Hello, and welcome to our latest video MacroMemo. We have much to cover this week.

We’ll talk about the latest infection numbers, and indeed some improvement at the global level. We will talk about the Indian variant and some very real concerns with regard to that, and indeed even risks there could be future waves coming from that variant. And so that will be a subject of focus. I will acknowledge the ongoing process of vaccinations.

We’ll spend a lot of time as well on inflation. And so inflation has just spiked in the latest U.S. reading. We’ll also talk a little bit about the risk of a commodity super cycle, the extent to which corporations have pricing power as well. So a number of different angles on the inflation story, which is also central to markets right now.

And from there we’ll talk a little bit about the journey back to prior pre-pandemic economic peaks. And we’ll also take a look at North American housing affordability, and where that stands. And the story’s actually quite different in the U.S. and Canada.

Let’s begin though with the global infection figures. And just to highlight the main points: global infections are now falling, global fatalities are tentatively falling as well, that’s a trend that’s now been in place for a few weeks.

And we can say when you dig deeper into the data, what you see is still quite a mixed story on the emerging market side. On the aggregate getting better, and India in fact now starting to get less bad at a minimum. But there are other parts of the EM space that are still struggling. And so, for instance, many South American countries still seeing rising caseloads and very significant numbers on a per capita basis.

On the flip side, most—in fact almost all developed countries are seeing some improvement. And that includes the U.S., which is improving gradually I would say, but given that it has very few lockdowns that is nevertheless a positive development. The few states in the U.S. that aren’t actively improving appear to be disproportionally states that are having trouble getting vaccines into arms, and so Mississippi and Alabama being prominent examples of that.

In Canada, the national level is seeing improvements. The biggest provinces are also improving. In fact Quebec is now at a point where its daily infection rate is similar to what it was during the trough between the second and third waves. So it has more or less fully undone its latest wave, which is a good thing. There are smaller provinces though that are still struggling to some extent, including Newfoundland and Manitoba.

Moving from the latest infection numbers though and into the subject of variants. We’ve talked in the past about the main three variants: the UK, the South African, the Brazilian variants. Each dangerous and problematic in its own way.

There has been some awareness over the last several weeks—indeed technically over the last few months—that there’s some sort of Indian variant out there. And now it seems though that variant has split into two. There are two subtypes and one in particular does seem to be quite problematic. In fact it has gone from being a very small share of Indian cases to the slight majority of those cases.

And now we’re starting to get better and better data from other jurisdictions, including the UK, and what we’re seeing is very fast growth of this new Indian variant. In fact there’s been a doubling to tripling of these Indian variant cases in the UK over the last week alone. It is considered by experts to be something like 50% more transmissible than the UK variant.

You should note the UK variant was previously thought to be the most transmissible, and so this makes this Indian variant hypothetically something like 225% more transmissible than the original strain, which is certainly not a good thing. And I guess the problem is we see in the UK, its UK variant, which was the most transmissible, actively declining. And that means that existing vaccines, and existing restrictions, and perhaps warming weather are sufficient to increasingly bring that under control.

However, at the same time we see this Indian variant actively accelerating. And that means essentially that the existing restrictions, and vaccinations, and so on are not sufficient to keep it under control. And so that is quite a concern. And there is a real risk that there’s a fourth wave out there brewing if this continues to play out.

I should note, India seems to be starting to control this itself. It’s possible to control it apparently. In theory, this variant is susceptible to vaccines, and so if you can get enough people vaccinated it will eventually be wiped out, but there’s a higher threshold.

And so whereas maybe the British variant you needed something like 70% to 75% of the population to be immune, it could be with this one suddenly you need more like 80%-plus of the population to be immune, which is quite a high hurdle.

And so unfortunately it means some restrictions have to stick around, and again there is the risk of additional waves even. And so I wouldn’t say that’s a guarantee. I’m certainly hoping it’s not. But that is now in play unfortunately. Vaccinations are moving along fairly well. They’ve gone particularly well, of course, in Israel, which leads the way globally. Though it’s notable that the countries that are furthest along are now seeing a very significant deceleration in the rate of inoculation. Israel quite literally has run out of willing arms to inoculate. It hasn’t quite inoculated all adults, but it’s done as many I suppose as wants to be inoculated, and waiting for full permission on children. And so Israel has slowed quite considerably.

We’re also starting to see some slowing in the UK and U.S. And so these are countries that still certainly have room to go, and there are many people who haven’t been inoculated yet. But nevertheless starting to slow their weekly rate.

And then conversely, places like Canada and Europe, which were well behind, are now racing forward. They haven’t caught these other countries, but they are inoculating at the fastest rate right now, simply because there is still a significant willing population to be inoculated.

And so some convergence is happening on the vaccination front. In general it remains a highly successful undertaking, but nevertheless we’re starting to feel out just where the resistance is and what fraction of populations aren’t that keen to be vaccinated.

