The economy will bleed ‘vacancies as opposed to jobs,’ says CIBC economist

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Despite the Bank of Canada raising interest rates 10 times since March, 2022, to the current rate of 5 per cent, the stock market and economy have absorbed the hikes without severe damage. Can this resiliency last?

The Globe and Mail recently spoke with Benjamin Tal, deputy chief economist at CIBC World Markets, who shared his views on the economy and interest rates, as well as the housing and equity markets.

There are growing expectations that we’ll see a soft landing, where a recession will be averted. What odds do you place on that?

I think that you can get a mild recession or a soft landing. In my book, it’s basically the same. It’s basically GDP very close to zero over the next six to nine months, which is basically our forecast. A real recession is the situation where you have blood in the labour market. Namely, the unemployment rate goes up dramatically.

The scenario that we’re seeing at this point is that we’re going to get a mild recession or soft landing without too much damage in the labour market. What we are going to see, according to this scenario, is that the economy will be bleeding vacancies as opposed to jobs. Namely, companies will not be hiring but they will not be firing.

Let’s talk about the course of interest rates.

I think we are either at a peak or very close to a peak.

Now, one of the reasons why I believe we are very close to the top is what the Bank of Canada did recently. In the Monetary Policy Report, the Bank of Canada surprised the market by doing two things. One, GDP growth for the first half of 2023 is forecast to be much stronger than before. As well, the 1.5-per-cent growth for the third quarter is much stronger than we think they assumed based on their previous GDP forecast. And the second thing they did, which was very important, is they said 2-per-cent inflation will happen in 2025, not 2024. I think that was a very smart move – I see it as strategic positioning.

If you raise forecast GDP growth, you basically eliminate the need to continue to raise interest rates even if the economy outperforms because you already predicted it. Also, when you tell the market inflation will go down to 2 per cent but it will happen in 2025, they’re not forced to react and have to raise rates again and again so they bought themselves some time.

When do you expect the Bank of Canada will cut rates?

I think a reasonable scenario is that the Bank of Canada will cut in May, June of next year so we still have about a year of elevated interest rates. Why? Because the Bank of Canada will have to make sure that inflation is absolutely dead before they cut interest rates. They don’t want to reignite inflation prematurely so they will buy insurance in terms of time. The same goes for the Fed.

What level do you believe the Bank of Canada will lower the overnight rate to and when would that occur?

First, let’s assume for a second that inflation goes down from 3 per cent to 2.7, 2.6, 2.5, 2.4 and then is stuck. Is it close enough to 2? Are you going to continue to raise interest rates, take the economy into a recession just because of 0.4 per cent of inflation?

We have to remember that over the past 20, 30 years, the target was 2 per cent but actual inflation was about 1.8. We were undershooting on a consistent basis so maybe you can overshoot a little bit on a consistent business and still call it 2 per cent. So, when we say 2 per cent, it can be 2.2, it can be 2.3, it can even be 2.4 per cent.

Second, the reality is that we have some long-term inflationary forces happening. COVID accelerated so many processes. We have deglobalization – that’s inflationary. We have just-in-case inventory replacing just-in-time inventory – that’s inflationary. The labour market is getting tighter demographically due to increased retirement – that’s inflationary. And some of the green initiatives are inflationary.

The Bank of Canada is not going to change the 2-per-cent target any time soon. So, you need higher interest rates because there’s more inflation. We started this cycle at 1.75 per cent. We are going to 5, 5.25. We rest there for a year, and we go down to what? I say to 2.75, 3 by mid- to late 2025. Now, why is this important? Because 2025 is a major year.

If you look at 2020, 2021, the middle of COVID, interest rates were basically at zero. That’s where we saw a significant increase in borrowing. If you look at total mortgages outstanding, close to 50 per cent were taken in those two years. Most mortgages are for five-year terms, variable and fixed, so upon renewal in 2025 and 2026 we will get a big wave of renewals at mortgage rates significantly higher than the rates seen in 2020 and 2021.

So clearly that would be a major shock to the system if interest rates don’t go down.

Staying on the housing market, what’s your outlook? The fundamentals of the housing market are very strong with limited supply and rates that appear to have peaked. We have low unemployment and high household savings. What’s your pricing outlook for the low-rise as well as the high-rise markets?

The market was slowing until January. In January, the governor of the Bank of Canada said that they were pausing. After that, sales and prices started to rise. So, what we learned from that is you need clarity about rates in order for people to go back to the market. And we have seen this mini-recovery over the past six months.

Now, in June, July, interest rates went up, and we are not clear whether or not rates are going to go up again. You will see activity slow down, and that’s exactly what’s starting to happen.

Over the next six to eight months, we might see a resumption of prices going down in both low-rise and high-rise. But I think that this is not going to be a free fall by any stretch of the imagination.

Beyond that, the softening that we’re going to see is a blip. The fundamentals of the housing market are so strong, we simply don’t have enough supply and that doesn’t change. In fact, the opposite is the case. Demand for housing is rising faster than expected and the industry simply does not have the capacity to increase supply.

We simply don’t have enough labour in construction, and I’ll give you some examples. Over the next 10 years, no less than 300,000 people will be retiring from construction. The number of apprentices is going down. If you look at the number of construction workers among new immigrants, only 2 per cent of them are in construction. So, we have to change policies in a way that is consistent with more labour.

Your real GDP growth forecasts are 1.5 per cent in 2023 and 0.8 per cent in 2024. Is the macroeconomic backdrop that you’re forecasting bullish for equity markets?

The short answer is yes, to an extent. Although the economy is going to slow down, it’s already priced in.

And the minute it’s clear that the Fed and Bank of Canada are done, and people start talking about the timing of the first cut that would be bullish for stock markets in general.

Long-term, what impact will generative AI have on GDP growth and productivity?

One issue that we are facing is the potential growth of the economy. Potential growth is a function of two things: one is the labour force, the other is productivity. The labour force is rising because of immigration but productivity is basically zero. If you can lift productivity by 1 or 2 per cent, you can increase the ability of the economy to grow without inflation and everybody will benefit from that.

So far, we are relying too much on people, new immigrants to grow the economy. Sure, you grow the economy but per capita, you’re not growing the economy, the economy is shrinking and therefore you need productivity.

You know, 10, 15 years ago, Mark Carney, back then the Governor of the Bank of Canada, was talking about dead money – corporations sitting on mountains of cash, not investing. If back then it was dead, now it’s very dead as companies are sitting on much more money.

So, the minute the fog clears, which can be a 2025 story, I think we’ll see more and more business investment happening that will enhance productivity and AI will be a big part of it.

This interview has been edited and condensed.

 

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