Is the Fed Back in Play? With Paul Hodges

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0:39Is the Fed back in play? Hi, everyone. Welcome to this extended Real Vision daily briefing. With me today is Paul Hodges, chairman of New Normal Consulting. Hi, Paul. It's great to see you. Yeah, lovely to be back. Thank you, Maggie. So before we jump in, just a reminder to everyone, this is the extended daily briefing. So the back half is exclusively for Real Vision members. So if you're watching or listening and you are not already a part of our community, get on it. Come join us. You can just scan the QR code or hit a link that Brian will put in the chat. So, Paul, lots of red on the screen.

1:11All the major U.S. equities markets were down today. Treasury yields up. It seems like investors were a little spooked by some of the ISM readings. Should they be? I don't think they should be spooked or surprised by them. I think they should however be pretty worried about what's really going on. You know we've been floating along on a sort of a bubble of euphoria really for a while but in the in the real world as you know Maggie you know I come from the chemical industry and you know we've said over the years the chemical industry is the best leading indicator for the global economy because we're right at the start of the value chain.

1:59We're third biggest industry in the world after energy and agriculture. We've been around a long time, 100, 150 years. And so, I mean, everything in the viewers' rooms and so on, we'll all have chemicals in them. So we see all these things a long time before, usually six to nine months or so. And I can tell you, I've been in this game, you know, decades rather than years. and i've never seen the industry so bad we're operating yeah we're operating in the states at capacity utilization just over two-thirds at 68 percent asia is operating at 68 percent the middle east is operating at 68 europe unsurprisingly is worse it's at 57 percent so you know when people try and tell me i mean i was listening to uh jim bullard from uh St.

2:53Louis, formerly St. Louis Fed, who I've got a lot of time for. And he was kind of today on a webinar and he was trying to take a kind of taking a victory lap. Oh, we've done all this. We've managed to reduce inflation by six points. And, you know, we haven't really hit employment and so on. So, you know, all these people who are worried about recession and so on. And I, Jim, I've never seen operating rates in the world's third largest industry at two thirds of capacity. You know, if that's not a definition of a coming recession, I've no idea. Is it a recession? Or is it actually something worse?

3:29Well, that's the only question to me. so let me play devil advocate devil's advocate for a second is the nature of growth changing so do you think the chemical industry is still that canary in the coal mine that it was because we have seen a sort of um bifurcation of sort of service-led growth and what would be more traditional manufacturing is it possible that for some reason where we are now in the cycle that things are more heavily slated to the service side of the economy? Well, I found myself recently thinking back to 2006, 2008, when we were flagging up more and more powerful warnings all over the place, really.

4:18And we kept being told, oh, you don't really understand, or something's changed and you're an old fool, none of you understand it. And of course, in the end, it turned out we did. And the military acronym VUCA came back to me, of volatility, uncertainty, complexity and ambiguity. And just your point there, Maggie, I think is absolutely right. Yes, we are getting very confusing and contradictory signals, if you like, which you can understand. okay everybody bought lots of stuff when they were locked down they clearly don't need a lot so therefore you know you should expect a lower pace of of of purchase going on no problem at all with that you know the normal way that would sort of ease off this has been going on now for 18 months so you will kind of think um it might be coming to an end but no sign of that on the other hand we've all been locked down for you know for two two years and so on and you know my normal recession signal is I get on the plane and it's half full.

5:25Oh, I've been on, you know, not hundreds, but I've been on tens of planes. Every single one has been completely full. And, you know, I've been out with friends who said, oh, I tried to book this restaurant, but, you know, it was full. So, you know, you've got that complexity coming into it that people, after two or three years of lockdowns, want to get out. They want to see their friends and family. They want to see their business colleagues and so on um and you know and because of uncertainty actually that becomes more important that you want to so i you know i think that the you know the the fundamentals of the of the chemical industry are always changing uh things that we were doing 20 30 years ago we're not doing today and the things we'll be doing in 20 30 years time but chemicals themselves are a fundamental part of life.

