It's Tightening, Jim, But Not As We Know It

Published Aug 19, 2022, 9:13 AM

Marcus Ashworth on another tool central banks are ramping up. Not the PBOC though, which actively eased this week as 2022 GDP growth looks increasingly precarious. Dan Moss joins us. And Jared Dillian on markets, looking towards Jackson Hole and companies digest a new 1 percent buyback tax in the Inflation Reduction Act.

Welcome to Bloomberg Opinion. I'm Varney Quinn this week. You've got this passive. You've got this active on the same time as interest rate hikes for a lot of central banks around the world. Marcus Ashworth on some central banks amping up quantitative tightening and the perils associated with Also, we don't have a lot of history at looking at what a recession in China might actually make. Dan Moss on what china surprise rate cut says about the world's second largest economy. First though, to US markets digesting all of the above and prepping for Jackson Hole. But first, here's a clip of Stephen Major Hong Kong and Shanghai Bank recently. The market at the time was convinced a FED pivot needed to be priced in at some point. Stephen Major had other ideas. The elegant outcome would be, presumably to do less, and any central banker who's candid enough to admit it would say that, if it's so obvious we're going to make a policy in mistake, let's not make the mistake. I want to bring in Jared Dillion. That was Stephen Major, their Hong Kong and Shang High Bank. Is this what's happening now that we've seen the f O m C minutes. Do they bear out this analysis that the FED will try to be elegant as opposed to overdoing it and underdoing it. Well, I think so far the rate increases have been in the elegant and this is not an elegant central bank. They tend to overdo things in both directions. I mean, if you recall, we had a period of time that lasted eight or nine years where we had rates at zero. That was overdoing it in one direction, and now we're overdoing it in the other direction. Having said that, I don't think there's anyone at the FED who thinks that rates are going to go above four percent. If you believe the dot plots that come out at the FED meetings, the median dot is around three and a half percent for FED funds, maybe three and three quarters four percent. But I think that's going to be about the terminus for the rate hikes. So you do think that we might see another fifty basis point increase, Oh absolutely, I absolutely believe we're going to see that. I don't know if we'll get a fifty or seventy five, I don't know. Which it will be in the September meeting, and we'll probably get one more rate hike after that, and then I think there's going to be a pause for a while and they're going to reevaluate. So consumer spending obviously held up. Walmart and Target reporting healthy quarters. Is this an economy that's booming. It's a strange sort of economy. It's booming in some ways and it's very weak in other ways. I mean, if you look at the manufacturing surveys, the regional manufacturing surveys like Empire State in Richmond FED, Dallas FED and stuff like that, you're seeing very poor sentiment among manufacturers. But if you look at retail sales and some of the other metrics, like the consumer is actually doing pretty well. So we have a very distorted economy as a result of the message that would pertinent place after the pandemic and in fact our Jonathan and even pointed this out in a column as well, pointing to the fact that the problem isn't uniform and the FED to avoid upsetting the whole apple carts. But at the same time, the FEDS instruments are pretty blunt, right, it either raises rates or it doesn't raise rates or raisism by less. Yeah, the Fed only has one tool and I was actually thinking about that earlier today. The economy that we have now is very confusing to a lot of people. This recession or whatever it is, is unlike any recession we've ever experienced before. And the only tool that the Fed has to deal with this is raising or lowering the Fed funds Right, That's pretty much all it is. Yes, So what do they do? I mean, they do have QT, but that's a slightly separate thing. So what do they do about raising or lowering the Fed funds rate? To try and have this guide path because elegant as possible. Well, the problem is there are politics involved here. Inflation is the number one issue in the minds of voters going into the mid term. The Fed cannot be seen as being complacent or ineffectual on inflation. They have to be seen taking action. So it's very hard for Jerome Powell to make the case to pause here without being viewed as having done enough on inflation. So what will you say at Jackson Hole? Because this is a market that's continuously looking for more from this Federal Reserve of more explanation, more answers more signal. No, I mean, forward guidance seems to be a thing of the past. But will you have anything to say? I think that forward guidance is drawing to a close. If the FED is approaching a pivot or a pause or whatever you want to call it, and they're going to be dated dependent, it's going to be really hard to give guidance out six, nine, twelve months as to what the FED is going to do. And actually I'm not a big fan of the four guidance anyway, because it locks the FED into a certain