MacroMemo | 12 September 2023

Sep 12, 2023


Ukraine war update

Since we last wrote on the war in Ukraine there have been a number of developments.

From a military perspective, Ukrainian forces have broken through part of Russia’s defensive line, raising hope that further significant advances may be possible in the coming weeks. However, further gains are likely to be incremental as Russia is well dug in.

The former head of Russia’s mercenary Wagner Group, Yevgeny Prigozhin, died in a suspicious plane crash not long after staging an aborted insurrection against the Russian state. The combined effect of these two developments is that Russia’s highly effective Wagner Group fighting force is significantly diminished in Ukraine.

Oil prices continue their ascent, exceeding U.S.$90 per barrel for Brent and just below the threshold for West Texas Intermediate (see next chart). This is a sharp increase from less than U.S.$70 per barrel over much of the summer.  In truth, the reasons have less to do with Russia, and more to do with production restraints set by the Organization of Petroleum Exporting Countries (OPEC) that are expected to be extended, underpinned by Saudi Arabia’s desire for $90-plus oil prices, plus a pinch of economic resilience that has allowed demand to remain elevated. This has implications that include additional inflation around the world, economic weakness for oil importers, and economic strength for oil exporters. Russia, of course, benefits, with potential relevance for the military outlook.

Oil prices surge lately on production cuts by OPEC+

Oil prices surge lately on production cuts by OPEC+ chartAs of 09/08/2023. Source: Bloomberg, Haver Analytics, RBC GAM

Ukraine remains without a Russian grain deal, greatly complicating the country’s food exports via the Black Sea. The expectation is that Russia wants concessions from the West before signing onto another deal. Specifically, Russia claims that the West is not honouring a separate agreement that was meant to permit Russian agricultural exports to reach export markets (though Russia managed to export a record amount of wheat over the past year, despite this). Ukraine is now working on a plan that would see the Ukrainian government take the first insurance loss on damage to ships transporting Ukrainian grain. This would make insurance coverage for Black Sea routes more affordable.

Finally, the Russian ruble continues to plummet, as it has for much of 2023 (see next chart). After initially collapsing during the early phase of the Ukraine war, the ruble had then more than reclaimed its lost territory. Recent weakness is now taking the currency back to levels not experienced outside of the early months of the war, and the trend isn’t necessarily over yet.

The best explanation is that the Russian economy managed to delay a substantial portion of the economic pain resulting from widespread sanctions, but the impact is finally hitting home. As an example, much of Russia’s energy infrastructure relies upon foreign technologies and parts, and as components break down under regular use, it is becoming much harder to replace them. Indeed, the consensus forecast for Russian gross domestic product (GDP) growth in 2024 and 2025 is worse than that of 2023.

Ruble has been falling against USD since EU imposes ban on Russian oil

Ruble has been falling against USD since EU imposes ban on Russian oil chartAs of 08/26/2023. Source: Central Bank of the Russian Federation (CBRF), Macrobond Financial AB, Macrobond, RBC GAM


Technology boom

The jury remains out on the extent to which generative artificial intelligence (AI) technologies will revolutionize the world. We budget for a faster pace of productivity growth over the coming decades, but it is hard to say by how much, or the effect in any one year.

In the short run, the effect of the new technology is mainly through a different vector: additional capital expenditures on technology. We continue to note that the sums involved aren’t enormous relative to the colossal size of national economies. But chipmaker Nvidia – fabricator of the computer chips of choice for those training these new AI systems – is nevertheless raking in money. The company’s latest quarterly report revealed a big $13.5 billion in revenue, substantially higher than the $11 billion forecast the company provided three months ago that – at the time – had utterly shocked financial markets.

Nvidia’s data center revenue is now $10.3 billion, more than two and a half times what it was just six months ago. So the technology investment boom is real and might add up to 0.5 percentage points to the level of U.S. GDP so long as it lasts. The sum would be considerably smaller in most other countries. This amount might grow further with time, as the Nvidia CEO indicates that the company is nowhere close to meeting demand. But capacity cannot increase overnight in the chip sector. Again, as significant as the capital spending (capex) boom is, the real question is the extent to which these investments will allow for radical society-altering technological change – but that comes later.


