This video interview is owned by Channel News Asia, and the original source can be found at https://youtu.be/U_Im05ClsN0
The United States Federal Reserve’s plan to ease its pace of interest rate hikes as soon as December would bring some relief for markets concerned about the central bank overtightening too quickly, Mr. Tony Nash, founder and chief executive of data analytics firm Complete Intelligence, told CNA’s Asia First.
Transcript
CNA: Federal Reserve chair Jerome Powell has signaled policymakers could slow interest rate increases starting this month. That sets the stage for a possible to downshift to a 50bps rate hike when Fed officials gather again in two weeks.
Powell: Monetary policy affects the economy and inflation with uncertain lags. And the full effects of our rapid tightening so far are yet to be felt.
Thus it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.
CNA: But it isn’t quite a dovish turn. The U.S Central Bank Chief also stressed that they have a long way to go in restoring price stability despite some promising developments.
Mr. Powell warns against reading too much into one month of inflation data saying that the FED has yet to see clear progress on that front. In order to gain control of inflation, the Fed chair says the American labor market also has to loosen up to reduce upward pressure on wages. Job gains in the country remain high at nearly 300,000 positions per month and borrowing costs are likely to remain restrictive for some time to tamp down rapid price surges.
This is where U.S interest rates stand after an unprecedented series of four 75 bps rate hikes. Policymakers projected earlier that this could go as high as 4.6 percent but Powell says they will likely need to keep lifting rates more and go beyond that level until the inflation fight is done.
The less hawkish tone from Powell Boyd U.S market stow and the S&P500 erased losses it searched three percent. The Dow gained two percent while the NASDAQ jumped more than 4.4 percent. the 10-year treasury yield also dipped as Bond Traders dialed back their expectations on how high the Fed may push interest rates while the U.S dollar retreated.
Tony Nash is founder and CEO of Complete Intelligence joining us from Houston, Texas for some analysis. Now Tony, just looking at Powell’s comments, the first differs in some way with what the Fed and its officials have been telling us earlier in the year and how we’ll get there fast to try to reach the terminal rate. But now it’s signaling that it will get there slower. What is this going to mean for businesses and consumers in the US?
Tony: I think what it means is we’re going to get to the same destination. It’s just going to take a little bit more time to get there. So the Fed has seen jobs turn around they’ve seen jobs aren’t necessarily slowing but the rate of rise in open jobs is slowing. We’ve seen mortgage rates go up. We’ve seen the rate of inflation rise slowly.
So the Fed is seeing some things that they want and they’re worried about over-tightening too quickly. Because what we’ve seen so far is really just interest rate rises. They really haven’t even started quantitative tightening yet. I mean they’ve done a little bit maybe a couple hundred billion dollars. But they have nine trillion dollars on their books give or take.
They haven’t even started QT yet. And they’re starting to see inflation and some of these pressures on markets at least slowed down a little bit. So I think they’re saying “hey guys we’re still going to get to a terminal rate of five percent or five and a half percent but we’re going gonna slow it down from here unless we see things accelerate again.”
CNA: When do you think we will actually see that five to five and a half percent?
Tony: You’ll see it in the first quarter. You know if we do say 50bps in December and maybe another 50 in January, we’ll see some 25bps hikes after that but I think what markets the cyber leaf that markets are giving right now is just saying. Okay, we’re not at 100 or 75 in December.
I think that’s a big size that you saw today and you know. It raising at 75bps per meeting just put some real planning challenges in front of operators people, who run companies. So if they slow down that pace and people know we’re still going to get to that 5 to 5.5%, it allows people to plan a little bit more thoughtfully, and a little bit more intelligently.
I think this does relieve some people of the worries of the Fed over-tightening too quickly and it also relieves worries that the Fed is only relying on monetary policy. They’re not relying on interest rates I’m sorry and they’re not relying on quantitative tightening. so the Federal balanced approach sometime in Q1.
CNA: Okay, you also mentioned before in our past conversations, the concern that the market has been having for this week especially since it’s China’s lockdowns and you see these restrictions ending gradually. What is that going to mean for Energy prices and inflation?
We see Energy prices say now they’re what high 70s low 80s somewhere in that range. We do see a rise of say crude oil prices by about 30 percent once China fully opens. We could easily be 110-120 a barrel once China fully opens. And so there will be pressure on global energy markets once China opens. Other commodity prices will see the same because we’re just not seeing the level of consumption in China that we expect.
What we also expect is for Equity markets to turn away from the U.S. and more toward Asia. So the US has attracted a lot of investment over the past year partly because of the strong dollar partly because of kind of a risk-off mentality consolidating in U.S markets. As China opens and there becomes more activity in Asia than we would expect, some of that money to draw down out of the US and go back to Asia.
CNA: Can you look at the jobs market in the US even as we expect this potential pivot towards Asia for stock market investors? The jobs market and the picture on wages there because the ADP data shows that there seems to be a cooling in demand for labor how soon do you think we can see a broadening out to the broader jobs market?
Tony: You would have broader cooling of demand in the jobs market I think, that’s definitely hidden tech. You’ve seen a lot of layoffs in technology over the past say three weeks. And that will cascade out. I don’t necessarily see think that you’ll see that in places like energy, but you will see that in maybe finance, some aspects of financial services. You’ve seen some of that and say mortgage brokers and this sort of thing so you’ll see that in some aspects of financial services. Some aspects of say manufacturing at the edges. but I do think there’s a lot of growth in U.S manufacturing as this reassuring narrative really takes uh gets momentum in North America. And so even though we may shed some manufacturing jobs in one area I think we’ll see growth in manufacturing jobs in other areas.
CNA: Okay, Tony. We’ll leave it there for today. Thanks for sharing your analysis with us. Tony Nash is founder and CEO of Complete Intelligence.
The released Fed minutes show that most officials are backing a slower pace of interest rate hikes. Markets reacted positively but this is false optimism as the terminal Fed Funds Rate may eventually be higher. The 3Q reporting in the US is also coming to a close and 75% of corporates experienced downgrade in earnings. Have the cut in earnings by analysts been adequate or will there be further downside, with 2023 outlook still uncertain? For answers, we speak to Tony Nash, CEO, Complete Intelligence.
Transcript
BFM
BFM 89 Nine. Good morning. You’re listening to the Morning Run at Thursday. It’s Thursday, the 24 November November Friday, junior, as we like to call it. Here. I’m Shazana Mokhtar with Wong Shou Ning and Chong Tjen San. As always, let’s kickstart the morning with a look at how global markets closed overnight.
All key US markets showed gains as most members of the Fed said the pace of rate hikes will slow down. So the Dow was up 0.3%. The S&P500 was up 0.6%, and Nasdaq was up 1%. In Asian markets, the Nikkei and Hang Seng was up by 0.6%. The China Composite was up by 0.3%. The Straits Times Index was down by 0.1%, and our very own FBMKLCI was up by 0.2%.
Joining us on the line now for more on what’s moving markets, we speak to Tony Nash, CEO of Complete Intelligence. Hi, Tony. Good morning. Now, let’s start with just some reactions on the Fed minutes that were released. It showed that most officials are backing a slower pace of interest rate hikes, but that the terminal rate might need to be higher. What do you think? Are we seeing a relief rally? And is that sustainable in the short term?
Tony
Yeah, I think the ultimate destination is probably the same, but the pace of getting there is slower than many people thought a couple of weeks ago. So I think what it means is we’ll see more, say, 50 and 25 basis point hikes. That’s the expectation. It’s still possible we’ll see a 75 if Powell really pushes hard for December, but we’re still going to see a 5, 5.5 terminal rate, depending on really how things end up for CPI and PPI next month. But it’s just the pace and markets are more comfortable with a gradual adjustment to higher rates than the continued kind of shock treatment.
BFM
And Tony, the US reporting period is coming to a close. How would you assess the quality of corporate earnings release so far? How well have they tracked market expectations?
Tony
They’re OK, they’re pretty weak, actually. Compared to 2021, we had, I think, 25% earnings growth in ’21 about this time last year. They’re just over 3%. So it’s not even near where it was last year.
Something like 75% of companies are seeing estimates for their downgrade. So people expecting inflation to endure longer than they thought. If you remember a year ago, people were saying inflation was transitory, so they’re saying inflation will endure longer and rate hikes will continue.
So with credit tighter, businesses and consumers are not expected to spend as much.
So going forward, there is a fear that wallets will be more closed than they are now and earnings will continue to be tight.
BFM
Which just confuses me, Tony, because if the Fed stops their rate hikes at least decelerates the pace of it. And at the same time, corporate earnings aren’t going to be as robust as ever. Then why is the S&P500 above 4000 and the Dow Jones at 34,194 points? I mean, they’re just in fact, the Dow is only down 6% on a year to date basis and the S&P down 15%. Shouldn’t markets be actually more bearish than they are now?
