Overview

This week’s note revisits the Russia-Ukraine war, assessing alternate scenarios, the economic implications, the extent of Russia's allies and the additional headwind this presents to globalization. The report also runs through recent economic developments, emphasizes how important it is that goods spending transforms into services spending, and highlights some supply chain improvements. We also touch on central banks, declining societal trust and the latest COVID wave.

War in Ukraine

The war in Ukraine continues. Russia has now significantly shifted its focus and military resources toward east and south Ukraine. However, many of the Russian battalions that withdrew from northern Ukraine were so badly damaged that they won’t be in a position to re-deploy for some time. Russia is reportedly seeking to mobilize 60,000 reservists to fortify its forces.

Ukrainian forces have lately limited Russia’s advances in the east and south, though the city of Mariupol has largely been destroyed. Ukraine is endeavoring to retake the one regional capital held by Russia – the southern city of Kherson.

Alternate scenarios

The most likely scenario remains that the war continues at approximately the current intensity. However, other scenarios remain.

Escalation?

With Russia’s hands full disputing just a fraction of Ukraine, it is unlikely that the war metastasizes back to all of Ukraine let alone to other parts of Eastern Europe. Instead, the great worry about an escalation has more to do with whether Russia might deploy chemical weapons or even tactical nuclear weapons. 

The risk of the former is considerably greater than the latter. Large-scale chemical weapons were deployed by Syria in 2013, and have been used on a number of occasions since the last (and only) deployment of nuclear weapons at the end of World War II. Russia used its veto to shield Syria from punishment at the United Nations (UN) over the country’s chemical weapon usage. 

Furthermore, Russia has itself used chemical weapons on a small scale in recent years in attempts to kill various political opponents – demonstrating both its possession of such weapons and its willingness to use them. In the last month, members of a negotiating party seeking a ceasefire between Russia and Ukraine were also poisoned, though it is not clear by whom.

It is considerably less likely that Russia would use tactical nuclear weapons. However, it is notable that Russia’s doctrine for nuclear warfare changed in 2020, permitting it to use nuclear weapons not just in response to a nuclear attack, but also in response to any threat to the territorial integrity of Russia. This would theoretically include the loss of Crimea, which both Russia and Ukraine claim. It could also possibly include parts of Ukraine’s two eastern provinces. 

But the probability is surely extremely low that nuclear weapons are actually used. The risk that chemical weapons are used is still well short of 50%.

De-escalation?

It is also possible that the war de-escalates from here. We may see a cease-fire, for example. However, this prospect has diminished in recent weeks – even though Ukrainian President Zelensky has reiterated that Ukraine no longer aspires to join NATO and U.S. President Biden walked back his comment that Russian President Putin has to be removed from office.

There are several reasons why a cease-fire may be difficult to achieve in the near-term:

• For Ukraine to deliver military neutrality as Russia insists would require a country-wide referendum. This process might take a year to achieve, with an uncertain outcome.
• Ukraine says it needs credible military guarantees for its future protection. However, the west has been shy to make formal commitments that might draw its forces into a future war with Russia.
• Ukraine might be willing to accept the permanent loss of Crimea, but not of the Donbas region. Conversely, Russia is unlikely to want to give up the portion of the Donbas region its proxies have now controlled for eight years.
• Russia’s participation in negotiations may just be a play for more time to achieve its military objectives.
• Russia claims that its military shift away from Kyiv was an effort to increase “mutual trust,” but in reality it is more a reflection of what is attainable for Russia’s military.
• Russia may be less willing to agree to a peace deal after Ukrainian forces initiated a raid to damage an oil depot in Russian territory.
• Ukraine may be less likely to agree to a cease-fire because it has been successful in pushing Russia back in some locations, and because Russia’s economy will progressively weaken the longer sanctions are in place.
• The poisoning of several parties participating in peace talks is not a promising omen for negotiations.
• Russia has now been accused of committing atrocities in Ukraine – not a development that helps negotiations.

Reflecting all of this, betting markets have significantly downgraded the likelihood of a cease-fire, to just 17% by June 1 and to 56% by December 1. The latter number was 73% just a few weeks ago.

More sanctions

Additional sanctions – albeit relatively small compared to the original wave – appear on their way in response to reports of Russian atrocities in Ukraine. These include: 

• more sanctions on wealthy politically connected Russians
• stricter enforcement of existing sanctions
• the addition of four more Russian banks to the European Union’s (EU) restricted list
• a possible closure of European ports to Russian ships. 

