Hello and welcome to the Download. I'm your host, Dave Richardson, and it is that time of the month for Canada's hardest-working economist to join us. That's Eric Lascelles, and he is up early on the first Friday of every month watching the jobs report come out of the U.S. wondering what surprise is coming. And one of these days, things are going to slow down. This morning, was it another disappointing job number that fell well below expectations or was it another one of those ones that just keeps happening, Eric?

Well, let's start on a different tack and say that if 8:30 AM is up early, you must not have liked the 7:00 Canadian job numbers that used to come out there for a decade or two when Stats Canada insisted on having the numbers out in time for the Newfoundland radio drive time or something like that, and made all of our lives very miserable having to be at the office at 6:30 in the morning once a month. Actually twice a month; the inflation numbers also came out at 7:00, come to think of it. So 8:30 was just fine. But that wasn't the question. So strong U.S. job numbers.

Eric, I just want to make sure that I refer to you as Canada's hardest-working economist because, yes, you were up at 7:00 am listening to those numbers. I have never referred to myself as Canada's hardest working podcast host because 8:30 is really early for me. But yes, we got strong jobs numbers in the U.S.

No numbers in Canada, strong numbers in the U.S. It was 353,000 jobs created. I feel like if we continue to see this employment strength, it will crumble in on itself as economists start to be laid off for making the wrong predictions here. So this may not be sustainable, just in a weird sort of side way. But 353, that's a big number any day of the week. That's a huge rate of job creation. 180,000 was expected. That was a doubling, essentially. And so that is a big number. In recent months, we've had okay numbers and then the revisions were negative, and you were taking something away. Not this month. 126,000 positive revisions, in fact. Now, the prior month, the December data — this is January that we just got today — that was 333. So now we're two in a row that are north of a third of a million new jobs created. And probably no one's surprised that unemployment therefore did not rise. That had been the forecast, but it didn't rise. It stayed at 3.7%, which is a little up from its lows of six months to a year ago, but still quite good. It was mostly private sector hiring, so not too many holes in the data there. If you're interpreting this through the lens of can the consumer keep spending? Well, the first conclusion is yes, they're still getting jobs. The second conclusion is also yes, because wage growth was up a pretty robust 0.6% in the month. Now, that also has implications for inflation, which we can get to in a moment, and hopefully we can talk about the Fed in a couple of seconds. But that was strong, too. It's still the case that there's a particular chunky hiring coming from one sector, which is education and health services. Those can be great jobs, but it's not clear what it's telling us about the economy. But that was 112,000. That still left a quarter of a million jobs being created for other reasons. And it was, as I mentioned, mostly private sector reasons. So that looked pretty good. Now the interlude, Dave, where I give you the small caveats.

Okay, very good. This is actually my favorite part of the podcast when you're on, the small caveats.

Yeah, that's right. I try to justify my view that the labor market shouldn't be this strong. And so it's funny, we continue to get the same caveats. I must say, they are significant. It's so hard to reconcile what I'm about to say versus what I just said. For a third month, out of four, aggregate hours worked in the U.S. have fallen. So somehow you added a third of a million more workers, and collectively, all of the American workers worked a bit less. And so that's weird. It was actually down 0.3%, which might sound like a tiny number, but that's actually a pretty significant one. That's strange. And it's not that all the hiring is temporary or anything; it just seems to be of a lower quality in some subtle way. Strangely, companies are hiring, but they're getting nothing more for their efforts. That's a weird one, and that's not great. The other one is, you'll recall there's this other more volatile, less closely watched job number that comes out, the household survey instead of the payroll survey. It was down again. It was down for the third month out of four, so it was down 31,000. The prior month had been a giant, I forget, minus 500 or something, but it was down a tiny bit. And I think back to the ADP survey, which came out a couple of days ago, and it was fine, but it was 100,000 or something. So I don't know what to make of this. That's not really the conclusion your listeners are hoping for, I suspect, but the headline checked all the boxes. Most of the things you turn to look really good, but then Americans are working fewer hours and other surveys are saying things aren't so good, and it's just kind of a big mess. I think, to be honest, we should still say this is a pretty good report. I think that headline number is sufficiently important that that's the right resting place. But maybe it wasn't quite as good as it looked. I think I've said that a thousand times, but that's where I find myself settling on this.

I get that for someone who works twenty-five hours a day, for the rest of us who want to work a little bit less, you find that absolutely dismaying. But no, it’s just continued strength. I come and say this every time because we almost sound like we're looking for weakness and then we're kind of disappointed when it's strong. We're not, because a good economy is good for so many people, and that's what we'd much rather have. But when we're trying to take this information and pull it into some kind of view of what's going to happen, and then how do you invest money based on that? Or how do you provide information that helps people make good decisions around investing money in their financial planning? It's somewhat confusing because so many things point to where you need to have a slowdown or a recession. But time and time again, we just see the consumer continuing to come to the table. We know governments there. And then even with all this, Eric. We saw the fourth-quarter GDP number come out in the U.S., which was what, 3.3%, Eric?

