The Canadian Investor - US Debt Downgrade, Inflation Base Effects and Canadian Bonds

Episode Date: August 10, 2023

In this special episode of the Canadian Investor Podcast, Daniel Foch joins Simon to talk macro! We discuss the recent downgrade of the US Debt by Fitch, the recent downgrade of US banks by Moody’s, the impact of base effects on headline inflation and how bond yields impact fixed mortgage rates. Symbols of stocks discussed: XBB.TO, SPY, AGG, XIU.TO Check out our portfolio by going to Jointci.com Our Website Canadian Investor Podcast Network Twitter: @cdn_investing Simon’s twitter: @Fiat_Iceberg Braden’s twitter: @BradoCapital Want to learn more about Real Estate Investing? Check out the Canadian Real Estate Investor Podcast! Apple Podcast - The Canadian Real Estate Investor  Spotify - The Canadian Real Estate Investor  Sign up to Stratosphere for free 🚀 our platform for self-directed stock investing research. Register for EQ Bank, the seamless digital banking experience with better rates and no nonsense.See omnystudio.com/listener for privacy information.

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happened, but he'll be back next week for his regular episode. So not to worry. Dan, how are you doing? Fantastic. I'm excited for a little macro. So you're probably my favorite, favorite person to talk to about macro. So this is gonna be a good one. Yeah, likewise.

I mean, too bad we didn't have that much time during the TCI meetup in Toronto was kind of hectic. You had to drive back a couple hours and me and my back issues, but we had the chance to do it again today. And we'll get started with, well, I guess we'll do a mix of news that are kind of macro related. And then we'll talk about, you know, base effects, inflation. We'll also talk about government bond yields. You'll chime into with the effects on real estate, because I'm sure a lot of people are interested with your take on just the Canadian real estate market as a whole, how it's going and the macro impacts of that. So that work with you?

Yeah, for sure. Okay. So like I mentioned, so we'll start off with some that. So that work with you? Yeah, for sure. Okay. So like I mentioned, so we'll start off with some news. So Fitch last week, news came out that Fitch downgraded the US debt. And we also had news today that Moody's downgraded 10 US banks. So the rating agency Fitch downgraded long-term US debt from AAA to AA plus and place a stable outlook on the new rating. For those not aware, essentially, if there's like a stable outlook, it means they're not looking at downgrading anytime soon. But they'll sometimes also put a watch or a unstable outlook. There's different terms they

use, but basically, or they'll say, you know, it might be under review. That's just because they are debating whether they are downgrading or not. And to touch on the Moody's downgrade, so they downgraded 10 important U.S. banks. However, none of them were G-SIB banks, so globally systematically important banks. But still, it was pretty significant. There are some pretty large banks that were downgraded but there is one g-sib bank that was put under review and that is bny melon it's the only g-sib that kind of made the list here there's also some other large banks that are under reviews that could potentially see their

rating downgraded now uh did you i'm assuming we were talking so you saw that earlier today any kind of initial thoughts on that and i'll I'll break it down a bit more, especially the US debt. You know, I'm not super well versed on the equity side, but like the market's been, I think, remarkably strong. And I think that that controls a lot of and dictates a lot of the consumer sentiment, which trickles into what we see on the real estate side. But, you know, as you and I discussed in our most recent commercial real estate episode, the crossover, the two part. And as we discuss a lot on our show, you know, that consumer sentiment is really what's going to continue to drive. And as long as people's inflation expectations are capped and as long as their growth expectations are positive, then the downside scenario in the market is a big question mark. It can change very quickly based on a piece of news or the sum of all parts of a lot of pieces of news. And this kind of is one of those ones that goes in a more bearish direction, right? Yeah, exactly. And from my perspective, I mean, I do agree with you to some extent. And I'll just give an overview of what Fitch

actually stated for the reason for the downgrade, and then I'll give my thoughts. But the first one is erosion of governance. They said the debt ceiling standoff is eroding fiscal confidence in the U.S. government, lack of medium-term fiscal framework, and no political willingness to tackle the rising costs of Social Security and Medicare. So basically the ballooning costs that are coming up in the medium to long term, rising general government deficits. I'm sure that comes to no surprise. But historically, the GDP had been the deficit to GDP had been around 3.5 percent, but they projected to rise to 6.3 percent 2023, 6.4 percent 2024 and 6.9% 2025. This is what obviously Fitch is stating here. The general government debt to rise, so the debt to GDP levels remain elevated, was around 100% 2019,