Tony
Well, I think there are a couple of things happening there. I think first, there really is consumers have continued to spend and businesses have continued to spend in the US. Although we’ve seen economic growth slow dramatically, we’ve had spending continue to push forward. So if the Fed slows its tightening cycle, and keep in mind, they haven’t really started quantitative tightening, meaning getting things out of their balance sheet. They’re only, I think, $200 billion off of their high.
But if the Fed continues to tighten at an accelerated pace, then markets are worried. But again, if they slow it down, the feeling is that spending will move in stride. It won’t necessarily be too shaken up.
Also, on inflation, don’t forget inflation didn’t really start on an accelerated basis until November of ’21. So we had inflation, but fairly muted inflation then. And so what we get after November, well after this month, is what’s called a base effect.
So we’ll likely continue to see inflation rise, but not necessarily at the pace that it’s been over the past, say six to nine months. So does that mean inflation is peak? No, not at all. But it means the pace of the rise of inflation is likely going to slow on base effects.
So if that happens, we’ll have a lot of people declare victory over inflation, but I think that there is an expectation that that rate will slow as well.
BFM
Can you look at the prospects of retailers like Best Buy? We see Abercrombie and Fitch. These names are defying inflationary trends and higher rates to post better results than expected. So why has this sector been the exception to the norm?
Tony
Yes, the quick answer is most of those guys have been pushing price. So they’ve been passing along their higher labor and goods costs onto consumers.
Now they’ve been pushing price while sacrificing volume. So they’ve been pushing 8 to 10 to 15% price hikes in many cases. But they’ve had fewer transactions between one and say 6% fewer transactions.
Regardless, they’re earnings have risen. So they’re not as worried about fewer transactions. They’re focused on keeping their margins up.
And so when you look at retailers like Walmart, which has mixed, say, general goods and food, they’ve done very well. They had a very difficult Q2, but they did very well this past quarter.
Home Depot, which is a DIY store, has done very well because they pushed price Cracker Barrel has done very well.
Cracker Barrel. These are not these are not retailers that are at the high end of the market either. These are mid and even, say lower end companies, but they’re pushing price on the middle and lower end of the market.
Higher end of the market? They’re doing great. So it’s tough to be a consumer in this market because price definitely continues to be pushed and we expect price to continue to be pushed through probably Q2 of next year.
BFM
And Tony, with potentially slower pace of interest rate hikes, how do you expect the technology sector to do? Is there more pain to come for the likes of Amazon and Meta?
Tony
For sure. Amazon, Meta and technology companies generally do very well in very low interest rate environment, where the money is effectively free or negative real interest rates.
As you have to pay for that money, it becomes tougher for those companies to do well because their core investment is in technology. And we had things like Mark Zuckerberg at Meta really went off the rails with some of his spending and investment.
It’s not to say that the Metaverse investment is not ever going to happen, but much of that stuff really went way overboard. Same thing with, say, Amazon with some of their infrastructure investments and delivery investments.
So we do expect HP today, I think announce 6,000 jobs to be lost over the next, I don’t know, twelve months or something. So we do expect much more pain in tech. We expect that to continue until at least the end of Q1, if not a little bit further.
BFM
And Tony, let’s talk about oil because WTI for futures delivery in January, $77 a barrel. And we know that there’s an upcoming OPEC meeting in December. What are your expectations in terms of oil price then?
Tony
Yeah, it’s tricky, right? Because oil prices are kind of in that zone where a lot of people are comfortable. And so the question is, is this acceptable to OPEC members? So Saudi Arabia, UAE, Iraq and Kuwait have already come out and said they’re going to stick to the current plan, the current cuts that were already announced last month.
But we have things like the Russian price caps coming into play. And you know, our view is the price caps are pretty meaningless actually, because Europeans are pretty good at circumventing the kind of emotional embargoes they put in place.
I’m sorry to put it that way, but they put these laws in place and then they circumvent them pretty well. A lot of this is theater. So that’s not the price caps are not going to have as much of an impact as many people thought. So it’s possible if we get into next week and crude prices start coming back pretty strongly, or sorry, if we get into next week and crude prices are as weak as they are now, we may see a 500,000 barrel per day cut. I think that’s a possibility, but it’s likely they’ll stay on what’s already been announced.
BFM
Tony, thanks very much for speaking with us. And since it’s Thanksgiving eve. Happy Thanksgiving to you. That was Tony Nash, CEO of Complete Intelligence, giving us his take on the trends that he sees moving markets in the days and weeks ahead.
All eyes, of course, on that all-important inflation number and how that will affect how the Fed raises hikes moving forward.
I think the key takeaway for me was he mentioned that 75% of corporates in the US had downgrades, which I feel it’s a good thing as it brings expectations lower and more in line with future expectations and it also gives perhaps some room to surprise on the upside.
Yeah, well, markets seem to be at crossroads, but a little bit cheered by the fact that the Fed isn’t going to raise rates as aggressively as they have in the past. But I want to keep my eye on corporate earnings. I think that if you see continuous downgrades by the analyst community, you see the messaging coming out of US corporates that things aren’t looking as rosy as they are, then it’s just going to be hard for the Dow, S&P500 to actually break through their current resistance levels. So I think it’s something we have to keep an eye on.
This Week Ahead, we’re joined by Daniel Lacalle, Tracy Shuchart, and Sam Rines.
First discussion is on liquidity drain and quantitative tightening (QT). How difficult is it?
Rate hikes get a lot of the headlines, but QT peaked at just under $9 trillion in April of this year. The Fed has pulled just over $200 billion from the balance sheet since then, which isn’t nothing, but it’s not much compared to the total.
Where do we go from here? Most of the Fed’s balance sheet is in Treasuries, followed by Mortgage-backed securities. What does the path ahead look like – and where is the pain felt most acutely? Daniel leads on this discussion.
We also look at the copper gap with Tracy. We don’t really have enough copper over the next ten years to fill the demand. Despite that, we’ve seen copper prices fall this year – and Complete Intelligence doesn’t expect them to rise in the coming months. Tracy helps us understand why we’re seeing this and what’s the reason for the more recent fall in the copper price. Is it just recession? Will we see prices snap upward to fill the gap or will it be a gradual upward price trend?
We’ve had some earnings reports for retail over the past couple of weeks and Sam had a fantastic newsletter on that. On previous shows, we’ve talked about how successful US retailers have pushed price (because of inflation) over volume.
Costco and Home Depot have done this successfully. Walmart had serious inventory problems earlier this year, but their grocery has really saved them. Target has problems, but as Sam showed in his newsletter, general merchandise retailers have had a harder time pushing price. What does this mean? Is Target an early indicator that the US consumer is dead?
Key themes: 1. Liquidity drain and QT 2. Copper Gap 3. Retail and the US Consumer 4. What’s up for the Week Ahead?
This is the 42nd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to The Week Ahead. I am Tony Nash. And this week we’re joined by Dr. Daniel Lacalle or Daniel Lacalle. Daniel is a chief economist, he is a fund manager, he’s an author, he’s a professor. Kind of everything under the sun, Daniel does.
Daniel, thank you so much for joining us today. I know you have a very busy schedule. I appreciate you taking the time to join us. We’re also joined by Tracy Shuart. Tracy is the president at Hightower Resources, a brand-new firm. So pop over and see Tracy’s new firm and subscribe. We’re also joined by Sam Rines of Corbu. Thanks all of you guys for taking the time out of today.
Before we get started. I’m going to take 30 seconds on CI Futures, our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies commodities, equity indices.
Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast error.
We also forecast about two thousand economic variables for the top 50 economies globally, and that is reforcast every month.
There are a few key themes we’re going to look at today. First is liquidity drain and quantitative tightening, or QT. Daniel will lead on that and I think everyone will have a little bit to join in on that.
We’ll then look at copper gap, meaning we don’t really have enough copper over the next, say, ten years to fill the needs of EVs and other things. So Tracy will dig into that a little bit.
We’ve had some earnings reports for retail over the past couple weeks and Sam had a fantastic newsletter on that this week. So we’ll dig into that as well. Then we’ll look at what we expect for the week ahead.
So Daniel, thanks again for joining us. It’s fantastic. You’ve spoken to our group about a year ago or so. It was amazing.
So you tweeted out this item on screen right now about the liquidity drain.
You sent that out earlier this week and it really got me thinking about the complexities of draining liquidity from global markets, especially the US. Since I guess global markets are hypersensitive to draining in the US.