Yes, 3.3%. That's a good-looking number, right? Normal would be 2% these days. And here we are worried about numbers that could be below normal. So that was a great one. As you know, it came on the heels of the craziest one we've seen, which is 4.9% annualized growth in the third quarter of last year. That's two in a row that are not just a bit faster than normal, but we're talking 50 to 130% faster than normal growth. That's a significant deviation. Even the ISM manufacturing, Dave. The way I've taken to saying is we're just getting serial upside surprises in the hard economic data. The actual activity type metrics are coming in awfully strong. The ISM manufacturing isn't hard data, it's what's called soft data, not because it's weak, but because it's survey-type data. And on that front, still not a wonderful reading. It was a 49, and technically below 50 means you're contracting in the manufacturing sector. But a little bit of context is appropriate here, which is that was a two-point jump. We've been sitting at a 47, the 49.1 — I'm eyeballing this in real time, which is not advisable — but it's the strongest number we've seen since October of 2022. There's been a little bit of a bounce there, too. It's still saying manufacturers aren't feeling great, but they're feeling less badly than they have at any point over the last year and a third or so. We are getting some strong data. And one thing I'd want to flag is that we've been talking certainly about recession risks for quite some time, and we are still flagging that at a minimum, as a real risk, just because the theory is so clear. When you raise rates five percentage points, there has always been — and theory would strongly argue there should be — a degree of economic suffering. You can debate whether it's a period of slow growth versus a recession, and there are all sorts of debates you can have. It is verging on unprecedented to see the opposite thing happen and the economy accelerate. Maybe if we want even faster hiring, we should just go to a ten-percentage point interest rate. I'm not sure what the answer is here, Dave. I say that facetiously, obviously, but it's quite remarkable. So this is running completely contrary to all the theory and the models and so on. We've got all sorts of heuristics and rules of thumb, like inverted yield curves and global trade declining. On a real basis, that has always been a recession. And you can just run through indicator after indicator that says something bad should be happening. At the moment, it's not. And you have to, at a minimum, acknowledge that and say that when every data point surprises in one direction, maybe it's not the greatest strategy to be betting on the opposite outcome. Things can change over a period of time, but we're getting no evidence whatsoever. The US economy is cratering in early 2024, that's for sure. What we have been doing for the last couple of months is simply saying a soft landing — which is, of course, the better outcome; that's the economy keeps growing — is a very real scenario here. This is something that, frankly, has been happening so far. It's not certain to continue, but there is a very real chance that it can. And we've officially been giving numbers like a 40% chance of a soft landing and a 60% chance of a recession. I have to say, particularly with the numbers we got today, those numbers are a moving target, and we'll have to circle around with the investment team and settle just exactly where that lands. And I can't envision a scenario in which a recession risk is gone, because there are quite a number of things still suggesting that's at a minimum a real possibility. And as we've talked before, the window was still open, from a timing perspective. It's not overdue or anything, but it's much less of a certainty than it was. It was never a certainty, clearly, but it was much less likely than it was some time ago. So we're grappling with that. I guess in the meantime, it's worth just reflecting on the fact that this is why the most important thing is to have a reasonably balanced portfolio and not to stick your neck out too aggressively in either direction, and take small wins when you can, accept small losses on occasion, but move forward in a reasonable way. And I guess this is just the latest example of that.

Well, at the risk of insulting my favorite economist, and economics is not an exact science, which is why you kind of lay out in the way that you forecast the idea that, okay, this is what we think is the most likely scenario that's going to happen, but we've got to acknowledge that this other scenario could play out. And then that's what dictates, as you work with investment managers, or that informs them on how they think about building their portfolios. And again, coming out of all of this, a balanced portfolio has been very good because long-term rates have come down a full percentage point. And I guess one of the other things that we often talk about is that the stock market looks forward. And as we're getting these surprising reports month after month — the GDP, third quarter, fourth quarter, good jobs reports, etc. — well, the stock market is at an all-time high. So it's saying, as we look out a little while from now, nine to twelve months, we're probably in a pretty good spot. That would be one of the indicators. That would be one of the things it's indicating by being where it is, right?

