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Podcast Transcript: Phil Suttle on Fed Murdering Expansions and Bond Worries
- By Bilal Hafeez
- Sign-up to discuss on Slack
- 40 min read
This is an edited transcript of our podcast episode with Phil Suttle, published 27 January 2023. Phil is the founder of Suttle Economics – a leading research consultancy. Before that, he held senior roles at Tudor, the Institute of International Finance (IIF), JP Morgan, Barclays, the New York Fed and World Bank. He was educated at Oxford University and lives in the US. In the podcast, we discussed the US recession outlook, China’s reopening, Japan’s response to high inflation, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Introduction
Welcome to Macro Hive Conversations with Bilal Hafeez. Macro Hive helps educate investors and provide investment insights on markets from crypto to equities to bonds. For our latest views, visit macrohive.com.
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Now onto this episode’s guest, Phil Suttle. Phil is the founder of Suttle Economics, a leading research consultancy. Before that, he held senior roles at the hedge fund Tudor, the Institute of International Finance, the IIF, JP Morgan, Barclays, the New York Fed, and the World Bank. He’s one of the best global economists out there, so I’m sure you’ll enjoy this podcast. So, greetings and welcome, Phil. It’s always great to have you on the podcast at the start of the year.
Phil Suttle:
Great. Bilal, real pleasure to see you again and happy 2023.
Bilal Hafeez:
Yeah, likewise. Now there’s a lot to talk about.
Phil Suttle:
Yeah of the rabbit, of course, I should mention.
Bilal Hafeez:
Year of the rabbit indeed. Yeah, yeah, yeah. The Chinese New Year. And we’ll get to China in a moment, but before we do that, let’s talk a bit about the US. There’s a lot of debate at the moment around hard landing, soft landing, fed cuts, no landing. And where do you stand on the US right now? When you sort of step back, look at the US economy, what’s your overall take?
Fed Will Cause Recession (02:30)
Phil Suttle:
I think we’re in this sort of environment where we’ve set up the conditions for an economic downturn, but we’re not yet seeing it. So frankly, it’s that sort of almost like a phoney war type of environment where you know something’s coming. The fact it doesn’t appear each week to some extent makes people feel a little less pessimistic and possibly a little more optimistic. But I worry that that’s just sort of missing the obvious that’s coming down the pike at us and I think increasingly fast as we go through the early months of 2023.
Bilal Hafeez:
And I wanted to ask you, what are the signs you normally see running up to a recession? And is this time different because we had this COVID shock and that distorted the economy and we had all sorts of odd things happening this time round? But what normally should you see and how does it compare to today?
Watching Interest Rate Sensitive Sectors (03:30)
Phil Suttle:
Right. So, putting it very simply, part of it depends on the nature of the recession that you’re talking about. Obviously in 2020, one just hits us out of the sky, hit us with no warning. This one is a much more, what I would call, conventional counter looming. To quote dear old Rudi Dornbusch from the ’90s, “This is an expansion that’s going to be murdered by the Fed.” And the murder weapon is already out. The Fed’s been bashing us with it and it’s a matter of now sort of having that effect bleed through. So where do you look for that? The most obvious point initially is interest sensitive demand. And that putting it very simply is housing, but it’s also capital spending and then it’s interest sensitive spending by the consumer. And I think as you go through each of those three pieces in the US context, housing’s clearly moved down decisively.
I think the interesting thing about this housing downturn is it’s been sharper in terms of the quantities involved, but actually it’s had very little financial fallout. So it’s very different from the last time when the slide was more gradual, but the financial fallout was huge. The other place I think you’re seeing clear signs of effect is capital spending by businesses, but there are some important kind of factors there that add a little bit of noise, not the least of which is that although business CapEx is falling, some commercial CapEx is actually improving because of this lag response to the pandemic. So commercial construction, a lot of it is frozen during the pandemic and has begun to improve on the private side. And we also got this public infrastructure programme which has begun to kick in. It’s past a year and a half ago, but it’s now beginning to improve.
So that side of it is, I would say, sort of 60%… Housing’s 100% going as it should be. The broader construction sector is more like 60%, 65% going like it should be. CapEx on equipment and stuff like that I think is beginning to slump significantly as reflected in the durable goods numbers. And then the final one is interest sensitive spending by consumers. And that’s even more cloudy because the big item there tends to be auto sales, and they got so depressed for so long because of a lack of supply. And some of that supply is now beginning to get resolved. So you have the paradox that auto sales have actually improved as interest rates have gone up. And it’s not the latter causing the former, it’s simply that you see one of these restrictions from the pandemic beginning to fade. So, I think looking through that noise, I’d say I feel comfortable enough to continue.
I’ve had a view that the economy would dip into recession in the second half of the year. I’ve had that view now for a few months. Before I thought it would be more like 2024, but then the Fed upped the pace of hiking and that caused me to bring it forward a bit. So I’m sticking with that view with a reasonable degree of conviction. What I want to see… This is not good, but I think will happen for that view to be realised, I want to see the labour market begin to deteriorate through the first quarter. And the plainest way that will show up… Everyone will tell you this. I’m not telling you anything special. It’ll show up in the acceleration in jobless claims. So jobless claims will move from the low 200s up towards 300, and then by the middle of the year, broach the 400-weekly level. If that doesn’t happen, my view’s wrong, and it’s a week-to-week way of reading the situation.
