Hi, everyone. Welcome to our latest video MacroMemo. We’ll cover quite a few things in this addition.

We’ll talk about happier financial markets over the last few weeks. Why that is; whether that’s sustainable.

We’ll spend a moment on COVID, though not a lot of time there.

We’ll talk about inflation. In particular is inflation peaking? Which I think is the key question. But we’ll also spend a moment on Japan and Japanese inflation. We’ll spend a moment on whether this is stagflation or not. It’s a definitional issue mostly.

And then we’ll pivot to the economy and indeed acknowledge still high recession risks, and we’ll see what central banks are up to and the extent to which the housing market is weakening, and whether the inventory cycle is perhaps turning as well. So quite a bit to cover off here.

Let’s begin with happier financial markets. And so over the last couple of weeks we have seen risk assets like stocks go up and express optimism. And in general I think we can say that optimism is on the back of the thought that perhaps inflation could be peaking. We’ll talk about that in a moment. The thought that central banks might not have to raise rates as much as previously feared. And indeed I have to say I concur on both fronts. But I should say, we are still cautiously positioned from an investment perspective ourselves. And I would say it would be unusual for markets to bottom before the economy has even really begun to show any serious weakness.

We’re looking for evidence of inflation actually turning lower instead of possibly peaking. We’re looking for significant downgrades in earnings expectations, which will then set a sufficiently low level of expectations that you could easily see markets rising off of that. So we’re still looking for other things to happen before we can speak with confidence about markets bottoming. But nevertheless, it’s fair to say a few things have gone perhaps tentatively right over the last few weeks.

A very quick moment on COVID. And so the comment really is one that I think we broadly appreciate but is starting to show up in the data, which is just that we can see that the economic damage from COVID restrictions is continuing to shrink. Our measure of global stringency of government restrictions is easing quite nicely. And so again, no surprises there, but it’s always good when the data aligns with what you think is happening.

I will say though on the COVID file that we are starting to see something of another wave form. It’s most obvious in Europe. It seems to be the BA.5 Omicron subvariant, which is more contagious than the BA.2 that was the dominant entity in recent waves. I wouldn’t say we’re expecting lockdowns though at this point in time. I would say we’re thinking this could be a fairly short-lived and a fairly small wave. That’s been the experience in places like Portugal that have already experienced a fair chunk of that.

And in general I guess the comment still stands, which is we’re assuming there will continue to be future waves of COVID-19. There is a seasonal element as well. And so this coming fall and winter could be interesting on that front, but we are not expecting significant economic damage from them to the extent that governments just don’t seem to be in the business of locking down anymore.

Let’s move from that into the inflation story. And so inflation is the big issue right now. It is so incredibly high relative to the norm of the last several decades and indeed just the historical norm more generally. We’ve been musing about—and as I mentioned a moment ago, markets have been musing about—whether inflation might finally be peaking after a very long run higher.

There’s no guarantees, but I would say we do see a few things that suggest it might be beginning to go through that process. And perhaps there could even be a modest decline then over subsequent months. And there are a few ways of tackling this. One would be to say the biggest drivers of high inflation came from supply chain problems and from commodities. And when we turn to those two things we do see some improvement.

And so on the supply chain side we are definitely seeing some improvement. The cost of shipping is down. In fact it’s back down to the levels of last summer. The number of ships waiting in port are also significantly lower. Manufacturers are complaining less about supplier deliveries and the time it takes to get those things, so that’s been a material improvement. And they’re saying they think there should be some further improvement.

And then China’s reopening again at least for the moment, though that’s been an on-again/off-again story for some time. There are seasonal challenges ahead to the extent that, believe it or not, the holiday shopping season, or at least the procurement for that season, is already beginning. But in general, I think it’s quite clear that supply chains are not as troubling as they were. And we’re hearing anecdotes in the field as well to that effect. And then on commodity prices, which were the other big driver of inflation, we are beginning to see lower prices there. And so lumber prices are down. Copper and other base metal prices have fallen quite notably. Oil prices are down somewhat over the last month or so. The price of wheat is down too. And certainly food still very expensive, and still quite troubled as it’s difficult to get those products out of Ukraine and Russia. But still, we’re seeing improvements even in food it would seem. And so it would make sense if inflation stopped to be quite so high as those things begin to turn. So that’s an optimistic thought.

And then we also tackled it in a different way, whether inflation is peaking as we built a 19-input scorecard, and it again asks whether U.S. inflation is turning lower. And two months ago all 19 indicators would have said no. Today, 2 out of the 19 say yes, inflation is turning lower; 9 say maybe; 8 say no. And so hardly definitive, but nevertheless that is a significant change. And so we do think that we’re beginning to see some sort of pivot here. It’s not a one-way street. There could yet be reversals and so on, but we’re beginning to see some sort of turn. And in terms of the variables that are saying tentatively yes, inflation is turning, that includes pandemic boom goods, that is to say things for which the price rose particularly spectacularly in the early phase of the pandemic, we are starting to see those prices come off.

Similarly, market-based inflation expectations are beginning to come off as well. And so, again we are getting some evidence that maybe inflation is not far from a peak, which is a very good thing indeed.

Japanese inflation is a bit of a different story in the sense that Japanese inflation just isn’t as high as it is elsewhere. Much of the developed world is recording 7, 8, 9, 10% inflation. Japan is running 2.5%. And Japan also has a different motivation than other countries. It’s been stuck with too low inflation for a long time. And so actually, it doesn’t mind running a little bit too much inflation for a while, in part to catch up from prior undershoots. But even more importantly, maybe to reset expectations in a way that might let them run closer to 2% inflation in the future, which is what they’d like to do.

