Speaker 1: Hello, Odd Lots listeners. We wanted to take a quick
Speaker 1: moment to let you know that this episode of odd
Speaker 1: Lots is a little bit unique. First of all, we
Speaker 1: recorded it on March second, so that's before some of
Speaker 1: this recent turmoil struck. Nonetheless, it remains really relevant because
Speaker 1: it's a discussion in part about how much extra liquidity
Speaker 1: is in the system and how much will we have
Speaker 1: to taken out in order to get inflation back to target. Now,
Speaker 1: our guest Matt King brought a lot of charts to
Speaker 1: show us, and those charts are referenced throughout the conversation.
Speaker 1: So if you want to see those charts and follow
Speaker 1: along with them as you listen, you can find a
Speaker 1: companion article for the episode at Bloomberg dot com slash
Speaker 1: odd Lots, or you can watch a full video version
Speaker 1: of this episode at YouTube dot com slash Bloomberg Podcasts.
Speaker 1: Thank you and enjoy. Hello and welcome to another episode
Speaker 1: of the Odd Thoughts podcast. I'm Tracy Alloway and I'm
Speaker 1: Joe wisnal Joe. It feels like it's been a pretty
Speaker 1: whiplashy start to the year. Yes, it felt like there
Speaker 1: was that moment in February where maybe there were signs
Speaker 1: that inflation was cooling, people were talking about a soft landing,
Speaker 1: and then just a few weeks later we're talking about
Speaker 1: inflation being entrenched. Maybe the Fed has to go even
Speaker 1: harder on the terminal rate. It just feels like it
Speaker 1: changed so quickly. Absolutely, I mean, and I think even
Speaker 1: like January it was still recession watch. So it went
Speaker 1: from recession watch to soft landing to landing to no
Speaker 1: landing overheating fears again. And yeah, quite a lot of
Speaker 1: ambiguity for this short of time into the year. Okay, Well,
Speaker 1: when we have ambiguous macro environments, there was one man
Speaker 1: that we like to turn to an all thoughts favorite,
Speaker 1: and we need to talk to Matt kid Over at
Speaker 1: City Group. Well absolutely, and it's like, okay, has anyone
Speaker 1: gotten the last few years? Right? Completely? No. But the
Speaker 1: last time we talked to Matt was in late twenty
Speaker 1: twenty one, and he said, inflation isn't transitory. It's going
Speaker 1: to be hard. This isn't coming down anytime soon. And
Speaker 1: I think in early twenty twenty three, March twenty twenty three,
Speaker 1: people would say, yeah, that's pretty vindicated. Yeah, I remember
Speaker 1: in that conversation He also talked about the possibility that
Speaker 1: the FED might need to induce a recession to bring
Speaker 1: inflation down, which, again in late twenty twenty one, not conventional, right,
Speaker 1: that was not the consensus. So we need to check
Speaker 1: in with Matt, and I am very happy to say
Speaker 1: that we have him here with us right now. Matt,
Speaker 1: Thank you so much for coming back on our thoughts.
Speaker 1: Thank you very much for inviting me. So how would
Speaker 1: you characterize the current environment? Where are we in this
Speaker 1: sort of macro cycle? I would say that markets are
Speaker 1: still in frul to central bank liquidity to a much
Speaker 1: greater degree than is widely appreciated. That this is contributing
Speaker 1: to the uncertainty about the underlying economic outlook. So, as
Speaker 1: I say, at the central puzzle is, how is it
Speaker 1: that with the inplacent proving stickier than many people imagined,
Speaker 1: and with central banks basically being hawkish on the back
Speaker 1: of that, and with yields and real yields rising again,
Speaker 1: how is it that risk assets are doing so well?
Speaker 1: And most people would say, oh, it's because the economic
Speaker 1: data of surprised positively and the economy is more resilient,
Speaker 1: and maybe we can have this soft landing on the
Speaker 1: landing or whatever, and unfortunately my work puts this in
Speaker 1: a rather different light. For me, the big factor which
Speaker 1: has contributed to the strength of risk assets beneath the
Speaker 1: surface is the way in which even as the central
Speaker 1: banks have told us that they're going to be doing qt,
Speaker 1: actually when you look at the details, they've ended up
Speaker 1: doing QE. They've injected over the last three months a
Speaker 1: trillion dollars of liquidity and on my framework, that equates
Speaker 1: very directly into ten percent directly on equities, and the
Speaker 1: moment that you think of it in those terms, it
Speaker 1: just puts the whole outlook in a very different light.
Speaker 1: Can you explain what is the mechanism bro which you
Speaker 1: would say central banks are still adding to liquidity, because
Speaker 1: of course we know we're in one of the huge
Speaker 1: historic hiking cycle, not just in the US but elsewhere.
Speaker 1: What is actually going on this liquidity expansion? So the
Speaker 1: main thing that I look at is reserves or changes
Speaker 1: in reserves on central bank balance sheets, and the main
Speaker 1: mechanism I think as at work here is the portfolio
Speaker 1: balance effect or how much money have we given to
Speaker 1: the private sector in the form of reserves or deposits.