Bilal Hafeez:
And on the labour market, a lot has been talked about the level of job openings. That the labour demand is very high, whereas labour supply has been relatively low. So the argument is that we have an unusually large supply demand mismatch today compared to historic periods. Does that change things for you?
Phil Suttle:
Again, you could argue where we are, it’s more deeply overheated than any labour market we’ve had in the last 50 years, certainly compared to the late 1990s and 2019, which was the last time we were at these levels on the unemployment rate. And you could say, well, wage growth has begun to reflect that. It accelerated and it’s not gone through the roof, but it remains relatively high compared to its history through the last expansion. And I think what we’re beginning to see now, and this is something I’ve been looking for and I think is quite important, is a sense of companies beginning to say we over-hired in the expansion.
I think there’s a natural tendency in this situation where there’s a perceived shortage workers to hold onto workers in the initial part of the downturn. Like a hoarding narrative. But I think what’s going on here is that companies are beginning to say enough is enough and it’s time to start letting workers go. Now everyone makes with their quarter earnings announcements, big pronouncements about how you’re going to lay off 10% of your workforce. But that’s now beginning to happen in the tech sector especially.
Impact of US Sectoral Shocks (09:00)
Bilal Hafeez:
And then about the tech sector, when I look at the labour market data, what I find is that there’s certain sectors over-hired during COVID, so tech, finance, legal services, warehouses. And so, the level of employment in those sectors are larger than before COVID, whereas other sectors, especially in other services sectors, nurses, restaurant workers, hoteliers and so on, they’re below the level that we had during COVID. So does that kind of imbalance… Is that different from before? So, we could hear about the job layoffs in tech and so on, but that doesn’t necessarily tell us anything about the broader service sector.
Phil Suttle:
I think one, what you’ve raised, you’re coming back to a point I was making through a lot of last year, which actually ironically is that precisely because we’ve got some of these structural, sectoral changes that have gone on over recent years, we’ve probably ended up with a higher NAIRU or higher natural rate than we had pre-disturbance or pre-pandemic. So, there’s a shortage of, as you put it, restaurant workers, and to some extent, face-to-face workers. People don’t want to do that thing anymore. It doesn’t have its appeal and you’re not paid enough for it. So, I think one of the features of the next few years is going to be that we’re going to end with a higher perceived natural rate of unemployment. NAIRU. Now that was an interesting discussion to have last year when we were talking about how much tightening must the Fed do. And I was arguing a lot more than the market thought, and that view has prevailed, I think.
But the point being here that I think the NAIRU discussion has gone a little bit into the background and becomes more relevant when we talk about the next expansion. For example, how much the Fed can cut once we go through this next recession. But now, the key labour issue I’m looking for is the front end of layoffs and the deterioration there. And that will then begin to spiral into a much higher rate of unemployment. I’m projecting the unemployment rate to get up to around 6.5% by the early part of 2024. And that sounds dramatic from where we are, but would put the coming recession into a sort of average bucket, if you see what I mean. Not a very serious one and not a totally mild one, but more like we had in the early ’90s and in the early part of the 2000s.
Fed Will Accept Higher Inflation (10:30)
Bilal Hafeez:
And where does that leave inflation then? Has the Fed defeated the inflation dragon?
Phil Suttle:
No. So, what it means, I think, with inflation is that the Fed succeeds in stopping the acceleration that’s already happened. And then the reduction that we get, I believe, will be to a level that is more consistent with the rates that we had in the early ’90s through the 1990s. So, we average somewhere around the 3.5, let’s say, rather than two or below two. And I think the reason we end up with that environment is because I think while the Fed has been talking very tough on inflation for about six months, once the economy begins to weaken, it will have to put its focus a little more on the employment mandate. For now, there’s no issue because employment is super red hot. Levels and unemployment rates and all these indicators point in the direction consistent with having a tight policy to deal with inflation.
But as we go through the year ahead, I think those dual mandate objectives will come into some conflict with each other, and we’ll still be seeing an inflation rate well above three like current, but depends which indicator you look at. My current CPI forecast for the end of this year on a core basis is 4.25. And I’m assuming the traditional relationship between core PCE and CPI gets restored off about half a point. So that takes you to 3.75 on the core PCE. That’s probably enough for the economy for the Fed to begin to ease. It does leave you with a dilemma however that you haven’t restored [00:12:30] the around 2% number that you were so interested in doing.
Bilal Hafeez:
And then does that lead to a question about the Fed’s credibility?
Phil Suttle:
Well, to me, for an institution that’s messed up so much consistently over the last few years, I’m not sure how you measure. There’s no credibility monitor here. I think what it tells you is that the likely appropriate blend viewed through the prism of the board sitting there making decisions is [00:13:00] we’ll accept de facto. We’ll accept some inflation that’s a little higher than we used to having to have an economy that kind of holds in there as we go into the early months of 2024.
