Inflationary Pressure--The Biggest Risk No One's Considered? (w/ Kit Juckes)
KIT JUCKES: Hi, I'm Kit Juckes. I'm chief foreign exchange strategist at Societe Generale, whatever that means. I've been working with them since 2010 here in London. I went to work for them because my mum banked with them. Before that, I worked at a small hedge fund in the West End for a while. Spent a long time at NatWest, then the Royal Bank of Scotland until 2009. I went to work for them because I banked with them. It's always the wrong way to decide things, but I was the best [INAUDIBLE] before that. And I've been doing this since 1984. So long rundown for bond yields, long run up for equities, and a lot of chaos in the foreign exchange market to have fun with. VOICE-OVER: What's been driving bond yields in 2019? KIT JUCKES: What drives bond yields. I think there's the various things are changing about the bond market. The thing that strikes me most now is this is the cycle when more than any other, the rest of the world is driving US bond yields. Donald Trump, everyone knows, is upset by how strong the dollar is. The dollar strong because the US has got the strongest economy, the most accommodative fiscal policy. So our monetary fiscal stance that supports the currency and keeps bond yields up. And we're all dragging his currency up and his bond yields down and down and down and down and down. And given how negative we've got, minus 0.75% rates in Switzerland now, we don't look like we're stopping. If we're Japanifying Europe, we're Japanifying the global bond market as we go. VOICE-OVER: Where do bond yields go from here and why? KIT JUCKES: I think in the end, we'll get nearly everybody's bond yields to zero, in truth. The exchange markets job in this process is to force it to happen. But it was striking for example, even looking at recent events, that when the Swiss National Bank decided not to cut interest rates from minus 0.75%, they tried to sound dovish while they were doing it, the currency strengthened. When the Japanese said, we're not going to change policy yet, we may at some point extend our current very easy monetary policy stance, the yen got stronger. They want a weaker yen, but they just can't have one. So we're still dragging currencies up for any country that doesn't want to play this game and keep going down. And finally, the one thing we are finding out is that there is a floor for rates. The Swiss National Bank again came in to increase the effective subsidy they give to the banks to compensate them for not imposing too much negative rate on their customers. So by not charging them negative rates for all of their excess reserves. Tiering was introduced by the European Central Bank, which is the way of doing the same thing. Saying actually, we don't want banks just to pass on negative rates. So if there is a bottom for rates somewhere at minus 1%, the danger is we drag everybody to a bond yield that gets to 0 one day. VOICE-OVER: Are central banks in control of yields or our yields driving monetary policy? KIT JUCKES: I think the central banks are mostly in control. But I think they're struggling with the market because the market is pulling them. And we come from a cult in the last few years where central bankers look at what market pricing is for interest rates, and they don't want to disappoint because they don't want to hurt the equity market in particular. We don't want to hurt the equity market, and the bond market is pricing more cuts than you want to give them, then you're tempted to push the boat out a bit, and give the market what it wants. Particularly because it's worth saying, at the moment, we just don't have the kind of inflationary pressures that are going to scare central banks. So core inflation is edging a little bit higher in Europe. Wage rates edging a little bit higher in the States. But in the grand scheme of things, interest rates are not constrained by inflation. So interest rates are constrained in that sense by sentiment in the equity market as much as anything else. VOICE-OVER: Compare US and European bond yields over the past 30 years. KIT JUCKES: I was very struck a couple of weeks ago. I pulled up a chart kind of casually one day looking at how long dated bond yields have done pretty much exactly through my career from the early 1980s until now. I spend a lot of my day job looking at the yield differentials and plotting them against currents, and saying, look, here's a correlation, look, it's broken down, or whatever. Anyway, by and large, US yields were much higher than they were in Europe in the early to mid 1980s. They worked pretty similar, really. There was gap from the late '80s all the way through until after the financial crisis. And now there's a big gap again. The gap in the early '80s was the result of the US policy. President Reagan was winning Star Wars, pushing up the budget deficit to do it. And Fed chairman Paul Volcker was offsetting that with very high interest rates. We had 14% bond yields on the day I started work. If only I'd just gone long and kept on going forever, it would've been easier. But that drove up a big gap with Europe and that drove the dollar to the levels which gave us the