Hello and welcome to our latest video MacroMemo. We have plenty to cover off over the next few minutes.

We’ll talk about the deteriorating virus numbers and rising virus variants. Alas, we’ll talk about our expectations of a third wave over the next month or two, but we’ll also go into reopening trends in terms of economies that have been reducing their restrictions. We’ll certainly talk about success with regard to vaccinations. We’ll work our way, of course, through the economic data and mostly good actually. We’ll also acknowledge inflation worries, and that’s been a real focus for economists but also for markets recently, and so give you our view on that. And also rising interest rates. We’ve seen bond yields back up significantly and that’s causing some concern as well.

Let’s start with the latest virus numbers. And so, unfortunately, the global trend is back to rising. As you’ll recall, between early January and, gosh, mid-March, we could say that the infection numbers were falling quite happily across much of the world, and that’s no longer the case. We have a rising global trend, more aggressively in emerging markets, particularly Brazil, also notably India, but also to some extent among developed countries and Europe especially. And so, unfortunately, France, Germany, Italy. Poland as well now seeing significant inflections higher in the infections they’re suffering. Canada also pivoting a little bit higher, so rising numbers nationally. And indeed, three of the four largest provinces, Ontario, Alberta, and British Columbia see rising trends now. Quebec has managed to dodge that so far.

The U.S. still falling and so that’s an interesting one. But the majority of U.S. states now rising, and so it sounds as though the U.S. may begin to rise as well, though it’s a bit of a more nuanced conversation given how much vaccination has happened there. And the UK’s still doing well. So they have driven down their numbers quite significantly. They’re vaccinating quite nicely. Simultaneously, they’ve already learned, it would seem, how to deal with these new variants and so they’re still doing fine. But on the [average] it seems as though the number’s getting a little bit worse as opposed to better.

In terms of why the virus numbers are now getting worse, there are several reasons, but the big ones really relate to the new virus variants. They seem to be more transmissible, somewhat more fatal, perhaps somewhat more resistant to vaccines as well, and they are accelerating, certainly in Europe. It would appear in North America, the numbers, I’ll admit, are murky and you can’t always get exactly the precision that you would like, but based on the tracking that we’re doing it certainly seems as though those new variants are growing week on week in both Canada and the U.S., arguably quite significantly, and indeed, they are now the dominant strain in several jurisdictions, including Ontario. And so the variants really are the main concern here, and indeed they are spreading.

With regard to the prospect of a third wave, that is our active expectation right now. And so there are a number of reasons for that. The fact that the recent trend is more cases, not fewer, is certainly a good starting point. The fact that virus variants are accelerating is probably the most compelling reason. Previously there was a sufficient amount of social distancing for the original form of the virus but existing rules arguably aren’t sufficient for these new variants.

We’ve seen rules, if anything, ease as opposed to tighten. So more on that a little bit later. Social distancing fatigue we think is rising as well. So people becoming a little bit less compliant. It’s not that there’s a guarantee of a third wave here. In fact, you can see exceptions galore. South Africa somehow has dodged that despite its own variant. Ireland and Denmark were saturated by the British variant and yet have done broadly fine. And so it could be that there’s no third wave, but the trend so far and the underlying drivers seem to suggest it’s more likely than not.

I will say we expect fatalities and hospitalizations to be less under any additional wave, in large part because the most vulnerable people have now been vaccinated. I should say we expect the economic damage to be fairly limited because the second wave damage proved to be quite limited but also because we suspect there may be a reluctance to significantly shut down given that, for instance, hospitalizations and fatalities probably don’t set new highs with this next wave.

We expect market damage to be limited to nonexistent. The financial market was not particularly bothered by the second wave and likely continues to look forward toward a world in which most people have been vaccinated over the next few years. And we think any third wave would probably also be short-lived in the sense that within a few months, at least a month, wealthy developed countries, we should have the vaccines outmuscling the new variants. Not so much dominating in the next month or two but ultimately, vaccines should win. And so we expect a third wave but it doesn’t have to be as problematic in a variety of ways as the earlier waves were.

Let’s talk now about reopening trends. And so globally the pattern is still more towards economies being opened as opposed to closed, but the rate of opening is slowing and so the global stringency measures we look at, they’re easing, but they’re easing much less quickly than they were, say, a few weeks to a month ago, and they haven’t quite returned to the early fall level of minimum restrictions. And that makes sense, given what we know about these new variants.

In Canada, there was some good data actually being maintained by the Bank of Canada. They look at it on a regional basis. And so we can say, for instance, Ontario has eased its restrictions the most among the various regions of Canada, but that’s only brought it really to the national average level. So it’s not that rules are especially easy, it’s more that they were especially strict beforehand. Quebec is now the most stringent province, and so it holds that mantle, perhaps helping to explain why its numbers are continuing to improve.

At the opposite end of the spectrum, Atlantic Canada is the least stringent but, of course, it’s had such success controlling the virus previously that it hasn’t had to go as aggressively as other countries have.

