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Europe’s economic recovery: More like Japan, China or the US?

Europe's economic recovery like Japan, China, or US?

We have a first-time QuickHit guest for this episode, Daniel Lacalle, a well-respected economist, author and commentator. Daniel shares his expertise on the eurozone and European Union. What is happening there in terms of Covid recovery? How does the region compare to other economies like Japan, China, or the USA? Will the ECB follow what the BOJ did? Will there be talks of deflation or inflation in Europe? How about the quantitative easing especially with a possibility of a more conservative ECB chair? Also, will Europe suffer the same power crisis as China and will Europeans be able to absorb inflation?

 

Daniel Lacalle started his career in the energy business and then moved on to investment banking and asset management. Right now, he’s into consulting and also macroeconomic analysis and teaches in two business schools.

 

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This QuickHit episode was recorded on November 18, 2021.

 

The views and opinions expressed in this Europe’s economic recovery: More like Japan, China or the US? Quickhit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

 

Show Notes

 

TN: We spoke a few weeks ago on your podcast, and I’ve really been thinking about that since we spoke, and I wanted to circle back with you and talk about Europe. There’s a lot happening in Europe right now, and I think on some level, the US and China get a lot of the economic commentary. But really, Europe is where a lot of things are happening right now. And I’d like to generally talk about what is the near term future for Europe. But I guess more importantly, in the near term, what are some of Europe’s biggest economic impediments right now? I’m really curious about that. So what do you see as some of their biggest economic impediments.

 

DL: When we look at Europe, what we have to see from the positive side is that countries that have been at war with each other for centuries get along and they get along with lots of headlines. But they’re getting along sort of in a not too bad way. Good. Yeah, that’s agreed. But it is true that the eurozone is a very complex and a very unique proposition in terms of it’s, not the United States, and it’s not unified nation like China. It’s a group of countries that basically get together under the common denominator of a very strong welfare state. So unlike China or the United States, which were built from different perspectives. In the case of the eurozone, it’s all about the welfare state as the pillar.

 

DL: From there, obviously, productivity growth, job creation, enterprises, et cetera, are all, let’s say, second derivative of something that is a unique feature of the European Union. No, the European Union is about 20% of the world’s GDP, about 7% of the population, probably. And it’s about 55% of the social spending of the world. So that is the big driver, 7% of the population, 20% GDP, 55% of the government spending in social entitlements.

 

So that makes it a very different proposition economically than the United States or China. Where is the eurozone right now? The eurozone and the European Union in particular were not created for crisis. It’s a bull market concept. It’s a Bull market agreement. When things go swimmingly, there’s a lot of agreement. But we’ve lived now two crisis. And what we see is that the disparities between countries become wider when there is a crisis, because not everybody behaves in the same manner. Cultures are different. Fiscal views are different. So that is a big challenge. The situation now is a situation that is a bit of an experiment because the Euro has been an incredible success. When I started.

 

DL: When I started in the buy side, everybody said the Euro is not going to last. And there it is. And it’s the second world reserve currency in terms of utilization, significantly behind the United States. So it’s been a big success. But with that big success comes also a lot of hidden weaknesses. And the hidden weaknesses are fundamentally a very elevated level of debt, a very stubborn government spending environment that makes it very difficult for the European Union and the eurozone to grow as much as it probably could. And it also makes it very difficult to unify fiscal systems because we don’t have a federal system. We don’t have like the United States is.

 

The situation now is the eurozone is recovering. It’s recovering slowly. But some of those burdens to growth are obviously being very clear. Think about this. When Covid19 started, estimates from all global entities expected China to get out of the crisis first, the eurozone to get out of the crisis second, and the United States to be a distant third. It’s… the United States has surpassed its 2019 GDP levels. The eurozone is still behind. So it’s interesting to see how the expectations of recovery of the eurozone have been downgraded consistently all of the time. And therefore, what we find ourselves in is in a situation in which there’s almost a resignation to the fact that the eurozone in particular, but also the European Union. The eurozone is a small number of countries. The European Union is larger, for the people that are watching. It’s going to recover in a sort of almost L shape. It was going to recover with very low levels of growth, with much weaker levels of job creation and with a very significant and elevated level of debt. So that’s basically where we are right now.

 

Obviously, the positives remain. But it’s almost become custom to accept low growth, low job creation, low wage growth and low productivity.

 

TN: It seems to me that if we switch to say, looking at the ECB in that environment, how does the ECB deal with that in terms of higher inflation, lower growth, a weakening Euro? Now, I want to be careful about saying weakening Euro. I don’t necessarily think the bottom is going to fall out. I know there are people out there saying that’s going to happen. But we’ve seen over the past, particularly three weeks, we’ve seen some weakness in the Euro. What does that look like? Do we see kind of BOJ circuit 2012 type of activity happening? Or is there some other type of roadmap that the ECB has?

