Questions? We've Got Answers 

Q1.  How is the global outlook evolving?  

• The global economy is bouncing back, but 2021 is shaping up to be a two-track recovery. On one side, advanced economies (AEs) with robust healthcare systems and substantial fiscal power have used their resources to deploy aggressive mass vaccination schemes and social supports. On the other side, emerging and developing markets (EMs) have struggled to acquire vaccines and contain the virus, resulting in exponential spread and depleted resources to treat the health and economic symptoms.
• New COVID-19 variants continue to form the largest risk factor in the forecast (Chart 1). In AEs with high rates of vaccination, vaccine passports (or health certificates) are becoming increasingly commonplace, reducing the need for large-scale shutdowns when cases pick up. We have seen versions of this applied in Israel, France, Italy, and regions within Canada and the United States. Even with these adjustments, rising caseloads threaten to prolong labor shortages, weaken consumer confidence and reduce business capacity, thereby slowing the recovery.  
• Fiscal spending in AEs is likely to remain elevated and income supports to extend as long as the health crisis continues to weigh on activity. In Europe, NextGen E.U. funds should help support growth in the second half of 2021 and into 2022. Meanwhile, the fiscal impulse from the pending U.S. infrastructure bill should provide a lift to the global economy.
• China led the way out of the recession in 2020, but its outlook is now muddied. Authorities are committed to stamping out any local transmission of the virus, and this is interrupting shipping and transportation linkages. These types of strict public health interventions have the dual effect of depressing global demand while maintaining the supply chain disruptions that have become synonymous with this recovery.
• The outlook for 2021 continues to be heavily virus dependent. Despite rising infections, abundant vaccine supplies and ongoing fiscal stimulus in advanced economies leave this outlook relatively unchanged from our previous forecast. At the same time, a dearth of vaccines and difficulties in managing viral transmission add more downside risk to the recovery in emerging and developing markets.

Q2. What are the economic implications of moving from a pandemic to an endemic phase? 

• At this juncture, the endemic phase applies only to those countries that have benefited from high vaccine access, and it will be multi-staged. This is just the first inning. Economic growth is anticipated to persist but remain restrained relative to the counterfactual environment that would lack supply disruptions and trial-and-error tactics to measure health outcomes against the pandemic phase. 
• In the short term, global supply chains will remain pressured. Manufacturers in Europe and the U.K. have already reported shortages of raw materials as key reasons for being unable to meet production targets. Meanwhile, limited vaccine supplies in many emerging markets mean strict public health measures can be imposed to limit strain on hospital resources. We had previously suggested that supply disruptions could persist for a year once economies re-open, and there's no reason to think otherwise at this stage.  
• A transition away from strict lockdowns to less stringent interventions is allowing for broader economic activity. But, labor supply may continue to reflect the tension of lingering hesitancy on the part of workers, as officials transition to accommodating a degree of viral spread in the post-vaccine environment. At the same time, workplaces will need to navigate their responses to outbreaks, while any outbreaks that lead to periodic classroom closures would also impact parents. 
• Using the UK experience as guidance, these challenges can manifest in frequent disruptions and price spikes for certain goods (food items, for example) and challenge businesses in ensuring adequate staffing levels and health-safety requirements.
• The rebalancing of demand from goods back to services is occurring and will be a critical piece to easing the pressure on supply chains and allowing manufacturers to clear backlogs (and restore depleted inventories). So far, strong demand for goods and raw materials has limited the logistics industry’s ability to address stranded containers and port traffic. Global container prices surged 50% month-over-month through July due to a lack of available units (Chart 2).

