Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe Joe. Happy parody day
Speaker 1: to you. So I looked I actually got a little
Speaker 1: late this morning at five am instead of four, But
Speaker 1: I don't think it did. It quite exactly hit a dollar.
Speaker 1: I saw the ambiguity. It looked like the low on
Speaker 1: the terminal was like euro one zero zero zero zero
Speaker 1: zero zero zero one or something. And then I saw
Speaker 1: others posted I don't know. It's sad that we work
Speaker 1: for a gigantic financial data company and we can't figure
Speaker 1: this out. I thought it did. I'm pretty sure it did,
Speaker 1: very very briefly. Um, but let's just you know, even
Speaker 1: if it hasn't actually hit parody today, we're recording this
Speaker 1: on July twelve. It seems like it's going to any moment.
Speaker 1: And I got to say the fact that we're recording
Speaker 1: this episode though, probably means that this is marketing the peak, right. Yeah,
Speaker 1: So of course when this episode comes out, it's going
Speaker 1: to be the peak of the dollar, because that's how
Speaker 1: it works. Nonetheless, yes, euro has come very close to
Speaker 1: parody with the dollar. De facto parody. The dollar itself
Speaker 1: is just like incredibly strong. It might even be you know,
Speaker 1: obviously inflation and the trajectory of inflation is sort of
Speaker 1: this huge variable question for the economy. But in terms
Speaker 1: of like maybe the defining market story right now has
Speaker 1: just been this incredible strength of the US dollar, which
Speaker 1: all kinds of different ramification exactly. So setting aside what
Speaker 1: happens to the Euro, you cannot argue with the fact
Speaker 1: that we have had this broad based dollar strength. You know,
Speaker 1: there's some irony that, of course everyone's talking about the
Speaker 1: end of the world, and we recorded episodes about how
Speaker 1: the Russia Ukraine conflict and the sanctions mean that the
Speaker 1: dollar is going to fall out of favor in the
Speaker 1: global financial system. And yet the immediate knee jerk reaction
Speaker 1: to the world falling apart is dollar strength. It almost
Speaker 1: always is, yeah, right, because in the end, in the
Speaker 1: good times, you never really have to pay your bills.
Speaker 1: You just sort of roll over your debts or you
Speaker 1: don't worry about that or your flesh with money. In
Speaker 1: the bad times, you're like, oh, how am I going
Speaker 1: to pay my bills? I can't pay my bill is
Speaker 1: probably in bitcoin. I can't pay my bills and shares
Speaker 1: of Tesla. I can't pay my bills in you know,
Speaker 1: shares of arc or whatever. What I do is I
Speaker 1: need dollars. So everyone scrambles for dollars and they get
Speaker 1: more expensive. Right, so the dollar is basically a play
Speaker 1: on risk appetite at this point. But I guess the
Speaker 1: ultimate irony This is the second time I brought up
Speaker 1: irony so far. Ultimate The ultimate ultimate irony is that
Speaker 1: when everyone's worried about the future of the economy, the
Speaker 1: dollar tends to strengthen, and then the dollar strengthening actually
Speaker 1: has a negative impact on the global economy, and so
Speaker 1: you can get the situation where it becomes a self
Speaker 1: fulfilling cycle. The dollar doom loop is what some people
Speaker 1: have called it, Yeah, a feedback loop. But if you're
Speaker 1: a Germany and you're already sort of like moving from
Speaker 1: this huge current account surplus to current account deficit largely
Speaker 1: due to the surging price of energy, and then obviously
Speaker 1: everything becomes even more expensive now, especially things price and
Speaker 1: dollars or invoice in dollars, and so yeah, you can
Speaker 1: have this sort of doom loop where the strength of
Speaker 1: the dollar even further puts the squeeze on different players.
Speaker 1: So without further ado, to talk about the doom loop
Speaker 1: and more broadly what's going on with the dollar and
Speaker 1: a bunch of other currencies like the euro and the yen.
Speaker 1: We are going to be speaking with John Turke. He is,
Speaker 1: of course the founder of JST Advisors and the author
Speaker 1: of the Cheap Convexity blog. John, Welcome to the show.
Speaker 1: Thank you so much for having me. So, I think
Speaker 1: the first time we had you on was actually to
Speaker 1: talk about exactly this dynamic, the dollar doom loop. Yeah,
Speaker 1: it was. It was actually I think in the beginning
Speaker 1: of around pandemic had just started, and it was really
Speaker 1: the first time that FED really fully unleashed its swap
Speaker 1: program in terms of foreign exchange, and I felt that,
Speaker 1: you know, the doom loop was a very prevalent factor
Speaker 1: in kind of the cycle where we saw this slow
Speaker 1: down in the manufacturing side of the economy, largely on
Speaker 1: the fact of China's aggregate growth numbers starting to structurally fall,
Speaker 1: which you know, as the US is less exposed to
Speaker 1: global trade, global manufacturing saw it become a relative beneficiary,
Speaker 1: and then given the dollar linkages through global trade and manufacturing,
Speaker 1: it only reinforced the weaknesses of manufacturing. So it seems
Speaker 1: like we're in a similar dynamic with different catalysts. So
Speaker 1: before we even get into the dynamics, like how would
Speaker 1: you describe, I mean, everyone is sort of waking up
Speaker 1: to this weird phenomenon, which is that after an era
Speaker 1: of like so much stress and so must talking, you
Speaker 1: know another like end of the dollar, it's going to
Speaker 1: be replaced. It's gonna be a if my bitcoin, or
Speaker 1: China and Russia are gonna like circumvent the dollar or
Speaker 1: something like. You know, all this every crisis, this kind
Speaker 1: of talk. I am old enough to remember when the
Speaker 1: euro was going to replace gold. We've we've we've we
Speaker 1: all we've heard it, the bricks are going to like
Speaker 1: form some sort of new like deutsch mark whatever. You
Speaker 1: you know, that all the theories. If someone's like, Okay,
Speaker 1: here's the dollar, it's like basically back at all time highs.
Speaker 1: And someone says, John, well, as the dollar so strong,
Speaker 1: what's your answer? Well, I think that that part of
Speaker 1: the reason this time is that it's a structural dynamic.