 

DL: It’s a very good comparison. The ECB is following the footsteps of the Bank of Japan. In my opinion, in an incorrect analysis of how the ECB the European Central Bank behaved in the 2008 crisis. There is a widespread of mainstream view that the ECB was too tight and too aggressive in its monetary policy. Aggressive in terms of hawkishness in the previous crisis. And if it had implemented the aggressive quantitative easing programs that the Federal Reserve implemented, everything would have gone much better. Unfortunately, I disagree. I completely disagree.

 

The problems of the eurozone have never been problems of liquidity and have never been problems of monetary policy. In fact, very loose monetary policy led to the crisis. Bringing interest rates from 5% to 1%. Massively increasing liquidity via the banking channel, but increasing liquidity nonetheless. And so the idea that a massive quantitative easing would have allowed the eurozone to get out of the crisis faster and better has been also denied by the reality of what has happened once quantitative easing has been implemented aggressively.

 

So now what the ECB is doing is pretty much what the Bank of Japan does, which is to monetize as much government debt as possible with a view that you need to have a little bit of inflation, but it cannot be high inflation because in the United States, with 4% unemployment, 4.6% unemployment, you may tolerate 6% inflation. For a while. But I can guarantee you that in the European Union, in the Eurozone with elevated levels of unemployment and with an aging population, very different from the United States. Very different in the European Union almost 20% of the population is going to be above 60 years of age pretty soon. Aging population and low wages with high unemployment or higher unemployment than in the United States. A very difficult combination for a very loose monetary policy.

 

The Bank of Japan can sort of get away with being massively doveish because it always has around 3% unemployment. So structural levels of unemployment. But that’s not the situation of the eurozone. So I think that the experiment that the ECB is undertaken right now is to be very aggressive despite the fact that the level of inflation is significantly higher than what European citizens are able to tolerate. Obviously, you say, well, it’s 4% inflation. That’s not that high. Well, 4% inflation means that electricity bills are up 20%, that gasoline bills are up another 20%, that food price are up 10% so we need to be careful about that.

 

So very dangerous experiment. We don’t know how it’s going to go. But they will continue to be extremely doveish with very low rates. That’s why the Euro is weaker, coming back to your point. Extremely dovish despite inflationary pressure.

 

TN: So it’s interesting central banks always act late and they always overcompensate because they act late. So do you think that maybe a year from now because of base effects, we’ll be talking about deflation instead of inflation like, is that plausible in Europe, in the US and other places, or is that just nonsensical?

 

DL: Well, we will not have deflation, but they will most certainly talk about the risk of deflation, because let’s start from the fact that the eurozone has had an average of 2% inflation. In any case, most of the time. There’s been a very small period of time in which there was sort of flat inflation. Right. So will they talk about the risk of deflation? Absolutely they will. I remember the first time I visited Japan. I remember talking to a Japanese asset manager and saying, “well, the problem of Japan is deflation, isn’t it?” And he said to me, you obviously don’t live in this country. So will they talk about deflationary pressures? Maybe. Yes.

 

Think about this. If you have 5% inflation in 2021 and you have 3% inflation in 2022, that is 8.1% inflation accumulative. But falling inflation.

 

TN: Right. Exactly. Yeah. And it could be a way to justify central banks continuing to ease and continuing to intervene. And so Japan’s found itself in a really awkward position after eight, nine years of really aggressive activity. It’s just really hard to get out once you stop, right? So I do worry, especially about the heritage of the ECB, with kind of the Dutch and German chairs being very conservative. This is a pretty dramatic change for them, right?

 

DL: Huge. Because you’ve mentioned the key part is that everybody says, well, the ECB will do this. The ECB will do that. But the problem is that the ECB cannot do most of what they would consider normalizing. Because Spain, Portugal, Greece, Italy, it would be an absolute train wreck if the ECB stops purchasing sovereign bonds of those countries. Because the ECB is… This is something that you don’t see in the United States. The ECB is purchasing 100% of net issuances of these countries.

 

So what’s the problem? Is that? Think about this. Who would buy Spanish or Portuguese government bonds at the current yields if the ECB wasn’t buying them? Nobody. Okay. Let’s think of where we would start to think of purchasing them. We would probably be thinking about a 300-400% increase in yields to start thinking whether we would purchase Portuguese, Greek, Italian, French bonds? Not just the Southern European, but also France, et cetera.

 

So I think that is a very dangerous situation for the ECB because it’s caught between a rock and a heart place. Very much so. On the one hand, if it normalizes policy, governments with huge deficit appetite are going to have very significant problems. And if it doesn’t normalize, sticky inflation in consumer goods and nonreplicable goods and services is going to generate because it already did in 2019, protests. Because we tend to forget that in 2018 and 2019, we had the gilets jaunes, you probably remember the Yellow Vests in France. You probably remember the protest in Germany about the rising cost of living. The protests in the north of Spain. So it’s not like everybody is living happily. It’s that there were already significant tensions.

 

TN: Right? Yeah. I think the pressure is, the inflationary pressures that say consumers are feeling here in the US and Europe and parts of Asia, definitely acute, and people are talking more and more about it.

