Overview

We would argue that the latest developments have skewed more negatively than positively. While the economic recovery appears to be continuing and many countries report declining infections, U.S. inflation has just jumped to a worrying degree and one particular subtype of the virus variant in India is quite concerning.

Third wave in decline

Globally, the latest COVID-19 wave is clearly in decline as measured both by new infections and new fatalities (see next chart). As with the past several weeks, both developed and emerging nations can claim a measure of success.

Global COVID-19 cases and deaths

As of 05/16/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

However, the improvement among emerging market (EM) nations is still fairly precarious, and far from universal. While India is now beginning to improve – a most welcome development – its outbreak remains intense (see next chart).

COVID-19 cases and deaths in India

As of 05/16/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Additionally, quite a number of EM economies -- including a large swath of Latin American nations -- are still recording transmission rates of greater than one. That is to say, their daily caseload is rising (see next table). While India has captured the most attention, many of these countries also officially recorded more new cases per capita than the South Asian nation.

COVID-19 transmission analysis in emerging market countries

As of 05/16/2021. 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

Turning toward developed nations, there has been a changing of the guard of sorts. The U.S. long held the unfortunate position of having recorded the most cumulative infections of any country over the entirety of the pandemic on a per capita basis. However, Sweden has just taken the lead. Sweden has had far fewer overall infections than the U.S., but its population is much, much smaller (see next chart).

Cumulative COVID-19 cases per capita

As of 05/16/2021. Cumulative cases per 1 million residents. Source: WHO, Macrobond, RBC GAM

On the whole, European nations have managed to sharply reduce their rate of infection in recent weeks (see chart for France). Among European Union (E.U.) nations, all but one are now enjoying a trend rate of decline.

COVID-19 cases and deaths in France

As of 05/16/2021. 7-day moving average of daily new cases and new deaths. Sources: WHO, Macrobond, RBC GAM

The U.S. continues to improve gradually, seemingly successfully balancing its aggressive vaccination campaign with ever-fewer mobility restrictions (see next chart). Only three states are presently experiencing a rising number of cases. Time will tell whether these are mere blips, a function of certain states (such as Alabama and Mississippi) lagging in their vaccination campaigns, or perhaps a reflection of the population in the warmest states (once again, Alabama and Mississippi, plus Nevada) beginning to retreat indoors for the summer (see subsequent chart).

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

As of 05/16/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Transmission rate, U.S. states

As of 05/16/2021. Transmission rate calculated as 7-day change of underlying 5-day moving average of new daily cases, smoothed with 7-day moving average. States above dotted line at 1 have increasing new daily cases. Includes Washington, D.C. Source: Haver Analytics, Macrobond, RBC GAM

Canada’s daily infection rate continues to improve, now seemingly at an accelerating rate (see next chart). The four largest provinces have all now staged significant improvements, though several others -- including Manitoba and Newfoundland -- have not yet crushed the latest wave. Remarkably, the daily rate of infections in Quebec is now nearly back to the trough between the second and third wave (see subsequent chart).

COVID-19 cases and deaths in Canada

As of 05/16/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RC GAM

Spread of COVID-19 in Quebec

As of 05/16/2021. Calculated as 7-day moving average of daily cases and total cases. Source: Government of Canada, Macrobond, RBC GAM

Japan is increasingly notable in that, after successfully minimizing the pandemic during earlier global waves, it is now recording a record number of infections (see next chart). The country’s vaccination campaign has moved particularly slowly due to a combination of procurement, logistics and wariness issues. The Olympics are now just over two months away.

COVID-19 cases and deaths in Japan

As of 05/16/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Variant of concern

The new variant (B.1.617) from India has already been officially deemed a “variant of concern,” and is responsible for the bulk of India’s case explosion over the past few months.

