China is in quite an unusual position in 2023 in the sense that we think most of the world will be slowing, perhaps even succumbing to recession. But China is reopening. It kept its zero-tolerance policy until very late in 2022. Upon abandoning that, it went through quite a wave of infections and it's now emerging from that. And we can see in the real-time economic data that China is bouncing economically. We can see that the traditional numbers are starting to revive as well. And it seems reasonable to expect faster than normal growth for China this year as a helpful counterweight to weakness elsewhere in the world.

Now, we do need to set expectations correctly, and so we're forecast Chinese growth of 5.3% for 2023. That's pretty good. It's better than the sub 3% growth China managed last year. But all the same, it's actually no more than what would have been deemed an average year before the pandemic. It's worth acknowledging the recovery, celebrating that, recognizing the pent-up demand that may be unleashed there. But at the same time, recognizing that China does have some structural challenges that, if anything, intensified in recent years. And those are frictions with the U.S. and parts of the western world. So the geopolitical picture is a more challenging one for Chinese growth going forward. The Chinese demographic picture is famously difficult with a shrinking population now that does limit growth to some extent. The housing market was in bubble conditions for a long time, driving the economy forward. It's stabilizing now - we think some of the worst things are over there, but it's not going to be the driver of growth that it once was.

China also seems to be favoring the state over the private sector right now. And so that doesn't lend itself to fast productivity growth. And so we can celebrate the 2023 rebound. I do suspect over the long run, China might be a 3 to 4% growth kind of country, which is a lot less than it used to manage.

We're still looking for recession across much of the developed world in 2023. And the logic behind that is really, essentially, that we've seen a big interest rate shock. Interest rates have gone up by quite a lot and it would be quite unusual to avoid recession after a rate increase of that magnitude. We do cross-check that idea. And so, for instance, we run a recession scorecard looking at different heuristics that try to assess whether a recession is coming. And I can say fully half of them are giving a firm “yes” and about a quarter of them are saying “likely.” And so we think indeed, a recession is more likely than not in the realm of maybe a 70% chance.

Our business cycle work makes similar claims, saying it's an end of cycle moment right now, which would suggest that a recession should arrive within several quarters. We're seeing a number of indications like that. And we can tell that higher interest rates are starting to bite because housing markets have been weak and lending standards are now tightening significantly.

I should emphasize that we think any recession should be fairly brief - a few quarters. I can say that we believe the recession might arrive a little bit later than we were previously assuming. We have it penciled in for the second half of this year instead of the middle of this year, as we previously assumed. That's a reflection of some economic resilience in early 2023. But at the end of the day, recession is more likely than not. It might be a more useful recession than many, to the extent it helps to right size the housing market and get rid of some excesses from an overheating economy. But ultimately, a recession is what we look for.

Maybe the last thought is just to share that, keep in mind, recessions are temporary. They don't last forever. We are budgeting for a pretty good-looking economic recovery in 2024. And so, there is a light at the end of that tunnel.

We feel pretty confident that inflation has peaked. In fact, we think it peaked around the middle of 2022. There's been a notable decline since then. To be sure, this has been and will likely remain quite a choppy process. There will be months that don't cooperate and months that hopefully do. Let's recognize there is, I would say, more uncertainty than usual around the inflation outlook right now. I don't want to pretend that we can pinpoint exact numbers. And it is worth keeping in mind alternative scenarios to the base case, including, for instance, the fact that as the Chinese economy reopens, it could spur a bit of commodity-based inflation. As the war in Ukraine and Russia drags on, there is the risk of energy prices rising. So you could imagine some scenarios pointing in that direction.

But I think more fundamentally, the four big drivers that created such problematic inflation in 2021 and 2022 - those have all turned to varying degrees. And so the commodity shock has significantly faded. To the extent economies weaken, we might get a little bit more help on that front. Supply chain problems I wouldn't say are completely gone, but they are almost completely gone. There's been a huge improvement on that front. Central banks have gone from extreme stimulus during the pandemic to pretty substantial restraint at this point in time. And so that's been more than a full unwinding of support. And government spending isn't quite as generous as before.

So we think it makes sense that inflation comes down. We actually have a slightly below-consensus inflation forecast. We're slight optimists on that front. When we look at the trajectory, we think we can get down to 3% or even a little bit below inflation toward the very end of the year. I will warn that we're not forecasting normal inflation tomorrow, or the next day, or the next month. We are aware wage growth is going to take some time to settle.

We're aware that inflation got so broad, it's going to take time to unwind. That might be a bit of scarring from the recent experience. But ultimately we feel pretty good about the idea that inflation can significantly decline, if not quite all the way to 2%.

