A Kick in the Face to End the Cycle

Speaker A: Are we there yet? Something my children kept asking me on a long drive home from Cornwall. And something investors are now asking us about. The end of the cycle. Not yet, but we're getting there. And the increase in clients questions is telling. We'll map out how it might end a little bit later on. Hormuz grinds on but thankfully this week we've had proper central bank action, so. So we can ignore it. In this podcast hawkish hold was the overall tone from the monetary mandarins. And we didn't actually get any hikes, but hikes are coming. So let's answer, number one, busy week of central bank meetings. What were the takeaways? Number two, what does a world without forward guidance look like? And number three, when will this cycle end? Right, Dario, let's go through each central bank meeting and get your thoughts and then we can tie it all together. And then of course, we can talk about how right we've been in our hawkish stance all year long. We've been pretty good. We've been pretty good since January. We've been pretty, pretty right with the Fed, well, very much since January.

Speaker B: So, I mean, we can go through each. But I think the overall tone is one of missed opportunities and not exactly a brilliant week for central bank credibility. So with the bank of Japan that was intervening in the currency but decided not to raise interest rates, even though that was the really obvious thing to do, that would have strengthened the narrative around the currency. Then you had the Fed that just basically gave us 45 minutes of complete spin and just talk tough, but obviously doesn't deliver. And so you've got investors asking, is he full of it or is this just all talk? I'm trying to put that as politely as I can. Well done. And then you have the bank of England that published 100 page report with every chart showing this inflation, and yet three people voting for a hike. And Andrew Bailey spent the entire press conference talking about oil price scenari scenarios. And at one point he was just reading out different oil prices on different dates. Which at, uh, that point was just me thinking, I need a holiday. I really can't take this anymore in a long drive. So in terms of the Fed, I mean, like, the decision was sort of obvious. Um, it was the only thing you really could do given that they hadn't moved six weeks earlier, because the data hadn't really changed. And the data that we did have was on the dovish side. So we had weaker cpi, a weaker payroll number. Um, if you weren't going to hike Six weeks ago, it wasn't obvious why you would hike this week, apart from the fact that six weeks had passed. And that was another six weeks added onto the five years where you missed your inflation target. But that was something that you could have predicted six weeks earlier. So it would have been a strange way to behave. I think the issue is we have these debates about forward guidance. We'll talk about that some more in the second question. Um, but there's a basic issue of accountability, which is that this guy is the most powerful man in the world in terms of monetary policy. If he makes mistakes, he has the potential to put millions of people out of work. Um, he has a duty to come and explain what the Fed is doing, why it is thinking in certain ways, um, why it is doing what it's doing, why it's not doing what it isn't doing in terms of raising interest rates. And he basically just gave a spin for 45 minutes. We just brushed off every question. You know, there is a. You, you have to be basically accountable. Like, you don't have to give us hints and nudges about what interest rates are going to do next month. You don't have to give us code words like, um, Trisha used to give us. But you have to explain yourself. And I think the most shocking thing about this meeting and. All right, I lost it a bit on Twitter, just in press conference, had a bit of a meltdown. But, you know, I was getting dozens of DMS from people saying, you're absolutely spot on. What is this guy doing? The accountability is terrible. Um, but nobody wants to criticize him. I just don't understand why people are so scared of this administration that they won't ask questions. These are just go back to the 90s. We used to have these debates about whether central banks could be independent. And there were lots of different views. People thought they should, people thought they shouldn't. Um, but the compromise was that they had to be accountable. If we were going to give technocrats this much power, we had to make them accountable. And they had to explain themselves. And what we're getting from a, uh, fair chair that just refuses to engage in any discussion, not a discussion about the future, but about the past and the present as well, is that you're just losing accountability. And I don't see why people aren't prepared to call that out. Yeah, all right. Rant over.

Speaker A: Right, yeah. Off your soapbox. Get down. Um, maybe going a little bit back onto the central banks. Some of the others. I know the ECB was Last week and we can sort of count it as this week. Anything on the ecb, anything on the BOJ before I turn over to Freya?

