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by  Eric Lascelles Aug 9, 2022

What's in this article:

Monthly economic webcast

Our August economic webcast is now available, entitled “A recession appears likely, but might inflation be peaking?

COVID-19 wave plays out

The latest COVID-19 wave continues to play out. European nations -- including the U.K. and Germany -- are now enjoying a decline in infections. However, the fatality numbers – which operate with a lag – have not yet significantly retreated (see next two charts).

COVID-19 cases in U.K. begin to ease; deaths have yet to follow

COVID-19 cases in U.K. begin to ease; deaths have yet to follow

As of 08/05/2022. 7-day moving average of daily new cases and deaths. Source: Our World in Data, Macrobond, RBC GAM

COVID-19 cases in Germany also ease; deaths have yet to follow

COVID-19 cases in Germany also ease; deaths have yet to follow

As of 08/07/2022. 7-day moving average of daily new cases and deaths. Source: Our World in Data, Macrobond, RBC GAM

In North America, the wave of U.S. and Canadian infections may be flattening out, but has not yet materially declined. For most countries, the BA.5 wave is proving milder than the prior two waves, largely thanks to prior immunity.

Conversely, Japan is suffering mightily under its latest COVID-19 wave (see next chart). It appears that the country is doing significantly worse than others because, perversely, of its great success at minimizing infection previously. There are far more Japanese people without antibodies, making the country a ripe target for the virus.

COVID-19 cases and deaths in Japan remain high

COVID-19 cases and deaths in Japan remain high

As of 08/07/2022. 7-day moving average of daily new cases and deaths. Source: Our World in Data, Macrobond, RBC GAM

One wonders whether China will eventually crack and experience something similar. Meanwhile, in China, the resort city of Sanya on the southern island of Hainan has locked down after several hundred cases were reported. This has stranded more than 80,000 tourists.

Wheat prices are falling

Ukraine is normally the world’s third largest exporter of wheat. The scope now exists for some Ukrainian exports after a fragile deal was struck with Russia to permit transportation from Ukrainian ports. However, evident challenges remain as the area remains a battlefield.

As such, it is superficially surprising that wheat prices have now retreated all the way back to pre-invasion levels (see next chart).

Prices have retreated as wheat harvest gets underway

Prices have retreated as wheat harvest gets underway

As of 07/28/2022. Shaded area represents U.S. recession. Source: S&P, Macrobond, RBC GAM

What has supported this sharp decline in prices? Several things:

  • While Ukraine is a major wheat exporter, its importance to the global market is overstated. Under normal circumstances, Ukraine exports 24 million metric tons of wheat per year. This is a lot in absolute terms, but merely 3% of the global wheat market. Even if Ukrainian wheat exports fell to nothing, 97% of global wheat production would remain.
  • Ukrainian wheat exports are not expected to fall to zero. Instead, Ukraine is forecast to export around 15 million metric tons of wheat this year. That leaves a shortfall merely equal to 1% of global production.
  • Other countries have not been standing still. Russian, Chinese, Canadian, U.S. and Australian wheat production and/or exports all look set to be higher than normal this year, filling much or even all of the remaining gap. Conversely, India’s poor monsoon season could leave it somewhat short of normal production.
  • Demand for wheat is expected to be lower than normal this year as ranchers shift their animal feed usage from wheat toward cheaper corn.

To be fair, Ukraine is also an important producer of several other crops. Diminished access to Belarus’ potash supplies is also problematic for global crop yields in the future. Furthermore, certain countries in Africa, the Middle East and central Asia are disproportionately reliant on Ukraine’s wheat supplies. Lastly, wheat prices may be back to pre-war levels, but are still elevated relative to the norm of the past decade.

Putting it all into perspective, the UN estimates that the war in Ukraine will increase the number of people going hungry by 13 million in 2022 and by 17 million in 2023. Thus, the effect of the war is on the order of a 1.7% increase in hunger. There will be very real human suffering.

From an inflation standpoint, our main takeaway is that the decline in food prices in recent months is likely sustainable. This is helpful for inflation.

Geopolitical stress builds

This is a time of high geopolitical stress. Russia features centrally, alongside recent flare-ups between Israelis and Palestinians (since resolved via a cease-fire). Other recent developments include the Taliban takeover of Afghanistan, Iran’s imminent possession of nuclear weapons, and now China’s anger at U.S. House Speaker Nancy Pelosi’s August 2nd visit to Taiwan. Economically, de-globalization is underway, in significant part due to these frictions.

