Overview

This week’s note covers the usual COVID-19 infection and vaccine terrain, then celebrates further economic strength, revisits spiking inflation, provides a brief central bank update and then concludes with thoughts on faster productivity growth ahead.

Recent developments continue to skew more positive than negative.

Key positives include:

• The third wave now appears to be shrinking in most developed countries.
• Vaccinations continue to zip along.
• Economic data remains quite strong and is mostly accelerating.
• We posit that productivity growth over the next decade may be faster than it was over the past decade.

Conversely, negatives include:

• The third wave remains quite problematic in many emerging market economies, most prominently in India.
• Some central banks are beginning to scale back their monetary stimulus, with Canada a prominent example.
• Inflation is rising significantly, although this was widely anticipated and is partially temporary.
• The consensus growth outlook is rising to the point that we are no longer materially above consensus. In turn, there may be less room for outsized market returns now that so much good news is priced in.

Virus numbers

The third wave remains quite serious, though it is trending in different directions depending on the country. Loosely, emerging market nations continue to suffer a deteriorating trend while developed nations are now beginning to improve (see next chart).

COVID-19 emerging market and developed market infections

As of 04/25/2021. Calculated as the 7-day moving average of daily infections. Source: WHO, Macrobond, RBC GAM

India remains among the most concerning nations, with spiking infection and fatality figures (see next chart). It is now recording more new cases per day than any country has since the onset of the pandemic.

COVID-19 cases and deaths in India

As of 04/25/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

While India is most certainly faring poorly, its enormous population means that it is not actually recording the most new cases on a per capita basis (see next table). Turkey is actually in the lead, followed by a trio of Latin American nations. Of course, it is the interplay between infections per capita and the transmission rate that really matters. A high number of infections per day is tolerable so long as the rate is declining, as it is in Turkey. However, India’s transmission rate of 1.49 is much too high – well above the 1.0 threshold that separates a rising from a falling caseload.

COVID-19 transmission analysis in emerging market countries

As of 04/25/2021. Transmission rate calculated as 7-day change (presented as a ratio) of 5-day moving average of daily new cases. Source: WHO, Macrobond, RBC GAM

Developed nations improve

Most developed countries are now recording declining infection rates once again. This appears to be the result of:

• Stricter social distancing rules over the past two months.
• Further distance from Easter, when holiday socializing likely accelerated the rate of infection, much as happened at Christmas.
• Warming weather as summer approaches.
• Incrementally rising vaccinations (this is the most important and enduring factor over the medium run, but has not advanced enough over the past two weeks to explain the pivot from spiking infections to falling infections all by itself).

After briefly edging higher, U.S. daily infections are back to falling again (see next chart). The country never suffered the recent spike in cases recorded in many other countries, presumably because the U.S. is so far along in the vaccination process. Whereas the great majority of states were recording rising infection figures just two weeks ago, the number has now plummeted to fewer than 10 (see subsequent chart).

COVID-19 cases and deaths in the U.S.

As of 04/25/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

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

As of 04/25/2021. Transmission rate calculated as 7-day change 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

In Canada, the infection numbers are also beginning to improve, albeit only slightly and from a record high (see next chart). It makes sense for the fatality numbers to continue rising for another several weeks given the classic one-month lag between new cases and new deaths. Quebec and British Columbia are definitely improving, Ontario is likely improving, and it is possible that Alberta is now starting to turn. Conversely, Manitoba is suffering a rising infection rate.

COVID-19 cases and deaths in Canada

As of 04/25/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Illustrating the sudden turn in Canada’s COVID-19 trend, the rate of variant growth has collapsed from +190% per week two weeks ago to +101% per week last week, to just +2% per week in the latest week. This will presumably turn negative with the next reading (see next chart).

Variant growth rate in Canada

As of 04/23/2021. Week-over-week growth in total new variant cases. Source: Government of Canada, RBC GAM

Canada’s recent improvement is likely centrally driven by tighter rules in parts of the country, including Ontario and Quebec (see next chart).

