It’s tough times for curmudgeons. After a year of tapping our feet, waiting for a recession that seemed inevitable to sweep across North America, we are now being forced to admit that, darn it, things might turn out to be just fine.
A soft landing for the economy is far from certain but it has gone from a faint hope to a strong possibility, particularly in the United States. Only six months ago, a majority of economists expected the United States to slide into a downturn over the coming year. Now the consensus calls for no recession.
Granted, the Canadian picture is less encouraging. Eric Lascelles, chief economist at RBC Global Asset Management, pointed out in a recent report that retail sales per capita in this country are already sliding. Meanwhile, business surveys are registering more woe-is-me than a country-and-western song. All of this would be consistent with a downturn soon.
Even in Canada, though, the overwhelming probability is for a mild recession at worst. That’s not just happy talk: Housing starts, normally a good indicator of the state of the economy, have remained robust in recent months despite soaring interest rates. It’s hard to square all that vigorous building with an economy in deep distress.
Investors may want to start thinking about a scenario in which good news outweighs bad. In fact, they may want to start thinking about what would be a true shock – the possibility that everything from the 2008 financial crisis onward was largely a bad dream from which we are just now waking up.
This is the position of Jan Hatzius and his economics team at Goldman Sachs. In recent notes, they argue “the hard part is over” and predict that 2024 will demonstrate that the global economy has at long last escaped the environment of wealth-destroying bond yields that has prevailed since the Great Financial Crisis of 2008.
“The upside of this Great Escape is that the investing environment now looks more normal than it has at any point” since 2008, they write. Investors, they say, can expect “firmly positive” returns even after accounting for the bite of inflation.
Stow your skepticism, at least for a moment. Over the past year, the Goldman team has been way ahead of most of Wall Street in arguing that the world doesn’t need a painful recession to tame inflation. At first, they were mocked for their optimism. Now their once-controversial take has become conventional wisdom.
Wall Street’s change of heart has occurred because the economy has defied expectations. A year ago, most observers expected central banks to hammer down runaway inflation the same brutal way they did in the 1970s and early 80s. Policy-makers would raise interest rates to punishing levels. Lending would dry up. Unemployment would jump. Eventually, the rising numbers of jobless workers would reduce inflation by dragging down wages and prices.
It hasn’t happened that way. Despite soaring interest rates, unemployment rates in both Canada and the United States have stayed unusually low. Defying expectations, inflation has tumbled despite that low unemployment.
It now seems likely that the burst of 8-per-cent-plus inflation in 2022 was largely about how a temporary burst of pandemic stimulus overwhelmed supply chains. As the stimulus has faded and global supply chains have unknotted, inflation has plunged. As a result, we haven’t had to flog the economy with rounds of brutal layoffs to cut inflation in half.
This is excellent news. It’s still premature to talk about cutting rates, but the Bank of Canada and the Federal Reserve can wait and see what happens next. With inflation running at 3.8 per cent in Canada and 3.2 per cent in the U.S., it is quite possible that inflation will continue to fade over the months ahead. The path back to central banks’ 2-per-cent target could be relatively painless.
What does this mean for investors? As any self-respecting curmudgeon will tell you, it’s important to watch out for fresh trouble. It’s possible inflation won’t fade away or that higher-for-longer interest rates will break something in the financial system. It’s also possible that big government deficits will start to spiral out of control.
Over all, though, the message is positive. The Goldman team argues that many developed economies, including the U.S., should be able to avoid a recession in 2024. If inflation continues to dwindle, central banks should be in a position to start cutting interest rates in the second half of next year.
This suggests it’s time to start moving out of cash. Goldman expects both bonds (which go up in price as interest rates fall) and stocks to do modestly better than cash over the coming year.
Still skeptical? Curmudgeons may want to keep an eye on temporary help numbers in the U.S. A falling number of temp workers has been a reliable early warning sign of recessions in the past, because one of the first things companies do when they suspect a downturn is ahead is to cut temp workers.
The numbers right now are ambiguous. The number of temp workers is falling, but is still at historically high levels. If the number continues to fall, it is time to worry. If it levels off, though, even curmudgeons may have to get optimistic.
Ian McGugan