Bubbles, Burnham and Bashing Warsh

Speaker A: Foreign.

Speaker B: A, uh, podcast with no questions about Iran. Markets have moved on. Let's just ignore the weekend clashes because the oil price certainly did moved on, or rather moved back to AI bubbles and central bank hiking concerns. Much more our, uh, wheelhouse. Anyway, volatility has not left us. And while markets have performed fine, we haven't had the kind of relief rally associated with oil returning to pre war levels that many, many had hoped for throughout April and May. So what's the story, morning glory? Well, former Manchester Mayor and soon to be UK Prime Minister Andy Burnham thinks he has the answer, and we'll discuss his plans later. Before that, though, let's answer. Number one, do you believe Kevin Walsh's hawkish start as Fed chair? Number two, what do you make of the latest BIS warning about an AI crash and how much damage would this inflict on the global economy? And finally, why is the market ignoring this latest bout of UK political instability? Dario, you put out a note this morning titled Kevin Borsh has already annoyed me. You can tell us why. But also, some of our listeners have been annoyed, too. After last week, the complaints have continued to flow. Is that right?

Speaker C: Yeah. And this time, I mean, it's really, really serious because they're all about Freya. Lots of people very angry saying that, um, Freya is, Is too difficult to understand, she's too smart, too complicated. And I have to admit, I was a little bit pleased about this at first because it's nice when all the complaints aren't about me. But then I thought about it and I thought, well, I mean, the tone, I mean, you know, it's so different. I mean, I read to you last time the hate mail that I got from somebody or the F bombs, you know, insulting my honor. And Freya gets. Freya gets complaints to the tune of, oh, I'm worried that she's too smart and I don't understand. Too smart. I mean, come on, how is that, how is that fair? And the worst part is I tried to escalate it, right? I offered to give them her email address. I even offered to draft hate mail for them, and they weren't having it. They're all sort of apologetic and blaming it on themselves and not her. I mean, it just doesn't seem right,

Speaker B: a chasm between the two complaints.

Speaker A: Just to be clear, my connection dropped. So I don't know what the beginning of the podcast. Podcast was about. Um, but we. We're getting on to the questions now. Right?

Speaker B: Excellent, good, good. Put down and segue.

Speaker C: That's you putting your answer she's ever given. So in terms of, in terms of wash, this is a sort of theme. Should we believe Kevin Walsh, you know, is all hawkish, um, threatening to raise interest rates. The market is clearly buying into this. I think the issue is that it goes back to something we were saying about a month or so ago, which is that, um, there is this sort of theme that the market always tests new Fed chairs. And my response back then was it's actually the Fed chair that tests the market. And all of these Fed chairs, they come out and they try to be hawkish at first to try and establish credibility. And obviously with Walsh, he's got a very strong incentive to establish credibility, given that there were these big question marks going in about whether he would just come in and cut interest rates. Regardless, I'd say there's two things why we should believe him. The first is that, uh, it's not just him. I mean, the whole FOMC was already turning much more hawkish. And then the other thing is the data. We're in this situation where inflation has been above the target for five years in a row. We're now into year six and recently it's been getting worse. Even on core measures of inflation, when you strip out the impact of energy, you've got the AI boom, which I would argue is inflationary. We'll talk about that later. Um, but also the labor market is re accelerating. So I just think there's a sort of fundamental justified reason for actually raising interest rates at this point, or at least discussing the prospect of interest rates going up. So I think it's right that he's come in and been hawkish. Um, you could expect that given the sort of questions about his credibility. But I think it is backed up by the data. I think they will need to start raising interest rates at some point.

Speaker B: But do you believe it? I mean, you think his credibility is genuine? He's not just talking the talk.

Speaker C: I mean, he's always been a bit of an ick. He's usually like contrarian, like the time when he wanted him to be dovish back in the 2010s when the economy was in a deep recession. That was when he was super hawkish. And then recently he was quite dovish when the economy was actually doing really well. Um, no, I think it's genuine. I think there is this question about this continued overshoot of the inflation target. We're six years into this now and the issue before was that you had this sort of plausible deniability. You could keep saying, well, the labor market is weak and inflation we back down to target next year. But we've been saying next year for six years now. Um, you're sort of pushing the credibility there. And if inflation and growth are starting to re, accelerate why wouldn't you raise interest rates? I mean I don't think that's particularly dangerous or a radical thing to do. So I do believe it.