Canadian wobbles

The Canadian economy reported a decline in Q2 real GDP – the second quarterly decline out of the past three (see next chart). This points to an economy not performing well, though the level of concern should be tempered by the fact that GDP rose nicely in the one quarter that did manage a gain.

Canadian economy contracted in latest quarter

Canadian economy contracted in latest quarter chartAs of Q2 2023. Source: Statistics Canada, Macrobond, RBC GAM

We recently entertained the possibility that our recession call might prove correct, but only in retrospect – in the sense of “ah, so that period of wobbly activity we just went through officially netted out into a few quarters of consecutively declining output – short-hand for a recession.” But this scenario is fairly unlikely.

Historical recessions have included broadly based economic suffering, substantial job losses and acute financial market discontent. None of that happened in recent quarters. All of those things are unlikely to go unnoticed in real time. We may not know the day a proper recession begins, but we should have a clear sense that all is not well while it is happening, as opposed to learning about it months later.

It continues to be a bad sign and frankly perplexing that the Canadian economy has added a significant number of workers, yet manages little to no additional production with their extra assistance. Productivity in the second quarter again fell sharply.

On the subject of Canadian employment, August managed a solid 40,000 job gain. We hesitate to described this as “excellent,” even though it would once have merited that label. Canadian population growth is now so fast that even 40,000 jobs in a month aren’t enough to absorb the rising tide of available workers. The details of the report revealed a mix of good (hours worked rose by 0.5% month-over-month) and bad (private-sector employers didn’t add any workers).

As with GDP, there is evidence of sputtering: Canada has experienced two months of declining employment out of the last four, though the gains have outpaced the declines.


Mixed signals from the U.S. economy

The U.S. economy spans the extremes.

At the happy end of the spectrum, the Institute for Supply Management (ISM) Services Index for August rose from 52.7 to a robust 54.5. The ISM Manufacturing Index edged upwards from 46.4 to 47.6.

U.S. third-quarter GDP is now tracking an utterly ebullient 5.6% annualized gain according to the Atlanta Fed’s nowcast. That’s a big enough number to put significant upward pressure on the country’s overall 2023 GDP print. Recent contributors have included a large 0.8% personal spending increase in July, though the fact that personal incomes only rose by 0.2% adds to the narrative that U.S. consumers may be nearing their spending limits.

Fascinatingly, Bloomberg Economics figures that 0.5ppt was added to third quarter GDP growth by a cluster of pop culture phenomena: Taylor Swift and Beyoncé concerts, plus the “Barbenheimer” double blockbuster in movie theatres!

We now pivot from the “good” to the “OK, but slowing” department. U.S. Payrolls for August managed 187,000 new jobs, a perfectly respectable number and technically a little higher than the consensus expectation. But the rest of the report tilted toward a weaker interpretation. Due to 110K of negative revisions, the past three months have now all undershot the 200K job creation threshold after 29 consecutive months in which that didn’t happen even once (see next chart).

U.S. employment still growing but slowing

U.S. employment still growing but slowing chartAs of Aug 2023. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

The unemployment rate has now increased to 3.8%, from 3.5% the month before and an earlier low of 3.4%. Sahm’s Law finds that when the 3-month moving average of the unemployment rate increases by just half a percentage point, that signals the onset of a recession. There is still some distance to go before the 3-month average manages that (as opposed to the individual monthly prints, which are now close), but an upward trend for the unemployment rate is now tentatively in place (see next chart).

Not much room for cooling the economy without triggering a recession

Not much room for cooling the economy without triggering a recession chartAs of August 2023. Unemployment rate is 3-month moving average. Source: U.S. Bureau of Labor Statistics, National Bureau of Economic Research, Macrobond, RBC GAM

Other labour market signals are mostly negative:

  • Temporary employment continues to decline (see next chart), a powerful leading indicator historically and in our eyes. However, some pundits note that this decline could be partially for benign reasons if the temporary workers are taking advantage of low unemployment to trade up to permanent jobs rather than being laid off.

