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by  Eric Lascelles Dec 20, 2022

What's in this article:

Year in review / 2023 preview

The final #MacroMemo of the year is a fitting venue for a quick review of 2022 and a preview of 2023.

The past year was extreme in many regards. The economy spent most of the year in a position of significant excess demand, on the heels of the fastest economic rebound on record over the prior two years. Inflation bubbled to its frothiest heights in a generation, in part due to said economic conditions and in part due to lingering pandemic distortions. Central banks responded to the inflation threat with their most aggressive monetary tightening in decades. Markets of virtually all stripes reacted to this with deep discontent. The Chinese economy stumbled as it confronted a mix of cyclical and structural headwinds, none more intense than the country’s zero-tolerance policy toward COVID-19.

As one year turns to the next, several of these dynamics are now changing:

  • Economic growth has slowed.
  • Inflation is finally beginning to turn downward.
  • Central banks are starting to raise rates less quickly.
  • China has abruptly reversed its zero-tolerance policy, to the betterment of the economy but at the potential cost of the public’s health.

Gazing into 2023, we continue to believe that the combination of higher borrowing costs, elevated prices and an assortment of other headwinds will further slow economic growth, to the point of inducing a middling recession. As China tentatively revives, inflation falls and the U.S. economy proves surprisingly resilient, our conviction on this matter has diminished slightly. But a recession remains significantly more likely than not and our forecasts are incrementally below the consensus.

Inflation, conversely, should continue to decline and may normalize faster than the market is imagining. Central banks are accordingly nearing the end of their tightening cycles. An economic recovery could begin in late 2023 or early 2024, paving the way for a multi-year expansion.

Pandemic wave

The pandemic story remains the same. The BQ family of variants continue to take over (see next chart) and global infections are starting to rise (see subsequent chart). But the intensity of the wave (ex-China) will likely fall short of earlier outbreaks and governments are unlikely to significantly lock down in response.

BQ.1 and BQ.1.1 are now the dominant variants

BQ.1 and BQ.1.1 are now the dominant variants

As of 12/17/2022. Sublineages of BA.4 and BA.5 are aggregated to BA.4 and BA.5 respectively. Source: Centers for Disease Control and Prevention, RBC GAM

Global COVID-19 cases and deaths are starting to rise

Global COVID-19 cases and deaths are starting to rise

As of 12/15/2022. Source: Our World in Data, Macrobond, RBC GAM

With so much less testing relative to earlier in the pandemic, the U.S. COVID-19 infection rate appears to be quite low, but this is likely masking a somewhat higher and rising rate of infection – as hinted by an elevated and now rising test positivity rate (see next chart).

COVID-19 cases and positivity rates are rising in the U.S.

COVID-19 cases and positivity rates are rising in the U.S.

As of 12/15/2022. 7-day moving average of daily new cases and test positivity rates. Source: CDC, Our World in Data, Macrobond, RBC GAM

COVID-19 infections in the U.K. are also reported to be rising. However, the flu is increasing even more quickly, to the point that more people are being admitted to British hospitals for the flu than for COVID-19 right now.

China’s pandemic about-face

China remains a story unto itself with regard to the pandemic. Until recently, it maintained a strict zero-tolerance policy that repeatedly damaged the economy and proved incompatible with ever-more virulent COVID-19 strains.

As cases surged and the country locked down, intense protests recently arose to an extent not witnessed in more than 30 years.

Surprisingly, the government has responded constructively to that dissent. First, the country conducted local experiments with lighter COVID-19 restrictions. It is now easing restrictions at the national level. The consensus thinking had been that China wouldn’t make such large changes until the spring.

The four central elements of the government’s pandemic control policy have all been radically dismantled:

  1. Mass PCR testing has effectively come to an end. Proof of negative tests are no longer required to access most public areas.
  2. The use of centralized quarantine facilities is being greatly reduced, to be replaced by quarantining at home. Some isolation requirements are also lightening.
  3. China’s famous electronic tracing app has been discontinued, greatly reducing the risk of a person being arbitrarily quarantined because they briefly crossed paths with someone who later tested positive.
  4. Local governments have been instructed to be much more discerning about the scale of the lockdowns they impose. Once a positive test would motivate the lockdown of an entire region of a city, or at least a neighbourhood. Now lockdowns are meant to be limited to a particular apartment unit or at worst the floor of a building. Suspension of work, production and businesses are not allowed outside of high-risk areas.