dollar trading against the pound at almost parity, worse pound than Brexit has given us. And the Americans push too eventually for a plaza meeting and a plaza record for others to help them. I was really struck when I was looking at that period in time that the dollar went on going up long after the yield differential started to narrow. And they had to get rates down quite a long time quite a long way first. Because at the beginning of the process that that yield gap was just so big that money was just plowing into the dollar. And I think there are echoes of that now. The yield differential has narrowed, but it's huge. It's huge, because German 10 year government bond yields are well below zero. And maybe the lesson for me and that is the dollar is going to remain strong, the euro is going to remain weak, even if the differential is narrowing when the reality is for a European investor, I'm only earning a little bit better than minus half a percent for 10 year debt at home. Does it really matter whether the US is offering me 1.5%, 1.75%, or 2%? Maybe not. All of those are vastly bigger than I have at home. So what happens? President Trump leans on the Fed to ease policy faster than they want to. The foreign exchange market leans on the dollar upwards. And I think that ends with effectively, the US being forced to ease more than any of us at forecast. Probably the US economy suffering in the process, eventually. And then US rates dragging US bond yields down. Only changes when inflation comes back into the system. And all the structural things holding that down suggest that that might be just around the corner. VOICE-OVER: What does this mean for the US? KIT JUCKES: It means that I'm going to continually forecast for our clients that the dollar is turning soon and I'm going to permanently be annoyed by how persistently strong it is until it does turn. In that sense, we're somewhere in-- we must be somewhere in 1983, '84 in the similarity. Do we have a Plaza Accord meeting to try to do something about this next year? It gets more complicated. And then to throw it out-- in the process, how low The US yields get depends whether there's a recession in 2020 or not in the States. That risk is clearly growing. But if it doesn't happen, this problem just gets bigger. If President Trump comes back with another fiscal package, which the Europeans feel unable to replicate, the problem gets bigger. And just to throw things into the mix, since I started working, one new great big monster player has come to financial markets and the global economy. And that's China. VOICE-OVER: What is the outlook for risk assets? KIT JUCKES: I think the most difficult bit-- I wish I'd just gone along equities on the first day I started work. I have been a fixed income currencies person for-- whatever that is-- 35 years and counting. And I'm loath to turn around and say that negative bond yields mean the world's a scary place. What negative bond yields, low interest rates in the States, low bond, super low real interest rates mean is that equity prices and valuations have gone up. It's been easier to carry debt. And we've got a brand new kind of bubble in the global economy coming through. One day, that's going to be bad for equities. I worked with a colleague of mine called Albert Edwards who-- he's waiting for that day every day. He has been monstrously right about the bond market, but he's found the equity market more difficult, frankly, because you've got to get the timing right. I think that's a huge problem for everybody in that sense. And I should probably introduce into this, my 500 pound gorilla called China, into this process. China is clearly a growing part of the global economy. To put it in context. 15 years ago, so not that long ago, 2004, China was sort of nearly the size of Japan in terms of global trade share, a little bit higher than the UK. Now it's a little bit higher than the United States of America and not quite as big as the eurozone. There are three countries with more than 10% of global trade. I think that's a huge change. For a long time, what they were doing was allowing their currency to appreciate in real terms, effectively trying to transform their economy towards a domestic focus, and exporting some inflation to the rest of the world from their appreciating currency. The trade war appears to have changed that. They're now letting their currency weaken, spending less money fighting to defend their currency, because they'd like to offset the impact of import tariffs. And as their currency weakens, the trade weighted value of both the euro and the dollar goes up. So although we stare at euro dollar all day long, the trade weighted value has gone up. And the same is true of Japan, which is even more affected by China than the rest of us. So they're now exporting deflation and stronger currencies in real terms to the rest of us, which just adds to this whole process in my mind of a disinflationary world. It makes my life difficult as a currency strategist, because if for example, the Chinese were to just sort of mechanistically offset all the import tariffs that have been preannounced when they come through, the dollar Yuan rate at 7.1 today, would