CIBC Deputy Chief Economist Benjamin Tal joins Bipan on this edition to chat about several hot button topics affecting the US and Canadian economies
Disclaimer: The materials disclosed on this podcast are deemed to be sales desk literature and subject to our client communication policy and code of conduct as well as IIROC rules.
Benjamin Tal: Should we lose sleep over inflation? Listen. Let’s face it. Nobody knows. When I say nobody, I include the Bank of Canada and the Fed in this nobody. Nobody knows. So pretending that we know that inflation will be sticky, we don’t know. So there is a risk element to it.
Bipan Rai: Welcome, everyone, to another edition of The FX Factor podcast. As usual, this podcast is available on all the major platforms, including iTunes, Google and on Spotify. So this episode is particularly special. We have one of the pre-eminent economists in Canada, Benny Tal, joining us to talk about a lot of important macro issues that pertain to both Canada and the United States. Now, what you’ll notice is that we refer to the federal budget released in Canada and also the Bank of Canada is happening this week. Now, we recorded this podcast last week. That’s probably the reason why you might be a little confused. So, again, please keep that in mind as you’re listening. But first and foremost, welcome, Benjamin. Thank you for joining us today.
Benjamin Tal: Thank you very much. It’s a pleasure.
Bipan Rai: Excellent. Excellent. So why don’t we start off with the covid variants? I mean, to what degree do you think we should be worried about these new variants both in the US and in Canada?
Benjamin Tal: Yes, I think we should be worried about it. There is no question about it. You look at the UK, about 95% of cases are the B117. In the US, it’s approaching 55% of new cases, they’re rising in Canada. Clearly this is an issue and we know that the vaccine is helping. But this is an issue that we have to worry about. We have the Indian variant now entering Canada and we definitely have to stop it very, very soon. So I’m worried about it. But overall, quite frankly, it’s a tug of war between the variant and the vaccine. And it seems that in the US and the UK, the vaccine is winning. It’s amazing, Bipan. By June, the US will achieve herd immunity. That’s unbelievable. So we are behind, but clearly they are moving in the right direction.
Bipan Rai: So that’s a good point that you bring up. In Canada, we are behind the curve when it comes to vaccinations, but for some reason, the market doesn’t be paying much attention to this story. I mean, at what point do you think it’ll impact the way Canadian assets are trading?
Benjamin Tal: You know what, I am not sure it will impact, I’ll tell you why. First of all, clearly, we are behind. We are behind for two reasons. First, we start from behind. Remember, for a given level of infection since the beginning of this crisis, the US economy was much more open than the Canadian economy. Now you want to put a negative spin on that. Of course, the number of infections in the US was higher. But you want to put a positive spin on that, economically speaking, they were doing better. Therefore, their unemployment rate did not rise as much as ours. The GDP did not go down as much as ours. So we are starting from behind and we have to run faster to stay in the same place. And now we have the vaccination trajectory. We are behind the curve. We know the story. And therefore I think that we are lagging by about three months or so. So the impact will be more on government policy, how much more support we need. Maybe a little bit on the Bank of Canada. But given the fact that we are talking about only two or three months, the negative impact on the Canadian economy, on markets will not be very significant.
Bipan Rai: That’s a good point, actually. The fact that we are going to be lagged behind by a couple of months. And I’ve heard you make the point or the distinction between prior recessions and this one and really in the context of prior recessions have impacted goods more so than services. And this time, it seems to be the other way around. Can you speak a bit to that?
Benjamin Tal: Yes. This is a totally different recession, something that we have never seen in our lifetime for a few reasons. First of all, the damage of this crisis was very, very deep. But it’s also very narrow. If you were impacted by that, you really feel the pain. If you are aviation, if you are a small business, if you are hospitality, you feel the pain. But the number of industries that are feeling the pain is much smaller than in any other recession. So it’s very deep, but also very narrow, which means that when we get the green light and we are on the other side of this madness, we are going to see a relatively rapid recovery, given the fact that it’s relatively narrow. That’s one thing. The other, as you suggested, it’s all about services. All recessions in the past, Bipan, all of them were led by the goods segment of the economy and services were the second derivative. Now it’s all about services because you press a button and you get your exercise bike, no issue. So it’s all about services. That’s the bad news. The good news is that, let’s face it, it is much easier and faster to start a new restaurant than to establish a new manufacturing facility. So the speed of the recovery will be much faster than in any other recession. Another positive.
