Questions? We've Got Answers 

Q1.  How have global economic conditions evolved since the September quarterly outlook?  

• Economic growth has generally disappointed while inflation has shown more heat. In the third quarter of 2021, U.S. real GDP is estimated to have grown by 2.1% (annualized) and Canadian GDP by 3.4%, 1.3 and 0.6 percentage points percentage points lower respectively than expected in September. The main culprits for the miss were worsening global supply constraints, fading fiscal stimulus and Delta virus-related headwinds. Fortunately, economic rebounds are evident for the fourth quarter, though floods in British Columbia add downside risk to the Canadian outlook.
• Economies of China and Europe have shown mixed performances. China posted a downside surprise to growth in Q3, as its economy succumbed to a toxic mix of supply chain issues, dwindling coal supplies, blackouts, regional lockdowns and a regulatory push to limit borrowing in the property sector (tackled further in Question 4). In contrast, Europe managed to outperform in the third quarter, but is losing momentum into Q4 due to surging natural gas prices and another uptick in Covid-19 cases. 
• Supply constraints are showing more staying power than anticipated, causing economists and central banks to serially revise up near-term inflation forecasts. Significant relief now appears unlikely until the second half of 2022. This will leave headline CPI running just shy of 4%, on average, in the U.S. and Canada, nearly a percentage point higher than we expected in September.
• The higher trajectory of inflation in the first half of next year will eat into real disposable incomes in North America and globally. This would normally lead to significant downgrades in 2022 economic growth performances, but the outlook is buttressed by 1) large pools of excess savings that continue to support spending patterns, 2) ongoing growth in job opportunities and 3) in Canada, higher fiscal spending than initially forecast.

Q2. Where are we now in the battle against Covid-19? 

• Globally, Covid-19 cases are rising again after several months of decline. The increase is most notable in Europe, while emerging markets have recorded a sharp improvement since the summer peak (Chart 1).  
• In Europe, Germany is facing its most severe wave yet, as cases have surpassed all previous highs. Yet, in Spain, France and Italy (countries that suffered mightily in earlier waves) a relatively small uptick has been registered. In response to rising caseloads, countries are adopting modified restrictions. For instance, Austria is currently only subjecting those that remain unvaccinated to new public health measures. 
• China remains committed to a zero-Covid policy, which has been one among many factors contributing to global supply chain issues. With the 20th National Congress set for next year, it is possible authorities elect to keep this policy in place until 2023. We've seen the knock-on effects this can have globally, with the shutdown of a terminal at the Ningbo-Zhoushan port (the third busiest in the world). However, China will need to weigh this hardline approach against the need to encourage corporations to expedite supply chain resilience plans via country diversification and domestic production.

• The U.S. and Canada are generally in good shape, recording caseloads and hospitalizations well below their previous peaks. Seasonal influences are starting to come through, with infection rates trending higher in the U.S. northeast (Charts 2 and 3) and in Ontario and Quebec, as colder weather prompts more indoor activities. So far, governments are, for the most part, not signaling the re-imposition of tighter restrictions, particularly among highly vaccinated populations, with third dose protocols rolling out. However, it remains a risk that cannot be dismissed, as we proceed through this “testing” phase of the endemic.
• So far, 30 million boosters have been administered in the U.S. since August when they became available to people with weakened immunity. Eligibility was extended to seniors and others at risk of severe Covid-19 in late September, and some jurisdictions have expanded access even further. In Canada, most provinces are readying plans to inoculate children aged 5 to 11, as well as provide booster shots to vulnerable segments of the population. 
• With increased access, vaccination rates are likely to continue to edge up. At last count, 77% of the total population was fully vaccinated in Canada, in line with Europe and above the 59% comparable rate in the United States.  
• The potential spread of the virus in the coming months could prompt more governments to implement new restrictions. Any new measures adopted are likely to be more targeted and less economically disruptive than those in past waves, given the growing use of vaccine passport systems, mandates and other tools. Some jurisdictions have moved pre-emptively, including Ontario, to pause further reopening plans of high-risk settings in the hopes of avoiding “rollbacks” among those businesses already in higher operation.   
• In sum, an outbreak this winter should have far less impact on economic growth. We could see some slowing in growth in high-contact services in regions with elevated covid levels, but the impact on national trends is likely to be marginal.       