rose to 122% 2020, but came back down to 113% this year, but they do expect it to go back up to 118% by 2025. Medium-term fiscal challenges that are unaddressed. So it is in the coming decade, there will be some significant challenges due to interest costs rising as a result of higher debt levels, but also higher interest rates. Excessional strengths supports the rating so that is a more positive one. They said that the U.S. remains strong as a large advanced and well-diversified higher income economy and the U.S. is also the world's reserve currency which gives the government extraordinary financing flexibility. And the last three here, the economy, they predict that it will slip into

a recession late in Q4 2023 and into Q1 of 2024, which is a contrast to what the Fed said recently. They thought that a recession might be avoided. So it kind of goes to show that, you know, different people will have different perspective here. The Fed tightening, obviously, they expect another 25 basis point increase this fall and say that inflation is staying stubbornly higher with core PCE at 4.1% year over year. Now, for those not familiar, PCE is the personal consumption expenditure. It's a different inflation measure than CPI, but something that the Fed pays attention to. I can do actually a segment on that in a future episode to go into more detail.

ESG governance, so the U.S. ranks well in terms of governance, so specifically governance here in terms of effective rule of law, strong institution, and low levels of corruption. effective rule of law, strong institution, and low levels of corruption. And for additional context, back in 2011, S&P actually downgraded the U.S. debt from AAA to AA+, and now the only major rating agency with a rating of AAA is Moody's. And Warren Buffett had some comments that he told CNBC, Becky Quick, last Thursday. He said that Berkshire bought $10 billion in U.S. treasuries last Monday. We bought $10 billion in treasuries this Monday.

And the only question for next Monday is whether we will buy another $10 billion of three- or six-month treasury bills. So that's what Warren Buffett was – The guy loves betting on America. Yeah, exactly. He does. He doubled down on it. I mean, it's kind of – from from my personal perspective it's good to see because i have my cash mostly in short-term treasury bill

etfs because they pay well and ultimately they're backed by the u.s government and they're very liquid so it's kind of nice to see that uh you know has as the brayden would say the buff dog is is doing something similar. It is. Yeah, I mean, it's interesting in the comparison and contrasting of, you know, his philosophy versus somebody like Dalio, who talks about maybe the US dollar losing its reserve currency status within our lifetime, which I don't really know, necessarily know. I mean, if you had asked me six months ago, I might have agreed with that thesis. But seeing China's economy faltering right now is also a big question mark, right? Like, you have

the quote in your notes here that there are some things that people shouldn't worry about, and this is one of them, and that the dollar is the reserve currency of the world, and everybody knows it, right? I mean, he just loves betting on America. And you're starting to see some people, some, you know, further macro philosophy investors with different concepts around whether or not that could actually be the case. But I'm curious to get your perspective as well. Well, the latest data I saw is that you're seeing central banks around the world reducing slightly their treasury, US treasury holdings, but it's still very kind of slow, I would say, in terms of reducing it. And it's not like there's one like the Chinese Yuan, for example, that is really going over the

US dollar as a reserve currency, like you said, whether it's their economy faltering or the fact that you can say what you want about the u.s yes they've weaponized their currency and the swift system in the past it's nothing new i'm sure they'll probably try and do it again whether you agree or not that's not the you know what i'm trying to say here the main thing is that if you're another country and you know you're seeing the u.s weaponize that if you're on the good side of the u.s now now, you might still tell yourself, well, if I'm not on that good side, will I remain on the good side in 5, 10, 15 years? And will the U.S. potentially weaponize that against us? So you try to diversify it a little bit. But on the other side is you diversify into what? Because if you think the U.S. can

weaponize their currency, what do you think China might be able to do as a de facto, obviously, dictatorship that they have over there? So it's not like there's necessarily a good, good option. And I think that's, that's kind of where I stand is, I mean, we'll have to see whether there is an option that's kind of neutral and used by other countries more widely than the US dollar, but I don't think it's coming anytime soon. I think the hardest part for them is going to be reaching a consensus. If you look at BRICS, you've got multiple countries that all want to usurp the US as a superpower and economics seem to be the most efficient way to do that. But what happens when they actually are

looking at the opportunity to do that and they have to pick a leader and now all of a sudden, they're not friends anymore. And so to me, that's the opportunity to do that and they have to pick a leader and now all of a sudden they're not friends anymore right and so to me that's that's the the biggest case against that um change or that shift away from the u.s dollars reserve currency actually happening from a geopolitical is that eventually you're going to get down down to a point where bricks won't be able to decide whose currency does get to be the world currency. And I mean, if they come up with some sort of unified one, then we've got a whole different story. But I don't know if I necessarily see that happening either.

