Hello and welcome to our latest video MacroMemo. There is, as always, a lot to cover off.

So we'll spend a moment on financial markets and what they've been up to. We'll talk about COVID-19 and the latest wave that has formed there. I will spend some time on Ukraine in the context of both food and natural gas. We'll look at currencies and the extent to which the U.S. dollar has been king and other currencies have been quite weak, and just what that means. And we'll also spend a little bit of time on taxation on a few different fronts. We'll talk about China and really a Chinese whiplash and a sense of bad, good, bad, good. They're just bouncing back and forth. Inflation, of course, merits some attention to the extent it's the central macroeconomic issue of our time. And then we'll talk about the economic trend and what central banks have been up to. So plenty to cover off.

Without further ado then, let's jump into the first one. And so financial markets have actually been fairly happy over the last few weeks. The stock market has been more inclined to go up than to go down. And it seems to me the central thinking behind that has been that markets are starting to bet that inflation has perhaps peaked. And actually, we think there's a fair chance that that's true.

We would warn that inflation may not come down all that fast, and it's likely to be an unsteady process and so on. But nevertheless, plausibly, inflation is in the realm of peaking. And that is an important thing. I would just say though that we think equally it's important to keep in mind that the economy is only starting to weaken at this point in time. And we think there's further weakness out there. We think a recession is more likely than not. Earnings have not yet been adjusted downwards in terms of expectations or the actual earnings themselves. And so it would still make sense if there was some additional stock market and risk asset weakness out there. We're not convinced that story is done despite the possibility that inflation gets a little bit less bad.

And then on bond yields just for a moment; bond yields are down fairly sharply over the last month or so as well. And that's on the back really of two things. One is that inflation expectations have been coming down. So, as per the inflation peaking story. And the other is that central bank expectations have also been coming down. Markets no longer think central banks have to push the policy rate all the way into the fours; into 4% plus terrain. The thinking now is three point-something should suffice. And so that's helped to push yields down as well. I would say in general, all of that seems fair to me and bond yields seem about right.

Let's talk about COVID-19. And so the BA5 wave is the one currently underway. And it is unfortunately getting worse. It's quite clear in Europe. We can see it across a fair chunk of the developed world though, including in North America. And it's hard to directly observe the infections just because far less testing is happening than was over much of the last two years. But we can get a sense through hospitalizations which are now rising in a lot of these markets. Not as high as they were during the peaks of prior waves, but neither is this wave necessarily quite done. From an economic standpoint, not a big impact outside of China, which is maintaining that zero tolerance policy. Small effects, though, in terms of staffing levels via sick days and people behaving a little bit more cautiously. But nevertheless, there is a wave underway. That's the main conclusion.

And there is talk about – and indeed, it's realistic to expect additional waves down the road. This is wave seven or so right now. And so it would be a bit naive to think that is necessarily the last one. – And indeed tongues are starting to wag about another sub-variant called BA.2.75, which might be, you guessed it more contagious, more capable of evading immunity, the usual pairing.

And so presumably we will get extra waves in the future. The good news is that there is another round of vaccine that’s expected for the fall that are meant to better target the army family of viruses. And so that should help at least a little bit.

Let's pivot to the war in Ukraine. And so it's still a grinding war. Likely to last for quite some time. Russia is, if anything, making slow gains of winning at least at the margin. And markets right now really don't expect a near-term ceasefire – a 92% chance assigned by markets that the war continues at least into December. So unlikely to be resolved in the near term. It's still a central source of uncertainty for the world, as per recent food and natural gas developments. And so let me elaborate on that. On the food side there have been efforts to allow Ukraine to begin shipping its rather extensive agricultural products to the global markets that it normally supplies. And that's been a challenge during the war to the extent that Ukrainian ports have been very limited. Ukraine and Russia did sign a deal just a few days ago. That was wonderful. Russia then almost immediately, within several hours, bombed the port that was meant to be shipping the food. And so leaving very much up for interpretation whether this will proceed or not. Even if it does proceed, it will take several months arguably to set up the inspection process and the various mechanisms and get the ports ready to go and to get ships and sailors who are willing to traverse a war zone to transport this food. And so food prices are down from where they were, but they are still somewhat elevated relative to normal. We're hopeful some food does get out, but it’s likely to remain quite a central issue, particularly from a humanitarian perspective.

