted for. But yeah, we've got an approximate plan right now and we'll start implementing that in the fall, I think.

Yeah. And just because Eric's modest, he was a second round draft pick and one of the top picks ever out of Canada.

Yeah, it was pretty amazing. I will say, he would go to school if it was anything other than that. We were pretty hard set on that path and then we got pulled aside and I guess we were skeptics but persuaded that his baseball talent was such that he should get a chance to explore that. And so we're going to do that. And you know, a lot of people— certainly baseball people— all said you should do that, which we knew they would. The question to my mind was what would non-baseball people think? So we canvassed a lot of people. There's no right answer. When you've got two good options, it's a good outcome either way, as much as it's hard to say no to the other thing. But the number of professionals and executives and, should I dare say, CEOs of RBC Global Asset Management who said: take the adventurous course, do the thing you can only do when you're young, think about what you want on your epitaph when it's all over. So we figured this is a pretty extraordinary opportunity. So he can go for it and figure out the rest later.

Yeah, and I think Eric forgets that we were at a company event about 14 or 15 years ago. It's the only time I met his son, and I was wearing a baseball cap, and I think that was the source of his interest in baseball. So I'll take credit for that.

I have no recollection of that, Dave, but we'll take your word for it. Thank you so much, I should say. Or we'll curse you later, because baseball is hard. If you go into to the major leagues, it's years and years. And he's gone from the 6th level to the 5th level. And there's still 4 more levels. And you may or may not progress through those levels. So we'll see how that goes.

And was there a tariff slapped on him as you flew him down to San Diego?

That's a good question. Well, we're hoping not. I would say the tax implications to be sorted out later. But at this juncture, we're under the impression not. Actually, one of the neat things is in a week and a half as we're recording this, my wife and I and younger son have been invited down to a Padres game. I guess the first and second round picks are going to be introduced to the crowd, so we're getting a little bit of something out of this ourselves. So far we've been living vicariously through him.

Awesome. But since I started, let's talk tariffs. Because I think that's what people are going to want to hear. I'm more excited about the baseball and your son getting drafted, but a lot of people get excited about the tariffs.

Yeah, no kidding.

And as we've talked about it over the months— and you can go back and listen to Eric if you follow the podcast, wherever you get it. If you want to watch on YouTube, you can subscribe to the YouTube channel and you can hear all the things that we've talked about with Eric and many others about tariffs. And I guess our perspective would have been and may still be— we'll see what you have to say— but that this was all going to work out in the end, that there'd be some give and take— a lot of take given who we're negotiating with— and things would end up being okay and we'd press on, but it just keeps lingering around, and this seems to be another escalation, not a de-escalation.

Yeah, it sure is, and we'll get into those details in a moment. I would say it's useful remembering the journey we've been on so far, which you've described nicely, but also the part whereby there were moments along the way where we got really scared and even a little bit panicked, and that proved not to be the most useful of responses. There were moments when we were really optimistic a deal was imminent, and so keeping a level head has been useful, and I think is still probably the best advice here. And so very much, this is a moment when the Canada-US tariff level is going up. That was threatened a month ago, and it has been implemented a couple of days ago. And of course, Canada didn't back down and talked about tit-for-tat, or one-for-one tariff response, and has done just about that. It seems to me it's coming in a little below that, but still a significant tariff response. And so not great all around, obviously. And in fact, we just spent the morning, Josh Nye and I, sorting through the Canadian GDP forecast and chipping little bits off it, I'm afraid to say, and adding little bits to inflation as well. But the word «little» does fit in there. And so I don't want to diminish, of course, the immense suffering for the particular sectors affected and the people working in those industries, because it's awfully challenging, though it does look as though there will be some recompense and subsidies and support programs that are now being introduced and that were announced this morning. But just to give you the loosest of magnitudes here, the section 338 tariffs, the new US tariffs on Canada, they cover about 0.5% of Canadian GDP in jobs. So, first of all, you say, well, that's not a trivial fraction, but keep in mind, no one is predicting those industries to disappear. It's more about how much damage happens to that 0.5% of GDP. So, it's not the whole economy. It's a relatively small part. We will see at the end of the day and now that there are government supports, perhaps the damage will be less, but just at face value, doing some simple math, you would say maybe the Canadian unemployment rate would go up by 0.4% or something, which, I mean, that's real pain. Equally, we were down more than 0.4% over the last few months alone. So actually, it would take you to the average unemployment rate from last year, just to put it into context. It's not a recession or something like this.

But the Canadian unemployment rate, as we've talked about, is higher than we'd like.

