Hello, and welcome to the Download. I'm your host, Dave Richardson, and it's economics day. And when it's economics day, we lean on Canada's hardest working economists, Eric Lascelles, chief economist at RBC Global Asset Management. Eric, you must be working super hard today because you actually took a vacation. I think it’s the first vacation that I'm aware of, you've ever taken in your entire life. And so you must be scrambling to try and squeeze an extra week into today just to make up for it, because I know you get that guilty feeling.

Yes, first vacation ever. Well, I happen to do this quarterly internal call with one particular group within RBC Global Asset Management, and it always is the first Monday after the 4th of July and Canada Day week. And that was earlier today, at least, as we're recording this, and I could not be less qualified to present that presentation. I did do my best, but my goodness, my brain did go a little stale over my week off. But it was nice. I enjoyed it. I've been scrambling today, as you say, and I think I'm just ready to share some semi-intelligent thoughts with you about employment numbers and a few other things.

Well, if anyone deserves a vacation, it's you, Eric. In all seriousness, I've never seen anyone work like you. Anyway, let's put that aside and get into it because you did miss some exciting stuff last week and that you've now come back and seen. We had a couple of big employment reports— one out of Canada, one in the US. But a real kind of odd hiccup in the markets last Thursday, when the ADP report that comes out, in front of the actual Bureau of Labor Statistics report, showed about 500,000 job gains or new hires. And then all of a sudden, when the actual number comes out the next day, it's around 200,000, and they cut 100,000 off the previous couple of months. So markets were kind of roiled by that, as you'd expect. It's just a little bit of a shocker— I think it was 497,000 to be precise. But what do you make of that? And maybe go back and do the review of the different reports and what's different about them and why we have to judge or take each of them and analyze them in different ways.

You got it precisely right. That ADP number came out mid last week, roughly speaking, and it was about 500,000 jobs announced, which was the biggest one of those we'd seen in quite a while. And it did hint, all else equal, there could be a pretty happy payrolls number trailing along on Friday. And then, as you say, it wasn't as happy as expected. There was nothing wrong with it, let the record show. There were 209,000 jobs created in June, which is a good number in any kind of absolute context, if not by the standards of the last year or two. And I guess that's the rub. And so that 209,000 wasn't 500,000. It was a little below consensus, which by the way, as we've discussed in prior months, is almost unfathomable over the last year. It's always been above consensus. The number was also below the prior month, which was 306,000. And the private sector employment was «only» 149,000. Some of the hiring was public sector. It was a bit less. Again, if you looked at the private sector— the jobs in the private sector aren't necessarily better; often they're worse jobs—, but it tells you more about what the economy is up to in terms of intentions and businesses, whereas governments move a little slower on the hiring side. So, private employment was weaker too. And then you mentioned, Dave— and this was maybe the kicker— was that after a semi-okay job number, we got big negative revisions. So the prior two months lost 110,000 jobs versus the prior gains expected. There was no actual job loss, it was just fewer job gains. But you tallied up and there was certainly some disappointment there. So a bit of whipsawing of markets certainly going on. Just to add one more bit of semi-negative news to the interpretation, if you looked at where the jobs came from— this was already the case based on my comments earlier about the public sector—, but even when the hiring was in the private sector, it was less economically sensitive sectors. So the government added 60,000 jobs; healthcare and social assistance added 65,000. That's not something that you would necessarily think would be that attuned to whether the economy is looking great or not. Construction was good. There are other sectors certainly adding, but retail lost some jobs, transportation and warehousing lost some jobs. Those are interesting things to be losing jobs from because of course they've been quite hot sectors in recent years. And so I think the right interpretation then is, this was a bit softer. The household survey wasn't super strong. We've seen some general trend higher in jobless claims, though not in a linear pattern. We are seeing a bit of softness, though I can't say it was outright weak unless it's running well below 200,000. I don't think that's quite the right description.

And as we talked about a lot in these discussions we've had on the podcast before, at some point all of these interest rate increases— and now as you look forward into the fall, particularly in the US—, some of these programs that have been running that have, quite frankly, put some extra money in people's pockets, or at the very least haven't been taking money out of people's pockets so they can go and choose to spend it on something else; those are running down. So is this maybe finally the signs that this much talked-about recession is actually coming, or is this just a number? It's a month in isolation with a couple of revisions, and then my view is still pretty much the same; not changing the way I think about things at all.