I think the way to think about this whole inflation process is we were in a very nice place of low and stable inflation for 20 years plus, and then they screwed up by pushing us out of that. And now we must pay the price for that, and that will be a mild recession. [00:13:30] But there’s no chance anytime soon of returning to the price stability environment that we had between the late ’90s and the mid-2000s, mid 2010s, because now expectations have fundamentally shifted up. We’re now a generation of people who were used to inflation that they weren’t before. That’s a loss, but it’s happened and make the best of it.
Bilal Hafeez:
Is there a chance that we could return to the ’70s or the [00:14:00] ’80s in the sense that we haven’t controlled inflation, it ends up being 3%, 4%, might go back up to 5% or 6%. So surely, it’s better to just completely bring it down so that you don’t have to worry about unanchored expectations.
Phil Suttle:
Well, I’m not sure if it’s… The best would’ve been not to create it in the first place, but now we’ve done it. It’s a case of how we manage the second best. And I think my assessment of the most likely outcome is, as I say, the desire was to make sure we got back well below five. But once we are back into the threes and the economy is weak, then I think that the trade-off will be to accept that policy must ease to provide some support to the economy. To me, the way to think about inflation… It’s not a very complicated process. On one level, it’s all about shifts in relative demand and supply. And the big change of the last few years is we’ve had these consistent negative supply shocks. The demand picture was initially to boost it, which was the worst thing you could do and then to cut back.
Question I’ve got as far as the inflation outlook is how much in the way of more negative supply shock will we get in the next couple of years? I’m basically assuming we’re done for now. But if the world geopolitically falls apart even more and because of that, for example, in the US context, the dollar falls apart, which I don’t think is inconceivable. It’s not most likely, but it could happen. Then that could be very bad for US inflation from a sort of secular standpoint. But for now, I’m just assuming, projecting, that we get back towards that old normal, but not quite to the level where we can suddenly reestablish those nice conditions we had where literally inflation wasn’t a concern. It was only a concern to an academic economist who thought somehow it might be too low. But if you take those out of the equation for most people in the economy, inflation was a non-issue. And we blew it.
Bilal Hafeez:
And in terms of the Fed in this context, currently the market expects the Fed to go up to around five and then to start cutting rates in the second half by 150, 200 basis points into 2024. What’s your profile look like, your expected profile for the Fed?
Phil Suttle:
It’s similar, but basically, I’m assuming they take a bit longer. So in other words, we get to that 5.125 peak, which is what the Fed’s been talking about. I think that’s justified. But then rather than cutting straight away, I think they’ll be on hold until, frankly, the early part of 2024. Now I think that view is conditional on weakness but not disaster. So in some sense, what I’m assuming is that it’s the old-fashioned business cycle where you are actually going to have some debate for a few months as to whether we’re in recession or not. I actually worked in the New York Fed briefly in 1990. So sorry. In 2000. Get my decades right.
Bilal Hafeez:
Recession’s wrong. Wrong decade recession.
Phil Suttle:
Yeah. And during that time up until 9/11, there was a high degree of conviction within the institution, not amongst us in the foreign department, but in the domestic guys. High degree of faith that the economy wasn’t in recession because it was retrospectively. So, when you get these mild downturns, there is an act of debate that goes on for a few months within the institution and beyond as to whether you are actually in a recession or not. And I think that’s the sort of discussion we’re going to start having in the middle of the year through the second half. And then by the time we get to, let’s say, early ’24, I think there’ll be enough of a consensus that, yes, it’s time to begin to ease. Markets will, of course, long anticipated that. But I would argue that pricing today is a little too aggressive for the second half of this year.
Hard Landing Risks (18:00)
Bilal Hafeez:
And in terms of potential upside risk to growth, is it possible that we don’t have a landing this year? That we just end up with positive growth sequentially quarter on quarter and this turns out to be fine? We’ll put it another way. What could lead to that outcome in terms of all the factors that you look at?
Phil Suttle:
Yeah. No, it’s certainly possible. One of the problems that we’ve got is that the growth data seemed to have fallen apart in quality just at the very time we need to rely on it. I don’t believe that the economy contracted in the first half of last year and grew nicely in the second part. Seems to be the exact opposite. But not contracted at the end of the year, but certainly was stronger in the first half than the second half. So, it’s a bit of an issue. Maybe in five years time, we’ll get all the GDP revisions and it’ll be clearer again. But I think in the near term, there’s some concerns about quite what some of these numbers are telling us. And having said all that, that means blend the data together and look at supply side data, look at labour data as well as demand side data.
And I think what we could see happen in an alternative to my recession view is we just kind of hang in there at a reasonably sort of sluggish below trend rate. And it’s not a recession, it’s sort of almost like a feeling of sluggishness. But I think all that does is it just builds up the pressure for 2024. At that point, we move down. I remember going way back. I remember this atmosphere developed in the late ’80s, early ’90s. The Fed had raised rates. We had the stock market crash, then we had the rebound. And the Fed had raised rates into ’89, and it was all a matter of waiting for the recession to unfold. And it took well over a year from the peak in rates, I believe, to the recession unfolding. So, we’ve certainly got precedent for that.