EU leaders are also meeting this week to determine whether to ban coal and oil imports from Russia outright. If oil were banned, it would likely be a phased-in approach. The U.S. has suggested it will try to recruit more countries to implement their own Russian sanctions.

Corporations also continue to exit from Russia. Maersk – one of the world’s great container shipping companies – is stopping all shipments to Russia. Other companies that recently left Russia include Ikea, H&M, Toyota, Honda, Mercedes-Benz and Volkswagen.

Commodities

Commodity prices have settled down somewhat. Oil and gas prices are not as extreme as they were a month ago, though they remain elevated (see next chart). It is the same for several metals. But the final word has not yet been written on these subjects. 

Germany NCGI Natural Gas Index

As of 04/08/2022. Source: Intercontinental Exchange (ICE), RBC GAM, Macrobond

Natural gas

In particular, there remains considerable risk around European natural gas prices. 

Arguing that prices could fall further, the supply of Russian natural gas has not actually been impeded. Russia continues to supply it and Europe continues to import it – a bit more eagerly than usual, if anything, as it seeks to plump its inventories. As such the entirety of the natural gas price increase represents a risk premium rather than an actual supply shortage. 

However, Europe continues to scramble to find other supplies of natural gas. Given that the natural gas market is highly regionalized, this means that any extra supply Europe procures will result in a difficult-to-remedy shortfall elsewhere in the world. So the potential for significant mismatches continues to exist on this front. 

Further, Russia still cannot be fully trusted in its supply of natural gas. There is the possibility that it arbitrarily halts its exports. In addition, it has now insisted that foreign buyers pay for their gas in rubles. Europe is so far refusing to do so. Payment is due by early May, with supply potentially impeded if the condition is not met.

Meanwhile the pivot back to long-scorned nuclear power continues. Of no help in the short run, this is highly telling about the expected energy mix over the long run. In addition to China and France’s embrace of the energy source, four Canadian provinces have now announced plans for a new breed of small nuclear reactors.

Oil

We continue to assume that the global oil market has lost a net two million barrels of supply per day due to reluctance to consume Russian oil. There is a chance it might not be as bad as this, for several reasons. 

• The U.S. recently announced the release of an extra one million barrels per day of oil from its strategic petroleum reserve over the coming six months. 
• A variety of producers are also trying to increase supply (from U.S. shale oil, Canada and some others) or being asked to (Saudi Arabia, United Arab Emirates, and possibly Venezuela and/or Iran). The Organization of Petroleum Exporting Countries (OPEC) has declined to help so far. 
• Some countries are also taking advantage of the cheapness of unpopular Russian oil and buying more of it, including India.

Conversely, the International Energy Agency recently estimated that the war will result in the loss of more than three million barrels of oil per day. And, as mentioned earlier, Europe could yet join a handful of other countries in outright banning Russian oil.

The oil supply-demand mismatch is arguably consistent with oil prices in the $100—150 per barrel range, meaning current prices are at the low end of that range. Even without the war, the oil market had shifted from a glut to a position of somewhat tight capacity (see next chart).

Global crude inventory levels have fallen below historical average

As of Feb 2022. Global oil inventory reflects OECD commercial crude stock and consumption. Historical average since 1997. Source: U.S. Energy Information Administration (EIA), RBC GAM

Economic considerations

The World Bank recently estimated that the Ukrainian economy will decline by 45% in 2022. This is roughly in line with the Ukrainian central bank’s estimate of a 50% drop.

In Russia, the World Bank forecasts an 11.2% GDP decline in 2022. This is slightly worse than the consensus and in the realm of our own -10% forecast. Tempering the amount of economic damage, the Russian central bank has cut its policy rate from 20% to 17%, after having increased it from 10% at the beginning of the war to defend the currency and maintain domestic savings.

Nevertheless, Russian economic damage should be quite large – the country’s auto, aviation and appliance sectors all rely on imported equipment that is no longer available. The Russian government has also pre-emptively closed access to the likes of Facebook and Twitter, and is threatening to block YouTube. Professionals are reportedly fleeing the country, representing a colossal brain drain for Russia.

The Organization for Economic Co-operation and Development (OECD) recently estimated that global growth will be 1 percentage point less than otherwise as a result of the war. This is in contrast to a 0.5% paring of growth assumed by the private sector (and a very similar cut in our own forecasts). Of course, much depends on where commodity prices eventually settle and how long sanctions last.