6:15And so, you know, you're always going to have a chemical in this industry. Yeah. And I, and I, going back to that statement that you made, even the service industry, everything has. So presumably, even if it was shifting, you could see if it was from goods, like refrigerators to trips, but the planes need, everything has chemicals in it. They are the sort a building block. So it would make sense that if we are seeing that reduced capacity, it would be a worrying sign. What are you hearing about why? Who are the customers that are disappearing? Can anyone tell why capacity is so low? Because it would not match up with some other things we're talking about in the US economy that's so resilient, although we are seeing weakness abroad.

7:05What's happening? Does anybody have a read on that? We can come back to that. Okay, put a pin on that because Paul's like, no way, that's not true. Let's take the first question first. I mean, what's happened? What is the fundamental problem that I have? It's that for the last 15 years, since 2008, the Fed, the central banks have gone for zero interest rate policy, fabulous liquidity. So one, you've got a generation of people who actually genuinely think that interest rates are always zero and there's always liquidity out there. I don't know what the exact number is in the S &P 500 or the Russell 2000 today, but you know something like 20 % of companies have not been making enough money for years now to roll over their, out of their earnings to pay their debt.

7:59They've just been rolling over debt. Well, that particular party has come to an end. And essentially, so that's people's understanding of the real world has been broken because the central banks have interfered with the key role of markets. You and I have discussed this in the past, which is price discovery. I want to buy an airline ticket from LA to New York, you want to sell me one and we agree the price. And if markets can't do that basic transaction because the Fed keeps piling in money, oh goodness dear, poor Maggie can't sell all their tickets, let's give it more money and so on, let's stimulate.

8:40What they've been doing therefore is they've convinced a lot of companies to invest in capacity far in advance of real demand. We did some work a little while ago where we looked at what it what are what's the basis of interest rates and if you go back to the Bank of England you've got a history of 300 years which is probably reasonable in terms of you know telling you what happens and of course it bounces around you've got world wars and depressions and all sorts of things but over that 300 years the average real interest rate is really pretty steady at inflation plus two and a half percent so you know if we assume that we're going to go back to inflation plus two and a half percent that is going to be a tremendous shock to a whole generation of people who think no no you know it doesn't doesn't matter and so you you see you've got false expectations and that is not only in behavioral but it's also meant you've put a lot of capacity on the ground i mean we've come to china i'm sure later on but um you know china is the classic example it's being subprime on steroids with this real estate bubble um but uh you know These things do catch up with you in the end.

10:04And the war, basically, Russia's invasion of Ukraine has been the catalyst, really, for the change. 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. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and unlimited demo. See a trading opportunity? You'll be able to trade it in just two clicks. Feel ready?

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11:26So you made a comment when I said the U.S. economy has been resilient. So what do you think about what's happening here with the U.S. economy? Well, I mean, I've lived and worked in the States. I have a son who was born there. So I feel I have a bit of a stake in the country. and you know what what we're seeing is some bits of the economy doing very well some bits like commercial real estate not doing very well at all um i saw the wall street journal has a thing about doom loop um which is quite a surprising headline for the journal but there you go we did we did some work on the u.s housing market recently and on the one hand it looks absolutely fantastic uh you know builders have been selling out lots of you know start housing starts and so on up at one and a half million and so on and you know the normal course of events you just look at the headline you think oh yeah things things are going well it's resilient but then you look down and you say well the majority of people have got mortgages mortgage rates at below four percent if they move they're going to pay seven percent plus so unless somebody gives them a very good job offer then they're not going to move you know because that's the average of average house size and and yet so you you've you've also got but again when you dig down into it if you wanted to buy a new home today then you'd actually have to have an income household income of over a hundred thousand dollars so because of the of the uh you know i think it's 2700 bucks a month is the average mortgage payment so you at the one hand exactly as you say you look at the new homes kept being built and so on one and a half million not quite at the two million and subprime but pretty good really much better than 700 000 uh in 2009 or something exactly but then you say well why is that and the answer is large part of the market either owns their home and they're older people they've paid off the mortgage or they've got a low low price mortgage and can't afford to back And the only people who are buying, therefore, are the people who have to move for some reason or another.

