Odd Lots - Brevan Howard's Top Economist Sees Three Huge Macro Turning Points Under Way

Episode Date: January 22, 2024

Right now, there's a lot of hope and optimism that the US economy is on a path towards a soft landing. Nonetheless, there are aspects of the current landscape that are unsettling. Inflation has come down, but there's significant debate as to why and how sustainable that move is. Geopolitics is another source of concern, given multiple ongoing conflicts. According to Jason Cummins, the chief economist and head of research at macro hedge fund Brevan Howard, we're currently seeing the demise of three different eras: the end of secular stagnation, the end of China's "get rich it all costs" era, and the end of "the end of history," as liberal democracy clashes with other competing frameworks. On this episode of the podcast, we talk about how these ideas are applied practically, in terms of trades, and also why he believes that recession is coming to the US economy in 2024.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, you know what actually surprises me a little bit about 2024, maybe 2023? We're only two weeks in. So go on. Or maybe it's 2023. So here's one surprising me to think about that. like we've had this a huge increase in rates we're coming to the end uh you know the pandemic like shook up the world but by and large like things have normalized in some level i'm surprised

that things aren't more different than they are in fact like you know we have the nasdaq surging i was just looking at it's like the nasdaq was surging back of the day the nasdaq crypto is back like i thought the world was going to change or turned upside down and yet like i'm kind of surprised like we have this seemingly different macro environment. And I'm a little surprised by how many themes actually did not go away or did not change. It's kind of crazy. So rates have basically like tripled or at least funding costs for companies. And yet, as far as I can tell, we're sort of heading back into 2022 territory.

I know the S&P 500 has been wobbling a bit. We're recording this on January 17th. So it's been down for the past couple days or so. But we did have a really big rally going into the end of 2020. a lot of the tech companies, the usual culprits, the ones you would recognize from 2021, 2022, were sort of leading the way. It is strange that like we are in a new regime of higher interest rates and yet the new regime looks a lot like the old regime.

And then throw in some of these huge things. So I mentioned the pandemic, which had this huge disruptive effect on society. But then there's multiple wars happening right now. The war in Ukraine remains. ongoing, the war against Gaza, the firing against the ships in the Red Sea, etc. So geopolitics is back in a big way. We just had the Taiwanese election. We did a recent episode on sort of thinking about some of the geopolitical risks outside of China. Like there's a lot going on. Also, speak of China today, did you see the population numbers that came out? I did. Pretty staggering

statistics. Yeah. So the second year in a row that the population in China actually shrink birth rates continue to fall there's just a lot of stuff going on you know throwing stuff like AI you know they're probably talking about I think they're talking about that in Davos right now like there is a lot going on so it's like okay they're talking about demographics too Joe probably and geopolitical risk I guarantee you there's someone in Davos talking about the big risk for 2024 is geopolitical probably talk about elections and elections in the U.S. there is a lot going on and it's like yeah maybe like we're in all-time high in stocks are close enough but like It still feels like everything feels very unsettled or sort of like the ability or easily

unsettled at this point. Well, I think the issue is there's sort of there's an unease about the current economy, which is that we have seen this incredibly dramatic run up in rates. And yet it feels like we haven't really seen, I guess, the full result of it or the shoe dropping just yet. We've had three banks failed in 2023. It's definitely not nothing. but compared to how people were talking about 10 years of ultra low interest rates after the 2008

financial crisis, this idea that central banks were distorting markets, there were all these zombie companies, everything was artificial because of low rates. It feels like something more should have changed in sort of 2023. Should we have a big picture macro conversation? Let's do it. All right. Well, I am really excited. We have a perfect guest.

I'm thrilled that we have him here in studio. We're going to be speaking with Jason Cummins. He is the head of research and chief economist at Brevin Howard Asset Management. Been there for a long time. He was also previously an economist at the Federal Reserve Board. So really the perfect guest to be speaking about some of these big macro issues. Jason, thank you so much for coming on odd lots. Thank you, Joe.