rise to about 7.5. If the president decides to push the boat out and put higher tariff levels on all imports from China, perhaps you could get to 8. If you got dollar Yuan to 8 when it accounts for more than 20% of the trade weighted basket of the ECB for its own currency, that just strengthens the euro to an absurd degree. The a euro dollar would go up. Whatever I think it should, whatever my forecast says. It just won't work. And so China becomes a huge player, because they were passive keeping their currency in a small range, letting it appreciate in real terms. And now they're just passively letting it move because they no longer intervened to stop that. VOICE-OVER: How will fiscal policy impact inflation? KIT JUCKES: I think the fiscal monetary balance becomes really interesting. If you were really simplistic-- and I'm a pretty simple bloke when it comes to currencies quite often-- you would look and say, you know, the dollar's strong because President Trump has been willing to ease fiscal policy, cut taxes, support the economy. The US has got higher interest rates. The Europeans are hamstrung by their own rules. Germany is running a budget surplus. Germany has not offset the huge hit to its economy from the weakness in China with easier fiscal policy. The ECB has been left as the only game in town for Europe. And so they have tight fiscal policy and easy monetary policy, recipe for a weak currency. If you were to get significant fiscal easing in Europe, it would be a game changer in the short term in terms of strengthening the currency, which they might not like. Weakening the dollar, which he would definitely like. And balancing them all and probably getting growth to run. In fact, I can't think of a single good reason why you wouldn't want easier fiscal policy, particularly in Germany, to offset that demand hit from China's weakness. So it's a game changer. I don't think it's a game changer for the global economy in terms of the inflationary recycle. I still think that although you could get some inflation coming back into the world, the reality of whatever you want to call it, the Amazonification of the world, or the whatever the terms we are using right now, that we are crushing the prices of things that get sent around the world, the goods and services. What you pay for phones, laptop, computers, 70 inch televisions, or anything else. And we're absolutely annihilating a lot of pricing, and there's very little price pressure for workers. I don't think that kind of massive wave certainly doesn't look as if it's over to me. So that'll still be there, and that'll still challenge central banks. But a change in fiscal policy lets them refocus and say actually, in a kind of holistic sense, my interest rates are too low. My low interest rates have sent equity markets to too high valuations. And have sent debt levels in various places to places where I didn't really want them. Do I really want a structured credit market that's bigger than the one I had in 2007? I think we all know the answer to that. VOICE-OVER: What comes next-- recession or stable, low growth? KIT JUCKES: I think from where we are now-- I mean, particularly the United States, so globally, that follows from that. I think we're in danger of a recession, we've been, where we are twice already since the financial crisis. You can draw charts and all you can do of all sorts of things. Purchasing managers surveys. Percentage year over year change in the share price of FedEx was one I did yesterday when their results came out. Anything that's trade sensitive globally, really, that does multitude employment growth year over year in the United States. They all were weak 2011, they recovered. They slowed down in 2015 and '16 when China slowed down. They've recovered. And now they've all weakened again. And most of them are weaker than the last two. For my money, I mean, apart from the fact that the boy who cried wolf was right on the third time, which is a bit simplistic, but-- for my money this cycle of weakness looks more synchronized into an aging economic cycle. And I do think that an economic cycle, it's not like us. A cycle doesn't just die of old age. But I do think it's a little bit like me when I run. That as I get older, it gets harder if you put something in the way, let's put it that way. I don't run as fast as I used to by any stretch of the imagination. I think if I sprinted now on the back of President Trump's injection of I don't know, sort of Red Bull that he gave the economy with his fiscal policies, I might run quite quickly for a bit and then sort of collapse in a heap. And I think the global economy looks a bit like that. But I might have said something like that in 2016 as well. VOICE-OVER: What are the risks of a US dollar surge? KIT JUCKES: I worry about the ability of the dollar to be strong in recessions. I also think the world is changing. I don't go out in the morning without some yen in my back pocket for a rainy day, because the apex predator really is the yen under all circumstances. Because they're the people who need to recycle the world's biggest international net financial position every day. When they get scared, that has ramifications. As