Speaker B: You do believe, you're a believer Freya? Do you believe in so far as you know where we have our view, September hike and then lots more hikes next year. Ah, so you believe he's going to, he's going to be hawkish.

Speaker A: We uh, didn't think that inflation was going to come back down to target. Uh and I think that's the part where um, he hasn't really been tested yet. The market has responded to his uh, call to get more involved but only in a very very narrow sense. We've seen a move in sofa, we've seen a move in the short term, uh, the short end of the curve, um, which is really just the response to the perceived threat of a little bit more energy cost pass through. If you look at the way the market is pricing at the moment you've just got one maybe two hikes and then things revert to the same old, same old of um, maybe inflation is going to come back down and there's sort of plausible deniability. Whereas for us it was never really about um the straight upon the energy shock. In fact the profile, the dynamics in the energy market at the moment with the drop in prices um is perfectly timed to uh, amplify the second round effects. Uh, you've got the sort of the energy shock that comes through is the first round effect. But the second round effect uh, is that this is happening in the context of an economy that is re accelerating of a labor market that is re accelerating against the backdrop of constrained supply. So I think Walsh is okay with potentially the profile of the way that markets have reacted so far. I think where he had his hawkishness hasn't been tested with respect to the actual increase in domestically generated inflation um, which is yet to come. Um, now we've always sort of thought that it would be the market that would be, that would be leading. Um and we've yet to see uh, the response of the longer end of the curve that isn't just about sort of trying to get ahead of the Fed reaction function but it is actually pricing in a high for many years now. Um, and we expect that to continue.

Speaker B: Thanks Freya. So I guess in terms of our view then, and Daria do chip in as well, we are saying to clients somewhat off consensus, but it certainly was off consensus when we called, when we made the call of September hike and three to four hikes next year. How off consensus is that still? Are we comfortable with that view or where has our thinking progressed since our last podcast?

Speaker C: So I think that sort of short term rate expectation is quite consensus now. I mean last time I looked there was a very strong probability of a rate hike by um, September. Um, I think where things differ is that then the market sort of has these, the curve is sort of kinked and then it has these rate cuts in for next year. And so it's a sort of transitory inflation issue where basically the Fed does a sort of ECB move and then corrects it. Um, to me that's where my sort of real conviction is, it's the 2027 outlook. Because I just think we're going to look at a much higher terminal interest rate in terms of how far the Fed is going. And then the Fed won't stop hiking until something has gone wrong. The economy. So we've got sort of one rate hike quarter until something goes wrong. So either the AI boom starts to unravel or you know, something breaks in the economy. M. I still think we're some way from that. So definitely on the hawkish side, particularly in terms of the terminal rate. But the sort of short term, you know, should they go in July, September doesn't really make a huge difference. I mean, you know we had that, we had that forecast. I think it's basically been priced in um, you know, given that oil prices are coming down, take um, some of the pressure off, sort of near term pressure to hike rates. But you know, as Freya said in her answer, the Fed was never going to raise interest rates just in response to headline inflation. And oil, you know, it isn't like the ecb, it's going to wait for the labor market and you know, we get more labor market data this week if that reacceleration is confirmed and it becomes, you know, confirmed by more data over the next few months. And I think that's when it gets you onto this sort of more sticky inflation, uh, sorry, interest rate hiking cycle.