Thanks, Tracy. All right. I'm going to ask an embarrassing question, but maybe, hopefully it's something that our listeners will find useful. What is a chief economist and a head of research at an asset manager like Brevin, or specifically Brevin, what do you do? And what is your role within the company and within the investment process? Okay, I think it's useful instead of going through a job description

about what a chief economist does, is to frame this up both for economists and for the investment management industry more generally. Sure. I make the distinction between desk generals and special operators. And whether you're an economist or operating in a hedge fund

or across the asset management industry, this taxonomy is helpful to try and think about people who are big-picture desk generals who move pieces around on a map, and people who are special operators who do house-to-house combat every day with the data and with markets. What we do at our fund, Brevin Howard, is much more like house-to-house combat, whereas other shops, certainly a Warren Buffett, or the old David Swenson model of endowment management, that has more the air of a desk general moving things around strategically, very long, live bets. And what we do at a hedge fund, is really different from that.

We don't afford ourselves the ability to just make long-term bets and then walk away because we have stewardship over capital that has to be marked to market every day for our investors who face very real budget constraints. We don't manage money for the Warren Buffets of the world or the Yale endowments of the world. We manage money for shops more like the investment committee that I'm on, two of them, Brookings and Swarthmore.

Swarthmore has a really impressive endowment Tracy, but 50% of the operating budget is funded by that endowment. They can't afford to have a year where their private equity partners come to them and say, sorry, no distributions this year because then the kids don't have their scholarships. They need partners more like Brevin Howard who are doing this house-to-house combat with markets every day trying to extract risk premium and all different kinds of markets. So we are neither long-risk assets all the time, nor are we sitting around just buying VAL all the time because, as you well know, people overpay for options. So if you're a long vol all the time, you would end up going out of business sooner rather than later. So what a chief economist does, Joe, is try and provide the framework for thinking about investment management, whatever the environment is, and then figuring out exactly the ways in which we're going to go about that on a high frequency basis, because we aren't paid for our long-term views about whether we're in the new normal or the new abnormal for interest rates. We have to figure out when the Fed pivot is, when the next interest rate cuts are, And so what the essence of a macro hedge fund is is not figuring out the terminal destination,

but it's figuring out how you get there, what the exact path is, the volatility along the way, all those different elements. And the chief economist tries to weave together all those different pieces. Wait, can I ask an even broader stepback question, a step back from the step back? And you sort of touched on it just then. But what does a macro hedge fund actually do? Because I take the point about, I take the point about, you know, being tactical. and having to sort of pivot on a day-to-day basis.

But my impression was that macro hedge funds were all about making the big bets on big changes in the global economy, macroeconomic regime shifts, that sort of thing. So a macro hedge fund is defined by the kinds of assets that's trades. So it trades foreign exchange, currency, credit. And traditionally, but certainly in the kind of older style, Soros, big macro hedge fund bets where we broke the bank, of England. It's certainly true that in Brevin Howard's history, we've had amazing returns through very difficult times in the economy, for example, 2008, and certainly during the pandemic. But we wouldn't be good partners with our stakeholders if we told them we were only going to make money if there's a pandemic. We can't count on a pandemic happening. We can't count on

breaking the Bank of England once. So we try and make the integral, the path integral of what goes on and markets make money through all those different environments, which sometimes might mean, Tracy, that you're long just carry. Last year, it turned out that some of our best performing parts of our fund were long credit. And that's not something that is the essence of the old style macro of let's pick a big up or down. But it is true. We punctuated some of our best returns in those periods of time where being the chief economist, we looked at what was going on with the pandemic and people were enormously complacent. You'll remember that period of time in February March of 2020 when we went through the, it's just the flu phase of thing.

and we were looking out across the investment landscape and saying people are not tuned to the global economy shutting down. We were probably, Tracy, only a week or two ahead of people in that case, but that was all that we needed in order to be able to, in one of our funds, make 100% during that period of time. I remember that time in early 2020, and it was amazing, like, how slim the edge was, but also kind of how obvious, because I remember in January, February, 2020, I mean, China shut down like a huge portion of its economy. And stocks were still rising in the U.S. And everyone was talking about the Trump impeachment.