China Rebound and Its Impact on the World (20:00)
Bilal Hafeez:
Yeah. And one potential upside risk is China. We’ve had this earlier than expected reopening. Quite dramatic one as well. It seems like they’ve gone from zero to fully open in the country to what a lot of people are expecting. They seem to have eased up on some of the restrictions on property and tech sector and so on, so there seems to be this shift going on in China. From your perspective, number one, what’s your expectations for China now? And then second, what does it mean for the world?
Phil Suttle:
Well, I’ve made a pretty big change in my China view in the last two or three months going essentially from a world where they were growing around 3.75% in both 2022 and ’23 on a sequential basis through the year to one where 22’s ended up weaker. We were at 2.9, I think, in the end, so it wasn’t quite as weak as I thought. But ’23 on a Q4 basis will be something like 7.5, 7.75. So a three to four percentage point increase in activity in China relative to what I was thinking three months ago. Now that’s got nothing to do with monetary easing or fiscal easing. It’s everything to do with a reopening of the economy. And obviously, I’m sitting here in the US and I’m reading stuff and seeing stuff about what I think is going on in China, but I wouldn’t say I know exactly. It’s hard to be 100% clear.
But it seems to me the real story here for China is something we’ve seen everywhere else now. It started in the US, and we saw it in Europe and Japan last year, which is this normalisation of the service sector, normalisation of service sector demand and associated with that, I think, more goods absorption back in the domestic economy. So what’s really going to happen here is that Chinese demand will strengthen significantly consumer demand. The saving rate which has gone up, the household saving rate’s gone up appreciably in the past year, will come back down again, kind of mirroring what happened in the US in ’21 and ’22. So, it’ll be very good for Chinese demand. Very good, I think, for suppliers of services in China. I think it will also be good for commodity producers because there will be a demand for product within China. There’ll be a reallocation of Chinese exports.
One of the remarkable stories of the pandemic was that as China slumped domestically, it was able to reorient its production into the global market better than anyone else. Surprise, surprise. So that supply will be reabsorbed into the domestic market. So you’ll get good growth numbers, but the real benefit to the rest of the world will be somewhat more limited because much of the spending will go to Chinese service producers. But those that will also benefit outside of China will be the commodity suppliers. So, we’re talking Australia, Canada. In the DM world, Brazil, Chile, and a few others. Being brutally honest, Russia as well. China’s going to be important to keeping Russia afloat in the year ahead.
Bilal Hafeez:
And does Chinese growth… From the sounds of things, you don’t think it’ll have much impact on US growth?
Phil Suttle:
No. All the time China is becoming a bigger player globally, but I think one of the ironies of China’s geopolitical approach is that they’re actually going to spread the wealth as it were. In some fashion, the bigger role that China played in the US growth story was in the past couple of years when it was willing to supply product to help keep the US economy improving and, in some sense, take the pressure off US inflation. Now going back to the US inflation discussion, you could say to the extent China’s pulling more of this product back in and they’ll see a big fall in their trade surplus as a result of that. One of the aspects of that is the goods pricing for the US may become a little less cheap than it’s been in recent months. I think we have just passed the low point in US goods pricing, to be honest. It will continue to be soft, but we won’t keep going down at the pace we’re going down. And the important aspect of that is the China story.
Bilal Hafeez:
How long do you think the reopening growth impulse will last for? Because there’s a debate now within markets around have we seen the big growth story or will it have momentum into Q1, Q2 as a whole?
Phil Suttle:
I must admit I’ve had a lot of discussions with clients and colleagues, competitors, let’s call them, on issues like this, where the dynamic, I think I’ve convinced myself obviously that the Chinese people were relatively cautious about this reopening. So, it’s not sort of parts of the southern US where everyone rushed out day one, they were allowed to get out and go crazy. There’s a lot of caution here and I think counsels against Q1 being too strong as it were. There will clearly be a rebound from Q4 and there’s good things happening with the new year and people’s willingness to travel and things like that. But to me, this is really a Q2, Q3 story. Those are the quarters that I think will show the most robust growth in service activity.
And the best way of tracking that is not that complicated. Every month, I draw my chart updating the trend in retail sales versus industrial production. And for the decades, the decent period after the mid-2000s, retail sales growth far exceeded industrial production growth. This was an economy that was gearing itself more towards consumption than production. And then that relationship flipped in 2020. And for three years, we’ve seen a big negative differential. It’s become a production. It’s become a supplying economy more and more. And I think what we’re going to see not just for the next few months, but for the next couple of years is a flip in that relationship back again to a much stronger consumer.
Japan’s Inflation and the BoJ (26:00)
Bilal Hafeez:
And staying in the region, you’ve been looking at Japan a lot, I’ve noticed, in your reports and you’ve been quite adamant that they have an inflation problem. They need to make some adjustments. So, we’ve had some policy changes by the Bank of Japan. In December, they widened the YCC. More recently in January, they didn’t do anything. Their commentary doesn’t seem to say that they think they have an inflation problem. What’s your view on this?
Phil Suttle:
Well, I don’t know if I’d call it an inflation problem or an inflation solution. They’ve, in a sense, set themselves a set of conditions to be met that say we’ve done enough to get rid of these extreme policies, which I think the policies have been extreme. And so I think what’s going to happen as we go through the spring is especially under a new leadership… And I think that’s a very key point is… Surprise. Through most of last year I was saying they’re going to have to lift the ceiling on YCC in Q4. And I got to November and I’d been so beaten up by being wrong on that view that I changed it, which is what a ridiculous thing to have done one month in front of when they did actually change it.
