Is the Business Cycle Rebounding? with Christophe Ollari

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1:24And now to the top analysis of today's markets.

1:33Is the business cycle rebounding or not? Welcome to this Real Vision E5 series interview. I'm Andreas Steno, and it's an honor to introduce my guest, Christophe Olari, founder of Olari Consulting, and in my opinion, one of the absolute best contributors to the global macro community. I've been wanting to host this conversation for a while, and we finally made it. So great to see you, Christophe, and welcome to the show. Thank you very much, Andreas. Yes, it's a pleasure as usual to be in the region and it's a honor to do it with you today. I really look forward to it. We are sending live here hot on the heels of the US CPI report just a few hours ago.

2:15A very soft reading, at least on the surface, with 4.8 % core inflation and 3 % headline inflation, both numbers below the consensus expectations. What do you make of the CPI report here just a few hours after it? I think that even well beyond the actual numbers which were weaker than expected, I think that when you go into the details, there were clearly very good news on the patient side. When you look at the super core ex-housing, we had a flat reading in June, which is the lowest print since September 2021. Shelter was 0.4 % on the month, which is the lowest read so far in 2023. and shelter was still 70 % of the actual inflation momentum, which means that if we have in the second part of the year the expected shelter of disinflation, it means that inflation in the U.S.

3:36should make progress toward the Fed's goal. US CAR where lower food was going the right direction. Airfares were tumbling by more than 8%. So in fact, in my opinion, it was the first inflation report that shows strong progress across the world. And that will be likely welcome by the Fed. They will not claim victory, of course, because I think that they will need to see more. But I guess that if it, in my opinion, doesn't change the outcome of the July FOMC, I guess that the plan will still go for 25 dips. and i think that if we have another uh decent and comparable uh report next month i think that's tightening competitive the fed is uh is a likely over so given that this is the first report with clearly soft signs from the inflation front how close are we to that pause or pivot from uh the reserve first of all is it something that is within reach this year or how do you see that playing out i think that yeah i i i believe that uh if again if um i think the fed will be very cautious to say you know the job is done um we had you know too many event flows in the in the micro energy in the micro dynamic or even in the uh inflation side so i think that the fed is very, I think, focused on not, you know, we talk a lot about it, but they don't want to repeat the mistakes of the year 70s.

5:33And even if to some people, it seems a bit too much. I think that in Powell's mindset, he wants to avoid, you know, leaving a green light in terms of, okay, we are done and being forced to restart again. So I think they're going to pause. In my opinion, if we have a second inflation report comparable to today, next month, I think we're going to have a pause up to the July hike. That sounds very plausible. And let's see whether inflation stays at this cost. It would be good news for the Fed Reserve, indeed, if it happened. And if we look at other, yeah, sorry. And I think that even if I don't believe in, you know, that kind of central banks being on the same tempo, I think it's interesting that the RBNZ clearly flagged the pause overnight.

6:36I haven't seen the end result of the Bank of Canada meeting today. But I think there is most, there is a reason to believe that if they hiked, it would be one of the last ones as well. So I think we are on that, you know, like dynamic where it's time to assess and to stay in restrictive territory, which is in fact, adding to the tightening, you know, campaign anyway. If you stay at about 5 % for six months or eight months, you are anyway still tightening. Yeah, and that's an interesting point because I think no matter where you look, both in Europe and in North America, but also central banks elsewhere, they communicate that we're kind of close to the peak, but that they want to stay at elevated interest rate levels for long.

7:31So the most recent example of such communication came from the French governor from European Central Bank, Francois Wigilar. He said the same thing, that we're close to peak, but we want to stay there basically for as long as we can see. Do you see that as a feasible scenario that central banks can actually stay at a plateau of elevated rates, say into 2024, maybe into 2025? I think they're going to keep on repeating the same communication for longer. Again, the last paragraph of the RBNZ today was very crystal clear. First of all, they say we are confident that now the level of rates will be enough to bring back inflation within the 1 % to 3 % target range.

8:20Confident is one of the first times they are using that term, that some decent progress is made, but they say as well that we're going to stay there for an extended period of time. And I think that this is the second step. Okay, we pause, but for now, pause doesn't mean pivoting, pause means we stay in restrictive territory for, I think, I don't think they will stay there for 2024 to be honest, but I think that their timeframe is at least communicating until no cuts in 2023 for sure. Yeah, makes sense. And in relation to this discussion on a pause relative to a pivot. I wanted to discuss your pivot framework with you.

