Inflationary Pressure–The Biggest Risk No One’s Considered? (w/ Kit Juckes)
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Inflationary Pressure–The Biggest Risk No One’s Considered? (w/ Kit Juckes)


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

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