Bilal Hafeez:
Everybody was wrong footed by that, to be honest.
Phil Suttle:
Yes, at least. Most people are wrong footed just saying it wouldn’t happen ever where I was like-
Bilal Hafeez:
That’s fair. That’s fair. Yeah, you were calling for a while.
Phil Suttle:
I majestically managed to change my view at just the wrong time. That’s the story of my life. But I think the more important point here is that he’s been very reluctant to make changes, but I think he was eventually forced to make some. But his successor, or successors in terms of a new team, I think, will be much more willing to adjust policy to what I would call a more sustainable basis. And I liken it a little bit to moving from a fixed exchange rate to a floating exchange rate. I think Japan needs to get back to freely functioning fixed income markets. They can set the policy rate where they want and everything else adjusts. There are many issues to discuss with Japan about, for example, whether, at some point, they’ll ever do Q2. And I think that’s a very premature discussion to have. I think much more likely, it will be a move away from negative rates.
I wouldn’t be surprised, frankly, if Kuroda does that at his last meeting to leave a clean sheet, but I think the successor will do it quite quickly. And we’ll see the wage condition met. That’s an important inflation condition. Everything else, I think on the inflation side, is falling into place. And here’s the really important point on Japanese inflation. It’s not that it’s out of control or anything like that. It’s just I think they’ve been told very plainly by both the markets, but especially by their population, that actually trying to keep inflation above 2% is not a good idea. It’s not a desirable situation. And in fact, you could almost imagine the Japanese coming to the US and saying, “You guys just sold us a bad bill of goods. You told us if we did this, everything would be great. And then you told us that we needed to get inflation above two and keep it there because that was the magic solution. And as soon as you did it, you said it was a stupid idea. Now what do we do?”
So, I think there’s a general disaffection with manipulated and managed bond markets, which is a very, I think from a market perspective, a really important point. We’re entering a decade where the whole disaffection with QE makes the outlook for central banks very different from the last decade. If I was a central banker, I would know that most of what I have to do now has to be done without the tool of the balance sheet. I’ve got to think about just having rates again. I can hope that I can use the balance sheet, but in most cases, it’s no longer a viable option. And when it comes back to Japan, I think that’s the factor that the new team will have to factor into their thinking.
Bilal Hafeez:
And on the inflation side, are you surprised that inflation didn’t go higher in Japan? In Europe, we reached 8%, 9%, 10%. US as well. Even Korea was high as well. Australia. Yet Japan didn’t [00:30:00] really go up that dramatically despite massively weak currency, oil shock, the whole thing.
Phil Suttle:
Yeah. No, I think there’s two or three things going on here. One of which is they obviously didn’t have this bigger energy shock as most other places did. Europe stands out on that front versus everyone else. And in some ways, Japan’s main shock, ironically, has been a food shock. When you look at a lot of the goods pricing it’s fed through, it’s been through the food channel. If I look at the inflation dynamic developed in Japan over recent months versus everywhere else, Japan’s still going up whereas everyone else is rolling over to different degrees.
And you can say, well, some of that’s the currency, the effects of the currency. But even then, I think you’re seeing more later inflation in Japan than, frankly, I would’ve expected and certainly more than elsewhere. I think this is the general point, as we come to the early part of this year, you’re going to see some annual price resetting which will catch up to some of the inflation we had last year. In Japan’s case, that’s possibly the first price resetting in 20 years. In many other places, including in the US, it’ll be, I think, possibly a shock on the positive side when it comes to core inflation.
European Growth Outlook (31:30)
Bilal Hafeez:
Yeah, yeah. That all makes sense. Now if we move back towards the west, the Euro, your area, lots of people were looking for a deep recession because of the NG shock. It looks like we’ve had a mild winter, and the Euro zone numbers are starting to stabilise somewhat. What’s your view in Europe, your area to start with?
Phil Suttle:
That’s a case. Again, go back three months and I had a narrative of China stable and sluggish and Europe first into recession. And both of those views have changed. And the Europe story is precisely that the big supply side negative, which I expected to play out, to cause the downturn and materialise. It’s interesting to try and figure out whether how much that was weather and how much that was agile EU policy, which sounds like an oxymoron. But say it’s the case, the ability to both suppress demand through in informal rationing, but more importantly perhaps to generate natural gas inflows from other sources. I think that turns out to have been quite impressive. So I think the bullet on Russia has been dodged for now. Although, by the way, one of the things I think is kind of very important about this whole past year is that Russia has exerted a big, negative shock on the region.
It’s just affected parts of the region that were doing well the most, Central and Eastern Europe, but also Germany. And actually, had least effects on what we think of as, for the past decade, the weaker countries. Italy, Spain, Portugal, and Greece. So actually, ironically it’s from a sort of Euro stability standpoint in a less negative shock than it might have been. So I’m definitely of the view that the cyclical downturn from Russia, the forces are there, but they’re not enough to tip you into overall recession. On the other hand, that leaves you with the ECB, and the ECB has now… You talked earlier about how things have shown up in Europe that earlier showed up in the US.