Russia's allies

Contrary to the idea that Russia is a pariah state or that it has only a few lukewarm friends, Russia has more partners than commonly imagined. These span Europe, Asia, Africa, the Middle East, South America and North America (see next chart). 

If one identifies Russian allies as those countries that refused to demand an end to Russian military operations in Ukraine in a March 2 UN vote, 48 out of 195 countries can today be described as being a part of this group. Collectively, these nations generate 27.7% of the world’s gross domestic product (GDP). They include India, Pakistan, Bangladesh, Vietnam, South Africa and Iraq, though China represents the lion’s share.

Russian-aligned countries account for $26.3 trillion, or 27.7% of global GDP

As of 04/07/2022. Shaded area represents countries that voted against, abstained from, or were absent for the UN vote on the Russia-Ukraine war. Source: Trading Economics, Wikipedia, mapchart.net, RBC GAM

These countries are collectively responsible for 39% of the world’s oil production, and 24% of its wheat and copper production.

As an interesting aside, Russia's group of allies is not a warmed over version of the old Warsaw Pact that acted as a pro-Russian opponent to NATO during the Cold War. In fact, none of the old Warsaw Pact members are of this group today. Those countries are, if anything, some of the most vocal opponents of Russia today. 

Far fewer countries support Russian in the UN today than in 2014 during the Crimean invasion. At that time, a remarkable 93 countries declined to vote against Russia. It is unclear whether this is due to Russia’s more egregious conduct this time, or to a loss of Russian clout over the intervening years.

It is possible that Russia could now gain greater influence over the world’s poorest nations. As western developed nations shun Russian resources and instead pay top dollar for supplies from elsewhere in the world, they force poor nations into the arms of Russia if those countries are to secure sufficient supplies of now-scarce materials.

Globalization headwind

This Russian war deepens a pre-existing geopolitical fracture in the world, with negative implications for globalization. Factions of countries are forming in a way that has not been so apparent since the heart of the Cold War. It is particularly concerning that the likes of India and China find themselves tentatively on the other side of the divide from the U.S. and most developed nations.

Globalization was already decelerating before this latest negative impulse struck (see next chart). While international trade had once grown more than twice as quickly as the global economy, this outperformance has steadily waned over the past two decades, to the point that international trade now grows (on a percent basis) at approximately the same clip as the global economy. That means globalization is only holding steady as opposed to advancing.

Trade growth has been decelerating compared to GDP growth since the turn of the century

Ratio of 5-year growth of real export of goods and services to that of real GDP. Ratio for 2021 based on OECD forecast. Shaded area represents U.S. recession. Source: OECD, Haver Analytics, RBC GAM

What made globalization decelerate over the past two decades? There are a variety of forces. 

• Tariffs were long ago driven to fairly low levels. This means that there hasn’t been the opportunity for big new trade deals to encourage further integration. 
• The world has become more homogenous over the past several decades. Wage differentials and productivity differentials have diminished to the point that gains from trade are somewhat reduced. 
• The steady march of automation further reduces the importance of labour cost differentials. 

China – a big engine of growth and globalization – has itself slowed and its competitive advantage over the developed world has diminished. Then, as tensions with China grew during the Trump administration (see next chart) and as supply chain problems mounted during the pandemic, companies began to think beyond simply which location provided the lowest costs and the most reliable production under normal conditions. The focus has shifted to having more resilient supply chains and ensuring critical materials and technologies are always available. 

This is not to say that existing factories are being abandoned, but rather that new capacity is often being located outside of the traditional locations. Some of this change involves on-shoring back to home markets, but most involves finding other friendly nations – often less advanced than China – and expanding production in them. This part is not a retreat in globalization at all.

Americans have soured on China

Note: Don’t know/Refused results are not included. Source: Pew Research Center, RBC GAM

So the changes to globalization were already substantially advanced when the war in Ukraine came along. The war undeniably makes this worse, in the short run as Russia is unable to trade as much, and in the longer run as factions of countries form. 

It is mildly concerning that several of the popular new production hubs for companies moving away from China have seemingly also sided with Russia, including India, Bangladesh and Vietnam. But many others have not, and the situation is not black and white. Most of Russia's allies aspire to be on good relations with both the U.S. and Russia (and China), not just one. As an example, India now appears to be willing to pen new trade deals with a variety of pro-U.S. countries after dragging its heels for the better part of a decade over negotiations with Australia, Canada and the EU.