 

If we move on to say specifically to energy, since that’s where you came out of, right? So we’re seeing some real energy issues globally and energy prices globally. But when we look at gas, natural gas, specifically in Europe, do you expect to see a crisis in Europe like we’ve seen in China over the last three months where there are power outages, brownouts, hurling blackouts, that sort of thing? Or do you think there’ll be a continuity of power across Europe?

 

DL: In my opinion, what has happened in China is very specific to China because it’s not just a problem of outages because of lack of supply. Most of the lack of supply problem comes from a shortage of dollars. So many companies in China have been unable to purchase the quantities of coal that they required in a rising demand environment because they had price controls and therefore they were losing money.

 

They would have to purchase at higher prices and generate at a loss. That is not the case in Europe. In Europe, the problem of gas prices is a problem of price definitely, obviously. It’s very high and it’s also feeding to our prices because of the merit order. But it’s not a problem of supply in the sense that getting into an agreement with Russia to increase 40% their supplies of natural gas into the European Union was extremely quick. From the 1st November to beginning of this week, gas form has increased exports to Europe by 40%.

 

Problem? Prices have not fallen as much as they went up before. For the south of Europe, it’s a problem fundamentally, of access to ships because LNG obviously is very tight. Vessels are not available as they used to be. There might be a certain tightness in terms of supplies, but I find it very difficult to see, let’s say, a Chinese type of shortage of supply because it’s a matter of price. Will we have to pay significantly more for natural gas and significantly more for power, but not necessarily feel the problem that the Chinese did because they had lost making generation in coal.

 

TN: Great. Okay, that’s very good. That’s what I’d hoped you say, but it’s great to hear that. Let’s switch just a little bit and talk about kind of European companies because we talked about rising prices, like energy. We talked about inflation and consumers say bearing inflationary pressures.

 

In European companies, we’ve seen that American companies have been able to raise prices in America quite a lot, actually. And consumers have borne that. Chinese companies haven’t really been able to do that. Their margins are really compressed because consumers there haven’t been able to bear the price rises. What are you seeing in Europe, and how do you think that impacts in general European companies, their ability to absorb price rises or pass them on to consumers? And how long can they continue to bear that?

 

DL: Yeah. One of the things that is very distinct about Europe is the concept of the so called, horrible name, “National Champions.” In power, in telecommunications, in banking, in oil and gas, etc. Etc. We tend to have each country a couple of dinosaurs, most of them, that are so called National Champions. These cannot pass increases of inputs to final prices because they receive a call from the red phone from the Minister in the country. And no my friend, the prices are not going up as they probably should.

 

So the automotive sector? Very difficult because there’s a lot of over capacity and at the same time, tremendous cost pressure that you cannot pass because of the lack of demand as well, or the lack of demand relative to supply. The airline sector? Cannot pass the entire increase of cost to consumers. The power sector? Very difficult, big companies, very close to governments. They’re suffering immensely from regulatory risk. So very difficult. So you have those.

 

However you would say, okay, so that sort of shields inflationary pressures out of consumers. Unfortunately, it doesn’t because those are very large companies, but they’re very small in terms of how much they mean, for example, the prices of food or the prices of delivered natural gas. Even though you purchase natural gas, there’s a strict pass through in those, for example. You might not increase your margins. You might lose a little bit, but the pass through happens. It goes with a delay. In the United States, everything happens quickly. In the United States, shut down the economy, unemployment goes to the roof, then it comes down dramatically like V shape, opposite V shape. In the Eurozone, things happen slower. And that’s why it’s a bigger risk, because the domino effect, instead of being very quick and painful and quickly absorbed is very slow.

 

TN: Interesting. Okay. Very good. Well, Daniel, thank you for your time. Before we go, I’d like to ask everyone watching. If you don’t mind, please follow us on our YouTube channel. That helps us a lot in terms of adding features to our podcast.

 

Daniel, thank you. As always, this has been fantastic, and I hope we can come back and speak to you sometime in the future. It will be a great pleasure. Always a fantastic chat. Thank you very much.

 

DL: Thank you very much.

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QuickHit

Quick Hit Cage Match: Van Metre vs Boockvar on Inflation (Part 2)

Van Metre vs Boockvar on Inflation (Part 2)

This is Part 2 of the inflation discussion with Steven van Metre and Peter Boockvar with your host Tracy Shuchart. In this second part, they talked about the possibility of the Fed tapering this year or early in 2022. How about the possible rate hike and what will possibly happen in other parts of the world like Bank of Japan and Bank of England if ever this happens? What is Powell doing exactly and why? Is there a possibility of a new Fed chair next year? And what do they think about stagflation?

 

For Part 1 of this QuickHit Cage Match episode, please go here. 

 

Steven van Metre is a money manager who have invented a strategy called Portfolio Shield. He also has a YouTube show that discusses economic data and the news three days a week.

 

Peter Boockvar is the Chief Investment Officer and portfolio manager at Bleakley Advisory Group. He has a daily macromarket economic newsletter called The Boock Report.

 

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This QuickHit episode was recorded on October 14, 2021.

