Global credit and foreign exchange markets have been roiled in recent weeks owing in part to fears that the Delta variant might throw the recovery off track.
Those fears have contributed to a substantial drop in longer-term interest rates here and abroad and have led to significant flight to safety into U.S. dollar assets, triggering a large and unwarranted depreciation of the Canadian dollar. How justified are those fears? Will the Delta variant have a large impact on the outlook? In short: no, they are not justified, and only minor impacts on the outlook are likely.
Naturally, investors look to the past to predict what might happen with the Delta variant. Second and third waves of COVID-19 unquestionably had significant impacts on economic activity here and elsewhere. Since the Delta variant is so much more transmissible than earlier versions of the virus, it stands to reason that it too risks having a large impact on economies, or so the logic generally goes.
There are two critical challenges to that reasoning from a Canadian perspective. The first is the state of vaccination programs in major economies. Canada leads the world in the proportion of individuals that are either fully or partially vaccinated, and the lead over other countries grows daily. In the U.S., the largest economy in the world and the most important to global economic and financial prospects, just over 55% of the population has received at least one dose of a vaccine. This protection against the virus is also a protection against its economic impacts, as worrisome as the variant may be. The greater the share of the population that is vaccinated, the greater the ability for governments to manage public health without resorting to economically damaging mobility restrictions. The second is that some countries, notably the U.S., are very unlikely to reimpose restrictions even if the public health challenges rise further. A quick scan of any U.S. news or sports channel shows how far the U.S. has come in its reopening process and how fearless scores of Americans appear to be about COVID. While it may be that individuals curtail their own activities even if not mandated by governments, which is what was observed in previous lockdowns around the world, this appears unlikely this time. Vaccinated individuals are well protected and are largely acting accordingly, whereas unvaccinated individuals generally discount virus-related worries. As a result, we don’t think the Delta variant will have a large impact on Canada or the U.S.
The situation is quite different in countries that have lagged on the vaccination front. Australia is a good example, where mobility restrictions have been re-imposed, with large impacts on economic activity expected. Canada is often compared to Australia, but there is no COVID comparison possible now. Barely 30% of the adult population is vaccinated in Australia while over 70% of adult Canadians are. We will avoid the fate of Australia and other countries with poor vaccination efforts. Don’t look to them as indications of what may befall us.
Not only are we not very concerned about potential economic impacts of the Delta variant in Canada, the financial market reaction thus far will have a positive impact on us. The Canadian dollar has fallen roughly $0.03 against the U.S. dollar in the last couple of months. These moves are not fully justified by the evolution of fundamentals that typically drive the loonie and, as a result, the dollar is now under its equilibrium value, meaning that it is boosting our economy. Same with longer-term interest rates. The Bank of Canada is in the process of withdrawing stimulus by tapering its asset purchases because growth is strong and inflationary pressures are mounting. Markets, on the other hand, are easing financing conditions, offsetting the Bank of Canada’s actions thus far, effectively acting like interest rate cuts. The yield on 10-year government of Canada bonds is down nearly 30 basis points over the last two months.
The Delta variant is no laughing matter. It is having devastating health consequences in a number of countries. Thankfully, countries like ours with world-leading vaccination rates, are quite likely to see limited economic impacts from this hopefully final wave of the COVID virus. Sound public health policy in recent months will pay off in both health and economic terms. By inoculating ourselves against the virus, we have largely inoculated ourselves against its economic impacts. •
Jean-François Perrault is Scotiabank’s senior vice-president and chief economist.