Further, and counter to the idea that all aspects of global trade must now dry up, some international institutions are now thriving as a result of the Russia-Ukraine war. NATO has enjoyed a renewed purpose, and Finland may now be a matter of weeks away from joining NATO – an unfathomable idea just a few months ago. The EU is also experiencing greater demand for membership, and a greater willingness among members to expand the scope of the organization. Western allies are also seeking to integrate more deeply, including a recent U.S.-EU deal on digital data and ongoing trade negotiations between the UK and U.S., and the UK and Canada.

The bottom line is that globalization had already all but ceased to advance before this war began. The war in Ukraine now looks set to keep it at an idle or even put it into a slight reverse. But a major collapse is unlikely. There are still strong incentives for companies to secure products at a competitive price. Also, significant trade barriers have only been erected around Russia, not Russia plus its allies. In turn, global economic growth may be a hair slower and global inflation may be a bit higher than otherwise on a structural basis.

And let us not exaggerate the extent to which inflation was depressed by globalization when it was advancing at full steam: most estimates figure inflation ran a few tenths of a percentage point per year less quickly than normal thanks to globalization – not multiple percentage points. And most of this benefit was already given up over the past decade. So any reversal of those forces should be fairly slight, albeit enough to argue that steady-state inflation might be a bit higher in the future than it was over the decade leading up to the pandemic.

Economic developments

Economic data remains quite mixed. A key real-time economic indicator for Canada’s business sector shows an enthusiastic rebound as pandemic restrictions have now been all but eliminated in the country (see next chart). While significant global headwinds now exist, Canada’s latest Business Outlook Survey argues that businesses are still quite keen to hire and invest. This is an important undercurrent of support for economic growth across quite a swath of the world right now.

Business conditions in Canada improved as COVID restrictions eased

As of 03/21/2022. Equal-weighted average of Business Conditions Index of Calgary, Edmonton, Montreal, Ottawa-Gatineau, Toronto, Vancouver and Winnipeg. Source: Statistics Canada, RBC GAM

Conversely, a real-time measure of activity in Germany now shows the sharpest drop since the earliest part of the pandemic. This is presumably in response to sanctions imposed on Russia (see next chart).

Deutsche Bundesbank Weekly Activity Index

As of the week ending 03/27/2022. Weekly Activity Index (WAI) estimates the trend-adjusted growth rate of economic activity by comparing the average over the past 13 weeks to the average of the preceding 13 weeks. Source: Deutsche Bundesbank, Macrobond, RBC GAM

In China, a measure of subway traffic has been low ever since the country began its battle against the Omicron and BA.2 virus variants. Subway traffic has fallen even further recently as Shanghai was locked down (see next chart). Most economic indicators are not nearly so distressing with regard to China. However, suffice it to say we continue to expect the Chinese economy to grow less quickly than the government’s targeted 5.5% pace for 2022.

Chinese subway traffic in major cities has dropped sharply

As of 04/10/2022. Index is the weighted 7-day rolling sum of subway trips in Beijing, Guangzhou, Nanjing, Shanghai, Suzho and Zhengzhou. Source: Chinese metro agencies, Macrobond, RBC GAM

Globally, purchasing manager indices continue to drift lower. This is consistent with the decelerating economic recovery theme (see next chart).

Global manufacturing expansion has slowed significantly

As of Mar 2022. PMI refers to Purchasing Managers’ Index for manufacturing sector, a measure for economic activity. Source: Haver Analytics, RBC GAM

In North America, employment indicators remained strong in March. The U.S. gained a large 431,000 new positions and the unemployment rate fell to just 3.6%, a mere tenth of a percentage point above the pre-pandemic low. In Canada, a strong 73,000 jobs were added in March. The unemployment rate fell to a remarkable 5.3%, its lowest reading since at least 1976.

While the level of U.S. employment remains modestly below its pre-pandemic rate, this may not last for long. In the short run, hiring remains sufficiently robust that it could take only a handful of months to return to the prior peak. As wages rise and fears abate, some of those who sat out the past two years may opt to return. Others may remain outside the workforce as they embrace different priorities. However, there are rising anecdotal reports of retirees now re-entering the workforce since their pensions do not go as far after recent price increases.

