Global | Monetary Policy & Inflation | Politics & Geopolitics
This is an edited transcript of our podcast episode with Phil Suttle, published 29 April 2022. 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. In the podcast, we discuss the inflation combustion model, whether real earnings will increase, energy investment and higher inventories as the new normal, 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.
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This is an edited transcript of our podcast episode with Phil Suttle, published 29 April 2022. 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. In the podcast, we discuss the inflation combustion model, whether real earnings will increase, energy investment and higher inventories as the new normal, 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
Bilal Hafeez (00:00):
Welcome to Macro Hive conversations with Bilal Hafeez. Macro Hive helps educate investors and provide investment insights of all markets from crypto to equities to bonds. For our latest views, visit macrohive.com.
Another week and another multiple standard deviation market move. This time it was the Chinese Yuan which tumbled against the US dollar. Expectations of lots of hikes by the Fed are certainly working their way through global markets. And we’re likely to see many more extreme moves in the coming months. Lucky for you, we track all of these types of moves on a weekly basis, which you can find on the Macro Hive site. Now, on China specifically, it’s worth noting that the approximate trigger for weakness was a possibility of more lockdowns related to COVID. This comes as most other countries are lifting COVID restrictions. And I’ve written a note looking at how China may not have been as successful managing COVID as many people think. And I look at what this means for equities. Elsewhere, we also give our take on Elon Musk’s purchase of Twitter, and we give our latest view on crypto markets.
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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 Tutor, the Institute of International Finance (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.
Greetings Phil. It’s great to have you back on the podcast. I always look forward to our conversations and as well as our listeners know, I’m a huge fan of your work. And so I always enjoy every opportunity I can get to speak to you.
Phil Suttle (02:13):
Great. Well, nice to see you again, Bilal.
Bilal Hafeez (02:16):
Well, I thought we’d jump straight into it. Inflation. A year or so ago, it was all about transitory inflation, big debates around how fast will it dip, is it going to spread and so on. Now we’re at a level of inflation where it seems like the transitory debate’s gone. Now, it’s just a question of… It’s more shifted away from “is inflation transitory or not,” it’s more about “how much will central banks hike now.” We’ve kind of moved to that sort of level now. So will it be 2, 3, 4 hikes, or 8, 9, 10 hikes? It’s shifted to that stage. So let’s go through each part of that. On the transitory side, what’s your current view of inflation and the transitory debate. Let’s kind of just get that out the way first.
The inflation combustion model
Phil Suttle (02:54):
I mean, I think my model of inflation, to the extent I could call it that, and it’s one of these processes that, and again, this is going to sound a bit pretentious, it’s very non-linear. And all I mean by that is every now and then we ignite something really bad. You know, it’s a bit like every now and then get a bad fire. And that the inflation fire comes when we essentially kind of mix conditions together. And specifically we have a lot of goods price inflation, which I always think of as the combustion to an inflation process. And then we combine that goods price inflation with the rest of the economy, the service sector let’s call it, in sort of tight conditions. So that ignition finds some fuel elsewhere to begin to burn an inflation process. And then the final piece, as it were, is that it then translates into expectations.
So in a pre-fire environment, expectations are stable, because everyone’s got used to low inflation. And then all of a sudden this combustion occurs and everyone panics and runs for the doors and begins to expect more inflation. And I think that’s the process we’ve been through. And it’s the first time we’ve been through that process since basically the early 1970s. We’ve had a few false alarms along the way. They always occur in the early stage of a recovery. And one false alarm we had was in ’94. I remember that well when everyone was freaking out about goods price inflation and the Fed was very aggressive, at least in relative terms, very aggressive. And it worked. To stall the inflation processes, it put the fire out. And then we had another one in 2010 after the financial crisis. This time, however, the Fed didn’t need to do anything because there was no fuel there.
The rest of the combustion in the goods sector didn’t spread because there was no fuel in the rest of the economy. The rest of the economy was still flat on its back after the financial crisis. Best illustration of that is look at unemployment rates in that period. Compare the unemployment rate then, 18 to 24 months after the end of the US recession, compare that to where it is now. And that’s the biggest difference today, versus, as I said, the last recovery. But the way I think about the inflation process is there’s, you know, there’s no inevitability to anything. It all depends. And the conditions we’ve had that have developed over the past year have given us a persistent inflation.
Inflation to settle at new higher inflation levels around the world
Bilal Hafeez (05:24):
Yeah. And you’ve been great in recognising this process and calling for high inflation. Every time people are doubting your notes, kept telling me it’s here, it’s going to come. Everyone’s going to be shocked by how persistent this is, and you’ve been right. So what types of numbers are we looking at for this year and next year, say for the US on headline inflation, say.
Phil Suttle (05:41):
Just to make sure that there’s no misunderstanding of my ability to do it forecasting. I mean, every now and then a blind squirrel finds a nut, sort of. And I must confess, throughout my career I’ve probably made systematically more inflation overshoot forecasts than I’ve met, you know, got it right. So I need to give that little health warning.
But I think the sort of rates that I’m looking at, if I go back to my combustion model. Now we’ve got this incredible amount of fire that’s been burning through March. So 8, 9, you know, even 10% possibly in the UK the next month or two, you know, that’s not the true inflation rate. But I think what we’ve done is we’ve moved up from sub-2% in most jurisdictions to something now in the, I want to say, 3 to 5% range. And I think it depends a little bit on the extent of overheating in the domestic economies.
In the US and Canada it’s probably closer to five. In Europe it’s probably closer to 3, 3 and a half, on an underlying basis. But it’s not two anymore. And we’re not going back to two quickly. We’ll go back quite quickly, I think, over the next 12 months to those underlying rates that I was mentioning. So we won’t, you know, in UK will be most spectacular with this coming month and it’ll go to 9% or something like that, but it won’t stay there. I don’t think. It’ll come back down to sort of the 3 to 4% range in the UK, let’s say.
