Hello and welcome. My name is Eric Lascelles. I'm the chief economist for RBC Global Asset Management and delighted to be sharing with you our latest monthly economic webcast entitled Probing Economic Resilience. And it'll cover off quite a range of themes, but among them is just the observation that we've seen some surprisingly resilient economic activity recently, particularly in the U.S., not exclusively there and just continuing to look in that direction.

And the theme for us in recent months has been to increase the chance of a soft landing, of avoiding a recession. We still think a recession is a little bit more likely than not, but there certainly has been some very real economic resilience.

Report Card:

Let's jump our way in, as we always do, and we'll start with a report card of sorts. And we can talk our way through some of the good and not so good things happening out there in the global economy. And on the positive side of things, I can say a number of observations. One would be that the U.S. economy is still growing and normally that's not a particular cause for celebration. But in this time of sputtering economies, particularly across the developed world, in the face of much higher interest rates than we'd grown accustomed to in recent decades, that is a notable feature.

And indeed, the latest quarterly GDP print for the U.S. was another fairly handsome looking number. So that's good news. Inflation is falling again, and so inflation fell quite nicely from the middle of 2022 through to really the summer of 2023. It went maybe sideways and even in the wrong direction a little bit for a month or two.

And it's now broadly back on a declining trend. I think it's going to be a harder journey from here all the way back to something resembling normal. But we are still seeing some decline and we are still a bit of an optimist, slight optimist, versus the consensus in terms of the ability for inflation to fall somewhat further. When we talk about the central bank world in the U.S., the Fed has been signaling rate cuts.

Now, as I say these words literally one hour ago, we just heard from the Federal Reserve in the U.S. and they indicated probably not a rate cut in March. And so we need to set our expectations accordingly. But nevertheless, they are thinking rate cuts and the market has embraced that idea. And I'll speak more about that in a moment.

And then lastly, on the positive side, I can say there just is continuing to be mounting optimism for a soft landing. The idea that maybe a recession can be avoided, we're not completely sold, but even we would acknowledge that the prospect has improved. And you look at the stock market and risk assets more generally, and they've been soaring in recent months.

And that is very much on the idea that maybe there doesn't have to be a recession. So all sorts of good news to deal with here. Let's switch from that now to the negative themes. And so sadly, there are some negatives, a fair number, in fact. And so let's work our way through those. And the first comment would just be interest rates are still pretty high.

They're not as high on a bond-yield basis as they were a few months ago. In October, they peaked in the U.S. at 5% for a 10-year yield and now they're closer to four and a little bit percent. But still that's a lot higher than we'd seen a few years ago. It is notably above the average over the last couple of decades as well.

We think that some of the special tailwinds that notably helped the U.S. economy in 2023 may be starting to fade into 2024. I'll get into that in a moment. But even the U.S. might be a bit less resilient this year. We still think the business cycle is quite late, and so that is informing some of our thinking. We're still more than aware that outside of the U.S., the rest of the developed world is broadly sputtering.

These are not economies moving forward with much enthusiasm at all. U.S. recession risk accordingly, we think is still higher than normal and indeed still slightly more likely than not. We're still assigning a 60% chance. And so it certainly doesn't have to happen, but it is fairly likely to happen. And so we'll talk our way through that in a moment.

And then in terms of other negatives that are maybe a bit more recent and worthy of attention, one would just be that we are continuing to see some new supply chain disruptions, most acutely in the Red Sea, and we're seeing the cost of shipping rise quite a bit at this point in time. And then I suppose related to that, I can say as well, this is a time of elevated geopolitical risks and that's been true for a number of years.

But now the Middle East has gotten awfully messy in addition to some longer standing issues that have existed in a U.S.-China context and in a Ukraine-Russia context. And then let me move to the interesting column and just highlight a few other items, several of which we'll tackle in this presentation. And so the first thought is it is a busy political year ahead internationally, lots and lots of elections, every which way may be headlined by the U.S. presidential election in November. I mention this just because there is the scope for policy changes, there is the potential for politics to be quite relevant for the economy this year. I can say that from a fiscal standpoint, lots of fiscal stimulus being run. Therefore the, theoretical at least, need for some fiscal austerity at some point over the next several years.

