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New paradigm means markets may fall with the economy as stimulus runs out



To most people, it may seem logical that stock markets rise and fall with economic growth. But for the last decade or more, that has been anything but true.

As the value of assets like stocks, bonds and houses has continued to climb, the growth of variables like wages and production has nowhere near kept up.

“The stock market can be relatively divorced from the real economy as measured in terms of GDP for significant periods of time,” said Gurupdesh Pandher, a specialist in finance who has worked in the private sector and in academia.

As Canadians try to understand how 2023 will unfold for investors, for homeowners and for wage earners struggling to keep their heads above water, Pandher’s message is that the previous 15 years — when asset values have persistently outpaced the economy — may be a poor guide to the immediate future.


New financial paradigm

In the very long term, history shows that asset values do track the economy, but for lengthy stretches, including the last decade or so, that relationship can get very much out of sync. And now, after years of what seemed like proof positive that asset prices had nowhere to go but up, suddenly the rules have changed.

As one finance specialist told me, newer investors whose experience of the last decade had taught them that the stock market was an easy money-spinner were being forced to rethink. Many are now looking for someone or something blame, but the truth is that economic and financial cycles, while inevitable, are complicated.

The essence of the problem, say many analysts, is that after years of struggling to boost an economy and a job market that seemed too cool, governments and central banks are suddenly being forced to deal with an economy that they fear has grown too hot.

Friday’s jobs data, especially in the U.S, is expected to show a persistent shortage of workers. Newly released minutes of the committee that guides interest-rate decisions at the Federal Reserve revealed worries about continued strong employment and a fear that financial markets are still too optimistic — suggesting central banks have not finished raising interest rates.

As Pandher, now professor of finance at Windsor’s Odette School of Business, explained it, ever since the fallout from the economic crisis of 2007 and 2008, when a U.S. real estate bubble popped and led to a banking crisis, governments and central banks have been laying on the stimulus. In the past, economists might have expected years of low interest rates, tax cuts and high government spending to have launched a round of wage and price increases.

But for reasons that include a surge in production from elsewhere in the world, notably China, businesses were constrained from raising prices and workers from demanding higher wages. With inflation refusing to budge, market signals became confused. Repeatedly we saw that gloomy economic signals, perversely, led to asset price increases as traders anticipated more and continued economic stimulus.

That process extended into the 2020s as governments struggled to save the world from a COVID-led economic collapse.

Not just stocks but property too

A graph of stock prices against economic growth, seen above, shows a long upward trend since the beginning of 2009 as asset prices almost continuously grew much faster than the underlying economy — only interrupted last year after interest rates began to rise. Canadian house prices, never really hit by the U.S. property crash, did something similar.

Even as tax cuts were promoted as a boost for main street (“It will be rocket fuel for our economy,” Trump promised at the time) later economic analysis showed that the principal effect was to boost asset prices.

As Pandher explained, the phenomenon did not just apply to stocks. He said 15 years of excess liquidity — in other words lots of cheap money — seeped into all asset markets. For Canadians, the obvious asset to outpace incomes and the wider economy has been house prices. And cheap money, intended to allow companies to invest in expansion of their businesses was often redirected to share buybacks that again stimulated the market more than the economy.

It is not just stocks that can rise faster than the economy, a long period of excess liquidity can boost the price of houses before incomes can catch up. (Don Pittis/CBC)

“The cost of borrowing for companies came down so they could borrow money for stock purchases,” said Pandher. “The same thing for households. They could invest in additional real estate, buy a second home, or buy another car as financing became cheaper.”

Riding to the rescue

Some trace the use of low rates and high government debt as a tonic for weak growth and struggling markets back to former Fed chair Alan Greenspan, who has been described as “extremely proactive in halting excessive stock market declines.”

For years, low and stable wages and moderate price rises made that possible. But under the new paradigm of tight money and inflation-fighting, everything changed, and for many that may come as a shock.

“Financial markets in particular get conditioned to this world where every time something goes wrong, a central bank comes riding to the rescue,” said markets analyst Tommy Stubbington in a slightly frightening Financial Times documentary looking ahead to 2023.

