No Sure Signs of Recession — Yet

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Luc de la Durantaye

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Luc de la Durantaye, chief investment officer, CIBC Asset Management.

The Bank of Canada, I would say surprised us a little bit on the hawkish side with 50 basis points and the rundown of their balance sheet, which is faster than I think what the consensus was expecting. And that’s a reflection of its assessment on inflation and the need to get ahead of inflation expectations.

I think the comments from the Bank of Canada has been the concern that they have that of de-anchoring inflation expectations. I think that’s a common element also in the U.S. And when we look at both labour markets in both Canada and the U.S. we see — we have inflation in the goods sector that is expected to come back down. But, what we’re seeing is that that is replaced with inflation in the housing sector and inflation in the wage element because of a very tight labour market. And that takes a little longer to turn around.

I think that what we’re going to see also for the Federal Reserve is that they’re going to start also giving a similar signal of accelerated hikes, accelerated balance sheet rundown, because they’re starting to be concerned about de-anchoring inflation.

Some of the market indicators around inflation expectations, you can’t necessarily say that they’re starting to be out of control, but if they don’t start stepping up the interest rate hikes and the balance sheet reduction, there is a risk that inflation gets de-anchored. And that brings a bigger problem because then you have to hike more and faster, and that can create some risk down the road.

So our forecast for the next 12 months is not for recession. We see a deceleration in growth and a peak in inflation from very high levels. But the issue that we’re going to see is that the peak in inflation, even in 12 months from now, inflation will very likely be well above the 2% target for the Federal Reserve and for the Bank of Canada. And so we’re left with a dilemma, and I think what’s important has been in our forecast to look at is not necessarily the central scenario but the two alternative scenarios, which is if they hike too much too fast, they can create a recession. And if they don’t hike fast enough, then they can lose control of inflation. And that’s also actually a negative scenario.

So the central banks are managing a very narrow landing strip, if you will, to achieve a soft landing. And I think this is what is going to have to be managed by investors this year, is that tug of war between tightening too much and tightening not enough. And will they be able to achieve a soft landing? And I don’t think anybody can say at this stage whether that’s going to be achieved.

So far, what you see, like some of the leading indicators of recession, the yield curve is not inverted and there’s still some room before it inverts. And we have to remember that it has to invert for a period of time, not just a few days. But historically you have to see an inversion for three to four months, and it’s got to be an inversion that’s deep enough, at least 40, 50 basis points, to really increase the accuracy of that indicator for a recession.

You do have consumer sentiment that’s quite low by historical standard and that usually is part of a recession risk. So that’s another thing we’ll have to monitor, but there’s no sure sign in the next 12 months that we’re heading into a recession just yet.