Webcast

Our December economic webcast is now available: “New and lingering headwinds for growth”.

COVID cases

COVID-19 infections remain high in developed markets (DM), but have actually stopped rising in recent weeks (see next chart). Emerging-market (EM) infections remain fairly tame.

COVID-19 emerging markets vs. developed markets infections

As of 12/3/2021. Calculated as the 7-day moving average of daily infections. Source: WHO, Macrobond, RBC GAM

Europe remains the epicenter of the Delta wave, with German cases recently beginning to flatten out after a long ascent (see next chart).

COVID-19 cases and deaths in Germany

As of 12/3/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Conversely, Canadian and U.S. infections continue to edge higher, though not at the rapid rate seen until recently in Europe.

Omicron variant

But these recent COVID-19 trends may yet be swamped by a new virus variant. The new Omicron variant possesses a large number of mutations, including more than thirty to its spike protein alone. The spike protein significantly influences the extent to which the virus can take over human cells, and also the degree to which it is susceptible to vaccines. Interestingly, the Omicron variant did not evolve from the dominant Delta variant, but rather from earlier in the genetic lineage.

The virus first appeared in Botswana and is now found across southern Africa, with cases rising particularly quickly in South Africa (see next chart). The World Health Organization has described the new variant as possessing a “very high” global risk.

COVID-19 cases and deaths in South Africa

As of 12/3/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Key questions

There are three key questions about the Omicron variant that must be answered to properly understand the way forward.

1. Is Omicron more contagious?

The Omicron variant is likely more contagious than the Delta variant, which was the previous record-holder in this regard. Omicron has not only become the dominant variant in South Africa, but achieved the feat in a matter of weeks: more quickly than the Delta variant did. Cases are now reported around the world, including in Canada and nearly a third of U.S. states.

While the Beta variant from South Africa and the Gamma variant from Brazil were once expected to take over the world after conquering their home nations, they never did. As such, there still remains the sliver of a chance that the Omicron proves somewhat less potent outside of Southern Africa. But based on preliminary analysis of the nature of the variant’s mutations, it is considerably more likely that the Omicron will become the new globally dominant variant, and that global infections will accordingly rise as this process plays out.

2. Is Omicron more vaccine-resistant?

Because the Omicron variant has many mutations to its spike protein, there are widespread concerns that vaccines will prove significantly less effective. Moderna luminaries have argued there is a high likelihood of a “material drop”, though Pfizer experts have predicted existing vaccines should still deliver some benefit. These statements are not contradictory: vaccines will probably be less effective against Omicron, but not entirely toothless. A test of vaccines against a synthetic spike protein with similar mutations to the Omicron variant found vaccine efficacy fell to quite low levels. Elsewhere, Regeneron indicates that its antibody drug cocktail is less effective against Omicron.

Vaccine-makers indicate they can rework their vaccines to target the Omicron variant in as little as two months, if necessary. However, this new formula will then need to be tested, approved, manufactured and distributed. As such, it would take several quarters to restore the level of vaccine-induced immunity. In the meantime, additional social distancing may prove necessary.

Preliminary results suggest the Omicron variant may be as many as three times more likely to re-infect those who have previously been infected. If true, this will help the variant propagate. Furthermore, this hints that Omicron might be better at evading vaccines as well since naturally-developed antibodies work on a similar principle to vaccine-developed antibodies.

3. Is Omicron less fatal?

In contrast to these two pieces of bad news, there may be one piece of good news: the Omicron variant is thought likely to be less dangerous than earlier variants.

Anecdotal reports from South Africa are that hospitalizations are rising only modestly, that very few people are requiring oxygen and that the symptoms are less lung-concentrated. Symptoms also tend to present for a shorter period of time – only lasting for a few days.

Of course, most cases of earlier variants were also mild, South Africa is a young country such that it should have fewer serious cases than the average, and it takes weeks for infections to turn into hospitalizations and hospitalizations into deaths. Still, the preliminary evidence is promising in this regard, and the first infection has now been dated back to November 9 – long enough to begin making coherent comments about hospitalizations and fatalities.