It's hard to say. I tend to think the only way you can really see what's going on is on a trend basis. And so one data point doesn't make a trend. But what if we get another one that looks like this or is weaker next month, that would be a trend. And so you would have needed this month to start it off. But we can't speak with precision yet. So it might be there's a chance it's just one of those blips that comes along every once in a while, but it's different enough from the prior trend that it could be something new and indicating some weakness. I will admit, as someone who's just come back from holiday, I detected very few signs of recession on my holiday. I paid a lot of money for hotels, shopping malls seem to be pretty full, tourist attractions were hopping. That certainly didn't increase my confidence whatsoever in a recession call, but this does suggest that we're seeing a little bit of a turn. And of course, as you well know, we've seen business expectations have been quite soft for a while. Those aren't getting any better. We got some twin ISM numbers you might know as well from last week and the manufacturing side in particular, which has historically been the bellwether, it was weak and even a little bit weaker. So the reason we're forecasting recession is maybe we're seeing a bit of tilting in the labor market, but more so just, as you say, the amount of rate hiking is theoretically consistent with a recession. Our big fancy models say you're supposed to get one after this much hiking. And of course, one of the developments in the last maybe six weeks is that we're into a new mini-tightening cycle, you could say. It's a bit ambiguous because not everybody actually stopped tightening. Nevertheless, the thinking was central banks were on their way to 4 to 5%, and suddenly it looks like it's actually 5 to 6%. And of course, that takes a bit off growth. And bottom line is, it still makes sense to forecast a recession. And that's what the models say. It's what the heuristics say. It's what our business cycle work says. It's not quite what the labor market data is saying, but it could be on its way in that direction.

It's something I do just because I'm interested in a lot of people who listen to this podcast who tend to be more in the financial industry or they're investors who are interested in watching and observing what's going on in the economy around them. I go into the mall or when I'm booking a vacation, how much the airfare is, and how many seats are available on the flight, and what I'm paying for the hotel. It's kind of a sign of are people out spending money? They're feeling good about stuff or they're being more reserved. But doesn't a recession happens out of the blue? People are out and they're spending and everything looks good and then just all of a sudden they're not. And we figure it out afterwards. So that's not necessarily going to tell us as soon as we go to the mall, and we can find a good parking spot that the recession is about to hit. That's not really the way it's going to feel, right?

No, I think that's right. I used to have a boss— at a different employer, I'm happy to say—, who used to say, oh, the shopping malls are full, we're fine. But you can't really go based on your own personal shopping mall. By the way, your ability to gauge whether there's 3% fewer people is probably not perfect, nor exactly how much each person is spending. But I take your point, which is, yeah, that's probably not the first thing to go. And they happen abruptly. And one thing we've been thinking about is there's this fairly reasonable counterclaim that maybe we can avoid a recession because we've already had like a rolling recession or rolling weakness where banks had problems and now they're healing. And the tech sector had problems, now it's healing. Housing had problems, now it's healing. Maybe everybody had their problems separately and it wasn't enough of a push downward to get a recession. And I should say that is worth thinking about in heating. It's possible that's happening. It's not normally what happens, but it's possible. But I think the best rebuttal to that is just that recessions don't happen because nine sectors all at excesses that happen to resolve at the same time. Recessions tend to happen because you have one big shock, like higher interest rates that kind of slam everybody all at once and everybody goes down, or almost every sector goes down, whether or not they were being naughty beforehand or doing bad things or overheated, there's just a hit and there's a pullback everywhere. And so I think that's probably the way to think about it.

So before we get into looking at rates, maybe the Canadian job number, the details on that; was that a particularly strong number? Because I always work off Canada. You take Canada, you multiply by ten, that's the US. Or nine. And so that gets you 60,000 new jobs in Canada. It’s like 500,000 new jobs in the US. And so that seems like a big month. Is that a misinterpretation?