Speaker B: Well, I think that, I think that the boe, I mean, you know, it's just about oil. It's purely about oil at this point. Like if you look at uh, um, what's actually happening with wage growth or the labor market or services inflation, all of this is disinflating. Um, as I said, you know, the monetary policy report showed this in pretty good detailed account of how monetary policy is genuinely tight, probably the tightest monetary policy in the developed world. It's squeezing the private sector. Uh, the only growth we've got is coming from the public sector. But that's not a sign that of the government is massively overspending. That's a sign of just how weak the private sector is. And yet they're absolutely fixated on the danger of second round effect. Something that they say there's no evidence of these second round effects. And in theory, as they say in the report, there shouldn't be any second round effects because conditions are just so different to how they were uh, three, four years ago when we had previous energy price shocks. But you know, we still get three of these nutters voting for rate hikes. And um, you know, they still want to give this sort of hawkish tone and these worries about the 1970s and the wage price spirals. But I think it's pretty clear that if we didn't have this energy price situation, if we did actually get a resolution, um, interest rates in the UK would be headed a lot lower, like at least 100 basis points lower. Um, and so it's just the prospect of oil and second round effects that is stopping them from delivering that bank, uh, of Japan, you know, the bank of Japan has spent this whole tightening cycle worried that uh, it didn't want to raise interest rates too quickly. You know, it finally got some inflation. It spent years battling deflation and in the past they'd always tightened policy too quickly and then the yen had gone through the roof and they were obviously really, really deeply worri about making that mistake again and sort of derailing this gentle inflationary process. But now they've gone to the other extreme where the currency is basically screaming at them, um, you need to get tighter, you need to raise interest rates faster. And so this week they end up intervening and it looks like coordinating intervention with the Fed. So they've got Besson on board, they're intervening, but then they had an opportunity to Back it up with an interest rate move and it looks like they're chickened out. So again, you know, another central bank that is talking and the market is pushing it in a certain direction, it's refusing to actually deliver.

Speaker A: I was going to say. Can I just, can I get you to start with the boe? Just because I really want to highlight this off consensus view that we have in terms of BoE, bank of England cuts, um, which I haven't really seen out there from many people. So we're calling for 100 basis points cuts. Well, not that it's going to happen, but that's what should happen. And then obviously.

Speaker C: Well, eventually I think, yeah, if you

Speaker B: look beyond the oil price issue, then interest rates are too high in the UK and the bank is squeezing the life out of the economy.