To me, the main economic issue and the main economic development in recent weeks is on the inflation front. And disproportionally a U.S. story, though not uniquely one. And so what we’ve seen essentially is U.S. inflation really jump in the latest month’s data.

And so we saw inflation rise from 2.6% all the way to 4.2% on a year-over-year basis with the April data that came out. That was a fair chunk beyond the expectation. Core inflation did something fairly similar, it rose from 1.6% to 3.0%.

And so we’re now in a position where inflation numbers are higher than normal, and it is creating some trepidation. And it’s relevant to the extent inflation were to become a chronic problem it argues for higher nominal bond yields. It argues for lower stock valuations. There are a few different ways that can slice out. And so it’s important to figure out whether this is a temporary, transitory thing or something that’s longer lasting.

We’ve said for some time, we think inflation should be very high in the short run. And indeed we are getting that quite clearly. We’ve thought it should be a little bit high over the medium run over the next few years, and then fairly normal over the long run, if not even with some downward pressure. So we don’t think this is a permanent story.

But when we dig into the details, there are very much real forces pushing inflation higher right now. Some of them are base effects. Just weak inflation from a year ago, falling out of the year-over-year change. But that’s not the only story because we did see genuine inflation heat in the latest month. Prices did rise by 0.8% just in the month of April in the U.S., and so that is genuinely hot.

In terms of why that’s happening, well some of it is a commodity price story. We’ve seen a big commodity boom. Some is container shortages. The cost of shipping via containers is three times higher than normal right now. Some relates to a chip shortage, and that’s playing out in car availability and car prices, and the same with electronics. Chips can be found in almost everything these days.

We know that inventory levels are low at retailers as they restart and prepare for additional activity. Housing-driven inflation is real as well. We see high lumber prices, we can see high furnishing prices, we can see home prices of course rising as well.

And there are some new pinch points in newly possible activities. And so as people start to return to doing things like going on vacation, and eating out, and shopping at the mall, and getting on an airplane, things they didn’t do a whole lot of over the last year, we’re seeing additional pressures in those spaces anew as well. So there are absolutely new pressures and it’s worth evaluating whether this continues.

And I guess I would say a few things. I would say we think we’re fairly close to the inflation peak here. We think the inflation numbers get a little higher in the next reading in May, but probably not beyond that based on what we’re seeing.

Let’s note that as much as inflation’s been very high now over the past year, if you look over the last two years—in other words relative to the pre-pandemic norm—essentially what we’ve seen is a little bit more than 2% inflation per year over two years. We just had one year of really low inflation, one year of really high inflation, and the two are mostly still balancing each other out. I can’t say prices are higher than they would’ve been really absent a pandemic.

We can say that as much as shifting to vacations and doing things that weren’t possible is creating inflation now there, we should equally see less inflation elsewhere in places and things that people are doing a little bit less of as they are now able to go on vacation. And so we should see less pressure on televisions, and electronics, and furnishings, and these kinds of things. So there should be a symmetrical shift that occurs on that front.

It’s also worth acknowledging fiscal stimulus. Americans were given $1,400 cheques in the month of March. And so they spent quite a bit of that, and that drove spending and inflation. We think we’ve seen the biggest amount of that pushed out the door already, and so we’re beginning to see retail sales soften a little bit. Probably less inflation pressures coming from that in the future as opposed to more.

It’s worth also acknowledging there’s nothing inevitable about high inflation after a pandemic. We can say that looking at other countries like Canada and the eurozone, the inflation readings still look fairly normal. There hasn’t been a big spike.

We can say looking at China, which is already all the way more or less out of its pandemic experience. Chinese inflation’s up less than 1% over the last year. That’s quite low, especially for an emerging market nation. So there’s not an inevitability that inflation has to be high.

And we’ve also seen U.S. inflation go temporarily high on occasion in the past. In 2008, it hit almost 6%. In 2011, it touched 4%. And that vanished very quickly. It was gone within a year. It didn’t become a chronic thing. And so, in all likelihood, we will see some decline in pressures this time as well.

And so I would say there are new risks and new pressures, and inflation is quite high right now. Likely is that it peaks next month. It starts to come down somewhat after that. We don’t think we’re into a new regime of high inflation.

Now, there are two risks I think in addition to that worth discussing for a moment in the inflation space. One would be the risk of a commodity super cycle, and we’ve already seen commodity prices move a lot. And some of that is just rebounding from prior lows, but some is commodity prices, in certain cases, going beyond pre-pandemic norms. And if you want to make an argument that there could be a commodity super cycle over the next decade or something like that, you would generally argue the following.