Q3. How will supply chain challenges and higher energy prices impact the 2022 outlook? 

• The autumn months saw energy join the list of supply-side impediments impacting the global economy. An energy supply crunch in China and Europe sent natural gas and coal prices skyrocketing, with knock-on effects to North American natural gas and world oil prices. The supply squeeze has left a particular mark on base metals and energy-intensive manufacturing industries – such as aluminum, zinc and fertilizers. Elsewhere, weather disruptions have elevated crop and food prices.   
• The jump in oil and gas prices contributed to consumer price indexes hitting multi-decade highs in October. Although these impacts are visible and easier to monitor within the data, it is much more difficult to extract the broader impact of unprecedentedly intricate global supply chains. Used and new vehicle prices were once the sole example of supply-chain disruptions, but a broad array of goods and service sectors now carry the markings. This is consistent with purchasing manager surveys that show an increasing share of businesses are passing higher input costs to the end consumers.
• One way to see how supply chain challenges are leaving a mark on U.S. economic growth is through the restraint on vehicle sales and the inability of firms to build inventory more broadly across sectors. The inventory-to-sales ratio is at an historic low (Chart 4), with the drawdown subtracting almost two percentage points from GDP growth in the first half of the year. The rebuild phase will add significantly to growth in future quarters, but it is occurring more slowly than we originally anticipated, leading to a net downgrade to our near-term outlook relative to September.
• In Canada, where data are less timely, the most pronounced growth effects of supply shortages have been observed in transportation manufacturing (Chart 5). As of August, GDP in the sector was down nearly 25% relative to pre-pandemic levels.
• Even with these supply-side pressures proving more prolonged than we had anticipated a few months ago, the intensity of bottlenecks should ease in the coming months. There is already evidence that this process is underway through a few channels:
• An incremental rotation in spending towards services, which remains below pre-pandemic levels.
• A waning in the Covid-19 crisis, particularly in emerging markets, where vaccines are starting to become more widely distributed.
• Less stimulus – as governments cease “cutting checks” for immediate pandemic income supports and central banks remove monetary accommodation.
• Still, the supply system will remain fragile in the near term and susceptible to additional shocks.  The devastating floods in parts of British Columbia are a case in point. The flooding has damaged highways, disrupted rail service, halted fuel flows on the TransMountain pipeline, and impeded transportation access to Canada's largest port – the Port of Vancouver. Reports of stockpiling and empty grocery shelves have resurfaced, and the provincial government has instituted a gasoline rationing order in parts of the province. While highways, rail service, and flows to the Port of Vancouver are being restored, these delays will weigh on Canadian real GDP growth in the fourth quarter.
• Although we anticipate that year-over-year inflation rates are likely to begin to roll-over by mid-2022 and energy prices to begin subtracting from the headline rate by this point, we still expect the inflation environment to remain higher relative to the pre-crisis period due to firmer demand drivers. For instance, we anticipate core inflation to be around 3% in both Canada and the U.S. at the end of 2022 compared to a rate under 2% in the decade prior to the pandemic.
• Given the unusually high uncertainty around global supply, it will be important to follow some leading indicators: monthly purchasing managers' surveys, global freight rates among data sources. 

Q4. How worried should we be about China's property market?

• The real estate sector has been an indispensable source of growth for the Chinese economy. It is estimated that 30% of Chinese GDP is tied to the upstream or downstream effects of the real estate sector, which is higher than any advanced economy prior to the Global Financial Crisis.
• Rising land prices are important for local governments, where revenues are derived from the proceeds of land sales and collateral is placed against loans. The funding crunch from a reduction in land values, as debt fueled demand dries up, has led some local governments to implement restrictions on the discounts that can be applied to property sales. The intent is to prop up property values to avoid upsetting investors that purchased similar properties at higher prices. 
• The "Three Red Lines" outlined by authorities to rein in borrowing by property developers appears to have been an opening salvo into cooling the real estate market. There are now reports of a new regulatory push to investigate cozy relationships between lenders and industry. As authorities look to rein in real estate speculation, this could be another avenue for tightening credit conditions.  
• This paints a bleak picture, but there are reasons not to expect a crisis to breakout. First, the current situation is a product of regulators imposing rules to limit borrowing by property developers. On November 10th, authorities tipped their hand at a willingness to step in and prevent worsening liquidity issues, as state media reported some real estate firms planned to issue debt in the inter-bank market. State-owned developers too have increased their share of land purchases from local governments, providing support for a key revenue line. 
• Secondly, the 20th National Congress of the Chinese Communist Party is set for next year. Political appetite for economic instability will be minimal given that the regulatory push on the real estate sector is part of a broader strategy to limit economic inequality.  