Bipan Rai: Very good point that it is easier to start up some of these services business as opposed to some other heavy duty manufacturing. But what about the other aspect that could drive this recovery as well? And that’s something you’ve pointed out in the past, being the cash factor. You’re saying it’s going to be a big part of the upcoming recovery for both the US and Canada. Can you explain a little bit in more detail why?
Benjamin Tal: Absolutely. I think that we really have to understand the trajectory here, because that’s the story of the second half and into 2022 with major implications for the Bank of Canada, the Fed, FX markets and clearly the stock market. We are talking about a significant amount of money. You are all aware of that. But let’s put it in perspective. This has been the most asymmetrical recession ever. All the jobs, not some. All the jobs that were lost during this recession were low paying jobs. In fact, the number of high paying jobs went up by three hundred and fifty thousand in Canada. So you have a situation in which if there was an income gap before the crisis, this income gap is widening. Now, all the decline in spending was amongst high mid-income Canadians. It makes sense because low income Canadians spend most of their money or government money on necessities. So the people not spending are people with money. And that’s why we have this cash position. And then you have the government injecting money. Listen to this. This is crazy. For every one dollar decline in wages, the government of Canada injected seven dollars into the economy. So that’s unbelievable. So therefore, we are sitting on this mountain of cash. I estimate about one hundred billion dollars of excess cash sitting on the sidelines. And businesses are sitting on one hundred and thirty billion dollars of excess cash. Together, close to two hundred and fifty billion dollars of excess cash sitting on the sidelines. Now, the finance minister asked me once, what can we do to convince those people to spend that money? And I said, provide the vaccine and get out of the way. They don’t need any motivation. They are motivated enough. They just need the green light. And the question is what kind of spending we are going to get. And the good news is that this spending will go exactly where you need it. It will go to the service sector. That’s exactly where you need the jobs. And that’s one of the reasons why we are very optimistic about the second half of the year, clearly in Canada, but also in the US.
Bipan Rai: Can you touch on a little bit on maybe some other areas which could also drain some of this excess cash, potentially even debt payments by households or maybe even debt payments by corporations in the United States? Is that as big of a risk going forward in your mind?
Benjamin Tal: Yes, that’s a very, very good point. So let’s put it in perspective first. We have a situation in which the amount of deposits went up by 20, 25%, as I said, excess deposits of about 100 billion dollars in Canada for households. Remember, those deposits for the economy as a whole will not go down. What I mean by that is that if tomorrow I spend some of this money on something, especially the service sector, this spending will go to somebody else because I’m basically spending money and somebody else is selling the service and my deposits will tend to be his or her deposits. So the deposit level in the economy as a whole, money supply, if you wish, will not change dramatically. It simply will rise more slowly. And then we will see some debt payments. For example, part of the one hundred and thirty billion dollars of excess cash held by businesses is what we call the CEBA money, namely the government loans that were provided to businesses. They have to return those loans by 2022 December. Therefore, some of it, about forty five billion of it will go back to the government and therefore will not be used for spending. But I do believe that you will see some of this money being used to pay down debt, but it’s already happening. So I don’t see an acceleration of that.
Bipan Rai: Right. Right. So switching gears a little bit and maybe getting a little bit more specific to Canada, this past week was very, very busy and was a big week, especially at the federal level, with the Trudeau government released its latest budget plan. And as expected, we’re going to be deep in the red for many years now. The question that often gets asked is eventually, how do we pay for this debt? What is the end game here with the Canadian federal government taking on this amount of debt?
