Eric Lascelles - Managing Director, Chief Economist and Head of Investment Strategy Research

Hello, and welcome to our latest video #MacroMmemo. As always, we have quite a lot to cover off here. And so we're going to run our way through a number of things. We'll talk a little bit about the recent economic data – but actually framed in the context of ‘bad is good.’ So I'll explain that in a moment, if that's not already clear to you.

We'll talk for a moment on the Strait of Hormuz, which is beginning to allow some energy to flow. But it is a tricky situation.

We're going to talk about, get this, the economics of space. And so not trying to calculate GDP or demand and supply, but just the sort of industries that are growing and there is some excitement around and how viable they are and so on.

We'll also talk for more about physical artificial intelligence. We spend so much time on large language models, but there are robots or other things that are actually fascinating and moving forward quickly. So we'll talk about that.

And then we'll spend brief moments on bank lending, which is growing. It's a good macro signal. Also on Kevin Warsh as the new U.S. Federal Reserve (Fed) chair.

That era begins, so we’ll look at some of the things that we've seen tentatively so far.

And then Canadian housing. There are some signs of life that emerged over the spring. We're ultimately a little bit skeptical this is a new leaf, but we'll acknowledge those never the last. So that's the plan. Let's start at the top.

With that ‘bad is good’ claim – and I'm overstating the case for sure – but to maybe to rewind a few months, in the spring financial markets were worried about the energy shock, the economic damage it might do to economies. And so, the concern was economic weakness. And when good, strong economic data came out, there was celebration.

The stock market went up, not down.

It is getting more complicated now. And so, as an example, there was a U.S. payrolls miss not long ago, as I'm recording this. It was 57,000 jobs created. The expectation was a low, six figure type of number. It was okay, but it did miss expectations. And the stock market actually went up a little bit.

So that does lend itself to the tentative conclusion that we are in a ‘bad is good’ mode right now, within reason, obviously. Right now, arguably the stock market and risk assets are more worried about overheating than they are about a recession, about too much good economic growth. What they want and what we really we want is the economy to move and grow at a solid pace.

Too much growth would threaten to further increase inflation and force Fed rate hikes eventually. Maybe compromise the economic cycle and markets. And so not to say that a horrible number would be good, because that's not true either. But I guess there's a sweet spot here. What we're looking for is decent growth.

And actually that is broadly what has been happening.

Okay. On to subject number two. Let's talk about the Strait of Hormuz, of course, in the context of the U.S. and Iran. As of mid-June, as you would know, there was a memorandum of understanding between Iran and the US. Part of that was to allow the Strait of Hormuz to permit the transit of vessels and tankers and ships and so on and unclog the energy market.

It's been a shaky ceasefire, you might say. There have been some flare ups, including in recent days. But the bottom line is ships are getting through more often than not, the number that we're tracking is rising. It’s up to about a quarter to a third of the normal transit. We're seeing empty tankers come in as well.

So the expectation, it would seem, by insurers and by shipping companies and producers is they can produce, they can provide this material to the ships, and the ships should be in a position to get out as energy production revives.

In particular, you would think these numbers can continue to go up. And certainly if you look at the oil market, it is feeling awfully confident. The price of West Texas oil, as I record this, is sub $70 a barrel. It looks pretty similar to where it was before the war began. And so, that is the market saying they think this will continue to normalize.

That's our base case too. We think that is reasonable. We can see real-time inflation metrics already looking lower, which is great. We should get better inflation prints if this holds over the summer and hopefully into the early fall. We would flag just in the risk department that this deal isn't fully settled. There's 60 days to sort out some additional things.

Whether Hormuz gets told or not . . . how or if those $300 billion investments into Iran occur and from who and so on . . . whether Israel, Lebanon, Hezbollah fighting will stop . . . whether Iran will give up its nuclear material. So it's really not quite done. We do think they will find their way to an imperfect deal and noses will be held and so on.

But there is a little bit of a risk here, so I do want to flag that – as much as for the most part, it is a good news story.

Okay, on to the economics of space. So space is just increasingly in focus on a couple of fronts here. Obviously, the SpaceX IPO recently and valuation of 2.1 trillion is pretty extraordinary all by itself.

But also we have seen major achievements in the realm of SpaceX recently with reusable spacecrafts and return, unmanned missions to the moon. You would say at this juncture a number of prominent companies, none more so, of course, than SpaceX. And so I think it is a natural question to ask what kind of economics can we expect?

How big is the industry? And so on.

