Overview

Our latest #MacroMemo tackles a wide range of subjects, spanning COVID-19 infection trends, virus-control efforts and a range of economic findings. These include our latest economic forecast revisions, softening economic data, the fundamentally healthy U.S. consumer and new thoughts about inventories. Finally, we find some evidence of peaking inflation.

Positive themes include:

• Many emerging market (EM) nations are reporting fewer COVID-19 infections.
• Even with the Delta variant, economic growth is still proceeding fairly quickly.
• The U.S. consumer is in a strong financial position.
• There may be more upside from future inventory accumulation than we first thought.
• Inflation may be peaking.

Conversely, negatives include:

• The Delta variant is still quite concerning, with a high level of infections globally.
• U.K. infections rose in recent weeks, souring hopes that the U.K. might be through the worst of its Delta wave.
• Booster shots appear to be needed sooner rather than later to limit the spread of COVID-19.
• Inflation remains high.
• The U.S. Federal Reserve took a more hawkish stance, temporarily worrying markets.
• Economic growth is slowing.
• We have downgraded our 2022 growth forecasts and sit modestly below the consensus.

It is fair to observe that many of these factors represent different perspectives on the same subjects. Growth is fast but slowing. Inflation is high but probably peaking. The Delta variant is worrying but declining in many EM countries. There is something for both the optimist and the pessimist.

Virus progress

The number of global COVID-19 infections per day remains high, but is no longer actively rising (see next chart).

Global COVID-19 cases and deaths

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Within this, EM countries are actually starting to enjoy a decline in cases, whereas developed countries are still – on the aggregate – rising (see next chart).

COVID-19 emerging market vs. developed market infections

As of 08/22/2021. Calculated as the 7-day moving average of daily infections. Source: WHO, Macrobond, RBC GAM

The EM improvement is far from universal, but is nevertheless fairly broad. African infections are high but declining (see next chart). Many Latin American countries are also on the mend (see Brazil in subsequent chart). The same goes for many developing Asian nations, including India and Indonesia (see third chart).

COVID-19 cases and deaths in Africa

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

COVID-19 cases and deaths in Brazil

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

COVID-19 cases and deaths in Indonesia

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

That said, there are certainly other EM nations that continue to grapple with their Delta wave. Prominent examples include Mexico, Thailand and Malaysia (see next chart).

COVID-19 cases and deaths in Malaysia

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Developed nations

Among developed nations, the story is extremely mixed in Europe. Cases are falling in Spain, flat in France, Italy, Portugal and the Netherlands, and rising in Germany and Sweden. In Asia, Japan is now suffering its worst outbreak of the pandemic (see next chart).

COVID-19 cases and deaths in Japan

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Turning to North America, Canadian cases are not yet high, but continue to rise at a brisk pace. Colder weather plus the return of in-person schooling seem likely to push it further over the next few months (see next chart). Cases are rising particularly prominently in British Columbia and Alberta.

COVID-19 cases and deaths in Canada

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

The U.S. infection rate is considerably higher, though the pace of increase may now be slowing (see next chart). Almost all states are continuing to deteriorate, though, intriguingly, infections and hospitalizations in Florida might now be peaking (see subsequent chart). It would be unexpected but fascinating if this were sustained, as Florida has been a leading U.S. indicator in this Delta wave.

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

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

State of Florida

As of 08/20/2021. Hospitalization data before 07/10/2020 from Department of Health and Human Services. Source: CDC, HHS, Macrobond, RBC GAM

The U.K. remains important to watch given that it has served as something of a global leading indicator for the Delta variant. A few weeks ago, the situation was extremely promising: not only were U.K. hospitalizations fairly low but the country’s infection count was actively declining, well ahead of expectations. Today, the hospitalization rate is still fairly low but the infection rate is again rising (see next chart). As an aside, the U.S. hospitalization rate is much higher per infection.

COVID-19 cases and hospitalizations in the U.K.

As of 08/22/2021. Source: WHO, Our World in Data, Macrobond, RBC GAM

It would seem that the earlier decline was either an artificial function of the end of the Euro football championships or that the recent increase reflects the lightening of U.K. social distancing restrictions in July, or both. In any event, it remains ambiguous whether the U.K. is pursuing a sustainable course of action, and whether it should be viewed as a model for emerging from lockdown.