No, no, exactly. And so it'll be interesting for those not aware, BRICS is Brazil, Russia, India, China, South Africa. There you go. Didn't have that in my notes, so I'm glad I remembered that. Yeah, we went off script a little bit there, yeah. That's all good. And now just to finish kind of where I stand, I mean, I do agree with Warren Buffett to some extent. I don't think it's personally, I mean, if you're into macro and

you're pretty well versed into macro, the downgrade really doesn't mean all that much, in my opinion, just because you were well aware of the US financial situation. And for example, if you think about Medicare and Social Security, the potential issue that they'll be having in probably a decade from now, depending on who you listen to and what kind of data you're looking at. And one of the big issues I have, which fits is the reasoning is comparing them to their peers. So they're comparing the U.S. to their G7 peers. But I think that's just I don't know about you, Dan, but to me, that's just fantasy land, because let's be honest, there is no comparable to the U.S. because the U.S., I mean, has the reserve currency status. And even if you compare them to a similar economy like we just talked about with China with a similar GDP, they are far behind the U.S. when it comes to GDP per capita.

And just they don't have the reserve currency. nation. I don't know about you, but I think that's just stupid because they ultimately, you know, they have a lot more fiscal flexibility than even a country like Canada. Yeah. I think the other piece is that, you know, I mean, the U.S. from a size perspective is difficult to compare to any of the other G7s. I mean, they're just, they're massive by comparison. And also the, like you said, productivity per capita. I mean, US economy is so good at squeezing the labor market for everything like that you just can't match the productivity per capita that you see in the States. And the other piece that, you know, wasn't really mentioned there was that their ability to attract global talent. I mean, I don't see this and this is one of the things that I think a lot of these BRICS countries,

like don't necessarily have against the US and a lot of the Western world. I mean, I don't see this. And this is one of the things that I think a lot of these BRICS countries, like don't necessarily have against the US and a lot of the Western world. I mean, you don't see people lining up to move to all of these countries to work or to join the labor force or to become some of those, you know, to join that productivity per capita. And I think until that changes, it is hard to imagine a world in which things shift away from what Buffett's saying. No, exactly. And a lot, like I wouldn't say all the innovation, but there's a lot of innovation happening in the US compared to other countries. So that's something to consider. And my view, I would say in terms of the actual rating, I'll be very blunt.

I think they, you know, they matter because it can have an impact in terms of the rating on how easily a company or country can get financing and at which rate. But for the U.S., I don't think it's going to have a major impact. And the last thing I would say here is just I wouldn't make an investment just because of that, whether you're looking at a company or a country to potentially buy their bonds. I'll do my own assessment because I'll be very blunt. I think the rating agencies are full of, you know what? Because they'll do these downgrades. I think we learned that in 2008, right?

Well, 2008, and we got a reminder with SVB earlier this year where they're essentially, when everyone knew bank one bank run was happening the rating agencies downgraded svb so i i thought that was hilarious because if you're a rating agency aren't you supposed to see these things and downgrade obviously i know there's a whole business and you know political kind of maneuvering involved and I think that's one of the reasons why they didn't do it during the great financial crisis. But I do take, you know, these downgrades with a grain of salt. I wouldn't, you know, wouldn't be a make or break for an investment thesis personally, as long as you do your own research and you know the company or government well.

And the last thing I'll say is, you know, the reality is that U.S. treasuries are still widely held by tons of countries around the world. The top one is Japan. So they have over $1 trillion of U.S. dollar treasuries. Second one is mainland China with close to $900 billion. And then the U.K. with $700 billion. And Canada is further down the list,

it's around, I think, number eight or nine at 247 billion. So it does a US default, which I don't think is happening anytime soon, would have a major impact on those other countries because essentially they hold all, like not all the debt, but they hold a significant amount of that debt. For sure. Yeah, I think that's a big component. And I mean, a lot of these other massive countries that are jockeying for that position still hold USD securities and USD. So, I mean, there's speculation that, you know, they're trying to move back towards a gold standard and all of that. But I just think, you know, as far as it stands right now, I think most of those

economies, most economies in the world have more pressing issues on the home front than solving the reserve currency status of the remainder of the world. No, exactly. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees.

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Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com. Here on the show, we talk about companies with strong two-sided networks make for the best products. I'm gonna spend this coming February and March in an Airbnb in South Florida for a combination of work and vacation and realized, hey, my place could be a great Airbnb while I'm away. Since it's just going to be sitting empty, it could make some extra income.

