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From geopolitics, uneven inflation and economic uncertainty, there’s much for investors to consider in the current market landscape. Beata Caranci, Chief Economist at TD, addresses some of the key financial questions being asked with MoneyTalk’s Kim Parlee.
Kim Parlee: Every quarter, TD Economics gets barraged with questions about what is happening with the economy. And given the complicated nature of what is happening in the world, there are more questions than ever. So they published this — Questions? we’ve Got Answers, where they look at the big, big questions that are out there.
And Beata Caranci, TD’s Chief Economist, is here with us now to discuss. It doesn’t get any simpler, does it?
Beata Caranci: We tried to make it–
Kim Parlee: I know.
Beata Caranci: Not the report, the world, is what I mean to say. The world is not getting simpler.
Kim Parlee: OK, so we want to run through questions. We’ve got eight here we’re going to touch on. So the first one is how are geopolitical risks impacting global growth, inflation risks, and commodity prices? So take us through geopolitics 101 — what you’re watching.
Beata Caranci: So I think we start– the natural tendency of economies is to expand, right? And so then when you bolt on geopolitical risks, it either puts a bump in the road or it actually throws you off the road. In this particular case, what we’re seeing with tensions between Israel and Hamas, in particular, is we’re seeing the bump in the road come through in the data, meaning the rerouting of ships as they try to avoid some of the negative tensions happening there is increasing the freight costs between China and Europe and China and the US, because they’re taking longer routes.
Kim Parlee: I’m going to just listen. We’re going to bring up a chart here just to show that because we can see some of those costs and what they’re doing right now. So there we go. There’s a look.
Beata Caranci: Yeah. It doesn’t look much like much of a bump on that graph.
Kim Parlee: Yeah.
Beata Caranci: What it’s actually telling you is you are getting a re-elongation of the supply chain. So now for China to ship freight to Europe, it’s a fourfold increase relative to what it was, and to go to the US is a doubling in freight costs — nowhere near the pandemic levels, but not ideal because most of the disinflationary forces that have been happening in Europe, and Canada, the US is coming from goods products, which is exactly what’s getting shipped overseas.
So basically, you’re getting some unwinding of the dynamics that were benefiting advanced economies. But these economies are still very much moving along in expansion mode, especially the US. So it’s not as if the geopolitical risks have derailed that growth pattern for them.
Kim Parlee: So that was question one. Let’s go to question two– what is behind divergent inflation outcomes between the US, Canada, and Euro? I did my homework, and by that I just mean I’ve read your report, which is not a lot of homework. But I think the States is coming in around like 3.1%, Canada 2.9%, and Europe 2.8%. So we’re seeing, I’m assuming, more growth in the States leading to more inflation.
Beata Caranci: Yeah. So that’s a headline, your total inflation. And what we’ve seen central bankers focus more and more on is what is, the three or six-month trend in inflation? When you break it down, because that’s going to tell you what it will look like in another three to six months as opposed to the year-over-year, which has base year effects. So when you do that analysis, Europe has come down significantly in inflationary pressures on a quarter-over-quarter basis.
So they basically had no economic growth in the second half of 2023, and that has corresponded with a lot of economic slack. And we’re getting traditional economic dynamics between interest rates and prices — imagine that. We haven’t had that for two years. It’s evidence now in Europe that actually still exists.
So they’ve had their inflation come down really fast in the three-month space, telling us what to look for in the next three. The US has not had as much of a movement there because the service side of the economy is showing stickiness, to your point, that they have stronger economic growth. They are not in excess supply. They had 4% GDP growth in the second half of 2023.
They’re looking like they’re going to be north of 2% in the first quarter. So they haven’t even hit the stage of too much supply relative to demand. And so service prices are sticky. Goods prices have been coming down, but not enough to offset what’s happening in services.
And then Canada is the true anomaly. We’ve had a little bit of downward pressure on goods prices, but not as much on the service side because our service measures are so heavily weighted to shelter. And we stand out a little bit to our peers because when we do the calculation of inflation, we actually input mortgage interest costs into the metric, which other countries have not done. And so it’s leading to higher inflationary pressures in Canada, because, in part, of the methodology itself.
Kim Parlee: Yeah. It’s crazy in terms of rates go up, and then you complain about inflation, and it’s because rates went up. And yes, that’s interesting. The devil’s in the details on this one, isn’t it?
OK, question three, then — how are central banks viewing these divergent outcomes that you just talked about on their potential policy path? So what are they going to do?
Beata Caranci: Yeah, this is an interesting question. I would back it out and say, what do the markets think the central banks are going to do? And if you look how the ECB is priced, the BOE, Bank of England, Bank of Canada, and the Federal Reserve, markets basically have all of them cutting around midyear — sometime between June and July, which seems a little inconsistent considering that inflation is coming down much faster in Europe than what you’re seeing in North America.
So someone’s got it wrong. Either Europe’s going to be cutting a little earlier than everybody else, or, perhaps what’s more likely, is the Federal Reserve and the bank can be cutting later and less than many are expecting.
Kim Parlee: Let’s bring up a chart while you keep going.
Beata Caranci: Yeah. And so I think this is a situation where now, as the central bankers are trying to figure out their way through inflation, the reality is they target the annual rate, although I was talking about the three-month trends and six-month trends– they target the annual rate. They need that to be sub-3% and to hold sub-3%.