Let's be clear that the U.S. government has enough money in a general sense to continue servicing its debt, and I don't think there's any serious talk of the U.S. fundamentally not being able to pay for all of its debt. But there is the matter of the debt ceiling, which is just a rule that says the government can't borrow money unless Congress says that it can. And there is a real battle brewing on that front.

We think the debt ceiling likely gets hit around the middle of this year. And now that it's a divided Congress, with Republicans controlling some elements of the government, they have promised it will be something of a battle. Republicans would like to reduce government spending to some extent, and the Democrats don't particularly like that.

And so we can look back to the 2011 experience, which was the last time something like this happened, and it was temporarily messy affair. We had bond yields falling at that time. We had stock prices falling. There is room for some level of trepidation by markets as we deal with this next debt ceiling. And it's one of the downside risks we're thinking a lot about for 2023.

But I do want to emphasize, at the end of the day, the risk of an actual technical default is fairly low. In fact, markets are assessing about a 1% chance of that. And even if that 1% or so probability transpired, keep in mind that the expected recovery rate, the money that you'd get back later if you were investing in U.S. Treasury debt, would be pretty close to 100%.

And so no one is all that seriously thinking that there is permanently money to be lost. It's more a situation in which it could get messy. We will see U.S. political polarization on display and markets could gyrate for a period of time. But perhaps one would view that as an opportunity, to the extent it is likely to be inherently temporary.

For several decades, the global economy was driven forward in part by globalization. By accelerating trade, and companies finding cheaper places to make things, and more markets in which to sell things. But that globalization trend really slowed significantly over the last decade. And tentatively, we can say, it seems now to actually be slightly reversing. So that means trade growth is now underpacing economic growth.

We have a pretty good sense for why that reversal has happened. Some of it is simply because the low-hanging fruit of trade was already plucked. That is to say that we're seeing a great deal of integration already and so on, and there wasn't much room for more of that. But I think more acutely and more recently, we are now seeing pressures in the opposite direction.

For instance, many of the world's big, powerful nations are experiencing large frictions with one another. China and the U.S. not getting on as well. Russia subject to sanctions, tariffs rising to some extent, industrial policies on the rise as well.

And so we're in a situation now in which globalization does seem to be in at least slight reverse and on-shoring is happening where companies start to produce more in their home markets. We see ‘friendshoring’ happening, which is really just shifting production, perhaps still internationally, but to more friendly, more ideologically aligned nations. You see nearshoring happening, which involves shifting to countries close to one's home country so to have easier access and maybe reduce on transportation costs. All of these things are happening right now. They're actually happening a little faster than we've been assuming at one point.

To summarize, it is net negative for China, to the extent China is on the losing end of some of these things. It is a net benefit to the likes of India, Vietnam and Southeast Asia, and perhaps Mexico as well. So winners and losers. But ultimately, as globalization goes into reverse, we talk about the global economy moving a little bit less quickly and inflation running a little bit more quickly. Neither of those are particularly attractive attributes, but that's likely to be the trend for the foreseeable future.

The Canadian housing market has suffered over the last year or so. That's not a particular surprise to the extent that interest rates have gone higher and housing is the ultimate interest rate-sensitive sector. And it's not unique to Canada either. We've seen housing markets weakening almost everywhere. When we look at housing resales in Canada, they've fallen quite a ways. It's in the realm of about as weak as we've seen since the turn of the millennium. When we look at national home prices, they're down by around 15%, which is quite a substantial decline. We think there's a little further to go. We think ultimately, home prices will fall 20 to 25% from their peak to trough, though I will admit that's a national number and it's not very helpful for people living in individual cities. And we see more weakness as an example in the likes of Ontario and British Columbia, significantly less so in markets like Alberta and Newfoundland. So it really does depend where you are, and implicitly, how much your home prices rose over the prior several years.

Now, a 20 to 25% home price decline is large, clearly by any sort of measure. And yet it's not that large, in the sense that that does not envision a full reversal of home prices from, or rather to, pre-pandemic levels. I guess the reason behind that is simply that Canada still has very strong population growth that's mostly immigrant driven. And as a result, it really isn't a situation in which we can realistically talk about historically normal affordability levels returning. We think it's likely to remain a market that is more expensive, I suppose, than the average.

And maybe looking more generally and explaining why we don't think housing stabilizes quite yet. That's a statement that we've seen some stability recently, but the story might not be fully over, is partially one in which a lot of people still haven't been exposed to the higher mortgage rates out there. They're rolling into them. So there's still some pain to come. And the other one is simply that as we forecast the economy, we think a recession is more likely than not. That’s usually a reason for housing softness as well.

Again, we look for a little further housing softness, but maybe not a return to historically normal kind of levels. That is a restraint on the Canadian economy. And it's a reason why the Canadian economy might underperform the U.S. through any kind of recession, because we're hit a bit harder by those housing factors.