Q5. What if we're wrong and these headwinds prove more persistent? 

• We conducted a thought exercise examining the impact on medium-term growth among key economies in the event that the trifecta of risks take one-to-two quarters longer to abate relative to our baseline assumptions. These include elevated inflation and energy prices, as well as a greater-than-expected slowdown in China’s economy. The full report can be found here.  
• We estimate that global growth could fall 0.6 percentage points (ppts) short of current expectations, equivalent to roughly $570 billion in foregone real value added. China would suffer the most, potentially losing out on 1.4 ppts of growth in 2022. Among advanced economies, Eurozone growth could miss by 0.8 ppts, while the U.S. and Canada could miss by 0.7 and 0.6 ppts, respectively. These estimates offer guidance rather than precision, as it is difficult to estimate the knock-on impacts to the “confidence” channel. However, the over-riding message is that the Canadian and U.S. economies would be meaningfully negatively impacted, but recessionary forces failed to materialize within the modelled outcomes given the starting point of these economies. 

Q6. Will wage growth continue to accelerate?  

• The gap between the rate of job openings and hires remains near a record high, but nothing tells the story of strong demand for workers and rising wages better than record quit rates. Employees are clearly finding greener pastures elsewhere.  
• The gap between openings and hires also implies a skills mismatch. The "Beveridge Curve", as discussed in our recent report, has shifted outward since the pandemic, supporting a higher-than-usual degree of labor market frictions. The pandemic has rapidly shuffled the deck on which sectors and regions are growing most rapidly, and it will take time for workers to relocate, or shift to different industries.
• Another challenge for employers has been that labor supply growth has not kept pace with economic growth, as evidenced by a stalled labor force participation rate (for greater detail see our recent report). There are many reasons for this, including a wave of retirements, a sharp depression of women in the age of 25 to 29 relative to male peers, and a decline in people holding multiple jobs.
• Labor market frictions will not resolve overnight. The U.S. history supports a significant amount of time for people out of the labor force to be enticed to rejoin. Current higher wages and inflation may hasten the timeline relative to history, but it is also our belief that demand will remain healthy. This combination supports a persistence in wage growth in the 4% to 5% range over the coming quarters. 
• Although Canadians tend to identify with the media south of the border, wage trends have not drawn strong parallels. Wage pressures, on aggregate, are more muted in Canada. Since provinces began lifting restrictions in June, growth in average hourly wages has been stable, rising at a monthly rate of 3.6% on a two-year annual basis. Also, even on a fixed-weighted basis (which accounts for employment composition effects), average hourly wage gains have not picked up and are growing at a 2.5% monthly pace from June to October. 
• Canada's outperformance in keeping workers engaged with the labour market is a key reason for this deviation from its U.S. counterpart. The participation rate in October was 65.3%, only a touch below its February 2020 level. And, within the core working age group of 25 to 54 year-olds, the participation rate is already higher than pre-crisis, compared to 1.2 ppts below in the U.S. This has created less pressure to increase pay even with demand rebounding strongly. However, on the flip side, Canada may be nearing capacity limits within the labour market, and that would place upside risks to the outlook.
• In addition, labour market outcomes are not evenly distributed across industries. For example, the accommodation and food services industry has seen a strong rebound in labour demand, but the supply of labour has not kept pace, leading to staffing shortages (Chart 6). Businesses within this sector may soon follow the U.S. experience of increasing wages to attract new workers.  

Q7. How do the U.S. infrastructure bill, and potential social spending bills factor into the outlook?   