• Even without formal restrictions, the rise in Delta-variant cases is likely to weigh on consumer confidence and slow the rebound in spending. We are seeing signs of caution in the high-frequency data for restaurant reservations, credit card spending and reports from airlines of slower bookings and increased cancellations (Chart 3). The early-endemic phase also means certain sectors are unlikely to return to anything resembling their pre-pandemic level. Conferences/conventions, large entertainment venues, business travel and tourism are likely to bear the markings of the infamous "L-shaped" recovery, as countries navigate infection levels and vaccine requirements.
• Importantly, the endemic phase means different things to different countries. However, a common thread is apparent: vaccine requirements are preferred to the re-imposition of business restrictions. The wave of infections and hospitalizations within the U.S. leaves regions with low vaccination rates at risk of re-imposing restrictions to protect the health care sector. Louisiana is among those noting this threat. However, others are taking a defensive tactic, such as Chicago's "orange list" of states that requires unvaccinated travelers to obtain a COVID-19 test in advance of arrival or quarantine for 10 days. More meaningful has been a surge of major industry players announcing workforce vaccine requirements, from the Federal government to airlines to banks to food processors to entertainment firms. 
• In contrast, other regions are applying a national strategy, such as the UK, France, Italy and Israel, by imposing domestic "vaccine passports" for access to high risk, indoor and group activities.  National strategies have the advantage of greater transparency and consistency for businesses and households, but may also limit economic activity within regions that are experiencing lower infection risks. 

• Canada's vaccine rate is near the top of international rankings (Chart 4), but are still not high enough to put the virus fully in the rearview mirror. Alberta's attempt to lift nearly all mitigation measures by mid-August was postponed due to rising cases and health considerations. Other regions are imposing changes to allow for more sustainable outcomes, such as vaccine passports in Ontario, Quebec, B.C. and Manitoba. However, past infection waves have shown that Canada tolerates much lower hospitalization thresholds relative to other countries. This makes the country vulnerable to the possibility of more restrictive measures, even if case counts accelerate to a lesser extent than others. This may have been the catalyst for the federal government to follow the U.S. lead by announcing workforce vaccine requirements despite higher vaccination rates.       

Q3. What does "peak growth" mean for the economic cycle? 

• For much of the G7, the current reopening phase will mark the fastest point of the economic recovery. This will then transition into less volatile (albeit slower) growth, with labor markets continuing to normalize through 2022.
• Apart from the initial re-opening induced growth spurt in the third quarter of 2020, the "peak" pace of U.S. GDP was likely in the second quarter of this year at 6.5% annualized. The combination of two rounds of economic impact payments to households in the first half of the year, businesses re-opening, and rising vaccinations unleashed a deluge of pent-up demand (Chart 5). Much of the spending was on durable goods. Due to the big-ticket and longer life span of these purchases, the spending patterns tend to be lumpy and we expect a decline in durable goods to weigh on overall spending in the second half of the year. Services spending, which remains well below its pre-recession level, is expected to continue to rebound, however, the recent rise in COVID-19 cases is likely to slow that recovery relative to prior expectations. 
• Slower economic growth does not mean the recovery is over, but that it is leaving the initial "spurt phase" that was simply unsustainable. Recently, pandemic-related restraints have held back labor force participation and led to shortages for many goods, making it seem like the economy is running up against resource constraints. However, low inventory-to-sales ratios suggest upside risk to production growth once these constraints are alleviated. At the same time, record-high job openings suggest a strong foundation for ongoing employment growth. The recovery stage of this cycle has not been marked by employers being hesitant to hire, but rather by employers complaining there are not enough people to hire.
• In Canada, the economic recovery is still very much underway. After contracting in the second quarter, reopening measures will give way to stronger spending in the latter half of the year, with growth likely peaking in the fourth quarter.
• Even with Canada's peak growth yet to come, the level of economic output will be below its productive capacity, notwithstanding temporary supply constraints. Indeed, we anticipate the economy will remain in excess supply territory until the second half of 2022, when actual output will finally catch up to the economy's potential. This indicates the economy is still likely in the early stage of the business cycle.

Q4. As governments step back from pandemic support, how much economic drag will it create? 

