Eric Lascelles, Chief Economist, shares his views on current macroeconomic trends.
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What is the outlook for the global economic recovery?
COVID-19 has induced the greatest economic decline in the better part of a century. We’ve seen many countries lose 10% to 20% of their economic output, albeit briefly.
And I suppose the good news since then is that a recovery is now well underway. In fact, it’s been underway since late April. Roughly half, if not more than half now, of the initial economic decline has been recovered in many countries, including we believe in the U.S. and Canada.
And so broadly speaking it’s been a good news story and many things have come back actually more quickly than initially imagined. But I have to say, as we look forward now into the fall and beyond, we are assuming something of a decelerating rate of recovery.
And part of that is we’ve already seen, for instance, the U.S. run into a second wave of the virus. And it seems now to be taming that, but that slowed the recovery there.
The eurozone is going through something very similar right now, and so we should be aware there’s always that risk of additional outbreaks, particularly as schools restart and as the weather grows both colder and drier.
But in the end, we look for a recovery at a slower rate. And the big reason is just that the easy gains have now been achieved. We’re no longer in a position in which multiple sectors are being reopened each week or each month. Most of the sectors have been opened to their limits, if not slightly beyond. And so at this point, further growth is going to have to come from rising productivity, cleverer ideas in terms of balancing the virus versus economic activity. And so it’s just a slower rate of growth.
And we’re aware as well, I think, that some lagged economic damage probably hasn’t yet manifested. And so for instance we see mortgage payments being deferred and these sorts of things in the credit space. And at some point that will have to land. And that will do a bit of damage as well.
And we’re also looking very closely at the fiscal side of things. And so governments have spent enormous sums of money and sent that out the door. And done very useful things for the most part, but we’re now in a position in which some of that fiscal support is starting to come off. Some will have to come off over the next year and beyond, just because deficits of this size are utterly unsustainable.
And that represents an economic drag. And it’s already starting in the U.S. The average unemployed American has lost a few hundred dollars per week of money already. It hasn’t happened as obviously elsewhere, but we will start to see these programs trickle off, and that induces a bit of a drag as well.
And so we’re in for an ongoing recovery at a slower rate. And then we’re looking very closely to when will there be a widespread available vaccine. And the betting markets we look at suggest mid-2021 as not a bad guess for that kind of outcome.
And so that would be the point at which economies can in theory completely normalize and perhaps life as well. However, keep in mind, economies don’t fully snap back to normal all at once. And so we’re budgeting for it to take another year. Really until the middle of 2022 until economies are as big as they were at the end of 2019. And plausibly not until the middle of 2023 until economies are fully back to their prior trajectory. And so there’s certainly still some work left to be done.
How will trade relations between the U.S. and China impact the economic recovery?
The global trading environment has been challenged for the better part of a decade as we’ve seen trade flows diminish and rising frictions emerge between countries. And of course the U.S. and China are the most obvious major superpowers at odds with one another.
And one way of thinking about this is really just to recognize that we’ve been operating in a hegemonic world for a very long time. The U.S. has been the undisputed sheriff in town and now there are two sheriffs. China is also a big global power and is trying to claim some share of influence.
And so this is creating frictions galore. And these frictions probably don’t go away anytime soon. And in fact they’re not even specific to any particular administration. That said, the last four years and the current White House have of course escalated tensions with China.
We’ve seen several rounds of tariffs come on. We’ve now seen sanctions applied to prominent politicians extending in both directions. A number of tech companies have been limited in their operations in one country or the other. And there have been also concerns expressed about changing Hong Kong laws.
And so for all of those reasons tensions are even higher over the last little while than before. And furthermore, COVID-19 has not been a helpful development. Not just in the sense that China is where the virus perhaps originated. But equally in the sense that global immigration, global flow of people has been practically halted altogether.
And there’s an even greater desire now to on shore supply chains and reduce reliance on other countries, regardless of who those other countries are. And so on a number of fronts, this trading environment is now quite a challenged one.
