(en anglais seulement)

Hello and welcome to our latest video #Macro Memo. In terms of a table of contents:

• We'll talk about the economy and good economic data that continues to roll out.
• We're going to do a little bit of a dive into why wasn't there a recession? It's arguably a bit premature for that. But nevertheless, we'll just run through some of the special factors that may have helped to explain this outcome.
• We'll certainly talk inflation and central banks.
• We will spend a moment inquiring as to whether U.S. companies like higher rates. By the way, anytime you get a question like that, the answer is almost always no. But in any event, there's a reason we're asking that question. And so we'll ask it.
• We'll look at Canadian business bankruptcies, which have spiked, maybe not for economic reasons.
• And we'll do a quick preview of the Canadian budget.

So that's the plan. Let's circle around to the top and let's acknowledge the strong economic data that persists. Global economic surprises remain positive. They continue to rise. We are getting economic data that's pretty good and indeed exceeding expectations, which is quite nice. In a U.S. context the payrolls, the monthly job numbers, came out recently.

They were up a nice 303,000 and so that looked pretty good. I will say that we also got some small business metrics that looked a little bit worse. And so that's interesting and we're digging into that as we speak.

But in the grand scheme and overall, we can still say the economic data for the most part is looking quite good – although you can acknowledge it tends to be bigger businesses thriving and smaller businesses not doing quite as well.

In Europe, the eurozone composite PMI (Purchasing Managers’ Index) rose above 50 for the first time in nearly a year. That's an important threshold, signifying growth as opposed to decline.

More generally, we've been seeing various recession signals fade. And so previously we'd seen lending standards start to ease and profit margins stop falling and recreational vehicle shipments rise and things like that, which suggested that prior recession signals were reversing.

I can say we've got another one to add to the list: global inflation-adjusted trade. So the world trade, the number of things being traded as opposed to their value. It had been falling, which was a classic recession signal. It's now rising a little bit again. And so another thing pointing to growth.

So indeed, we are continuing to say we think a soft landing, a.k.a. growth, is more likely at this point than a hard landing.

We've actually upgraded the soft-landing likelihood from 60% to 65%. And so implicitly downgrading the risk of recession from 40% to 35%. So do be aware of that.

Let's now dig into maybe the meatiest subject of the day. And so why wasn't there a recession? And I want to start again by saying we don't know with certainty there won't be.

I just told you there's maybe a 35% chance. So this is arguably premature, but I don't want to sit and wait for a year and a half before we try and dismantle exactly what happened over the last year or two.

So let's run through some reasons. One would be that a lot of countries did suffer economically, including Germany, U.K., Japan, all stringing together consecutive quarters of declining output.

Many people call that a technical recession. So we can't say that everybody did just fine. There was a degree of U.S. exceptionalism.

I can say that there was more immigration than expected in a lot of developed countries, and that probably helped to keep a number of them growing as opposed to contracting. I would put Canada very much in that mix. And it wasn't something you could really see coming because it wasn't through permanent immigration policies. It was through a mix, depending on the country, of temporary immigration and even illegal immigration.

So that came as an upside surprise to growth. The U.S. was always supposed to be less interest rate sensitive. It certainly has proved to be less interest rate sensitive, and so more durable in the face of higher rates. It was surprisingly rate insensitive. It was less sensitive even than had been expected. Economies in general, in fact, have arguably been a bit less rate sensitive than normal.

The damage from a 5% type of interest rate was supposed to be bigger than this, and it just simply hasn't been. Companies hoarded labor. So this is something that many of us speculated about. Maybe they would hoard labor to some extent, not lay people off, even if demand was weak because they'd had such a hard time hiring previously.

Turns out they did. And it turns out that might have been the saving grace. You look at some of those countries I mentioned that saw declining economic output, their labor markets held together. That almost never happens. But clearly the labor market behavior of businesses was different this time. And so that that helped to keep the economy from tumbling too far.