As Stubbington, Pandher and many others have observed, once an economy becomes overheated, cutting interest rates, buying up government debt with quantitative easing and distributing unfunded government stimulus spending only make inflation worse.

“You can no longer buy up government debt every time there’s a wobble in the markets because you need to concentrate on your main mission which is fighting inflation,” said Stubbington in the FT video.

Of course the long period of low interest rates has not been the only economic force implicated in surging inflation, said Andriy Shkilko, professor of finance and Canada Research Chair in Financial Markets at Wilfrid Laurier University in Waterloo, Ont.. Supply chain problems that cut off imports, the effects of the Russian invasion of Ukraine and the sudden demand for goods rather than services when COVID-19 hit all helped push up prices.

Expect booms and busts

Booms and busts in the economy and in financial markets are completely normal, said Shkilko, which may have come as a shock to new investors or those who had forgotten.

“Most of the younger generation has not seen this before and I can even see that in my students because in the last 10 years, they all thought of themselves as these brilliant investors because they made money in their little investment accounts,” Shkilko said.

He is one of those who recommends investors hang tight and not panic.

“The way to get rich and not to lose sleep is to just steadily put money into the market and wait for retirement,” said Shkilko. “If you look at the long term trend, markets have always been going up because the economy is growing.”

But if, over the very long term, markets really do track the economy, it may be reasonable to ask whether a long and strong rise in valuations above economic growth must inevitably and eventually lead to the opposite.


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How Russia is pushing its central bank to give ‘upbeat’ economic updates



The Russian government is not loving its central bank’s gloomy economic assessments. Instead, it is reportedly asking for more jolly outlooks.

The Russian economy has been under stress ever since the country invaded Ukraine in February 2022, triggering widespread sanctions from the West and its allies, which hit the energy giant’s oil and gas revenue.

Through it all, the Russian central bank has been candid about its assessment of the country’s economy, which at times stood at odds with more bullish statements from the Kremlin.

But that may soon change — Russian officials are putting pressure on the country’s central bank to give more “upbeat” assessments about the country’s economy, Bloomberg reported on Tuesday, citing people familiar with internal deliberations.


In December, analysts at the Bank of Russia — headed by governor Elvira Nabiullina — said they anticipated “new economic shocks,” due to a $60 per barrel price cap on Russian oil and the European Union’s ban on the country’s crude. In October, research from the Bank of Russia showed the country’s economic activity stalled in September — in part, due to President Vladimir Putin’s partial mobilization order that sent many fleeing the draft.

Senior government officials have criticized the central bank for mishandling market expectations and for giving forecasts that were too pessimistic and alarmist, Bloomberg reported.

The Bank of Russia, though, is open to improving these forecasts so as to send a signal that it’s on the path to monetary easing in the months ahead, per Bloomberg.

The Russian economy likely contracted by 2.5% in 2022 from a year ago, but was still beating expectations, President Vladimir Putin said in televised remarks on January 17, per Reuters.

It’s not just propaganda. Key to the central bank’s messaging is interest rates. Russia’s key interest rate is 7.5% now, but the government wants the central bank to express more optimism about the economy in a signal that it could start cutting rates, per Bloomberg. But the Bank of Russia is concerned about higher inflation should rates fall.

Russia covers its budget deficit by borrowing domestically, so interest rates are important for the government. A slump in energy revenues, coupled with an increase in defense spending has pushed Russia’s budget deficit to 1.76 trillion rubles in January, or $24.75 billion.

The deficit — which is only for the first month of 2023 — is already at 60% of Russia’s plan for a $2.93 trillion-ruble deficit, Insider previously reported.

The Bank of Russia did not respond to Insider’s request for comment sent outside regular business hours. It’s also in a communication blackout ahead of its first board meeting of 2023 on Friday, per Bloomberg.


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Biden highlights economy, spars with Republicans in State of the Union speech



U.S. President Joe Biden sought to overcome pessimism about the country’s direction — and his own political prospects as he stares down a re-election bid next year — in his second State of the Union address to Congress and the nation Tuesday night.

