Hello and welcome to our latest video MacroMemo. As usual there’s a lot to talk about these days.

And we’ll begin with a discussion, of course, of high inflation, but high inflation in the context of what that means in terms of recession risk. We’ll then talk a little bit about consumer attitudes toward inflation. How consumers are changing their behaviour due to high inflation and what that means.

We’ll talk about labour market tightness. It’s tighter than it looks.

We’ll talk about the business cycle, which continues to advance. And we’ll draw some parallels to the late 1940s. There are a lot of similarities to the economic experience then and the one today.

We’ll talk about economic weakness. We’re seeing some softening in the U.S. and quite a bit of weakness in China, which has been a recent thesis of ours.

And then lastly, we’ll spend a moment on COVID infections and how all of that is playing out.

Let’s start with infections—pardon me—let’s start with inflation and recessions. And on that front, there are any number of recession models swirling around right now, and giving mixed billings. You can say yield curve models themselves are saying maybe, some are saying yes, some are saying no.

We could say that oil shock models are saying maybe. We’ve seen a big jump in oil prices. Often that triggers recession. Has it been big enough; it’s not quite clear.

The hiking cycle histories say the risk of recession is quite high. Most rate hiking cycles do end in recession. We’re in one of those now.

And then inflation can tell us something all by itself. And of course, inflation is still extremely high right now. We think it’s going to take some time to work its way back down.

And actually, when you look at the historical charts, any time inflation runs up as profoundly as this, as quickly as this, a recession has resulted in the U.S. And so recession risks would seem to be quite high on the basis of what inflation is saying right now. It’s another tick in the yes column. And indeed, we do think the risk of recession is high over the next 18 months.

The good news in this is that, after those experiences, after the recessions that resulted from high inflation, inflation then fell sharply thereafter, which is actually the most important goal for the next few years to make sure this high inflation doesn’t get stuck at high levels.

Let’s talk now about consumer attitudes toward inflation. And so maybe the big observation here is just that there are big differences in the consumer attitudes toward inflation now versus the late 1970s, which is another useful time to parallel with today.

And so in the late 1970s, people saw high inflation and their conclusion was this is, therefore, a good time to buy, which maybe feels counterintuitive but the idea was they fully expected prices to be even higher a year later. And so they wanted to buy now as opposed to delaying their buying even though things were much more expensive than the year or two before that. Prices were expected to keep rising quickly.

Today, the attitude is exactly the opposite. People are saying this is not a good time to buy because prices are higher than they were a few years ago, and implicitly on the expectation that prices don’t keep rising at a rapid rate going forward. So consumers don’t have the mindset that inflation stays high. That’s useful. It actually reduces the risk of inflation staying high, and so we’ll take anything we can get on that front. That’s a useful outcome.

The small negative though—or maybe not-so-small negative—is of course to the extent consumers don’t think it’s a good time to spend now. That could mean less consumer spending growth in the future. That could mean some economic softness.

Let’s turn now to labour market tightness. And so, I guess maybe the story here is one in which the labour market is reputed to be looser than it looks, but actually, we think it’s tighter than it looks. And so let me explain that. The standard means of looking at the labour market is just through the unemployment rate. And so, unemployment rates have fallen. They are either at or near pre-pandemic levels, or in Canada’s case, at generational lows, but they show a strong labour market, a tight labour market.

People, though, can quibble with that and say, well actually the level of employment, particularly for the U.S., is still short of where it was before the pandemic. There are actually fewer people employed. What’s happened is that some people dropped out of the labour force and so maybe they were exaggerating how tight the labour market is if those people could come back in.

I can’t deny that. But I would say, in the end, my conclusion is actually the opposite, which is, the behaviour of people has changed, seemingly in an enduring way. If we look at the behaviour of workers, we look at the behaviour of employers, they’re acting in a way that suggests this is an extremely tight labour market as opposed to one that’s only fairly tight. And so we can see, for instance, that quits rates—the number of people quitting their jobs, meaning that they have other opportunities, they feel confident about the labour market—that’s well above prior cycle peaks. We can also say that from a company perspective, job openings are around 50% higher than we’ve ever seen before.

This is a supercharged labour market if anything, and again goes some distance towards explaining why inflation is so high right now. It’s a really tight labour market. Don’t get too hung up on the fact that employment isn’t quite as high as it was before the pandemic.