Over the long run, the pandemic is likely to increase the supply of labour beyond pre-pandemic norms, if anything. Virtual working allows for far greater geographic and time flexibility, permitting people to work who are currently in the wrong location and/or juggling other responsibilities.

Goods versus services

The root cause of most supply chain problems is that the demand for goods has been unusually strong across the pandemic. This is presumably in large part because many services were unavailable due to restrictions. 

It is also one of the key reasons for why inflation has been so high: goods prices have soared due to elevated demand, while service prices have not retreated to the same extent despite diminished demand. There is a downward rigidity in the price of services, in part because labour costs frequently make up a large fraction of the cost of a service, and wages are themselves resistant to declining.

As such, to resolve supply chain problems and thus high inflation, the demand for goods must ease, and ideally transition toward services. In theory, this seems like a reasonable expectation. People have already bought a lot of televisions and bicycles and computers, and should in theory return to a more normal level of goods consumption simply because they don’t need any more. There is even the risk that goods consumption could be artificially low for a period of time if everyone has already front-loaded their purchases. Simultaneously, it is now possible to eat in a restaurant and go on a vacation, and not unreasonable to think that there is considerable pent-up demand for such services.

In practice, it seems as though people are indeed consuming more services. Restaurant reservations have rebounded (see next chart). Air travel is nearly back to normal in the U.S. (see subsequent chart).

Restaurant reservations are rebounding 

As of 03/30/2022. 7-day moving average % change vs. 2019. Seated diners from online and phone reservations and walk-ins, based on a sample of restaurants on OpenTable. Source: OpenTable, RBC GAM

Air travel in U.S. is nearly back to normal

As of 03/30/2022. 7-day moving average change compared to same weekday of prior years. Source: Transportation Security Administration (TSA), Macrobond, RBC GAM

As such, it is a bit perplexing that inflation-adjusted spending on goods has only begun to decline slightly as a share of total spending. At the same time, inflation-adjusted spending on services has only begun to edge higher according to the official economic statistics (see next chart). Part of the story may be that people have not actually had their fill of goods. For example, it is still quite hard to get a car or an appliance. Thus a significant amount of pent-up demand for goods likely still exists for certain products. This is being converted into sales as those products become available.

U.S. consumer spending shift to goods from services should reverse

As of Feb 2022. Source: Macrobond, RBC GAM

Still, goods demand should ebb somewhat with time, helping to alleviate supply chain and inflation problems.

To the extent this transition continues to happen, it constitutes an obvious opportunity for services companies. It also represents a threat for goods-producing companies and for manufacturing powerhouses like China.

At the margin, could the demand for goods be structurally higher after the pandemic as some people opt to stick with the convenience of home gyms (necessitating the purchase of extensive equipment) rather than gym subscriptions, or increase their cooking at home (necessitating kitchen equipment) relative to restaurant dining? 

Yes, but much of that extra spending should already be done. And, if anything, the structural forces unrelated to the pandemic push more in the opposite direction as many goods transform into subscription services. For example, people are switching from CD purchases to music streaming subscriptions, from books to e-book and audio book subscriptions, and from cars to car sharing.

Supply chain improvements

Although resource supply chains have just been greatly complicated by sanctions on Russia, manufacturing supply chains are improving slightly. There are significantly fewer container ships waiting to unload in Southern California (see next chart). The cost of shipping containers has also fallen modestly (see subsequent chart).

Container ships at anchor or loitering around Port of Los Angeles & Long Beach

As of 04/05/2022. Source: American Shipper, Marine Exchange of Southern California, RBC GAM

Shipping costs retreating, although still high

As of the week ended 03/17/2022. Source: Drewry Supply Chain Advisors, RBC GAM

Costs associated with shipping via dry bulk have also fallen as has the cost of shipping freight by air. However, the port improvements are not universal. Unsurprisingly, China’s Shanghai port is now struggling to keep up with demand, and Shenzhen – which had been locked down before Shanghai – has experienced a 300% increase in trucking costs. Finally, over one million containers that would normally travel from China to Europe via Russia must now transit by sea, adding to the shipping pinch.

U.S. manufacturers are complaining a bit less about supplier deliveries (though not about inflation – see next chart). It is promising if highly imprecise to observe that the terms “supply chain”, “shortages”, “car shortage” and “chip shortage” all appear much less frequently in Google searches than last fall (see two subsequent charts). Of course, some of the decline may simply reflect the fact that these issues have become a part of life rather than fresh news.