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I'll let you lead the one. So which segment did you want to go and talk about next yeah i mean i guess we can jump to the i'll probably chat a little bit about how bonds canadian bonds um are responding to some of this these changes happening in the u.s and around the world um just because it's probably the easier jumping off point. So, um, cause I think it's been interesting to, to watch, um, the Canadian five-year bond yield, um, especially when USCPI was announced a couple of weeks ago. Um, and it traded kind of in that 4% channel and it blew off a little bit today, today being Tuesday, August 8th when we're recording. Um, but you know typically, mortgages are priced based off of these Canada five-year bond yields. And they seem to be responding just as much to US news as they are to Canadian news. And I think this is basically, from my perspective, it's the market assuming the Bank of Canada will

have to keep matching the Fed. Otherwise, we'll start importing inflation. And so imported inflation would be when we talk about that settlement currency that we were just talking about, or the reserve currency, you know, this is what most international trade is paid in, right? And so if we're paying for international trade in US dollars, buying goods to bring into Canada in US dollars and Canada devalues their currency too much, um, then, or by, by not hiking, um, or by not matching the fed, if they deviate too much from the fed, then basically the Canadian dollar becomes a less compelling investment because as a lower yield, it's earning a lower interest rate. And then if we devalue against the US dollar,

now all of a sudden you're importing inflation and it becomes more expensive to buy goods since we buy goods in US dollars. And that would become an inflationary effect. And on the last US CPI report, the Canadian five-year bond yield jumped to 4% range during that day. And it's worth noting here that five-year bond yields are kind of the pricing mechanism for mortgage rates. I can get into that a little bit. So, because it's interesting to get an understanding for how the Bank of Canada can even can or can't game the system on the housing market and all credit dependent investments, which is basically everything. Anything you want to add there before I jump into how bonds impact? Well, I wanted your take on this.

Yeah, I wanted your take on this. So the Bank of Canada, I kind of know where you're going to go with it, but just to be facetious a little bit. So do you agree with the Bank of Canada that, you know, housing has been resilient in Canada despite those aggressive rate hikes? And it's been more resilient, I think, than they thought. It's interesting. I mean, the data, like there's this book called How to Lie with Statistics.

I reference it a lot on our podcast. But I think the challenge is that you're looking at a housing market from January to May that did exceptionally well. It was ripping, right? But typically does seasonally. And then the other part is if you're looking at national statistics or the HPI, which is a house price index, none of these are really good, absolute ways to measure the performance of a housing market. And because 60% of the transaction volume, dollar volume of real estate is traded in the greater Golden Horseshoe, and 70% of it is in the province of Ontario, the national average gets skewed so massively. And these national indexes get skewed so massively.

And Toronto, I mean, it blew off really hard last year. It had a very forward-looking drop as soon as rate hikes started. Biggest house price drop in history on a year-over-year basis. And obviously, it was going to recoil a little bit and recover in the spring market of this year. And it did. And now it's rolling over again after they resumed rate hikes or hit the unpause button. Um, and so I, I would, I would never have said that, um, the market was being resilient. I mean, it wasn't, it stopped falling. And so that was, um, and I, and, and I guess it was going up in, in, in uncertain terms,

but if, if you seasonally adjusted it, the market grew about 1%, which adjusted for inflation, you know, was a negative real growth. So I don't think it did, but I just think that they've been using the wrong data points in a lot of cases the whole time. And this is probably just a very easy indication of it for me to explain because I know real estate data exceptionally well. What do you think? Yeah, I mean, it sounds like they had, you know, according to the model they're using, whichever model they're using, they had projected a steeper drop in prices if they had gone that aggressively. And it's been, you know, not as high as they anticipated.

you know, not as high as they anticipated. You know, I listen to you guys as much as I can with, you know, you and Nick on the Canadian Real Estate Investor Podcast. I listen to other people that are pretty well versed and I've seen a lot of data, not as much as you. But one thing I notice is the volume and the inventory level and on the market is just extremely low, right? So obviously, if you have a really short supply, even if there's not that much demand, I mean, there's probably just enough demand to keep the prices or keep a certain floor to those prices, just because there's a lot less volume available, like people are just not moving. They're not putting their homes for sale it's easy it's hard to qualify for a bigger home if you're you know like us for example me and my wife we'd be interested in moving in something bigger but we'll probably have to stay here just because i'm

not sure we'd qualify at the uh the current rates and even if we did i'm not sure if we would want that high of a mortgage payment because then we you you know, it would just kind of strap us under. Yeah, exactly. House poor. That's the term I was looking for. But yeah, that's kind of the perception I have is it's been kind of artificially staying high just because of the current MeyerKid dynamics. high just because of the current MeyerKid dynamics. But as we see more and more people that have to renew, whether they're on fixed mortgages that had really low rates and they have to renew at potentially double the rate, if not more. And then you have those variable mortgages as the

OSFI starts clamping down on those, all this impact and the variable mortgages that are, I guess, getting interest added to their principle. I mean, something's got to give. I don't know when, but it feels like it's just a ticking time bomb or there's cracks in the foundation. And you'll just need one event, one catalyst, and things might get pretty ugly in the housing market. Yeah, it's interesting you mentioned the demand destruction element. I mean, I think one of the challenges there is also like, I think that they're expecting things to change a little bit too quickly. Like, I just don't think they're respecting the lag at all.

