Hello and welcome to our video MacroMemo. And there's plenty, as always, to cover off this week. We'll start with our view that maybe there's a little bit too much optimism out there, and I'll elaborate on that. We'll talk a bit about the war in Ukraine, which could be intensifying. We'll discuss China, which is in the midst of an economic recovery of some importance.

We'll talk more generally just about economic strength disproportionately in the labour market. And we'll also spend some moments on recession thoughts, on inflation, and on housing as well. So, plenty to cover off. Let's circle around and let's start with that thought that maybe there's a bit too much optimism out there. And I don't want to suggest the optimism is completely unfounded.

We've had good things happening over the last 3 to 6 months. We've had inflation come down nicely. We’ve had China revive earlier and more completely than initially imagined. We've had European gas prices fall more than expected, which is a welcome thing. Labour markets have proven quite resilient. Financial conditions have eased somewhat. So there's plenty of genuine good news. I guess we would just say maybe there's too much optimism out there. We still do believe recession is more likely than not.

We don't think inflation is fully vanquished yet. And there are a number of near-term risks. China's revival could send commodity prices higher, complicating the inflation story the same way, if the war in Ukraine does actually intensify. Labour markets could remain overheated and that would also be an inflation problem. And you have other financial risks; Japan perhaps more acutely than others as it exits from negative interest rates, a U.S. debt ceiling debate that's ongoing as well.

And so, I guess the story is one in which there are some issues here. Maybe there's a bit too much optimism out there. We're happy enough to remain fairly cautiously positioned from an investment standpoint.

Let's talk the war in Ukraine. So, the war in Ukraine is seemingly intensifying and could intensify further. We can say at a minimum, the momentum has shifted somewhat toward Russia. Russia is making some small incremental gains, whereas it was Ukraine that was doing that in the fall. Ukraine is responding by upgrading its weaponry with significant help from the West. Ukraine is warning of an imminent major Russian offensive. Some have said that the anniversary of the war on February 24th could be when something like that occurs. So, the risk is quite elevated at this exact moment.

And Russia's said to want to reclaim all of Ukraine's two eastern provinces. It's not clear Russia can achieve that, by the way. But nevertheless, there could be some intensification. Russia has cut half a million barrels of oil production recently as a form of punishment to the West for its support of Ukraine.

In terms of China - the Chinese economy does continue to revive. It seems quite clear China is past the worst of its COVID wave, and there are now plenty of anecdotes suggesting people are returning to restaurants and malls and traveling and those sorts of things.

We do have a real-time indicator for subway traffic that is now the highest in a year. And so that suggests it's not just a Lunar New Year rebound. Something genuine is going on. We're forecasting good growth for China in 2023 - 5.3% - which is an upgrade from our prior forecast, and quite a lot more than the 2.9% that was managed in 2022.

Though I should warn there might be a little bit less pent-up demand waiting than some people imagined. I think the narrative has often been China was locked down for three years, and just wait and see how much they can spend now is they're finally unleashed. And it's not quite as straightforward as that, because actually for a large fraction of those three years, China was actually among the most open economies in the world as the rest of the world was locking down.

And indeed, China's lockdowns, even over the last year, were often quite regional in nature. And so I think the way to view this is there is a genuine revival and reopening. There should be some spending boom, but it's not quite three years’ worth of pent-up demand all being unleashed at once.

Let's talk economic strength, more generally outside of China. One global metric that we've been tracking is global commercial air flights, and those are now back fully to pre-pandemic levels. We've seen a full revival, a little nudge higher, we suspect, from China's reopening over the last month or two. In the labour market space, North American job numbers in particular have been quite astonishing. The U.S. created 517,000 net new jobs in January. That was more than double what was expected and an extremely strong rate of job creation. Canada added 150,000. That's even stronger on a per capita basis. This is an argument that the labour market is white hot, not just red hot. Interestingly, the market's not loving these developments. In fact, we’ve generally seen stock markets fall and bond yields rise as these things have happened.

Rather than embracing it and the implications that the economy can keep trucking along, I think the view instead is that it means the economy is overheating, there's more inflation at risk, more rate hiking might be necessary, maybe a worse economy later. So, at this point in time, actually the best scenario would be a labour market that cools somewhat, which we just haven't seen all that much of yet.

The story is different, by the way, on the business side of things. We have a U.S. business expectations composite metric, and it's now the worst it's been since the global financial crisis in 2008-2009. It’s falling, and that's entirely consistent with a recession. And we have metrics of Canadian anticipated business sales as well. And those expectations are also about the worst we've seen outside of recessions in recent years. And so, just quite a dichotomy between strong labour markets and expected weakness in a number of other areas of the economy.

We have revised our growth forecasts, by the way. We formally do this once a quarter, and we've revised them broadly higher. And the logic has been that we've had some better data, as just discussed. The logic is also that we think any recession could happen a little bit later in 2023 than previously assumed. That makes the 2023 number look better since the weakness is hidden towards the end of the year.