When we look forward, some of the outcome will depend on the U.S. election that is approaching. And one might imagine a slightly less contentious relationship were there to be a changed administration, though I would pushback against the idea that the world would return to normal as much as it was four years ago. This is an altered world and these frictions to our eye likely remain on several fronts. But, of course, it does again depend in part on the election.
In the end though, as we operate in this world of higher tariffs and more limited flow of people and so on, it does generally hurt economic growth a little bit. It also tends to increase inflation a little bit. Not to the extent that we’re seeing from COVID-19; that’s still very much the dominant economic force at work right now. But I would say some of these protectionist inclinations are a secondary consideration and at the margin exerting a drag as opposed to providing support.
What forces are behind the recent rally in gold prices and will it continue?
The price of gold has rallied quite noticeably over the span of the last six months, linked obviously to COVID-19, but it’s worth spending a moment just thinking about some of the underlying factors and considerations that are ultimately pushing the price of gold higher.
And the most obvious initial force was simply risk aversion. And so when risk aversion goes up, often investors flood to the perceived safety of gold. But what’s interesting about that is we don’t have investors right now in an overly risk averse positioning.
Investors in general have embraced things like stocks over the last six months, and so that argument in support of gold has arguably faded. That’s no longer a particularly compelling one. However, there are several other reasons why gold is nevertheless arguably justified in being fairly elevated compared to the historical norm.
And so one would simply be that inflation expectations are now starting to edge higher and even if you’re skeptical that inflation will be high, there’s a risk. The risk of high inflation is higher than usual. Whether it’s your base case or not.
And supporting that, of course, central banks have printed a lot of money. Public debt loads are now quite high. Central banks, the Fed in the U.S. at least, is now targeting an average inflation rate, instead of a specific number. And that might sound minor, but it does argue for more inflation over the next few years. And so those sorts of thoughts have created enthusiasm for gold, an asset that historically has fared well during higher inflation environments.
And then keep in mind as well, gold can serve as a substitute for bonds in some people’s portfolios. And so as bond yields have gotten ever lower, the coupon that one is missing by investing in gold has diminished.
And simultaneously we can say that were there to be a future recession or were there to be a future crisis, there are some questions whether bond yields could fall all that much further, given how close to zero they are. And so would they actually provide that hedge during a downturn? Whereas the thinking is that perhaps gold could fairly easily continue to rise. There’s no magic number that insists it can’t substantially exceed $2,000 in a crisis, as an example.
And maybe the last factor that has been supporting gold, is U.S.-dollar weakness. And so some of that is just mechanical as the U.S. dollar goes down. Foreigners aren’t paying any more for gold, it just looks more in U.S.-dollar terms. But also the idea that as the U.S. dollar has lost some of its lustre and maybe even lost a little bit of its reserve currency status, some argue that maybe gold could pick up a little bit of that reserve currency status.
I’m not sure I agree with all of those arguments, but I think several of them do hold. And so gold may continue to perform over the next little while. But let’s keep in mind, from a long-term perspective, as with almost all real assets, the real return tends to be fairly close to zero. It’s hard to get rich on gold over the long run. Though of course it can swing substantially in the short run, and it’s been a winning bet over the last several months at a minimum.
How might the U.S. election affect economic growth and the stock markets?
As we record this, the U.S. election is now rapidly approaching, and a hotly contested one. And at this point in time, it really is a referendum on the current president. That’s where the focus has been. Biden, the democratic candidate, has laid fairly low recognizing that’s how voters will largely respond.
And when we look at platforms, we can say that the Trump platform isn’t that different than what we’ve already seen. Perhaps a push for more tax cuts again, but not radical changes beyond the shifts that have occurred over the past four years.
And so when we talk about and compare policy platforms between the two candidates, really we’re talking about how Joe Biden and the democrats might look different than the status quo right now. And it’s a relevant question because current polling does have Biden out modestly in front and indeed suggests that the democrats could well sweep the House of Representatives and the Senate and the White House. It’s far from a done deal, both in the sense that there are several months left to go and also that opinions could yet change on a dime, but nevertheless, it makes the Biden platform quite important to look at.