• The U.S. has passed multiple rounds of pandemic relief, from the CARES Act to the American Rescue Plan. Federal spending increased by just shy of 50% in 2020 (over $2.1 trillion), leading to record deficits (Chart 6). It rose even more in fiscal 2021, adding over 20 percentage points to the U.S. debt-to-GDP ratio over the last two fiscal years.
• Under current policy, government spending will fall $1.3 trillion (over 5% of GDP) in fiscal 2022, due to sunsetting pandemic-related spending. However, the reduction in expenditures is unlikely to be noticeable in the headline growth figures for two reasons. First, the change in government spending will be swamped by the continued recovery in private spending. Private domestic demand – households and businesses – is expected to grow by roughly 4% in 2022. Second, because much of the government outlays were not spent when they were distributed, they will continue to support private spending over the course of the next year.
• Fiscal drag in 2022 will also be mitigated by any new spending measures that should be passed in the coming months. The Democrats' recent budget resolution calls for $3.5 trillion in spending on elements outlined in the American Family and American Jobs plans (see summary here). This is in addition to the infrastructure spending the Senate has recently approved. At the time, our June forecast conservatively assumed an $800 billion infrastructure package with money spent over 10 years, partly offset by tax increases. The current infrastructure bill looks slightly larger than we assumed, and doesn't include full offsets via taxes. 
• Fiscal measures have also been crucial in supporting the Canadian economy through the pandemic. According to the International Monetary Fund, without fiscal help, GDP would have contracted by an additional 7.8 percentage points last year and the unemployment rate would have been 3.2 percentage points higher. 
• The federal government is continuing to extend support through 2021. In the April budget, a number of COVID-19 response programs, such as the Canada Emergency Wage Subsidy and the Canada Emergency Rent Subsidy, were extended until late-September. And recently, the government announced it would further extend these measures until late-October, while increasing the subsidy rates from August 29th to September 25th.  

• Still, government support will have to wind down in late 2021 and beyond. The budget deficit as a percent of GDP is projected to decline from 16.1% in fiscal year 2020 to 6.4% in 2021 and 2.3% in 2022. This will pose a drag on economic growth, but the exact amount is highly uncertain. Households and businesses saved much of the support payments over the last year and these additional savings will continue to fuel the recovery in private spending. Indeed, according to the Bank of Canada's Canadian Survey of Consumer Expectations, respondents who had accumulated savings said they would spend about 35% of those funds over the next two years (Chart 7)
• Households and businesses are also likely to direct more of their employment income towards consumption and investment channels as the economy opens further. This too will blunt the fiscal drag. Although slowing, we expect the Canadian economy to continue to grow at a solid clip in 2021 and 2022. 

Q5. How is the American job market recovery unfolding? 

• Job growth slowed in August, but the U.S. has made solid progress on the job front. The unemployment rate has fallen from 6.1% in April to 5.2% in August. While that headline figure still understates the extent of joblessness, broader measures of unemployment have made an even larger improvement than headline unemployment – like the U-6, which includes marginally attached workers plus those working part-time for economic reasons (Chart 8).
• The stagnating recovery in labor force participation has been a key disappointment. The participation for core aged workers (25-54 years) has started to make some progress, but the total measure has gained less ground due to older workers (55+ years). Indeed, the U.S. has lost about a million workers over the age of 65 since COVID-19. These workers are less likely to return to the workforce, and this shift alone reduces the participation rate by 0.4%-points. This is a key reason why we are unlikely to see labor force participation re-attain its pre-pandemic peak. 
• The improved hiring pace and unemployment rate decline exhibited at the national level are reflected across most states within the country. The East Coast region continues to lag the rest of the country due to a softer showing in the Northeast. The southern half of the region, meanwhile, is faring better. 
• The recovery of the labor force participation rate across East Coast states has been a mixed bag over the last several months, with only half of all states in the region recording an improvement in this metric relative to the start of the year. Demographic headwinds pose an added challenge for Northeast states, but above-average vaccination rates are offering a tailwind in the near-to-medium term.

