Martin Lefebvre
Hi, everyone. Thank you for tuning into our NBI podcast. Today's topic will be on the state of the economy and the potential impact on fixed income strategies. And to help me navigate the subject, I'm joined by François Garneau of AlphaFixe Capital, Senior Economist and partner over there. Welcome, François.
Francois, let's start with the state of the economy. We know that the last quarter of 2025 was a little softer than expected due to the shutdown in the U.S. But overall, 2025 was pretty strong despite the tariffs and the uncertainty in the economy. What's your view or your take on now what's to come in 2026?
François Galarneau
Before we go down to 2026, we’re just going to have to take a step back and look at 2025, which was quite a resilient economy. The way we look at it is that the economy managed to grow at around 2% or maybe 2.5% or two 2.2%, maybe 2 1/2%.
Martin Lefebvre
Around potential…
François Galarneau
Actually, above potential, which is 1.8% if we're looking at the Fed forecast. But it was actually pretty good growth because we had some good shocks in 2025. First, we had the DOGE (U.S. Department of Government Efficiency) with Elon Musk getting rid of close to 600,000 people. And then we had the tariffs on April 2. We had the immigration policy in 2025 and the shutdown. We had some pretty good shocks in 2025 and managed to get some good growth coming from the final domestic demand, which is, if you take away all the noise from the tariffs and all the international trade and all the inventory variation in the companies and you only take a look at consumer consumption, investments and government spending, it's pretty solid in 2025. And maybe the last quarter was a little bit mild because of the government shutdown and some of the people that were employed by the government didn't get their cheques - and we know there's a lot of families and households over there that live from pay cheque to pay cheque -, so consumption in the second and the last quarters was milder than the than the previous ones, but we still managed to get some really good growth. You know, the economy is stronger than people have thought. The only thing that bothers us right now is that if you're looking at consumption in the [United] States, it's holding up well but revenues from wages are not holding up at the same rate. Consumption is around 5% on a nominal basis and revenues around maybe 1% or 2% right now. People are just drying up their savings to spend a lot. And if you take a look at the savings rate as a percentage of disposable income rate now, it’s at 2.6%. Taking away all the noise from the pandemic area, we have to go back to 2020 maybe 2007 or 2008 to get us a savings rate as low as 3.6%. In 2007-2008, people were just using their cash from their houses, the gain they get from housing prices, and they were borrowing against that to spend. Right now, what we're seeing is that there is also a wealth effect coming from the stock market. There's maybe a K-shaped economy, a wealth effect coming from the upper end of the income distribution.
Martin Lefebvre
People who have money have money. And they keep spending…
François Galarneau
They keep spending from the gains they get from the stock market, but people from the bottom K are just drying up some of their savings to keep on spending.
Martin Lefebvre
The cost of living is really having an impact on them…
François Galarneau
Especially food right now. Food is really a big subject in the [United] States as far as the cost of saving…
Martin Lefebvre
Something that monetary policy doesn't have much traction on, right? So, what's your forecast for 2026? Are we going to see some similar growth? What are you expecting?
François Galarneau
We're at a stage right now that is not actually dangerous, but we have to monitor what's happening because if you take a look just at the labour market at this point right now, it's stable. There's no hiring, no firing there. There's actually no growth in the labour market. If you take a look at the BLS [U.S. Bureau of Labor Statistics] number in the last year, there's only 181,000 people that got hired in 2025. Most of them were just in health industry. If you take away all the healthcare industry, I think you're losing. You're losing around 400,000 jobs in 2025. So right now, there is just no growth in employment. What worries us is that every time there's a recession, before, there's always growth in employment and there's like a stabilization at one point and then everything shuts down and there's a recession. We're at this point right now. In order for the economy to keep on growing, we need to get some more jobs. Households cannot continue to spend using their savings as we have seen in the last couple of quarters, especially with the stock market. If it's not going up, we're going to lose all the wealth effect from the stock market as well. We need to see some jobs in the next couple of months. If we don't see jobs and if it keeps on being what it is right now or even starts to drop, then we could easily go into a recession.
Martin Lefebvre
You're expecting a deceleration that could lead to a recession at some point in time in 2026?
François Galarneau
We're looking at the job market as an indicator, but we are not thinking that 2026 will be a year that we are falling into a recession.
Martin Lefebvre
How much of that could be compensated by the AI frenzy and the impact on capital spending. Is it possible to see no hiring, no firing, no job growth, but still the economy staying robust?