9:11You sent me some notes ahead of this interview, and you had a hilarious way, but also very tangible way of assessing whether a pivot from a central bank is feasible or not. So let's go through your pivot framework for the Fed Reserve. When is a pivot feasible? So I tried to read them by your own according for a pivot and some kind of, you know, a guideline to assess when we're going to shift from posing to pivoting. And so I put P as a, you're going to need two or, let's say two or three negative payroll to see the Fed starting to wonder whether pivoting is necessary. I is for inflation, of course, to target and remaining around target on a sustainable way.

10:09V, VIX, above 50. O, for oil, oil 345. And T, in fact, is maybe the most important because Because we saw that it really impacted, not for long, but the Fed in March, T for treasury dysfunctionalities or credit events or like in September 2019, a very acute funding or repo stressing period. So when you look at that, it doesn't mean that they compose, but when you look at the five parameters, we are not there yet for a decisive pivot towards the Red Cuts. But the question is, how far are we from such territory? Is it something that you could envisage, say, within six, 12 months from here, that we actually take all of the five parts?

11:12I think that in that pivot acronym, obviously, if I, it's very difficult to preempt, you know, a credit event or very acute treasuries or dysfunctionalities. So I would emphasize on the P, on the payroll side. I think the job market has been one of the, you know, the pillar of the hawkish communication of the Fed. How can we basically be sure that inflation will remain at acceptable levels if the job market remains super strong, if wages are not contained? So I think that the payroll side for me is, on top of that, the job market has been crucial for the U.S. animal spirit. If you know that even if you lose the job, you're going to get back another one very quickly, it's super supportive for your psychological mindset.

12:18But it's supportive as well to extend your consumer credit and your credit card and everything. So I think that for me the job market is the most important right now, especially knowing that inflation is heading toward the Fed goals and we made some progress on that side. It has been extremely difficult to assess the job market. You know, we had some jobless claims hinting that maybe the real deal was in place. Still not convincing. Working hours are also just like a little red flag. So far, no. But job market is a lagging indicator. So we can have a surprise by, you know, by year after the summer or in Q4.

13:19So I don't push it away. But for that, it's still a pending question. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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14:36speaking of the job market and the spin overs to inflation um the the inflation report today was obviously a good um sort of first slide of inflation reaching uh levels closer to uh to target range again but where do you see this inflation debate heading over the next say three to five years. Will we ever get back to that pre-2020 range or is it a new territory this? I think it's one of the most important debates and what I like some words. There is no gray area. You have two camps. you have the uh you know uh you know a colleague and and uh and um but the post-covid uh amplified by the russian invasion was just a bleep in a long-term and a fundamental uh inflationary trend and you got a second camp thinking that that in fact something has changed and uh the um And the big forces are supportive for the low inflation paradigm has been held.

15:54And to be honest, I think that the globalization has been repaired and will remain so. I think the two big shocks you had are the world labor force. So the admission of China in the WTO and the fall of the Iron Curtain are gone. I think we're going to more scarcity of the world and more occultation and fracture of the world. So, in my opinion, we will not go back to the very low inflation regime that we witnessed pre-COVID. And maybe we can conclude with the discussion on how to asset allocate in such a scenario, because I want to focus on the near-terrible first year with this potential pause from the fair reserve upcoming after the July hike.

16:59It seems like the July hike is still the base case for most people out there, even despite the soft inflation report today. But should we get this as the last hike of the rate hiking cycle, is that then a green light for equities to rally even further? That's the big question here. How do you see that scenario? I'm guilty myself of posting a lot of charts on how equities tend to rally after a pause from the Federal Reserve. But is that the base case from here in your opinion? Yes, you know, this is, I think, the most difficult, almost the most difficult question. I would tend to say that obviously, equity markets love any pause from the Fed, much more than any cut.

17:46And this is, I think, much more important than anything else. It's because usually when the Fed cuts, it's too late and it means that the U.S. recession is already in place. So I think that's a pause with inflation going back to target for the time being. I doubt that the U.S. equity will not like initially the less aggressive Fed giving some more chance to achieve the soft landing. So, yes, I personally actually will likely be equity extending their ability. One of the things I really wanted to discuss with you today is whether we are at a juncture where there's actually a rebound ongoing in the U.S.

18:42economy. Some people have started floating various macro indicators, hinting that the economy is actually rebounding, not just doing better than Gielfeld actually rebounding. So where do you see this discussion right now? Do we have signs of the economic growth actually doing better on a momentum basis than just a few months ago? Or how do you see that for stuff? I think that's what is key in the US economy. It's the US consumers. I always go back, you know, to what is the net worth of the US households compared to where to one 2020, it's 40 trillion higher. And you've got a staggering performance of the US equities in the beginning of the year.