Economic implications

We lay out three economic scenarios resulting from the Omicron variant.

Base-case scenario

Our base-case Omicron scenario, with a 50% likelihood, is that the variant is moderately more contagious, moderately more vaccine resistant but moderately less dangerous. People are likely to behave more cautiously and governments are likely to impose some additional restrictions to prevent hospital demand from overwhelming capacity. Economic activity will be about 1% lower than otherwise over the first half of 2022, followed by a return to normality in the second half of the year as the variant fades and better-targeted vaccines are introduced. This is a bigger hit to activity than suffered under the Alpha and Delta variants, though similar to the dip in the fall of 2020, and far less than the sharp drop in the spring of 2020.

Pessimistic scenario

The pessimistic scenario, with a 20% likelihood, imagines that the Omicron variant is much more contagious, moderately more vaccine resistant and no less dangerous than the Delta variant. This results in stricter restrictions imposed by governments, and in turn a deeper 2%-plus hit to economic output over the first half of 2022, followed by a return to economic normality in the second half of the year.

Optimistic scenario

The optimistic scenario, with a 30% likelihood, combines two possible outcomes.

The first is that the Omicron variant proves not be more contagious after all, meaning that the world is little different than before.

A second optimistic outcome is that the Omicron variant is more contagious, but significantly less dangerous. The Omicron might thus crowd out the more dangerous Delta, allowing the world to quickly reach herd immunity via natural means, without having to lock down. The rapid resolution could actually improve the economic outlook, though we hesitate to embrace this positive conclusion too eagerly as many people would have to quarantine at home even if merely mildly ill or exposed to others, temporarily reducing the labour supply.

A risk to this scenario is that if the Omicron is sufficiently different from earlier variants that it can easily re-infect individuals, then might the more deadly Delta variant be sufficiently different from the Omicron that it isn’t crowded out but rather continues to infect people in parallel?

Another risk to the optimistic scenario is that even if Omicron proves less problematic than feared, the very fact that the virus has managed to mutate to such an extreme degree argues that future major mutations are nearly inevitable: there will likely be another problematic variant at some point.

From a market perspective

It is notable that the Delta variant – despite being the most contagious and dangerous on record – didn’t actually do much damage to financial markets. As such, it is far from assured that the Omicron variant will inflict carnage. Nevertheless, it makes sense that markets should be somewhat less constructive if growth is likely to suffer a moderate hit as in our base-case scenario.

Other considerations

A few other considerations about the Omicron variant may prove instructive:

• China could be more adversely affected than most from an economic standpoint purely due to its zero-tolerance policy. This stance might require widespread and repeated lockdowns to maintain. This, in turn, could exacerbate global supply chain problems.
• From a sector perspective, travel and high-touch service activities are most at risk, consistent with prior waves.
• To the extent that Omicron is reported to be particularly adept at breaking through the natural immunity developed in prior infections, that leaves countries like the U.S. with a low vaccination rate and a high historical infection rate particularly vulnerable. Many developing nations are in a similar position.

Restrictions rise

Our global stringency measure shows a modest further increase in restrictions (see next chart).

Global Stringency Index

As of 12/5/2021. Global Stringency Index measuring the strictness of lockdown policies that restrict mobility, calculated as stringency index of 50 largest economies. Sources: University of Oxford, IMF, Macrobond, RBC GAM

This largely predates the Omicron variant. As Delta variant infections rose across the developed world in recent months, governments have incrementally tightened restrictions, most prominently in Europe where a number of countries now have what amount to lockdowns for those who are unvaccinated.

The U.K. has reintroduced mask requirements for shops and public transport. Children are also now advised to wear masks in communal parts of schools.

Looking forward, it seems prudent to expect further restrictions due to the arrival of the Omicron variant. Already, international flights have been reduced.