Speaker 1: But its reserves that correlates best relative to how many
Speaker 1: securities are available to absorb that, and it's actually at
Speaker 1: the FAT in particular, where over the last couple of
Speaker 1: years it's become really apparent that changes in reserves correlate
Speaker 1: much better with changes in risk than looking at securities,
Speaker 1: which is made of the obvious way of doing this,
Speaker 1: And I think the underlying explanation is that money growth
Speaker 1: has always been important for markets, but over the last
Speaker 1: decade changes in money growth have just come overwhelmingly from
Speaker 1: often technical changes on central bank balancies. When the FED
Speaker 1: or other central banks are adding all withdrawing four or
Speaker 1: five hundred billion dollars of liquidity, sometimes even in a
Speaker 1: single week, there's nothing the private sector is doing on
Speaker 1: anything like that scale, and so it has this outsized
Speaker 1: impact on markets. Well, just on that note, talk to
Speaker 1: us about where the liquidity it has been coming from,
Speaker 1: because I think, as you mentioned, most people when they
Speaker 1: think about central banks at the moment, are going to
Speaker 1: be thinking about balance sheet reduction. The FED has said
Speaker 1: that it's started QT, although clearly there's a lot of
Speaker 1: disagreement about whether or not it practically has, and in
Speaker 1: other parts of the world central banks have been raising
Speaker 1: rates and withdrawing liquidity, so where is that access coming from?
Speaker 1: So this gets quite geeky quite quickly, but I think
Speaker 1: it's the most okay. So roughly, depending a little bit
Speaker 1: on when you measure it, this trillion dollars has come
Speaker 1: about two hundred and fifty billion dollars from the BOG,
Speaker 1: about four hundred and fifty billion dollars again depending on
Speaker 1: when we measure it from the PBOC, and about three
Speaker 1: hundred billion dollars also from the ECB. In addition, the
Speaker 1: FED was draining liquidity and reducing reserves last year and
Speaker 1: this year, even as the QT has continued and securities
Speaker 1: have been coming down, reserves have not actually been falling.
Speaker 1: So the fence contribution is technically zero. But again, as
Speaker 1: you said, say, that's surprising when notionally they're doing QT.
Speaker 1: And each of these has its own story, and I'm
Speaker 1: probably more confident in the framework than I am in
Speaker 1: the outlet, but when you start talking at trillion dollars
Speaker 1: over three months, it just has this massive impact on markets.
Speaker 1: How has the FED been doing QT, continued with its
Speaker 1: quantitative tightening, and yet in twenty twenty three we haven't
Speaker 1: seen the decline and reserved in the US. So the
Speaker 1: way that I tend to analyze all of this is
Speaker 1: almost just empirically, what correlates best with markets, and specifically
Speaker 1: what's been going on is the change in reserves. The
Speaker 1: FED in particular is influenced by not only the change
Speaker 1: in securities what most people think of as QT, but
Speaker 1: also the change in the Treasury General account whether you
Speaker 1: as treasury deposits money at the FED, and the change
Speaker 1: in RRP, where money market funds deposit money at the FED.
Speaker 1: And it's actually even reasonably intuitive as to why both
Speaker 1: of the have an impact. So if, for example, the
Speaker 1: Treasury is issuing a lot more bills and you take
Speaker 1: money from your bank account to go and buy those bills,
Speaker 1: but then they don't send you a stimulus check, or
Speaker 1: they don't spend the money in the real economy paying
Speaker 1: employees or whatever, and they just lock the money away
Speaker 1: on the FED balance sheet, well that's kind of like QT.
Speaker 1: The private sector has got less money. There are more
Speaker 1: securities needing to be absorbed in markets, And empirically what
Speaker 1: we observe is that in periods where that's happening, like
Speaker 1: January February last year and April May last year, securities
Speaker 1: may or may not be going down, but is reserves
Speaker 1: full risk trades off. What we've had this year, or
Speaker 1: in fact over the last six months or so is
Speaker 1: that even as securities have continued to roll off, that
Speaker 1: impact has been offset by declines in the Treasury General
Speaker 1: Account and then to a lesser extent by declines or
Speaker 1: moves in RRP. That means that even as the FED
Speaker 1: has nationally been typing and reducing the balance sheet, actually
Speaker 1: in terms of what matters for markets, it hasn't. And
Speaker 1: what we've seen over the last few months is, whereas
Speaker 1: last year you could explain almost everything that was going
Speaker 1: on in terms of the FED balance sheet and only
Speaker 1: the FED balance sheet, what's become relevant over the last
Speaker 1: three months is to look at equivalent processes going on elsewhere.