• U.S. fiscal policy had been a major support to the economy through the pandemic, totaling over $5 trillion, or nearly 25% of nominal GDP over two years. The 2020 CARES Act more than offset the drop in income due to pandemic-related shutdowns. 
• The upcoming fiscal spending initiatives are smaller and spread out over a longer period. These include the Infrastructure Investment and Jobs Act (IIJA) – recently signed into law and already incorporated into our forecast – and the Build Back Better (BBB) reconciliation bill – currently under negotiation in Congress. Since these packages are more focused on investments to support the economy over the medium term, the boost to growth is unlikely to be realized quickly. 
• For example, the net budgetary impact of the IIJA is $25 billion in 2023, or roughly 0.1% of nominal GDP, and peaks at $79 billion in 2026. While economists agree that spending on infrastructure gives some of the biggest economic multipliers, this spending takes time to be rolled out, with only a modest boost to growth in 2023 and beyond. In contrast, the BBB, which is not yet finalized or included in our baseline forecast, would provide a more noticeable near-term boost to growth in 2022 thanks to the extension of the more generous Child and Earned Income tax credits enacted in the American Rescue Plan (passed in early 2021). Therefore, it represents a modest upside risk to our forecast. 

Q8. How are Canadian federal and provincial fiscal plans evolving?

• At the federal level, the government is expected to provide a fiscal update in the coming weeks. Given economic developments since the 2021 Budget, we can expect a healthier fiscal position in the forthcoming statement. For instance, in the April Budget, the government projected a nominal GDP increase of 9.3% in 2021. The Parliamentary Budget Office (PBO) revised up this figure to 13.4% in August when it constructed a baseline fiscal projection for the federal election. This had the impact of decreasing the budget deficit by about $20 billion. With energy prices and overall tax revenues expected to rise at a faster rate through 2022, we can expect similar deficit reductions relative to their prior baselines next fiscal year.
• However, the newly elected Liberal government will likely introduce new federal spending to carry out parts of its campaign pledges (see report). First, the government is enacting new, more targeted Covid-19 programs like the Canada Worker Lockdown Benefit, extending some supports such as the Canada Recovery Hiring Program, while letting others expire (i.e. Canada Recovery Benefit, Canada Emergency Wage Subsidy). The Liberals have also promised to boost health transfers and undertake a number of measures to making housing more affordable. 
• On the other side of the ledger, the Liberals planned to implement a number of policies to increase revenues by $25.5 billion over the next five years. Around 40% of this amount is expected to be raised through a 3% surtax on the largest banks and insurers, as well as a “Canada Recovery Dividend” which would place an additional levy on these businesses for the next four years.

Table 1: Liberal Platform Positive for Growth In Near-Term

Note: GDP growth impacts estimated off PBO baseline. Source: TD Economics.

	2022	2023	2024	2025
GDP Growth Impact (p.p.)	0.2 to 0.5	0.1 to 0.2	0 to -0.1	0.0

• While it remains to be seen which policies are enacted, the campaign platform could provide a modest boost to GDP growth over the next two years (Table 1). We calculate an impact in the range of 0.2 to 0.5 ppts in 2022 and 0.1 to 0.2 ppts in 2023. We have provided ranges for the economic impact due to the uncertainty around multipliers. Since the economy will be further along in the recovery when stimulus is rolled out, we expect the contribution to growth from new spending will be on the lower end of the estimated range.
• Provincially, the fiscal picture is generally much healthier than policymakers envisioned at the time of their budgets. Quebec, for example, is in a surplus position through the first three months of fiscal year (FY) 2021/22, against full-year expectations of a $9 billion deficit. Ontario, meanwhile, posted a $16.4 billion deficit last fiscal year – a cool $22.1 billion below projections, and it expects the fiscal shortfall to be $7 billion lower than previously expected by FY 2023/24. B.C. has also revised its deficit estimate for the current fiscal year to $4.8 billion, down from an earlier estimate of $9.7 billion. A mention of provincial finances would not be complete without Alberta. The province slashed its deficit estimates by more than half, from a sizeable $18.2 billion earlier in the year to $7.2 billion in its first quarter update. Further positive surprises should be expected given the stronger energy price backdrop. Of note, New Brunswick managed to buck the trend by posting a record surplus in FY 2020/21, with another surplus in the cards for the current fiscal year. 
• Improvements to FY 2021/22 fiscal positions have largely come on the revenue side of the ledger, driven by both own-source revenues (income as well as resource royalties) and higher-than-anticipated federal transfers. This has offset higher-than-anticipated expenditures. The provincial economic outlooks embed a degree of upside risk because of these developments, as regional governments may look to spend portions of their “windfalls” in 2022 budgets. Ontario is a likely candidate, given it will coincide with an election year. 

