Hello and welcome to our latest video MacroMemo. There is, of course, lots to cover off. There always is, it seems.

And so this week we’ll talk about high inflation. It remains high. In fact, it continues to rise even further, creating some concern. We’ll talk about what central banks are planning on doing about that, which is to say more than they were previously planning on doing. So quite large rate hikes now happening.

We’ll work our way into the economic data and acknowledge that the hard economic data—the actual economic activity indicators are still holding up fairly well. But forecasts are falling sharply, and confidence measures are falling sharply, perhaps presaging some weakness in the hard economic data.

Recession risks have been quite high for a while. Arguably going up even more as inflation stays high and as central banks look to do even more than before.

And then pivoting a little bit, China. China remains in focus. China was rebounding somewhat economically as of a few weeks ago. Unfortunately, we’re getting a bit of Chinese whiplash right now in the sense that China’s now having to lock down again. And so that’s, of course, bad economic news.

And then lastly, we’ll spend just a moment in the crypto space. Cryptocurrencies have suffered recently, and let’s talk a little bit about what’s going on there and what that means from an investment perspective. Let’s start with inflation. So, inflation still extremely high; still the biggest problem out there in the macro economy. The U.S. recorded its May number and, indeed, it exceeded expectations. What else is new? It was a 1% monthly gain in the Consumer Price Index. That’s the second-biggest single-month gain that we’ve seen since this started heating up in early 2021.

And so that leaves U.S. CPI at 8.6% year over year right now, which is a very high number indeed. Not the highest out there, though. If we look at the UK, it’s now up to 9.0% year over year. It’s even higher as the UK is grappling with Brexit challenges and closer proximity to the war in Russia, in addition to all the sorts of forces that are affecting the U.S. and Canada, and others as well.

And indeed, the UK is something of a leading indicator on a few fronts. Not only is it suffering even more inflation than most, but also, its economy has actually shrunk in each of the last two months. And so, to the extent we expect some weakness in other countries, it’s getting some of that weakness, at least right now. So let’s keep watching the UK as potentially a leading indicator of sorts.

But back to inflation. Inflation is incredibly high. It has a lot of momentum to it now. It has a lot of breadth to it now as well to the extent that a lot of different products are now rising quite quickly, unlike the initial phase when it was a few things that happened to be surging particularly notably. Food prices still moving quite aggressively higher in particular.

I will say though, however, we are seeing some tentative evidence of some things starting to cool. And so, as we mentioned, I believe, a few weeks ago, car prices starting to edge lower after a huge run-up. We think there’s less room for dwelling cost inflation going forward as housing markets start to cool.

We’ve seen base metals come off fairly notably, and that includes the likes of nickel, and aluminum, and copper, and so on. And so that’s taking a little bit of pressure off, and nowhere near the highs that were achieved right after the invasion of Ukraine.

Lumber costs are down as well, as do-it-yourself projects are apparently easing also. And I should also say, natural gas prices still very high, but not as high as they were in the earliest phase of the war in Ukraine; and indeed, despite the fact that Russia is continuing to block access to a handful of European countries.

We think supply chains are getting a bit better. Now that could get interfered with from a seasonal perspective and as China locks down again, so I’m not sure I’ll promise we’ll see a lot more improvement there. But nevertheless, supply chains have been getting a little bit better.

And of course, don’t forget, maybe the most important thing right now is that central banks are raising rates and that’s bad economically. It’s good from an inflation perspective.

And so, to summarize on inflation, inflation’s extremely high. Still seemingly rising at this juncture. I don’t think we’re that far from a peak, though. I think it’ll take quite a while to come down after that. So we’re not talking normal inflation any time soon, but it seems to me a number of forces have turned in a way that perhaps inflation gets a little bit less intense. Perhaps central banks don’t have to do quite as much as they’re currently conveying that they plan to do.

Central banks. That’s the next obvious topic here. And so central banks are certainly tightening with enthusiasm right now. We’ve seen bond yields race higher. The U.S. 10-year yield is now well through the 3% threshold. Inflation, of course, is proving a big motivator as central banks feel obliged to do more as inflation keeps clocking high figures.