19:36Housing prices are starting to rise again. um if if you know you send the message that that the fed is posing for now you think that u.s consumer is still it's still very well alive and uh and you know you always said i don't fight the fed in my career i i always kept somewhere in my mind don't don't fight the u.s consumers So, so far, I don't see any evidence that the economy is slowing for sure. When you look at the various metrics in June, the U.S. consumers are sentiment and spending as a bounce again. And so I don't see for now any strong evidence that the U.S. economy is doing anything else that they keep doing very well.

20:32And which is not surprising. We have, and I think that has been the biggest mistake of the central banks, post-COVID, it's thinking that post-COVID would be like a post-GFC. Thinking that their monetary stimulus would be non-inflationary and just supporting the economy rather than giving the big boost. The big difference, obviously, we know it was not only a monetary stimulus, but it was a huge fiscal package. And we talked about it. When you look at post-COVID and post-GFC, everything looks quite similar, except that the velocity of M2 bounced, which means that the cash sent into the system went somewhere, went into the real economy.

21:29Which is a big difference compared to a post-GFC. Christophe, you were one of the few very loud voices at the early innings of the year saying that sentiment was too negative, positioning was very bearish. And you highlighted that, so I wanted to give you an on-air hat tip for that. But where do you see the positioning and the sentiment moving right now among your clients, speaking partners, etc.? Do you still sense that negativity or is the positivity coming? Now it's… the positioning has massively changed compared to January. There is absolutely no doubt about it. What is very interesting, again, it's the systematic community has given the tempo again.

22:16They were the first one to be squeezed at the end of 2022, first one to re-laverage very aggressively. and you saw that slowly but surely it has triggered that human foeball and so there are the hedge fund community is meaningfully releverage the retail as well the global fund manager really jump into the bullet train over the last month. So in terms of positioning and sentiment, we are definitely far away from January. We are getting a very fair and great indexes in the extreme grid. All the metrics in terms of positioning jump aggressively. So on that side, I really think that there is less room.

23:16It has changed massively. Now you need a trigger. And I think that the first one to exit will be the systematic community as well, again. So CTS, vol control, and risk parity. For that, you need a change in the vol regime because the vol is their only one positioning token. If the central banks are, you know, hinting for a pause, it's difficult to see a vol regime change very soon, not for now, unless we have an exogenous, you know, event, which is impossible to to preempt to uh to pricing so i'm checking vol um uh interest rate vol especially because we spiked for for the last 10 days unless i see meaningful reason to see a vol change i can't see the systematic community exiting so i can't see an immediate end of you know formal six months to go, you know how it works.

24:31I need to perform. I need to beat my competitor. Can I beat my competitor going short of equities right now? I don't think that anyone will think that at that specific moment. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

24:55I tend to agree with you on that assessment. And it is also my impression that what I tend to label as real money players, so pension funds and asset managers, have been underway in equities through the years. So they're basically trading bench box, meaning that they will have to try and load up on risk to sort of recover some of that towards the end of the year here. It's very interesting that you highlight interest rate volatility as sort of a guiding staff or systematic trading strategies, etc. I know you have a background within proprietary trading as well, Christophe. So why is interest rate volatility so important for all sorts of strategies?

25:33Can you please elaborate a bit on that? In fact, what has been the most amazing development in 2022 and somehow 2023. It's your pillar of safety. You anchor in any diversified portfolio, which is the fixed income side, has been the one who has created volatility and has been the destabilizing part of your portfolio, which is why 2022 has been so if you go to trade and why even in 2023, because you had no visibility on the right side, you had a very slow re-reverging, especially on the risk parity side. If you can see more clearly the end of the tightening cycle of the Fed, it means that the distribution of outcomes is very limited, which means that you can price more currently the end of the terminal rate and that volatility on the short end of the curve is much reduced.

26:48If you can price that, it means that your fixed income side of portfolio really gain that, you know, pillar of safety and anchoring in your portfolio, which means that you can leverage your portfolio knowing that your fixed income side will do what it's supposed to do, which is preserving your portfolio in case of unexpected events. So when you have your interest rate volatility which is going down, you can replace accordingly your different scenarios for the near future. Yeah. I remember entering a large player in the European private equity space right at the point where the doom curve was essentially zero throughout the foreseeable future in the euro curve.

27:50Was it in 2020, right? And the interesting thing is that most people within the private equity space, but also the asset management sectors etc they've been almost brainwashed with the so-called discounting cash flow model so if there are no interest rates and there is no interest rate volatility then you can essentially pay right about everything um no matter what the cost for for a company because you don't punish future cash flows by any means uh so the resurgence of volatility and interest rates has also been a game changer for a lot of these players um that had grown the custom to interest rates being zero forever, at least very low, with very low volatility.

