Richard: Hi, welcome to FRA RoundTable Insight. Today we have Caroline Miller and Yra Harris. Caroline is currently BCA’s Chief strategist Global strategy since joining BCA in 2012. She has had a cross-functional roll to both contribute to In-Shape the Global Research view while communicating this message to BCA clients at an executive level. Prior to joining BCA, she’s been 20 years as an Institutional Global fixed income asset manager, and Yra is a hedge fund manager, global trade, currencies, bonds, commodities, and equities for over 40 years as a floor trader. He has also served at CME director from 1997 to 2003. Welcome Caroline and Yra.
Caroline: Thank you.
Yra: Thank you, Richard
FRA: Great, I thought we’d begin with what your current global macro themes are, Caroline, at BCA research? If you can take us around the world in and what your views are at the economy level and the financial markets level.
Caroline: Sure, I’ll just start by saying that we see quite a divergence paths in in pricing. Bond market seemed to be at to have a very pessimistic view of the outlook for global growth and yet equity desert are close to recent highs and seem to be benefiting from low rates, but I was interpreting below, complex of interest rates as such an omen for the outlook for the business cycle. We think that that diversions will be resolved by a pickup in global gross into the end of this year. Certainly the manufacturing sector is weak and pretty ubiquitously so it’s as a vertically integrated component the economy, but if you look at the more domestic service areas, for example, of the US economy, it seems to us that it’s Gross still ticking along at an above trends pace and course US economy is a little bit less exposed to global trade then Europe and Asia. We see a lot of the weakness and Global manufacturing as coming out of China and and that this trend really predates the escalation of hostilities in the in the trade sector has been exacerbated by that but really you can trace the recent slowdown and go to manufacturing to type policy in China from a couple years ago that has slowed a fixed asset investment. They’re deliberately I think to a certain extent to control the pace of leverage growth are but the impact has been a reduction in China’s demand for resources and capital goods know that’s a large part of their import activity and that’s had a knock-on effect on Japan, and Europe, and you know most of global trade but we see the recent easing and financial conditions and also likely stimulus from China because it’s be no it does it suits them to prioritize deleveraging and containment of speculative risk when the economy strong, but we see them pivoting to a much more reflationary policy that we expect to manifest in the second half of the year. So we see global growth stabilizing and picking up and I think by the end of the year, the outlook for global growth could look a lot brighter than it does today.
FRA: And Yra, are you seeing the similar trends from your perspective?
Yra: (inaudible) I think the bond markets are so badly distorted by Central Bank action that it’s hard for me to know what the impact they are telling me because of the national arbitrages. So, you know, I don’t go deep into data I’m searching for the geopolitical uncertainty. (inaudible) There is so much pressure put on global rates, especially the long end, because people are searching for yields where ever they can. (inaudible) I think that geopolitical uncertainties are increasing dramatically, and the uncertainty is whether to slow down the capital expenditures and I don’t its because of the trade I think it’s because of other things and the way that they’ll play out, of course. (inaudible)
FRA: And to what extent does your research, Caroline, factor in like Central Bank policies, monetary transactions, monetary policy, fiscal policy into the views that you come up with in terms of the global economy in the financial markets?