There is a real risk that this variant could become a major global problem. Already, it is spreading quickly elsewhere in the world. The U.K. reports that the number of new cases of the variant from India have tripled over the past week alone. The data is patchier elsewhere, but its share of new cases in North America has more than doubled over the past month. It is a similar situation in Europe and South America. Fully 4% of African cases are now the variant from India.

What is notable is that this variant is seemingly expanding even in places that have a high level of vaccination and are successfully tamping down other highly contagious variants. As an example, see the next chart with data from the U.K. (see next chart).

Variant share of cases in the U.K.

As of 05/16/2021. Share of cases by variant. Source: GISAID

There would seem to be just two possible explanations for this:

1. The variant from India could be even more contagious than the variant from the U.K.
2. The variant from India could be more resistant to vaccines.

One or both must be true.

So far, experts argue that neither is true – that the variant from the U.K. is the most contagious and that the existing vaccines work against all known variants, including the one from India. This is hard to reconcile. The chart, above, argues that the variant from India is significantly outcompeting the one from the U.K.

One point of particular confusion is that many of the statistics kept and tests conducted seem to be performed on Indian subtype B.1.617.1 or do not distinguish among the subtypes. But the real problem appears to be with a newer Indian subtype, B.1.617.2, which has gone from roughly 1% of all Indian cases at the start of March to more than 50% today. At the same time, the B.1.617.1 subtype has fallen from over a third of sequenced cases to less than 5%. Words of assurance about the variant from India may be premature until proper studies can be performed on the more dangerous of the two subtypes.

British officials indicate that most cases of variants from India appear to be in people who had not yet been vaccinated. The most likely explanation is that the variant (specifically, subtype B.1.617.2) is substantially more contagious even than the variant from the U.K. This is concerning by itself, but even more so when a country like the U.K. – again, highly inoculated and, until recently, highly locked down -- appears unable to halt its spread.

To be clear, the fact that India’s own caseload is now declining argues that this new variant can ultimately be controlled. Furthermore, rising vaccinations and warming weather will surely help everywhere. But it could be that, if the variant from India becomes the globally dominant strain --as seems possible -- herd immunity might only be achieved once something like 80+% of the population has been inoculated, rather than the 70% to 75% rate we had assumed with the variant from the U.K. as the dominant strain. Depressingly, a fourth wave is not impossible.

Vaccinations motor along

The world has now inoculated nearly 1.5 billion people, averaging 24 million doses per day. Israel remains the leader at 122 shots per 100 people, but it has practically run out of people to inoculate, now delivering just 0.8 doses per 100 people over the last two weeks.

The U.S. and U.K. remain near the top of the cumulative vaccination leaderboard (see next table), and accordingly appear to be slowing slightly now as the number of unvaccinated individuals declines. Conversely, Canada and Europe – laggards in the overall rate of vaccination among developed nations – are now recording some of the highest number of new inoculations per capita in recent weeks.

COVID-19 global vaccine ranking

As of 05/16/2021. Cumulative total doses administered by country per 100 people. Source: Our World in Data, Macrobond, RBC GAM

Vaccine efficacy

A recent study finds that the antibody count generated by the Pfizer vaccine is a remarkable 3.5 times higher if the second dose is delivered 12 weeks after the first dose rather than the officially recommended three week gap. This provides further – if accidental – vindication to those nations that have pursued a strategy of inoculating as many people as possible with one dose before circling around to deliver second doses.

Casting some doubt on the efficacy of the Sinopharm vaccine, the small nation of Bahrain is experiencing its highest rate of new COVID-19 cases right now (over 1,500 per day among a population of just 1.6 million) despite ranking ahead of the U.K. and U.S. (and third overall) in the vaccination standings, above. The Sinopharm vaccine had been especially heavily used.

Vaccine supply

India is again blocking vaccine exports as it tries to secure enough for its own population. This is simultaneously understandable and also a major problem for the developing world since India is the primary manufacturer of vaccines destined for emerging economies.

