Jason Daw:
Hello and welcome to Macro Minutes. During each episode, we'll be joined by RBC Capital Markets experts to provide high conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures. Hello everyone and welcome to this edition of Macro Minutes called It's Politics, stupid that we're recording at 9:00 AM Eastern time on April the 22nd. I'm Jason Daw, your co-host for today's call, and I'm being joined by Blake Gwinn to cover US macro and rates and Lori Calvasina on US equities. Now, political decisions are increasingly driving economic outcomes in asset markets rather than the other way around, and we're going to unpack a number of these dynamics in today's episode. So let's jump right into it. Blake Trump has been ramping up the verbal assault on Jerome Powell. Is Powell a useful scapegoat or would Trump do the unthinkable and push the envelope with Fed independence and actually fire him? This obviously has important implications for every corner of asset markets, so your insights are invaluable.
Blake Gwinn:
Yeah, and Jason, I'm not going to pretend to know what's going on inside of Trump's head at any given, given point in time. And to be fair, I think there've been multiple times so far since the election where we've made this mistake of assuming that Trump was really maybe going to talk a lot about things, talk a lot about tariffs, talk a lot about firing pal, et cetera, but ultimately avoid making some kind of decision that's going to do a lot of damage to markets or economy. This is kind of the idea of the Trump put essentially that he does care about what the stock market's doing, what economic data is doing, et cetera, and that would kind of curb some of his worst tendencies. We've been wrong on that front. We saw that with how tariffs have played out. So on the one hand I would say yes, this is really just an attempt to kind of deflect or muddy the waters around the economic narrative and kind of deflect attention away from what tariffs are doing to the data and to markets and kind of move it back towards the Fed.
But I don't know there's a possibility that he does actually go through this and I think from his standpoint of the way he probably views this is that there's not a lot of downside for him personally. Now, obviously ramping up these attacks on Powell have negative effects, have had negative effects on the markets already and could have negative long run economic impacts. But from Trump's perspective politically he probably sees pretty little downside. If nothing really goes forward and he just kind of keeps beating up on Powell on Twitter, then that's probably politically good for him. Like I said, it muddies the waters and kind of deflects attention away from the impact that tariffs are having on the data. If we continue to see that kind of soft data crossing over into the hard data, he can say, well, this is all Powell's fault, so that's fine.
Or Powell caves and delivers rate cuts, he probably is fine without that outcome or this continues to escalate and he ends up firing Powell and he's basically assumed control of monetary policy. So I guess he kind of sees it as a win-win win from his personal political perspective. So I don't really know where it's going, but I think what we can say at this point from a market perspective is that Trump at least trying to fire Powell is no longer this far off tail risk. Like I said, we've made that mistake of assuming that a lot of this was more bark than bite, we've made that mistake with tariffs, we can't really make it here. Markets can't really make that mistake again, so it's no longer this kind of far off tail risk. It's a very real possibility and whether or not it's enforceable and there's a whole conversation around whether he actually has the legal capacity to fire Powell, but whether it's enforceable or not, I think if he were to announce that he was moving forward with these plans, it would really supercharge this kind of us off type of trading activity that we saw on Monday, but really is just a continuation of what we've seen over the last weeks.
That includes rates moving higher, the curves steepening out, risk assets getting hit and the dollar lower. So that would certainly accelerate if Trump continues to move forward with these plans even if they're not ultimately enforceable. And the last thing I would just say that even if Trump doesn't pull the trigger, he's making enough noise about it right now that I think there is the possibility that once this Supreme Court case, there's this Labor board case where a few people were fired and that's going to be going before the Supreme Court and a lot of people have assumed that that has some implications for whether or not he can fire Powell. If that case is judged in a way or if that is resolved in a way that people think opens the door for Trump to fire Powell, that's also going to drive some of this US off price action. Whether or not Trump actually walks through that door, just leaving that door open is for sure going to move markets in a very similar way, even if not to the same magnitude as if Trump actually does attempt to fire Powell.