And, you know, they've just started acknowledging the lag in their most recent press releases on the hikes. I mean, we should just see, be seeing the impacts of the first rate hike now. And, and one of the big reasons for this is people only need to service debt on a monthly basis. So in order to, you know, people only have to pay their mortgage once a month. And so in order for the, the impact to really be felt and to materialize, you need time under tension. You need people to be absorbing these rates over and over. The other piece of it is that the Bank of Canada isn't actually, they can't destroy demand because nobody's using the variable interest rate right now to buy houses. Everybody is using fixed rates because fixed rates are priced better.

And so you would assume consumers are rational. And so they're going to want to use the cheaper rate because it'll qualify them for more, I guess, for a greater buying power. And it's cheaper. It's the better, more economically sensible thing to do. And the Bank of Canada has no control over the fixed rate, really. The bond yield kind of controls that the bank of Canada, or sorry. So the bond yield typically basically fixed mortgages are government of Canada, five-year bond yield, plus 2%. You typically hear GOC plus 2%. Um, whereas variable is prime plus or prime minus, you know, 90 bps. Um, and prime is a function of the bank of Canada's overnight rate. Um, and prime is a function of the Bank of Canada's overnight rate.

And I can explain that whole system why, but it's basically a replacement factor. So they're the same duration, right? So Canada five-year is when you take out a fixed-year mortgage, you're essentially borrowing money from a lender. The lender needs to secure those funds to lend you. So one of the ways that they would do that is by purchasing bonds, which are issued by governments or corps. And the yield on that bond is the return an investor receives from holding the bond. So if they can get a five-year bond from the government, or their alternative investment

would be to make money lending that money to you, and you are a little bit riskier than the government, a little bit less likely to service that loan than the government, they're going to apply a risk premium of about 2%. So when the five-year bond increases, investors demand higher returns from bonds. So lenders, in order to attract investors, and these are your banks, you guys talk about bank stocks a lot and investors, they may need to offer higher interest rates to do that. And as a result, they might increase the rates they charge on fixed rate mortgages to align with the higher yields in bonds. The inverse is true for lower yields. And so

the Bank of Canada, I mean, during the pandemic, over 60% of people were buying with variable rate mortgages because they were so cheap. And so if the Bank of Canada keeps cranking that up, they're actually gaming the supply side of the equation of the housing market, not the demand side. Because they would actually be putting more and more financial stress on people and pushing more and more people out of their houses. Or not out of their houses, maybe it out of their houses maybe it's a lot of investors and stuff like that but they're basically pushing more and more people to have to sell to put into a position of financial stress where they have to sell and so they can really only control the supply side right now and the bond market is in control of the demand side yeah and you can also make a case that are crushing part of the other supply side by making it harder for builders to go ahead and build those homes, right? Because if there's higher rates, then, you know, the margin just becomes slimmer, slimmer for builder. There's tons of lots that were bought clearly to build apartment complexes.

And they've had these notice in Ottawa. You have like, I guess, a notice with the zoning department that you have to put where people put their comments in and so on. And usually, you know, you'd see the sign up for a few months and then comments would be in. And then a few, you you know amount of months later the construction would start while i've seen an increasing amount of these signs that have been up for like two three four years now so these projects that are clearly were probably going to go ahead when interest rates were lower and then interest rate has gone up and it just doesn't make any sense for the builder or the developer. Yeah, for sure. I think that and, you know, I mean, policy, the policy environment has proven to become almost very inflationary or creating a lot of

friction in the housing market by like squandering supply in that monetary policy side, but also, you know, in the legislative side. And then you also have, I mean, we have record population growth for the last year. We have a record population growth and we're going to see it again this year, right? A million people coming to Canada. And so that's more and more demand on the quantity side. It's just the buying power side that becomes the question mark. No, exactly. And it impacts, you know, just to get back, obviously, to more like investing in stocks. I have this little graphic here that I'll show for Patreon audience. And essentially, you know, bonds have fared pretty poorly.