AstraZeneca usage continues to decline among developed nations. The U.S., many European nations and several Canadian provinces have stopped using the vaccine. Even the U.K. is now offering people in their thirties a vaccine other than AstraZeneca. The concern mainly regards blood clots, though there are also some questions about the relative efficacy of the vaccine, especially against certain variants. Ultimately, this could prove a major opportunity for developing nations as supplies are redirected.

Finally, a vaccine under development by Sanofi and GlaxoSmithKline has demonstrated a robust immune response in early-stage clinical trials, allowing the project to move forward to a late-stage study. It joins a host of other vaccine candidates that continue to move through testing and approval.

Spiking inflation

Our base-case inflation scenario remains largely unaltered. This is to say, we expect quite high inflation over the next few months, slightly higher than normal inflation over the next few years, and then normal to below-normal inflation over the long run.

Nevertheless, the latest U.S. inflation release contained more fireworks than we, the consensus or financial markets had expected. Whereas the expectation was for the annual rate of change in the Consumer Price Index (CPI) to jump from 2.6% in March to 3.6% in April, it actually hopscotched all the way to a giant 4.2% year-over-year (YoY) gain. Core inflation also leapt higher, from 1.6% to 3.0% YoY (well past the 2.3% consensus).

While much of this was via long-anticipated base-effects – big price drops from a year ago falling out of the equation – that doesn’t explain the entirety of the move. Prices were also actively surging in April, up 0.8% in the month alone for the overall price index and an even bigger 0.9% monthly increase in the core index.

Furthermore, the monthly sequence is undeniably ominous. The monthly change in U.S. headline inflation from last October through April is a monotonically increasing function: +0.12%, +0.18%, +0.24%, +0.26%, +0.35%, +0.62% and +0.77%. Once might dismiss all but the final two months as being roughly normal increases, but the rate of price increase over the past two months has been genuinely aggressive. Over the past six months, the inflation rate annualizes out to a 5.0% increase. That is substantial.

It can’t be said that the inflation increase is entirely out of the blue. When we plug the output gap, inflation expectations, import prices and commodity prices into our model, it aligns almost exactly with what has happened in recent months (see next chart).

Official number in line with model – higher inflation

As of Apr 2021. Shaded area represents recession. Source: Haver Analytics, Macrobond, RBC GAM

And while a greatly disproportionate share of the annual price increase is a function of rebounding oil prices (see next chart and note the break in the energy bar), it must be conceded that such categories as transportation, furnishings, food, communication, “other” and housing are all now also running at above a 2% YoY rate, if only slightly for most.

Inflation is now above 2% for most sectors

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

It is also noteworthy that inflation expectations have now heated up (see next chart). The implied outlook over the next five years is now the hottest it has been in more than 15 years. While the longer-term outlook – for years six through ten – has also increased significantly, it remains lower than the norm of just a few years ago. So one might say that the market is now expecting fairly high inflation over the next several years, but that the increase is not permanent.

U.S. inflation expectations at multi-year high

As of 05/13/2021. Source: Bloomberg, RBC GAM

Why have prices increased so much over the past few months in particular? It appears to be a function of several things:

• There are the aforementioned base effects – earlier weakness falling out of the equation.
• There is the substantial rise in commodity prices – discussed in more detail later.
• A significant container shortage has increased shipping costs by a factor of three.
• There is now a shortage of computer chips due to a surge in spending on electronics.
• More generally, demand has boomed for consumer goods, with the effect that Chinese factory gate prices have now risen by a big 6.8% over the past year.
• Retailers now report unusually low inventory levels (see next chart).
• The housing boom is trickling through into inflation via direct means (the direct cost of owning a home, with rental costs conceivably following) and indirect means (the cost of furnishings, the cost of lumber).