Q6. How does Canada's job market recovery compare? 

• After a brief decline due to the third wave, Canada's labour market moved back into the 'plus' column in June and July. Over these two months, a total of 325k positions were gained, the labour force expanded by nearly 200k workers, and the unemployment rate fell to 7.5% – the lowest it has been since the start of the pandemic.  
• The recent improvement was due to the services-producing sector. Hiring in high-touch services was especially strong, as this area of the economy accounted for 52% of the total number of jobs added in June and July. The same cannot be said for the goods-producing sector, which saw nearly 50k net positions lost. This sector's woes are attributable to a drop off in employment in the construction industry, which coincides with the cooling Canadian housing market. 
• Despite robust advances over the past few months, labour market conditions have not returned to pre-pandemic norms. As of July, employment was 1.3% below the February 2020 level, hours worked were 2.7% below, and long-term unemployment was still 150%, or 250k people, higher than historical standards. 
• By province, B.C. is the only province to have employment above its pre-pandemic level. In most other regions, employment is still 1% to 2% below where it was prior to the pandemic. Notably, Saskatchewan and PEI are 3.5% off the mark. 
• Even with these shortcomings, Canada's labour market recovery is ahead of the U.S. Employment in the U.S. was 3.8% below its February 2020 level compared to 1.3% in Canada (as of July). The official unemployment rate was lower at 5.4% in the U.S. in July, but in addition to methodological differences, this is due mainly to a drop in labour force participation through the pandemic. In Canada, the labour force participation rate is only a touch below pre-pandemic rates (Chart 9). Helpful government policies, better handling of COVID-19, and higher vaccination rates likely contributed to the outperformance north of the border.

• As we look ahead to the rest of the year, there are some downside risks to the Canadian labour market recovery. Nearly all provinces have seen an uptick in COVID-19 cases recently, although hospitalization rates remain low (Chart 10). A localized outbreak has already prompted the B.C. government to re-impose some restrictions in early-August, and more stringent measures could follow if hospitalizations rise as they had during the second and third waves. Elsewhere, Alberta and Ontario have paused their re-opening plans due to the rise in cases.
• The U.K.'s recent surge in Delta variant cases offers a cautionary tale to Canada. Its hospitalization rate, while well below what the country faced previously, is close to the peaks seen in Canada this year. With provinces further relaxing public health guidelines, and schools reopening, Canada could see a pickup in the number of people admitted to hospitals, which could prompt a revisiting of strategies. 

Q7. What's next for North American housing markets?   