Falling U.S. temporary employment usually leads recession

Falling U.S. temporary employment usually leads recession chartAs of August 2023. Shaded area represents recession. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

  • A recent benchmark revision to the past year’s job numbers finds that there are actually 306,000 fewer American workers than previously estimated.
  • The ADP survey estimated just 177,000 new jobs in August, the weakest print in five months.
  • Job openings continue to fall briskly, though they are still elevated (see next chart).

U.S. job openings rate has come down nicely but still high

U.S. job openings rate has come down nicely but still high chartAs of July 2023. Estimates for all private non-farm establishments. Shaded area represents recession. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

  • Wage growth continues to decelerate, though it also remains elevated (see next chart).

Wage growth in U.S. softening but still quite strong

Wage growth in U.S. softening but still quite strong chartAs of August 2023. 3-month moving average of year-over-year percent change in average hourly earnings. Source: U.S. Bureau of Labor Statistics, Haver Analytics, RBC GAM

  • Layoff announcements have also been rising (see next chart).

U.S. announced job cuts have been rising

U.S. announced job cuts have been rising chartAs of August 2023. Source: Challenger, Gray & Christmas, Inc., Macrobond RBC GAM

  • The exception to the labour market softness is weekly jobless claims, which had been rising but then fell substantially in the latest week.

Finally, let’s pivot to the outright bad news about the US economy.

First, there is evidence that the lifeblood of the U.S. economy continues to flow less and less rapidly. U.S. railcar loadings are in sharp decline. They are now reporting their weakest level since just after the Global Financial Crisis (see next chart).

U.S. railcar loadings stay on its downward course

U.S. railcar loadings stay on its downward course chartAs of the week ending 09/02/2023. Shaded area represents recession. Source: Association of American Railroads, Haver Analytics, RBC GAM

Second, the latest U.S. Beige Book gives off powerful “end of cycle” vibes. The Beige Book is a qualitative encapsulation of economic conditions as reported by businesses across the country to the 12 District Fed offices. Lowlights included:

  • “Economic growth was modest” during July and August (it is impossible to reconcile this with the extremely strong third-quarter GDP tracking!).
  • Most contacts viewed the surge of tourism as the last stage of pent-up demand for leisure travel from the pandemic era.
  • Other retail spending continued to slow, especially on non-essential items.
  • Some districts indicated consumers may have exhausted their savings.
  • Demand for manufacturing goods waned.
  • Job growth was subdued across the nation.
  • Most contacts anticipate softer wage growth over the second half of 2023.
  • Most districts reported price growth slowed.
  • Profit margins reportedly fell in several districts.

Lastly, the wildcard in the U.S. economy over the next month is surely the distinct possibility of a government shutdown starting on October 1. The White House has asked for a short-term funding package to avoid this. But at this point the two parties have not reached an agreement and the feeling is that a shutdown could easily arise. Let the record show that this has happened before without catastrophe, but it still isn’t ideal. It does short-term damage to the U.S. economy and long-term damage to the international reputation of the U.S.


Consumer distress

The U.S. 30-day credit card delinquency rate is now surging (see next chart). It is especially pronounced among the clientele of smaller banks, reaching an ominous three-decade high. The rate is also rising and at a decade high for the country’s largest 100 banks.

Credit card delinquency rates at smaller U.S. banks hit record high

Credit card delinquency rates at smaller U.S. banks hit record high chartAs of Q2 2023. Shaded area represents recession. Source: Federal Reserve, Macrobond, RBC GAM

We are slightly perplexed that the same financial distress is not visible in the 90-day delinquency rates for credit cards, auto loans and mortgages (see next chart). The data sources are the same. One possible explanation is that the people who are 30 days delinquent on their credit cards will become 90 days delinquent over the next 60 days. But that doesn’t completely make sense since the 30-day delinquency rate has been rising significantly for several quarters now.

A more reasonable explanation is that people are falling a little behind on their payments, but not a lot. The money is coming in too slowly to make payments when they are due, but the next paycheque arrives in time to avoid a second or third month of delinquency.

U.S. consumer loan delinquencies start to climb

U.S. consumer loan delinquencies start to climb chartAs of Q2 2023. Percent of balance of 90+ days delinquent loans. Shaded area represents recession. Source: Federal Reserve Bank of New York, Macrobond, RBC GAM

However, the 30-day delinquency rate continues to rise. In addition, the 90-day delinquency rates for credit card loans and mortgages are both at least slightly higher than they were several quarters ago. There is definitely mounting financial distress.