Yes, a little bit. That's right. Yeah, we'd love it to be a half point lower than it is. And so here we are going almost a half point the other way, you could say. So not at all desirable. But you're talking about maybe a 7% unemployment rate, not a 8, 9 or 10%. That would be more of a recessionary blow. So keep in mind, when the US applied tariffs to Canada, it hurts the Canadian economy, but it wouldn't add to Canadian prices. The extra Canadian prices is now the Canadian response. I think the Canadian government appreciates this is not a desirable long-term position. This is game theory playing out and hoping to discourage the US from continuing down that path. But the Canadian response, we would figure, would add in the realm of 0.1 to 0.2 to Canadian inflation. So again, here you are sitting in the mid-2s, you'd rather not go up as opposed to down, but it's not 10% inflation. So that's relevant too. And then when we try and map it onto Canadian GDP, we're currently thinking you lose about 0.3% of Canadian GDP. Would have been a little more, but now that we're getting a policy response, it's a little bit less. And I should emphasize— and we have no precise information to work off of other than the history of the last 18 months, or even the last 8 years, 9 years, you might say, given that there was an earlier Trump term— we're assuming these higher tariff rates last for a couple of quarters. We're assuming it's not forever. Now, there are risks to that view every which way. There could be a rapid step down by the White House. There have been certainly instances in the last year and a half when that's happened very quickly indeed. So that’s very much a possibility, though we're not budgeting for it.

This is a Tuesday that we're taping this, by the way. And I believe there's a particular food type that goes—we won't say it directly. We wouldn't want to be perceived as insulting in any way. But on Tuesdays, you can get a particular sandwich. There's a debate whether it's a sandwich or something else. Anyway, I think everyone knows what we're talking about.

Yeah, so it could get better quickly, I guess, is the takeaway from that. Conversely, of course, the White House has now threatened even more tariffs to be applied January 1st. Now, it's certainly good news that it's not to be applied tomorrow. The January 1st suggests some reluctance to apply them and give some breathing room in which perhaps deals could be struck and so on. So, we're not assuming that either, but it could get worse, it could get better. We're assuming it's going to be this, which is somewhat painful as just discussed, but not a killer blow for a couple of quarters. And then we're assuming very vaguely and without a precise sense of how it resolves that you then start to get a little bit better, let's say, in the spring of next year, in a couple of quarters. Do keep in mind, you may recall last fall there have been talk about those steel and aluminum quotas, and there were going to be effectively a reduction. It didn't happen. Some Reagan comments got in the way there. They did come back to that. It did take 8 or 9 months, but that was very much a part of the discussions that again didn't get through but were very seriously being discussed. And so the US would like some deal as well, would be my very loose takeaway. They initiated the latest round of talks by putting that time deadline on things. And so it does seem as though there are a few different views within the White House, and a more aggressive interpretation ultimately prevailed there. But it's not certain that continues, particularly since Canada did not comply. And so again, you get into all this complicated game theory, but it does some damage, is unfortunate. Canada was one of the countries that we were not above consensus in our growth forecast for before. We are relative optimists for a lot of countries. Canada actually wasn't one. And so I guess we're not too badly positioned just in that very narrow context as this plays out. But there is some real pain. But as much as there was talk of one-for-one tit-for-tat type responses— and this is just today's news and we don't have a perfect read— but it does look as though it's maybe not quite fully. Like, it's also on $20 billion US worth of products that Canada is importing, much as the US applied tariffs to an equivalent sum. But the US numbers were 50% tariffs, and it seems like the Canadian numbers are a mix of 15, 25 and 50% numbers. And so it's actually a little bit less than a proportionate response. And so, probably useful in the sense of given the optics of this is a hit, and it certainly will be visible in the US, maybe without hurting Canadians quite as badly as it might otherwise have.

Really important, Eric, to say— and this is sometimes what doesn't flow over the border in terms of media coverage, particularly in some areas of media— that both sides have quite a bit to lose here. I mean, even on a global level, this is a massive trading partnership. And it's important for as much as possible for both economies for goods to be flowing back and forth.

