WEBVTT - Matt King Sees a $1 Trillion Liquidity Drain Heading for Markets 0:00:10.119 --> 0:00:13.000 Hello, Odd Lots listeners. We wanted to take a quick 0:00:13.080 --> 0:00:15.560 moment to let you know that this episode of odd 0:00:15.600 --> 0:00:18.800 Lots is a little bit unique. First of all, we 0:00:18.840 --> 0:00:22.720 recorded it on March second, so that's before some of 0:00:22.760 --> 0:00:27.240 this recent turmoil struck. Nonetheless, it remains really relevant because 0:00:27.280 --> 0:00:30.960 it's a discussion in part about how much extra liquidity 0:00:31.000 --> 0:00:32.800 is in the system and how much will we have 0:00:32.960 --> 0:00:37.480 to taken out in order to get inflation back to target. Now, 0:00:37.520 --> 0:00:39.920 our guest Matt King brought a lot of charts to 0:00:40.000 --> 0:00:42.880 show us, and those charts are referenced throughout the conversation. 0:00:43.320 --> 0:00:45.280 So if you want to see those charts and follow 0:00:45.320 --> 0:00:47.440 along with them as you listen, you can find a 0:00:47.440 --> 0:00:51.000 companion article for the episode at Bloomberg dot com slash 0:00:51.040 --> 0:00:53.720 odd Lots, or you can watch a full video version 0:00:53.760 --> 0:00:58.600 of this episode at YouTube dot com slash Bloomberg Podcasts. 0:00:58.600 --> 0:01:03.600 Thank you and enjoy. Hello and welcome to another episode 0:01:03.640 --> 0:01:06.319 of the Odd Thoughts podcast. I'm Tracy Alloway and I'm 0:01:06.400 --> 0:01:10.040 Joe wisnal Joe. It feels like it's been a pretty 0:01:10.040 --> 0:01:13.880 whiplashy start to the year. Yes, it felt like there 0:01:13.959 --> 0:01:17.559 was that moment in February where maybe there were signs 0:01:17.560 --> 0:01:21.080 that inflation was cooling, people were talking about a soft landing, 0:01:21.480 --> 0:01:24.559 and then just a few weeks later we're talking about 0:01:24.640 --> 0:01:28.319 inflation being entrenched. Maybe the Fed has to go even 0:01:28.520 --> 0:01:31.800 harder on the terminal rate. It just feels like it 0:01:31.920 --> 0:01:35.320 changed so quickly. Absolutely, I mean, and I think even 0:01:35.400 --> 0:01:39.039 like January it was still recession watch. So it went 0:01:39.080 --> 0:01:42.520 from recession watch to soft landing to landing to no 0:01:42.720 --> 0:01:47.640 landing overheating fears again. And yeah, quite a lot of 0:01:47.640 --> 0:01:51.120 ambiguity for this short of time into the year. Okay, Well, 0:01:51.280 --> 0:01:55.160 when we have ambiguous macro environments, there was one man 0:01:55.200 --> 0:01:57.800 that we like to turn to an all thoughts favorite, 0:01:58.160 --> 0:02:00.600 and we need to talk to Matt kid Over at 0:02:00.600 --> 0:02:03.919 City Group. Well absolutely, and it's like, okay, has anyone 0:02:04.000 --> 0:02:07.040 gotten the last few years? Right? Completely? No. But the 0:02:07.120 --> 0:02:09.040 last time we talked to Matt was in late twenty 0:02:09.160 --> 0:02:12.040 twenty one, and he said, inflation isn't transitory. It's going 0:02:12.080 --> 0:02:14.880 to be hard. This isn't coming down anytime soon. And 0:02:14.960 --> 0:02:18.280 I think in early twenty twenty three, March twenty twenty three, 0:02:18.320 --> 0:02:21.000 people would say, yeah, that's pretty vindicated. Yeah, I remember 0:02:21.000 --> 0:02:23.960 in that conversation He also talked about the possibility that 0:02:24.000 --> 0:02:26.959 the FED might need to induce a recession to bring 0:02:26.960 --> 0:02:31.200 inflation down, which, again in late twenty twenty one, not conventional, right, 0:02:31.280 --> 0:02:33.720 that was not the consensus. So we need to check 0:02:33.760 --> 0:02:36.399 in with Matt, and I am very happy to say 0:02:36.440 --> 0:02:38.400 that we have him here with us right now. Matt, 0:02:38.440 --> 0:02:40.280 Thank you so much for coming back on our thoughts. 