Credit Suisse’s prominent global strategist Andrew Garthwaite believes that a U.S. recession is inevitable and, since the Canadian economy is oriented around U.S. demand to a significant extent, this is not good news domestically.
Credit Suisse notes that the U.S. economy is currently growing at a nominal (not inflation-adjusted) rate of over nine per cent, the highest in 40 years. In order to tame inflation, growth will have to slow by two-thirds, according to Mr. Garthwaite’s estimates.
The strategist believes that wage growth - the most important inflationary force for investors as it makes up 60 per cent of corporate costs - will be difficult to tame. Inflation has become embedded in labour markets and deglobalization, higher minimum wages and expectations for public sector pay increases are all driving labour costs higher.
Mr. Garthwaite believes that central banks must raise rates until wage growth declines by a full percentage point, and the unemployment rate climbs by the same amount. He estimates this will not happen unless real GDP contracts at a rate between 0.5 and 1.0 per cent for a nine-month period.
The Federal Reserve is unlikely to stop hiking anytime soon because it is gauging its progress with lagging indicators, according to Credit Suisse. While leading indicators like consumer confidence and ISM Manufacturing New Orders already indicate recession, the Fed is concerned with employment growth which is only affected by rising rates over time. The risk here is that the central bank continues raising rates long after a recession has occurred, exacerbating the slowdown.
The difference between three-month and 10-year Treasury yields is 12 basis points. Credit Suisse believes that rate hikes will push the three month yield above the 10 year yield later this year - meaning that part of the yield curve will join the two-year/10-year spread as being in inversion. The past eight times the three month has exceeded the 10 year yield, a recession has occurred an average of 10 months later.
The U.S. consumer price index was reported Wednesday at 8.5 per cent year over year. This was below estimates of 8.7 per cent but still represents an extraordinary increase in prices. If Mr. Garthwaite is right, investors will have to endure this higher inflation pressure even as economic growth slows on both sides of the border.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: With the Canada Deposit Insurance Corporation, would it not be accurate to suggest one’s concern might be low in investing over $100,000 in GICs with one of the main banks, as the chance of insolvency is remote? For example, should I have concern in investing more than $100,000 in a BMO GIC? [GICs issued by banks and other member institutions are covered by CDIC for up to $100,000 in principal and interest.]
Answer: The chances of any of the Big Six Canadian banks going down are extremely slim. If that happened, our whole banking system would be at risk, and Ottawa would have to step in to prevent a collapse. The old mantra of “too big to fail” would kick in.
Smaller institutions are a different story. I don’t see them as high risk but there have been failures of trust companies and small banks in the past, and it could happen again if we hit a period of severe financial stress as in 2008. It’s not likely, but it’s not impossible.
So, to answer the question, I would not be concerned about placing more than $100,000 with Bank of Montreal or any other major bank. But I would think twice about doing so with a smaller financial company, unless you use deposit insurance to its maximum advantage.
You can expand your insurance coverage by spreading the money over several accounts or GICs. You and your spouse are each entitled to $100,000 coverage. A joint account is viewed as a separate entity. So is an RRSP account, a TFSA, an RESP, etc. Go to cdic.ca for full details.
What’s up in the days ahead
What should investors take away from the latest earnings season in Canada and the U.S.? Brenda Bouw will report.
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Compiled by Globe Investor Staff