Speaker A: In a sense that oil price coming down is actually just like reconfirming the re acceleration of the, of the labor market and the ability of this economy to sort of bounce back. So it's the oil price coming down in some commentary is perceived as oh well, it's less inflationary but to me it's like, well that means there's more likely to be domestic inflation and given that the labor market is tightening then the second round effects, the pass through to um, other prices is going to be stronger and the relationship with um, wage growth is going to be stronger. Not that we see wage growth bottoming right now. We could see low income wage growth starting to bottom out given that that's where the great scarcity is as a result of de immigration policy. Sort of the leading indicators that we do already have an increase in vacancies um, versus unemployment rates. And that suggests that this is an economy that is starting to warm up and it's not really just up to wash. Like when we look at the SEP, um, there's a 2.5% forecast for next year for core inflation and that is not 2%, that 2.5 is not 2% and that's probably as high as you could go, um, given the Fed, um, modeling process for their forecast for next year. So we really have a situation here where the market is starting to, is sort of taking on board. That wash is not just going to come in and tell the productivity story and tell the AI story, but we're still some way away from the economic reality and it's the economy that is leading the story here. The Fed is, yeah, there's a lot of politic political change but the Fed ultimately is responding, is going to respond to the economy. It's not the sort of the be all and end all of guessing that reaction function, which is how uh, markets are behaving at the moment. They're just focusing on that sort of what's the short term story there?

Speaker B: Yeah, makes sense, right? I mean, let's move on to question two. But I mean there is a connection with question one as well. So Dario, if we do get three, four hikes next year, is that what pops the AI bubble? I mean there's been a lot of talk of people who've done a lot of investigations, yourself included, uh, into the bubbles of the past and generally it's interest rates going up that pops them rather than anything else. So is that the kind of scenario you're envisaging, maybe a pop in 2027 or could it come before that?

Speaker C: Yes. So that was the sort of bis. The BIS made some headlines over the weekend. Um, it was covered in lots of um, newspapers as well. The warning about this overinvestment cycle and the fact that this could then lead to this big crash. And so you've got what pundits always do at times like this. When the BIS publishes the warnings they're using a sort of contrarian indicator, you know, oh my God. The BIS is extremely bearish. So this must be really good. You know we're going to get a massive mount up. I would just point those people to box C because I've read the report now and box C of the BIS annual report talks about accelerating super exponential GDP growth coming from AI. So you know, I wouldn't say it's all bearish in terms of the contours. Um, what the BIS is saying. I think it's right, they're warning that inflation is already above target, that this AI boom, particularly the build out phase which we're in now is going to be inflationary. I've got a big note on that coming out this week. Um, that's adding to these pressures and if that then pushes the Fed to start raising interest rates, you get this pattern that we see at the top of every sort of technological boom which is that um, these companies are engaged in this race which they have been for several years now. They're investing huge amounts of money. It's beginning to weigh on their balance sheets. But more significantly you now have the potential for a margin call in the sense that the marginal growth for this boom is now coming from debt markets. And so if you get to a point where the cost of money is going up and um, financial conditions start to tighten, then you've potentially got something outside of this AI ecosystem pulling the plug on this and then that's when you get to the problem. So that I think is the right sort of contours. Um, you know, I don't think 25, 50 basis points is going to be enough to create that sort of dynamic. But you know, if we're right that it could end up raising interest rates a lot more than that, then I just think that's something you have to be aware of. Um, I'm not sure that it will just be interest rates going up. Um, when you look at those previous sort of boom periods, it was that combination of interest rates going up and people beginning to ask questions about the fundamentals of it. So you know, and we've, we've talked about this over and over again, you know, all the sort of red flags that suggest, you know, potential problems in this area. You know, the fact that we're not really seeing the revenues, there's still this sort of circular financing. The capex is still 85% of the profits in the sector. Uh, you know, all the things we've talked about and, you know, we've had a little taste of that just over the last month or so. You know, since we started to warn a little bit about these things. Um, you know, we've seen some jitters in this sector. You know, we've seen the stuff about token maxing, which we joked about about a month ago. You know, that's become more of an issue.

Speaker B: Yeah.

Speaker C: Um, we're seeing sort of Chinese share of token consumption suddenly going up rapidly. Um, you know, you've got Sam Altman talking about potentially delaying the ipo. You know, there are certain, you know, jitters that have started to come into this. Now. I'm not saying this is the end of that process, but, you know, if you've got these questions about the fundamentals and then you've got monetary tightening on top of that, I think potentially you've got the how this is going to sort of play out and how it ends. But I don't agree with those people. So the other part of this is all those people that are saying, you know, this is some massive disaster waiting to happen in terms of the economic fallout. So I constantly, you know, listen to other macro podcasts. I hear people talking about, you know, Andrew looks disturbed by that.

