Economic webcast and key themes

Our monthly economic webcast for February is now available here: “Good news dominates, but now too much optimism.”

Indeed, it is worth dwelling on that theme for a moment. There has been more good economic news than bad recently:

• Inflation is falling nicely.
• China reopened not just early but more fully than expected.
• Europe appears to have enough natural gas for the winter.
• Employment data remains wildly strong.
• Financial conditions have eased somewhat.

But we warn that sentiment may have shifted too far from pessimism to optimism. In our view, a recession is still likely, inflation is likely to cooperate but not yet fully vanquished, and there several elevated downside risks in the near term:

• China’s economic rebound could stir commodity prices, complicating the declining inflation narrative. The same goes for recent U.S. dollar weakness.
• There is a considerable risk that the war in Ukraine intensifies further, also boosting inflation at an inopportune moment.
• The labour market could remain stubbornly overheated, forcing more monetary tightening and a worse economic trajectory later.
• Heavily indebted Japan is exposed to considerable financial risks as it begins the process of abandoning extreme monetary stimulus.
• The U.S. debt ceiling could become problematic mid-year.

Not all of these risks will trigger, but some could. Accordingly, a degree of caution remains advisable.

Ukraine war threatens to intensify

The war in Ukraine grinds on and threatens to intensify. In contrast to last fall, when Ukraine was advancing, Russia now appears to have the momentum, with small gains reported.

Ukraine continues to warn that Russia may launch a significant invasion around the February 24 one-year anniversary of the war. An estimated 500,000 Russian troops are ready to attack. The Institute for the Study of War – which has carefully monitored the war from the beginning – predicts an “imminent offensive.” Russia apparently wants its troops to capture the entire Donetsk and Luhansk provinces, though the viability of this goal is viewed skeptically by analysts on both sides.

The West continues to commit ever more weapons to Ukraine. Details are now being negotiated for the provision of fighter planes, with tanks already largely secured.

The bottom line is that the war is more likely to intensify than ebb. The economic consequences of an incremental intensification are fairly small. Russia has already been hit by a comprehensive set of sanctions. But it remains prudent to assume that each incremental intensification will bring with it some further severing of the macro connection between Russia and the West. Consistent with this, Russia recently announced that it will reduce its oil production by 500,000 barrels per day in March – about 5% of its overall supply.

Moldova has recently been in the spotlight in the context of the war in Ukraine. Moldova is located immediately to the west of Ukraine and is Europe’s poorest country. The country’s pro-European Union Prime Minister recently announced her resignation, blaming a series of crises caused by Russia’s war on Ukraine. This is somewhat worrying, as Russia is thought to aspire to greater control over Moldova, and indeed already effectively controls the rogue province of Transnistria. However, the next Prime Minister is also expected to be pro-European Union, so the consequences of the transition may not ultimately be that great.

Finally, the risk of nuclear war has risen somewhat as Russia has engaged in a proxy war with the West and threatened to deploy its nuclear arsenal. It is worth checking in at this time with the Bulletin of Atomic Scientists, which assesses major threats to humanity via its Doomsday Clock. This was set at an ominous 7 minutes to midnight upon its origination in 1947. Since then, it has ticked backwards and forwards, but mostly closer to midnight. The clock was most recently advanced to just 90 seconds to midnight on January 24, largely due to concerns about Russia.

Two caveats are in order:

1. The Doomsday Clock has been unrelentingly pessimistic across its entire existence. One might even posit that it was grossly mis-calibrated upon its initiation given that only 1.2% of the theoretical 24-hour range has ever been used over its 76-year existence.
2. The clock is now also used to convey warnings about non-nuclear existential threats including climate change, biological threats and disruptive technologies.

Despite these caveats, it is fair to say that nuclear and broader existential risks do seem greater than normal right now, even if 90 seconds to midnight seems an extreme assessment of the risk.

China’s economy in recovery

First, a quick word on balloons, though not the party kind. The U.S has now shot down four alleged Chinese spy balloons over North America in recent days and retrospectively identified several others. Now, China claims that the U.S. has flown at least 10 spy balloons over China.

Regardless of the precise details and motivations, it is fair to conclude that tensions are mounting again between China and the U.S. in a way that more than unwinds a small détente over the prior month. As such, the de-globalization theme remains fully intact and could proceed at a slightly faster pace.

