Why QE is the Fed's Only Weapon Left (w/ Julian Brigden)
JULIAN BRIGDEN: Thanks very much for having me on Real Vision. Nice to be back again. For those of you who don't know me, my name is Julian Brigden. I am the co-founder of MI2, or Macro Insiders 2. We set the business up eight years ago. The whole intention is basically to look at the macro space and to try and make our clients money. VOICE-OVER: How do you see the overall macroeconomic environment? JULIAN BRIGDEN: So when we look at the world, we've had this 10-year extended cycle, right? We've been running an economy pretty hot. We have seen some tightening of policy from the Fed over the last year or so. That is now reversing, and we're beginning to discover that there are some not so pleasant things below the surface, right? In the process of generally running things hot, which is what Trump was trying to do, and the Fed has been trying to do in the US, we have created some quite large asset excesses. I think it's arguable, when you look at the US market, equity market-- not necessarily in aggregate, but within pockets, whether it's the emblematic of WeWorks or something like Netflix, there are some very highly valued assets. We have re-inflated house prices again to arguably beyond the pre-global financial crisis levels. And then we tried to normalize policy. And as we're discovering, it's not necessarily gone 100% smoothly. And I think one of the things that's been vexing me and concerning, I think, a lot of my clients is, over the years, we've seen this what I would call-- what I dub financialization. And by that I mean the feedback loop that basically exists between the financial markets and the real economy. And we like to use this expression that the tail wags the dog. OK? Now, implicitly, we all know it's the dog that should wag the tail. But what I mean by the tail wags the dog is it's the financial markets that basically drive the real economy. Where that becomes problematic is when you've inflated these asset prices to such high levels. If you then step away, as the Fed's tried to do over the last year or so-- done some QT, done some rate hikes-- and we start to see those assets start to normalize, and suddenly, you start to get this response function, whether it's reticent CEOs starting to look to cut costs, because their stock price is no longer rising anymore. And it's unfortunate, but there was a great interview on Real Vision with one of your other clients, where he said, the product of CEOs now is their stock price. Right? We used to put it in a slightly less PC way. But essentially, it's the same thing. Their job is to keep their stock continuously rising. So when it stops rising, because, say, the Fed has done QT, their response function is to start to look to cut costs. So where have we seen cutting costs? We're seeing faltering Capex. We're seeing faltering signs of employment. We're recording this particular interview on the Friday morning of non-farm payroll. The number looked OK, but we're definitely seeing a loss of momentum. And when we look at all of our work, it suggests that as we move into the end of the year, there are actually some quite significant risks, that this was kind of the low. And what worries me is that the economies are very sensitive. It's all about the maintenance of this momentum game, right? You can't allow an economy to decelerate too far before that that deceleration becomes selfgenerating. I tried to find it, but I can't find it. But it was reported that Bernanke said, once unemployment rises 0.3, you're kind of done. Because that just becomes self-fulfilling. There are too many people losing their jobs. Their next door neighbor knows that they lost their job. He becomes more conservative, and the whole thing just becomes a vicious circle. We actually think it takes far less deceleration for that before the cycle turns over. And so when we look at the world, we think there are opportunities. We think we can extend the cycle. We wrote to MI clients this last month. We said, we can do this. You can pull this off. You can keep this game going. If that's Powell is publicly on the record for saying his number one priority is to extend the cycle and to keep the economic growth going. But it takes decisive action. And we said, well, a classic example was what they did in 2016. Late 2015, we had all the weakness that we were seeing in Asia. We've had the Chinese devaluation. It came in and started to hit sentiment very heavily in the United States. The economy started to roll over. All the central bankers went off to Davos. They sort of panicked, for want of a better term. And we saw a policy wave after policy wave of verbal intervention, to physical intervention, to fiscal spending from some places, and ultimately, very heavily in the United States. So we kept the cycle going. But they nipped that one right in time. And when we look at the world, our biggest concern is we're not 100% sure that either it's going to be as easy to do. We are another three years along in this cycle, though excesses are arguably bigger. And we're just not sure the Fed quite understands the risk that they are taking by not delivering. We think, ultimately, they