That's right. By the way, as an aside, thank you for saying «or nine» instead of «ten». The debate now is «or eight or nine», Dave, by the way. Canada's population grows so fast as you may know. It hit 40 million people officially in the middle of the last month. So the US is eight point something at this point. So some convergence is happening some distance from one to one though. Nevertheless, your point is taken. 60,000 jobs were created in June in Canada. That's a big number. Whether you multiply by eight, nine or ten, that is a whole lot more than the US generated. I think everybody knows Canada's job numbers are very choppy, so you do get 60,000, whereas the US doesn't get too many 600,000. And sometimes we get 100,000 and the US hasn't notched too many one million month job creations outside of pandemic recovery times. And so this was a big month. Let the record show, it came after a negative month. So I think we had a conversation last month and we were saying it was minus 17,000. Is that the new trend? It turned out no. So I think further to the idea that I'd like to see more than one month before I make too many definitive comments. So there was weakness then, but nevertheless it's relevant just in the sense that well this was 60 and that was minus 17, you sort of averaged the two, and you're not clicking along quite as wildly hot, and so I think that's a useful way to think about it. Full time hiring was all of that hiring, and then some. So there were actually 110,000 more full time jobs. So I think the right interpretation was it was quite a strong month. Do note though, Canada's population growth is so strong right now. Some of that is just long-standing policy. Some of this is there's just a stronger policy towards immigration targeting half a million people. But as you may know, Canada has actually pulled in over a million people in the last twelve months, at least through to March. I don't know what the numbers are since; probably something like that. A million people is a lot, and not everybody works; some people are kids and retired and others, but you do need maybe 600,000 jobs for all those immigrants and so they do need 50,000 a month to get to that. And so, 60,000 is a strong number. It's not quite as wide and certainly entirely genuine, if you're talking about what does that mean for the ability to spend or demand for housing and things like that? Of course, those are real jobs and creating spending capacity. But in terms of a sign of overheating? The answer is a bit less than you would think, just because actually so many people are coming in that you need 50,000 jobs a month just to gainfully employ them. And maybe reflecting that, and this is very weird, but we're reflecting that Canada's unemployment rate rose from 5.2 to 5.4%. It had been 5% the month before, so it's actually gone up two months in a row by a couple of tenths. And all sorts of swirling things happening here, like more people coming in, more people looking for jobs. Are they looking because they're optimistic they can get one? Are they looking because they're getting a little stressed by higher interest rates? There’re good and bad interpretations to the expanding labor force participation rate, but the bottom line is unemployment rate managed to somehow go up despite 60,000 new jobs. So again, we'll see if that trend continues. I would say that it tentatively looks like, both in Canada and the US, perhaps unemployment rates are edging off the floor a bit. So Canada had a 5, now it's 5.4%. That could be reversed. It's possible. But nevertheless, that's a real movement. It's a bit less clear in the US. In fact, the US was confusing in the opposite way. You might recall, US had a 3.4% unemployment rate a couple of months ago. It went to 3.7% last month. So it was a big jump. It actually fell to 3.6% despite the fact that the hiring was only okay. But nevertheless, the point is you're a couple of ticks above the low there. We'll see if this is a trending sideways or going higher. But one thing we know— and we used to have no name for this, but then somebody told me there was a name for it recently: Sahm's law— whenever the unemployment rate goes up by 0.5 percentage points, there's always a recession. We're only at .2 or .3 right now, and it could go back down next month, but nevertheless, we're not that far. In fact, really the normal state of affairs is when an economy is expanding, unemployment is dropping almost ceaselessly. It's very unusual to have a sideways unemployment rate, which we've actually arguably had for the last six months to a year. And anytime it's been sideways, it has presaged an increase to come. Again, we're waiting on that. All these recession predictors that have not yet come to fruition. But the point being, if this upward trend were to persist, we're not that far from what has historically been a trigger for a recession. Or vice versa; I don't know the causality.