For all of the excitement the balloons are eliciting, the most important economic subject in China at present is the extent to which activity is reviving as the COVID-19 wave fades. By most accounts, the COVID-19 wave continues to recede, with around 80% of the population infected since December. Happily, The Lancet reports that no new COVID-19 variants have yet been detected. There was a considerable risk of that outcome as one-sixth of the world’s population was exposed to the virus in short order.

China’s economy is now significantly reviving, as demonstrated by a sharp rebound in traffic congestion and subway traffic (see next two charts). The interpretation of these is admittedly blurry given that Lunar New Year festivities in late January likely contributed to the rebounding. But the fact that subway traffic is now at its highest reading in more than a year makes a strong case that activity has not merely returned to pre-holiday and pre-wave levels, but actually represents a genuine normalization of mobility after a long era of restrictions and fear.

Chinese traffic congestion index rises

As of 02/08/2023. Congestion Index measured as 7-day moving average of weighted average of daily peak congestion levels and numbers of vehicle registrations in 15 cities with highest number of vehicle registrations in China. Source: Baidu, BloombergNEF, RBC GAM

Subway traffic in major Chinese cities rebounds

As of 02/12/2023. Index is the weighted 7-day rolling sum of subway trips to Beijing, Chengdu, Chongqing, Guangzhou, Nanjing, Shanghai, Suzhou, Wuhan, Xi’an and Zhengzhou. Source: Chinese metro agencies, Macrobond, RBC GAM

Anecdotes abound of people beginning to emerge from their apartments and returning to restaurants, shopping malls and movie theatres. In fact, China’s holiday movie theatre sales were the second best on record and better even than 2019 – the most recent pre-pandemic year.

There is still space for hotel bookings, sightseeing and other forms of activity to revive further. Goldman Sachs estimates that early-acting Chinese cities have already returned to full mobility, while laggards could take until March or April.

Consumer spending should be a source of strength over the coming year, contributing to our recently upgraded 2023 Chinese growth forecast of +5.3%. Housing should also stabilize.

That said, for all of the theoretical pent-up demand in China, it would be best not to expect fireworks on the scale of the developed-world reopening over 2020—2021. China was not really locked down for three straight years. In fact, for much of the time period, China was among the least restricted countries in the world (notwithstanding international and regional travel restrictions). Chinese citizens were happily shopping in malls while the rest of the world went through repeated COVID-19 waves. To be sure, some cities and neighbourhoods suffered fierce lockdowns sporadically over the three years. But the point is that China does not have three years’ worth of spending waiting to be unleashed in a single deluge.

Economic signs of strength 

The number of commercial flights globally has finally returned to pre-pandemic levels, presumably aided in part by the recent reopening of China (see next chart).

Global commercial flights tracked by Flightradar24 increase

As of 02/10/2023. Include commercial passenger flights, cargo flights, charter flights and some business jet flights. Source: Flightradar24 AB, RBC GAM

North American hiring remains astoundingly strong. U.S. payrolls added a huge 517,000 net new workers in January, paired with positive revisions of 71,000 extra workers in prior months. That took the unemployment rate from 3.5% to 3.4%, its lowest reading in more than 53 years.  At the same time, hourly earnings fell from 4.8% to 4.4% on an annual basis. This suggests that a full-on wage-price spiral is unlikely despite that strength.

The story was similar in Canada. The country added a herculean 150,000 new jobs, 121,000 of which were full-time. That kept the unemployment rate at a very low (for Canada) 5.0%. A twist in Canada is that much of the strength came from the retail and wholesale trade category. Normally, such employers are shedding workers after the holidays, but the seasonally adjusted nature of the official release normally conceals that. Perhaps they simply opted not to lay off these extra workers this time as those workers represent a solution to longstanding staffing shortfalls. Whatever the reason and seasonal complexities, this still adds up to more employment than otherwise.

The market’s interpretation of this employment strength wasn’t entirely welcoming. Equities sold off and bond yields rose in response to the U.S. release. This response was motivated by the view that the economy will continue to overheat and so will require yet more monetary tightening to tame inflation. This will have the effect of eventually hurting the economy and corporate earnings.

Temporarily, what’s usually good is now bad.

We continue to monitor (some might argue obsessively) various signs that the labour market, for all its strength, is starting to soften. Examples include the fact that announced job cuts are rising palpably (see next chart). Conversely, our index of hiring intentions is steadily ebbing, albeit from a strong level (see subsequent chart).