And I've been I was talking about that in 2000, 2000, sorry, in 2020, 2021. Because, you know, a lot of the things you saw there was still having a portfolio, 60% equities, 40% bond, the classic 60-40s. And I wanted to show how poorly these bond funds have actually performed. And I just took, you know, I compared four, so two bond funds and two index funds. So I took the XIU, the iShares S&P TSX ETFs to track the Canadian equities. SPY, so the SPDR S&P 500 ETF to track the US S&P 500. XBB, which is the iShares core Canadian universe bond index ETF, primarily government bonds, but there's also a little bit of corporate in there. Same thing for AGG, which is the iShares core US aggregate bond ETF. And needless to say, since the rate hiking cycle from

central banks in early 2022, the bond funds have performed really poorly. So the two bond funds are down 11 and 12%. And then you have the SPY and XIU that are almost flat, not quite. So the SPY is down 4% and the XIU for the TSX is pretty much flat. And these are total returns. So they include dividends or payouts. And that's something important because we talk about higher yields and you hear a lot in mainstream media how it's great for retirees that they can get additional kind of income from fixed income, whether it's GICs, whether it's purchasing government bonds straight out right now. But I think we tend to forget about those retirees that had bonds or pension plans or whatever you want to look at that have bonds before the rate hiking cycle happened. And those bonds,

depending on the duration, are still quite underwater. And especially those bond funds for retirees, if they're forced to sell these to be able to get income for their everyday life, well, these were typically seen as safe. So something to stabilize your portfolio, lower volatility. And we've actually seen the opposite happen the last couple of years. So I think that's really important for people to remember because it's probably hurting a lot of people that are retired that were banking on those bond funds to hold in value or those bonds. And then if they can't hold them to maturity, they will be stuck and getting less than they probably had planned. For sure.

less than they probably had planned. For sure. you can buy all North American ETFs, not just a few select ones, all commission-free, so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com. Here on the show, we talk about companies with strong two-sided networks make for the best products. I'm going to spend this coming February and March in an Airbnb in South Florida for a combination of work and vacation and realized, hey, my place could be a great Airbnb while I'm away.

Since it's just going to be sitting empty, it could make some extra income. But there are still so many people who don't even think about hosting on Airbnb or think it's a lot of work to get started. But now it is easier than ever with Airbnb's new co-host network. You can hire a local quality co-host to take care of your home and guests. It's a win-win since you make some extra money hosting on Airbnb, but can still focus on enjoying your time away. Find a co-host at airbnb.ca forward slash host. That is airbnb.ca forward slash host. Should we try and wrap this one up with both of our thoughts on

inflation here? Yeah, let's go for it. Okay. So I guess the big question is, and this is a discussion that I wanted to have with you, and I was curious to get your take. Everybody seems to be cheering because inflation in Canada is at 2.8. Actually, I found that both governments celebrated that they had the lowest inflation in the G7. Canada tweeted, the Liberal Party has tweeted twice now that we have the lowest in the G7 because they're using CPI trim against the US. The US doesn't have a CPI trim.

And then the US stated that they have the lowest CPI in the G7 at 3%, and they show Canada on the same chart. And I'm assuming they're using core CPI, which is a greater comparable to U.S. CPI. And our core is still over 3.2 or 3.4. And core has been very sticky um anyway i think that both of these governments might end up um becoming a classic example of celebrating too early like you know when you see those memes those memes of like uh a cyclist like cheering and then they fall before they cross the finish line or somebody put throws their hands up and then the other racer

comes and beats them like it just feels like that could happen because I think they're really missing the base effect. And it's especially funny from a political commentary perspective, and I try not to get into politics too much, but one of the things that's important in investing is acknowledging the existence of this thing called the political business cycle. And this comes from Keynes, I think, or Friedman. He acknowledges that basically you get parties shifting or power in parties shifting back and forth between parties who create inflation. So typically your left parties are the ones who are creating inflation by growing the job market.

Their goal really is to support the job market, support employment, make sure everybody's getting jobs. And that's an inflationary effect. And then you get these parties on the right that are coming as inflation fighters. And really you can see for the first time in our lifetime, I think that conversation really swinging back and forth. And anyway,

the other piece is that I think that there's really ignored or ignoring the base effect. And I think BMmo just recently acknowledged this in one of their articles and stat can acknowledges it as well in um in their most recent cpi print this is the funniest part is that they literally show how base effects have kind of driven um cost declines in um especially in the gasoline thing. And they actually show a chart where it basically shows how because CPI and the change really ramped up during last summer, there's a huge hump in all of these price curves. And as you're climbing up that hump, CPI is getting worse and worse and worse.

And then as you get to the other side of it, it gets better and better and better. And so we're going to go through that period. CPI could look good probably for the next maybe one or two prints. And then as you get towards the end of the year, where you're back at the bottom of that growth curve and looking at growth or increases since then, when it was basically stagnant towards the end of last year, nothing was really going up in value, then you're going to end up with a new comparison and a new base effect. And we'll actually get to a point where CPI could be higher. And a lot of people are saying that CPI is bottomed. I think the only wrench, and this is something that you and I have discussed, the only

wrench that could be thrown in that is if we hit a recession, which I think, you know, recession has 100% success rate of getting inflation down to the neutral range. Yeah, it also depends, I guess, how severe recession, but there's also, you know, if something actually breaks, if there's some major banks that start getting into trouble, for example, and I pulled up, I did some, did a few graphs just for fun. So I did when I was preparing for the episode. So one of the graphics is basically similar to what Stats has done, but I actually added energy because energy includes gasoline and both obviously, you know, if energy is a bigger component and gasoline is kind of a subcomponent of that. But the graphic I have up clearly shows kind of headline inflation trickling down as the CPI energy component, gasoline component kind of trends down. And you can also see it with WTI crude, right?