Caroline: Well, I would certainly share with Yra’s assessment of the fact that uncertainty is a big feature of the landscape today. And I think you can see that in the global turn Premia that are so unprecedentedly depressed partly as a result of Central Bank intervention, but if you think about what the term Premia embodies, it’s a measure of expectations about inflation and the volatility of inflation, and the volatility of gross. And so I think that uncertainty is has driven a lot of flows into the perceived safety quality government bonds. I think there’s no value in those markets. I think it’s a term premium to wear at a more normal level relative to history than the yield curve would look a lot more like it has in the past. And so I would agree that the signaling mechanism from the curve isn’t what it would it has been but I also think that mean if you think about the fed’s mandate, their mandate is to try to sustain full employment and their statutory definition of ability for you know, most of the time or as much of the time as possible and send the FED’s mandate expanded in 2012, not just to include full employment, but also this inflation target, you know, they haven’t met that. They have not defended the lower bound of that inflation targeting. So I think that’s.The reason that they are most likely tomorrow going to cut interest rates because they are they’re concerned about a lack of attitude based on the fact that interest rates are so low, I would say though that if if it were the case that interest rates were at a distorted low level relative to what you know, the supply and demand for credit then inflation would be a lot higher. So there’s some element of the low term structure of rates that is a reflection of a slower growth environments. I think it could turn out that in fact the US economy is more resilient (inaudible) hindsight we could look back. And they didn’t that monetary policy had been loose for too long. I don’t think that’s a story for now or or really the next 6 to 12 months that’s a story for a couple years from now. But the fact that you have coordinated Central Bank set of signaling in a fairly coordinated fashion the need to support growth and aggregate demand by continuing to keep rates low is partly in response to the political uncertainly, there is no question, but I think that people are ignoring the very high likelihood that the Chinese economy is it is going to turn around as a result of a fairly reflationary policy there. And so that’s Billy’s roof for a positive growth surprise, but I do concede that geopolitical risk is elevated.
FRA: And your thoughts Yra?
Yra: No, I is it just you at least I think that’s the trading the Chinese I think bought that doing certain things because, for the last at any time, he’s been on the cusp of the downturn, I think the Chinese have stepped into the global void and certainly ramped up from where they sit right now. So there is they are they tighten does is trying to talk about in their own methodology last year and it and it has slowed things down and I think you’re getting, you know, there are some people following who are following Trump, because if you look at the Japanese pushing on the South Koreans to the South Korean numbers that turn down, the Singapore numbers are weak. I think those indicators to whatever changes are going to be taking place when we start to see those started to shift and right now. They haven’t they still alive portending in pointing to some weakness. Now. You haven’t gotten to Europe yet, which is problematic in many ways and the fact that you know, I think well, I won’t open up your up until we’re ready to but you know, I I don’t I don’t disagree with that. I just didn’t you know, it’s more than a course interest rate Cuts. There’s that were talking about here. So where we go from here will be critical. And again, with them said tomorrow, I heard an interesting discussion about an hour ago on Bloomberg Radio. They were talking about the possibility that the feta and quantitative tightening tomorrow. So you get 25 basis-point cut – an end to the tightening immediately rather than waiting until September 30th, which gets you to get you almost in my estimation then almost at 37 and 1/2 basis point cut. So Powell will be able to shred the needle on that boom. (inaudible) If Europe really continues to slow, it will put some pressure on Germany for some fiscal stimulus.
FRA: What are your thoughts, Caroline, on Europe? Especially the interplay between what’s happening in the UK and the Euro Zone in terms of monetary, policy fiscal, and the relationships between the two.
Caroline: So I continue to believe that Brexit is in a European issue, but it’s Britain’s problem. I think that it’s convenient but erroneous to do a tribute to weakness on the continent terms of growth president. I think it has a lot more to do with global trade. I recited Singapore Japan and Korea exports slowing. I think a lot of that is related to China if you could say the same thing for Europe, but Europe’s also had some idiosyncratic, you know, domestically sourced headwinds unimportant won. Last year certainly was the election of the populist government in Italy that caused the riot and bond markets and doubling of interest rate there. Well, you know that tightening in financial conditions was with Thursday problematic positions and has since really completely reversed and if you look at some of the floor. If we look at the data, you know, Italian non-financial corporate credit growth on a second derivative basis is it looks like it’s starting to turn around in a very early statement. I think the ECB is as concerned about tighter lending standards in the area and they absolutely want to see more credits flowing to the private sector ,and I think you’re going to see that it’s a high chance that they reinitiate after asset purchase program via by more corporate bond, but I think if you look at France the consumer sentiment data is improving, and I would agree that overall the economy looks very weak. But again if you start to see a pickup in China, I think that will have a knock-on effect on Europe’s export sector. I think you need to see the effect of the recent drop and bond yields later in the year. And I absolutely agree. That fiscal policy is the big elephant in the room and it’s interesting. I think Europe doesn’t have a lot of monetary space left to ease rates are obviously already negative and that’s problematic for the European Banks profitability. European banks are a big part of it, but they do have a lot of physical space and I think it’s sort of the opposite of the U.S. where in the U.S. is a high-yield market. The short rate is it to 2 and 1/4 there’s room to cut. Yet fiscal policy in the states is going to turn out to be kind of maxed out. So if that’s how we see the policy landscape between the two I think over the coming year, if you look at the overnight index swap market, you’ll see that that investors expect the ECB to ease by 22 basis points over the next 12 months and the FED to ease by close to 90 and I think that it’s going to turn out that the FED does less than that and Europe may ratify the market expectations. So we see the spread between billings and treasuries possibly narrowing over the coming year.