U.S. inventory-to-sales ratio declined as sales rose

As of Jan 2021. Real inventory-to-sales ratio of all manufacturing and trade industries. Shaded area represents recession. Source: U.S. Bureau of Economic Analysis, Haver Analytics, RBC GAM

A common theme around much of this is the economic recovery, which is happening unusually quickly as artificial restraints are removed. In turn, pinch points are arising in supply chains. Furthermore, government stimulus has put a great deal of money into consumers’ hands, all at once.

As new activities now become possible (or more palatable) – going on a vacation, eating out, going to the mall, getting on an airplane – the cost of these activities is rising sharply since businesses had reduced their capacity during the pandemic and will take some time to rebuild their inventories, workforce, and so on.

Reasons for calm

But, for all of the upward forces plying inflation higher, it is important to appreciate there are also many reasons to remain calm about the inflation outlook, particularly if one is willing to look beyond the next few months.

1. The rate of inflation is somewhat less dramatic when viewed through a two-year change lens rather than simply over the past year. Versus 2019, prices have increased at just a hair more than 2% per year (see next chart). It is just that commodities such as oil crashed (in the case of oil, to below $0 per barrel!) before fully rebounding, and then some.

U.S. inflation is not as high as feared

As of Apr 2021. Shaded area represents recession. Source: Haver Analytics, RBC GAM

2. There are more favourable base effects coming. Although the annual inflation rate should rise somewhat further when the May data is released – from perhaps 4.2% to 4.5% year-over-year (YoY) – that will probably represent the high-water mark. In June and July of last year, prices rose by a stiff 0.5% in each month. Unless prices rise by 0.5% or more in each of June and July of this year, the annual rate of inflation will fall. This seems fairly likely.
3. While the focus on demand normalization has been the way to stoke inflation in previously constrained sectors such as tourism, the effect should actually be roughly symmetrical. New money going into such activities should mean less money going into currently hot sectors such as electronics. In turn, the supply constraints and the price increases should abate in those areas.
4. Broad arguments that a strengthening economy must spit off high inflation are flawed. Even as economic activity returns to its prior peak (discussed later), it remains well short of its full potential, as demonstrated by a still-elevated unemployment rate. Even when the economy does get back to its full potential – conceivably, as soon as late this year – the Phillips curve is so flat that only a pip of additional inflation should result.
5. The fiscal stimulus that has spurred unprecedented consumer spending is already beginning to fade. The big $1,400 cheques have been delivered and some was spent. True, a sizeable fraction was saved, but based on prior experience much of this will remain as savings or merely trickle out. Already, we witnessed a softer retail sales trend in April versus March. The March/April period was likely the peak of artificial consumer demand.
6. It would appear that a fading pandemic doesn’t have to generate major inflation. The rate of monthly price change remains normal in Canada and the Eurozone, and only slightly higher than normal in the U.K. and Japan. It is fair to argue that these countries have been mired in a third wave and so do not provide a perfect comparison relative to the U.S. But China has fully recovered from its own pandemic experience and yet reports just a 0.9% YoY inflation rate – well below normal. The pandemic’s end does not have to mean high inflation for years.
7. This is not the only time that inflation has spiked in recent memory. U.S. Consumer Price Index (CPI) touched 5.6% YoY in 2008 before collapsing immediately afterwards. Of course, that was because the commodity boom came to an end and the Global Financial Crisis struck – arguably a poor point of comparison. But what about 2011, when inflation touched 4.0% YoY during the relatively early stage of an economic expansion? It was back below 2.0% within a year and no lasting damage was done to inflation expectations.
8. Productivity growth has been fast over the past year, and we budget for somewhat faster than normal productivity growth over the coming decade. This is at worst neutral to inflation, but probably deflationary in that:

• It means there is more economic slack at any point in time (since GDP growth comes disproportionately from productivity gains rather than from job gains).
• A lot of innovation is itself deflationary – the creation of ever-cheaper technologies.

9. As we have detailed in earlier reports, while one might imagine certain of the upward inflation pressures persisting beyond the current year, most of these are fairly small. The Fed only wants a bit more inflation than normal, and only temporarily. Carbon taxes add just a few tenths to the inflation rate, and only when actively being increased.  Supply chain on-shoring will likely be real for certain medical products, but not for most sectors.

