Banks had a lot to say about the economy this week: It’s complicated
After Canadian banks finished reporting their latest quarterly financial results this week, investors hoping for some clarity on the economy may have come away disappointed. No clarity here, which could limit the recovery in bank stocks.
The banking sector is meandering between two very different outlooks: mild optimism that a recession will be brief or avoided altogether, while lending activity holds up and borrowers pay off their loans; and simmering pessimism that rising interest rates will wallop economic activity, pushing bank loan losses sharply higher.
Reflecting the optimistic take, bank stocks have risen by an encouraging 8 per cent this year, on average. Then again, pessimists will point out that these stocks are down more than 14 per cent since the start of 2022.
Though bank executives had lots to say about the economy during earnings calls with analysts, offering valuable insights given the banks’ unique perspective on lending activities and consumer indebtedness, there was no definitive take.
Dave McKay, Royal Bank of Canada’s RY-T chief executive officer, said during an earnings call that the bank is forecasting a “softer landing, characterized by a modest recession” – which sounds like a good reason to buy bank stocks right now.
But Mr. McKay also said that banks were operating within a “complex and fluctuating macro and market environment,” characterized by stubbornly high inflation, labour shortages, geopolitical shocks and the lagging impact of central bank interest rate hikes.
Ugh. And if actions speak louder than words, then the banking sector’s reaction to rising borrowing costs and slowing economic activity merely added to the murky backdrop for investors.
The banks set aside more money in their fiscal first quarter to handle the prospect of defaults: The Big Six banks collectively reported nearly $2.5-billion in provisions for credit losses – or PCLs in banking jargon – up from a net $373-million in provisions in the same period a year ago, when some banks were booking recoveries from previous provisions.
The spike in provisions supports the bearish case against bank stocks, but there was an upbeat context here: Provisions were actually lower than what most analysts had been expecting, and executives framed the increase as a step toward historically normal losses after a period of unusually low losses a year ago.
“This is indicating that credit is deteriorating and we’re still not at historical averages. But the question becomes: Will PCLs just stop there or will they overshoot?” John Aiken, an analyst at Barclays, said in an interview.
“This is where both the bulls and the bears can look at the PCLs this quarter, and it can bolster their case,” Mr. Aiken added.
It’s little wonder, then, that bank stocks are also sending conflicting signals about whether this economically sensitive sector is in the midst of a further recovery or poised for another downturn.
Bank-stock valuations are slightly below the historical average, based on estimated price-to-earnings ratios. According to Gabriel Dechaine, an analyst at National Bank Financial, the discount was 8 per cent as of market close on Thursday.
But this discount is considerably narrower than it was at the start of the year, before stock prices rebounded. Valuations are no longer particularly cheap in the face of economic risks – suggesting that the collective wisdom of the market can’t figure out whether the sector should be avoided on fears that the economy is in trouble, or scooped up on hopes that central banks have beaten inflation.
Specific stocks within the sector reflect similar bafflement.
CIBC CM-T is leading the way among the Big Six bank stocks in 2023, with gains of nearly 15 per cent. The bank has a relatively large exposure to the domestic mortgage market, making the stock sensitive to economic data. The stock’s outsized gains this year suggest some investors are betting on a healthy economy.
But wait a minute: Over the past year, CIBC is near the bottom of the pack with a decline of more than 21 per cent. Compare that with RBC – a bigger and more diversified bank, making it a safer bet during economic uncertainty: The stock is down less than 2 per cent over the past year. RBC’s outperformance suggests that investors are still nervous.
The one thing that just about everyone can agree on? If the banking sector’s financial results were supposed to give investors a clearer view of the year ahead, they failed to deliver.
What to expect from budget 2023 as ‘storm clouds’ gather over Canada’s economy – Global News
Canada’s Liberal government is in a tight spot heading into the 2023 federal budget.
A year of surging prices and rising interest rates has put fresh stress on Canadian households struggling to make ends meet.
Landmark investments in the green transition from the United States have turned up the heat on the Canadian government as it looks to stay competitive with the economic juggernaut south of the border.
And after years of higher spending and a surging recovery from the COVID-19 pandemic, storm clouds are gathering in the economy, putting new scrutiny on government coffers.