We keep thinking once we've worked our way through the big question of will or won't there be a recession in 2024, markets might start to turn their attention to the need for fiscal deficits to start to shrink, and that can be a little bit economically painful. The de-globalization theme continues. I'm going to spend a moment on that and really just elaborate and separate de-globalization from friendshoring, from on-shoring, all of which are similar ideas.

But ultimately a bit different and with slightly different trajectories for each of them. And then lastly, I will also speak for a moment about just mortgage market distress, mortgage delinquencies in Canada. And I guess the good news is there have been surprisingly few so far. You would have guessed in a world of higher rates and falling home prices and all sorts of negatives that perhaps we'd be seeing quite a worrying level of mortgage delinquencies and it's still pretty low. And I'll just talk through how it is that that's possible despite housing market weakness.

Why was 2023 so resilient?

Okay. So let's get into the details here. And why don't we start with that big question of why was 2023 so resilient, particularly for the U.S., which just sailed along, almost unperturbed by higher interest rates despite the theoretical headwind that presents? And we can really give a number of answers.

And so one set of answers would revolve around the idea that there were some nasty, not so good things going on at the very start of 2023, and several of them just faded over the year, taking away, I guess, non interest rate headwinds. And so one would be inflation became much less high. And so on that basis we can say that less inflation means less of a corrosive effect on the economy.

Supply chain problems eased materially really over multiple years, but including over much of 2023 taking away a drag there. China ended its lockdown at the very end of 2022. And so there was a Chinese economic recovery. It was a bit underwhelming, but it was still a recovery. And then U.S. regional banking stress, which admittedly peaked in early 2023, not before 2023, but nevertheless, the degree of stress there has at least diminished to some extent.

And so that did open up avenues for additional economic growth in the U.S. We can say simultaneously that the U.S. had some special, really unique supports that other countries didn't enjoy if we're trying to understand how it is that the U.S. was particularly resilient in 2023. And so one of those was just unexpectedly large fiscal stimulus. And so it's a strange one in the sense that there really wasn't any new legislation of note.

It wasn't that there was a new tax cut or a new spending plan that came out in 2023. It really was more just that previously budgeted for pieces of legislature had bigger uptakes than expected. There were tax credits, the presumption was X number of businesses would pursue those credits and it turned out to be X times two or three in some cases.

And so there ended up being much bigger deficits and just much more economic support inadvertently coming out. That looks like it will be less supportive in 2024, importantly. The U.S. consumer was very enthusiastic in 2023 for a number of reasons. I'll get into at least one a little bit later. We think consumer spending enthusiasm could be a bit less in 2024. The last support, and this one doesn't go away, is that the U.S. is just fundamentally a less interest rate sensitive economy and so it is damaged less by high interest rates than are other countries.

So that's an advantage to the U.S. mostly gets to hang on to in 2024. And indeed to the extent we were to get economic weakness, we think the U.S. probably does experience somewhat less. And then just one last thought here, which is in all of this good news, we do need to remember that higher interest rates do still hurt.

It's clear they've been inflicting pain on the rest of the world already. Again, we're not seeing much growth in most of the developed world outside of the U.S. And from both a theoretical perspective and from a historical perspective, even with lower rate sensitivity than many other countries, the U.S. economy has historically slowed from higher rates and theoretically it should.

And so the point being that we can't just assume the U.S. economy continues to shrug off this pretty remarkable increase in interest rates that's taken place over the last two years.

Our two main macro scenarios for the U.S. in 2024:

I'm going to throw this up here. This is actually very similar, possibly identical to what I shared in last month's webcast. But I want to do it again just because it's so fundamental to our thinking right now.

And so let's just do that. And so, when we think about the outlook for 2024, I wouldn't say we have 100% conviction on where things go. And indeed, much of the thrust of this presentation is just weighing the relative odds and trying to assess which is more likely, we think, a soft landing, meaning avoiding a recession is quite possible.

We think a hard landing, meaning succumbing to recession is also quite possible. They're not quite equal odds, we would say a 40% chance of a soft landing. And if you're good with math, you can probably guess what the hard landing likelihood is, more like 60%. And those are different numbers, and yet they are both pretty close to 50/50 in the grand scheme.

And so these are both conceivable scenarios. If you want to be an optimist, if you want to argue for soft landings, you can start by saying that in particular the U.S. economy has just refused to quit in 2023 and it has serially surprised to the upside. And so, we should just accept that at some point and stop trying to be clever and forecasting some sudden inflection downward in the next quarter or two.