So the price of oil, if you look at when the price of oil peaked last year around kind of June, July. Actually, yeah, around June, July of last year. So it peaked around 120. And then it kind of started going down. And now it's starting to go back up a little bit. So you see that trend really aligns with the CPI, at least the headline number going down. And then I, you know, did a little table as well. And you don't have to go into too much detail but you clearly see as the headline cpi number actually at its highest point it was because energy was up close to 39 percent and gasoline on its own was close to 55 percent increase and then going back to march of 2023 and recent months have been similar i didn't go as far out because I thought it showed pretty clearly the trend here. As you go to March 2013, energy was down 7% and gasoline was down 14%. And obviously headline CPI was 4.3%. how big of an impact and i do wonder like honestly uh in terms of you know the the politicians not

to get into politics too much because they they all do the same shit right they regardless of whatever party like they'll try to swing things to make themselves look better um you know if inflation was high i'm sure you know governments would be blaming that on the previous uh government and so on but you do wonder if you know they fully understand the economic data on the one hand and how quickly it can change because you know i don't know when the next federal election is i guess that you know would be what year and a half two years it's a minority government in canada i think yeah that's 25 is how long they agreed on the coalition i think with um okay so yeah i guess it could be potentially yeah a bit before that depending if it falls through or not between the ndp and the liberal but it just kind of shows like i don't know whether it's their misunderstanding or whether

they need a kind of crash course in pr and maybe under promise over deliver type of deal. It's just like I just don't see any upside with them kind of celebrating this headline inflation, especially right now when food food is elevated. elevated housing remains elevated which are you know for the vast majority of people this is where most of their money goes towards in one single month obviously the richer you are the smaller component of your budget typically that will be and it's i don't know i find that a bit confusing because they're celebrating that yet i'm sure if you polled a thousand people if they feel like they're in a better financial situation right now than they were two, three, four years ago, I'm going to say that most people will say no. So it's just a little confusing, I'll be honest. Yeah. No, I think it's

a little bit of a lack of understanding probably. And then it's also just, I mean, I think they're trying to, I think they've realized that, and again, this is more of a reflection of the political business cycle and how politics and economics become intertwined during these inflationary cycles and election cycles rather than a commentary on politics in general. But I think that politicians are starting to realize that that's the conversation right now. That's the most important issue to voters. And so they're trying to create their own narrative around it and join, not even create a narrative, but join the conversation. And that's the best way I think that they both thought of to do it was, you know, to talk about how they've, what they've done to try and take credit for everything that monetary policy has done in you know getting inflation to where it needs to be it'll be interesting to see as well

because i think yeah you do have two elections basically that are coming down the pipe in the u.s and canada in in likely not an exceptionally good economic time like i don't i don't necessarily see a uh you know you know you saw theody's suggestion that we'll see a recession next year. I would agree with that. I don't see it being resolved or in a steep recovery phase by the time either of these elections take place. And so I think it's really an uphill battle for politicians. And I think that this is why you start to see people lean towards the alternative politicians who are the ones who come in as these individuals fighting the good fight on the economics. And it's worth just thinking about that from an economic thesis perspective or an investment thesis perspective. If you're looking for a really good read, I don't know if you've read the new Fourth Turning book, but it just came out from Neil Howe, but it's basically a follow-up to the original Fourth Turning. I want to to i heard a great interview on another podcast with i think it was neil that was on there uh starting to get

out there it was just him who wrote that he's an older guy now for sure but yeah it's just he the other author i don't know if he's passed away or what but he's he didn't write the second book okay okay yeah so i know i was wondering but it was just so fascinating to uh to hear him talk but um yeah it's just it just i find it a little confusing and sometimes just what uh politicians will put out there but even central banks right if we kind of go back and it's just it's just a very strange situation because you have on the one hand governments who you know want to spend because they want to do infrastructure project there's health care there's all these different things right they want to spend on and the more spending they do well it kind of counteracts what