Speaker B: Yeah, there are other.

Speaker C: Well, you've got to know what the other people are saying, you know, and I constantly hear these sort of, you know, this is just like 2008. You know, there was one guy saying, some, one guy I used to work with actually a long time ago saying, this is even worse than 2008. This is the biggest misallocation of capital in history. You know, it's going to lead to some sort of Great Depression environment. You know, I, uh, really can't see that. Uh, I think, you know, this could be very bad news for the stock market. I think you could get a recession on the other side of this. But to argue that this is going to be some deep financial crisis, I just can't see that.

Speaker A: You almost have a sort of a bubbling, natural bubbling tendency that comes with this type of a, uh, of a new technology, new general purpose technology. Because there's a perception among investors that there's potentially infinite demand that they want to chase. And in this, in the case of this particular technology, there idea of needing to be at the frontier of this development. Now, whether that turns out to be a good place to be in terms of being able to capture rents, um, in future, particularly as Daria was talking about with regards to Chinese models being a few months behind um, that it may not turn out to be a good place to be in terms of capturing rents. In which case at the very frontier we're going to have questions on um, on uh, the sustainability of earnings growth and the ability to sort of monetize and transition to uh, out extra tech uh, revenues. In terms of the relationship with the macro economy. It's almost like you're always going to have a tech sector and a non tech sector and the pursuit of this perception of infinite demand is going to create an increase in leverage that is faster, that cannot be contained by interest rates which could be sustained by the rest of the economy. So the non tech sector couldn't sustain interest rates that would be high enough to prevent investors from chasing um, this dream of the potentially infinite demand. Again none of this says that it's a bad technology or that it's not going to create, it's not going to diffuse into the economy at some stage in the game. It's just the natural, potentially the natural kind of progress of what happens in financial markets with respect to the rest of the economy when you get this type of a technology. So the worst thing that could happen would be if the Fed was to sort of be dovish and kind of not recognize that this is an economy that actually um, funnily enough as a result of all of the wealth that's being created by this, this new technology, with all the capex creating earnings growth which pushes up um, stock prices, um, there is ah, a greater ability of consumers to sustain higher interest rates and there's a willingness to depress the savings rate in the household sector. So if ever there was a situation in which you could see um, uh, an economy that was capable of sustaining higher interest rates, it would be the U.S. the risk is just that the Fed doesn't realize that and the way the market is priced at the moment, we're nowhere near close enough to being able to contain the increase in the rapidity of the increase in the rise in leverage. When we look back through history, the best indicators of financial um, risk and crisis is the rapidity of the increase in leverage. It's not sort of the level, there's not some sort of magic level. There's it's are you breaking the speed limit of um, effectively how quickly you can create productivity growth and create new equity in the system. Total factor productivity growth is effectively what you get out of um, your production that you don't have to pay, your factors of income you don't have to pay, um, your employees and you don't have to pay your debtors, um, in terms of wages and interest. So at the point when this new technology, uh, translates into total factor productivity growth and diffuses into the economy, um, that will create new equity in the system. But if leverage rises too rapidly ahead of that process, then uh, you're creating a bubble. And if the Fed isn't able to keep up with that and raise interest rates to prevent that happening, um, then the bubble gets bigger. So the last thing we want is for the Fed to only do one, go once or twice, or kind of fail to move until later on when leverage has risen more rapidly because then the fallout will be bigger.

Speaker B: That's quite interesting. So for the bulls, they should be almost wanting a few hikes next year so that the Fed gets in there early.

Speaker A: Yeah, I called it a healthy hike, um, when that hike got priced in. But to me, interest rates, when they're responding to, um, demand led growth and sort of demand led inflation, that's a great equity market environment. It's also an environment in which the economy systemically can probably sustain higher interest rates. Um, and a central bank that sort of embraces that as a, as a sign of health in the economy is providing the best, um, counterbalance to the buildup of systemic risk and leverage. So sort of falling behind the curve, being too dovish, running all of these stories with regards to diffusion is going to come through quickly enough that we won't have to worry about inflation, which is just already being proven not to be the truth. Getting behind the curve is risking, uh, a bigger fallout further down the line.