COVID restrictions tightened in Ontario and Quebec

As of 04/14/2021. Atlantic region includes New Brunswick, Newfoundland and Labrador, Nova Scotia and Prince Edward island; Prairies region includes Alberta, Manitoba and Saskatchewan. Source: Bank of Canada, RBC GAM

Most of the variants have similar properties from a transmission perspective: they spread more easily than the original form of the virus. Yet it is still worth tracking the specific trajectory of different variants (see next table). In North America, the British variant is easily the dominant strain, representing 96% of all new variant cases. The South African strain, in contrast, is minimally present, representing no more than 1% of the total and – according to the latest figures – in outright decline in Canada.

However, the Brazilian variant occupies a somewhat larger share of the total (3—4%) and is problematic in two other ways.

1. It is expanding ferociously: by 5,150% over the past four weeks in the U.S. versus “just” +585% for the British variant.
2. It is less well understood and possibly more pernicious than the British variant, with reports of diminished vaccine effectiveness and a greater ability to re-infect those previously ill with the original virus.

COVID variants in North America

As of 04/23/2021. Source: CDC, Government of Canada, RBC GAM

A worst-case scenario would be if a vaccine-eluding variant takes over and significantly undermines the progress made toward herd immunity. It is unlikely that the Brazilian variant will do this. New cases in Brazil are actually declining at present. But it is not impossible, and there appear to be new variants somewhere in the world practically every week. The focus is now on India, where new variants are being detected due to the presence of so many infected people.

Prematurely easing rules

Elsewhere in the developed world, many European countries continue their cautious improvement. However, we are nervous that some of these countries – most obviously, Italy – may be reopening too quickly and too enthusiastically (see next chart). Japan continues to report rising infection rates and has now announced further restrictions.

Severity of lockdown varies by country

Based on latest data available as of 04/21/2021. Deviation from baseline, normalised to U.S. and smoothed with a 7-day moving average. Source: Google, University of Oxford, Macrobond, RBC GAM

Our global stringency metric is beginning to decline. This is likely sustainable to the extent it emanates from well-positioned countries like the U.S. and U.K. However, easing regulations is premature in many parts of the world where the infection rate is still high (see next chart). Much depends on the extent to which warmer weather can counterbalance easier rules.

Global Stringency Index

As of 04/25/2021. Global Stringency Index measuring the strictness of lockdown policies that restrict mobility, calculated as stringency index of 50 largest economies. Sources: University of Oxford, International Monetary Fund, Macrobond, RBC GAM

Social interaction versus immune population

One can calculate the amount of social distancing needed to control COVID-19 given the fraction of the population that is immune (see next chart). We assume that the transmission rate of the COVID-19 variants that now dominate is around 3.5.

Legend:

• Blue line depicts the point at which the number of infections per day should be steady. Operating below the blue line should result in a declining number of infections, while operating above it should result in rising cases.
• Red dots depict our estimate of the current positioning of each country.
• Green dots show where we expect them to be in three months.

Reduction in social interaction necessary to control virus at different rates of population immunity

As at 04/23/2021. Source: Macrobond, RBC GAM

We assume, as an example, that around 35% of Canadians are now immune to the virus. That is the combination of people who have achieved protection via infection and via vaccines. Keep in mind:

• Some people who were infected naturally have since lost their immunity.
• Some people who have been vaccinated already possessed natural immunity.
• Vaccine efficacy is below 100%.

As such, this is an estimate as opposed to a pinpoint figure. At this level of immunity, Canada needs to keep its level of social interaction nearly 60% below normal. By July, Canada’s social interaction will only have to be limited by approximately 30% – half as much as today.

We figure the U.S. is already above 50% immunity, and so it only needs to limit its social interaction by around 40%. By July, the U.S. should be at nearly 70% protection. This means that the country’s social interactions will only have to be limited by 10% then – a quarter as much as today.

How do we reconcile minimal official U.S. restrictions today with the idea that the country is apparently still reducing its level of social interaction by around 40% versus normal (a necessary condition given that U.S. infection figures are falling slightly)? We assume that voluntary social distancing at the individual and corporate level, including ongoing use of masks, is proving sufficient to achieve the 40% reduction.