Speaker 1: You know. I think a lot of it was the
Speaker 1: US was the cleanest of the dirty shirts, and I
Speaker 1: think that this time, the US is the most self sufficient,
Speaker 1: and I think that is that is I think the
Speaker 1: relative dynamic at play this time, as opposed to last time,
Speaker 1: when we were just broadly in a slowing nominal GDP
Speaker 1: world where we had you know, low levels of realized
Speaker 1: growth and the US was kind of growing just a
Speaker 1: bit faster. Um. Now, I think it is really a
Speaker 1: self sufficiency thing that I think is you know, really
Speaker 1: been encapsulated by this energy crunch that we're seeing, especially
Speaker 1: you know, Tracy, And I'm thinking back to our last
Speaker 1: conversation from a few months ago, exulting Posar, and of
Speaker 1: course he has this whole framework of like you know,
Speaker 1: Brent Wood's bree commodity centrality, and I did have that
Speaker 1: thought at the time, and I think it's on the episode.
Speaker 1: It's like it's in the US also like filled with
Speaker 1: tons and tons of commodities, like maybe like you know,
Speaker 1: it's like if we are going to be entering this
Speaker 1: new like commodity oriented regime where whoever has the most stuff, right,
Speaker 1: and like US is pretty good on that front too, right,
Speaker 1: It's not the worst place to be. But Okay, so John,
Speaker 1: maybe talk to us a little bit more about how
Speaker 1: energy factors into currency, you know, the weakness in the euro,
Speaker 1: the strength and the dollar, if it all comes down
Speaker 1: to energy, could you maybe walk us through exactly how
Speaker 1: energy prices or an energy shortage actually feed into currency
Speaker 1: weakness or strength. Yeah, of course, So you know, I
Speaker 1: think that a good way to do this also take
Speaker 1: a step back in the sense that a lot of
Speaker 1: currency movements, especially in the previous cycle, and I would
Speaker 1: say even really argue until the Russian invasion, was a
Speaker 1: lot of it was predicated on relative interest rates and
Speaker 1: kind of you know which central bank was a bit
Speaker 1: more hawkish, which was dubbish, That was kind of usually
Speaker 1: the forward rate space was a big marginal factor in
Speaker 1: kind of you know which currencies would be best off.
Speaker 1: And I think you know, really what changed now is
Speaker 1: that we're really in a terms of trade trade balanced
Speaker 1: current account world where the market in currency space is
Speaker 1: really looking beyond you know, which central bank is going
Speaker 1: to do the most to where are trade balance is
Speaker 1: going to settle. And given that energy has now a
Speaker 1: two pronged effect on that, I think it really emboldens
Speaker 1: that to play a more determinant role in exchange y prices.
Speaker 1: And I think you know, getting into the role of energy,
Speaker 1: especially when it's this sort of crunch where you know,
Speaker 1: we're talking about the potential of Russia turning off gas
Speaker 1: flows into Europe, it really does have a two pronged effect.
Speaker 1: One is that either the price of you know, related
Speaker 1: fossil fuels or energy inputs goes up, which is something
Speaker 1: we've seen that gas prices in Europe are very very high,
Speaker 1: power prices as a byproducts that have risen a lot,
Speaker 1: so the trade balance is getting hit on that. And
Speaker 1: then we have this factor where because it is a crunch,
Speaker 1: Europe is not able or at least projected to not
Speaker 1: be able to produce as much as it's product as
Speaker 1: its capacity is, so their exports by nature will fall
Speaker 1: relative to what they could have been because they don't
Speaker 1: have the energy inputs to facilitate it. So really, in
Speaker 1: terms of thinking about the current account of the trade
Speaker 1: balance more importantly is it's really a a double whammy
Speaker 1: because they're importing more energy inputs and they can't export
Speaker 1: as as as many outputs. And as we started to
Speaker 1: see with the Northern European trade balance, you know, Germany,
Speaker 1: after twenty years of running significant significant trade surpluss is
Speaker 1: now running a pretty significant trade deficite, and I think
Speaker 1: that is why this factor is so so important, because
Speaker 1: it really hits on both fronts. So I have two
Speaker 1: quick questions, one short and one is a little bit more.
Speaker 1: But the first one real quickly, have we actually seen
Speaker 1: exports start to weaken in Germany? Because I know, obviously
Speaker 1: the import bill has surged, and we know a lot
Speaker 1: of industrial players have said like, look, we can't just
Speaker 1: we can't work economically with these high gas prices. But
Speaker 1: have we actually seen that in the data where the
Speaker 1: exports start to turn down. So exports haven't started to
Speaker 1: fall all meaningfully yet, but we have already seen the
Speaker 1: imbalance grow between the imports side and the export side
Speaker 1: by nature of you know, the trade deficit, and we've
Speaker 1: already started to see at least in you know, the
Speaker 1: p m I data on the manufacturing side, that there
Speaker 1: will be slowdowns. It's just not economical for a lot
Speaker 1: of the heavy industry players at these prices. So and
Speaker 1: then my related question is in a situation like this
Speaker 1: where there is a true crunch that you know, the
Speaker 1: energy bill is soaring, but also you have domestic weakness
Speaker 1: because you just can't even maybe run the factories at
Speaker 1: these level of power prices. Does that contribute to does
Speaker 1: that make it essentially harder for the e c B
Speaker 1: to fight inflation? Because here, I guess look like maybe
Speaker 1: I don't know, you know, the U S economy is hot, right,
Speaker 1: or at least has been up until very recently. So
Speaker 1: it's sort of like a very natural thing for the
Speaker 1: FED to wanna hike rates and tap the brakes and
Speaker 1: try to diminish demand. It does doesn't seem like the
Speaker 1: ECB has that luxury. Yeah, so the e c B
Speaker 1: is really in a proper bund here, and I think
Speaker 1: it really boils down to two problems. One is even
Speaker 1: taking I think more meta structurally, even looking beyond this
Speaker 1: shock in its specific nature, is that the ECB was
Speaker 1: already faced with a problem of you have central banks
Speaker 1: around the world who are aggressively responding to much above
Speaker 1: target inflation and the threat of higher inflation expectations, and
Speaker 1: the e c B was going to have to play
Speaker 1: catch up in some capacity. And we've we we already
Speaker 1: started to see that pivot over the course of the year.