Commodity supercycle?

While it ultimately seems reasonable to expect inflation to cool somewhat over the second half of 2021, there are two upside risks that nevertheless merit investigation:

1. The first, discussed in this section, addresses the possibility that commodity prices continue to rise significantly.
2. The second, discussed in the subsequent section, looks at corporate pricing power and whether that might continue to drive inflation.

Technically, a commodity supercycle is defined as a decade-plus period of significantly rising commodity prices. This usually requires a large, persistent and unexpected positive demand shock, like China’s massive economic liftoff beginning in the 2000s.

The argument in favour of another commodity supercycle goes as follows:

• India is now growing nearly as rapidly as China did in the 2000s, and with a similarly enormous population.
• China may be past its moment of maximum resource-intensive growth, but it is still growing quite quickly and its economy is now so large that even slower growth on a percent basis represents large further increases on a dollar basis.
• A materials-intensive infrastructure boom is likely in the aftermath of the pandemic.
• The shift toward green technologies like electric cars and solar panels is likely structural in nature and could provide an enduring tailwind for such materials as copper, cobalt, lithium and silver. An electric car requires four to five times more copper than a gas-fueled one. Demand is expected to rise 31% YoY for electric cars, 15% YoY for solar power and 12% YoY for wind power.

The argument for a boom in base-metals demand is particularly compelling. Not only do these benefit disproportionately from most of the above factors, but there has been chronic underinvestment in the space. It takes a few years to expand a mine and a decade to open an entirely new facility.

The argument for lumber also appears to be fairly strong: housing markets are booming globally right now. Even as the pandemic-induced surge cools, the U.S. remains in a good position to enjoy further housing strength, as do countries expanding their middle class like India.

The bear case

However, let us not forget several things. The price of copper is already at a record high, with some of the rise reflecting anticipation of the very trends detailed here. Net speculative long positioning is already very high. As such, there may be less room for metals such as copper to continue advancing than commonly imagined. In fact, the last time copper prices were in this range – in 2011, also shortly after a recession – the price then fell by more than half over the subsequent five years despite an ongoing economic recovery.

U.S. mining output is currently operating at 10% below its pre-pandemic norm. Further, many South American mines are reported to be operating below potential due to ongoing viral outbreaks there. Accordingly, there is some room for existing facilities to increase their supply.

The switch to electric cars and green energy sources will take decades to happen, and ultimately means greater use of certain input materials but diminished use of other inputs. Gasoline-powered cars require resources to produce as well.

More generally, real assets like commodities have very likely benefited from extensive monetary and fiscal stimulus over the past year. The generosity of these programs is set to diminish in the years to come.

While India’s economic growth is genuine, it is unlikely to skew as heavily toward infrastructure as China’s did over the past two decades. This is in part because China has already cornered the market in certain sectors, in part because India lacks the top-down system that drove China, and in part because India’s economy skews more toward services.

The increase in agricultural prices is mostly cyclical – a function of poor harvests in the U.S. and Brazil that will be remedied with the next crop. In fairness, some part may reflect the structural force that is climate change and some may reflect rising wealth in emerging market nations. But the biggest part of the recent spike is surely temporary.

The increase in precious metals prices is largely a response to inflation concerns, rather than an active driver of them. Furthermore, cryptocurrencies represent a potential substitute.

Oil prices have more than rebounded from the pandemic, and one might imagine a reluctance to use public transit encouraging further demand as economies reopen. However, a structural increase in people working from home and a structural decrease in business travel should limit appetite in the short run, with electric cars and the like eating into demand over the longer run. Oil demand is widely expected to peak no later than the 2030s. Simultaneously, OPEC is currently sitting on substantial excess capacity and may be reluctant to allow oil prices to advance too far lest they encourage an accelerated pivot toward green technologies.