Lori Calvasina:
All right, so Blake, let me jump in here. You recently changed your fed call and I always find the way you approach this really interesting and insightful. What are your thoughts on the timing of the first cut? How is that potentially impacted by this issue with Powell and Trump that's going on right now? And also when you think about your base case view, what do you think the Fed would do if tariffs say we're rolled back in the short term?
Blake Gwinn:
Yeah, I think what we've seen from the Fed is that they're still in this kind of wait and see mode. That is kind of the message we got from Powell. It was a repetition of the message we heard after the last FOMC meeting. They want to see which way the data breaks. This could either be a big inflation problem or it could be a large downside growth and labor problem. They just don't really know which direction is going to be the most impactful with these tariffs. So they're kind of waiting to see if this weakness we've seen in the soft data and all the kind of negative sentiment actually starts translating into business decisions and consumption decisions. I don't know that that really changes much If Trump pulls back on the tariffs. I think really they still want to see what the data does. I mean, my personal view is that the uncertainty that's been injected into the psyche of C-suites of consumers by how these tariffs have been rolled out is that even if we see some pullback, that uncertainty is going to continue to drag.
So my assumption would be that we're still going to see this crossover from the soft data into the hard data and the Fed is eventually going to react, but the timing of those impacts matters. Inflation impacts are probably going to happen much more quickly. That's probably going to keep the Fed staying put for the time being. And then later in the year, that's when we're really going to see those accumulation, the accumulation of those kind of downside impacts start to grow to a point where the Fed basically has to start turning away from the inflation side and react to slowing growth and arising unemployment rate. So that's why we have our cuts actually happening later in the year and I really don't think the Fed is going to be swayed by either Trump's pressure or really by whether these tariffs are pulled back. It's really going to be more about what the data does.
Lori Calvasina:
Okay, and I want to switch gears a little bit to treasury refunding. This is usually a non-event except in isolated cases. What do you think about the upcoming one? Is it going to be a market mover and how does that fit in with your general views on yield levels in the shape of the curve?
Blake Gwinn:
Yeah, I don't think anyone is expecting treasury to really be changing coupon auction sizes. They have given us forward guidance basically suggesting that we're not going to get changes to Cuban auction sizes for the time being. Also, keep in mind we're still kind of under these debt limit constraints, which does probably keep them from making any increases to issuance. But what I think is going to be really interesting, and I don't know if we'll get any comments around this, but I think one thing that we have been thinking a lot about is that about the administration might use issuance as a lever to control tenure rates. You know that from Besson and Trump that they care a lot about longer term rates even to what we were just talking about with Trump trying to pressure Powell to get rates lower. One lever that they have to do that is to just cut longer term issuance.
That would certainly send yields lower. So I think we're going to be watching very closely from any signs that thinking may be leaking its way into these issuance decisions. Again, I don't know if we're going to get any guidance like that or any suggestion of that at the refunding, but certainly what I'm watching for and I think the risk or the possibility that they actually end up cutting issuance, whereas we've always expected them to increase to be increasing issuance over the next couple years and the longer end, the possibility that might go down in order to accomplish this goal of getting lower tenure yields certainly something that is a real possibility going forward. So turning things around to you Lori, we've had very little hard data. As I kind of mentioned, we haven't really seen that soft data. The weakness in the surveys leak into the hard data itself. One of the places I think you might get a very early read on that is through earnings calls and I think you're uniquely positioned to really see the early warning signs that we are seeing some of those slowdowns CapEx hiring at the corporate level. So are you seeing anything there like earnings calls or anything? Are you noticing companies talking a lot more about the tariff effects and how that's going to impact business decisions going forward?
Lori Calvasina:
Sure. So it's a great question and I'll just give you the caveat that we're getting underway and reporting season as of the day that we're recording this. There are 290 companies set to report over the next say kind of week and a half. So we'll see where we are after we get that next 290 companies. But what we're seeing so far and a lot of the information has really been skewed by what we're hearing from financials and banks which are giving us great color but are generally sort of impacted indirectly. But we are getting some good color so far. So the first thing I would say is we're having a much more honest and detailed conversation than what we've had in recent months and that's a huge step forward because companies in general have been very reluctant to share details until policies have actually been enacted and I think it's contributed to some of the problems and choppiness we've had pricing this risk into equity markets.