Depressingly, Israeli cases are now extremely high as well, despite having administered one of the world’s most thorough inoculation campaigns (see next chart). Fatalities have remained lower than prior waves, but not altogether low. Israel has responded by delivering a third booster to its citizens and restoring its vaccine passports.

COVID-19 cases and deaths in Israel

As of 08/22/2021. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Delta is different

It is widely appreciated that the Delta variant is significantly more contagious than earlier forms of the virus, which explains how it has taken over the world. A recent Chinese study found that those infected with the Delta variant are carrying a viral load that is a startling 1,260 times higher than those infected with the original strain of the virus. In turn, it is much easier to transmit.

Buried in this research was a second finding. The Delta variant yields a positive test result much more quickly than the original virus – just 3.7 days after exposure rather than 5.6 days. While this could be interpreted in a negative way – people get sick even more quickly, very likely because the viral load is so much higher – there is an under-acknowledged positive side as well. One of the most pernicious aspects of COVID-19 is that people can infect one another before they are even symptomatic. The Delta variant appears to be less good at this.

In the end, this observation doesn’t make the Delta variant any less contagious – we’ve already seen that it spreads much more easily in the real world than prior versions, meaning that the higher viral load (and its other evolutionary advantages) are ultimately outweighing the diminished asymptomatic period. But it is at least heartening to realize that the asymptomatic period is in play, and can become less bad.

Vaccine developments

Vaccine mandates/passports

Vaccine mandates and passports are becoming increasingly popular as a policy alternative to the blunt force method of shutting down entire industries. Public sentiment remains mostly favourable.

It is now quite common for governments to require their public service, health care workers and teachers to be vaccinated. The U.S. has now said it will also require its gigantic military to obtain COVID-19 vaccines. Every one of the top 25 U.S. universities now require their students to be vaccinated.

In most cases, there is an escape clause by which unvaccinated people can be heavily tested and still be eligible for employment or schooling.

Mandatory vaccination is not exactly revolutionary – armies have mandated vaccines for hundreds of years. Schoolchildren have long been required to be vaccinated against a range of illnesses.

Now, more and more companies are requiring vaccines. Job postings mentioning vaccination have increased from just 50 per million in February, to 600 per million in July, to 1,200 per million in August. This is admittedly still a puny fraction of the total (0.1%!), but the trend is nevertheless explosive. Also, many employers may not mention vaccination in their job listing but nevertheless require it.

Some companies are mandating vaccines not just for their employees but for their customers. Cruise ships have greatly restricted non-vaccinated customers and this has held up to legal challenges. Some sports teams are now requiring fans to be vaccinated or to bring a fresh negative test.

It is also increasingly common for governments to require proof of vaccination for residents to engage in a range of activities such as boarding public transportation, eating in an indoor restaurant or going to the gym. Israel famously did this; France and Italy now have a similar program and more are sprouting up. In Canada, Quebec has such a program and British Columbia is on the cusp of introducing one.

Canada also now plans to require all federal public servants to be vaccinated, along with those employed in federally regulated industries and those travelling by airline or rail. Federally regulated industries include banking and telecom.

Booster shot

A growing number of studies find that vaccine protection fades surprisingly quickly. A new British study reports that the Pfizer vaccine’s efficacy for those aged 35—64 falls from nearly 80% two weeks after the final dose to just 60% 100 days after the final dose.  The efficacy appears to continue declining from there.

Paired with the lower efficacy of vaccines against the Delta variant relative to the original virus, the clamour for booster shots is only growing louder. Many countries are now committing to delivering boosters over the coming months, either to a vulnerable subsection of their population or to everyone. Israel has already inoculated 14% of its population with a third dose.

A preliminary study of those aged 60-plus finds that a third dose increases protection by a factor of four times against infection and five to six times against serious illness or death.

While this is helpful, it undermines the vaccination campaigns of developing nations who must again battle with wealthy nations for a limited number of vaccines.

Limited lockdowns

Despite the spread of the Delta variant, lockdown efforts have been used only sparingly. Instead, some countries are allowing the virus to spread with the hope of keeping hospitalizations down and/or counting on people to organically change their behavior. Many countries are also pursuing vaccine mandates or passports as discussed earlier.