13:45So I don't think that's a stable position. That's why I sort of looked askance when you said resilient. And this is the question that's been so hard to nail down because people have very differing views on what's happening with the economy. So let's talk a little bit about inflation as well, because I think the trigger from the ISM was, oh, it looks stronger. Prices paid were a little higher. And so we had once again come around to the idea that the Fed was definitely on pause in September and maybe things were moderating. We started to hear those messages coming from Fed officials like we can afford to wait here.

14:21And then you get a hot reading and it gets the bond market nervous again. So you're a little concerned about maybe that the growth underneath is not as strong or the economy not as strong as maybe some think in problem spots in housing. What about inflation? What's happening on the inflation front? Well, I think that inflation, again, we became used, and I kind of understand that. In the 90s, oil and food prices really didn't matter very much. And so if you wanted to get a reasonable reading on what inflation was, CPI or whatever, you tended to say that, yeah, we know food prices just jumped up because it was a orange juice harvest or something in Florida was wrecked or energy prices, there was Gulf War in 1991 or something, but it was only six, three months or something.

15:17So let's cut them out. But if you look today, this is where we come back to the war as being the really critical factor here, what we saw with the war was almost immediately Russian gas being cut off. And that led to 70%, 70 % of Europe's fertilizer plants being shut down. And you say, does fertilizer matter very much? Well, half of the world's population depends for its food on nitrogen fertilizer. And if you remember Chemistry 101, You know, you go natural gas into methane, into ammonia, and that gives you your nitrogen fertilizer. So it's 70 % of Europe's capacity is shut down. Plus, of course, we got the problems with exports from Ukraine and the sanctions on Russian.

16:10So you start to see fertilizer costs moving up. But of course, that doesn't have an immediate effect. It's not that the farmer goes out in the morning and sows his crop and fertilizes it and then brings it to market next day or that evening. What wasn't planted or wasn't fertilized last year doesn't come into the market this year. And that's why we're now starting to see food prices looking rather sticky. And of course, what we call over here in Europe, Sod's Law, something else happens that makes that worse. And the something else this time is El Nino. And the World Bank has come out and said, look, rice, for example, and other commodities in El Nino events tend to have problems with growing.

17:03India, the largest rice exporter in the world, 20 odd million tons out of 40 million tons or so, has banned exports of all non-Basmati rice. It's thinking about banning exports of sugar. Other Asian producers of rice are doing the same. So you're starting to see, you know, yes it's been a bit quiescent, a bit quiet for the last few months, but you're going to see oil food prices moving up again and of course for the last couple of months we've seen oil prices moving up and Brent prices are up 25 26 and there are you know very credible people around who are saying they think oil could get to 100 bucks I used to trade oil in Houston Texas you know I understand their point because I think that what's happening with OPEC plus particularly with Saudi and Russia isn't an economic debate it's a political debate they want to get rid of Biden they want a Republican candidate they'd love to have Trump back but if it can't be Trump well they let anyone because they think that would be the end of the war and they think they'd have a you know an easier ride so they're going to push up the price of gasoline in the hope that that encourages Americans to vote against Biden and bring in somebody that they want that kind of foreign interference in democracy doesn't seem very good to me, but that's where we are.

18:31So those two things that the Fed is happily ignoring at the moment, oh no, we don't need to worry about food prices, we don't need to worry about energy prices, and as I say, I completely understand why historically they've been saying that, I think they're flat out wrong. Those are going to be the key things over the winter. You are going to see higher food prices, you are already seeing higher gasoline prices. And those are the things that impact our daily lives. Yeah. Do you see that as a short-term phenomenon or shorter-term phenomenon through this winter? Or is this something structurally that's changing where these supply issues, whether because of the supply chain or just the supply available, changing geopolitics, realigning alliances, becomes more problematic on both food and energy?

19:27Is this a sort of new normal, so to speak? Well, I think the new normal is another way around, because we were already moving towards renewables and so on. I mean Texas for example, home of oil and gas, I think it's the third large, if it was a country, it would be the third largest country in terms of renewables capacity and you know when they had the big freeze renewables kept going it was gas, that natural gas that froze up. So you know renewables are a good thing and they're also much cheaper. So what we've already been seeing because of climate change and all the fires everywhere, I mean, even coming down into the tri-state areas, we know all that smoke.