U.S. student loan payments

U.S. student loan interest started to accrue again in September after several years of suspended animation during and after the pandemic. Payments will recommence in October after a remarkable nine prior extensions. Approximately 44 million Americans have student loans totaling more than U.S.$1.8 trillion. Before the pandemic, the average payment was a sizeable U.S.$503 per month.

Naturally this additional obligation should hurt consumer spending. The effect is small at the aggregate level – just 0.2% is subtracted from effective disposable income. But it will bring potentially outsized consequences for the many households without a sufficient financial buffer given the sharp increase in the cost of living over the intervening years. A Morgan Stanley poll finds that only 29% of respondents can afford to restart their student loan payments without adjusting their spending.

The increase in interest rates is not set to play as large a role as one might imagine. Although the prescribed rate for new student loans has risen to 5.5%, this is quite charitable in the context of the current interest rate environment in which the risk-free overnight rate is also 5.5%.

Even more importantly, the 93% of student loans provided by the federal government have a fixed rate assigned at the moment of their initiation that then persists over the lifespan of the loan. A loan taken out a decade ago would continue to be charged a 3.85% interest rate. As such, few will experience an abrupt increase in their debt-servicing cost. Instead, it is the resumption of the payments that constitutes the shock to personal finances.


Manufacturing not necessarily bottoming

While weak, the ISM Manufacturing Index has lately gone mostly sideways, even rising slightly with the August print (see next chart).

U.S. manufacturing activities now contracting

U.S. manufacturing activities now contracting chartAs of August 2023. Shaded area represents recession. Source: Institute for Supply Management, Macrobond, RBC GAM

What to make of this?

On a level basis, the ISM Manufacturing Index is still sub-50, meaning that the manufacturing sector itself remains in contraction. But this doesn’t mean the broader economy is in a recession. Since 1980, the index has fallen below 50 on 26 occasions, of which only six culminated in an economy-wide recession. A sub-50 reading is a necessary condition for a recession, but far from a sufficient one.

Since 1980, one would need the index to fall below 45 to guarantee a recession. The low so far this cycle is 46.0: close, but no cigar – at least not yet.

On a change basis, the ISM Manufacturing Index has now risen for two consecutive months. Does that mean a recession is no longer possible? Not necessarily.

In fact, we find that in four of the last five recessions, the ISM Manufacturing Index dipped moderately below 50, briefly recovered back above 50, and then plummeted below 45 and into recession. The recent consolidation is entirely consistent with that pattern (though, again, there were 20 other occasions when the index continued to rise from that point, avoiding recession altogether).


German recession

After Germany reported what was effectively unchanged economic output in the second quarter, on the heels of two consecutive quarters of shrinking output, it seems reasonable to conclude that the country has suffered a genuine recession (see next chart). The unemployment rate has risen over this period, though admittedly only slightly. While Germany could conceivably manage growth in the third quarter, the country’s Manufacturing Purchasing Managers’ Index (PMI) remains at an abysmal sub-40 level, arguing otherwise. We still budget a further economic decline for Germany toward the end of the year and into early 2024.

Germany’s economy stalls after falling into technical recession

Germany’s economy stalls after falling into technical recession chartAs of Q2 2023. Source: Stadtlishes Bundesamt, Macrobond, RBC GAM

Blame for the recession has been cast in a number of directions. Germany’s considerable exposure to the underperforming Chinese economy is one plausible reason. A weak global manufacturing sector also affects Germany disproportionately given its expertise in that space. Germany also suffers from the imposition of sanctions against Russia, the resulting higher natural gas prices, a subtle Brexit drag, an inefficient government, under-investment in infrastructure, and European Central Bank rate hikes.


Strike alert

The U.S. and Canadian United Auto Workers union is on the cusp of a strike later this week. The prior four-year contract is set to expire on Thursday. Traditionally, the union strikes against one of the Big Three automakers, with the final deal then applied to all three companies. That said, the United Auto Workers (UAW) president has suggested this strike could well occur against all three.