And so that's a fairly compelling argument. We've had resilient consumer spending, far exceeding expectation, and that's the biggest single part of most developed world economies. Inflation has fallen, as I spoke about a moment ago. Yes, interest rates are a lot higher than two years ago, but they're notably lower than a few months ago. So, we have seen this extra small helping hand as financial conditions have eased.

We have a central bank, a Federal Reserve, that is no longer solely concerned about inflation. It is now starting to be able to absorb and interpret and deal with economic considerations as well. You might say the Fed put is back. The idea there is that to the extent things might go wrong in markets or in the economy, there is again scope for the Federal Reserve to cut rates and just lend a helping hand.

There's also been just a positive confidence shock. People are feeling good. We've seen consumer confidence rise. We've seen stock market surge and credit spreads narrow and so on. And so, whether that's fully justified or not, the actual event itself does make people a bit richer, makes them feel more enthusiastic and could by itself maybe allow the economy to keep growing.

So, it's quite possible that we pull off that soft landing. We still think it's a bit less likely than a hard landing. Hard landing again, that 60% likelihood. And so, again, pretty good arguments here, too. This is the problem. There are good arguments on both sides. I think you just have to be rational about this and say these are both conceivable outcomes.

We should have less conviction about how 2024 plays out than we might have in the average year. We should sort of weigh the relative likelihood and invest accordingly as opposed to pretending we have all the answers. In terms of hard landing arguments, an aggressive monetary tightening cycle has most certainly taken place over the last few years.

That's still a pretty profound economic drag. Despite some decline in yields recently, there is famously a long lag between higher rates and the economic pain. For instance, on average it takes 27 months from a first rate hike to a recession, and that would actually pinpoint June of this year would be the time you might expect a recession if that historical pattern were to hold.

We have businesses that are still feeling pretty pessimistic. Expectations just about universally are still quite cautious. We have a big long list that I'll show you in a moment of classic recession signals that are still, for the most part, signaling recession. Our business cycle work says that the cycle is quite old and thus vulnerable. As I've said a few times, international economies are already weak.

Some of the supports that the U.S. enjoyed uniquely in 2023 are fading and some economic data is softening. And I feel a little bit guilty saying that just because some economic data isn't softening. And so maybe I'm just cherry picking. I don't think I am though, just in the sense that most of the time, under normal circumstances, all of the economic data looks pretty good and very little of it looks to be weak.

Right now we're in this confusing situation where some looks quite good, some looks pretty weak. That is unusual. It's not it's not a slam dunk that bad things happen. But it is telling us that this is not a normal, easy growth environment.

U.S. economy has remained resilient despite two-decade-high interest rates, serially exceeding expectations:

Okay, on from there, let's just run through some really pictures to support some of those claims.

And I'll do this fairly fast. And so this is U.S. quarterly GDP growth. The point being over the last 18 months or so, the U.S. economy has grown reliably and not just grown but grown fairly fast. You can't quite tell that it's fast because this time frame really encompasses some remarkable growth periods from the post-pandemic era. But I just want to say anything north of 2% is pretty good growth in the modern era, and we've seen consecutive quarters that are 2% plus and indeed even touching 3%.

And there was a a wild quarter in Q3 of last year that was actually 5% annualized growth. So if serially exceeding expectations, maybe that does just continue. This, by the way, is my list of optimistic charts. And then we'll pivot and show you some of the more pessimistic ones in a moment. I can say that consumer spending is very much supported by household wealth, as an example. This is American household wealth as a percentage of income. And yeah, there's been a bit of a drop in the latest data, though that data is now a bit stale and doesn't actually pick up the stock market boom that's happened in recent months. So I wouldn't be surprised if that jumps back up. But to me, the bigger point is just you see a pretty clear upward trend here.

And the upward trend really includes the last several years. So households are objectively wealthier than they were. And so we can worry about higher rates quite rightly, but we can equally acknowledge there is just more money sloshing around that people could spend even if their employment situation or even if their borrowing situation does become somewhat more adverse.

And so those are certainly benefits the consumer enjoys. I wouldn't want to pretend it's a one-way street in the sense that we do see consumers to some extent eating through some of their excess pandemic savings. We do see similarly some tentative evidence of distress mounting in terms of credit delinquency rates and things like that. But fundamentally, most consumers still have their job.

