Catching up with Benjamin Tal

Benjamin Tal: Listen, there are 4500 banks in the US. There will be more names and that will keep the market guessing. But the fundamental story is that the banking sector in the US is very different than it was in 2008. This is a story of a few banks that really were very stupid.

Bipan Rai: Welcome back to another edition of the FX Factor podcast. This is our first one in quite some time, and we brought back an old friend who just so happens to be one of Canada’s premier economists, Benjamin Tal. Hey, Ben, how are you?

Benjamin Tal: Good, How are you?

Bipan Rai: Not bad, all things considered. This is an interesting time for the markets. Indeed. What a time. I mean, there’s a lot of topics we could talk about for today’s episode, but given the importance of this so far and how much cute these pressures have become over the last couple of weeks, I’ll start off with the most obvious topic. What do we make of what’s going on in the banking system globally and what are your thoughts on it?

Benjamin Tal: You know what?

Benjamin Tal: Quite frankly, I don’t lose much sleep over it. I think that this story will disappear soon. Listen, there are 4500 banks in the US. There will be more names and that will keep the market guessing. But the fundamental story is that the banking sector in the US is very different than it was in 2008. This is a story of a few banks that really were very stupid when it comes to risk management. Quite frankly, that’s the best way I can put it. You know, the mismatch between short term liabilities, long term assets, we know the story. So this is not going to disappear. It will impact the Fed in a marginal way. But don’t think it’s a big story. It’s not a credit quality story. It’s a liquidity story. And when it comes to liquidity, the Fed can deal with it. And we have seen that they’re doing. 

Bipan Rai: And when it comes to liquidity and how the Fed deals with it, it’s very different than prior cycles or at least hiking cycles in the fact that, you know, at this point the Fed has to hike rates to address key domestic concerns, including a tight labour market and of course, inflationary pressures and the like. But then all of a sudden we’ve got these banking system stresses. How does the Fed balance the two potentially those two goals are conflicted at some point, no?

Benjamin Tal: Absolutely. And that’s why it’s so difficult for the Fed to communicate to the market what they’re trying to do, because on the one hand, they are still very hawkish about inflation. Inflation is rising. We know the story. And then on the other end, if you don’t move, then you’re submitting a panic signal that you’re really worried about the financial situation, the banking situation. So what to do? That’s why we believe that they’re going to raise interest rates just because of this communication nightmare. You know, the Fed was working very hard in terms of quantitative tightening over the past six months, removing $600 billion from the market. And in five minutes, they added 3 billion, $300 billion. So you are really undoing some of the shrinkage in the balance sheet, but none of it is going to the market. None of it is going to the economy. It’s all in reserves. That’s why I’m saying it’s a liquidity story. Therefore, you don’t see this money being moved to actually support economic activity. That’s why it’s not really expanding monetary policy in this sense.

Bipan Rai: Yeah. Another pertinent question that we keep getting asked as well is whether or not these banking system stresses can sort of migrate outside the United States. From a macro lens, I would say. What do you see different in terms of how the Canadian banking system is structured that would prevent something like this happening here?

Benjamin Tal: Yeah. So first of all, we have the European story. Credit Suisse, of course, is the story, but this has been a basket case for a long period of time. So this is very unique story. It’s not really reflecting what’s happening in Europe as a whole, although the banking sector in Europe is not as strong as the banking sector in Canada. So really, Canada has the biggest in terms of the how strong it is, the best banking sector, if you wish, relative to the US and Europe. So I’m not worried about something like that in Canada by any stretch of the imagination. However, it doesn’t mean that Canadian banks will not take another look at providing credit. That’s why this story is disinflationary. The whole business with the banking sector is disinflationary. It will invite regulations into the system and they will come and clearly banks will think twice before they extend credit regardless where they are. So that’s something that will be disinflationary, no question about it. That’s the most significant impact of this crisis.

Bipan Rai: So it’s almost like financial tightening is finally make its way through the banking sector via judicial lending potentially, is what I’m hearing from you, is that correct?

Benjamin Tal: Exactly. That’s exactly what we are seeing. And that’s the most significant derivative of this crisis. It’s not about credit quality. It’s not about the run on the bank. It’s really about reduce the appetite to lend. And that, of course, will have a negative impact on the economy, will add to those recessionary fears.

