Cue the Recovery, but Watch for Inflation

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Benjamin Tal

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Benjamin Tal, deputy chief economist, CIBC.

If you look at the overall situation, we are basically in the midst of what we call, back then, the zigzag economy. The economy goes up and down with the virus, and that’s exactly what we’re seeing now. The fourth quarter of the year was actually better than expected. In fact, double the rate at which the Bank of Canada was focusing for the fourth quarter.

In the first quarter of the year, the Bank of Canada expected negative economic growth. We’re actually going to get about 6% GDP growth positive. So much for economic forecasting.

So obviously, this economy is moving along the line of the virus, and we are at basically the sweet spot, if you wish, between the second and the third wave during the winter, and therefore the economy was better than expected.

As you know, now we are in the midst of a third wave and the economy is going to slow down, might even shrink in the second quarter or at least we’ll see very slow economic growth in the second quarter.

However, beyond that, I believe that the second half of the year, it will be extremely strong. Assuming that we are going to reach some sort of herd immunity, let’s say by September, October, we believe that the second half will be very strong for three reasons that we have to understand.

One; the damage as far as this crisis is concerned is very deep but also very narrow. Namely, if you feel the pain, the pain is very severe. However, the number of industries that are significantly impacted in a negative way is much smaller than in any other recession. Which means that when we reach the other side of this madness, it will take very few industries to recover to go back to normal. So the speed of the recovery will be stronger than any other recession. That’s not the one.

Number two: all the damage — not some — all the damage is in the service sector. Why? Because you press a button, and you get your exercise bike. So, goods are doing fine. It’s only services that are suffering in a very significant way, which means that in the short term, that will continue to be the case.

The good news is that services are much more flexible. It’s much easier to start a new restaurant than to establish a new manufacturing facility. Again, the minute we have the green light, you will see the speed at which this recovery is going to unfold will be very rapid. Number two.

Number three, and the most important factor, is the cash factor. Individuals in Canada now are sitting on no less than $100 billion of excess cash. Businesses are sitting on $130 billion of excess cash.

This money is sitting there in chequing and savings accounts collecting 0% interest. The minute we have the green light, this pent-up demand will be utilized in a very significant way, and a lot of this money will be spent. And the good news is that this money will be spent where — not on goods but on services. Exactly where you want it to be.

So, all the money will be going to create jobs in the service sector, where we need those jobs, when we need this investment, and that’s another reason why I believe that the second half of the year will be very strong.

So, the big question, given this recovery that we are focusing, what will happen to inflation? After all, the Bank of Canada is printing money at a rate we haven’t seen before. The government is spending like there is no tomorrow. What will happen to inflation?

At this point the hope is that, although inflation will accelerate over the next few months, we might see inflation stabilizing at about two, two-and-a-half percent over the next year — something that the Bank of Canada and the Fed are counting on.

However, there is a risk here. Any investor has to take this risk into account, because nobody knows how thick inflation will be. When I say nobody, I include the Bank of Canada and the Fed in that nobody.

Inflation is a lagging indicator. Inflation is like that brown spot on the banana. By the time you see it, it’s way too late. What I mean by that, is that it’s possible that inflation will be there; it will not correct. And the Bank of Canada and the Fed will be behind the curve. And when you do that, when you chase a lagging indicator, you raise interest rates way too quickly. That risk that we are facing at this point, this is not the main case scenario, but any investor has to think about this risk, because really at this point, nobody knows what inflation will do six or eight months from now.