And so that monetary restraint is now coming. We’ve seen central banks do some 50 basis-point rate hikes. They’re now talking about taking their policy rates up, not just to the 2-to-3% range, but north of 3%. And in fact, markets are thinking policy rates may end up in the 3.5-to-4% range, at least temporarily, when all of this is done.

It seems central banks may be shifting. In fact, as I record this, the Fed is set to raise rates tomorrow. As you listen to this, that may already have happened. But the point being, the debate is not whether central banks raise rates; the debate isn’t any more whether they raise rates by 25 basis points versus by 50 basis points. The debate now is 50 versus 75 basis points. In fact, the debate maybe is being solved in favour of the 75. It looks like the Fed is set to raise rates by three-quarters of a percentage point in a single go, and some people have even speculated they could go by a percentage point.

And so the point is, they’re moving quite fast. They’re expected now to go, also in Canada, by 75 basis points at the next opportunity. The thinking is the Fed could do another one of those big 75 basis-point hikes in July. The market is thinking there could be big 50 basis-point hikes in the fall. There’s a lot of tightening coming. We’re going from a policy rate of effectively zero not that long ago to one that will be above 3, and markets are increasingly thinking potentially close to 4 by the end of this year, an incredible swing. And so, of course, that does significant economic damage, and hopefully, reigns in inflation, which is the main goal.

Now a little bit further out, I would say, eventually, we’re going to have to be talking about rate cuts. Normally, you talk about that as soon as economies start to weaken. I don’t think that’s the story this time to the extent that central banks need to kill inflation; they’re willing to tolerate some economic weakness.

But just in terms of getting that discussion going, markets are thinking that rate cuts could begin in 2024. Central banks don’t seem to think it happens before 2025. I’d say 2024 is quite reasonable, but I would flag the possibility, if the economy has weakened and if inflation is coming down as we expect, rate cuts could happen as soon as the second half of 2023. But again, 2024 is a reasonable guess as well.

If given the extra luxury of looking even further out, I think I would make the comment that here we are with rates soaring, rising to levels that are, frankly, unfamiliar over the last decade or so. I’m not convinced we’re permanently leaving the era of low interest rates. Clearly, we’re temporarily leaving it, but I’m not sure it’s a permanent thing.

Keep in mind, we’re still in a world of quite challenging demographics. It is still a world of quite high debt loads. Those were some of the more central arguments in terms of why interest rates had to be quite low, and I don’t see that changing. And so I’m assuming interest rates will get to descend eventually off of the levels that they are imminently set to reach. And as much as we shouldn’t think that a 10-year yield of 1% is normal, neither is necessarily a 10-year yield of 3.5 or something like that. I suspect a number in the 2s could be the longer-term normal.

That takes us to the economic data. And so from a forecast perspective, we’re clearly seeing forecasts revised quite sharply downward. The World Bank and the OECD recently cut their outlook for the next few years by multiple percentage points. The private sector consensus outlook is continuing to edge lower from one month to the next.

And our own forecasts have also been sliced lower over the last quarter. We’re now looking, in particular, for quite weak 2023 economic performance. And our numbers are still below the consensus, where they’ve been for most of the last year.

Now for all of that, I can say hard economic data isn’t actually all that bad. In fact, it continues to show ongoing economic growth. U.S. job numbers, Canadian job numbers, other figures broadly consistent with growth, not decline.

But those forecasts I just mentioned are informed by various headwinds that clearly exist. And that includes higher interest rates and high inflation, high oil prices, supply chain problems, China slowdown, and more recently, a collapse in consumer and, to a lesser extent, business confidence. And so it still makes sense to expect quite weak growth, even if we haven’t seen it quite yet.

On the subject of consumer confidence, we’ve seen quite a sharp decline. In fact, the University of Michigan measure in the U.S. is now the weakest it’s been on record going back 50 years.

Curiously, it’s not showing up in weaker consumer spending yet. We see some changes in what people are buying, but not a whole lot of diminishment of the buying itself, but we do expect to see additional weakness down the road.

And it’s a similar story with businesses. Business expectations have now fallen pretty sharply, if not to the extent of consumer expectations. It’s starting to bleed a little bit into CapEx intentions, into hiring intentions. But for the moment, those both remain fine. And so, again, we’re looking for some softness; we’re not really getting it in the hard data just yet.

