A ‘soft landing’ may still be in sight

Despite central banks’ best efforts, inflation is still too high.

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And while 2023 started out stronger than expected, Avery Shenfeld, chief economist at CIBC, said the economy still needs a period of slower economic growth to bring inflation back down. 

As for when that will be, it’s become a moving target. The economy has proven more resilient to higher interest rates than many expected, Shenfeld said. “But I think this is, in total, really more of a stay of execution than a full relief.”

Central banks are committed to keeping interest rates elevated long enough to see that stall. What’s changed, he said, is the timing. Unexpected employment growth at the beginning of the year created spending power that has delayed the start of a flat period of economic growth into the second quarter, he said.

Shenfeld said Canada’s record-low unemployment rate is not so much a sign of economic strength, however, as it is proof that businesses are finally filling job vacancies from last year.

Canada added another 22,000 jobs in February and the unemployment rate held steady at 5%, raising concerns that more rate hikes may be necessary to cool the economy.

Speaking before last week’s release of the February jobs data, Shenfeld said a soft landing is still possible. “We’ve made some progress on inflation already,” he said, and that’s happened despite the tight labour market.

Shenfeld was also speaking before the dramatic collapse of Silicon Valley Bank, which has shaken bond markets and changed expectations for interest rates.

World commodity prices have softened, cooling inflation on the oil and gas front, and food prices around the world have started to level off, he said. In the U.S., rent prices are easing, and in Canada, new home prices have also come down.  

“This isn’t going to be immaculate disinflation. We’re going to need some economic pain, but we don’t think we need to see a full-blown recession in North America” to get inflation back to 2% by next year, he said.

The largest risk is an “overzealous” central bank in the U.S. “The Federal Reserve is clearly not done hiking rates,” he said.  

Conversely, the Bank of Canada has chosen to pause rate hikes for the time being and assess the economic impact of last year’s major increases after seeing reasonable progress on inflation.

That’s not to say rate hikes are done, Shenfeld said, but he thinks the Bank of Canada is wise to sit tight and see what happens in the economy over the next few months before taking any additional steps. He said it’s a bit of assurance that the Bank of Canada won’t overdo it and send the economy into a full-blown recession in the second half of this year.

Regardless, earlier hopes that the central banks might start slashing rates in 2023 have gone out the window. Shenfeld said investors are starting to understand that a period of economic pain is necessary in order to bring inflation down, and it’s actually a good thing. It would be “self-defeating” for central banks to start cutting at the first sign economic pain, he said.

Either way, Shenfeld is confident that by 2024 both Canada and the U.S. are going to reach their 2% inflation targets. 

The challenge for equity investors is that although higher rates have been priced into the market, the full effect on corporate earnings has yet to be seen.

“There’s no way you can even see a stall on economic growth without seeing a good chunk of the corporate sector in the U.S. see negative year-on-year growth in earnings per share,” he said. 

For this reason, it could be a “wobbly” first half of the year for equity markets, he said. But he’s hopeful that will change by the latter half of the year.

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