Speaker B: History of the last 15 years has essentially been the Fed keeping the party going for equities. And that's always seems to step in and just cut or do whatever it needs to do to keep the party going. I mean we haven't really had a sustained like many, many months bear market in equities for a long, long time. 22, 2022 was a bad year, obviously not a great year, but it wasn't disastrous. Covid was, was bad, but that was really just March and April and then May was all okay again. Uh, that is interesting. I mean, what you're saying, Freya, is if the Fed tries to just do the same thing again next year, at some point that's going to be even worse and we're going to have even bigger problems later down the line.

Speaker A: Dario looked last year, we've had one increase, one year of increase in leverage. We've now had sort of, uh, since, since he did that We've had about one. A year and a half of increase in leverage. If. If the Fed, um, in fact, you know, 25 basis points from the Fed is not really going to do all that much to contain any further increase in leverage. But if. If the Fed sort of does nothing against, to check speed of the economy, then we're going to have had, say, three years of rise in leverage and then a much more rapid increase in interest rates, um, which is what could potentially cause the end of the cycle. Whereas if they kind of start raising rates now and then sort of hike rhythmically, there's probably still going to be a buildup in leverage because it's such a hot chase. But, um, it does to some degree curb the systemic. The scale of the systemic risk that is building up. And that then needs to be checked. That needs to be corrected by, uh, an economic downturn.

Speaker B: Yeah. So, Dario, in terms of the second part of the question, we haven't really got onto that, but just in terms, then let me paint a scenario. Sometime. Next year, the bubble pops. We get a bear market in equities. What is the, uh, damage for the global economy? I remember you saying, someone on that podcast was saying depression, obviously, that's one extreme, maybe the other extreme is. Is not much. The economy keeps cracks on. Where you. Where are you thinking the economy is? If we get a bear market in

Speaker C: equities, I think it would be. Well, it's not. I mean, it's not just a bear market in equities. We tend to talk about equities coming down quite a long way. Um, just.

Speaker B: Sorry. By bear market, I mean 20% off.

Speaker C: Yeah, I mean, you know, it could do that. And m. It might not do anything to the economy. I'd be more worried about, you know, a situation where you've got a proper sort of end of the boom tile, you know, style dynamic. Um, and I think it would be like dot com, you know, I think it'd be closer to dot com than subprime. So, you know, both cases, you got a big decline in equity markets. But with, um, dot com, because it was housing and because the leverage extended, you know, across a lot of the private sector, uh, um, it was devastating. You had this very severe balance sheet recession. I just don't think you can have that with this. I think you could get a big hit.

Speaker A: Financial crisis. Right. Not dot com.

Speaker C: Yeah, you could get a big hit to. You just get a recession. You get a normal recession. Um, we used to have normal recessions without the end of the world. And you can have a recession without it being the end of the world. I think it would be bad for equity markets if you've got a lot of AI exposure particularly I don't think you're going to get a really nasty recession and a really nasty type financial crisis. I think it's quite concentrated in terms of an bet. I don't know how uh, sort of optimistic that makes me talking about not having a financial crisis. A recession would still be uncomfortable. I just don't think it would be the end of the world. And I don't think it goes back to the narrative that we've had for the last 18 months. People saying the US economy is all about AI, it's all about this capex boom. It just isn't. The sort of global consequences would be big if you're in that supply chain. So if you think this AI investment boom, what 1% of GDP and you know at least half of that is spilling out into the Asian supply chains to the semiconductor producers there. So you've got like a lot of potential knock on effects to global equities and global economies but mainly concentrated around the uh, AI supply chain rather than you know, 2008 type dynamic.

Speaker B: Makes sense. Makes sense. Okay, let's get on to the final question. Um, so for non UK listeners, if you haven't been following this closely, Keir Starmer has said he's stepping down as Prime Minister and most people know that Andy Burnham, who is the former mayor of Manchester has now become an mp and he will become Prime Minister sort of sometime the middle of July roughly. That's obviously some instability. Another change of a Prime Minister for the uk. We're getting pretty used to it now. Gilt market hasn't really wobbled too much. Sterling hasn't wobbled too much or at least not as much as most of us thought. Freya, why is the market ignoring this?