28:34And then I want to, a key driver on that very, you know, low interest rate, that is, regime that we had, because you had very low inflation volatility, because we are always focused on, you know, the level itself of inflation, but I think what is more important is the volatility of inflation. High volatility of inflation makes it impossible for central bankers to express what they love the most and what the market loves the most. It's a crystal clear forward rate guidance. If you know where you go, you know how, again, you know how to price the potential path with a very high certainty. So, I think that lower inflation volatility would be key to slowly go back to a much more feasible and two-way communication between central banks and markets, which means lower interest rate and a more stable, I would say, framework.

29:51And speaking of interest rate volatility, there's been a lot of chatter this week on whether the Bank of Japan could decide to sort of pull the rock from under the local bond market in Japan by moving the needle on their yield curve. It's obviously a discussion that we've had before this year. So far, without any move from Bank of Japan last one was in December last year. So Christoph, is this something that's been on your radar this week and what's your take on the Bank of Japan here? The Bank of Japan has always been a very big focus of mine. It's not only because it has been the outlier for a while, not only because because it has been very, very crucial in the overall asset capital flows, asset allocation, in terms of global safety net for risk assets for the last 10 years almost, until COVID-19.

30:53And I think that we need to think about what Kuroda and Ueda have repeated for a long time. Ueda for three months but Kuroda for a long time. It's there is no way inflation can be sustained in Japan without pricing wages. And you remember even Kuroda explained that the weak yen policy, without expressing it that way, but he was welcoming a weak yen because it was making the Japanese multinationals more competitive, creating some, you know, like, amnitions to raise wages domestically. So wages are key. And last week, for the first time, we had the earnings in Japan, which were massively higher than expected, 2.5 % against the 1.2 % consensus, a consequence of, you know, the union's work, and so the spring renegotiations in terms of wages.

32:16So this is a very important development. Do I think that the BOJ will shift its monetary policy after one set of number, I really doubt that is going to be the case. So I don't think that the BOJ will deliver any meaningful monetary policy shift in July. Remember, the BOJ has always been criticized to hide too quickly in the past, So I think they're going to take a little bit more time. They are worried about the deflation muscle memory in the Japanese household. So they're going to wait for that as well. I think they may be concerned about a potential loss of momentum in terms of growth in the world toward the end of the year.

33:16So they don't want to get that inflationary impulse being killed very quickly by external developments. And also, I don't think it was innocent that Luida mentioned 2024 for a potential shift of the monetary policy of the BOJ because some were not interfering with Kishida who wants to use the next six months for early election. So I think that everybody would like somewhere to have a finally a shift for one reason when the shift is done we can move on and not you know waiting for that event to uh to be repeated um but i think it's too early that said um in july so we will have three weeks time to have a week's time we're gonna have the new cpi forecast and in my opinion, the POJ will rise higher the CPI forecast, which has to be seen the way it is.

34:25It's acknowledgement of a slow progress toward the target. Yeah. But it's a really good point you make on interfering with Japanese politics. It's something that we've seen other central banks also considering when they, when they set monetary policy, not to interfere right around a potential election date and so on so forth uh it's something that i didn't uh take note of until you um you mentioned that's a really good point i i know christoph you have a tremendous chart on um is it japanese wages versus dollar yen uh with a long time lag so please try and elaborate why the japanese wage formation is so important for these trends yeah you say it's because he eats i yeah you know when you look at For example, Luleida in Sintra told us that underlying inflation in Japan was still below 2%.

35:22I spent a lot of time trying to find what he was talking about because naturally it displays the same reality to me. but if you take the ex-food and the underlying ex-food and the energy goods, we are at 4.3 % here on here. So I think that it's a way to convince everyone that it's not the actual level of inflation that matters, it's a dynamic. And again, Puroda has said it for years, I need to see wages going higher. And this is why I think the market reacted so strongly on the data on Friday, because it's the first, you know, like first progress on that side in many, many years. and um the job we have on the screen now is is uh that sort of a relationship between uh stephanies wait yes yeah yeah the u.s earnings and the japanese earnings again the dollar yen with a hundred dollar yen the two years like it shows that that in fact it shows that it's gonna be the the key the cornerstone that will allow the BOJ to uh to shift the monetary policy not not they will not take for granted inflation at five percent because they don't believe it will be sustained in the in the long run if there is not you know um a shift in the mindset of the household in terms of inflation, and that will only come if the pricing power and the possibility of spending of the Japanese are increasing.

37:18So earnings is what matters. And speaking of Japan, we've obviously spent a lot of time both on Real Vision, but also in the global macro community discussing whether China is rebounding or not over the past months here. And I don't think, basically, I think every single day we see a new headline now with Chinese attempts to at least talk up the probability of stimulus coming, etc. But how do you view the situation at this juncture, Christoph? Is it a true rebound that we see in China? By any metrics you can just come to the conclusion that the grand reopening that made all the highlights in January was a short leap and the momentum has faded very quickly.