Chrystia Freeland, the government’s finance minister and deputy prime minister, has pledged that the 2023 budget will include “targeted” support to help vulnerable Canadians but will not “pour fuel on the fire of inflation.”
Can Ottawa thread the needle through the competing pressures and economic uncertainty while still meeting Canadians’ ends?
Here’s what economists think.
Budget planning in a ‘challenging time’
The federal budget comes at a “challenging time” for Freeland and Prime Minister Justin Trudeau, says Sahir Khan, vice-president at the University of Ottawa’s Institute of Fiscal Studies and Democracy.
Now in their third term of governing, Khan tells Global News that the Liberals’ second budget of their current mandate is set to arrive amid a “change in context.”
He says the Liberals have had the “good fortune” of inheriting large revenue surprises in previous budgets, which has helped the government spend more while staying fiscally sustainable.
But government revenues are set to dry up with the economy slowing, Khan warns, even as spending priorities mount.
Among the pressures facing the government are commitments already made on a new health-care accord with the provinces, defence spending both at home and in Ukraine and the green energy transition.
Freeland gives detailed outline of funding in proposed health-care plan
“Storm clouds” are gathering for a possible recession on the horizon, Khan notes, and the federal government will feel pressure to “keep some of their powder dry” for emergency spending to resuscitate the economy if the worst-case scenarios come to pass.
Randall Bartlett, senior director of Canadian economics at Desjardins, says that even with the first quarter of the year off to a stronger start than most economists anticipated, the government still finds itself in a bind with uncertainty about how much the economy slows this year.
“It’s a challenging environment to do budget planning overall,” he tells Global News.
How will inflation impact the budget?
A surging economy through the COVID-19 recovery helped push government revenues higher and Ottawa spent much of this money on support for Canadians hit hard by the pandemic.
While those programs have largely wound up, a recent analysis from the Bank of Montreal showed that government spending per capita is still 11.3 per cent higher than in the pre-pandemic era.
Bartlett says that while government revenues generally see a boost amid high inflationary periods, the federal government is about to experience the “insidious” nature of rising price pressures on the downturn.
Canada’s inflation rate cools to 5.2%
Government spending supports that are indexed to inflation, such as Old Age Security (OAS), are now costing more, just as subsiding inflation and a cooling economy are set to slow government revenue growth, he says.
“We’re going to continue to see those knock-on effects of high inflation on the spending side, even as those tailwinds to revenues start to fade,” Bartlett says.
But Bartlett adds that the government is facing “a lot of political pressure” to continue to spend to support vulnerable households.
Some economists worry that too much direct financial support from the federal government will end up fuelling inflation, as Canadians use their contributions to buy more goods and services and end up stimulating the economy all over again.
More on Money
Top officials at the Bank of Canada, which has raised its benchmark interest rate aggressively over the past year to cool the economy and tame inflation, have said that letting up on pandemic-era stimulus sooner could have limited inflation.
In order to avoid driving inflation higher with government support, Ottawa will need to be “well-targeted” in its spending plans, says Lindsay Tedds, associate professor of economics at the University of Calgary.
Rather than sweeping tax cuts, which would lessen the burden on households but could inadvertently spur more spending, Tedds tells Global News that the Liberals could again double the GST credit or top up guaranteed income supplements.
More students turning to food banks as inflation shrinks already tight budgets
Doing it this way would ensure government spending goes more towards Canadians who need it to make ends meet on the basic necessities, she says.
“We’re talking about just trying to get them through being able to pay rent and buy groceries and things like that. So it doesn’t have an inflationary impact,” she says.
Khan says the government could also “stagger” its promises, with spending ramping up in years three, four and five of its budget horizon. Doing so could allow the Liberals to keep money back to respond to emergencies while also showing Canadians they’re listening to affordability concerns, he says.
Pressure from the U.S. demands action
Economists who spoke to Global News say the federal government is feeling pressure to respond to the U.S.’s Inflation Reduction Act, which rolled out a number of incentives for companies to make investments in the green economy south of the border.
Despite restrictions on the government coffers, the Liberals will need to put a “down payment” on some of the clean energy priorities it has talked about for years, Khan says.