 

The views and opinions expressed in this Quick Hit Cage Match: Van Metre vs Boockvar on Inflation Part 2 episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TS: Do you see the Fed tapering? And if they do, how much is this going to affect inflation? And also, I know the market is saying the Fed is going to raise rates in ’22, 2023. But is this a reality at all?

 

But before we jump into that, I just wanted to remind you to please subscribe to our YouTube channel.

 

PB: I think the Fed will at least start the taper and see how it goes. The thing that is different with this taper is that it’s coinciding with central banks around the world that are also beginning to remove accommodation. However slow, however glacial that process is, they’re all outside of the BOJ. They’re all doing it at once.

 

So if the Fed starts to taper in December, which they basically told you that they will, well, the Bank of England could be raising rates in December. We recently got a rate hike from Norway a month or two ago from South Korea. We’ve had Canada and Australia trimmed QE. Even the ECB has trimmed QE. So there’s a global shift to tightening. And I do believe tapering is tightening to define that. Just as we saw last year, the past 18 months obviously massive global easing.

 

Now I can’t even discuss the rate hike situation because I’m not even sure that they’re going to be able to get through the tapering. If you look back to 2010, every single notable market correction in equities and also fixed income markets outside of Covid and the one evaluation in August 2015 coincided with the end of QE, where it was a hard stop QE1 and QE2. And then obviously you had the taper 2013 and then obviously around rate hikes. Every single one coincided with a tightening of policy. And even again, it was gradual. It still affected markets. And we’re going to have it again to think that we’re going to somehow get through tapering without any accidents, I think, is delusional. And you believe that there’s a free lunch and it’s a matter of what kind of accident occurs by this.

 

Now QE itself essentially, at the end of the day, it’s an asset swap. And yeah, does some of that money sort of filter into markets? Yeah, maybe, I guess. But a lot of it’s psychological, but it also does help to, at least on the short end, suppress interest rates to where they would be otherwise. That said, when QE has been on, you’ve been paid to steepen the curve when QE is off, it pays to flatten it. And I think we’ve seen some recent flattening in the yield curve. And I think that that has been the right trade to do when QE is about to turn off.

 

But to Steve’s point about the bottom 50%. Well, if you get a short equity market correction, well, the top 50% is going to feel that as well. And yeah, can that filter into how they spend for sure? But that doesn’t necessarily resolve the supply issues.

 

That’s how this inflation story is going to recalibrate. The supply side is going to take a couple of years, and it’s going to be less demand. That is going to recalibrate this inflation story. And I think that is. No central bank wants to preside over a declining economy. But unfortunately, you’re going to have to have a trade off. You want lower inflation and a slower economy or an economy, as is but fast inflation, that’s going to hurt the people that can least afford it.

 

SVM: Yeah, this balance sheet taper thing is really interesting because I will be on record. I’ll hold on record still, and I don’t think the Fed’s going to do it. Although, as Peter mentioned, you just said that you think that the Fed is going to start and then quit. I’ve had to come to your side of the fence on that deal, mainly because when Powell spoke at Jackson Hole, it seemed like he was saying, we can’t make this mistake. We got to keep easing because we could let off the gas too soon.

 

And then for whatever reason, there’s this massive pivot between that and the last meeting. And he’s going to have a disadvantage going into the November F-O-M-C. And not have the non farm payroll report because he concludes me on Wednesday. Nonfarm payroll is out on Friday. Maybe he’s got some early access, who knows? But it seems like all of a sudden he’s in a panic to start tapering.

 

Now, could this be because we know the treasury is going to reduce their issuance of notes and bonds as we borrow less money, and he doesn’t want to be over purchasing? Sure. Could it be, as Peter mentioned, that the other central banks are tapering and starting to raise hike rates. And that’s interesting, because the way I look at it is that would be a catalyst if the Fed doesn’t start tapering, that the dollar goes higher.

 

Well, there’s part of the inflation story that almost nobody is looking at. What if the dollar gets up into 96, 97, maybe even close to 100? I mean, we’re talking about destroying the inflation story just from the dollar alone. And is this one of those things where we had coordinated easing? So now we need to have coordinated tapering to keep the dollar from going up too much? I’m not sure what his motivation is, but I will say this. There’s no way that they get to the end of that taper. There’s a 0% chance they’re going to raise rates. And even if they did, it doesn’t matter. They’ve effectively given the banks a pass by saying, look, there’s no reserve requirement because, well, you’ve got all these QE reserves you don’t need anymore.

 

The whole idea that we’re going to get this balance sheet unwound. I think the bond market is telling us the Fed’s making a mistake. I think, Peter, you and I agree that we don’t know how many months they’re going to go? The only question is, at what point is there a payroll report or some data that comes out that the Fed goes, “Oh, my God, we made a big mistake.”

 

PB: I’ll tell you why he’s doing this. Well, first of all, the whole purpose of monetary policy, as we know, is to push the demand side. And if you look at what are the two most interest rate sensitive parts of the economy — it’s housing and autos. So is Powell with a straight face going to say, I need to pedal to the metal, continue to stimulate the demand for housing and autos, when you can’t find an auto and the price of the home is worth 20% more than last year? They need to take their foot off that demand pedal. And he does not want to be Arthur Burns. He does not want to be Arthur Burns. And right now he is headed towards being Arthur Burns.

