Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is time to catch up with Canada's hardest working economist. We haven't had him on for a few weeks, and the way things are going these days, Eric, we should have you almost on every day because there's something happening around the global economy that is significant. Because it's a very strange time.

It is awfully hard to keep up, Dave. I'm not sure if I could handle a podcast every day. I can barely handle the run of data as it stands right now, but let's pretend I have all that in my head. And as you say, there's an awful lot going on.

Well, I was out with Eric on the road a couple of times over the last month, and if I ever doubted the label I've given him as Canada's hardest working economist, it was put aside after this. I've never seen anybody work harder. And I know you've got this flow of data and everything that's happening. Plus, you're out speaking and doing all the stuff you do. It's just incredible.

Well, thank you very much, Dave. I think you greatly exaggerate. And let the record show, when we were in Vancouver, I snuck off one night and caught a minor league baseball game. So, it wasn't all work on my part, but nevertheless, in fact, I'm presenting twice today in a castle, both times, Dave. Now it is only the Western Harbor Castle in Toronto. It's not quite as exciting as it sounds like, but nevertheless, anytime I'm in a castle, I'll brag about that.

Well, I'm in a castle in Sardinia, so look at that. Maybe the economy is not that bad if we're doing okay. But let's get to the economy. Maybe we'll start with the jobs report from Friday. We had Canada and US jobs. What are your thoughts on those reports?

Yeah, I think, as with the prior five or six, you could take it a couple of ways. And you could start by saying these are good numbers. There is still hiring happening in the US. And by the way, in Canada as well, we saw 253,000 new jobs. That's a good number. That's faster than you'd normally need just to keep pace with the population. And so that's all a very positive story. It is fair to say that if you look at it on a chart, you will still note that the rate of hiring has slowed materially over the last year. I would say half of that is because it was incredibly fast a year ago and six months ago, and half is because it is starting to settle down. Genuinely, it's fair to say— and this is something that we've spent some time studying over the last month— but it's fair to say that with all this hiring, you'd think the labor market would just be screaming tight and overheated and all those sorts of things. It certainly is a strong labor market and the unemployment rate is now even lower. It's 3.4%. It's tied now with the cycle low that we saw a few months ago, but the supply of labor has broadly kept pace. Now, it wasn't anything special this month, but if you look over the last year or the last year and a half, a lot of the people who dropped out of the labor market actually have come back. It's not quite all. And there were certainly people who went off into retirement and so on. But nevertheless, basically, we saw a lot of hiring in the last year and we saw a lot of people start looking for jobs, and they actually balanced each other out in a way that argues that the labor market is still tight. But it's actually not any tighter than a year ago and not as much as you would have thought, based on all the hiring that's happened. So, they've been able to absorb these extra people. The final perspective you could maybe give on the labor market; one being that it's still strong hiring, two being that it's decelerating, three would be— and we've said this before—, but when you dig into the details, you do find still a pretty long list of evidence that the labor market is probably going to cool significantly from here. I'm a broken record, as you know, Dave, on that. So I'm not sure quite how much credibility I possess and I rue the day that I agreed to do these on employment days, since employment numbers are the one thing that refused to cooperate with the economic slowdown story. But I will say jobless claims are now rising. They're still low enough, but they are definitely rising. We were all a bit fooled by that because they weren't rising, and then suddenly the statistical agency said, oh, what do you know?, we've revised them and they were rising for the last six months— we just didn't know. So they've actually been rising for longer than people had thought and jobless claims are about a quarter higher than they were at the start of the year. There is a real increase there. There's a bit of a turn. As we've said many times before, temporary employment is falling and so that tends to be correlated with some softness in the broader labor market several months later. So that's still happening. Mass layoffs are still up. They're not pandemic-level up, but they are significantly up and we think that continues. And hiring plans are definitely softening. They're not atrocious, but they are softening. So I still think we're going to see labor market weakness. I wouldn't say the April data was quite that and I guess that's where we're left. And you know what? Just let's save you the trouble; you can just repeat this next month, I guess, since it's been sort of a similar story for quite a while, Dave.

Well, let me support you a little bit more. I should do this probably more than I do on this podcast but as well, the two previous months in the US were revised downward for jobs and job openings have been declining quite rapidly. So yes, don't claim defeat on your forecast just yet and then even then you might be a couple of months off, which in economics terms is pretty much spot on. Right?