Yeah, absolutely. And that's one of the debates. I think everyone was a little bit surprised during the early phases of the pandemic, when the market turned higher in late March. And that was so early in the pandemic, and it was a rough go for quite a long period of time thereafter. And it was the market essentially saying, okay, we fully appreciate that earnings are going to be a disaster for the next several quarters, but we can also see that this is an inherently temporary phenomenon and there is a light at the end of the tunnel eventually. We're just going to essentially ignore the bad stuff in the near term and look towards that eventual earnings growth, which was delivered and ultimately validated or vindicated the market's behavior. One of the questions here: you get a soft landing, that's just good news all around. And so that's obviously nice for risk assets and for stocks. If you get a recession, and that's, again still a possibility, we're thinking fairly mild, fairly short, a fairly nimble rebound. And if the market simply decides we're not going to fret over those couple of quarters of diminished earnings and look forward and recognize that, if it happens, it's sort of a business cycle kind of recession, not a crisis, and it's not quite a certainty that the market has to be all that upset about it. Now, there's a huge psychological element when you get to these sorts of things. And one of the things we've been thinking pretty hard about actually in recent weeks is: to what extent are recessions inherently irrational? And we've talked before about the idea of stall speed and the idea that historically, every time the U.S. economy falls significantly below a normal growth rate, it then tumbles all the way into recession, into contraction. And it's not mathematically the case that missing normal growth by one percentage point means you therefore have to miss by two or three. There's nothing mathematical that says that has to happen. There is arguably a psychological component to that, or an irrational element, or at least a suboptimal element. And the debate then is, okay, is this suboptimal behavior just because of liquidity and credit constraints that arise when things aren't going so well? Maybe banks are scared not lending, and businesses totally get that it's irrational to lay off all these people because they're just going to have to hire again a year or two from now. And it makes no sense to stop doing capex, which has a runway of ten years, when you're reasonably confident demand will be back five or ten years from now. But they just can't get the money either in a lending capacity or their own liquidity is temporarily so poor that they're just not in a position to do it. So maybe there are just hard mechanical reasons why overreactions happen, but it's pretty rare that the headwinds in the economy are big enough to say like, yes, that's just three percentage points off GDP growth, that is now a negative one instead of a plus two. It's pretty rare to get that. It's usually more like, okay, these are some headwinds. The plus two logically becomes a plus one and historically, with plus ones, people get nervous, and they take it right into a recession. It's sort of an open question whether has that psychological dynamic somehow changed. And here we are observing, I guess, non-U.S. developed countries that have really not been growing in any kind of regular way for the last year. It wasn't quite a recession, but it was certainly the kind of subpar experience that would often trigger one. And we haven't seen that panic. Maybe it's because the US has held together and that's the one people care about. Or maybe it's because we just have these economic actors and investors who are really being brave and being calm and choosing not to panic. I don't have an answer, by the way. This is sort of a useless digression. I don't know for sure whether it's all psychological or not, but it's possible that you're just getting the headwind and people are saying, I don't care, and therefore it's not as bad as it might have been.

Well, let's throw another one of the charts that I track. I'll throw a couple out that you and your team produce. One is a long-term look at long-term U.S. interest rates for the 10-year U.S. treasury. And basically, I know when I'm showing it to investors, it kind of says that interest rates are normal. They're not particularly high from a historical perspective. They're kind of in the normal range. So as long as rates are normal, we should be in a period where we should have maybe not spectacular growth but we should still be humming along. And then the other is business lending standards. And that was one that was spiking towards more challenging business lending standards, particularly last year around this time when you had some of the smaller regional banks in the U.S. struggling. By the way, there's been a couple of flashes on that front, which we'll get into with another guest next week, but we saw that roll over and we started to see some of those standards ease again. So maybe, as you say, we saw the worst. Europe and Canada who kind of flashed recession, third quarter. The fourth quarter in Europe was a little bit better. And Canada preliminary numbers looking a bit better too. It is still just a mishmash though, isn't it?

Yeah. I certainly wouldn't want to prejudge for the non-U.S. economies just because we had a surprise to the upside, which was a zero or 0.1%. It wasn't good. It just wasn't a disaster. Canada is looking like it's a 1% plus annualized for the fourth quarter and it had been looking like it could be flat. And so that's still bad. It's not as bad as it was, but yeah, I absolutely take your point there.

Yeah. So we wrap it all up and let's just focus in on rates then to finish off. From the Federal Reserve's decision and comments on Wednesday of this past week, they hold tight on rates. One of the other interesting numbers that we did talk about coming out of the GDP announcement from last week were some fairly tame PCE numbers; inflation numbers for 2023 and for the last quarter of 2023. You package all this up and you've got kind of two flight patterns for rates. Rates are coming down. I think that's pretty widely a consensus, particularly for the Fed funds rate and bank of Canada rate. But you kind of got two flight paths. One that starts more in June and maybe comes down three or four reductions this year. And then there was the more aggressive flight path that at one point even markets were saying we're going to start in March with the first reductions and then maybe come as much as six to eight times a quarter point down over the next twelve months. So after all of this, you wrap it all up. You take the comments from the Federal Reserve. What flight path are we on right now? Or is there something in between that makes sense?