Vaccinations roll along

More than one billion vaccine shots have now been administered globally. Israel remains the leader with 120 shots per 100 people. The U.S. and U.K. are the leaders among large nations at 68 shots per 100 people. The U.S. has now (barely) passed the U.K. (see next table).

COVID-19 global vaccine ranking

As of 04/25/2021. Cumulative total doses administered by country per 100 people. Source: Our World in Data, Macrobond, RBC GAM

Canada continues to race up the vaccination table, with 10.7 new doses per 100 people over the last two weeks alone. The country is now surpassing EU nations and inoculating at a rate that now outpaces the U.K. and nearly matches the U.S. (see next chart). To illustrate the extent of the acceleration, more than one-third of Canada’s vaccinations have occurred over the past two weeks.

Coronavirus vaccine daily doses administered

As of 04/25/2021. 7-day moving average number of new daily coronavirus vaccine doses administered per million. Source: Our World in Data, Macrobond, RBC GAM

The countries furthest along in their vaccination campaigns have enjoyed spectacular success controlling the pandemic. In the U.K., daily new cases are now down by 96% from their peak and fatalities have fallen by 98%. In Israel, cases have declined by 98% and deaths by 97% (see next chart).

COVID-19 cases and deaths in Israel

As of 04/25/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

It remains a bit strange that fatalities have not fallen by significantly more than cases. Inoculations have been targeted at the most vulnerable and vaccines are better at preventing death than preventing infection. The lag between fatalities and cases may ultimately resolve some of this mystery.

Supply issues

In the grand scheme, the supply of vaccines has met or even exceeded initial expectations. However, this is largely a function of Pfizer producing far more than had been expected, whereas several others have under-produced:

• AstraZeneca only delivered 30% of its promised 100 million doses to the EU in the first quarter of the year. The company is set to provide just 70 million in the second quarter – far short of its 300 million contract.
• AstraZeneca’s U.S. plant has been repurposed for Johnson & Johnson after a contamination error.
• AstraZeneca’s production in India is no longer being exported as India grapples with its own outbreak.
• Moderna has regularly fallen short of its production commitments and its supply has been highly irregular.
• Johnson & Johnson’s vaccine was held up by U.S. reviews, though it is now moving forward again.

Last wave for developed nations?

This could be the last major infection wave for developed countries (see next table). The accelerating rate of inoculations plus warmer weather should substantially slow the rate of infection over the summer. By next fall – when seasonal factors would normally begin to deteriorate – vaccinations should be approaching herd immunity and further waves should be much smaller.

The factors driving repeated virus waves – hopefully the last major wave for developed markets

As at 04/24/2021. Vertical height of category reflects its relative importance. Colour conveys its effect on pandemic as noted in legend. Source: RBC GAM

Economic developments

Economic developments remain mostly good, with the U.K. (and less enthusiastically, the EU) joining the recovery party.

Real-time data

Real-time credit and debit card spending in the U.S. has actually retreated somewhat recently. But we believe this is in part because the artificial spike from stimulus cheques is fading and perhaps also because of Easter distortions (see next chart). Spending is nevertheless sharply higher than two years ago (recall that comparisons to one year ago are now unhelpful given that the economy was in a tailspin then).

U.S. aggregated daily card spending

As of 04/17/2021. Total card spending (7-day moving average) includes total BAC card activity which captures retail sales and services which are paid with cards. Does not include ACH payments. Source: Bank of America COVID-19 and the consumer weekly publication, RBC GAM

U.S. weekly jobless claims continue to improve, and at a somewhat accelerated rate in recent weeks (see next chart).

U.S. jobless claims reached pandemic low

As of the week ending April 17, 2021. Shaded area represents recession. Source: Department of Labor, Haver Analytics, RBC GAM

U.S. traditional data also strong

The U.S. manufacturing PMI (Purchasing Managers’ Index) rose in April from a good 59.1 to a great 60.6. The service sector index, which is more affected by the pandemic than manufacturing, rose from 60.4 to an incredible 63.1. One explanation may be that such sectors were previously depressed to a greater extent and are now in a position to grow even more quickly as they seek to catch up to prior norms.