0:02:40.639 --> 0:02:43.680 Thank you very much for inviting me. So how would 0:02:43.680 --> 0:02:47.520 you characterize the current environment? Where are we in this 0:02:47.639 --> 0:02:51.799 sort of macro cycle? I would say that markets are 0:02:51.840 --> 0:02:55.560 still in frul to central bank liquidity to a much 0:02:55.600 --> 0:03:01.359 greater degree than is widely appreciated. That this is contributing 0:03:01.400 --> 0:03:04.639 to the uncertainty about the underlying economic outlook. So, as 0:03:04.680 --> 0:03:06.960 I say, at the central puzzle is, how is it 0:03:07.000 --> 0:03:10.560 that with the inplacent proving stickier than many people imagined, 0:03:12.080 --> 0:03:14.320 and with central banks basically being hawkish on the back 0:03:14.320 --> 0:03:17.360 of that, and with yields and real yields rising again, 0:03:17.400 --> 0:03:19.359 how is it that risk assets are doing so well? 0:03:20.080 --> 0:03:23.080 And most people would say, oh, it's because the economic 0:03:23.120 --> 0:03:25.919 data of surprised positively and the economy is more resilient, 0:03:25.919 --> 0:03:28.079 and maybe we can have this soft landing on the 0:03:28.200 --> 0:03:31.320 landing or whatever, and unfortunately my work puts this in 0:03:31.360 --> 0:03:35.320 a rather different light. For me, the big factor which 0:03:35.360 --> 0:03:38.440 has contributed to the strength of risk assets beneath the 0:03:38.440 --> 0:03:41.200 surface is the way in which even as the central 0:03:41.200 --> 0:03:42.840 banks have told us that they're going to be doing qt, 0:03:43.480 --> 0:03:45.960 actually when you look at the details, they've ended up 0:03:46.000 --> 0:03:48.800 doing QE. They've injected over the last three months a 0:03:48.920 --> 0:03:53.640 trillion dollars of liquidity and on my framework, that equates 0:03:53.720 --> 0:03:58.280 very directly into ten percent directly on equities, and the 0:03:58.360 --> 0:03:59.920 moment that you think of it in those terms, it 0:04:00.160 --> 0:04:04.200 just puts the whole outlook in a very different light. 0:04:04.440 --> 0:04:07.240 Can you explain what is the mechanism bro which you 0:04:07.280 --> 0:04:10.680 would say central banks are still adding to liquidity, because 0:04:10.720 --> 0:04:13.000 of course we know we're in one of the huge 0:04:13.560 --> 0:04:16.040 historic hiking cycle, not just in the US but elsewhere. 0:04:16.279 --> 0:04:19.719 What is actually going on this liquidity expansion? So the 0:04:19.720 --> 0:04:22.760 main thing that I look at is reserves or changes 0:04:22.800 --> 0:04:26.159 in reserves on central bank balance sheets, and the main 0:04:26.320 --> 0:04:28.640 mechanism I think as at work here is the portfolio 0:04:28.640 --> 0:04:31.400 balance effect or how much money have we given to 0:04:32.000 --> 0:04:34.359 the private sector in the form of reserves or deposits. 0:04:34.400 --> 0:04:37.720 But its reserves that correlates best relative to how many 0:04:37.760 --> 0:04:41.920 securities are available to absorb that, and it's actually at 0:04:41.920 --> 0:04:43.960 the FAT in particular, where over the last couple of 0:04:44.000 --> 0:04:47.279 years it's become really apparent that changes in reserves correlate 0:04:47.400 --> 0:04:51.839 much better with changes in risk than looking at securities, 0:04:51.839 --> 0:04:53.640 which is made of the obvious way of doing this, 0:04:53.880 --> 0:04:57.040 And I think the underlying explanation is that money growth 0:04:57.040 --> 0:05:00.760 has always been important for markets, but over the last 0:05:00.839 --> 0:05:04.960 decade changes in money growth have just come overwhelmingly from 0:05:05.040 --> 0:05:07.599 often technical changes on central bank balancies. When the FED 0:05:07.680 --> 0:05:09.880 or other central banks are adding all withdrawing four or 0:05:09.880 --> 0:05:12.120 five hundred billion dollars of liquidity, sometimes even in a 0:05:12.120 --> 0:05:14.640 single week, there's nothing the private sector is doing on 0:05:14.760 --> 0:05:17.280 anything like that scale, and so it has this outsized 0:05:17.279 --> 0:05:20.320 impact on markets. Well, just on that note, talk to 0:05:20.440 --> 0:05:23.919 us about where the liquidity it has been coming from, 0:05:24.000 --> 0:05:26.920 because I think, as you mentioned, most people when they 0:05:26.920 --> 0:05:28.919 think about central banks at the moment, are going to 0:05:29.160 --> 0:05:32.239 be thinking about balance sheet