Hello, and welcome to our video MacroMemo. In terms of topics we’ll cover, we’ll talk about recession risks and the fact that they are rising and perhaps quite significant over the next few years.

We’ll, of course, touch on the present state of the pandemic. We’ll take a look at the war in Ukraine and speak to developments there. We’ll also talk about inflation, which remains extremely hot. We’ll talk about the breadth of inflation and whether inflation might be a little different over the long run as well. We’ll spend a moment on the great resignation, which has been quite a theme and a catchphrase over the last few years, and just what that entails and what it means going forward. And lastly, we’ll look at central banks and what they’re up to. And, of course, they’re very vigorously raising rates right now.

Let’s start with recession risk. And so we’ve been saying now for several months that the recession risk over the coming year is elevated to perhaps in the realm of a 30% risk of recession in North America; perhaps in the realm of a 40% risk in Europe. And so those are three or four times higher than normal, so quite significant, though not the base case or the default outcome for the coming year.

The recession risk is, if anything, rising, as rate hikes become seemingly ever more aggressive, as inflation remains not just high but higher, and as China now slows down significantly on pandemic problems. And so the risk is quite significant.

I think, though, the more interesting question and maybe the new observation from us is with regard to the subsequent year, to year 2, or perhaps even you could say the outlook over the next couple of years as opposed to just the next year. Normally, actually, you get a recession after rate hikes in the second year, not the first year, and so that second year is quite important.

And so we can say a number of reasons why the recession risk is ultimately high. And so, one would just be that, historically, if you look at past—in this case, past U.S. tightening cycles by the central bank over the last 70 or so years, dating back to World War II, 8 of the 11 tightening cycles have ended in recessions. So it’s unusual, actually, for significant rate hiking to avoid recessions. That’s sort of the starting observation.

But on top of that, we happen to be in a mode right now where central banks are being unusually aggressive. They were late to start tightening. They need to go further perhaps than usual. They’re responding to inflation more than to growth. And so that means we’re used to, over the past few recessions or near recessions, the central bank starts cutting rates and delivers support. And this time round, that might not happen to the extent that the focus will be on taming inflation, even if it means allowing the economy to be quite soft for a period of time. So the Fed put, or the central bank put, as it’s called, may not exist.

Simultaneously, commodity prices have risen. And so when you see oil prices up by something like 50% relative to the average level of the prior year, that’s also historically associated with recessions.

So I guess the point would be we have a number of quite important headwinds here. They do speak to an elevated recession risk. If given the luxury of talking over the next two years, say, instead of just the year, it probably is more than a 50% chance of recession over that two-year period of time. And so that’s significant. We need to be aware of that.

Recession can be avoided. There are absolutely scenarios in which soft landings can be achieved. That would be the best case outcome. But you need a lot of things to go right for that to happen. You need supply chains to significantly fix themselves and for commodity prices to settle down, and ideally, for the pandemic to be resolved in a neat and tidy way. And so, those things can happen. In fact, many of them may well happen, but we need almost all of those to happen, and so it’s far from a certainty.

I will say, though, that we need to recognize, recession isn’t necessarily the worst thing that can happen. In fact, in some ways, as much as the best-case scenario is a soft landing and growth continues and inflation settles, maybe the second-best scenario is a recession, but one that successfully tames inflation in a way that sets us up for another generation of low inflation. Markets could actually take fairly well, fairly constructively to that outcome that is a good outcome, because the key goal right now is to get inflation back down and not to compromise the prosperity growth that we’d otherwise anticipate for the next generation.

Let’s move to the pandemic now and I’ll be brief on this front. And so I suppose the comment would just be that this BA.2 subvariant wave is the dominant entity right now. It has already come and largely gone for Europe, and so we can size the wave on that basis. And it seems not to have been quite as problematic as Omicron; much less problematic from an economic perspective, to be sure.