And it was kind of stunning to me that we'd been worried about a trade war with China for so many years. And then China shuts down most of its economy. And everyone was like, it doesn't matter. It's fine. Can I ask a question? So obviously, you're making good decisions, hopefully, pivoting at the right moment, being ahead of others in terms of curves. is there a describable persistent source of alpha that you could say across the cycle, something that like, you know, and I think like some hedge funds, like maybe like their

expertise as like all their different portfolio managers and the risk management practices that they apply to sort of allocating capital internally and maybe their ability to do that as a source of alpha. Or maybe some of them are really good at like applying the cutting edge of technology or AI, et cetera. And that is their edge, et cetera. Is there like a describable edge that Brevin aims to exploit across the cycle? So I've thought about how to answer this question a lot because everyone is hardworking and everyone is smart in market.

So there's no real alpha from working an extra hour per week and having an extra IQ point because that's an arms race where everyone is up to the frontier. I think about it in three different ways going from narrowly out. So first is muscle memory. I've seen as chief economist all kinds of different things. So I was just reminded, you know, we were talking about the pandemic just a moment ago. You need to have seen a lot and be able to pull together my academic training, my policy training, or markets training to be able to make a view. So in that period right around February, when I saw that when the people who were put away in Travis Air Force Base

actually started community spread at Vacaville Community Hospital a mile away, I knew that there was going to be spread everywhere. When I saw that the LA Unified School District was shutting down, I knew that the whole economy was shutting down. That kind of muscle memory knowing what happens when those developments are going to hit markets is a key source of alpha. Going back to earlier periods, you were just talking in the intro about how things seem fine now. You flip the calendar and it doesn't really seem like anything really changes.

I'll tell you another period of time where you flip the calendar and something really changed. GDP growth at the end of 2007, just a few days before the business cycle peak in December of 2000, printed 4% on a quarterly annualized rate, which was the fastest run rate of growth going into the business cycle peak a few days later than you had seen in four years. A few weeks after that, the unemployment rate went up three-tenths. The Fed did an emergency 75-bases point cut, followed just a few days later by regularly scheduled meetings, 50-bases point cut. things can change very quickly. And one of the persistent source of alpha that we have is that experience of the individuals we have in the firm, me as chief economist and others.

The two others I would just mention quickly are I think it's underappreciated how important trust is in organizations. And that may seem like something that's a very soft consideration when it comes to something that sounds like a corporate slogan. But it's not, which is you can get sources of information anywhere. But if you trust me, Tracy, when I come to you and say, listen, the U.S. economy is going to shut down. That may be the difference between you putting on a trade that's one unit or 10 units.

And then finally, the last one is there's intangible capital that is developed over a period of time in a firm. We've been around for more than 20 years. We have intangible capital in the way we structure trades, the AI, the individuals, and that is something that we have as a permanent source of strategic ballast for us. Joe asked you about Alpha. How much of global macro alpha is systematizable? because, again, I think about the landscape of hedge funds. I think about the hedge funds that have been popular in recent years.

It's sort of all, you know, like relative value, algo-driven type momentum hedge funds. And you're here, you're talking about like very specific things that have happened in the global economy. Like, you know, I was watching the spread of the pandemic and I saw this one base in what was happening there. How systematizable is that kind of insight? I think almost none of it. I think that you have to, there's no designer indicator. People will look at financial conditions indexes or they'll look at regularities that they've seen in the past and hopefully be able to, you know, extract some risk premium out of the markets. But I harken back to a podcast you just did the other day with Harley Bassman, who's developed some, you know, pretty sophisticated financial products.

But in the hands of people who aren't sophisticated investors, they're weapons of mass destruction. If you just kept your P-Fix throughout the cycle, it's an excellent financial. instrument, but what if you miss the day of the Fed pivot? What if you miss the day that there's, you know, essentially a failed auction because this is the day that people decide that the U.S. credits is really in question. Those are the kinds of things that I think require a real feel for the analysis plus mapping into the markets. It's very difficult to systematize. You might take a step back and look at markets and say, listen, most of the returns in stocks and bonds have been around Fed days. But which Fed days?

pick them. Was it just because you were able to know that J. Powell was going to do a trillion dollars of QE in response to the pandemic? It was important to pick that week. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gura. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Rafini. We'll bring you the latest headlines, in-depth analysis, and big interviews, all the stories that hit home on your days off. And I'm Lisa Mateo, Watch and listen to Bloomberg this weekend for thoughtful, enlightening conversations about business, lifestyle, people, and culture. On Saturday mornings, we put the past week's events into context, examining what happened in the markets and the world.