Speaker A: I think almost the entirety of gilt market underperformance has been a result of bad policy, not a prediction that bad policy is going to continue. I think the reason why gilt yields are so high is because UK nominal GDP growth is high and gilt yields are high for all the wrong reasons. So we've said essentially that the UK is basically front run all of the bad aspects of the new macro regime, which in a nutshell are negative uh, supply shocks. Uh, and I think it's hard to uh, overestimate the extent to which that supply side deterioration is a problem. You can have big negative supply shocks and that will push up term premium. But if you have sort of a sequence of smaller negative supply shocks, um, over time and it becomes clear that the economy just can't really process inflation through the system, the bond is just not doing what you need it to do in the portfolio. Um, and that's the bad aspect of the new macro regime that we're talking about. Just as a reminder, the new macro regime is basically um, determined by the structural changes, uh, secular changes in demand and the change in the types of shocks that are hitting the economy. So the structural changes is that the labor market is globally tightening on a structural basis. Um, and we have this new general purpose technology, uh, the demand changes is that we're in a re leveraging cycle. So there's a natural propensity for these economies to overheat or to sort of run, to have demand running ahead of supply, which isn't necessarily a bad thing. And it's more likely that you get positive demand shocks and negative supply shocks from politicians because there's more interventionist policy and because we're in a much more multipolar um, global order. And the UK has basically front run all of the bad aspects of that which are these kind of negative supply shocks. So we're stuck in this kind of negative equilibrium in the uk. Whether Barnum can get us out of it or not is a different question. I think the narrative around this has all been sort of focused on um, oh my gosh, is he going to expand the fiscal deficit? That's not really the thing that has driven the deterioration in the gilts market. What has driven the deterioration in the gilts market is these sequence of negative supply shocks that have pushed up interest rates and that has then reduce the fiscal headroom um, for the uk, uh, for the Chancellor, for the government, um, in the sense that there's so much that is going to interest um, and there is also a lot going to sort of depreciation for different reasons as well. Kind of six monthly or at least kind of yearly shimmy m underneath the fiscal headroom which causes the Chancellor to have to completely rethink fiscal policy um, on that frequent basis. Um, it's not so much to do with the size of the deficit per se, it's just that the UK economy is less able to process inflation through the system and that causes higher interest rates and people label that as a fiscal black hole.