reduction. The FED has said 0:05:32.279 --> 0:05:35.479 that it's started QT, although clearly there's a lot of 0:05:35.480 --> 0:05:38.640 disagreement about whether or not it practically has, and in 0:05:38.720 --> 0:05:41.279 other parts of the world central banks have been raising 0:05:41.360 --> 0:05:45.800 rates and withdrawing liquidity, so where is that access coming from? 0:05:46.480 --> 0:05:48.840 So this gets quite geeky quite quickly, but I think 0:05:48.839 --> 0:05:54.200 it's the most okay. So roughly, depending a little bit 0:05:54.200 --> 0:05:57.600 on when you measure it, this trillion dollars has come 0:05:57.760 --> 0:05:59.920 about two hundred and fifty billion dollars from the BOG, 0:06:00.040 --> 0:06:03.039 about four hundred and fifty billion dollars again depending on 0:06:03.040 --> 0:06:07.640 when we measure it from the PBOC, and about three 0:06:07.680 --> 0:06:10.839 hundred billion dollars also from the ECB. In addition, the 0:06:10.960 --> 0:06:14.760 FED was draining liquidity and reducing reserves last year and 0:06:14.920 --> 0:06:17.320 this year, even as the QT has continued and securities 0:06:17.320 --> 0:06:20.279 have been coming down, reserves have not actually been falling. 0:06:20.279 --> 0:06:22.720 So the fence contribution is technically zero. But again, as 0:06:22.720 --> 0:06:26.320 you said, say, that's surprising when notionally they're doing QT. 0:06:26.760 --> 0:06:28.480 And each of these has its own story, and I'm 0:06:28.520 --> 0:06:31.359 probably more confident in the framework than I am in 0:06:31.360 --> 0:06:33.480 the outlet, but when you start talking at trillion dollars 0:06:33.480 --> 0:06:36.960 over three months, it just has this massive impact on markets. 0:06:37.000 --> 0:06:41.000 How has the FED been doing QT, continued with its 0:06:41.080 --> 0:06:44.479 quantitative tightening, and yet in twenty twenty three we haven't 0:06:44.480 --> 0:06:48.839 seen the decline and reserved in the US. So the 0:06:49.000 --> 0:06:51.840 way that I tend to analyze all of this is 0:06:53.400 --> 0:06:59.279 almost just empirically, what correlates best with markets, and specifically 0:06:59.279 --> 0:07:01.800 what's been going on is the change in reserves. The 0:07:01.839 --> 0:07:05.039 FED in particular is influenced by not only the change 0:07:05.040 --> 0:07:07.880 in securities what most people think of as QT, but 0:07:08.080 --> 0:07:10.680 also the change in the Treasury General account whether you 0:07:10.720 --> 0:07:12.680 as treasury deposits money at the FED, and the change 0:07:12.680 --> 0:07:16.840 in RRP, where money market funds deposit money at the FED. 0:07:17.240 --> 0:07:21.239 And it's actually even reasonably intuitive as to why both 0:07:21.240 --> 0:07:24.560 of the have an impact. So if, for example, the 0:07:24.600 --> 0:07:26.640 Treasury is issuing a lot more bills and you take 0:07:26.680 --> 0:07:29.200 money from your bank account to go and buy those bills, 0:07:29.240 --> 0:07:31.600 but then they don't send you a stimulus check, or 0:07:31.640 --> 0:07:34.120 they don't spend the money in the real economy paying 0:07:34.160 --> 0:07:36.760 employees or whatever, and they just lock the money away 0:07:36.760 --> 0:07:39.280 on the FED balance sheet, well that's kind of like QT. 0:07:39.520 --> 0:07:42.360 The private sector has got less money. There are more 0:07:42.440 --> 0:07:46.080 securities needing to be absorbed in markets, And empirically what 0:07:46.120 --> 0:07:49.640 we observe is that in periods where that's happening, like 0:07:49.800 --> 0:07:53.240 January February last year and April May last year, securities 0:07:53.280 --> 0:07:56.440 may or may not be going down, but is reserves 0:07:56.520 --> 0:08:00.960 full risk trades off. What we've had this year, or 0:08:01.000 --> 0:08:03.240 in fact over the last six months or so is 0:08:03.280 --> 0:08:07.000 that even as securities have continued to roll off, that 0:08:07.200 --> 0:08:11.280 impact has been offset by declines in the Treasury General 0:08:11.280 --> 0:08:14.520 Account and then to a lesser extent by declines or 0:08:14.560 --> 0:08:18.200 moves in RRP. That means that even as the FED 0:08:18.280 --> 0:08:21.720 has nationally been typing and reducing the balance sheet, actually 0:08:21.760 --> 0:08:24.960 in terms of what matters for markets, it hasn't. And 0:08:25.600 --> 0:08:28.080 what we've seen over the last few months is, whereas 0:08:28.160 --> 0:08:30.520 last year you could explain almost everything that was going 0:08:30.560 --> 0:08:33.160 on in terms of the FED balance sheet and only 0:08:33.200 --> 0:08:35.920 the FED balance sheet, what's become relevant over the last 0:08:35.920 --> 0:08:39.480 three months is to look at equivalent processes going on elsewhere. 