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by  Eric Lascelles Mar 9, 2023

As China has shaken free of its COVID-19 wave, its economy is accelerating. There is also strong economic data in other parts of the world. Yet our Chief Economist, Eric Lascelles takes a cautious view.

In this short video, he covers a wide range of economic news – including his thinking on why a recession is still likely but may arrive later in 2023 – and what that means to the outlook for 2024. He also explores inflation trends, interest rates, the growing friendshoring trend and more.

View transcript

Hello and welcome to our latest video Macro Memo. We'll cover off quite a range of subjects this go round. We'll spend a moment on the pandemic, though it might be one of our last moments on it as it ceases to be particularly economically relevant. We'll discuss China's economic recovery, which is ongoing and looking quite strong at this juncture.

We'll take a peek at decent economic data elsewhere. Indeed, people are speculating there might be a ‘no landing’ scenario instead of a ‘soft landing’ versus ‘hard landing.’ We're dubious, but I'll get into that a little bit later. Recession Watch continues. So we're still anticipating a recession. We're still watching for one. And we're certainly paying close attention to inflation as well.

And unfortunately, inflation stuttered a little bit in its latest month. And so isn't cooperating quite as nicely as it did over the second half of last year. And that's created some trepidation on the part of central banks. Speak briefly to that and we'll finish with just a moment on geopolitics, but really specifically on French during the idea that we're seeing some very interesting pivots in production away from China and towards other countries to the advantage of those other countries.

All right. That sounds like a lot. Let's jump right in. And we'll begin just with a quick peek at the pandemic itself. And I guess the biggest comment here is, is the pandemic no longer has much economic relevance. We are no longer seeing any major countries lockdown or respond even to minor waves of infections. And so it's ceasing to be relevant.

The XLB .1.5 sub variant is, for what it's worth, the dominant variant right now there are no obvious replacements for it yet. I would say the extent there's trepidation in a virus direction, it's actually right now at least less to do with COVID and again, COVID could become relevant again if a more deadly variant came along, but simply hasn't happened.

But some trepidation, in fact, about avian flu, the H5N1 avian flu outbreak does seem to help bridge the gap to mammals. It does seem to be more upper respiratory than lower respiratory, which means more transmissible. Historically, this particular avian flu has had a high fatality rate when it's found humans. And so probably not something of relevance to all of us probably doesn't ultimately impact the economy.

But I suppose if there is a risk as it stands right now, that's one just to pay a little bit of attention to off of the grim business of viruses, let's switch over to China. And so China, I suppose, is benefiting by having abandoned a zero tolerance policy. It had a huge pandemic wave over the months of December and January.

It is now very much an economic rebound mode. And the real time indicators we look at look quite good. China's subway traffic, as an example, has now bounced significantly, not just higher, but to the highest point we've seen in over three years at this point. So China really is embracing the reopening. Some formal indicators are now starting to trickle out for the month of February, which really was that first reopening month of significance.

And manufacturing purchasing manager indices are jumping nicely to the highest level in several years. And so China has a good little recovery going here. We're forecasting 5.3% GDP growth for the year, which is a little above consensus. China's targeting 5% for what it's worth. And there's real pent up demand. Pent up demand might not be quite as big as some people think.

It's tempting to think China was locked down for three years and is finally reopening and there's three years worth of demand. That's not quite right. In fact, China was more open than most countries for much of those three years. So it's not three years worth of pent up demand. And actually, when we measure the amount of household savings in China that's been accumulated more than the normal household savings, it's significant.

There is some pent up demand here, but it's actually not all that notable versus other countries. And so I would say there's a nice rebound here and China can play counterweight to a slowing global economy. But nevertheless, it's not to the tune of 8 to 10% growth, which was once the norm for China not that long ago. And that's actually a reasonable segway toward the observation that we're still fairly cautious on China's longer run growth prospects.

We see quite poor demographics. We don't think housing will be the driver that it was not that long ago. We think that China has pivoted, perhaps unwisely, towards favoring the state over the private sector. And there are serious geopolitical frictions, which we'll talk about in a moment, but which are hurting Chinese growth, including crimping its access to high tech computer chips.

Okay. On from there, the economy more generally. And so we've seen this is now more of a North American flavor. We've seen pretty decent economic data recently. January job numbers were good, quite good in the US and Canada. Retail sales in the US was astonishingly good in the month of January. I think you do need to stop for a second and recognize that January might have had some distortions in it.

So for instance, there tend to be big seasonal factors in January that make the numbers a little bit more twitchy. I can say that it was a warm month in January that probably encouraged more spending, not necessarily in a sustainable way. There were also big cost of living adjustments of people with pensions that were index got their pensions indexed much, much higher.

And so that unleashed a lot of room for consumer spending in the month of January. And so none of those things get repeated in February and beyond. And so probably that strength softens a little bit. But the other day, I can't say otherwise. It was strong economic data and as I briefly alluded to earlier, it has people talking about a no landing scenario, the idea that the economy is strong.

How come it doesn't just get to stay strong? Why can't we do that instead of debating whether it weakens a bit or weakens a lot? And I guess my rebuttal to that would be that I'm not convinced a no landing scenario is our real scenario. Pretty clear that economies are overheated, already know a lot of precedent for overheated economies just staying overheated indefinitely and and trucking forward, and particularly at a time when inflation is too high.

Central banks can't ignore economic strength. They can't ignore high inflation. And so they would be forced to raise rates more. And I view the no landing scenario, really more of a delayed recession scenario where you still get the recession. Maybe it happens a bit later, maybe it has to be a bit deeper. But again, at the end of the day, I don't see how you can just sail along happily for several years going forward from here.