Recession risks are obviously high in this context. It’s slowing growth. It could be quite challenged growth over the next couple of years. And if anything, that high recession risk is actively rising over the last few weeks, as we’ve dealt with yet another increase in inflation and even more monetary tightening that seems likely to come, and of course, that loss of confidence as well.

And so, recessions are increasingly the most likely scenario, in particular for 2023, particularly for the first half. There’s a Financial Times survey of academic economists that was just released and it found that 70% of them expected the U.S. to be in recession at some juncture over the next year-and-a-half or so. So it is perhaps more likely than not.

I will say it’s not the only scenario. There are soft landing outcomes that are also quite possible, thanks to the economic momentum that was enjoyed going into this year. With a bit of good luck, it’s certainly possible to avoid recession. But you need a pretty snappy improvement in supply chains, you would need a faster-than-expected rebound in China, a sharper drop in energy costs than expected, or just inflation to begin declining with some enthusiasm in the near future.

All of those things are possible, but it does take a bit of good luck to get a few of them clicking all at once. And so again, the recession risk is high. Fortunately, recessions are temporary events, usually followed by a period of brisk growth as the economic damage is undone. It’s worth emphasizing that markets are not unaware of this risk. That’s precisely why stocks and risk assets have been in decline since the beginning of this year as they increasingly price that kind of outcome in.

Further, I think it’s fair to say that any recession could be useful to the extent that it would be helpful in wrangling high inflation down to more tolerable levels, and so permit rising prosperity over the coming decade and coming decades. And so not to say recession would be good, but recession could be necessary to achieve a better long-term outcome. And I guess, again, the main point would be the risk of recession is admittedly quite high right now. A quick word on China. So China had been reopening happily, and we’d seen lockdowns ease in Shanghai, and Beijing seemed to have dodged COVID despite not having locked down, and that was all feeling fairly good. And real-time indicators had begun to rise, including subway traffic.

Unfortunately, we’re now going in the opposite direction. We’ve had some whiplash on this front. So China is back into a lockdown mode, at least for a multimillion region of its population, as it’s encountered more cases. Beijing has just reported an outbreak of 200 cases from 1 individual bar, and it’s experiencing a pitter-patter of other cases as well. And so, China’s zero-tolerance policy is still proving quite tricky, and it’s preventing China from growing very quickly, and preventing China from enjoying much of an economic tailwind. And so China still quite challenged on that front.

And then lastly, let’s talk about cryptocurrencies just briefly. And so, cryptocurrencies certainly not living up to their billing from an investment perspective. They’ve fallen extraordinarily sharply. They’re down—Bitcoin, I should say, is down 60% or so from last fall.

Certainly not alone in that regard. Most financial market assets have done poorly, so it’s not entirely fair to pile on Bitcoin and cryptocurrencies alone. But the decline has been considerably deeper than most, including in so-called stable coins, which are supposed to be stable, and they’ve proven to be unstable at precisely the moment when it was most critical that they be stable.

It’s fair to say that cryptocurrencies have often been advertised as inflation hedges. They’re not doing that; they’re falling into high inflation. They’ve been advertised occasionally as hedges against market volatility. Not proving to be the case; they’re falling sharply. They’ve been advertised as perhaps being hedges against adverse market sentiment, and of course here we are in exactly that situation, and they are collapsing, so they’re not doing that.

They’ve been advertised as being uncorrelated to other asset classes, and so attractive from a portfolio construction perspective, and seemingly not that either. They seem to be highly correlated, in fact, with the riskiest of investments, including profitless tech companies, and meme stocks, and non-fungible tokens, and those sorts of things. And so, I would say not really fitting the purpose for most people in their investment portfolios right now. Now that’s not the final word on the subject. Cryptocurrencies are still fairly young. They have appreciated a lot from their inception despite recent declines. They’re still, I suppose, fair game for speculators. They could yet develop more attractive investment characteristics. But again, they’re not seemingly acting in a way at present that would fit well in a traditional investment portfolio.

Okay. I’ll stop on that glum note. Thanks so much for your time. As always, hope you found this useful and interesting, and hope to talk to you again soon.