0:08:56.320 --> 0:08:59.679 He mentioned the portfolio substitution effects, and I think when 0:08:59.720 --> 0:09:02.880 we talk about the impact of liquidity on markets, it's 0:09:02.920 --> 0:09:07.360 sort of like an abstract thing, and could you maybe 0:09:07.480 --> 0:09:10.720 explain to us, like in detail, what is the process 0:09:10.760 --> 0:09:14.000 by which a liquidity injection And I suppose it will 0:09:14.000 --> 0:09:16.559 depend on the form, but like, what is the process 0:09:16.600 --> 0:09:20.199 by which that gets transformed? Into a greater bid for 0:09:20.400 --> 0:09:26.199 risk assets. So I do all of this empirically by 0:09:27.000 --> 0:09:32.640 looking at what correlates effectively with market moves and everything 0:09:32.679 --> 0:09:36.080 I've observed, and I tend to work with the theory afterwards. 0:09:36.080 --> 0:09:37.640 But I do think there's a unifying theory, and as 0:09:37.640 --> 0:09:40.880 I say, it's basically portfolio bounds. But everything I've observed 0:09:40.960 --> 0:09:43.520 over the last decade or so where quee has dominated 0:09:43.960 --> 0:09:46.680 all of my underlying fundamental relationships that used to work, 0:09:47.640 --> 0:09:50.200 suggests more or less the opposite mechanism from what you 0:09:50.200 --> 0:09:51.880 hear from the central banks. So there was a lovely 0:09:51.920 --> 0:09:54.839 article by Bill Dudley on Bloomboad just the other day saying, oh, 0:09:54.880 --> 0:09:58.839 it's the level of the reserves that matters, and this 0:09:59.000 --> 0:10:03.440 all this money change is irrelevant, And on everything I 0:10:03.480 --> 0:10:06.920 see from markets, my chart suggests the opposite is the flow, 0:10:06.960 --> 0:10:10.160 it's the changes. Similarly, the central banks tend to assume 0:10:10.160 --> 0:10:12.360 once they've announced it it's in the price, and instead 0:10:12.400 --> 0:10:14.840 I find it's only as the liquidity hits the marketer 0:10:14.920 --> 0:10:16.960 or is with born from markets, that we see incapable 0:10:17.000 --> 0:10:19.240 of pricing it. In the central banks always look for 0:10:19.280 --> 0:10:21.880 an impact on government bond yields and think in terms 0:10:21.920 --> 0:10:24.920 of reducing duration from bond markets, and then everyone updates 0:10:24.920 --> 0:10:28.120 their dividend discount model with a new estimate for the SMP. 0:10:28.400 --> 0:10:30.160 That's not what I think is going on at all. 0:10:30.640 --> 0:10:33.599 For me, it's all of it. It's kind of simpler 0:10:33.600 --> 0:10:38.680 and cruder, and it's really about this balance between how 0:10:38.760 --> 0:10:42.400 much money has the private sector got relative to how 0:10:42.400 --> 0:10:46.240 many assets are available to absorb that money. And when 0:10:46.360 --> 0:10:50.560 say the treasury or another private borrower borrows in markets, yeah, 0:10:50.559 --> 0:10:52.720 that creates some bonds or some bills that somebody needs 0:10:52.760 --> 0:10:55.280 to buy, But if they spend that money in the 0:10:55.320 --> 0:10:58.560 real economy, that kind of nets out. It's closer to 0:10:58.600 --> 0:11:01.560 being self funding the people imagine. And in fact, that 0:11:01.640 --> 0:11:04.000 process of money creation is the system gains assets and 0:11:04.120 --> 0:11:08.760 liabilities is associated with risk on que though is kind 0:11:08.800 --> 0:11:13.360 of doubly powerful because it simultaneously gives the private sector 0:11:13.679 --> 0:11:16.359 more money in the form of reserves or bank deposits 0:11:16.720 --> 0:11:21.240 and