Unemployment is low, wage growth has been pretty good. And household wealth is fairly strong as well as shown here.

Market optimism as Fed clearly signals rate cuts ahead:

I've talked about the Fed, expectations of rate cuts. As you can see, how much more rate cutting is priced in in the blue line than had been priced in in the gold line back in the summer of 2023. And so the market's much more convinced the rate cuts are coming.

I would say we're dubious that happens in the early spring, but I would say later in the spring and into the summer of 2024 is entirely fair game right now. And there could be a material amount of cutting. One tricky thing here is I suspect there will be a very different trajectory depending on whether that soft landing is achieved or whether there's a hard landing.

If there's a soft landing, I would think there will be less cutting than the blue line would suggest. If there's a hard landing, I wouldn't be surprised if there was materially more. And so that really is the debate that exists right now. One way or the other, rate cuts are likely and bond yields are already starting to embrace that.

Financial conditions eased as Fed-cut expectations buoyed:

Financial conditions have eased fairly significantly. That dark blue line for the U.S. shows a nice drop. Lower means easier conditions and it really just puts into a chart the idea that bond yields are lower and the stock market is higher. And there have been some other positives like that.

Lending standards have tightened a lot, but tentative reversal could be good sign for economy:

Lending standards, and so this is a tricky one. This is how willing banks are to lend and specifically lend to businesses. In this particular chart, there's been a lot of tightening. Technically, any line above zero is a tightening of bank lending standards. Technically, even that decline on the far right is a continued tightening of lending standards just at a slower rate than before. So that's the technical interpretation. I can say, in practice, however, whenever that line has started to come down, it's usually been good news. It usually means that banks are at least beginning the process of reversing course and maybe are on their way towards easing lending conditions. And so, the fact that we've seen that decline, the technical interpretation isn't all that positive. But practically speaking, there is a glimmer of hope that comes from there.

And of course, if banks were willing to lend more enthusiastically, that would be quite a welcome thing.

Can the usual recession over-reaction be avoided?

Okay, so let's talk about this other idea here, which is can a recession be avoided because recessions are inherently irrational? And so let's just talk through this idea here. And so I can start by saying recessions are usually overreactions. When we look at what businesses normally do during recessions, they normally lay off more than they probably should.

If they were optimizing their medium-term outlook, they cut back on capital expenditures more than would be in their best interests if they were again looking out several years as opposed to just to the next quarter. The stock market usually falls by more than you could justify if you were just plugging in numbers about earnings expectations, let alone the fact that earnings then probably bounce back the next year.

And so you can say there is a lot of irrationality in recessions. So by that token, maybe they don't have to happen if people aren't being irrational. I think a big question is, is that irrationality or that suboptimal behavior unavoidable or is it not? And so maybe it is unavoidable in the sense that, you know, businesses and investors just face liquidity and credit constraints.

It might be that businesses know that they should be doing more CapEx and they shouldn't be cutting back so sharply, but maybe they just can't get a loan from a lending institution. Maybe they suddenly need all the money they've got to make payroll because the bond market just isn't open for business and they're not able to manage their cash flow as normally as possible.

It's possible that businesses aren't optimizing just because other constraints have been imposed on them by difficult circumstances. So I would say there is a debate here. However, it could just be, or at least a part of it may be, is just that people panic when things don't look so good. And there's a concept called stall speed that we think a lot about.

And the idea being historically, whenever you see and again, using the U.S. as an example, whenever you see the U.S. economy shift below a notable rate of growth, really underperform in a visible way, usually it then tumbles even further into outright recession. And strictly speaking, that doesn't have to happen. It doesn't have to happen in the sense that there's no reason why an economy can't just grow slowly for a period of time.

But it seems like people panic. They get really nervous and you end up with people then responding even more aggressively than they need to. And that's maybe one of the ways that we find our way all the way to things like recessions. And so I don't have an answer here. I wish I could say recessions are irrational, therefore they don't need to happen, if people are calm.

I will just say there is a degree of psychology in recessions and historically, those feelings and the panic and risk aversion arise. And you do end up with a recession when there's enough economic adversity out there. But it is worth just speculating, Gosh, you know, we've seen the rest of the developed world already go through a period of almost non-existent growth and not panic.