Speaker C: Yeah, the short, the short end of the curve everywhere apart from. I, um, would say ironically the ECB is very far from what is justified from the perspective of domestic economies. And partly it's because there are all of these global shocks and central banks don't really know whether to react to them. But on the spectrum from sort of the Fed and sort of the bank of Japan that really should be raising rates and the long end is telling us that to the bank of England that really should be cutting rates, we have almost literally 200 basis points of divergence in where the short end should be and currencies are telling us that. And the long end movements short term versus for sort of long, longer term or uh, kind of trend movements are all sort of telling us that. So let's, let's start with, start with the Fed and then we'll work through the spectrum, um, and, and sort of figure out what's, what, what markets are, are ah, telling us about these domestic economies and how you know, a lot of this is really being sort of misinterpreted I think, um, by you know, by, by central bankers, by monetary policymakers. So, so from, from the perspective of the Fed, what happened? We, we had this initial meeting that was kind of ostensibly more hawkish than people were expecting. And then he's come in and he hasn't really sort of backed any of that up. Uh, the market and sort of talked itself into 50, 50 on, on July and then it didn't happen. And the long end of the curve reacted, the long end of the curve rose and that's. The yields rose. Um, and that's essentially what we've been saying, that that long end of the curve is responding to a uh, re. Accelerating labor market a hotter US economy potentially over the next kind of 12, 18 months. Wage growth. If you strip out education um and some of the, the, the way the sectors that contain less information about the cycle wage um growth probably has already bottomed out. The low income sector of the distribution is probably now bottoming out. Um and we have a labor market re acceleration. We may have a soft patch in the middle of the year. Um if we do we think that the uh, that the labor market will then re accelerate um and we're already, we're already with um, you know, high inflation and have had high inflation in core services ex shelter um for, for a very long time. So the long end of the curve is justifiably saying yeah actually um, maybe we should be having a little bit more compensation. This is an economy that can sustain higher interest rates um and gradually inflation is, is break evens. Should, should be kind of closer to 3% we think than, than 2%. So that's 1, one end of the spectrum and the long end is telling us is moving sort of in the opposite direction from um, what happened at the short end of the curve. So we didn't get a hawkish enough stance from the Fed and the long end said hey wait a minute um and we had an increase in yields. The other end of the spectrum is the bank of England where the long end is just trading off of the short end which is trading off of oil. And that tells me that the long end is really telling us nothing about um, it's not moving off of inflation expectations anymore. There's a lot of movement there in sort of the real component. Um and it's sort of term premium being driven off of that kind of short end movement. Now that to me is more a function of the gilts market being very dominated at that, at that maturity, uh, in the long end of the curve by um, leveraged players such as hedge funds, um as the real money, um the liability matches uh, are no longer in the position where they need a lot of demand out there uh that maturity. So it's very much leveraged buyers. And so when you get this energy shock that the UK is perceived as being less able to process and the central bank is, is coming in in a sort of a hawkish way against that because they're worried about how that might affect inflation expectations. That then translates into the long end of the curve because the long end of the curve can only be bought by these hedge funds that are financing potentially through repo or are financing sort of against um, where, where we're seeing uh, the, the rest of the world. We're seeing yields in the rest of the world. So relative trade trades. So the, the when you get increases in the short end, um, it is translating into the, the long end of the curve. And really what we sort of should be seeing is, is not this kind of worry over the, a short term inflation shock or even sort of El Nino was mentioned for UK as something could that, how is that translating into, into the 30 year? Well it's, it's purely because the, the bank of England is taking a, a hawkish stance and that's, that's translating into term premium um, at the, at the longer end of the curve.

Speaker A: Maybe the MCP are blaming this heat wave on El Nino and so they're wanting to try and get that in there.

Speaker C: Well, just, I mean, yeah, I think that the uh, El Nino thing was, was mentioned, I think it was even mentioned. I can't remember now. I think it was mentioned in the presser. But these are, I'm going to say it, transitory inflation shocks and the inflation profile expectations in the UK is actually already higher than globally. So uh, it already I think incorporates this increased likelihood of negative um, supply shocks increasing the average of inflation over, over time. That's not really anything about kind of systemically and domestically generated inflation. It just means that there are more of these shocks and so the average of inflation is going to be higher over time. But I think the UK already sort of incorporates that into long end pricing a lot more than elsewhere because the UK has had more of these shocks and people are just more used to it. So it's more now the real yield just reacting to the fact that the central bank is taking this hawkish view and worrying about it feeding through into inflation expectations when um, actually that long end is just telling us oh the oil price rallied and you guys had a uh, hawkish response to it. And then it comes off again as soon as the oil price sort of comes back down and bank of England hikes get, get priced out. So I think once the, the upshot is that over the next kind of 12, 18 months we are going to see the Fed getting dragged into more um, hiking and we are going to see assuming our kind of base case comes through and we're assuming that the, the, the uh, Strait of Hummer's shock does leave oil prices around 80 with kind of limited escalations that come back to 80 then, then we're going to see the bank of England being able to cut rates and whether they Go to the full extent of where we think they could, um, is a different question. But uh, there's, there should be quite a significant divergence in the short end of the.

Speaker A: And then finally quickly on the BoJ before we move on.