Economic data

Most economic indicators have been strong recently, with the caveat that none of this data yet reflects the Omicron variant.

The New York Fed’s Weekly Economic Index for the U.S. suggests a continuation of robust growth (see next chart).

New York Fed Weekly Economic Index

For the week ended 11/27/2021. Change vs. 2019 derived by linking WEI for current week and WEI for the same week a year ago. Source: Federal Reserve Bank of New York, Macrobond, RBC GAM

Consumers and Thanksgiving

U.S. Thanksgiving retail sales have received a mixed billing. In-store traffic rose a huge 61% over last year according to RetailNext, though this remains 27% below 2019 levels. Adobe estimates that sales over the holiday weekend were actually slightly lower than last year once online purchases are included, but only because Black Friday has increasingly become Black November – deals now last the entire month in many cases, pulling sales forward (sales from the start of November to Thanksgiving were estimated to be 13.6% higher than a year ago). Additionally, some products were unavailable due to supply chain issues.

The U.S. personal savings rate has now retreated back to historically normal levels. This is perfectly fine, but suggests less scope for big personal spending gains from here – the dissaving boost has already happened (see next chart).

U.S. personal saving rate surge unwinding

As of Oct 2021. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM

Solid employment

U.S. employment technically disappointed due to the formation of “just” 210,000 new jobs in November according to the payroll survey, but the report was better than it looked. Revisions uncovered an additional 82,000 jobs created over the prior few months. The unemployment rate continued to fall, from 4.6% to just 4.2%.

Crucially, though this was underreported, the household survey argued that employment rose in November by an astounding 1,909,000 new workers – nine times the official increase. The household survey tends to be the more volatile of the two surveys, but it still has informational value. Bolstering the optimistic interpretation, jobless claims have continued to fall, touching the lowest reading in 52 years (albeit in part due to seasonal distortions). Suffice it to say, U.S. employment continues to do just fine.

In Canada, the interpretation was clearer, and also optimistic. Canada generated 154,000 new jobs in November, five times what had been expected. This more than offset disappointment in the prior month’s reading. Accordingly, the unemployment rate collapsed from 6.6% to just 6.0% – a strong reading by Canadian standards. All of this was a welcome development as the Canadian economy had been stumbling previously. Of course, it will also stumble again once recent British Columbia flooding enters the numbers.

Canadian wage growth, having long lagged, appears now to be accelerating. Permanent worker hourly wages leapt from +2.1% year-over-year (YoY) to +3.0% YoY in November, and the annualized rate of wage growth in recent months is closer to +5% YoY growth.

Purchasing Manager Indices (PMIs) strong

Purchasing Manager Indices were strong in several developed markets. The U.S. ISM manufacturing and service PMIs both rose in November, with the service measure setting another record. Eurozone PMIs also rose, and U.K. PMIs remained solid.

In China, the official manufacturing PMI inched above 50 for the first time since August, arguing that the Chinese economy is no longer decelerating. This also hints that supply chain problems are beginning to be resolved.

Downgrading our growth forecasts

We will officially publish updated growth and inflation forecasts with the forthcoming release of our quarterly Global Investment Outlook. Until then, we flag that the growth outlook has diminished slightly for 2022, and that the inflation outlook has increased slightly.

The growth reduction primarily reflects the incorporation of an Omicron virus wave into the first half of 2022, partially offset by a somewhat less negative assessment of supply chain problems for the year ahead. In the end, the growth outlook for several developed nations falls from just under 4.0% to around 3.5%. These are below-consensus forecasts, but still consistent with an economic recovery for the year ahead.

On inflation, the implications of the Omicron virus are ambiguous but the recent trend has continued to yield above-consensus inflation prints, and so we adjust our forecasts higher to reflect that pattern. We continue to sport an above-consensus inflation outlook, though we maintain the view that inflation should become somewhat less hot over 2022.