 

And the Fed is going to reach a pivot point, where if inflation still remains sticky and persistent, but growth is really decelerating to a greater extent than it already is. And we know that the Atlanta Fed third quarter GDP number has one handle on it. He’s going to have to reach a point, do I try to come inflation, but then risk further weakness in the economy and a fall in asset prices, which JPowell obviously inflated. Where is he going to just not really respond quick enough. And being in Washington, we can be sure he probably leans towards trying to save the economy, but then that creates its own problems.

 

The one thing in the dollar, the dollar is going to get tied into this, too, because if he remains too easy for too long, well, that may sacrifice the dollar. If he is more aggressive at dealing with inflation, well, then you can see a faster move in the dollar. So he’s just been an absolutely no win situation here. But there is going to be a pivot point where he’s going to reach that we’ll have to see, does he go down the Paul Volcker route, or is he going to go continue down the Arthur Burns route?

 

SVM: See, Peter, you just said it best. He didn’t know what his situation. And all we’re debating is, at what point does he back off and quit because he realizes it’s not working? I mean, we can look at the velocity of money and see the monetary policy is not functioning properly.

 

I mean, there was a lot of people that predicted at the end of the last quarter that as economy reopen, velocity would pop. But it didn’t because of the fact that monetary policy is not transmitting into the economy. And so now the real issue is if he starts tapering and it does do what it’s supposed to do, does he inadvertently tighten financial conditions? I mean, this is such a mess of what he’s got to deal with. And I don’t know if you’ll agree with me honest, but I don’t think they have a clue what they’re doing.

 

I think they’re just betting that this is all going to work out, that Powell, as himself, is going to get renominated. And somehow, in the end, either he’s going to look like a superhero and say, look, see, I did it and go out as one of the most celebrated Fed chairs ever. Or he’s going to find someone else to blame this on when it doesn’t work.

 

PB: The Fed has been winging it for decades, and this all goes back to Greenspan. In 1994, he raised rates aggressively. We know he blew up Mexico, he blew up Orange County, California, and he took that at heart. He learned a lesson. And so you go into the late 90s when everything is on fire. Stock market bubble. We know he was very slow to raise interest rates because he didn’t want to repeat 1994.

 

And then, of course, you have the blow up. And he’s obviously quick to raise interest rates. But remember the mid 2000s, every single. When he started raising interest rates, he did it every single meeting, and in every single statement, it said, we are doing this at a measure pace, because he didn’t want to repeat 1994.

 

And then what we have, obviously, the housing bubble and so on and so on. And then now you take Powell. We know Janet Yellen was afraid to raise interest rates. Took them seven years to get off zero. And then after finally raising, took them another twelve months to finally raise rates again. And then Powell started to pick up the pace. And then he blew himself up in the fourth quarter of 2018. And then that helps to explain why they’re going so slow now.

 

Then you throw in, of course, the whole social justice. The Feds become the Ministry of Social Justice now and how they view monetary policy. But yeah, to your point, they are winging it. And they’ve been winging it for decades.

 

SVM: And you bring up an interesting point about 2018. I’m really glad you did, because a lot of people forgot that we started easy to the point that it didn’t really make a lot of sense from the outside look in it. And so now this whole notion, and I don’t know what your reaction was, but I remember hearing the press conference when he’s like, okay, when Powell said, “We’re going to gradually unwind the balance sheet by mid 2022.” I’m like, since when is “gradual” six months. There’s no way this is going to work for you, buddy, but good luck if you’re going to pull it off.

 

PB: Yeah. And the Fed got lucky for a period of time. They got lucky in 2017 because the markets rallied and ignored Fed rate hikes and the beginning of the shrinking of their balance sheet. They were double tightening and they got bailed out because everyone focused on the corporate income tax cut. That obviously happened at the end of 2017. But that entire year, the Vix got down to eight. Every dip was bought because everyone was pricing in that tax cut. But once that tax cut was in place, the Fed then raised interest rates again in January 2018. And then we immediately shift back to the Fed is double tightening here between the balance sheet and rates. And that obviously coincided with the fourth quarter of 2018.

 

So we know in the Fed tapering, the Fed tightens until they hit a wall. The Fed tightens until something breaks, and you can be sure something will break in 2022. It’s just a matter of how deep they get. And also one last point here is that having low inflation gives central banks that Wayne’s World Concert pass that all access to do anything they want for how long as they want, when there’s no inflation. But once you get inflation into the numbers, into the economy, their flexibility is greatly diminished. And that will be an interesting sort of tug of war as they get further into the tapering and something eventually breaks.

 

TS: One last question, a couple of last question. How do you feel about Stagflation? I kind of amend the Stagflation camp. Do you think that’s a cop out or how do you feel about that?