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I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really, really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts. Let's talk about this moment. Interesting times, obviously debates about whether the Fed is going to cut in March. We recently had the Waller speech.

Waller was one of the Hawks leading the way. And though he didn't say we're going to go right away, he clearly indicated that on some level, he is ready for the rate cut cycle to happen. Inflation trajectory generally seems fine. Labor market seems solid. Lots of optimism about the soft landing. January 17th, here we are. How do you see just sort of the short-term macro picture, the medium term? Let's weave that into the, you know, very recent Waller speech and especially his Q&A. The Fed has pulled a little bit of a fast one. They told you that they're data dependent and you just needed to look at the data. So let's over the last six months look at what's happened with the data.

The June SEP is an important milestone. At that meeting, the median forecast for that 19 member committee was 3.9% for core PC inflation. We project at the end of this month, and we, like many others, put a lot of effort into this kind of high frequency data analysis. We project at the end of the month, the release for core PC inflation will be 2.9%. They've missed by 100 basis points in six months. In the era the SEC is going back to 2014, they've never missed in that direction by that magnitude. In 2019, when they missed by a mere 30 basis points, it was enough to get a 75 basis point, you know, mid-cycle adjustment, as they called it, in an economy that was performing otherwise pretty well. It faced some shocks with, obviously, the Trump trade war,

and so on. But just a 30 basis point miss got them to cut three times starting in the summer and into the fall. They missed by 100 basis points just on what we know. And furthermore, in terms of thinking about where we're going farther down the line, monetary policy now is as tight as it's ever been on the precipice of recessions. If you take the Fed seriously, they think that long-term neutral is 2.5%. So rates are broadly 300 basis points above neutral. Whenever that's been true, you've had a recession with one small exception in 1984. But if it's the case that monetary policy is tight, what is the natural equilibrating force of the economy

to bring it into equilibrium and just keep it there? Well, it's not monetary policy because that's putting continual downward pressure on the economy. So we fully expect the economy to continue to slow. And the interesting thing about Waller's take-on thing is he had obviously taken on board what's happened with inflation and what he projects to happen in inflation. He's discounting the prospects of a deterioration in the labor market, which we do foresee. But he slipped in something very important, Joe, especially in the Q&A, which is he went from data dependence to his own personal.

preference dependence, which is he said the biggest mistake we could make is starting and then stopping or having to reverse. And in fact, he used the word worst mistake. And so he talked three times in the official speech about how he had more confidence in various parts of the outlook coming together, which would lead to rate cuts. But then in the Q&A, he was unwittingly revealing of his own personal preferences, which has said the worst thing we could do is stop and start. And furthermore, that he had to be thoroughly convinced that inflation had been

Slade. So we think that the Fed is well on its way to rate cuts. Figuring out the exact timing is going to depend upon one piece of data or another. How does the next employment report play out? But I think you can have more conviction about the ultimate destination than about the exact timing. I'd just remind you, the last two normal rate cutting cycles started out with a bang with a 50 basis point cut. One of them was intermeeting, followed up by in that same month in January 2001, another cut. And remember, the 2001 recession, we called a recessionette. You never even ultimately strung together two quarters of negative GDP, and the Fed was cutting by 100 basis points because they kind of waited around, and then Greenspan did his thing. He said, I

looked at initial claims and second week auto sales in December of 2000, and the economy's changed. He said to his colleagues, the last move is always a mistake. We need to take it back and take it back quickly. So the March versus May debate, I think in some ways, obscures what's really going on because that's a guess about a policymaker's utility function and how risk averse they're going to be with regard to this really severe aversion to policy reversals. And that's tough to judge. So I take the point about timing and in some respects it's academic, whether it's March or like a few months later. But you mentioned something earlier that was really interesting to me, which was that I think you said you went long credit in 2023. And that was kind of a bold and

unusual call because, again, going into 2023 towards the end of 2022, everyone, the consensus was that we were going to have a recession and that corporate defaults were going to spike. And we have seen a pickup in defaults. This is true. But certainly not to the extent that a lot of people were thinking we have seen spreads come in since towards the end of 2023. What went into making that specific call? I go back to 2006 as a good template. So 2006 saw the end of the rate hiking cycle then in June of 2006. There was widespread worries about the economy, and there were more manifest than they are now, because housing was obviously slowing down and looking very dodgy in certain parts of the country at that point.