François Galarneau
We're going to see a lot of investments coming from the companies. Because of the One Big Beautiful Bill, people can just invest right now and there's a acceleration period of amortization. You can amortize all your expenses in the first year, so that's interesting for the companies to do it right now. There's going to be some investments. And to build up the infrastructure, you need to get some workers and everything. There's still going to be some activity that's going to create some jobs eventually. The One Big Beautiful Bill, as far as we're concerned right now, is that there's going to be a lot of big refund coming in April because of all the lower taxation bracket that we have. And the One Big Beautiful Bill applies to the 2025 tax refund. In April, some people will get a big refund, bigger than what they had in the last couple of years. And in 2026, we do have a new taxation that bracket that is lower. There's going to be more people being able to consume, so a shock that's coming over in April not from a wealth effect, but just more money to spend. And more companies are going to be investing and spending, even if it's just to create or get big data centres, you need to build them up and you need to employ people to build them up. There’s going to be activity in construction, energy generation. What we've seen the last four quarters, around 70% of the annual growth in investment from companies goes into AI. And the part that goes into energy generation is small right now. There’s going to be a bottleneck somewhere because you cannot build such a big infrastructure in AI without having all the energy to supply it. You need to have the energy to supply everything right now. I think at one point there’s going to be a deficit in energy to supply all the AI that we have. There needs to be investment in there. We have to see in 2026 if we get some.
Martin Lefebvre
But how fast they can do it. We haven't talked about tariffs very much, but the Supreme Court of the United States has just invalidated Trump's tariffs for 2025. What's your take on that? And we learned this morning that it was 10% instead of the 15% [tariff].
François Galarneau
It was supposed to be 15% Saturday [February 21] Donald Trump told us. But all the numbers that they got from the [U.S.] customs right now is that they have to charge only 10%, not 15%.
Martin Lefebvre
And the law says for 150 days, if I remember correctly.
François Galarneau
Exactly. Above that, you need to get the approval from Congress. And he doesn't want to go there because the Congress doesn't approve all the tariffs right now.
Martin Lefebvre
But is that a positive? That 10% is lower than the effective rate that was in place.
François Galarneau
Exactly. It’s lower than what we had before. As far as the effective rate, I think it came in at around maybe 9% right now. It used to be 16%. Now it’s going to be 9% when you have the 10%. But he needs to get revenues from tariffs in order to reduce the deficit as much as possible. And the One Big Beautiful Bill, there was a lot of less revenues coming from taxation, but eventually you get revenues from the tariffs to compensate that. If you're losing that, you need to get revenue somewhere else. That's why he wants to have this, or you need to cut spending. But that won't happen.
Martin Lefebvre
Not before the midterms, right?
François Galarneau
Exactly. But as far as the strategy is concerned, we had some kind of a period that we had nothing related to tariffs. It was just calm, easy going. And now we're going into another era of what is going to happen with tariffs. Is he going to go 15%? He’s looking at different sections of the Tariff Act that he can apply in different areas, different sectors. There’s going to be more uncertainty going forward with tariffs in 2026. But because it's a midterm year, I don't think he wants to go into a big fight in tariffs right now and get them stock market going down big time because the stock market is some kind of a poll for him on the economy. If the stock market goes well, he thinks that his economic policies are good and that he should continue.
Martin Lefebvre
So, he should look at the rest of the world, because the U.S. stock market is on a relative basis not doing as well as the rest of the world. You're a fixed income guy. Let's turn the subject onto monetary policy. How do you see things evolving? We potentially have a new Fed chair [Kevin Warsh]…
François Galarneau
Potentially. He needs to be confirmed by Congress. And right now, I think there's one or two senators from the Republican side that are reluctant to approve him as long as the accusations on Powell are still in place, they won’t validate the Fed chair.
Martin Lefebvre
But let's suppose that he gets it.
François Galarneau
I know that he's a guy that was looking at AI as a deflationary environment. He wants to cut rates for sure. The problem that we have right now is that because on was on the Fed before, he had a strong sense against QE (quantitative easing). And he wants to reduce the balance sheet of the Fed because he doesn't believe in QE. We don't know exactly how this is going to turn out because if you are starting to reduce the balance sheet at a time when you need more and more supply because you don't get the revenues from the tariffs to compensate for the One Big Beautiful Bill Terry, reducing tax that you get. So, there is going to be more deficit and more bond supply. And if you're selling bonds as well, you need to have investors to get it. There’s going to be some risk in the long end of the curve just because of that. If you're looking at the world right now, there are more opportunities elsewhere. In Japan, for example, a lot of investors weren’t buying Treasuries. Now they can get a 30-year bond in Japan at 3 1/2%, roughly. They didn't get that before. They're going to be more reluctant in investing in the States because they can get they can finance their own government like that, without any currency risk. Same in Europe. There are some alternatives in which investors can invest right now at the same kind of rate that is that Treasuries offer. The pool of investors that are going to be buying Treasuries is shrinking a bit, but there is going to be more and more supply eventually, down the road, if he gets the balance sheet reduced. And for the long end of the curve…
Martin Lefebvre
It could exert up the pressure, I guess. On the economy side, you see maybe a slowdown of deceleration linked to…
François Galarneau
The economy can surprise. We're looking at the employment market right now. And if the job market picks up in the next couple of months, then spending can keep on going. And if you look T inflation at this point right now, even the core PCE was pretty solid at around 3%. Inflation can surprise on the upside. Even though the Fed wants to reduce the rates maybe two or three times in 2026…
Martin Lefebvre
Where would inflation come from? You say AI is deflationary. We got the housing pressure.