Q9. What are the risks posed by excess household savings to the consumption and inflation outlook?  

• Americans have built a $2.7 trillion cushion of excess savings over the course of the pandemic, amounting to roughly 13% of nominal GDP. However, excess savings have now stopped accumulating. The personal savings rate returned to its pre-pandemic pace in September and is likely to edge below that level in the quarters ahead.
• It is highly uncertain how much of these savings will be spent versus saved and invested (either directly or indirectly). The bulk of savings are held by higher income households with a greater propensity to save. However, modest income households have built-up nest eggs far higher than their pre-pandemic levels (Chart 7). In a recent report, we outlined a couple of scenarios for the upside risks to consumer spending and resulting inflation depending on what share of savings is ultimately spent. Our baseline assumption was that 5-10% of these reserves are spent over the next two years. Given strong consumer spending data up to October, there is likely upside risk to that assumption. The possibility that consumers go on a larger post-pandemic spending spree is the largest upside risk to growth, and inflation.
• Canadian households continue to amass excess savings too. According to our estimates, consumers have built up $190 billion in extra savings in deposit accounts that can be easily accessed and deployed towards consumption (see report). Of note, Canadian households face competing priorities, such as paying down high levels of existing debt relative to their U.S. counterparts.
• In the recent Bank of Canada Survey of Consumer Expectations, respondents said they had intended to spend about one-third of their accumulated savings by the end of 2022. Using the $190 billion in deposits as an approximation of “savings” implies a spending impulse of around $60 billion (3% of GDP) over the next several quarters.
• By our calculations, the Bank of Canada’s MPR embedded around a $40 billion increase in spending through a drawdown in excess savings over the three-year projection. In their forecast, this contributes to robust consumption growth of around 5% to 6%, and above-target inflation of 3.4% in 2021 and 2022. If consumers spend the full $60 billion as they had indicated in the Bank’s own survey, this could lead to higher inflation in the near and medium term. Likewise, the Bank would respond in kind with higher interest rates. 

Q10. How are global central banks reacting to elevated inflation?

• With inflation becoming the chief worry among central bankers, a movement is afoot towards tighter monetary policy. The Federal Reserve (Fed) has taken a first step by tapering its Quantitative Easing (QE) program and has signaled a rate hiking cycle is likely to start next year. 
• We have already seen rate hikes from a number of central banks, which have cited the strength of the economic recovery no longer justifies emergency level monetary stimulus. The Reserve Bank of New Zealand, the Bank of Korea and the Norges Bank are three major central banks that have already hiked policy rates. 
• Others are gearing up as well. The Bank of England is set to lift rates in the coming weeks on persistent inflation worries. We have even seen a surprise tilt from the European Central Bank. For much of the last 10 years, it has kept a heavy foot on the monetary accelerator due to the fallout from the sovereign debt crisis. But even the ECB is advising that a change is coming now that the worst of the pandemic appears to be over. 
• This is also the case in Canada, as the Bank of Canada (BoC) has been very nimble with its policy actions. It has already ended QE and is set to start hiking its policy rate in just matter of months. 
• The time for very loose monetary policy is over. Central banks around the world are faced with economic rebounds and levels of inflation that haven't existed for decades. This is putting pressure on them to act, setting up 2022 as the year for tandem moves to tighten the screws on monetary policy. 

Q11. How will government bond yields react to central bank policy pivots?