Speaker C: I think there was a lot of um, quite poor sentiment about the uk. We talked about this a couple of months ago. Um, the fact that everyone was expecting some big energy bailout in response to the energy crisis. A lot of hawkishness about the bank of England. A lot of those rate expectations come down with energy prices coming down. So that's helped. Um, I also think that, um, you know, all this stuff about worrying about socialists taking over in the uk, I mean, you know, Andy Burnham's hardly a socialist. I mean, I know he uses that word sometimes in his literature, but you know, I. It's just, you know, he's already softened the tone around the bond market. So he famously said, you know, we shouldn't be in hook to the bond market. He's changed that. He's changed his idea about that pretty quickly. You know, he's appointed a pretty sensible group of advisors. Sensible. I'll use that as a sort of broad term. Um, you know, James Purnell, sort of Blairite, pro business, anti welfare state, not exactly a socialist. Jim o', Neill, ex Goldman Sachs. Not exactly a socialist. Andy Haldane, Freya and I quite like Andy Haldane. Quite sensible macroeconomist with some sensible ideas about the uk. Used to annoy bond traders because he'd never give any guidance on interest rates. But that seems to be the vogue now, so maybe that's right. It's much more comfortable talking about sort of 150 years of economic history, which I quite enjoyed. So the big question is about Chancellor and everyone is petrified it's going to be Ed Miliband. But, you know, the idea that this guy's going to come in and spend huge amounts of money or sort of, you know, get even more religious on net zero, I just don't see it. I mean, this is a guy I worked with for a long time in the Treasury. I mean, he's got a lot of experience in the Treasury. I don't think he's going to just come in and spend huge amounts of money. You know, I think he'd be much too scared. Like they all, they're all really scared of the Bond vigilantes. So the idea we're going to spend huge amounts of money, I don't really buy, you know, and I don't buy the idea that Andy Burnham is some crazy ideologist. I mean, if you listen to. I'm going to flag another podcast now, but if you listen to the Air Balls George Osborne podcast, Ed Paul seems to be the advisor to, um, Brown. He said that he played football with Andy Burnham and he said that it was difficult because you never knew if he's going to go to the extreme left or the extreme right when you're trying to. So there's this sort of, you know, he has got this sort of history of flip flopping. I think he's quite pragmatic to be honest. I don't fully buy the growth strategy. So there's all this stuff about what's his growth strategy going to be. Um, you know, the King of the North. I now get that because I've finally finished Game of Thrones five years behind everybody else. Uh, so I finally get that. Ah. Um, and obviously the term, um, that's sort of in vogue at the moment is Manchesterism. So the idea, it sort of works. I mean if you look at the GDP data by regions, um, London has sort of been sinking since 2016. I don't know what happened in 2016. Something happened. And um, Manchester's share of the UK economy has been going up extremely rapidly over the last few years. And you know, if you look at the sort of ideas for this growth strategy, it's all about sort of boosting, you know, infrastructure in cities. It's basically looking at the UK economy and seeing that you've got this sort of over dependence on London. You've got no sort of mid tier, very productive cities and it's not like, like Germany or even France to some degree. And so you need to get some of this growth going outside of London, you know, particularly as Something happened in 2016 and we're not really going back on that. You know, if you, if you read the sort of literature on this, I mean it's sort of consistent with all these think tanks have been saying for a while, um, you know, I'm not convinced this is going to radically turn around the economy, you know, quickly. But I think he might get lucky on this because you know, he's very good at setting up a narrative. This is sort of what he does. You know, this was his sort of big advantage being the mayor of Manchester because, you know, he didn't have to make tough decisions and he could just sort of sell a narrative. And I think that if you get this inflation coming out of the system quite quickly now in the uk, I think that allows the bank of England to cut interest rates faster than people realize. You know, private sector balance sheets are in really good shape. I think you could get an economic recovery from that and then I think you could sell that as a narrative about, you know, Manchesterism or whatever you want to call it working. So I, I think you get lucky. I the odds of him just coming in and transforming the economy through some sort of growth strategy, I don't really buy that, but I think he could just get lucky. Better to be lucky than smart, isn't that?

Speaker B: And I think your key point around borrowing and spending loads of money, I think that holds. And as long as that's the case, bond investors don't really mind. I mean sure, we'd all love gangbuster growth for the UK economy but uh, fixed income investors, they're not hugely fussed about that. They're just, just, they don't want socialist policies and uh, they don't want colossal unfunded tax cuts.

Speaker C: It's basically, I mean, you know, the event. I was looking at some of the data today and one of the advantages he obviously had in Manchester was that huge amounts of money came in from Manchester City Football Club. You know, I reckon it was about 2% of the city's gross domestic product, you know, which is a lot of money coming in. I mean, you know, it started off with um, sort of rebuilding the stadium and then the training facilities and then sort of leisure complexes, but also a sort of public private partnership to build housing. You know, huge amounts of houses have been built in the Manchester area. There's money coming in. So I don't know. He's sort of being very friendly to global investment, if you want to spin it that way. You know, it's sort of encouraging, um, global investment. That's not the sort of narrative that people are associating with him. It's not just going to be, you know, open ended fiscal spending. I don't see that happening. I think they're all too scared. You know, I can't see us going down that route. I don't know. I mean this, this seems like, like okay compared to expectations two months ago. I don't, I don't think this is going to be a disastrous outcome.