We got upside surprises in the U.S. in consumer spending and consumers maybe behaving differently, living in the moment in a way that perhaps they didn't previously. So just a change in mentality.

And we got a lot of fiscal support in the U.S., which was not at all included in the budget projections, and it just happened as the uptake of certain programs is much bigger than expected.

There's a bit of egg on the face of the Congressional Budget Office and others, but there was ultimately about $300 billion of additional support for the U.S. economy in 2023 that hadn't been expected.

We're speculating a little bit here, but in terms of other reasons why recessions were mostly avoided, well, economies may just be more resilient than in the past.

When we look at the shift in the composition of the economy, it's more service sector-oriented, which tends to be more stable. It's less inventory-oriented. So inventory cycles don't happen and don't influence the economy as much. And historically, those have triggered recessions quite frequently.

You can say that we haven't actually had really a proper business cycle going back quite a number of decades.

In fact, the last three recessions, you can argue, were all exogenous shocks. It was less explicitly that the economy is just running out of gas and overheating. It was more of a pandemic and a global financial crisis and dotcom bubble going even further back. And so it's actually been a while since we've seen the usual sort of business cycle/recessionary forces take hold.

And again, it may just be that they're weaker forces right now.

And then we look at some of those recession signals and many of them had previously had a 100% track record over their lifespan at predicting recessions. As I mentioned, some of them are now reversing. It may just have been that these were lucky historically, and so they still signal an elevated risk of recession, but maybe they weren't signaling a 100% chance.

Maybe they were signaling a 70% chance. And maybe this time we got the 30% outcome.

So parsing through that, I think we can reconstruct and say we can understand perhaps how a recession was avoided. I will say it's a tricky business. Hindsight is always 20/20. There's always a ‘this time is different’ narrative swirling. And oh yes, temporary employment is falling, but it's because companies are converting them to permanent employees instead of laying them off and these sorts of things.

And so sometimes those things are right, but often they're wrong. It's dangerous to embrace the ‘this time is different’ narrative too much. But it turned out that this time was different as it pertained to things like consumer spending and perhaps to temporary employment and a number of other important variables. And so I think the bottom line here is that lessons have been learned.

We can understand a little bit more going forward how this all fits together. I do think, though, it's still a very tricky time to be forecasting. I do think it was reasonable to forecast a recession a year and a half or two years back as we were observing this incredible rise in rates and the overwhelming evidence that argued for a downturn.

But in the end, we didn't quite get there. And so we should celebrate that. But equally, we should, I suppose, be humble in recognizing it's awfully hard to predict the future when it comes to the economy.

Okay, on from that, let's talk about a few other things fairly quickly. One would be inflation. So U.S. inflation coming right up for the month of March.

It looks like inflation readings are going to be fairly lofty just about everywhere. Oil prices have risen, economies are holding together. The consensus tracking is about 0.3% gain. And we've actually flagged, if anything, a slight upside risk to that, at least as I record this.

Over the medium run, we are seeing U.S. shelter costs start to edge higher again.

And so that does potentially complicate the ability for inflation to settle below the two and a half to three percent range. So we're alert to that as well.

One other inflation thought, and it's just that China was in deflation quite recently, you might recall. China has recently escaped from deflation. It saw prices rise now has an annual price increase.

Certainly low inflation continues to make sense for China. Its economy isn't great, but we're not convinced that China will get stuck in a Japanese style, multidecade deflationary trap. That seems unlikely to us.

On to central banks: so central banks are grappling with stronger than expected economies. They are grappling with stickier than expected inflation that makes it harder to cut rates.

And so the theme very much has been pricing out rate cuts. And so the Fed now in the U.S. is only expected to cut rates two and a half times in 2024. At one point at the start of the year, six times was the expectation. Canada has a little bit less than three rate cuts priced for 2024. So the market has pulled this back.