Benjamin Tal: The short answer is nobody. We all know that. You look back at 50, 60, 70 years, the Government of Canada never pays down its debt. You know, Margaret Thatcher in the 1980s said that governments are like households and vice versa. You basically have to pay down your debt. No, governments don’t pay down their debt. They roll it over. We all know that. And that’s exactly what you are going to see. What it means? It means that as a society, we are getting much more sensitive to the risk of higher interest rates or any other economic shock. So the real issue is really debt servicing and the impact of higher interest rates on government’s ability to finance their debt. It’s not about paying down the debt. It’s not going to happen.
Bipan Rai: Right. So good point then. What does that mean to the sensitivity of interest rates, particularly at the household sector then?
Benjamin Tal: Well, that’s the big one. That’s the big one, because we all know that we are in emergency interest rate situation and the craziness in the mortgage market is definitely a function of those low interest rates. We’ll talk about housing in a second, if we can, however, we have a situation in which I believe that the sensitivity of the economy and households to higher interest rates has risen dramatically. So people say yes, but interest rates are so low, meaningless. 100% of debt in this country was taken in a very low interest rate environment. So what I’m saying here is that the effectiveness of monetary policy has risen dramatically. You have a situation in which when interest rates go down, their effectiveness is not very significant because interest rates are very, very low. We have a generation of Canadians that never experienced high or even rising interest rates. For them, those extremely low mortgage rates, that’s the norm. So it’s not as exciting as it used to be. But now when you have interest rates starting to rise, every basis point counts. You raise it by 150 basis points. It’s like doubling your mortgage payments. I estimate, Bipan, that 1% increase in interest rates today in effective interest rates today on debt is equivalent to 200 basis points only seven years ago. So clearly, the Bank of Canada would be much more powerful in its ability to influence households by raising interest rates than at any other time in history, something we have to keep in mind when it comes to the impact and effectiveness of monetary policy. And now the economy will respond to the Bank of Canada.
Bipan Rai: Absolutely. And let’s talk about another major issue here in Canada or even outside of Canada. We get asked this question often. On the domestic housing market. And again, there were some measures that were implemented earlier this week, the federal budget. What impact do you think these latest budgetary measures are going to have on the household sector here in Canada?
Benjamin Tal: Yes, the list is changing. OSFI’s requirements on the stress test is very, very insignificant. We’re talking about twenty to thirty thousand dollars extra. Not a big deal. What we have seen coming from the government, definitely nothing that will change the reality in the housing market. We have to remember that the reality in the housing market now reflects two things. One, those extremely, extremely low interest rates. People are taking advantage of it. And there is a sense of urgency to get into the market and enjoy those interest rates as long as they last. But also it goes back to the asymmetrical nature of this crisis. As I suggested, all the jobs lost were low paying jobs, those were renters. They are not homebuyers. And that’s why the rental market is down. The people who are able to buy a house did not lose their jobs. So you have a very unique situation, Bipan, in which you get the positive of the recession, namely low interest rates, without the negative, without the cost, because people kept their job, they kept their income. In fact, their income went up. They are able to pass the stress test and take advantage of extremely low interest rates. In this environment, you have a huge lack of supply. We are trying to fight a supply issue using demand tools. It will never happen. The only way to deal with the housing market in Canada and especially Toronto, Vancouver, Montreal, is to increase supply. All the rest is nonsense.
Bipan Rai: Right, right. So that dovetails into my next question I was going to ask in terms of what is the cure in the long term? Now, you say it’s about increasing supply. There are restrictions, I believe, with respect to laws here in Ontario. Can you speak a little bit to that and potentially what could happen there to maybe mitigate this housing issue and potentially increase supply at the end of the day?