Russia often captures top billing and has certainly had the largest effect on economic conditions in 2022. But the U.S.-China relationship is arguably still the most important from a geopolitical and economic standpoint over the long run.

After the U.S. visit to Taiwan – which China claims as its own – China demanded an apology and suspended communication and coordination with the U.S. over matters including climate change, military activities and international crimes. China also sent its military aircraft to fly over Taiwanese territory, shot missiles over the country, and conducted military drills around the island. Some air and shipping traffic was also impeded.

Chinese President Xi is on record saying that the “reunification [of China and Taiwan] must be fulfilled.”

Even as President Biden replaced President Trump, tariffs and economic restrictions have remained in place, with Biden suggesting that tariffs will not be dropped in the future, either. Indeed, the risk was that the U.S. would add rather than remove tariffs even before this latest imbroglio. That risk has increased following the visit.

But it still seems unlikely that China will actually invade Taiwan in the near term, or that China and the U.S. will come to blows. The main reason is that such a conflict would be disastrous for all parties, from both a military and an economic perspective.

A conflict between the world’s two largest militaries would be very costly on both sides, risking great loss of life to the countries’ respective militaries, the Taiwanese civilian population, and potentially also the Chinese and U.S. civilian populations.

The economic damage would be truly stupendous. Imagine comprehensive sanctions on China: the consequences would be an order of magnitude larger than the effect of Russian sanctions given China’s far greater importance to the global economy. Chinese manufacturing production would crater; Western demand would similarly collapse as many products would become unavailable. Meanwhile, Taiwan plays a key role in the production of electronics and high-tech chips for the world, meaning that any conflict would greatly limit the availability of key technologies and perhaps even limit innovation.

The timing is also arguably not right for China to invade Taiwan. The harshness of the Western response to Russia’s recent attacks via sanctions may make China think twice (conversely, some argue the fact that NATO has not put troops on the ground in Ukraine adds uncertainty as to whether the U.S. would actually wage war on behalf of Taiwan). Taiwanese attitudes are also very much against China, with a recent poll finding less than 10% of the population desires an eventual political union with China. It is far harder to integrate people when they are unwilling. Both China and the U.S. have important elections in the fall. It is thus in the best interest of both countries to sabre-rattle, but not to actually wage war.

China is already beginning to de-escalate. Air and ship traffic is normalizing. The risks remain elevated, but the status quo is still quite likely to prevail.

Inflation takes a breather in July

The U.S. consumer price index (CPI) for July will be released on August 10. It continues to look like the monthly and annual prints will decline somewhat. The consensus now anticipates a mere +0.2% month-over-month (MoM) price change in July, dropping the annual figure from +9.1% year-over-year (YoY) to +8.7% YoY. That monthly figure would be more than six times lower than the +1.3% MoM change recorded the month before. The central reason, of course, is that commodity prices have fallen from June into July. Accordingly, core CPI is not expected to soften quite as much.

The outlook for the producer price index (PPI) is similar: a mere +0.2% MoM gain after a +1.1% MoM jump the prior month.

It makes theoretical sense that inflation is peaking. The four main drivers are all turning:

  • Monetary stimulus is less supportive.
  • Fiscal policy is now a drag.
  • Supply chains are being fixed.
  • Commodity prices are declining.

As a result, inflation expectations have fallen quite substantially – a further argument for inflation easing in the future.

Of course, there is a lot of momentum and breadth to the current high rate of inflation, such that a sudden return to normal inflation readings is probably optimistic. Our forecasts budget for a gradual deceleration of inflation across the remainder of 2022 (setting aside the extremely soft July enabled by the sharp move in commodity prices). Even this will still leave the inflation rate in the realm of +7.5% YoY in December.

A key thing to watch is the extent to which the non-commodity components of CPI soften in July. If there is no deceleration, the fundamental problem remains.

Looking back to the 1970s

We recently looked back to the 1970s to obtain a better sense for the context in which inflation peaked during the three main inflation cycles of the era. In two of three cases examined, inflation required another 2 to 3 years to peak after the start of monetary tightening (see next chart). In the third case, inflation peaked right around the first rate hike. We are hopeful the present-day experience will be more like this third case, though the possibility exists that controlling inflation will require another few years.