Bilal Hafeez (07:02):
And on the Asia side, Japanese inflation’s been really quite low. Part of that is mobile phone fees declined. So maybe you exclude that. Even so it’s still low relative to the rest of the world. I guess you could say it’s high relative to Japan’s history. So maybe one needs to look at it in that way. And also China’s at least CPI numbers are quite low as well. I mean, what do you make of that part of the world?
Phil Suttle (07:23):
You know, one danger is over fitting explanations and all that, but I think the fundamental point there is the expectations have remained, to use that old cliche, well anchored. Japan, the problem’s obviously they’re too anchored. You know, they really want to be chipping away at anchor for years and they haven’t been able to move it. But I think in Japan, it’s that inflation psychology that’s been very difficult to break. And by the way, this is a very important point in my view, it’s a good thing. Inflation psychology as well anchored. You know, I think one of the huge mistakes that policy makers made over the last couple of years, which is to think somehow it would be a good idea to get that oil tanker of inflation expectations moving. Because I don’t think they realised the sort of the implications of making that shift, especially in the global environment in which they were doing it.
But I think on the Asia story more generally, I think it’s less of a cyclical picture. If you see what I mean. Asia is inevitably going to get caught up in these global price trends and all these low core inflation rates we saw in emerging Asia over the past year, year and a half have now begun to move up appreciably. But they’re going to peaks of three and a half, four, rather than eight or nine.
Bilal Hafeez (08:35):
One of the hesitations I have about… Well, not hesitation, I should say, one of things that concerns me about having a view that inflation’s going to stay at high-ish levels, not 8%, but say 5%, is that I think one of the reasons we’ve ended up with persistent inflation is that COVID has lasted a lot longer than we all thought. So I think part of the transitory argument implicit behind that was that COVID is going to end, vaccines will fix it all, but it actually it’s just dragged on and on and on.
I mean, now we seem to be kind of coming out of it, at least outside of China, it seems. You know, China’s still has its sort of lockdown strategy. And so let’s say we are now out of COVID, no more restrictions, nothing like that, then could that lead to an accelerating decline in inflation. So, that’s one question. And then the other one is how much of the inflation we’re seeing right now is just energy or commodities. And so, you know, when commodity prices stabilise a bit, everything kind of goes back to normal.
Phil Suttle (09:28):
Both excellent topics. First, I think the issue is really, a lot of it comes down to, frankly, to labour markets and the extent to which we’re going to see this pass through from higher goods price, and now service price inflation into wage inflation. I mean, one of the features of the US of the past year is actually profit margins have widened. So companies have been trying to raise their prices, but you know, workers haven’t in some sense enjoyed the full benefits or they’re been compensated for the price increases. And in my somewhat simplistic view of the world, I am a believer in the Phillips curve, is the chances of that happening go up when you have a three handle on the unemployment rate. If you have a five or six or seven, eight, nine handle on the unemployment rate, then there’s no way that pass through is going to happen.
You know, that’s why 2010 and 11 of what they were in terms of the inflation moderation. And one of the things that sort of struck me and actually surprised me a bit is how generalised labour market tightness has been across the developed market world. So where you’re sitting in the UK and you’re looking at unemployment rates. I mean, I frankly expected the UK labour market to be a bit weaker in the last part of last year when the wage support scheme was taken away.
But when it went, things got stronger. Same happened in Australia earlier in last year. So I think we’ve got this generalised strength in labour market. So that’s important. On the energy side, I think one of the risks, and this is something that, amusing set of stories about the old Arthur Burns in the 1970s, who would keep demanding the Fed staff produce an inflation number that was X this and X that, so as to show low inflation. You know, if you take all the price rises out, then look, inflation’s low. And the nearest we’ve come to that is dear old Jerome Powell saying a few weeks ago that we had the wrong sort of inflation, which I thought was quite funny.
So I think that the problem with interpreting energy as a sort of something over there that we don’t need to worry about is, you forget that it’s actually the most fundamental product in the economy and it gets embodied in everything else. And so once energy prices rise, it sets in place a whole set of relative price adjustments that then feed their way through the system. And that’s what we know as inflation. And that’s why I’ve got so much focus on comparing as well as contrasting, but especially of comparing, the current environment with the early 1970s. Because I did my economics training in the late seventies and early eighties. And, you know, you’d sit there and you’d look back and say, “how could these guys have been so stupid? It was so obvious. You know, why did they let inflation get out of control?”
Well, frankly, they had exactly the same views as we’ve had for the last, not necessarily the last two years, but the last five, seven years. And in particular, there was this bias to treat everything that was negative, that happened that was negative, as a negative demand shock. To not understand that some things that are negative are actually negative supply shocks. And when you have a negative supply shock, which we’ve now had two of, COVID and the war in Ukraine, your desirable policy response is a bit different. The world gets tougher and therefore being easy and accommodative becomes a little more of a risk.
Parallels to the early 1970s and key differences
Bilal Hafeez (12:58):
You mentioned the early seventies as a parallel. There’s a few important differences. And I just want to get a sense of how important those differences are. One is the level of unionisation is much lower today than back then. And if you look at worker company power dynamics, I mean, it’s completely skewed against workers today. So does that, you know, affect things? And then the other one is in the early seventies, you also had the breakdown of the Brenton Woods agreement, which led to an expansion of money supply, you could say. So there was a switch of monetary regime, which I don’t think we’re really seeing today. So how much do those two things matter?