So I don't put much weight in that. I still think you've got about a 70% chance of a recession in the next year, but a 30% chance of a soft landing, which is a slowdown that isn't quite a recession. On the subject of recession. So just gave you some probabilities there in terms of the timing of recession. We have pushing that back a little bit, and that's fully in recognition that we've had some economic strength at the end of 2022 and into early 2023.

And so we now think that a recession, if it happens, is likely to be the second half of this year. We've penciled in the middle of 2023. Now we think it's more the second half of 2023. And just mechanically, that actually makes the 2023 growth forecast look better. Mechanically, it makes the 2024 growth, that growth forecast look worse since it's crowded against the start of 2024.

Don't lose sight of what's important here. So what I'm telling you is the annual numbers start to look a little bit wonky right now. What's important is that we are still looking for a recession. We are still a little bit below consensus in our forecast. We think a recession could be a bit worse, could, could could come. More relevantly than the market thinks.

And despite that, we still look for a nice looking recovery in 2024. So we're still more cautious for the moment, but we do believe there's a good recovery at the end of the rainbow. Right now, our recession scorecard is still arguing for recession. We have 12 inputs. Six say, yes, the recession is coming, three say likely only three say maybe or no.

So we're still getting a likely conclusion out of all of that. And we can see this is a fairly new development. We can see lending standards tightening for business loans. That's very clear, in particular in the US and in Europe and is happening to an extent you only see outside of a recession. So this does seem to be another hint in that direction.

On the subject of inflation. Well, inflation, I suppose, has been stuttering lately. We had some really nice improvements over most of the second half of 2020 to January, didn't fully cooperate. We had gas prices that went upward. So that complicated inflation for a number of countries. We saw service inflation not capitulating quite as much as had been hoped for.

So inflation didn't look great in January, went basically sideways on an annual basis and we'd like to see some declines. It's been choppy for a while. Let's not use revisionist history here. There were some big months in the second half of 2022 as well. That happens. I think the real test will be does February soften again or does it stay strong?

And we'll learn a little bit more. But our working assumption is still that inflation can come down to some extent. It's fair to say that central banks now need to ask themselves whether a little bit more tightening might be needed. They're seeing strong hiring and strong spending and inflation didn't fully behave in January, but nevertheless, we do believe it's more likely than not that inflation can fall from here.

That is our forecast. We are a little bit below consensus, but realistically it's not going to snap to 2% tomorrow. And in particular, we need that service side to get going. And unfortunately, service inflation is heavily informed by how hot the labor market and how the economy is. Those things are going to need to cool to achieve that inflation target.

So central bank central banks have remained busy. They've been raising rates for a very long time now and by quite a lot, the Bank of Canada might be on the cusp of changing that as I record this, at least as it's expected this week, to keep its policy rate unchanged, just a six or 7% chance assigned to a rate hike.

The market, though, has revised its thinking for further out in the year. And so the market is of the view that we may not actually see the end of tightening just yet. There could be a hike that's hidden away somewhere later in the year really responding to the fact that inflation is sticky. So there's a chance of that as it pertains to the US.

The US goes later this month and is expected to raise rates again by 25 basis points and to a peak policy rate eventually of five and a half percent, which is a slight upgrade from before. But I guess the big point here is one in which even as we see central banks expectations shifting, we're seeing just fairly small additions as opposed to big additions because the other central bank comment, Bank of Japan has now chosen its next governor.

It is an academic named you Wade, and he was once on the Bank of Japan's board. He has certainly experience with monetary policy. He was once thought of as a dove. Some people think he's a hawk now. His views have been changing. I think most importantly, we should use him as pragmatic and he's expressed some doubt or concern about the yield curve control system Japan is currently employing.

And so we will likely see some unwinding of that over time. My fear remains that as interest rates in Japan cease to be so negative, we could see some problems emerge given all the debt that they have. The last subject from us on the geopolitical front, really two angles to this. The first is just to say we've seen some negotiations between the UK and the European Union to lighten some of the small Brexit frictions with regard to Northern Ireland.

It's a fairly small change, but it's heartening that there are some adjustments that are possible there. And so that's good news Though Brexit does continue to weigh on the UK. The other one is ensuring and so we've talked for a while about how globalization has been turning to globalization, and that's manifested in, I should say, it's driven by a number of things, including greater frictions between China and the US and Russia and so on, and so driven in part by that.

But ultimately we're seeing some on shoring where companies are bringing back production closer to home and some friend shoring. And that is to say shifting from, say, China, which in some cases isn't viewed as a friend to other friendlier countries such as India and Southeast Asia and Mexico in the case of the US. So we're seeing shifts like that.

We generally been inclined to say it should be quite a slow process. It probably will be a fairly slow process. It'll be measured in years and decades, not in in months. Nevertheless, we've been a little bit surprised by how quickly it's been happening, despite that comment. And so, for instance, we really can see some increases here. And it's partially China's growth is slowing and India's growth is picking up.

But we can see some of this in the numbers, too. And you can see Chinese as an example, furniture and footwear exports really falling off and Vietnamese exports of those products really surging. And similarly, when we look at Chinese exports to the world versus the rest of developing Asia, China really outpaced the rest of developing Asia's exports from the year 2000 through to the mid 20 tens.

And then a significant reversal since then, it's partial, it's incomplete. If you look at exports from Asia to the US specifically, it's been almost complete. The China clout relative to the rest of developing Asia has now unwound really since President Trump came in in 2016 through today. So over six or seven years, it's pretty much fully unwound back to the turn of the millennium level.

So there's a big shift here. And I guess, again, the big takeaway is this is not great for China's long term growth and it is quite an opportunity for the likes of India and South Southeast Asia and Mexico in particular. All right. That's it for me. I thank you, as always, for your time. Hopefully you found all that useful.

Please consider tuning in again next time.

For more information, read this week's #MacroMemo.


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