Transcript
Hello and welcome to the Download. I’m your host Dave Richardson and it is Economics Friday, with Canada's hardest working economist, Eric Lascelles. Eric, how are you doing?
I'm doing fine, thank you. We were just saying it's a very cold day. We're all glad not to be outside right now, but otherwise all is fine. Thanks very much. I should say, I was the only person complaining about this, but notwithstanding the US job numbers, which were really quite strong— and I'm sure we'll get into that—, but I've been looking for the economy to weaken, so I don't like them personally, but I must say, it's good for literally every other person, I suppose.
That's right. So, cold in Toronto. But hot job numbers. Actually, it’s kind of warm where I am, too, because I'm in California. Eric is worried about having to cancel a family cross-country ski excursion tomorrow. I'm contemplating maybe doing some surfing, so we’re in different worlds. But again, what's really hot and what has to be a massive surprise are these job numbers out of the US this morning. It just keeps confounding the experts, in terms of how these jobs just keep coming and coming, with unemployment rate down too. Why don't I let you take it away? You do a better job than I do.
Sure. I guess maybe the headline is worth sharing, if you have 517,000 new jobs. The consensus was for fewer than 200,000. That's a big month. That is the biggest month we've seen since spring of last year. And even that was a bit of an outlier when it arrived. So, this is a lot of job creation, and the backdrop is one in which we've seen surprisingly robust job creation throughout the last six months or so. And I keep saying, and it's true, that if you squint a little bit, you can see bits of softness here and there. And okay, initial jobless claims are still really low, but continuing jobless claims are starting to rise. And a couple of months ago, you could say that the other employment survey— the household employment survey— was significantly lagging. And then last month, it played catch up in a big way, and it's not that much late anymore. So that story kind of vanished. And then you could say as of last month that, well, the job creation is still quite good. It was running at, as originally announced, 223,000 jobs a month ago, but that was weaker than the prior month and weaker than the month before that. There was a downward trend in place, and it was ultimately the weakest print, this one for December. It had been the weakest print since late 2020. So at least there was some deceleration that was consistent with weakness. And then we got this goliath, and none of that really seems to apply. So I guess the conclusion is that we're still seeing quite a strong labor market. It's a curious thing because it seems to me every time I read the papers, they are filled evermore with fairly large companies resizing their labor forces in a way that yields the loss of several thousand jobs at each turn. It seems that isn't yet enough to move the needle. And I guess the fact that I'm using the word «yet» suggests that I'm still skeptical. This can’t persist indefinitely. Classically, the labor market is a lagging indicator and so you don't see job losses until the recession is several months underway. So we're not in one of those right now. You do normally see significant weakening of job creation a few months before recession. So I guess we can say, as of this indicator, we shouldn't expect a recession before the spring at the absolute earliest, which by the way, seems quite reasonable to me. We're thinking it's a mid-year proposition, but the job number is looking great. And just to throw an extra hot number onto the barbecue here, we could say the ISM services index just came out also for January, and it just popped. It just went from 49 points— which meant a contraction, below 50— to 55. And the weird thing is it had fallen from 55 or 56 the prior month. So basically, we had this huge drop one month and it's been completely unwound. So we've just had a number of very strong indicators. I will say the timing of our conversations is not always ideal, Dave, so we're always in this kind of scramble mode of another strong job number. So when will we learn? But I will say the intervening month usually has a more mixed billing. And so here we are sitting on two very hot numbers. However, retail sales in the US have now fallen for two consecutive months, both in November and December. Industrial production, another really important indicator in the US, has fallen for two consecutive months as well. That's starting to say something we think. The ISM manufacturing index— it's the twin of the service index—, is falling still. It's below 50. The new orders are now getting down into quasi-recessionary territory. So I wouldn't say that this is a story of the economy just beautifully sailing along. It's a story of the labor market, in particular, proving surprisingly resilient as we do see evidence of other things at least starting to soften.
So, Eric, you touched on it in your comments, but I'm at a conference here and for everyone, the question is: are we in a recession? Or, when will we be in a recession? Referring to the US, in general, but obviously that spills over into Canada. From what you're saying, we're not in a recession right now with job numbers that are that strong?