It is important to put any commodity price increases in context. Our modelling argues that a 10% increase in the Goldman Sachs Commodity Index maps through to just a 0.5% increase in U.S. consumer prices. Thus, even if commodity prices did rise robustly for years to come, it would argue for perhaps 2.5% inflation, all else equal. That’s a far cry from the current 4.2% rate. Furthermore, if commodity prices manage to remain at current elevated levels, that bleeds fully out of inflation within a year’s time.

Finally, to the extent that China has been the key driver of commodity prices over the past two decades, it is notable that China’s credit impulse has now turned sharply negative (see next chart). This means that Chinese demand for commodities should also slow. Incredibly, China is responsible for 60% of global base-metals demand, in contrast to just 25% from the U.S. and Europe combined.

Chinese credit impulse turned negative

As of Q1 2021. Credit impulse measured as year-over-year change in credit outstanding as percentage of GDP.

As such, while there is the real risk of a commodity supercycle, it certainly isn’t guaranteed. It would likely only apply to certain commodities if it happened, some of it is already priced in, and the effect on inflation may be more moderate than imagined.

Might corporate pricing power drive inflation?

The other risk to our inflation view is if companies start jamming through large price increases. At a minimum, companies are highly attuned to new inflation pressures. The term “inflation” is coming up more than twice as often as it did before the pandemic on U.S. earnings calls.

The National Federation of Independent Business (NFIB) small business optimism index in the U.S. finds that 36% of owners are raising their selling prices – the highest reading since 1981. The size of the planned price hike is set to be the largest since July 2008 – during the last commodity boom.

In Canada, the Business Outlook Survey finds the highest net percentage of businesses planning a price increase since the turn of the millennium, and the country’s Canadian Federation of Independent Business (CFIB) barometer reports an average price increase plan of 3.1% higher than normal.

Providing some small amount of calm, the latest U.S. Beige Book makes only one reference to “pricing power” – in the Atlanta district section – and this is merely referred to as “mixed.” Elsewhere, at the national level, “there were widespread reports of increased selling prices … but typically not on pace with rising costs.” There is a similar finding in Canada. Company-driven price increases are expected to rise slightly less than input costs.

Thus, we can say that businesses are absolutely raising prices, and fairly significantly. But it would appear that, on average, businesses are raising their prices by somewhat less than their input costs. Thus, they are also acting as a slight dampener to underlying commodity and input-cost pressures.

Wage-price spiral?

Historically, inflation problems become chronic when a wage-price spiral occurs. Product prices (or wages) rise, and then the other responds – repeatedly.

Is this a serious threat? It isn’t completely trivial in that some sectors, mostly those that employ lower-skilled workers and those that are now beginning to reopen after long closures, are reporting significant wage increases and challenges finding workers. The Beige Book reports that “wage pressures were modest overall but rising.”

But, on the aggregate, a major boom in wages seems unlikely. In Canada, the average wage increase plan reported by the CFIB is just 1.7% – tame and roughly half the rate of anticipated price increases. In the U.S., the labour market is certainly healing, but not to the extent of being outright tight. One would struggle to anticipate more than around 3.0% wage growth. Recall that the Phillips urve – the relationship between the labour market and inflation – is unusually flat.

Some artificial constraints on the supply of labour should ease as schools and camps reopen, virus fears fade and generous unemployment payments cease. Structurally, wage growth should remain limited by the multi-decade decline in unionization, the rise of a truly global pool of labour and rising automation.

The bottom line is that a wage-price spiral is quite unlikely and businesses are ultimately unlikely to jam through significantly above-cost price increases. Nevertheless, they are capable of passing some fraction of their higher costs along, meaning that higher raw materials prices do have some relevance to consumers and will inform the near-term inflation outlook.

Overall, we would argue that the inflation risk isn’t quite as high as it seems right now, though the annual figure will get worse (with the May data) before it starts to get better into the second half of the year.