Yeah. And maybe the other key point— lots of key points here— is just that the labor market is not the leading indicator. Don't look to it to gauge recessions. We have business cycle tools that we recently revisited. They still say it's end-of-cycle. We have other metrics of economic momentum and they're okay. But there's a bit of sputtering happening and I'm hoping we actually get a chance to talk a little bit about loan officer survey and some lending conditions because that's actually saying something we think quite powerful as well. But the labor market is still sending that very mixed reading, not capitulating fully yet.

Well, if you're tipping questions for me on the podcast now, let me ask you about lending conditions in the United States?

Really great question, Dave. I'm glad you asked that. We really should plan a little more in advance, but nevertheless. I want to go here just because I would never want to hang my hat on one indicator, whether it be the number of jobs created or something else. And of course, there's a huge danger in anchoring to a certain view and cherry picking numbers that support you. I don't like to do any of those things. We like to take a broader picture. But I will say that when we go through our list of things that usually happen before recessions and things that, when they happen, almost inevitably mean a recession, lending conditions are in that list. And so here we are in a world in which interest rates have risen quite a bit over the last year and a half. And so that's been on the back of central banks and a few other things. And so, that does some damage to the economy and with a lag. And we're starting to see a bit of that damage manifest. And of course, banks are struggling. There's this other bank stress channel and that's starting to do some damage to lending as well. But in the middle, you have lending conditions— not so much the cost of lending, which is what interest rates largely convey—, but the availability of loans at any price. And loan officer surveys, particularly for the US— but not uniquely, we see this in Europe as well and a little bit in Canada—, but the US senior loan officer survey came out. It's a quarterly survey, and we've already seen a fair amount of tightening. Just so you know, even before the latest quarter, we were seeing, particularly for willingness to lend to businesses, that had already tightened a lot and was frankly consistent with a recession happening in future quarters. We continue to see more of that. It wasn't a huge leap, but nevertheless, as regional banks have struggled, we saw those lending standards tighten further. The willingness to lend to businesses has further tightened. The willingness to lend for commercial real estate, to no one's surprise, has tightened quite a bit. That's a source of concern right now in the US. The willingness to lend for mortgages and to consumers in general has also tightened quite a bit. And so, we are continuing to see lending standards tighten. Some people will say it tightened, but not as much as they thought it might, given bank stress. And I would say it tightened a lot in the prior few quarters. So I don't know how much more tightening you could get, to be honest. And so that doesn't disturb me too much. I still think it's evidence of weakness. But on the demand for loan side, this latest quarterly data show that the demand for a lot of types of credit has really come off too. Businesses don't have grand plans at this point, and the same on a number of other fronts. The one exception was consumer borrowing. That's still quite weak. It was just one of these slight tilts the other way. And so the debate there— and I don't have a perfect answer—, is the demand for mortgages rising, because the housing market seems to be stabilizing this spring and maybe even having a bit of a bounce to its step. And so that would be the optimistic take. The pessimistic take would be that consumers have been spending beyond their means for a while now and maybe they're having to tap credit to not run into trouble. I'm not quite sure how to take that, but I would say, on the whole, these lending standards are tightening a lot in a way that would normally take you to a recession, just like an inverted yield curve would and a number of other signals.

Yeah. It costs more to borrow. It’s harder to get the loan. So that just kind of grind. And lending and borrowing, that's sort of the oil that keeps the wheels turning, the gears moving in the global economy. So that would certainly be pointing to at least slowing down. And as you've been saying for some time, it’s much more likely that we do have a recession. Eric, are you still thinking that it's likely more of a shorter and shallower recession than the average recession?

Minimum than the last two, so versus 2020 and versus 2008-2009. There's no reason it needs to look like that, in our opinion. Mild to middling, by a longer-term historical standard, but nevertheless more of a classic business cycle recession or monetary policy induced recession, as opposed to the crisis kind of recessions that we've had more recently.

That would reset things, which is what a recession does. It takes that pressure, that over-heatedness out of the economy, and then you're left with probably pretty decent conditions for growth from that point on. You’d likely have slightly lower interest rates, and you'd get lots of things that are working in favor of some growth down the road. Right?