Phil Suttle (13:34):
Right. There’s this whole adage that history rhymes rather repeats itself. And I mean, in that sense, it’s dangerous to say, “Well, this is exactly what we’re going to… How we’re going to play out,” without playing the game of here’s this, what’s different, and here’s similarities, too much. I think I would say you’re right. The unionisation point, the sort of nature of the labour market contest, let’s say, has shifted. But of course the other way of looking at that is it means that the guys who really set the prices are much more powerful. There’s this big sort of debate that hasn’t really got going, but I think will keep going in the US about antitrust. And its implications for profit margins and price setting.
I used to have a view of the that someone like Amazon was de-flationary because they would sort of force lower prices on everyone else. But I’ve come to realise that as they’ve become a sort of quasi-monopolist, that they’re probably going to, you know, maintain their margins. You could say that’s the counter to the union point. Obviously the other big difference is that it starts a policy. You know, I used to think we were running expansionary monetary policy in the seventies, which is because we kept rates low. But now, you know, look at what we’ve been doing, both with interest rates and QE, or, you know, now it’s going to become QT, but the quantitative easing process is hard to figure. Because we’ve never done it. We’ve never seen it. So we don’t fully understand all of its implications.
And then the final product to throw out there, which I think is interesting more specifically in the case of Germany, for example, is that precisely because when Brenton Woods broke down, it gave the US more inflation, but it gave Germany and Switzerland and a few other European countries less inflation because they were able to appreciate their currency. Now, Germany is stuck in a monetary union with the rest of Europe. And in a very amusing way, in some ways, has the most outrageous inflation rates that we’re seeing across the developed world. I mean, if you look at German producer prices, they are rising at a rate that we don’t see anywhere else outside of an emerging economy.
And I’m not just talking about energy, I’m talking about exc. energy. So there’s something weird going on in the European relationship that I think’s a function of having this new fixing of currencies that we didn’t have in the seventies, which is intra-European inflation issue.
Whether real earnings will increase and the impact of immigration on the labour market
Bilal Hafeez (15:57):
We’ll come back to that, actually, when we talk about ECB. And just on this point about, you mentioned this earlier, about labour market tightness, and we talked about unions and so on. Why do you think real wages aren’t higher, say in the US? Like obviously in nominal terms, wages have picked up, but you would’ve thought that given labour shortage, given all this demand, real wages should be going up and profit margins should be going down. I mean, why hasn’t it happened? I mean, surely if companies need people, they just pay them more than inflation and you get them.
Phil Suttle (16:25):
You know, my only explanation in some sense is lax. They will happen. And obviously in a world where capital is more powerful than labour, you can say, well, maybe they’ll just, you know, it’ll be the workers who lose out in terms of inability to defend, their realising is in the face of nominal escalation. But I think one thing that strikes me as pretty amazing about the US is how, you know, I don’t think anyone really understands where all the workers went. You know, the number of sectors who are struggling. I went to a presentation last night here, I’m based in Georgia at the moment, sitting in Georgia. And the guy from us, from the state, the governor’s office talking about the local economy. And he was saying the problem in Georgia is that they don’t have enough truck drivers. And he said, when they did a sort of bit of research on this, where the truck drivers went, they basically went to get jobs at the warehouses that they were delivering stuff to.
Because you know, most of their interaction is taking stuff in and out of warehouses. And those jobs were not only paying much more than the drivers’ jobs, you know, they also got to go home every night and not have to be on the road. And so there’s been this sort of, I think, this phenomenon where we’ve suffered a major erosion in the supply of workers. And I think a lot of it’s immigration in the United States. And it’s kind of knocked its way through sectors. And I think that just means that increasingly sectors looking to expand or at least maintain their output by hiring workers will have to pull them from somewhere else. I think that’s the game we’re going to get into over the next couple of years. So as that goods price inflation process fades away you into this kind of wage inflation, you know, wage price catch up, you know, scenario. And I think that’s where we are in the process now. Just entering that.
Bilal Hafeez (18:18):
I mean, the point you make on immigration’s interesting. I mean, in some ways, I guess, is it like a Marxist view that the foreign labour is the excess supply of labour that capitalists always have, and that was kind of broken because of COVID or is this…
Phil Suttle (18:35):
I’ve never been called a Marxist.
Bilal Hafeez (18:36):
I’ve framed it provocatively just to see…
Phil Suttle (18:39):
Groucho Marx perhaps, but not Karl. But I think that there’s a number of supply side things that have gone on in the United States. And one of them is obviously more people retiring, one of them’s, obviously people who died and then, you know, you’ve had a great reluctance to participate in some face-to-face sectors and stuff like that. But I think when you kind of look at the system as a whole, you know, and I look at this incredible decline in labour supply growth, across many countries. The countries that seem have seen its greatest switch from high to low are countries that I think have relied on immigrant labour for much of the last sort of 15, 20 years or so.
And that’s partly the US, probably the UK. But also for example, Australia. When you look at why the Australian market, labour market, has tightened so fast, relative to everyone’s expectation, especially the central banks, it’s not because they boomed in growth terms, or in employment terms, it’s just because their labour supply. Just slump the growth in their labour supply, it slumped, and I think a lot of that in Australia certainly has to do with immigration and the lack of people coming especially from east Asia.
Bilal Hafeez (19:50):
On the sort of broader labour supply issue, there was one whole story, I guess, that was doing the rounds last year about people retiring early, sort of intentional retiring. But it seems like more recent data suggests that mass resignation hasn’t happened. Do you kind of have a view on that?
Phil Suttle (20:06):
A lot of things in economics thankfully are endogenous, you know, so the system adjusts, and what was happening through 2020 and into early 21 was people were retiring because it was, why would I take the risk? And it’s such a hassle and all these things. Now the wages have gone back up in the area where I was previously working, or there’s another job out there that looks quite attractive. And you know, so I think you should expect one of the sort of aspects of the next year, year and a half, in the US, I think, which sort of helps us skirt the recession risk, is I think we’ll see a little bit more labour supply response.