Speaker 1: He mentioned the portfolio substitution effects, and I think when
Speaker 1: we talk about the impact of liquidity on markets, it's
Speaker 1: sort of like an abstract thing, and could you maybe
Speaker 1: explain to us, like in detail, what is the process
Speaker 1: by which a liquidity injection And I suppose it will
Speaker 1: depend on the form, but like, what is the process
Speaker 1: by which that gets transformed? Into a greater bid for
Speaker 1: risk assets. So I do all of this empirically by
Speaker 1: looking at what correlates effectively with market moves and everything
Speaker 1: I've observed, and I tend to work with the theory afterwards.
Speaker 1: But I do think there's a unifying theory, and as
Speaker 1: I say, it's basically portfolio bounds. But everything I've observed
Speaker 1: over the last decade or so where quee has dominated
Speaker 1: all of my underlying fundamental relationships that used to work,
Speaker 1: suggests more or less the opposite mechanism from what you
Speaker 1: hear from the central banks. So there was a lovely
Speaker 1: article by Bill Dudley on Bloomboad just the other day saying, oh,
Speaker 1: it's the level of the reserves that matters, and this
Speaker 1: all this money change is irrelevant, And on everything I
Speaker 1: see from markets, my chart suggests the opposite is the flow,
Speaker 1: it's the changes. Similarly, the central banks tend to assume
Speaker 1: once they've announced it it's in the price, and instead
Speaker 1: I find it's only as the liquidity hits the marketer
Speaker 1: or is with born from markets, that we see incapable
Speaker 1: of pricing it. In the central banks always look for
Speaker 1: an impact on government bond yields and think in terms
Speaker 1: of reducing duration from bond markets, and then everyone updates
Speaker 1: their dividend discount model with a new estimate for the SMP.
Speaker 1: That's not what I think is going on at all.
Speaker 1: For me, it's all of it. It's kind of simpler
Speaker 1: and cruder, and it's really about this balance between how
Speaker 1: much money has the private sector got relative to how
Speaker 1: many assets are available to absorb that money. And when
Speaker 1: say the treasury or another private borrower borrows in markets, yeah,
Speaker 1: that creates some bonds or some bills that somebody needs
Speaker 1: to buy, But if they spend that money in the
Speaker 1: real economy, that kind of nets out. It's closer to
Speaker 1: being self funding the people imagine. And in fact, that
Speaker 1: process of money creation is the system gains assets and
Speaker 1: liabilities is associated with risk on que though is kind
Speaker 1: of doubly powerful because it simultaneously gives the private sector
Speaker 1: more money in the form of reserves or bank deposits
Speaker 1: and deprives them of the safe assets like t bills
Speaker 1: or bonds to go out and investing, and crowds investors
Speaker 1: into riskier assets as a result. And it's sort of
Speaker 1: unsatisfying in a way because you can't see all these
Speaker 1: moving parts. I think what goes on is the guy
Speaker 1: that would have bought bills by his bonds, the guy
Speaker 1: that would have bought bonds bys ig credit, that would
Speaker 1: have bought ig heal, and so on. You can't see
Speaker 1: all of those moving parts. But this helps to explain
Speaker 1: what is otherwise a significant puzzle, which is how can
Speaker 1: I have all these lovely charts that point to strong relationships,
Speaker 1: but it's always between queue and risk assets and equities
Speaker 1: and credit spreads, even though all of the action is
Speaker 1: mostly in treasuries and government bonds around the world. I
Speaker 1: like this daisy chain. It's like someone buys the bill
Speaker 1: buyer buys bonds, the bond buyer buyers treasury is, the
Speaker 1: treasury buyer buys corporates, the corporate buyer buys junk, the
Speaker 1: junk buyer buys stock, and the stock buyer buys doge coin.
Speaker 1: And that is like the It's like that little domino meme, right,
Speaker 1: It's like that slight change that's some dgen way out
Speaker 1: at the end of the chain is like buying crypto.
Speaker 1: But here's my question. Listen, just since you mentioned that, ironically,
Speaker 1: the best correlations I find of all are exactly with
Speaker 1: the most popular assets like cryptocurrency. You'll like test la
Speaker 1: stop for example. It's just amazing how it shows up
Speaker 1: there in the in the hottest assets, even though the
Speaker 1: correlation applies more broadly too. But let me just ask
Speaker 1: you why there isn't a simpler answer to all of this,
Speaker 1: because I'm just looking, you know, I can look at
Speaker 1: the SMP, or I can look at the relationship between
Speaker 1: QQQ and the SMP. You know, something that's more hibta
Speaker 1: And in Q four of twenty twenty two, we got
Speaker 1: a string of pretty encouraging inflation prints that said, ah,
Speaker 1: it's finally happening. Lots of people saying, yes, it is
Speaker 1: finally coming down, a lot of confidence from the Fed disinflation.
Speaker 1: We can feel confident that the inflationary process has peaked.
Speaker 1: And then in the last you know, the for you know,
Speaker 1: after starting in the middle of January, people started saying, no,
Speaker 1: maybe it hasn't. And we're starting to see some upward
Speaker 1: surprise and used car prices, and we're starting to see
Speaker 1: some ongoing firm dison rents, etc. And why is that
Speaker 1: real activity not a sort of useful way, because that
Speaker 1: would seem to my mind, also explain the trajective risk assets,
Speaker 1: this fact that inflation is not coming down the way
Speaker 1: we might have thought in Q four twenty twenty two.