As many as 146,000 American workers and 18,000 Canadian workers may go on strike. The last such strike lasted 40 days, targeting General Motors only. A strike would do temporary damage to economic output and presumably temporarily increase the cost of some vehicles, with relevance to the Consumer Price Index (CPI).

The two sides are quite far apart. The union is asking for a large 46% wage increase over the next four years (10% per year, compounded), combined with future cost-of-living adjustments, shorter working hours, and the extension of the defined-benefit pension plan to workers who started after 2007. In contrast, the car companies have offered between a 9% and a 14.5% wage increase, one-time lump sum payments and additional paid time off.

There has been more strike action than usual in recent years across the economy, motivated by low unemployment rates and thus greater-than-usual clout for workers. A further motivation has been that high inflation bit into workers’ real incomes. In the context of the auto sector, carmakers have also enjoyed outsized revenues in recent years due to pandemic-era shortages.

On the other hand, the incumbent automakers and their unionized workforce are unusually vulnerable to disruption right now. Reasons include:

  • Unionized workers in the U.S. auto sector represent just 16% of the total workforce as of 2022, creating the risk that sharply higher wages cause them to be undercut by non-unionized assembly plants.
  • U.S. automakers are being challenged by a bevy of European and Asian carmakers, with Chinese companies in particular now arriving on the scene for the first time.
  • The pivot toward electric cars may create big winners and losers at the company level, and also appear to require significantly fewer workers given the relatively simpler components within an electric vehicle.

As discussed earlier, the broader labour market context is certainly one of tightness, but arguably to a diminishing extent. Recall in particular the Beige Book expectation that wage growth will slow from here. ZipRecruiter recently reported that companies in five out of nine sectors were offering new hires less money in 2023 than in 2022, and a fifth was offering unchanged salaries.


Inflation odds and sods

With the recent surge in oil and gas prices, inflation is unlikely to cooperate over the next few months. Brent oil prices are now more than U.S.$90 per barrel. European natural gas prices are also somewhat higher, at least in part due to a strike at a liquid natural gas facility in Australia.

U.S. CPI for August, to be released later this week, is set to experience another leap in the annual headline number, potentially rising from 3.2% to 3.6% or even 3.7%. This is primarily due to higher energy price. It represents a second straight month of increasing annual inflation from a low of just 3.0% in June.

But we emphasize that the broader inflation trend is still largely fine. Core CPI will probably decelerate from 4.7% year-over-year (YoY) to around 4.3% YoY. When energy prices cease their rise, the broader inflation picture should then resume improving.

With relevance to the longer run, the U.S. government has announced that it is targeting 10 popular drugs for aggressive price negotiations, in an effort to lower healthcare costs. Some pundits have gone so far as to call this the biggest shakeup of the pharmaceutical industry in decades. Many other countries have long engaged in this sort of cost-saving practice, but it is a new concept in the U.S.

The danger is that pharmaceutical companies might invest less in future drug research due to diminished cash flow in the short run and the expectation of a lower return on investment in the long run. Price cuts would, of course, lower inflation, though this seems unlikely to be a near-term phenomenon.


Central banks

The Bank of Canada’s September 6th rate decision yielded a hawkish pause, with the overnight rate unchanged at 5.00%. The governing council remains concerned about inflation and is “prepared to increase the policy rate further if needed.” At present that seems unnecessary, especially after Canadian economic weakness and broadly cooperating inflation, but it is premature to render a final judgement.

The next Federal Reserve rate decision is still more than a week away at the time of writing. The market assigns a low probability for a further rate increase, even though the Fed’s most recent dot plots indicated one further 25bps rate hike in 2023. The market is more favorably disposed toward a rate hike on November 1, though even this is considered around 50-50. We flag the upside risk – that central banks may still deliver a bit more tightening than markets forecast, and/or that the peak policy rate is held in place for longer than expected given comments by Federal Reserve Chair Powell at Jackson Hole.

The European Central Bank delivers its next rate decision later this week. Markets are on a knife’s edge, assigning a 40% chance of a further 25bps increase on top of the current 3.75% policy rate. We also flag the upside risk here, though an increase is a long way from certain.