Of course, rate hikes get a lot of headlines, but you mentioned QT, so it’s a bit more complicated. Obviously, QT peaked in April of this year. There’s a chart on the screen right now at just under $9 trillion.
And the Fed’s put about $200 billion back from their balance sheet, back in the market from their balance sheet, which isn’t nothing, but it’s really not much compared to the total.
So I guess my question is, where do we go from here? Most of the Fed’s balance sheet is in Treasuries as we’re showing on the screen right now, followed by mortgage backed securities.
So what does this say about the path ahead? What do you expect? How quickly do you expect? Does it matter that much?
Daniel
Thank you very much, Tony. I think that it’s very important for the following reason. When people talk about liquidity, they tend to think of liquidity as something is static, as something that is simply there. And when central banks inject liquidity, it’s an added. And when they take liquidity away from the system, that simply balances the whole thing. And it doesn’t work that way.
Capital is either created or destroyed. Capital is not static. So when quantitative easing happens, what basically happens is the equivalent of a tsunami. Now, you basically add into the balance sheet of central banks trillion, whatever it is, of assets, though, by taking those assets away from the market, you generate an increased leverage that makes every unit of money that is created from the balance sheet of the central bank basically multiplied by five, six, we don’t know how many times. And it also depends on the transmission mechanism of monetary policy, which is at the end of the day, what the reason why central banks do QE is precisely to free up the balance sheet commercial banks so that they can lend more.
Tony
Let me stop you there. Just to dig into so people understand what you’re talking about. When you talk about transmission mechanism, and the Fed holds mortgage backed securities, the transmission mechanism would be through mortgages taken out by people because mortgages are cheaper, because the Fed is buying MBS. Is that fair to say?
Daniel
Not cheaper. They don’t necessarily have to be cheaper. They have to be more abundant. Ultimately…
Tony
That’s fair. Yeah. Okay.
Daniel
Ultimately, this is why when people talk so much about rate hikes, rate hikes or rate cuts are not that important. But liquidity injections and liquidity training are incredibly important for markets because rate hikes or rate cuts do not generate multiple expansions. Yet liquidity injections do create multiple expansion, and liquidity draining is much more severe than the impact of the rate hike.
Tony
Okay, so when you say multiple expansion, you’re talking in the equity markets?
Daniel
In equity markets or in the valuation of bonds price. That means lower bond yields or in the valuation of private equity. We saw, for example, in the period of quantitative easing, how the multiples of private equity transactions went from ten times EV to even to 15 times easily without any problem.
So what quantitative tightening does is much worse than what quantitative easing does, because the market can absorb an increase of liquidity through all these multiple assets. However, when quantitative tightening happens, the process is the reverse. Is that the first thing that happens, obviously, is that the treasury, the allegedly lowest risk asset, becomes more cheap, ie, the bond yield goes up, the price goes down, the bond yield goes up, and in turn it creates the same multiplier effect, but a larger dividing effect on the way out.
Tony
So the divisor is greater than the multiplier.
Daniel
The divisor is greater. And I tell you why. In the process of capital creation, there is always misinformation that leads to multiple expansion. Okay? So one unit of capital adds two more units of capital plus a certain excess valuation, et cetera. Now from that point, if you reduce one unit of the balance yield of the central bank, the impact down is much larger. So where it goes to, this is the problem that we as investors find it very difficult to analyze is where is the multiple at which equities, bonds, certain assets are going to stop because it is very likely to be below the level where they started.
The challenge of quantitative tightening is even worse when the process of quantitative easing has been prolonged, not just in period of compression of economic activity or recessions, but also in the periods of growth.
Tony
Okay?
Daniel
Because the level of risk that investors take becomes not just larger but exponential under QE. Under QT. Under QE, you get Bitcoin going from 20 to 60 under QT, you get bitcoin going from 60 to maybe zero.
I don’t know. I don’t know.
Tony
The comments are going to be full of angry bitcoin people.
Daniel
I just want people to understand that just like on the way up in a roller coaster, you go slowly and it seems that everything is going relatively smoothly. When you start to go down, you go down really fast and it’s truly scary.
Tony
Okay, so let me ask you this, because when you talk about multiple expansion, I’m sure we’re going to get some comments back about tech firms because we’ve seen tech firms multiple expansion decline pretty dramatically in the past, say six months, certainly past year, for companies like Meta. So although we’ve only seen $200 billion in quantitative tightening, how does that reconcile with your statement about interest rates not necessarily impacting valuations.
Daniel
No, interest rates impact valuations, but not as aggressive as quantitative tightenint. They do, particularly in tech for a very simple reason. I think that all of us can understand that a technology company is in the process of money creation. A technology company is one of the first recipients of newly created money because it absorbs capital quicker and it obviously benefits enormously from low interest rates, obviously.
But the process of multiple expansion tends to happen in the early stages of those companies. Now the process of multiple compression is much more viscious because I would be genuinely interested to have a discussion with, I don’t know, with people that invest in nonprofitable tech, but I would really like to understand how they get to the current levels of valuation comfortably.
The biggest problem I see of quantitative tightening is the same problem I see of the hidden risks of quantitative easing is that central banks cannot discern which part of the wealth effect comes from the improvement in the real economy or simply from bubbles. And the creation of bubbles obviously, we can imagine that something is a bubble, but we don’t really know until it bursts.
So it’s going to be very problematic for a central bank to achieve almost one thing and the opposite, which is what they’re trying to do. What they’re trying to do is to say, okay, we’re going to reduce the balance sheet. Hey, we’re going to reduce the balance sheet by 95 billion a month and think that that will have no impact on the bond market, on the equity market, and on the housing market. The housing market is already showing.
Tony
Yeah, I don’t necessarily think they’re saying that will have no impact on that stuff. Sam, from your point of view, is that their expectation that QT would have no impact on asset prices?
Sam
I wouldn’t say it’s their expectation that it wouldn’t have an impact on asset prices. I think they understand that there’s an impact on asset prices from just the narrative of tightening generally. But to the point, I think it is very difficult to parse what portion of their tightening is doing what particularly for them.
You look at some of the research on coming out of the Fed, on what QT is expected to do and what QT does, and you come out of it thinking they have no idea. I think that they would probably say that quietly behind closed doors, without microphones. But to the point, I would agree that there is an effect and that the Fed likes to say set it and forget it, because they don’t really understand what the actual impact is on either the real economy or the financial economy. Come up with our star-star, which is some stupid concept that they decided to come up with to rationalize some of their ideas. But I would say no, that makes perfect sense, that they really don’t understand exactly how much it is. Which is why they say we’re just going to set it, forget it, and we’re not really going to talk about it.
Because if you listen to the Fed, their concentration is on the path to the terminal rate and the length of holding the terminal rate there. And if you Google or try to find any sort of commentary about quantitative tightening within their speeches and their statements, it’s actually pretty hard to find.
Daniel
Yeah. So just to clarify one thing, just to clarify. In the messages from, for example, of the ECB and the Bank of Japan, less so of the Fed. And I would absolutely agree with that because the Fed is not so worried because they know that they have the world reserve currency, but the ECB and the Bank of Japan certainly expect very little impact on asset prices. For example, the ECB are just saying right now that they’re expecting to reduce the balance sheet in the next two years by almost a trillion euros without seeing spreads widening in the sovereign market. That is insane to be fairly honest. So that is what I’m trying to put together is that the same… A central bank that is unable to see that negative bond yield and that compressed spreads of sovereign nations relative to Germany is a bubble. It’s certainly not going to see the risk of tightening.
Sam
I would start with saying that if the ECB thinks they are going to take a trillion off the books in a couple of years, that’s the first insane part of that statement.
Tony
Good. Okay. So what I’m getting from this is taking liquidity out of markets can be really damaging and the guys who are doing it don’t really know the impact of their actions. Is that good top level summary?
Daniel
Absolutely. That is the summary.
Tony
Okay, so since they’ve only taken 200 billion off, I say “only,” but compared to 9 trillion, it’s not much. Since they’re pulling the interest rate lever now at the Fed and they’re kind of tepidly moving forward on the balance sheet, do we expect them to finish the interest rate activities before they aggressively go after the balance sheet or are they just going to go march forward with everything?
Daniel
No, I think that’s.. They want to see the impact of interest rates first before they make a drastic action on the balance sheet. Particularly in the case of the Fed with mortgage backed securities, and the case of the Bank of Japan with ETFs because the Bank of Japan is going to kill the Nikkei if it starts to get rid of ETFs. And certainly the Fed is going to kill the housing market with mortgage backed securities are warranted.
Tony
Yup.
