Avery Shenfeld joins colleague Andrew Grantham to discuss the slowing in the US economy and emerging recession fears, and shares their interest rate forecast changes for both Canada and the US.
Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets. A podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.
Andrew Grantham: Welcome to the latest edition of Eyes on the Economy podcast. I’m Andrew Grantham, Executive Director and Senior Economist at CIBC. And today I’m joined by our Chief Economist Avery Shenfeld. Avery, welcome.
Avery Shenfeld: Nice to be here.
Andrew Grantham: So Avery, it’s the summer, but we have seen some volatility in financial markets, some concern over the US outlook in particular. Let’s just take a step back, though. What has actually changed, if anything, in terms of the economic backdrop?
Avery Shenfeld: think it’s that the perfect world that financial markets were thinking of, particularly from an equity investor point of view, doesn’t seem quite so perfect. So we’ve had a long run where the US was resilient in the face of high interest rates, in the face of slowing elsewhere outside the US borders. And then we had some data come in that suggested that maybe the US wasn’t the bright and shiny object that it looked like. At least it too, was starting to see some fraying at the edges that created at least some volatility, as you said, and some concern over what happens next.
Andrew Grantham: Yeah, so we heard a lot about the unemployment rate in the US, the fact that that’s risen. The Sahm rule about the unemployment rate rising by more than half a percent. And that’s sparked some concern about a potential US recession. Maybe walk us through just what this rule is and how accurate it may or may not be, particularly in the current environment in terms of tracking US recession.
Avery Shenfeld: Well, what Sahm had discovered was that if you went back to 1960 at least, that a rise in the unemployment rate using three month averages of more than a half a percent within a calendar year typically meant that we went on to be in a recession. It wasn’t that you were necessarily in a recession at that point. It’s that once the unemployment rate had climbed that much, it typically climbed a lot further and you were in a recession. There’s actually a new paper out just this week by a couple of economists that amend Sahm’s rule to also include the job vacancy rate and it gets a little more accuracy. But that rule actually says that we’re at about a 40% chance of being in a recession, so not there yet. I think what we like to do is take a bigger picture because if you take a single rule of thumb like that, those kind of rules are made to be broken. Remember that a lot of people a year, year and a half ago were saying that the inverted yield curve was a surefire never fail indicator of an upcoming recession. And we didn’t fall into recession in either the US or Canada after a long period with an inverted yield curve. And there are some other signs from other variables that suggest the US certainly not in recession yet. So generally speaking, employment has still been growing. Layoffs have been fairly muted. So we haven’t seen a lot of mass layoffs in the US economy. We’ve seen general increases in some of the other indicators of economic activity and we have to remember that we just came off a surprisingly strong second quarter for the US. I think if you put all of the data together, what you have is a picture of an economy that is in fact slowing in terms of the pace of growth from that very heated second quarter, but might be headed for something like one and a half percent growth in the third quarter. So a deceleration for sure, but not really yet any definitive sign of an outright recession.
Andrew Grantham: So what about the volatility in financial markets? Is that telling us anything about the future or is that just people having to adjust their expectations for this new reality that we’re seeing for the US economy?
Avery Shenfeld: Well, they do say that the stock market is forward looking, but then we have Paul Samuelson, the famous economist with his quip that equity corrections correctly predicted nine of the last five recessions. In other words, there are, as Paul Samuelson was pointing out, other cases where we had a big retreat in equities and no recession. And some of us are old enough to remember the 1987 stock market crash. The S&P 500 fell by more than 20% in a single day. There was no 1987 recession. There was no 1988 recession for that matter. So stock markets are certainly not infallible predictors of economic downturns, nor do they necessarily cause a downturn. That’s particularly true when you’ve had a very long run up in equity prices as we’ve seen in the US market. So valuations get stretched. You’re counting on the best of all possible worlds with falling interest rates ahead, but still reasonable growth and earnings. And anything that shakes the confidence of that can certainly cause equity markets to retreat without predicting or causing an outright recession.
Andrew Grantham: Yeah, so we don’t seem to be too concerned about US recession, at least at this stage. The US economy is slowing down. But we have made a few minor changes, I would say, to our interest rate expectations. Maybe walk us through what they are, those changes, and where we see interest rates going in the future.
Avery Shenfeld: The changes we’ve made in our forecast are really fine-tuning that outlook to take into account a shift in the balance of risks. So the Federal Reserve may well think that they’ve come from a period where the risks were more concerns about upside risk to inflation, not as much concern about downside risk to growth. Now we’ve at least had enough signs of frailty, signs of a softening in the labor market, that rise in the unemployment rate. All that gives the Fed reason to start to put more emphasis on combating downside risks to growth and taking a little bit away from the pain that they’ve been inflicting on the economy to get inflation down. And so we do see the Fed cutting a little more steadily than we did prior to this weakening in the US growth indicators and labor market indicators. We now expect the Federal Reserve to cut a quarter point at each of its three remaining meetings this year, so that would be 75 basis points versus our prior call of 50 basis points. And we continue to see lots of room for further rate reductions in the U.S. over the course of 26 and 25 to get interest rates over the next couple of years down to something closer to neutral, which might be in the three and a quarter percent range. But we added one rate cut to this year. And similarly in Canada, the progress we’re making on inflation and now some signs of fragility in Canada’s key trading partner, again, should have the Bank of Canada decide to be a bit more persistent in terms of the rate cut decision. So earlier we thought that the Bank of Canada might cut two more times and then pause to see how things are going in December. Our view now is that there’s enough downside risks to growth in North America and enough progress on inflation, importantly, for the Bank of Canada to again, cut at each of its decision dates. So that would be three cuts rather than two between here and the end of the year. And again, continuing on the path to lower interest rates in 2025. The vision in our forecast means that we end 2025 at a two and a half percent overnight rate. Our prior target was two and three quarters. So just dipping a little bit into stimulative territory in order to fend off some of those downside risks to growth that would be associated with any signs of a slowing in the U.S.
Andrew Grantham: So I think relative to our previous forecasts, a very slightly quicker reduction in interest rates. But interest rates kind of really end in still around the same level that we’d predicted just a little bit lower. So it all seems reasonably good news given the fact that we don’t forecast a recession.
Avery Shenfeld: That’s right. And we’re not jumping into the bandwagon of an accelerated or something not gradual in terms of the path of rates ahead. Remember that while one could easily make a case that both the Fed and the Bank of Canada should actually do some larger rate cuts first, then pause and see how things go, that doesn’t seem to be the style or the playbook that either the Fed or the Bank of Canada have. We know that from the Fed because they publish a dot forecast that showed a very gradualist path. While they might be adding a bit to that, they’re not going to throw out that playbook. As far as the Bank of Canada, of course, they don’t reveal their intentions on interest rates, but they reveal to some extent that their tastes are towards a gradual process, having cut by only 25 basis points at each of the last two decision dates. You know, they could have opted for a larger 50 basis point cut, for example, in order to get rates moving down faster. Certainly that would have mirrored what they did on the upside where they did some very large hikes when they felt that they were sure that rates were too low. You could make the case that rates are clearly too high now and they should move in larger steps initially. But we’re not forecasting that because that simply put doesn’t seem to be the modus operandi of either the Fed or the Bank of Canada. We see them as retaining this sort of gradualist approach as long as we do in fact stay out of recession
Andrew Grantham: Excellent. Avery, thank you very much for joining us, walking us through those slight revisions to our forecasts. And thank you everyone for listening.
Outro: Please join us next time on the Eyes on the Economy where we will share our latest perspectives and outlook for the Canadian and US economy.
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