Despite COVID-19 cases being on the rise, consumer demand and spending, employment and accumulated savings remain strong in Canada. However, supply chain constraints and transportation blockages are temporarily holding back growth, warranting a revision to the Canadian outlook. Rising cases of the Delta variant didn’t stop the greenback from strengthening after losing ground for two straight weeks, while the loonie continued to lag most of its peers. Meanwhile, investors’ optimism and global equities continue to make new highs, but near-time GDP cuts driven by COVID concerns could warrant portfolio adjustments.
Scotiabank analysts and economists weigh in on what the pandemic means for economic growth, currencies, and equities.
Growth outlook
- Supply chain constraints are temporarily holding back growth. A big revision to the Canadian outlook is in order owing to supply chain constraints that appear longer-lasting and more binding than previously assessed. Growth in 2021 is now expected to be 4.8%, down from 6.1% previously forecast, and 3.6% in 2022 (4.1% previously). Our first cut at a 2023 forecast points to growth in the 3% range. These changes mainly reflect negative revisions to second-quarter growth, largely due to challenges in obtaining key production inputs because of component shortages, such as semiconductor chips, or transportation bottlenecks.
- There is plenty of evidence demand remains robust and, barring additional supply disruptions, the recovery remains on a solid track. In Canada, employment growth remains exceptionally strong, household wealth is at record levels, commodity prices remain high, and business confidence remains particularly strong even as COVID-19 cases have been on the rise again. Together, these fundamental drivers of growth continue to point to remarkably strong growth in coming quarters even if the economy’s ability to import or produce goods is temporarily impaired. Helping offset some of the challenges on the goods side, the service industry — travel, accommodation and food — is picking up steam, as mobility restrictions have been unwound.
- Supply chain challenges exist to a large extent because of the strength of demand. For a broad range of goods, low inventories are leading to pent-up demand. Given the strong financial position of many households and still extremely accommodative financing rates, robust consumer spending will follow as more goods become available. This underlies our view that Canadian growth will remain quite strong, at 3%, in 2023. In both Canada and the US, we continue to anticipate that core inflation measures will remain above central bank targets through 2023. Read the full Global Outlook report here.
— Jean-François Perrault, Senior Vice-President & Chief Economist
Foreign Exchange
- The US dollar strengthened through the early part of the week following two weeks of steady losses and despite the release last Friday of weaker than expected August payrolls data. Markets remain on edge due to a slowdown in global growth owing to the spread of the Delta variant and concerns over supply bottlenecks that are severely limiting global manufacturing output. China’s continued crackdown on private enterprise, particularly in the tech sector, is also weighing on global equities.
- The Canadian dollar lagged practically all its major peers through the week with its 1%+ decline only surpassed by the Brazilian real (where protests have damaged market sentiment). The Bank of Canada’s meeting on Wednesday largely met expectations holding all its policy levers unchanged and treading carefully on its assessment of the economic outlook, seeking to strike a neutral tone ahead of the Sept. 20 Federal election. Recent polls point to a steadying in the Conservatives’ chances at government, with a Liberal minority with the support of the NDP still the most likely scenario.
- The main drivers of USD price action next week will be the release of the August consumer price index (CPI) on Tuesday, August retail sales on Thursday, and September University of Michigan consumer sentiment on Friday. The latter two releases will be key in determining the impact of the Delta variant on household sentiment. Generally, we expect the USD to remain on a broadly ascending trend as solid economic growth firms up the case for US Federal Reserve rate hikes as soon as late-2022. Canada also publishes prices data on Wednesday, but we expect limited reaction in the CAD, which should continue to trade in line with the broad dollar and risk mood. Markets will continue to monitor election opinion polls next week, although we expect the outcome will have little influence on the currency.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
Equities
- Injecting a dose of quality (...and growth). While we believe the long-term macro-outlook remains robust, near-term uncertainty is on the rise. The Delta variant continues to spread, the US Federal Reserve taper is now a near-certainty, the US debt ceiling has yet to be addressed and China is not only slowing, but also enforcing a regulatory crackdown/antitrust campaign against its own tech industry. Those concerns have not made a scratch on investors’ optimism and global equities continue to make new highs. Still, we have started to witness negative revisions to 2021 gross domestic product (GDP) growth forecasts. For now, the cuts are somewhat offset by positive revisions to 2022 forecasts. The good news is that negative GDP revisions are not driven by weak demand, but rather pandemic fear (more people staying at home) and supply/production constraints.
- World PMI: A peak followed by a slow mean-reversion. Although the deceleration phase could be slow, it nonetheless makes investors uncomfortable (the second derivative has turned negative). Value tends to outperform in the year following an ISM Purchasing Managers Index (PMI) peak, but other investment styles are also performing well: a blend of value could prove superior to pure value.
- The value trade’s biggest problem: bond yields. We see one big missing link for value to enjoy a more sustained/stable leadership: bond yields. The relationship between US 10-year bond yields and investment styles has never been so extreme. US Value’s relative performance vis-à-vis the S&P 500 has never been so highly correlated to bond yields.
- Conclusion. The uptrend in equities is likely to extend over time. Still, those near-term concerns, weak seasonality and unresponsive bond yields commend some portfolio adjustment. We’re injecting a dose of quality (and growth) as we believe some hedges are probably needed after such an uninterrupted streak of gains.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
Legal Disclaimer: This article is provided for information purposes only. It is not to be relied upon as financial, tax or investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, and other investment factors are subject to change without notice and The Bank of Nova Scotia is not responsible to update this information. All third-party sources are believed to be accurate and reliable as of the date of publication and The Bank of Nova Scotia does not guarantee its accuracy or reliability. Readers should consult their own professional advisor for specific financial, investment and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly, and action is taken based on the latest available information.
For Scotiabank, Global Banking and Markets Research Analyst Standards and Disclosure Policies, please visit www.gbm.scotiabank.com/disclosures