The buoyant stock market is signalling a healthy economy and many experts agree, but David Rosenberg says don’t be fooled: A recession looms just around the corner.
In his view, central banks took too long to change course when they eased off their monetary tightening bias that, in the case of the U.S. Federal Reserve, saw nine interest rate hikes in a row.
While both the Fed and the Bank of Canada, which abandoned talk of rate hikes altogether on Wednesday, are now on hold, the damage has already been done, the chief economist at Gluskin Sheff + Associates said at a speech in Toronto on Thursday at the Canadian Alternative Investment Forum held by Introduction Capital.
“The Fed has murdered every cycle. And I believe the Fed has murdered this one,” Mr. Rosenberg said.
If he’s right, and overzealous monetary policy has basically ensured a recession, the end of the economic cycle is likely to come much sooner than the market is expecting.
Most economists aren’t as pessimistic as Mr. Rosenberg, who is known for his bearish calls. Many have been saying that recession risks are relatively low for at least another year or two, and major stock indexes in both Canada and the United States this month have climbed to all-time highs.
Stock market optimism has been reinforced by some stabilized economic readings. Chinese first-quarter GDP beat forecasts, while retail sales showed signs of rebounding globally.
“What remains is a global economy that has transitioned from two years of above-average growth to a spell of below-average growth – but still growth,” Douglas Porter, chief economist at BMO Financial Group, wrote in a recent note.
CIBC economist Katherine Judge says she doesn’t believe central banks have overtightened, but the true impact of rate hikes can’t be known until they fully spread through the economy, which can take up to two years.
“They filter through the housing market first, then autos and big-ticket items,” Ms. Judge said. “From there, they spread to business investment, and then just general demand.”
In the three years up to December, the Fed implemented nine rate hikes, taking its federal funds rate to a range of 2.25 per cent to 2.5 per cent – its highest level since before the bankruptcy of Lehman Brothers Inc. in 2008.
Canada’s rate-hike path, meanwhile, was delayed by the collapse of oil prices starting in 2014. But the domestic economy ultimately strengthened enough for Bank of Canada Governor Stephen Poloz to raise the overnight lending rate to 1.75 per cent through five rate hikes between mid-2017 and last October.
That was also around the time Federal Reserve Chairman Jerome Powell unsettled markets when he said the Fed was “a long way” from “neutral” – the rate that is neither stimulating the economy nor slowing it down.
Concerns over excessive tightening, combined with signs of fragility in the Chinese economy, ultimately sent stock prices into a tailspin.
Mr. Powell continued tightening into the sell-off, with the final December hike triggering steep losses toward the end of the year. The S&P 500’s slide stopped just shy of the 20-per-cent mark, while the peak-to-trough decline of the S&P/TSX Composite Index amounted to 16.8 per cent.
Around that time, the Fed chair vowed to be patient with rate policy, in what has become known as the “Powell Pivot.” Mr. Poloz followed suit, promising to be “data dependent."
Central bankers backing off of rate hikes effectively ended last fall’s nosedive in stocks, setting up a rebound in the S&P 500 index that stood at 24.5 per cent by Thursday’s close. The S&P/TSX Composite Index is up by 20.3 per cent over the same time. Recession fears have been replaced by a revival of economic confidence.
But some data suggest enduring economic weakness, Mr. Rosenberg pointed out.
The Citi Economic Surprise Index has declined steadily over the past three months, suggesting that U.S. economic performance has failed to meet economists’ expectations.
In March, an indicator produced by the Federal Reserve Bank of New York based on bond yields showed the probability of a U.S. recession over the next 12 months hitting its highest level since 2008.
Meanwhile, U.S. unemployment is showing signs of increasing after hitting a low last September, Mr. Rosenberg said. That kind of job market inflection tends to predate a recession by an average of nine months.
An inverted yield curve, which was seen in the United States and Canada in late March, also tends to signal an economic recession.
“When the yield curve inverts, it’s the bond market’s way of saying, 'Mr. Fed, you’ve gone too far,’” Mr. Rosenberg said.
Of the 13 previous Fed rate-hiking cycles since the Second World War, 10 of them landed the economy in a recession, Mr. Rosenberg said.
If rate hikes already implemented do prove to be excessive, there is little that can be done about it now, Mr. Rosenberg said.
“Can the Fed stave off a recession? Too late.”