So we can keep the unemployment rate. We can still have growth, but not have an unemployment rate going to 2% or something like that. You know, we can keep the unemployment rate in the mid to high threes, even as we grow at a steady pace. And I think that’ll be, you know, this endogenous response of labour supply. And you mentioned earlier that COVID should be going away, I’m not so sure, but you know, that’s clearly fading as an issue affecting decisions and outcomes.
Why recession risks are overstated
Bilal Hafeez (21:15):
And you mentioned the R-word, recession, which we haven’t mentioned so far. Obviously there’s a lot of focus on the possibility of recession. The yield curve is started to do flatten and invert. You know, we have some recession models that use the yield curve and input, and they’re kind of assigning, it’s fluctuating a bit, but assigning like 50% probability of the US recession in the next 12 months. Of course the yield curve alone has its flaws. But there’s a lot more talk about this. I mean, what’s your take on kind of recessionary sort dynamic.
I think there’s that old Rudy Dormish adage that expansion’s don’t die of old age, they’re always murdered by the Fed. And we don’t have an old expansion. We have a relatively young expansion. But we are already clearly in late cycle territory. Meaning the unemployment rate is at near historic lows and the inflation rate’s very high. So everything is flashing “late cycle.” The big thing that isn’t positioned late cycle is policy. We have monetary policy still positioned. There’s a lot of talk of what’s going to get done and it’s increasingly priced into markets. But the positioning of policy is super easy. And what’s priced into markets in terms of where we are going takes us from super easy to still easy. If you see what I mean. So my sort of dilemma, as I think through this, is what I’m seeing both priced into policy and what is likely to happen to policy?
Is it going to be enough to murder the expansion? Or is there something out there that means we only need a little bit of an assistance from the Fed for the economy to topple over the cliff? You know, all the fed needs to do is sort of, you know, the body’s standing on the edge of the cliff face and all the fed needs to do is just a little bit of a nudge in the back with a 300 basis point rate hike and everything goes down onto the beach below. You know, is that where we stand? And I think sometimes that happens, and it happens when we have a big financial vulnerability. You know, when we have a system that’s sort of got itself in a very leveraged fashion, or there’s some sort of weird thing that’s gone on that people didn’t quite realise.
And then all of a sudden it’s, “Oh my God, we’ve got all this leverage. We’ve got all these mismatched positions, we’ve got all this.” And that’s sort of what happened with Lehman’s in ’07, ’08, and the housing sector. Of course at that point, policy rates were already five and a half or whatever they got to. So we also had the Fed with a knife or two, rather than just a little nudge from the elbow. So what I’m consistently doing is asking myself, can I see either enough brutality from the Fed, or more importantly perhaps, can I see a sort of crack or two developing? And I have a very hard time doing that. Now there is one condition that will give us a recession, I think quite quickly. And that would be a major as it happened in April, 2020, or March, 2020, another major negative supply dislocation.
And the obvious one is Russia turns taps off on gas. So we don’t just have higher energy prices. We have a phenomenon where we just don’t have the supply of energy in key parts to global economy. And if you turned it off in Europe, it would create a panic and a scramble in Asia and the United States. If you said there’s going to be a recession in the next 12 months, what’s going to cause it, that would be my… It’s not going to be the Fed raising rates 300 basis points. Or the ECB doing 100, 150.
Bilal Hafeez (24:58):
And does it matter if the Chinese economy’s weak? I mean, does that fit into any of this or not?
Phil Suttle (25:05):
Well, that’s another very interesting question. And I shouldn’t pretend I’m a hundred percent confident in my answer to that because, you know, I think we’re a bit like QE. We’re in a world where we’ve not had such an integrated China into the financial and economic system. You know, I think China’s been progressively slowing for a long while now. For, you know, probably to 10 years. So I’m not sure what we’re seeing is anything that different. I think it would take a major financial crisis in China to be a big problem. You know, that could be the crack. You know, the credit environment in China could finally blow up.
But again, I’m not a real expert on Chinese financial structures, but I don’t see… I think they built even more buffers and short circuits or resistance circuits into their system. And in particular, you know, what always gets us in a financial crisis, what always sparks us, is a panic on the part of the creditors. You know, so you end up essentially funding, less good, long term assets with increasingly vulnerable, short term funding. One way or another that’s been the generation of every crisis I’ve ever seen. And that’s what I’m not seeing anywhere, I don’t see a lot of short-term funding of long-term investments.
The return of pre-GFC level of bond yields
Bilal Hafeez (26:26):
And so, yeah, we get to the fed then and the most recent hiking cycle, the fed hike to, I guess, two and a half percent. Before the GFC, we were four and a half, five. Five, you could say, was kind of the terminal rate, so to speak. So where do you think it should get to and where do you think it will get to?
Phil Suttle (26:45):
Frankly, back to where we used to be. I think what will happen is we’ll see the last expansion as the exception rather than the new rule. What I mean by that is, aside from the fact that it was kind of cut short by COVID and we never really will know what would’ve happened if we’d played it forward. You know, I had to think that what would’ve happened is that what has happened. Which is the inappropriate easing that now what was at the end of the last expansion will have generated higher inflation, you know, an overheating and we’d have ended up with higher Fed rates and a recession the conventional way. And that higher fed rate would probably have been somewhere closer to 4%, which is where I think we’re going to go over the next 18 to 24 months.
I think my view is recession is most likely in ’24. Bad news for the president trying to get reelected. But that’s when policy from the Fed will probably be tight enough to create some tensions. And I’m thinking the fed funds rate in the 4 to 5% range. And a bond yield that is also at least that high. Because I think what’ll happen as the fed tightens is the yield curve will shift in a somewhat parallel fashion. And it kind of just goes back to this idea that, okay, what is there out there that if I said to a business, look, you have to pay a 2 or 3% real rate.