U.S. manufacturers complained less about suppliers, but price increases ticked up

As of Mar 2022. Shaded area represents recession. Source: Institute for Supply Management (ISM), Haver Analytics, RBC GAM

Google News searches for “supply chain” and “shortages”

As of Apr 2022 (partial data used for the month). The number of Google worldwide news searches is scaled and normalized to arrive at the search interest over time. Source: Google Trends, RBC GAM

Google News searches for “chip shortage” and “car shortage”

As of Apr 2022 (partial data used for the month). The number of Google worldwide news searches is scaled and normalized to arrive at the search interest over time. Source: Google Trends, RBC GAM

An item to watch in the coming months is that dockworkers on the U.S. west coast are in a position to strike as of June 30. They will presumably ask for a significant jump in compensation given the extraordinary demand for their services, plus high inflation. In 2014 there was a lockout and a slowdown that resulted in a backlog that took six months to clear.

In a stroke of bad luck, 14% of the workers on the world’s commercial ships are either Russian or Ukrainian. Setting aside the acute tensions that no doubt exist on some of these ships, the Ukrainians in particular have been leaving in significant numbers to support Ukraine’s war effort. It has been difficult to rotate new Ukrainian crews onto ships.

Central bank tightening

The Bank of Canada appears on track to raise rates by a large 50 basis points (bps) this week, bringing the overnight rate to 1.00%. This is hard to argue against given the lowest unemployment rate plus highest inflation reading in several decades.

The next U.S. Federal Reserve decision is not until May 4, but is also anticipated to be a 50bps rate hike. The Fed is also indicating via its latest Minutes that it would begin selling bonds on that date, ramping up over a period of three months to a pace of $95 billion of sales per month. At that rate, the balance sheet should be back to a neutral position in around four years. Meanwhile, bond sales at that clip represent the equivalent of another 25bps of rate hikes per year.

Tighter monetary policy is already beginning to bite given that bond markets are forward-looking and have already priced in quite a number of rate hikes. Indeed, the U.S. 30-year mortgage rate has increased from just 3.05% at the end of 2021 to 4.72% now. That represents a 55% increase in debt-servicing costs in just over three months. The appetite for borrowing should accordingly dim. Canada’s housing market merits particular attention given its outsized run up in prices and high household debt levels. This may restrict how far the Bank of Canada opts to tighten relative to the U.S.

As we have noted in the past, the bulk of additional borrowing over the past few years has been from governments rather than the private sector. Given that the governments are not especially rate-sensitive in the short run, it isn’t strictly true to claim that interest rates cannot rise by much due to high indebtedness. 

However, the view that rate increases are potentially tricky beyond a fairly low level may still be valid, if for a different reason: economic actors simply aren’t used to borrowing costs that are very high. They may not be at risk of defaulting on their debt, but businesses and households have nevertheless made decisions for more than a decade on the basis of very low borrowing costs. Significantly higher rates would invalidate some of those decisions, creating economic pain.

Conversely, in the silver lining department, it is surely a good thing that the share of global bonds trading with a negative yield has shrunk from a high of nearly 30% to just around 5% today (see next chart). Negative rates were a nasty distortion best avoided wherever possible. Fixed income investors with a longer investment horizon than the duration of their bond portfolio should also be quite pleased.

Share of bonds with negative yields has dropped substantially

As of 04/07/2022. Percentage of bonds in Bloomberg Barclays Global Aggregate Bond Index trading at negative yields. Source: Bloomberg, RBC GAM

In sharp contrast to much of the rest of the world, Japan’s central bank remains committed to extremely loose monetary policy even as its inflation rate rises. The yen has accordingly weakened past 120 to the dollar for the first time since 2016. Interestingly, the central bank highlights the fact that, although nominal wages have increased, real wage growth is about as weak as it has ever been. The Bank of Japan flags the damage this could do to consumer spending. Of course this issue is far from unique to Japan right now, though it captures much less attention elsewhere.

Declining trust

As the U.S. political divide has broadened, it has had surprisingly little obvious ill effect on economic growth over the past several decades. But the possibility of economic damage in the future has to be acknowledged, either because societal trust diminishes to the point that commercial interactions become less smooth, because a disputed election or coup might spook markets and increase risk premiums, or simply because public policy drifts so far from the centre (in either direction) that it ceases to provide a good foundation for society and the economy.

