Talking Points
February 14, 2020 | 13:34
Dove is in the Air
Economics
Economics
It never rains, it pours… or, in Canada’s case, it blizzards. In the final weeks of 2019, it seemed like everything was finally falling into place for a brighter global economic outlook. And then that’s all been unwound in the opening weeks of 2020. In quick succession, we’ve pinged from a near-war with Iran (ending in tragedy), brushfires in Australia (since doused by torrential rain), the spread of COVID-19 (and the near shutdown of China’s economy); and now, widespread rail shutdowns in Canada. So, instead of looking at a mild upswing in global GDP growth, we’re now busily trying to assess to what degree it will slow further this year—largely due to the virus, of course. While equities are more than willing to look beyond the Q1 valley for growth, commodities, currencies, and bonds have aggressively adjusted for a much more modest economic backdrop. |
Full disclosure, a running debate within our department is whether markets/analysts are: a) over-reacting to the risks that COVID-19 poses to the outlook—see 15% drop in oil prices, 30+ bp drop in bond yields, and markets priced for more than 25 bps of rate cuts by the Fed and BoC this year; or b) understating the risks—see record equity markets across the board in North America, and next to no change in G7 growth forecasts for 2020. Personally, I lean to the latter view, given the many unknowns we are dealing with, the potential for the virus to spread well beyond China, and the very real damage we are already seeing inflicted on China’s economy and on supply chains. Admittedly, for a few days this week, it appeared that the “markets have over-reacted” camp was ascendant, as the number of new cases was steadily and forcefully retreating. That trend was all cast into doubt on Thursday with a new methodology for calculating cases, although early indications are that the underlying trend is still down (from a much higher base). Amid that lack of clarity, markets have divided back into their usual camps, with stocks headed for new record closes (S&P 500 up more than 1% this week), and bond yields flat or down slightly on the week. The latter was also influenced by more mundane factors, such as a pair of soggy reports in U.S. retail sales and industrial production for January—which solidified our view that U.S. GDP is on track for a sluggish growth rate of little better than 1% in Q1. Arguing in favour of the “markets are understating the risks” view was the sputtering re-start to China’s economy this week after a prolonged shutdown. We are reassessing our call on China’s growth outlook on a week-by-week basis, according to new information that becomes available. And that new info mostly landed on the soft side this week. Adding some spice to the mix, China’s CPI inflation rate bolted higher last month to 5.4% y/y—largely on soaring food costs, but still implying real pain for consumers there. As a result, we now believe the economy will contract outright in Q1 in seasonally adjusted terms (always a challenging exercise in China during the first quarter), and have shaved our call for the entire year GDP another quarter-point to 5-1/4%. For some perspective, the latest Blue Chip Survey posed the question just last week of (paraphrasing) “how much will the virus cut China’s annual GDP growth rate this year?” The consensus answer was -0.7%, which just so happens to be almost precisely by how much we have now cut our call since the start of the year. Given that China now accounts for just under 20% of global GDP, that downgrade—along with some small shaves to economies nearby—translates to a 0.2 ppt clip in the world economy. In turn, this implies next to no adjustment in the outlook for advanced economies this year. Note that the latest Consensus Economics, based on a survey conducted earlier this week, reveals that 2020 growth estimates for G7 economies have not been shaved even 0.1 ppt in the past month (a timeframe that would essentially capture the emergence of COVID-19). The consensus call on some economies was nudged lower by a tick (Japan, France and Italy), but that could as much reflect extremely sour December industrial activity as a rethink on what lies ahead. Meantime, the conventional view on each of the U.S., Canada, Germany and Britain was unchanged in the past month. Given that economists have not, on balance, adjusted their calls on the advanced world, it seems tough to assert that the risks of the virus are being overstated. The results from Europe this week suggested that perhaps the growth forecasts there should be coming down, even without taking the virus into account. Industrial production took a nasty 2.1% spill in December across the Euro Area, leaving it a whopping 4.1% below year-ago levels, matching the biggest drop in a decade. A plunge in China’s auto sales in January points to further weakness ahead for Europe’s automakers. Euro Area GDP edged up just 0.1% in Q4, or +0.9% y/y, with Germany reporting no growth in the quarter. Things were little better in the U.K., where GDP stalled in Q4 (and up 1.1% y/y) amid the uncertainty around the late-year election. Turning back to Canada, both Finance Minister Morneau and BoC Governor Poloz noted this week that the virus poses downside risks to this year’s growth outlook. Poloz notably suggested that he has “no quibble” with the market’s reaction—to which we would ask “stocks or bonds?”. Presumably, he is referring to the drop in yields and oil prices. Loaded on top of an already sluggish and uncertain global backdrop, the economy is now also dealing with a widespread rail shutdown. The ultimate cost will depend on the duration of the shutdown, and we have plenty of recent evidence to make an early assessment. The November CN strike, which lasted more than a week, ended up carving less than 0.1 ppts from GDP that month. However, this shutdown threatens to be more open-ended, with the situation “fluid”. Acting as a partial counterweight on that potential drag, all signs suggest that housing is poised to add heavily to growth, with starts and permits bouncing higher in the latest month, and existing home prices on the march—average transactions prices popped 11.2% y/y in January, a four-year high. While that measure may be a tad flawed in capturing the precise rise in actual prices, it does a wonderful job as an early indication of which way the wind is blowing in the housing market—and the wind is howling again. One need look no further than the NHL for a real-world example of the wide-ranging effect of COVID-19. The Globe and Mail reports that there is a looming shortage of high-end hockey sticks for the players, since roughly three-quarters of these $300+ sticks are produced at CCM or Bauer factories in China. The other one-quarter is made in Mexico, which is a story unto itself that all high-end sticks are now manufactured in China and Mexico. But this small example also provides a clear glimpse into some of the world’s supply chain issues. The stick factories in China have now been shut for three weeks, and it is “hoped” that they will re-open next Monday (a week later than planned). If so, sticks can be out the door in two days, but it will reportedly take two weeks to get them to the players. And that’s the optimistic case. In the meantime, I have three perfectly good Koho sticks (vintage 1979, like-new) that I am potentially willing to let go and contribute to the cause, in order to ensure the local squad makes the playoffs. Naturally, they can be had for a reasonable price in these dire circumstances—perhaps somewhat north of the said $300, given the demand/supply dynamics, you understand. (Disclaimer: In case it's not painfully obvious, this does not represent an actual offer, but instead a rare attempt at humour.) |