If Ottawa does not roll out its own incentives to compete with the U.S., Canada risks losing jobs and investment from large-scale companies in the green economy, he argues.
“They will suck that capital and those jobs out if we don’t look like we’re doing the same for our industry,” Khan says of the U.S.
“There’s going to have to be something actually quite tangible in this budget. It can’t just all be narrative.”
Tedds agrees and notes that announcements on measures like carbon capture and storage will be attractive in Alberta.
Ottawa can’t necessarily go toe-to-toe with American capital, however, and Bartlett says the government should focus spending on industries where Canada has a “comparative advantage.”
He highlights critical minerals as one such area where Canada could position itself in the green economy.
‘Champagne taste’ and a ‘beer bottle budget’
Tedds says Canadians should “moderate their expectations” for the upcoming budget.
While it’s possible Canada avoids the worst of the economic downturn, the outlook is “too unpredictable” for the Liberal government to offer significant relief or big-ticket items in this budget, she says.
Tedds notes she’d like to see an overhaul of the employment insurance program to ensure that when and if Canada’s jobless rate starts to rise, the government is ready to support Canadians through the downturn.
“We really should be recession-ready. There are some sectors that are really hurting, tech being one of them. We’ve seen massive layoffs, especially here in Calgary. And so there are people hurting,” she says.
Despite all the pressures facing the Liberals in their third term in office, Khan says the Trudeau government will need to demonstrate that it’s still “got some fire in its belly” and can deliver results for Canadians.
“I think this time it’s going to be less about aspiration and more about perspiration,” he says.
As opposed to a newly elected government delivering a budget of change in its first spending plans, the Liberals will have to prove they still have ideas and can make progress on projects that matter to Canadians, Khan says.
He expects the Liberals will devote a fair bit of the budget text to the already announced health-care spending announced in February as a “victory lap” of sorts.
If the government wants to hit every spending priority while maintaining the federal debt-to-GDP ratio — a key fiscal guardrail watched not only by the government but by credit rating agencies and international observers — it may have to find new sources of funding.
Canadian banks are stable, but ‘something is going to break’ in economy: experts
Bartlett says that with the revenue sources drying up and the Liberals under pressure to maintain their fiscal guardrails, tax hikes could be on the table, likely aimed at corporations or higher-income earners.
Otherwise, he says the Liberals might have “champagne tastes,” but they’re working with a “beer bottle budget.”
“They’re not going to get everything on their wish list,” he says. “And so they need to they need to be mindful of that and exercise some genuine prudence.”
— with files from Global News’ Touria Izri
Swedish Housing Market Crash Exposes Economic Divisions: Big Take – Bloomberg
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Swedish Housing Market Crash Exposes Economic Divisions: Big Take Bloomberg
Climate Change, Deglobalization, Demographics, AI: The Forces Really Driving Our Economy
Our economy today has been described variously as “weird,” “really weird” and “very, very weird.”
Weird because this is a yo-yo economy where gas prices shot up to more than $5 a gallon and then settled back down. The inflation rate for used cars dropped, then accelerated at a 40 percent rate before deflating at a record rate. Housing has gone from boom to bust, then to boom again. Economic indicators have been described as “a Jackson Pollock painting of data points and trends.”
Economists can’t figure it out. Economic models are only getting us as far as separating top-flight economists into Team Stagflation and Team Soft Landing. Alan Blinder, the Princeton economist, talks about the prospects of the Federal Reserve nailing a soft landing like he is handicapping a team’s Super Bowl prospects: “I think they still have a chance, but it’s a tougher chance than it was.”
Economists tried to deal with the twin stresses of inflation and recession in the 1970s without success, and now here we are, 50 years and 50-plus economics Nobel Prizes later, with little ground gained. The Fed and the Treasury Department buttressed the banking structure in the aftermath of the 2008 crisis. Fifteen years later, we are seeing it breached.
There’s weirdness yet to come, and a lot more than run-of-the-mill weirdness. We are entering a new epoch of crisis, a slow-motion tidal wave of risks that will wash over our economy in the next decades — namely climate change, demographics, deglobalization and artificial intelligence. Their effects will range somewhere between economic regime shift and existential threat to civilization. The risks to the economy, to the stability of our society and to civilization are enormous if we don’t get the economic models right for what’s coming.