New home sales in March absolutely exploded in the U.S., rising from 846,000 to 1,021,000. This easily exceeded expectations and is also the highest level of the past two business cycles. Indeed, it is running at twice the rate of just five years ago. Conversely, existing home sales have edged a bit lower but remain strong.

U.K. joins the party

The U.K. economy is now beginning to seriously wake up. Retail sales rose by a big 5.4% in March after a 2.2% gain in February. The U.K. Markit manufacturing PMI increased from 58.9 to 60.7 in April and the services PMI surged from 56.3 to 60.1 That measure was just 39.5 three months ago, and so has accelerated from a level consistent with deep recession to one associated with rapid growth in short order.

It makes sense that the U.K. economy is reviving, for several reasons:

• It is among the leaders in the vaccination race.
• It is finally beginning to reopen its economy after a long period of stringent restrictions.
• By virtue of significant economic underperformance last year and then again in early 2021, it has plenty of room to play catch-up.

EU recovery more cautious

The EU recovery is proving more cautious. The EU Markit manufacturing PMI continues to do very well (rising from 62.5 to 63.3), but manufacturing was never the problem. Manufacturing is booming globally. The service PMI rose from 49.6 to 50.3 in April. It is good that it is rising and particularly nice that the number now resides above the 50 delineation line – the first such achievement since August of last year. But this is hardly an enthusiastic rebound. Perhaps the May data will prove more welcoming given that we can see European restrictions being eased in the stringency data. Europe lags other major developed countries in its vaccination program and its economy has been reliably hurt more than North America by each wave.

Canadian recovery

Canada’s housing starts reached unprecedented heights in March, surging from an already very high 276,000 annualized units to 335,000. This construction clip has never been achieved before. It would appear that builders are doing their very best to meet the remarkable surge in housing demand that has occurred in Canada (and many countries) over the past year. Whether that outsized demand still exists in a year when these houses are completed is another matter, but it seems fairly likely given the expected resumption of immigration and the apparent shortfall of homes today.

More generally, as we examine a variety of traditional economic indicators in Canada, it looks to us that the Canadian economy is conservatively about 85% of the way back to normal (see next chart). The country had been stuck at around 70% at the start of this year. The level of employment has already recovered 90% of lost jobs.

Significant progress made in Canada

Employment as of Mar 2021; retail sales, food service & drinking places, and industrial production as of Jan 2021. Trough since Feb 2020. Source: Macrobond, RBC GAM

Inflation addendum

We wrote extensively about the inflation outlook a month ago (see that write-up here). Our views remain largely unchanged, but we have a few additional charts and details to share. The main motivation for the update is that the March inflation numbers have now arrived, spiking higher as we had warned (see next chart).

Inflation rising in major economies

As of Mar 2021. Source: Bureau of Labor Statistics, Office for National Statistics, Statistics Canada, Statistical Office of the European Communities, Haver Analytics, RBC GAM

As a reminder, we continue to look for quite high inflation in the extreme short-term, slightly high inflation over the medium term and then normal-to-low inflation over the long term. The next graphic nicely summarizes the various forces at work over each time horizon (see next exhibit).

Inflation to be quite high in short term, a little high in medium term, normal to low in long term

As of April 2021. Source: RBC GAM

Reasons for worry

To the extent there is reason to worry that our base-case forecast is too benign, the most compelling argument is that most of the short-term inflation drivers aren’t quite as idiosyncratic as they look. Rather than being random shocks that all happen to have aligned on the positive side of the inflation pressure scorecard, one might argue they are all the result of the same thing: altered demand preferences during the pandemic. People want bigger homes, hence the housing boom and rising home prices, rental costs and cost of furnishings. People want more electronics, hence the container and chip shortage. And so on.

Might these forces therefore be more pernicious than they first appear? Conceivably. But to the extent the pandemic is likely on its last legs, one could alternately reach the opposite conclusion. These demand preferences should not just abate but outright reverse once the pandemic is over. In turn, there could be downward pressure where upward pressure currently exists.