And then for natural gas, again, in the context of Russia and Ukraine, natural gas flows to Europe have been greatly impeded. And initially that was on the back of a missing turbine. And then there was a maintenance period. And Russia has since restored some service after the maintenance period ended. The turbine is returning, but Russia is still finding excuses not to provide the usual or full flow of natural gas. And so we’re assuming that that constraint remains. It's more profitable for Russia to provide less at a much, much higher price. Russia wants to put pressure on Europe over the winter, perhaps encourage some sort of ceasefire. I'm assuming natural gas prices remain quite high, if not rising. And this is a pretty central reason why the European economy likely looks worse than much of the rest of the world, particularly across the winter.

Let's talk about currencies for a moment. And so I guess the main story is one of U.S. dollar strength. You can also map that onto other currencies and say the yen in Japan is now down sharply. It was ¥115 to the dollar at the start of the year. It's now ¥136. That's an extreme depreciation over a fairly short period of time. And by some measures it's now 45% undervalued. The euro has also been weakening significantly. In fact, it touched parity versus the U.S. dollar for the first time in about 20 years. So a lot of weakness there and certainly the trend should eventually reverse. Valuations would suggest the dollar eventually gets less strong. These currencies eventually recover, likely in alignment with when risk appetite enduringly revives, which we don't think is quite yet. In terms of why the euro and yen are weaker – well, I mean, a big part is just safe haven flows as investors have been scared. They pursue the liquidity and relative safety of the U.S. dollar and U.S. markets. A big part though was also interest rate spreads. And so that is to say the U.S. Federal Reserve has been raising rates with enthusiasm. The Bank of Japan has done nothing to that effect. The European Central Bank has only just started and is thought to have a fairly low ceiling in terms of where it wants to go. And so that skews to the advantage of the dollar in terms of implications that come from big currency moves like that. In addition to profits and losses for investors, of course, we can say that inflation, all else equal, should be a little bit lower in the U.S. Can't say it's all that visible, but that's what the theory says. Inflation should be, all else equal, a little higher in the likes of Europe and Japan.

Similarly, with currency moves like this, there are competitiveness implications and so it makes U.S. companies a bit less competitive. They're already complaining their overseas earnings are converting back in a less favorable way into dollars. And of course, the reverse is true for foreign companies and so there's a competitiveness pivot as well. And it's worth mentioning Japan likes what's going on. They like their weaker currency. They like the higher inflation that results. They've been stuck with too little inflation for a long time. And so they're likely to let this run. Europe maybe feeling a little bit more mixed on that front. Maybe lastly, the Canadian dollar didn't get any mention in there. Canadian dollar has been more or less holding pace with the U.S. And so no real change for Canada's biggest trading partner, but the Canadian dollar is up significantly versus some of these other markets as well.

Taxation is a subject we don't usually spend a lot of time on, but there's been enough developments in recent months that it's worth carving out a minute or two to that end. And so I want to talk in a few directions. One is on windfall taxes, which is not something we very often see, but we have seen some recently. And so a windfall tax is a one-time or a temporary tax usually applied at a particular sector because it's perceived to be doing better than it should or better than the overall economy. And so we saw a windfall tax applied in the Canadian context, in Canadian financial institutions in 2021. We've now seen the plan at least to have a windfall tax in the UK on British gas and oil companies. They’re earning big profits at a time of economic challenges for the UK. And so there are fears that this could begin to apply to other oil and gas sectors around the world. That's a risk. There are worries more generally this could become a trend whenever a sector performs well during otherwise challenging times, and at least in theory, windfall taxes aren't great. You know extra taxes, of course, not wonderful for investors from that perspective. But more fundamentally and more generally, there's just an unpredictability and a fickleness to windfall taxes such that they're not a great way to conduct tax policy. And really, they encourage the reallocation of capital into other markets and they encourage businesses to shift their operations into other markets as well. And in a sense, that's precisely what you don't want to happen to your most successful industries. And so it's a trend worth watching. I would say in general, it's a cautionary trend as it stands right now.