Well, I'm going to date myself here: I hope that's not Sam from Cheers who's making that law. I'm going to catch right now, and we should bank this one Eric for a future discussion. We should take a look at the impact that accelerated immigration is having on the Canadian economy. It's almost all positive, but it does create some disruptions and some dislocations because the pace is so fast. It helps in terms of investors and people who are watching the economy interpret some of the things that they're seeing. So we should spend some time on that. But if we go back, as you were suggesting, that maybe we peak at 5 to 6% instead of 4 to 5%, and it has led to this kind of new rate hiking cycle where the bank of Canada raised last month, they're likely going to raise this week. Federal Reserve is back on board. Maybe they've got a couple more in them as well. Is this what you're expecting as well?

I wish I could say I had a super clever off-consensus view that marked my genius or something, but no, I'm pretty much in line with what the market is thinking, in the short run at least. And so, as you say, bank of Canada goes this Wednesday, the 12th July, and in fact the market's not totally sold on this. The market has two thirds of a rate hike in. I think the default expectation is probably there's going to be one. Not a certainty, but probably there's going to be one. Market prices in more or less the full hike then by the next meeting. So it's saying, well, there's a chance they pause once and then maybe they go in September instead. And so there's a bit of ambiguity there, but probably this week, and if not, probably the one after that. But either way, getting to something in the realm of a 5% policy rate. For a moment it looked like we might have topped out at 4.5%. And so there's that little bit extra. I wouldn't give any sort of guarantee that's it. It depends. I think that the tricky one would be the housing market. Housing market has staged a little bit of a revival recently, and if housing keeps reviving, that is problematic for central banks and for economies in general. Because not only does stronger housing suggest a stronger economy and more overheating— it's a big chunk of Canadian GDP in particular, but a big chunk of almost every country's GDP at some level—, but also on the inflation side. Shelter, dwelling costs are a big part of inflation and there's such long lags involved that maybe this is less problematic than I'm thinking it is, and maybe it wouldn't show up till the early 2024 inflation numbers, just given how it all fits together. But nevertheless, if home prices are off to the races again, it's going to be pretty hard to hit inflation targets. And so, one of the reasons the bank of Canada and other central banks are going, well, an extra 50 basis points of rate hikes do incrementally slow the economy a little bit more. But I think it's also a signal saying, hold on, don't get too excited about housing markets or other rate sensitive sectors because we need these to be cooler. And so if you do not cool of your own volition, there will need to be more rate increasing to get there. And you mentioned earlier, Dave, the big X factor is, and there are long and variable lags involved and so how much of the journey from zero to nearly 5% has already been felt and how much hasn't been felt? And of course, that then greatly informs how much more work is or isn't needed and nobody has a good sense for that. It's quite wild in fact, the extent to which models disagree and theories disagree. And so I would say I don't think we've seen the full effect. Anytime you raise rates by five percentage points more or less in a year, that's got to hurt somebody. And historically that will be more than enough to induce a recession and to weaken housing market. So I'm inclined to think they do get there. But just note that, to the extent housing revives or to the extent the economy keeps moving along, that's a problem because it's bad for the inflation target, and it's also potentially a problem because service sector inflation in particular is so linked to the labor market. You probably can't have 3 and 5% unemployment rates respectively, without making progress.

On the real estate market as well. And we'll roll this back into the immigration discussion for a longer answer. But for a short answer, you're of the view that the strength we're seeing in the housing market is almost an aberration; because of what's happening with rates, you just don't have enough supply out in the market. There's a little bit of demand, so it's artificially creating what looks like a tight market with rising prices, whereas really there's nowhere near as much going on as there was a couple of years ago.