Yes, I think that's right. I guess you could say well, technically you can't say definitively until a few months after it's begun, but still, the fact that job creation isn't slowing suggests strongly we're not right now. In fact, it's quite fortuitous in a different way, despite the job numbers crimping my style a little bit, and that's because we've just finished our quarterly business cycle scorecard update. And so, using the business cycle is one way of triangulating to a recession or not. And so I can say that that's remaining pretty firm in its conviction that we are towards the very end of a cycle and nearing perhaps a recession. End of cycle is still the most popular claim. That's been true for three straight quarter. This is the third consecutive quarter that's been true. So it's been true for about six months. The recession counter claim is strengthening so that is getting stronger, there are fewer inputs arguing that we're only late in the cycle. So in other words it seems as though we're moving even further beyond. So I would say that's still consistent with the recession. We do still think one's more likely than not and it doesn't seem to be a Q1 debate— whether it's a Q2 proposition—, but it does still seem likely, using separate tools. We've been arguing that whereas the risk used to be 80% plus, it's maybe now 70% or a bit below. So things have gotten better as markets have rebounded and China has reopened and inflation has come down. So let's be clear about that. There has been some genuine good news but at the end of the day it would be— and this is picked up in this business cycle model in part— it would be extraordinarily unusual for yield curves to invert as profoundly as they have without a recession coming out on the other side. It would be unprecedented to avoid a recession after having seen an inflation spike of this magnitude. It would be pretty darn unusual to avoid a recession after rate hiking this fast, this aggressive, to this fairly lofty level in this world of high debt. And so, it still seems more likely than not; the business cycle is still saying probably yes. And as you parse your way through— and I was just looking the Conference Board leading indicator has been falling and that's a pretty reliable sign of recession. And we look at even some quirky things like RV sales. When RV sales are falling sharply, that usually says something. And of course, you can say well, this is a special one because people bought so much over the prior year that maybe this is just normalizing as opposed to really reflecting some level of true trepidation. And of course, there'd be a gas price consideration as well with regard to these big heavy gas consuming RVs. But nevertheless, RV sales are plummeting in a way that would normally be consistent with a recession. We go through 100 different indicators; not that they're all saying recession, but I guess the plurality of them are. The one thing I will say, Dave, and I guess this speaks to that 30% chance— the inverse of the 70% that maybe there isn't a recession—, interestingly, there was a rising fraction of the inputs that claimed that we were at the start of a new cycle. Now it was only about 7% of the total. So let the record show other things were multiples of that. So that's not the best guess. We had a couple of things saying maybe that was it. But maybe we're not at that. Most of those inputs, by the way, were the usual suspects, the flighty ones: market volatility is down, and the stock market is up. A lot of it was very much sentiment-type measures as well. And so things tend to be jittery and we could well say the exact opposite thing two months from now. But nevertheless, I did want to flag, well, to the extent there's a chance that we avoid something significantly worse, the business cycle measure was starting to at least nod its head in that direction.
Very interesting. And again, these numbers are just confounding because it doesn't seem like this is where we should be even with an indicator that, as you always point out, is a lagging one. So maybe now we're going to look back to just a couple of days ago and the Federal Reserve and their announcement to raise rates a quarter point. And try and take their comments afterwards and try and look forward around where we go from here with interest rates. So, Eric, maybe a quick synopsis of what was the most important things that you heard out of what the Fed had to say and where do you think we head going forward?
Right, as you said, the Fed raised rates again, but it was a lesser increase. We're down to the 25-basis point land, which once upon a time would have been the normal pace of tightening, but it's been, of course, not the recent trend. The Fed was clicking along there at 75-basis point hikes for quite a while and has only decelerated recently. And so, yes, a slower pace of tightening and we now have a policy rate— and it's of course this confusing range—, but it's sitting in the 4.5 to 4.75% range. Let's call that 4.75%. That's what I feel like doing. So up to 4.75%, which is a long way from the quarter point this all started at really just a year ago at this point in time. So it's still a lot of tightening. And I guess if you were to take away the Fed comments, it was a hawkish hike in the sense that they were acknowledging the robustness of job creation, which has become ever more so since, and they were celebrating that inflation is eased. But it was quite clear, particularly in the press conference, they were not in any way declaring victory. And they were still nervous that many parts of the service sector weren't really seeing inflation coming down quite yet. So we're still waiting on some of these second and third order effects to start to move lower. I do think they will, by the way, but we just haven't seen full cooperation there. And I guess maybe the big takeaway was— and I think I got the quote here from Fed Chairman Powell— we are talking about a couple of more rate hikes. So the debate had been: do they stop at 5% or do they go a little further? And that signal was, well, it looks like it's a little further because if they do 25 next time, that's 5%. And then apparently there's another one after that that they're penciling in right now. And so I guess they’re going a little further than previously imagined. And again, in the