Hello and welcome to our video #MacroMemo. This week, we’ll talk about the war in Ukraine and our latest thinking and forecasts emerging from that. We’ll work our way into the pandemic and, unfortunately, some undesirable trends there, particularly in Asia. We’ll take a look at the economic situation, and the recent economic trend is, in fact, quite positive. However, that largely predates the war in Ukraine, and so we’ll talk a bit about some of the challenges economically emerging from that, and the idea that the recession risk has probably increased somewhat, if not resulting in a base-case forecast of recession.

Let’s start with Ukraine, and so, this war, unfortunately, grinding on, Russia having invaded Ukraine. It does appear as though it could yet stretch on for quite some time, with a result that Russia holds most of Ukraine, and then followed by a long insurgency by the Ukrainian population. So that remains quite a conceivable scenario.

I will, though, flag another outcome, which is that it does seem at least conceivable as well now that there could be a cease-fire. And so, I say that simply because negotiations between the two countries do seem to be quite serious. There have been fairly positive comments emitted by both sides, and so there’s a scenario in which a cease-fire is achieved, as much as I’m not sure that’s something anyone can quite guarantee.

I will say, commodity prices seem to have responded in significant part to that. Oil prices, for instance, at least as I record this, have actually fallen below $100, which represents about a 30% decline from their peak, though still a very high level of oil price. Maybe the other reason for lower commodity prices—again, one scenario being the possibility of a cease-fire; the other just being, it’s now multiple weeks into this war and the supply of energy hasn’t been unilaterally cut off by Russia. And so that fear perhaps has abated a little bit as well. Maybe that’s not in the offing.

That said, for the moment, we are assuming that the war continues. We are assuming that there is some shortage of commodities, including of energy, that results. We’re of the mind that around 2 million barrels a day of oil supply will be lost somewhere along the way. And if that were to be the case, you could argue that oil prices should be in the realm of about $60 higher than they would otherwise be, so you could easily find yourself back fairly deeply into triple digits on that basis.

It's also the case, of course, that natural gas prices are a lot higher than they were before that invasion, and food prices as well, and so there is still a real economic damage emerging from this. Of course, enormous damage to Ukraine; enormous damage, largely via sanctions, to Russia. And those sanctions continue to mount, and corporations, in particular, now exiting Russia en masse. But also in the context of the rest of the world, and so Europe, the most affected of that group, given its proximity and energy reliance.

We have been downgrading our European economic forecasts somewhat in recent weeks. And so we had gone, before the war, with a view that the Eurozone growth would likely be in the high 3s. We downgraded that fairly sharply as soon as the war began into the high 2s. We’re now thinking Eurozone growth for 2022 might be around 2.5%. So that’s still growth. In fact, it’s still technically a recovery, but it’s a lot less than was imagined not all that long ago.

Inflation also set to be higher by virtue of the increase in commodity prices that’s taken place in recent months, and so, U.S. inflation currently running at 7.9%. It could fairly easily find its way to around 9.5%. And of course, that’s within shouting distance of double digits, which could well have psychological implications on the market, so something to watch.

Obviously, much of this depends on the path of commodity prices; that’s the main channel by which the rest of the world is affected by this war. Europe is doing and planning to do its best with regard to reducing its reliance on Russia. And so it has a new plan to cut natural gas imports from Russia by two-thirds by the end of the year, but that does require everything going almost exactly right.

The food price story is also quite relevant. Ukraine and Russia both are among the world’s breadbaskets, and so huge exporters of wheat, but also other grains and other commodities and fertilizers as well. And so, the parties globally set to be most affected are, broadly, the poorest countries and poorest people in the world for whom food spending is a large fraction of their budget.

And so, for instance, you look at Sub-Saharan Africa and, normally, just over 20% of spending goes toward food. It’s likely, because of what’s happening right now, that will have to rise to well over 30%, and so that’s a huge hit to the incomes of poor people and, obviously, hunger a serious concern as well. So a lot of problems on that front.

And keeping in mind, of course, the Arab Spring of a number of years ago was motivated in significant part by poverty and high food prices. The risk of, I suppose, political unrest in the poorer countries of the world is very much increasing on the back of these higher food prices as well.

And then I guess lastly, within the Ukraine space and Russia space, it seems quite unlikely that Western companies are going to be keen to return anytime soon, even if there were to be a cease-fire. Russia is now waiving intellectual property rights and allowing asset seizures of corporations that have left, and so that doesn’t exactly make people confident in the Russian economic system. And so, further to the idea that Russian economic damage is massive now but, conceivably, also quite significant for a very long period of time.

Let’s talk now about the pandemic and, in fact, unfortunately, the revival in some of the infection numbers, and so most obviously within Asia. In fact, within China, we’re seeing surging infections, and so the highest numbers seen really since that first wave in China in very early 2020. It’s rising exponentially at this point in time. Shenzhen, one of China’s big three or four cities, has been locked down. The northeastern province of Jilin has been locked down. Shanghai sort of wavering on edge with schools having closed and restrictions being imposed, perhaps on the cusp of also being locked down. And then Hong Kong is experiencing a massive surge in infections as well and, seemingly, not one that it can quite handle.

And of course, the twist with China is that China has this zero-tolerance policy, so they are inclined to lock down quite fiercely to try to eradicate the virus. As we’ve been saying now for months, it’s just not quite clear that that can be achieved in a world with Omicron infections and now this BA.2, this sub-variant that may yet be even more contagious. It seems to me there’s a real risk that China is unable to eradicate this particular wave, and so perhaps China will go in a more pragmatic direction and simply accept that some infections exist.