That's interesting. We can say that in this particular instance, recession has been so widely advertised and predicted for so long and not come to fruition for so long that people might just not be that scared anymore. And so maybe there is a scenario where the economy weakens but nonetheless doesn't just succumb fully to recession, instead achieves a soft landing.

So again, there's an optimistic thought in there that maybe history doesn't have to repeat itself. So that's the good news.

Declining Fed liquidity is a theoretical economic headwind (though pace of decline should soon slow as QT ebbs:

Let's pivot now and just talk about some of the things that are still pretty challenging out there and that argue for a worse outcome. One would be that, of course, not only have central banks raised rates, but they are also in the business of shrinking their balance sheets.

This is the Federal Reserve's balance sheet. So it got really, really big as money was printed and rates were cut and so on. And you can see now the balance sheet is starting to shrink and part of that is quantitative tightening. And part of that is other factors such as special bank lending facilities and liquidity programs coming off. The point being though, historically when the central bank balance sheets are growing, it's been a time of market enthusiasm and a time of fast growth. Historically when it's shrinking, it has been more challenging, particularly for risk assets like the stock market.

And so this would argue that things are getting more challenging even as the rate of decline might start to slow.

U.S. fiscal impulse likely to turn negative in 2024:

From a fiscal perspective, I can say that 2023 was a year of fiscal stimulus. It was a year in which there was net support to the economy. And these are estimates from the IMF and the OECD and both saw a significant amount of support delivered in 2023.

You look to 2024, that's the two bars that are circled just after 2023, and you can see the expectation is a fiscal drag. Not that governments are going to run surpluses, but just the deficit will be smaller in a way that means the economy experiences a headwind. And so not everything lines up quite as generously in 2024 as it does in 2023.

Higher rates start to hurt household finances:

I can say, as I mentioned cryptically earlier, that there is evidence of rising loan delinquency rates and just households running into trouble. And so this is, again, for the U.S. and we can see really right across mortgage delinquencies, auto delinquencies and credit card delinquencies that the delinquency rates are all rising. And indeed, in the case of credit card delinquencies and auto delinquencies, these are now the highest delinquency levels that we've seen in over a decade.

So there is some pain being felt. It still doesn't look a whole lot like it did during the Global Financial Crisis. But there is a subset of Americans who are feeling some pain and it makes sense. Interest rates have gone up, policy rates have gone up by more than five percentage points. It would be quite remarkable if there wasn't any pain.

And we're budgeting for that pain continuing to mount in the sense that the average interest rate this year probably will be higher than the average interest rate last year just by virtue of the fact that they were raising rates across much of last year. And it's not clear that rate cuts are in the immediate offing just yet, though we do budget for some a little bit later in the year.

And so those high rates are still going to hurt and classically high interest rates hit with a lag. And so even if we were to see rates peak and even interest rates start to come down a little bit, you would still assume that some of these delinquency rates will rise for a number of quarters beyond that.

U.S. banks still carry significant investment losses:

I would flag that there is still an issue, or at least there are still concerns, about some fraction of the U.S. banking sector.

U.S. regional banks, you'll recall, had some serious problems in 2023. And just as we look at the balance sheet of the banking sector right now, we can still see that there are significant losses in significant part due to holding of bonds that are underwater, that have lost money because interest rates rose. But nevertheless, we are talking about more than $500 billion of theoretical losses that the U.S. banking sector is holding on to.

And at this point, I would say the situation is stabilized in a way in which we wouldn't presume that there's serious financial trouble coming. But it is something that argues this isn't really an environment in which the banking sector can enthusiastically lend. And so there is still going to be fairly tight credit conditions in this sort of environment.

And high interest rates may not be hurting the average American with a mortgage that much because they've perhaps locked in that mortgage rate in a way that renders them immune to higher rates. It does affect the banking sector, though. The banking sector is not immune to higher rates and it's just a different channel into the economy by which higher interest rates travel.

Recession signals point mostly to “yes” or “maybe” – We estimate 60% chance over the next year:

We've used this table over and over and I think it is very useful. At least I hope it's going to be useful. Only time will tell whether it's made the right prediction or not. But this is a list of recession heuristics. And so the idea being that usually these things trigger before a recession. And so we should be paying close attention to whether they're triggering and some are fairly popular, like when the yield curve inverts, when long term rates fall below short term rates.