Speaker 1: We know they'll hike at their meeting next week and
Speaker 1: they'll hike again in September and kind of commence a
Speaker 1: hiking cycle. But the problem we started to see as
Speaker 1: more hikes got priced into the European curve is that
Speaker 1: it started to create stresses in the periphery where we
Speaker 1: had an uneven transmission of policy as spread heads between
Speaker 1: you know, Italy and Germany UM and really the periphery
Speaker 1: and the core started to blow out. And this was
Speaker 1: really emblematic of the structural um imbalance that is sort
Speaker 1: of innate to the your area, where we started to
Speaker 1: see the world of potentially you could have a rate
Speaker 1: that is not high enough to fight inflation and too
Speaker 1: high for the perfect and this led to the forthcoming
Speaker 1: ECB meeting will be sort of introduced to a anti
Speaker 1: fragmentation tool. We've seen that the ECB has already started
Speaker 1: flexibly reinvesting their their pet purchase portfolio kind of a
Speaker 1: way to alleviate these issues in spreads, but nonetheless it's
Speaker 1: still a big issue. And going before all of the
Speaker 1: gas related energy country issues, that we were already entering
Speaker 1: a world where rates weren't getting high enough to cut
Speaker 1: off imported inflation by currency weakness, and they were getting
Speaker 1: to you high for some of the perfect holders, namely Italy.
Speaker 1: So that is one side of the ECB challenges, which
Speaker 1: is already pretty drastic. The other side is the nature
Speaker 1: of this shock is innately very stagflationary in the sense
Speaker 1: that it raises the cost of energy by a lot,
Speaker 1: and it also reduces output by that actually isn't enough
Speaker 1: or there'll have to be some sort of reallocation of resources.
Speaker 1: Right if the decision becomes you know, making sure that
Speaker 1: everyone stays on in the winter or turning off one
Speaker 1: or two factories, the decision is going to be pretty
Speaker 1: easy for policy makers, um as unfortunate as it is.
Speaker 1: That is the second fold of it, where the now
Speaker 1: we have a shock that really worsens the inflationary pressure
Speaker 1: in Europe but also further reduces the growth impulse and
Speaker 1: on the output side, all in the backdrop of a
Speaker 1: imbalance at the ECB is fighting that is almost innate
Speaker 1: to their bout design, which is you know, common common
Speaker 1: Currency Union, no common fiscal So it's gonna be an
Speaker 1: extremely challenging task for the e c B. I think,
Speaker 1: you know, at the forthcoming meeting it will be interesting
Speaker 1: as we begin to outline you know, the e c
Speaker 1: B has taken a stand that growth is still good,
Speaker 1: and you know, nominal growth, especially on the consumption side
Speaker 1: in Europe is still pretty good. But we we know
Speaker 1: that once the industrial side, especially in the Core and Germany,
Speaker 1: becomes uncompetitive, that the economic spillovers are going to be
Speaker 1: pretty significant. And we could be looking at, you know,
Speaker 1: for the second time and into the last two e
Speaker 1: c B hiking cycles, or the ECB is hiking into
Speaker 1: a recession, and you know how the e c B
Speaker 1: kind of structures, you know, their inflation fight in the
Speaker 1: context of the material growth slow down. It's going to
Speaker 1: be very interesting. And I think the currency right now
Speaker 1: is proving to be on top of all of these factors,
Speaker 1: proving to be an outlet for that unknown what happens
Speaker 1: to capa all flows or capital inflows when the ECB
Speaker 1: starts hiking, because one of the weird things about what
Speaker 1: we've seen so far this year is that even with
Speaker 1: all the challenges that your faces at the moment, I
Speaker 1: think they've still had net inflows into the euro Zone.
Speaker 1: And you would expect if the ECB hikes rates that
Speaker 1: that would make um them more attractive compared to some
Speaker 1: other yields on offer. But like even if inflows happened positive,
Speaker 1: it doesn't seem to have had much of an effect
Speaker 1: on the euro. Yeah, it's it's it's an interesting one
Speaker 1: because this year was supposed to be and I you know,
Speaker 1: I think if we scrolled back to the last time
Speaker 1: it was on going into our preview, this year was
Speaker 1: kind of supposed to be a very positive euro currency
Speaker 1: story in the sense the potential of the end of
Speaker 1: negative interest rates was going to spur this return of
Speaker 1: you know, longer term stick year capital, either through reserve managers,
Speaker 1: pension funds, etcetera. That kind of became you know, priced
Speaker 1: out by negative rates, and you know, we saw the
Speaker 1: story of a p P and nerve in Europe is
Speaker 1: very much this one of you know, starting from on.
Speaker 1: It was basically this replacement of ownership between a lot
Speaker 1: of foreign owners who owned buns BTPs in Italy and
Speaker 1: and and French government bonds, and it was basically replaced
Speaker 1: by the e CB. So the currency channel was we
Speaker 1: had what called portfolio The portfolio channel was really in
Speaker 1: full effect, and there was some thought that we could
Speaker 1: trigger the inverse by leaving negative rates, and I think
Speaker 1: we really did start to see that, especially after February
Speaker 1: ECB when it became clear that you know, negative rates
Speaker 1: were probably going to end this year. I think it
Speaker 1: was a trigger. There were yielding, nominal, yielding securities in
Speaker 1: your area that we're compelling that hadn't been for eight
Speaker 1: years almost, and I think that was a spur for capital.