And just as the inflation process took longer to feed through in Europe, so the tightening process has taken longer to feed through in the Euro area. But I think of it as significant and well underway and enough eventually to produce a downturn in Europe milder than the US but a downturn in Europe as we go through this year. Now do I have great conviction with that? Much less than the US downturn, which is one of the reasons I have it as a milder downturn. But I think we’ve got fiscal neutral, possibly expansionary but less so now because the lower gas price means there’s less need for support programmes. But monetary tightening on three grounds. Number one, rates, which matters. The downturn on European rates is significant by the time we get to the middle of… I’ve got the ECB at 3% by the middle of this year. So 400 basis points on policy rates and then spread increases across the board when it comes to actual lending rates.
ECB Balance Sheet Reduction Could Be a Risk (36:00)
So, there’s that effect. There’s the balance sheet effects which is more significant in Europe than it’s going to be anywhere else because not only are they beginning to do some QT… And everyone’s doing modest amounts of QT. Nothing big there anywhere really. But what they’re doing is big draw-downs on their lending to banks through the TLTRO process, and that’s going to tighten bank lending standards more aggressively than any other form of central bank balance sheet behaviour as far as I can see. So that will permeate through and add. And then the final thing is because the currency, of course. I think the currency will appreciate further. I think the forward interest differentials will narrow. We talked earlier about people beginning to see Fed easing just as the ECB continues to possibly do its last hike. And that narrowing, I think, will cause the Euro to probably end the year closer 120 or so. You’re the FX expert. So, the couple things and those three, I think, is enough independent of whatever happens in Russia, et cetera, which I don’t think is going to get solved anytime soon.
Bilal Hafeez:
And you thought threefold monetary tightening. And does that also then mean we could have a sharp easing by the ECB? So, they got to 3.5 and quite soon after, they have to start to cut rates.
Phil Suttle:
Maybe I just don’t have much imagination, but I think what’s going to happen as we go through ’24 is fairly coordinated monetary easing across the world. Again, it’ll be a case of first in, first out. So, in fact the first easing is already occurring in the EM world, and that’ll continue and accelerate as we go through this year. Then it spreads to the sort of what you might call the Anglo world. And then with a lag, it’ll permeate Europe, the Euro area. The notable outlier in this process will be Japan, which will have hyped into the early part of ’24 and will probably stay there in my view.
UK Woes (37:00)
Bilal Hafeez:
Yeah. And what about the mother country, the UK?
Phil Suttle:
Not good. Famous Reagan Gorbachev discussion where Reagan says to Gorbachev, “Can you describe your economy in one word?” And Gorbachev says, “Good.” And then Reagan said, “Well, what about two words?” “Not good.” So, the problem here is that it’s the one country where I would identify a little bit of unanchoring of expectations on inflation. Primarily through a labour market, it’s got some big issues. You’re living this, but the number of daily strikes we get and the pressure for higher wage increase, it seems to me to be fairly unusual, certainly compared to anywhere on the other side of the Atlantic.
And I think the economy is doing badly but not badly enough to compensate for that effect in the short run if he means to offset it. And he’d say, “What’s the driver behind this?” And I think I have to keep coming back to the idea that Britain has this extra negative supply shock that no one else has, which is our beloved Brexit. And I’m sufficiently old fashioned and versed in UK under-performance. I’ve got all these comparisons. And to me, Brexit will go down as a very similar policy mistake to going back on gold in 1925. It created six years of massive under-performance before everything fell apart in 1931. And we’re in that same environment now, I think. It’s hard to project the medium-term outlook to this. You can be very bullish and say ultimately everything will turn around and there’ll be a lot more external focus and all that. But I just worry that in the near term, it’s just a very, very grim picture.
Bilal Hafeez:
I’m very sympathetic to that view. But then what does that mean for the Bank of England? They’re in a tough bind. They seem to want to be very dovish, yet they don’t have enough help from the inflation side, you could say, to allow them to be dovish. So, what are they to do?
Phil Suttle:
I think they just chip away at those 25. They’ll do 50, I’d say, as of next month. But we’re in this process where central banks have been quickly lifting rates to what they perceive to be neutral values. But then I think from that point having done 50 in February, the bank will be biased towards doing 25s. But I think the key here is that it’s almost like a process of price discovery. They’re trying to understand what the neutral level of rates is or what the damaging level of rates is. And the discussion that we had in the markets over the last two or three months was effectively the bank staff, the governor allowing his chief economist to take over in some sense and the bank staff saying, “No, we think the neutral rate is a lot lower than the market thinks it is.”
And that battle of wills is playing out. And to be honest, what’s happened is we’re getting convergence in the middle. The bank’s having to raise its assessment of where neutral is. The markets come down on its assessment. And I think that means we settle. I’ve got the bank peaking at 4.5 in the middle of the year, so that’s probably not far these days from where the markets price. I think the bank’s point was it’s not above five and they’re probably right in that it’s above four.
The Year of EM (40:30)
Bilal Hafeez:
And we talked about some of the bigger economies. Now outside, whether it’s EM or the smaller G10s, is there anything else that sounds out for you? Any observations?
