March 12, 2021 | 13:43
Modern Monetary Triumph
This week’s key event for the economic outlook was the passage of the $1.9 trillion U.S. fiscal support package, which arrived remarkably close to President Biden’s initial proposal. It may have been quite clear since the day the Democrats won control of the Senate in early January that the world had changed on the fiscal front, but few may have fully appreciated just how quickly and how completely that extreme makeover would unfold. Financial markets and economic forecasters have been building in the changed outlook steadily and surely in the past two months, but most only fully recognized the sheer scale when ink was put to paper this week.
With the massive fiscal package now law, we have accordingly further revised up our U.S. GDP growth call to a whopping 6.5% for this year (from 6.0%), and a follow-up sturdy 4.5% rise in 2022. Such a powerful, sustained advance hasn’t been seen since the Reagan boom in the mid-1980s, another period marked by heavy-duty fiscal stimulus after a deep recession. (In that case, it was tax cuts and defence spending.) And, lest you think that we are wild-eyed optimists, this new forecast is only modestly above a rapidly changing consensus. In the past month alone, the average view on U.S. growth this year has vaulted a full percentage point (to 5.7%), and a towering 2 percentage points from six months ago (i.e., just prior to the election and the vaccines).
President Biden also set a goal for the U.S. to return to some semblance of normality by Independence Day, as the pace of vaccinations continues to gather speed. There has been some pushback on our upward revision to next year’s growth call in addition to the bump to 2021, given that the bulk of the stimulus will land in Q2 of this year. Two factors help explain the robust gains next year: 1) almost a third of the new spending doesn’t arrive until next year, and 2) almost half of 2021 will be still marked by some restrictions (well, outside of Texas), whereas we are assuming that 2022 will be a nearly normal year for U.S. activity.
Financial markets generally welcomed the final fiscal package. Even with a retreat on Friday and a full-fledged correction in the Nasdaq, equities ended the week higher and the Dow drove through 32,000 to an all-time high. The TSX fared even better, managing a solid gain of more than 2% to a record high near 19,000 as cyclical stocks are now thriving. As well, the Canadian dollar rose 1.3% to above 80 cents(US), and moved broadly higher on the crosses. Toronto found support from oil prices holding around $66, while financials are benefitting from the improved growth outlook and a steepening yield curve. And that curve did take yet another step higher in a topsy-turvy week for bonds. The 10-year Treasury yield ended higher for the seventh consecutive week at above 1.6%, now up about 70 bps just since the start of the year. Canadian yields have powered up even more forcefully, up nearly 90 bps to a 14-month high. Thresholds fell like dominoes in the GoC market, with 30s driving above 2% and 5s above 1%.
One of the key factors lifting yields across the board is the meaty size of the U.S. fiscal effort, both through the growth channel and the bond supply channel. Curiously, most of the debate around the $1.9 trillion package was whether, at nearly 9% of GDP, it could potentially drive inflation higher, and less so on the burden it could put on future taxpayers through much higher government debt levels. In a sense then, this represents a victory by Modern Monetary Theory (MMT), which posits that the only real restraint on the fiscal position of a national borrower such as the U.S. is inflation. On cue, the one major U.S. economic release this week was February CPI, which revealed still-mild core inflation of just 1.3% y/y. While headline inflation ticked up to 1.7%, and is poised to jump in coming months, Fed Chair Powell has already deemed this as transitory.
The lingering question for Canada is how does the massive U.S. fiscal package change the policy outlook here? We learned this week that the Federal Budget, which has been MIA for more than a year, will be further pushed back well into April. It is likely the case that a major debate has developed in Ottawa on the appropriate degree of fiscal support. On the one side, the huge spending stateside provides cover for Canada to follow in line with aggressive spending of its own. However, we would argue that precisely the opposite message should be delivered. There are five major developments since the November Fiscal Update that would argue for a less aggressive fiscal program than the $70-to-$100 billion “jumpstart” the government looked for over the next three years. To wit:
On the final point, the one major economic report from Canada this week was Friday’s employment release for February, and it was a whopper. Completely erasing January’s setback, the 259,200 jobs surge cut the unemployment rate to its lowest since last March at 8.2%. Moreover, full-time jobs also advanced 88,200, and a big rise in hours worked (+1.4%) suggests that our recently revised call of 3.5% growth in Q1 GDP may still be light. In turn, our weighty call of 6% growth for all of 2021 may even prove to be a tad cautious. Not unlike the U.S. situation, the consensus call on the Canadian economy has also taken a huge step higher in the past month alone, with the average forecast now looking for 5.5% growth this year (4.6% a month ago) and 3.8% next year. Given the powerful rebound in February jobs, look for further upward revisions ahead for the consensus.
The only question for financial markets on this front is the extent to which the Bank of Canada shifts its view in the next month. This week’s Statement readily recognized the surprising strength in activity at the start of 2021, preparing the way for a big-time upward revision in April’s MPR from the modest 4.0% growth expected in January. The Bank played down the better GDP recovery by pointing to much greater slack in labour markets… but then the February jobs jump promptly washed away some of that story. After all, if the economy can produce just a few more monthly gains like February, it won’t take long to reverse the missing 600,000 jobs. We still expect the Bank to be extraordinarily patient before raising rates; markets are much less patient, and continue to build in a series of rate hikes starting in mid-2022.