Alongside this, the Chinese government is making a vaccination push, with a particular focus on the elderly. Seniors are under-vaccinated and the most vulnerable to COVID-19. The country’s vaccination rate has risen from 195,000 per day to more than a million per day over the span of two short weeks. This is still far lower than the 10-15 million vaccinations achieved per day in early 2022, so some further acceleration is possible. Unfortunately, China still does not have a bivalent vaccine, so the efficacy will be limited.

What happens next?

Financial markets are pleased, as the Chinese economy will be less constrained by restrictions going forward.

Of course, it is a bit more complicated than that. There is a push and a pull in the short run. The supportive push, of course, is the reduction of restrictions on businesses, workers and consumers. But the damaging pull is that as infections temporarily surge in response to fewer controls, some people will opt to behave more cautiously and others will miss work due to illness.

So far, it is unclear which effect is dominating. Real-time activity metrics look good: traffic congestion is rising (see next chart), as is subway usage (see subsequent chart). These metrics signal that people are beginning to travel around more. However, anecdotes are more cautious: Chinese streets are described as being empty as people try to avoid being infected as restrictions ease and one business confidence measure has plummeted.

Chinese traffic congestion is rising

Chinese traffic congestion is rising

As of 12/07/2022. Congestion index measured as 7-day moving average of weighted average of daily peak congestion levels and number of vehicle registrations in 15 cities with highest number of vehicle registrations in China. Source: Baidu, BloombergNEF, RBC GAM

Subway traffic is also up in major Chinese cities

Subway traffic is also up in major Chinese cities

As of 12/13/2022. Index is the weighted 7-day rolling sum of subway trips in Beijing, Chengdu, Chongqing, Guanzhou, Nanjing, Shanghai, Suzhou, Wuhan, Xi’an and Zhengzhou. Source: Chinese metro agencies, Macrobond, RBC GAM

Over the medium run, the economic upside is unambiguous: the pandemic surge eventually fades and then the Chinese economy can operate more freely. Keep in mind that this was already expected to happen – it is simply occurring several months ahead of schedule, pulling that Chinese rebound forward. Chinese policymakers appear to be putting together a plan to encourage more consumption.

All of that said, and at the risk of drifting too far from the pandemic’s effect on the Chinese economy, we mustn’t forget that China has other economic challenges that remain unaddressed:

  • The demographic picture is poor.
  • The property sector is unlikely to resume driving the economy forward even as the government seeks to stabilize it.
  • Entrepreneurs remain beaten down as the balance of power shifts back to the state.

That leaves the critical question of whether China will suffer a massive pandemic wave as it abruptly ends so many restrictions all at once, especially given that the country’s most significant wave of infections since early 2020 was already underway. Credible estimates call for hundreds of thousands to as many as two million deaths in China over the coming months due to COVID-19.

Curiously, the number of reported daily infections in China has plummeted from 41,000 to just 15,000 over the past few weeks. The country has reported just two fatalities over the period. This is precisely the opposite of what would be expected. Either a miracle has occurred, or China’s sharp reduction in testing is capturing far fewer of the actual infections that are occurring. The latter is much more likely, and China’s National Health Commission even said on December 14 that it will no longer try to tally the number of infections.

Anecdotally, it would appear that Chinese infections are actually surging. The clearest evidence comes from Beijing. As reported by the Financial Times, a Beijing lawyer said most of his colleagues had COVID-19 and an Apple store security guard said that employee illnesses were limiting the store’s hours. Funeral homes and hospitals in the city are reporting many times more fatalities than normal right now. Chinese stores are running out of fever medication and the Beijing municipal government indicated that 16 times more people than normal received treatment for fever in the city on a recent day.

In short, China is reopening in deference to popular demand and the needs of the economy, but there will be a price to pay via public health.

To the extent that China has bowed to the demands of its population, one wonders the extent to which the Chinese government could be turning over a new leaf and becoming more responsive to public sentiment in other regards. That wasn’t the impression given at the recent National Congress in the fall, but much has changed since then.

Economy in focus

We passed through an unusual stretch in 2022 when good economic news was interpreted negatively by the stock market due to the implication that inflation would stay high for longer and central banks would have to raise rates by more. This relationship has again reverted back to where good economic data is welcomed by the stock market and poor economic data is not.

This is not the final word on the subject. In particular, labour market strength continues to represent a threat to the view that inflation can continue to descend from here. The relative sensitivity to inflation risks versus growth risks will likely continue to ebb and flow. But it seems reasonable to think that the stock market has now pivoted from fretting exclusively about inflation to incorporating growth concerns. There is a good chance that the growth concerns – and, in our view, an impending recession – will preoccupy the stock market more than other issues.