For sure. I mean, there's no doubting that on the net, globalization and free trade has been a good thing for both parties. It's win-win. It's one of those rare things that is win-win. And unfortunately, the opposite is lose-lose. I didn't talk about the economic damage to the US, but there is a negative on US GDP. There is a positive on US inflation. It's probably a smaller magnitude just because the US economy is bigger. And so it fits in a little bit less visibly, but there will be sectors and regions of that country that are adversely affected. And to the extent that this is a very integrated North American economy, particularly, you might say, in the auto sector, there's pain that goes both ways. If you're thinking at the assembly level, at least, that pain accrues to US companies significantly. And so not a great position to be in. And stepping back even further we had seen through court order in significant part, but we'd seen a reduction in tariffs globally to some extent from the winter through to the summer, you might say. We're seeing a bit of a revival on a few fronts of that right now, as the US finds other ways to implement its global tariffs, and now, I guess you could say, plays hardball— to circle back to our original topic there, Dave, of baseball— with Canada right now.

Yeah, it is a hardball tactic, but the other thing that's interesting to me is the political aspect of it. We don't go one way or the other in terms of politics. We look at politics from the lens of, well, how does a particular decision around the economy or something that's happening in the economy affect the political landscape. But if I'm thinking of some of the key Senate races that are up in November of this year— and the Senate is very much in question in terms of who will control the Senate post the midterm elections— you've got Maine, you've got— it's not particularly competitive, but it will be less competitive now in New Hampshire, you've got Michigan, you've got Ohio, you've got Wisconsin governor, and you've got Minnesota, which are all races that could in theory go either way. And I don't think these decisions are particularly popular in those states, because those are the states that are going to get hurt the most.

Yeah, that's exactly right. It's a tricky time, and who knows, maybe that is a very small part of the Canadian calculus in terms of this isn't actually a time when the US should be playing these sorts of strategic games with the midterms that are really very rapidly approaching right now. 2 and a bit months away, if my math is right. So it is a position of a little bit of vulnerability for the US right now. And I should emphasize a lot of the tariffs that Canada's put on to try to persuade the US— to put it politely— are often on the same products. And so it's not quite a fully Senate-targeted, but I think it's fair to say in the end that that is part of the equation. It's a tricky moment for the Republican incumbents. The House already looks more than precarious, and that's been known for quite some time. And that's the normal midterm experience too, though, the White House loses that chamber very often. But the Senate's very close right now. So that could be relevant. Again, we will see whether these US and Canadian tariffs stick around or not. We're assuming a couple of quarters, but it could be resolved sooner. It's quite possible.

And what's interesting, and I hope some of it is because of podcasts like this in Canada and similar podcasts in the US, or US listeners to this podcast, I think there's a broader appreciation that tariffs are inflationary. You say it might be more modest in the US, but one of the main topics of conversation politically around this particular campaign is affordability— is the word that a lot of people are using— but it comes down to prices have risen quite a bit over the last few years. They're not falling as was discussed through the last campaign, and this is not going to help prices fall.

No, that's right, and at a time, of course, for the broader context, the gas prices are still fairly elevated, mortgage rates are fairly high as well. We're going to get into yields in a moment, but it's just that all fits together. It's not the ideal time to be doing this thing, that's for sure.

Yeah, exactly. You see, you missed how the skilled host is segueing into the yield conversation by pulling inflation into the broader conversation. See how that works? The hardest working podcast host in Canada as well. So let's turn to inflation. We can point at the war, we can point at tariffs, which have been in place one way or another for a while, and the discussions never left the table. And, as time passes, that debt clock ticks away. Last week we crossed $40 trillion in US debt. It wasn't an alarm clock going off, but for a long time, we've talked about the level of debt across a number of countries, but the US in particular, because it just doesn't seem to be, as we talk politics, any political courage to deal with this problem from either side or anyone. It's just spend, spend, spend, win the vote, and move on and kick the can down the road. But most interest rates are set in the bond market, which is all of us, many people all around the world buying and selling bonds. And when the price of a bond goes down because we don't want the bonds as much as we did before, or the supply has gone up, the price goes down and yields go higher. That's the way it works. And then at some point you cross some lines where people get really concerned about that and the yields go higher a little faster. And we saw a little bit of that over the last 6 weeks, right?