Okay. A word from me on the business cycle. And so the business cycle seems to be advancing, which has been a theme for some time. It’s still giving mid-cycle readings, which by itself is a fairly benign thing, but we’re getting a lot of forward movement beneath the surface.

And so, in the latest scorecard reading, the early-cycle score shrank a lot. So mid-cycle was the strongest score, but early-cycle shrank a lot, whereas previously, it had given mid-cycle a run for its money. The late-cycle score increased significantly. The end-of-cycle score increased somewhat. The recession score increased a little bit. And so we can certainly say the cycle is still moving forward quite quickly. And actually, if you were to tally up the number of claims to late-cycle, to end-of-cycle, to recession, collectively, those are almost as high as the mid-cycle claims.

So I’m starting to twist numbers a little bit here. The main point is that it’s still saying mid-cycle, but it’s showing a lot of forward movement. It wouldn’t be a surprise if we were getting a late-cycle reading in a quarter or two.

We’ve been saying for the last couple of years this is probably going to be a shorter business cycle than the prior few, maybe something like five years instead of a ten-year cycle. I guess we should just flag the chance this could just be a three or four-year cycle as well. There’s nothing precise about claiming it’s five years. The real story is one in which it would make sense if it was a shorter cycle, given the rate at which we’re advancing through the different phases.

Let’s talk now about parallels to the late 1940s. And so, first of all, it’s been a bit of a sport to compare the current experience to different time periods. People compare it to 1994, to the extent that was a period of aggressive and sharp rate hiking, and so we’re getting that now. There are some parallels to that. Of course, the 1970s are ripe for comparison to the extent it was the period of high inflation. Here we are with high inflation.

But I think the late 1940s are underappreciated as a useful parallel because there are a lot of similarities. And so, in both cases, then and now, we’ve had an economic boom after a shock, after an artificial shock. In the 1940s case, it was after World War II ended. And in this case, of course, it’s after the pandemic.

In both cases, pent-up demand was unleashed. People were looking to spend after years of constraint. Simultaneously, supply chain issues were significant in the late 1940s as manufacturing was retooled from military to civilian purposes; and today, as factories sometimes struggle to get going under lockdowns and given altered demand preferences. In both cases, inflation surged. In both cases, central banks hiked.

And so from there, we have to say, what might happen next today? And so we can look to what then happened in the late 1940s, and we can say that they did suffer a recession. It was a pretty mild recession, though. And so that would be a decent outcome this time as well, I suppose. Inflation was vanquished, which is key. So that’s a positive outcome.

The stock market did fall by 17% from peak to trough, which actually isn’t that different than the decline we’ve already seen today. Markets are forward-looking. Markets know that the economic outlook isn’t as good as it once was. So markets fell by 17%.

Interestingly, the market recovered back to prior peaks within about six months after the recession was over, and so it was quite a quick rebound. Hard to say whether that’s exactly how things play out this time on a number of fronts, but nevertheless, it’s one quite viable path forward from here.

To be clear, this is not a perfect analogy. The late 1940s weren’t exactly the same situation as now. You can argue, in fact, that wars tend to be inflationary, pandemics tend to be deflationary. There are some fundamental differences as well. But I do think that episode nicely captures the artificiality of the changes in supply and demand; something very similar going on today. And so we should pay some heed to that. And I would say not a bad set of outcomes in the late 1940s in terms of how it all wrapped up.

Okay. Economic weakness, that has been a theme for a while. And so we’re seeing some evidence of U.S. economic data softening, though not to an extreme degree. We’re getting ISM indices that are a bit less high; we’re getting the New York Fed’s Weekly Economic Index that’s now falling after a couple of years of rising, with the OECD’s high-frequency economic indicator also rolling a little bit over. So we’re seeing a decelerating U.S. economy, is the way to put it.

And then consistent with comments in prior Video Macro Memos, I can say that the Chinese economy is very much suffering. And this is on the basis of that zero-tolerance policy, cities being fully locked down. And so Chinese retail sales, as an example, are now down 3.5% on the year versus a year ago. And so that’s unusual for a country that’s normally growing at 9% and 10% and 11% on a nominal basis. And so that is quite a sharp drop and suggests some suffering. Subway traffic is down, traffic congestion is down. And so, the Chinese economy is doing poorly.