deprives them of the safe assets like t bills 0:11:21.320 --> 0:11:25.359 or bonds to go out and investing, and crowds investors 0:11:25.400 --> 0:11:28.720 into riskier assets as a result. And it's sort of 0:11:29.040 --> 0:11:31.719 unsatisfying in a way because you can't see all these 0:11:31.760 --> 0:11:33.760 moving parts. I think what goes on is the guy 0:11:33.760 --> 0:11:35.319 that would have bought bills by his bonds, the guy 0:11:35.320 --> 0:11:37.480 that would have bought bonds bys ig credit, that would 0:11:37.520 --> 0:11:40.760 have bought ig heal, and so on. You can't see 0:11:40.760 --> 0:11:43.960 all of those moving parts. But this helps to explain 0:11:44.160 --> 0:11:47.319 what is otherwise a significant puzzle, which is how can 0:11:47.360 --> 0:11:50.880 I have all these lovely charts that point to strong relationships, 0:11:51.000 --> 0:11:54.160 but it's always between queue and risk assets and equities 0:11:54.160 --> 0:11:57.560 and credit spreads, even though all of the action is 0:11:58.080 --> 0:12:00.320 mostly in treasuries and government bonds around the world. I 0:12:00.400 --> 0:12:02.920 like this daisy chain. It's like someone buys the bill 0:12:02.960 --> 0:12:05.880 buyer buys bonds, the bond buyer buyers treasury is, the 0:12:05.960 --> 0:12:09.520 treasury buyer buys corporates, the corporate buyer buys junk, the 0:12:09.600 --> 0:12:12.360 junk buyer buys stock, and the stock buyer buys doge coin. 0:12:12.559 --> 0:12:15.679 And that is like the It's like that little domino meme, right, 0:12:15.720 --> 0:12:18.559 It's like that slight change that's some dgen way out 0:12:18.600 --> 0:12:21.439 at the end of the chain is like buying crypto. 0:12:21.520 --> 0:12:26.199 But here's my question. Listen, just since you mentioned that, ironically, 0:12:26.320 --> 0:12:29.680 the best correlations I find of all are exactly with 0:12:29.920 --> 0:12:33.520 the most popular assets like cryptocurrency. You'll like test la 0:12:33.559 --> 0:12:36.800 stop for example. It's just amazing how it shows up 0:12:36.840 --> 0:12:39.079 there in the in the hottest assets, even though the 0:12:39.120 --> 0:12:42.120 correlation applies more broadly too. But let me just ask 0:12:42.200 --> 0:12:45.480 you why there isn't a simpler answer to all of this, 0:12:45.559 --> 0:12:47.520 because I'm just looking, you know, I can look at 0:12:47.800 --> 0:12:50.559 the SMP, or I can look at the relationship between 0:12:50.640 --> 0:12:54.560 QQQ and the SMP. You know, something that's more hibta 0:12:54.880 --> 0:12:58.079 And in Q four of twenty twenty two, we got 0:12:58.080 --> 0:13:01.640 a string of pretty encouraging inflation prints that said, ah, 0:13:01.679 --> 0:13:05.040 it's finally happening. Lots of people saying, yes, it is 0:13:05.080 --> 0:13:09.079 finally coming down, a lot of confidence from the Fed disinflation. 0:13:09.240 --> 0:13:12.080 We can feel confident that the inflationary process has peaked. 0:13:12.559 --> 0:13:15.280 And then in the last you know, the for you know, 0:13:15.960 --> 0:13:19.240 after starting in the middle of January, people started saying, no, 0:13:19.320 --> 0:13:21.400 maybe it hasn't. And we're starting to see some upward 0:13:21.440 --> 0:13:24.360 surprise and used car prices, and we're starting to see 0:13:24.400 --> 0:13:28.280 some ongoing firm dison rents, etc. And why is that 0:13:28.440 --> 0:13:33.080 real activity not a sort of useful way, because that 0:13:33.120 --> 0:13:37.640 would seem to my mind, also explain the trajective risk assets, 0:13:37.640 --> 0:13:40.000 this fact that inflation is not coming down the way 0:13:40.040 --> 0:13:42.560 we might have thought in Q four twenty twenty two. 0:13:43.360 --> 0:13:47.200 I agree that that's probably part of the explanation. But 0:13:47.280 --> 0:13:51.360 if fundamentals were as strong a driver as people traditionally think, 0:13:51.760 --> 0:13:54.160 all my stupid charts with central bank balance, she shouldn't 0:13:54.160 --> 0:13:57.679 work at all, and instead so they are most of 0:13:57.720 --> 0:14:01.040 them all right, Sorry, sorry to keep going like they 0:14:01.080 --> 0:14:03.960 were better than