Speaker 1: I think the problem now is is as the e
Speaker 1: c B fights this is we really don't know, you know,
Speaker 1: what is it going to look like and kind of
Speaker 1: in the in the choices of bad choices, which bad
Speaker 1: choice do they lean on me? And I think the
Speaker 1: thing that you know is probably worth watching the most
Speaker 1: is that if there really is rationing and some of
Speaker 1: the industrial activity has to go offline, is there's going
Speaker 1: to be a fiscal response? Right? I don't think we
Speaker 1: none of us really assumed that, you know, the fiscal
Speaker 1: authorities are going to just let companies default or people
Speaker 1: be laid off because their factory can't run because they
Speaker 1: don't have the proper inputs. There is going to be
Speaker 1: a response. And then the question is, you know, especially
Speaker 1: in the context of an already problem in Italy in
Speaker 1: terms of perferee spreads, is how does the e c
Speaker 1: B respond and you know, I think we are setting
Speaker 1: up for the potential. I wouldn't you know that everything
Speaker 1: on this, but you could envision a world where the
Speaker 1: ECB is actually net buying securities again while they're hiking things.
Speaker 1: And this is something that you know, tri she actually
Speaker 1: talked about on a Bloomberg interview not too long ago.
Speaker 1: And you know, I, I don't know that it's I
Speaker 1: wouldn't say it as a base case, but given how
Speaker 1: the energy crunch could turn into a liquidity crunch at
Speaker 1: the same time that you know, Italy is facing a
Speaker 1: problem with you know, rising European rates, it's not impossible
Speaker 1: start to think about, you know, kind of what does
Speaker 1: the ECB balance sheet approach look like in that context.
Speaker 1: And I don't think it's one of significant contraction, even
Speaker 1: though they are tightening policy to deal with above target inflation.
Speaker 1: If the ECB is expanding its balance sheet in order
Speaker 1: to maintain or constrain Italian spreads while at the same
Speaker 1: time hiking your rates in order to fight inflation, that
Speaker 1: seems like one of those things where it's like, yeah,
Speaker 1: a bunch of people are going to dunk on that
Speaker 1: on Twitter and get it it's like, oh, those look
Speaker 1: at the A, C, E, C B folks, they don't
Speaker 1: know what they're doing. They're trying to fight inflation but
Speaker 1: expanding the balance sheet. But said I, I I said, Twitter
Speaker 1: dunks like, it's not necessarily economically unsound, right, Like you
Speaker 1: could do both at the same time. They're not. It's
Speaker 1: not necessarily contradictory. It is not necessarily contradictory. It will
Speaker 1: be in a relative sense because we'll be in a
Speaker 1: world where every other central bank outside of the Bank
Speaker 1: of Japan is withdrawing liquidity, So it would be in
Speaker 1: that sense, and I think the currency message would be confusing.
Speaker 1: But I personally think and you know, I don't know
Speaker 1: how relevant this is, but I think the ECP did
Speaker 1: make a mistake in terms of linking a p P
Speaker 1: their QI program to rates the same way that every
Speaker 1: other central bank had, only because we know that in
Speaker 1: for the b o E or for the FED that
Speaker 1: they've kind of outlined, QWI is sort of this almost
Speaker 1: forward guidance tool, which you know, when it exists, we
Speaker 1: know that they can't high rates, and the linkage between
Speaker 1: KIWI and rates actually enhances the net easing effect. And
Speaker 1: I think the ECB wanted to do this, which was
Speaker 1: basically kind of set up these guardrails for the market
Speaker 1: to price and hikes via the balance sheet. The problem
Speaker 1: is is that as we're sort of seeing, especially in
Speaker 1: periods of wide economic variants, is that QUI is probably
Speaker 1: a more structural dynamic to Europe given the innate and
Speaker 1: balances of the Union then it is let's say in
Speaker 1: the US, or in the UK, or in you know,
Speaker 1: really any other developed country. So I think that is
Speaker 1: something that will probably become more talked about as we
Speaker 1: get to the end of the year in Europe. Is
Speaker 1: in this you know, kind of nasty stagflationary world, is
Speaker 1: you know, what is the role of you know, QUEI
Speaker 1: even in a hiking cycle, especially as the e c
Speaker 1: B is never going to be able to kind of
Speaker 1: have a quote unquote QT episode where the stock of
Speaker 1: liquidity would also basically fall not only the flow but no,
Speaker 1: I I think it would be you know, on the
Speaker 1: day if that were to be announced, I think you
Speaker 1: would like further amplify currency weakness just as a byproduct
Speaker 1: is they would be the only ones injecting liquidity at
Speaker 1: the same time that everyone else is withdrawing it, and
Speaker 1: as we move forward on I think it could become
Speaker 1: like it, just a more institutionalized. Part of how the
Speaker 1: ECB kentuckt monetary policy is that you know, there is
Speaker 1: sort of this like net sticky buying of government bonds,
Speaker 1: even that is agnostic for the policies. So you mentioned
Speaker 1: something striking, which is the idea of a lot of
Speaker 1: the major central banks, you know, being in tightening mode
Speaker 1: all at once. And we've had previous situations where the
Speaker 1: major control banks have been in loosening mode all at once,
Speaker 1: and they've been you know, launching their own keeweep programs
Speaker 1: and things like that and lowering interest rates all at
Speaker 1: the same time. And in that environment, people used to
Speaker 1: worry about competitive currency devaluations and a sort of race
Speaker 1: to the bottom. With more people tightening, do you worry
Speaker 1: about currencies going up like a competitive valuation? That seems
Speaker 1: kind of weird. Like what I guess what I'm asking
Speaker 1: is what is the impact of all these people trying
Speaker 1: to raise rates at the same time. Yeah, it's a
Speaker 1: it's a great question, and I think it's it's only
Speaker 1: has added importance given that many of the world central
Speaker 1: banks right now we're fighting imported inflation much more so
Speaker 1: than excess demand. We do have cases like the UK
Speaker 1: and the US where there is there was some signs
Speaker 1: of overheating or excess demand. But you know, taking the
Speaker 1: Europe example, and something that I think Leguard has been
Speaker 1: quick to point out, but even more so the Chief
Speaker 1: economist Philip Laying, is this idea that you know, real
Speaker 1: real output has not exceeded it's pre pandemic level in Europe.
Speaker 1: Yet it doesn't mean that this hasn't been a strong recovery.
