-Find out whether inflation is finally getting under control and when Canadians may begin to see lower interest rates. -Discover how interest rate hikes, unemployment, pricing, and more are impacting the overall Canadian economy. -Learn more about the market outlook and what it could mean for our investments.
The strength of the economy and how it impacts Canadians is top of mind right now. Over the last year, Canadians have faced high inflation, multiple interest rate hikes and a rising unemployment rate. So it’s no surprise, many are wondering what to expect next.
In this episode, CIBC’s Managing Director and Chief Economist, Avery Shenfeld joins us to give his insights and analysis on the market and answer some pressing questions about the Canadian economy. From inflation and interest rates to buying and investing, Avery talks to us about the current economic situation in Canada and what it might look like in the next few years.
Listen to this episode and find out what the Canadian economy looks like today and how that can impact your daily life.
Carissa Lucreziano: Welcome to Smart Advice, a podcast bringing you financial advice, investment strategies, and economic trends. I'm CIBC’s financial advice expert, Carissa Lucreziano. And today we're tackling two buzzwords that are on the minds of Canadians from coast to coast, inflation and interest rates.
The Canadian economy has been experiencing rapid shifts with the Bank of Canada raising interest rates a whopping 10 times since March 2022. And while this has slowed down the economy, it certainly hasn't brought it to a screeching halt. With inflation lingering at 3.3%. We're all wondering when or if the tides will turn.
To help us unpack these complexities. I am thrilled to have Avery Shenfeld with us today, CIBC’s chief economist. With over 30 years of experience and wisdom and a Harvard PhD in economics, Avery is a trusted voice that Canadians turn to for the straight goods on trends in the market and the economy. You will find his insights through top-tier outlets like the Global Mail and BNN. But what truly sets Avery apart is his unique ability to connect the dots of what is happening here at home to the bigger picture of the global economy and how that story impacts us, Canadians, in our everyday lives.
Avery, welcome to the podcast. I am so thrilled to have you here.
Avery: Happy to be here.
Carissa: So as we're recording this episode, the Bank of Canada has just made the latest decision which was to hold steady at 5%. The decision was made in response to evidence that the impact of the previous interest rate hikes is finally kicking in. With the economy declining in the second quarter, which we learned just ahead of this announcement, there's so many things on Canadians’ minds, and we'll get into that for sure. I'm excited for your insights. But is the Bank of Canada convinced yet that inflation is under control? Are we done for rate hikes in 2023?
Avery: The Bank of Canada isn't fully convinced, but we and CIBC’s economics group are more convinced that interest rates are high enough to do the job. That doesn't mean that inflation is going to magically melt away tomorrow. We're gonna have to go through some economic pain, a period of slower growth, a bit of an upturn in unemployment, before we cool spending power enough for inflation to come down.
But our view is that, what the data are in fact telling us is that the impact of all those prior rate hikes was kicking in even before the Bank of Canada's last interest rate decision, which was back in July, was slowing spending. And with time, that will bring relief on the inflation front. So we'll need to be patient. And we're hoping that the Bank of Canada will be similarly patient in waiting for inflation to fall, which we think it will over the course of the next year.
Carissa: And a question you get often in the headlines, it's always really hard to really see, into the future is, are we in a recession? Are we not in a recession? Do we have to worry about that? Is that behind us?
Avery: Well, economists aren't always great at forecasting the future but we're pretty good at forecasting what's already happened. So we do have data from the second quarter, which showed a slight decline in GDP. But we also know that that was impacted by strikes, and of course, by the wildfires roaring in many provinces in the country. And so growth would have been positive, maybe meagerly positive, but still positive without that.
We also know that job creation is still ongoing. We're still getting enough new jobs to suggest that the economy, in fact, is returning to growth in the third quarter. So we're not yet in recession, but not yet is the right word here because we're close. The unemployment rate has moved up from five to five and a half percent. And if it were to go up another half a percent, we'd be, again, getting close to the kind of climb and unemployment that is consistent with recession.