Speaker 1: I agree that that's probably part of the explanation. But
Speaker 1: if fundamentals were as strong a driver as people traditionally think,
Speaker 1: all my stupid charts with central bank balance, she shouldn't
Speaker 1: work at all, and instead so they are most of
Speaker 1: them all right, Sorry, sorry to keep going like they
Speaker 1: were better than most of the fundamentals. Other ways of
Speaker 1: saying it are when we look at the moment, the
Speaker 1: economic surprises on the city economic surprise indicies, yes, are
Speaker 1: very very positive, but the economic data changes are not.
Speaker 1: You know, we've raised our growth forecast globally by by
Speaker 1: thirty basis points, but it's still to one of the
Speaker 1: lowest levels two point two percent, one of the lowest
Speaker 1: levels over the last forty years. Is that really enough
Speaker 1: to make you super excited to put back? It might
Speaker 1: be if I thought that we were going to if
Speaker 1: I thought two months ago that we were staring down
Speaker 1: the barrel of a hard landing. Yes, true, But the
Speaker 1: sort of explanation people normally come up with this all
Speaker 1: the central banks are being really dovish, and then you
Speaker 1: have power and the guards saying no, we're not being devish.
Speaker 1: We're going to stay the course because the most important
Speaker 1: thing is inflation. You just get to disconnect if you
Speaker 1: try and explain it in those terms. And I think
Speaker 1: what people are trying to do is they're trying to
Speaker 1: retrofit fundamental explanations to price action that was actually driven
Speaker 1: by these technicals. So your contention is that the that
Speaker 1: we've seen recently doesn't really have anything to do with
Speaker 1: what's been happening in the real economy, as evidenced by
Speaker 1: the collapse in private money. But if you look at
Speaker 1: what's going on with public money i e. Central bank
Speaker 1: balance sheets and things like that, the correlation is much stronger.
Speaker 1: That puts it slightly too strongly. But yes, okay, basically okay.
Speaker 1: So one thing like I was kind of wondering just
Speaker 1: on this topic is if you look at China, I mean,
Speaker 1: China is currently a place that wants to stimulate I guess,
Speaker 1: but seems to be having a hard time convincing private
Speaker 1: companies to actually go out and borrow. Can you talk
Speaker 1: a little bit more about what you're seeing there? I
Speaker 1: think that's a very good description of it. So we
Speaker 1: debate this because the Chinese, the cridity injection in December
Speaker 1: was so large, they've been a little bit late publishing
Speaker 1: the January number. But as you say, what we see
Speaker 1: and have seen over the last few months is normally
Speaker 1: at this time of year we're falling off our chairs
Speaker 1: with the sheer magnitude of the total social financing them
Speaker 1: as the broad credit us in China. And what we've
Speaker 1: seen the last few months is actually total social financing
Speaker 1: in particular has been really quite disappointing. Even M two,
Speaker 1: where growth has been of its struggle has not been
Speaker 1: not surprised to the upside. And I think for me
Speaker 1: this is part of a broader story that has maybe
Speaker 1: two legs. The first of them is that what we've
Speaker 1: seen over an extended period, I mean literally decades, is
Speaker 1: one economy after another kind of getting saturated with debt,
Speaker 1: even as it's been cheap to borrow. So Japan drove
Speaker 1: the world borring until nineteen ninety. Since then they haven't
Speaker 1: wanted to do much. US and Europe drove the world's
Speaker 1: boring until two thousand and eight. Since then, the private
Speaker 1: sector hasn't wanted to do much on What they're doing
Speaker 1: is often for share buybacks, and that's where China is
Speaker 1: stepped in. But even in China recently, it feels as
Speaker 1: though you're kind of getting this saturation where it's the
Speaker 1: state run banks lending to the state owned enterprises rather
Speaker 1: than as you say, the private sector of ball and
Speaker 1: oroughly wanting to borrow. In addition, what we tend to
Speaker 1: feel is that even as the authorities are intervening and
Speaker 1: providing support and injecting liquidity to banks at the moment,
Speaker 1: it's not that they want a new investment and real
Speaker 1: estate driven boom in the same way as they've targeted
Speaker 1: in the past. Instead, they're trying to achieve the rebalancing
Speaker 1: to all the consumer that they always wanted. And as
Speaker 1: a result, you see that kind of relative disappointment in
Speaker 1: the broad credit metrics and in the credit impulse. The
Speaker 1: implications for things like commodities and the rest of the
Speaker 1: world are much less positive than they have been in
Speaker 1: previous investment lad booms. Consumer related stuff we still see
Speaker 1: the positive, and things like China equities we still see
Speaker 1: the positive. But if what I care about is those
Speaker 1: credit numbers, it all feels a bit more halfhearted than
Speaker 1: we used to perhaps in the past. And even as
Speaker 1: there's been some narrow liquidity injections on the central bank
Speaker 1: balance sheet recently, again it feels to us as though
Speaker 1: those have been a bit extraordinary and it would be
Speaker 1: a mistake to extrapolate them through the rest of this year.