Well actually if it’s four to five on nominal and at least three on inflation, then it’s less than, you know, it’s one or one and a bit. If you have to pay one and a bit real rate, is that going to cause you to contract your business? And they’ll look at you and say, “You must be joking. You know, if you can guarantee that to me for the next 10 years, I’m going to expand like crazy.” You know, you have to have something else out there, I think, that’s going to come along and whack you to create this major negative environment. I mean, I think it’ll be higher inflation, persistently higher inflation. Not higher than where we are today, but just higher than is perceived to be acceptable, forcing the Fed to basically, you know, to use that old English phrase to squeeze it, you know, until the pips squeak.
How Bernanke set the Fed on the wrong course
Bilal Hafeez (28:54):
Yeah. I had Dominique Dwarfico recently on a podcast show and obviously she’s someone who I work with, so I obviously follow her work very closely, but she’s been arguing that the fed could raise rates to like 7 or 8%. Well, if you just look at any kind of type of metric, as you know, as an economist, you know it should be much, much higher. It should be even higher than the pre-GFC period. So why shouldn’t the Fed go to 7, 8%?
Phil Suttle (29:21):
I don’t know. I’ve been tired of being a wild man on Fed for years, so I don’t want to sort of go too crazy. And what I mean, you know, I shouldn’t say that, but what I mean is I think we’re entering a phase where it pays to think more about how expansions developed pre-2008, 2009, rather than to treat the last one as the rule. That’s my basic point. And Dominique’s perfectly correct. If you look at the Taylor rule they’re all doing a fantastic job of, in a sense, predicting the fed. It was almost a rule that they were using implicitly. And it did a great job until Ben Bernanke took over. You know, I’ve got a book in me that is a critique of modern, terrible macro policy making. And it’s working title is called Blame Ben Bernanke. Because the influence of his thinking from 2001, 2002 onwards, I think has been very, very, very corrosive on global policy making, on DM policy making.
Bilal Hafeez (30:28):
Yeah. I look forward to that book. I mean, maybe we could help you publish it as well through… Yeah, it’d be quite provocative.
Phil Suttle (30:35):
I’d have to put it under your name.
Bilal Hafeez (30:36):
Oh, okay. You want to keep your friends in the policy circles. Actually, just on that. I mean, how important is kind of the personnel at the Fed? You know, because in markets we all like to kind of talk about this personality’s going to join the board or not joining the board, or this person’s influential. I mean, is that helpful, do you think? Or is it just the macro conditions are such that it doesn’t really matter who’s at the helm?
Phil Suttle (30:59):
Well, I think the Fed’s in real trouble personally. So I think they made a bet on a particular way to think about the economy that has been shown to be disastrously wrong. Now, you know, that’s the second time they’ve been disastrously wrong within two cycles. They were disastrously wrong on the financial stuff before the financial crisis. I mean, I would urge everyone, if you want to be of light time, entertaining afternoon reading, go back and look at some of the speeches that Fed officials made about the US housing market in 2005 and six and the mortgage market. It is shockingly, shockingly bad. In a sense, you can do the same thing, look back at what Fed officials were saying about the inflation outlook for much of the last couple of years.
And you think, “Well, if it was any other organisation and I keep making such terrible mistakes that really matter, shouldn’t people be losing their jobs and these sorts of things?” So, you know, I mean, I guess the way I’d think about is the Fed’s sort of become the Manchester United of policy making. It’s time for, I’m not sure who Eric Vandertak or whatever his name is. I think Larry Summers is the closest. You know, Larry would be the… But no, I think they’re just in an environment where because they’ve kind of got it so wrong, they now have to go somewhat to the other extreme. And I think you have it, a very amusing sort of thing last week, just before the blackout started. You know, you had two of the most dovish individuals, Mary Daley and Charles Evans, giving these incredibly hawkish speeches. And you think, “Well, where’s your consistency?”
Bilal Hafeez (32:45):
And what about the ECB? They haven’t hiked. I mean, they’re still kind of talking about ending APP in Q3 then sometime after raising rates. And there’s a debate inside the ECB, some hawks and doves, but they don’t seem to be on the same page as the Fed.
Phil Suttle (33:02):
Yeah, no, I mean, I think ECB is in an even bigger problem because obviously what’s becoming exposed is the sort of the risks of the system they’ve created. Which they never made the Euro system work perfectly. And it’s been held together through the bandaid of negative rates and massive QE. And as that begins to look like it has to be unwound, I think these systemic wide risks are building again.
And the thing that amazes me about the ECB is not just the board in Frankfurt is pushing the line that it keeps pushing, which that’s been their sort of structural DNA, it’s that the Germans in particular have not created so much of a fuss. I would’ve expected by now the Bundesbank’s new head, Mr. Nagle, to be much more aggressive on the need for rapid policy normalisation. But he seems to be willing to sort of go along… I think what’s happening behind the scenes, an agreement that we will move in July. And from that point onwards, it’s going to be a steady adjustment.
Bilal Hafeez (34:03):
So, you’re saying move in July as in you think they’ll hike in July rather than September.
Phil Suttle (34:09):
Yes. Well, I’m sort of waffling a bit between the two. I think they definitely end the QE programme in June, at the June meeting. And then they almost certainly make some kind of announcement in July that says, we’re either going or we’re going to go. Because I just feel by that point, there’ll be enough… Well, first of all, I think we’re already seeing it, hearing it from individuals that that’s going to happen. And I think if they don’t, there’ll be sufficient pushback from, I wouldn’t even call them the hawk, from the harder money groups in ECB, that something has to give there.
