Hello and welcome to our latest video #MacroMemo. We’ll cover a few things today.

• We’ll talk about recessions more in the context of why didn’t we get one a year ago and why are we still expecting one after not having gotten one for the better part of a year? So we’ll get into that.
• We’ll talk a little bit about some new headwinds, U.S.-specific, but some new short-term headwinds need to be considered.
• We’ll talk about the U.S. 2024 election, which I’ll grant is still more than a year ahead, but we should be thinking more than a year ahead every once in a while. So let’s just set that up a little bit for further contemplation later.
• Q3 GDP, both the US and Canada merits a bit of discussion. Quite different tracking, I can say, just as a bit of a teaser.
• Inflation has continued to back up on higher gas prices. We’ll talk through whether the happy downward trend is broken or not.
• We’ll also just give a couple of words to central banks who are broadly engaging in hawkish pauses right now.

But let’s circle around to the top and we’ll begin with those recession questions.

Recession outlook: We were predicting a recession a year ago, but we still haven’t gotten one yet. So I think it’s quite fair to say why? what went wrong? what changed, etc.

Let me just start by saying the reason we think the recession risk leapt higher a year ago, a little over a year ago, had less to do with central bank rate hikes. That was part of the story, but it had less to do with the fact that central banks were raising rates all of a sudden and those increases were coming furiously at the time.

It had more to do with a series of other aggressive headwinds that were presenting themselves at that point.

• Inflation was still really high a year ago. That has its own corrosive effect. Even if you set aside what it means for central banks.
• War in Ukraine was ongoing. That was affecting not just trade flows, but it created a pretty huge energy shock. And so that was a big negative.
• High oil and gas prices, supply chain problems were still significant, if not at their peak
• China was engaging in rolling lockdowns and that wasn’t great for the world’s second biggest economy.
• North American home prices were falling. And so basically the idea was that was more than enough to make a recession by itself.

Of course, we didn’t get that recession. And so the question is, why didn’t we get that, given that there were all of these headwinds?

Part of it was just that the economy proved to be really resilient. That’s been a common theme since the start of the pandemic. Government stimulus was helping, pent-up demand was helping and so on.

But a big part was those headwinds I just listed all faded pretty quickly thereafter, if to varying degrees. High inflation became materially less high. The energy shock faded significantly. It’s a funny thing to say as we grapple again with gas, it’s going higher right now, but still nothing like a year ago. And so a lot of that went away, which was welcome.

Supply chain problems continued to improve. China’s lockdowns went away for good. At the end of 2022, North American home prices started to rise in the first half of this year, wobbling again now. But nevertheless, they started to rise. And so essentially those headwinds went away and a recession was avoided for the moment.

I think the next logical question is, well, then why are we still forecasting a recession, given that many of those headwinds have gone away?

And the answer is because now those central banks and those interest rates are coming into focus. Central banks kept raising rates through to the end of 2022 across 2023. Until quite recently, bond yields have continued to rise – not just proportionate to what you would expect, given the central bank rate hikes, but by even more. We’ve seen term premiums go up, etc. Also because there’s a really long lag from higher interest rates to the full effect on the economy.

But that’s all now coming into view. And we know that historically the first rate hike to a recession has had about a 27-month gap, and that would be somewhere in the middle of next year. Other arguments would say maybe it’s a little sooner than that.

But the point being, the window isn’t closing. Even though central banks are slowing down here, the window is still wide open, maybe even starting to open at this point.

And so still quite credible to think those higher rates, as history has been a guide, could lead to recession. Certainly some are noting that there is a reduced level of rate sensitivity, particularly in the U.S., given that there’s just less household debt, given that mortgages are locked in at very low rates for 30 years in many cases. That’s all true.

Do note though, there’s still plenty of debt. Do note that credit card debt, auto loan debt, people just moving between houses, people entering the housing market for the first time. All of those parties are exposed to those rising rates much more immediately than the lucky people who are locked in as of a few years ago for the next several decades.

Note that for every winner in the context of someone locking in at a low borrowing cost, there is a loser. Someone is lending money to them at that low rate, which is a below market rate and that represents them losing money. Do note as well that crucially higher rates affect the marginal decisions. For example, businesses deciding whether to build a factory or not need to be confident the return of that factory can exceed the hurdle rate, the cost of borrowing.