And that doesn’t look like it’s going to materialize until probably mid-year or the second half of this year, late this year. And so because of that, they are guiding markets into tempering their expectations. So at the start of the year, markets thought the Federal Reserve would cut 150 basis points this year. That’s all the way down to about 75, 80 basis points.
Kim Parlee: Wow.
Beata Caranci: And I think the Fed would be pleased with that because their own dots forecast of what they’re expecting only shows three cuts for the year. So it looks like they’ve got markets aligned for now. As for the Bank of Canada, tougher, tougher call, because we’ve had very little economic growth, but more so on the inflation side.And so they have to basically come up with a strategy of how you make sure the economy doesn’t go deep into a recession cycle, but at the same time anchor inflation expectations. So they’re going to have to walk a finer line.
Kim Parlee: Next question was, will a resurgence in housing demand run afoul to central bank cut intentions?
Beata Caranci: Yeah. It’s definitely going to make it harder for them. So the area in our forecast that’s had the biggest upward revision happens to be in housing– nothing else. Not unemployment rate, not the economic performance. So I always refer to housing in Canada as a coiled spring.
The minute a little bit of pressure comes off of it, it bounces back up. And that bounce-up came because yields had dropped significantly in the last few months, and you’re starting to see a little bit of that fear of missing out coming in and people getting off the sidelines and coming back in. So we thought the market and sales would be up about 5% this year. And we had to revise that up to about 13%.
So that’s a big revision. It doesn’t necessarily mean the price has moved by the same magnitude. But it is definitely an area that the Bank of Canada is going to have to figure out how to tiptoe around, because the minute they start cutting, it’s just going to keep coming back.
Kim Parlee: I’ve got a picture of somebody tiptoeing around all these springs popping up all around them. OK, next question– how will the recent changes to Canada’s immigration policy impact the economy? And I’m going to bring up a chart that you’ve got in your report showing that the population growth is set to decelerate.
Beata Caranci: But not much, as that graph will show you. And that’s the answer in terms of how much would it affect housing demand? Not very much. And it’s partly because when you look at non-permanent residents, they don’t tend to be the primary mortgage holders. And so, really, it’s not coming from that segment in terms of mortgage.
It does affect the rent element of the economy, but not as much as the homebuyers market. And it is deflating at a very slow pace in terms of the immigration policy. So it’s more of a 2025 effect. But what they’ve announced so far are 35% scaling back in student permits, which is about 220,000 people, in an economy that’s putting in 1.3 million people, is not going to do the trick. Demand is still severely outstripping supply of housing.
Kim Parlee: Interesting. OK, let’s get to our next one, and we’ll focus on the States– question is, how is US fiscal policy expected to impact growth? So, again, this is what the government’s spending. I’m thinking elections coming. But go ahead.
Beata Caranci: Yeah. Yeah. So there’s two things, right? Because in the near-term, they have to fund the government. And they have two deadlines coming up, one this Friday and then the following week, where they have to do continuing resolutions or something to fund the government. And then they have their budget process in April.
Then we have the elections. And so there is a lot, a lot of hurdles that we have to get over. In the past two years, fiscal policy has been extremely stimulative in the US. In the next two years, it’s probably not going to be the case. And so it should be a little bit of a restraint as we go forward.
Kim Parlee: Interesting. Question is, what’s going to slow the US economic juggernaut in 2024? And I just keep thinking about we keep hearing about reshoring, things coming back– and I think about elections and stimulus– there’s a lot.
Beata Caranci: Yeah. But we are seeing aspects of the economy start to bend. We are seeing delinquency rates on credit card and auto financing rise. And it’s actually higher than pre-pandemic. We are noticing that excess savings for low and middle income households is exhausted.
So most of the spending and the drive to the economy is coming from a smaller segment of households. And so as you continue to layer in more time, some of those extraordinary factors that have helped the US should continue to fade. Doesn’t mean they’re going to wash away.
We’re not at all in the recession camp at all for the US. In fact, I’ve been saying it’s quite an exceptional economy for where we are in this cycle. And we think that will still be how it gets defined relative to peers. But it doesn’t mean you’re going to keep putting up 4% growth rates.
Kim Parlee: Because that’s high. 4% is something else. All right, last question, and the one that probably people care the most about who’s watching right now is, Canada’s soft landing feels hard. How will the economy get its groove back?
Beata Caranci: Yeah, unfortunately, as you ask an economist this, we’re known for the dismal science for a reason.
Kim Parlee: Yes, you are.
Beata Caranci: Unfortunately, when you look at what is the source of the slowdown, it’s typically what you define as a deleverage cycle. And you are seeing, for example, consumption per capita has been contracting in three of the last four quarters. And we’re seeing more strain amongst individuals who are not necessarily mortgage holders, but holders of credit card and other debt.
And so that cycle typically does not finish itself in a year. It typically takes a few years when you have a deleverage cycle, which basically says consumer spending should be on the weaker side– one percentage, maybe as high as 2%, but is not likely going to just pop up suddenly. And we’ll see what happens on the housing market side. That’s where it’s going to prove me wrong, I’m sure, because that’s an area where we see when people do want to spend, that’s the area they want to spend in.