Recession musings

Our assessment of the likelihood of a U.S. recession in 2023 has diminished slightly, from 80% to 70%. This reduction is the result of China’s reopening, the resilience of the U.S. economy so far and inflation’s promising decline.

But that still leaves a recession considerably more likely than not. A useful way of gauging this is via the dozen simple recession signals we track (see next table). At present, seven give a resounding ‘yes’ to an approaching U.S. recession, two say it is likely, two indicate ‘maybe’ and just one lonely indicator says ‘no.’

Recession is still more likely than not

Recession is still more likely than not

As at 11/15/2022. Analysis for U.S. economy. Source: RBC GAM

This last item – which triggers when the unemployment rate increases beyond a certain point – demands further attention. It is a remarkable signal: every time the 3-month average of the unemployment rate rises by a mere 0.5 percentage points or more, a recession occurs shortly afterward (see next chart). That isn’t much margin for error. Apparently, once the labour market starts to weaken beyond a fairly minimal point, there is a snowball effect and a significant amount of damage may be inevitable.

Rising unemployment could signal recession

Rising unemployment could signal recession

As of November 2022. Unemployment rate is 3-month moving average. Source: Bureau of Labor Statistics (BLS), National Bureau of Economic Research (NBER), Macrobond, RBC GAM

We can make another interesting observation of relevance to the present situation. Right now, the U.S. unemployment rate is going essentially sideways. It has spent 10 straight months in a tiny 0.3 percentage point range. This is unusual. As the chart above reveals, unemployment rates are usually rising or falling, not treading water. Indeed, upon visual inspection, it seems to us that a period with a flat unemployment rate usually only happens at the trough, right before the unemployment rate is about to start rising. That’s why, in our recession signal scorecard, we have suggested an ‘Unemployment increase’ has not yet triggered, but that may be turning.

Data flow

The Atlanta Fed’s real-time Gross Domestic Product (GDP) tracker for U.S. fourth-quarter GDP is now falling, from more than a 4% annualized gain estimated in November to 2.8% now. That is still a perfectly respectable print and quite different than a recession. But the momentum has recently been negative, perhaps foretelling a further economic deceleration into the New Year.

A key contributor to the recent U.S. economic softness was the November retail sales print. This arrived at a below-consensus -0.6%, with broadly based weakness within it. Oddly, November was also when Black Friday sales occurred, and reports at the time had been of surprising strength.

Part of the disparity may be explained by the fact that there was particular weakness in housing-related items (including furniture, appliances and building materials). Few of these products feature in electronics-heavy Thanksgiving sales. But it would be inappropriate to suggest that consumer spending is truly rolling over, as the prior month enjoyed an outsized gain that still leaves the broader trend in reasonable shape.

In Europe, the main story has been an economy that is in the realm of a mild recession. The German Bundesbank’s weekly activity index remains fairly negative (see next chart). S&P Global’s composite Eurozone purchasing manager index actually rose slightly, to 48.8, but that keeps it in the realm of a mild contraction.

German Bundesbank’s Weekly Activity Index remains negative

German Bundesbank’s Weekly Activity Index remains negative

As of the week ending 12/11/2022. Weekly Activity Index estimates the trend-adjusted growth rate of economic activity by comparing the average over the past 13 weeks to the average of the preceding 13 weeks. Source: Central Bank of Germany (Deutsche Bundesbank), Macrobond, RBC GAM

Tech layoffs

An interesting unanswered question is how to interpret the significant tech layoffs underway. Should they be viewed as an idiosyncratic issue affecting only the tech sector (the wrong bet on digital vs brick-and-mortar demand post-pandemic, stricter digital privacy rules), perhaps exacerbated by the flighty nature of venture-capital funding as credit conditions tighten globally? Or should they be viewed instead as a canary in the coal mine for the broader economy?

What is clear is that tech layoffs are significant and continuing. Layoffs.fyi estimates that 979 tech companies have now laid off workers in 2022. More than 151,600 workers have been rendered unemployed. The trend is actually a bit blurry: there were fairly large layoffs over the summer, then a lull in September and October, followed by a large spike in November. December is tracking considerably more mildly than November, though the month is not yet over and companies are presumably loathe to shed employees over the holidays.