People deciding whether to buy a new car need to face those very high, in some cases double- digit car loan rates. People deciding to buy a house, to enter the housing market for the first time similarly are being confronted by something like seven and a half percent mortgage rates in the U.S. And so that has a real effect.

Also keep in mind, those are things that have a direct impact on gross domestic product (GDP). GDP is the amount of stuff purchased, the amount of stuff produced, alternately. And so an existing house isn’t really factoring centrally into that. Buying that new car, buying that new house, building that new factory. Those are the things that map into GDP and those are affected just as they ever have been.

And so, again, we still think a recession is more likely than not. It’s not a certainty. Nothing really ever is, particularly big events like that. But we believe the magnitude of the tightening, the magnitude of the bond sell-off, the timing is such that it’s still quite credible to think a recession is ahead and not entirely avoided.

Okay, let’s pivot from that just to talk about some new headwinds. In fact, I suppose that fits into the prior narrative to the extent that those headwinds also add a little bit to the argument for some economic weakness ahead.

New economic headwinds: I will admit, what I’m about to talk about is very short term in nature, not lasting forces. They’re U.S focused as well, less international in nature, but they are still headwinds. They do still merit a little bit of attention.

One would just be the auto strikes ongoing against the Big Three automakers in the U.S. There’s been a little bit in Canada, too. A rising number of plants are closed due to strikes at this point, strategically selected for maximum pain. So some economic impact there.

There has been some movement toward a resolution. In fact, one of the carmakers did find a resolution on the Canadian side of the border. But broadly, these are still five of six and the three biggest are still continuing. The wage demands are still tens of percentage points apart in terms of the wage increase desired versus that offered.

So long as a strike doesn’t last more than about six weeks, the economic damage should be fairly small, maybe a couple of tenths off quarterly GDP.

But if it drags on, if it broadens – and it has been broadening – the impact could be bigger. It can extend up and down the supply chain, it risks increasing car prices, which were a big inflation driver way back when. We had been enjoying the opposite trend in that might be stalled. So this does matter.

I can say elsewhere in terms of short-term headwinds, some expiring stimulus needs to be considered, mainly the student loan program where payments are due again after a multi-month freeze. And so 44 million Americans will be paying $500 U.S. a month on average starting October 1st. So that’s just begun. That represents a small but real hit to aggregate personal incomes effectively in the U.S.

There’s also been an expiry of a daycare subsidy program that could indirectly impact up to 10 million children. And so there are some economic hits that come along those channels.

Then there’s been a short-term headwind that, at least for the moment, has been averted. That is the U.S. government shutdown or lack thereof. It looked as though the markets were giving a 75% chance of a shutdown as of October 1st, but a solution was found.

There is no shutdown as I record this in very early October. I will note that there is still a real chance of a shutdown later. They just kicked the can down the road to November 18th. There is still fundamentally a pretty big Democrat-Republican divide. The Republican House speaker is under pressure within his own party and so this could still be messy later, there could still be a shutdown.

The last shutdown lasted 35 days. It had a palpable economic effect. Just as a loose rule of thumb, if we were to get that late November shutdown, you’d expect a loss of about 0.2% of GDP for each week of the shutdown. So you do get it back later.

But the point being, there are a number of short-term headwinds, maybe some uncertainty as well, a drag on growth right now.

Let me pivot from there.

U.S. 2024 election update: We’ll talk just for a moment looking a little further ahead to the U.S. election. This is still focusing on the U.S. 13 months out.

As I say these words, fascinatingly it could well be a rematch of 2020 in the sense that you could well have another Biden versus Trump race. Those are the leading contenders from each of the two main parties.

At present, if that were to be the matchup, it’s expected to be quite close. We’ve been looking at betting markets, we’ve been looking at polls. Those both slightly favor Trump, though it’s very close.

We’ve looked at probability markets, which really aren’t that different from betting markets other than I guess a lot of money isn’t being put in. It’s just smart people guessing. Probability markets still have Biden slightly ahead.

So you could say two avenues favor Trump. One avenue favors Biden. But that’s probably simplifying a little bit too much. Looks pretty close. Neither is technically assured of being the candidate.

Biden is quite likely to be but of course, he is fairly old. There is a chance he could be challenged. There’s been more talk about that than you normally see after a first-term president pursues re-election.

Trump also, of course, is fairly old as well, and has quite a few challengers. He has some legal troubles that could complicate things as well, though he is the strong favorite right now to win. He has more than three times the support of anyone else.

