The Balancing Act: Containment vs. Recovery

Election results and vaccine hopes buoyed market sentiment in early-November even as the pandemic continued to worsen in many countries. It took four days to declare Biden president-elect and even though Trump still hasn’t conceded, markets are discounting an upending of the election result. And with Republicans likely holding onto the Senate, investors are betting on more market-friendly policies than a Democratic “blue wave” might have produced. Treasuries rallied post-election but sold off again as positive vaccine trial results boosted growth prospects. US and global equities jumped sharply on the news that an effective COVID-19 vaccine might be just months away.

But until a vaccine is widely available, governments face a tough balancing act between containing the virus’s spread and keeping the economy open. Policymakers in the UK and Europe have re-imposed lockdown measures that aren’t as restrictive as in the spring but will nonetheless shift the recovery into reverse in Q4. Authorities in Canada and the US haven’t been willing to go as far, though record case growth and rising hospitalizations suggest further restrictions might be needed. In any case, both countries’ economic recoveries are slowing in the fourth quarter.

Governments have extended some support programs to manage the economic fallout of renewed containment measures, and a number of central banks are doing their part by providing additional stimulus. The ECB signaled more support will be coming in December, which we think will include an expansion of its QE program. The BoE expanded its own asset purchases, and we think negative rates remain on the table for early next year. Not to be outdone, the RBA cut rates slightly and launched a new QE program that goes beyond its existing yield curve control policy. Both the Fed and BoC stand ready to add stimulus if necessary, but seem content with the accommodation they’re providing at this stage. Central banks focused on keeping borrowing costs low will have a watchful an eye on rising yields, but might be reluctant to push back against modest increases that reflect improving economic prospects.

Highlights:

• A Biden election win and likely Republican Senate proved to be a winning combination for equity markets which more than reversed a late-October selloff. Promising vaccine trial results also boosted growth prospects and risk appetite, but the battle against coronavirus is still far from over.

• The US economy shrugged off a second wave of COVID-19 infections over the summer, but momentum slowed into Q4 and rising case counts and hospitalizations could necessitate fresh restrictions.

• Targeted restrictions in Canada should result in nearly-flat Q4 GDP, with downside risk if measures are tightened more significantly. The government has largely kept fiscal support in place, putting less pressure on the Bank of Canada to do more.

• Euro area and UK GDP will likely decline in Q4 as governments re-impose lockdown restrictions. The BoE increased the size of its QE program in November and we expect the ECB will do the same next month.

• The RBA announced a number of new stimulus measures, including a QE program that will complement its yield curve control policy.

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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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