Sam
And then it’s kind of interesting because there’s two dynamics that I think are intriguing here. One is that the Fed’s balance sheet is getting longer in duration as interest rates rise because those mortgage backs are just blowing out to the right because you’re not going to have to have the roll down and you’re not going to have the prepays on those mortgages anytime soon. So the Fed is putting themselves in a position where hitting those caps on mortgage backs is just simply not going to happen on a mechanical basis. And they’re either going to have to sell or they’re going to have to say, we’re just not going to hit we’re not going to hit our cap on mortgage backed securities for the next 20 years.
Tony
Yup. So I get to put those to maturity like they’re doing with all the treasury debt.
Sam
Yeah, they’re just letting them roll off, which means they’re not going to have mortgage backs rolling off with a six and a half percent refi rate.
Daniel
Yeah, I agree with that.
Tony
Wow. It’s almost as if QT potentially is a non issue for the longer duration debt? Are you saying they’ll continue holding? Sam you’re saying , “No.” So what am I missing? What I’m hearing is they may just hold the longer duration stuff. So if that’s the case, is it kind of a non issue if they just hold it?
Daniel
It’s not a non issue. They are in conversations all the time with the Bank of Japan to do this composite yield curve management, which in a sense means playing with duration here and there on the asset base. But it doesn’t work when the yield curve is flattening all over the place and when you have a negative yield curve in almost every part of the structure.
So the point is that by the time that markets realize the difficulty of unwinding the balance sheet, the way that central banks have said, probably the impact on asset prices has already happened because commercial banks need to end margin calls, et cetera, margin calls become more expensive. Commercial banks cannot lend with the same amount of leverage that they did before. Capital is already being destroyed as we speak.
Sam
Into the point. As soon as you had the Bank of England announce that they were going to have an outright sale of Gilts, you saw what happened to their market. They broke themselves in two minutes.
Tony
Right. Okay. So that’s what I’m looking for. So it’s a little muddy. We’re not exactly sure. Right. QT is complicated. It’s really complicated. And liquidity is dangerous, as you say, Daniel. It’s easy on the way up. It’s really hard coming down from it. And that’s where…
Daniel
I think it was Jim Grant recently who said how easy it is to become a heroin addict and how difficult it is to get out of it.
Tony
Sure, yeah. I mean, not that I know, but I can see that.
Daniel
We don’t know it, obviously. None of us do. But it’s a very visual way of understanding how you build risk in the system and how difficult it is to reduce that risk from the system.
Tony
Yeah, just stopping adding liquidity is a good first step, and then figuring out what to do after that is I think they’re right. A lot of people like to knock on the Fed, but doing one thing at a time is, I think, better than trying to reconcile everything at once.
Okay, great. Since we’re taking a little bit of longer term view on things with some of that mortgage backed security debt, I just also was in a longer term mood this week and saw something that Tracy tweeted out about copper consumption and demand.
This was looking at long term demand, say, by 2030, and there’s a gap of what, 20 no, sorry, 10 million tons. Is that right, Tracy?
Tracy
8.1 million tons.
Tony
8.1 million tons. Okay. Now, when we look at copper prices right now, we’ve seen copper prices fall. We don’t really have an expectation of them rising on the screen as our Complete Intelligence forecast of them rising in the next few months.
So why the mismatch, Tracy? What’s going on there? And why aren’t we seeing the impact on copper prices right now?
Tracy
Well, I think if we look at basic industrial metals really as a whole, except for, say, lithium, really, we’ve seen a very large pullback in all these prices in these specific metals that we are going to need for this green transition.
Now, part of that is, I think, part of that is QT, we’re just saying money liquidity drained from the system. But I also think that we have overriding fears of a global recession. We also have seen people are worried about Europe because with high natural gas prices, a lot of their smelting capacity went offline.
And one would think that would be bullish metals, but it’s scaring the market as far as global recession fears. And then, of course, you always have China, which is obviously a major buyer of industrial base and industrial metals. They’re huge consumer as well as producer of the solar panels. Wind turbines and things of that nature.
So I think that’s really the overriding fears and what I’ve been talking about even for the last couple of years, that I think metals is really going to be more of H2 2023 into 2024 story. I didn’t really expect this year for that to be the real story.
I know you thought that energy was still going to be the focus. And I think even though we’ve seen prices come off, energy prices are still very high. And I think energy prices we’re going to see a resurgence of natural gas prices again in Europe as soon as we kind of get past March, when that storage is kind of done. Because we have to realize that even though the storage is still this year, 50% of that did still come from piped in natural gas from Russia.
I think we’ll start to see natural gas prices higher. Oil prices are still high. Even at $75, $80, it’s still traditionally high. So the input cost going into metals to bring it all together, the input cost going in metals, we are going to need a lot of fossil fuels. It’s very expensive. We also see mining capex suffers from the same problem that oil does is that over the last seven years, we’ve seen huge declines. And then when we look at copper in particular, we really haven’t had any new discoveries since 2015. So all of those are contributing factors. But again, I don’t think that’s really a story until last half of 2023 and 2024 going forward.
Tony
Okay, so to me, the copper price tells me, and I could be, tell me if I’m wrong here. Copper rise tells me that markets don’t believe China is going to open up fully anytime soon, and they don’t believe China is going to stimulate anytime soon. Is that a fair assessment?
Tracy
Yes, absolutely. I think we kind of saw metal prices. We’re bouncing on some of the headlines back and forth, but really we haven’t seen anything come to fruition, and I think most people are not looking until probably spring for them to open up. And I think China really hasn’t changed its stance, right. As far as. There Zero Covid policy, they’re still on that. So I think markets have been digesting that over the last couple of weeks or so. And that’s also another contributor to seeing a pullback in some of these metals in the energy sector.
Tony
Yeah, if you look at the headlines over the past week, you definitely see a softer tone towards China, with Xi Jinping coming out in the APEC meeting sorry, not the APEC meeting, the ASEAN meeting. And he’s a real human being and all this stuff, and he’s talking with Biden and he’s talking with European leaders and Southeast Asian leaders.
So I think there’s been a softer tone toward China and this belief that good things can happen in the near term, but I don’t think most investors will believe it until they see it, first of all. And I think places like Japan, Korea, Taiwan, US. Other places, maybe not. The Germans are also a little bit worried about short term sentiment in China. Things could turn pretty quickly. So, like you say, I think base metals prices are down on that. But over the long term, obviously, it doesn’t seem like there’s enough capacity right now. So, anyway, we’ll see. So for bringing that up. Sorry. Go ahead, Sam.
Sam
Yeah, I think there’s just two things to add there. One, if you didn’t have investment in base metals and energy at zero interest rates, you’re not going to get it at five. Let’s be honest. That’s point number one, this isn’t a short term thing. This is a much longer term thing. And you need to have much higher prices for commodities broadly in order to incentivize any sort of investment, because they’re, one, very capital intensive, and two, capital is very expensive right now. So I think that’s also something to keep in mind over the medium term, is we’re not solving this problem at five and a half percent interest rates here. That’s clearly not going to happen. And the other thing is you haven’t seen the Aussie dollar react in a positive way. So if the Aussie dollar is reacting, China is not reopening. It’s just that simple.
Tony
Yeah, that’s a very point.
Daniel
If I may, I would also like to point out that the bullish story for copper, lithium, cobalt is so evident from the energy transition and from the disparity between the available capacity and the demand. But when the gap is so wide between what would be the demand and the available supply, what tends to happen is that the market, rightly so, sees that it’s such an impossibility that you don’t even consider, at least as a net present value view, that bullish signal as Tracy was mentioning until 2023 or 2024, when it starts to manifest itself.
Right now, it’s so far between the reality of the available supply and the expectation of demand that it looks a little bit like what happened with Solar in 2007, 2008. We just saw bankruptcy after bankruptcy because you didn’t match the two. And on top of it, Tracy correct me. But this is the first year in which you had a massive bullish signal on prices, in energy and in metals, yet you’ve seen no response from a capping.
Tracy
Exactly. Nobody’s prepared, nobody wants to really still spend that kind of money, particularly not the oil industry when they’re being demonized by everybody in the west in particular. So you know, you’re not going to see a lot of, nobody wants to invest in a project when they’re saying we want to phase you out in ten years.
Tony
What’s really interesting though also is BHP bought a small midsized copper miner in Australia this week, so I forget their name, but the miners are seeing opportunities, but they’re just not seeing the demand there yet. So we’ll see what happens there. So anyway, thanks guys for that. That’s hugely valuable.
Sam, you wrote on retail this week and you have really brought out some interesting dynamics around pushing price versus volume within stores over the past several months. And your newsletter looked at Target, Walmart, Costco, Home Depot. Earnings across retail sectors.