Benjamin Tal: Yes, first of all, in Ontario, you have something called Places to Grow Act that started in 2006 and basically makes it very difficult to release land. And that’s one of the reasons why you see prices in Toronto rising for the past 20 years. You simply don’t have enough land. And that’s something that in Vancouver, it’s an island. Toronto is an island from a real estate perspective because of policy. Then you have the process of releasing land by municipalities. It takes forever. You have to wait basically 10, 12 years to get the permit. That’s an issue. At the same time, you have population growth rising. The number of new immigrants after this crisis is over, we’ll reach four hundred thousand per year. We have not permanent residents, their numbers rising in a very significant way. So the demand is there. You don’t have the supply. And that’s the issue facing Toronto, facing Vancouver to an extent, even in Montreal, Ottawa. And that’s the number one reason. We have to realize this. Toronto, in a way, is becoming like Manhattan, like Berlin, like London. It’s not going to be the same because it’s not the same, but the direction is the same. So if you think Toronto is unaffordable now, you wait. This is just the beginning. And therefore, if we don’t do something about supply, it will be totally unaffordable. And what I suggest is not just release supply to build units for owning, but also much more, and that’s extremely important. The only solution and the only channel of affordability into this crisis is rental solution. And when I say rental, I mean purpose-built rental. The condo space cannot be the rental space and the rental space cannot be the condo space. And that’s something that we have to understand. We have to understand that we need purpose-built because the new wave of renters will be families and older people downsizing. They don’t want to deal with the landlord. They want to deal with a company. So I want to create the situation in Canada in which you are 35 years old, you are married, you have two kids and you are renting. Nothing is wrong with you. That’s the point.
Bipan Rai: Wow. So I’m sure that raised a few eyebrows, Ben. And again, to your point, it’s really more of a supply side issue and that’s really where the solution should be concentrated. One of the other things that I keep hearing about from some of our listeners outside of Canada is in the States and now there’s more and more of this chatter about a housing bubble potentially coming up in the United States. I mean, is that justified in your mind? I mean, what are you thinking about in terms of the US housing market?
Benjamin Tal: No, it’s not a bubble. I think that people use the word bubble too loosely. I think that we have to be careful. In order to have a bubble, you need to see a significant element of speculation in the market, the subprime type activity not happening in the US. We have to remember that the US went through a major deleveraging process during the crisis, did not recover from it in any significant way. Over the past decade, house prices were rising by about 4% a year. Nothing to write home about. So now it’s rising by about 10, 12%. I think it’s reasonable, given low interest rates, given the demand and given the abnormality of this recession in terms of the impact on high paying, low paying jobs, if it continues for another year, year and a half at this rate, then maybe we should discuss it. But I believe it will go back to about 4 or 5% where it belongs. And now simply we are borrowing activity from the future as people try to take advantage of extremely low interest rates. So to me, this is not a bubble.
Bipan Rai: Ok, so I guess we could switch gears again and talk about the other major macro issue that we’re all going to have to think about potentially later this year, maybe even in the coming years. And that’s inflation. I mean, the predominant macro view right now is that is expected to rise. What are your thoughts on this?
Benjamin Tal: Yes. Listen, if you are under the age of 30, you don’t know the meaning of the word, because it was missing in action. I actually checked in the Oxford Dictionary to see if inflation is still a word in the English language. It is. And should we lose sleep over inflation? Listen. Let’s face it. Nobody knows. When I say nobody, I include the Bank of Canada and the Fed in this nobody. Nobody knows. So pretending that we know that inflation will be sticky, we don’t know. So there is a risk element to it. There is a main case scenario that inflation will not be an issue, but clearly a significant risk that maybe we will be surprised. I’m sure that in the sixties, when inflation was 1, 1.5%, all those economists said, you know, any acceleration would be short lived and it was not. So let’s be realistic about the possibility of inflation being more sticky than people believe. Now why is it important? It is important because at this point, you just listen to the Bank of Canada yesterday. You listen to the Fed. They are telling you they are willing to tolerate higher inflation. In fact, the Bank of Canada is forecasting 2.4% inflation, suggesting that they will be flexible about inflation overshooting. The Fed is telling you we are targeting long term inflation, therefore, we allow it to overshoot. Now, what happens if it overshoots and doesn’t go down? What I mean by that is that there is a risk that you as a central bank will be behind the curve. And when the market says that, that will be risky for the long end of the curve. Again, what I mean by that is that inflation is a lagging indicator. It’s like this brown spot on the banana. By the time you see it, it’s way too late. And that’s the issue that I’m really struggling with now. This is not our main case scenario, as we all know, but we have to highlight to our listeners the risk that if you wait for too long as the central bank and then you start chasing inflation, a lagging indicator, you will raise interest rates way too quickly. And we just discussed the increased sensitivity to higher rates. So if you shock the economy with an accelerated trajectory of rate hikes, that can be very damaging to the economy. That’s the risk we are facing at this point.