But there’s a real risk here that there’s a big economic hit to China. And so it’s one of the reasons that we’re fairly content to have a below-consensus Chinese growth forecast, a sub-5% growth forecast at a time that the government has forecast 5.5%. So we do think this is a potentially serious challenge, and it’s coming to a head right now. The exponential increases in infections are familiar to those of us living in other countries.

I can say as well, elsewhere in Asia experiencing something similar. So South Korea, Malaysia, Singapore, Thailand, Vietnam all seeing quite significant surges, and it’s kind of a belated arrival of these new, more contagious variants.

Unfortunately, the European numbers also getting a little worse; not quite everywhere, but in a fairly substantial number of European countries. Wouldn’t say it’s on par with the surges being seen in Asia right now, but it may be thought of simply as restrictions easing and mask requirements easing and these sorts of things, and so seeing something of an increase. Chances are that warmer weather probably snuffs out most of these increases within the next few months, at least in the northern hemisphere, but I suppose the point is that we are still very much in the ebb and flow of the pandemic; we haven’t moved beyond that.

Let’s talk briefly about the recent economic trend. And so I suppose the point here is simply that recent economic data has been mostly strong. And so I look at the U.S. employment numbers and up by more than 600,000 jobs for the month of February. I look similarly at the ISM Manufacturing Index; for February it was up. The January retail sales print, it was up by quite a number of percentage points. And so we’ve seen quite strong economic momentum to begin the year in the U.S.

I can say, in Canada, Canada blew the barn doors off February employment with just hundreds and hundreds of thousands of jobs created, well beyond anyone’s most optimistic imagination. We can see in Canada’s real-time indicators, as well, that there’s a pretty happy increase there also, in terms of credit card and debit card spending by Canadians, in terms of businesses reporting being completely open.

And in terms of globally, restaurant reservations increasing quite nicely as those restrictions from the Omicron wave broadly ease. And so, the economic momentum is quite strong.

That takes us, though, to the current situation, which is, here we are now trying to sort out the implications of this war in Ukraine and the prospect of central bank rate hikes and those sorts of things. And so, the momentum in the economy has been good, but likely slows from here. And so it is our assertion that recession risks are rising to some extent.

We were saying, before the war in Ukraine, that in the U.S., the recession risk was around 25% for the year ahead. It seems to us you have to put that above 25% now. In fact, what we’re tending to think is that the recession risk in the developed world is in the realm of 25 to 50% for the next year. And so the likes of U.S. and Canada would be toward the lower end of that range, though maybe a little higher than 25%. The likes of Europe will be toward the higher end of that 25-to-50% range, though probably a little shy of 50%. And so the risks have gone up, but the base-case scenario is still certainly for growth.

I do want to say, though, as we think about recession risks, and just to emphasize, it is far from automatic that a recession is coming. And so I can present any number of reasons why. One would be, normally recessions come from excesses in fairly standard places. Normally, you have either banking sector excesses, or inventory excesses, or housing market excesses, or consumer finance excesses. And actually, as we dig our way through those four things, in most countries, those don’t exist right now. So those aren’t the obvious setups for a recession. We’re not seeing all that much stretching there.

I can say that our recession models continue to point to a recession risk of no more than about 10%, so they’re saying the risk isn’t overwhelmingly high. Our business cycle scorecard is continuing to indicate it’s mid-cycle, not end of cycle or recession. So that’s not suggesting the risk is overwhelmingly high either.

I think it’s worth emphasizing, as this war unfolds and as it imposes a negative shock on growth, that more fiscal support in particular seems forthcoming, particularly in Europe. And so we’re likely to see more energy subsidies for the cost of energy, more infrastructure, more energy investment, as Europe in particular seeks to pivot away from Russia. And good old Keynesian spending, as necessary. If European governments feel their economy is at risk of tipping into recession, they’re actually in a pretty good position, from a fiscal deficit and a public debt perspective, to do more work on that front. So I think we’re going to be hearing more about fiscal support over the coming year.

Central banks are raising rates—that’s undeniable—but they can raise rates less if needed, and so that’s a thought as well.

And I should emphasize, as much as in general, we don’t like it when economies are decelerating, which is very likely to happen here, it may not be the worst thing in the world right now, in the sense that we’ve seen such remarkable progress, and many developed-world economies are now in the realm of their full capacity; if we were to continue to see 3.5 and 4 and 5% growth rates over the next year, we would actually potentially have fairly serious problems.

Just to give you a really simple example of that, the U.S. unemployment rate now is just 3.8%. If it continued to improve as quickly over the next six months as it improved over the last six months, the U.S. unemployment rate would fall from 3.8% to 2.4%. That would be the lowest number since World War II. It’s not clear whether that could be sustained. It might well create wage-price spirals that would create all sorts of problems. And so actually, we probably want economic growth to be no more than about 3% for the year ahead; 4 and 5 is a dangerous place to be. So maybe these new headwinds aren’t quite the worst thing in the world. And then it’s worth mentioning as well—and this gets trotted out every time there’s an oil shock these days—but nevertheless, the energy intensity of the global economy is significantly less than it was, say, in 1973. There’s just less exposure to energy than in the past. And so I would say, yes, there is a real recession risk. It’s higher than it was before. Probably shouldn’t be the base case. Quite a number of reasons why, more likely than not, it can be avoided.

Okay. Well, hopefully, you found that useful. I thank you so much for your time and wish you well with your investing.