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Happy New Year! Hello and welcome to our first video #MacroMemo of 2025. And gosh, there's a lot going on. As always, we're going to talk a little bit about U.S. politics and policy and some changes that have taken place since our last video. I will discuss economic softness, a little science here and there, though I think things are ultimately fine.

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We'll take a peek at the recession scorecard we track and what the recession signals are saying. I would say more good news than bad news on that front.

We are going to talk Canadian politics because there have been some pretty momentous changes there recently of perhaps economic consequence. And we'll talk a little bit about Canada in a different context as well.

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First the currency, which has been quite soft, and then the Bank of Canada. I should mention the prior #MacroMemo did have key themes for 2025, so feel free to dig back to that if you're looking for that instead.

Let's start with U.S. politics. The 119^th U.S. Congress was installed on January 3rd. Of course, it’s a Republican sweep both in the House and Senate.

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President-elect Trump will become President Trump again on January 20th. And so that is rapidly approaching, just under two weeks away. And we're going to learn a lot fairly quickly, after his inauguration. There have been stated intentions to proceed quite rapidly. We will learn essentially whether we're going to get the strong or the moderate form of Trump policies.

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Do we see big tariffs or moderate tariffs? Do we see a lot of deportation or more moderate deportation? Do we see big government spending cuts or more moderate? Our bet is on the more moderate version. Certainly there are still negatives in terms of the economic implications from tariffs, from less population growth. We think there could be positives from things like tax cuts and deregulation.

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On the other side of the coin, notable things recently have given us a bit more clarity. One would be some of the future White House staffers have indicated that U.S. tariffs may be narrowly targeted at national and economic security-related sectors and products. So that is a good news, I would say. It suggests that we may not get the big blanket tariffs that have been threatened.

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I should note Trump has since denied that, though. That also makes sense because of course these are starting negotiating positions. And so I still think there's a good chance that we get those narrower tariffs in the end. That should do a bit less economic damage.

Another area that has been in focus, though, in the context of tariffs or at least tied to tariffs, is the military spending of U.S. allies.

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President-elect Trump has complained that other countries aren't carrying their own weight, are not spending enough on their militaries. Generally, that's been interpreted in the lens of the NATO preference that countries spend 2% or more of their GDP on their militaries to ensure adequate defense. Trump just talked about a 5% of GDP military spend.

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And so we're skeptical about that. The U.S. actually only spends about 3% itself. The biggest country that we could find in the among major developed countries was Poland. And it spends about 4%. So no one is spending that much. We're a bit dubious. But again, maybe you view that as an opening negotiation tactic. Ultimately countries will not need to spend that much.

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But maybe the point is, even the countries that are spending 2% of their GDP on the military might need to ramp that up somewhat as well, so that is another key pivotal point.

We think another key U.S. political item is the debt ceiling. A government shutdown was averted on December 21st. The debt ceiling has not yet been addressed.

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Mid-January is when current Treasury Secretary Yellen has indicated that extraordinary measures will need to begin to avoid a technical default. We do expect the debt ceiling to be lifted by the time those are exhausted a couple of months later. Trump has indicated he doesn't like the debt ceiling. It is a Republican sweep of Congress. So it would be surprising if there were serious problems.

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Nevertheless, we'll have to keep half an eye on that. At least one thing I'll mention, though, is that in the meantime, sort of perversely, because the U.S. is now obliged to drain some of its essentially chequing accounts that are hiding within the government, as opposed to borrowing via the bond market that's actually injecting liquidity into the economy.

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So there could actually be some extra economic support over the next couple of months until the debt ceiling is addressed at that point. The extra liquidity then, of course, goes away.

Let's pivot from politics just to the broader economic landscape. And so the economy, I should say, is fine. And we're seeing pretty decent economic indicators for the U.S. and inadequate ones, I would say, for the rest of the developed world.

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But it would be fair to say that we have seen some evidence of a mild deceleration, particularly in the U.S. Economic surprise indices have gone from positive to slightly negative territory. The U.S. Q4 gross domestic product (GDP) tracking has diminished. It was looking like there could be as much as about 3.4% economic growth as recently as December for the fourth quarter.

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That's now tracking more like 2.4%, which is perfectly fine. But nevertheless, you could say the brief spurt of extreme economic strength that came along in the fall, particularly for the U.S., does seem to be fading a little bit. Might be for the best given concerns about overheating, but ultimately it seems to be a more moderate economic trajectory right now.

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I will mention just briefly, on the central banking front, the Federal Reserve (Fed) implications. So the Fed did cut rate by 25 basis points in December. It doesn't look like there's a whole rush for the Fed going forward. Now, the Fed expectations are that there could be another rate cut somewhere in the first half of 2025, but it's not a January 2025 thing.

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The market now prices in fewer than two rate cuts across the entirety of 2025. That might be a little bit low. We'd be inclined to think there could be a bit more cutting than that. But it is fair to say that the scope for easing is diminished because U.S. inflation is proving a bit stickier than had been previously expected.

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I will still stubbornly say that we believe the neutral rate for the Fed is lower than a 4%-type number, which is where the market has to figure it sits at the end of next year. Whether we get more rate cutting than that in 2025 is an open question. But I do think in subsequent years we can talk about a neutral rate or an R star rate that's closer to 3% than 4%.

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And so the market might be underestimating that in terms of recession signals. Well, the main point is that we are not expecting a recession. For a long time it was our second most likely outcome. It's actually only number three on our list right now. We think most likely is a soft landing. Next most likely is actually a no landing, which is the economy overheating temporarily.