Speaker 1: So this era of large bank central bank balance sheets,
Speaker 1: I mean, it really started in the wake of the
Speaker 1: Great Financial Crisis, and all the central banks cut rates
Speaker 1: to zero, could not cut further, and so had to
Speaker 1: use balance sheet activities to compensate for their inability to
Speaker 1: cut rates any further. By large, they didn't want to
Speaker 1: go negative. But the reversal of that sowenty twenty. You know,
Speaker 1: we saw some reversal of that in the mid twenty
Speaker 1: tens when the rate hikes and the quantitative tightening. Then
Speaker 1: we're seeing the reversal of that. Now you've been talking
Speaker 1: about what the trajectory is a balance sheet, what is
Speaker 1: the role of the tightening, because Okay, yes, it's true,
Speaker 1: as you point out that in some cases bank balance
Speaker 1: sheet central bank balance sheets still are growing, but we
Speaker 1: do know that they're all tightening, and that part has
Speaker 1: not really changed. What is the rate effect and how
Speaker 1: does that affect either markets or what we see in
Speaker 1: the real economy. So this is unclear and I have
Speaker 1: a very different view from the central banks and traditional economists.
Speaker 1: And this comes back to what I was saying about
Speaker 1: versus level and Mervin King has been doing some nice
Speaker 1: talks for city clients where he actually echoes the points
Speaker 1: that I'm making about the flows of money being important.
Speaker 1: So in the central bank models, not only is inflation
Speaker 1: potentially self reinforcing, but also the level of rates almost mechanically,
Speaker 1: without looking at flows of money, growth is thought to
Speaker 1: translate through into inflation. And never mind that over the
Speaker 1: last decade until recently, that didn't seem to be happening. Again,
Speaker 1: they don't have money growth or a did financial markets
Speaker 1: more broadly, and therefore again it's the rate levels, which
Speaker 1: for them are super important. And the way I think
Speaker 1: about it is instead, no, that low level of rates
Speaker 1: counts only if it dry, if it stimulates somebody to borrow,
Speaker 1: and even when it comes to them and things like unemployment. Again,
Speaker 1: it's the changes that are actually more associated with recessions
Speaker 1: rather than the levels in themselves. And while I'm open
Speaker 1: to the possibility that actually there is now more momentum
Speaker 1: in the economy because of green investment or some of
Speaker 1: the other things that people are speculating about as drivers
Speaker 1: of an increase in our star. In general, I don't
Speaker 1: see that. What money growth I did see as often
Speaker 1: defensive stuff like credit card borrowing, and seems now to
Speaker 1: be reducing being killed off by the rises in rates.
Speaker 1: The bank lending surveys are all showing tightening, And my
Speaker 1: general impression is that actually, while the M two and
Speaker 1: the M three numbers may exaggerate the tendency and the
Speaker 1: negativity because to some extent those are influenced by QT,
Speaker 1: in general, i'd say central banks and economies assume that
Speaker 1: there is a momentum there which would have been the
Speaker 1: case in the past when it was the private sector
Speaker 1: driving the money growth because rates were too low and
Speaker 1: they had a great investment idea or whatever. And this
Speaker 1: time around, while we had the bigger surge of money
Speaker 1: growth since the Second World War, it never came from
Speaker 1: the private sector. It came from the fiscal students. It
Speaker 1: came in the que that had already been turned off
Speaker 1: even before the rate hikes started, and all this to
Speaker 1: my mind, points to the risk of overtightening. I'm not
Speaker 1: convinced that there is this super strong momentum which the
Speaker 1: central banks tend to assume, and yet they're in a
Speaker 1: really difficult place because the lags are so long, and
Speaker 1: it becomes really it's almost impossible to tell the difference
Speaker 1: between a two year lag on inflation and then converse
Speaker 1: relative to money growth and then conversely, Oh, a genuine
Speaker 1: d anchoring and decoupling, especially when you claim that the
Speaker 1: inflation transitory to begin with, and then we're disappointed that
Speaker 1: it took longer to go away than you thought. This
Speaker 1: was going to be my next question on the long
Speaker 1: and variable lags. But talk to us, like, what evidence
Speaker 1: are you seeing right now of higher interest rates impacting
Speaker 1: not markets but the real economy, And what are you
Speaker 1: looking for in terms of signs or evidence that they
Speaker 1: are in fact having an effect in many respects. This
Speaker 1: is hard because those lags are long, and also because
Speaker 1: there's been so much turning out of debt in recent
Speaker 1: years that makes it kind of difficult to tell. So
Speaker 1: let me answer that a different way. Some of that
Speaker 1: I lead to our economists, and you were seeing weakness
Speaker 1: a housing market, and then in the US housing market
Speaker 1: is re strength and you're still getting weakness in other places.