Speaker 1: It has. We know that unemployment is the lowest it's
Speaker 1: ever been in Europe. There are signs that you know,
Speaker 1: wage games are picking up, and it has been a
Speaker 1: strong recovery from COVID. But it's not just purely a
Speaker 1: there is too much demand story. There is a lot
Speaker 1: of There is an imported inflation terms of trade shock
Speaker 1: that is clearly amplified the inflationary dynamics that we've seen.
Speaker 1: And in that world, the biggest health in terms of
Speaker 1: tightening policy is the currency because that's sort of how
Speaker 1: you nwter the imported inflationary dynamics. This is something that
Speaker 1: we've seen China do actually relatively well over the last
Speaker 1: call it year is being able to kind of neutralize
Speaker 1: the imported inflationary dynamics from energy, commodities, food, etcetera by
Speaker 1: having a stay able, strong currency basket, you know, the
Speaker 1: remmby against the currency basket that they track um and
Speaker 1: I think, you know, we're in a world now where
Speaker 1: central banks, who are all dealing with above target inflation,
Speaker 1: have very little tolerance for massive currency weakness because it's
Speaker 1: thought to only amplify the pressures that they're dealing with
Speaker 1: by hiking rates. And this is something we've seen pretty
Speaker 1: much across the board. We've seen the SMB in Switzerland
Speaker 1: high rates fifty basis points at the first meeting. They
Speaker 1: surprised the market, and part of their calculus is that
Speaker 1: even though the Swiss frank has been strong, it hasn't
Speaker 1: been strong enough in the real terms to kind of
Speaker 1: offset some of the above target inflation that even they're seeing.
Speaker 1: We've seen kind of a little bit of a pivot
Speaker 1: from the Bank of England, who originally had was kind
Speaker 1: of the first central bank to entertain the idea that
Speaker 1: a growth scare should also be part of their kind
Speaker 1: of calculus in in resetting policy. But we've seen from
Speaker 1: you know, external OLYMPC member Katherine Man put out his
Speaker 1: speech about the idea that not if we're not keeping
Speaker 1: track with the FED, then we're gonna be you know,
Speaker 1: we're going to further exchange right pressures, which is going
Speaker 1: to further the important inflation dynamics that we're dealing with already.
Speaker 1: And we've seen kind of you know, more people on
Speaker 1: the b OE entertained this idea that you know, the
Speaker 1: exchange passed through is amplified right now, especially as we're
Speaker 1: in this like kind of bind and in terms of
Speaker 1: where inflation expectations are they moving away from target, and
Speaker 1: we've seen that central banks have sort of taken a
Speaker 1: risk management approach to that where if there is no
Speaker 1: doubt that they're kind of threat at all, then they're
Speaker 1: going to act. So I do think, you know, I
Speaker 1: don't know that it's we're averse currency war in a way,
Speaker 1: but I do think you have central banks around the
Speaker 1: world saying that, you know, our currencies have weakened and
Speaker 1: that has only amplified the pressure that we're facing because
Speaker 1: a lot of the nature of the shot is imported
Speaker 1: by the commodity side. So I I do think we
Speaker 1: are in that sort of world. And to further this
Speaker 1: that we've seen central bank that have relied on currency
Speaker 1: strength as a way to almost not hike interest rates,
Speaker 1: hike interest rates the cycle because the currency is either
Speaker 1: weakening or not doing enough. We've seen Switzerland hike, We've
Speaker 1: seen the Bank of Israel hike, We've seen Taiwan hike.
Speaker 1: And these are central banks last cycle that we're able
Speaker 1: to weather sort of you know, participating in hiking cycles
Speaker 1: via just having a very strong nominal effective exchange rate.
Speaker 1: And this cycle we're seeing is there's a difference between
Speaker 1: your near and your rear, which is your real effective
Speaker 1: exchange right, and you kind of they don't move automatically
Speaker 1: one for one in a very high inflation environment. So
Speaker 1: I do think we are in this sort of you know,
Speaker 1: reverse currency war. But I think that central banks are
Speaker 1: clearly making an emphasis on the role of currencies, some
Speaker 1: more explicit than others, of course, But I do think
Speaker 1: given the nature of the shop, it doesn't make sense
Speaker 1: for central banks to have a very big, you know,
Speaker 1: overarching currency focus. We need to do like a series
Speaker 1: of john with like all these niche central banks or
Speaker 1: these smaller ones. All right, let's Bank of his reel day,
Speaker 1: Swiss National Bank day, uh Taiwan new Central Bank. That
Speaker 1: would be you know, of course we would need to
Speaker 1: have a whole week just devoted to Australia and New
Speaker 1: Zealand because they tend to be bill whethers that being said,
Speaker 1: I wanna pivot a little bit to Japan, where we
Speaker 1: see dollar yen basically at its highest level. Since I
Speaker 1: don't think my understanding, I don't think the Bank of
Speaker 1: Japan has pivoted in any way like some of these
Speaker 1: other major central banks in terms of easing. I think
Speaker 1: they're still doing old curve control. The yield on the
Speaker 1: tenure Japanese government bond is still like, you know, point
Speaker 1: to five or something like super low. Like what's going
Speaker 1: on there? I seem to recall something to were like
Speaker 1: last month the market thought it was gonna try testing
Speaker 1: the b o J in some way and the GGB
Speaker 1: futures got out of hand a little bit. But what's
Speaker 1: going on there? Yeah? So, I mean the last B
Speaker 1: a J meeting in June, we really had a real
Speaker 1: earnest test of b o j's resolve in terms of fighting,
Speaker 1: where we saw ten years swap rates in Japan move
Speaker 1: a lot further away from where the you know, ten
Speaker 1: year equivalent j GB yield is, which is you know,
Speaker 1: enforced by the b O. J saw the same thing
Speaker 1: in futures, and it was kind of of this idea
Speaker 1: that you know, once dollar an gets above one thirty
Speaker 1: gets to one thirty five, you know, maybe they don't
Speaker 1: drop yield curve control, but maybe they readjust the band.
Speaker 1: Maybe they go from you know, targeting twenty five basis
Speaker 1: points to fifty basis points. Maybe they move y c
Speaker 1: C to the five year instead of the ten year.