Inflation before and after first Fed rate hikes (1972, 1977, 1980)

Inflation before and after first Fed rate hikes (1972, 1977, 1980)

As of August 2, 2022. X-axis represents months prior to and after the first Fed rate hike. Day 0 represents the first Fed rate hike. Source: Bureau of Labor Statistics (BLS), Macrobond, RBC GAM

Examined relative to the onset of recession, inflation began to fall right as the recession began in two of the three historical 1970s cycles. It took another year to peak in the third case (see next chart). To the extent a recession seems likely toward the end of this year or in early 2023, this would suggest an inflation peak within the next six months – a reasonable proposition.

Inflation before and after onset of recession (1969, 1973, 1981)

Inflation before and after onset of recession (1969, 1973, 1981)

As of August 2, 2022. X-axis represents months prior to and after the onset of recession. Day 0 represents the first month of recession. Source: BLS, National Bureau of Economic Research (NBER), Macrobond, RBC GAM

‘End of cycle’ arrives

The U.S. business cycle just made a giant leap forward. A quarter ago, our cycle scorecard had provided a ‘mid cycle’ diagnosis for the U.S. economy, though the cycle was advancing quickly and had significant ‘late cycle’ claims already.

This quarter, we find that the business cycle has left behind ‘mid cycle,’ skipped right over ‘late cycle,’ and is now firmly in ‘end of cycle’ – a position that normally only lasts for a quarter or two before recession strikes (see next chart).

U.S. business cycle score shifts to ‘end of cycle’

U.S. business cycle score shifts to ‘end of cycle’

As of 08/05/2022. Calculated via scorecard technique by RBC GAM. Source: RBC GAM

Inputs that argue for an ‘end of cycle’ or later interpretation (see next graphic) include inventories (see subsequent chart), prices, sentiment, the behavior of the stock market, business investment and the broader momentum of the economy. It is also notable that wage growth is rolling over – a classic ‘end of cycle’ indicator (see third chart).

U.S. business cycle scorecard advances

U.S. business cycle scorecard advances

As of 08/05/2022. Darkness of shading indicates the weight given to each phase of a business cycle. Source: RBC GAM

U.S. inventory-to-sales ratio climbs as inventory builds and sales fall

U.S. inventory-to-sales ratio climbs as inventory builds and sales fall

As of May 2022. Real inventory-to-sales ratio of all manufacturing and trade industries. Shaded area represents recession. Source: Bureau of Economic Analysis (BEA), Haver Analytics, RBC GAM

Wage growth of U.S. low-skilled workers has slowed

Wage growth of U.S. low-skilled workers has slowed

Limited-service restaurants as of June 2022, total private non-farm as of July 2022. Source: BLS, Macrobond, RBC GAM

The new positioning of the business cycle makes a strong endorsement that a recession is nigh. We now assign an 80% chance to a U.S. recession over the next year. The probability in the Eurozone and U.K. is even higher.

Economic miscellany

The sentiment in newspaper articles is again declining. It has now reached the sourest level since early in the pandemic (see next chart).

Daily news sentiment declines

Daily news sentiment declines

As of 07/31/2022. Source: Federal Reserve Bank of San Francisco, Macrobond, RBC GAM

Declining GDP

U.S. GDP fell in both the first and second quarter of 2022. While this is not technically the definition of a recession, it is a popular rule of thumb. In this case, while the development does highlight a weakening economy, we think it falls well short of a true recession. This is in part because of its root in weaker inventories and stronger imports rather than deficiencies in consumption or investment. It’s also in part because significant job losses have so far been avoided; and in part because there have not been a significant number of sectors in the economy damaged yet. Further to the notion that the recession didn’t simply start sooner than planned, third-quarter GDP in the U.S. is currently tracking +1.4% annualized.

To be clear, we still anticipate a recession later, but don’t believe the first half of 2022 was it.


On the subject of employment, U.S. payrolls managed an unexpectedly large 528,000 job advance in July. However, the household survey reported a much milder 179,000 job gain, and that was after reporting the loss of 315,000 jobs the prior month. It is perhaps more useful to look at the labour market more broadly. All is still mostly fine, but key variables are starting to weaken. Jobless claims are rising, and layoffs are also now increasing (see next chart). Business hiring intentions have weakened moderately. Job openings and the quits rate are still quite elevated, but are peaking (see subsequent chart).