And we can identify a real mix of economic drivers that emerge from that. On the economically negative side, we could say that the democrats would likely institute somewhat stricter rules around COVID-19. And that might be a short-term economic negative, limiting activity to some extent.
We’ve also seen quite prominent proposals to raise taxes. And so generally that’s not a growth enhancing move. And similarly, there have been some rumblings about additional regulation, most obviously in the energy sector but perhaps elsewhere as well, particularly to the extent that Trump has been noted for his deregulatory efforts.
And so those would be some of the economic negatives. However, arguably the economic positives might well outweigh those. And so when we look in particular to several things, we see that as much as tighter COVID rules might limit the economy in the short run, they might actually unleash it over the medium run, to the extent that fewer infections would allow the economy to behave more normally in six months or in a year’s time. So that one could rebound quite nicely.
We can say that as much as Biden proposes higher taxes, which is an economic drag, the overall fiscal package is actually quite powerful. And so you could argue the fiscal proposals would generate more of an economic boost from the Democrats than from the Republicans as currently envisioned. And recognizing there’d be more debt as a result also, which we’re not fully discussing here.
And then plausibly the trading environment could get somewhat better. Still frictions between the U.S. and China, but likely a return to more multinational negotiations and perhaps somewhat fewer tariffs. And then also we’ve seen the Democrats propose more immigration over time. And that’s one of the determinants of medium-term economic growth.
And so when we put all that together, we recognize that plausibly a Democrat victory could be modestly positive from a growth perspective over the coming year.
However, I would stop short of saying necessarily that financial markets will reach the same conclusion. Recognize that the stock market in particular really cares about the corporate tax rate. And so the idea that the Democrats would like to raise the corporate tax rate, probably makes Trump the preferred stock market outcome, if not necessarily the preferred economic outcome.
But again, much may yet change here. It depends enormously which way Congress goes as well. And of course politicians don’t always deliver on their platforms either.
What is your outlook for the Canadian housing market?
The Canadian housing market and indeed the global housing market, has been surprisingly strong so far through COVID-19. It really has been a revelation the strength that we’ve seen in home prices, and resales, and in activity more generally. It really hasn’t missed a beat, and if anything, it’s stronger than it was perhaps before COVID-19 came along. And so certainly a wonderful thing for those benefitting from a stronger housing market.
I will say however, there have been some shifts in terms of preferences as you might imagine. And so, for instance, low-density enjoying more of a boost than high-density housing. And so apartments and condos not quite as attractive or not rising in attractiveness to the extent that we’ve seen suburban and maybe rural living rising. And so that’s one twist and one differentiator across the housing market.
But I will say this: we still think there is a risk of somewhat softer housing over the coming year and beyond. And it’s hard to escape that conclusion just looking at the facts on the ground.
And so here we are in a world in which the unemployment rate is the highest it’s been in several decades. And so that’s a smaller pool of people capable of buying a home. And it’s also a pool of people perhaps more at risk of losing their home as well. And so that’s a challenge.
Immigration has ground virtually to a halt. And even with optimistic assumptions that it begins to restart in 2021 and beyond, that’s significantly less demand for housing. Let’s keep in mind the bulk of population growth in much of the developed world is immigration. Without that, you don’t actually need a whole lot of new houses, and that changes the supply demand dynamic quite significant.
And then the Canadian example, specifically of course, we went into this pandemic with high household debt levels. And we’ve seen Canadians defer their mortgage payments at about twice the rate as in the U.S. And so there is some vulnerability on the household debt side in particular.
And then a few other smaller thoughts, like as students often pursue university now virtually, fewer apartments needed by students. As people travel less, Airbnb and these sorts of secondary short-term uses for apartments and condos have diminished as well.
And so the bottom line is it makes sense to us that there should be somewhat softer demand out there for housing. I’m not convinced we can see the sorts of rapid gains that have dominated the first six months of the pandemic.
To be clear equally though, we’re not calling for any kind of crash. This is a story in which perhaps some of the enthusiasm has to slow over time. And we may see a little bit of pain a bit later.