For climate, we already are seeing a glimpse of what is to come: drought, floods and far more extreme storms than in the recent past. We saw some of the implications over the past year, with supply chains broken because rivers were too dry for shipping and hydroelectric and nuclear power impaired.
For demographics, birthrates are on the decline in the developed countries. China’s population is in decline, for instance, and South Korea just set a mark for the lowest birthrate in the developed world. As with climate change, demographic shifts determine societal ones, like straining the social contract between the working and the aged.
We are reversing the globalization of the past 40 years, with the links in our geopolitical and economic network fraying. “Friendshoring,” or moving production to friendly countries, is a new term. The geopolitical forces behind deglobalization will amplify the stresses from climate change and demographics to lead to a frenzied competition for resources and consumers.
We can see the impacts of climate change, demographics and deglobalization coming. The fourth, artificial intelligence, is a wild card. But we already are seeing risks for work and privacy, and for frightening advances in warfare.
These risks are going to accelerate and affect us for decades. If our economic models can only get as far as Team Stagflation versus Team Soft Landing — if we can’t get a firm hold on pedestrian economic issues like inflation and recession — the prospects are not bright for getting our forecasts right for these existential forces.
The problem here is not that our economic models don’t work at all. The models seem serviceable when things are simple and stable, when we are in a steady state with tons of past data to draw on. The problem is that the models don’t work when our economy is weird. And that’s precisely when we most need them to work.
Economists have admitted as much. At the height of the 2008 financial crisis, Queen Elizabeth II asked the question that no doubt was on the minds of many of her subjects: “Why did nobody see it coming?” The response, some months later, by the Nobel laureate economist Robert Lucas, was blunt: Economics failed with the 2008 crisis because economic theory has established that it cannot predict such crises.
A key reason these models fail in times of crisis is that they can’t deal with a world filled with complexity or with surprising twists and turns. For example, the mathematical models of economics analyze a representative agent — be that an individual or a firm — and assume the overall economy will behave the way that this one agent behaves. The problem here, and a problem broadly with complex and dynamic systems, is that the whole doesn’t look like the sum of the parts. If you have a lot of people running around, the overall picture can look different than what any one of those people is doing. Maybe in aggregate their actions jam the doorway; maybe in aggregate they create a stampede.
Economists fancy themselves as the physicists of the social sciences, wielding mathematical models to bring solutions to the economic world. But we are not a mechanical system. We are humans who innovate, change with our experiences, and at times game the system. Reflecting on the 1987 market crash, the brilliant physicist Richard Feynman remarked on the difficulty facing economists by noting that subatomic particles don’t act based on what they think other subatomic particles are planning — but people do that.
What if economists can’t turn things around? This is a possibility because we are walking into a world unlike any we have seen. We can’t anticipate all the ways climate change might affect us or where our creativity will take us with A.I. Which brings us to what is called radical uncertainty, where we simply have no clue — where we are caught unaware by things we haven’t even thought of.
This possibility is not much on the minds of economists. Charting Fed policy or forecasting consumer demand might have surprises here and there but operate with a well-worn vocabulary. It’s with the longer-term risks that “unknowable” has force.
How do we deal with risks we cannot even define? A good start is to move away from the economist’s palette of efficiency and rationality and instead look at examples of survival in worlds of radical uncertainty. Take the cockroach: It has survived for hundreds of millions of years as rainforests turned into savannas and savannas turned into deserts. And it has done this with a coarse escape system, simply running from puffs of air on its cercal hairs. Not very elegant. It will never win the Insect of the Year award but has done well enough to survive a world of radical change.
In our time, savannas are turning into deserts. The alternative to the economist’s model is to take a coarse approach, to be more adaptable — leave some short-term fine-tuning and optimization by the wayside. Our long term might look brighter if we act like cockroaches. An insect fine-tuned for a jungle may dominate the cockroach in that environment. But once the world changes and the jungle disappears, it will as well.
Rick Bookstaber has served as chief risk officer at major banks and hedge funds. His 2007 book, “A Demon of Our Own Design,” warned of the coming financial crisis. His latest book is “The End of Theory.”
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