• Following a strong run in the second half of 2020, U.S. existing home sales have slowed this year. By mid-year, sales appear to have found some footing just below the six million (annualized) mark.
• With inventories of existing homes for sale remaining exceptionally low at a little over a million units, strong competition from buyers has continued to drive price growth. According to CoreLogic data, more states joined in on this trend as the second quarter unfolded. 
• Home price growth across the East Coast region exhibits a similar pattern, with the rate of change accelerating across most states. The main outliers to this theme are New Hampshire, where strong momentum earlier in the year has given way to some recent moderation, and New York state, where home price growth continues to move mostly sideways near the 3% (annualized) mark.  
• Housing demand is likely to remain well supported over the medium term as the U.S. labor market healing continues and more jobs are recouped. The fact that mortgage rates have once again reversed course to their lowest level on record offers an added tailwind in the near term.  With time, the arrival of additional new inventory (as signaled by a healthy pace of housing starts over the last several months) should help lead to a more balanced U.S. market.
• Since hitting the absolute peak of the mountain in March, Canadian home sales have now fallen 28% through July.  Although sales are falling at a rapid pace, they likely have further room to normalize. Accordingly, further near-term declines could be in store before activity stabilizes in 2022 
• This captures a "soft-landing" scenario (where sales eventually settle at lower, but at still-healthy levels). Stronger job markets, low interest rates, faster population growth, and high household savings (which can be funneled into down payments) form a healthy backdrop for housing demand.
• Canadian home price growth has cooled, but this is partly a function of the compositional shifts in sales. Between March and July, Canadian average home prices dropped 5%, reflecting declines in Alberta, Ontario, Saskatchewan, New Brunswick and PEI alongside modest growth in most other Provinces. Softer demand has weighed alongside tough affordability conditions in several markets (exacerbated by the tightening of stress test rules in June). Buyers are moving down the value spectrum to lower priced units within the condo market.
• Because average home prices in Canada can be heavily impacted by transactions at either end of the price spectrum (i.e., "compositional effects"), what is being sold matters. In this regard, sales of less-expensive units have outperformed, downwardly pressuring the average home price metric. Note that benchmark prices (which control for compositional effects) increased, on average, from April to June, in contrast to the drop in average prices. In addition, sales of condos have consumed a rising share of the overall market (Chart 11), as their affordability vis-à-vis other structure types has dramatically improved, and investor demand has risen.  
• Moving forward, home prices across Canada should continue growing at a more moderate pace – marking a notable change from earlier in the pandemic. The combination of cooler demand, more balanced market conditions and compositional forces should weigh on price growth. On this latter point, re-openings and a return-to-office should improve the attractiveness of urban centers, supporting a rising share of condo sales. 

Q8. Does elevated inflation still appear 'temporary'? 

• A confluence of forces has combined to push inflation to heights not seen in years. As measured by the consumer price index (CPI), inflation rose to 5.4% year-on-year (y/y) in June of this year and held at that level in July. This is the highest rate of headline consumer price growth since July 2008. As it was then, rapidly rising energy prices explain some of the increase in the headline rate. Unlike that earlier period, however, core inflation (excluding food and energy) has also picked up noticeably. Core CPI inflation hit 4.5% in June, the highest rate in almost 30 years, before edging down to 4.3% in July. On a month-on-month (m/m) basis, core price growth slowed to 0.3% in July, down from an average of 0.8% in the previous three months.
• Much of the acceleration in inflation in 2021 is associated with supply chain issues, shortages or re-opening the economy, and this suggests a transitory nature. Notably, "things associated with travel" saw big price increases in the spring, in line with Americans hitting the road again after a year of staying close to home (Chart 12). Demand for travel-related goods and services is outstripping the industry's ability to ramp up. In addition, service providers are trying to make up for steep pandemic price drops. For instance, airfares, which fell nearly 30% from January to May of last year, are still more than 9% below pre-pandemic levels, even though monthly price gains have been as high as 10% (in April of this year). Rental car prices are also rising swiftly due to rental car companies having sold off their fleets during the initial lockdown and finding themselves short on supply as demand has rushed back.  Then there are unique industry specific factors, like semiconductor shortages limiting vehicle production and pushing up prices for both new and used cars. 
• After accounting for two-thirds of the monthly increases in core inflation from March to June, these "travel-related" price increases eased in July. Other categories are showing signs of heating up, albeit more modestly. Medical care inflation had been decelerating sharply after big increases in 2019 but shows early signs of picking up again. Excluding hotels, shelter inflation decelerated earlier in the pandemic but has also firmed up. This portion of inflation is persistent and carries a large weight in the consumption basket. In turn, it will likely keep inflation from fully mean reverting in the coming quarters.
• While we expect more moderate m/m increases in consumer prices going forward, base effects will likely result in a move higher in the y/y rate of core inflation in the final months of this year and early next. Inflation is expected to remain high enough to persuade the Fed to begin tapering asset purchases later this year and raise rates towards the end of next year.
• Like the U.S., inflation is elevated in Canada. On a year-over-year basis, inflation in July was 3.7%, partly due to base-year effects, and partly as a result of the rising price pressures. Indeed, the 3-month moving average of 0.4% m/m in July (Chart 13) was two times the pace of inflation in the pre-pandemic period. 
• Canadian inflation should trend higher as pent up demand is unleashed with a lag due to the lingering public health measures north of the border. As in the U.S., this will most likely be evident in high-touch services industries that cannot boost operations quickly enough to meet demand. Canada is also not immune to supply chain disruptions, particularly the global semiconductor shortage. This should keep the price of vehicles and other electronic goods elevated for some time.

