Transcript
Speaker: Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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Speaker: This podcast was recorded for publication on the 25th of January 2024 by HSBC Global Research.
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Speaker: Hello and welcome to the Macrobrief.
Speaker: I'm your host, Piers Butler.
Speaker: Inflation is coming down in core markets, fueling hopes that 2024 will be a year of substantial policy rate cuts.
Speaker: However, our guest today isn't so sure and argues in his latest report that there are significant risks associated with prematurely cutting interest rates this year.
Speaker: I'm talking to Stephen King, HSBC's Senior Economic Advisor.
Speaker: Stephen, welcome to the podcast.
Speaker: Well, thank you, Piers.
Speaker: It's a joy to be here.
Speaker: Well, the last time we spoke, Stephen, it was around your latest book, We Need to Talk About Inflation.
Speaker: And the overall premise was that inflation was back and it was going to be harder to eradicate than, say, the advocates of team transitory would have have us believe.
Speaker: And yet we're now seeing everyone talk about immaculate disinflation.
Speaker: This is what happened in 2023.
Speaker: What
Speaker: actually did happen and why do you think subscribing to that view might be a little bit risky?
Speaker: Well it's worth noting, Pearce, first of all, that interest rates are way higher than team transitory had ever argued for.
Speaker: So central banks have had to put the brakes on to a much greater degree.
Speaker: Why?
Speaker: Because actually inflationary pressures themselves were significantly greater than they themselves and indeed team transitory had anticipated.
Speaker: Secondly, it is certainly true that inflation rates have come down.
Speaker: They come down a long way from the peaks a couple of years back.
Speaker: But inflation actually, judged by where we were pre-pandemic, is still sticky.
Speaker: I mean, inflation is still relatively high compared with
Speaker: target certainly considerably higher than was true pre-pandemic.
Speaker: And one way, I suppose, to think about this is that whereas pre-pandemic we were all worried about deflation and the idea that inflation would consistently undershoot central bank's targets, we've now got a debate about how far
Speaker: inflation will overshoot targets a lot, not much, but nevertheless a sense that there's a kind of overshooting going on.
Speaker: Now, to be fair, there are lots of things that will help to bring inflation down in the very short term.
Speaker: We've had some big declines in energy prices and food prices and so on.
Speaker: But when you look at sort of underlying cyclical indicators, whether it's wage growth, unemployment and so on, these are all suggesting that economies are in many ways quite tight still.
Speaker: So the idea you should be slashing interest rates at this point might be
Speaker: a little overly optimistic.
Speaker: And indeed, you've looked back at a couple of episodes in history to perhaps inform us as to why that would be risky.
Speaker: Yes.
Speaker: So there's a sort of habit, I think, that people have to say that interest rates are a sort of binary story.
Speaker: They're either going up continuously or they're coming down continuously.
Speaker: But there are periods in history where they've come down a bit,
Speaker: And then the central bank has had to do a kind of handbrake turn and suddenly reverse course.
Speaker: So I focused on two episodes, the first of which is in the late 1990s, actually in 1998.
Speaker: Now, we know in hindsight that the U.S. economy was absolutely booming in 1998, but at the time it didn't really feel like it.
Speaker: You'd had the Russian debt default that year.
Speaker: You had the failure of long term capital management, which was a major US hedge fund.
Speaker: And the initial preliminary estimate for second quarter GDP in 1998 was one of considerable weakness.
Speaker: So the Federal Reserve, looking at the combination of a financial upheaval and very weak GDP growth, reached the kind of logical conclusion that said,
Speaker: we better cut interest rates and there were three rate cuts at the end of 98 going into the early stages of 1999 so rates fell from five and a half to four and three quarters percent and a lot of people thought right this is the beginnings of a sustained series of of rate cuts but as it turned out in effect those rate cuts were the equivalent of pouring monetary gasoline on an overheating economy that was already on fire basically so you go rapidly from this idea of
Speaker: concerns about financial upheaval to what was the technology bubble that the economy absolutely surged ahead second half of 98 through 1990-99 and then of course you had the Federal Reserve having to do that handbrake term pushing rates back up
Speaker: well above 6%.
Speaker: And at that point, of course, the bubble bursts and all goes rather horribly wrong in 2000.
Speaker: So that's one good example.
Speaker: The second example is from the mid-late 1980s, which is relevant given what's happened to energy prices recently because it went up a long way, partly because of Putin's invasion of Ukraine.
Speaker: But the same thing happened in 1986, where earlier increases in energy prices went into reverse.
Speaker: There's a big fall in energy prices in 86.