Speaker 1: And the market was really, you know, kind of wrestling
Speaker 1: with this. You know, how do they adjust because certainly
Speaker 1: they're not okay with kind of this further rapid depreciation
Speaker 1: in the end, especially as Japan, like everyone else, maybe
Speaker 1: to a lesser extent, is dealing with an energy shock
Speaker 1: and you know, higher levels of spot inflation domestically, etcetera.
Speaker 1: It's funny, I'm looking at the Bloomberg and Japan's inflation
Speaker 1: is its highest in multiple years. But so two and
Speaker 1: a half of the through that's a big change. Anyone
Speaker 1: that grew up in Japan, that's a big change. Yeah, right, right,
Speaker 1: And you know, I think the so where where the
Speaker 1: b o J is And I think what their stubbornness
Speaker 1: has has surprised a lot of people. But I actually
Speaker 1: think they've been pretty you know, consistent with their reaction
Speaker 1: function and their idea is that they're not going to
Speaker 1: jump on this bandwagon of you know, global tightening of
Speaker 1: policy in the context of something that they think is
Speaker 1: only a one year phenomenon. Because what's idiosyncratic to Japan
Speaker 1: as well is that a big part of the above
Speaker 1: target inflation we're seeing this year is not only from
Speaker 1: the energy side, it's also from mobile phone prices, which
Speaker 1: has kind of had this mechanical upward pressure on prices
Speaker 1: that will kind of come out next year. They're committed,
Speaker 1: so they're still team transitory in Japan. They're still team
Speaker 1: transitory in Japan. I think the thing that would change
Speaker 1: them from being team transitory is that something that Kuroda
Speaker 1: has really emphasized is that the medium term forecast or
Speaker 1: inflation has to move close to two percent. Maybe that
Speaker 1: would be the catalyst for a change, because as we've
Speaker 1: seen is the b o J has sort of operated
Speaker 1: in this well. Inflation is at two percent right now
Speaker 1: or it's going to be above two percent for this year.
Speaker 1: But if you look at kind of we the last
Speaker 1: bank View meeting we had, which is where the b
Speaker 1: o J publishes their economic forecast, was in April, and
Speaker 1: looking back at that meeting, they had three inflation between
Speaker 1: one point one one point three percent for three and
Speaker 1: then twenty four, you know, somewhere around that ringe. And
Speaker 1: the b o J has contextualized their reaction function as
Speaker 1: that prices need to be going to two percent in
Speaker 1: a stable manner, and you know one point one percent
Speaker 1: inflation next year would not be considered stable. So what
Speaker 1: that is meant in terms of them setting policy is
Speaker 1: that not only is it do not don't move y
Speaker 1: c C continue to let these like currency pressures manifest
Speaker 1: between widening interest rates, but also if you look at
Speaker 1: the bankage fan statement, it still has an easy by us.
Speaker 1: And we've even heard from Corona over the last few
Speaker 1: days where he's talked about, you know, the b o
Speaker 1: J could be willing to do more, which I just
Speaker 1: think really like encapsulates how all in they are as
Speaker 1: and this is going to be you know, some sort
Speaker 1: of procyclical reflation that is b o J endorsed because
Speaker 1: not only is it do they not want to marginally tighten,
Speaker 1: it's they actually still have their full easing posture in
Speaker 1: terms of four guidance. So I think that, you know,
Speaker 1: in terms of thinking about the b o J and
Speaker 1: especially as it relates to the currency, I think really
Speaker 1: this whole year we've been in this inconsistency between what
Speaker 1: the market implied pain point is for the b o
Speaker 1: J and what the b o J keeps telling you
Speaker 1: their pain point is. And they have continued to say
Speaker 1: implicitly effectively that there's still plenty of room to go
Speaker 1: on getting resetting inflation, inflation expectations higher. And I think,
Speaker 1: you know, the thing to look for now is less
Speaker 1: of a well dollar young goes to one forty, so
Speaker 1: they'll definitely move. And I think this has kind of
Speaker 1: become amplified by the fact that the politics and Japan
Speaker 1: have become less favorable to a very weekend policy. But
Speaker 1: I think the thing to look for now is as
Speaker 1: we actually this month will get a new fresh forecasts
Speaker 1: of you know, more medium term inflation in Japan, and
Speaker 1: I think that would be the catalyst who maybe a rethink,
Speaker 1: especially as energy pressures have only increased a lot since April,
Speaker 1: currency has weakened a lot. It's very plausible to think
Speaker 1: that that the medium term inflation projections are starting to
Speaker 1: move higher, and as they do, I think the kind
Speaker 1: of wrinkle will be is the b o J is
Speaker 1: not the FED, they're not the ECB, they're not the
Speaker 1: Bank of England. There don't promise to be overly transparent.
Speaker 1: Is that y CC starts to move in a kind
Speaker 1: of non announced way. So I think that is kind
Speaker 1: of the thing to sort of look out for. I
Speaker 1: think for now we're in this world where the b
Speaker 1: o J is still max easy because they have seen
Speaker 1: the things that they've told you or told us that
Speaker 1: they want to seek to trigger some form of marginally
Speaker 1: tighter monetary policy, and they're dealing as much of the
Speaker 1: developed world is is with this massive trade shock in
Speaker 1: terms of deterior terms of trade and worsening trade balance.
Speaker 1: So it's kind of been this this double whammy. Um
Speaker 1: And I don't think that you know gets arrested immediately,
Speaker 1: but I do think the thing to watch in terms
Speaker 1: of why SEC is these and will see in July
Speaker 1: and we'll see again in October, I believe is kind
Speaker 1: of this medium term inflation forecast is that would be
Speaker 1: kind of more the catalyst change. Of course, in the intro,
Speaker 1: Joe and I were talking about the doom loop and
Speaker 1: this idea that it sort of becomes a self reinforcing
Speaker 1: cycle because people worry about global growth and that sends
Speaker 1: the dollar higher, and then the higher dollar implies slower
Speaker 1: global growth, and so you get this never ending cycle.