most of the fundamentals. Other ways of 0:14:04.080 --> 0:14:07.600 saying it are when we look at the moment, the 0:14:07.679 --> 0:14:11.360 economic surprises on the city economic surprise indicies, yes, are 0:14:11.440 --> 0:14:14.559 very very positive, but the economic data changes are not. 0:14:14.920 --> 0:14:17.080 You know, we've raised our growth forecast globally by by 0:14:17.120 --> 0:14:19.200 thirty basis points, but it's still to one of the 0:14:19.200 --> 0:14:21.160 lowest levels two point two percent, one of the lowest 0:14:21.200 --> 0:14:24.720 levels over the last forty years. Is that really enough 0:14:24.760 --> 0:14:27.280 to make you super excited to put back? It might 0:14:27.320 --> 0:14:28.960 be if I thought that we were going to if 0:14:28.960 --> 0:14:30.760 I thought two months ago that we were staring down 0:14:30.800 --> 0:14:35.280 the barrel of a hard landing. Yes, true, But the 0:14:35.320 --> 0:14:37.080 sort of explanation people normally come up with this all 0:14:37.120 --> 0:14:39.120 the central banks are being really dovish, and then you 0:14:39.160 --> 0:14:41.280 have power and the guards saying no, we're not being devish. 0:14:41.280 --> 0:14:42.960 We're going to stay the course because the most important 0:14:43.000 --> 0:14:46.040 thing is inflation. You just get to disconnect if you 0:14:46.120 --> 0:14:48.800 try and explain it in those terms. And I think 0:14:48.800 --> 0:14:50.400 what people are trying to do is they're trying to 0:14:50.480 --> 0:14:55.680 retrofit fundamental explanations to price action that was actually driven 0:14:55.680 --> 0:15:00.320 by these technicals. So your contention is that the that 0:15:00.360 --> 0:15:03.560 we've seen recently doesn't really have anything to do with 0:15:03.600 --> 0:15:07.360 what's been happening in the real economy, as evidenced by 0:15:07.480 --> 0:15:10.720 the collapse in private money. But if you look at 0:15:10.800 --> 0:15:13.720 what's going on with public money i e. Central bank 0:15:13.720 --> 0:15:17.040 balance sheets and things like that, the correlation is much stronger. 0:15:18.160 --> 0:15:22.840 That puts it slightly too strongly. But yes, okay, basically okay. 0:15:23.040 --> 0:15:27.160 So one thing like I was kind of wondering just 0:15:27.520 --> 0:15:30.920 on this topic is if you look at China, I mean, 0:15:31.080 --> 0:15:36.600 China is currently a place that wants to stimulate I guess, 0:15:36.640 --> 0:15:40.720 but seems to be having a hard time convincing private 0:15:40.760 --> 0:15:44.360 companies to actually go out and borrow. Can you talk 0:15:44.400 --> 0:15:46.640 a little bit more about what you're seeing there? I 0:15:46.680 --> 0:15:49.720 think that's a very good description of it. So we 0:15:50.720 --> 0:15:54.400 debate this because the Chinese, the cridity injection in December 0:15:54.520 --> 0:15:56.720 was so large, they've been a little bit late publishing 0:15:56.720 --> 0:15:59.960 the January number. But as you say, what we see 0:16:00.280 --> 0:16:02.080 and have seen over the last few months is normally 0:16:02.080 --> 0:16:04.360 at this time of year we're falling off our chairs 0:16:04.360 --> 0:16:06.640 with the sheer magnitude of the total social financing them 0:16:06.640 --> 0:16:08.760 as the broad credit us in China. And what we've 0:16:08.760 --> 0:16:11.160 seen the last few months is actually total social financing 0:16:11.160 --> 0:16:14.560 in particular has been really quite disappointing. Even M two, 0:16:14.560 --> 0:16:17.200 where growth has been of its struggle has not been 0:16:17.840 --> 0:16:21.600 not surprised to the upside. And I think for me 0:16:21.680 --> 0:16:25.200 this is part of a broader story that has maybe 0:16:25.240 --> 0:16:28.680 two legs. The first of them is that what we've 0:16:28.800 --> 0:16:32.360 seen over an extended period, I mean literally decades, is 0:16:32.640 --> 0:16:36.720 one economy after another kind of getting saturated with debt, 0:16:36.880 --> 0:16:39.160 even as it's been cheap to borrow. So Japan drove 0:16:39.200 --> 0:16:41.280 the world borring until nineteen ninety. Since then they haven't 0:16:41.320 --> 0:16:43.480 