Energy investment and higher inventories as the new normal
Bilal Hafeez (34:45):
When I read ECB speeches and the press conference and everything. I mean, they do seem to think that the Ukraine-Russia conflict, as well as causing some inflation, is a negative growth shock to them in a way that it’s not for, say, the US. And I wonder if Germany’s particularly worried about that, hence why they’re so hawkish because it’s the whole industrial base and Germany’s based on cheap energy from Russia. And so that’s been undermined.
Phil Suttle (35:11):
I think you’re dead right there. That that’s the explanation of why the Bundesbank isn’t more hawkish. But I think, again, that goes back to this discussion of how do you think about shock like that? Is it a negative demand shock or is it a negative supply shock? And, you know, one way of thinking about what’s going on in Germany is precisely because they’ve been very prudent on their public finances. They actually now have the ability to be a little more expansionary.
So what you’re going to get is higher costs and the shiftward leftwards in the economist aggregate supply curve, at the same time that the policy is going to push the demand curve out. And Germany is going to have a more persistent inflation problem than even the rest of the Euro area. Let me throw out another idea here, which I think’s very important, which is that I think there’s this mentality out there that inflation’s negative for growth. I actually think in the near term, it can be very stimulative for growth.
What I mean by that is if you’ve got an environment where two things go on. One where you’ve got big relative price shifts, there’s a lot of new incentives for investment. So obviously the energy price increases are a big drag on users of energy. But there’s going to be a phenomenal investment programme developing globally, including in Europe to build alternative energy production facilities, whatever they may be. You know, that’s quite similar, dare I say it, to what happened in the later 1970s. When we had an investment boom, particularly in north America, but across the world, that was stimulated by the first oil price shock. So that’s one thing.
The second thing which seems even more important and it’s one of these nerdy things economists like to talk about. I like to talk about. Is inventories. You know, we’ve spent the last 20 years or so trying to keep inventory low because it was like a negative carry position. You know, they just cost you money. The prices went down, they just burn a hole in your pocket. Now, in an inflationary world, or a less deflationary world, let’s say, and a world where lots of businesses have found themselves too short of inventory at various points over the last couple of years. I think there’s going to be a tremendous tendency, and this is Europe but also US and globally, tremendous tendency to want to build inventory. So I think we’re going to get goods demand much stronger than most people think for the next couple of years as this structural change in inventory takes place.
Bilal Hafeez (37:55):
Yeah. And I wonder what other legacies there are of the pandemic. You know, so for example, so what one, as you rightly pointed out, could be highest, inventory bounces going forward. There’s also been this kind of energy shock that’s been due to, or was happening anyway, and COVID exacerbated it. So there’s some sort of shifts around that. I mean, what about other things like people working from home or greater use of tech in the service sector? You know, these other things that we’ve kind of experienced over the COVID period? I mean, you know, can we draw any conclusions or is it just too kind of fluffy to kind of pin down?
Phil Suttle (38:27):
Well, no, I think… You know, you’re right. There’s lots of things that we’ll understand better when we’ve got more time and more evidence and things. But one way of thinking about it is we’ve taken the capital stock that we had designated for a particular way of doing economic activity. And we’ve shaken up economic activity. So we’ve got a capital stock that’s sort of somewhat in the wrong place. You know, one way of thinking about that is depreciation on capital is accelerated. You know, we’ve got the wrong stuff. You know, too many subway systems and too many offices and not enough, whatever we need to service us all at home and stuff like that. I think of that as a consumer supply shock, that’s what COVID was in many, many ways. And we’re going to kind of live it through the implications of that.
And of course you could say Ukraine’s another angle to that because we got used to enjoying the benefits of much lower defence spending, especially in Europe. And we could put those resources into more productive things. Now we’re going to have to go back to basically buying stuff that when it gets used, all it doesn’t blow something else up. An investment in a tank is not a very productive investment. As far as I can see. So, I just feel that there’s lots of things that are happening.
Which in some ways, the way to think about it, I think, is in the distribution of shocks, global shocks, there is a reasonably sort of symmetric distribution over time. But for about 30 years or 20 years starting maybe in the early nineties. Late eighties, early nineties. We had regular drawings from the positive side of the distribution. You know, we were getting a positive. And now, in somewhat biblical fashion, you know, we’re getting a set of negative ones. And then in the policy and markets world, you have to deal with that. You have to recognise that. And recognise that those have implications.
US housing market
Bilal Hafeez (40:23):
One way I was thinking about this to try to think of it bigger picture, was that if you think about the GFC, what happened in the run ups with the GFC was that we, in effect, had this globalised financial system. So it seemed like there’s no friction, no inventory in banking, capital, you know, everything just worked really sort of lean. And then what the GFC did was it said, actually, no, it’s not globalised. It’s nationalised. You know, everything comes back to the national balance sheet. So suddenly you realise actually everyone has to come home. The banks have to come home and it’s more fragmented and we’ve had all this regulation ever since.
And I think what COVID has done is something similar to the labour markets in terms of labour stock. You know, it was like globalised labour supply, labour stock, everyone could move around. And it all kind of worked really well. And the gig economy, people could work or not work. But suddenly COVID basically was a shock to human capital, you could say. So suddenly you don’t have this movement of labour across borders. You know, what you touched on earlier, sort of immigrants on the immigration side and then the gig economy and so on. So suddenly there’s this awareness now that where you live, kind of local labour, is quite important. You can’t always get people crossing borders and things like that. Anyway, maybe I’m not articulating this that well, but I’m trying to think in terms of making parallels with like shocks to capital or some kind of fact or production and you have to adapt to the new norm now.