Speaker 1: But let me maybe answer onto this a different way.
Speaker 1: So one of the puzzles of the last few cycles,
Speaker 1: in twenty eighteen in particular, is that in general, it's
Speaker 1: taken lower and lower levels of real yields to kind
Speaker 1: of end each cycle until now, and each time what
Speaker 1: caused the pivot was effectively dysfunction in financial markets threatening
Speaker 1: to feed through into the economy. And each time there's
Speaker 1: been more debt into the system. And maybe there's that's
Speaker 1: part of the explanation as to why it was a
Speaker 1: lower rate each time, And in twenty eighteen to nineteen
Speaker 1: in particular, it's not the case that anyone was running
Speaker 1: around saying, oh I can't roll my corporate debt or
Speaker 1: oh I can't pay my mortgage. Instead, what you had
Speaker 1: was weakness in equities and the weakness in the housing
Speaker 1: market threatening to feed through into something broader. And it
Speaker 1: was that that coupled with broad of his about deflation,
Speaker 1: which allowed the FED to pivot relatively rapidly. Now this
Speaker 1: time around, we haven't had that to anything like the
Speaker 1: same extent. Again, we've seen this year. In particularly last year,
Speaker 1: we had an orderly sell up infant markets. This year
Speaker 1: we're rebounding. But you get this debate as is the
Speaker 1: recession postponed or invoided entirely. And while there are some
Speaker 1: signs of more ongoing momentum in the US consumer in particular,
Speaker 1: perhaps than I had imagined previously, in my economists have
Speaker 1: had a better call on that, I'm still deeply suspicious
Speaker 1: that a lot of the exuminents in markets has come
Speaker 1: because of this stealth que from the global central banks.
Speaker 1: And then in addition, it's just that the lags are
Speaker 1: long before you see that equity markets are correcting downwards
Speaker 1: and house prices are correcting downwards, and then the stock
Speaker 1: of eating accumulated savings begins to diminish. And the main
Speaker 1: thing that would convince me that I'm wrong on all
Speaker 1: of this is if we saw a significant upturn in
Speaker 1: the loan growth numbers, in the money growth numbers, and
Speaker 1: it looked resilient, and that's not what I'm seeing, and
Speaker 1: so and so. There's a similar debate with respect to
Speaker 1: when I speak to corporates themselves. Yes, everyone's having difficulty
Speaker 1: recruiting workers in hotels, and restaurants in particular. And yes,
Speaker 1: there's this pent up demand for things that weren't possible
Speaker 1: during lockdowns. But the question I keep coming back to
Speaker 1: is are the corporates saying we need to build more
Speaker 1: hotels and restaurants? Again? Is there this longer term demand?
Speaker 1: And I'm not nearly as convinced as many people are
Speaker 1: that everything has turned around as much as people like Ian.
Speaker 1: Maybe some of the backstory here, if I may, is
Speaker 1: I think again, this difference between how I think about
Speaker 1: it and how the central banks think about it. So
Speaker 1: the central banks are really embarrassed because while everyone has
Speaker 1: had difficulty forecasting inflation, Oh it's a hair chart, It's
Speaker 1: a Medusa chart. I love that exactly, the hedgehogs over
Speaker 1: there form fines. So not only have they been surprised
Speaker 1: by the inflation being higher than they expected over the
Speaker 1: last couple of years, but of course for the preceding decade, yeah,
Speaker 1: they kept expecting more inflation and then there was less.
Speaker 1: And so they're really having to scratch their heads and say,
Speaker 1: what is it that's turned one hundred and eighty degrees
Speaker 1: and caused our models to go, you know, wrongly in
Speaker 1: one direction in this is it direct. This is one
Speaker 1: of the themes that I'm going back to, this idea
Speaker 1: of like the twenty twenties being the inverse twenty tens
Speaker 1: and that hair chart, hedgehog Medusa chart what have you
Speaker 1: is a good example. It's like, first, you have a
Speaker 1: decade of perennially over your your your inflation expectations being
Speaker 1: perennially over optimistic or too high, and then maybe what
Speaker 1: are we going to have. It's possible that we have
Speaker 1: a decade now of continuing to expect that inflation will
Speaker 1: come down sooner, you know, I want to go back.
Speaker 1: And seems like part of this debate is and the
Speaker 1: sort of the variability of the long and variable legs
Speaker 1: impact on en And it feels like the fat is
Speaker 1: the belief that these lags are much shorter that there
Speaker 1: used to be. The instantaneous financial market effects reflect the speech.