Still, some tightening is visible, especially in countries that have historically pursued a zero-tolerance policy toward the virus. These include China, Australia and New Zealand. China has locked down pockets of the country that have been stung by the Delta variant, such that Goldman Sachs now estimates that the Chinese economy may temporarily be diminished by 4% relative to before the lockdown. To be clear, China’s economic output would only be 4% less if such restrictions were maintained for an entire year. So far, it has only been a matter of weeks.

Elsewhere in the developed world, our lockdown metric reveals countries that have either stopped actively reopening or are slightly tightening their rules (see next chart).

Severity of lockdown varies by country

Based on latest data available as of 08/08/2021. Deviation from baseline, normalized to U.S. and smoothed with a 7-day moving average. Source: Google, University of Oxford, Macrobond, RBC GAM

Downgraded economic forecasts

Our latest working GDP forecasts continue to anticipate strong growth. However, the estimates for 2022 are now moderately lower than before, and also slightly below the consensus (see next table). We are roughly in line with the consensus for 2021 – unsurprising given that nearly two-thirds of the year is already complete.

RBC GAM GDP forecast revisions

RBC GAM forecast as of 07/30/2021. RBC GAM vs. CE (Consensus Economics) calculated as RBC GAM forecast minus CE forecast. Developed countries include U.S. Canada, Eurozone, U.K. and Japan. World includes developed countries aforementioned, plus China, India, South Korea, Brazil, Mexico and Russia. Source: CE, RBC GAM

Several considerations support this thesis of below-consensus and decelerating growth:

• The consensus is very strong, leaving little room for positive surprises, particularly at a time when recent economic surprises have lately slipped from positive to negative.
• With particular relevance to the U.S., there should be considerably less buoyancy in 2022 than 2021. After all, we expect the remaining U.S. economic slack to be gone by early 2022. Normally, economic growth slows considerably once a country reaches its economic capacity.
• We believe pent-up demand will fade over time as the novelty of reopened sectors fades (though, as discussed shortly, consumers are still in very good shape).
• The next year will see a fiscal drag no matter how large the U.S. infrastructure plan is.
• Central banks are now signaling some reversal of monetary stimulus for 2022, however slight.
• On balance, we judge that there are more downside risks than upside ones surrounding the base-case forecast.

Despite all of this, economic growth should still be good and we believe the business cycle remains at an early stage. This is entirely consistent with further moderate gains for risk assets, but it may be harder to replicate the ebullient gains of the last year.

Fed primes the pump

The U.S. Federal Reserve’s recent Minutes were incrementally more hawkish than before, triggering a temporary bout of market alarm. While the ongoing pandemic and risks therein were acknowledged, the focus was on improving economic conditions and the progress being made toward policy objectives in recent months.

The Federal Reserve participants didn’t quite deem their criteria of “substantial further progress” to have been met, but that objective appears fairly close. In turn, the Fed is likely to begin tapering its asset purchase program between October of this year and early in 2022.

While risk assets initially choked at this prospect, they have since seemingly come to terms with it. It is crucial to understand that tapering is not a removal of stimulus but rather a slowing of the rate of stimulus delivery. The Fed will buy fewer bonds, rather than outright sell bonds. Furthermore, it is not the first country to do this – the Bank of Canada has been tapering for a few quarters, as have some others.

Fundamentally, financial markets should be happy when central banks are doing the right thing, not just when they are delivering stimulus. Sometimes, tighter policy is the best possible strategy for keeping the economic expansion going because it minimizes the risk of overheating. That arguably describes the Fed over the next few years.

Further insight may be gleaned at the annual Jackson Hole summit later this week, including a speech by Fed Chair Jerome Powell on August 27. Occasionally, Fed chairs have rocked the market with their comments at the summit. The title of the speech leaves open that possibility: “Economic Outlook.” Yet it would be strange to use a conference to signal a change in monetary policy direction given that:

• The Fed has already given the market a fresh sense for its plans.
• The modern Federal Reserve now affords ample opportunities to communicate with the public and financial markets via statements, Minutes, dot plots, press conferences and the like.

Softer real-time indicators

A variety of real-time economic indicators point to a slackening of economic growth in the latter part of the summer. However, in some cases there are debates about the extent to which this reflects seasonal distortions (vacation season) versus fundamental drivers such as the Delta wave or fading fiscal stimulus. Real-time hours worked data recently slipped after a long period of gains (see next chart).