Phil Suttle:
I think there’s interesting pair wise discussions in the DM world. So, for example, I think we’re in another one of these worlds where the Swedish are having an extreme cycle and the Norwegians are your sort of low heartbeat central bank. So, there’s going to be a lot of action there. Sweden probably overshooting on the right side on high side as Norway is much more gradual. And then on the down cycle, a lot more aggressive easing. And the same pair wise relationship I think holds in New Zealand, Australia, where the RBA is a much more steady adjuster up, and RBNZ’s been much more aggressive. And once everything tanks, will probably end up being much more aggressive on the downside. So, it’s kind of like that tortoise and hare relationship there, I think, is quite important.
And actually, sort of behind that, there’s a little bit of a message here, which is that if you are a big oil and gas producer and resources producer, the negative shock you face from an income perspective is far different from if you just import all the stuff. And so ironically, your inflation pressure is probably less than if you’re totally dependent on imports of this stuff because, in effect, your negative income shift is much smaller. So, you don’t have to ration the demand of your domestic economy in quite the same aggressive way that you do if you’re in the UK or the Euro area. So, I think that’s an important kind of point to bear in mind.
And then just generally coming back to EM, I would say this is actually a pretty good environment for EM. There’s a huge amount of political oddity going on in EM. And the two obvious cases are… The extreme one is Turkey, which I would stay away from personally, but Brazil, I think, is interesting because I think we’re kind of facing this. Is Lula III really similar to Lula I and II or is he gone complete crazy? He’s going to blow everything up. And I think the market is very uncertain at the moment. My bias is to say he’ll be like Lula I and II, but everything he’s done in his first month in office and month before that has rattled me a bit. So I’m kind of little more nervous about that.
But I think, generally, the EM world is looking pretty good as we go through the next year. And some of its China, some of its natural cyclical leadership ironically. So instead of responding to the Fed, they led the Fed. So, we’re at the point in their rate cycles where there’s pressure to ease. And what can get in the way of those two positives? And by the way, a weaker dollar is an important backdrop to this. So those positives, what can get in the way of them is domestic stupidity and poor policy setting, which many of them seem to have a capability of being able to do.
Bond and Equity Outlook (43:00)
Bilal Hafeez:
So overall, in terms of if we switch over to market implications, I know you tend to be more kind of in the weeds on the economy, but you’ve talked about a weak dollar view, more of a positive EM view. In general, for equities, would you have a view on equities?
Phil Suttle:
I suppose I’m frankly just a bit negative because I think where we sit now is the equity market has enjoyed the downside of interest rates without realising that that’s a leading indicator of a massive slump in earnings. I think the earnings picture as we go through this year is going to be a lot more negative than the market currently accepts, even after the downgrades of recent months. So that’s my reason for some caution on the equity side. I think the US versus non-US trade is interesting because once in a long, long time, we do appear to see some attractiveness to non-US equities relative to US, which is a mixture of valuations, but also with these relative fundamentals, including some of the dollar messages. And EM equities, I think, look to me, relatively attractive. Obviously, China’s made a major move, but there’s plenty more upside there if you really think China’s going to be as strong as I think it’s going to be.
Bilal Hafeez:
And bond yields? Anything? Will they just go sideways because we have-
Phil Suttle:
To me, there are two narratives about the bond market. One is this sort of cyclical story, which is a very powerful one. And it’s probably going to dominate the next year or so, meaning a little bit more on the tightening side, but then an easing cycle comes into view. In a bond market, that’s a bit like being at the top of a snow sled with a nice, fresh pressed fall. Everyone wants to slide down that one. The secular story, I think, however, is important, which goes back to that earlier discussion about the medium-term trend to inflation. But then on top of that, I would say that there’s a really important issue here, which goes back to something I’ve alluded to a couple of times, which is this very different world facing central bank balance sheet management. And in a downturn as I think we’re going to get, we’re going see widening budget deficits. Not necessarily dramatic use of fiscal policy, but just wider budget deficits on a cyclical basis.
And the last two times that’s happened, we’ve had a massive increase in central bank buying to more than offset that effect. This time I’m pretty confident that what’s going to happen is that as deficits widen, central banks will actually be adding bond supply to the market so that the sum of the two keeps going higher. So I think that has to raise term premium or at least some pressure on bond yields to be higher than they would otherwise be. So to me, that’s from more of a perspective of ’24 and ’25, perhaps. That makes me very cautious about DM bond yields generally, but especially in the US, UK, Japan and Europe. What’s fascinating is you’ve got Japan out there at 100% of GDPQE, and the others in the mid-thirties, and then everyone else trivial. And it’s those four, the three in the thirties, the UK, US ECP, and then Japan, who I think face this dilemma. In effect, it’s like a secular unwind of the post 2010 QE effect.
Books (47:00)
Bilal Hafeez:
Yeah. Well, that’s something to look forward to or not to look forward to. Sounds quite sort of scary prospects as we get through the recession and we have to worry about that. But no, that’s great. We could go on and on and talk more about markets and the economy, but I did also want to ask you some personal questions as I always like to do. One was, have you read any good books or good academic papers or anything? Has anything stood out for you recently?