Yeah, that's the idea. Now, let me say I don't have 100% conviction, and this is one that got me a little nervous here, but I think logically the arguments against the recent booms being sustained is precisely as you say, which is just that there's so little supply in the market. It's just distorting things. And over time people's lives change. They get married, have children or children move out, or they get different jobs or they retire. Things happen that necessitate moving and so that supply will come to the fore eventually and maybe balance things out. It's not unusual to see a spring flare up in housing, so there might be a seasonal element as well. Undeniably, if you want to be an optimist, you can see immigration so strong in Canada in particular, that maybe it does just keep going. We've done work. I haven't published this just because I don't know if I fully believe it yet, but we have done the literature review and I'm surprised by actually how little population growth drives home prices. This is not the case, but just to give you a stylized example, let's imagine Canada's or any country's population increases by 10% overnight, you'd guess that home prices would go bananas, like everybody needs a place to live. You'd think home prices would be up by, I don't know, 40% or something. You could imagine quite wild increases. And yet the modeling we found says it's kind of a one-to-one ratio. Like if your population were up 10%, home prices would have to be 10% higher without extra supply, which just can't come on instantaneously. And so if you're talking about Canada and maybe population growth is for a moment 2% instead of 0.8% or something like that, it's claiming home prices need to be 2% higher and suddenly it's all fixed, which doesn't seem like a whole lot. And so again, I won't say I'm totally satisfied with that number, but that's the number that we got. And so theoretically, immigration should be driving home prices, it could be the thing to sustain all of this, but actually the model suggest it shouldn't quite as much as you'd guess. And then on the flip side, I guess this is important, affordability is very poor. We were just looking at the numbers and just versus June of 2020, affordability has gone 60% offside. It was not good, by the way, before the pandemic, but it was 80% offside. It's reclaimed a bit. Home prices have come down, but it's still 60% versus that moment. It'd be weird to have a housing boom with that level of poor affordability as a starting point. Historical housing bus averaged 6.6 years. This one would have lasted one year if that was it. And that would be out of keeping with history. We think there's a recession coming and if that happens, usually housing is weaker. So we are assuming there's some housing weakness to present itself, maybe in the form of a malaise instead of a collapse. So flat to slightly lower nominal prices for a period of a few years as opposed to big gains or the big losses that dominated last year.

And that's what the chart suggests, at least charts that I've looked at. The worst from the pricing point is at the front end and then it just flattens out until things ultimately pick up somewhere down the road. Just a couple of more quick questions. We're running a little bit longer than we normally do, but you look all rested up, so I can hit you with a couple more. This last half a percent or three quarters of percent— the bank rate goes from zero to 5%, so now we take it to 5.5 or 5.75%— that last little bit, how significant is that? I've heard a couple of analysts go like, the Federal Reserve, they're going to really regret this last 25 basis points they do. They're going to look back and regret they ever thought of doing that. Is there any validity to that kind of a comment?

Yeah, well, I think probably if I was a proper economist, just answering in models, I would say every 25 basis points are equal and it's all linear and that's that. I could be persuaded that maybe it's a little more relevant to the extent they said they were done or almost done, and then they said more. And so that's a signal: look out, you better behave or else we'll threat we could do even more. So you could maybe persuade me of that. I think you could persuade me it matters a little bit more than earlier percentage points. For those of us old enough to remember more than the last cycle, it used to be that policy rates went up to 4.5 or 5, maybe 5.25%, 15 years ago or so. That was the normal peak for the policy rate at the end of a cycle. And so they go to 5.5 or 5.75 or 6%. That is notable. It's not shocking to those of us who lived in the 2010s, but this is even more than that. Maybe there's a bit of extra punch, but not I don't see how you can say that it could be just a straw that broke the camel's back situation, but I don't see why it's not a magical rate hike that has ten times the power or anything like that.

And then let's just finish off. The CPI number in the US is coming out later this week. And this is one where you would think that the math, just the straight math of the calculation works in your favor this month, right? You're going to roll off the worst month from last year and roll in a month where obviously inflation we know is down from where it was a year ago. So just the math and let's not go to a forecast. If something happens that's particularly interesting around the number, we'll get you back on and get some comments on it. But let's say the number is particularly high relative to what people are expecting, or particularly low relative to expectations. Would either of those things start to change your view again? That's been very stable and quite accurate, quite frankly. Would that change your view that you've had for a lot of the last 18 months in terms of the direction we're headed?