U.S. job cuts announcements surged recently

As of January 2023. Source: Challenger, Gray & Christmas, Inc., Macrobond, RBC GAM

Hiring intentions are good but falling

As of December 2022. Hiring intentions index based on combination of seven surveys of hiring intentions. Source: Macrobond, RBC GAM

Meanwhile, temporary employment has now fallen for five consecutive months. It usually only falls significantly before a recession (see next chart). The logic is that companies will shed their temporary workers first as these are the easiest to disengage with, followed by permanent workers later.

U.S. temporary employment share has been declining

As of December 2022. Shaded area represents recession. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

Elsewhere, economic strength was visible in U.S. Gross Domestic Product (GDP) Q1 2023. We now anticipate a solid 2% annualized increase. Be warned that it is still early in the quarter, however.

The Institute for Supply Management (ISM) Service Index for January also managed a large jump. This completely unwound the large drop reported in the month before. It is now back to a level consistent with moderate economic growth.

Consumer spending has been more good than bad in recent quarters, though evidence of strain is mounting. Not only is the U.S. personal savings rate now significantly lower than before the pandemic, but credit card borrowing has increased by a substantial 15% over the past year (see next chart).

U.S. credit card balances are rising

As of Q3 2022. Source: Federal Reserve Bank of New York, Macrobond, RBC GAM

Some theorize that January represents a temporary last hurrah for spending because North American pensioners enjoyed a large upward inflation adjustment in their government cheques in January, unleashing a one-time jump in spending.

Meanwhile, the ISM Manufacturing Index, historically the better predictor of the economic cycle than the ISM Service Index, continues to ebb. At a 47.4 reading, it is now even further below the 50 threshold delineating growth from contraction. The new orders component is now just 42.5.

Our index of U.S. business expectations has fallen to the point that it is now weaker than it was at its 2020 trough. This is entirely in line with a recession (see next chart). The story is similar in Canada (see subsequent chart and note inverted scale).

U.S. business expectations composite has fallen

As of December 2022. Principal component analysis is using National Federation of Independent Business optimism and business conditions outlook, ISM Manufacturing and Services new orders and The Conference Board survey of CEO expectations for economy. Source: The Conference Board, ISM, NFIB, Macrobond, RBC GAM

Canadian firms increasingly expect sales to fall

As of Q4 2022. Source: Bank of Canada Business Outlook Survey, RBC GAM

It might be simplest to summarize the economic signals as employment remaining sunny with some ominous clouds in the distance, the service sector holding up for the moment, consumers spending normally but showing themselves to be increasingly stretched, business expectations turning increasingly grim, and housing suffering (more on that later). It is a complicated world!

New growth forecasts

Our new interim growth forecasts are available (see next table). There are three key themes.

1. We have mostly upgraded our 2023 growth forecasts relative to a quarter ago. This is for a range of reasons including the fact that inflation is falling nicely, China reopened more quickly and the labour market is holding together. But it is also because we have delayed the timing of the presumed recession from early 2023 to mid-2023. That has the mathematical effect of making the 2023 growth forecast look less bad.
   
   
2. Our new forecasts now straddle either side of 0% growth. For instance, the Eurozone and U.K. remain firmly in recessionary territory, with -0.2% and -1.2% 2023 growth forecasts, respectively. However, our Canadian forecast is now for 0.0% and our U.S. forecast is for +0.1%. That doesn’t mean we have abandoned the recession call for North America. The forecasts for both countries still contain a few quarters of shrinking GDP. But the way the quarters now add up leaves a flat to slightly positive annual reading.


RBC GAM Q1 2023 forecast as of 01/26/2023. Change versus prior quarter. RBC GAM vs. consensus calculated as RBC GAM forecast minus December 2022 Consensus Economics (CE) forecast. Source: Consensus Economics, International Monetary Fund, Macrobond, RBC GAM

3. Despite the upgrades, our forecasts are still mostly below the consensus. The consensus has also moved somewhat higher recently (see next chart). This is to say, we look for a slightly worse forecast than the market, which continues to represent a partial motivation for our more cautious investment positioning than in late 2021.

U.S. consensus growth forecast is bottoming

As of January 2023. Source: Consensus Economics, International Monetary Fund, RBC GAM

Incidentally, and not depicted in the table, our forecasts anticipate a fairly robust economic recovery in 2024, with many developed countries averaging approximately 3% annualized growth per quarter. However, you wouldn’t know this from the annual growth forecasts, which mostly sit in the realm of +1.5% for 2024 due to an unusually negative base effect from the weak second half of 2023.