There is no shortage of anecdotal evidence of societal problems in the U.S., from a large jump in the murder rate over the past year, to disputes around what should have been a straight-forward 2020 election outcome, to mounting accusations of bias in the press.

How real is this problem? The World Values Survey can help us answer this. First, U.S. public trust has indeed become more negative (see next chart). Relative to 1984, more Americans believed in 2020 that society must be radically changed, that people cannot be trusted, and that the press and government does not merit their confidence. It should be noted that such attitudes were not exactly optimistic in 1984, but they are worse now.

American political attitudes have become more negative

Source: World Values Survey, RBC GAM

This deterioration of public trust is not unique to the U.S. The same data for Canada shows a stylistically similar deterioration (see next chart). It would appear that some of the underlying forces behind this deterioration are universal, be it due to the fragmentation of the media, the rise of social networks, the anonymity of the internet, an increasingly diverse population, or some other aspect of modern society.

Canadian political attitudes have become more negative except for confidence in government

Source: World Values Survey, RBC GAM

The real question, then, is how the U.S. now compares to other nations (see next chart). On this front, and with the caveat that the “Average” reading includes a wide range of developing nations for whom concerns such as civil wars and corruption are very real, the U.S. does appear to be somewhat more troubled than most. It demonstrates less confidence in the press, in government and in political parties than Canada or than the average, and a greater belief that corruption is high. The U.S. shows less contentedness than Canada, in fact, in every category but one. 

Americans are less confident in their institutions than Canadians, but see less need for radical change

Source: World Values Survey 2020, RBC GAM

In a question that didn’t exist in 1984, the U.S. is significantly more worried about a civil war than are Canadians, though still not to the same extent as the average. Curiously, despite everything else, American respondents were less likely than both the average and Canadians to believe that their society must be radically changed. This may be due to the high esteem in which Americans hold their constitution and Founding Fathers.

For Canada, an interesting question is whether the country is fundamentally less troubled than the U.S., or instead – as seems more likely – is simply lagging the U.S. in political and attitudinal trends by a few decades.

The bottom line is that public attitudes have truly soured, and so the spectre of negative economic implications over the long run has mounted somewhat. But, so far, risk premiums have not at all increased and commercial interactions continue to proceed smoothly.

Unsynchronized COVID wave

The BA.2 wave of COVID-19 infections is proving less synchronized than many of the previous waves. The wave is already retreating across much of Europe (see next chart).

COVID-19 cases and deaths in France

As of 04/11/2022. 7-day moving average of daily new cases and new deaths. Source: World Health Organization (WHO), Macrobond, RBC GAM

Conversely, it is only starting to build in North America. The number of states with a rising infection count in the U.S. is surging (see next chart). So is the number of infections in Canada (see subsequent chart).

Number of U.S. states with transmission rate above key threshold of one

As of 04/08/2022. Transmission rate calculated as 7-day charge of underlying 5-day moving average of new daily cases, smoothed with 7-day moving average. Transmission rate above one suggests increasing new daily cases. Includes Washington, D.C. Source: Haver Analytics, Macrobond, RBC GAM

COVID-19 cases and positivity rates in Canada

As of 04/10/2022. 7-day moving average of daily new cases and test positivity rates. Source: Our World in Data, WHO, Macrobond, RBC GAM

Fortunately, the BA.2 wave in Europe was smaller than the Omicron wave, suggesting a similar outcome in other countries with similarly high vaccination rates and similar pandemic experiences to date. As a result, we continue to budget for a middling wave that peaks within the next month in North America, followed by a fairly swift decline and a low-infection summer.

China remains an exception. When asymptomatic cases are included, it is setting massive daily infection records (see next chart). We continue to think it will be hard for China to maintain its zero-tolerance policy against the extremely contagious BA.2 sub-variant. Other regions of China are reportedly complaining that Shanghai’s outbreak is spreading. More than 70 cities representing approximately 40% of China’s economic activity have now implemented some form of restriction in response to this COVID-19 wave.

COVID-19 cases and deaths in China

As of 04/10/2022. 7-day moving average of daily new cases and new deaths for mainland China. Asymptomatic cases are not included in official tally of confirmed cases. Source: John Hopkins University, Haver Analytics, RBC GAM

-With contributions from Vivien Lee, Andrew Maleki and Aaron Ma