FRA: And your thoughts, Yra, especially with the UK as a potential repeat of what happened during the financial crisis with a weakening pound sterling currency?
Yra: Yes, I think I’ll take a different view on Brexit. Not that I am worried about Europe, I just think that the negative aspect of the way that the market is viewed, the whole Brexit has just been wrong. And I think the weaker the pound sterling gets – easier it is for the safety valve and the pressure release for the UK because that’s the advantage of Britain has. The currency will go down, we are almost at 92 on the euro sterling cross today, but in the same vein where the German stock market really go whacked, maybe half percent, maybe .4 points not much for the gilt market has held up beautifully. So if you’re telling me that there’s going to be an absolute financial crisis in Britain due to a hard Brexit, I’m just not seeing it in the financial instruments and I will say that is actually genuine relative to what takes place in the European sovereign market because we know that the bank of England has not bought any QE for a number of years. I think they halted at 475 billion just after and they are not rolling it. If it rolls off, they renew it so just the numbers don’t change but it’s still reflects that people are buying gilts. And if I was worried about some type of really financial calamity some of the hard Brexit meaning of private investor doesn’t buy gilts, I understand that the banks are buying gilt but in Europe, would you really buy a French oath for negative 15 basis points?
It just pure insanity. And I know I know that they go up in value because European Central Bank ensures that they go up in value. It is really a difficult situation in Europe and even more so because of me what the Central Bank you email Richard I’ve been on quite a bit with you, I am not a Mario Draghi fan because I don’t worship the author of loose money driving asset prices. That’s not the game that I play. I think he’s been very dangerous, and it gets more and more dangerous. This is actually an article that we haven’t seen in years. But in the today’s FT by Clair Jones, the piece on the German Court hears AT&T CD bond-buying again and the name of the plaintiffs in the case. The number is 2000, so there is a lot of unhappiness and I’m not sure the way that that is totally going to play out. And I’ll say one more thing about Europe. Between the president Macron and Angela Merkel, Donald Trump is going to make their lives miserable. And as soon as he turns to the tariffs on China going to try to just stir the pot as I would say is easy always you like to do for the pot and will start to record some more conversation towards terrors, which would certainly will not do this. Well, we’ll see how they respond.
FRA: And Caroline, your thoughts on what Yra see?