Recession risk still elevated

Despite recent mixed economic data, we continue to believe a recession is more likely than not for most of the developed world in 2023. There are a few ways to objectively assess this likelihood.

Several recession models give the impression of a higher than normal recession risk over the year ahead. One such is the New York Fed’s yield curve recession model. It now argues that the recession risk is the highest it has been in four decades (see next chart). Furthermore, the assigned probability has never been this high without triggering a recession.

Yield-curve based U.S. recession risk skyrockets

As of December 2022 for NY Fed model, RBC GAM estimates as of 02/01/2023. Probabilities of a recession 12 months ahead estimated using the difference between 10-year and 3-month Treasury yields. Shaded area represents recession. Source: Federal Reserve Bank of New York, Haver Analytics, RBC GAM

The Philadelphia Fed’s survey of private-sector forecasters shows the largest fraction predicting negative GDP growth since the global financial crisis (see next chart). The reading has not been this high in the past four decades without a recession occurring.

Probability of a negative GDP growth from private forecasters rises

As of Q4 2022. Mean probability of private forecaster’s estimates of negative growth in annual average real Gross Domestic Product (GDP) in the following calendar year. Shaded area represents recession. Source: Federal Reserve Bank of Philadelphia, Haver Analytics, RBC GAM

Our own econometric model combines financial market and economic variables. It argues that the recession risk has recently declined fairly sharply (see next chart) due mainly to happier financial market variables. However, the risk is still elevated relative to normal, and there is no episode within the past half century in which the probability rose as high as it did a few months ago without a recession arriving shortly thereafter.

Probability of U.S. recession within a year is declining

As of December 2022. Based on RBC GAM model which includes financial and macro factors. Shaded area represents recession. Source: Haver Analytics, RBC GAM

Business cycle

Meanwhile, the business cycle continues to subtly advance. Our updated U.S. business cycle scorecard has delivered an ‘end of cycle’ reading for a third consecutive quarter, with the interpretation that a recession is likely to arrive within the next few quarters (see next chart). Interestingly, the second-most likely interpretation in the scorecard is now ‘recession’ rather than ‘late cycle.’

U.S. business cycle score continues to read ‘end of cycle’

As of 02/03/2023. Calculated via scorecard technique by RBC GAM. Source: RBC GAM

Intriguingly, the ‘start of cycle’ signal also strengthened noticeably this quarter. Certain notoriously jittery variables such as the direction of the stock market, sentiment and volatility became more positive over the past quarter, enhancing that claim. Our risk appetite index exemplifies this interpretation (see next chart). This is an intriguing possibility: that the worst is already over and the economy could be starting its next expansion. While conceivable, we shouldn’t put too much weight into this because ‘start of cycle,’ while strengthened, is merely the fifth most likely out of six possible categories.

Investor appetite has rebounded a tad

As of January 2023. Measures risk appetite based on 45 normalized inputs. Grey area represents recession. Source: Bloomberg, Bank of America Securities, Consensus Economics, Credit Suisse, Federal Reserve Bank of Philadelphia, Ned Davis Research, Haver Analytics, RBC GAM

A sampling of key inputs to the business cycle scorecard:

• The U.S. Conference Board’s leading economic indicator has turned downward to a degree not witnessed outside of a recession (see next chart).

U.S. leading economic indicator has turned

As of December 2022. Shaded area represents recession. Source: The Conference Board, Macrobond, RBC GAM

• Credit standards for lenders of U.S. commercial and industrial loans have tightened more than at any other point in the last 30 years, outside of a recession.
• Demand for recreational vehicles (RVs) has fallen to a nearly unprecedented degree (see next chart).

U.S. RV shipments as predictor of recession

As of December 2022. Annual data before 2017. Shaded area represents recession. Source: RV Industry Association, RBC GAM

Recession depth

As we revise our economic forecasts incrementally higher, the anticipated recession technically migrates from a ‘medium recession’ to a ‘mild recession.’ But the difference should not be overstated, as the movement was quite small.

We define a mild recession as a 0.0% to 1.5% peak-to-trough decline in real economic output. A medium recession is a 1.5% to 3.0% decline, and a deep recession is a 3%+ decline.

It just so happens that our U.S. forecast was upgraded from -1.6% to -1.4%, barely crossing the threshold between a medium and mild recession. But the implications are essentially the same.