course of action. So it's going to be interesting to see what happens China, Jared, we had worried some data out of China recently, and then an actual interest rate cut this week. I mean it was tiny, but it was a sign that the Chinese economy is maybe a little bit of troubled waters. Does that impact your investment decisions here in the US at all? Not really. I mean, the one thing I found interesting about the price action after the interest rate cut. You know, I've been in the markets for a long time twenty one years, and usually the market goes down when China raises interest rates, and now it's going down when China lowers interest rates, so I find that to be very unusual. Well, I suppose the fear is that China might actually experience a recession, one of the first in the lifetime of the modern Chinese economy, and that would have a blowback effect on the US. I mean, for sure, absolutely are you a buyer or a seller at these levels? Jared, I'm actually a totally neutral. I've gone absolutely as neutral as I can possibly get. I think technically we're in the middle of a range. There are no clear signals. I'm actually not doing anything at all. And then the whole meme stock thing has come up again. The stock do you or I don't know what you can call it? These days? Will this continue on for the rest of our lifetime? It's probably going to continue on for longer than you think. I mean, what's going on here now? This isn't retail investors that are pushing up at Bath and beyond. It's absolutely not retail investors. So these this is hedge fund activity, and this is pro versus pro I mean, basically, after these stocks declined a bit, a big short base built up. Somebody in the hedge fund world at the idea maybe we can squeeze these shorts. Absolutely, what's happening here. The retail investors don't have cash, they don't have any m O. They've lost a lot of money, and it's not them that's doing this. Don't forget listeners, get into to be a Twitter at Valley Quinn or email v Quinn at Bloomberg dot net. Opinions of comments always welcome. Let's get down to the Inflation Reduction Act. One percent tax on stock buybacks sounds small, but it might be deceptively mighty. So Jared, you did the math as to the government. By your accounts, it will raise, according to by backs, about eight and a half billion dollars in revenue. It's not nothing. Government calculations suggesting seventy four billion over ten years. What's the bigger picture here, though, Well, the bigger picture here is that what the government is trying to do is nudge CFOs into paying dividends instead of doing buy backs. And I think this has been a goal for a while. If you look at the dividend yield of the SMP in it was four percent, and the dividend yield of the SMP today is one and a half percent, And basically what happened was CFOs got smart and they figured out that we had double taxation of that income, and they started doing returning cash to shareholders in a more efficient way. So how do we think of buy backs? Because on the one hand, if you think of it from a corporate point of view or an investor point of view, you have one opinion. On the other hand, if you're thinking in terms of redistribution of wealth, then you've got pension funds and retirement funds that like the buy backs. But people like Senator Warren and Senator Sanders that loads buy backs because they don't do anything actually for a company's employees or consumers. So how are we meant to think of them? Well, you know, the way I think of it is, you know, buy backs kind of have a bad reputation. And just to be clear, I don't like buy backs either, kind of for different reasons. But if you pay dividends instead of buy backs, the managers and directors and officers are still going to get dividends, you know, because they own a lot of stock. So if you're returning cash to shareholders, you're necessarily returning cash to all shareholders, including the largest shareholders, the pension funds and people like that. Yes, but also management. If a company is already spending plenty on investments, so the cash can't go there. So so so say a company decides not to do a buy back because of this tax, they're already spending plenty on investment. Boosting worker pay isn't an option. What's better than sit on more cash or do a buy back anyway, even with the one tax? Well, what's what's better is to pay a dividend even though they're double taxed. And the reason you want to do that is because you know, if a if a corporation doesn't have any projects that are worthy of investment, then they should return that cash to shareholders somehow. So if by backs are being taxed, even at a small rate, um, you should return it in the form of dividends. Why, well, I mean it's better than it's better than keeping the cash at the corporate level. Like, basically, shareholders are better stewards of that capital than the corporation is. So if you if if you're a shareholder and you get a dividend, you can you can reinvest it in the stock or you can reinvest it in other stocks, or you can simply spend it. All of that is better than the corporation pursuing an investment project which isn't going to yield the high rate of return. So, Jerry, between this one percent tax on buy bax on the minimum tax on