Canadian consumers less free-wheeling

Canadian households are in fairly good financial shape: they have enjoyed significant job gains, accumulated significant excess savings during the pandemic (see next chart), and are experiencing historically low levels of financial stress.

Considerable excess household savings due to pandemic

As of Sep 2021 for U.S.; Q3 2021 for Canada and Germany; Q2 2021 for Japan and U.K. Cumulative excess savings vs. 2019 average since March 2020. Source: Macrobond, RBC GAM

However, Canadian households are still somewhat more constrained than American households. The U.S. debt-service rate (which measures the fraction of income that must be spent servicing debt) is around a percentage point lower than before the pandemic and, crucially, about two percentage points below the norm of the past 40 years (see next chart). This means Americans can allocate an extra percentage point or two of their income toward spending, all else equal.

U.S. household debt servicing capacity improved during the pandemic

As of Q2 2021. Source: Federal Reserve Board, Macrobond, RBC GAM

Canada’s household debt-service ratio has also improved during the pandemic, but only marginally (see next chart). While interest rates fell, households took on a lot of extra debt. Home prices surged during the pandemic, nearly completely offsetting that benefit of lower rates. Furthermore, on a level basis, Canada’s household debt-service ratio is still near record highs, and multiple percentage points above the norm of the past thirty years.

Canadian household debt service burden fell during the pandemic

As of Q2 2021. Debt-service ratio defined as cost of interest payments on debt only. Average effective interest rate since 1995. Source: Statistics Canada, Macrobond, RBC GAM

Relevant to all of this, interest rates appear likely to rise over the coming years as central banks transition to monetary tightening. That will make debt-service ratios worse.

We don’t expect disaster for Canadian households: the unemployment rate is falling, households accumulated significant additional savings, many who will be renewing their mortgages over the coming years may still enjoy a lower rate than they were paying before, and recent homebuyers were stress tested against higher rates. But Canadian consumers are less likely to deliver a spending boom over the coming few years than Americans.

U.S. political update

We highlight five U.S. political developments of interest.

First, Congress passed the bipartisan infrastructure bill three weeks ago. The money trickles out over the better part of a decade, so it doesn’t greatly change the near-term growth outlook.

Second, the larger partisan social spending bill continues to idle, with an uncertain timeline for implementation.

Third, a government shutdown was averted in early December, but politicians merely succeeded in punting the deadline to February 18.

Fourth, the debt ceiling was not addressed as part of those efforts. Treasury Secretary Yellen indicates that the government could run out of financial resources as early as December 16. As such, the familiar game of extending government funding and waiving or expanding the debt ceiling will have to be played again fairly soon. The risk of a bad outcome is fairly low given that the Democrats control both chambers of Congress plus the White House.

Fifth, President Biden’s popularity has fallen from 53.0% at his inauguration to just 42.6% today. This is still better than President Trump at the same point in his presidency (37.3%), but lags behind the prior 12 presidents. This adds further weight to the expectation that the Democrats will lose ground in the midterm elections next fall, resulting in the Republicans likely taking control of the House of Representatives, and possibly of the Senate as well. Given that legislative progress normally becomes quite difficult well before the midterms, Biden’s one opportunity to make significant legislative progress during his entire four year term is arguably now.

Inflation musings

Inflation readings remain high. The latest published figures come from the Eurozone, which reported a big +4.9% YoY consumer price index (CPI) reading, a record high since the euro was implemented. With one notable exception (discussed later), developed-world CPI rates are broadly in the 4% to 6% range – two to three times normal.

Service inflation

Even as goods-sector inflation could cool due to lower oil prices and the prospect of diminishing supply chain problems, service-sector inflation is only finding its stride. Not only have rent prices been increasing more quickly, as discussed in a prior MacroMemo, but cable costs, recreation costs and legal fees are also leaping forward. This adds credence to the view that inflation pressures are broadening, and in turn that it will take some time for them to ease even after some of the original drivers fade.