This is not just a story of consumers having already upgraded their computers over the pandemic, leading to a lull later. After all, these days most tech companies are not so much firms selling technology as companies using technology to advance their interests in a diverse range of sectors. Analyzing the layoffs by sector, –the job losses are fairly broad. The largest tech layoffs have come in the retail and consumer sectors, followed by transportation, finance, healthcare, food and real estate. Given this, it would appear that the tech layoffs are telling us something about the health of the broader economy, and signaling weakness to come.

Overall economy-wide layoffs – led by the tech sector, of course – are now accelerating rapidly (see next chart), even if the monthly employment figures through November continue to insist that hiring is still outpacing these layoffs.

U.S. job cuts announcements have picked up speed

U.S. job cuts announcements have picked up speed

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

More good inflation news

The inflation news was mostly good for a second straight month – a happy reversal after more than 18 months of relentless upside inflation surprises. Consistent with this, global inflation surprises are becoming substantially less positive (see next chart). We already sport below-consensus inflation forecasts for 2023.

Global inflation surprises are still positive, but falling

Global inflation surprises are still positive, but falling

As of November 2022. Source: Citigroup, Bloomberg, RBC GAM

The U.S. Consumer Price Index (CPI) print for November was embraced by both stocks and bonds as inflation was not only below expectations, but was tame in an absolute sense. Overall inflation rose by just 0.1% month-over-month (MoM), with core inflation up by 0.2%. Annual inflation is now down to 7.1% year-over-year (YoY), from 7.7% the prior month and a peak of 9.1% in July (see next chart).  This was a third soft month for inflation out of the past five, and the first time two such months have been strung in a row.

Housing, food, energy and new motor vehicles are driving U.S. inflation

Housing, food, energy and new motor vehicles are driving U.S. inflation

As of November 2022. Source: BLS, Macrobond, RBC GAM

Lower energy prices helped, as did the ongoing reversal in used vehicle prices, air fare and health care costs. Housing costs were by far the largest upward driver of inflation in the latest month (see next chart). However, as we have detailed in prior reports, this is a famously lagged indicator. We can speak with a high level of confidence that shelter costs should begin to reverse by the middle of 2023 as falling rent and home prices map onto the CPI.

Housing contributed most to latest U.S. monthly inflation rate

Housing contributed most to latest U.S. monthly inflation rate

As of November 2022. Source: BLS, Macrobond, RBC GAM

The U.S. Federal Reserve has remained reluctant to celebrate inflation’s tentative decline for two reasons:

  1. Annual inflation has only made a quarter of the journey back to a normal reading.
  2. Various measures of inflation breadth and of core inflation are still much too elevated.

But both are at least starting to cooperate. Inflation breadth has clearly begun to narrow over the past two months (see next chart) and most metrics of core inflation are now ebbing (see subsequent chart).

Inflation in the U.S. remains quite broad

Inflation in the U.S. remains quite broad

As of November 2022. Share of Consumer Price Index (CPI) components with year-over-year % change falling within the ranges specified. Source: Haver Analytics, RBC GAM

U.S. core inflation metrics are improving

U.S. core inflation metrics are improving

Personal Consumption Expenditures (PCE) deflator as of October 2022, CPI measures as of November 2022. Source: Macrobond, RBC GAM

In other U.S. price figures for November, import prices fell by 0.6% MoM. The producer price index rose by a fairly mild 0.3% MoM. These shifts portend tamer consumer prices in the coming months.

It is fair to worry that the rate of improvement for U.S. inflation could slow in the coming months now that the U.S. dollar has given up some of its prior strength. This may be the case, though the effect will likely be fairly small. The weaker U.S. dollar should also help other countries get closer to their own inflation targets.

As we had speculated, U.K. and Eurozone inflation finally began to decelerate in November. British CPI fell from 11.1% to 10.7% YOY – a below consensus outcome. The challenge is greater in Europe and the U.K. given high natural gas prices, but those have now partially unwound their earlier gains. However, the implications for consumer prices remain complicated. Consumers were shielded from much of the initial jump and some of that armour is now being incrementally removed.

Real-time inflation cross-check

We now enjoy two sources for real-time inflation data. Each provider trawls the internet, extracting price points from online vendors and other online data providers. The approach is imperfect: not everything is sold or quantified on the internet, and online pricing can be different than that found in brick-and-mortar establishments.

But there is nevertheless more signal than noise in the real-time data. Both successfully anticipated the turn lower in CPI data last summer, several weeks to months in advance. Both measures have steadily declined since, arguing that inflation can continue to ebb in the next CPI report. With the caveat that both have tended to underestimate the absolute level of inflation over the past year, one now estimates an inflation rate of around 6% YoY while the other points to a sub-5% rate.