the central banks are trying to do with rising interest rates so again it's just a very strange situation when people kind of stop and think about it. On the one hand, you have a lot of spending from governments. And then on the other hand, you have central banks that are almost like trying to put the brakes on. So one is kind of counteracting the other one. And what's really interesting with central banks, I think that we're seeing right now is, and you referred to that earlier, is I think they just don't know what the lag effect will be. And I think it just shows the reality of there's never been rate increases that were this quick historically. And they may have had a sort of model showing that there's a lag effect of 12 to 18 months for interest rate hikes. But I think there's a very big difference between hiking you know once

or twice 25 basis point and then there's a lack effect of 12 to 18 months after that versus you know we went to what basically zero to five five percent and what like uh 15 months 16 months or so yeah i mean i think if you if you look at like magnitude's tough because if you look at the overnight rate like magnitude seems almost infinite right like i think you've seen a two thousand percent increase or twenty thousand sorry twenty thousand percent increase in in the overnight rate but um so like a 20xing from 0.25 to five i guess we're at now but but if you look at prime which is maybe better right because that's really more reflective of what the borrowing environment is prime prime basically tripled which is is similar to what it did in the 90s

um but it but in the 90s it tripled over several years rather than in a year um and so it is i agree with you i think and and i've spoken with a lot of economists on this and a lot of them are worried that they're that we've already seen a massive overshot and to continue to keep tightening and keep cranking it up, it could be reckless. I guess we're going to find out the hard way shortly. But, you know, I mean, Ben Tao says it best. I think that, you know, the alternative is if the Fed's right and if other central banks are right that we're not going to see a recession in any of these countries, then the reason we're not seeing a recession is because we have persistent inflation.

And I think we as investors and as individuals who have to go and consume things, need to ask ourselves, would we rather have a recession or would we rather have inflation? And Ben Tao says that the central bank would choose a recession every single time if they're given that choice right and so we don't like the last time the economist did a great podcast on this but the last time that we dealt with a um a um inflationary regime was like in like the 70s right late 70s so we don't really like i don't even know if we have policy tools left anymore to to to deal with that um the last piece i'll leave with and then we can probably

wrap up, is I think that the M1 money supply in the state seems to be pretty efficient at getting some of that out of the market. So, I mean, if they're able to get all of that excess cash out, maybe they're onto something down there, and hopefully we can kind of follow the same path here. Yeah, no, I mean mean i find it really fascinating because you can listen to five different really smart people on the subject and they'll probably have five different point of views on where everything is going maybe some will be similar to the other but um you know i've heard people saying that we're gonna to enter deflation the next couple of years or so. I've seen people that mention that we'll probably have a decade long of higher than usual inflation.

So that the 2% to 3% range that the central banks in Canada, US, and I think the major kind of Western central banks have is not really achievable. And then comes into the question, should we just have a new target? Because at the end of the day, I mean, I think it was, do you know which country? I think it was New Zealand that first came up with that 2% target range. Do you know how that came about? I don't. Sorry, I'm putting you on the spot right now. Yeah, I actually have no idea. Okay, yeah, I think it may have been New Zealand probably 20, 25 years ago. I could be wrong and people feel free to correct me, but it just makes you wonder why that 2% range, why it's so important. Maybe it makes more sense now having it around 3%, say 3% to 4%, whatever it is, 2.5% to

3.5%, where maybe that's the target. And then central banks can adjust accordingly. And maybe interest rates can actually level off and not keep increasing if that's the direction they want to go. Yeah, it's an interesting insight. I think like average inflation in Canada during the observation period of like the past 100 years is like 3.8%. It's like close to 4%. So I don't know why they'd be trying to calibrate down from that. Yeah, I'm not sure either. I mean, at the end of the day, I think there's just a lot of forces at play. And I guess we'll probably wrap it up on that point.

It was pretty fun. It was really fun actually having you here, Dan. A little change from Brayden, which thank you for stepping in. It was very last minute. So that's why we decided to do a more macro show. I'm sure people are getting used to having you on at this point. But for those not aware of where can they find you on Twitter? I also heard that you have a podcast as well. Do you want to tell us how they can find it? Yeah, I got a decent podcast. It's on this network. If you're on your podcast platform,

just search the Canadian real estate investor. My last name is Foch. My first name is Daniel. If you Google those, typically you can find me pretty easily. Yeah, exactly. And on Twitter, what's your Twitter again? You're pretty active there. Daniel underscore Foch. Yeah. Okay. Well, that's great. Thanks a lot. And then on everything else, it's just Daniel Foch. Okay. Perfect. Well, thanks a lot, Dan, for coming in and substituting for Brayden. And we'll be back for Brayden will be back next week. So not to worry, he's not gone. He'll be back for a regular episode next week. The Canadian Investor Podcast should not be taken as investment or financial advice.

Brayden and Simone may own securities or assets mentioned on this podcast. Always make sure to do your own research and due diligence before making investment or financial decisions.