Speaker A: The moves in the, in the bond market have been so tightly correlated with just expectations for the bank of England which in turn is, is just that. So recently has been that reaction to, to the, to the, the shock emanating from the straight of Humut. So it's, it's more of again the sort of perception that the UK can't process inflation through the system. Um, and how is the bank of England going to react to that? Um, rather than any sort of clear driver of sort of political instability, it's just that sort of how is the bank of England going to react? That's been the main sort of driver, um, of yield. So in a sense the way to get out of the sort of negative equilibrium around fiscal Policy and this kind of perception of high, of fiscal unsustainability, um, is the growth package or whether that happens sort of naturally or whether it's a result of something that Andy Burnham kind of brings in. That's the way to sort of get out of it. It's very rare in history that you get debt to GDP declining in uh, a sort of a low pressure system where the private sector is weak. It's much more likely that it's uh, a demand led story where the supply side is responding. So there does need to be sort of reform and yeah, I think some kind of broadening out from the city of London into sort of other cities and second tier cities, mid cities would um, help to sort of get those agglomeration effects which could show up aggregate productivity data. And London is quite congested. So the benefits of kind of agglomeration um, appear to be capped. That's quite a, well, um, rehearsed theory in the sort of the think tank world in, in the UK now it's kind of known, um, the question is whether that can be sort of executed and that would help to get the UK onto a more kind of balanced growth path that would eventually get it um, out of this kind of fiscal headroom quandary.

Speaker B: Right.

Speaker C: And the other thing about this sort of socialist message about Andy Burnham is it forgets that in 2015 he was the one pushing massive austerity. He was saying that it was, it was a mistake for labor not to be going down the George Osborne route. I'm not saying this is a good thing because I actually think that was a big mistake. But you know, this is a guy that changes his mind about stuff or flip flops if you want to be.

Speaker B: He's a politician, in other words.

Speaker C: He's a politician. Yeah, but he's, but he's, he's a politician that seems to get on with people. I mean that's the big difference with Starmer. Like people just didn't like Starmer. You know, he wasn't particularly inspiring.

Speaker B: Um, I think the days of real prime minister, bureaucrat prime Minister, uh, I've been gone dead and gone for a long time. You need someone with some sort of a vision and some sort of a charisma and character to them. So I think Starmer's demise makes a lot of sense in that way.

Speaker C: This is, yeah, I think it's really our last chance because we're basically sort of heading into this populist spiral, aren't we? I mean, you know, you think about how the UK's got into this position. It's sort of fascinating because the only growth strategy we've really had over the last 30, 40 years was basically to become Europe's financial hub. And it was all about London financial services. And one, that left us massively exposed to the global financial crisis. And we've never been able to recover from the global financial crisis. And two, it created this massive disconnect between London and the rest of the country, which created the sort of populist backlash. And so then you had an immediate aftermath of the global financial crisis. This was a disaster because your growth model had basically broken. But then you had the populism and Brexit that then made the situation even harder for London without really resolving the problems that were facing the rest of the country. And, um, so we just wanted slipping further and further towards populism. And this is really the last chance they've got to correct that because.

Speaker A: Final point, Fred, I think the word spiraling is, is the key one, because you can have a virtuous spiral or you can have what the UK has at the moment, which is that sort of doom loop where you, you have deterioration of wealth because the UK wealth is exposed to its own gilts market. And you can see that in the, in the LDI crisis there was a massive loss of wealth. And so you need to save more. And so the UK savings rate rises. And at the same time, because of that rise in interest rates, there's the perception that something is critically wrong with fiscal policy. And so, uh, consumers continue to save rather than to consume because they're worried about, um, the tax rises and tax rates coming through. So both from a wealth effect and from the perspective of expectations of fiscal policy, you get these kind of negative feedback loops, um, where you're in that sort of negative, negative equilibrium and it's very hard to get out of it. It needs some kind of a catalyst, whether Andy Barnum can sort of provide that or not, or whether just, you know, a little bit of stability. If there could be a little bit of stability around the UK economy, I think it would do okay. It's not like, like Dario said, it's not as though we. There's a great need for sort of private sector deleveraging or anything. The private sector should be okay as, as long as we sort of get out of these, these, um, these, uh, these kind of constant shocks and, and a little, some kind of a catalyst outside of the, of that negative equilibrium that I described.

Speaker B: Yeah, good stuff. Right. We've gone over time and apologies. Um, I know this podcast is a few days late according to our normal cadence, but Dario and Freya were publishing last week, working hard, getting reports out to our clients and our prospective clients. So if you want to be a prospective client, look in the show notes, grab the email, email me, ask for a trial. Institutional investors only. Uh, very happy to provide one, but that's it. Freya, thank you very much. Dario. Thank you. And, um, thank you all for listening. Bye. Bye. Mhm.