Supply chain improvement continues

Supply chain distortions continue to fade, as evidenced by the ongoing sharp decline in shipping costs. These costs are now nearly back to historically normal rates (see next chart).

Shipping costs are falling further

Shipping costs are falling further

As of the week ending 12/08/2022. Source: Drewry Supply Chain Advisors, RBC GAM

The Southern Californian ports of Los Angeles and Long Beach have reported imports are down around a quarter from year-ago levels. This presumably reflects weaker demand in part, but it is also a function of a shift in importing from the U.S. west coast to the east coast. In fact, the Port of New York and New Jersey has just claimed the mantle of America’s busiest container port from Los Angeles for the first time in more than 20 years. Some of the shift could presumably unwind now that the west coast ports are unstuck. But some also reflects an incremental shift from production in China to other Asian locations. Those other locations are apparently more inclined to transit American-bound goods through the Suez Canal to the east coast.

Shelter deflation

Shelter costs continue to rise robustly in the U.S. CPI.  In fact, the housing component contributed more to inflation in November than the overall inflation rate actually rose (a sign that other components were actually becoming cheaper).

But this is purely the result of a lag. Actual home prices are now flat to falling, as are rental rates (see next chart). If this were being immediately reflected in the CPI, core inflation would already be in the realm of 2%. Fed Chair Powell said recently that the central bank knows these changes are in the pipeline and coming: the drop in market rents “portends a significant deceleration in CPI rent measures.”

The CPI methodology captures dwelling costs with a lag, when people actively encounter such changes (when they buy a new home or renew their lease). It will take until the middle of 2023 before the softness in shelter costs is visible in the CPI.

Surge in U.S. rents eases

Surge in U.S. rents eases

As of November 2022. Source: Zillow, Macrobond, RBC GAM

Car prices reverse

Used car prices experienced an extreme price increase during the pandemic. This is now reversing (see next chart). Car selection is still limited and so a complete return to normality is unlikely in the short run. However, there are few reasons why car prices cannot continue to retreat in the direction of prior norms, especially as borrowing costs rise. For used vehicles, that could mean as much as a 40% further decline.

Wholesale used car prices have retreated from peak, but remain elevated

Wholesale used car prices have retreated from peak, but remain elevated

CPI Used Cars & Trucks Index as of November 2022, Manheim Used Vehicle Value Index as of December 2022. Shaded area represents recession. Source: BLS, Manheim, Consulting, Macrobond, RBC GAM

Wage-price spiral concerns

Labour markets remain strong and wage growth is robust. As other inflation pressures fade, there is some concern that brisk wage growth could turn into a wage-price spiral, preventing inflation from returning to target. But this risk is probably overstated. Wage growth may slow the inflation normalization process slightly, but is unlikely to prevent it altogether. There are several reasons why:

  1. A likely recession in 2023 should make short work of labour market strength and rapid wage growth.
  2. Although nominal wage growth zips along at 5-6% per annum, inflation-adjusted wage growth is still profoundly negative (see next chart). Wages can hardly be driving inflation if they are significantly underperforming it.

Real wage growth in U.S. has dropped significantly

Real wage growth in U.S. has dropped significantly

As of November 2022. Average hourly earnings of production and non-supervisory employees. Source: BLS, Macrobond, RBC GAM

  1. The relationship between inflation and wages in recent decades is not supportive of a wage-price spiral. Prices have spurred wages, but wages show little evidence of driving prices. A 2020 paper by the New York Fed found that U.S. manufacturing firms did not usually raise their prices in response to wage increases. This likely reflects a more globalized economy in which workers and firm must compete with labour and companies in other jurisdictions, and greater company-level concentration in which firms possess more control over their costs.
  2. The recent increase in worker clout should not be exaggerated. Some relates to a cyclically tight labour market that won’t last forever. Some may represent structural changes, but this is fairly small so far. For instance, unionization has tentatively stopped declining in Canada and the U.S. – a notable development – but it is not really in significant ascent. Canada’s unionization rate rose by a mere 0.1 percentage point (to 28.7%) from 2019 to 2022. In the U.S., the rate held steady at 10.3% over the same time period. Further, most wage settlements continue to significantly lag the annual rate of inflation.

A new, higher inflation target?

There has been an up-swell of chatter about central banks potentially opting to officially target higher inflation rates. The thinking goes that instead of targeting the standard 2% inflation rate, they might choose 3-4% instead. We are dubious.