far as the dollar is concerned, I don't know. I mean, the caveat to that is the speed at which the Fed responds by turning the tap back on. And we've seen in the last few months you know that the Fed is relearning how to run repo operations, the Fed's relearn how to think about managing the front end of the curve. And is becoming aware really quite early in the process that there is a danger if you gum the system up, because the people who need it can't get hold of the dollars when they need them. And they do have a plumbing job to do. My sense is the policy response. In the next cycle is likely to be central banks being if anything, too quick to add, if anything, too much liquidity too fast. Eventually, that could see that spike in the dollar last much less time. But I'll keep my Swiss, my yen, and possibly some Swiss francs in my back pocket just for that. I certainly think it delays the process. VOICE-OVER: Is the US coming back to QE? KIT JUCKES: The US will end up backing QE at some point in the next cycle. I think particularly-- also, there are really two reasons to think that must happen. One is that the US is very resistant to the idea of zero or negative rates. And I think by the time the Fed gets close to having zero or negative rates, I think we'll have had a longer to explore just how politically unpopular negative rates can be. We're in uncharted territory with this experiment of negative rates. I would say you can see in Europe that there's a real reluctance on the part of central bank authorities as well as banks themselves to pass on negative rates to customers unless they really have to. Yes, we used to be charged for our current accounts on our bank accounts. But we haven't for a long time. We like free banking and the world's very used to free banking. I think that's a big step. If you want to avoid that, you have to be willing to go to more QE earlier in the process. And I think the US is emotionally ready for that, to be something that comes before they get to zero. So I think they're almost bound to if there's a recession, they'll get there. I also think they're probably encouraged by the fact that the front end of the money market curve in the US got more complicated, that they lost control of overnight rates in a way they haven't done pre-crisis, which doesn't necessarily mean much of itself. But it's enough to focus on the fact that the plumbing worked better when there was a lot of liquidity in the place, and maybe we should be putting it back in at the first sign of trouble. VOICE-OVER: What is your outlook on Japan? KIT JUCKES: The Japanese will fight a strange stronger currency tooth and nail. They've almost got no choice. Part of the problem is of their own making now-- the yen was overvalued relative to purchasing power parity against the dollar every day from Plaza until Mr. Abe came into power. The whole way through. Sometimes, very. We were all very used to the idea that when you turned up into Tokyo, you just didn't take a taxi from the airport, for starters. That everything costs a lot of money. Post-Abe, that's changed a lot. The yen, despite not moving, it became very cheap over a number of years. And because you keep dollar yen level steady in nominal terms, but with a dose of disinflation in Japan, the yen is getting slowly cheaper every day. Anybody who's at the Rugby World Cup this autumn will find that a pint of beer is extremely good value in Tokyo. That on my experience, the cheapest decent vodka martini in the world is in Tokyo now. And the cheaper Starbucks in the world of the major economies that you can go to Istanbul if you want a really cheap one. But Tokyo is cheap for all of that kind of stuff. So the currency is not overvalued very obviously at this level. That said, they'll fight. They'll fight, they'll fight, and they'll fight to do it. I just think that in a fight to defend your currency starting from a point where you've got a massive asset buying program and negative interest rates is much harder than when you had room to ease further. VOICE-OVER: Can anything change US dollar hegemony? KIT JUCKES: I think the topic of dollar hegemony-- there's almost a book in it. We can be on this for a long time in some sense. But it's in, I think, the press most recently because the BIS has come out with its latest triannual foreign exchange survey, and the Chinese Yuan has made no progress at all in growing its share. The Chinese had wanted that to happen. The most traded currency pair by far is still euro dollar. The second most traded is dollar hand. The third most traded is cable. That's sort of set in stone. I think there are a number of things to say about it. One, if I were China, I wouldn't be trying too much to challenge it, because the euro done a really, really bad job of challenging the dollar, and it's starting from a really strong base to do so. And all the value, all the value of being the world's dominant currency comes to one currency. I don't think second place is worth very much to the euro. So you kind of worry about the privilege that comes to the US, but there's not much privilege to the Europeans from this. So if I were China, I would be looking and saying, OK, do I really