Another emerging market central bank has joined the rate cutting party: Poland. It cut rates substantially more than had been expected, by 75bps rather than the consensus -25bps forecast. However, unlike in Chile – another early cutter – Poland’s monetary easing appears to have been motivated primarily by political considerations as an election looms, rather than by economic ones given that inflation remains at double-digit levels. Despite this aspect, we continue to view most emergingmarket central banks as a leading indicator for where developed-world central banks may go next (see next chart).

Global central bank policy convergence: end of tightening by developed market central banks may be in sight

Global central bank policy convergence: end of tightening by developed market central banks may be in sight chartAs of 07/28/2023. Policy rates of the U.S., Canada, UK, Eurozone, Switzerland, Sweden, Norway, Japan, Australia, China, India, South Korea, Russia, Brazil and Mexico aggregated and weighted by Purchasing Power Parity (PPP) based Gross Domestic Product (GDP) share. Source: Bloomberg, Haver Analytics, RBC GAM

On the subject of interest rate lags and recessions, we continue to anticipate a recession for much of the developed world. The window remains wide open for higher interest rates to fell the economy, even as many central banks near the monetary tightening finish line. It was notable recently that U.S. Fed Chair Powell opined at Jackson Hole that a “wide range of estimates of lags suggest there may be significantly further drag in the pipeline.” Similarly, Bank of England Governor Bailey said “it appears that there is a longer transmission, that the lags are longer.”


Stocks versus bonds

The U.S. 10-year yield has worked its way back up toward 4.3% over the past month. The push has come less from central bank expectations – which have remained largely static – and more from a risking term premium (see next chart). The term premium cannot be directly observed and so this is imputed data from the New York Federal Reserve. It would appear the term premium has been rising and yet remains slightly negative.

The historical norm prior to the Global Financial Crisis (not shown) was a substantially positive term premium. Thus, even though we are inclined to think that a “normal” bond yield will eventually prove to be somewhat lower than current levels, one cannot quite rule out the possibility that the term premium normalizes further and delivers the opposite outcome, even if central banks were to settle their policy rates back down to a comfortable 2—3% range over time.

Term premium has risen recently

Term premium has risen recently chartAs of 08/23/2023. Source: Federal Reserve Bank of New York, Macrobond, RBC GAM

As yields and equities have simultaneously risen, the equity risk premium has collapsed from its usual 1—2 percentage point positive reading to a substantially negative one (see next chart). Explained simply, since the Global Financial Crisis it has reliably been the case that the yield on a stock exceeds that of a bond, which is a big part of why one normally expects stocks to beat bonds over the long run. However, at current valuations, the inverse is now true. An investment-grade bond portfolio now offers a higher yield than the U.S. S&P 500.

U.S. equity risk premium turned negative amid latest market rally

U.S. equity risk premium turned negative amid latest market rally chartAs of 09/07/2023. Source: ICE Data Services, Bloomberg, Haver Analytics, RBC GAM

To be sure, stock market earnings normally rise with time, providing a further potential return for equities, whereas bond coupons are relatively fixed; on the other hand, investors usually require a significantly higher return in the stock market to compensate for its greater risk and volatility.

The bottom line is that stocks are not paying their usual risk premium over bonds. This says nothing about the short-term outlook but argues that the bond market has a better chance than usual of keeping pace with the stock market or even outpacing it over the next few years. This, in turn, significantly informs our lower-than-normal equity allocation and our higher-than-normal fixed income allocation.


Better U.S. fiscal picture

The expected economic impulse arising from the U.S. fiscal environment has improved. It is not that the government has implemented new expansionary legislation, but rather that existing programs have been shown to be more generous than initially expected.

As we have covered in the past, initial estimates for the U.S. Inflation Reduction Act were well below the actual subsequent uptake. Such forecasts are always a guess when the money spent is in the form of tax credits that are geared to the level of private-sector spending on various investment initiatives.

Now, an even more obscure credit is also injecting money into the economy, years after it expired. The Employment Retention Credit was designed to reward employers for keeping idle workers on their payrolls during the worst of the pandemic in 2020 and 2021. At the time, the program received little uptake. But, thanks to heavy marketing, the uptake has since increased sharply. To be clear, the credit still only applies to wages paid in 2020 and 2021, but the deadline for amending tax returns for those years doesn’t expire until 2025. Some estimates are that as much as U.S.$20 billion per month is being sent to companies, all these years later.