And then moving away from Canada again and looking back to the global picture, we can say reopening has been the trend ever since January or so. Now we’re starting to see some jurisdictions shut down again, which makes sense as the virus numbers rise. And so various parts of Europe have now done that, and the big question is whether that becomes a more common theme. And, indeed, you could argue it should to the extent that there may be another wave coming.

On the other hand, the counterpoint would simply be that people are really tired of locking down, and governments probably don’t want to do this again, and if they could avoid it, they probably will. And moreover, to the extent they really cued their decisions in the past on the rate of hospitalization and whether hospitals are saturated, to the extent the next wave might not result in as many deaths or hospitalizations might make a reluctance to significantly shut down. There could just be a tolerance for more infections that don’t have the worst-case outcomes attached to them. Let’s pivot toward vaccinations now. And so proceeding well, 450 million people globally have now been inoculated at least once, and so incredible progress. Though, of course, significant distance left to go with a global population of 8 billion.

Israel still very much winning, with 112 shots per 100 people. And so, just as a reminder, most vaccines require two shots, and so that’s why they’re past the 100-per-100 mark. The UK and the U.S. doing very well among the larger wealthy nations at 44 and 36 shots per 100 people, and so making significant progress. Europe lagging considerably those others at 12 doses per 100. Canada lagging further, 10 doses per 100. But it should be said, all making significant progress, most accelerating here.

And we’re assuming that vaccine passports do become a fairly common occurrence. Whether formal or not, the idea that different rules apply to people who have been vaccinated versus not seems reasonably likely, and we’ve seen that already. Israel has done that quite significantly in terms of getting into shopping malls and the like. The U.S. now allows vaccinated people to interact with others inside without masks. Iceland allowing vaccinated people to come visit for vacations. China is creating some sort of international travel scheme based on vaccinations, and the European Commission doing something similar for Europe. And so I think we’re going to see more of that.

It’s not fully fair in the sense that people, through no fault of their own, are not eligible to be vaccinated yet in many cases, but it makes sense in terms of allowing as much normalization as possible.

Let’s talk economic data now. Makes sense. I’m an economist. And so overall, strong data. We’re seeing broadly good news here. The one exception being, when you look at the February U.S. economic data, it looks quite weak, however, for a very good reason, which is there was a winter storm in the U.S. in February. Retail sales fell 3%. Industrial production fell 2%. We don’t think that reflects the underlying nature of the U.S. economy. And actually, when we look at the real-time data, which gives us an insight into March already, we can say our overall economic activity index is rising. US hotel occupancy is not just rising but now the highest it’s been since the pandemic, so higher than it was last summer when people were feeling fairly good. Global air travel is rising and is now the highest it’s been since the pandemic, higher than it was last summer as well. U.S. credit demand starting to inflect higher after eight months of easing.

And so, broadly speaking, we’re seeing good economic data, but I will certainly acknowledge a significant divide between North America and Europe. And so, for instance, the North American numbers looking fairly good. European numbers have generally looked somewhat worse. And, of course, that’s also the region that seems to be locking down again, and so some extra economic suffering there. There’s been quite a significant divide and that looks likely to stick.

I should say for all of that, we’re still mostly above consensus in our growth forecasts, including for Europe. And so Europe may not do quite as well but we do think it still may outperform current expectations for it.

Let me talk about inflation now. And so, inflation worries have been rampant recently. It’s the new great worry among financial market participants. But I do want to say a few things.

And so, to begin with, inflation has actually been very low so far during the pandemic, which makes sense. That’s what happens during a recession. It’s hard for workers to demand wage hikes, and it’s hard for businesses to push through price increases. We’re starting to see some rebound, that is true, but it’s still fairly tame. Inflation numbers for the most part still below where central banks would like them to be, so no huge issues yet.

However, it is fair to say there are some special, mostly idiosyncratic pressures that are blossoming right now and may send the very short-term inflation readings somewhat higher. And so, again, in the U.S., there was a winter storm; the winter storm increased the price of oil; increased the price of plastics and certain other goods because production was shut down. That’s a temporary effect on inflation, though it should fade.

Certainly, we’ve seen oil prices revive significantly, and so that is a driver of inflation in the near term. But I think it’s worth putting this into broader perspective, which is, the price of oil was $60 a barrel before the pandemic. It fell very far for a period of time. But the price of oil has returned to $60 a barrel. There was no net inflation from oil over the last few years. It just artificially depressed inflation last year; it’s going to artificially inflate it this year. There’s no real underlying pernicious trend, as far as we can tell.

It’s fair to say that the residential property market is booming in a lot of countries right now, and that’s a murky mix of inflation and asset appreciation. And economists really struggle to sort out just how to classify that. It shows up in inflation numbers to varying extents; usually less than people think it should, but arguably the right amount when you get right into the details.

And so, an upward pressure on inflation to some extent. Probably not quite as big as you might imagine if you look at the big home price gains out there in many markets. And indeed, in the U.S., the housing market is now cooling at least a little bit as mortgage rates go up, and we can see that in builder confidence measures. Undeniably, though, building materials like lumber, brick, copper, becoming notably more expensive.