Now, we may avoid that this time because part of the rise we're seeing in the unemployment rate isn't that job creation is falling off. It's that we're bringing in so many people each month. So we can have, as we did in the most recent data, for example, a month to regenerate quite a lot of jobs, 40,000 new jobs. But the unemployment rate doesn't fall and could even have nudged up a bit had some Canadians not decided to just stop looking for work. So we could have a combination of growth continuing, but because we're bringing in more people, the unemployment rate is actually moving up. So to some extent, it may feel a bit like a recession, even if it technically isn't one.
Carissa: Yeah, that's fair. I mean, there's been some thoughts that rates might start to come down in 2024. And we know the Bank of Canada wants to get inflation in and around that 2% by 2025. Is it almost premature to ask when rates will start to follow? When we think they're gonna start to come down?
Avery: So it is a little like the kids in the backseat saying, “Are we there yet? When can we get out of the car? When can we have dessert?” And so on. And I think the reality is that we may well start to see lower interest rates by the spring of 2024. They'll still be high, they just won't be as high as they have been.
So the current rate of interest, 5%, overnight rate from the Bank of Canada is, by the standards of the prior decade, very high. And our view is that by the end of 2024, for example, that overnight rate might be, say, three and a half percent. And while that's a welcome relief for borrowers, we have to remember that that level would still be twice the highest interest rate we had in the last business cycle. In other words, the one that ended with the pandemic, we never even got the overnight rate up to 2% in that cycle.
So lower interest rates, certainly in the cards in our view for 2024. But low-interest rates, what Canadians would think of as low-interest rates, probably not in the foreseeable future because unless we have a bruising recession, we're not going to get inflation down sharply enough that we're going to need that sort of stimulus again for a long while.
Carissa: Yeah. Which leads me to the next question. I think those kids in the backseat are the majority of Canadians. But if we talk about the Canadian household debt. Are Canadians busting at the seams yet? Like thinking about mortgage defaults, people that have bought investment properties that are now closing. How are Canadians being pressed? And where do you see that continuing or any relief?
Avery: This is certainly a squeeze on those Canadians who took on large mortgages at very low rates four or five years ago, and are starting to see those being renewed at much higher interest rates. It's not necessarily something you can judge by looking at the average. Because when you look at average debts and average incomes, of course, you're including the incomes of very wealthy people. And the debts, perhaps some people aren't quite so wealthy. So we really have to focus on the indebted slice of the economy.
The good news is that when we were doling out all those mortgages at very low rates, there was a stress test in place, at least for those who borrowed from banks where they had to prove they could afford at 2% or so higher interest rate, if that renewed at that rate. And so we've gone up more than that, in some cases. But we've also had some income growth over the past several years. So we're not seeing a deluge of defaults. And remember that most people's houses, even though house prices have come down off their peaks, for most people, they still have a house that's worth more than they paid for it. So the worst case scenario is they have to sell their house and downsize if they find the mortgage too much of a squeeze.
We're not really seeing that yet. We are seeing some upturn in defaults on other types of credit. So lines of credit, and so on, but not really on mortgages. And so this is a painful process. People will have to adjust their spending in order to devote more of their incomes to paying the mortgage payments. We may see some people have to downsize, but we're not expecting a calamity in Canada's household sector, just a dose of a bit of pain.
Carissa: Yeah. And when we talk about, household income in the future and what percentage of that income is going to go to supporting household expenses and the things that we need each and every day. When inflation finally comes back under control, rates start to come down. How is the dust going to settle in your opinion? Like, do we need a reality check still to where real estate prices are going to be, rates, and price stability of goods and services?
Avery: If I look out to 2025, if you give me a crystal ball that goes out that far, we should at that point have somewhat lower interest rates. We should have an economy with still a fairly high level of unemployment. So we might have an unemployment rate a bit above where it is now, but not hugely above. And we’ll have lower inflation.
Now, what Canadians often miss out on the fact is that lower inflation probably means lower wage inflation, too. So those of you who have been getting a 4 or 5% pay increase each year might be back down to a world of 3% pay increases again. But price increases will be more muted, which should improve spending power.
