Dec 8, 2022
David Rosenberg: A bleak outlook for 2023
Canadian economic situation in 2023 will be clouded at best: David Rosenberg
David Rosenberg, the founder and president of Rosenberg Research, has a bleak outlook for Canada’s economy in 2023.
“In one word or less, recession,” he said in a phone interview Nov. 29.
Recessions come after periods of monetary tightening around 80 per cent of the time, according to Rosenberg. Since March, the central bank has increased interest rates seven times, something Rosenberg said marks Canada’s most aggressive rate hiking campaign in three decades.
“When you have a monetary tightening cycle that inverts the yield curve to the extent that has already happened, whether you're talking about the Bank of Canada or the Fed [U.S. Federal Reserve], a recession probability goes very close to 100 per cent,” he said, adding that it is a matter of understanding the lags between central banks actions and subsequent economic impacts.
Aggressive monetary tightening undertaken by the central bank has pushed short-term interest rates above long-term yields, and there is no “get out of jail free card,” he said.
“It is the bond market's way of crying uncle and telling the world that a recession is staring us in the face,” Rosenberg said.
“So 2023 is the year of the recession, 2022 was the year of the financial turbulence and 2023 will be the year of the economic turbulence.”
Canada’s yield curve hit its steepest inversion since the early 1990s on Dec. 5.
On Dec. 5, Canada’s two-year short-term bond yield was at 3.8 per cent, while the 10-year bond yield was at 2.8 per cent.
Following the central bank’s aggressive rate hiking campaign, Rosenberg said deflation now presents a more significant problem than inflation in 2023. According to Rosenberg, there are already early signs of deflation in the commodities market.
“Oil is down 35 per cent from the peak, copper is down 25 per cent. The Baltic Dry Index, which is the poster child for global freight rates has collapsed 60 per cent. So a lot of the items that we're early in kick-starting the inflation process are now rolling over in real-time and in a very major way,” he said.
Around 40 per cent of the consumer price index (CPI) is comprised of goods, an area where Rosenberg said you can see early signs of deflation.
Large swings in the CPI commonly occur in materials and goods sectors, according to Rosenberg, which “will overwhelm what we’re going to be seeing on the services side...but the deflation will come through the goods market,” he said.
As an economic slowdown occurs and deflation takes hold, Rosenberg said. He expects corporate earnings to decline in turn. In a typical recession, corporate earnings usually decline by around 20 per cent with a tight standard deviation, he said.
“There's never been a recession where corporate earnings expanded. And yet the consensus amongst the bundle of analysts is that we will continue to see positive growth in the next year, although those estimates are coming down,” Rosenberg said.
Canada’s housing market could present some risks for the economy amid an economic downturn, according to Rosenberg. One of the risks is that Canadian households have never had a higher level of exposure to residential real estate, Rosenberg said.
Following the series of interest rate hikes and given the fact that housing is the longest-duration asset in the economy, Rosenberg said there will be an economic fallout in 2023 with negative effects on the housing market, consumer balance sheets and consumer spending.
“This price bubble in housing and the excessive exposure the economy has to residential construction, and the household balance sheet to residential real estate, has never been this high before. And the price from these rising interest rates will be felt next year,” he said.
“Canada has never been this far exposed to rising interest rates and declining home prices as is currently the case.”
Additionally, Rosenberg said Canada’s economic position could be made worse in 2023 by its reliance on the U.S.
“Canada is going to face a double whammy, because at the same time we are a small open economy. And the U.S. is going to be entering a recession too,” he said.
Rosenberg said he bases his U.S. recession predictions on eight consecutive months of declines in The Conference Board Leading Economic Index, which is a leading indicator. Something that has “never happened before without foreshadowing a recession.”
A recession in the U.S. could have compounding effects on the Canadian economy as demand for export manufacturing wanes, he said.
“So it's going to be really a two-front war, housing and exports,” said Rosenberg.
CENTRAL BANK DIVERGENCE
The Bank of Canada and the Fed may need to take different paths forward with regard to interest rates as a potential recession looms, Rosenberg said in a television interview Dec. 8.
“I think that we may end up seeing a split between where the Bank of Canada goes and the Fed goes,” he said.
“It has to be emphasized that Canadian household balance sheets are way more stretched than they are in the U.S.”
Rosenberg said inflation is a lagging indicator and interest rates are cyclical. He said he is not aware of any recession where interest rates did not come down.
Central banks are generally slow to respond in either direction, according to Rosenberg, who added he thinks inflation will come down next year.
“I think that in every recession rates come down. So depending on how you're financing your mortgages or your business, rest assured by the second half of next year rates are going to be a lot lower than they are today,” he said.