But his optimistic vision faces stiff headwinds from Republicans in control of the House of Representatives, who the president called on to help him “finish the job” of rebuilding the economy from the COVID-19 pandemic and record inflation at home and abroad.

“The people sent us a clear message. Fighting for the sake of fighting, power for the sake of power, conflict for the sake of conflict, gets us nowhere,” Biden said. “That’s always been my vision for the country: to restore the soul of the nation, to rebuild the backbone of America — the middle class — to unite the country.

“There is no reason we can’t work together in this new Congress.”


House Speaker Kevin McCarthy, sitting behind the president for the first time since he took on the role, appeared unmoved by Biden’s pitch for bipartisanship and the listing of his administration’s accomplishments during two years of Democratic control of Congress.

McCarthy — who vowed to be “respectful” during the speech earlier Tuesday — is leading negotiations with Biden and Democratic leaders on raising the nation’s debt ceiling, which Republicans say must be tied to significant government spending cuts. Biden has pushed for a “clean” debt ceiling increase without cuts to future spending or existing programs like Social Security and Medicaid, longtime targets of fiscal conservatives.

Biden faced boos and shouts of “liar” during his speech when he mentioned some Republicans were eying changes to those programs. That led to what appeared to be an ad-libbed response from Biden, and led to a seemingly vocal pledge from members of both parties that the programs would remain untouched.

“I tell you, I enjoy consensus,” he said with a grin.

U.S. hitting debt ceiling could destabilize global economy

The president on Tuesday made the case that targeted government spending found in major bills he has signed like the US$1-trillion infrastructure act will achieve results in the coming months and years.

“Jobs are coming back, pride is coming back because of the choices we made in the last two years,” he said.

The speech showed Biden has shifted his focus from pushing for a flurry of major legislative victories to accepting more limited action with a divided Congress. House Republicans have vowed to undo many of those achievements while prioritizing investigations into allegations against Biden’s family and administration.

Biden promised he would veto any bill that would raise the cost of living for average Americans.

Click to play video: 'State of the Union: Biden talks shootdown of Chinese spy balloon, says it’s not good to ‘bet against America’'

More Buy American policies

Biden has walked a delicate tightrope over the past two years, balancing the need to work with Republicans on some matters while criticizing the party’s positions. He began his term two weeks after rioters stormed the U.S. Capitol to disrupt the certification of his victory over Donald Trump, who remains a force within the Republican party.

Although he celebrated on Tuesday that democracy remained “unbowed and unbroken” two years after that Jan. 6, 2021, attack, Biden’s address showed his continued efforts to appeal to “America First” conservatives aligned with Trump’s policies while continuing to pursue Democratic priorities.

He announced new standards that will require all construction materials used in federal infrastructure projects to be made in the U.S., an expansion of his Buy American policy that has alarmed key trading partners like Canada.

“On my watch, American roads, bridges, and American highways are going to be made with American products as well,” he said.

A request for comment from Canadian Trade Minister Mary Ng’s office was not immediately returned Tuesday night.

Biden’s focus on the U.S. economy came after an unexpectedly strong jobs report last week that found unemployment fell to a 53-year low of 3.4 per cent, and over 517,000 jobs were added in January.

Click to play video: 'U.S. Inflation Reduction Act ‘changed playing field’ in terms of global competition: Freeland'

U.S. Inflation Reduction Act ‘changed playing field’ in terms of global competition: Freeland

The White House is using those numbers and other signs of economic improvement, including falling gas prices, to counter Republican attacks and recent polling that found a majority of Americans are unsatisfied with the country’s direction and don’t want Biden to run for re-election.

Biden has not officially announced his re-election bid for 2024, which could pit him against Trump once again.

Crime and policing

Among Biden’s guests for the State of the Union was the mother and stepfather of Tyre Nichols, a Black man who died last month after being beaten by five police officers who are now charged with second-degree murder and other crimes.

Biden called for more action on national policing standards in response — a slim prospect in the divided Congress, although both parties rose to their feet to applaud the president’s remarks and Nichols’ family.