want that? And I think that's a slightly different question if you turn around and accept that yes, the US has the world's most significant currency. There are some things to come back to that, But If I were China, I would be looking and saying, well, actually, what I want is a powerful currency, a currency that's influential. And now that China it has such an important role in the trade weighted value of everybody else's currencies, just allowing dollar Yuan to pop its head above 7 had a huge impact on financial markets globally and everything else. So where they were keeping their currency very steady, they are now in a position to say, I can use the value of my currency much more aggressively. If anybody wants to have a currency war, as powerful as the US in that war in terms of how they can impact things, I wonder whether their focus might quietly-- and they'll never tell us-- might quietly start shifting in that direction. That seems to me more important. But that won't stop a shift towards more bilateral trade deals in Yuan in the Asia-Pacific area. That kind of thing will go on. The people who have a bigger bellyache about the US abusing its privilege are probably the Europeans, because it's been politicized under the Trump presidency in terms of a lot of the rules about if you don't obey the sanctions that I put on or agree to them, I will find anybody who does anything in dollars, which is effectively leveraging the currency at it. At that point, it becomes political. But I'm not how you shift it. And I'm not sure I like the idea of it being shifted. When the dollar took over from the pound, look through history and we say, yes, the dollar took over from the pound. And sort of the pound had lost its global status by the end of World War I. And the dollar didn't really get its status properly until halfway through World War II. That's a big gap in real time. I don't if we can cope with 20 years of chaos terribly well. So be careful what we wish for. I think it's going to come out. But the important thing globally is we should understand that use of a currency might not be as useful as the soft power of your currency. VOICE-OVER: How do you play the current environment? KIT JUCKES: I think in terms of the overall shape of a world what old economic cycle with central banks falling over themselves to see who can ease the most, and with a floor coming through, first thing, I think US bond yields are going to get dragged down towards European levels over time. I think that's further to come next year. So any time we get three good bits of economic data that get yields up, I'm going to be interested in buying US treasuries, because that's the way the tide is going to flow. I know, I've watched these things come down all of my career. There isn't a level that scares me that you can't get below this. So I think that's the first trade you're at. Europe's harder because if there is a flaw in nominal rates somewhere near 1%, below zero for policy rates then, when you're significantly below zero for a 10 year government bond, they'll probably just go sideways. I would like to buy the euro at some point. I will definitely be buying the yen persistently before that. And I think moving into currency markets more generally. And anybody who really doesn't want to cut rates is a winner. And anybody who's vulnerable to what the Chinese are doing is vulnerable. So if China lets the currency go further, the Australian dollar's going to get cheaper, the New Zealand dollar is going to get cheaper, the Latin American economies are going to see that. They're just going to let their currencies take the strength. Anybody who's tried it-- the Koreans will let theirs take strength. The winner in that region is Japan, fighting tooth and nail. We will trade below 100 in dollar yen over the course of the next six months, I'm sure. That'll happen eventually. It'll happen overnight some moment when I'm not paying attention. And it will happen fast, but it will happen. VOICE-OVER: How would you summarize your views? KIT JUCKES: I think we're in a world where the structural forces dragging inflation down are still the dominant feature of the long term story. The shorter term story is we've got an aging economic cycle that's becoming more, not less synchronized. And we've got a global trade cycle that's in recession already. So we have a bunch of countries really suffering. We've learned some things along the way. We learned, I think, in 2019 that Germany was by far the biggest winner from the Chinese boom. The Germans sold things to the Chinese, while the Chinese sold things to the rest of us, and the Germans won. The Germans are paying for that today. And that they'll go on paying that. But I think we will feel looking forward from here that those who can cut interest rates probably will be. Those who can't cut interest rates will be struggling. And the uncertainty is when the penny drops on fiscal policy that and I think that there's an intellectual sea change. Definitely that-- why have tight fiscal policy with zero interest rates and zero bond yields. Someone explain that to us. It'll probably drop last in Europe. It's harder to get a consensus around at that.