Speaker C: Yeah, so it's a bit disappointing that they didn't just back that up with the, with the hike. Um, I think what was, I think we were talking about this on the previous podcast where we were saying look, there's just no point in the bank, in, in Japan intervening, um, when you've got this hawkish repricing of the Fed. And then as soon as we had the opposite of that, the um, the, the, the bank, the, the Japan started to, to intervene again but then they didn't back it up with the, the hike. So again this is one where you probably again have a lot of kind of leveraged plays at the long end of the curve. The other, the thing that sort of ah, relates Japan and um, and gilts and the sort of, the, the high term premium in both of those cases is that the, the private sector globally already holds a lot of duration with respect to these, these economies because the average maturity is so much higher. It's like 8.5 in, in Japan and, and close to 14. Am I right on that? In, in, in the UK that's, you know, that's a lot of duration in a world where the hedging qualities of bonds for equities have deteriorated. So why would you want to hold as much? Um, and in a world where we know that there's this kind of volatility because it's really only sort of hedge funds, uh, especially in those markets that are able to sort of come in and clear the market. So it's almost as though that um, interest rate risk has been transferred from the government. So refinancing risk is lower in these countries, um, but to the private sector and the private sector sort of saying well we actually don't need that much duration anymore, so thanks, but we don't, we don't really kind of want that. Um, and so the long end of the curve is really sort of kicking up, especially when you've got more issuance there. Um, so we do think that the bank of Japan will uh, raise rates um, shortly, uh, and back up, uh, that kind of yen intervention, um, which is a good thing. The fiscal policy is there to support the economy. The economy can grow through wage growth. Um, and all we need now is for the bank of Japan to have the guts to follow that up.

Speaker A: Yeah, fantastic. Okay. Uh, let's counter on into question two. Dario, you were talking about forward guidance earlier. Since central banks have been independent, we've always had some sort of forward guidance. Some have been better than others, but we've always had something there. And it seems like WARSH is moving very far away from that. What kind of world are we moving into, Dario?

Speaker B: I think we need to define some terms to start off with. I'm sorry. So forward guidance, uh, to me, this is when a central bank gives you sort of a guide to its future policy. So usually interest rates, so that can take lots of different forms. So one of them is they can just publish an interest rate forecast. Like, I think the bank of New Zealand publishes an interest rate forecast. You got the Fed dots. Um, they can use code words. So there was a time when Jean Claude Trichet was the one winding me up, and he had this habit of saying, um, extreme vigilance just ahead the interest rate decision, before he raised interest rates. And I'll never forget this red Bloomberg headline that said, trichet won't deny there is a word that means something which I just always thought is just the most fantastic, like breaking news from the ecb. So it used to use code words. Um, you've, you, you've had sort of briefing, off the record, on the record briefing. So, you know, if you got to the point where a Fed meeting was, say, 50, 50 like we had this week, normally someone would call up a journalist, I'm not saying which journalist, and say, uh, you know, I think this might be what happens on Wednesday. And then suddenly we'd get this story on, um, like the Tuesday before, saying, this is what we think is going to happen. Yeah. Um, so there's always been like these hints, nudges, sometimes subtle, sometimes not so subtle. Um, that to me is what 4guidance is. And then you've got the reaction function, which is something quite different. So this is about a sort of mapping of data to different outcomes that these central banks could do. So to me, understanding the reaction function is about understanding how central banks are interpreting the world, how they're interpreting the latest data, uh, what the staff analysis is saying in terms of how the economy is performing, um, which in the Fed's case, it's like, which part of the dual mandate is the Fed focused focused on? Like, it can be employment, it can be inflation. Sometimes it changes, and sometimes this involves scenario analysis and fan charts. But then things get a little bit blurry because there was a time when the Bank, I think the bank of England still publishes the fan charts. And what did everybody do? They just looked at the center line of the. And they used to have this period where, um, bank of England watchers were basically getting their rulers out and marking on these fan charts where they thought the interest rate profile would be based on the middle of the fan chart, which is obviously, when you get into this, like, is that a reaction function or is that forward guidance? But anyway, the point is, like, we don't need, um, forward guidance. I don't need hints, I don't need the press telling me the day before what the meeting is going to show. Um, I don't need explicit forecast. Like, we, we can form a view of what the Fed is going to do based on what the data is. If we understand how the Fed is interpreting the data.

Speaker A: Yeah.