So Costco and Home Depot seem to have pushed price successfully. Walmart, as you say, had serious inventory problems earlier in the year, but their grocery business seemed to have really saved them. But Target really has problems and their earnings report this week was a mess. So we’ve got on screen a table that you took out of some government data looking at, has made a change of sales for different types of retail firms, building materials, general merchandise and food services. And things seem to be going very well for everyone except general merchandise stores like Target.
So can you help us understand why is that the case for, I mean, maybe Target is just terribly wrong, but why is that the case for general merchandise specifically and what does this say about the US consumer? Is the US consumer kind of dead in some areas?
Sam
No. US consumers is not dead, which is the strangest part about this earning season to me is everybody kind of read into Targets reporting was like, wow, this is horrible. It’s bad, it’s bad. Target is its own problem. Their merchandising, horrible. Their executive team, horrible. I mean, I don’t know how you survive this. With Walmart putting up huge comp numbers on a relative basis. I mean, they pounded Target and to me that was single number one. That’s Target’s issue.
The general merchandise store. We bought a whole bunch of stuff during COVID that we don’t really need to buy at 17 of right? We bought it during COVID You could get Walmart and Target delivered to you, that was a boom for their business and that’s just not being repeated. Same thing with if you look at Best Buy and electronic stores not doing great because we all bought TVs during COVID and computers, we needed them at home. These are just pivots. When you look at the numbers for restaurants, when you look at it for grocery, I mean, again, a lot of it is pushing price onto the consumer, but the consumer is taking it.
And those are pushing revenues higher. Look at something, the company that controls Popeyes and Burger King, absolute blowout, same store numbers. I mean, these are restaurants that are pushing price. They’re still having traffic and they’re not getting enough pushback.
Home Depot pushed 8% pricing, well, almost 9% pricing in the quarter. They didn’t care about foot traffic, but traffic was down mid 4%. They didn’t care about the foot traffic. They got to push the price and they, guess what, blew it out? Loads had a decent quarter. These are housing companies, at least home exposed companies and building exposed companies that had great third quarters that were supposed to be getting smashed, right? The housing is not supposed to be the place that you’re going to right now. And somehow these companies could push in a price.
There’s something of a tailwind to the consumer where the consumer is kind of learning to take it in certain areas and just saying, no, I don’t need another Tshirt or I don’t need to make another trip to Target. I think that it’s pretty much a story of where the consumer spending not if the consumer spending.
That retail sales report, it will get revised, who knows by how much, but the retail sales report, even if it gets knocked down by a few bips called 20 basis points, 0.2%, it’s not going to be a big deal. It’s still blowing number. These are not things you want to see.
If you’re the Fed thinking about going from 75 to 50, 2 reasons there. One is that pricing little too much. And if it begins to become embedded, not necessarily in the consumer’s mind, but also in the business’s mind, I can push price. I can push price. I can push price. That’s a twosided coin where the consumer’s willing to take it and businesses are willing to push it. That is the embedding of inflation expectations moving forward.
Going back to I think it was last quarter, Cracker Barrel announced during like, yeah, we’re seeing some traffic flow, but we’re going to push price next year, and here’s how much we’re going to push it by. These companies aren’t slowing down their price increases, and they’re not seeing enough of a pushback from consumers.
Tony
Cracker Barrel and Walmart are not topend market companies. They’re midmarket companies. And if they’re able to push price at the mid market, then it says that your average consumer is kind of taking it. But the volume is down. So fewer people are buying things, but the ones who are buying are paying more. Is that fair to say?
Sam
It’s fair to say. Fewer trips, more expensive. It’s fair to say. But there’s also something to point out where Macy’s, their flagship brand, kind of had a meh quarter. Bloomingdale’s, heirt luxury? Blew it out.
Tony
Okay.
Sam
So you’re seeing even within general merchandise stores, you’re seeing a significant difference between, call it luxury, middle, and low.
Tony
Okay. So what is it about, say, Target and Macy’s? I’ll say Target more than Macy’s, but is it just the management, or is it the mech?
Sam
It’s merchandising and it’s the Mexican.
Tony
Right, okay.
Sam
And if you don’t have the right stuff that you can push price on, you’re not going to make it.
Tony
So will we see some of these general merchandisers move into other sectors? Grocery or whatever?
Sam
I mean, Target has grocery. TVs closed. They have everything. It’s a question of do you have the right thing to sell right now in terms of that? So I don’t really think you’ll see many big moves, mostly because they already have too much inventory. So their ability to pivot is zero at this point. So it’s going to be a tough holiday season. I think it’s going to be a pretty tough holiday season to Target. But I didn’t see Walmart taking down numbers for the Christmas season. We’ll see with Amazon, but cool.
Tony
It seems healthy. Just observationally. They seem pretty healthy.
Sam
Yeah. And the other thing to mention, just as a side note, there’s a lot of this consternation around FedEx and UPS and their estimated deliveries for Christmas. This is the first year that Amazon has had a very, very large fleet going into the Christmas holiday season where they don’t have to send packages through FedEx and UPS only. They have a very, very large in house fleet of vehicles to do so with, and they built that out massively over the past 18 months. So I would read a lot less into that for the Christmas season, et cetera, than people are. That’s something I think it’s kind of taking the big picture and missing the finer points.
Tracy
I had a question really just on that same vein. I’ve seen a lot of the freight companies that report on freight, like Freight Waves, have been screaming at the top of their lungs, loadings are falling. People are going out of work. They’re firing everybody. Nobody’s delivering anything. Nobody’s delivering any goods. Do you think that’s sort of cyclical or because it seems like there’s a mismatch right now. There’s a lot of goods out there to be delivered, but for some reason, these guys can’t get loading.
Sam
I think it’s two things. One, everybody double ordered in spring and summer. So I think Freight Waves and a lot of other companies saw a lot of livings that they wouldn’t have seen otherwise. And you spread those out, and I think that’s point number one. Point number two is these retailers are stuffed with inventory. Target, even Walmart is somewhat elevated. They don’t have that big problem. They have the inventory. I would say it’s much more of a timing issue. You’ll probably see Freight Waves have too many loadings, called it in the spring and summer of next year because people are playing catch up and trying to get the right merchandise, et cetera, et cetera. So I think it’s just more of a Covid whipsaw than anything else.
Tracy
Makes sense, right?
Tony
Okay, so bottom line, us. Consumer is still taking it, right? They’re still spending, they’re still okay. Despite what bank deposits and other things tell us, things are still moving. And is that largely accumulating credit or how is the US consumer still spending? They’re accumulating credit?
Sam
A couple of things. One, they have their bank deposits are fine, particularly at the middle and upper levels. They’re still relatively elevated. Two, you’re getting a much higher wage. So your marginal propensity to consume when you see a significant pay raise, even if prices are higher, is higher, right. So you’re going to spend that dollar.
So you’re getting paid more. You’re switching jobs a lot more. Your switchers are getting something like a double digit pay increase. These are rather large chefs, so I would say the consumer feels a lot more comfortable with taking the inflation because they’re getting paid a lot more. Unemployment is sub 4%, so they’re not afraid of losing their job unless they’re at Twitter. So the consumer is sitting there like, all right, I’m not losing my job. I’m getting paid increases. Why would I stop spending? I think it’s that simple.
Tony
Great.
Sam
Yeah, they have credit cards.
Daniel
That is a very important point. What you just mentioned, employment. Employment makes all the difference. The pain threshold of consumers is always being tested. Companies raise prices. Volumes are pretty much okay. So they continue to raise prices to maintain their margins. And that works for a period of time.
I think that what is happening both in the Eurozone and in the United States is that after a prolonged period of very low inflation, consumers also feel comfortable about the idea that inflation is temporary. Basically everybody and actually I have this on TV this morning, we’re talking about everybody is saying, okay, so prices are rising a lot, but when are they coming down? But I’m still buying.
The problem, the pain threshold starts to appear when employment growth, wage growth, starts to stop, and at the same time, prices go up. And obviously the companies that feel comfortable about raising prices start to see their inflation rate, rise. So it’s always difficult because we never know. There’s a variable there that we’re very unsure of, which is credits. How much credit are we willing to take to continue to consume the same number of goods and services at a higher price?
But it is absolutely key what you’re saying, which is as long as even though wage growth in real terms might be negative, but you’re getting a pay rise and you still feel comfortable about your job, you feel comfortable about your wealth to a certain extent and credit keeps you safe, consumption in the United States is not going to crack.
However, where do you see it cracking? And we’re seeing it cracking in the eurozone. In Germany, where you don’t get the pay rise, you don’t get the benefit of taking expensive credit from numerous different sources or cheap credit from different numerous sources and at the same time you get elevated inflation. Consumption is actually going down the drain. The way that I see it is that the problem, the consumption, not collapsed, but certainly the consumption crack is very likely to happen more north to south in the eurozone than in the United States at the rate at which the economy is growing.