Phil Suttle (41:46):
Yeah, absolutely. And I would extend that, repeat a point I made, but extend that thing by saying, “Look, post GFC, it was all about greater buffers in the financial system,” which is, you know, partly regulatory, but mainly behavioural. To give myself more protection. And that’s, I think, precisely what we’re going to see in the broader economy, let’s call it in the real economy. The housing’s fascinating because we didn’t build many houses around the world for 10 years. You know, we built some, but we didn’t build as many as we… We built a lot in China, by the way, but that’s a different rateable issue. But in most places, so when you think about the impact, going back to this discussion of the effects of fed tightening or BOE tightening on the economy, housing’s the heart of the transmission mechanism, always.
And you think about, you know, how much effect a point or a point and a half is going to have on housing. In, for example, the US. It’s much less damaged this time than it did in ’05 and ’06 and ’07, and probably much less damage than it did in even the nineties. I mean, just to give a very simple illustration. We’re record lows on home inventory for sale in this country. And one third of houses for sale in this country are new homes. In other words, if you want to buy a house, there’s one in three chance it’s going to be a new house. Whereas that relationship is normally something like one in 20. But there’s just such a shortage of old houses that you’re going to have to produce new ones to meet the demand for housing. Either that or people live in, you know, with their parents or in the front yard or something.
Bilal Hafeez (43:35):
I mean, the other interesting thing I think on the interest rate sensitive side is the auto sector, because normally the other important part is the auto sector. But this time around what’s happened is there’s been… Auto sector’s been dislocated by COVID. So everyone’s had to buy used cars, rather than new cars and so on. So if you do jack up rates, you don’t get that, the auto sector transmission either in the same way as you had before.
Phil Suttle (43:56):
No, we’re going to have people doing some really screwed up regressions over the next couple of years because they’re going to get auto sales going up and interest rates going up and they’re going to be saying, “oh look, that’s grand.” You know, and then that’s welcome to the post-COVID world sort of thing. And I think, you know, what none of us know, and I certainly don’t, is how businesses will respond over the next couple of years in this world where constraints begin to get eased.
So, you know, once Toyota, et cetera, BMW, whatever, can start producing the cars that they really want to produce. Are we going to peak at 25 million sales in the US or are we going to peak at 18? You know, we’re currently down at sort of 12, 13, we’ve been sitting there. You know, in other words, are these sales that didn’t happen for the past year, are they permanently gone? Or do we have to get back to a normal run rate at say 17, 18, and then some to make up for the sales?
Bilal Hafeez (44:54):
Kind of like an output gap type thing, you know, what is the output gap in that sector, yeah.
Phil Suttle (45:00):
And I think it goes back to this idea that you’ve got to think about shortages, and underproduction. Not just during the recession and recovery, but for an extended period, that’s left us with some pent-up demands, which are very hard to know where they’re going to settle. But you do know they give you this, what I would call, late cycle strength. At a time you just don’t want it. You just don’t need it. Again, it feeds back into the policy discussion.
Equity market view
Bilal Hafeez (45:26):
And just, finally, on kind of the macro stuff. What do you think this all means for equities? Because you could see a scenario where equities are weak, the feds hiking and the economy could be doing okay. I mean it could just simply be that, stocks were boosted by low rates for a long, long time. And so you kind of get this decoupling between equities and the economic performance of real… There’s this financial… Or, you know, maybe equities could have a boom. You know, this is a recent equity consolidation could be temporary and we could have a boom. I mean, do you have any thoughts on that side?
Phil Suttle (46:00):
Well, no, I’m not, you know… Put it this way. My macro outlook, I think, is quite negative for equities because it’s all about higher bond yields and bond yields are the primary sort of basis for equity pricing. So I think that’s my main take. But I don’t mean that means equities go down for the next year and a half. They bounce around I’m sure. But the next couple of years is wimper I think.
Phil’s favourite recent read
Bilal Hafeez (46:26):
Now I did want to ask a couple of personal questions. I always like to end with some personal questions. You know, the first one is, I’ve asked you before sort of the best ever books you’ve read, but have you read anything recently, could be articles or books that kind of stood out for you?
Phil Suttle (46:42):
So here’s my confession. I’ve really got into American history. Well, because we relocated partly to Georgia, part-time, and I’m fascinated with the whole issue of how, especially the Southeast, developed and all that. So I just finished reading a great book on the French-Indian war. We call it the French Indian war, but it’s in Britain known as the Seven Year War. That period is really the period, when I think about how much developed globally, it was sort of when Britain came into its own as an Imperial power or tried to, thought it could. And William Pitt was, and we have a stained glass window in our new house of William Pitt who is, you know, I won’t say my new hero, but he’s kind of an interesting character. Not Pitt the younger, but Pitt the elder. Who is the guy who promoted all this.
But what’s amazing to me is how quickly it turned from sort of triumph, which was basically, you know, we take over north America and kick out the French, to within 15 years or even less than that, five years, into the seeds of the American Revolution. So it’s a reminder, you know, and I think about that in the context of all these geopolitical changes we’re seeing now. The ending of the Cold War and Russia and all these things. And it’s a kind of reminder that these things, they’re always with us, these major geopolitical tensions. You know, they’ve been with us forever.
Bilal Hafeez (48:12):
And that book, what’s it called? Or who’s the author? I’m looking at your nice bookshelves there.
Phil Suttle (48:20):
It’s called The War That Made America. The War That Made America by Fred Anderson. It’s very simple, but for those of you who live anywhere near Greenwich in London, you got General Wolf, the hero who died at Quebec, storming Quebec.
Phil’s advice to students
Bilal Hafeez (48:33):
Yeah, I’ll have to look out for this. Now the other question I want to ask you was I, through Macro Hive, we have the kind of exposure and I often get questions from young students who are about to graduate. And they ask me questions about, you know, how to get a job at a bank or in finance and all these sorts of things or advice. So rather than me having to think of my answers, I thought I’d put it on you to give me answers so I can pass on to them. I mean, what advice would you give to youngsters who are leaving uni now. Presumably, there’ll be like physical in-person, you know, jobs that’ll be happening after the summer. Any advice you want to kind of give to grads?