Speaker 1: What what, in your opinion, is most likely to break
Speaker 1: that loop in the current scenario. It's a good question,
Speaker 1: So I think you know true. What we saw in
Speaker 1: the is there was really two circuit breakers to the
Speaker 1: dollar doom loop. One is, you know, a massive Chinese
Speaker 1: credit easing that had global macro economic spillovers by just
Speaker 1: increased global aggregate demand. The other was a dubbish pivot
Speaker 1: from the FED. And the pivot from the Fed is
Speaker 1: something we saw a few times in times. We saw
Speaker 1: it at the end of We saw it in January
Speaker 1: after hiking once and the dollar kind of went nuts,
Speaker 1: and you know, commodity prices started to follow manufacturings or
Speaker 1: the fall. The FED after that said, you know, we're
Speaker 1: not going to be hiking as much. And sixteen, as
Speaker 1: we said we were going to be in fifteen. I
Speaker 1: think that has also been a catalysis time. What makes
Speaker 1: this version of the doom loop really scary is it's
Speaker 1: kind of hard to see how those circuit breakers play
Speaker 1: out over the near term, where you know, we're now
Speaker 1: in this world of we have a European problem, which
Speaker 1: creates pressure on the euro, which sends the dollar higher,
Speaker 1: which worsens the manufacturing cycle, which does this whole thing again.
Speaker 1: But is the FED going to pivot with spot inflation
Speaker 1: at an eight handle? Is we've seen that China has
Speaker 1: already um started a pretty significant credit easing. We saw
Speaker 1: two numbers this week which were high. We've seen we
Speaker 1: started to seem like new loans beat. But we also
Speaker 1: are going to be very cautious and almost doubtful of
Speaker 1: some sort of Chinese credit expansion when we don't really
Speaker 1: get passed through in the context of COVID zeroth. So
Speaker 1: you know, it seems a little bit like a broken
Speaker 1: transmission mechanism, at least in the context of the current
Speaker 1: economic constraints. So it's it's very I think that is
Speaker 1: kind of the dynamic we're now where it's a little
Speaker 1: hard to see what kind of stops this, and I
Speaker 1: guess the best answer is that it could stop itself.
Speaker 1: And I think, you know, something to start to think
Speaker 1: about as we get specially path September fom C and
Speaker 1: really into the end of the year depending on how
Speaker 1: you know bad the growth conditions are, especially in Europe,
Speaker 1: is that the will the FED sort of be able
Speaker 1: to do this implicit handoff from interest rates to global
Speaker 1: economic conditions for an exchange general f C. I s
Speaker 1: where you know, I think something that's possible to me
Speaker 1: and something I started thinking about, you know, talking to clients,
Speaker 1: is that the FED may be able to hand off
Speaker 1: in a sense to the dollar. It's not this idea
Speaker 1: that the FED would stop hiking or would be easing immediately,
Speaker 1: but sort of this idea that the FED can start
Speaker 1: to slow down maybe in November UM as we get
Speaker 1: like a few more consistent readings of lower core PC
Speaker 1: or point threes on core PC, and you know, the
Speaker 1: FED can be able to point to look at what
Speaker 1: the dollar is doing, look at what financial markets are doing,
Speaker 1: and basically the FED can net effectively tightened by staying
Speaker 1: still given the context they're in. And I think this
Speaker 1: is like an interesting dynamic that could possibly start to
Speaker 1: curtail some of these pressures. But you know, I think
Speaker 1: until we get there, we're still in this bind of
Speaker 1: you know, these are big disinflationary forces that the FED
Speaker 1: is cheerleading at the moment. Right. The thing that we
Speaker 1: saw last cycle is the FED wanted to prevent them
Speaker 1: because it was always a financial conditions tightener that was
Speaker 1: more than what monetary policy setting warranted. Where even where
Speaker 1: the FED was on a you know, a quote unquote
Speaker 1: path to neutral is, it always ended up being tighter
Speaker 1: than they thought. And this was obviously the case when
Speaker 1: they only had hiked once in December fifteen. Where now
Speaker 1: the FED is telling us they want to be restrictive,
Speaker 1: they want to get to restricted expeditiously, and this is
Speaker 1: sort of a mechanism that amplifies the outcomes they're trying
Speaker 1: to engineer. I think it's very hard to see sort
Speaker 1: of you know what the off ramp is in sort
Speaker 1: of an indulgent sense. I mean, the obvious you know,
Speaker 1: other off ramps is sort of some sort of resolution
Speaker 1: in in Ukraine and that you know, I don't I
Speaker 1: don't have any uh and any good insights into but
Speaker 1: it will also become a byproduct, you know, of how
Speaker 1: much pain Europe is willing to take. I would assume,
Speaker 1: you know, I think that is kind of what makes
Speaker 1: this version of the doom loop so challenging is that
Speaker 1: it is a condition or externality that the Fed, in
Speaker 1: its efforts to lower inflation and lower inflation quickly, is
Speaker 1: actually accentuating that I think is almost in their view positive.