You would say India’s now growing fast like China once did and has a similarly large population and potentially ravenous demand for materials. China’s still growing quite fast for that matter, so it’s not done its own consumption of those materials. There now seems to be something of an infrastructure boom brewing with Joe Biden in the U.S. planning infrastructure initiatives and many other countries perhaps following. That’s the classic thing governments do after a recession. And there’s also a green technology boom, and so there will be more appetite for electric cars and solar panels and things like this, and those require very specific materials like copper and lithium and so on. And so it’s fair to say there is going to be structurally higher demand for some of those things as well.

I guess when we look at it, we say yes, there’s a fairly good argument for base metals prices to be higher than they once were, and for demand to remain elevated in that space. Maybe for forestry products as well, to the extent housing booms aren’t quite done, but we think the increase in agricultural prices are probably a one-off.

We think oil prices still have some long-term challenges ahead, and so they’ve probably done most of the heavy lifting already. Precious metals are something of an echo chamber. They’re high because of inflation fears. They’re not rising for their own reasons and so that settles itself over time we think.

And keep in mind, just looking even more into that commodity super cycle thesis, there is a fair bit of spare capacity in U.S. mines. They’re running 10% below pre-pandemic output levels. They can recover that. That will stabilize metals prices, we think. South America, similarly, running well below normal because the pandemic is hitting those regions so hard, their mines just can’t keep operating. That’s a temporary thing.

We can say the switch to green technology takes time and it means less investment in other things. And so to the extent that people buy more electric cars, they’re buying fewer gasoline cars, and that means less are the materials that go into the gasoline cars, and so it’s not just a carte blanche increase in demand for resources.

We suspect India won’t have as much of an infrastructure-driven growth cycle over the next decade as China did over the last. And for that matter, let’s recognize China now is demonstrating a negative credit impulse. That means the Chinese economy, if anything, is slowing right now, and that’s previously been the biggest determinant of commodity demand and commodity prices in the past.

And so we would say there’s very much the risk of a commodity super cycle, but it’s not a guaranteed thing when we dig into the details. And even if we did get commodities rising at say 10% a year each year over the next decade, we could say that very little of that passes through into CPI. We find that only about a twentieth of the commodity price increase shows up in inflation. And so a 10% commodity price growth per year would actually only translate into a 0.5% addition to inflation per year, a much more tame thing.

A quick word on corporate pricing power, which is we do see corporations raising prices more than they have in quite some time. In fact, some surveys even say the most since 1982, which is kind of a frightening thing given where inflation and interest rates were at that time. But we can say in general, they appear to be passing through their own input costs at less than a one-to-one rate. That is to say if their input costs go up 10%, they’re passing through 9% of that. They’re not actively generating inflation, they’re passing through some of it, but they’re dampening part of it as well. And then similarly, when you really worry about inflation, you worry about a wage price spiral. Big price increases, big wage increases, and back and forth it goes. And that’s actually fairly unlikely in the sense that we’re seeing much less evidence of wage pressures and much less ability structurally for wages to really get into that kind of a cycle. And so we would say this is another upside risk for inflation, but it’s not certain to be something that just creates its own self-fulfilling prophecy.

A moment on the journey back to prior economic peaks and so I’d just highlight the fact that we think right about now, the U.S. economy is now operating at its highest output level ever. It’s recovered more or less the entirety of what it lost during the pandemic. And we’ve seen many sectors there for months and months and months, though not all. We know that the significant majority of businesses are already at or above their pre-pandemic levels of output, though of course other businesses were well below. And now, based on our own GDP tracking, we think in late May, which is as I record this, we think that the U.S. economy is now as big as it was, more or less, in February of 2020. And so it has recovered that lost ground, which is a wonderful thing.

Of course, there’s still work to be done, and so the U.S. economy still has a high unemployment rate, still has work to do to get back to its full potential. Conceivably, that could happen toward the end of this year if the recovery remains quite brisk.

And then let me finish with the briefest of comments on housing affordability. And so clearly, there’s been a global housing boom. I think that’s well established nearly everywhere. It’s been a function of lower mortgage rates driving additional demand and we’ve seen home prices respond quite significantly.

The question is how does affordability play out, out of all of this. Lower mortgages help; the higher home prices hurt; which one wins? And the answer is actually quite varied in the North American context.

We can say in the U.S., the lower rates are still winning. Lower rates have outmuscled higher home prices. Affordability is net improved relative to before the pandemic. And Canada is very much the opposite story. Mortgage rates went down; home prices went up a lot. The affordability is now net worse than it was before.

And so I guess the conclusion or takeaway from that is it would be easier for U.S. housing to continue moving upwards from here, a little bit harder for Canadian housing to. I’ll admit that hasn’t stopped the Canadian housing market in the past; there have been similar theses applied over the last decade or two. But nevertheless, in theory, less upside, though I shouldn’t say no upside whatsoever because we do fully anticipate lower unemployment rates over the next few years, and particularly for Canada, quite substantially higher immigration which is ultimately the driver of population growth.

Okay. I’ll stop there. Thanks for sticking with me through all of this. I hope you found some of it interesting and please consider tuning in again next time.