Bipan Rai: Yeah, and it can absolutely be destabilizing to the market potentially as well. So having said that, what are your thoughts for the Fed and the Bank of Canada heading into 2022 potentially? Actually, why don’t we start off with 2021? Do you think we’ll get some sort of announcement from the Fed about potentially a taper sometime later this year?
Benjamin Tal: Yes, I think that it’s time for the Fed to start at least talking about it, but they will have to use a very gentle language knowing the experience of 2012. So clearly, this is something that is going to happen. I believe the Bank of Canada already did it, as we all know. I do believe, however, that both central banks deep inside know that they will start hiking in late 2022, but they will not admit that. And that’s something, again, that they are playing, because if you start talking about inflation risk, that would spook the long end of the curve, the last thing they want to do. So they are really talking from both sides of their mouth at this point. At one end, they are saying that, you know, we are going to improve nicely, but then they say we’ll tolerate higher inflation and therefore we wait with interest rates. I think this is a very risky game that they are playing here because you cannot time it. I would rather see that moving earlier than later, because when you move later, you will again address a lagging indicator, which is inflation, and you can overshoot. And that’s a significant risk. So to me, I think a reasonable scenario, both central banks would start raising interest rates in the fourth quarter of 2022 and the Fed will be the first. For some crazy reason, as you know Bipan, the market is still pricing in a situation in which the Bank of Canada will move before the Fed. I’m not sure what the market is smoking. It’s not going to happen. The last thing the Bank of Canada would like to do is to see us moving before the Fed. That will take Canadian dollar higher. Exactly the opposite of what you want to see at this point.
Bipan Rai: Exactly. Again, that’s one of the reasons why we are a little bit more constructive on dollar CAD over the long term. Of course, we’ve modified that view a little bit this week, given what we heard from the Bank of Canada. But nonetheless, I mean, it really doesn’t make sense to think about the Bank of Canada really hiking ahead of the Fed when push comes to shove? Really, when we do get closer to rate hikes, we do think that the market will course correct for that and that ultimately, will lead dollar CAD higher? I mean, that’s a long term story. It’s probably not a story for the here and now. So thank you so very much, Benjamin, for joining us today.
Benjamin Tal: Perfect. Thank you.
Bipan Rai: Thank you to our listeners as well. Feel free to subscribe. Again, that’s FX Factor at Apple iTunes, on Google or on Spotify. Until next time, thank you so very much.
Disclaimer: The information and data contained herein has been obtained or derived from sources believed to be reliable, without independent verification by CIBC Capital Markets and, to the extent that such information and data is based on sources outside CIBC Capital Markets, we do not represent or warrant that any such information or data is accurate, adequate or complete. Notwithstanding anything to the contrary herein, CIBC World Markets Inc. (and/or any affiliate thereof) shall not assume any responsibility or liability of any nature in connection with any of the contents of this communication. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice. CIBC Capital Markets is a trademark brand name under which different legal entities provide different services under this umbrella brand. Products and/or services offered through CIBC Capital Markets include products and/or services offered by the Canadian Imperial Bank of Commerce and various of its subsidiaries. For more information about these legal entities, and about the products and services offered by CIBC Capital Markets, please visit www.cibccm.com. Speakers on this podcasts are not Research Analysts and this communication is not the product of any CIBC World Markets Inc. Research Department nor should it be construed as a Research Report. Speakers on this podcast do not have any actual, implied or apparent authority to act on behalf of any issuer mentioned. The commentary and opinions expressed herein are solely those of the individual(s) ,except where the speaker expressly states them to be the opinions of CIBC World Markets Inc. Speakers may provide short-term trading views or ideas on issuers, securities, commodities, currencies or other financial instruments but investors should not expect continuing analysis, views or discussion relating to these instruments discussed herein. Any information provided herein is not intended to represent an adequate basis for investors to make an informed investment decision and is subject to change without notice. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice.