Speaker 1: Paul gives a speech, even if he doesn't raise rates,
Speaker 1: then it all reprices and then the actual rate rises
Speaker 1: are a mirror formality after that. And it sounds like
Speaker 1: from your point of view, it's like the actually you
Speaker 1: still have these long lags because of things like well,
Speaker 1: how companies turned out their debt, and eventually they are
Speaker 1: going to have to roll them over, even if they
Speaker 1: haven't yet. And when that rollover happened, there will be
Speaker 1: a kick up in their interest costs and that will
Speaker 1: create a burden on investment. So it sort of sounds
Speaker 1: like that's where the tension is in your view is
Speaker 1: simply no, there really are still long and variable lagged
Speaker 1: all these rate hikes that we saw in twenty twenty two,
Speaker 1: their impact is still coming. Basically, yes, maybe I have
Speaker 1: a particular view there. I'm not an economist, I'm a strategist,
Speaker 1: and so for me, asset price inflation and CPI inflation
Speaker 1: have always been two sides of the same coin. Now
Speaker 1: this central banks gave up on money growth in the
Speaker 1: eighties and nineties when they said, all there's lots of
Speaker 1: money growth, but there's hardly any inflation. Our job is
Speaker 1: to control CPI inflation. So this money growth thing is
Speaker 1: useless and let's stop using it, or in the FEDS case,
Speaker 1: you can stop measuring some of the metrics they ran previously.
Speaker 1: And for me, though, and I think virtually anyone in
Speaker 1: financial markets, it's kind of obvious what went on. We
Speaker 1: had asset price inflation instead, and those correlations that break
Speaker 1: down with money growth. Even if you build quite crude
Speaker 1: models where you put together asset price inflation and CPI inflation,
Speaker 1: there's correlations that break down with CPI inflation. They basically
Speaker 1: carry on. And so for me, what we're seeing is,
Speaker 1: as you say, not this drastic, drastic turnaround where something
Speaker 1: you know, the globalization shifting to deglobalization and long and
Speaker 1: persistent inflation instead. For me, no, it's just these long
Speaker 1: time lags, and there's a very clear pattern. It's that
Speaker 1: the Surgeon money growth showed up first in asset price inflation,
Speaker 1: then in goods price inflation, now in services inflation, and
Speaker 1: yes in things like wage growth. But the lags are
Speaker 1: long enough that it's really difficult to tell whether this
Speaker 1: is genuinely persistent. Let me ask it a double advocate question.
Speaker 1: Could the correlation go the other direction and where it's
Speaker 1: the surgeon asset prices creating the surge in monetary aggregates.
Speaker 1: And the reason I ask that is because there are
Speaker 1: models of the economy, more managers and bank lenders, etc.
Speaker 1: Look at the price, and I'm going to be more
Speaker 1: likely to make a mortgage loan if I feel like
Speaker 1: this is an ear where house prices are going up,
Speaker 1: I'm going to be more likely to approve a business
Speaker 1: loan if this is an err where stock prices are
Speaker 1: going up and the company is likely to be able
Speaker 1: to tap the equity market. Could it be that some
Speaker 1: of these charts, which do seem to show a compelling
Speaker 1: relationship go from assets first to money supply next. You
Speaker 1: are certainly right that the relationship often works both ways.
Speaker 1: It's not only the credit growth stimulates the housing market,
Speaker 1: it's also the the buoyant housing market encourages more credit growth.
Speaker 1: But if it only worked that way, then this chart
Speaker 1: shouldn't work. Then I shouldn't be able to find a
Speaker 1: really nice relationship going back to the early nineteen hundreds
Speaker 1: where the money growth in the US links through to
Speaker 1: real estate, but with about a one and a half
Speaker 1: year leg. So, yes, you're right, that's part of it.
Speaker 1: But for me, money growth is still the best driver.
Speaker 1: And to come back to this question of lags, it's
Speaker 1: reasonably short when I look at things like the equity market,
Speaker 1: especially now that central banks are driving it. But the
Speaker 1: link to real estate is about one and a half years.
Speaker 1: The link to commodities prices is about one and a
Speaker 1: half years. The link to CPI is harder to tell
Speaker 1: because the relationship is weaker, but as far as I
Speaker 1: can see, it's something like a two year lag. Now
Speaker 1: that puts the FED in a terribly difficult spot because
Speaker 1: you're not going to see the impact of even the
Speaker 1: first rate ikes until late April twenty twenty four, never
Speaker 1: mind the hikes that you're doing at the moment. You know, Matt,
Speaker 1: you emphasized that you are indeed a strategist and not
Speaker 1: an economist, and on this podcast you're you're somewhat famous
Speaker 1: for the sort of flows before pros idea, this idea
Speaker 1: that you know, for many years post financial crisis, it
Speaker 1: made sense to just follow the money and never mind
Speaker 1: whether valuations were reasonable or not. If we assume that
Speaker 1: liquidity does have a big impact on markets, which you
Speaker 1: argue it does, and if it does seem like all
Speaker 1: these one off, sort of stealth liquidity injections are now
Speaker 1: going away, what should investors do here just flee on
Speaker 1: mass or what would be your recommendation? Actually, the outlook
Speaker 1: for the various liquidity factors is complicated. For all of them.