Speaker: And the central banks responded as you'd expect, which is to say, well, this is good news for inflation with the cut interest rates.
Speaker: That again was a kind of monetary gasoline effect.
Speaker: The economies did very well in 87, again a handbrake turn in terms of policy.
Speaker: Then you have the October 1987 stock market crash, which is partly triggered by this monetary tightening.
Speaker: That, again, is not sufficient to slow economies down.
Speaker: And the path of Fed funds in the late 1980s was around about 8 percent down to 6 percent.
Speaker: all the way up to 10 by the end of the process.
Speaker: So we never got that kind of binary story of continuous rate cuts or continuous rate increases.
Speaker: It was a very bumpy ride in the second half of the 1980s.
Speaker: And where we are today, I think, you know, is it risks the same kind of story whereby, yes, you have some rate cuts coming through this year.
Speaker: But at the same time, there are reasons for caution, one of which is that the U.S. economy itself is far, far stronger than people had anticipated at the beginning of last year.
Speaker: It's done something similar in one sense to what we saw yesterday.
Speaker: in the late 1990s.
Speaker: And why is that?
Speaker: I mean, people have really been taken aback by the strength of the US economy.
Speaker: It's worth, I think, first of all, reminding ourselves of how strong it's been compared with forecasts.
Speaker: So at the beginning of last year, the general view was you might get 1% annualised growth at best through the course of 2023.
Speaker: And at worst, you might see the occasional contraction in GDP.
Speaker: As it's turned out, in the first half of the year, you had growth rates well above 2% of an annual rate, an absolute whopper at 4.9% in the third quarter.
Speaker: Simultaneously, you have an unemployment rate in the US, which is down at 3.7% in the last couple of months.
Speaker: which are among the lowest numbers we've seen in 55 years.
Speaker: So these are very, very tight measures of the economy.
Speaker: And one possible reason for that is that monetary policy just doesn't have the traction that it used to have.
Speaker: And one reason for that is that the long period of quantitative easing, zero interest rates and so on, allowed many people, whether it's households or companies,
Speaker: to effectively refinance at these very, very low interest rates.
Speaker: And there's no pressure for them to refinance at higher rates currently.
Speaker: There was short rates gone up a long way, but so long as people can hang on to their 10-year loans when they took out loans at...
Speaker: you know, half percent or 1% or 1.5%, then they're not really affected by this monetary tightening.
Speaker: And you can see this in some very odd ways.
Speaker: So if you take the U.S. housing market, for example, housing transaction volumes have been pretty depressed, which you normally think of as a sign of weakness associated with falling house prices.
Speaker: but actually currently you've got weak transactions but relatively buoyant prices and the reason for that is that there are a lot of people who would like to buy but very few who want to sell because if you sell you have to get yourself a new mortgage at significantly higher rates so the better thing to do is to hold your property even if it's too big for you you don't downsize you hang on to it because the cost of servicing the debt on your older property are much lower than would be the case if you move to a new property
Speaker: One of the other aspects in terms of an economy is the interplay between monetary policy and fiscal policy.
Speaker: And we are obviously in a year where we're going to get very many elections, particularly in the US.
Speaker: Do you think that's a factor that's going to play?
Speaker: It's a much more important factor than people tend to think about.
Speaker: One of the big problems with fiscal policy currently is we have some very, very big budget deficits, particularly during Covid and beyond Covid.
Speaker: To be fair, we've also had some pretty big budget deficits before Covid.
Speaker: So one way to think about this is that government debt, which is basically the accumulation of deficits over many years, government debt as a share of GDP has risen dramatically over the course of the last 10, 15 years.
Speaker: Now, that also matters from both a monetary and an inflation perspective, because if you've got large, large amounts of government debt and it's continuously rising, and it's not my projections, but you take the Congressional Budget Office's projections in the US or the OBR, the Office of Budget Responsibility, in the UK's projections, they're pointing to very big increases, further increases in government debt as a share of GDP, partly because of population ageing and the impact it has on pensions and health care and social care and so on.
Speaker: If you take those numbers,
Speaker: then it does suggest that there's a kind of fiscal brick wall ahead of us some way or another.
Speaker: Now, when you've got a fiscal problem, a lack of sustainability, the normal response is you raise taxes, you cut public spending.
Speaker: But if your tax takers, a share of GDP is already very, very high.
Speaker: And you've already pre-committed to big increases in public spending in certain areas, particularly because of population ageing.
Speaker: Those options are not so obviously available for you.
Speaker: So what are you left with?
Speaker: Well, some emerging markets in the past would have defaulted in these circumstances, but that just shifts the burden into the future because, of course, creditors will then demand much higher prices.
