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Hello and welcome to our video Macromemo. We have quite a bit to cover off this week. We'll talk about the general run of good economic news over the last few months, which has been well acknowledged. We’ll then talk a little bitabout whether perhaps there's too much optimism embedded in terms of assumptions about the future. There are still some real risks out there.

We'll spend a moment on China as its COVID wave seemingly abates and its economy seems ready to revive. I will do a quick run through the latest economic data, the latest recession thinking and the latest inflation data. We'll spend a moment on central banks, which are all queued up to raise rates in the next week or so. And we'll finish just with a thought about the U.S. debt ceiling, which could become relevant in the coming months.

Let's start with that run of good news and so really when you look back over the last few months, a number of very important things have gone right. I think the biggest is that inflation is falling enthusiastically, having been much too high previously.

Maybe secondarily, though, also very important is that China has abandoned its zero tolerance COVID policy and is now positioned for an economic revival. You've got smaller items like warmer weather in Europe and a successful energy pivot there that has resulted in a bit less economic damage than feared as access to Russian energy has diminished. And more generally, economic data has just held up a little bit better than had been expected.

So that's been a wonderful sequence of good news. You've seen risk assets more up than down. It's been quite a positive story. I don't want to discount that all of those things have happened. It has changed the dynamic to some extent, but I do wonder if there's a bit too much optimism out there right now.

And so one way of thinking about that is just to say we've gone from having really almost everything going wrong across much of 2022 and markets expecting everything to continue going wrong last fall to a number of things suddenly going right -- and markets now assuming that almost everything is going to continue to go right in the future.

The truth lies somewhere in the middle, we think. There are still some problems and risks ahead. There are some things that could go wrong. Recession is still more likely than not in our view, so that's probably the big one.

De-globalization is happening and that's a growth negative and inflation positive development, neither of which are ideal. China's reviving now, but it has some pretty serious structural constraints, we think. And a weaker U.S. dollar may get in the way, at least a little bit, of U.S. inflation continuing on its happy downward path. The U.S. dollar has been softer in recent months.

It does seem as though the war in Ukraine is getting messier. Russia has made some advances for the first time in the better part of a year. It's been deploying mercenaries who seem more effective than their standard troops. And Ukraine is warning of a major Russian offensive to come. So not a fully resolved situation there.

The other one, and it's just a risk, but we’re watching Japan quite closely. The risk of financial problems is greater than normal to the extent that Japan is allowing its rates to go up and it's not an entirely controlled process. And Japan has the highest level of public debt in the world as a share of GDP.

So there are some real issues here. Some of those could trigger, some of those could slow the rate of progress going forward.

Back to China: the country’s COVID numbers have been extremely high for the last month and a half after China abandoned its zero tolerance policy. As we had speculated, though, in the last video #MacroMemo, China does seem to have peaked. China seems to be now enjoying a decline in its infections, and the National Health Commission there has confirmed that in a number of ways.

They've said they see a significant decline in visits to fever clinics. The number of patients with severe symptoms is sharply lower. The number of people in hospital with COVID-19 is down quite a lot, with different competing estimates as to just how many Chinese people have been infected by COVID recently. One estimate from the University of Peking estimates 900 million out of the country's 1.4 billion have already been infected. So that would be a very significant fraction.

Others estimate numbers that are even higher. One province says 90% of its citizens have been infected already and it seems as though rural areas have also been infected. It has been a concern that they might get hit by a second wave. But no, it seems as though COVID has already raced through the bulk of rural areas also.

And so really what that means is that China's suffered quite a bit from a health perspective, but it's now in a position where its economy gets to start reviving. We are starting to hear anecdotes of people crowding into shopping malls and shopping. And we can see in real-time data that subway usage and things like that are starting to revive.

We are assuming pretty good-looking economic data starting in February. We are budgeting for a Chinese economy that grows 4 to 5% in 2023, which is a lot better than 2022.

Don't get me wrong, there are some real structural issues and structural restraints in China over the longer run relating to poor demographics, relating to a housing market that can't push forward like it once did, and relating to the Chinese government maybe wielding a little bit too much control over its corporate champions.

In fact, the government is increasingly taking a golden share in some of these big tech companies and exerting a very heavy influence over major decisions that could get in the way of productivity and innovation down the line. So we're still nervous about China long run, but in the short run, it's looking pretty good for 2023 now.

More generally on the economic side, well, I can say retail sales data is starting to soften after consumers were very keen spenders for several years. So we've seen, as an example, U.S. retail sales down for two straight months now. British retail sales were down fairly sharply in December as well. Appetite for durable goods and big ticket items seems to be starting to soften, though it's still higher than normal, but starting to soften as well.

Elsewhere in the economic space, we've seen industrial production weakening to some extent. We've seen a number of measures of international trade, both global and Chinese and U.S. and elsewhere, starting to cool as well -- and that’s seemingly a sign that global demand is weakening as well.

Canada’s a similar story. Not every indicator aligns on the same side of the ledger, but I would say most do. Most are consistent with a slowing Canadian economy, including a Business Outlook Survey from the Bank of Canada, which shows a significant increase in expectations of economic decline to come, decelerating plans to hire and invest as well.

So in general, we're getting an economic deceleration story. It's been least visible in the job numbers. But even there we can say as an example that temporary employment figures are starting to weaken. Often that predicts declines in permanent employment.

Turning to recession thoughts and musings and so on, I'll just share a few disparate thoughts here. The first one is that a recent Conference Board survey in the U.S. finds that 98% of U.S. CEOs surveyed expect a recession in the relatively near future. So that is a near unanimous view. And so another recession is more likely than not.