Economic tidbits

Dr. Copper

Let us now consider copper prices in a different context – what they can say about the economic outlook. After all, copper is known as the metal with a PhD in economics! More than most materials, copper can be found inside the basic building blocks of the economy. The very fact that copper prices have increased so substantially, to the point of setting records, is a sign of economic optimism about the future.

Chinese movie theatres

Chinese movie theatre ticket sales are now running ahead of pre-pandemic levels on a seasonally adjusted basis. This provides further confirmation that consumers will return to the activities that were long not possible due to pandemic restrictions. More generally, Chinese consumption is rising especially notably for consumer services – the very definition of pent-up demand.

U.S. economy returns to pre-pandemic peak

We believe the U.S. economy is finally back to the vicinity of its pre-pandemic economic peak.

At the sector level, many sectors have already been there for many months (see next chart). Late last year, five of 19 sectors were already past their prior peak. Another four were extremely close – that’s nearly half. And economic growth has been rapid over the ensuing six months.

Pace of recovery varies across industries

As of Q4 2020. Trough since Q4 2019. Source: Macrobond, RBC GAM

Providing some context at an even more granular level (though turning, out of necessity, to Canadian data), the latest Business Outlook Survey finds that two-thirds of Canadian businesses already report sales at or higher than their pre-pandemic norm. So most businesses have been fully recovered for some time, versus a smaller number that remain well short of normal.

Turning, finally, to the actual U.S. GDP numbers, our tracking indicates that the U.S. economy should return to its pre-pandemic peak as of late May. That’s right now.

While this is a symbolic achievement, it is clear that unemployment rates nevertheless remain elevated and the economy isn’t entirely normal. It will take a few more quarters to get back to the vicinity of where the economy would have been if it hadn’t lost more than a year’s worth of growth.

North American housing affordability

Much of the world has experienced a global housing boom, driven by some combination of low mortgage rates, an appetite for real assets and – arguably – too much time spent idle at home.

Interestingly, the effect on affordability has varied substantially by country. Whereas affordability uniformly improved during the early stage of the pandemic as mortgage rates plummeted and home prices briefly sputtered, the story diverges from there.

In the U.S., falling mortgage rates (even after the partial backup more recently) have outweighed rising home prices, with the implication that housing affordability remains better than it was before the pandemic (see next chart).

U.S. housing affordability gap

As of Q1 2021. Fixed floor imposes a minimum “normal” mortgage rate in the affordability calculations, and so reveals how affordability would look at normal mortgage rates. Fixed actual calculates the current carrying cost of a home versus the historical norm. Source: Haver Analytics, RBC GAM

In contrast, in Canada, the two variables played out differently. Mortgage rates fell, to be sure, but home prices then increased by so much that any affordability advantage was more than lost. This data doesn’t even include the first quarter of the year, when home prices rose to an unprecedented degree. Canadian home affordability is now worse than it was before the pandemic (see next chart).

Canadian housing affordability gap

As of Q4 2020. Fixed floor imposes a minimum “normal” mortgage rate on the affordability calculations, and so reveals how affordability would look at normal mortgage rates. Fixed actual calculates the current carrying cost of a home versus the historical norm. Source: Canadian Real Estate Association, Statistics Canada, Haver Analytics, RBC GAM

Finally, and representing a persistent theme for the past five years, U.S. affordability remains much better than the historical U.S. norm, while Canadian affordability remains somewhat worse than the historical Canadian norm.

As such, and looking forward, one might expect more upside from the U.S. housing market going forward than from the Canadian housing market. Then again, that would have been a credible – but incorrect – claim at any point over the past decade! And, even as mortgage rates become somewhat less favourable, there should be a helping hand from falling unemployment and rising immigration. In Canada’s case, immigration may positively skyrocket based on government plans to make up for lost immigration over the past year.

-With contributions from Vivi en Lee and Sean Swift