Canadian infections, perhaps now starting to fall already, so maybe Canada beginning to improve as well. The U.S. numbers are still getting worse. But again, I think that the proper thesis is that, for the developed world at a minimum, indeed, for most countries, this wave is proving less consequential from an economic and a financial market standpoint.

China is the exception to that, though. And so China persists in its zero-tolerance policy. It all but fully locked down Shanghai. It now looks as though it might have to do the same thing with Beijing. And I would just say, my sense is the genie is out of the bottle for China. It’s going to be very hard to keep COVID at zero in China, given how contagious these new variants are.

And so, as a result of the economic damage that comes from these lockdowns and the potential for a series of them, we have again downgraded our Chinese growth outlook. We’re now looking for just 4.4% Chinese growth in 2022. That’s a little less than we had previously forecast, but fairly substantially less than the 5.5% growth forecast that China, the Chinese government itself has laid out. And, of course, a Chinese slowdown also complicates the global supply chain outlook, so not ideal on that front.

On the Ukraine war, well, it continues, unfortunately, and the odds of a cease-fire have been steadily falling. They’re not looking very good at all. In fact, when we looked at betting markets just over a month ago, they were giving about a 70 or 75% chance of a cease-fire by the end of this year. Those prospects have now dimmed to the point that the odds being given are around 30%. So most likely this war continues. That’s what we are assuming.

We are seeing sanctions, if anything, intensify a little bit at the government level, with the risk of more, particularly a limitation on European oil imports, but equally, at the corporate level. And so now, 60% of major international companies surveyed have either permanently left Russia or have suspended their operations in Russia. So 60%, so there are significant negative economic consequences for Russia from that as well.

From a military perspective, Russia, one general has talked about aspirations of taking not just Eastern Ukraine, but Southern Ukraine, and perhaps even working to Transnistria, which is a rebel republic within Moldova and one in which Russian troops have already been situated for quite some time. So the risk of escalation would be there, though Russia’s hands seem to be quite full right now elsewhere.

And then on the NATO front, NATO’s purpose has been found once again. It is seemingly about to expand. And so Finland and Sweden, previously quite skeptical frontier countries with Russia, now look very likely to be joining NATO in the next few months. And so NATO’s strengthening. And so for all of the world breaking apart in some ways, indeed, the West is fusing itself more tightly together.

Inflation remains the macro topic, I think. It’s extremely high right now. The latest inflation prints in many countries have confirmed that, with inflation around 8.5% in the U.S., and now in the high 6s in Canada.

Maybe the point to make here, though, is inflation has broadened a lot. In fact, if we look at the U.S. basket of goods and services, half of all components are now experiencing annual inflation of more than 5%. So it’s not just used cars and it’s not just computer chips at this point in time; it is most things that are rising quite quickly. Very few, in fact, are rising by less than 2%.

And so, we can debate the origin of this broadening of inflation. It may just be that the narrow pressures initially were allowed to fester for long enough that they ceased to be quite so narrow; they bled their way into other areas of the price basket. Or it could be that the broad effects of a lot of monetary stimulus and fiscal stimulus have ultimately had their effect. I’m not quite sure it’s clear. I’d say it’s likely a mix of the two. My sympathies actually lie a little more toward the first theory. But either way, we’re now in a position in which we need quite a bit of monetary tightening to deal with this. It’s harder to pull down inflation when it’s broad as opposed to when it’s narrow, so it makes the job somewhat harder.

And when I think about the long-term inflation outlook, if given the luxury of doing so, I still think that demographic forces are deflationary, so that will help to put a cap on long-term inflation. It should be materially lower than it is today.

But I have to confess, this experience may well result in expectations being stuck a little higher than before, which could mean inflation ends up a bit higher than it was over the decade before the pandemic. And for that matter, deglobalization has intensified, climate change, and climate-change mitigating measures have increased. Workers have gained a bit of structural clout, we think. And so all of that suggests we could be in a world in which inflation looks more like 2.5% than the 1.5% that prevailed before the pandemic; 2.5% would be fine; perfectly consistent with growth continuing, but a slightly altered world, if that future indeed arrives.