And so, for the moment, the Bank of Japan isn’t talking about rate hikes. It isn’t trying to cut down on inflation. That could change. If 2.5% inflation becomes 5 or 10% inflation, obviously that changes the dynamic, and we’d see the Bank of Japan raising rates as well. But in the meantime, actually, Japan is probably secretly pleased that it is finally running inflation closer to where it would like to be.

And then my last thought on inflation is, is this stagflation? And so we should define that and say stagflation is slow growth or bad growth combined with bad inflation or high inflation. And I would say we’re not there right now in the sense that growth is still okay for the moment, even though inflation is much too high. If you use a broad definition, for the next year I think maybe you could argue we could be going into a temporary period of stagflation to the extent that we’re expecting quite weak growth, that we expect inflation to stay a little too high for a while.

But we don’t think it’s a long-term story. We’re not convinced that stagflation will persist over the long run. And actually, if you really ask me what is the definition of stagflation, yes, it’s too little growth. Yes, it’s too much inflation. But over an era, not just over something like a year. And so that’s just not what we’re expecting right now.

Let’s turn to the economy. And so, really, the story of the economy is a familiar one. We’re seeing clear weakness in the economic confidence data. So confidence has fallen both from consumers and businesses. That suggests there should be some economic weakness to come. However, we’re not actually seeing that much genuine weakness in the consumer and business spending and investments. So we think that probably still happens, but we’re not there yet. So we’re still getting okay economic data.

Despite that, the recession risk is still quite high, we think. We’ve said we think it’s quite high, the highest in some time. Arguably, more likely than not, over the next 18 months or so. There are just so many headwinds in terms of high gas prices and high interest rates and high food prices and all those sorts of things.

There is new evidence on that front, though. And so we can say, for instance, the Wall Street Journal came out with a survey of economists who assigned a 44% probability of a recession. You should know economists tend to be somewhat conservative. And so just about every time you’ve had a probability that high, there has been one. So I would say that probably argues the recession risk is even higher than that.

Similarly, the New York Fed just released its latest big econometric model forecast. And it forecasts a recession and forecasts minus 1% GDP over the next four quarters. And so when you get big models like that predicting recession, that’s also a pretty strong signal because it’s quite rare for such models to make those claims.

A brief thought on central banks; it’s a familiar one. Central banks are still raising rates and doing so aggressively. In fact, the Fed just delivered a 75 basis point rate hike. That’s the fastest increase since 1994. Likely another one of that magnitude at the next opportunity later in the summer; other central banks thinking broadly similarly. Maybe we’re passing peak central bank expectations in the sense that the market’s no longer convinced that policy rates have to go to 4% or higher at the end of this cycle. I have to say I agree. I think it probably ends in the 3s somewhere. But nevertheless, we are seeing still quite significant tightening, and it’s a painful experience for borrowers.

Now when there’s pain for borrowers, the housing market often gets involved. And so we’re seeing the economic weakness in housing that you would expect. And so in the U.S., we can see, for instance, that mortgage applications are sharply lower. Higher costs are perhaps set to impede the supply of houses as well. I could say that housing market expectations via a variety of surveys have weakened as well. And so we’re expecting weakness there, but we don’t see many parallels to the global financial crisis. In fact, I could say that credit scores are in a very, very different place for people getting mortgages today relative to the mid-2000s.

And it’s a similar story in Canada. We can see now that home sales are falling fairly sharply, though still only at this point to pre-pandemic norms. We can see home prices falling, not just in the hottest, bubbliest markets, but in a lot of markets at this point in time, though prices are still a lot higher than they were before the pandemic.

I will say we expect those trends to continue for some time. And so I must say, as much as we’ve been talking for a while about Canadian home prices perhaps falling 10% with other scenarios that are better and worse than that, I am starting to think maybe we were too conservative in that call and that a base-case forecast perhaps needs to predict more than a 10% price decline. So do be braced for that. Not expecting financial crises to emerge from it, but Canada’s housing correction is likely to be a bit more intense than other markets where the run-up wasn’t quite as great.

And let me finish on inventories. And so for much of the last year, companies were desperate to build their inventories. And that no longer seems to be the case, at least at the economy-wide level. You are increasingly getting companies that are complaining they have too many inventories, that are regretting all of the procurement that they did. And so they’re starting to look to adjust that. And so that’s bad from a short-term economic growth perspective. That’s not great from that perspective, but it is good in a couple of other ways. And so maybe the most important way is just it helps to fix supply chains. Supply chain problems have been, in significant part, because you and I were buying perhaps too many goods. But also in part because companies were trying to jam through even more orders to bolster their inventories, and they’re not trying to do that anymore. So that’s a good thing for supply chains.

And then simultaneously, if companies find themselves with too many things, they’re unlikely to raise the prices on those things. They want to get those things out the door. And so that could actually help to contain inflation as well. And so I would say, broadly, some helpful things on the inventory front, though I wouldn’t want to completely ignore the fact that, historically, the inventory cycle has preceded the economic cycle. And so the fact that companies are now looking to shed inventories does maybe say something about the economic outlook. It does suggest the economic outlook might be somewhat dimmer in the future.

Okay. As always, I’ll stop there. Thanks for sticking with me. Hopefully you found some of that useful and interesting. Please tune in again next time. Thanks so much.