François Galarneau
If the job market picks up and you still have all the immigration tools and policies that are constraining the supply of labour, then you're going to have a problem getting some new workers and you're going to have to pay up to get them. Demand can surprise. The economy can surprise as well in 2026. Eventually, if Americans get a cheque from the tariffs going into households. I know a lot of companies are looking into getting back their money from the tariffs they paid. And there's going to be litigation in the next couple of months. But I think the stance from the White House will be: “you guys didn't have the burden of paying up the tariffs. You pass it on to the consumers. So, you're not going to get the money. We're going to give it to the consumers.”
Martin Lefebvre
And that too would be inflationary. More money chasing too few goods…
François Galarneau
Exactly.
Martin Lefebvre
In terms of strategy, what sector of the fixed income world do you do you favour, in terms of duration or maybe corporate bonds? What's your take on corporate bonds?
François Galarneau
Corporate bond spreads are pretty tight at this point right now. You have to go back to 2007 or 2008 to get a spread as tight as we have at this point. But the quality of the index is not the same. In 2008, the percentage of triple Bs in the index, which must lower than what we have at this point right now, you have the same yield, same spread gives you, but not the same quality of bond, not the same quality of companies. It's too risky right now at this point.
Martin Lefebvre
The spread is not wide enough to compensate.
François Galarneau
If you widen a bit, then you're losing all your carry eventually. And what we're seeing at this point – and it's something that bothers us right now – is a couple of companies from the [United] States that are coming into Canada to get financing even though they don't have any activity in Canada. They're from the States, they don't have any assets in Canada, no activity in Canada, but they can get financing in Canada using one credit rating because in our index, it's only one credit rating that you need to get into the index. There's a Bloomberg article saying that DBRS [a credit rating agency] has been really loose and giving some triple B minus, which is just a notch above high yield. You're still in investment grade, but you can get a fine and you can get a credit rating in triple B minus from DBRS and still get into the index and get financing from investors in Canada. And there's been a lot of companies recently that wouldn't be able to get financing on an investment grade basis that just got one rating from DBRS and managed to get into the index. If they got any rating from S&P and Moody's, it would have been a junk rating or high-yield rating, and they wouldn't be able to finance the same kind of level. That's a stretch in the market at this point that it's worrying us because usually when you see that kind of stretch, you're pretty much at the bottom of the spread that you can get, eventually will pick up. If there is a recession coming over from the States because the job market doesn't pick up and we're going into a recession, then for sure spreads are going to widen in 2026.
Martin Lefebvre
And that's when it's usually a good time to go back…
François Galarneau
Exactly. Just be careful. Just take a look at the market. In the last couple of couple of weeks, we've seen spreads widening a bit. Just wait, go into defence mode, maybe close to the index as far as weight is concerned. And on your credit, wait until spreads are gapping up and then get into the market at this point. But right now, I wouldn't touch it at. I would just keep a low profile in the credit market. Duration? The long end of the curve worries us a bit. The short end will be eventually because – Canada will not change the rate whatsoever in 2026 –, but we're going to have some rate cuts in 2026 from the Fed, maybe two or three rate cuts, but it's already priced in. There’s not going to be a lot of changes from that. But in the long end, if the economy picks up and inflation is higher than what the market was expecting and the Fed stops cutting rates, the long end could actually also get priced up as well. Som be careful on a duration. Just watch the job market at this point. If the job market picks up, then the long end of the curve could be dangerous. If the job market slows down and we're losing jobs in the [United] States, then we're going to a recession.
Martin Lefebvre
It’s always a balancing act. If borrowing costs do go up, then recession scenarios come back in the markets.
François Galarneau
The job market is doing nothing. We're at an inflection point in the job market, either it picks up again, which as it has never happened before. That's the reason why we are…
Martin Lefebvre
But we could be in a sort of a jobless recovery like what we got in the 1990s where the economy is doing well, but…
François Galarneau
Yes. And what companies are doing now is that, with all the uncertainties we had, they managed to answer all the demand without adding more jobs. They’re just using what the employees they have at this point and getting all the profit. The economy is growing rapidly, but the job market is doing nothing. What's happening is that companies are getting more and more profits from that. And the profit of the companies as a percentage of the GDP is at a higher level, you know. The companies are going to wait. They have the time to wait because it doesn't affect their margin at this point. I think they still have PTSD from the pandemic era in which they had problems getting some new workers. I remember at one point there were two job offers for one unemployed person. Now it's balanced, it’s one for one, maybe a little lower. But it, it took companies maybe a couple of months to get a new worker that they were looking for. Before they lay off new workers out, before they can get some layoffs, they will think about that and make sure that the demand is really slowing, which we are not seeing at this point. Demand is still there for investment and from consumption.
Martin Lefebvre
And of course, there's always the hope of productivity gains coming from AI. Thank you very much for participating. François, il was a pleasure of having you. And for all of you watching, we'll talk again next month.
François Galarneau
Thank you for having me.
Martin Lefebvre