U.S. job cuts announced have started to rise

U.S. job cuts announced have started to rise

As of June 2022. Source: Challenger, Gray & Christmas, Inc., Macrobond, RBC GAM

U.S. job openings and quits ease from record high

U.S. job openings and quits ease from record high

As of June 2022. Estimates for all private non-farm establishments. Shaded area represents recession. Source: BLS, Macrobond, RBC GAM

Incidentally, in the case of the still-elevated job openings rate, it has been popular to argue that job losses can be avoided if a recession occurs since companies will cancel their hiring plans before they lay anyone off. And with job openings numbering more than 10 million, it is unlikely that companies will need to reduce their ideal head count by more than that. We would concede that the labour market is likely to prove relatively more resilient than normal in the face of any recession for this reason.

However, as amply demonstrated both in 2008-2009 and in 2020, a high starting level of job openings does not preclude significant real job losses in a recession. Many of these openings are/were predicated on the assumption of further enthusiastic growth in business revenues, which are proven incorrect when a recession occurs. Sector-level mismatches mean that some sectors will be unsuccessfully pining for more workers while others are actively laying them off. The tightening of financial conditions may preclude some companies from having the funds to expand, even though their market opportunities would otherwise advise it. In short, significant real-world job losses will still occur in a recession.

Meanwhile, Canada reported a second consecutive month of outright job losses, with a 30,000 job decline in July. While we do ultimately expect Canada to have a somewhat worse recession than the U.S. given greater household debt in Canada (more on that later), it can’t genuinely be said that the GDP performance has been worse in Canada so far. Despite the worse employment trend, Canada’s GDP has done better than the U.S. over the first half of the year.

Corporate earnings mostly resilient

Overall, corporate earnings held up well through the latest quarter. With most public companies in the U.S. now having reported, sales growth and earnings growth have surprised positively by 3-4% relative to expectations.

But, at the risk of cherry picking, there are little pockets of weakness. Walmart, for instance, issued its second profit warning in less than a quarter, noting that consumer spending is being adversely affected by high fuel and food prices. The company also has more inventory than it would like, with an expectation that its income will fall by a significant 13-14% over the coming quarter.

The tech sector is a more extreme case. Many major technology companies are already laying off, planning layoffs, or at least scaling back their hiring plans. It is a similar story with their cap ex plans. This may or may not prove to be a bellwether for the rest of the economy: the sector is not only more volatile than traditional sectors, but was already suffering a sector-specific meltdown that began last fall, well before the rest of the economy started to weaken.

Working from home

One of the enduring consequences of the pandemic is that rates of working from home remain much higher than they were before the pandemic. Indeed, the most widely cited estimates, from Kastle Systems, put U.S. office occupancy at just 40% of normal despite two years of recovery (see next chart). Furthermore, the level now appears to be stagnating, suggesting a resistance to further gains.

Office occupancy of U.S. metropolitan cities stalls

Office occupancy of U.S. metropolitan cities stalls

As of the week ending 07/27/22. The Barometer represents the weekly office occupancy based on swipes of access controls. Source: Kastle Systems, Bloomberg, RBC GAM

However, there is reason to think this significantly underestimates the true office occupancy, and implicitly over-estimates the extent to which people are working from home:

  1. Simply to clarify, this is a study of office workers rather than all workers. Around half of workers do not toil in offices, and nearly all of these other workers must do their jobs from the workplace, be it a factory, restaurant, store, school or hospital. Thus, one might estimate that the Kastle Systems data is truly arguing that around 70% of all workers are in their workplaces on an average day.
  2. The Kastle Systems data only reports for the 10 largest cities. Workers in larger cities have been shown to be more reluctant to return to the office, in part because the commute is significantly more painful.
  3. The access control systems the company monitors are likely concentrated in Tier 1 offices, which are predominantly used by larger companies. Many of these firms have been slow to push their workers back to the office for fear of aggravating their precious human capital.
  4. To the extent the data simply captures the number of times workers swipe into the office, if workers are behaving more cautiously and, say, reducing their trips up and down the elevator for lunch, coffee and errands, that will also reduce the estimated number of workers.

It doesn’t seem like a leap to suggest that the office occupancy rate could therefore be substantially higher than Kastle Systems estimates. By extension, working from home runs significantly lower.

To this point, the Bureau of Labor Statistics estimates that, as of July, just 7.1% of employed persons teleworked at some point over the prior four weeks due to the pandemic. To the extent these people might have split their time between the office and home, the figure would substantially exaggerate the fraction working at home on an average day. However, one might imagine many people working from home for reasons no longer strictly related to the pandemic – instead taking advantage of the greater flexibility – who are not picked up in these figures. As an example of this, in Canada, 24.2% of workers in July conducted most of their work from home – a significantly higher rate.