Yeah, very much so. Of course, here we are with yields that have been on and off rising really since 2020, though some of that was just rebounding off extraordinary levels. But still here we are with the 30-year yield in the US that went to the highest level in 20 years recently. And so these are unfamiliar levels. They would have been considered rather normal in the 2000s. Not to suggest there's any great problem at this exact point, but when you combine that with all that debt, it is a little bit tricky right now. And as you say, the lack of political will. And so, yeah, yields— and I should say yields falling today— it's up and it's down, it's very sawtooth and it's not a single direction. But yields are inclined to rise. We would still be inclined to say that the risk is they go higher, not lower, and the curve steepens, not flattens. And so that would be our take on things right now. Big fiscal deficit is part of it. The $40 trillion US national debt symbolically at least, is a pretty eye-watering number. I’ll remind everyone, of course, one of the reasons interest rates were so much lower in the 2010s was you had quantitative easing. You had the central bank printing money and buying bonds. And that's not happening, though we're going to talk in a moment about maybe the Treasury thinking about doing things like that. When we talk to the fixed-income teams, they also flag, of course you've now got all these big AI companies that are issuing a significant amount of debt. And so that is crowding a little bit the sovereign debt and sending yields a little higher. A lot of those are long-dated bonds. And so the 10 and 30-year yields are relevant. We can see this in a widening term premium, there is a bit of just declining trust in US policymakers in general. And so a couple of questions around the Central Bank. And as we record this, we're going to learn some things at Jackson Hole later this week. And so we can check in after that perhaps. But also just not paying attention to the deficit and sometimes questionable public policy. With some inflation concerns which have been just compounded marginally by the tariffs, but on top of a few other things. And even just a changing Treasury base. Because it used to be you could count on foreign reserve managers to faithfully purchase Treasury bonds, and that's less so these days. In some cases, they're buying gold instead. Gold's been bouncing again recently. And in Japan's case, which has been the biggest holder— it was almost always the bigger holder than China, which often got overlooked— Japan is now in the business of defending its currency. That takes selling dollars and Treasury bonds and buying other things. So the buyer base has shifted too. So there's upward pressure on yields. The question is: what will stop this? And so there are some efforts being made. And so there has been a concerted shift in the bond being issued, in a structural sense. And they want to issue more T-bills and fewer bonds. And so that should, in theory, raise short-term rates but hold long-term rates down. And so I think they've had some success with that. And now you've got the Treasury Secretary, increasing— it's not a new plan, it's a ramped-up plan to buy more longer-dated bonds. For a number of years, they've had a system where essentially they were at least tidying up the bond market, you could say, and buying off-the-run bonds and illiquid bonds and just making it all function a little bit more smoothly and making it more liquid. And now the announcement is they're going to double the pace of the buying. And so in a way, the goal is in part to hold yields down.

And they're buying the long end. Which is not where they've typically been.

That's fair. And you can certainly say from a financial standpoint, it's an interesting-slash-questionable strategy, setting aside the very real desire to hold yields down, just because a lot of these long-dated bonds were issued during periods of very low rates. And so, to be a little bit stylized, you could say they're retiring bonds that they're paying 2% interest on, and they're funding it with T-bills that they're now paying 4% interest on. And so, other than the outsized importance of long-term bonds for mortgage rates and for corporate borrowers and this sort of thing, it's not actually a financially strong strategy for the Treasury itself. But I think it's important to mention what they're talking about is upping their buying from $20 billion to $40 billion, essentially, through the middle of November or so. And that's not a lot of money, right? It's a $40 trillion national debt. And so $40 billion is, to my math, 1/1,000th. And so for it to have a significant effect, it needs to be viewed symbolically as a warning and a symbol, and we could do more. And the tricky thing here is, this is the Treasury Department, not the Fed buying it. So the Fed could print all the money it wanted and buy all the bonds it wanted and unlimited capacity to buy bonds. The Treasury needs to use real money for this, and so they are a little bit more constrained. I know more recently they've talked about the Treasury General Account, which is this trillion dollars they have that in theory is like their checking account, and that would suggest you could buy a fair number of bonds. But as I understand it, a lot of that is accounted for, just because they're now so reliant on short-term debt, they need a big float just to handle the bills that are maturing. And so I think they need $800 or $900 billion of that just to survive a regular week. So they maybe don't have quite as much as you would think. And of course, the debt ceiling in theory gets hit maybe sometime next spring or something like that. And so you may recall that Treasury General Account's an important buffer to stay alive at that point. So not to suggest it's all a disaster— I don't think it is— but it's not overwhelming, bazooka-like bond buying. And so it's a real question whether yields hold down. I think the bond market right now is challenging the Treasury, and it's not entirely clear. Today, it looks like the Treasury's winning, I must say, as yields fall, but over a longer period of time, that's not at all certain to be the case.

Yeah, and I guess this has just been what we've become accustomed to in terms of the way that they govern and move pieces around. And deal with the debt ceiling and where they try to play in the bond market. But the thing I wanted people to get a picture of— between Stu that we had on earlier this week and yourself— is the idea of the amount of supply that's coming to market. It's not just government, it's now the companies that are building out the data centers and the whole infrastructure around artificial intelligence with hundreds of billions, if not trillions of dollars. That debt's coming to market at the same time. When you push up supply and demand is soft to begin with, that becomes a problem for yields. Price goes down, yields go up.