Speaker B: And that, I think, is what, um, power was quite good at. So if you think about inflation, he gave us these frameworks, so he would say, well, you know, we're breaking inflation down into three components. You've got core goods, core services, housing. We think that the services bit is the sticky bit. That's the bit that we're watching. So that sort of analysis, I think is quite helpful in understanding and obviously it helps if, you know, that the Fed is putting more weight on employment versus, um, inflation. The problem with Walsh at the moment is that his definition of forward guidance is basically just all encompassing. It's like, we're not going to tell you anything about the future interest rate, but also we're not going to explain what we did today and we're not going to give you any sort of assessment of how we're seeing the economy, apart from these really vague spinny terms like, it's resilient, it's doing well, everything is great, almost like putting value judgments on data rather than, like, assessment. So I don't think what we're doing now is sustainable. I don't think he can keep saying nothing. I mean, he can have fewer press conferences next year, seems to be hinting at that.

Speaker A: Oh, really?

Speaker B: He did a review of the bank of England in 2014 and said that they should do fewer press conferences, which I think they did. So that would seem obvious. But you can't just not say anything and just spin things for 45 minutes because people are just going to get frustrated with that. Um, where does this end up? Uh, well, I think the obvious outcome is that we're going to get more volatility, so we're going to get more volatility in yields. On Fed days, when we get decisions that Maybe we didn't expect because we haven't been told two days before by certain newspapers that this is what the decision is going to be. Um, we're going to get more volatility in between, um, meetings. And there's an article in the FT today arguing that maybe this is actually what he wants, this is like the underlying thing, but he just can't say it. What he wants is more volatility. And the reason for that is this sort of, well, there's this sort of BIS view of the world which is that if you've got lots of short term volatility in interest rates and uncertainty and it gives you wider risk premia, then you get less volatility longer term because you don't get into this sort of breeding of these imbalances. So if everything is very, very tranquil and stable on the surface underneath you can get these big imbalances building up. So like, um, Bill White, who's on one of his task forces, he used to have this thing about the paradox of credibility, that central banks were always hitting their 2% inflation targets and always perceived to be hitting their targets and there was no uncertainty about what they were doing. Then you get these massive imbalances building up underneath the surface in the credit system and that in the end would give you massive financial instability. So maybe that what this is all about. But you can take that to extremes. I don't know in practical terms how you use the Bill White view. We don't want central banks to be too good at hitting their targets because then we're going to take crazy risks. I mean, I don't know how you put that in terms of practical policy. And then you've got the Mervyn King view, which is the Maradona economics. We can ask Breyer about Maradona economics because she had her own experience with that this week. Um, but Mervyn King, like had a slight, almost disdain for financial markets, right? He had this sort of school, masterly approach that used to really widen people up and used to irritate journalists in particular. But his argument was that he always talked about the Maradona goal in 1986, that not the handball one, there was the other goal, the other goal where basically Maradona just ran in a straight line from one end of the pitch to the other and scored, beat the entire England defense. How? Because those defenders were just completely hapless. They kept anticipating these moves from Maradona which then didn't arrive. These like feints and step overs and stuff. And so they would Fall around all over the floor. And so the implication of that seemed to be that actually sometimes it's a good idea to deliberately mislead financial markets. Now, I was talking to some former bank officials and they said, like, internally there was a lot of pushback at the bank of England about this because that was the message, like we should deliberately mislead financial markets. That seems to be the opposite of what Walsh is saying, because Walsh is telling us that the market is this all powerful, all knowing thing and we should just bow in reverence to it. Whereas, um, King was saying, let's just mess around with financial markets and get them to anticipate things that aren't going to happen. Um, but I think that's the end game. Like you get more volatility in financial markets. Um, that seems to be the obvious thing. And that means wider term premium in, in yields.

Speaker A: Yeah, yeah. Freya, where does this all end? Lack of forward guidance.

Speaker C: So now that Dario's mentioned, I just know I'm going to get a lot of questions about what is my alternative to this Maradona football. And it's nothing. Yeah. Okay. All right, so I have an admission to make.

Speaker B: You need a name for it first. Like, what's the name that you're going to describe this method of central banking?