I’d like to spend a moment on the great resignation, as it’s called. And so, during the early part of the pandemic, of course, there were many layoffs, and others quit to avoid getting sick at their jobs, due to a lack of childcare options and/or they were dis-incented from working by very generous jobless supports during the early phase of the pandemic. So that was the initial blush of the great resignation. But we’ve continued to see it, if in a different form since then.

And so, during the pandemic recovery that then took hold, rapid hiring occurred that pulled most former workers back. But some remained outside of the labour force, in some cases due to altered priorities, in some cases due to early retirement. And others were leaving existing jobs in pursuit of greener pastures. And so, either moving jobs because the market was so hot, they could do so, because strategic decisions were made to exit from structurally depressed sectors and enter other maybe structurally hot sectors in this new era, because pandemic-induced automation changed where the jobs were and weren’t, because high-contact jobs became much less attractive than before, or because people moved to new regions. So all sorts of sort of quitting and rematching of employment going on.

And I guess the biggest takeaway of an economic relevance is that, by virtue of some people opting to remain out of the labour force, by virtue of others opportunistically hopping between jobs, wage growth and inflation are both running a little higher than they normally would for this level of employment. So there’s a bit more pressure that emerges from the labour market than you’d think if you were just looking at the employment rate.

Over the long run, by the way, I think more people get pulled into the labour force by the post-pandemic changes, which is a little bit different. So the story over the long run is one in which all sorts of people who might have been geographically constrained can maybe work in hotter job markets, or people with competing obligations on their time can have a more flexible schedule by virtue of virtual working. And so I think there are good things that come from this over the long run, but in the short run, the labour market is even hotter than it looks.

Let me finish with some thoughts on central banks. And so the obvious comment is that central banks have been raising rates aggressively, and 50 basis-point hikes are the new normal, including one from the Bank of Canada not long ago, one from the U.S. Federal Reserve very likely in the next week or so.

On another note, related to inflation, we do worry that as central bank rate hikes expectations have built, so markets pricing in more rate hiking, we haven’t actually seen inflation expectations declining, which you would have thought. You would have thought the more hiking that gets priced in, the more likely inflation goes down, expectations would therefore dim; that hasn’t happened yet. So that’s got us a little bit nervous that perhaps markets aren’t convinced enough tightening is set to happen, or maybe just that other things need to go right as well, like supply chain issues being resolved to get inflation back down. So that’s a little bit worrying.

And then, I guess, separately—and I’ll finish on this thought, though still very much in the central bank vein—central banks experienced a great deal of scope creep over the last 30 years. It used to be they just targeted inflation. And then they did such a good job of that, they said, you know what, we can do more. And so they were targeting inflation really plus the economy, trying to maximize the economy. And then they did a good job of that, and they said, well, let’s target inflation, and the economy, and financial stability that came after the global crisis. And then, really, over the last several years, it feels as though they’re not just doing inflation, and the economy, and financial stability, but also dealing with matters like climate change, and inequality, and cryptocurrencies, and so on. And many of these are noble objectives, but it’s really hard to optimize all those things at once, particularly if you have one lever of raising or cutting interest rates.

And so, arguably, a reason why inflation is so high today is because central banks were a bit distracted by those other measures, and in particular, by the desire to maximize the economy, even if it meant that inflation would be too high. And so, the good news is central banks have now retreated from that thinking. They’re recognizing that, oops, a mistake was made; inflation needs to be the focus here. If we have to sacrifice these other variables, that’s simply what has to be done.

And so, as we look forward, just be aware, central banks are almost exclusively focused on inflation right now. Even if the economy were to weaken or some of these other problems or situations were to change, it wouldn’t necessarily be one in which the direction of the Central Bank would change. They’re focused on inflation, and that means rate hikes for the foreseeable future.

Okay. I’ll stop there. Hopefully you found some of that useful. I wish you well with your investing, and please consider tuning in again next time. Thanks so much.