Phil Suttle:
I must admit, I live in DC part of the time and right next to the National Gallery of Art. And I’ve recently become obsessed with Andrew Mellon, and I read this fantastic biography of Andrew Mellon by a guy called David Cannadine, who’s actually an English academic historian. The guy is absolutely fascinating, not the least of which is he literally gave his art collection to the country and provided all the funds to build the National Gallery in Washington. And it should have been called the Mellon Gallery, of course, if there was any justice in the world. But he didn’t want that. He just wanted it to be called the National Gallery. And, when he did this, he was treasury secretary. And there were so many interesting angles around this guy. He’s one of your classic robber baron capitalists but somehow came out of it better than all the rest of them. Better than dare I say it, the JP Morgans.
Bilal Hafeez:
Okay. Yeah.
Phil Suttle:
So yeah, I’d really recommend getting to know Andrew Mellon a little more. He’s a fascinating character. This book-
Bilal Hafeez:
Yeah, I’ll add it to my reading list and that sounds great.
Phil Suttle:
It’s a big book. It’s good.
Bilal Hafeez:
And then on the TV, movie side, anything you’ve seen good recently?
Phil Suttle:
Well, I’m afraid I’m a follower, not a leader on a lot of this. I’ve become, like everyone else, obsessed with this show White Lotus, which I think is a fascinating show. But my favourite one of recent months has actually been Welcome to Wrexham. I don’t know if you’re familiar with that.
Bilal Hafeez:
Oh yeah, yeah. The Ryan Reynolds one.
Phil Suttle:
Yes, yes. And I’ve actually become a surrogate Wrexham fan, and it’s a very interesting story.
Bilal Hafeez:
So for the benefit of our listeners, can you tell them a bit what Wrexham is and what happened just briefly?
Phil Suttle:
Well, it’s a soccer club from North Wales, just really outside Manchester. Their town is a steel town that just kind of fell into despair over a 30, 40-year period, and with it went the soccer team. And then in come these two Hollywood guys, buy the team. We’re not talking about Etihad and Manchester City or something like that. We’re talking about modest amounts being put in and the beginning of a resurgence. The great thing about this show is they show not just the resurgence of the soccer team, but the resurgence of the town. So, it’s actually very, very novel. I have a good friend from high school days who actually lives in Wrexham, so that makes it even more-
Bilal Hafeez:
And speaking off football or soccer, what were your thoughts on the football World Cup?
Phil Suttle:
Well actually, here’s the amusing thing. We all went in saying, “Oh, a terrible idea of holding it in Qatar. Terrible idea of holding it in the winter.” And I thought it went rather well. Everything about it was impressive. And good luck. And I was very pleased. Of course, same England. We had the usual of missing a penalty, which was our usual ritual of going on in World Cup. But after that, I was actually very pleased to see Argentina and Messi win.
Bilal Hafeez:
Yeah, yeah. I thought it was a really nice World Cup in that respect. Very exciting, lots of great sub-story lines, Morocco doing really well, and some of the big teams getting knocked out early. Spain, Germany, and so on.
Phil Suttle:
I think it was, globally, a very good competition. So well done. Well done all around.
Bilal Hafeez:
And then on the Premiership, Arsenal, top of the table, is at the end of Manchester City and Liverpool are doing terribly.
Phil Suttle:
Well. No, I suppose I might take away from watching probably too much of it is how even the division has become. I think Arsenal are something special this year, but I’m just struck. You see teams that you never thought would survive, but all of a sudden, competing for European spots and things. In some ways, it’s a sad reflection of the excess money that if they could divert some of this money from the Premier League into the broader economy, maybe the country would be a bit better. But for now, it’s very impressive to see the breadth of strength of the Premier League.
Bilal Hafeez:
And how’s your Luton doing, by the way?
Phil Suttle:
Unbelievably well. The Championship, which is the next division down where we are, looks like it’s going to be run away with by Burnley, and then next to them is Sheffield United. So, everyone else who’s competing for that third playoff spot… So, we’re in the mix in a way that I didn’t expect. So yeah, a very good-
Bilal Hafeez:
Fingers crossed. You could be in the Premiership next season.
Phil Suttle:
I think it’ll be a disaster, personally. But anyway.
Bilal Hafeez:
No, that’s great. Yeah, with that, it’s great as always to talk to you. I do urge people to reach out to you and get a hold of your research. I do continue to believe that you write probably the best global economics daily in the market. What’s the best way for people to reach out to you?
Phil Suttle:
Well, by far the easiest way, we do have a website, but I would just say reach out to me at phil@suttleeconomics.com. And if you’ve got any appetite to see what we do. Thanks for the shout-out, Bilal. It’s very kind. But seriously, the best way of seeing what we do is literally having it for a while and seeing if it’s any use to you. As I say, it’s phil@suttleeconomics.com.
Bilal Hafeez:
Yeah. And again, I do urge people to look at it. It’s very, very good. So, with that, Phil, thanks a lot as always. And good luck with all your views and your forecast for this year.
Phil Suttle:
Thanks very much, Bilal. And likewise to you.
Bilal Hafeez:
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