 

SVM: I think it’s temporary. I mean, we’re supposed to be rising unemployment. I mean, I guess with people coming off the ranks, I don’t know. Maybe it’ll go back up. I don’t think that’s likely to happen. And then you tend to get that with higher prices. But when we start looking at the bond market. The bond market is starting to tell us that, hey, this Stagflation is going to be transitory. And then the risk that I see is that we get into outright deflation from here.

 

PB: To me, I just look at stagflation as just slower growth and higher inflation. And in an economist textbook, they think that slow growth means lower prices. Faster growth means higher prices. I’m just looking at the Bank of Japan. The Bank of Japan said we need to get inflation at 2%, and somehow that will then generate faster growth. To me, they’ve got that backwards. You need stable prices in order to develop and sustain healthier growth.

 

So right now. But the Stagflation it’s sort of intertwined in the sense that it’s the inflation and what is driving it. So it’s the inflation itself that is beginning to impact consumer spending. And it’s the factors that are creating the inflation, like the supply bottlenecks that in itself, are also creating slower growth.

 

TS: Excellent. One last question, just for a thought experiment. I mean, say Powell does leave the Fed next year and we have find a Dove, right. So what does the Fed look like at that point if we have a dove as a Fed chair?

 

PB: Well, 2022 becomes completely politicized. The Fed’s already politicized, but it becomes Uber politicized in 2022 because of the elections in November. And if a Lael Brainard becomes the next Fed chair in February, 2022, you can be sure that Steve and I are right, that there’s no chance in hell they’re going to finish this taper because the second something breaks, you know, they’re going to back off and they’re going to do their best to, or at least the Democrats headed by the Lael Branard will do their best to maintain control of Congress.

 

SVM: Yeah. I’ll put that as a low probability chance that Powell is out. If he does, I’m 100% agree.

 

PB: I agree. I think he stays as well.

 

SVM: Yeah, 100% agree. I think it’s a big risk for the Biden administration to pull him. He hasn’t really done anything wrong. But if he does, again, I think Peter is spot on. I mean, now it becomes even more political than the Fed is supposed to be. And he’s right, as soon as something goes wrong, I mean, we’re going to 120 billion a month. Yeah, right. It’ll be multiples of that in a second.

 

TS: All right. Well, I want to thank you both again for everything you shared with us today. Can you each tell us where we can find you on social media or otherwise?

 

PB: Well, I just want to say thank you to Tracy and Steve. Thank you for having me in this debate and discuss this with you. It was definitely a fun time. If you want to read my daily readings, you can subscribe to boockreport.com. boockreport.com And our wealth management business is at bleakley.com.

 

TS: Excellent.

 

SVM: I want to thank you as well. Peter, you and I know this has been a long time coming for us to be on the same screen together. I had a blast. Totally looking forward to the next time. If you want to find more about me, you could go to my website. stevenvanmetre.com On Twitter @MetreSteven. On YouTube at @stevenvanmetrefinancial.

 

TS: Great. And for everyone watching, please don’t forget to subscribe to our YouTube channel and we look forward to seeing you on the next QuickHit.

Categories
QuickHit

Sentiment has soured: How will governments and companies respond? (Part 1)

Sentiment has soured: How will governments and companies respond? (Part 1)

Companies are saying that the Q3 revenues will be down a bit. What’s really happening and how long will this last? Chief Economist for Avalon Advisors, Sam Rines, and a returning guest answers that with our first-time guest Marko Papic, the chief strategist for Clocktower Group.

 

In addition, both the Michigan Consumer Sentiment and the NY Manufacturing survey down as well. Watch what the experts are seeing and what they think might happen early in 2022.

 

Watch Part 2 here. 

 

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This QuickHit episode was recorded on August 19, 2021.

 

The views and opinions expressed in this Sentiment has soured: How will governments and companies respond? (Part 1) QuickHit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TN: So I guess we’ve started to see some negative news come in with the Michigan Consumer Sentiment with the New York Manufacturing Survey and other things. Most recently, we had some of the housing sentiment information come in. And I’ve heard companies talk about their revenues for Q3 will be down a bit. And so I wanted to talk to you guys to say, are we at a turning point? What’s really happening and how long do you expect it to last? Marko, why don’t you let us know what your observation is, kind of what you’re seeing?

 

MP: Well, I think that, you know, the bull market has been telling us that we were going to have an intra cyclical blip, hiccup, interregnum, however you want to call it since really March. And there’s, like, really three reasons for this. One, the expectations of fiscal policy peaked in March. Since then, the market has been pricing it less and less expansion of fiscal deficits. Two Chinese have been engaged in deleveraging, really, since the end of Q4 last year, and that started showing up in the data also on March, April, May.

 

And then the final issue is that the big topic right now is something we’ve been focused on for a while, too, which is this handover from goods to services, which is really problematic for the economy. We had the surge of spending on goods, and now we all expected a YOLO summer where everybody got to YOLO. It really happened.

 

I mean, it kind of did. Things were okay but, that handoff from good services was always gonna be complicated, anyways. And so I’m going to stop there because then I can tell you where I stand and going forward. But I think that’s what’s happening now and what I would be worried about. And I really want to know what Sam thinks about this is that the bull market been telling you this since March. There’s some assets that were kind of front load. The one asset that hasn’t really is S&P 500, as kind of ignored these issues.