wanted to do much. US and Europe drove the world's 0:16:43.480 --> 0:16:45.400 boring until two thousand and eight. Since then, the private 0:16:45.400 --> 0:16:47.520 sector hasn't wanted to do much on What they're doing 0:16:47.560 --> 0:16:50.040 is often for share buybacks, and that's where China is 0:16:50.040 --> 0:16:52.200 stepped in. But even in China recently, it feels as 0:16:52.200 --> 0:16:54.960 though you're kind of getting this saturation where it's the 0:16:55.040 --> 0:16:58.200 state run banks lending to the state owned enterprises rather 0:16:58.240 --> 0:17:00.080 than as you say, the private sector of ball and 0:17:00.200 --> 0:17:03.720 oroughly wanting to borrow. In addition, what we tend to 0:17:04.320 --> 0:17:09.280 feel is that even as the authorities are intervening and 0:17:09.920 --> 0:17:13.159 providing support and injecting liquidity to banks at the moment, 0:17:13.720 --> 0:17:16.040 it's not that they want a new investment and real 0:17:16.160 --> 0:17:18.760 estate driven boom in the same way as they've targeted 0:17:18.760 --> 0:17:21.719 in the past. Instead, they're trying to achieve the rebalancing 0:17:21.760 --> 0:17:24.200 to all the consumer that they always wanted. And as 0:17:24.240 --> 0:17:27.000 a result, you see that kind of relative disappointment in 0:17:27.040 --> 0:17:29.399 the broad credit metrics and in the credit impulse. The 0:17:29.480 --> 0:17:32.280 implications for things like commodities and the rest of the 0:17:32.320 --> 0:17:34.240 world are much less positive than they have been in 0:17:34.240 --> 0:17:37.400 previous investment lad booms. Consumer related stuff we still see 0:17:37.400 --> 0:17:39.880 the positive, and things like China equities we still see 0:17:39.880 --> 0:17:42.320 the positive. But if what I care about is those 0:17:42.359 --> 0:17:46.000 credit numbers, it all feels a bit more halfhearted than 0:17:46.040 --> 0:17:48.199 we used to perhaps in the past. And even as 0:17:48.200 --> 0:17:51.600 there's been some narrow liquidity injections on the central bank 0:17:51.640 --> 0:17:54.640 balance sheet recently, again it feels to us as though 0:17:54.680 --> 0:17:56.600 those have been a bit extraordinary and it would be 0:17:56.640 --> 0:17:59.240 a mistake to extrapolate them through the rest of this year. 0:17:59.400 --> 0:18:02.680 So this era of large bank central bank balance sheets, 0:18:02.720 --> 0:18:04.440 I mean, it really started in the wake of the 0:18:04.480 --> 0:18:08.040 Great Financial Crisis, and all the central banks cut rates 0:18:08.040 --> 0:18:10.399 to zero, could not cut further, and so had to 0:18:10.480 --> 0:18:14.199 use balance sheet activities to compensate for their inability to 0:18:14.200 --> 0:18:16.920 cut rates any further. By large, they didn't want to 0:18:16.960 --> 0:18:20.240 go negative. But the reversal of that sowenty twenty. You know, 0:18:20.320 --> 0:18:22.920 we saw some reversal of that in the mid twenty 0:18:23.000 --> 0:18:26.000 tens when the rate hikes and the quantitative tightening. Then 0:18:26.200 --> 0:18:28.879 we're seeing the reversal of that. Now you've been talking 0:18:28.880 --> 0:18:31.639 about what the trajectory is a balance sheet, what is 0:18:31.680 --> 0:18:34.719 the role of the tightening, because Okay, yes, it's true, 0:18:34.800 --> 0:18:37.639 as you point out that in some cases bank balance 0:18:37.680 --> 0:18:39.960 sheet central bank balance sheets still are growing, but we 0:18:40.000 --> 0:18:41.960 do know that they're all tightening, and that part has 0:18:42.080 --> 0:18:45.120 not really changed. What is the rate effect and how 0:18:45.160 --> 0:18:47.159 does that affect either markets or what we see in 0:18:47.160 --> 0:18:51.520 the real economy. So this is unclear and I have 0:18:51.640 --> 0:18:55.800 a very different view from the central banks and traditional economists. 0:18:56.240 --> 0:18:59.679 And this comes back to what I was saying about 0:19:01.080 --> 0:19:05.360 versus level and Mervin King has been doing some nice 0:19:05.400 --> 0:19:08.480 talks for city clients where he actually echoes the points 0:19:08.480 --> 0:19:13.800 that I'm making about the flows of money being important. 