Tony
Yes, yes, very good. Thanks for that, until on Europe, Daniel, that was really helpful.
Okay, let’s do it very quick. What do you expect for the same week or two weeks ahead? We have a Thanksgiving holiday here in the US, so things are going to be kind of slow. But Tracy, what are you looking for, especially in energy markets for the next couple weeks? We’ve seen energy really come off a little bit this week. So what’s happening there?
Tracy
Yeah, absolutely. Part of the reason of that, besides all the global factors involved, the recession didn’t help UK him out and said they were already in the recession. That then sparked fears. We have pipeline at reduced capacity right now, which means that’s going to funnel some more crude into cushion, TWI contract is actually cushing. So that’s putting a little bit of pressure. I think holidays, obviously I think this next week we’re not really going to see much action as usual. So really looking forward to the following week is we have the Russian oil embargo by the EU and we also have the OPEC meeting and I would suspect that at these lower prices they would probably, they might be considering cutting again. So that’s definitely those two things. I’m looking forward to in that first week in December.
Tony
Great, thanks. Daniel, what are you looking for in the next week or two?
Daniel
The next week or two are going to be pretty uneventful, to be fairly honest. We will see very little action or messages that make a real difference from Fed officials or from the ECB. On the energy front, there’s plenty of news that we pay attention to Tracy’s Twitter account. But in Europe we will get quite a lot of data, quite a lot of data that is likely to show again this slow grind into recession that we’ve been talking and very little help. I think that from here to December, most of the news are not going to change where investors are and that will probably start to reconfigure our views into the end of the trading season, 27 to 28.
Tony
Okay, very good. And Sam, what do you see next week? The week after?
Sam
I’ll just be watching Black Friday sales that are coming in. Honestly, I think that will be a pretty important sign as to how things are developing into the holiday season and begin to set the narrative as we enter in December. Again, there’s no real interesting Fed talk coming out next week, but we’ll begin to have some pretty good data coming from a number of sources on Black Friday, foot traffic, internet traffic, etc. Tuesday and Wednesday.
Tony
Very good.
Sam
The following week. That’s all I care about.
Tony
Excellent. Really appreciate that. For those of you guys in the States, have a great Thanksgiving next week. Daniel, thank you so much. Have a fantastic weekend. Always value your time, guys. Thank you so much. Have a great weekend.
The Bank of England surprised markets by announcing that it would buy long dated government bonds in order to stabilise capital markets. Tony Nash, CEO of Complete Intelligence explains why and what does this mean for the Pound.
Transcript
BFM
Good morning. You’re listening to the Morning Run on Thursday the 29 September. I’m Shazana Mokhtar with Wong Shou Ning. Now, in half an hour, we are going to discuss the political future of Crown Prince Mama bin Salman, or MBS of Saudi Arabia, now that he’s been named the Prime Minister of the country. But as always, let’s kick start the morning with a look at how global markets closed.
BFM
Yesterday, US markets had a very good date was at 1.9%. S&P 500 up 2%, while Nasdaq was up a whopping 2.1%. Meanwhile, in Asia, it was all red. Nikkei was down 1.5%, hong Singh was down a whopping 3.4%. Shanghai and Times Index both down 1.6%, while our very own FBM KLCI was down 0.6%.
BFM
So for some thoughts on what’s moving international markets, we have on the line with us Tony Nash, CEO of Complete Intelligence. Tony, good morning. Thanks for joining us. I want to start off with moves by the bank of England that said it would move to buy long dated government bonds in order to stabilize capital markets. Can you talk us through what the BoE is trying to do and whether this will ultimately be successful?
Tony
Yes. So here’s what happened. You had some pension funds who bought debt, debt instruments called Guilt, and they used those gilts as collateral to borrow more money to buy more debt instruments. And they use that as collateral to borrow more money to buy more instruments. So they were many times leveraged on these government debt instruments. And when the value of those gifts declined, they had to provide collateral against the loans they had taken out to buy that debt. So it’s a very circular kind of series of events that’s happened. So because these pension funds got in trouble, the UK, the bank of England wanted to prevent their insolvency, of course, because many of them are government pension funds. So since the bank of England has nearly endless currency, they can help the government come to a relatively orderly decline. So is it ideal? No, but there was some messaging out from the new Prime Minister in Whitehall that was very disturbing to government bond investors and that triggered the sell off and then that triggered a multibillion pound rescue from the bank of England.
BFM
Okay, I want to stay on the topic of the United Kingdom, but us about the currency. They must be the only G seven countries still doing quantitative easing in some way. Where do you think the pound is heading? Dendu?
Tony
Well, because of the energy environment, they’re going to be spending more money on subsidies to help the British people through the winter and more pound? Denominated spending actually makes the pound stronger, but you have aggressive quantitative easing and you have a relatively stronger US dollar. It’s possible that we see the pound decline, say, 35% more, unless something dramatic happens, like another event like today or another event by the government that really erodes credibility, I don’t see a lot more decline happening, but it’s a weird year. It’s a weird few years that we’re having right now. Right. So I think on some level it’s really hard to tell. And the problem with losing credibility is that you lose credibility. And if they erode even more credibility, it could be worse than anybody thinks. So I think that’s a small chance. I think we’re probably in a range at this point.
BFM
And if we take a look over at the US, we have seen federal officials reiterate the very hawkish stance that they have. But San Francisco Federal Reserve Bank President Mary Daly said that the bank is resolute by bringing down high inflation, but wants to do so as gently as possible so as not to drive the economy into a downturn. Do you think it’s possible at this point to engineer a soft landing, or is a recession inevitable?
Tony
I think it’s possible to engineer a softish landing. I think the problem with the Feds facing as they were very slow to respond to inflation, and so now they’re trying to respond as quickly as they can, and they’re responding in a very kind of brutal kind of way. Mary Daily coming out with these as gently as possible comments are good. And that’s new. Neil Cashari yesterday said he’s another Fed governor. He said there is the risk of overdoing it on the front end, meaning that the Fed could raise rates too quickly. So some of these governors are getting out with messaging, trying to soften the Fed’s hard message over the last couple of months. So the wording from the Feds, ongoing wording generally from especially JPOW, has said that they’re going to be ongoing aggressive hikes, and that’s scaring people. So, like, the Fed needs to be less aggressively hawkish in their language. So that doesn’t mean they turn dovish. That doesn’t necessarily mean they start doing QE. They just need to be less aggressively hawkish. And that’s just toning down the language. I think it’s a little bit too little too late in as much as markets have fallen by, say, 23%, I think, since the highs.
Tony
But I think if they start inserting some less aggressively hawkish language, we can have a smoother glide path to balance, meaning higher interest rates, more moderate equity markets at a slower pace.
BFM
Okay, Tony, can you help us understand what happened today in markets? Because I’m a little bit confused in the sense that US ten year treasury yields fell the most since March 2020. On a day like this, equities shouldn’t go up, but it did. Why?
Tony
Well, I think equity investors are seeing what the bank of England did, and I think on some level they see equity markets versus central banks as a bit of a game of chicken. And the bank of England blinked. And I think equity investors are hoping that the Fed will slow down or blink. This is not a pivot. Meaning when people talk about the Fed and say a pivot, they mean pivoting to quantitative easing and pivoting to dovish language. I don’t see that at all, but I think equity investors are seeing a chance of the Fed becoming less aggressively hawkish, as I was saying. So I think that’s really what happened is just a quick breath think, oh gosh, maybe they’re going to slow down a little bit, which would be positive for equity markets.
BFM
And if you take a look at the Nordstream gas pipeline disruption, that does seem to have changed the energy calculus in Western Europe. How do you think it’s going to affect the dynamics of energy prices over there, especially with winter looming?
Tony
Yeah, I think it will affect, but there isn’t a lot of gas coming by Nordstream. There are other pipelines bringing gas to Europe, so it’s really, at the moment, more perception than reality. So Europe has a fair bit of gas and storage for winter. It’s 87% of their goal, so they’re in pretty good shape. They’re not in great shape, but they’re in pretty good shape. They can make it all the way through winter with what they have in storage, but they aren’t reliant on Nordstrom to fill their reserves further. So I think the kind of the gut punch on this is that it’s a pretty damaging leak and so it would be really hard to get it back online. If Russia say something happened with a resolution of UK, sorry, Ukraine, Russia, and there was optimism that Russia could turn on the taps again, that would be really hard to achieve. So it’ll be an expensive winter for energy in Europe. But Nordstream doesn’t really impact it all that much. It’s more, say, the long term hopes and expectations for Nordstream.