Every number matters. Every number incrementally does. I would say certainly inflation is particularly important at this juncture, despite the fact that we're only mentioning it now, Dave, however many minutes into this podcast. But here we are. Inflation does matter quite a bit. As you say, the base effects are friendly with this one June of 2022. I'm forgetting if it was 1.2 or 1.3%, but a big month, just in that one month, prices rose by more than a percentage point, which was about as bad as it got. And so we get rid of that in the annual number. And so it's not that people are predicting especially low inflation this June, but it's just that it's a whole lot lower than last June, and that gets you down to the low 3s. One twist in all this, by the way, is, we might be able to say, hooray, inflation is just over 3% in a couple of days, but the underlying trend rate is more like 4.5 or 5%. And that is to say that we went from having gas prices that were a big positive on the annual number to gas prices that are a big negative. And unless you think barrel of oil is going to be $40 next year and $20 the year after and 10$ the year after that, which seems like a bit of a stretch, then you're not going to get this artificial depressant force from energy prices indefinitely. And so the underlying trend rate is still in the 4s or almost 5%, and so there's still more work needed. So a lot depends on exactly why inflation did or didn't come down. But, yeah, I think this is an important one in part because you've got central banks that are on the cusp of doing or not doing things, and so it could incline them to raise that extra rate hike or not. If inflation came in under 3%, I think symbolically that would look really good. I'm not sure it's that different than 3.1 if it was 2.9%, but I could imagine people getting awfully excited about that and thinking maybe central banks were approaching the finish line, whether it really changed the equation or not. If inflation surprised materially to the upside, that would be a concern. Central banks would need more economic weakness down the road. So I guess I'm giving you the pablum here: if it's bad, it's bad; and if it's good, it's good. Each one would incrementally influence my view. But I still think of the recession call. Not that it's independent from inflation whatsoever, because if inflation just miraculously vanished, then you could cut rates pretty fast and that would maybe be that. But as it stands right now, the parts of inflation that are pretty persistently not cooperating rating are consistent with an economy that's just too hot. And so I think that maybe to me, the constant isn't so much where interest rates go— that could be a number of things—, but the constant is they're going to need a weaker economy, and they're going to have to get it via interest rates one way or the other. And maybe it takes less hiking, maybe it takes more, but I think there's going to have to be some economic weakness to achieve the ultimate inflation goals.

Yeah. And again, whether that happens precisely in this previous May or July or September or next January, as you keep coming back to, as I ask each question, yeah, the numbers matter and the time matters, but the fact that we're heading in that direction is really what people should be thinking about as they're making decisions around their personal finances and investments.

Yeah, that's right. Now, Dave, I'm too honest by half here. Too humble by half as well, clearly. But too honest by half, in the sense that I've been calling for a recession for a while. We'll see if it happens. But it hasn't happened yet. That's for darn sure. But we've been saying the second half of this year now, let the record show we are ten days into the second half of this year, Dave. So we haven't seen a recession yet. The data is lagged, blah, blah, blah. We'll see whether maybe what does manifest before too long. But I guess at this point, if there's a risk to the view, the risk is maybe it happens a bit later. I still think Q3 is very much in play. That's the quarter we're in right now. But it wouldn't blow my mind if a month from now we said, you know what, maybe it's the fourth quarter of this year and the first quarter of next year. I'm hoping not. I don't like changing views, but the most important thing is to be right. And so I'm delighted to change a view if it gets us closer to being right. And so at this point, I don't think that's necessary because we are seeing enough signals that it certainly could be something that manifests in the coming months. But I'll just flag that as a risk, or at least an acknowledgment that here we are in the quarter that's supposed to have a recession. We don't have one quite yet.

Well, here's a good data point for you, Eric: I'm down ten pounds since July 1. I don't know if that's a data point. That's a little deflation that you weren't counting on. I love the fact that these are audio podcasts. That's why I'm doing a podcast instead of a YouTube video channel or something.

Well, it's a nice pink jacket you're wearing as well, by the way.

Little ode to Don Johnson. More references that the young folks who listen to this can go back and check out. Anyways, Eric, great catching up. A lot of interesting stuff. And again, if that inflation report surprises us one way or the other, in a big way, we'll get you back on. But otherwise we'll see you later this month and we'll tee up that discussion on immigration, particularly if you've been doing some work in that, because I think that's a really interesting one for Canadian investors, just Canadians in general, around something that is working really well and has some real implications for where we go from here in the Canadian economy.

Yeah, that's right. Well, thank you so much, Dave. It was my pleasure. Have a great July, everybody. Bye.