Wage pressures

We continue to expect wage pressures to persist over the next year, even if inflation becomes somewhat less heated. Workers have noticed the damage to their cost of living, and are in a position to demand recompense given low unemployment and high job openings.

There may now be some evidence of this thesis in the strike data. A recent John Deere strike yielded a big 10% wage gain in the current year, an $8,500 signing bonus, a 5% increase in each of the next two years, and also production target bonuses. It remains blurry in the official data whether there are a rising number of work stoppages (the figures are extremely volatile), but tentatively the answer appears to be “yes.”

Where is Japanese inflation?

Japan is a prominent exception in this high inflation world. The country’s overall CPI print is up just 0.1% over the past year, and its core inflation measure is actually down 0.7% YoY. This is curious, to the say the least, given that most of the inflation pressures vexing other nations are theoretically global in nature – higher commodity prices, problems procuring internationally-produced goods, and so on.

Our digging has uncovered two plausible answers.

First, Japanese companies have a “steady management style” that leaves them loathe to adjust prices abruptly. To the extent this is true, it would suggest that Japanese corporations should suffer declining profit margins during bouts of higher inflation, and by extension that the country’s equities may be less of a natural hedge against inflation than those of other markets.

Second, and largely explaining the first reason, Japanese shoppers are very resistant to paying higher prices after decades of essentially non-existent inflation. They defer spending rather than pay the extra price – a phenomenon that was visible when Japan twice raised its sales tax in recent years and spending surged beforehand and collapsed afterward.

All of that said, it is one thing for Japanese companies to eat cost increases when cost inflation is a bit higher than normal, and something else altogether when cost inflation is quite elevated, like today. As such, we budget for somewhat higher inflation in Japan as well, if less than elsewhere.

Central bank developments

Central banks are mostly continuing along their recent hawkish trajectory.

In the U.S., recent testimony by Fed Chair Powell yielded several important insights. The Fed acknowledged that inflation has spread more broadly, and that “transitory” is no longer the correct term to describe this episode of high and lasting inflation (though the Fed does not believe it is a permanent condition). Powell indicated that the upcoming Fed meeting could yield a plan for a faster tapering of bond-buying than previously envisioned. Instead of ending purchases in the middle of 2022, this might occur in the spring of 2022. Markets now price in three rate hikes for 2022. While conceivable, we feel this is slightly excessive. We would highlight the fact that central banks have not yet fully incorporated the Omicron variant into their thinking.

In Canada, the next Bank of Canada decision will be delivered December 8. The economy and inflation have evolved roughly as forecast in the Bank of Canada’s October update, though the unemployment rate is now moderately below expectations. While the general tendency has been for central banks to become more hawkish, we wonder if the Bank of Canada might stick to a more neutral script given that markets already price in five rate hikes for 2022, and the Omicron variant could yet reduce the need for monetary tightening.

Some other central banks are already tightening their policy rates, including the Bank of Korea and the Reserve Bank of New Zealand.

Conversely, China just delivered its second reserve ratio cut of the year in response to decelerating economic growth.

BC flooding update

Fortunately, recent waves of heavy precipitation have not significantly added to the damage inflicted by extensive flooding and mudslides in southern British Columbia several weeks ago.

The Trans Mountain Pipeline recommenced operation on December 6, restoring the bulk of the area’s fuel supply. The main rail lines were returned to service on November 23, though it is unclear whether they are again operating at full capacity. Road restrictions have been eased, but many remain and some highway segments will take months to restore.

More generally, British Columbia extended its state of emergency on November 29, limiting travel along affected highways and the amount of fuel that can be purchased by a non-essential vehicle until December 14.

The disaster recovery is happening roughly in line with our prior expectations, meaning that Canada-wide economic growth is still on track to be negative in November and up to a few percentage points below normal in the final quarter of 2021, before bouncing back in the first quarter of 2022.

-With contributions from Vivien Lee and Aaron Ma