Speaker 1: The surge feels as though it's been extraordinary. There is
Speaker 1: a lot of debate as to just have a negative
Speaker 1: or at least positive they all become on balance, though, Yes,
Speaker 1: what I think we have seen is an extraordinary three months. Yes,
Speaker 1: that's left equity and especially riskier credit valuations at levels
Speaker 1: where I don't like chasing them at this point, especially
Speaker 1: for the more expensive equities, which is still the tech
Speaker 1: sector and the growth sector. And still the US are
Speaker 1: relative to the likes of Europe. If we want risk
Speaker 1: on positions, we would tend to do them through currencies
Speaker 1: or reversus dollar, or through regional preferences European versus US equities,
Speaker 1: or maybe you can say the same thing about China.
Speaker 1: But yes, you're right. The biggest problem that we see
Speaker 1: generally is that for every individual asset class that considered
Speaker 1: in isolation, might seem sort of attractive, what really matters
Speaker 1: is is that the valuation relative to money market farm is,
Speaker 1: especially in dollars, and so you know, IG credit, for example,
Speaker 1: has some the best fields available for the last decade,
Speaker 1: but actually the pickup relative to money market funds or
Speaker 1: deposits is actually the lowest it's been in multiple decades,
Speaker 1: and so that does argue for significantly increased allocations to
Speaker 1: cash and cash equivalents exactly those things which were basically
Speaker 1: uninvestable over the last decade. All right, well, Matt, we're
Speaker 1: going to have to leave it there, but it was
Speaker 1: fantastic having you on the show once again. Really appreciate it, Joe.
Speaker 1: You know what I just realized. Tell me the last
Speaker 1: time we spoke to Matt, I think we ended the
Speaker 1: discussion by saying that we wished that we had a
Speaker 1: video product because during the conversation Matt was bringing up
Speaker 1: all these different charts and showing them. So now we're
Speaker 1: finally able to do it and show off some of
Speaker 1: the So if you just listened to this episode on
Speaker 1: up Apple or Spotify or something like that, go to
Speaker 1: you find this on YouTube where if we had the
Speaker 1: charts that he was bringing up during our conversation, we're
Speaker 1: going to have a video or we're also going to
Speaker 1: write a post with some of the charts, or as
Speaker 1: many of the charts as possible, so you can read
Speaker 1: a story about this with all the charts. Because I
Speaker 1: love the way talking to Matt, how he brings up
Speaker 1: all his charts in real time. It's very fun. Yeah,
Speaker 1: and the charts are excellent, especially the hair charts, which
Speaker 1: I can never get enough of. But I do think
Speaker 1: he hits on something. You know, this overall feeling in
Speaker 1: the market at the moment, which is it does feel
Speaker 1: a little uncomfortable that we still have this overarching question
Speaker 1: of is inflation coming down? Yeah, our central Bank's going
Speaker 1: to have to go harder. I mean people are talking
Speaker 1: about terminal rates at like six point five percent now,
Speaker 1: which seems extreme, and you would think that would have
Speaker 1: more of an impact on asset prices. Yeah, I mean
Speaker 1: it is really striking. I mean it's still you know,
Speaker 1: the fundamental story still seems like it explains something, especially
Speaker 1: like setting aside what markets have done in twenty twenty three,
Speaker 1: as you talked about in the intro, a lot of
Speaker 1: people have gotten suddenly anxious about the overheating and so
Speaker 1: you see it if today we're recording this ten year
Speaker 1: back above four percent, etc. But on the other hand,
Speaker 1: he's right, and one of the charts he showed during
Speaker 1: the conversation specifically had the title of like monetorism has
Speaker 1: gone out of fashion and he's coming back and at
Speaker 1: one hundred percent true. The out of fashion part, I
Speaker 1: think especially in the twenty tens. Yeah, no one was
Speaker 1: talking like M two and all that stuff. And so
Speaker 1: then the question is does this become once again as
Speaker 1: sort of like the eighties, like the Vulcan Era, or
Speaker 1: these monetary aggregates become a sort of like central focus
Speaker 1: for how investors view the economy bringing back M two. Yeah,
Speaker 1: let's do it. It is true though, that you can
Speaker 1: have both things, right. You can have you can have
Speaker 1: technicals that are a tailwind for risk assets and also
Speaker 1: have fundamentals that so far because of the long and
Speaker 1: variable lags that Matt was also laying out like pretty strong.
Speaker 1: Its traces look pretty good to me. All right, shall
Speaker 1: we leave it there? Let's leave it there. This has
Speaker 1: been another episode of the Old Blots podcast. I'm Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway and
Speaker 1: I'm Joe Why Isn't All? You can follow me on
Speaker 1: Twitter at the Stalwart. Follow our producers on Twitter, Carmen
Speaker 1: Rodriguez at Carmen Arman and Dash Bennett at Dashbot. Follow
Speaker 1: all of our podcasts at Bloomberg under the handle at podcasts,
Speaker 1: and for more Oblots content, go to Bloomberg dot com,
Speaker 1: slash oddlots, or we post the transcripts. In this case,
Speaker 1: we're going to post the charts as well. We are
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Speaker 1: Thanks for listening.