To me, the main story with inflation is how much progress has already been made. in the middle of 2022, Inflation prints were eight, nine, 10%. We're now in a world in which at least the headline inflation print is more like 3%. So that's a whole lot closer to the 2% target that a lot of central banks maintain.

Now, I will concede that the 3% numbers we see are probably a little bit generous in terms of where we really are. Gas prices have fallen and so that's maybe helping the numbers a bit more than they deserve to be helped. And so we look at other metrics, we look at core inflation, we look at median inflation, we look at inflation just excluding gasoline.

And most of those are a little higher still. They're often in the 4%, 5%, even 6% range on an annual basis. I think it's quite fair to say that more work is needed and we're not quite there yet. But even those metrics that have been a little more stubborn and a little stickier, if you look at them over the last few months and actually they're making significant progress and maybe they're looking more like they could be threes and fours before too long.

So inflation is a lot better than it was. We are technically optimists when it comes to inflation. We think there's room for it to improve even a little bit more than the market is assuming. We see some further downward path ahead. It might be a little bumpy in the next few months just because we know gas prices have bounced a little higher.

We think there might be some risks around food inflation as well. The progress could be slower in the short run. But over the next year, say we do believe there's more progress possible we can work our way deeper into the twos and more normal type of numbers. And that's a big deal because central banks raise rates so much precisely because of this problematic inflation.

And it's a big deal for the economy because the reason we think a recession is more likely than not is because the central banks did all that rate hiking. And so it really does come back to inflation. It's great news that it's getting somewhat better. I'll admit there's a high level of uncertainty around all of this. There are upside risks in the context of gas and food and a few other subjects as well.

But there are downside risks as well. And if we get a recession, that's often a deflationary experience, which puts a downward pressure on prices. And for that matter, we see a number of products in the price basket and just can't figure out why would they need to stay this expensive indefinitely. They're so much higher than they were before the pandemic.

There may be some room for deflation in that space as well.

Central banks, including the U.S. Federal Reserve, have gone an awfully long way over the span of the last 18 months or so. And so central banks have gone from really roughly a 0% policy rate to now numbers that are 5% or often even higher. This is a pretty extraordinary amount of tightening in a short period of time.

We've gone from outright stimulus backed extreme stimulus to pretty substantial restraint right now. I would judge the success of central banks, including the Fed, largely on the basis of inflation. And so on that basis, I would say we've seen inflation come down significantly from nearly double-digit levels to three and 4% at this point in time. And so I think there's been some success there.

I don't believe that means they're about to pivot and start easing, though, just because there are enough uncertainties with regard to inflation. For that matter, inflation still isn't quite where it needs to go, such that I guess the jury is ultimately out on whether they've been completely successful. But I think they've done some of the heavy lifting and the policy has been credible.

It's not obvious they need to go a whole lot further. And so I think they've done a reasonable job at this point in time. They're very, very data dependent. They don't know whether the next move is a rate hike or a rate cut. [It] comes down to whether the economy rolls over or not, or whether the inflation numbers continue to improve or not.

Our best guess is that central banks are either done or very nearly done. The Fed could have one more rate hike. By our way of thinking, probably no rate cuts in the near term, even if the economy were to start rolling over. I think just memories are too fresh of the errors of the 1970s and prematurely cutting rates.

I think they'll be on an extended pause in all likelihood followed by some easing because this is restrictive policy. We don't need to be here indefinitely. And so really, that's where our thinking lies right now. If there were to be a big surprise relative to that base case, it would be if a recession is avoided, it'll be hard to fully tame inflation, particularly service sector inflation.

And you could imagine a scenario in which central banks suddenly realize they need to do another percentage point of tightening. But that's very much a secondary scenario in our view.

Well, for a long time, Japan was the one major developed country that wasn't participating in the monetary tightening that so many other countries have delivered in recent years. And that's begun to change. And it's subtle and they've still kept their policy rate unchanged, but essentially they're tolerating higher bond yields.

And so functionally, that's the same as something like a rate hike. This is a pretty important change by Japanese standards. Interest rates are suddenly very high, very unfamiliarly high. I should say, compared to the rest of the world, Japanese interest rates are still very low. And so it very much depends on your perspective.

In terms of the domestic implications of that for Japan. Well, I guess to start with, it suggests that they feel more confident that maybe they're starting to revive inflation expectations because for a long time, for decades, inflation was too low in Japan. And they've been using this as an opportunity to try and normalize expectations and hopefully lock in a positive inflation rate coming out of this. I think they feel some level of comfort they might be capable of achieving that.

By the same token, inflation is beyond those targets right now. I think they wanted to limit the extent of that. I believe they also wanted to limit the extent of the Japanese yen's depreciation, which has been quite significant as investors were flooding elsewhere looking for higher rates of return. And I guess domestically, there's also a pretty significant risk here, which is Japan is probably the most heavily indebted country in the world.

And so those higher interest rates really bite. And not predicting doom but I am saying we need to watch them very closely as a guide for whether this is sustainable and whether there could be sovereign debt problems or other debt problems elsewhere in the world. We'll be watching Japan quite closely on that front. The one other international implication beyond maybe a more stable Japanese yen or maybe even a depreciating one, is that as Japanese interest rates have risen, that's actually starting to pull a bit of money out of the rest of the world.