In terms of the guides that have come out recently, things have still been a bit mixed. Some companies are putting things into guidance, others are not. Others are maintaining guidance. We're going to have to see how those numbers shake out in the end, but the conversation level is much better Now in terms of what the companies are saying, the financials are generally going out and surveying their clients trying to understand their own exposures, but they have come back with some interesting takeaways on what they're hearing. And so generally they're telling us that the uncertainty has caused a pause in activity in deal making m and a CapEx plans, investment plans. Some of them have cautioned that things could snap back pretty quickly once we get policy clarity. So when we look at the broader economic discussion that's going on, the banks in particular are saying, look, we think the impact here is softer growth.
Some of them have said they expect inflation pressures to be upward, but most of them are not calling for recession at this point in time. Just softer growth and talking about how the risks of a recession have risen. When we sort of rewind and go a little bit farther back beyond those banks that reported the last say week, week and a half, and think about some of the conference commentary we got towards the end of last month, that has also helped us fill in some of the blanks. What we're seeing there, and we've also heard some echoes of this from some of the non-banks that have reported in the last week or two, China seems to be the main problem in terms of tariff exposure. Companies that have Canadian exposure are generally calling out U-S-M-C-A compliance. We have sort of heard, and we heard this from the banks as well, that companies are trying to get through these issues in the short term through pulling forward inventories.
Pre-buying pricing is something to a t we hear that companies are going to really try to pass through outside of the consumer area. I would say in the consumer companies there's maybe a little bit more of a recognition that you can't just keep jamming pricing down the consumer's throat, but I would say anyone who has a corporate customer as planning on jamming that pricing as far as they can. When we zoom out a little bit and think about more this soft data issue and the deterioration we've seen in some of the sentiment surveys, we're obviously keeping a very close eye on commentary around the consumer. The banks that reported last week and the week before are generally saying that spending is fine. We did have one regional bank last week call out some issues with the high end saying they thought they were seeing sort of an early signal emanating from the equity market decline.
They didn't really elaborate on what they meant by that, but generally the consumer commentary sounds okay if you're not talking to a consumer company. When we go back to the end of March and early April and conference season, the consumer companies had a little bit more of a dower tone and we're talking about more event driven spending, episodic spending. So we don't think the consumer has gotten out of this unscathed, but so far it doesn't look like the consumer's falling apart. The last little tidbit I give you on this, and I'm seeing this more from the non-financial companies, there have been some hints that companies are going to be able to manage through the tariffs pretty well in the short term and some of the impacts may be coming in the back half of 2025 or 2026. So as a strategist when I kind of put my thinking cap on, I'm starting to worry that maybe the financial community has gotten a little bit too pessimistic on the short term but not pessimistic on the more kind of intermediate to longer term.
Jason Daw:
Okay, I'm going to jump in here Lori. So we had a big surge in the equity market, 10% from the lows on the partial tariff rollback on April the ninth, but since then stocks have been leaking lower and I guess the question on everybody's mind is where could we end up in various scenarios for the economy and rates for example?
Lori Calvasina:
It's a great question, Jason. I'll tell you, I was actually out seeing investors the week that the pause was announced and the immediate reaction that I saw was really this idea, a kind of disbelief on some of the kind of rebound saying I might fade this move. So it's sort of interesting to kind of see us as you say, leaking lower since then because I think there was some disbelief on that kind of initial pause rally that we observed. If I sort of think about how we model this and the different scenarios we're in, and by the way, that's something else, the companies are all saying that it's impossible to know exactly what these tariff impacts are going to be yet. So everyone's making their best educated guess. I think we can approach it from a couple of different ways on our end. If I do it from a strict sort of modeling approach and I bake into my earnings and valuation model, say half a percent on GDP this year, a mid 3% number on inflation, a couple of fed cuts and some margin contraction and say 10 year yields around 4%.