Bipan Rai: So, I mean, with that in mind, then that sort of does speed up the process of prior hikes and how they filter through to the real economy. Now, I mean, how much further does the Fed and the Bank of Canada Well, we know the Bank of Canada is on conditional pause at this point. But with respect to the Federal Reserve, how much further can they tighten rates?

Benjamin Tal: Well, in my view, they should have stopped yesterday. Quite frankly. I think that we are in a process of overshooting. As I told you in the past, I believe that every economic recession over the past 30, 40 years was helped, if not caused by monetary policy error, namely raising interest rates way too much too quickly. Why? Because inflation is a lagging indicator. And clearly we are seeing it with the Fed. The Bank of Canada is smart enough to stop. I think that there are 25 basis points more than there should be, but we are okay. The Fed is still talking about inflation, about all kinds of things happening. Think the Fed is overshooting and think that now it’s basically in the corner because they will have to raise interest rates even if they don’t want to because of the risk of sending a panic signal to the market regarding the banking system.

Bipan Rai: So you use the R word there. Do you see a recession coming in North America for both the US and the Canadian economies?

Benjamin Tal: Yes. I think that we are already in many ways in a recession. Manufacturing in the US is a recession is in a recession. The housing market is in a recession so soon, I think this consumer will also join the parade. Quite frankly. Again, I don’t think it will be a very severe one. I think that it’s going to be a wannabe recession. We are going to get a zero negative growth over the next two quarters, but nothing big. The labour market is still very strong, although I do believe, quite frankly, that this consumer is no longer able to sustain the economy. We have to remember that we have seen this excess savings that everybody was talking about. In the US They’ve been using this excess savings and what’s ever left is held by Rich people. So their propensity to spend is not really high. So I don’t think that the consumer can sustain consumer spending that we have seen to date just by reducing savings and therefore see the economy is slowing down. The housing market is definitely slowing down and clearly investment is not there down significantly. So I don’t see a situation in which the US will be able to avoid a wannabe recession, but the labour market is tight enough to prevent it from being a very strong. 

Bipan Rai: Very good point. I was going to bring up the labour market. What is it about this labour market that keeps it tight relative to some of the other indicators that would point towards a recession at this juncture?

Benjamin Tal: Well, first of all, demographics is part of it. We have a lot of people retiring and not being replaced. But I think, quite frankly, that the labour market is not as tight as perceived. You know, people are talking about this, what, 11 million vacancies in the US don’t buy it. Think all those vacancy business is one big mirage. If it was really 11,000,017% of the labour market missing wages would be in the sky and they are not. So it’s very easy to put a name and say, okay, well I need five people, but actually hire them and pay them. No, I’m not doing that. So I don’t think it is as tight as perceived. Same goes for Canada and we are starting to see those vacancies disappearing like they were nothing. So I’m not so sure that the labour market is as tight as perceived. The wage mechanism is not telling you that, especially in Canada. We know that there is a clear correlation between negative correlation between wages and vacancy rates in Canada. The lower the wage, the higher the vacancy rate. Restaurants, hotels. We know the story clearly, we need them. But if you look at the wage inflation first, quantiles, second quantile hardly rising relative to other wages. Therefore, if you are not willing to pay, you’re not getting them. And we talk to a lot of small businesses and ask, why aren’t you paying? Said, Listen, minimum wage went up by a significant amount in 2018. We don’t have the margins and economists like yourself are telling me are talking about a recession. I’m not going to raise wages five minutes before a recession. So I’m saying if you are not paying, you don’t need them as much as you think you need them.

Bipan Rai: So I guess to summarize that, Ben, is to once again understand that the labour market is a market that after all, does need to clear very good points when it comes to upcoming recession talk and what that would ultimately mean. What do central banks do in that environment? Right. Because if we look at how the markets are pricing both the Fed and the Bank of Canada, they’re price for cuts before the end of 2023. Again, given the situation has changed, given that new risks have arisen with respect to the banking sector, do you agree with how the market is pricing both central banks at this point?

