SEI recently released its third-quarter Economic Outlook. A summary of the conclusions is provided below:

• Canada and the United States are both suffering from significant inflationary challenges.
• Central banks, in both advanced and emerging economies, are adopting similar policies aimed at creating the economic slack necessary to push inflation down.
• The Bank of Canada (Bank) and the U.S. Federal Reserve (Fed) have been quite clear with their intentions to return inflation levels to their respective longer-term targets of 2.0%. Bond markets currently reflect aggressive interest rate hikes going forward with at least another 75 basis points of increases expected over the 2 remaining Bank of Canada meeting dates for 2022 to bring the rate to 4.0%.
• Recent and expected rate hikes will be the most significant percentage increase in borrowing costs over the shortest period in Canadian history. The move in rates has been the prevailing force behind record-setting bond market losses for 2022.
• A global recession is appearing on the horizon, with Europe and the United Kingdom more vulnerable to a downturn than Canada or the United States in the months immediately ahead.
• Similar to the COVID-emergency of 2020, fiscal policy is once again being used by European governments to lessen the pain, this time to shield households and businesses from the full impact of the energy crisis.
• The United Kingdom, under the newly installed Truss government, has been especially aggressive in its tax-reduction and spending proposals; it is paying the price in the form of a sharp interest-rate spike across the maturity spectrum in its sovereign bonds and a decline in sterling to record-lows against the U.S. dollar.
• Risk assets more generally have come under pressure.We expect further up-and-down volatility across asset classes. We would not rule out another relief rally in the equity markets, given the extent of bearish sentiment currently prevailing and an oversold condition that matches what was seen in mid-June.
• The U.S. dollar also appears vulnerable to some sort of pullback given traders’ extreme long positions in the currency.
• Inflation in the U.S. has probably peaked, but we do not expect it to fall as rapidly or as far as the Fed is projecting. We look for wage growth to be sticky because labour markets are still very tight. The drop in productivity this year is an aggravating factor, but also a puzzling one that economists have yet to resolve.
• The Fed historically has stopped raising rates close to the time the economy enters a recession. The central bank usually begins to cut its policy rate aggressively as the recession deepens and unemployment climbs.
• Corporate profits have held up well in the U.S., but the coming slowdown should pressure margins lower. We anticipate a mild-to-moderate recession in the United States and a more severe downturn in the U.K. and Europe. Profits could decline about 20% in the U.S. and a bit more in Europe when all is said and done.
• Equity prices are already anticipating an earnings hit, with U.S. large-cap stocks down already some 20% in the year-to-date. Although further stock-price weakness probably lies ahead, it is possible that the worst of the damage to equities may have already occurred.

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