20:16you know what we're seeing has been a move towards renewables and of course one of the paradoxically one of one of the advantages of the war there is a silver lining is that it's encouraged everybody to say well no we do under no circumstances do we want to be held ransom by Russia and Saudi Arabia again so so we are seeing expediting of of solar and wind and water and so on. So there is a systemic change there, a structural change going on, but it won't, you know, it will take 12 to 18 months to get, you know, depending on where you are. Some countries, you know, are already pretty much 100 % renewables, but it's expensive.

21:03You know, you're moving towards in the States, towards phasing out gasoline and diesel cars by 2030 or 2035 and so on, But it takes time and people have already got a car. They're not going to suddenly throw it away or anything. And nobody would want that to happen. So the process of transition is probably five to ten years. It's not five to ten minutes. We're used to, in the financial world, to the idea that everything happens in milliseconds. Yeah. We're in addition to that lately, right? The cycle has been compressed and we get these big lurches. So you see this, you think that although we are having these short-term pressures from energy and food, that the longer cycle here, the change, is more deflationary than inflationary.

21:56Is that right? Very much so. And if you sort of think about where would you want to invest, like all occasions, it's actually a complex decision, unless you're a meme stock follower, in which case you just lose your money and you smile. But in terms of what we're looking at, we're clearly in an inflationary period for the moment. And it's hard to say when that will come to an end. It will come to an end. but the deflationary aspect is there so as an investor you've got to be got to be cautious about saying well I can see I see ahead till Christmas no problem at all I suspect the war will be going on for another couple of years or so in which case we probably will be an inflationary spiral for that period of time but supposing the war finished in three or six months time now you would be revealed as having an awful lot of capacity which you don't need and of course you've got this thing of the of the aging populations of which the states is just typical you take the the 10 richest countries in the world nine of the 10 the biggest growth in population for the next five to ten years and after that is in the over 55s the perennials and And the perennials like myself, we're lovely people, but the fact is we don't consume very much because we're not having children anymore.

23:28And we're having grandchildren, but that's indirect, if you like. And we already own most of what we need. And once people move into retirement, they have less money as well. So if you take the data from the Bureau of Labour Studies, for example, what you see is that consumption peaks, household consumption peaks at around the age of 55 or so. And then by the age of 75, it's down by about 45%. Now, you know the numbers about the baby boom as well as I do, that we've got, you know, the 18 years from 1946 to 64, we had 52 % more babies born than previous 18 years. That was the baby boom. almost all of those babies now have become perennials and the oldest ones are old perennials so you're really looking at you know a a very deflationary environment China is is far worse we'll say we'll probably talk about China later on but because of the one child policy China selectively aborted a lot of female babies so if you look at the numbers instead of 103 105 male babies to females which is the normal ratio around the world you've got a ratio since 1980 of about 114 so that's because you know if you're only allowed to have one child a lot of rural families said well it's better be a boy to help me with the farm or whatever you know you know it's you know we may not agree with it but that's what happened and so you get to a situation now where the numbers show, these are government numbers, they're not made up by me, over 70 million lost females from 1980 onwards, which means over 70 million of females who can't now have babies themselves.

25:26And no surprise, because this starts that you're on an edge now, They're looking, instead of having 15 or 20 million babies a year in China, they're at 9, 9.5 million last year. And they're saying it may be 8 million this year. 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.

25:53Yeah, that's a huge, huge drop off. So we have these big, big, big trends. And we've talked demographics. You and I have talked before. we've talked on the program, which are this longer term deflationary trend. If we bring it back a little bit shorter term, so surely the Fed sees this, surely the markets are sniffing this out. It's sort of the timing of that long arc of that story is tough. In the short term, a couple of questions. If we've got some pressure, some supply pressure in the short term, what does that mean for commodity prices? Do they go higher or are they capped because they sort of sense some of the economic weakness you're talking about?