Historically, that's been a very strong signal of recession. We continue to get that signal. Others are, for instance, when inflation has risen by five percentage points or more, historically, you have succumbed to recession within a few years. And we did get that a couple of years ago. I can go on and talk about tighter lending standards and talk about the idea that when global trade is shrinking on an inflation-adjusted basis, that's almost always been a recession.

We've seen global trade shrinking in recent months. And so the point here is just that a good half of these recession indicators are blinking red and a significant fraction are blinking yellow. Not very many are saying no. And so you would have to acknowledge the risk of recession is at least higher than normal right now, arguably is outright high and perhaps even north of 50% as we're arguing.

Central banks have started to pivot from hikes to cuts; the amount depends heavily on soft vs. hard landing:

When we look at central banks, and so this is central banks now perhaps beginning to respond to concerns about the economy, but maybe more acutely just celebrating that inflation is coming down. This is a fun chart or only an economist might call this fun, but nevertheless, I'll call it a fun chart. This is the fraction of the world's central banks that are raising rates versus the fraction that are cutting rates.

And so in gold, you can see that there was a very large fraction indeed raising rates over the last few years, including Canada and the U.S. and many others. Very few were cutting. You can see that story is changing. Far, far fewer central banks are raising rates right now. You see the gold line, the gold bar is descending quickly and increasingly, we are getting more central banks that are cutting rates in blue.

It's still a pretty small fraction. It's almost all emerging markets, in case you're wondering. But nevertheless, we are starting to get there. And when you I guess, combine the two in that dark blue line, you can see that that triangle, that mountain appears to be continuing on a downward slope. And not to suggest that charting and trend following can tell you everything you need to know about central banks.

But nevertheless, it does appear that we're now pivoting to a time where rate cuts dominate, whereas rate hikes dominated for a period of time.

Why hasn’t Canadian mortgage distress exploded yet?

Okay, so let me talk about this. This is a bit of a special topic. And so why haven't Canadian mortgages proved more of a problem? Why haven't we seen higher mortgage delinquency rates? The mortgage delinquency rate in Canada right now is 0.16% of mortgages.

That's actually an extremely low number, the all-time low is 0.15%. This is not a sign of great distress. So let's try to understand that. I think the starting point would be, and this is going to be a Venn diagram by the time we're done with this, meaning we'll look at the overlap. You have trouble when a number of things go wrong at the same time.

And so one thing most certainly has gone wrong. We've seen interest rates go higher. That is painful for borrowers. Note, though, that we don't just say higher interest rates, we say exposed to higher interest rates. And so at this juncture, a significant fraction of Canadians with mortgages have not been exposed to higher rates. They will roll into those higher rates over 2024, 2025 and 2026.

It's just the 2022 and 2023 cohorts that have so far felt the pain in terms of five-year fixed term mortgages. And indeed variable rate mortgages in theory have already felt that pain, but in many cases haven't because banks have made adjustments that have allowed people to continue to pay their prior payment. And so there is a significant fraction of Canadians that have been exposed to higher rates, maybe not quite as big a fraction as you might have thought.

That's the starting point. The next comment is it's important to sort out who has negative home equity, whose house is worth less than the ownership they have in that house. And so the answer is a pretty tiny fraction of Canadian households right now. And so, yes, home prices have fallen. However, they rose so incredibly, so spectacularly, over the prior several years that only a very small fraction of houses actually have negative equity in them, meaning the mortgage that is owed is more than the value of the house.

Obviously, you could think of perhaps some people in the last couple of years getting in who might be in that position, but even they would have had some down payment to eat through first and so it's a pretty small fraction that is exposed to higher rates. And as negative home equity, you might think that's a group that would be conceivably having some pain and would represent some fraction of those with mortgages that are delinquent right now or otherwise distressed.

There's one other item I want to throw in here, which is job losses. And so, you know, the real trifecta, the real trouble happens when you hit the intersection point of all three of these things. So if you've been hit by higher rates and your house is worth less than you owe on it and you've lost your job, just compounding the inability to make a mortgage payment, it really is that intersection that would be the fraction of people in deep trouble.

And we haven't seen really economy wide job losses at this point in any significant number. People lose their jobs every day of the year. And so certainly there are some people in that position. On the aggregate that hasn't been that large a problem yet. That's why the circle is so small. And so it's a pretty small fraction that's really, really suffering across all three of those avenues.