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TN: Right. Sam, what are you seeing and what do you think?

 

SR: Yeah, I’ll jump in on the third point that Marko made, which is that handoff from services or from goods to services. That did not go as smoothly as was planned or as thought by many. And I don’t think it’s going to get a whole lot better here. You have two things kind of smacking you in the face at the moment. That is University of Michigan Consumer Sentiment and the expectations. Neither of those came in fantastically. Today isn’t great. Tomorrow isn’t expected to be great.

 

Part of that is probably the Delta variant, depending on what part of the country you’re in, that is really beginning to become an issue. Not necessarily, I mean, it’s nowhere near as big of an issue as COVID was for death and mortality in call it 2020. But it’s a significant hit to the consumer’s mindset. Right?

 

And I think that’s the part, what really matters is how people are thinking about it. And if people are thinking about it in a fear mode, that is going to constrain their switch from goods to services and the switch from goods to services over time is necessary for the economy to begin growing again at a place that is both sustainable and is somewhat elevated. But at this point, it’s really difficult to see exactly where that catalyst is going to come come from, how it’s going to actually materialize in a way that we can get somewhat excited about and begin to actually become a driver of employment. We do need that hand off to services to drive employment numbers higher.

 

And what we really need is a combination of employment numbers going higher, GDP being sustainably elevated to get bond rates higher. So I think Marko’s point on what the treasury market is telling us should not be discounted in any way whatsoever.

 

The treasury market is telling us we’re not exactly going to a 4% growth rate with elevated inflation.

 

United States GDP Annual Growth Rate
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TN: Right.

 

SR: It’s telling us we’re going to something between Japan and Germany at this point.

 

TN: Yeah. That’s what I’m a bit worried about. And with the consumer sentiment especially, I’m a bit worried about sticky sentiment where we have this Delta variant or other expectations, and they remain on the downside, even if there are good things happening.

 

Do you guys share those worries, or do you think maybe the Michigan survey was a blip?

 

SR: Oh, I’ll just jump in for 1 minute. I don’t think it was a blip at all. I think what people should be very concerned about at this point is what the next reading is. That reading did not include the collapse of Afghanistan. It did not include any sort of significant geopolitical risk that is going to be significant for a number of Americans.

 

Again, it’s kind of like Covid. It might not affect the economy much. It’s going to affect the psyche of America significantly as we move forward. And if consumer sentiment were to pick up in the face of what we’ve seen over the last few days, I would be pretty shocked.

 

TN: It would be remarkable. Marko, what do you think about that?

 

MP: So I’m going to take the other side of this because I have a bet on with Sam, and the bet is, by the end of the year, I’m betting the 10-year is going to be closer to 2%. He’s betting it’s going to be closer to 1%. So he’s been winning for a long time, but we settled the bet January 1, 2022.

CBOT 10-year US Treasury Note
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Here’s why I think I would take the other side of a lot of the things, like when we think about where we’re headed. So first, I think there’s three things I’m looking at. There’s really four things. But the fourth is the Fed. And I’m going to like Sam talk about that because he knows a lot more than I do. The first three things I’m looking at is, as I said, there are reasons that the bond market has rallied. And I think a lot of these reasons were baked in the cake for the past six months, or at least since March.

 

The first and foremost is China. And China is no longer deleveraged. The July 30th Politburo meeting clearly had a policy shift, but I would argue that that been the case since April 30. They’ve been telling us they are going to step off the break. And, quite frankly, I don’t need them to search infrastructure spending a lot. I don’t need them to do a lot of LGFB. I just need them to stop the leverage. And so they’re doing that.

 

And the reason they’re doing that is fundamentally the same reason they crack down on tech. And it has to do with the fact that Xi Jinping has to win an election next year. Yeah. And an election. It’s not a clear cut deal. He’s going to extend his term for another five years. CCP, The Chinese Communist Party is a multi sort of variant entity, and he has to sell his peers in the communist party that the economy is going to be stable.

 

And so we expect there to be a significant policy shift in China. So one of the sort of bond bullish economic bearish variables is shifting. The second is fiscal policy. Remember I mentioned that in March, investors basically started, like the expectations of further deficit increases, basically whittle down. This was also expected.

 

The summer period was also going to be one during which the negotiations over the next fiscal package were going to get very difficult. I would use the analog of 2017. Throughout the summer of 2017, everybody lost faith in tax cuts by the Trump administration. And that’s because fundamentally, investors are very poor at forecasting fiscal policy. And I think it has to do with the fact that we’re overly focused on monetary policy. We’re very comfortable with the way that monetary policy uses forward guidance.

 

I mean, think about it. Central bankers bend over backwards to tell us what you’re going to do in 2023. Fiscal policy is a product of game theory, its product of backstabbing, its product of using the media to increase the cost of collaboration, of cooperation. And so I think that by the end of the year, we will get more physical spending. I think the net deficit contribution will be about $2 trillion, the net contribution to deficit, which is on the high end. If you look at Wall Street, most people think 500 billion to a trillion, I would take double of that.