26:36They sense some of the capacity that may come online. What do you see happening with commodity prices? I think it comes back to my point about complexity here. There's no easy answers to this. I could be quite confident in saying that food and energy prices are moving up uh you know cereals are moving up in price rice is moving up in price and so on so you look at all of that but because of the war and because of el nino and you know people can can investigate that in more detail we put some stuff on our website of course uh already if they want to go there um but if you then say well what what's what's let's take let's come back to house house building in the states as an example now you might get lured into saying well housing starts are at one and a half million that should be good for lumber that should be good for all the things that go into into housing and then you look at the people who supply housing markets and you see they're all going out of business because you know they're people aren't actually moving into these new homes.

27:48And so the risk that you've now got is that builders have been lured into buying plots and building homes and now they're coming to sell them and people would love to buy them. You know you never have a housing market where people don't want to buy houses. That is never the problem. The question is whether they can get the mortgage to do it. I have a very good friend who relates all this to diamonds. And she says, there is no shortage of demand in my household for diamonds. It's just the shortage of the cash to buy them. I love you to that. Yeah, that's what I say, Paul. I can relate to that message.

28:30So where does this leave the Fed? Because they're dealing with this complexity too, right? Well, I think the Fed is a bit adrift at the moment. If you look at the three main central banks, the Bank of Japan is just lost completely. No idea what it's doing. The yen has gone from 100 to the dollar two years ago to 150. A 50 % change on the world's third largest economy. that tells you the markets have woken up to the fact these guys do not know what they're doing but when they find out it ain't going to be pretty europe um christine lejard at um at the central european central bank made a very interesting speech at jackson hole a couple of weeks ago where she talked about the changes that are taking place and the fact that our models don't work anymore and you know we're trying to look backwards to see what's what might be happening but actually um she quoted Kierkegaard and said we look backwards to find out you know where we've been but we have to look forwards to find out where we're going and you know I was I had to laugh when you know Jay Powell said oh you know at the Fed uh you know we're we're navigating by the stars, but the sky is rather cloudy.

29:58And I go, Jay, have you ever thought of getting a GPS system? There are other things that are possible. Real-time information, technology. Yeah. I mean, can you imagine a CEO of a company saying, well, I'm navigating by the stars and it's a bit cloudy? I think the shareholders might find him in an astronomer's job. Yeah, exactly. And there are some questions about why there is not more, you know, about the, I don't want to say accuracy of the data, but whether there should be more real time ways to sort of get a look at the forward leaning as opposed to the data that comes in. we know it lags and then it gets these has these big revisions a year later you know presumably it's not the struggle of just the fed um certainly others do others are are doing this as well the whole nature of economics is that it's a series of guesses some of them are more educated than others but you know in in my neck of the woods in chemistry you know the rules of the laws of chemistry are the laws of chemistry you can't change them you know that's the way it happens but there are no laws in economics you know various people have opinions and some shout louder than others and their opinions tend to get more listened to because they shout louder but it doesn't make them right yeah absolutely and and we're i think we're seeing that debate really play out right now and we're going to be talking a lot we've got a great content campaign coming up for all of you and we're going to really be diving into these sort of they're not But they're opposing views in many ways, but we're going to try to drill down a little bit and see what makes it different.

31:40What are people looking at that might be different and how much is their time horizon involved in that? Speaking of time horizon, we're at the bottom of the half hour. So we're going to flip over to the platform. We appreciate everyone who joined us for the first half. If you want to stay with us, ask some questions of Paul. We're going to talk a little bit more about how Asia fits into this and some of the concerns that Paul has there. Scan the QR code, jump on a trial and come join us. What's up, revolutionaries? Thanks for tuning in to the Real Vision Daily Briefing. For more content like this, head over to realvision.com and get unfiltered access to the very best, brightest, and biggest names in finance.

32:33in just two clicks. Feel ready? You can move to real money with as little as$100 once your account is approved. And the great thing is that in addition to crypto, Plus500 gives you access to a wide range of instruments. S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus500. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone.

33:10Not all applicants will qualify. Plus 500. It's trading with a plus.