Yeah. Well, I've taken to saying — and this is an utterly useless set of comments — but I've taken to saying I'm dubious that the Fed will do what the market is priced in currently. What do I think they'll do? They'll either do more or less, which really isn't all that helpful for investors. And really all I mean by that is just that in a soft-landing scenario, I don't think there's going to be six rate cuts in the next year. That seems too many. I pick the under there. The odds of that are rising of course. If we were to have the hard landing, which is still a realistic possibility, I would think it'd be quite a bit more than six rate cuts. And in fact, we were just looking, historically you get on average nine rate cuts, or at least 225 basis points worth of cutting, maybe delivered in fifties, but over the span of the subsequent, I think even just six or seven months historically. So either more or less, one or the other. You can take that to the bank, Dave. I think the odds are increasing, though, that we don't get quite as much as a soft landing becomes more conceivable. Yes, you're certainly right about the inflation. The PCE (Personal Consumption Expenditures) deflator, the Fed's favorite inflation gauge; the headline I guess, was unchanged, 2.6%. But it's nice to have a two handle. It's just nice to say the word «two» sometimes. Inflation hasn't been there in a while. The core inflation was 2.9%, which was an improvement. That was the first-time sub three. So we should be celebrating those. And it is signs of some progress. I would say in general, the progress has been pretty limited over the last few months. If we take a slightly more holistic view and we look at CPI and PCE and median CPI, all the different ways that you can measure, and service inflation and different things like that, I would say we're seeing a bit of progress, not a ton of progress. I would say the central tendency for the inflation numbers is three to a little bit higher than three among the various metrics we look at. There is more work to be done. And this is sort of the interesting thing, which is inflation is certainly not where it needs to be. It's maybe on a trend towards where it needs to be, but a pretty slow, fitful trend. And the economy has remained strong, particularly in the U.S. And so to me, I would say we've been skeptical of a March rate cut for quite some time. That didn't make a ton of sense to us, unless you were to get just full-on recession signals in the data this month, which we just haven't gotten. I guess you could hold out hope for some incredibly abrupt pivot in February. But again, it doesn't seem too likely based on what we're seeing. March, we've been suspicious of. I was just looking. And so the market at one point had that as the most likely outcome. The market's taken it down. There's only about a quarter of a rate cut now assumed, or 22% chance, you might say, priced for March. So that one looks like everybody's sort of recognizing that, particularly after the Fed decision and some of the comments that were made there. May, though has been a big debate. And it's May 1, by the way, which is not as far away as you might think. It's the very start of May. The market is still sitting at a 66% of a rate cut, and so it thinks it's probably happening. Certainly, that's in play. I would say, if we get a soft-landing scenario, I don't think it's going to happen. That would be hard to believe. And so the 66% feels a little high to me, I would say. It wouldn't surprise me if we ended up getting rate cutting, maybe starting in June or something like that. It's a bit far away to try to give false precision on, but I would say I'm suspicious of March and I'm a bit dubious of May. I think once you get into June and beyond, you can start to talk about it. But again, it does depend so much in whether the economy just keeps moving forward. One tricky thing here, keep in mind, strong economic growth isn't necessarily quite the optimal outcome here. The threading-the-needle scenario is one in which you get okay growth, because the US economy is already in a position of excess demand by a little bit, at least. And here we are, worried a little bit about inflation. And we just talked about wage growth that was up 0.6% in a single month. It's not likely to do that for twelve straight months, but if it did, that's 7.5% type wage growth, and so it makes it harder to tame inflation. And so I would say that the data I'm seeing makes it a bit harder for the Fed to cut rates and also isn't necessarily totally conceivable. It's just an argument that the rate cutting, if this continues, might have to be quite ginger, and it might not even be on the table for a little while until the economy slows somewhat.

And sitting here in the heart of a Canadian winter, June does seem a long way away.

It does. Though the fact that my grass is green, and I rode my bike yesterday tells me that that says more about this Canadian winter and climate change.

Yeah, it has not been a normal winter, similar to it's been an unusual period with some of these numbers that keep popping up and surprising us. Well, Eric, thanks as always for getting up early with us today and talking about the latest reports. Really, a thorough update of where we're sitting. We'll check in with you maybe in a couple of weeks just to see where we start to get in early February as we start to really try to hone in on when these rate cuts might start.

Perfect. Thanks so much. Bye everybody.