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Luc De la Durantaye, chief investment officer, CIBC Asset Management.
The world economy is still digesting the impact of several shocks that have led to elevated inflation. The war in Ukraine is raising energy and food prices. The demographic shock, which I don’t hear a lot about, but it’s leading to shortage of labour, bringing elevated wage pressure. And then you have China that’s forced to maintain a more stringent COVID approach, and then introduce lockdowns that are disturbing supply chain production. So all these have forced the hands of central banks around the world to tighten monetary policy, and in some cases, aggressively, as they start zeroing in on bringing inflation down almost regardless of the economic impact.
So certainly, in our various scenarios, the one on global recession, probability of a global recession, we have increased that probability. We don’t have it as our main case, but it is a higher probability than the previous quarter. So if inflation is expected to start to decelerate, there is a silver lining in that approach of central banks, which is that the sooner you can tame inflation, the less damage, if you will, you do to the long-term economic activity.
So maybe what you do, and this is what we’re seeing as a likely scenario, is that you are going to generate a very meaningful economic slowdown. You are going to be helping re-anchor inflation expectations, which is a good sign, right? We’ve seen various surveys and various inflation expectations coming back towards central banks’ targets, which is a good sign, which means that they will have to deliver their hikes, but they will not necessarily need to do more than what is currently priced in the markets.
And so that’s an environment of at least meaningful deceleration and growth, peaking inflation in the second half of 2022, with inflation starting to come back down in the first half of 2023.
The R risk, if you will, remains a risk for us, but it’s an elevated risk. And where that risk resides is in various places that are difficult to predict. One is the labour demand is slowing, and we’re seeing gradual easing in the labour market. But you still have a two to one ratio in terms of job openings versus available workers. So that’s still a tight labour market. And the Ukraine war, you still have an unstable stalemate in Ukraine with pressure on energy and food prices. What Russia is going to do in terms of its supply of oil and gas to Europe could determine whether Europe goes into a recession. So that’s an uncertainty that we need to monitor, and that’s one of the reasons why we’ve raised our probability of a recession in Europe.
And then finally, the COVID situation, rolling COVID lockdowns in China is also an uncertainty, particularly with the new variant B5, which needs to be watched. And China is in that predicament because they have an elderly population that has a low degree of vaccination, which makes them difficult to reach for herd immunity, if you will, because that would trigger quite a bit of a catastrophe in terms of its population. Yeah. There are elements that continue to force the central banks to raise interest rates, create a meaningful slowdown to manage inflation, and that’s certainly going to be continuing to be priced in financial markets.