I think it is worth acknowledging that some of the other intersection points can make trouble of their own. And so again, particularly people exposed to higher rates and with negative home equity would be perhaps inclined to consider their options. But nevertheless, it's a pretty small fraction right now. And you can kind of further mitigate it with the acknowledgment that Canadian lenders have been I would say, unusually willing relative historical patterns to negotiate and change repayment schedules to avoid people falling behind or creating too much trouble.

And so that really has smooth things over. And I'll just mention one other thing, which is just mathematically, 64% of Canadian households don't have a mortgage. And so some fraction of those people don't own a home. Some fraction do own a home, but own it outright. It's only 36% of Canadian households with a mortgage. And so that also, I suppose, mitigates things somewhat.

And so really, we're not seeing that much distress in a financial context. We've taken to saying that we think that this is an economic issue, home prices that are lower, housing resales that are slower. This is something that is a drag on the economy, as befits a highly interest rate sensitive sector. We're not budgeting for it to be a financial crisis or anything as exciting as that.

And this helps to explain how that's been avoided so far. I do want to flag one thing, though, which is that it is reasonable to guess that these three circles could get a little bit bigger, could get a little bit worse over time. And so the fraction of Canadians exposed to higher rates can only mathematically rise as mortgages reset.

Negative home equity could get a little bigger if home prices edge lower, which is our base case assumption over the next year or two. And then if we were to get a recession, of course job losses would go up. If a soft landing is achieved, it wouldn't. But that that risk also exists. And so I would presume mortgage delinquency rates will rise from here.

But one astonishing thing is if you go back as an example to the late 1990s, you would find a normal mortgage delinquency rate was about three times higher than where it is right now. And so we could go up by a factor of three and really not be in particularly unusual territory by historical standards. So there is a fair amount of wiggle room, I suppose, for the financial institutions that made those loans.

Geopolitical risks abound

Okay. Let's pivot to geopolitical risks here. I'll just go for a moment, since these are enormously involved topics that I couldn't possibly get into all the details on, but just maybe to flag some of the red areas here. And so one would be this war between the Ukraine and Russia continues. If anything, Russia is making small advances, funding and Western support for Ukraine is perhaps becoming a little bit shakier.

And so there are some real risks here that Russia could make some gains. It could feel somewhat emboldened. In a China versus the U.S. or China versus the West context, those frictions are very much continuing, not in a military sense, but just in terms of economic competition primarily. And so we are budgeting for further de-globalization along that avenue, which I'll get into in a moment, and friendshoring and the like.

And then really the other the other element is in the Middle East. And of course we have Israel versus Hamas and we have a lot of tension in the Middle East more generally. And I'll just flag that purely through a very narrow economic lens and say the two ways we're seeing a little bit of that show up in the economic data is in the cost of shipping.

And so with the Houthi rebels in Yemen firing at ships trying to transit the Red Sea, which leads to the Suez Canal, this is a situation that is materially increasing the cost of shipping goods around the world. I don't think we end up with a reprise of the big, big problems of a few years ago with supply chains, but it is adding a little bit at least to European inflation, since that's where many of these products would normally end up.

And it is starting to show up in shipping costs for other areas of the world as ships we’re presuming were diverted to go around Africa instead of through the Suez Canal. And so there are implications there. We have also seen oil prices rise somewhat because the Middle East, of course, is a major producer of oil and a number of countries are now involved, at least at the periphery, in conflict with others.

And so there is some inflation risk that exists there as well. And we're watching that very closely indeed.

Supply chain concerns rising again on Red Sea disruption = inflation?

Okay. Let's move from there. And I can say that just to give you a visual depiction of those supply chain costs rising, this is the cost globally of shipping a container, one of those standardized shipping containers. And it's gone up a lot.

Doesn't look like 2021, 2022, but it's gone up by about a quarter or a third as much, which is not a trivial development. And to our slight surprise, we've seen shipping costs rise to the Canadian and U.S. West Coast, not just to Europe, from Asia, which might have been the default assumption.

China: muted recovery in short run/more restrained in long run:

Let me spend a moment on China here. And so really just to run through the big ideas, we still think there is a Chinese economic recovery. It is still growing to our eye at 4-4.5% annualized, which is great by most countries standards, disappointing by China's standards. We do see some pretty acute near-term challenges as to why it's not growing as fast as it used to and the housing market is the big one.