Phil Suttle (49:10):
I mean, I suppose the obvious one is, which I give to my kids, is be flexible and keep an open mind. Don’t go into things with preconceived notions. You know, I guess when I look at the jobs that all my kids do, none of them existed when I was graduating from university. A lot of that. The advent of technology. One of the things I think is a little different is, and this is kind of showing that I’ve become an old man. Kids don’t seem to want to work quite as much.
Bilal Hafeez (49:47):
Okay, we’re going there are we? Okay. Let’s do it. As lazy kids. The music today’s music is terrible, movies are terrible, you know, back in my day…
Phil Suttle (49:55):
Oh no, no, no. You know, I guess my main advice is seeing the success of your company, whether it’s a big company or small as part of your success. In other words, don’t sort of view work as a hassle. View it as positive thing that by enjoying it and doing well. You’ll help your company do well.
Bilal Hafeez (50:12):
I mean, I definitely notice that for the younger people that work for Macro Hive, I mean, there’s definitely a sense of, they want a sense of purpose behind the organisation. You know, it can’t just be a job, you know, there has to be something bigger about the organisation they’re working for. And then there’s also just more, I’m not saying more demanding, but like there’s more willingness to ask for things in the job. Like when I was starting, you know, I’d basically almost do whatever the company would tell me to, but this time it’s more like, “Okay, no, I won’t do that because of this. Or I want to do this because of this.” And so, you know, it’s kind of more of a balanced relationship in some ways.
Phil Suttle (50:52):
No, yeah, I think, you know, the main metric, think like an owner, which is hard to tell starting in your career, because you tend to think like a slave. But don’t think a slave. Think like, you know, so I’ve got a vested interest in everything doing really well.
Bilal Hafeez (51:06):
Yeah.
Phil Suttle (51:07):
That’s my main tip. And make sure you look after your old dad. That’s my other tip.
Bilal Hafeez (51:13):
That’s a good one. I like that. Yeah. Yeah. Don’t forget the parent. Now, final thing, I have to talk about football. You know, we’re coming to the end of the English premier league. I know you are a Luton supporter. So maybe, you know, forgive me if I say this, but not many people may know what Luton is or what it is, but can you give a bit of background of Luton, the football club and then what’s going on with them in this season?
Phil Suttle (51:37):
We are almost certainly, I’m pretty sure, that the most cyclical soccer club in the country. So in my viewing lifetime, I started going to the ground in 1968. And we were in the fourth division then, which is now league two. By the mid seventies we were up in the first division, the premier league. We went up and down a bit. And then by the mid-2000s, we were down in the conference. You know, we actually dropped out of the football league to the fifth division. And now we’re back in the second or like the championship, vying for a spot maybe even in the premier league next year, if we do well in the playoffs. So I don’t think I know of a team that has had so much volatility. It certainly makes for entertaining watching.
Bilal Hafeez (52:26):
So if they do get promoted, if Luton does get promoted to the premier league, that will be the first time since the seventies there’ll been in top flight.
Phil Suttle (52:33):
Well, we actually did the magnificent job of being relegated the year before the premier league was started, so we were in the top flight for about a decade from the early eighties through to the early nineties. And in fact, the absolute peak in Luton’s performance, and there may be some Arsenal fans listening, was when we won the, what I guess it’s now called the Carabao Cup, the league cup at Wembley in 1988, beating Arsenal three two. It is clearly, you know, the highlight of my life.
Bilal Hafeez (53:07):
Yeah. I’ll have to excerpt this clip and send it to all my friends who are Arsenal supporters just to kind of remind them of some of the past. And I support Liverpool. So obviously Liverpool’s doing very well. And there’s this tie at the top, Liverpool against Manchester City. I mean, do you have a view on what’s kind of happening at that level?
Phil Suttle (53:25):
Well, I have to say, I think the two most impressive business managers in the world are Pep Guardiola and Jurgen Klopp. I’d like to make one President of Europe and the other President of the United States. And we’d really good. We’d have a really good system. Because I just think these… You know, what’s fascinating to about soccer management is it’s really got professional. If you see what I mean. I don’t know an important thing to say, but these guys are very analytical, very thoughtful, and adjust to shocks in a way that, unfortunately, the Fed and ECB, maybe aren’t quite able to, so, you know yeah. Put Jurgen head of the Fed and Pep head of the ECB.
Bilal Hafeez (54:05):
Yeah. I could see that. Yeah, yeah. They’d probably do a better job to be honest. And then van Dijk as kind of a prime minister or something. He’s a really sort of cool, cool customer, you know, you kind of feel very sort of secure and safe with him.
Phil Suttle (54:22):
Yeah, no. Well, I love the Man City goalie, Edison. I think he’s actually got cold ice running through his veins.
Bilal Hafeez (54:30):
Yeah, he does. Yeah. I’d probably cross the road at night if I saw him as well. But yeah, no, it’s turning out to be a great season. Well, you know…
Phil Suttle (54:39):
Good luck is all I can say.
Bilal Hafeez (54:41):
Well with that, I mean, just for the benefit of our listeners, if people did want to get in touch with you or follow your research and what’s the best way for them to do that.
Phil Suttle (54:50):
Very, very simple. I mean, we have suttleeconomics.com. There’s various entrees through that. Or you can email me at phil@suttleeconomics.com.
Bilal Hafeez (55:01):
Yeah. I’ll include all this information on the show notes as well. So yeah, so with that as always great, great chatting to you, we kind of talk about everything. Anything and everything, which is always fun. So, thanks again.
Phil Suttle (55:11):
A real pleasure. Thanks Bilal.
Bilal Hafeez (55:17):
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