BFM
Tony, thanks very much for speaking with us. That was Tony Nash, CEO of Complete Intelligence, giving us his take on some of the trends that he sees moving markets in the days and weeks ahead. Really assessing what’s happening over in the UK with the actions by the bank of England overnight. That has helped somewhat to calm the plunge in the pound sterling that we’ve seen over the past few days. I think this pound has rallied, but how long this equilibrium will last, I think, is anyone’s guess.
BFM
Well, this morning pound against ringgate is 5.0260 at the lowest in the last two days, if I’m not wrong, 4.8. Right. So it has truly, truly recovered. But volatile markets ahead, I think still question marks about whether this trust economic policy makes any sense. Confusion over the tax cuts, how they’re going to pay for it, reverberating around global markets because we’ve seen actually global bond yields peak. Question about whether there will be more activities by central banks to intervene, to prop up their currencies or to restore come to their own respective markets, because we saw that in Japan. And apparently even South Korea says it plans to conduct an emergency born buyback program.
BFM
Indeed, we do see also that the yuan is coming under pressure, and China central bank has issued a strongly worded statement to warn against speculation after the currency dropped to its lowest versus the dollar since 2008.
BFM
I love the language. The language is released yesterday. Do not bet on one way appreciation or depreciation of the yarn, as losses will definitely be incurred in the long term. Can’t spell it out more clearly than that, right? Indeed.
BFM
716 in the morning. We’re going to head into some messages. And when we come back, what does long or need more? Another quarry or preservation of its forests? Stay tuned. BFM 89.9 you have been listening to.
We’ve seen so much about oil for rubles, gas for bitcoin, etc this week. Does it represent a fundamental shift for energy markets? And is the dollar dead? The yen fell pretty hard versus the dollar this week. Why is that happening, especially if the dollar is dead? Bonds spike pretty hard this week, especially the 5-year. What’s going on there and what does it mean?
Key themes from last week:
Oil for rubles (death of the Dollar?)
Rapidly depreciating JPY
Hawkish Fed and the soaring 5-year
Key themes for The Week Ahead:
New stimulus coming to help pay for energy. Inflationary?
How hawkish can the Fed go?
What’s ahead for equity markets?
This is the 12th episode of The Week Ahead in collaboration of Complete Intelligence with Intelligence Quarterly, where experts talk about the week that just happened and what will most likely happen in the coming week.
0:00 Start 0:34 CI Futures 1:22 Key themes this week 1:48 Oil for rubles (death of the Dollar?) 3:15 Acceptance of cryptocurrency? 5:34 Petrodollar Petroyuan? 7:32 Rapidly depreciating JPY 10:12 Hawkish Fed and the soaring 5-year 11:58 Housing is done? 13:10 Stimulus for energy 15:53 How hawkish can the Fed go? 17:34 What’s ahead for equity markets?
Transcript
TN: Hi, everyone, and welcome to The Week Ahead. My name is Tony Nash. I’m here with Albert Marko, Sam Rines, and Tracy Shuchart. Before we get started, please, if you can like and subscribe to our YouTube channel, we would really appreciate it.
Also, before we get started, I want to talk a little bit about Complete Intelligence. Complete Intelligence, automates budgeting processes and improves forecasting results for companies globally. CI Futures is our market data and forecast platform. CI Futures forecasts approximately 900 assets across commodities, currencies and equity indices, and a couple of thousand economic variables for the top 50 economies. CI Futures tracks forecast error for accountable performance. Users can see exactly how CI Futures have performed historically with one and three month forward intervals. We’re now offering a special promotion of CI Futures for $50 a month. You can find out more at completeintel.com/promo.
Okay, this week we had a couple of key themes. The first is oil for rubles and somewhat cynically, the death of the dollar. Next is the rapidly depreciating Japanese yen, which is somewhat related to the first. But it’s a big, big story, at least in Asia. We also have the hawkish Fed and the soaring five-year bond. So let’s just jump right into it. Tracy, we’ve seen so much about oil for rubles and Bitcoin and other things over the past week. Can you walk us through it? And is this a fundamental shift in energy markets? Is it desperation on Russia’s behalf? Is the dollar dead? Can you just walk us through those?
TS: All right, so no, the dollar is not dead. First, what people have to realize is that there’s a difference. Oil is still priced in USD. It doesn’t matter the currency that you choose to trade in because you see, in markets, local markets trade gasoline in all currencies. Different partners have traded oil in different currencies. But what it comes down to is it doesn’t matter because oil is still priced in dollars. And even if you trade it in, say, the ruble or the yuan, those are all pegged to the dollar. Right. And so you have to take dollar pricing, transfer it to that currency. And so it really doesn’t matter.
And the currency is used to price oil needs three main factors, liquidity, relative stability, and global acceptability. And right now, USD is the only one that possesses all three characteristics.
TN: Okay, so two different questions here. One is on the acceptance of cryptocurrency. Okay. I think they specifically said Bitcoin. Is that real? Is that happening? And second, if that is happening and maybe, Albert, you can comment on this a little bit, too. Is that simply a way to get the PLA in China to spend their cryptocurrency to fuel their army for cheap? Is that possibly what’s happening there?
TS: It could be. Russia came out and said, we’ll accept Bitcoin from friendly countries. Mostly, they were referring to Hungary and to China. Right. And I don’t think that is a replacement for USD no matter what because not every country except for perhaps China really accepts or El Salvador really accepts Bitcoin or would actually trade in Bitcoin. Right.
TN: In Venezuela, by the way. I think. Right. So on a sovereign basis. Okay. So Sam and Albert, do you guys have anything on there in terms of Bitcoin traded for energy? Do you have any observations there?
AM: No, this is a little bit of… This is even a serious conversation they’re having? With El Salvador going to be like the global hub for Russian oil now because they can use Bitcoin?
TN: That would be really interesting.
AM: But this is just silly talk. Every time there’s some kind of problem geopolitically and they start talking about gold for oil or wine or whatever you want to throw out, they start talking about the US dollar dying and whatnot.
I mean, like Tracy, I don’t want to reiterate what Tracy said, but her three points were correct. On top of that, we’re the only global superpower.
TN: Okay.
AM: That’s it.
SR: Yeah. My two cent is whatever on Bitcoin for a while.
TN: Right.
SR: Cool.
TN: I think that all makes sense now since we’re here because we’re already here because we all hear about the death of the petrodollar and the rise of the petroyuan and all this stuff. So can we go there a little bit? Does this mean that the petrodollar is dead? I know that what you said earlier is all oil is priced in dollars. So that would seem to be at odds with the death of the petrodollar.
AM: Well, Tony, in my perspective, the petrodollar is a relic of the 1970s. Right. Okay. Today it’s the Euro dollar. It’s not the petrodollar that makes the American economy run like God on Earth at the moment. It’s the Euro dollar. Forget about Petro dollar. Right. Because it’s not simply just oil that’s priced in it in dollars. It’s every single piece of commodity globally that’s priced in dollars.
TN: And Albert, just for viewers who may not understand what a Euro dollar is, can you quickly help them understand what a Euro dollar is?
AM: They’re just dollars deposited in overseas banks outside the United States system. That’s all it is.
TN: Okay with that. Very good.
SR: And the global economy runs on them. Full stop.
AM: It’s the blood of the global economy.
TN: So the death of the petrodollar, rise of the petroyuan and all that stuff, we can kind of brush that aside. Is that fair?
TS: Yeah. I mean, even if you look at say, you know, China started their own Yuan contract rights, oil contract and Yuan futures contract. But that still pegged to the price of the Dubai contracts. Right. That are priced in dollars.
TN: Let’s be clear, the CNY and crude are both relative to dollars. Right?
TS: Right.
TN: You have two things that are relative to dollars trying to circumvent dollars to buy that thing. The whole thing is silly.
TS: Exactly.
AM: Yeah, of course. Because Tony, the thing is, if China decides to sell all their dollars and all their trade or whatever, everything they’ve got, they risk hyperinflation. What happens to the Renminbi and then what happens in the world? Contracts trying to get priced right.
TN: Exactly. It’s a good point. Okay. This is a great discussion.
Now, Albert, while we’re on currencies, The Japanese yuan fell pretty hard versus the dollar this week. Do you mind talking through that a little bit and helping us understand what’s going on there?
AM: Yeah, I got a real simple explanation. The Federal Reserve most likely green light in Japan To devalue their yen to be able to show up the manufacturing sector in case China decides to get into a bigger global geopolitical spat with the United States. Simple as that.
TN: Great. Okay. So that’s good. This is really good. And I want people to understand that currencies are very relevant to geopolitics or the other way around. Right. Whenever you see currency movements, there’s typically a geopolitical connection there.
AM: Of course. And on top of that, if it was any other time and they started to devalue the currency like this, the Federal Reserve where the President would start calling the currency manipulators. And there’d be page headlines on the financial times.