And so most likely them, though not a certainty.

It’s a little early to talk about policy differences. We haven’t even really seen much by way of platform and the Trump platform in particular really doesn’t have a lot to say on the economic side.

Maybe in a nutshell, you could say Biden’s been pushing hard on green initiatives. You could imagine Trump would not.

Trump has talked about further tax cuts. That’s not been a Biden priority. And so maybe that’s a Trump featured policy.

In terms of the war in Ukraine, Trump might well be much less supportive, and so that would be a significant effect.

But both don’t mind large deficits. We’ve seen that clearly over the last seven years. Both are anti-China. So some similarities there as well.

Of course it is nevertheless a consequential election. This is really the starting gun. We’ll be following this more closely going forward.

Economic developments: A couple of economic words here, really just Q3, third quarter GDP in the U.S. Fascinatingly, the most popular, the most successful GDP nowcasting tracker is pointing to a 4.9% annualized gain in that third quarter. That’s a huge number. I will say that the two other widely followed publicly produced nowcasting models -- in fact, they’re all just from different competing district Feds – are pointing to 2.1 and 1.6% growth.

I say that just to highlight there’s quite a divide here. You’ve got a 3.3 percentage point gap between the most optimistic and the most pessimistic forecasts. It could be great, might just be okay. A lot of uncertainty, it would appear, so let’s watch it closely.

I guess for now, the point is that the U.S. economy hasn’t been in a recession in the third quarter. It’s almost certainly grown. The question is how much, there’s a chance it was actually surprisingly fast. Though let’s not forget about those new headwinds I was just talking about in terms of slowing things down going forward.

A quick little word on Canadian Q3 GDP. We have our own nowcasting models for Canada as we do for the U.S. as well. They’re just not obviously better than some of these publicly produced ones. The Canadian one, though, which we do quite like, it’s forecasting or pointing to just 0.1% annualized growth in the third quarter in Canada.

So (a) growth is a lot weaker than in the U.S. and (b) you might recall the second quarter for Canada was already negative. So here we are tracking something that might be barely positive, or not, but something sort of hovering around there. The Canadian economy really isn’t moving all that quickly right now.

Two quick things for me just to finish up.

Inflation backs up: One, on the inflation front, it’s a very familiar story with the latest August data that came out. Essentially inflation is continuing to back up a little bit in the U.S. It went from 3.2% year over year to 3.7% inflation year over year. In Canada, it went from low threes to 4% year over year.

So again, in both cases we’ve seen it increase. It’s mostly a gas story. Unfortunately, gas prices are higher than they were as of a few months ago. That’s continued and it might well be a theme that persists into September.

In the U.S. there was a little bit of airfare inflation as well, but it was after a few months of decline. I would just say even though there’s been a back up, even though we might not get those headline numbers looking a whole lot better in the next month or two, I still feel pretty good about North American, really, the global inflation trend. It’s still much lower than a year ago.

Beneath the surface, you see shelter inflation still broadly slowing, food inflation broadly slowing, the breadth of inflation is narrowing in terms of the fraction of things rising quickly. So I still think it’s credible to think that inflation can trend lower, even if gas is going to obscure that for a little while.

Central banks pause: And the other quick thought just on central banks, we’re getting a lot of the big developed central banks now pausing. The European Central Bank raised rates, but they’re saying they may pause in the future.

But the Bank of England and the Bank of Canada and the Federal Reserve in the U.S all paused. These were all hawkish pauses, which is sort of what you have to do. You don’t change rates, but you say, “Listen, we’re not even thinking about cutting,” because if you admitted you were thinking about cutting, markets would get excited pricing those cuts and would sort of undo the power of some of the rate hiking because bond yields would be falling.

So central banks are in a hawkish pause mode. But I think realistically they are near or could be at the peak policy rate.

I think there are a lot of different viable scenarios going forward. They’re sort of wild scenarios in which they have to raise rates a lot more if inflation does take off. There are wild scenarios in which they would cut rates a whole lot to the extent a recession comes along and inflation rolls over.

And then there’s probably a more realistic scenario somewhere in the middle, in terms of holding here for a period of time and then starting to cut rates.

Okay, I’ll stop there and I’ll say thank you so much for your time. As always, I hope you found this interesting and I wish you well with your investing.