Speaker C: Smashing in the face?

Speaker A: Something to do with the, you know, the Mike Tyson quote that everyone overuses in the face.

Speaker B: Yeah, yeah.

Speaker C: Okay.

Speaker A: So everyone has a plan. Your son, your son had a good plan until he got kicked in the face by the foot.

Speaker C: By a foot in the face. Oh, my God. Don't make it worse than it is. I tried to lob. I had like 5 seconds left on the clock. I tried to lob the ball over him into the goal. And I insist, smashed my 11 year old son in the face with the football.

Speaker A: There we go.

Speaker B: No, but hang on. In front of loads of people. That's the key part. Like the embarrassment factor is. It's like the one thing is like kicking the ball in your son's face, but the other part of it is like, I would imagine this hush that fell over.

Speaker C: People were like walking their dog. And then for some reason decided, probably because we were so good at football, decided to like sit down and watch us play football. And the pressure for me obviously was just too much. And so the next thing that happened was I.

Speaker A: So in this analogy, is your son central banks or is your son markets? Are you central bank?

Speaker C: I guess my son would be markets. And I'm, I'm, I'm like Hike. Um, crazy central banker says no, we're gonna hike by 50 basis points, get it to where it needs to be, uh, and that's it. I actually don't think that would be an awful idea actually. I think if they were to just, you know, hike, that would be an indication that the economy is in a good place, um, and that they're doing their job. I don't think it would be a bad thing. I think it would cause some, some continuation of the healthy rotation that we've seen recently. Recently. There you go. See, there is.

Speaker B: We could call this like the Bundesbank, like I can't think of like a tough, German uncompromising defender, but like the Bundesbank would have, if it was worse this week, it would have raised interest rates, canceled the press conference and if anyone had complained it would have raised interest rates again by the end of the day. We need a German defender that can sum up that approach.

Speaker A: I love that. That's real schoolmaster. Anyway, yeah, I'm glad we've just had the World cup because uh, even, even our American listeners will be, you know, dialing into the, the football, soccer analogies.

Speaker C: Yeah. So, yeah, I mean, I think um, what the way that we try to operate in this environment is actually the way that we always try to operate, which is just to think that actually yes, these reaction functions matter. Um, but I think I always feel that they, they matter more so in a sort of a short term sense. Um, and the market will actually. So maybe it's the market that's smashing the, the central banker in the face rather than the other way around. Um, you had a little bit of a sense, um, of that with the movement in the long end, whether they, whether they really want that volatility or not. Like ah, ah, I don't know. Um, I think ironically in this environment, given what I said in the context of the first question, we already have that volatility. Like we're in a place where yields have risen, um, across the curve reflecting that new sort of macro environment. We have more shocks and we have, especially in, in some markets, such as the gilts market, um, we, we have a long end that is quite leveraged to the short end, um, and so is moving with the short end because it's a hedge fund that is, is requiring the gilts market at the 30 year to clear before they will step in and take the issuance, um, when, when the repo market has, has risen with, with bank rate. So you're going to have that volatility anyway without Central bankers obfuscating and sort of making things, making things worse. And I think ultimately to come back to sort of the actual forecast and whether Warsh's reaction function matters or not. It definitely does matter, um, in the short term sense of if they're behind the curve, it's not as good for the dollar, um, especially if the bank of Japan is going to take those opportunities to intervene, although not so much if they fail to back that up with a rate hike. And so if they are behind the curve, then they're going to see the effects of that in the dollar. Um, but eventually, I think the long end of the curve and the market and the economy will dictate where the short end goes. Um, that takes us quite nicely onto the third question.

Speaker A: It does, yes, exactly. And Dario, you put out a fantastic piece yesterday, uh, on Thursday, um, about the end of the cycle as we've had client questions increasing. You lovely little chart in there about, uh, how the worries have peaked throughout various times in the last 15 years. But is this finally it?

