TD Chief Economist answers top questions in uncertain times

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KIM PARLEE: Hello, everybody, and welcome to the MoneyTalk podcast. I'm Kim Parlee. I'm joined by the Beata Caranci. She's Chief Economist of TD Bank Group. And Beata and I are not in the same place because we are practicing social distancing. So we are talking and doing, as I mentioned, the podcast to bring you some of the interesting insights you had in your last report. Beata, how are you?

BEATA CARANCI: I'm well.

KIM PARLEE: Good.

BEATA CARANCI: No complaint.

KIM PARLEE: Good. Lots going on. You put out a report that I think was a great overview of all the questions that people are asking right now. And the measures that are being taken around the world to fight COVID-19, they're unprecedented. And in terms of the responses, we've seen monetary bazookas. We have been fiscal bazookas. A lot is coming out, but I think it all leads, for a lot of people, to one question, which is, are we headed for a recession?

BEATA CARANCI: Yeah, and that's the million-dollar question. And I think this gets back to what you think of the duration of the interruptions we're seeing and then breadth-- so how far across the country you go in terms of the labor market, not just stoppages of labor but actual losses of jobs.

So we know we're going to hit the duration mark-- sorry, not the duration. We're going to hit a depth. So we're going to have fairly deep contraction in the second quarter beginning in March but leading into the second quarter from the disruptions. GDP can be down about 3% minimum in the US and Canada. So that's kind of expected at this stage.

What we can't answer is the duration. So do we end up having these containment measures disrupt activity to the point that it bleeds into the latter part of the second quarter into the third quarter?

That would be untenable for businesses. I know there's a lot of government measures. More have been announced almost daily. We've had three stimulus packages announced by Canada already, and the US is trying to put together a bazooka one themselves, upwards of about a trillion dollars. So that's to stem job losses in the near term, but the reality is if you don't have a strong revenue base and it's extending for months on end, that's not likely going to be sustainable, and we're likely going to start to see broader job losses roll out across the country.

So this duration question is the one that's under debate. Nobody can answer it, including the governments themselves. And so that is a wait and see.

KIM PARLEE: I think the hard part for a lot of people too-- and we've talked about this-- is that when we headed into this, Canada was not as strong economically as the States. And then when you layer on to that the fact of what's happened with oil and the oil is bouncing around-- Western Canadian Select oil is now getting below $10. This has serious implications, obviously, for the west of Canada too.

BEATA CARANCI: Oh, this is it, right? So what we can say about a province like Ontario or Quebec versus Alberta are going to be very different. I don't think there's any question that Alberta will be in recession and formal recession in terms of job losses because they are getting the double hit. And then there's, of course, the financial-market effect in terms of undermining confidence in a lot of metrics as well.

Other provinces that were coming into that quarter on our stronger back foot like Ontario and Quebec, this is where it's more a measure of these containment measures having that longer-term job impact. So I think oil-producing provinces are certainly at a disadvantage in this environment, and our hearts go out to them because they're really absorbing a double shock.

KIM PARLEE: What about the stock market? I mean, this has been, I mean just personally, it's been nauseating to watch in terms of the market activity. Should we be scared at these wild moves in the stock market, in your opinion?

BEATA CARANCI: Well, looking at them is scary in itself because we're seeing some sharp moves. It's not that we're in bear territory. We absolutely are. We've been here before in terms of bear territory, in fact. You know, technically December of 2018 was one of those cases which did not correspond to any, really, economic event in terms of jobs, activity, or anything like that. It was more of a sentiment shock coming through.

What we're seeing today, where it differs is that the amount of movement is looking like a seven standard deviation from historical norms. So that means that the magnitude and the speed of movement is greater than we've seen in the past. And that I could probably dismiss if it was only in the stock market, but that's not actually what's occurring. What's really getting our attention is that we're seeing this driving out of financial stress across multiple credit and liquidity measures-- so inside the bond markets, corporate bond markets in particular, access to credit.

This poses a much bigger challenge in amplifying an economic shock because corporations could be restricted from liquidity and credit access. And so we've in the past flagged-- we've had a number of reports that said, listen, we know that Canadian corporations and US corporations are carrying a lot of debt on their books, but you don't really worry about it until you have a catalyst, something that makes the rolling over of that debt more difficult to sustain.

None of us imagined at that time that the catalyst would be a pandemic and this closure of businesses that is occurring that's going to make it more difficult for them to, in fact, finance that debt. So this could be that catalyst that amplifies the financial-market risk, and I think that's what you're seeing the investors reacting to because not only do you not know when this health shock is going to end, but now you have to figure out which companies are at that make-or-break point.

KIM PARLEE: Sobering. Let's talk about central banks. Why are we seeing central banks move so low when they actually have so little ammunition to do anything? I mean, rates were already at historic lows.

BEATA CARANCI: Yeah, so the next question you have to put a bit of a risk-management cap on because when you're a central banker, you're assessing the balance of risk based on the balance of risk around the shock itself. So if it's a small shock, if it's deemed to be short lived, if it's deemed to have a very certain outcome, meaning you can actually estimate and foresee the beginning and end period, you would have less urgency on doing anything in terms of a monetary response. You may play it through or have the government address it individually.

However, what we're now looking at is a fairly large shock. There's a huge degree of uncertainty around it, and it's not clear when these measures that we're seeing are going to be backed off. And so this is exactly the combination of events where you need a central bank to step in in order to anchor liquidity and confidence in the market, and so that's why the Federal Reserve and the Bank of Canada have been out early and they've cut rates.