As a result of these and other initiatives, the U.S. Congressional Budget Office recently revised its U.S. deficit estimate higher by 0.4ppt of GDP for 2023 and by 0.7ppt of GDP for 2024. The Organisation for Economic Co-operation and Development (OECD) increased its U.S. deficit forecast for 2023 by even more – a 1.3ppt swing. When we map these changes onto the economic impulse – which arrives with a lag since money isn’t usually spent immediately – the size of the fiscal drag shrinks in the near term and becomes an outright economic boost by approximately mid-2024.

All of that said, and just to confuse everyone, the actual economic boost might be a bit smaller than conventionally estimated since a fraction of the bigger deficit is due to higher debt-servicing payments, which don’t provide the same sort of economic pop that something like infrastructure spending would. Another fraction is that fewer Americans are paying taxes on big capital gains this year relative to last. While the effective decline in taxes might be stimulative by itself, the fact that Americans are realizing fewer capital gains is not.


Housing weakens anew?

With the U.S. 30-year mortgage rate now above 7.5%, there is some evidence that U.S. housing is starting to cool once again after a spring revival (see next chart). The National Association of Home Builders sentiment index is again falling from an already low level. Residential construction employment is also tentatively falling, and existing home sales have resumed their decline. Other measures are harder to gauge, and it must be conceded that we don’t look for profound weakness so much as a malaise that reflects poor housing affordability and a potential economic slowdown.

U.S. housing metrics show signs of softening

U.S. housing metrics show signs of softening chartStandard & Poor’s (S&P) CoreLogic Case-Shiller Home Price Index as of June 2023. Building permits, housing starts, employment and existing home sales as of July 2023. National Association of Home Builders Housing Market Index (NAHB HMI) as of August 2023. Source: U.S. Bureau of Labor Statistics, Census Bureau, NAHB, National Association of Realtors (NAR), S&P, Macrobond, RBC GAM

The story is similar in Canada, though the scope for weakness is theoretically somewhat greater given worse housing affordability and the quicker bite of higher mortgage rates. Just one-third of Canadian mortgage holders have been affected by higher interest rates so far, but the other two-thirds will eventually follow. Canadian existing home prices recently reverted to falling in some of the country’s larger markets and existing home sales are again in decline.


A small Chinese rebound

The Chinese economy remains quite weak overall. But, as we have argued for some time, the extreme pessimism in the market may be overblown. Policymakers have delivered a number of supportive policies in recent months that, while not huge in scope, should nevertheless have some impact.

Indeed, it now appears that at least one policy has started to click. Instructions to increase the amount of leverage permitted for home buyers has seemingly translated into a doubling of existing home sales in Beijing and Shanghai in the days following the implementation of the mortgage rule relaxation. We also note that mortgage-related searches on Chinese internet search engine Baidu have soared by about 60% in recent days. Activity is unlikely to remain so elevated, but the point is that housing may have bottomed.

Relatedly, the value of beleaguered Chinese home builder Country Garden’s Hong Kong shares has increased from a low of HKD$0.70 on August 23 to $1.03 on September 8. That is a significant bounce, though it is still quite depressed relative to a share price that was 10 times higher in late 2020.

Elsewhere in China, the country’s composite Purchasing Managers’ Index managed a slight increase from 51.1 to 51.3 in August. Similarly, Chinese air traffic passenger volume continues to rise (see next chart).

China’s international air passenger traffic reviving but still depressed

China’s international air passenger traffic reviving but still depressed chartAs of July 2023. Source: China Civil Aviation Administration, Macrobond, RBC GAM