The housing bust continues. Home prices are still falling, land sales are still very weak, builders are still seemingly insolvent or quasi-insolvent. And consumers aren't spending because so much of their wealth is tied up in housing. And they just lost confidence and in some cases, purchasing power. We are aware that if the global economy is softer, that's relevant to China because China is a big global exporter. And we're aware of some other domestic issues, including very high youth unemployment rates, which do speak to an economy that just isn't churning out jobs at the usual rate.

And so it makes sense that Chinese growth is diminished. We do still think there is a cautious recovery beneath the surface. And then just pivoting from that to long term issues without getting into all the weeds here, we think a normal long term growth rate for China is now 3 to 4% per year. So actually less than we're seeing right now despite recent struggles, the reason being that China is still managing something of a rebound after the pandemic.

And so they've got a headwind in particularly acute housing issues right now that could be less acute over the long run. However, they are also bouncing after a lockdown and they won't enjoy that. And China just gets richer over time and rich countries grow less quickly and on a number of fronts, be it infrastructure or housing or otherwise, there just isn't room for the kind of growth that China used to enjoy.

And we're not convinced China can be an engine of productivity growth, particularly given the favouritism shown by the state to the public sector over the private sector. And China is now a country that's shrinking population wise, down 2 million people over the last year. That's a drag. And of course, the geopolitical frictions with the West are significant as well. So still, China grows quickly. China is still said to be a quarter of global growth, which is rather significant, but nevertheless just not moving at the six and eight and 10% per year growth rates that it used to manage.

Trade barriers rising as part of de-globalization theme:

Okay, we're near the finish line here. Couple quick thoughts on trade and de-globalization and the like. And so in terms of trade barriers, we are most certainly seeing those mount.

It might be tempting to think that they rose under President Trump between 2016 and 2020 and have come back down. That's not been the case. We've continue to see them rise. And I should say this isn't just the U.S., this is around the world. We are seeing countries throw up tariffs and really even more popular than tariffs are non-tariff barriers, just preferential rules that advantage maybe your domestic corporate champions over foreign companies in a way that ultimately obstructs trade.

Key de-globalization themes:

And, you know, we are seeing this play out. We are getting some modest de-globalization, global trade is slightly, I guess, under growing global GDP, which is our definition of de-globalization. We see, I would say, significant friendshoring. And so take a look at that chart. And if you squint your eyes, you'll see this is U.S. trading partners. The U.S. is trading a lot less with China.

China's the gold line going down near the top. The U.S. is trading a fair bit more with Europe and Mexico in particular, and Canada a little bit more as well. And so we are seeing friends engage with more, people are considering ideologies and this sort of thing, not just who makes the cheapest good at this juncture. And then on-shoring, in other words, bringing production right back home, we have a chart on that as well.

And so the dark blue line here shows that there is indeed a huge amount, a huge boom of manufacturing construction in the U.S. for computer, electronic and electrical sectors specifically. And so chip makers and these sorts of strategic industries, these are things that are being subsidized by the U.S. government and prioritized. You can see, though, that if you look at other areas of manufacturing, construction, it's not obvious that we're getting other factories back into the U.S. Those numbers, those lines are much flatter.

And so I would say on-shoring is probably a little bit exaggerated. Where government incentives exist, it's happening. I wouldn't say we're just seeing a groundswell of factories deciding to leave China or leave Asia and come back to North America as an example. So I think that is exaggerated still, just when we summarize the overall story of de-globalization, it does generally tally up to a little bit less economic growth.

It tallies up to a little bit more inflation. All else equal, there are national losers and winners. You might say in this context that Mexico is a winner and India is a winner. Maybe Vietnam as a winner, picking up some of what China might once have made. Maybe China's a loser in all of this, though ultimately a lot of countries lose slightly by the extra inflation and less growth.

And this is a trend that likely plays out over years, not just over months. And so we shouldn't presume that this turns any time soon.

Okay. That's it for me. I think that was plenty long. I'm sure you'll agree. And so thanks for sticking with me. If you want more, if you want to hear regularly from me and from my team, you can follow us on Twitter, now X, you can see there. LinkedIn is the middle option. And at the bottom you can certainly go to rbcgam.com and the insights tab and you can follow along with all sorts of research we publish via that venue. And so I'll say thank you again. Thanks for your time. I wish you well with your investing and please choose to tune in again next month.