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The current strong labour market will be good for the economy, and it will also provide an economic floor under inflation.Adrian Wyld/The Canadian Press

John Rapley is a political economist at the University of Cambridge and managing director of Seaford Macro.

The global brass assembled in Davos, Switzerland, last week feeling better about life. After a brutal year of losses in stock markets, the new year brought plenty of good cheer. Inflation is falling, the job market is strong and hopes are rising that Western economies might avoid the recessions we’d been warned to expect. Indeed, investors are betting interest rates will soon come down again. In anticipation of this they returned to the markets, driving up stocks and bringing down interest rates.

Yet while some of that good news will continue, some of it won’t. Some may even turn positively ugly. These effects won’t fall evenly, mind you, and this is where it gets interesting. Because if I were to sum it up in a phrase, I’d say the Marxists would be happy: In relative terms, it’s looking like the year ahead will be, relative to where they now stand, better for workers than owners.

We haven’t been able to say that in a long time. And at first, given the cost of living crisis, it probably won’t feel that way either. Still, the deep trends suggest that compared to recent years, the road ahead will be less bumpy for people who live mainly off the fruits of their labours.

First off, inflation will keep falling as the supply-side effects of the pandemic finish working their way though the pipeline. With the job market steady, wages holding most of their gains and China’s reopening bolstering the world economy, there’s now a good chance that demand will remain strong enough to keep economies out of anything worse than short, shallow recessions – although Britain, still paying the “moron premium” in its politics, may face an unusually bleak year. (Boris Johnson did say he’d make Britain an extraordinary country, after all.)

That’s the good news. It’s the reason investors, keen to jump on the bandwagon, carried their partying into the markets in the year’s early weeks. Satisfied the worst has passed, they’re now predicting central banks will pivot and cut interest rates sooner than expected, unleashing another bull market.

But this is where the bad news starts, at least for them. While inflation is falling, core inflation is proving sticky. It’ll probably stay that way.

China’s reopening will stoke demand for many of the commodities whose falling prices had taken the sting out of inflation late last year. That will end the disinflation in commodity markets.

Closer to home, the strong labour market will keep demand from tanking. While good for the economy, it will also provide a floor under inflation. As the months roll on, watch for the decline in the inflation rate to slow. That’ll probably put an end to the pivot. Interest rates won’t rise as sharply as last year, but they will still rise.

So for asset owners, that could make things get ugly. Last summer, corporate profit rates reached record highs. Since then, things have gone into reverse, and there are reasons to believe this trend will last, possibly for years. So, after their positive start to the year, U.S. markets will probably resume falling, with Canada and other G7 markets equally staying in a bit of a funk. Moreover Canada’s real estate market may, as I wrote recently, turn especially ugly.

That produces an interesting dynamic. Recent employment reports indicate layoffs have begun, but many of them have been concentrated in high-paying jobs, in particular tech and finance. Add falling profits and asset values to the mix, and there’s something of a recession hitting the higher end of the income scale.

Following the trend in profits last year, luxury consumption by the world’s richest also reached historic highs in 2022. But since then that has also started to reverse. In recent U.S. reports, for instance, the biggest drop in consumption in the United States has shown up in richer households – in part because they have more income to cut, but in part because those incomes have been feeling more of the squeeze.

Any one of numerous “black swan” events could come along to completely disrupt everything, as did Russia’s invasion of Ukraine last year. That war could end, Mr. Putin could be overthrown, China could attack Taiwan, the U.S. Congress could refuse to lift the debt ceiling – something that has never happened, and so whose effects are hard to predict but could be disastrous. In a time of extreme uncertainty that’s been called the “polycrisis,” the risk of a meltdown is ever present.

But even these developments could only stem, not reverse, the deeper trends. So even if 2023 doesn’t feel like a fun year for a lot of working people, a big picture is starting to emerge – that when we reach the other side of this economic slump, the gap between rich and poor, which had widened so much in recent decades, will have begun narrowing.

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