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Only third is a recession, with about a 15% chance for the U.S. over the next year. But I do want to say when we look at our recession scorecard, we can see that sort of story playing out in the numbers. For instance, not much more than a year ago we had seven recession signals saying yes, and just one recession signal saying no, that we are tracking.

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Today it's a bit of a different mix. There are some ‘maybe’s’ in the mix as well. Today we've gone from seven ‘yeses’ to four ‘yeses.’ We've gone from one ‘no’ to six ‘no's.’ And so it's certainly a very different environment. Recession is less likely. In fact, we've just seen a ‘yes,’ in fact, we've converted it to a ‘maybe,’ but we think it might be on its way towards a ‘no.’

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That would be the Conference Board's leading economic indicator. It was falling for the last 2 or 3 years. And just in the latest month it started to bounce a little bit. And it negated one of what had been five recession indicators. I can say when we look at some of the other recessions, the signals that are still stubbornly saying ‘yes,’ three out of the four of them are yield-curve based.

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And we did indeed see yield curves invert. That's the classic signal. We've now seen those yield curves un-invert. Frequently you get that just before the recession. The difference though this time is that it has been a bear steepening in the bond market, not a bull steepening. Normally when you get that odd inversion, it's because yields are collapsing.

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Short-term yields are collapsing particularly quickly. That hasn't been the case this time. We've inverted, because yields have risen and longer-term yields have just risen by more. And so that's really not the normal recession signal. I mentioned all of that just to say that even the four ‘yeses’ that we're tracking right now, you could debate, you can argue that some of those ‘yeses’ are a bit of a false reading.

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So overall, we are feeling pretty good. We think that risk of recession has diminished pretty nicely.

Let's switch over to Canada now. We'll start with Canadian politics. The big news, at least is I'm recording this on January 7th, is that Prime Minister Trudeau has announced that he will be stepping down. He has been prime minister for 10 years.

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That is a fairly significant development. Parliament has been prorogued until March 24th. That is to say, essentially the government or Parliament, has been shut down for just over two months. That's really realistically the window in which the Liberal Party will have to pick a new leader. That is a pretty tight timeframe.

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For instance, Trudeau was chosen in a race that lasted about seven months. We have seen those shorter races, including, including the Dion to Ignatieff race, which was only two months. So this will be a shorter race, presumably, and then fairly likely there will be an election immediately afterwards. All of the opposition parties have indicated they don't want to support this government anymore.

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This is a minority government. And so unless that thinking changes, and it's not impossible that some party gets a sweetener that extends the life of the Liberal government and delays an election until the fall. But realistically, a spring election is likely. Right now, as it stands, even with a Liberal Party with a new leader, it doesn't look as though the leading candidates right now are polling all that much better against the Conservative opposition party.

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And so as it stands right now, a spring election is likely, and a Conservative Party majority win is quite likely based on the polls we've seen. In our view – and this is fairly simplistic, and we'll learn more going forward, and of course, there are always surprises when parties govern. Nevertheless, we're of the view that the Conservative platform right now would be incrementally supportive of the economy and productivity and businesses as well.

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In the meantime, trickier negotiations with the U.S. at a pivotal moment. And so tariffs will be in play in the coming months. That will presumably be left to Trudeau, who is something of a lame duck. That does put Canada at something of a disadvantage on that file.

In terms of other Canadian issues, on the currency front, the Canadian dollar has been under $0.70 in recent days, or 143 if you want to flip that ratio around.

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That is a reflection of lower rates in Canada, of concerns about the economy , and of simple U.S. dollar strength as well. It's not the weakest we've ever seen. In fact, there have been moments of similar currency valuations as recently as 2020 and 2016, but those were both very brief and very temporary. The longest sustained stretch of a currency valuation in this realm, was the 1998-2003 period.

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Speaker 1

We think in the very short run, the risk is the currency could even be a little bit softer. Yet, in the medium term, though, we do think this is a very soft Canadian dollar. We do think that perhaps, the world and markets are nearing peak pessimism on Canada. And so we would look for a Canadian dollar that actually could then start to strengthen at least a little bit.

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Fair value is as much at about $0.85 or 117. Not looking for that in the near future whatsoever. But just it is a magnetic pole and it is a reference point to be aware of. In the meantime, though, as the currency is soft, don't forget the currency markets act as shock absorbers. And so Canada is therefore enjoying something of a competitiveness boost at a time of economic need.

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And so that's one of the reasons we think the economy is more likely to grow than not in 2025, despite some pretty obvious challenges.

Just to finish with the word on the Bank of Canada here. So the Bank of Canada did cut rates, in fact, by a pretty chunky 50 basis points in December. That looks likely to slow. In fact, there was some debate as to the right size.

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We've learned in retrospect, the policy rate is now down to just 3.25%, which is a fair amount of movement from a 5% starting point, well ahead of the U.S., which is still in the 4.25-4.5% range. But with an inflation number at 2%, with mortgages rolling into higher rates in a pretty big way this year and next, with an unemployment rate that's risen by two percentage points over the last couple of years, you can justify rate cuts on that order.

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And so we think there's room for at least a little bit more cutting at this point. It looks as though there could be another rate cut in late January, probably 25 basis points. The Bank of Canada can likely get into the twos, at a minimum, this year.

So I'll stop there and say thanks so much for your time.

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I hope you found this interesting. And please consider tuning in again next time.