From the ongoing conflict in Ukraine, elevated inflation and aggressive central bank rate hikes, the outlook for the global economy is shifting. Kim Parlee speaks with Beata Caranci, Chief Economist, TD Bank, about the risk of stagflation, recession and policy overshoots.
- From the Russia-Ukrainian conflict to soaring inflation to rising rates right around the world, there's a whole lot of headwinds to global growth. Here to give us her outlook on what she sees and what is catching her attention, Beata Caranci. She's Chief Economist at TD Bank. Beata, it's always great to have you with us.
Let's start with just the last three months. I feel like I say this every three months for the past two years, that I can't believe these last three months just happened, but I can't believe these last three months just happened. So what surprised you the most in the last quarter following the Russia-Ukraine conflict?
- Yeah. I think when we first saw what was happening-- and was right around February 24th, when Russia invaded Ukraine-- I think there was a general view that this would be a shock that would extend a few weeks, and then you would have some kind of normalization in risk pricing. Obviously, that didn't occur. Nobody really anticipated you would see this series of sanctions, one after another-- I think Europe's on their sixth iteration-- and these structural shifts happening in the commodity markets, like natural gas, which is typically a very local, regional, weather-dependent commodity, now getting priced to European risks because you have US and others shipping LNG into Europe.
So some of the boundaries are now even moving in terms of what we thought were previously hardcoded in the globe. So a lot of structural change is underway, and it's not proving to be cyclical in the least. And when you look at the pass-through into a region like Europe, when you see how their growth rates are trending, it's trending as if it's a long-duration shock, meaning the amount of markdown on the growth equates to itself to a shock that extends about four to six quarters and not one to two quarters.
KIM PARLEE: It's fascinating. I think that's probably what the markets are-- that's at the core of everything, is trying to decipher how long this lasts, is this permanent, is this temporary, and just trying to understand the impact on that.
Maybe we could talk a bit about supply chains. Let's throw that one in there. We hadn't talked too much about that and the bottlenecks that are happening. I did mention the shutdowns in China because of COVID, but we'll add one more thing in. What do you see with the supply chain bottlenecks and how that's evolving?
- It's shifted, right? So it might still feel a little bit tight out there. But when you look at how the supply chain pressures were evolving during the pandemic, it was the pressure on everything, and now we have pressure on some things. Now, those some things are still meaningful, like metals and minerals and fertilizer and things that are coming out of Ukraine in particular. However, it's not as pervasive.
And you certainly don't see those stranded ships outside of the LA port. Remember, at one point, we saw 20, 30 ships just stranded? That has all cleared, but we're still feeling some elements of pain.
It's not all related to the war. China's zero-COVID policy has also extended out their supplier delivery times. This is predominantly being borne in Europe. They're getting the double effect because countries like Germany have very strong trade relationships with China as an export market, where it's less so for North America.
However, we got to be a little bit mindful because, when China goes through extended supply chain periods, it takes about three months, and then it tends to wash up on the shores of North America. So there's still the potential, though, while things are better and improving in the US and Canada, we might still feel some ramifications over the summer months. So we're very mindful of that, but the key distinction is it's not as pervasive as we saw during the pandemic.
- What-- I mean, the one thing though that has been talked more about the longer-term impact might be stagflation. And I know you've talked about this recently in report, and that's not something, I think, that was on anybody's radar a couple of years ago. So supply chain is one part, I think, of looking at contribute to stagflation, but I know you've got a chart that we're going to bring up and show how maybe the environment today is not the same as before. So maybe just talk about just what it is, what the concern is, and whether it's justified.
- Yeah, stagflation is one of these terms that gets used differently, depending on who's speaking about it. So, typically, people will say, oh, we're in a stagflation environment because inflation is high and growth is slowing. This is particular to US, not Canada, where it remains quite strong. That is not how we would normally define stagflation. It normally is where you break your economic relationship between unemployment and inflation, meaning you end up in a high unemployment situation and high inflation, which doesn't make sense because demand pressures should ease and push down inflation.
What we are seeing today is actually very consistent with economic theory. Record, like, we're looking at well-below-trend unemployment rates and high prices, and that's a normal relationship between demand and prices. Now, certainly, it's exacerbated by what's happening on the supply chain, but there are underlining drivers there, hence why we're having central banks raise interest rates. So that's a key distinction.
And so when you look back into the period in the '70s and '80s, the GDP and the unemployment rate environment are critical. And I would actually prioritize what the labor market is doing because that is what creates that stag part of the inflation environment. And so, without a rising unemployment rate, it's really-- I wouldn't characterize it in the same way as what we saw in the '70s.
- But any concern about that, I mean, as we move ahead? Now, again, we're also hearing people talk more about a recession, and not even kind of saying-- for some circles, I think we're not even talking about an if but rather when. How long? How deep? So is there concern that central banks, in order to fight the inflation, that maybe pushing economies into a recession and seeing unemployment levels rise?
- So this is where it gets tricky, Kim, because we're going to have to see the unemployment rate rise because it's too low relative to what's considered balanced conditions. So it's pushed back. It's pushed below its equilibrium level where you have balanced resource demands.
So, ultimately, what we're going to need to see is for businesses to either slow their pace of hiring, which I think is the most likely, going to happen irrespective. The concern that you point is that they actually move from not hiring to firing and then, therefore, you get your recession outcome. And this is where it's a balancing act with the central banks because the reason they're raising interest rates and have to push growth down so low is because we're in excess demand. There's just way too demand relative to the resources.
And so the laws of economics tell you, you have to now push growth below your potential growth, which means you've got to get it below 2%, and that means you have very little cushion for misses. Like, 1% won't feel very good.
And when you have 1%, really, what's the difference between 1% and 0%? And then what's the difference between 0% and a minus 0.5%. Oh, there you go. Now you've got a technical recession if you get two quarters of those.
So this is where you get the discussion on depth of recession. Right? Like, do we have the financial characteristics and risks like what you saw in 2008 in leverage and financial institutions to get us there? And that would be no. But do you have the risks assigned that, yeah, you could have some misses here? I would say, yeah, that's quite possible. We could see some negative quarters in the future, more likely a 2023 possibility.