Precisely, that's right. Not that recessions are to be celebrated, but if you're a savvy nimble investor, they can represent an opportunity, and they are an opportunity for economies then to grow more quickly thereafter. They would right-size. They can then move more quickly. And so, we are forecasting pretty good growth in 2024 and 2025. And I should say— not that anyone cares about this but me— but don't get too hung up on the annual GDP numbers. If you look at an annual GDP forecast for 2024 right now, you'll see some pretty grim looking numbers. Our own forecasts are actually a weaker number than 2023, but it's totally because of handoffs and base effects confusing things that probably don't merit detailed discussion here. I would just say, if you look on a quarter-to-quarter basis, that's what matters. And on a quarter-to-quarter basis, we've already seen just modest growth in the first half of this year. We are forecasting decline in the second half of this year. So that's not a great 2023. For 2024, we're pretty consistent in looking, in the likes of the US and Canada, for 3% annualized growth per quarter. This is a 2%-growth world. Under normal circumstances, that's good. That's a real recovery. And so don't be put off by the idea that people are forecasting a number that's lower for 2024. It's really just because of the bad ending to the prior year and things like that. There should genuinely be a recovery, and it could be a fairly brisk one.

So, Eric, you've done some work on the banking. Again, I call it more of a hiccup than a crisis because of how aggressively regulators and central banks have attacked this to make sure that it doesn't become structural, that it doesn't spread out across the banking system, as we did in the global financial crisis. But when you did some digging, what did you find about small- and medium-sized banks in the US?

I've been using the word «stress», which I guess is probably a little more intense than «hiccup», but certainly not «crisis». Anyway, we could debate semantics, but we've had mid-sized US banks, the regional banks, as they're called, that have struggled, and several have failed. And there are others that are still struggling for the moment. Let's not downplay that. That is of some significance. And generally, when interest rates go up by a lot, some things break. And this is one of the things that has broken and it is part of the story of diminished availability of credit, and it will limit the economy. So, I don't want to downplay that nor suggest that we've seen all the banks that are going to have trouble, have trouble, because there do seem to be a few that are still wobbling. Though I think at this point, there's a pretty clear playbook in terms of what the government and what larger private banks will do in terms of seemingly stepping in, as per JPMorgan and First Republic, recently. But to answer your question, instinctively, I was nervous about small banks. We were seeing a lot of headlines about mid-sized banks. It seems like the big banks are okay, they're well capitalized, not as exposed, and they were already marking to market their bond portfolios and things like that. But it felt to me like, if the mid-sized banks are having trouble, can you imagine the small banks which have in general even more specific geographic exposure or even less liquidity or less capital? Of course, they're smaller and generally they're not going to be in investment portfolios because most of them aren't publicly traded. But nevertheless, small banks are an important part of the US economy and that would be an issue if they ran into trouble. To my surprise— and I'm not an expert on this; I can't cite thousands of names because there are thousands of small banks—, when we looked in actually at the liquidity of different-sized banks, it was the smallest banks that were the most liquid in terms of the average bank portfolio. When we looked at which size of bank had the most capital, it was actually the smallest banks that were looking quite good. They were holding more. The mid-sized were lagging, but it was the smallest that had more. When we looked at the fraction of deposits that were insured, it was, maybe not surprisingly, smallest banks, who have smaller customers but ultimately had larger fractions of their deposit base insured and therefore in theory immune to worry about problems. And when we looked at exposure to commercial real estate— because you hear and it's quite true that the commercial real estate sector is funded disproportionately out of the mid-sized banks, and I was assuming maybe small as well— but no, they have less exposure to commercial real estate too. And so again, I don't doubt there are mismanaged small banks, but it didn't seem like it was obviously the next shoe to drop or systemic issue there. I think the focus is rightly on the mid-sized banks. It is a tricky thing. I think we've talked before— and I'm sure you have Stu Kedwell on regularly to talk through these things at a more sophisticated level—, but when the Fed put in that liquidity program, it was a generous program, and it provided, in theory, enough liquidity, and it even papered over some temporary insolvency because it was lending money out at the par value of the bank's bond holdings, not at its diminished face value. All that is quite nice, I will say. One thing that struck me recently is that this is one of these multiple equilibrium situations. If the depositors say, oh good, this is a credible solution, it's done, then it is done. However, if depositors irrationally continue to pull their money out despite the availability of the liquidity and despite the availability of filling in any kind of capital deficit that temporarily exists as bonds work their way back to par, unfortunately, there is a second equilibrium, which is that it also makes sense to pull your money out if everyone else is pulling your money out. Because these liquidity programs, they're quite good, but they cost 5% a year to finance. That's a lot more expensive for a bank than the 0% they're paying on the checking account that was previously there. And so that begins to challenge things by itself. And then simultaneously, this program is good for a year and they could extend it, but nevertheless it's good for a year at this point in time. And realistically, if you're a bank that's lost half your deposits, that's an extreme case. But if you lost, you're not doubling your deposits over the subsequent year, particularly if you're a bank that's been marked as having trouble. And so I guess the takeaway is, in theory, the liquidity program was enough to stop bank runs, but in practice, it hasn't always been. And so it is still possible for banks to run into trouble. And we've seen one more do that since that program was put in place. And again, I'm not an expert on names, but it seems like there are a handful of others that could have a similar fate. But as I briefly mentioned earlier, it seems like there's a playbook here. We've got the FDIC swooping in and depositors are mostly being made whole and other banks are finding the terms that are available fairly attractive to absorb these entities. So I think it's okay. But maybe the useful way to think about it is just that it's another thing tightening lending standards. And this is a story that may have a multiyear trajectory. I don't know if it's quite a savings-and-loan situation that’d span a decade. Probably not. But mid-sized banks are not going to be in a position to lend as freely for probably a number of years as they rebuild their deposit base. It's not just a story of waiting till June first, and then everything is perfect. It is very much a lingering issue from an economic standpoint.

