Everything is connected to everything else, as far as I can tell.
Let's start with the Federal Reserve decision on Wednesday, raising 25 basis
points. Not exactly saying what comes next, but
least opening the door to pausing. Is it justified?
The idea of a possible pause given where we are with the economy, you might say?
Well, of course, we've ended the week where the really strong employment
report, you know, we've had we've had 10 interest rate increases in a row, but
now 13 payrolls numbers that exceeded expectations.
And you know, David, economists. We expect them to be wrong.
Well, they're not usually wrong in the same direction every month for over a
year. So that does tell you something about
the underlying strength of this economy and certainly the labor market, which
has continued to confound the Fed and made its job quite difficult in trying
to balance that that tightening, that that historic degree of tightening in
the last year against sort of justified fears of a creeping credit crunch,
problems for regional banks. And, you know, still inflation above
target. Well, let's talk about inflation just
for a moment. The connection between the strong labor
market and, by the way, including those jobs numbers were some pretty robust
wage gains month over month. So as a practical matter, we really got
our arms around inflation. Do we have any reason to believe that
the monetary policy, the Fed Reserve thus far is having a material effect,
having some effect, a material effect on inflation?
Well, I think it is. It is one of those things that has the
policymakers in the Fed wondering, you know, has the transmission mechanism
that takes these rate increases out to the broader economy.
Has that broken down as it becomes slower than in the past, or is there
something that's something specific in the sort of post coded U.S.
labor market that's causing a delay, but not an end to that transmission of types
of policies? I think what has changed is you have in
these problems in the regional banking system, which I know we'll probably talk
about, you know, the failure of yet another bank that is telling you that
there's something that is very tangible that is going to quite shortly has to
have an impact on hiring. And that's the squeeze in small business
lending. You know, you mentioned my my podcast
economics. And we heard in this week's episode
actually about somebody who wants to invest in a pickle bull slash
restaurant, having trouble getting getting a loan.
A small business having trouble getting a loan.
Now, you know, pickle is a massive phenomenon at the moment if you can't
get money for that. I think we know that lending conditions
are tightening and that is if small businesses are the ones most affected by
that kind of lending, squeezing out, it's tightening up, drying up, and it's
small businesses that are the source of most job growth.
So it may not happen this month. It may not happen next month.
But we do now know that this labor market is going to cool and we have to
assume that's going to bring down inflation might also cause a recession.
Well, let's talk about recession specifically.
I want to come back to the original bank issued a moment.
But economists have been predicting a recession, likelihood recession for some
time now. Do the jobs numbers help put a lie to
that? Is there any prospect on the horizon
right now a recession, given what we're seeing and the strength in the labor
market? Look, I think those who have all along
expected it considered to be impossible to have that soft landing that the Fed
is certainly hoping for and not budging even in the face of these numbers,
because, for starters, you've got some a little bit of weakening below those
headlines. So you've got revisions in previous
months to the payroll figures. The household survey is a little bit
weaker than it's been. But also, as I as I just mentioned, this
this this creeping credit crunch that's happening and it's going to primarily
affect small businesses, those that can't raise debt in the markets that are
reliant on banks. You know, I think there we see quite a
good reason to expect, if not recession, then something very close to it.
All of our monitoring, the recession probability monitor, you know, maybe
take it with a pinch of salt. But we think it's still more likely than
not that we'll be in recession in the second half of the year.
Stephanie, let's go to the question of the original banks and the pressure
we've seen. We had the Silicon Valley Bank.
Then you had signature bank. And every time we wouldn't come up and
say, oh, it's really idiosyncratic. It was some special failure of the
management there. And then we had First Republic.
That's a different sort of integrity. This week we with sub PAC West.
We saw Western Alliance. It seems like every time we look around,
there's another idiosyncrasy popping up. At what point does it become systemic
rather than is credit? Yeah.
And I think we're starting to say idiosyncratic is if you're a bank that's
not one of the big four banks in the U.S.
at the moment, that's starting to feel like the divide because almost every
other bank at one point or another has been under pressure.
And almost every other bank in the US may not be in the kind of difficulties
that we saw, the kind of extreme business model, extreme disregard risk
that we saw in some of those other cases.
But it's certainly facing a kind of fundamental issue.
Inverted yield curve makes it very severely inverted yield curve in the
key. Part of the market between three months
and ten years, that making it hard to make money.