Caroline: I’m not sure that it’s going to be in Trump’s interest to expand escalate and proliferate is trade conflict the closer we get to the election as we’ve already seen from the CEO round tables in the states that political uncertainty around trade policy does have an impact on capital spending intentions. The closer we get to the election the more business sentiment I think becomes relevant for him and to the extent. It’s clear that interest rates are very low, and if you start to see the typical, but domestic sectors of the US economy performing well and the more globally exposed actors doing poorly because of this concern about trade conflict. I don’t see how that that that lines up with his incentive structure. So I think Macrone is has actually defeated the yellow vest movement. I would just in France. Very clearly that that roar has slowed to a whisper and I think he’s going to get through quite a bit of needed structural reform there. I think in Germany, ironically the more weakness you see in Germany proper the higher the odds that they also abandon this obsession with some with balanced budgets in and it increases the odds of some physical stimulus. As far as Brexit goes, I agree every day that you see the Pound Down you see the relative performance at the ftse 100 which is the large cap multinational index which basically has very little to do with the British economy. But a lot of English domicile firms outperform the ftse 250 which is the more which is the index with the more domestic firms in itself. Is it very clear relationship between the ebon flow of Sterling and those two indices? I think about the uncertainty related to Brexit on a Continuum and a part of that is because I grew up in Quebec which had its own separatist movement for years that also involve to referenda that never actually, from a statutory perspective, was passed. But the drain on business sentiment confident talent and capital from The Province over the last generation is very clear to see and it is no cause to center of Canada finish leadership from Montreal to Toronto and I think the longer this issue stemmers or boils in Britain without resolution the worse it is physically for a country that turning a 4% current account deficit.
FRA: Just running out of time here. But the last question. Yeah, you mention, Carolina, and your global macro and market Outlook that Europe that populism repeat review dated physical austerity more than it has stoked Euro skepticism. And Italy is prioritizing growth over deficit-reduction. Can you elaborate on it?
Caroline: Sure! I think if you look at the polls in Europe on attitude toward EU membership deals support for the Euro area as a as a club is actually pretty strong and it’s what most of the anti-establishment parties the source of their support. Is there their criticism of the parties that have heated to the demands from Brussels for balanced budget? So I think what you’re seeing is more rejection of fiscal austerity then a big statement any individual. Not talking about the UK. But it really thinks that their world and their citizens and their standard of living would be better outside the earlier than inside it. If you look at Italy is an example of the Lega Nord a and the Five Star movement in this coalition government, you know, they really haven’t been champ exiting the area they have just stood up to the demands from the EU in Brussels that they balance their budget and actually I think won that argument. The rules around excessive deficit procedure in the finding that they could technically be subject to, because they’re in violation of the Maastricht treaty, haven’t been invoked. I think that’s a tacit acknowledgement that a country can only service debt by knowledge that they have it. If they’re growing and they grow. If the private sector is in leveraging mode andso in the public sector is as well and slowly, but surely, I’m more permissive attitude for some deficit spending to help support those economies. And I think you know that is the bigger issue than then, you know, wanting to be outside the EU. It’s really just a push to acknowledge that fiscal austerity is to the stationary and I think you’re going to see more of that.
FRA: Interesting. And Yra, your thoughts?
Yra: Well, if I would certainly push back on that because I’ll look to ramp up the deficit he was met with the threats and find some glasses. And I think that the threat is there and had a lot to say that Macrone would like to do that for France’s up against the limits to fax their numbers on our 90% and says the budget deficit as percentage of GDP so you can’t get away from these. So yes, if you relinquish all those I agree that there are two things that can make me very bullish on Europe: the creation of a harmonized fiscal authority coupled with a Euro bar, which is why I think they course, they put the garden because they’re going to try to hold the whole ECB balance sheet into a Euro bond. Europe is already built on the capital of fee, which will be critical to that process. But I think we’ll ways from that and I think the Germans have not been heard from yet as to how they’re going to feel about this because again, they do have that amendment or the statutory law about a balanced budget. They have been running all budget surpluses, which Caroline notes, gives them the flexibility to increase physical spending which would help all of Europe. So I believe that Macrone goes to sleep at night and prays for recession in Europe and that euro per say, in Germany, especially, that export sector turns down and then gets forced into a situation where they’re going to start to expand the deficit spending which one aid all of Europe but I just don’t see it on the rise to yet. I hope I’m proven wrong because Europe needs some reprieve some of the ridiculousness that they embarked upon, but I just see it. Germans are getting angrier
and as you can see this weekend, Merkel, which phone is trying to take advantage of. So, we’ll see how it goes.
FRA: Okay great insight and perspective. I guess we’ll have to end up here, Thank you very much both of you – Caroline and Ira.
Caroline and Ira: Thank you. Bye.