A higher inflation target admittedly has some theoretical appeal:

  • Central banks would have less hard work to do in the coming months if they are only 3 percentage points from their target instead of 5 percentage points.
  • A higher inflation target would also reduce the risk of central banks getting stuck in deflation and/or bumping into the zero lower bound when disaster strikes.
  • The combination of de-globalization, the rising clout of workers and climate change will make it incrementally harder to hold inflation down to 2.0% in the future. This is in contrast to the past 30 years, when the opposite trends prevailed. Interest rates may have to be slightly higher than otherwise to achieve this, resulting in a slight economic sacrifice.

We actually do believe inflation could run incrementally hotter than the standard 2% target over the long run, largely due to the reasons articulated in the final bullet above. But we merely look for a slightly higher average inflation rate of 2.25% or 2.5%, not 3-4%. Further, this is unlikely to be due to a higher explicit target. It is more likely that we look back in a few decades and realize that inflation spent slightly more time above 2% than below it, much as the “miss” over the decade between the global financial crisis and the pandemic was to the downside despite a steady 2% inflation target throughout.

A significantly higher inflation target would probably be a mistake, for several reasons:

  • The timing would actually be poor for a sudden pivot toward a higher inflation target, however well-intentioned. Central banks are fighting to restore their credibility and would immediately lose quite a lot of it if they abruptly declared they weren’t going to bother to return inflation all the way to 2%.
  • Every time the monetary system comes under stress, there is a clamour to change the inflation-targeting framework. This happened during the global financial crisis in 2008-2009 and it is happening again today during a period of excessive inflation. Determining whether such changes are actually appropriate would ideally wait until the stress abates, the right lessons are learned and clearer thinking can prevail.
  • The main argument for a higher inflation target as presented during the global financial crisis was that it would allow for an additional buffer against the threat of deflation, and provide more room for central banks to cut their policy rate before bumping into the zero lower bound. Those particular arguments seem much less persuasive today given that the threat of sustained deflation seems quite low and the zero lower bound is not only quite distant, but less likely to revisited in the future given the policy errors associated with the last visit.
  • In Canada, the government carefully considered the pros and cons of lifting its inflation target in 2016, but ultimately opted not to because the advantages were at least matched by the disadvantages.
  • Emerging market central banks have spent the past few decades working hard to lower their inflation rates. They clearly see an advantage in a lower inflation target.
  • From an economic standpoint, a higher inflation rate creates additional distortions in the economy, including greater menu and shoe-leather costs. People can forget about inflation when it is a mild 2%, but this becomes harder to do as inflation rises from there. In turn, inflation expectations could become less anchored and workers might start to demand their wages be indexed to inflation – a problematic linkage.
  • From an investment perspective, the effective tax rate on capital gains would rise significantly. Capital gains taxes are charged on nominal income, not real income. Shifting the inflation target from 2% to 4% would effectively reduce the real after-tax return by 0.5 percentage point – a significant sum when investors only receive a percentage point or two of real after-tax returns.
  • The act of changing from one inflation target to another would also bring large, chaotic consequences. Borrowing rates would have to rise by two percentage points, rewarding those with locked-in loans and punishing those who had made the loans. The effect on banks, insurers, pension funds and the mortgage market would all be significant and potentially problematic. Stock market valuations would change to reflect altered discount rates. Pre-existing business plans and wage contracts would both be thrown into disarray.

The bottom line is it would be unwise and quite surprising if major central banks raised their inflation targets any time soon, despite some attractive arguments.

Central bank decisions

Central banks have been busy cramming in their final rate decisions of the year before the holiday break. At least 10 central banks rendered a verdict over the past week. We focus on four of these. As it happens, all yielded a 50 basis point rate increase, though the circumstances differed somewhat.

U.S. Federal Reserve

The U.S. Federal Reserve raised the fed funds rate by 50 basis points, from 3.75-4.00% to 4.25-4.50% on December 14. The Fed repeated its message that “ongoing” rate hikes will likely be appropriate, though Chair Powell did indicate during the accompanying press conference that the Fed can likely proceed at a decelerating pace, in so doing feeling its way to the right peak rate. Indeed, this decision represented a deceleration for the Fed, which slowed its pace of tightening from the prior gallop of 75 basis-point rate increases.

Powell acknowledged that inflation has shown “a welcome reduction,” but the Fed’s inflation forecast for 2023 was nevertheless nudged slightly higher even as the growth outlook was cut significantly, to the edge of a recession. The central bank’s dot plots now show a peak policy rate of 5.1% (we forecast a similar 5.0%). The Fed nevertheless believes that the neutral fed funds rate is in the realm of 2.5% – less than half that peak, signaling later rate cuts.