corporations, do CEOs have reason to breathe a sigh of relief or be a little annoyed by this inflation reduction Act? I mean it could have been worse. Each each of these could have been worst, right, Yeah, I think I think a little annoyed is probably a pretty good characterization. Um. You know, in the short term, the buy back tax is pretty small, almost insignificant. The problem is is that now that it's in place, it will for sure go up over time. So lower net effective tax rate areas such as healthcare I T they might see a hit too. EPs three. Would it calls you to change any investment decisions? Yard? Uh? Me. You know, people have different philosophies on this. Um. You know, somebody like Warren Buffett pays a great deal of attention to tax I. Actually, don't I make investment decisions sort of exclusive of tax considerations. Uh? You know, I look, what's going to provide the best return, maybe to my detriment. Okay, take that advice, and he did at your will. There are you know, buy back companies. Obviously, companies that you know like to do buy bax. There's an SMP buy back Index. There's obviously going to be a raft. Well obviously, but I mean I presume there will be a raft of buy backs between now and the end of the year before this takes effect. Does that e t F or do those companies outperform or underperform as a result. I think the outperformance of the buy back stocks is going to diminish over time. Um, I think the effect is going to be pretty minuscule at first. I think what you'll see happen is as the tax goes up, uh, the outperformance of buy back stocks versus the overall market is going to decrease. Darre dillion. There. China cut rates this week, a surprise cut. So in the last several days out of China we've heard both a warning on inflation and a call from economists for stimulus. How then do we read the signals emanating from the world's second largest economy, I asked Dan Moss in Singapore. So Dan back In April, the PBOC implemented targeted policy tools as opposed to rate cuts. There are twenty three measures and a targeted farmers and mortgage holders and all sorts of industries. Then this month it implemented an act tull interest rate card. It was a small one, but it was one. What do these moves indicate about the economy and its growth this year? It tells you, Vonnie, there is growing alarm among policy maker is Invaijing about the trajectory of the Chinese economy, not just that growth is slow, but it could be slow and continually slow. Wing We don't have a lot of history at looking at what a recession in China might actually mean, how even to define it, and might be worth asking ourselves what does this look and feel like in China, because if you go back for decades, we never had to encounter this question. Now I'm not predicting one, but you know, China's economy has gone from a world beating initial COVID recovery in the second half of to something that is looking pretty sickly right now right and this growth target of five and a half percent is probably fantasy at this point. It's probably been fantasy for quite some time. But if there were to be negative growth, if there were to be contraction, would we ever hear about it? Yeah, we probably would. One of the most interesting things about China's slump induced by COVID at the start of was that there was no effort to guild the lily on the numbers. There was no effort to ober sc for a long time. You've heard it. We've talked about on your TV shows. Sometimes a narrative guest has o, these numbers are man made, their massage, but give them cred. When GDP contracted in the first quarter of there was no answer to hide that. GDP is now back to a point in China whereafter taking off, when the rabents have basically order everyone back into factories and stores, it's now petering out again. So after three decades of almost uninterrupted growth, we now find ourselves looking at a very very subpire econom performance the second time in two years. Well, yeah, and what you said a moment ago, let's zoom in a little bit further, because, as you said, we don't have a traditional definition of what a recession in China looks like. We're so used to the idea of two quarters of negative growth plus a pronouncement by the n b R for us to know that we're in or have been in recession in the United States. Is there any policy on the part of the POC to define recession in China? H? No, it's highly unlikely that the POC would be the first people you hear that. Well, that's true too, Yes, you know, I mean a distinction has to be made. China Central Bank has done a lot of work and past five to ten years on how they communicate with the public domestically and globally. They are not an independent institution in a way we think of the Federal Reserve or the ECB or the b O e H. They answer to the State Council, which is the equivalent of the cabinet, which means they answer to the party. Now they have a degree of operational AUTONO, but being called that have political implications. I doubt you're gonna hear it. Just hasn't been that kind of discussion because if you look at the growth record since dung Shaoping began opening it up in the nineties, where we can't really encountered sadly. Yeah, Well, the other thing that was so fascinating was President