The bottom line is that while many more people are working from home than before the pandemic, they are in the distinct minority when the data is properly parsed.

U.S. fiscal progress evolves

Contrary to expectations just a few weeks ago, U.S. Senate holdouts Joe Manchin and Kyrsten Sinema have now acceded to a reconciliation bill proposed by Senate Democrats, sending it to the House of Representatives where it is thought to have sufficient votes to proceed. From there, the White House should approve the bill, entitled the Inflation Reduction Act.

Of relevance to investors, the bill contains a 1% tax on share buybacks. It also includes the following:

  • Implements a 15% corporate minimum tax for large, profitable American companies.
  • Contains over US$300 billion in clean energy credits – a key green victory for President Biden.
  • Allows Medicare to negotiate prescription drug prices.
  • Extends Obamacare subsidies.
  • Provides additional funding to the Internal Revenue Service (IRS).

Final analysis of the bill is not yet complete, but it is expected to raise several hundred billion dollars more in revenue than it deploys. As such, it is fiscally restrictive and represents another argument for the economy to slow. The bill doesn’t have much to say about its namesake – inflation – other than the fact that a fiscally restrictive bill should, at the margin, reduce inflation.

Monetary policy continues to tighten

Unsurprisingly, monetary policy continues to ratchet tighter. Over the past few weeks, the U.S. Federal Reserve delivered a second 75 basis point rate increase. Markets are now looking for another 75 basis point increase in September after the latest strong payrolls report.

In the U.K., the Bank of England hiked rates by 50 basis points. The central bank has been unusually candid, explicitly forecasting not just a recession but a fairly significant one involving a 2.1 percentage point peak-to-trough decline in output. The Bank of England also now targets a lofty 13% peak inflation rate.

The pace of monetary tightening in the developed world is likely to start decelerating in the fall as central banks near their desired policy levels, as the economy weakens, and as inflation – hopefully – continues to ease after July.

Canadians face challenges due to rate sensitivity

We’ve long expected the Canadian economy to fare somewhat worse in any coming recession, entirely because of the country’s greater interest rate sensitivity at the household level.

As interest rates rise, borrowers suffer. Canadian households have borrowed a lot more than their U.S. counterparts (see next chart). Canada also has worse housing affordability – suggesting greater scope for falling home prices and thus a negative wealth effect. Add to this the fact that Canadian mortgages tend to have 5-year terms versus 30-year terms in the U.S. and that means more Canadians will be affected by rising rates more quickly.

Household leverage is still low but rising in U.S.; nears record high in Canada

Household leverage is still low but rising in U.S.; nears record high in Canada

As of Q1 2022. Source: Haver Analytics, RBC GAM

A sliver of historical insight can be gleaned by looking back at the 1981—1982 recession: a recession induced more than any other by aggressive monetary tightening. When interest rates went up sharply, which economy did worse? The answer is that the Canadian economy declined by more than twice as much as the U.S. did.

Granted, the comparison is highly imperfect. For instance:

  • Canada didn’t suffer a recession two years earlier while the U.S. did.
  • The Canadian economy bounced back more enthusiastically than the U.S. after the recession.
  • 5-year mortgages were only starting to become popular in Canada at the time.
  • Canada didn’t have so much more household debt than the U.S. at the time.

Nevertheless, when one mixes the theory with the historical evidence, it seems reasonable to anticipate that Canada may be more vulnerable to rising rates.

What is interesting is that when one does some very rough math about the fraction of Canadian families that will be exposed to rising mortgage rates in the first year (ignoring the existence of other forms of debt), the answer isn’t all that high.

After factoring in the fraction of Canadian families with mortgages (around 32%), the fraction of mortgages set to renew over the coming year (about 20% of the 32%), the fraction of families that recently took out a variable rate mortgage and might have to reset their mortgage payments to a higher level as interest rates rise (perhaps 1.5%, but some estimate a much lower figure) and the fraction of families who will be exposed to rising rates via the purchase of a home over the next year (around 5%), that only adds up to 13% of Canadian families having to pay more for their mortgages over the first year of the tightening process. (Be warned this analysis ignores the subtle definitional differences between families and households.)

In turn, Canada may be more vulnerable than the U.S. to rising rates. But the vast majority of Canadians won’t directly suffer – via the mortgage channel, anyway – in the first year.

-With contributions from Vivien Lee, Andrew Maleki and Aaron Ma

Interested in more insights from Eric Lascelles and other RBC GAM thought leaders? Read more insights now.


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