That broadly makes sense to us. There’s a Bank of Canada decision this week, at least as I record this, and I don't think we're going to get a cut. I don't know that we're going to get a June signal. I think July perhaps is in play for a Bank of Canada first rate cut.

The European Central Bank also renders a decision soon.

It does seem to be on track for something like a June cut. So we're getting closer.

And as I mentioned in the last #MacroMemo, the Swiss National Bank cut rates recently. So we are into the realm of developed central banks that are cutting rates.

But it's a tricky time now, just focusing back on the economy and what it's meant. We're no longer in a ‘good is good’ scenario here for the economy versus markets.

Good is bad. We see strong economic data and the stock market goes down. Bond yields go up because central banks won't be able to cut as much. Bad is still bad.

Just to be clear, it's not a complete reversal. But what we're really looking for is mediocre economic activity. That's the ideal sweet spot that allows policy rates to come down without creating too much economic pain.

Okay, so I posed the question, “Do U.S. companies like higher rates?” The reason I pose that question is just that U.S. companies hold several trillion dollars in cash and cash-like assets, and they make more money on those assets when rates go higher. In fact, for the moment, they are temporarily earning a higher return in terms of the rate of return on those assets than the rate that they're paying on their debt.

So you can sort of spin an argument that maybe they're accelerating as rates go up. I don't think that's the right conclusion, though. One would be the rate inversion is temporary. Normally they're earning less on their cash than they're paying on their debt. The debt is just longer term, takes more time to adjust. So that adjustment will happen.

More importantly, the average American company, in fact, on the cumulative American companies have 3.4 times more debt than they have liquid short term assets. So they're definitely still paying more in interest than they're earning. As a result, they go slower, not faster, as rates go higher. There are a small handful of giant businesses, tech companies, many that do have a lot of cash and not much debt.

Maybe they are a little bit ahead, but they're still dinged by the indirect effect of higher rates. And so they still feel the pain of an economy that moves more slowly, even if their balance sheet itself isn't adversely affected.

So, no, I don't think the economy or the business sector, at least, accelerates as rates go higher.

Pivoting to Canadian businesses, Canadian business bankruptcies have recently spiked.

We've seen more than a doubling since last summer, and I think some part of that is what you'd guess, which is higher interest rates, the economy and things like that. But actually we think it's primarily something else, which is in part just the levels were really, really low previously. That was the pandemic era, government supports maybe artificially suppressing bankruptcies. But more acutely, there was a major Canadian government loan-to-business program that required repayment by mid-January.

And so businesses that couldn't do that are effectively going bankrupt. I should emphasize the amounts of money are pretty small. So the businesses that are going bankrupt on this basis are likely quite small, likely not really viable outside of the special support that governments had given them. So we don't think this is a broader signal of economic woe that's imminent in Canada.

And I can actually say – and this is a bit confusing and maybe not fodder for a longer conversation – but bankruptcies in Canada really don't correlate very well with the economy. We did not see spikes in the business bankruptcy rate during the last several recessions. We don't see declines when the economy is strong. It just seems to be its own disconnected thing.

And so I would say set that aside. I don't think it's signaling secret trouble in Canada.

I'll finish very quickly. The Canadian federal budget April 16th is rapidly approaching as I record this. The deficit is expected conservatively to double. So bigger deficit, lots of spending going on. That arguably makes sense. It's an election year at least within a year of an election in 2025.

The incumbent government is trailing in the polls. This is a time, I suppose, to pull out the stops in terms of spending. Potential spending priorities could include pharmacare, which has long been promised, more military spending to reach NATO's targets. A lot of housing programs have been announced and could be costed and detailed. Additionally, there have been a few billion dollars dedicated to increase Canada's artificial intelligence capacity.

There may also be a school nutrition program and I'm sure much, much more. But those could be some of the highlights.

Okay, I'll stop there and I'll say thanks so much, as always for your time. I wish you well with your investing and talk to you again next time.