she paying warning about the dangers of inflation, because you know, consumer prices came in this month of two point seven percent, which granted, you know, is not nothing, but to us in the United States, two point seven percent doesn't sound that bad. So it brings up several questions. How has killed it? Wouldn't we well almost, I'm sure somebody would. How has China been avoiding discourage? The rest of the world is racing. Many prices in China are controlled. But just get back to your broader point, and it's not just President She a pdoc report days before this Great Cup was breathing heavily about inflation. You know, we can't let our guard down. You know, we can't over reach use, we can't print one blah blah blah blah blah. So that really discouraged people from thinking that, you know, there's going to be a lot of monetary stimulus in the pipeline, and maybe even as far as interest rates are concerned. And then you've got it. And then forty five minutes afterwards, you had a string of data releases which could only be described as sub past. Preceding that you had very very poor data on credit growth. Yes, so yes, when you look at the data, sure, the data justified cut. It's not the BUBE that was seeming. Yeah, I mean, obviously COVID zero and its approach people have talked about, you know, how difficult it is to operate an economy under those kinds of restrictions. But it's not just COVID zero either. There's obviously the Twiff's question. There's obviously the consumer, the health of the consumer. You just mentioned credit growth and so on. So what are your thoughts on whether China inflation at two point seven present is a danger to the Chinese economy and the global economy. Well, if it got to five percent, they would be extremely concerned and there would be all sorts of direct policy responses regarding prices. But look, we're not at that point yet. A cause for concern a little bit, but they're clearly decided that growth is the first order concern. So inflations now on the back burner. We've seen a big shift in the last few days. You know, it's interesting, body. There was a prominent story in a p DOC aligned publication that sided a numberly kind of talking about an anticipation of further monitary stimulus for a p doc aligned newspaper to put it on the front page. That's not an accident. We have quipped here, it's all about supporting growth. There's this dual narrative, as there is in the United States. You need to fight inflation, we also need to support growth. So I guess the conundrum is there in China too. Just a word on politics, because there's always the potential for a disruption. I don't want to characterize it beyond but it did seem like we were headed for a bit of a cross moment between President Biden and Chinese President j and Ping. Suddenly the temperature cooled and in fact, let's just have a listen to what Singapore's next Prime minister told us recently. We are starting to see a series of decisions being taken by both countries that will lead us into more and more dangerous territory. If an accident would happened today, the consequences may be more difficult to manage. So then the Singapore Prime Minister in waiting is worried about it. Most of the world thinks about it from time to time. What are the options for the Biden administration. Well, I think we need to see what happens overcoming lots. Right now, there still seems to be some petulance in terms of the sort of response to announcy policies. There's there's a couple of opportunity President President Biden to meet in the one is it that you twenty meeting in Jakarta, and the other is the APEX meeting in Bangkok. So you know, we'll see what happened. I mean, I don't know is that a II one straight conflict as opposed to say, I don't know how that helps China's economic growth trajectory in all the United States, Dan Moss, don't forget to reach out with thoughts, suggestions, opinions. I'm at Vanney Quinn on Twitter or email v Quinn at Bloomberg dot net. Now to QT quantitative tightening or contraction of the Fed's balance sheet, withdrawing stimulus, decreasing the amount of liquidity in the economy, however you describe it. The FED and also the Bank of England are about to do more of it, even as both central banks continue with their rate hike cycle. Marcus Ashworth says beware, he joins us. Now there is general tightening. Marcus, the Fed engineering tightening financial conditions. And then there's this specific tool we call quantitative tightening. So to begin with brass tacks, what is it. It's the reverse of quantity of easing, in the sense instead of bond buying, they are not just on selling but also I think their holdings, which make sure as they come up to expiring it repaid, they're not piling them back in. Up from now, they've been maintaining the stock of their total holding close to nine trillion for the FED and nearly one trillion dollars for the Bank of England. But there's also the flow elements that they reverse the flow now, so the stock is going to stay quite high for some while, but it's going to come down by nearly a hundred billion in a month in the US, and you know, a bit less obviously in the UK's are a much smaller economy, but still quite announced effect as it comes at the same time that the