Bank of Canada

The Bank of Canada also raised its overnight rate by 50 basis points, to 4.25%. This was a minor meeting for the Bank, so there were no formal updates to the economic or inflation outlook. But the governing council’s forward-looking statement was quite important. In its October comment, it stated that the group “expects that the policy interest rate will need to rise further.” That shifted in December, when the group stated it “will be considering whether the policy interest rate needs to rise further.” The best guess remains that it will, but this is another sign that monetary policy in Canada is getting quite close to its peak setting.


The European Central Bank (ECB) lifted its deposit rate by 50 basis points, from 1.5% to 2.0%. This is already the highest setting since 2008. It came with hawkish language, including “inflation remains far too high” and “interest rates will still have to rise significantly.” The ECB clearly has further work to do.

Meanwhile, the Bank of England also raised its policy rate by 50 basis points, to 3.5%. The Bank of England landed close to the Bank of Canada in its forward guidance: “further increases … may be required.” The U.K. also continued with its pattern of two-sided dissent. In December, two members preferred to leave the policy rate unchanged at 3.00%, while another preferred to raise the policy rate by a larger 75bps. As with several of the other central banks, the Bank of England appears set to decelerate to a 25-basis-point per decision velocity.

Society in decline?

It is conventional wisdom to say that western society is in decline, with the U.S. arguably leading the way. Bolstering this view, political polarization has soared, measures of trust are down and social capital is declining as social bonds weaken alongside diminished participation in clubs, groups and religious orders.

U.S. life expectancy recently fell, in part due to drug overdose deaths that surged during the pandemic after a long, gradual climb (see next chart). Explanations for rising overdose deaths include:

  • a sense of hopelessness during pandemic lockdowns
  • a slower-than-normal rate of rising prosperity over the past few decades
  • rising rates of depression
  • the over-prescription of legal pain medication
  • increased opioid use
  • a new breed of more powerful and deadly drugs such as Fentanyl
  • possibly even the reduced severity of drug laws in recent years.

U.S. overdose deaths have surged

U.S. overdose deaths have surged

As of 2021. Data is reported provisional counts for the number of deaths received and processed for the 12-month period ending December 2021. Source: National Institute on Drug Abuse, Centers for Disease Control and Prevention, RBC GAM

None of this is good. However, the story is considerably more mixed than commonly imagined. For instance, at the national level, homelessness has only edged slightly higher in recent years and remains considerably lower than the level of 15 years ago.

U.S. homelessness has edged higher – but still lower than 15 years ago

U.S. U.S. homelessness has edged higher – but still lower than 15 years ago

As of 2020. Source: U.S. Department of Housing and Urban Development, RBC GAM

This admittedly doesn’t capture the entire story. Homelessness in the largest U.S. cities has increased significantly (see next chart). It would appear that people experiencing homelessness have flocked to the biggest cities, perhaps because those have the most expansive support services available. The homeless population of New York City (NYC) has increased more than threefold over the past 40 years. It has increased by more than 50% over the past decade alone.

New York City’s homeless population has increased more than threefold over the past four decades

New York City’s homeless population has increased more than threefold over the past four decades

As of September 2022. Data refers to the number of people in municipal shelters. Source: Coalition for the Homeless Advocacy Department, NYC Department of Homeless Services, RBC GAM

Interestingly, even in NYC homelessness did not actually increase during the pandemic. Or, more precisely, it initially fell as pandemic restrictions made fewer shelter spaces available and has since rebounded to the pre-pandemic level. But the NYC data has to be regarded with caution, as the figures merely capture the number of people in municipal shelters. Those sleeping outdoors or in makeshift shelters are not included.

That means that there may actually have been an increase in homelessness during the pandemic in NYC. However, one could just as easily posit that the increase in the city’s homeless population over the last several decades reflects a rising fraction of the homeless securing shelter beds without there being a parallel rise in overall people experiencing homelessness. This narrative would be consistent with the national figures, which include all types of homelessness.

Still, the point is that, nationally, homelessness has not actually risen in a major way over time. A small victory.

With regard to family structure, the ratio of two-parent households to single-parent households declined sharply over the 1960s, 1970s and 1980s (see next chart) as divorce rates rose (see subsequent chart).