And so I guess I would say this: In the very short run, over the next few months, we probably should expect annual inflation, U.S. CPI to spike to something like 3.5%. So be braced for that. However, most of these are very temporary factors. Several of them are actually actively unwinding, and so I wouldn’t expect inflation to stay in that range for very long at all.

Then you pivot to cyclical factors, ones that might stick around for a couple of years. And certainly, there are some there. The economy is reviving, as a prominent example. But I would emphasize, there’s still plenty of economic slack, and maybe even more than commonly imagined. And so inflation should go up; it’s unlikely to be high on this basis. In fact, if anything, it should still be a little bit low over the next little while.

Yes, the U.S. Federal Reserve has a new mandate. They want a little bit more inflation than before. But it’s really just a little bit; it’s not a lot more inflation, and it’s not forever more. It really is just to offset the low inflation recently. Yes, U.S. dollar weakness can be inflationary, but actually that means that every other country has a deflationary pressure from their currency having been somewhat stronger. In Canada, carbon taxes push inflation a little higher, but it’s really quite a small amount.

And so, when we look at the cyclical factors, we really—we do see some new upward pressures, but they’re pretty small. And so our working assumption is over the next few years inflation runs in the 2%, 2.5% context in North America. A little higher than we’re used to, but not really a problem in any grand scheme.

For people who are really worried about inflation, the main worry they usually articulate is money printing, central banks printing so much money. But I should say, there’s very little historical link between money printing and inflation. You just don’t find many models that can actually pick that up.

In this episode, and indeed in most historical episodes of money printing, there’s little—or I should say most of the money is returned to the central bank. Banks have all this extra money. They don’t have all these extra people who want to borrow, though, and so they return it to reserves, and we can see that happening. And indeed, that is what happened in the financial crisis, and it’s what’s happened in Japan as they’ve printed money for the last 20 years without generating much inflation. And so we’re not convinced that’s actually a driver.

And then you have structural considerations over the long run. And actually, the structural considerations mostly point down for inflation, not up. You have Phillips curve, which is very flat. That is to say, the link between a low unemployment rate and inflation is quite limited. It’s not clear if the economy normalizes that we will even get normal inflation, let along high inflation.

You have demographic pressures which seem to be profoundly deflationary. If you look at Japan, or the European experience over the last few decades, we think the rate of technological progress may pick up, and that’s a deflationary thing as well. And indeed, you look at inflation expectations over the long run, and they’ve revived, but they’ve really only revived to normal levels as opposed to high levels.

And so I guess the bottom line for me on inflation is in the very near terms expect a spike, but don’t expect it to be permanent. Over the next few years, expect inflation to be a little hotter than we’re used to, but really very close to normal. And then over the long run, I really don’t think many of those forces stick around.

And indeed, you look at central bank forecasts. And central bankers are the world’s experts on inflation. This is their job. Their job is to track and control inflation. They’re really not that concerned. Their forecasts have gone up a little bit but their forecasts are for an entirely benign experience over the next few years.

Okay. And let me finish with a section just on rising interest rates briefly. And so there’s been a big jump in bond yields. We’ve seen the U.S. tenure yield go from 0.51% to 1.69%. That’s a tripling over the span of seven or eight months, and so that’s a big move.

It does make sense that yields have gone up somewhat. They’re off a very, very low base. There was extreme risk aversion initially during the pandemic last spring, and that’s faded. Economies have strengthened. Economies are expected to strengthen further. Inflation has risen. Inflation is expected to rise further, as I’ve discussed. And indeed, there are some expectations that central banks may tighten sooner than they’ve said. I’m sympathetic to that. And so it makes sense that yields have gone up. And indeed, some emerging market central banks are already tightening.

However, I would emphasize, arguably, the bond market has pushed a little bit too far. As you look at central banks, you look at the Fed, you look at the Bank of Canada, they acknowledge the better economic picture. They probably will tighten a little bit before they had previously planned. It’s unlikely they’re going to move aggressively. It’s unlikely to be a near-term proposition.

And indeed, if there’s any kind of lesson for market expectations over the last decade or so, it’s that markets repeatedly expected central banks to tighten prematurely after the global financial crisis. They kept on pricing in rate hikes; they kept on not getting the rate hikes and so they had to price those back out. And so that might well be a consideration here.

When we look at past taper tantrums, in 2013 and 2015 the market started to panic. Central bank hikes seemed to be imminent. In both cases, actually, yields ended up retreating back significantly from where they were. And indeed, over the longer run, for several decades, anytime you see a big yield jump of 100 basis points or more, you tend to actually see the fixed income market outperform over the subsequent year. That is to say, yields more often than not come back down.

And fundamentally, it seems to us as though yields at these new levels are fundamentally a little too high. Just given where the economy is, given the unemployment rate, this is arguably not a sustainable level. And so we think the risk is that yields actually retreat back a little bit and they don’t keep pressing indefinitely higher from here.

Okay. I’ll stop there. Hopefully you found that interesting, and please consider tuning in again next time.