And this this long riding kind of expectation that you can make profits by
not passing on short term policy rates at the top at a time when short term
policy rates are rising. Well, that's harder and harder in a
world where we know we can have these digital instantaneous, massive falls in
falls in deposits and bank runs. You know, I think there are questions
about quite a lot of banks in the US right now.
Not that they're going to survive, but certainly it's going to quite hard for
them to make money in the near future, except for the very big ones, as you
suggest. They seem to be doing very well.
Thank you, ma'am. Does the Fed at the Fed Reserve face a
form of a zero sum game here where either it goes after inflation with
increasing rates or it helps the banks by not increasing rates or even cutting
rates? Because part of the problem here,
obviously, is an interest rate risk issue that was created maybe
intentionally, maybe it's a good thing by the rapid increase in the rate.
Well, that is you know, that's how the policy is supposed to work in many ways
at least. It is not aimed at reducing the banks
ability to make money or challenging its business model.
But it's certainly aimed at tightening credit conditions, reducing lending and
reducing economic activity as a result of that.
I think we've got to a point, though, where the Fed and indeed other central
banks are so keen to persuade us that they're not going soft on inflation as a
result. In response to these concerns around the
banks, that there's almost a risk of going the other way.
You could see that with Jay Powell this week, there was absolute determination
of that separation principle that we we are going to continue in our battle
against inflation and where we have other tools, we're thinking in a
separate way about about the banks, but they obviously can't be completely
separated. So everything you've just discussed
would be plenty. But on top of that, we had Janet Yellen,
the treasury secretary, this week saying, by the way, that so-called X
date when the government will really run out of money and capital to pay its debt
maybe as early as June 1. We have meetings coming up next week of
the president with leadership in Congress.
Give us a sense of how the debt ceiling crisis may play across the issues we've
been discussing. Well, when we talk about the US economy
dodging recession, so we're basically saying that it's going to shrug off the
effect of the credit crunch and the smaller lenders that I was talking about
earlier, but also that we won't have some default moment or a big increase in
financial tension around fears of a default in the next month or two.
And we think if that actually came to a head, that could have a very significant
effect on the economy, because, you know, if you think about it, it means
some overnight the federal government has to balance its books and balance its
books, and that means very significant reductions in spending there.
And then we don't think it'll come to that.
But the kind of tensions around that I think, you know, do give Janet Yellen
and the broader banking community I wasn't at the Milken Institute early
this week in L.A. You know, quite a lot of concern under
the surface about how this debt ceiling issue is going to play out and some
phone calls being made to Congress, but no real sense that people are getting a
handle on it. And finally, Stephanie, let's let live
Europe out of it. We've heard also from the European
Central Bank this week who hiked as well, 25 basis points like the Fed.
But unlike the Fed said, you know what, we're going to keep going.
Matt Miller guard, which I thought very clear about that.
What's the difference between the two economies?
And can the ECB take such a different route from the Fed if the Fed, in fact,
does pause? Well, of course, the European Central
Bank started later. It's in a very different kind of
situation. I think we tend to maybe.
Certainly when you if you talk to people in Frankfurt, they say we overplay the
amount to which they're watching every move of the Fed and thinking about their
moves in relation to that. But I mean, I think it is the case that
that interest rate rise from the Fed and the talk of possible pause from the Fed,
you know, it did give some cover to Christine Lagarde and her colleagues at
the European Central Bank to reduce the amount of increase that they had.
So we just saw that quarter point that slowing the path of interest rate rises.
She did talk about another two. We think it's more likely to be another
one that you will see a pause in the summer because they have other that
they're allowing their their balance sheet to run off after that after June.
So that's a continued form of tightening that they can rely on.
But you're right that ultimately, if the markets right, for example, that the
Fed's going to stop cutting rates the end of this year, that could prove very
difficult for the European Central Bank, because there's certainly a long way
from cutting. Is there a prospect in Europe of having
similar difficulties with the banks to what we see in the United States?
Given the fact that ECB has been raising rates?
Well, it's interesting. I mean, we haven't got quite the same
dynamic playing out. You certainly you don't have the same
inverted yield curve and that kind of pressure on on profitability of the
banks. But on the other hand, you have the fact
that, you know, bank the the broader economy.
There is much more dependent on bank lending, so a smaller problem, a smaller
squeeze on the European banking system could have actually as large or even a
larger effect on the economy. So, you know, it is something that the
European Central Bank has to look at. We are seeing credit conduct conditions
sharp and tighten dramatically in the last few months.
I think that will be another factor that will cause the European Central Bank to
pause in the summer.