will deliver. It is one simply just a function of timing. Do they do it before the end of the year, or do we have to wait till next year? And my fear is, is if we wait till next year, it possibly could be too late. Or at a bare minimum, it's going to take a Herculean lifting to actually prevent the cycle going at that point. VOICE-OVER: How should the Fed extend the cycle? JULIAN BRIGDEN: Enough to me, I think, when you're-- it seems that when you talk to policy folks, the view is that, given that you've got so much little ammo, you have to out-aggress the aggressor, to use that special forces terminology, right? So I think they will probably go big, if they see it as necessary. But you've only got basically 150 basis points. I think the big positive, if you can call it a positive, is that Jay Powell seems to have ruled out the possibility of negative interest rates. We're not going to go down that event horizon that the ECB and the BOJ have talked about. And we've explained that to Macro Insider subscribers why we think that's just a absolute disaster. But that does mean that you can run out of ammo pretty quickly, and you're going to be facing again unconventional monetary policy. I'm not saying we're necessarily there yet. If ahead of the October meeting, if we get some weak data, and in October, they cut 50, or at the very latest, in December, they cut 50, and then that was followed up early next year, I think you could probably keep this game going early into you next year. And by keeping this game going, there were three variables to me. It's that simple. You have to drive stocks higher. Stasis is not enough. You have to keep net rates low enough that you keep the housing market ticking over. And ideally, you want to weaken that dollar, because that will-- to the what we did in 2016, that has been the missing element. Because in 2016, we very successfully reversed the strength of the dollar, and it encouraged some of that reflationary, true reflationary, it, because if the dollar drops, it is a reflationary event, because it pushes up oil prices, gold, platinum, silver, et cetera, et cetera. And that's clearly been a strongly missing element of the reflation attempt that we've seen thus far. If you can pull it off, great. I don't think we'd have to go all the full hog to QE. But delay things too long, lose-- bleed even more momentum in things like employment. And we've been looking quite a lot at this, and we really think it takes very, very little loss of momentum in the employment market. And there are some nascent signs of that already for it to be unsavable. The next year, we're going to have to go the full hog. And ahead of election, that could really be quite problematic for the Federal Reserve. VOICE-OVER: Is QE coming whether or not the US economy slows? JULIAN BRIGDEN: I would hope that they will get it, and we will not have to go to QE. I think more QE is coming eventually. It's going to be different. It's going to look slightly different. It's going to walk slightly different. But it will quack like a duck. So it will be QE. But I think what we're looking at is, to use this beautifully PC term, social QE, fluffy QE. And it's basically going to be QE aimed at underwriting MMT-- so a Modern Monetary Theory, so directly underwriting government spending. So I think, certainly in the US, that would suggest that's really a 2021 kind of event. But given that we are getting to the end of the efficacy of central bank policy, and assuming that policymakers aren't just happy to go-- OK, we're done now, we surrender-- and watch the global economy slip gently under the waves and into global chaos-- which I'm pretty sure they are not going to be-- we really are prepping ourselves for this next stage of the cycle, which is this battle on handing over from the monetary authorities, the fiscal authorities. You can see very, very clear signs of that. When you look at the recent speeches of Mario Draghi, now he's removed that ECB pen from his lapel. You could see it in someone like Larry Summers. I mean, Larry Summers is sort of the father of all these-- let's say the intellectual backing of current central bank thought. And even he said, we're sort of done. So we are coming, I think, to a very big phase in the next cycle. As I said, I think we can avoid doing the old style QE, if the Fed acts. Failing that, they'll have to do some. I mean, people will say, and they will-- I think happy to go along with the spin, that what they're doing in terms of the repo is arguably some form of QE. It is certainly balance sheet expansion. I think it's going to have to become permanent, semi-permanent balance sheet expansion over the next few months, given the issuance calendar, given the factors that are actually driving that demand for liquidity, which are very domestic, quite technical in nature. But it will result in an increase in the balance sheet. Some people, I think, will be quite quick to say, ooh, ooh, ooh, QE. Not all QE is exactly the same. QE 1 was very different from QE 2 and QE 3. In my analogy, this is more akin to QE 1. When QE 1 was launched in late 2008, it was really to offset a negative. If you want a simple analogy, the US economy had