Speaker B: So it is, it is like you said, are we nearly there yet? Uh, when you're on, like a start of a long drive, I've actually got a solution to that. What you do is you put the sat nav on. So it shows you, like, how long there is left. And I found that my kids just never ask anymore because they just look at the sat nav. Although sometimes you get, oh, my God, four hours. Are you kidding me? So it depends how long journey.

Speaker A: My children are probably too young. One of them would do that, could do that, but the others couldn't.

Speaker B: So there was definitely a sense of that. So, like, we've had 15 years of this question, basically, and it's a reoccurring question, like every 18 months it would be, is this the end of the cycle? Are we nearly at the end of the cycle? Are we nearly there yet? Uh, you know, a lot of our analysis in the 2010s was about that question because it was being demand driven from this client interest. And clients were coming up with all of the sort of potential black swans because they were all inspired by the big short. Everyone wanted to find the next big short. And so you had like, more Mageddon. Remember? More Mageddon. You had Volmageddon, you had various emu breakup scenarios, you have fiscal cliffs in the US you had China's Lehman moment literally every 18 months for 10 years. Um, and, uh, none of these were really systemic. None of them were these black swans. Everyone had been sort of of misled by the big short. And what was more important is that there was nothing really going on underneath the surface that would bring a sort of organic end to the cycle. So we had no inflation. So central banks weren't really raising interest rates, they were just doing endless mindless qe. Um, you had no sort of over investment, you had no credit growth. The credit cycle wasn't really doing anything. Um, there was no excess, excessively low savings. The savings rate had gone up after the global financial crisis and was quite high. And so there was nothing really that suggest organically we were going to get to an end point in the cycle. And so what did we end up with? We ended up with the longest expansion in history. Really tepid, like crappy expansion, but it was just very, very long. And when it did end, it was ended by a pandemic which like nobody had that as one of their black swans that was going to kill the cycle. And so then we had the pandemic, came out of the pandemic. And then pretty quickly the question came back and you had a series of recession scares. So 2022, always in the summer, by the way, the summer recession. This is the first summer in five years where we haven't had a recession scare in the U.S. um, so we had a series of recession scares and at every instant it looked like people were just misreading what was actually happening in the economy. So we had a series of these, um, fake recession scares. And we always said that people are misreading what's actually happening in the cycle, that this isn't the end of the cycle. Um, yes, we had an inflation problem, but it was pretty clear that a lot of it was transitory and that we've come down to a level that central banks will be prepared to tolerate. Um, this sort of revealed preference for higher inflation. The stuff that really agitated Walsh at the press conference this week. Now I think things are beginning to change. So there are sort of organic things in the economy that suggests we could be reaching a point where these sorts of question actually matter. Uh, so one of them is obviously inflation. Like, yes, inflation was higher a few years ago, but it is still too high. And we've got to the point where central banks telling us that inflation is going to be 2% in 12 months time doesn't really hold any credibility anymore. So that plausible deniability is gone. Um, then you have, the labor market is starting to re, accelerate, but it's starting from a position of full employment. So we already had the labor market that we had in like 2019. We've got that now and we're just starting a re acceleration. Once the labor market starts to re. Accelerate, you get questions like, is monetary policy genuinely tight? Like is can we really say interest rates are above neutral anymore? I, uh, don't think you can. And then you have a massive investment boom in the US now on a macro level, this is nothing like the sort of big macro financial imbalances we've had in the past. Like, like we've got a few years of rapid credit growth and lending, but sort of macro perspective, it's nothing, it's not massive. But from the point of view of the companies that are doing the investments, the hyperscalers, their debt is now rising very, very rapidly and their investment is like over 100% of free cash flow now. So we're getting to the point where I think if you, on a sort of 12, 18 month horizon, you can potentially see how this cycle is going to end. It's going to be the inflation becomes more of a problem, one that central banks actually have to deal with rather than just like dismiss as they've been doing. And you start to get these fundamental questions about AI. Like, you know, we keep talking about this, but um, markets have sort of come away over the past couple of months, particularly compared to two months ago when we were getting the hate now. But um, you know, these questions about circularity, they're just becoming more and more important, you know, and that, uh, debate about all of this being sustainable, that hasn't been settled. And I think if you're an environment where interest rates are going up, monetary money's becoming tighter, and you've got these unanswered questions about the AI boom. I think you can sort of look ahead and say, well, we can sort of see what the contours for the end of this cycle look like. I'm not saying this is happening now or like the bubble is bursting now. I don't think it is. Um, but certainly as you look into next year, I think you can see the beginning of the end for this cycle.

