Economies and markets in wait-and-see mode

Canada and Europe continued to ramp up their COVID-19 vaccination programs in May, trying to close the gap to early leaders the US and UK. The latter countries have been able to ease restrictions more significantly and look set to post impressive GDP gains in Q2. But the virus threat remains, with a recent increase in cases in the UK underlining the challenge posed by virus variants even in countries with a relatively high rate of first doses. In the US, a persistent slowdown in daily vaccinations suggests hesitancy could be a barrier to herd immunity. Lingering concerns about the virus are likely one of a number of factors behind disappointing US job growth in April and May.

Central banks are keeping a close eye on re-opening as they evaluate how long extraordinary monetary policy support needs to remain in place. The BoC still stands out as relatively hawkish, having already begun to taper asset purchases and still guiding markets toward a rate hike in the second half of 2022. The BoE and RBA have also sounded more optimistic recently. The Fed hasn’t changed its guidance on QE though some FOMC members think a taper timeline should be put forth soon and we expect those conversations will heat up this summer. The ECB, meanwhile, continues to buy bonds at a slightly faster clip to head off tighter financial conditions as other central banks begin to evaluate reducing stimulus.

Waiting to gauge the pace of re-opening and recovery as well as central bank policy, financial markets were generally in a holding pattern in May. US equities saw a modest selloff early in the month following a disappointing payroll report but were back to near-record-highs in early June. 10-year US Treasury yields are close to the bottom of the 1.50-1.75% range of the past three months and breakeven inflation has been relatively steady despite strong inflation prints. The US dollar lost a bit of ground and commodity currencies including the Canadian dollar remained firm. We continue to think a US-led recovery and eventual taper talk from the Fed will break this holding pattern, with the US likely to drive a renewed (albeit more modest) increase in government bond yields over the second half of the year and a recovery in the US dollar from recent lows.

Highlights:

• US indicators have been mixed with GDP growth accelerating in Q2 but job gains disappointing. Higher wages and hiring bonuses are being used to attract workers and could add to cost-driven inflation. The Fed continues to view inflation as largely transitory and isn’t expected to flag QE tapering in June.
• With the Fed standing pat, the upward trend in bond yields earlier this year has stalled out. We expect a further, albeit more gradual increase in yields over the second half of the year as the recovery progresses and the Fed starts to sound less dovish.
• Canada’s strong vaccine rollout and lower case counts set up for a strong H2/21 following an expected slowdown in the recovery in Q2. The BoC is likely to continue reducing asset purchases in the second half of the year ahead of expected rate hikes in H2/22.
• The UK economy looks set for solid growth over the summer as restrictions continue to ease, though new variants pose a risk. Some MPC members have sounded a bit more hawkish of late but we still see the BoE holding rates steady through 2022.
• Europe’s vaccine campaign is ramping up and major economies are beginning to gradually ease restrictions amid lower case counts. Even as the recovery gains momentum, the ECB is likely to remain dovish relative to other central banks given its long battle with below-target inflation.

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Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.

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