Click to play video: '‘Do something’: Biden pushes for action from Congress on police reform'

‘Do something’: Biden pushes for action from Congress on police reform

He also urged lawmakers to pursue meaningful immigration reform that would tighten border security, offer a path to citizenship for migrants who cross into the U.S. legally, and crack down on fentanyl trafficking that has led to a surge in fatal opioid overdoses.

Another guest, former House speaker Nancy Pelosi’s husband Paul Pelosi — who was brutally attacked inside the couple’s San Francisco home last year — was introduced by Biden as an example of the need to reign in domestic extremism and political violence.

“We must give hate and extremism in any form no safe harbour,” he said. “Democracy must not be a partisan issue. It’s an American issue.”

Arkansas Gov. Sarah Huckabee Sanders, who gained a national profile as Trump’s press secretary, delivered the Republican response to Biden’s speech, which he alleged was full of falsehoods.

She focused much of her remarks on social issues, including race in business and education, and alleged big-tech censorship of conservatives.

“While you reap the consequences of their failures, the Biden administration seems more interested in woke fantasies than the hard reality Americans face every day,” she said. “Most Americans simply want to live their lives in freedom and peace, but we are under attack in a left-wing culture war we didn’t start and never wanted to fight.”

Sanders also criticized Biden’s foreign policy that she alleged has made America less safe from threats posed by China and other hostile actors.

—With files from the Associated Press


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Given high inflation, slowdown in Canada’s economy is ‘a good thing,’ Tiff Macklem says



Bank of Canada governor Tiff Macklem says that although a slowing economy may not seem like a good thing, it is when the economy is overheated.

Speaking in Quebec City on Tuesday, Macklem said that higher interest rates are working to cool the economy as elevated borrowing costs are constraining spending on big-ticket items such as vehicles, furniture and appliances.

As demand for goods and services falls, Macklem says the economy will continue to slow.

“That doesn’t sound like a good thing, but when the economy is overheated, it is,” he said.


In addition to global events, the overheated domestic economy pushed up prices rapidly, he said.

To slow the economy domestically, the Bank of Canada has embarked on one of the fastest monetary policy tightening cycles in its history. It has hiked its key interest rate eight consecutive times since March, bringing it from near-zero to 4.5 per cent.

However, last month, the Bank of Canada said it will take a “conditional” pause to assess the effects of higher interest rates on the economy.

“Typically, we don’t see the full effects of changes in our overnight rate for 18 to 24 months,” Macklem said on Tuesday.

“In other words, we shouldn’t keep raising rates until inflation is back to two per cent.”

However, the governor said the Bank of Canada will be ready to raise rates further if inflation proves to be more stubborn than expected.

Bank of Canada hikes interest rates again to 4.5%

The Bank of Canada is raising interest rates again, bumping it to 4.5 per cent. This marks the eighth increase in less than a year, leaving some homeowners scrambling to keep their mortgages.

As gas prices have fallen and supply chains have improved, inflation in Canada has slowed since peaking at 8.1 per cent in the summer. Macklem called this a “welcome development,” but stressed inflation is still too high.

“If new data are broadly in line with our forecast and inflation comes down as predicted, then we won’t need to raise rates further,” Macklem said.

For inflation to get back to two per cent, Macklem said wage growth will have to slow, along with other prices.

Wage gains lagging inflation

Wages have been growing rapidly for months but continue to lag the rate of inflation. In December, wages were up 5.1 per cent.

Though annual inflation is still at decades-high levels, economists have been encouraged by a more noticeable slowdown in price growth over recent months.

The Bank of Canada forecasts the annual inflation rate will fall to three per cent by mid-year and to two per cent in 2024.

Royce Mendes, an economist with Desjardins, said that Macklem is crossing his fingers that the rate hikes he has implemented so far will be enough to get it done.

“The head of the Bank of Canada seems quite comfortable sitting on the sidelines even as his U.S. counterpart will be discussing the need for further monetary tightening south of the border,” Mendes said.



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