Two-parent households have declined versus single-parent households

Two-parent households have declined versus single-parent households

As of 2022. Source: U.S. Census Bureau, BLS, RBC GAM

U.S. divorce rate has declined over the past 40 years

U.S. divorce rate has declined over the past 40 years

As of 2020. Source: U.S. Centers for Disease Control and Prevention, Our World in Data, RBC GAM

However, since then, the trends have improved substantially. The divorce rate then fell for four decades, to the point that it was less than half the late 1970s peak level when the pandemic struck. During the pandemic, the divorce rate has fallen even further, to the point that it is approaching 1950s-1960s lows.

For its part, the ratio of two-parent to single-parent households has been largely stable over the past three decades. It has even improved slightly over the past decade.

What about crime and punishment? Confusingly, the U.S. incarceration and crime rates have actually had very little relationship to one another for some time. The rate at which people were sent to prison soared from the mid-1980s through to around 2010 – increasing by more than seven times on a population-adjusted basis. This was less because of rising crime (which was actually falling steadily from the early 1990s) and more because of stricter laws and aggressive enforcement (refer to the next two charts).

U.S. incarceration rate dropped sharply during pandemic

U.S. incarceration rate dropped sharply during pandemic

As of 2020. Source: Prison Policy Initiative, Bureau of Justice Statistics, RBC GAM

U.S. crime rates are rising

U.S. crime rates are rising

As of 2020. Source: Federal Bureau of Investigation, RBC GAM

Of the two, the crime rate is clearly the more important gauge of society’s ills. Again, the crime rate actually fell quite significantly from the mid-1980s through to fairly recently. This is a story of success. The pandemic (possibly plus more cautious policing) then unwound some of those gains. Violent crimes in U.S. cities rose by 17% in 2021, and property crimes rose by 10%.

These are large increases. However, this only brings the violent crime rate back to a late 1990 level, while the property crime rate returns to levels of less than a decade ago. At the time, these levels were not thought of as particularly high.

This investigation is hardly a complete reckoning for how society is faring. For instance, there is more good news in the fact that the rate of U.S. educational attainment continues to leap higher, despite skyrocketing college bills. On the other hand, the number of people on disability has soared over time, helping to explain a structurally declining labour force participation rate.

Perhaps the most useful conclusion is simply that society is decaying less than conventionally thought. Rising polarization, overdose deaths and people on disability are all negative trends. But homelessness isn’t actually getting worse, the divorce rate is falling sharply, crime is still lower than in decades past and Americans continue to become more educated.

Canadian immigration

Canada is famously an immigrant-friendly nation. Almost 25% of the population is born elsewhere. The U.S. figure is just 14%. Canada is targeting a further acceleration in the future, with 500,000 new immigrants per year planned starting in 2025. That’s around 40% more than the pre-pandemic average.

Canada was already quite close to that figure in 2021 (+493,000), though this was in large part due to an unrelated plan to ‘make up’ for underwhelming immigration during the pandemic. For context, 284,000 people immigrated into Canada in 2019 – a ‘normal’ year.

But all of this actually understates the true flow of people (and workers) into Canada. Many also enter as temporary residents, often as international students or under a temporary foreign worker program (see next chart). Most of these temporary workers eventually leave. However, the programs have proven so popular that in practice there has been a net increase every year but two out of the past 24 years as even more people replace those who have left. The number of temporary residents was already surging prior the pandemic, but this went to an entirely new level in 2021 with a startling 205,000 additional people.

Canadian net immigration surged during the pandemic

Canadian net immigration surged during the pandemic

As of 2021. Source: Statistics Canada, RBC GAM, Macrobond

That means the true population increase in Canada (after subtracting a small amount of emigration) was a colossal 658,000 people in 2021. That’s 48% more than any other year in the past three decades.

Should that trend continue, Canada could actually be welcoming around 700,000 new people per year by 2025. In practice, one imagines that the flow of temporary residents could slow after 2021 made up for a net decline in 2020. On the other hand, Canadian businesses have struggled to attract Canadians to low-skilled jobs, and so they have been happy to recruit temporary foreign workers for such roles, all the more so because such workers cannot easily jump from company to company.

The rise in temporary foreign workers is not a new trend, but it needs to be factored into any analysis of Canada’s immigration trends and plan, whereas it frequently isn’t. Faster population growth is positive for GDP growth. At the same time, temporary foreign workers, especially those earning low wages, may be depressing the wages of low-skilled domestic workers – an undesirable side-effect.

Happy Holidays and Happy New Year!

-With contributions from Vivien Lee, Vanessa Adams and Aaron Ma

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


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