Now they had the advantage of having a much higher starting point than other central banks who have to look at other measures. But we had a cut on a Sunday of 100 basis points by the US. So this was really a historic moment for some things in terms of measuring the size of the shock.

So just because you have less firing power doesn't mean that you take that firing power out. It means you actually have to do it earlier because what you have to do is prevent those negative dynamics from really becoming rooted in the financial system and the economy because you don't have a lot of firing power. So that makes sense, right? So you basically have to be aggressive from the get go in order to smooth out the shock because you don't have a lot there that you can do after that point.

KIM PARLEE: Yes, get ahead and try and solve this early on before it becomes bigger. Fingers crossed. From your lips to God's ears on this one.

How about the downside risks for interest rates? I mean, because you cut them, but then at some point, they do need to come back up.

BEATA CARANCI: Well, yeah. And everybody knows a lot easier to cut. A lot of people are willing to take the cut. A lot harder to raise them. And, in fact, we know this because we saw this in 2013 when we had exited the financial crisis and the economy was in pretty steady foot. The Federal Reserve indicated all they wanted to do was not stop quantitative easing, which is asset purchases. They just wanted to slow down that measure, and we saw what we call now a taper tantrum where the markets did not like that messaging, and they lifted the 10-year Treasury yield by 100 basis points in a few months, which causes a shock from those who are on the consumption side of that where everything is priced off the yield.

So we know it's difficult to raise interest rates when you get to the other side of it. However, you deal with it when you get there, and the only reason you're raising rates when you're on the other side of it is because you feel the economy is on a strong-enough footing to absorb any of that angst. So you're less worried about it at that stage. It's about communicating a steady message and believing that you have a good economic cushion under you to absorb any of that shock. But it is a difficult thing for the central banks when they make that community-- not community but communication shift to markets because the markets don't like it when the punchbowl is taken away.

KIM PARLEE: Let me ask you about unintended consequences. And I would say they're not unseen but probably still not wanted. In Canada, obviously the housing is something that people worry about, housing bubble. Low interest rates could fuel higher prices. Also with all the spending coming out from governments, that's also an issue. You've got governments well in debt already.

BEATA CARANCI: Yeah, so in terms of-- so we're not worried at this stage given that we're dealing with a shock which has a lot of ambiguity around it. We're not worried about people spending too much. We're worried about them going into a confidence or demand downturn. And so for interest rates being as low as they are, we've been getting asked questions. Does this fuel a housing bubble?

You don't worry about that when you're trying to put confidence under demand. If we get into a situation where demand is sturdy and accelerating more than expected, that's a positive. And then the central bank can go the other way in terms of what they want to do with interest rates, or you turn to macroprudential rules, which is the more likely outcome, which is basically looking to your regulators, stress-testing exercises for mortgage qualification, those type of things to mitigate the responses because, at the end of the day, the central bank is not managing a housing market for a particular city like Toronto. It's managing an entire country's economic condition and backdrop.

So we rely on regulators to fine tune the policy across provinces, but the central bank has to keep their eye on the ball for the whole country, as do governments in terms of fiscal stimulus. So if we do get a situation that we're getting a lot of spending from governments and central banks that leads to more consumption by households, that's a positive because that's the risk you can you can manage.

KIM PARLEE: Last question for you. Your job becomes a whole lot more tricky in terms of trying to forecast where everything is going. And I first learned of analysts today saying-- and again, these are equity analysts, but companies saying at this point they see a lot of what they're saying is educated guesses. It's tough. It's very tough. So how do you-- I mean, how hard is it to really predict? And I think this is not just your job but businesses trying to predict where things are going.

BEATA CARANCI: Well, it's really tough from that perspective because even from the government side, we've been hearing more and more-- you know, this is budget season. So March and very early April is when you have governments releasing their budgets, and they're not doing it. A lot of them are delaying it because they can't actually get line of sight on what the revenue line is going to look like. They have a sense of where expenditures are going, but they actually can't consolidate to the other side of the balance sheet.

So a lot of uncertainty on that front by all parties. And I think when you're in the world of economics, you use history as much as you possibly can, but this is quite an unprecedented event. So we are really looking at real-time high-frequency indicators.

So the credit markets, like I mentioned, is a really important one. So the more persistence we see and dislocation there, the greater the likelihood that it pushes us closer to a recession because it's not going to be tenable in the long term.

So high-frequency data-- there's a lot of good high-frequency data in the US on jobless claims. So people who are filing for an unemployment, insurance, and that gives us a sense of the employment shock that may be feeding through.

And then we do have leading indicators out there by other countries. So China, South Korea, Italy, France, others were going through the pandemic cycle ahead of North America. So we're already seeing China starting to reboot their economy. They're probably not the best example for North America because they took even more stringent quarantine measures. So we're looking to the European economies like Italy who were slower off the mark, which is a little bit more like what we're seeing, especially in the US. If they can actually reboot those economies by April, then we think we're going to be following those same patterns, and that should mitigate some of the downside for us. So we're looking to other countries and high-frequency data and financial markets in particular.

KIM PARLEE: Beata, thank you. We appreciate your time. I know you're busy, and we look forward to talking to you again soon. Be well.

BEATA CARANCI: You too. Take care.

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