European double impact

The European economy has revived slightly over the past quarter as natural gas prices have fallen (see next chart). European economic surprises have turned positive, meaning the region has been more resilient than expected.

Eurozone Composite Activity Index revives slightly

As of December 2022. Index reflects the first principal component from PCA analysis on select indicators of Eurozone economic activity. Shaded area represents recession. Source: Center for Economic and Policy Research, Zentrum für Europäische Wirtschaftsforschung (ZEW), Deutsche Bundesbank, IHS MarkIt, Macrobond, RBC GAM

Eurozone’s fourth quarter GDP print arrived and rose by a small +0.4% annualized. Many are claiming that this means Europe has avoided recession and it is clear sailing from here. In our view, the final word has not yet been written on the subject.

It is helpful to think of the Eurozone economic trajectory in the following way. The natural gas shock was apparently not quite large enough to induce a Eurozone recession (see next chart). However, the interest rate shock is still building, both because the European Central Bank is not yet done tightening and because there are significant lags in how higher interest rates interact with the economy. It is still quite reasonable to expect a separate interest rate-induced recession later in 2023.

Eurozone is not out of the woods yet

As of Q4 2022. RBC GAM forecast as of 01/26/2023. Source: Eurostat, Center for Economic and Policy Research, Macrobond, RBC GAM

For that matter, even if the Eurozone were to avoid a domestically induced recession, it would be uncharacteristic for the bloc to dodge a recession if the U.S. succumbs to one.

The most anticipated recession in history?

This is arguably the most anticipated recession in history. The Conference Board CEO Confidence Survey has 98% of business heads predicting a recession. Fully 85% of banking CEOs anticipate a recession according to the KPMG Banking CEO Outlook survey. Most economists also anticipate a recession according to several surveys.

The question is whether this expectation makes an actual recession more or less likely.

Arguing a recession is less likely when it is anticipated, any coming economic deceleration won’t be a surprise, meaning that households and businesses should be able to avoid the kind of abrupt or even rash movements at that juncture that would otherwise turn a mere slowdown into a recession.

Furthermore, with the knowledge that a recession is likely, households and companies should theoretically be behaving more prudently in the quarters leading up to the recession, avoiding the excesses that make recessions especially deep.

But that isn’t the only way of thinking about an anticipated recession. One can alternately argue that anticipating a recession makes it more likely. With so many companies anticipating a recession, surely that means they will cut back on their spending, inducing a recession even if none was strictly necessary. An anticipated recession will also drive the stock market down and credit spreads wider, making a subsequent recession more likely.

Both sets of arguments are perfectly rational, with one force significantly neutralizing the other. We’d be inclined to argue that a recession becomes slightly more likely when it is anticipated, but not with great conviction.

Inflation receding

Inflation continues to recede, albeit fitfully. This is wonderful news given the gloomy spell that high inflation has cast over markets and central bankers.

However, all is not settled yet. Recent strong employment data argues that central bankers might need to tighten more if they are to wrestle inflation to the ground.

Additionally, the U.S. Consumer Price index (CPI) print for January, expected imminently, appears set to be less droopy than the prior two readings. Gas prices rose in January, making for a sprightlier inflation number, even if the year-over-year changes are still set to descend. This will cast some doubt onto the trajectory of inflation going forward, even though a further deceleration in future months is still materially more likely than not.

Who suffers more?

In a steady-state world in which inflation is twice as high as normal but all parties are properly compensated for the extra inflation, the world isn’t too much worse off than before. (To be sure, high inflation, even equally distributed, is inherently bad in some subtle ways. For example, the effective tax rate on investment income rises, equity valuations fall and the economy encounters slightly more headwinds.)

Instead, the problems with recent high inflation are clear:

a) The inflation rate differs from central banks’ targets such that they must tighten monetary policy aggressively to resolve it.

b) The process of inflation migrating from one level to another creates enormous gains and losses for different parties (think of fixed-rate borrowers versus fixed-rate lenders).

c) Inflation has not actually been equally distributed.

With regard to this last item, the average publicly traded business appears to have come out ahead given the upward leap in profit margins as inflation rose, followed by a partial decline as inflation has begun to fall (see next chart).

S&P 500 profit margin rose while inflation spiked

As of January 2023. Shaded area represents recession. Source: RBC Capital Markets, Bloomberg, RBC GAM

On the other hand, productivity-adjusted real labor costs have fallen sharply over the past 18 months (see next chart).