 

And then the final issue is the Delta. Delta is going to be like any other wave that we’ve had is going to dissipate in a couple of weeks. And also on top of that, the data is very, very robust. If you’re vaccinated, you’re good. Now, I agree with everything Sam has said. Delta has been relevant. It has, you know, made it difficult to transition from goods to services, but it will dissipate. Vaccines work. People with just behavior. So.

 

TN: Let me go back to the first thing you mentioned, Marko, is you mentioned China will have a new policy environment. What does that look like to you?

 

MP: There’s going to be more monetary policy support, for sure. So they’ve already, the PBOC has basically already told us they’re going to do an interest rate cut and another RRR cut by the end of the year. Also, they are going to make it easier for infrastructure spending to happen. Only about 20-30% of all bonds, local government bonds have been issued relative to where we should be in the year. I don’t think we’re going to get to 100%. But they could very well double what they issued thus far in eight months over the next four months.

 

So does this mean that you should necessarily be like long copper? No, I don’t think so. They’re not going to stimulate like crazy. The analogy I’m using is that the Chinese policy makers have been pressing on a break, really, since the recovery of Covid in second half of 2020. They’ve been pressing on the breaks for a number of reasons, political, leverage reasons, blah, blah, blah. They’re not going to ease off of that break. That’s an important condition for global economy to stabilize.

 

Thus far, China has actually been a head wind to global growth. They’ve been benefiting from exports, you know, because we’ve been basically buying too many goods. They know the handoff from goods to services is going to happen. Goods consumption is going to go down. That’s going to hurt their exports. On top of that, they have this political catalyst where Xi Jinping wants to ease into next year with economy stable.

 

Plus, they’ve just cracked down on their tech sector. They’re doing regulatory policy. They have problems in the infrastructure and real estate sectors. And so we expect that they will stimulate the economy. Think about it that way. Much more actively than they have thus far.

 

TN: Great. Okay. That’s good news. It’s very good news. Sam?

 

SR: Yeah. So the only push back that I would give to Marko and it’s not really pushback, given his assessment, because I agree with 99% of what he’s saying. But the one place that I think is being overlooked is, one thing is the fiscal policy with 2 trillion is great, but that’s probably spread over five to ten years, and therefore it’s cool. But it’s not that big of a deal when it comes to the treasury market or to the economic growth rate on a one-year basis. It’s not going to move the needle as much as the middle of COVID.

 

TN: Let me ask. Sorry to interrupt you. But when you say that’s going to take five to ten years, when we think about things like the PPP program isn’t even fully utilized. A lot of this fiscal that’s been approved over the last year isn’t fully utilized. So when these things pass and you say it’s going to take five to ten years, there’s the sentiment of the bill passing. But then there’s the reality of the spend. Right. And so you just take a random infrastructure multiplier of 1.6 and apply it.

 

There’s an expectation that that three and a half trillion or whatever number happens, two trillion, whatever will materialize in the next year. But it’s not. It’s a partial of it over the next, say, at least half a decade. Is that fair to say?

 

SR: Correct? Yeah. Which is great. It’s better than nothing in terms of a catalyst to the economy. The key for me is it’s not being borrowed all at once. It’s not being spent all at once. Right.

 

If it was a $2 trillion infrastructure package to be spent in 2022, I would lose my bet to Marko in a heartbeat. It would be a huge lose for me, and I would just pay up. But I would caution to a certain degree, it’s $200 billion a year isn’t that big of a deal to the US economy, right. That’s a very de minimis. Sounds like a big number, but it’s rather de minimis to the overall scale of what the US economy is.

 

And you incorporate that on top of a Federal Reserve that’s likely to begin pulling back, or at least intimate heavily that they’re going to begin pulling back incremental stimulus or incremental stimulus by the end of 2021 and 2022. And all of a sudden you have a pretty hawkish kind of outlook for the US economy as we enter that 2022 phase. And it’s difficult for me, at least, to see the longer term, short term rates, I think, could move higher, particularly that call it one to three year frame. But the ten to 30-year frame, for me is very difficult to see those rates moving higher. With that type of hawkish policy in coming to fruition, it’s kind of a push and pull to me. So I’m not obviously, I don’t disagree with the view that China is going to stimulate and begin to actually accelerate growth there. I just don’t know how much that’s actually going to push back on America and begin to push rates higher here.

 

I think we’ve had max dovishness. And strictly Max dovishness is when you see max rates and when you begin to have incremental hawkishness on the monetary policy side and fiscal side. And 2 trillion would be slightly hawkish versus 2020 and early 2021. When you begin to have that pivot, that it’s hard for me to see longer term interest rates moving materially higher for longer than call it a month or two.

 

TN: Okay, so a couple of things that you said, it sounds like both you agree that China is going to do more stimulus. I think they’re late. I think they should have started five or six months ago, but better now than never. Right. So it sounds to me like you believe that there will be the beginning of a taper, maybe a small beginning of a taper late this year. Is that fair to say.