a bucket of liquidity. Some of that was central bank provided liquidity. But most of it was commercial bank provided liquidity. And the GFC just blew a bloody great big hole in the side of the bucket. And basically, what happened is the central bank came along, and they patched the side up. And then they filled up the bucket. And as far as they filled it up to the prior level, that was just offsetting a negative. And that was what I saw QE 1 as. QE 2 and QE 3 were very different. They let all the liquidity spew all over the sides, and we were net additive. What we're doing in terms of this repo operation is really QE 1. Left unarrested, left untackled, by forcing more and more treasuries, particularly with the very heavy issuance calendar, onto the balance sheets of the commercial banks and the primary dealers that are part of those commercial banks, you're in danger of squeezing out other bits of the lending process. So by releasing some of that pressure on the primary dealers, then that's offsetting a negative potentially elsewhere in the system. We're not net pumping more cash out of the system than we did in QE 2 and QE 3. But look, to the extent that people see that as QE, maybe that is a mental crutch to the market. I think, probably unfortunately, that we will need a little bit more than just a mental crutch in the market at some point. VOICE-OVER: Will the business cycle end, even with central bank stimulus? JULIAN BRIGDEN: Look, I mean, we've gone through periods in history where you've had hardships. It's a bizarre world that we live in, where you're not allowed to have an economic cycle. But I do believe that policymakers are intent to try and extend this cycle. What I heard from G7 was an actual fact. Despite the negativity around Trump and the trade situation, it was much more collegiate than people would automatically have assumed. And one of the things that they could all agree on was the necessity to try and keep this game going. So if you're running out-- which, in Europe, you have run out of monetary bullets-- and you've got 150 left in the US, which is far less than we typically would need to extend the cycle, then we have to look to other parts of policy to pick up the slack. They have the ability potentially to do it. The Europeans certainly have the ability to spend money, if they so choose to do. The US doesn't seem to be an issue anymore about fiscal conservatism. There are no budget hawks out there anymore. So we just have to get to the circumstances to create that, that decision points. In Europe, I don't think we're there yet. We're starting to see the rumblings in Germany of climate change induced spending. But of course, the Germans have offset it with tax increases. So it's a net zero. So that's not an add. But you create a bit more pain, and you could get there. The issue for the United States-- and which is why it's likely the Fed has some ammo left-- is that nothing's really going to happen ahead of the election. So I can sit here and pontificate and say, we're going to get MMT. We're going to get our fiscal spending. I truly believe that is what we are going to get. But that's a 2021 issue. And for markets, that's a long, long way away, right? We are still at least a year away from that, even to a decision on the election itself. And in the interim, the Fed is the only game left, I think, globally really of all the major central banks. And I'm hoping that they realize the precariousness and the fragility of the underlying economy. It may not appear to be that fragile, particularly after today's non-farm payroll number. But there is a fragility, particularly in terms of maintaining this momentum. Because as I said, I don't think people necessarily understand how little a loss of momentum is necessary before the thing becomes self-perpetuating. And so I would hope the Fed will get it. I hope they'll get it quick enough, and they can keep us ticking over, ticking over till we get to the election. VOICE-OVER: What are the signs of a tipping point? JULIAN BRIGDEN: So one of the things that we've been looking at and working on quite a lot is employment. The unemployment rate is actually quite a bizarre, strange, economic series. Because also, most economic series tend to trend. But most of them are really choppy around that trend. And yet unemployment is insanely smooth. I mean, it's like a sort of sign wave you studied in high school, when you were doing your math class. It falls steadily, building upon itself. And then it loses momentum, and then it reverses, and it goes the same way. There aren't these wild pricks, pinpricks of prints which are all over the shop. And I think it makes sense. I mean, you get a job. You go and spend a bit of money. Someone else has to hire someone else because of your spending and all your cohorts, and et cetera. It becomes that rolling ball until all of a sudden, it isn't. And to me, I think that once you start to lose- - I mean, Bernanke was quoted once, saying that, once unemployment's risen 0.3, we're done. OK? Because it just becomes self-perpetuating. At that point, you know someone who's lost their job. And as a result, when your girlfriend says to you, come on, Johnny, let's