Some Japanese investors are withdrawing funds from the U.S. and other markets and returning it to Japan, where they can now earn a positive interest rate. That may be part of the story for why borrowing costs, bond yields in other countries, including the U.S. and Canada, are a little bit higher than they were. And so that's been actually a form of implicit tightening for the rest of the world.

The Chinese economy has been through a real roller coaster ride over the last year. And so in late 2022, it was locked down for pandemic reasons and then abruptly reopened.

There was a period of happy growth and since then it's really fizzled. And we see pretty fundamental problems in the Chinese economy right now. The trade side of things, the external facing side, is really struggling with exports and imports both quite materially down over the last year. We think that reflects weaker global demand to an extent, but also shift from goods back to service consumption.

China doesn't make as many services and also some geopolitical considerations as some companies pursue a China plus-one policy of shifting some of their production elsewhere. And so that's hurt China in an international context. But the domestic side really hasn't been all that much better. Chinese housing has been declining recently. It historically was a really large driver of the economy, and it's just not doing that right now.

And simultaneously, consumers aren't spending and arguably for housing related reasons, because in China, the great bulk of household wealth is in the housing market. When home prices are falling, people really don't feel like spending. The domestic economy has been quite soft. I will say that policymakers are not ignoring this fact. There's been some bellyaching that they're not doing enough.

That might be fair, but I think they're doing more than a lot of people recognize. And we see rate cuts that have been happening not a lot, but a little. We see a weaker currency, which helps. It helps to revive inflation, which is too low there, and it helps to revive competitiveness, which should help on the export side.

I can say that they've done some housing market policies to lower down payments and other things, and that may actually be starting to work in the latest data. They've done some business tax cuts. And so they are at work. It's not spending a lot of money, it's more tweaks to rules and these sorts of things. But I suppose I would say between that and what could be a little bit more, we think the Chinese economy can stabilize and can continue to grow, just not grow at a heroic rate.

I guess to pivot from that short term story briefly to the long-term story. I can say long term, China has some challenges as well. The demographic picture is quite difficult right now for China. That's not going to change as far as we can see. The geopolitical environment probably also remains difficult. And so that's a tough one.

From a competitiveness standpoint, China seems to be tilting back towards state control, away from private-sector control. In theory, that could limit productivity growth. And housing just probably doesn't return to be the big driver of the economy it once was, because, frankly, it was a bubble when that was happening decades ago. We think China is on a slower course at this point in time.

We're assuming the new normal growth rate is 3 or 4% a year, not the old five or six or eight or even 10% if you go far enough back. And so that's still fine. And China should be okay. But it's the biggest driver of global growth. That casts a bit of a shadow over all of us, not over just China.

Economics isn't an exact science. We really can't make promises with regard to any sort of economic outcome. But we do think a recession is more likely than not. We're assigning about a 65% chance to a recession in the U.S. over the next year with really similar probabilities for a number of other developed markets. And the reason we think that is simply because interest rates have risen so substantially over the last 18 months that you would normally expect a recession to emerge from that.

We don't think it has to be an especially deep recession. In fact, we forecast a fairly mild one. We don't believe it has to be especially long. In fact, we forecast just a few quarters, which would qualify as being fairly short. You normally get a pretty good recovery subsequently. All those sorts of things are especially egregious.

But we do think a recession is more likely than not. It does come with suffering. It can bring an opportunity for savvy investors in terms of perhaps diminished risk assets and rallying bonds and those sorts of things. And so we're well aware of that as well. From a recession standpoint, we really think the window is still wide open.

It's tempting. I think the narrative out there is maybe the window is closing and where's that recession? It hasn't happened yet. When we look historically, we find that, no, it's quite normal for there to be in the realm of a two year lag, for instance, from a first rate hike to a recession and this sort of thing.

You have to be patient. We think the window is still open. If anything, it might even be opening. We're assuming that a recession, if it happens, begins towards the end of 2023. Again, it's not an exact science. I can't commit to that exact time, but we think that's what's most likely. We're still positioned for and budgeting for some sort of period of economic contraction.

The Canadian housing market slumped badly in 2022 and then staged something of an improbable revival over the first half of 2023. We find ourselves at this juncture wondering just what the next step is for this housing market. And we think we're going to return to a period of softness, probably not on the order of 2022 when prices in particular were collapsing.

We do believe that there will be some sort of housing malaise out there for a number of years. And part of the story is one in which affordability is still quite poor. In fact, it's very, very poor, even relative to just before the pandemic, when, quite frankly, it wasn't very good at that time either. Mortgage rates are, if anything, still rising, not falling.

And so that's a further challenge. We know that historical housing bust last an average of six years. It would be quite unusual if we were to have experienced one last year that was only a year long. We think it's more likely than not there's still some housing weakness. We think the home price increases we saw in the fall are partially a seasonal factor, partially a function of very limited inventories, which will grow somewhat over time.

And so indeed, the latest data is starting to hint at a little bit of additional softness to come. That's our expectation. I should say when I speak about housing softness, I mean mostly in the context of home prices being flattish or not rising or some variation on that. I have to say on the construction side, on the actual supply side, I would assume that we will continue to see pretty good construction levels just because there does appear to be a genuine shortage in Canada, and indeed in a number of markets. For that matter, immigration has been so strong and indeed recent reports are suggesting perhaps even underestimated in a way that we will need that construction. We may not see the prices rise as they once did.