I'll give you the long and the short of it, which is just that we come up with around 53 51 as a fair value estimate for the end of the year. So that's one of five things that kind of goes into our price target modeling. Our price target is actually 55 50 for the end of the year, but that's what the valuation modeling would show if you just strictly put kind of that stagflationary margin contraction assumption into all of my models. What I've been talking about a bit more in meetings, to be honest, is what we call our four tiers of fear framework. And this is almost like a choose your own adventure because we do find that investors' views on the risks that are out there, they do vary a lot in terms of severity, intensity and frankly particular issue that someone may be focused on.
So the framework we generally use whenever we get into these dicer periods in the market I think has been very helpful for understanding where we are and what we've done and what we could do going forward. Tier one of fear garden variety, pullback five to 10% drawdown we were holding at that prior to the rose garden ceremony and blew through it right after. So where we are now is in the second tier of fear, and this is a growth scare drawdown similar to what we saw in 20 10, 20 11, 20 15, 16 and 2018, and those were all periods in which a significant crisis or recession was feared but didn't end up materializing. And so those drawdowns were all kind of 14 to 20%, about 17% on average. The worst one was 2018, which was frothy positioning in the market, frothy valuation to start the year, a trade war and fears of policy error by the Fed.
So rhymes with the setup for this year in a lot of different ways that drawdown was about 20% on our worst day so far in April we've been down about 18.9% and the market is trying to fight back and hold within that second tier of fear. Now what could take us down to tier three would be recession pricing. So if you look back over time, recessions have generally on average been about a median draw down of about 27% in the s and p and an average draw down of about 32%. So that would take you to kind of 4200 4500 on the s and p and that's our base case for if this tier two doesn't hold that we would price in a recession somewhere within that range. Now if you get into tier four, and this is where you really get into some shakier ground fears of a major crisis that unfolds something similar to the GFC, something similar to the tech bubble implosion more or less, you lost about half the value of the equity market in those which would take you down to 3,100. And that's not really on our radar right now, but it is for some clients.
Jason Daw:
Another question for you, Lori. So unlike the sector or country kind of rotation side, anything interesting happening there? And I guess specifically have you heard from any clients on whether money that's being taken out of stocks, whether that's not going into traditional safe haven type of places, but rather being repatriated back to their home markets?
Lori Calvasina:
So it's a great question Jason, and I'll tell you, I have heard a little bit of chatter in working with some of my colleagues internally primarily about European investors moving back either within their sector or their overall portfolio from the US back to Europe. So we've had some conversations on that, but I'll tell you my real intel comes from looking at the funds flow data, and so we do track the weekly EPFR funds flows, and what we've seen pretty clearly on there, and we talked about it in our most recent piece, was if you look at US equity flows and US bond flows on that dataset, we've really seen some significant pressure on both emerge in recent weeks in terms of outflows returning. So it doesn't seem to be particularly focused on either bonds or equities, but something that's happening to the US in particular.
And that's a combination of both passively managed funds, funds flows, and also actively managed fund flows. When I look across the landscape at what else is going on, most sectors are seeing outflows at this point. We've also seen some outflows from US money market funds. When I look at non-US geographies, and I've only really studied the equity side of this, but we're seeing a clear sort of improvement to Europe and we've seen Western European equity funds and German equity funds in particular have been seeing some inflows. Those paused for a week. We saw outflows return very briefly, but now those inflows are back. But what's even more interesting to me in the latest updates, it was really clear to us that the equity flows into, say France and the uk, they haven't really turned positive yet, but they are really starting to improve. So it does feel like a more broad based rotation into European equities that we've started to see on the dataset.
When we look outside of the US and Europe, the flow trends tend to be a little bit choppier on the equity side, but generally when we look at areas like Canada, Australia, Japan, emerging markets, those are all trending much better in some cases turning positive in most cases. There's still some choppiness in those. So it's a little bit to discuss on a week to week basis, but generally when we zoom out, we're seeing pressure on the US both equities and bonds, better trends in Europe to a lesser degree, better trends on the equity side and those non-European and non-US geographies. So Jason, now let me turn it over to you. Politics are obviously a huge focus as you mentioned at the top of the call and particularly in Canada where we've got the federal election coming up later this month. What are the polls saying right now and what are your takeaways for what that could mean for fiscal policy?