I think in terms of the housing market, the issue is that house prices have stopped climbing in many cities because mortgage rates are so high which means that houses are still not affordable because of those mortgage rates. And the unfortunate reality is, if we do get mortgage rates coming down, houses will again be not so affordable because of prices rather than mortgage rates. So to actually improve affordability there is a much more difficult process where we need to bring immigration numbers into line with homebuilding and it's gonna take a long time to get that rectified.
Carissa: Yeah, a little bit more on the consumer spending story. I know you've been following this. There's been many insights on where Canadians are spending and where they're pulling back and this has even been since the early days of 2022 for good prices. So it's still very daunting to look at our grocery bills. It feels like the decrease we have seen in the inflation numbers is not catching on to the price of food. So what needs to happen to bring these costs under control and have better price stability?
Avery: When the Bank of Canada tries to control inflation by raising interest rates and effectively slowing overall demand in the economy, it doesn't really have a toolkit that lets it slow inflation in any one given price. Canada, in many cases, is a bit of a price taker. So California lettuce isn't going to sell in Canada any cheaper than it will sell in the US. Why would they ship it here?
So the reality is, even if our economy slows, we're not in full control of things like prices globally for cars, or food items, and so on. But if we end up still spending a lot of our money on items like food, and the economy isn't as strong, there will be less spending power to go around in a slower economy, which will bring inflation down and some other components. So we may well find, for example, that things like services prices, either haircuts or movie tickets and so on. Those are much more domestically determined and it's those kinds of prices that might slow a bit as the economy cool. So we still are expecting a broad brace slowing and inflation, that's the positive news, but your favourite item may not see that.
Carissa: I wanted better news on that front but absolutely great insight. The falling gasoline prices were a big part of bringing inflation down over the last year, but they seem to be on the rise again. Is that going to throw a wrench into bringing inflation under control? How's that going to impact the overall story?
Avery: In the near term, it certainly is causing a slowdown in our ability to get inflation under control. Because a lot of the drop that we saw in the headline inflation numbers over the past year was we were lapping very high oil and gasoline prices a year ago and that became a big negative in the inflation rate. And we're reaching the point now where it might no longer be a negative and even a slight positive.
But that doesn't preclude getting inflation overall down. Again, if we slow job growth and income growth because the economy slows down, and that seems to be what's happening, then Canadians who might end up spending a little bit more to fill up their gas tank will have less spending power on other items. And it's in those other items that will start to see a slower pace to inflation.
High gasoline prices can sometimes trigger a general increase in inflation. If that gets passed on shipping costs and other goods, therefore, on the shelf start to rise to cover those costs of shipping the goods to those stores. But that's less likely to happen when the economy is sluggish, when unemployment is moving up as it has been, and when wage inflation starts to slow.
So we haven't yet really seen that slowdown in wage inflation. But our view is that five-and-a-half percent unemployment rate we have now might end up being something like 6% by the end of the year. And typically employers are going to be a bit less eager to pay up for workers if there are more workers out there looking for jobs,
Carissa: And on discretionary spending, a lot of Canadians see a big disconnect in what's happening out there in the economy, but many people are still willing to spend on things that are important to them. Whether that's travel dining out, or like the big Taylor Swift or Beyonce phenomenon.
Does the continued trend in spending on discretionary items reflect any bigger trends to household income? Like how do we make sense of this in the grander scheme of things, what's happening in the economy?
Avery: I often say that even when a recession hits, you can't always tell it with your naked eye. They probably have to be the great depression for you to really notice. So you may, if you live in Toronto, wander down to the Eaton Center and say, “Well, looks pretty cool to me.” But it's very hard to distinguish between that mall operating at 100% capacity and 98% capacity.
And even in an economic slump, there will be people still doing very well. Maybe the bankruptcy lawyers will be doing well if we have a big enough slump and they'll be buying the Taylor Swift tickets and booking the exotic travel but other Canadians won't be.
So we are starting to see a pullback in some items of discretionary spending. The restaurants were really booming when people were just getting out of their pandemic lockdowns. But I think there's been a bit of sticker shock. People are realizing how much it costs to go out to eat now and they're a little less enthusiastic about that.