go out for dinner tonight. You go, mm-hm, Sam just lost his job. Mine's not totally dissimilar to his. What if I lose my job? Maybe we shouldn't go out to dinner tonight. You don't go out to dinner. The restaurant you were going to go to closes down. And all of a sudden, you realize you're going to lose your job, as well, because you were in the restaurant supply business. So it does become self-fulfilling. We actually think it potentially takes significantly less than a 0.3 rise in unemployment. And we've been doing some work that suggests that-- we were not looking for a bad number today from non-farm payroll. But we're beginning to get very worried about the October number print and the November number print that we'll get next month and the month after, that we are starting to see some signs of a significant loss of momentum. The most obvious place you can look for them are in some of these PMI prints that you're beginning to see and some of the commentary that goes with it, which have suggested that firms, particularly as they plan for 2020, a lot of that planning goes on now. If you look at the manufacturing sector, there was some very interesting comments made about, we're in the planning phase now. We make decision over the next couple of months. We're producing too much. We've eaten through our backlog of orders. At some point, you have to make a decision about how you're going to right-size your firm next year. And if that decision is to cut costs, employment is going to be a key part of that as you try and right-size production. And I think we will know within the next two to three months whether we can skirt a recession or we could get to really pretty quickly to be on risk of a recession sometime in 2020. And at that point, I would say that the Fed's probably blown it, if we get to that. If we lose that much momentum-- and as I said, it doesn't take as much as you think, it's going to make for a really interesting election. Put it that way. VOICE-OVER: If we do get a recession, will it be severe? JULIAN BRIGDEN: No. Look, I think that the GFC was, in that sense, truly unique. We don't have the excesses broadly that we have there. We have, as I said, pockets within the equity market of excess. You have pockets of credit, which of excess. You have pockets in the real economy of excess. And those would be house prices. I have a feeling it will be a pretty ugly one, because we've pushed up a lot of these asset prices to very high levels. My sense is, though, that it won't be as systemically threatening as it was, I hope, I hope. But offsetting that in certain parts of the world may be the inability of policymakers to deliver. So particularly, when you look at places like Europe, the Fed does have some ammo and has a willingness, I think, to be pretty forthright and aggressive, once they deem it necessary. I'm not sure the ECB is in that position. They've gone down a route where they've chosen to prioritize negative interest rates over, let's say, QE at this point. The program they announced thus far has been very weak. It does very little to address the fundamental structural issues that, say, Germany may face. So my gut says it's not going to be a GFC. The assumption is it's not going to be a GFC. But it could still be a pretty ugly recession. When we model Germany, for example, we think she's looking at, outside the GFC, the ugliest recession she's had in 20 years. You've got to go back to the ERM crisis of the early '90s to find something this ugly. And that was a bloody ugly recession. VOICE-OVER: How should investors position for the future? JULIAN BRIGDEN: What we said to our clients is we think that the current state of markets is unsustainable. We have a super high equity price. We have the bond market priced almost for perfection at the other end. And we have a dollar which is trying to push the top end of the range. And what we really need, to keep this game going, is we need stocks higher, bond yields lower, and a weak dollar. And the Fed can deliver those, if they so choose. But at the moment, it doesn't appear to me that they're quite ready to make that step. And so we're watching those interplays of those three variables without fully committing. And we've been looking around for trades which we think can benefit in all-- whichever one of those three starts to break. Those are less easy trades for retail investors to play, because they tend to be relative value-esque things. So the curves steepen as their spreads in the eurodollar curve at the front end of the US yield curve, their spread trades within the equity market between, let's say, growth in value stocks. It's that sort of thing. And we're watching the dollar very carefully. When I look out a little further, and I say, OK, well look, if the Fed doesn't do it now, if the Fed doesn't deliver now, and we don't get those breaks now, they're still going to have to deliver sometime next year. So if I fast-forward to early next year, and I assume then, at that point, the Fed is getting religion-- they have seen the epiphany, they have seen the risks, they are moving now aggressively to deal with those-- to me, we go back to some of the trades that have worked