Yeah. And really important in what you just said, and what you've mentioned on previous podcasts, is the idea that there's a playbook in place. They have a very clear idea of how you backstop the financial system, coming from the experience we had in the global financial crisis, and then I think most importantly, it's not only that they know what to do, but they're doing it and they're doing it fast. And that just brings a different level of confidence versus dithering around and trying. Should or should we not? What's the moral hazard of doing this? It's like, look, let's make sure the deposits are covered, make sure the system is good, we'll worry about the after effects later. And that's not to dismiss those, but keeping the system whole is the most important piece.

I think that's right. And again, the magnitude of the problem is significantly less and you can say that, just objectively in terms of its mid-sized banks running into trouble— not giant banks—, there isn't the opacity of who owns what and what's it really worth and all these different mezzanine levels. It was sufficiently complicated in 2008-09. It was just hard to get a good read on things. And that spelled additional fear. And this is pretty straightforward. Banks have bond market losses and some of their customers are nervous and it's not an easy or perfect situation, but it's a whole lot clearer and the sums involved are quite a bit less. And regulators have learned some things. Clearly not quite enough in the sense that the deregulation in the late 2010s may have been ill advised in retrospect, in terms of the little less oversight that maybe was warranted. But nevertheless, it does feel like a different situation and you can establish that empirically too. You just look at bank credit spreads and okay, they're wider than they were as of late February to be sure, but they look absolutely nothing like what they looked like in 2008 and 2009.

Yeah. So just for the audience— because we've got a lot of very sophisticated people, investors who listen to this, but other people who are just starting out in economics—, what's a bank credit spread?

It could be any number of things. There are a number of ways of doing this. It could just be what's the credit spread on a bank when it borrows money in the bond market. Because bank fails and you don't get your money back and so the credit spread needs to compensate for that. And so that's a simple way. There are also credit default swaps, which literally is a bet on will this entity fail or not? And of course, the bet is higher than it was three months ago, but again it looks nothing like what it looked like during the global financial crisis. In fact, it looks like when people get nervous about banks every two years or so. That's the magnitude of the problem. Not a once in a 50-year event, which you could argue the global financial crisis perhaps was. And there are a few others as well. Basically, anything that is indirectly or directly gauging the credit worthiness of the banking sector is saying, yes, there's been some stress recently, but on the aggregate, at the industry wide level, it's still pretty straightforward going.

Excellent. Well, maybe we'll stop there, Eric. We've got a couple more things coming out later this week. In terms of numbers, we'll want to check back in with you, so we'll likely have you on pretty quickly. But that's a great synopsis of just an enormous number of things that are going on. Did the Vancouver baseball team win when you went?

No, they were utterly destroyed with a grand slam in the mix. But I had a ball. The tickets were cheap. That's maybe the most important thing for an economist. I'd bought tickets in the back row, but it turned out they flipped the map. I had tickets in the front row, so I was pressed against the screen. It was pretty fabulous. There were people preparing to bat who are making asides to us in the audience and things. It was a great time.

That's karma for all the hard work you're doing. And I've heard that Vancouver baseball experience is fantastic. I'm going to have to check that out when I get out there the next time myself.

Absolutely. Well, thanks for having me, Dave.

All right, Eric. Take care. Enjoy your trip to the castle, and we'll talk to you next week.

Okay, thanks. Bye.