And in general, if we look at the broadest measures of consumer spending in Canada, there was a little bit of an upturn in the first quarter of the year, and that got the Bank of Canada nervous that maybe high-interest rates weren't working to slow consumers. But I think that was a pretty hasty judgment. Consumer spending hadn't been that strong in the second half of 2022 and it looked quite sluggish again in the second quarter of this year. So overall over the last four quarters, particularly if you measure consumer spending on a per capita basis because we've had strong population growth, Canadians really haven't been opening their wallets that aggressively at this point. So we are starting to see a deceleration here and there.
Carissa: Let's pivot a bit to the economic impact on the market. So the stock market volatility continues to test investor patience. And for Canadians looking to invest for growth, because there's many that either are continuing to invest or have money on the sidelines, where should they look?
Avery: Well, let me start with the good news. The environment for investors is not quite as challenging as it was in 2022. Last year was actually a very rare year in which both stock investments and bond investments did badly. Typically when the economy slows enough to disappoint the equity market, the bond market is rallying, anticipating lower interest rates. But of course, last year, we had the worst of all possible worlds. We had fears of a recession coming and those fears were tied to rising interest rates that were also bad for bonds. So a diversified portfolio lost money on just about everything other than GICs.
This year, I think we've now got interest rates high enough that if the economy slows more than expected, and that causes the equity market to pull back, then markets will move up the expectations for rate cuts and the visa bond portfolio would rally. So the old advice of having a balanced portfolio of stocks, bonds, and some safe assets, like GICs, now, will again I think, perform reasonably well.
I think for the equity market, the challenge is that corporate profits are being squeezed right now. Corporations, of course, having to finance at higher interest rates. But also they're paying up for workers and now pricing power may be flowing a little bit. So they've given workers, say, a 4 or 5% wage increase. They may not be able to pass all that on and their prices so it's a bit of a squeeze on corporate earnings. And that's why I think the equity market could continue to really see-saw, not really go anywhere until we get more definitive signs that interest rate relief is coming, that that will eventually allow the economy to pick up, and that pickup in 2025 could start to be priced into the equity market at points in 2024.
So I think we're in a bit of a waiting game for the stock market to generally do well. That doesn't mean that there aren't segments of the equity market that have solid growth behind that. There's lots of spending, for example, in the US and alternative energy. There are segments of the economy, like tied to artificial intelligence that are doing very well. But the broader market, I think, for now, is a bit challenged by this earnings slowdown that seems to be underway.
I think the bond market is getting close to a point now where longer-term bonds, 10-year bonds, for example, may have room to rally. The market is building expectations that the Bank of Canada and the Federal Reserve will cut interest rates next year. But there's probably more rate cuts to come, I think, than the market is now believing. So I think bonds and high-interest GICs and other short-term assets that are paying quite generously now still could generate quite good returns.
Carissa: And what about globally? Like, there’s starting to see some of the headlines about investments in the global markets. Canadians typically invest domestic but there's so much more opportunity out there, as we know. What about globally?
Avery: So it’s almost a truism that Canadians are under-invested globally, in the sense that, particularly if you've got a lot of your assets in Canadian-only funds. While we like to wave the maple leaf and be supportive, that's 3% or so of the world's economy. That's a very concentrated portfolio. And in particular, Canada doesn't have that many companies in some sectors like technology and pharmaceuticals, and so on. So if you want a diverse portfolio across industries, you certainly have to look at the US.
The global economy is not booming right now by any means. I mean, China, by Chinese standards is in a recession. Doesn't mean wealth is negative, but it's quite slow. Germany looks to be in recession. Europe overall isn't but the global economy is fairly soft as well. And of course, in Europe, they've also been raising interest rates. Might be nearing the end of that again, but it's a very similar story sort of waiting for more relief on inflation before we get the all-clear on interest rates and really allow the global equity market, I think, to have another big leg higher.
Carissa: Yeah, well, you touched on housing a little bit and it's an understatement to say that Canadians are very concerned about housing affordability. Whether that is in terms of purchasing a home or funding household-related and mortgage expenses. When it comes to the supply and demand story, is there anything that we can glean out of that? Are we going to be looking at increased supply? Is that going to be in single homes, condos, like what does, maybe into 2024, look like?