Percentage change of hours worked by hourly workers in the U.S.

As of 08/10/2021. Impact compares hours worked in a day vs. median for the same day of the week in January 2020. 7-day moving average shown in chart. Source: Homebase, RBC GAM

Similarly, office occupancy recently declined across nearly every major U.S. city (see next chart). One might argue this is due to people going on vacation, but there wasn’t an obvious drop last August. That said, it is conceivable that the growth tailwind was so enormous last summer that the usual seasonal pattern was invisible.

Office occupancy of U.S. metropolitan cities

As of the week ending 08/04/2021. The Barometer represents the weekly office occupancy based on swipes of access controls. Source: Kastle Systems, Bloomberg, RBC GAM

The number of global commercial flights also appears to have dipped recently (see next chart).

Commercial flights tracked by Flightradar24

As of 08/11/2021. Include commercial passenger flights, cargo flights, charter flights and some business jet flights. Source: Flightradar24 AB, RBC GAM

Delta damage

In addition to the tentative damage revealed in recent real-time indicators, there has also been some Delta-influenced weakness visible in more traditional indicators. For example:

• S. retail sales fell 1.1% in July, though the decline was disproportionately related to extremely volatile vehicle sales. Curiously, big retailers including Walmart, Target and Lowe’s have all recently upgraded their outlook, so consumers are not universally falling out of bed. Back-to-school spending has been cited as being particularly strong, perhaps aided in part by a new child tax credit in the U.S.
• More startlingly, the University of Michigan’s consumer sentiment metric collapsed in August, from a mediocre reading of 81.2 to an awful one of 70.2. For context, the new reading is below the worst reading from the spring of 2020. But we are skeptical the world is truly ending. For context, confidence was at this level for several years after the global financial crisis and yet the economy nevertheless grew, and we have not seen other metrics that report such a sharp drop in August. A competing measure from the U.S. Conference Board will be released in the coming days, and probably won’t announce as extreme a decline.

These are unwelcome developments. But we are dubious that the U.S. economy will outright shrink. We have already accounted for Delta-influenced weakness in our forecasts, and we have long expected slower GDP growth in the second half of the year.

Households in good shape

Whether U.S. consumers spend or not, it is undeniable that they are in good financial shape. The country’s household financial obligations ratio is the lowest in decades, and sharply better than it was before the crisis (see next chart). At essence, households have an extra two percentage points of income sitting around that used to be dedicated to servicing debts. Interest rates should gradually rise over time, but it will be a long time before the average household is again stretched.

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

As of Q1 2021. Source: Federal Reserve Board, Macrobond, RBC GAM

Similarly, household net worth remains quite high – not exactly of a surprise given the appreciation of home prices and the ascent of the stock market, but this is still a source of strength for households.

U.S. household net worth very high despite the pandemic

As of Q1 2021. Shaded area represent recession. Source: Federal Reserve, Haver Analytics, RBC GAM

As we argued two weeks ago (See the “?”), we are dubious that households will spend much of the excess savings they have accumulated over the past 18 months. Most of this will likely remain in the form of financial wealth.

However, there is still some spending upside to come. The simple process of whittling elevated savings rates back to normal should unleash some additional consumer spending over time. U.S. households are currently saving 10.9% of disposable income. Should they revert back to the pre-crisis norm of 7.4%, that shift would represent another 3.5 percentage points of income that could be deployed as spending. This won’t happen instantaneously and will be significantly offset by declining government spending. But the point is that the household finances and the consumer outlook both remain bright even as a few recent economic clouds have come across the sky.

More positive on inventories

A few months ago we mused that companies might slow their rate of inventory accumulation over the coming year based on a survey suggesting businesses were already ahead of schedule in their stock-building efforts for 2022.

However, since then, more evidence has accumulated on the other side of the ledger – arguing that inventory accumulation could actually be a driver of growth over the coming year.

The U.S. inventory-to-sales ratio is actually fairly low right now. This suggests an eventual need to replenish (see next chart). It isn’t quite an ironclad argument given that the inventory ratio remains higher than at an equivalent point in the prior cycle. For that matter, two of the last three business cycles experienced steadily declining inventory ratios. But the most recent cycle had a rising inventory ratio over time, and it makes sense that companies would grow more confident with time – holding more inventory as they do so.