Officially then, our growth forecast for the likes of the U.S. and Canada are no longer negative for 2023. We forecast point 1% growth for the U.S., 0% growth for Canada, still negative for the UK and Europe, I should mention. But in terms of understanding that is still us forecasting a recession, we still anticipate a number of quarters of significantly declining activity. It's just that when you tally that up, when it's hidden in the second half of the year, when it's paired with some quarters of growth, it doesn't quite result in an annual decline. So, it's still a recession forecast. We are still also below consensus, by the way. That means we're still more cautious than the consensus.

In terms of understanding why we're more cautious than the consensus. Recession thinking figures centrally in that. Let's talk about a few aspects of that. The first one is I'm seeing a lot of headlines right now about Europe having avoided recession and doesn’t have to have a recession. I won't pretend to have all the answers here. We're dealing in a probabilistic world. I think the way to view this is a little bit different, though. Which is it seems as though Europe just barely missed a recession from the energy shock that it suffered over the last year from the high natural gas prices.

So that's nice. Let the record show the reason for that, that the recession was just barely avoided is because the government absorbed a lot of the losses. $1,000,000,000,000 worth, that otherwise almost certainly would have created a recession. But I don't think that means Europe is therefore scot-free from here. And the reason is that there's still a rate-shock recession coming. Or at least a rate-shock hit coming.

Interest rate increases operate with a lag. The maximum damage should actually be later in 2023, not yet. The European Central Bank in particular has also been operating with its own lag. It's been raising rates slower than other central banks and it still has more work to do. And so I would still say I think there's a pretty high chance that that Europe still succumbs to recession. Maybe not an energy recession, but an interest rate recession instead.

Looking at the U.S. and looking at some of the models we run, I can still say the recession models are indicating recession risk is high. We have a yield curve model that assigns a 70% chance of recession. By the way, it's the highest the probability has gotten in 40 years. And indeed, it's higher than any other recession that we have had. And so that's a pretty strong indictment.

Survey of private sector forecasts assigns the highest probability of recession outside of an actual recession that we've seen going back a number of decades. And our business cycle work continues to say that we are at an ‘end of cycle’ moment and seemingly actively moving forward.

One interesting twist in all of this is that in some ways, this is the most anticipated recession in modern history. It's been described as such anyhow. When you see surveys of business CEOs and 98% of them expect a U.S. recession and so on. So indeed, it is widely anticipated. I think the question is the extent to which that makes the recession more or less likely? You could say maybe it's less likely because it would avoid panicked actions when the economy gets a little softer that would normally induce a recession or make a recession worse.

Conversely, you can argue if everyone's expecting a recession, maybe they retreat now. They stop hiring, they stop investing, and it makes the recession even if one wasn't necessary. You can argue quite coherently both sides of that. I'm not sure which one wins, to be honest, whether recession is more or less likely because it's so anticipated. If I had to bet, I might say it becomes a little more likely a bit of a self-fulfilling prophecy. But it's an open question. It's something we're not used to seeing, and it adds an element of uncertainty.

Okay, inflation. So, inflation ranks too high. Inflation, though, mostly coming down. It's been a good news story over the last four or five months. We did just get the U.S. CPI print for the month of January as I record this at least literally minutes ago.

And in a sense, cooperation. The annual inflation print came down again. The annual core inflation print came down again. However, the monthly numbers weren't all that great. We actually saw 0.5% monthly increase, which is faster than you'd like to average at least. We know why that happened, by the way. It was mostly gas prices, which rebounded in January. So that was anticipated.

But nevertheless, between that and between some upward revisions to the three historical core inflation data released last week, inflation is taking its time coming down. It's not quite a slam dunk that it continues to decline happily. There are extra complications, as mentioned earlier, and China's revival could induce inflation. U.S. dollar weakness relative to the peak of several months ago could change the dynamic in the U.S. and make it a little harder for inflation to come down there.

There's still certainly hard work to be done. And I guess maybe at the margin, you would say central banks could have a little more work to be done. Bank of Canada says they're done. They might be done. But equally all that labour market strength could yet prompt them to do a bit more tightening. Very similar story in the U.S., particularly as inflation didn't fall quite as readily in the latest month. And so central banks cannot completely ignore the fact that inflation is getting a bit wobbly here and labour markets are remaining too strong.

Let me finish just with a quick housing thought. Housing markets are stabilizing in the U.S., at least by some metrics. So, we look at the National Association of Home Builders, bit of an increase in sentiment in the latest month.

When we look at mortgage applications, a bit of an increase too. And the logic behind that is that the U.S. 30-year mortgage rate has fallen from 7% to 6%. There's been an improvement. Pair that with incomes rising, home prices falling, some people are feeling bold enough to move into the housing market. I'm not convinced it's going to be a strong trend in the sense that usually housing market cycles play out over years, not just over a few quarters. And it is still a fairly challenging interest rate environment in particular and could become a challenging economic one.

I would say I still expect some U.S. housing weakness, but it's stabilizing by some metrics. In Canada, not quite the same story. We're still seeing weakening. It's slowed, we're still seeing weakening. That does make sense given additional household leverage there, and additional vulnerabilities on that front.

Okay, I'll stop there and say thanks very much, as always, for your time. Hopefully this was interesting and useful to you, and hopefully you tune in again next time.