Avery: Unfortunately, when you raise interest rates to control inflation, you tend to put a damper on homebuilding. We're not going to see a huge retreat in homebuilding that we would normally see in this sort of environment just because in fact, demand is so strong. But I think in the near term, we're not going to do much to address this imbalance.
The good news is that governments do seem to be now more fully engaged on this question. I guess if Canadians get cranky enough, and that starts to resonate, not just in Ottawa, but provincial capitals, and even at the municipal government level, government does eventually spring into action. So there are a lot of initiatives on the table to accelerate homebuilding over the medium term. I think those are very positive. And the federal government is on the verge of I think making some material announcements both on the housing file and maybe on the immigration numbers. Not so much permanent immigrants were I think they're committed to maintaining a fairly elevated rate. But the number of students that we bring in, for example, each year. Maybe at some point the number of temporary foreign workers we bring in. I mean, they certainly mostly are renters, but rent inflation is as problematic now, these days, as house price inflation. Because it's all well and good to tell people, okay, don't buy go rent. But rents have been moving up very quickly as well. And that reflects an imbalance between population growth and the rental stock in the country.
Carissa: You know, on new construction starts, there's been a lot of talk about the obstacles and challenges of skilled trades and getting workers and such. How much do you think that will impact new construction?
Avery: it might not be as much of an issue in say, the next six months because at least single-family home building has slowed. I mean, condo building is still proceeding at a reasonably brisk pace, but it might slow a little bit as well so we might have a little less pressure there.
But when we look out over the next few years, our ambition to ramp up homebuilding will run into a bit of a barrier owing to the lack of skilled trades. And again, this is something that governments have to get engaged in, in terms of ensuring that in that mix of hundreds of thousands of immigrants that we're bringing in each year, that enough of those are people who are already trained in the skilled trades, and can help us build, in some sense, homes for all those new immigrants. So we need to have the right balance there.
We need nurses as well, and doctors and there are other shortages. But I'd put construction workers, maybe not so much on the list for the coming year, but over the next five years, we'll certainly need more of them.
Carissa: Yeah, and to kind of sum it all up, we're talking to Canadians and our listeners out there. We're kind of heading into the later part of 2023, starting to think of 2024. What should the Canadian consumer, Canadian household really be mindful of and should be top of mind and look out for over the next few months into 2024?
Avery: I think for individuals, it's very important for those who do have mortgages that are going to be renewed in the next couple of years to take a realistic assessment of what that refinancing is going to look like. It might not look as ugly as it looks now. But it is going to take a bit of spending power off.
I think for those who are more in the savings years, a little further along in their careers, mortgages are not as big now and they're focused on savings. Now, there are some very good opportunities here. So for one, I think many people complained for years that there was no alternative to stocks because interest yields were so low, in some cases on a checking account zero. You didn't make any money on that. Whereas now we have an opportunity in fixed-income markets with relatively low risk to earn a decent base yield.
And at the same time, there is an opportunity, I think, for an investor looking at over the next three or four years to capitalize on the reality that this inflation problem will pass, that interest rates will at some point start to come down, and the equity market will respond to that as it anticipates pickup and global growth.
So this may not be like the happiest time right now. But in fact, it's an opportunity for investors to earn a reasonable rate of return on very safe assets, and still also have a diversified portfolio that promises a leg higher or looks to have a leg higher once we get out of this inflation cycle that we're in right now.
Carissa: Great advice. Thank you. What I'm hearing is we need to exercise a little bit more patience but a good time to revisit your household balance sheet and look at the opportunities for investing.
So Avery, a great conversation. Thank you for unravelling all of the intricacies of everything we talked about from inflation to interest rates and how that impacts our lives right here in Canada.
Avery: You're welcome.
Carissa: Thanks so much.
For our listeners, if you want to hear more from Avery, check out his weekly newsletter The Week Ahead available at cibc.com/smartadvice for Avery's take on the economic story shaping our lives.
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