One good estimate from the World Economic Forum and McKinsey is that the space economy can grow at a pretty impressive 9% per year pace through 2035. So pretty high single digit growth rates. If that occurs, it would be a US$1.8 trillion market by then, which is significant.

Now it's not nearly a big fraction of the global economy, but still, real numbers. We did a bit of work just evaluating kind of the near-term industries in the medium and long-term story as they might play out. I would say certainly the near-term projects seem viable, seem realistic. You probably can achieve growth rates of the sort that those estimates I just mentioned have provided.

And so continuing to provide launches for national space agencies, that should continue, maybe intensify . . . space-oriented defense spending at a dangerous time for the world likely to continue to rise. Enhanced satellite communication likely continues, too. We've seen the viability of that. Can it now provide not just access for rural people without traditional telecom access? Could it be the central telecom provider?

It's possible, though unclear at this point.

Space tourism is pretty niche but can probably grow. Cargo transportation to the moon –actually, SpaceX is commissioned by NASA in the next few years to start doing that as part of a plan to return to the moon. So there are some relatively near-term industries.

They can probably manage some growth. All are technically achievable.

We would say when you turn to the medium- and long-term aspirations, and obviously you can challenge some of the skepticism I’m about to express as a failure of the imagination. But it is much less certain and a key issue is the cost of launches.

Now, those have come down incredibly tenfold over the last 20 years. That is pretty remarkable. You don't see tenfold anything in most industries. To make some of these viable, though – in particular the space-based data centres that you hear some talk about – you apparently need to achieve another 18-fold improvement in the cost of a launch.

And so that is pretty hard to fathom. I gather it's not impossible. If the current rate of improvement were to continue for another 8 or 9 years you could plausibly get there. The cost of fuel is not actually the impediment that I assumed it might be when initially examining this. It's a pretty small fraction, less than I would have thought.

Nevertheless, it is a big leap of the imagination. But I think you can get there. So some of these medium-term aspirations are very dependent on that – and that is not clear.

A space-based data centre is an exciting idea. You harness the sun for the electricity which gets around a pretty big terrestrial issue. But you need solar panels that are hundreds of meters across.

The cooling needs would require builds almost as big as the solar panels. Radiation is an issue. Communication is an issue. You do need to get it up there as per the cost conversation. Maybe it happens, but it's far from certain, at this point, at any kind of scale.

Lunar resource extraction is possible, but awfully complicated to be doing mining entirely remotely without humans and so on on the moon.

In-orbit manufacturing, there are some theoretical advantages in the context of bigger pure crystals and a finer application of materials and so on. But it’s pretty complicated to do any kind of manufacturing in space.

We will see also some pharmaceutical charm there as well. There's talk of point-to-point Earth travel.

You could travel from New York to Shanghai in 45 minutes if you did it through space, which sounds pretty incredible – but, gosh, that would be very expensive. Arguably somewhat dangerous. But I should intercontinental ballistic missiles do exactly that. This is a known thing, though not with humans in it right now.

You need perfect weather and so how many days could you actually do this? The noise is incredible. You couldn't be near cities, which kind of diminishes the charm. So we're a little bit skeptical of that as well.

And then the long-term aspirations, kind of the really hard things, would require such scientific advancements and so on.

Asteroid mining and large-scale colonies and so on. And so we would say really to conclude here, the near-term seems achievable. There can be, we think, impressive growth in the coming years. Medium- and long-term is a lot harder. High uncertainty, unclear ability, requires new tech, requires significant efficiency gains. Would need to create entirely new industries.

In some cases, the scale is unprecedented or challenging. And so, I guess a bit of cold water on the medium or long run. Maybe you can circle around and express a bit of SpaceX skepticism or something like that, but that's not really the point of this. Nor is this a line-by-line critique of the SpaceX business.

Actually, the biggest part of their expected revenue is ground-based AI, which has nothing at all to do with space. So, maybe a separate conversation there.

Okay. Let's keep pushing forward here. Physical AI: so this is something else we've thought a lot about. We've done, I'd like to say, quite a bit of work on artificial intelligence over the past several years.

We mostly focus, though, on the large language models, the models getting built out and sitting on your phone and computer. But what about physical artificial intelligence? That's a broad subject. It includes autonomous vehicles, self-driving cars. It includes drones if they're using AI and not just being guided by a remote control. Also industrial robots, humanoid robots, etc.

And so, to an extent, they're already here, right? I mean, Waymo Robotaxis are a pretty prominent impressive example. Warehouse automation is ongoing and significant. Factory automation has long been significant but continuing as well. Humanoid robots, that's a little bit more early stage right now. But potentially it’s a fairly powerful trend. You do have some credible analysts out there estimating physical AI could reach almost a $500 billion market by 2030.