Speaker: interest rates than have been the case previously once you've defaulted and shown that you're not a very good credit, so to speak.
Speaker: You can do financial repression.
Speaker: You can force banks and other financial institutions to buy more in the way of government debt.
Speaker: But that simply means that governments jump to the front of the credit queue and it means that other potential borrowers are starved of credit.
Speaker: So it's not a good way of actually allowing the economy to recover.
Speaker: Or you can go down the time-honoured path of creating inflation or tolerating inflation.
Speaker: And the advantage for governments, highly indebted governments, of higher inflation is simply that higher inflation, when it's not anticipated fully, tends to redistribute wealth away from creditors towards debtors.
Speaker: If the government happens to be the biggest debtor in the economy, the incentive to print money is always there.
Speaker: And I think there's nothing new about those kinds of risks because they've been there for hundreds and hundreds of years.
Speaker: and they remain for the next few decades.
Speaker: And there is indeed some very good discussion about that in your latest book.
Speaker: I just wanted to come back to this risk of premature easing, which you've laid out very clearly.
Speaker: But where do you think we're at in terms of the sort of lobby to ease and the risks of premature easing coming through?
Speaker: Well, to be fair, given the extent to which inflation has come down and given the extent to which central banks justified raising rates because inflation was relatively high,
Speaker: you can see the political pressure coming through very strongly to cut rates this year.
Speaker: I fully understand that.
Speaker: For the US, there's a big election coming up in November.
Speaker: If you're the Federal Reserve, you don't want to be accused of interfering in the election story.
Speaker: So if the market's expecting to cut rates and you choose not to, then you may come under considerable political pressure and criticism, perhaps.
Speaker: The same may be true in the UK.
Speaker: It's true that central banks are independent, but they always have, I think, one eye on the political landscape because they've got to defend their independence.
Speaker: And the worry you always have as a central banker is that if you make a mess of things or you're criticised in one way or another, then their independence will be lost one way or the other.
Speaker: So it's a sort of strange kind of contingent independence, I think, is how I describe it.
Speaker: Obviously, we've started the year, more geopolitical shocks.
Speaker: How does that change the landscape for you?
Speaker: Well, the one great unpredictable aspect of any economic analysis is the nature of shocks.
Speaker: You know, no one easily saw the invasion of Ukraine coming.
Speaker: No one saw COVID happening.
Speaker: So
Speaker: These are shocks that can cause problems one way or the other.
Speaker: When you think about the disruption to freight and shipping in the Red Sea currently, well, it's a factor to look out for because if it continues for a very long time, then it could well change the dynamic in terms of pressures on energy prices, food prices, shortages of other commodities and goods as a consequence of the Red Sea being shut one way or the other.
Speaker: It's not for me to judge exactly what's going to happen there, and nor would I want to use it as an excuse for saying, well, that's why inflation is going to go back up again.
Speaker: But I do think that for central bankers, you shouldn't just assume that all the shocks come in one direction and that all the shocks therefore are positive.
Speaker: It's pretty clear that we live in a very uncertain world, and that uncertainty probably means a greater degree of conservative policy with a small C that might have been the case in the past.
Speaker: On that note, Stephen, thank you very much for joining us today.
Speaker: Thank you very much, Piers.
Speaker: Here's a roundup of some of the other reports published by Global Research over the past week.
Speaker: We just heard from Stephen about the potential dangers of premature monetary easing and the path for policy rates will be crucial for the currency markets.
Speaker: In his latest FX tactician report, Darren Marr, head of FX strategy in the US, says markets will be likely forced to reprice the extent of Fed easing, with a shallower cycle continuing to support the US dollar.
Speaker: His report also outlines our tactical views on the other G10 currencies, with the euro and sterling looking vulnerable.
Speaker: James Pomeroy, global economist, has published a new report on demographic trends.
Speaker: The latest data show that birth rates are falling quickly and the world's population could start shrinking before 2040.
Speaker: James says that although some may see fewer people as good news, drops in births create pressing fiscal issues down the road.
Speaker: Policy changes may be created, such as hiking taxes and raising the retirement age, but politicians may not be making too many pledges along these lines in a busy election year.
Speaker: For more details on any of these reports, please email askresearch at hsbc.com.
Speaker: And don't forget that you can follow the macro brief and our sister podcast Under the Banyan Tree on Apple, Spotify, or wherever you get your podcast.
Speaker: So that's it for this edition of the Macrobrief.
Speaker: Thanks very much for listening and we'll be back next week.
Speaker: Thank you for joining us at HSBC Global Viewpoint.
Speaker: We hope you enjoyed the discussion.
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