Speaker A: Yeah. So you have the inflation then you have interest rate hikes, AI gets into trouble, maybe a bubble pop, that sort of thing. Boof. End of the cycle. Okay. Freya, do you agree?

Speaker C: Yeah, I mean, I think that has been. Those contours, um, have been clear to us. When do we start saying that? Sort of end of last year.

Speaker A: Yeah.

Speaker C: Without not the time frame so much. But like that's, that's how it actually ends. Um, that's those Those contours sort of make sense in terms of like the timing of it. I think right now we have had this rotation within tech. More recently it's looked a little bit more like it's, it's sort of against tech and, and the broader rotation into the, the the rest of the economy and potentially global equities. Um given sort of upside surprises in, in Europe that story all seems to be sort of coming through. Um and I keep on going back to January um and that is the sort of the risk on narrative that I like on a sort of a short term trend basis. Um ahead of those contours really sort of playing out um I think the, in terms of like the relative between the US and Europe. Um like right now at this moment in time we have had sort of some nice consumer data come through in the, in the gdp. Like overall it wasn't that great largely because of imports in AI but the sort of the um leading indicators there with regards to real income growth and how that feeds into to consumption probably right now are at their weakest. So I um think the sort of the risk of further broad risk on before we get to that kind of um end of cycle is, is quite high. So let me try and unpack that a bit because I said risk twice in two different contexts in one sentence. Right now we have um high energy inflation still. The crack spread has still not sort of started to narrow again we've got the, the a strong fiscal multiplier on the tax refunds in Q1 that has now reversed. That's been fully used up by the energy shock. Um the savings rate has, has dropped and absorbed the energy shock almost entirely. Um but there isn't sort of the, this, this moment in time right now then is probably like the weakest with regards to real income growth. Growth. Um then with the reversal of energy prices so sort of energy price deflation, um we get into a better place where you can sort of see the savings rate maybe sort of repairing a little bit but without damaging consumption too much. Um and so gradually you sort of get back on track with, with, with, with underlying drivers of, of consumption and that's what keeps the, the labor market accelerating. Um I guess if you know the Fed is, we do think that they'll start hiking this year. I don't think the initial hikes are enough to slow down the economy. Like that's kind of the whole point. We think that this economy can sustain higher interest rates. So that again to me is why I think you know they, they should have just gone with the, the rate hike, hiking cycle because it's a good indication that the economy is strong and that they're doing what they need to do to, to, to preserve the cycle. Um, so I, I think essentially sort of summing that all up, we do have a, A, a, a moment now where you get further sort of re. Acceleration. You don't immediately translate that into um, into the, the Fed sort of being so far behind the curve that they then have to hike very rapidly, which is a, ultimately what um, what the end of the cycle would, would look like. So I think we still have some risk on, we probably still have some rotation. We probably still have a nice global equity market story to, to tell outside of tech that is starting to sort of come through. Um, and I think that all happens before we worry too much about the, the sort of, the contours of the end of this cycle.

Speaker A: Yeah, well, that was a very neatly answered question. I thought that was brilliant. So, yeah, I mean, I hope that makes sense. It is off consensus, especially around the stuff around Fed hikes. That's still off consensus. Uh, and then I hope that gives people a good idea, a good map on how the cycle ends ultimately. Just a flag. We are going to take a bit of a break over August from this podcast. Um, but our research output will not take a break. So if you're not a client or um, on trial to our research, please do reach out. You can read, read our stuff throughout August. Uh, reach out to me. My name's in the show notes and we can set you up with trial access. Very happy to, but that's all we've got time for. Freya, thank you very much. Daria, thank you very much and um, thank you all for listening. Bye Bye.