Yeah. That's exactly right. There's a little bit of doubt on the inflation file too. Fair chunk of it is the term premium, which reflects really supply-demand issues significantly. It's not so much the Central Bank right now, though maybe a little bit because they're less hawkish. People thought that might be part of the reason why the term premium and inflation is going up. But yeah, that's exactly right. And of course the deficit remains large. You need to be constantly churning through bill issuance when you are issuing short-term debt. But again, as I understand it, I'm obliquely referencing some of our fixed income portfolio managers who know much more about this than I do, but a lot of the bonds that were issued during the deficit and stimulus frenzy of the pandemic are set to come due over the next year. And so they will just reissue, of course, which is their right. But it speaks to there will be a fair amount of supply they need to get through at that particular moment.

And then when you have larger levels of debt with higher rates, which means more of your tax revenues going to pay off interest on debt— instead of going to either pay down debt or invest in things that can grow the economy— the ultimate economic effect is negative when debt gets to too high level.

Yeah, that's the idea. Now, the US is extraordinarily fortunate that there's an AI boom right now and private sector CapEx is very strong and productivity growth is good and all this. So that's helping. I will never underestimate the ability of the US economy to grow its way out of fiscal challenges, because that has been the history of what it's achieved, and it hasn't had to raise taxes and hasn't had to cut spending. It just grows its way out. So that is still on the table, and we can cross our fingers for that as people who'd like there to be a fairly tidy outcome, of course, at the end of the day. But in the meantime, it certainly makes sense that we are in a higher interest rate environment than we were a decade ago. That's 100% clear given all the different factors at work right now. And I guess the risk right now is that those yields could go a little higher again, and again, just make life more challenging for the government and prevent the housing market from lifting off in a way that you might like it to, and all of that.

Yeah, so we'll end it there, because I think what we'll have over the next several days, and probably next several weeks, is we'll be looking at these issues in relation to the bond market and what it means for equity investors as well. Talking to some investment managers who are managing in different areas of the market and talk to them about how this plays out within their strategies, which is ultimately what investors invest in when they invest at RBC, and give you that perspective. Because I think you would say— if I've got the old forest fire indicator, which we're very familiar with here in Canada these days, unfortunately— the risk level is elevated, or do you think this is something that we should just dismiss from an economic perspective?

Yeah, there's always risks. I would say my first comment whenever we talk risks is it's always trendy and fashionable to focus on the big downside risks, and there are some. There are geopolitical risks, energy shock risks, certainly interest rate risks, those are tip of tongue as well. I was just writing about cybersecurity risks. My takeaway was not quite as scary as I thought it would be. But there's lots of downside risks. I would just remind people, most of the time the economy sorts its way through it. You do have benevolent actors trying to achieve good outcomes, and that goes some distance. It's never fashionable to talk about upside risks. Hey, maybe AI is even better than we think. Maybe they're going to get incredible returns on investment for all this CapEx that they're doing. Maybe inflation just starts to come down. We think demographics are deflationary. We think over time AI can be deflationary. Maybe we're not going to have an inflation. So there are two sides to this. And so I would say both things, which is that there are some real risks and interest rates are part of that story right now. We need to watch closely because we just haven't seen rates as high, in some cases 20 years. And so it's just unfamiliar. Equally, I wouldn't want to obsess over that. I would still drive home the point— we’re imperfect forecasters— but from our standpoint, we're actually slightly above consensus. We're slight optimists on economic growth for the moment. Maybe not on Canada, sadly, post-tariff. It's okay there, but it's just not as strong. But yes, let's not dwell exclusively on that.

I did want to tee that up because I thought that would be the way you might respond. And again, that's what makes a market. There's buyers and sellers. Some people are negative, they sell. Some people are more positive, they buy. That's what makes a market. It is an actual market with supply and demand, and people come to the table every day deciding whether they're going to invest or take money off the table. And these are all the elements that come together. And as I say, we're going to have lots of people on over the next couple of weeks to talk about how this affects specific market strategies to help you invest. Because that's why we're here. And we're always happy to have the hardest working economist in Canada, Eric Lascelles, Chief Investment Officer at RBC Global Asset Management, to join us and provide a lot of clarity around those issues. And by the way, I can tell you where there's no demand. There is no demand for my baseball services in the major leagues, unlike your son. So congratulations on that, Eric, and, we'll talk to you in a couple of weeks when the jobs report comes out.

Fantastic, thank you very much.