TN: Right.
AM: And because that didn’t happen, It’s an automatic signal to me that this is what’s happening at the moment. Right.
What’s also interesting to me, Albert, is we’ve seen last week we saw Japan approach the Saudis and the Emiratis about oil contracts. We saw Japan call. There’s a meeting in Japan next week, I think, with China. So Japan is becoming this kind of foreign policy arm, whether we want to admit it or not, they’re kind of becoming foreign policy arm for the US. Because the US is not well respected right now. Is that fair to say?
AM: It’s more than fair to say, I believe Biden’s conference with South Asian leaders was just canceled on top of everything else.
TS: Sorry. And we saw this week Japan and India just signed, like, a $42 billion trade deal. So it kind of seems like they’re smoothing over the rough edges because the United States kind of came after India a little bit earlier about two weeks ago.
TN: Yeah, that’s a good call, Tracy. I think Japan and India have had a long, positive relationship. It’s especially intensified over the past, say, seven or eight years as China has tried to invest in India and the Japanese have kind of countered them and giving the Indians very favorable terms for investment and for loans. And so this is kind of a second part of that investment that was, I think, announced in, say, 2014 or 2015, something like that. And again, as we talked about it’s, Japan intervening to help the US out and obviously help Japan out at the same time. Thanks for that.
Now, Sam. We saw bonds spike pretty hard this week, especially the five year. I’ve got a Trading View source up there on the five year up on the screen right now. So can you walk us through what’s happening with US bonds right now, especially the five year?
SR: Sure. I mean, it’s pretty straightforward. The Fed is getting very hawkish and the market is adopting it rather quickly. And I don’t know how forcefully to say this. The current assumption coming from city is four straight 50 basis point hikes and then ending the year with just a couple of 25. That is a pretty incredibly fast off zero move time, some quantitative tightening, and you’re somewhere around three and a half percent to 4% worth of tightening in a year. That’s a pretty fast move.
So the two year to five years reflecting that the Fed is moving very quickly, you’re likely having the long end of the curve is lagging a little bit. You saw flattening, not steepening this week. The long end of the curve is telling you that the terminal rate may, in fact, actually be at least somewhat sticky around two and a half and might actually be moving a little bit higher. And that terminal rate is really important because that is how high the Fed can go and then stay there. It is also how fast the Fed can get there and how much above it the Fed is willing to go. So I think there’s a lot of things that happened on the curve this week.
TN: Okay. Albert, what’s in on those? Yes, go ahead, Albert.
AM: Oh, I’ve heard whispers that the long bond is going to 2.8% and maybe even 3%. That’s what the whispers have been telling me about that, which is going to absolutely devastate housing.
TN: But that was my actual idea.
SR: Oh, yeah. Housing is done. I mean, you saw pending home sales were supposed to be up a point and down 4%. That’s the first signal. The next signal will be when lumber goes back to $300.
TN: Okay. It seems to me you’re saying by say Q3 of this year we’re going to see real downside in the housing market. Is that fair to say?
SR: Oh, in Q2, you’re going to see real downside in the housing market. Yeah.
TN: Wow.
SR: Pending sales are, I think, one of the most important indicators of how the housing market is going. Right. It’s a semi forward looking indicator. If you begin to see a whole bunch of these homes in the ground stay as homes that are not being built. Right. So if you begin to see just a bunch of pads out there, it’s going to become a significant problem considering a lot of people have already bought the materials to build it off. And you’re going to begin to have some really interesting spirals that go back into some of the commodity markets that have been on fire on the housing front.
TN: Wow. Okay. That’s a big call. I love this discussion. Okay, good. Okay. So let’s move on to the week ahead. Tracy, we’ve had some stimulus announced to help pay for energy. Can you help us understand? Do you expect we’ve seen California and some other things come out? Are more States going to do this or more countries going to do this, and what does that do to the inflation picture?
TS: Well, absolutely. We saw California, Delaware, Germany, Italy talking about it. Japan already. They’re coming out of the woodwork right now. There’s actually too many to list. It’s just that we’re just now this week just starting to see the US kind of joining this on a state to state basis. The problem is that this is not going to help inflation whatsoever. You’re literally creating more demand and we still do not have the supply online. So all of these policies are going to have the opposite of the intended effect that they are doing. Right. It’s just more stimulus in the market.
TN: Do we think there’s going to be some federal energy stimulus coming?
TS: They’ve talked about different options. I mean, really, the only thing that they could do right now is get rid of the federal excise tax, but that’s only really a few cents. And they kind of don’t want to do that because that goes towards repairing roads, et cetera. That doesn’t fit into their plan that they just passed back in the fall. Right. We had infrastructure plan, so they need to pay for that. That’s already passed. So they probably won’t do that.
The other options that they have that they’re weighing are more SPR release, which is ridiculous at this point because they could release it all and it would still not have a long lasting effect on the market. And that’s our national security. It’s a national security issue. And we’re experiencing all these geopolitical events right now. We have bombs in Saudi Arabia. We’ve got Russia, Ukraine. So I think that’s like a poor move altogether.
TN: So if more States are going to come in, is it suspects like Massachusetts, New York, Illinois, those types of places?
TS: Yes.
TN: Okay. So all inflationary, it’s going in the wrong direction.
TS: It’s going to create demand, which is going to drive oil prices higher because we still don’t have the supply on the market.
TN: Okay. Wow. Thanks for that. Sam. As we look forward, you mentioned a little bit about how hawkish the Fed would be. But what are you looking at say in the bond market for the next week or so? Do we expect more activity there, or do you think we’re kind of stabilizing for now?
SR: We’re going into month end. So I would doubt that we’re going to stabilize in any meaningful way as portfolios either head towards rebalancing or begin to rebalance into quarter end. So I don’t think you’re going to see stabilization. And I think some of the signals might be a little suspect. But I do think back to the housing front. I’m going to be watching how housing stocks react, how the dialogue there really reacts, probably watching lumber very closely, a fairly good indicator of how tight things are or aren’t on the housing front.
And then paying a little bit of attention to what the market is telling us about that terminal rate. If the terminal rate keeps moving higher, to Albert’s point, that’s going to be a big problem for housing, but it’s going to be a big problem for a number of things as we begin to kind of spiral through, what the consequences of that are. It will be for the first time in a very long time.
TN: Okay. So it’s interesting. We have, say, energy commodities rising. We have, say, housing related commodities potentially falling, and we have food commodities rising. Right. It seems like something’s off. Some of it’s shortages based, and some of it is really demand push based. So energy stuff seems to be stimulus based or potentially so some interesting divergence in some of those sectors.
Okay. And then, Albert, what’s ahead for equity markets? We’ve seen equity markets continue to push higher. How much further can they go?
AM: Last week they eliminated, I think, up to about $9 trillion inputs, short squeeze, VIX crush. I mean, they went all out these last two weeks. It’s absolutely stunning. From my calculations, I think they expanded the balance sheet another $150 billion. Forget about this tapering talk. There’s no tapering. They just keep on going. How high can they go? That’s anybody’s guess right now. I think we’re like 6% off all time highs. On no news.
TN: So potentially another 6% higher?
AM: Honestly, I know that there’s hedge funds waiting, salivating at 4650. Just salivating to short it there. So I don’t think they can even get close to that, to be honest with you. So I don’t know, maybe 4590 early in the week before they start coming down.
TN: Okay. Interesting. So you think early next week we’ll see a change in direction?
AM: Yeah, we’re going to have to this has been an epic run, like I said, 90% short squeeze, 10% fixed crush. You don’t see this very often. Okay, Sam, what do you think, Sam? Similar?
SR: On equities, I like going into the rip higher. I’m kind of with Albert, but a little less bearish. I think you chop sideways from here looking for a catalyst in either direction. Bonds ripping higher today, yields ripping higher today. Bond prices plummeting. That I thought was going to be a catalyst for equities to move lower. It wasn’t. That kind of gives me a little bit of pause on being too bearish here, but it’s hard for me to get bullish.
TN: Okay.
TS: What’s interesting? I’ll just throw in like, Bama, weekly flows. We actually saw an outflow from equities for the first time in weeks. It wasn’t a lot 1.9 billion. But that says to me people are getting a little nervous up here. Profit taking, as they say on CNBC.
TN: All right, guys. Hey, thank you very much. Really appreciate the insight. Have a great week ahead.
AM, TS: Thanks.
SR: You too, Tony.
TN: Fabulous. Look. I’m married. I’m a man. I don’t notice anything. I noticed the other guys laughed at that. Uncomfortably. That’s great. Okay. I’m just going to start that over, guys. And we’re going to end it.
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.