I guess I would say maybe a silver lining, if there is one, is just that at some point, China’s going to be able to reopen. When that happens, there will be quite a powerful rebound in China, with some relevance to the global economy, I think.

And there’s a chance—it’s hard to say when this happens, it could be in the next few months, it might not be until next year—there’s a chance it could happen at a very helpful moment for the global economy. We could have a global economy that’s stumbling and China suddenly revitalizing in a way that provides some support to the global economy.

So the timing could work out well. There is an upside eventually, but for the moment, China is quite weak.

And so let’s talk now about housing and housing risks. And so, clearly, in the context of rising rates and with central banks raising their policy rates and the U.S. Federal Reserve having just added 50 basis points to its own policy rate quite recently, as I record this, with significantly more to come, obviously, this is challenging for housing.

Housing is the most interest rate-sensitive sector out there. It’s the thing you would expect to soften in a rate-hiking cycle. So we should expect that. This is happening, by the way, alongside what had been a deterioration of affordability over the prior few years because home prices ran up so much across the pandemic, given the prospect of an economic slowdown, which might reduce incomes and appetite for spending on that front. And so we’re expecting cooler housing markets in a lot of places; as this plays out, something like flattish home prices in the U.S. context and so on.

Canada may be more vulnerable than most, though. And so that would be because Canada experienced a bigger run up in prices, because Canada had bigger affordability problems even before this pandemic hit, and those have grown even larger since. Canada’s more exposed to rising rates because the five-year term is the most popular, so a significant number of people do cycle into higher rates during the amortization period of their mortgage, unlike in the U.S., which uses 30-year terms, which tend to match the amortization period.

There’s also been some regulatory tightening in Canada, so rules making it harder for foreign buyers and for speculators and for people to buy second properties and so on. And so, on a number of fronts, it would make sense for the Canadian housing outcome to be worse.

There is an offset in the form of strong immigration. There is an offset in the form of a pretty strong testing for existing homeowners, making sure they were in a position to handle rising rates, and so that’s a helpful thing. But still, pretty big headwinds for Canadian housing. Hard to predict, in fact, impossible to predict with anything approaching precision. Homebuyers’ psychology can be a fickle thing, can move one way or the other quite abruptly and isn’t really subject to precise analysis. I think it’s best to think in terms of scenarios.

And so I think there is a soft landing economic scenario, a positive scenario which home prices do get to inch their way higher over the next 18 months. Maybe they rise 5% or something, but still, a pretty modest gain by recent standards.

I think the base-case scenario is something like a home price decline that might be in the realm of minus 10%. And so a decline more likely than not, but not an extravagant decline.

And then, if you want to articulate a negative scenario, there are scenarios in which Canadian home prices have to fall by 25% or something like that. And that would more or less restore affordability to a more reasonable level. It would unwind a lot of the excesses of the last few years, but of course, it would then do some pretty serious economic damage as well. But again, the base case scenario would unwind about half the affordability gap in Canada. So bottom line, we are assuming housing is a weaker in a lot of places, maybe particularly so in Canada, potentially to the point of nominal house prices actually falling somewhat.

Let me finish very briefly on the COVID file. And so on that front, I’ll just say that, globally, COVID numbers are happily declining in general. The developed world, for the most part, has seemingly worked its way past the Omicron and the BA.2 mini wave. The U.S. is maybe peaking right now, but nevertheless, isn’t experiencing too much suffering at the economic level as a result of this.

As we look forward, we are seeing some places with additional waves and so, of course, China is one. South Africa, which has been a bellwether, is another, and it may be the BA.4 and the BA.5 and the XE subvariants. And so we continue to get these new subvariants, but I think the main point would be one in which these new subvariants are only a little bit more contagious than the old ones. They don’t seem to better at escaping vaccines or escaping immunity. They don’t seem to be more dangerous in a general sense.

And so I would say we’ve come off a little bit lucky maybe recently in that we’re not continuing to see the variants just leap forward in terms of their aggressiveness from one month to the next. And so we’re continuing to assume we just have to live with a couple of seasonal waves a year or COVID, but it doesn’t do too much direct economic damage.

Okay. I will stop there and say thanks very much for your time, as always. I hope you found this useful and please consider tuning in again next time. Thanks so much.