Benjamin Tal: You know. Quite frankly, I’m not sure what the market is smoking. I really not sure why the market is doing that, because the Bank of Canada, the Fed, have been talking about inflation until five minutes ago. And now you want them to cut. Yes, I understand the financial system, all these businesses that will disappear soon. I think that the focus is inflation and inflation is going down, not up down. Over the next few months, we are going to get the best factor the way we got it today. And it’s going to take you to four, 3.5% inflation. Then the move from 3 to 2% is more tricky, but we are very close to where we should be. Wages in the US are rising by 4.5%. You just take them to three and half a cent and you are good. You don’t need more than that because of productivity. So we are very close to where we should be. So I think that inflation is moving in the right direction. However, however, we are disinflationary fear. For the past year there was panic. People are still talking about it. So I think the Fed and the Bank of Canada will not touch interest rates, will not cut interest rates until they are sure that inflation is 100% dead. Otherwise you lose credibility. So I say early 2024. So I think that the market is wrong on this one and there is some opportunities here.

Bipan Rai: Okay. So Ben, let’s talk a little bit more about inflation. I hate to beat a dead horse here, but we look at the inflation numbers out of both the United States and Canada, maybe less so in Canada. What the ultimate concern now is what’s happening with respect to shelter. The fact that that is really driving car services higher. And we know that the Fed is paying attention to the shelter costs and also X shelter service costs. What is your thoughts there? I mean, at some point, owners equivalent rent, which does tend to track house prices with a bit of a lag. The weakness in home prices in the United States should start showing up there. How come we haven’t seen it already yet?

Benjamin Tal: Exactly. We will. We will. It’s coming, no question about it. You look at the inflation story in the US, there are five forces food prices, energy prices, wages, supply chain and rent, food prices, negative energy prices, negative supply chain. Basically, you look at the New York Fed supply chain index, basically back to where it was a wages as discussed. I think they are on their way down from four and a half to about three. So what’s left is rent. Now you look at rent and clearly we see this gap between existing rent and new rent. We have the Zillow private sector index that’s showing basically zero inflation in new contracts and new leases. Now, the Zillow is very different than the CPI rent because Zillow focus on detached and some sort of, you know, the suburbs while the CPI is more the cities. Nevertheless, the direction is there. There is a correlation there. There is a gap. We don’t know exactly how long this gap, but it’s very clear that every day that passes more of the flow, which is zero, gets into the stock, which is 7%. So we know that this stock will start going down. There is no question about it. It’s just a question of time. And the Fed knows that. And that’s why they look at the, you know, super core, whatever you want to call it, the takes rent out of the story because you have to do that because we know the direction. You cannot conduct monetary policy based on what you are seeing now. You know what’s coming. And that’s not a prediction. That’s a given. That’s simply pure math.

Bipan Rai: Okay. So let’s talk about another important sector in both economies. That is a housing market. But let’s focus on Canada for now. Now, we know that home prices have come off in Canada. Are you thinking going forward here?

Benjamin Tal: I think they will continue to go down, but the second derivative is approaching zero. Basically the rate at which it’s slowing, it’s actually slowing as well. And we have a situation in which what the market needs is basically stability and clarity regarding rates. And the Bank of Canada is now providing you this clarity, basically saying we are not moving anymore. So you see the five year rate starting to move down. You see the prime rate staying more or less where it is so people know where they stand. And we have to realize also that there is a huge amount of demand happening as we talk and supply is not happening. You know, last year, listen to this, we got 950,000 people into this country, 950,000 this year. I calculate roughly 1 million in new immigrants, non-permanent residents, foreign students, people from the Ukraine on a three year visa. None of them none of them is carrying their house on their back. So the demand is there. The vacancy rate in the rental market is like 1.5 on its way to zero. And I’m not kidding. And supply. We basically stop building one third of activity was cancelled or delayed because of cost. You tell me, where are we going from here? So over the next few months will continue to slow down. Sales are starting to recover. We have a situation in which what prevented prices from falling more is actually the lack of supply in the recent market. People were sitting on their hands doing nothing. I’m seeing more and more for sales happening. The market is getting back to normal in terms of rates. More people will be more comfortable to sell their house. So the combination of forced sales and regular sales will increase supply in the market and will prevent housing prices to improve in a very significant way in the near future. Although again, the second derivative is approaching zero. Beyond that, over the next 2 to 3 years, if we don’t improve the supply situation, don’t have to tell you prices will continue to go up. That’s more or less where we are seeing.

Bipan Rai: This is a great learning experience as it always is with you, Ben, and can’t wait to have you back.

Benjamin Tal: A pleasure. Thank you. Talk to you soon.

Bipan Rai: Thank you, everyone. Until next time, cheers.

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