July 09, 2021 | 13:13
Delta Dawns… on Markets
After largely putting the pandemic in the rearview mirror for much of this year, markets flashed a flicker of concern on that front to start the second half. A variety of unsettling upticks were reported in new virus cases across many jurisdictions, including Korea, Japan, some southern U.S. states, Spain, and Britain. While the upswing is not shocking, given some of the aggressive reopening schedules and the prevalence of the Delta variant, the U.K. surge was particularly notable given its high vaccination rates. Loaded on top was a drip, drip, drip of modestly disappointing global economic data in recent days, including sluggish Chinese PMIs, soft Euro Area factory production results, and a slight slip in the U.S. services ISM. All of this landed on a market that had already seen a steady bleed lower in bond yields in recent weeks, and seemingly triggered real doubts on the strength of the recovery—highlighted by 10-year yields touching 1.25% at one point.
Some order was restored by Friday, with China cutting its reserve requirements for banks, oil prices firming again, and yields bouncing off the lows. And while equities were staggered for all of one day, the bigger picture is that the S&P 500 was again testing record highs by Friday. Still, the net result was that 10-year yields did drop further for the seventh time in eight weeks and are off by more than 40 bps from the March high. And, despite some wild swings on the lack of an OPEC+ deal, WTI ended the week off slightly at around $74, while the Canadian dollar was barely hanging on to the 80-cent level after a 1.5% fall this week. And that latter move was despite the mild helping hand of a snappy 230,700 rebound in June jobs in Canada.
Given this week’s market and virus developments, and just before the onslaught of Q2 economic results start rolling in, it’s an ideal opportunity to review the global outlook. For most of the past year, we have been relentlessly—relentlessly, I say!—above consensus on the growth outlook for North America and for the world. That’s no longer the case. In part, that’s because the consensus has risen rapidly, and caught up to our mostly upbeat view. But, in part, it’s also due to some cooling in our unbridled optimism, as we have slightly trimmed both our Canadian and U.S. growth calls from earlier highs. In turn, that reflects the fact that supply constraints and bottlenecks have bit more deeply than anticipated, with the latest example the hit to rail traffic in Western Canada amid the B.C. wildfires. And, yes, it also reflects the reality that COVID-related restrictions have lasted longer in some cases than expected.
To be clear, it’s not as if we have taken an axe to our forecasts in recent months, more like nail scissors. We still expect GDP growth of 6.8% in the U.S. this year and 4.3% next, while we look for 6.0% and 4.5% in Canada, all of which are uninspiringly close to consensus at the moment. Ditto for the global economy, where we are projecting 6.0% growth this year and a still-solid 5.0% next, both well above a “normal” year of closer to 3.0%. With the possible exception of the U.S., all of these forecasts would still leave the level of output below its pre-pandemic trend even by the end of 2022, leaving room for some above-potential gains stretching into 2023—which may be how long it takes international travel to fully get back to normal-ish, especially for the “jab-nots”.
The biggest risk to this still-robust forecast would be new widespread restrictions related to another wave of the virus. Our projections do not make allowances for further lockdowns, and that appears to be the conventional wisdom. Perhaps the next most serious risk is for supply challenges to linger, or even deepen, which could both crimp growth and keep the burner on inflation pressures. Fundamentally, we believe the risks are reasonably manageable, and present only moderate downsides to our calls. On the restrictions, Canada offers a real-world example of an economy that has managed to claw out some growth even in the face of successive waves of partial shutdowns. And on the supply challenges, global evidence suggests they are a weight on growth, but not an anchor. On balance, we believe that the core view on the solid global recovery has not been altered by the emergence of the Delta variant or by the panoply of supply issues. But, those drags make us more comfortable being at, or even slightly below, consensus for the time being.
Perhaps an even bigger debate revolves around what happens after 2022, and whether the pandemic has wounded the medium-term outlook, or whether the response to it has actually improved longer-term growth prospects. Sal digs into that theme in more detail below but suffice it to say, we are highly skeptical that the global economy is on the cusp of a brave new world of growth. While it is possible that some productivity gains can be reaped from the wider adaption of a variety of new technologies, that may be offset by softer capital spending, as well as the possibility of lower labour force participation (e.g., early retirements, which the Fed mentioned in its latest MPR). Perhaps the biggest takeaway from the recent deep dive in long-term bond yields, including the persistence of deeply negative real yields, is that markets are certainly not pricing in a sustained economic boom. Yes, the flood of liquidity from QE is no doubt suppressing yields, but that was also the case a decade ago and real rates have taken another big step down.
In a relatively light week for major economic data releases, the Canadian jobs report loomed large. For a change, the result was close to expectations with a sturdy 230,700 employment gain and a four-tick fade in the jobless rate to 7.8%. One big quibble with the result was that total hours worked actually dipped 0.2% in the month, with all the new jobs in part-time positions. For all of Q2, hours worked sagged at a 3.8% annual rate after three consecutive double-digit quarterly gains. A solid productivity bounce is expected to lift overall GDP into the green for Q2, but the BoC’s 3.5% estimate still looks a tad optimistic.
That detail aside, the bigger point is the ability of the Canadian job market to recover quickly when restrictions are eased even a touch. The contrast on that front with the U.S. job market is remarkable, with Canada’s job tallies almost like a light switch that gets turned on and off from month to month. As an example, the range of percent gains or losses in jobs in Canada’s job market has been from -1.2% to +1.6% since last October, while the U.S. household survey range is just -0.01% to +0.4%, and payrolls just a bit wider at -0.2% to +0.6%. Some of that reflects inherent volatility in Canada’s survey, but the U.S. household measure is nearly as whippy. Looking ahead, this much more forceful response by Canadian employment to changes in restrictions suggests that the domestic job market is likely to return to something akin to normal much more quickly than its U.S. counterpart.