0:19:14.080 --> 0:19:19.640 So in the central bank models, not only is inflation 0:19:19.680 --> 0:19:25.240 potentially self reinforcing, but also the level of rates almost mechanically, 0:19:25.280 --> 0:19:28.320 without looking at flows of money, growth is thought to 0:19:28.320 --> 0:19:30.480 translate through into inflation. And never mind that over the 0:19:30.560 --> 0:19:33.600 last decade until recently, that didn't seem to be happening. Again, 0:19:33.640 --> 0:19:37.840 they don't have money growth or a did financial markets 0:19:37.840 --> 0:19:41.600 more broadly, and therefore again it's the rate levels, which 0:19:41.640 --> 0:19:45.960 for them are super important. And the way I think 0:19:46.000 --> 0:19:49.639 about it is instead, no, that low level of rates 0:19:49.800 --> 0:19:53.159 counts only if it dry, if it stimulates somebody to borrow, 0:19:53.480 --> 0:19:56.720 and even when it comes to them and things like unemployment. Again, 0:19:56.720 --> 0:19:59.520 it's the changes that are actually more associated with recessions 0:19:59.680 --> 0:20:02.960 rather than the levels in themselves. And while I'm open 0:20:03.040 --> 0:20:06.400 to the possibility that actually there is now more momentum 0:20:06.400 --> 0:20:08.760 in the economy because of green investment or some of 0:20:08.760 --> 0:20:10.919 the other things that people are speculating about as drivers 0:20:10.920 --> 0:20:13.760 of an increase in our star. In general, I don't 0:20:13.800 --> 0:20:16.920 see that. What money growth I did see as often 0:20:16.920 --> 0:20:20.760 defensive stuff like credit card borrowing, and seems now to 0:20:20.800 --> 0:20:23.119 be reducing being killed off by the rises in rates. 0:20:23.400 --> 0:20:26.399 The bank lending surveys are all showing tightening, And my 0:20:26.600 --> 0:20:30.280 general impression is that actually, while the M two and 0:20:30.320 --> 0:20:34.560 the M three numbers may exaggerate the tendency and the 0:20:34.680 --> 0:20:37.359 negativity because to some extent those are influenced by QT, 0:20:38.160 --> 0:20:42.000 in general, i'd say central banks and economies assume that 0:20:42.040 --> 0:20:45.679 there is a momentum there which would have been the 0:20:45.720 --> 0:20:47.959 case in the past when it was the private sector 0:20:48.280 --> 0:20:50.760 driving the money growth because rates were too low and 0:20:50.760 --> 0:20:52.760 they had a great investment idea or whatever. And this 0:20:52.880 --> 0:20:55.080 time around, while we had the bigger surge of money 0:20:55.119 --> 0:20:57.600 growth since the Second World War, it never came from 0:20:57.600 --> 0:20:59.720 the private sector. It came from the fiscal students. It 0:20:59.760 --> 0:21:02.240 came in the que that had already been turned off 0:21:02.560 --> 0:21:05.600 even before the rate hikes started, and all this to 0:21:05.720 --> 0:21:08.520 my mind, points to the risk of overtightening. I'm not 0:21:08.600 --> 0:21:13.199 convinced that there is this super strong momentum which the 0:21:13.520 --> 0:21:16.520 central banks tend to assume, and yet they're in a 0:21:16.560 --> 0:21:18.760 really difficult place because the lags are so long, and 0:21:18.800 --> 0:21:21.600 it becomes really it's almost impossible to tell the difference 0:21:21.640 --> 0:21:26.160 between a two year lag on inflation and then converse 0:21:26.359 --> 0:21:30.040 relative to money growth and then conversely, Oh, a genuine 0:21:30.119 --> 0:21:32.560 d anchoring and decoupling, especially when you claim that the 0:21:32.760 --> 0:21:35.679 inflation transitory to begin with, and then we're disappointed that 0:21:35.720 --> 0:21:38.200 it took longer to go away than you thought. This 0:21:38.280 --> 0:21:40.160 was going to be my next question on the long 0:21:40.240 --> 0:21:43.560 and variable lags. But talk to us, like, what evidence 0:21:43.720 --> 0:21:48.480 are you seeing right now of higher interest rates impacting 0:21:48.640 --> 0:21:51.359 not markets but the real economy, And what are you 0:21:51.480 --> 0:21:55.679 looking for in terms of signs or evidence that they 0:21:55.720 --> 0:21:58.359