Bloomberg has actually estimated it could be a $2.3 trillion market by 2032, so some differing numbers there, but the idea being quite a bit of growth, China is leading the way. There are a couple of things to think about as physical AI rolls out.

So we talk about white collar labor disruption being a risk for the AI natural language models. This is actually more of a blue-collar labour disruption risk. Though the counterpoint would be that with wealth and prosperity and efficiency, often you do find other good jobs, and you would certainly need skilled jobs operating and designing physical AI.

Just to conclude really briefly, and check out the written version of our #MacroMemo if you want more. This is an important AI channel. It's not presently getting the attention it merits. We're giving it a little bit of attention and it could be actually a significant source of efficiency gains on the manufacturing, construction and transportation side, etc.

Okay. I'm going to zip through three things here. Let's see how well I pull this off. First, just an observation on bank lending. We've been looking at bank lending growth across a range of developed markets. It is picking up. We are seeing a clear acceleration in the U.S., in the eurozone, in the UK, in Japan. I would say that is a positive macro signal for three probably fairly obvious reasons.

One would be, on the supply side, banks seemingly are in a position to lend, so they must be well capitalized, enjoying deposit accrual and so on. They must think that their customers are worthy of loans. And so that's a positive economic signal.

On the demand side, if businesses in particular believe now is a good time to borrow, they must believe there's an opportunity for growth at a good return on capital.

To the extent that lending is happening just mechanically, that is increasing the money supply. That's how it works in a fractional reserve banking system. It's a bit like quantitative easing. There's more money sloshing around. That's a positive macro signal as well. So broadly good news for Canadians.

I'll just say Canada actually is not seeing bank-lending growth of particular note right now.

Of course the housing market is still relatively cool and I'll talk about that in a moment. I will say, though, Canada has lightened some regulatory rules, though in some capital requirements. It could get going a little bit more over the next few years

Let's shift to the Fed. Kevin Warsh, the new era begins.

He's the new Fed chair. He's done his first meeting, his first press conference. In terms of takeaways, no shockers, but I would say, as expected, less communication going forward. So less transparent. Didn't provide his own forecast, by the way. He plans to provide less forward guidance. Too much forward guidance, he thinks, is a bad thing.

He's been viewed going into this as potentially dovish, a Trump pick and so on. But you know what? He may be trying to counter that. He very much focused on inflation in his first meeting, burnishing his inflation-fighting credibility. We know he wants a smaller balance sheet over time for the Fed. And so I don't think this is going to radically change the conduct of the Fed.

But we are going to see some real changes in communication and forward guidance. And maybe they will manage to shrink the balance sheet a little bit. And it makes sense to us that the yield curve is going to be a little bit steeper, perhaps, on his watch. No urgency for rate hikes at this point would be our judgment, particularly as the Strait of Hormuz starts to reopen.

Finally, let's talk Canadian housing. So we are seeing some signs of life. I'm going to pour a bit of cold water on that in a moment, but let's enjoy it before that. And so, of course it had been a very weak market. Home prices are down substantially over the last several years, housing sales and activity and construction (less so construction).

But the rest down as well. Of course, it’s not a single market. The housing market is actually strong in Quebec right now, strong in Alberta right now. So it's varied, but Ontario and B.C. in particular have been quite soft. Even there we are seeing some recent data showing a few green shoots. Home sales increased in April and May and inventories tightened and prices stabilized.

And so there is some new strength. There is some logic to that. Unemployment has stopped rising in Canada, lending conditions have stopped tightening among banks. The government is encouraging construction, removing GST from new home purchases. It would make sense if there was extra demand. All that said, though, we're assuming strength is still some distance off.

We think this is probably more of a seasonal upswing. We've had a few of those, in recent years in the spring as well. Don't forget that affordability is still challenging. Mortgage rates are actually no longer falling. They've actually gone up a little bit. Price expectations are subdued, so the fear of missing out is low.

People aren't racing in to avoid higher prices later. And rental affordability is improving, which means that renting is relatively attractive compared to owning right now. So we're still assuming, at least nationally, and in particular in Ontario, we see a subdued period for housing over the next year or two in the largest markets.

But we are getting a little bit of strength here, and it's actually a bit more notable this spring than prior springs. So let's watch closely just in case we're wrong and it is the start of something more enduring.

Okay, I'll stop there. Thank you so much for your time. I hope you found that interesting and above all, useful.

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