central banks, as you mentioned early, are hiking industry, so there's a double impact and they are now actively going to sell back into the market as well as just living maturities run off. So you've got this passive you've got this active contentate tiling going on the same time as indust rate hikes. Quite a lot of contracting to financial conditions. We just don't know whether or not the market, the banking system, the quidity, all these things could get a bit of a crunch. Let's home not as you say, it's uncharted territory. Now this is a different tool to raising rates. How does the transmission mechanism work in this case? Well, we're not really I'm so sure. I mean, we put some academic work gone into this, and and really you've not got a lot of clarity from the central banks. Obviously some of the investment banks have done their own re such into it. But you know at the moment that the clearest idea we got from J. Powell's that they expect to run up about a trillion in the first year. So we're around nine trillion now you'll go down to eight and below. He only equates that are around a twenty five basis point the hiking industrates, which is almost nothing when they're hiking seventy side basis points every meeting. So the point is is is he right? And the propact realities we don't know. I mean, simply the Bank of England's got other measurements, and it's it's quite weird. When they were quantitarily easing, they thought the effect in equivalent interest rate terms was much much more than they now believe it will be the reverse. When they whacking perverse and they tightened, they seem to think the effect will be hardly and at all. I don't know why they think that, because I don't know how they can know that. Yeah, and various houses have their own ideas of what this is equivalent to in terms of a basis point rate hike. Seen. You know, many efforts are trying to model this out. But in terms of the transmission mechanism, we know that raising rates makes it more expensive to borrow, for example, so that dampens housing and so on. What does taking liquidity out of the system do well, It's more about making banks perhaps less keen to lend as much or certain to offer leverage. So it's more about liquidity into the overall system. If you imagine quantitative easy, it's like building a massive climbing frame and you hang this balance sheet ever bigger and wider, and your assets against liability, so you're you're not really creating money until that money gets made into a proper loan by a bank, all of the total deserves doing is pumping money is a system and giving the bank costs equility, hoping at some point the banks will use that and actually start lending out, will comedy to corporates, what have you. If they don't just stays on balance sheets but take it back again. It has a psychological effect on corporate lenders, you know, do they want to offer as much as possible? And that's where the financial conditions index should we say it's very important because if that starts planting too much at the same time, as you've mentioned before, interest rate to going up, so that's not actually taking away a loan demands, it could have you know, it could have that that wobble effect and until the economy a little bit harder into a slow down. As I said, I'm sure that he's very careful about that, they're thinking about it, that are watching it very carefully. But they are pre programmed to take away ninety five billion dollars a month. That's most seniors treasuries, but also in mortgage backed security. So it's going to have a particularly not going to effect into the housing market, I think. Right and now the third is a little bit ahead of the b o E in this because it started QT in June, but it actually doubles next month to as you say, dollars sixty billion of treasuries thirty five billion of mortgage securities. Can the Bank Aving can learn anything from what it's seeing in terms of the American system or is it too early to say? Well, I mean they all learn a lot from each other. The point is and the back of thing actually were first they stopped to be one. They stopped it at the end of last year. I think I should have stopped it well before. That's not our argument, but I'm neither FED was still adding until until April, I think so um and they started letting bonds mature the Bank of England March. They had a big maturity there which had some impact. I've got a few big more maturities coming up in recent weeks. But as you quite already saying, the Federal Reserve a bit like where their interest rate hiking cycles have started behind, but they've caught up and will massively overtake the Bank Aving the aggressiveness of what they're doing. They've got a much bigger balance sheet and lots of different ways. And perhaps what we really need to learn from the FED is that they've done quantita tightening twice before on the Bonancie, which went horribly wrong, and again in twenty eighteen where they had to s stop and reverse under j Pale. So everyone has seen this movie before, perhaps in the US. We've yet to see it in the UK. But we are watching you guys very closely. Now as you say, I mean, this program it's not really designed to stop and start, but obviously it does at times. It's because it runs into technical