Jason Daw:
Yeah, so over the past month, the polls have shown a consistent pattern with the liberals around 43% of the popular vote and the conservatives at around 38%. And when you look at typical projections on 3 38 Canada or CBC at the district level, a liberal majority is the highest probability outcome at the moment followed distant second, a liberal minority and a very distant third, a conservative minority. Now fiscal policy would loosen under any government scenario we think, but given the heavy skew in the polling data, the focus is on the liberal fiscal plan that was released over the weekend. And here there's a few key takeaways. Pretty big increase in new spending measures over four years. Pretty decent increase in the deficit over a four year horizon. A large portion of that is being financed by expected tariff revenue this year and potential government productivity savings later on through the four year horizon.
Now, I would say for the tariff revenue and the government productivity savings, the risks are probably firmly to the downside, which means that deficits are biased to be larger than projected and the deficit assumptions probably don't necessarily factor in the current economic environment that we're in. And automatic stabilizers will probably add to the deficit projections if the economy slows and the unemployment rate rises to the extent that the RBC economics team is looking for. Now, why this is important is because issuance is going to be significantly higher in the current fiscal year versus last year and versus the previous four year average. Now supply was well digested last fiscal year when it was also record DVO one issuance, but the Bank of Canada was cutting interest rates during that period. Now, if the Bank of Canada is on hold, another record year of issuance does bring greater risk of supply, indigestion and possibly a higher term premium.
Blake Gwinn:
So Jason, to the monetary policy side, I think we had a pretty notable BOC meeting last week given that they held for the first time after seven straight cuts. So I guess my first question is are they done? Is that it? And the second question is, do you think from here on out there's a bit more connection or some kind of return of that relationship to what the fed's doing, meaning that they're basically on hold until the Fed starts cutting or if there is some more impact of the US side on BOC decisions from here on out?
Jason Daw:
Yeah, so starting on the bank Canada side, I would say the bar for them to restart the easing cycle seems quite high at the moment. They could cut later in the year for sure if the growth data starts to weaken, if inflation is contained. But it would probably take an accumulation of evidence for them to be comfortable doing more. And when I say an accumulation of evidence, it's probably three months of weak growth data contained inflation, not just one or two data prints. And they were pretty clear in their monetary policy statement that monetary policy is not well suited to manage tariffs and in that spirit fiscal policy can now take over once we get past the elections and alleviate the need for them to do the heavy lifting. And on your question on the link between the Bank of Canada and the Fed over the past year, the Bank of Canada has meandered its own way for monetary policy.
It's been pretty delinked from what the fed's doing. I would guess that for every two to three fed rate cuts from here, the Bank of Canada might cut once or possibly not at all, but probably not more than that because they have done a lot up to this point. And what this really means to me when I look at relative bond market performance, when you think about it from a relative monetary policy and fiscal policy angle, Canada Bond should underperform treasuries. And when we look across different places where there could be heavy issuance, the tenure sector in Canada is probably susceptible on a relative basis versus the us.
Blake Gwinn:
So I guess one other question. There's been this big theme about de dollarization and people moving out of the US and of the US exceptionalism, et cetera. So have you seen any of that on your side? I'm particularly thinking big real money type of accounts like pension funds, et cetera that you have up there in Canada. Are you seeing any of that rotation? If not, I mean, is it something that we should be looking for and how much of that reallocation do you think out of us back into Canada is possible?
Jason Daw:
Yeah, this is definitely a topic that's gaining attention, not just in Canada but globally, given how we've seen the dollar perform, how we've seen treasury yields perform during the recent risk-off phase in equity markets. To put in perspective, Canada's pension industry is around 3.5 trillion Canadian dollars or around 110% of GDP. It's well-funded domestic assets have been falling over the past 25 years as a proportion of total assets. And it is quite possible that incremental pension inflows are biased to stay in Canada instead of going to the US or foreign markets. And I would say that also it's not difficult to envision a scenario where the pension boards consider allocating more to Canada as a firewall against US tariffs. And if there was an asset allocation shift from foreign to domestic assets of let's say five percentage points, the inflow could be substantial, possibly an upwards of three to 4% of GDP, and this could offset some of the risk from issuance induced term premium increases and also be beneficial for the currency.
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