July 23, 2021 | 13:00
What, Me Worry… about Growth?
The past 16 months have been discombobulating for investors, analysts, and policymakers alike, and this week ranks high on the discombobulation scale. In an otherwise quiet stretch for key economic events and data, markets ventured forth from first fretting deeply about growth due to the Delta variant, to then largely brushing off those concerns. Had one—sensibly—taken the midsummer week off, one would be forgiven for wondering what all the fuss was about, given that the net result was a round trip to nowhere for almost all markets. After plunging more than 15 bps to below 1.15%, 10-year Treasuries were back to around 1.3% by Friday, basically unchanged. Similarly, stocks were headed for a decent weekly gain (and a new high for the S&P 500 and Nasdaq) after a big setback on Monday, with oil almost pulling the same trick. The Canadian dollar, which has never met a market rollercoaster it didn’t want to ride, plunged almost 2% on Monday to nearly 78 cents (or $1.28/US$)—wiping out its gains for 2021—but climbed back to finish the week a tad stronger on net above 79.5 cents.
Monday’s tempest passed quickly, but the key point is that the market focus has shifted from an inflation scare to a (brief) growth scare. But even at the low this week, the S&P 500 was down less than 3% from its prior high, so the “scare” is mostly being expressed in deeply negative real bond yields. For example, the real 10-year Treasury yield is back below -1%, close to the all-time lows it has hit a few times during the pandemic and compared with being just above the zero line at the start of 2020. Meantime, inflation compensation has been peeling off in recent weeks even as the actual CPI has popped above 5% y/y, with the 10-year implied rate dipping 25 bps from the mid-May peak to just below 2.3%. Even the “purer” 5-year forward inflation rate has dipped to around 2.1% from a high of nearly 2.4% just two months ago. The takeaway is that the bond market rally in recent weeks has taken a dimmer view on both the medium-term growth and inflation outlook.
We are certainly on board with the milder growth outlook. As detailed in this week’s Focus Feature, the confluence of a fourth virus wave and ongoing supply chain issues has prompted a shave in our growth calls. Most notably, U.S. GDP was clipped 3 ticks to a (still hearty) 6.5% for 2021, taking us a snick below consensus—unfamiliar territory. While that’s not quite enough to move the needle on the global growth estimate of 6.0%, it moves the second decimal place from just above that mark to just below. And the risks are tilting lower as the restrictions build in a variety of Pacific Rim economies.
We are much less on board with the milder inflation outlook now imbedded in market pricing. Yes, lumber prices have been chopped from the extremes, while oil and copper are down from the highs. But natural gas prices have quietly pushed above US$4/mmbtu, doubling from a year ago, while cattle, cotton and coffee prices have also perked up to multi-year highs. Combined, major commodity price indices are barely off their recent highs, with ex-energy measures higher than at any time prior to the past year. Meantime, home prices just keep marching higher almost across the board, even as sales have cooled from the superheated levels earlier this year. The median home price for U.S. existing sales was up 23% y/y in June, the fastest pace in more than 50 years of data, and well above the 2005 bubble peak of 17%. The huge gains in home prices will gradually begin to weigh more heavily into the official U.S. inflation statistics in coming months, posing a more persistent, or less transitory, risk than the spikes seen so far.
Canada’s housing market takes a backseat to no one, with quality-adjusted home prices still rising quickly and up more than 24% y/y last month. This, too, will make more of a mark on official inflation measures. In fact, StatsCan revealed this week upcoming revisions to the CPI basket which will crank up the housing weight, with a much bigger emphasis on real estate commissions (which ebb and flow with home prices… mostly flow). In turn, these prices are tightly correlated with the “house only” portion of the new home price index, which has shot up almost 14% y/y, the fastest since 1987.
Even so, we actually look for the headline inflation rate to take a small step back in next week’s June report to just above 3%—but this will be due to a reverse base effect, as the seasonally adjusted CPI had its biggest monthly rise in 15 years last June on a brief rebound in prices. Looking further out, we are notably above consensus in expecting headline inflation to average close to 3% both this year and next, while core inflation will stay sticky at around 2.5%. Bringing it back to the whipsaw market action this week, at least some concern on the growth front is certainly warranted by the unnerving jump in virus cases in many regions, even if the market has apparently brushed off such concerns. But while not wanting to be seen as inflationistas, our view is that inflation concerns should still loom large.
One truly discombobulating development for Canadian markets was that just as things are finally reopening on the home front among much lower virus cases and strong vaccination rates, markets are fretting about new restrictions in much of the rest of the world as case counts rise rapidly elsewhere. And, naturally, Canadian markets get taken for the global ride, and not by domestic conditions. So, just as Canada could finally look forward to some serious economic gains—and the June flash estimate of a 4.4% pop in retail sales and a 1.9% rise in manufacturing sales point that way—the loonie, TSX, and GoC yields were roiled by global growth concerns.
Yet despite this week’s market tremors, as well as the U.S. forecast shave, the outlook for Canada remains solid for the second half of the year and into 2022. Amid the raft of key events next week, including the FOMC meeting, U.S. Q2 GDP, Canadian CPI, keep an eye on Canada’s monthly GDP release on Friday; it will likely confirm a second straight month of decline for May, but also point to a solid rebound in June. That should mark the beginning of a run of solid gains as the economy steadily reopens, supporting roughly 6% growth through the second half.