or market difficulty. So what should the market be watching for any kind of mishap this time around? Well, I mean, you don't want to have a scenario wherebiobviously things like the pandemic. I mean, obviously that's a clear crisis, you know, obviously just let's just make coming up a hedge and goes down like a long term capital management did those types of crisis. You know, probably quite easy to spot what's happening. You could stop it, and I think they would stop it quite quickly. It will be event if you know, it yields all of a sudden shot up or shot down in a quite an extreme way. Very moon we've got quite high volatility at the moment, so and they're still going ahead with it. But I think the bar them stopping will be pretty high and in a pretty unpleasant crisis, but it will. You know, they clearly have the means and the and the understanding to do so. Um. You know, what happens. The Taper tantrum, as it was known at the time, was quite a sort of market rejection of perhaps what the FED was doing this time around. The Fed of have lagged up very clearly months and months in advance, so I don't expect we'll get quite the same reaction. But you know, the point is this is uncharted trying to orders for a lot of uh, you know, central banks around the world, even even the European central bankers stopped adding their continented pile that they're a long way away from producing it. But the point is everyone's watching. Winning dollar equimity is what keeps the world afloat King dollar. You know, it's been so strong in the last year and a half two years, and it's it's still something which is potentially the reserve currency of all the basically the entire world. So reducing the equidity in dollars is probably a good thing if it's done carefully, but it just needs to be made sure it doesn't get too extremes. And there are desks and banks that are trying to figure out when this ends, right, and I've seen different scenarios. There are even sort of a range of scenarios at particular banks that this could end at the end of next year, but it could also end at the end of twenty twenty four. We don't know, do we. Yeah, I think I think they'd wanted to go alonger than the next several years. I think I would say that the FED, like the Bank of England, doesn't want to get down to zero, and they were going to reduce back to where we've put before the pandemic, probably, but they do want to get back to pre pandemic levels. I would expect in balance sheets have shot up an awful lot many trillion through the pandemic, much more, you know, than you would actually expect, as a much bigger impact the pandemic response than even the global financial crisis. So in that context, I would certainly think, you know, the Federal reserves balance sheet now the sentence is close to sort of nine trillion. I would expect them to probably want to get back still at the level around four trillion, four or five trillion, which was where it took off in and minded to take off in March, and eight went and just over four trillion to more than double now, So I think they want to let it glide down maybe a trillion met year. We've been watching the yield curve obviously and its inversions, and this is the US yield curve I'm talking about. Does this impact the yield curve at any point as we go along? Given them even a hundred billion dollars a month, it's kind of a tiny amount of liquidity in some ways. Well, I know it sounds ridiculous to say, but when you're talking about nine trillion dollars, you know, two trillion pandemic transferend to what's that with tea of friends they say? I would say that the one impact people are perhaps not fully appreciating is that everyone thinks that the FED obviously controls the front end with fat funds and obviously official rate, but you know, depending on how they do it, what type of maturities they do sell bad, they cannot course influence the yeld curve to a degree because you know, by selling more longer ended uh young longer maturity bonds that will have by definition push the yields up belonging, which could in some senses, you know, semi sort of disinvert the curve art. So I think it's gonna be one of these types of effects. It really hasn't acted yet because the two reasons why you said that they stopped off smaller and won't be going up by billion a month until next month. But at the same time, as also been it's quite technical. It's put a mass amount of cash meeting through the treasury catch account, which is limited the impact of that, that initial liquidity withdrawn, that will stop. So I think the impact when it comes towards the end of this year could be a lot more than it currently is. Whether it's too much, we'll have to wait and see. Thank we can start selling guilds next month, and obviously the third is opping its sales next month as well, so Marcus, thank you, Marcus Ashworth there. We are now choosing to end all conversations not with you, though as always we love to hear from you. I'm at Vanney Quinn on Twitter or send your thoughts to v Quinn at bloomberg dot net, and we're also available as a podcast on Apple, Spotify, or your preferred platform. We're produced, as always by Eric mollow Until next time on Bloomberg Opinion.

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