really incredibly well in the last few months, which are things like precious metals. As I look out from early next year for the next five years, I look at valuations between-- and precious metals and, let's say, the NASDAQ 100 are just extreme examples of growth, NASDAQ 100, these growth stocks that really only grow when nothing else is growing, that live off super cheap money and are actually part of the problem that central banks are actually fighting against. By perpetuating this cheap money, you've led to the Lyfts and the Ubers in the WeWork, these disruptors, while at the same time, keeping the zombie firms that they're trying to replace alive, so there's no pricing power. But as we look out over the next four to five years, particularly in the US, and you say, look, to keep this game going, the Fed's got to ease policy. They've got to push stocks higher. But which stocks? And if you create true reflation, you don't really want to be in these growth stocks. Assuming that true reflation really means a significantly lower dollar, what you want to be in is there in some of these value type names and/or value type places. And there's not much more value than some of these precious metals on a relative historical basis to some of these other things. So I mean, if any of the listeners are in front of a screen, just go and type right in the NASDAQ 100 against platinum, and take it back 20-odd years. And you'll see that the ratio has perfectly topped out, this being the third time in a row at these levels. And ask yourself, where do I want to be for the next five years? Do I think that the Fed fails? Do I think that we go into this world where there is an inability to deliver reflation? Even before we consider the fiscal stimulus that potentially could come-- which I think would be highly inflationary-- but even before we consider that, the Fed has failed, that we're just awash with free money, right? Maybe not negative in this country, but it will be incredibly, incredibly cheap. And there's just any amount that you want. And then you can envisage a world where there's Uber 2.0 and Lyft 2.0 and all these super ridiculous ideas, where you can burn through billions of dollars and never have to make any money and still be worth billions. In that environment, then, clearly, growth stocks are where you'd want to be. Or do you want to beat the bet that the world's most powerful central bank-- and I say that, because it controls the reserve currency. And as the denominator of all the assets that we trade, as you push the value of that currency down-- which I believe, given the interest rate differential, given the potential to expand the balance sheet again, the Fed has that ultimate ability. Now, the ECB won't like it. The BOJ won't like it, at least initially, because it will push deflation on them, but ultimately will, because it is reflationary. Do you think they can succeed? In that environment, things like platinum, gold, silver, and then ultimately, as the reflation starts to manifest itself, copper and all these two industrials and soft, is that possible? And I think the answer is yes. So really, from a strategic view, I think that's pretty much where we're going. I think the era of the growth stopped momentum play, we saw last September. We had the first trend. I think we're going through the beginning of that unwind. It takes time to play out. These things and never smooth. It's not necessarily an incredibly bearish call on the broad market. Don't forget, in 2000, during the dot come bubble, the NASDAQ fell 40-odd percent, and the S&P was steady as a rock. I mean, March of 2000, the NASDAQ drops. The money flows into the S&P. The S&P hangs out for another six months, until September. Then it goes. Then the money goes into the Dow. And the Dow holds up until May of 2001. And it was only when that went, 14 months after the NASDAQ had gone, that the US economy rolled into a broader recession. So just because you have these sectors that become out of favor, it doesn't mean that you have to go into recession. But I think that's where, when I look at the world, that's what I'm hoping. I think we're in this period of not bleakness-- I have to retire and build my bunker up to the top of my hill. And I think there are a number of people out there that think that that's possible. But I do believe definitively, if we are going to keep this game going, we need to act decisively. The thing that you should be watching in a way is you should be watching the price action of asset prices and how they respond to policy. Because as I said, to keep this game going-- and it may be not what the Fed really wants to think about, because they're worried about these asset excesses. But the only way we do keep this game going is to keep forwarding and maintaining these asset excesses. And that means higher stocks, lower dollar, low bond yields. And if we can deliver those quickly, I think we can keep this cycle going into 2021. At that point, monetary policy will be pretty much globally amongst, certainly developed countries, exhausted. And then we hand the baton over to the politicians-- cheery thought, that one. But anyway, that's how I'm mentally setting myself up.