Speaker 1: The question I think that you know, market participants should
Speaker 1: begin to ask, is if the dollar is doing all
Speaker 1: this work, you know, does the Fed have to go
Speaker 1: to four and a half or something like that. I
Speaker 1: think that is an interesting question on its own. But
Speaker 1: in terms of like what arrests this current dynamic, it's
Speaker 1: really tricky. We have seen this pretty significant decrease in
Speaker 1: commodity prices over the last month, and granted commodity prices
Speaker 1: aren't cp I, but they feed through like there are
Speaker 1: signs of this disinflationary impulse. Gasoline prices have been rolling
Speaker 1: over other commodity prices, like some food commodities of like
Speaker 1: way down, Like is it a is it possible that
Speaker 1: inflation actually meaningfully starts to surprise on the downside? Like
Speaker 1: is there any prospect of that, yeah, I do think
Speaker 1: so I think that, you know, it will be very
Speaker 1: tricky to I think it meaningfully lower prints and some
Speaker 1: of the stickier stuff on the services side, where especially
Speaker 1: in the US will be dealing with headwinds from shelter
Speaker 1: for a while, where I think it will be tricky
Speaker 1: to kind of get back into the you know, high
Speaker 1: twos on inflation. But I do think that, you know,
Speaker 1: and something that markets are pretty clearly starting to suggest
Speaker 1: is that we're on a path back to you know,
Speaker 1: still maybe elevated inflation, but certainly nowhere near the levels
Speaker 1: we are now. And I think know the dollar has
Speaker 1: clearly been a big part of reinforcing that mechanism between
Speaker 1: the exchange rate and things like you know, break evens
Speaker 1: or the market supplied inflation rates, because I think that
Speaker 1: the nexus of all of that is that the dollar
Speaker 1: has started to get to a level which has really
Speaker 1: started to hurt commodity prices, even though we haven't seen
Speaker 1: any alleviations per se on the supply side. So and
Speaker 1: then my fun question is, and you mentioned, you know,
Speaker 1: and we talked at the start of the year, at
Speaker 1: the end of the last year, you know, there's hope
Speaker 1: it might have been a good year for Europe and
Speaker 1: the positive benefit to the end of nerve, etcetera. But
Speaker 1: the big thing that we certainly did not talk about
Speaker 1: the end of last year, and which most economists were
Speaker 1: not thinking about, is the possibility of the war in
Speaker 1: Ukraine and the effect that that would have on commodities,
Speaker 1: and so like, how much of this whole discussion that
Speaker 1: we're having, you know, we sort of talked tongue in
Speaker 1: cheek about a team transitory and everyone abandoned that last year, Like,
Speaker 1: how much does so much of the surprise to markets
Speaker 1: really just a function of this thing that happened that
Speaker 1: did not have to do with anything that at least
Speaker 1: economists were equipped to be predicting at the end of
Speaker 1: last year at the very beginning of two. Yeah, I mean,
Speaker 1: I think it's led to the stickiness partly. I think
Speaker 1: it's more amplified the severity. You know, I think that
Speaker 1: something we've seen, you know, in the US, we we've
Speaker 1: had more evidence that you know, there's a large part
Speaker 1: of the inflation that overshoot is non energy, especially as
Speaker 1: energy costs are so much lower than they are in Europe.
Speaker 1: But even in Europe we've seen in like Christian the
Speaker 1: Guard you know, talk at CenTra that you know, four
Speaker 1: fifths of their core basket is running above two percent.
Speaker 1: We've seen the Bank of England say, you know something similar,
Speaker 1: that of their core basket is running above I think
Speaker 1: two and a half. So I think that we were
Speaker 1: in a a higher nominal GDP world, with inflation being
Speaker 1: a big part of that to begin with. I think
Speaker 1: that probably what has contributed to further central bank fears
Speaker 1: about inflation expectations and very elevated readings of headline inflation
Speaker 1: has been the has been the resh of Ukraine War.
Speaker 1: But I think that we were in a probably higher
Speaker 1: inflationary regime than we realized, call it December of one
Speaker 1: that was probably going to be persistent regardless. John Turk,
Speaker 1: thank you so much for coming on odd lots. Always
Speaker 1: impressed by both your ability to explain all these things,
Speaker 1: but also like your breadth, like you know, keeping tabs
Speaker 1: on what the Bank of its real is up to
Speaker 1: is a very helpful. So thank you so much. Always
Speaker 1: a blast. Thank you so much. Guys really appreciate it.
Speaker 1: So Joe, I guess, uh, two things jumped out at
Speaker 1: me there. One is the US is in a relatively
Speaker 1: good place once again, dollar privilege strikes, but also in
Speaker 1: commodity privilege and commodity privilege. But to Europe just sounds
Speaker 1: like it's in a whole lot of trouble. Right, Yes,
Speaker 1: the double whammy on Germany is really striking. So the
Speaker 1: import bills soaring, and then if you can't even operate
Speaker 1: parts of your economy because they're dependent on this one
Speaker 1: specific input gas at a certain price, that's brutal, right.
Speaker 1: And it also feels like, you know, Japan, the bo
Speaker 1: j could sort of face off against speculators last month,
Speaker 1: and they were somewhat successful in doing that, but the
Speaker 1: e c B, facing that particular inflationary back drop, it
Speaker 1: just feels like there's no possibility that they're going to
Speaker 1: be able to job on the market in any way. No.
Speaker 1: And then and you know, on top of the sort
Speaker 1: of double whammy to the core of how your industry works,
Speaker 1: you have the spreads problem, and that's because of the
Speaker 1: nature of European you know, your area architecture and having
Speaker 1: to contain Italian spreads, which might mean expanding the balance
Speaker 1: sheet at a time when it's fighting inflation. That's tricky.
Speaker 1: That's a tough job for the ECB. Yeah, I feel
Speaker 1: like this always comes up when we talk about central banks,
Speaker 1: But like I do not envy central bankers and what
Speaker 1: they have to do right now. I don't know. I
Speaker 1: mean in Japan, it's just like we're setting the yield,
Speaker 1: we're setting rates at this you could just go on
Speaker 1: vacation for setting rates or setting tenure rates. Well, that's different. Okay. Wait,
Speaker 1: if you were going to be ahead of any central
Speaker 1: bank in the world right now, which one would you choose?
Speaker 1: I think I would choose Japan because it really does
Speaker 1: seem like they could say, like, you know what, and
Speaker 1: is John pointed out they don't have the same commitment
Speaker 1: to transparency as others have moved towards. She's like, you know,
Speaker 1: we're setting this at zero. We're gonna take off for
Speaker 1: a while. We'll be back in a few months, will
Speaker 1: check in. That's how I would do it. Yeah, two
Speaker 1: point five percent inflation looks good in any other country.
Speaker 1: Two point five basically target in the US. All right, um,
Speaker 1: shall we leave it. Let's leave it there. Okay. This
Speaker 1: has been another episode of the All Thoughts podcast. I'm
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy
Speaker 1: Alloway and I'm Joe. Why Isn't All? You could follow
Speaker 1: me on Twitter at The Stalwart, Follow our guest John
Speaker 1: Turret He's at ja Turret eighteen. Follow our producer Kerman
Speaker 1: Rodriguez at Carmen Arman, and check out all of our
Speaker 1: podcasts at Bloomberg under the handle add Podcasts. Thanks for listening.