2023 recession: a ghost story?

Ashleay:
Welcome to iA Financial Group's “In Your Interest!” podcast, where we aim to share with you the essentials of economic news and its impact on your finances. My name is Ashleay, and this week we'll be taking a look at the state of the global and Canadian economies. As always, I'm joined with Sébastien Mc Mahon, Chief Strategist and Senior Economist at iA Financial Group. Hi, Sébastien.

Sébastien:
Hello, Ashleay.

Ashleay:
Glad to see you behind the mic once again.

Sébastien:
Same here.

Ashleay:
So, Sébastien, economists have been talking about the risk of a recession in 2023 for a while now, but it's already midyear and we haven't seen it yet. We thought this would be a good time to maybe take stock of the state of the global and Canadian economies.

Sébastien:
Yeah, of course. And these episodes are important because things move quickly, stories change. And, you know, we are still expecting that the global economy will be digesting all the rate hikes that we've seen over the past year or so from central banks, which were very swift and steep, and it's going to take a while for this to have a complete impact throughout the economy. We always say that it takes between 18 and 24 months for one rate hike to do the rounds completely. The last hike from the Bank of Canada was in January 2023. The big one—100 basis points—was in July 2022, so that's less than a year ago. It takes time; it's normal. So, we think that the economy will be stalling: we're not expecting a deep recession, we're not expecting a deep economic contraction. And this is completely normal to have a slow digestion of all of that. As strategists, we think it's an environment that's not really favourable to risky assets, which is why we're defensive (but not in the sense that we think that everything is going down the drain! I just wanted to provide that context). So, the global economy has been slowing down since the post-Covid boom of 2020, 2021. There are several moving pieces on the chessboard. But, you know, just this morning—you can have surprises that are positive or negative, and we got a positive one today: the Canadian GDP came out for the first quarter, it was 3.1%. This is stronger than expected, stronger than everyone, especially at the Bank of Canada, was expecting. The Bank of Canada was expecting 2.5%. So there is some good news, but we still think that the path of least resistance will be towards a slowdown. But, you know, again, there is no historical parallel for what we're experiencing economically and financially right now. There is no parallel to post-global-pandemic-world. So let’s look at the pieces one at a time. We’ll look at GDP, so the state of the economy through its pieces and let’s see where we fall for each of these pieces individually.

Ashleay:
Okay. And the GDP always starts with household consumption, if I'm not mistaken?

Sébastien:
Right, what we spend in goods and services, which is about 60 to 70% of GDP, depending on the country or the region. We see that there's still a lot of savings that were accumulated during the pandemic that still remain in bank accounts. The Canadian savings rate is now back close to its historical average. Right now, we save an average of about 6% of our incomes in the country, but we're still drawing down some of the accumulated savings made during the pandemic. And we're starting to see that the use of credit cards is rising, meaning people maybe have less savings in the bank. And a good example of where these savings are going is that we see that people are using their savings to finance their spending at new, higher prices. So with inflation, of course, we pay for it with our savings. For example, at the grocery store, where inflation exceeded 10% at the start of the year, the average basket remains fairly stable compared to the previous year: we still buy pretty much the same thing, we just pay more for it. So, we finance that with our savings. And there's a drawing down of that which cannot last forever. The job market also continues to perform well. There are many new jobs that are being created around the country, around 40 to 50,000 jobs per month over the last year. This is good, but there's been some hoarding of workers by businesses: with labour shortages, businesses want to make sure that they are fully staffed, so they are hiring lots of people. However, recent surveys are showing that companies no longer intend to hire that much, which should eventually put a damper on the momentum that is keeping households so active. So I would say that if we have a column of pluses and minuses, I would put a small X in the plus column for household spending in 2023; but this could turn towards a neutral or maybe even negative territory in 2024 if the labour market slows down.

Ashleay:
So the current momentum is at risk, but it's normal.

Sébastien:
Yeah, absolutely. Monetary policy, as I said, acts with a lag that is itself unpredictable. So companies create jobs, but they also invest. Investment represents about 20 to 25% of GDP in developed countries. The key factor for business investment is confidence, and recent surveys suggest that companies may be more cautious before embarking on expansion projects. So that would be negative. On the other hand, we have the US Inflation Reduction Act, which we discussed recently when we talked about budgets. We saw federal and provincial budgets in Canada reacting to what was going on in the US, because governments now want to subsidize green and energy transition investments, make sure that every jurisdiction remains competitive. So maybe this will help long-term investments. I would say that, in the short run, investments could be volatile, but in the longer run—I would say for 2023 and 2024—we could potentially put a check in the plus column for business investment.

Ashleay:
And as far as the government spending is concerned, we're talking mainly about a return to balanced budgets. Is that a factor as well?

Sébastien:
Yes, it is. Government spending accounts for about 15 to 20% of GDP in developed countries, which is a significant part. If you have continued spending, that means that you have no growth in spending, government spending stops supporting economic growth. And this is part of fiscal rigour—which is what we are discussing, especially in Canada, where governments, federal government, provinces like the province of Quebec, want to balance their budgets—fiscal rigour means that government spending becomes a headwind for growth. Over the next 12 months, I would say that it's reasonable to put a check in the negative column for government spending.

Ashleay:
Okay. And I often hear you say that Canada is a small open economy. Do you see the contribution of international trade?

Sébastien:
Yeah, Canada is a small player. The American economy is our main economic partner and it faces the same economic challenges as we do. So, growth in the US is expected to be relatively weak in 2023 and 2024, meaning that we’re not likely to see a boom in exports of Canadian products over the next two years. And the same might go for China, which has finally reopened post-Covid, but which seems to be having trouble getting back on track. Remember, China is heavily dependent on world trade and its reopening came at a time when the planet was slowing down. So I would say it's fairly neutral on the balance of things internationally. I would put a check in the negative column next to international trade.

Ashleay:
And looking beyond purely economic issues, how do you integrate demographics into your outlook?

Sébastien:
Well, especially for the Canadian economy, demographics are probably now the most important variable: with the post-Covid catch-up, over a million new Canadians arrived in the last year and hundreds of thousands will continue to arrive every quarter for some time to come. We're talking about demographic growth of over 2% last year, which is enormous. You’d have to go back to the post-war period to see such sustained growth. Back then we had the baby boom, now maybe you could say we’re experiencing the “newcomers boom.” And this is what's driving a large part of economic growth right now. Newcomers that come here have assets and they integrate quickly into the job market, which is a game-changer, since we favor economic immigration in Canada (we choose who comes here). And this is a very strong tailwind for the Canadian economy. We’ll likely now need to start looking at per capita figures in the country, so likely per capita growth will slow, as it has elsewhere. Total growth should be driven by demographics, meaning that if you look at 2008, at 2020, the Canadian economy has proven resilient in downward cycles. With demographics being even stronger now, we expect the Canadian economy to be a very resilient story.

So if we wrap everything up, I would say that the odds of a recession by the end of 2024 in the US are still about 50%. So, we're still sitting on the fence here, and we’ll adjust these odds as data comes in. But in Canada we'd say that the odds are lower: by the end of 2024, we would put the odds of a recession here in Canada at maybe around 30, 35%.

Ashleay:
Wow. Well, thank you so much, Sébastien. Once again, it's been most informative. And to all our listeners, thank you for being here. If you like this episode, we invite you to share it with your friends or give us your opinion on the listening platforms Apple, Spotify or Google Podcasts. Thanks, and we'll see you next week.

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