Elsewhere in the tax space, it looks like the U.S. won't be raising taxes. That had been a Biden promise. He will not be able to do that because he cannot get the votes in the Senate. That seems fairly definitive. It seems also that climate change efforts won't proceed as desired for the same reason – not enough votes in the Senate, and it likely gets worse after the midterm elections. That also means that the global minimum corporate tax rate is not necessarily proceeding. The U.S. is unlikely to have the votes to support it. Hungary also expressing some reservation and so that takes that off the table for the foreseeable future as well.

Okay. A quick word on China. So China really has just been whiplashing back and forth. And so China's second quarter GDP was extremely weak. It shrank by 2.6% on annualized in the quarter due to a lockdown. Real time economic data had then been quite good recently. Now China is reporting more infections again, which may mean more lockdowns and more housing issues, as well as some home buyers engage in a mortgage strike protesting that the homes they purchased have not yet been built with builders, in many cases illiquid or even insolvent. So China still quite a tricky situation. We're looking for very weak growth in China this year, in particular.

On inflation, which is the biggest economic issue these days. Of course, inflation is still extremely high. Some hope that inflation is now in the realm of peaking. We run a scorecard looking at different aspects of inflation peaking and hardly unanimous that inflation is peaking. But we now have six indicators saying yes, ten saying maybe, just seven saying no. So we're seeing a gradual progression toward a more credible claim that inflation is indeed peaking from a theoretical perspective. You think inflation should peak. The big drivers are resolving themselves. Supply chains are improving. The commodity shock is fading at least a little. Monetary stimulus is going away. Fiscal stimulus has already gone away. And so all of that is quite welcome. We think likely there's some peaking. We just don't think it snaps back to normal all that quickly.

Briefly on the economy. Well, we're still seeing an economic deceleration. Purchasing manager indices are broadly falling, new orders components are falling even more. U.S. small businesses are expecting the worst economic outlook of the last 30 years. Or I should say their outlook is the most pessimistic of the last 30 years. It isn't strictly a question of what their GDP forecast is. I think it's consistent with what we've said now for many months. We think a recession is more likely than not across much of the developed world. And in fact, we have a scorecard for that as well. And of the ten inflation – pardon me, the ten recession signals we watch – five are now saying yes, three are saying likely or maybe, just two are saying no. And those no’s are actually kind of working their way closer to the yes threshold. And so I would say recession remains more than not.

And then lastly, for me, monetary policy. And so the familiar story now central banks are raising rates and they're raising rates quite a lot. And as I record this, the U.S. Federal Reserve is on the cusp of its next rate decision. Looks likely to be a 75 basis point rate increase, which is huge by historical standards. It would be the same though as their last meeting. The Bank of England's a little further out in early August. It's likely to raise rates by 25 or 50 basis points. The Bank of Canada just went. It raised rates by a full percentage point, which is the first time that's happened in well over 20 years. European Central Bank maybe most prominently raised rates. They no longer have a negative policy Rate. They were stuck in negative land since 2014 and they finally escaped from that, which I think is the most useful thing. They've also created a mechanism for supporting some of their weaker countries in terms of the borrowing costs for the likes of Italy and Greece.

And so central banks continue on the market. I suppose the one twist is just that markets are now looking for slightly lower peak policy rates than they were as of a month or two ago. And we think that that makes sense. You probably don't have to go to four percent plus to get the economy weak enough to control inflation. You probably can get into the threes and that should suffice in a North American context. And there's even some talk about rate cuts over the second half of 2023. And it's a bit premature to talk with precision about these sorts of things. We don't know if there is a recession. We don't actually know the peak policy rate either. Nevertheless, it does seem reasonable to expect some cuts thereafter if the economies weakened and if inflation is coming down.

Okay, I've gone far too long, I'm sure, but thanks for sticking with me. Hope you found some of this interesting and please tune in again next time.