Another upside inflation risk that is harder to dismiss is that, as the housing market strengthens, rent costs are only now starting to be pulled along. They were initially depressed as people fled apartments and roommates. The gap between the cost of renting and the cost of owning has grown quite large, highlighting the potential for this sector to drive additional inflation in the future.

Reasons for calm

Conversely, there are several reasons for calm.

One relates to the lack of breadth of the recent inflation increase (see next chart). We find that rebounding energy prices are a disproportionate contributor. Because we don’t expect energy costs to push significantly further, this force should abate with time. Food inflation is running a little hotter than usual – reflecting poor harvests and altered food consumption patterns during the pandemic. These should be temporary. Furnishings inflation is also a little higher than normal, a side-effect of the housing boom.

Higher energy and food prices push up inflation

15-year average based on data from 2005 to 2019. Source: Bureau of Labor Statistics, Haver Analytics, RBC GAM

Interestingly, all of the other categories are at or below the normal 2% rate, arguing that inflation pressures are narrowly based and so unlikely to be sustained as the pandemic fades and conditions normalize.

Of equal relevance, Google searches for the word “inflation” have recently plummeted. We were alarmed when this metric spiked a few months ago, but it has since reverted back to a normal reading. In turn, one might argue that the public is no longer so concerned and that the risk of a few idiosyncratic factors becoming chronic via self-fulfilling expectations has therefore diminished.

Google search: Worldwide inflation

As of the week ending 04/24/2021 (partial data used for the week). The number of Google web searches for the topic relative to the highest point within the finance category for the region and time period selected. Source: Google Trends, RBC GAM

One last inflation thought: a recent study by Goldman Sachs found that inflation is typically lower than normal after pandemics. While we are not sure that this conclusion is relevant for COVID-19, it is at least reassuring that the post-pandemic experience isn’t usually inflationary.

Central banks at work

So far, central banks are not panicking about the recent inflation increase. If anything, we suspect they secretly welcome it after the massive inflation undershoot last year. They universally expect inflation to settle down over the next few years, ultimately aligning with the state of the economy.

The latest European Central Bank (ECB) decision yielded largely steady policy. The rate of stimulus had been increased in March as a response to third-wave economic woes. The central bank still appears to be some distance from outright stimulus removal, as per its comment that the withdrawal of emergency support was not even discussed at the most recent meeting.

In contrast to this, the Bank of Canada (BoC) is already inching in the stimulus-removal direction. As had been widely expected, last week the Bank scaled back its bond purchase program from $4 billion per week to $3 billion. It also upgraded its economic outlook. Furthermore, the decision was considerably more hawkish than expected for two additional reasons:

1. The BoC didn’t just upgrade its forecast, but did so aggressively. Its forecast now outpaces the consensus with a 6.5% predicted growth rate for 2021. This is even higher than our own forecast.
2. As an extension of the first point, the BoC now anticipates that economic slack will be gone by the second half of 2022, implying that rate hikes should begin around that time.

This positions the BoC among the developed world’s most hawkish central banks, albeit starting from a position of extreme stimulus.

To the extent the U.S. is further along in its recovery than Canada, with even faster growth scheduled for the year ahead, it raises the question of whether the U.S. might end up tightening earlier than 2023 as well. Of course, the U.S. has a slightly different mandate that makes it somewhat more tolerant of additional inflation, conceivably allowing for some divergence between the two nations.

The turn from monetary easing to tightening can be a fraught one, as demonstrated by a number of U.S. taper tantrums over the past decade.

Productivity boom ahead?

Predicting the future of productivity growth can be a fool’s errand given the many forces at work and the serendipity and spark of genius sometimes needed for further advancement. We nevertheless believe there is a fair chance that productivity growth over the coming decade(s) will be somewhat faster than over the past one.