• With the Fed's QE tapering expected to end by June 2022, a rate hike that summer is penciled into our forecast. That would be the start of Fed's rate hiking cycle, where we have it eventually getting the policy lever to a peak of 2% by 2024. Market pricing has been solidifying around this view, which has caused government yields to track upwards by 50 basis points in just a couple months. We expect this trend to continue, with the U.S. 10-year Treasury yield rising to 2% within the next few months and pushing towards 2.3% by the end of next year.
• With the expectation for rate hikes coming into view, the curve has flattened with the U.S. 2-year yield rising faster than the longer end. This has caused angst among some clients given the indicator's history in predicting central bank policy mistakes and economic recessions. Although it gets a lot of attention, we aren't fussed. Any start of a rate hiking cycle causes markets to adjust expectations and a flatter yield curve is a natural by-product. Plus, the 10-2 year spread sits at a comfortable level of 1%, compared to the danger zone of 0% and below. The point here is that markets are not yet predicting a policy error from the Fed.
• In Canada, the story is a little different. With QE out of the way, markets are pricing that the BoC will start hiking the policy rate as early as March 2022. This has lifted the Canada 2-year yield to 1%, compared to 0.5% in the U.S. Though this divergence is large, our view of the BoC policy path isn't that far off from that of the market. We have the BoC hiking in April 2022, followed by one hike every three months until the policy rate reaches 1.75%.
• The timing and speed may vary relative to this view but the message is the same: the BoC will be hiking ahead of the Fed. Many think this seems unreasonable, but there is precedence with the BoC having moved ahead of the Fed in the last two business cycles. Additionally, economic data have placed the Canadian labour market recovery further ahead of the U.S. Not to mention, the BoC must consider the high levels of household debt and the risk that keeping rates too low will only further stoke financial imbalances.
• This tighter policy environment should result in higher government yields. We see the Canada 10-year yield reaching 2% in the next six months and the Canada 2-year yield rising towards that level in short order. The Bank of Canada is not going to sit around and wait much longer for inflation to ease. We believe there will be a bias towards hiking earlier and leaving sufficient time between policy decisions to observe outcomes, rather than risk a faster exit path than can be more disruptive to the economy. The path for yields with each central bank depends on the level of patience they are communicating, and we think that patience is running thin north of the border.

Q12. Will rising interest rates derail housing markets?

• The sharp increase in U.S. home prices soon after the pandemic's initial wave outstripped income gains and the benefit of lower interest rates (which troughed in early 2021), thereby taking a toll on affordability. The latter has trended down over the past six months and is now near early 2019 levels, according to a popular NAR measure (Chart 8).
• Looking ahead, further healing of the labor market will help on the income front, but higher interest rates will likely further stretch housing affordability. This will weigh on demand and eventually take some steam out of home price growth. CoreLogic home price data already point to a recent slowdown in home price growth, from an unsustainable 25% (annualized) pace in mid-2021 to a more moderate (though still strong) 15% in September.
• While a continued deceleration is the most likely outcome, several other forces will ensure a floor on price momentum. A dearth of inventory is one of the main supporting points. Existing home inventories remain at around 1.3 million – among the lowest levels in recorded history with data stretching back more than two decades. And while homebuilders continue to put more shovels to the ground, current homebuilding trends suggest that relief from new supply will be gradual. Putting the pieces together, price momentum will slow but remain in positive mid-single digit territory by the end of next year.
• In Canada, higher interest rates will slow but not upend market activity. October’s data is a glaring example, as sales jumped 9% month over month despite mortgage rates starting to trend up, albeit modestly.

• Supportive fundamental factors to the market include rising employment and incomes, high savings and a resumption in stronger population growth from immigration flows. In addition, a large chunk of the population has aged into what have historically been prime homebuying years. Previously implemented stress tests mean that most Canadians have already been qualifying for home purchases at rates that are much higher than current levels. This suggests significant room for rates to rise before qualification thresholds are threatened.
• The affordability backdrop in Canada is a complicating factor. The rapid house price growth has left affordability at the worst level since the mid-1990s. While this could amplify the impact of rate hikes, affordability was even worse from the late 1980s through the mid-90s, and sales managed to avoid a sustained retrenchment (Chart 9). And, although it’s not an apples-to-apples comparison, the economic backdrop is expected to be stronger than those periods, alongside a new and resale supply market that are currently drum-tight -- a stark difference to those periods. The tight market conditions argue for positive price growth, even as higher rates take some steam from demand.