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

As of May 2021. Real inventory-to-sales ratio of all manufacturing and trade industries. Shaded area represents recession. Source: BEA, Haver Analytics, RBC GAM

Fortunately, we don’t need to idly speculate about what businesses might do next with regard to their inventories. There are surveys that can inform us (with the caveat that an earlier survey arguably misled us!). The National Federation of Independent Business’ flagship survey reveals that small- and medium-sized businesses find their current inventory level to be too low, and logically plan to increase their inventories (see next chart). It is already likely that the third quarter of 2021 will enjoy a positive contribution from inventories as a drawdown from the prior quarter is offset.

U.S. businesses think their inventories are too low

As of Jul 2021. Shaded area represents recession. Source: NFIB Small Business Economic Survey, Haver Analytics, RBC GAM

Lastly, businesses should arguably want larger-than-usual inventories right now. Most are growing quickly and many were burned by the sudden disintegration of supply chains at the beginning of the pandemic. Just like companies wanted more financial liquidity after the global financial crisis, they may want more inventories after the pandemic. The difficult debate for many will be whether to build inventories now – when shipping costs are enormous and certain supply chain issues persist – or to cross their fingers that such matters are resolved before the holiday season.

Inflation check-up

U.S. inflation finally eased a notch in July. While the annual reading remained at an elevated +5.4% YoY, the monthly change cooled. It fell from a white-hot +0.9% month-over-month (MoM) to a warm +0.5%. That represents the slowest rate of monthly inflation since February, though it is far from slow. Core inflation similarly softened, down from +0.9% MoM to +0.3%. Tentatively, then, we may be past the worst of the inflation spike.

Confusing matters, Canadian inflation actually jumped in July, from +3.1% YoY to +3.7%. This partially undermines the story we had been telling before of inflation that was seemingly already beginning to decline in places like Canada and the Eurozone. But the fact remains that the Canadian inflation rate is a lot lower than the U.S. rate, despite a seemingly similar set of global influences. That still argues for less U.S. inflation over time, and we still believe Canada is in the realm of its inflation peak.

There are several other considerations that also argue inflation is unlikely to get much worse.

While U.S. wage growth has undeniably increased in certain sectors such as leisure & hospitality and retail, the overall rate of wage growth remains no more than robust (see next chart). It is a similar story when one slices wages by skill level. Low-skill workers are receiving larger wage increases, but the numbers are far from crazy (see subsequent chart). The point is that a wage-price spiral remains unlikely.

Wages of low-skilled workers growing faster than national average

As of Q2 2021. Shaded area represents recession. Source: BLS, Haver Analytics, RBC GAM

Wage growth of low-skilled workers returned to pre-pandemic levels

As of Jul 2021. 12-month moving average of median wage growth. Source: Federal Reserve Bank of Atlanta, Haver Analytics, RBC GAM

Notably, manufacturers are now complaining about high input prices and sluggish supplier deliveries a bit less than before (see next chart). This hints that certain supply chain constraints are becoming less intense.

U.S. manufacturers grapple with elevated raw material prices and slow delivery from suppliers

As of Jul 2021. Source: ISM, Haver Analytics, RBC GAM

Indeed, our primary measure of shipping costs, while not yet declining, has seemingly levelled off for a moment (see next chart). Another shipping cost series, from Freightos, now claims that container shipping costs from East Asia to the U.S. are finally beginning to decline, though the improvement isn’t yet visible on routes to Northern Europe.

Shipping costs soared during the pandemic

As of the week ended 08/12/2021. Source: Drewry Supply Chain Advisors, RBC GAM

A risk: as China locks down pockets of its country, some Chinese ports have been caught up in the web, potentially worsening supply chain issues.

Lastly, it is quite heartening that the wildest inflation driver – used car prices – is now beginning to ease at the wholesale level (see next chart). One might credibly argue that car prices should remain somewhat elevated for the foreseeable future, but probably not to this extent, and definitely not at the recent rate of price increase.

Wholesale used car prices retreating from peak, but still elevated

As of Aug 2021. Shaded area represents recession. Source: Manheim Consulting, Bloomberg, RBC GAM

-With contributions from Vivien Lee and Lucas Hervato