Good afternoon,

First and foremost, the U.S. Fed followed through with a widely-expected 25 basis point hike in the fed funds target range to 5.25% to 5.5% (a 22 year high) after 'skipping' a hike in June. As markets and investor decipher the messaging from Powell’s statements, it is important to remind ourselves that while a number of (long) leading indicators continue to signal above-average risk of a downturn in the coming quarters, slowing inflation amid resilient growth has fueled market confidence in the Fed’s ability to achieve a soft landing for the economy. Given the debate around the likelihood of recession should stick around for a while, the Fixed Income Team of our Portfolio Advisory Group did a great job today of providing three scenarios in which the U.S. economic expansion could stay intact for longer than anticipated.

Scenario 1: Current unemployment rate turns out to be roughly equal to full employment.

If the prevailing historically low unemployment rate of 3.6% is merely consistent with “full employment”, then the Fed may not need to tighten monetary policy further, especially with inflation on a decelerating path. The scenario of falling inflation without higher unemployment has generally played out over the past 12 months, with a strong labour market continuing to support resilient household spending and economic growth. However, sustaining the unemployment rate at “full employment levels” for an extended period could prove challenging as any positive shock to demand could spark another bout of inflationary pressures. Meanwhile, any negative demand shock could lead to job losses and push up the unemployment rate. It is worth noting that the U.S. economy has historically been unable to avert a recession when unemployment has reached today’s very low levels (see chart below).

Scenario 2: A strong pickup in productivity.

Given increasingly constrained supply of workers in the U.S.—the participation rate for workers ages of 25 and 54 (prime age) is above pre-pandemic levels—the only way the economy could potentially boost aggregate supply that is not accompanied by inflationary pressure would be though improving productivity growth. Unfortunately, recent productivity trends have been underwhelming (see chart below).

However, the recent breakthroughs in AI bolsters hope that productivity growth could accelerate over the coming years. A productivity boom triggered by AI developments could potentially resemble previous productivity growth spikes, such as the one seen following the invention of electricity and personal computers (see chart below). As the chart below cautions, however, the main risk to this view is timing, as the productivity boost from the new technologies came well after their invention. The adoption rate of AI technologies remains highly uncertain, and it seems unlikely they will be embedded into the broader economy in the following 12 to 18 months when the perception of recession risk may start worsen anew.

Scenario 3: The Fed successfully achieves a soft-landing

there are still a few reasons why the Fed may still be able to avoid a recession. Healthy household balance sheets continue to support consumer spending, which has in part contributed to the ongoing economic resiliency. Low housing inventory and vacancy rates also suggest the housing market is on a stronger solid footing compared to the last cycle. And the relatively low business capital expenditures over the past two decades point toward more capex to be potentially deployed in the years ahead, which would provide an economic tailwind. Inflation has decelerated sharply without significant economic weakness.

The scenarios outlined above highlight a few ways in which the U.S. economic expansion could stay intact for longer than expected; however, does not change our view on the market or strategy. While all economic expansions end in a recession, the lack of any major imbalances in the economy suggest the next downturn could be a relatively mild one and supports our relative underweight positioning.

Please continue to call us as we are here to answer any questions that you may have or help in any way. We can also be made available to speak with any family members or friends who may need reassurance during these times.

The smoke has lifted, the sky is blue, and it is a beautiful sunny day in YYC. Enjoy the rest of the week.

Devin