Q9. Have commodity prices peaked?  

• We had previously forecast a peak in commodity prices during the second and third quarters of the year. For the overall commodity complex, this view still holds. Supply-side risks and curtailments are beginning to dissipate. At the same time, a shift in consumer demand from goods to services is helping to ease pressure on some tight markets. China's government has also taken steps to reduce commodity speculation and has released some of its strategic reserves to ease domestic price pressures. Still, despite the moderation, prices in several parts of the complex are expected to remain well supported above pre-pandemic levels.
• The pace of growth in China's manufacturing sector has been a key driver of base metal prices over the past year. Its expansion has been easing in recent months, as evident in the PMI data. This should keep metal prices on a modest downtrend. 
• In crude oil markets, OPEC+ has recently agreed to add 400K barrels per day (bpd) starting in August, accumulating to two million bpd of additional supply by year-end. Even then, OPEC+ will have plenty of spare capacity heading into 2022. 
• Lumber markets have seen a sharp correction after repeatedly breaching all-time highs in late 2020 and early 2021. This was driven by a supply-side response in the United States and a moderation in the pace of demand. 
• There are exceptions to the rule. Natural gas prices have been firing on all cylinders. Warm weather and a supply squeeze in Europe have lifted global markets. A continued increase in production should help moderate prices in the coming quarters. 
• If there is one part of the commodity complex that stands out, it is agriculture.  Severe drought conditions in North America and Brazil are hindering harvests, with spillover effects on feed and livestock markets. Uncertainty remains elevated, and the outlook for agricultural commodities will remain at the mercy of weather. 

Q10. How will central banks react to the latest economic developments?  

• In spite of the risk that the Delta variant could slow the recovery, the Federal Reserve (Fed) and the Bank of Canada (BoC) have maintained an optimistic view of the economic outlook. The expectation remains that the economies of the U.S. and Canada will be fully recovered by the second half of 2022 – i.e. both economic and labor market slack. 
• With confidence in ongoing growth, we have seen members of the Federal Reserve increase their openness to tighter monetary policy. Members have pulled forward the expected start of the rate hiking cycle, with most expecting rate hikes in 2023 and an increasing number of them calling for rate hikes in 2022. At the same time, the Fed is beginning to plan a tapering in its Quantitative Easing (QE) program from the current pace of $80 billion and $40 billion a month in purchases of U.S. Treasuries and Mortgage-Backed Securities, respectively. 
• The Bank of Canada has been quicker to remove monetary accommodation when necessary. In addition to preparing markets that it will likely lift interest rates in the second half of 2022, it has steadily reduced the size of weekly asset purchases. In its July meeting, the BoC once again cut its purchases of Government of Canada debt to $2 billion a week. We expect the BoC to taper once again in October, before ending all net new purchases in early 2022.  
• With both the Fed and BoC poised to tighten policy in the coming months through an adjustment to their QE programs, and with the start of the rate hiking cycle coming within the next 18 months, it is surprising that government bond yields remain so low. Both the U.S. and Canada 10-year government bond yields are hovering around 1.2% to 1.3%. With inflation running between 3% and 4%, this leaves long maturity real interest rates at their lowest level in over 40 years. Even with inflation expected to ease towards 2%, the current level of interest rates is not sustainable. If yields were to reflect the current economic fundamentals, we would likely see 10-year yields in the U.S. and Canada rise to 2%. As the year moves along and investors realize the ability of the economy to continue to grow, we expect this economic security to push yields higher.