This prediction is not overly bold: the 2010s were a period of unusually subdued productivity growth, so much of this forecast is simply a reversion to the mean. That said, let us acknowledge that the true rate of technological advancement has probably been somewhat faster than the official measures could capture. This is in part due to the difficulties of capturing “free” technologies in GDP, and in part because many of the enhancements appear to have increased the quality of our leisure time rather than our work output. As a result, our prediction of faster productivity growth isn’t a complete slam dunk.

Several considerations drive our optimistic productivity forecast.

1. Pandemic factors

The constraints imposed by the pandemic on working and living will almost certainly boost productivity over time. Workers have learned how to toil remotely, and businesses and shoppers are learning how to operate virtually. U.S. patent applications that support work-from-home technologies have approximately doubled since the pandemic, suggesting a long productivity tail from the experience.

Digital technologies enjoying a massive leap forward include:

• video conferencing and tools that allow remote access to corporate servers
• online job searches
• the provision of government services
• the expansion of digital payment options
• automation in the manufacturing sector (and beyond)
• the provision of education and health care.

These last two sectors were notorious for their Luddism before the pandemic. While their transformation is hardly perfect or complete – especially for education – it may represent the starting gun for future innovation that unlocks improvements in sectors that had long been resistant to productivity gains.

More generally, people have been jolted out of their routines and are now more open-minded to finding better ways of doing things.

2. Cap ex trend

Predating the pandemic, we were beginning to see capital expenditures pivot away from structures and machinery and equipment, and toward computers, software and research and development. In many developed countries, R&D finally resumed growing in inflation-adjusted terms in 2017, after a long decline. This should boost labour productivity over time.

Cyclically, to the extent capital expenditures were temporarily held back by the pandemic, there is scope for pent-up cap ex spending to be unleashed over the coming few years – potentially providing a further jolt to productivity.

3. Scientific advances

From a medical perspective, the pandemic-related development of mRNA vaccines and antibody treatments may have much broader application after the pandemic. A malaria vaccine is now in late-stage trials. Gene editing is now possible, with potentially radical implications. Major advances in the computer modelling and folding of proteins may unleash further rapid advances in medicine. A form of blindness was recently reversed in mice. Meat is even starting to be grown in labs, with potentially huge implications for agriculture.

Advances in chip technology and artificial intelligence are now permitting computers and robots to do things that were previously the sole domain of humans, such as sophisticated natural language processing and self-driving cars. These can upend additional industries.

From an environmental perspective, battery technologies continue to improve, renewable energy is becoming ever-cheaper and solar power is now the cheapest energy option in many locations. Electric cars are increasingly mainstream and electric planes are nearing viability. While nuclear fusion always feels like it is several decades away (and has repeatedly proven to be even further!), real advances are occurring in mini-nuclear fusion technologies. Commercialization would radically change the cost and environmental consequences of energy consumption.

4. China

It is no longer just a small number of wealthy developed nations that are pushing against the technological frontier. China has now broadly caught up and is in a position to push as well. While this is a stylized viewpoint, one might argue there are suddenly twice as many people in the world working to advance the state of global technical knowledge.

Bottom line

To be clear, we do not predict productivity fireworks. Forecasts of a second Roaring Twenties are probably exaggerated. Many of the technologies mentioned are still years away from commercialization.

But, at a minimum, we can say there is a good pipeline of science and technology lined up, and that businesses seem more motivated than usual to invest in them. The pandemic experience may further jolt productivity forward, as does China’s ascension to the technological frontier. In turn we assume that whereas productivity growth was stuck in the realm of 1.0% growth per year across the 2010s, that the 2020s and beyond may manage more like 1.5% productivity growth.

This has a range of consequences. Most importantly, it should modestly accelerate the rate at which society’s quality of life increases. Secondarily, though of great relevance for investors, it should permit slightly faster economic growth and slightly faster earnings growth. That said, challenging demographics should keep the absolute rate of economic growth from fully reviving back to historical norms. Finally, faster productivity growth would argue that the neutral rate of interest could be slightly higher than otherwise imagined, though we still anticipate structurally low interest rates for as far as the eye can see.

-With contributions from Vivien Lee and Sean Swift