U.S. productivity-adjusted labour cost declined after initial lockdown spike

As of Q4 2022. Shaded area represents recession. Source: U.S. Bureau of Labor Statistics, Federal Reserve Bank of St. Louis, RBC GAM

To be sure, neither of these are brand new trends. Rising firm-level concentration, globalization and a host of other factors have allowed profit margins to rise over time and forced productivity-adjusted wages lower. But the latest moves appear to be at least partially related to inflation. This is significant inflation damage from a distributional perspective.

As inflation softens, one would imagine that profit margins should ease somewhat and productivity-adjusted wages should revive somewhat.

Central banks slowing

Central banks continue to raise their policy rates, but at a diminishing pace. In fact, after the Bank of Canada raised its policy rate by 25 basis points to 4.50% in late January, it indicated it may well now be done. One wonders whether it might have second thoughts after the latest employment numbers wildly exceeded expectations, but the end is at last near if not here.

The Federal Reserve isn’t quite done: Fed Chair Powell indicated ‘a couple’ of further rate hikes will likely follow the latest 25 basis point increase to a 4.50%-4.75% range. That would leave the terminal policy rate in the low 5% range, though also with the chance that it has to go further given the stubborn muscularity of the labour market.

The European Central Bank continues to lag its peers but is making up for lost time with a 50 basis point rate increase in early February and another penciled in at the March meeting. Indeed, the market now assumes that the policy rate will rise from its current 2.5% setting to a terminal rate of 4.50% by the fall.

The Bank of England also raised its policy rate by 50 basis points in early February, to 4.00%. It is also expected to culminate at around a 4.50% setting.

Finally, the Bank of Japan opted for a dark horse candidate as its next Governor: Kazuo Ueda. Presently an academic, Ueda was a former member of the Bank of Japan’s policy board two decades ago. The expectation is that this selection will allow the Bank of Japan to exit from its quantitative and qualitative easing programs sooner than otherwise scheduled, though not with undue haste.

In turn, that puts some upward pressure on Japanese yields and highlights the risks associated with Japan departing from its policy of extreme monetary stimulus (though these exit risks only grow larger the longer the central banks retain them).

Housing stabilizing?

Some measures of U.S. housing activity are tentatively stabilizing. New mortgage applications have risen slightly after a long fall (see next chart). Pending home sales are slightly higher. The National Association of Home Builders’ Housing Market Index has also risen slightly (see subsequent chart).

U.S. new mortgage applications have risen slightly

For the week ending 02/03/2023. Source: Mortgage Bankers Association, Macrobond, RBC GAM

U.S. housing metrics reveal weakness

Case-Shiller Home Price Index as of October 2022; building permits, housing starts and existing home sales as of December 2022; employment and National Association of Home Builders Housing Market Index (NAHB HMI) as of January 2023. Source: U.S. Bureau of Labor Statistics, Census Bureau, NAHB, National Association of Realtors (NAR), S&P, Macrobond, RBC GAM

Why the stabilization? The 30-year mortgage rate has fallen significantly, from just over 7% to just over 6%. This is attracting some buyers into the housing market. That’s still an elevated mortgage rate (it bottomed at just 2.6% in early 2021). However, it is sufficiently easy to renegotiate one’s mortgage in the U.S. that some buyers are opting to ‘buy the house, date the rate.’ In other words, they buy with the expectation that lower mortgage rates will become available in the future. Furthermore, nominal wages have risen significantly and nominal home prices have fallen, helping affordability.

All of this isn’t quite enough to argue that U.S. housing pain is totally over: most housing metrics are trending lower. These include existing home sales, building permits, housing starts and home prices. Normally, the housing market doesn’t rebound while policy rates are still high, especially just before what could be a recession.

But the U.S. housing decline doesn’t have to be too deep given the low leverage households carried into the correction and the reasonable affordability that prevailed before rates started to rise.

Canada’s housing market isn’t deteriorating quite as quickly as before. However, higher household leverage and worse affordability than in the U.S. argue that a significant further correction is still likely there (see next two charts).

Canadian existing home sales decline

As of December 2022. Source: Canadian Real Estate Association, Macrobond, RBC GAM

Canadian home prices dropping across markets

As of December 2022. Source: Canadian Real Estate Association, Macrobond, RBC GAM

-With contributions from Vivien Lee, Thao Le and Aaron Ma