We've been thinking a lot about this concept of a stall speed. This is really the notion that historically, at least from about 1950 to the early 2000s, 10 of the 11 times the U.S. economy grew by less than 2% a year. It fell all the way into a recession. It just wasn't possible to grow at 1% sustainably.

When the economy was moving slower than normal, people noticed. People got nervous. Businesses changed their plans. So you ended up getting a recession just because people could see that things weren't quite normal. I don't think the 2% stall speed applies anymore. Two per cent these days is a pretty good rate of growth.

And so our suspicion is the stall speed is slower than it once was. Maybe it's 1% today. But I mention all that just because you see a lot of forecasts out there from central banks, from some of the more optimistic private sector economists that expect the U.S. economy and a lot of developed world economies to bottom out in the realm of 0.5% economic growth.

And I'll just say it's may not be impossible, but historically it's been very unusual for something like that to happen. Normally, when the economy softens palpably below normal, it starts to stall out and people change their behavior and you get a full-fledged recession with outright negative GDP prints. And so we would make that comment. It's going to be hard to achieve a soft landing here. It's significantly more likely that you get a recession.

The other recession related thought is just from a timing perspective. I think we've all been pleasantly surprised that a recession hasn't come together quite yet. It's taking a little longer to congeal than initially expected, and maybe we shouldn't have expected it to have come so quickly. It's been well documented that from the first rate hike it takes up to 18 months for that effect to be felt.

And of course, we've had hikes regularly across the last year, so it will take the better part of this year for that impact to be felt. But beyond that, we can see as well when yield curves invert. This is something that happened across the curve over the last six months or so. When those invert, there is normally a significant lag to the start of a recession as well.

And when we look at those metrics, it actually argues, I should say they actually argue that we should expect a recession in the realm of September of this year. And so the fact that we're not in one right now doesn't mean we're avoiding a recession. It probably means that we're still waiting for it to manifest a little bit later.

Okay, let's talk inflation. So inflation, of course, the story in recent months has been broadly good news. I think it's fair to say that's still true. Most developed countries are still reporting falling inflation and small business pricing plans continue to fall. So they're going to pass through fewer price increases down the road. And when we look at the consensus inflation outlook for a whole range of countries, actually in the month of January, we saw the most inflation forecasts revised downward that we've seen since 2020.

So really ever since inflation picked up, this has been the best month for people pulling their forecasts down as opposed to up, which seems quite positive. I will nevertheless admit there are a few potential risks or complications to the inflation improving story. One would just be if the war in Ukraine intensifies, there is the risk that energy prices get affected again.

Another is that as the Chinese economy revives the prices of base metals and energy prices in particular have some upside risk as China buys more of those things essentially. And the third one is really just acknowledging that as much as inflation is getting better, some of the improvement is artificial. And I say that just in the sense that we saw artificial price gains when there were shortages of available vehicles and when gas prices went through the roof and these sorts of things, we're now seeing those artificial things unwind, which is perfectly reasonable, it's fully expected.

And so that's quite nice. But it's equally worth acknowledging that this is not a sustainable proposition. We're going to unwind the excessive increase in car prices and some of these distortions that happened, and then we're going to stop doing that. And at some point, inflation needs to be soft, even without the help of artificial things that are going negative.

And just to give you a bit of a flavor, for instance, over the last six months in the U.S., overall inflation is average .15 percent per month, which is pretty soft. That annualized is to less than a 2% rate. But if you start to exclude some of these artificial deflationary forces and look, for instance, at core inflation, which isn't a perfect gauge, but nevertheless you've seen that average about 0.38% per month over the last six months.

That's a four and a half percent inflation rate. So the way to think of this is, well, inflation is trending as though it's sub 2% right now, but for artificial reasons, if you got rid of or when those artificial reasons and it's still running in the 4-5% range, there's still some more work to be done, I guess is the point before we can say that inflation is well and truly vanquished once those artificial distortions are gone, a quick thought on central banks, they are busy.

They are lined up to make decisions. In the very near term, as I record this. So the Bank of Canada goes on Wednesday of this week with a 25 basis point hike lightly. A pause is possible, though thought to be less likely. The Fed, the European Central Bank, the Bank of England all go in very early February and are all expected to raise rates.

The Fed in the US by a quarter percentage point in Europe and the UK by 50 basis points. And so we're still seeing monetary tightening, but it's getting very close to the finish line. Bank of Canada might well actually be done by the end of this week. The Fed might have a few more months, but it's within sight of the finish line as well.

A last very short thought for me on debt ceiling. So the US has a debt ceiling at the federal level. That means that they need to explicitly approve the ability to borrow more money. And to the extent the US has been in chronic deficit for 20 years, it regularly has to borrow more money. If you don't raise your debt limit, you end up defaulting on interest payments and defaulting is never a good thing.

So it's a high stakes event. We've actually technically hit the debt ceiling in the last week, but accounting tricks at the Treasury allow them to keep chugging along for a few more months so they can probably get to early June without actually defaulting. Historically, the two parties agree and raise the debt ceiling. That's happened 78 times since 1960.

This one could be more contentious than usual. Republicans have more power than they have had in a few years. There have been threats made already. Really what we want to do is to avoid the 2011 near-miss when the stock market fell by 15% and bond yields collapsed and the US debt rating was downgraded by Standard and Poor's. Never did get upgraded later.

And so I mentioned all that to say that the risk of that isn't zero right now. We think it's more likely that the Democrats make some concessions and the Republicans get some goodies and ultimately the debt ceiling goes up. But it could be a fairly messy and a little bit scary affair over the next six months as we get to that point.

All right. I'll stop there. Thanks so much for your time. I hope you found that useful and interesting. And please tune in again next time.