context of these recent economic numbers, it’s hard to imagine them feeling compelled to stop abruptly before that. So we're heading into the low 5s. But I will say, to me the two equally important comments: one is this is already quite restrictive territory. We've done most of the heavy lifting, so we're in the realm of the peak. So most of the hit is already here and now being absorbed. And so it's a bit of fiddling at this point as to exactly where it peaks. And then the other thought is, just don't assume that 5 or 5.25% is the new normal. This is an emergency setting in response to an inflation emergency and they will need to reverse that to some extent later. I would say many people would argue that a true neutral policy rate might be half the peak that they're dealing with. And so, they need to get rid of 2 to 2.5 points at some point out there just to get to normal, let alone if we're in a position where the economy has gone into recession and inflation vanished and suddenly you're considering some measure of stimulus, if not zero at that juncture. And so I guess to that point, markets are playing with the notion that there could be a little bit of rate cutting later this year. The market has priced as much as two rate cuts towards the very end of the year on the final quarter. The Fed was clear in saying that's not their plan, so let's be aware of that. The market has subsequently taken a little bit out of that pricing. But nevertheless, we're in a position in which it's reasonable to think there could be a bit of cutting later this year. That would be consistent with our forecast, which is: you get a recession and inflation is coming down a little faster than the market thinks. That's one in which you might want to start easing a little bit. And let's be clear that it's not in the interests of central banks to signal rate cuts at this point in time. They're trying to tighten financial conditions, not ease them. So I don't think we're going to get a lot of transparency over that until it's absolutely necessary. And simultaneously, they thought they weren't going to do any hiking at all, as if not more than a year ago. We know that forecasting is not an exact science, and so we need to at least hold open that possibility. And it's quite reasonable to think there could be a fair bit of cutting come 2024 in particular.
There is zero incentive for the Federal Reserve to not talk tough right now, in any way. Whether they're talking about right now and what they're going to do the next time they meet, or what they're going to be doing, let alone later this year, it makes no sense. So it makes your work harder. But as we all know, it's not about talk, it's about action. That's the most important thing. So let's just take a quick second— because we've been talking all US— the Canadian jobs report is out next week. We'll see where that falls. But the Bank of Canada has also raised rates— 25 basis points— and sort of signaled a bit of a different tack than where we are in the US. Are they going to be able to do that? Or if the US continues to go higher, will they be forced higher as well?
Certainly the Bank of Canada and the Fed rhyme, and you see very similar patterns when you overlay them on the same chart, but they're not identical. And I'm not quite predicting this, but historically you see gaps that emerge as large as a couple of percentage points on occasion. I don't see that whatsoever this time, but I think it's entirely reasonable to think that the Bank of Canada could be done at a 4.5% policy rate, whereas the Fed could be done at 5.25%. That's not a giant stretch, and I would say markets largely price that. The currency therefore largely reflects that already. So I don't think there's any great impediment there. And I guess I've stolen my thunder, which is to say that the Bank of Canada says it might be done. They are evaluating whether more might be needed, but it seems quite clear the default plan is to pause and see what happens from here. I'm assuming they are done. But I wouldn't guarantee it to the extent that Canadian inflation probably hasn't behaved quite as well as the US in terms of coming down recently. That's true of a lot of countries outside of the US. And if there's been less of a helping hand from their currency. The US dollar was rising for so long and that's a deflationary force that's its own separate discussion as the reverse now plays out. That could put a bit of a hitch into the inflation improvement in the US and maybe help everybody else. But in the meantime, it seems like a reasonable place to be. Bank of Canada is among the first to make that sort of announcement, but then again, it was among the more aggressive and among the first to get going a year ago, and so it all holds together fairly well. And keep in mind, Canada needs a lower peak policy rate, we think, in large part because it has a more heavily indebted household sector.
Exactly. So we talk about incentives. Incentive is for the Fed to talk tough. Because of housing in Canada, for the Bank of Canada— and you've mentioned this many times before—, incentive is, if they can, to soft pedal a little bit relative to the US.
Yeah, I think that's right. And I'd like to think they've done enough. I mean, it's a tricky situation in which central banks cannot afford to do too little, so they are biased toward doing too much as opposed to too little. Too little is a disaster if inflation revives, and you've lost more credibility and you've got an inflation problem. Doing too much isn't great; we get a deeper recession or a deeper downturn and that sort of thing, but it's less costly. And so I would say central banks are already in a position in which theoretically they've done plenty with regard to the forces at work right now. And so it's a question of how much too much do you want to do and are you willing to have a little bit of egg on your face in a scenario in which Bank Canada pauses and it has to go a bit more later. But as it stands right now, 4.5% seems like quite a reasonable level to me.
Excellent. Well, Eric, always great to hear from you, particularly in these weeks where there's lots of news that is going to impact investors and what they should be thinking about doing in their portfolio. Nobody does it better, Eric. Thanks again.
My pleasure. Thanks so much. Bye, everybody.