With contributions from Vivien Lee and Aaron Ma

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This document is a marketing communication and it may be produced and issued by the following entities: in the European Economic Area (EEA), by BlueBay Funds Management Company S.A. (BBFM S.A.), which is regulated by the Commission de Surveillance du Secteur Financier (CSSF). In Germany, Italy, Spain and Netherlands the BBFM S.A is operating under a branch passport pursuant to the Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC) and the Alternative Investment Fund Managers Directive (2011/61/EU). In the United Kingdom (UK) by RBC Global Asset Management (UK) Limited (RBC GAM UK), which is authorised and regulated by the UK Financial Conduct Authority (FCA), registered with the US Securities and Exchange Commission (SEC) and a member of the National Futures Association (NFA) as authorised by the US Commodity Futures Trading Commission (CFTC). In Switzerland, by BlueBay Asset Management AG where the Representative and Paying Agent is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich, Switzerland. The place of performance is at the registered office of the Representative. The courts at the registered office of the Swiss representative or at the registered office or place of residence of the investor shall have jurisdiction pertaining to claims in connection with the offering and/or advertising of shares in Switzerland. The Prospectus, the Key Investor Information Documents (KIIDs), the Packaged Retail and Insurance-based Investment Products - Key Information Documents (PRIIPs KID), where applicable, the Articles of Incorporation and any other document required, such as the Annual and Semi-Annual Reports, may be obtained free of charge from the Representative in Switzerland. In Japan, by BlueBay Asset Management International Limited which is registered with the Kanto Local Finance Bureau of Ministry of Finance, Japan. In Asia, by RBC Global Asset Management (Asia) Limited, which is registered with the Securities and Futures Commission (SFC) in Hong Kong. In Australia, RBC GAM UK is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of financial services as it is regulated by the FCA under the laws of the UK which differ from Australian laws. In Canada, by RBC Global Asset Management Inc. (including PH&N Institutional) which is regulated by each provincial and territorial securities commission with which it is registered. RBC GAM UK is not registered under securities laws and is relying on the international dealer exemption under applicable provincial securities legislation, which permits RBC GAM UK to carry out certain specified dealer activities for those Canadian residents that qualify as "a Canadian permitted client”, as such term is defined under applicable securities legislation. In the United States, by RBC Global Asset Management (U.S.) Inc. ("RBC GAM-US"), an SEC registered investment adviser. The entities noted above are collectively referred to as “RBC BlueBay” within this document. The registrations and memberships noted should not be interpreted as an endorsement or approval of RBC BlueBay by the respective licensing or registering authorities. Not all products, services or investments described herein are available in all jurisdictions and some are available on a limited basis only, due to local regulatory and legal requirements.

This document is intended only for “Professional Clients” and “Eligible Counterparties” (as defined by the Markets in Financial Instruments Directive (“MiFID”) or the FCA); or in Switzerland for “Qualified Investors”, as defined in Article 10 of the Swiss Collective Investment Schemes Act and its implementing ordinance, or in the US by “Accredited Investors” (as defined in the Securities Act of 1933) or “Qualified Purchasers” (as defined in the Investment Company Act of 1940) as applicable and should not be relied upon by any other category of customer.

Unless otherwise stated, all data has been sourced by RBC BlueBay. To the best of RBC BlueBay’s knowledge and belief this document is true and accurate at the date hereof. RBC BlueBay makes no express or implied warranties or representations with respect to the information contained in this document and hereby expressly disclaim all warranties of accuracy, completeness or fitness for a particular purpose. Opinions and estimates constitute our judgment and are subject to change without notice. RBC BlueBay does not provide investment or other advice and nothing in this document constitutes any advice, nor should be interpreted as such. This document does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product in any jurisdiction and is for information purposes only.

No part of this document may be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, in whole or in part, for any purpose in any manner without the prior written permission of RBC BlueBay. Copyright 2023 © RBC BlueBay. RBC Global Asset Management (RBC GAM) is the asset management division of Royal Bank of Canada (RBC) which includes RBC Global Asset Management (U.S.) Inc. (RBC GAM-US), RBC Global Asset Management Inc., RBC Global Asset Management (UK) Limited and RBC Global Asset Management (Asia) Limited, which are separate, but affiliated corporate entities. ® / Registered trademark(s) of Royal Bank of Canada and BlueBay Asset Management (Services) Ltd. Used under licence. BlueBay Funds Management Company S.A., registered office 4, Boulevard Royal L-2449 Luxembourg, company registered in Luxembourg number B88445. RBC Global Asset Management (UK) Limited, registered office 100 Bishopsgate, London EC2N 4AA, registered in England and Wales number 03647343. All rights reserved.

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