It appeared to be an environment that it would just be crazy to be long. Some of these risk assets, especially ones that were tied to housing. In the event, Fed stopped raising rates in the middle of the year, like they did in 2023. There were lots of worries, even dating back into 2005 in that prior episode and in this one as well. But it was fine to be long credit because you hadn't seen the deterioration in the economy. So ultimately in 2006 and in 2023, stocks were up by double digits. Credit did fine. And those indicators, despite the market's interest in trying to find designer indicators to tell you what's going to happen somewhere down the road,

financial conditions indexes predict nothing reliably. They have false negatives, they have false positives. Sometimes credit has predicted a downturn or a financial market ruction. Sometimes it hasn't. Again, going back to that period of time like in 2007, real GDP growth was 4% going into a recession. I remember one of the times that I was the most bearish in Brevin Howard history was just after Bear Stearns was bailed out. We thought the economy was absolutely falling apart. And in the event, if you look back at private payrolls at that point, you were losing,

250,000 jobs per month in April and May after Bear Stearns failed. Stocks went right up, credit did fine, and it was only until later on in the year. And even in the week that Lehman failed, stocks went up. It's oftentimes going to be the case that financial instruments and financial markets do fine until they don't. I want to get into some big picture stuff, but just before we do on this sort of current moment. So we talked about the Waller speech. We talked about how, you know, historically speaking, The Fed is, you know, the recent overestimation, I guess, of the inflation trajectory is quite large.

They've expected inflation to be much hotter, at least measured by Corp.C.E. than it has been. So what's your sort of views specifically in terms of rate cuts and the prospect of recession in 2024? So we are a recession shop because of the reason I mentioned earlier, Joe, which is that whenever monetary policy has been tight, you've been falling into recession, again, with that exception of 1984. And I take the point that Waller was implicitly trying to make in his speech, which is that everything that has happened in the past has happened for the first time once. So maybe this is a business cycle where everything comes out with the perfect soft landing. But let me frame it this way. Even if they have the Sully Sullenberger soft landing of all soft land. The U.S. the U.S. Air 1842 of soft landings, it's still the case that monetary policy is miles off in terms of. of its terminal destination because they should be it around neutral if you're getting a soft landing. And right now you're, you know, arguably on their own standards 300 bases points. So the market is pricing in how many cuts this year right now? As of today, less than six cuts.

And you think it'll be more? Listen, let me go back to 2021 and 2020. Intellectual consistency that got you to the rate hikes seen during that cycle with inflation going up and demanding that you do what turned out to be four 75 basis point hikes in a row, intellectual consistency demands that if you thought that that was appropriate, it's similarly appropriate to be doing cuts not of the same magnitude in total going back down to zero, but certainly back down to neutral. And the reason for that is because you have policy set to a very high inflation environment now

that's no longer out there. Waller said in his speech, the six-month change will be around two. I'm not going to argue with the policymaker, what a round two is, but it'll be 1.8%. On a three-month annualized basis, it'll be 1.4%. This is exactly what I wanted to ask you, because it feels to me like rates at the moment are sort of the solution to and the cause of all the market's problems, right? So we might get a recession because interest rates have gone up so much and the cost of financing is high. But if that starts to happen, I mean, the Fed can start to cut and they can do insurance cuts

even before they see a sort of durable impact from the higher rates. How much of a problem is this if the issue is kind of caused by higher rates but can also be solved by lower rates? Is the limiting factor here is the constraint really what happens with inflation? I think we need to bring in the other part of the dual mandate here, which is that you're playing with fire. So a very careful look at the labor market now will suggest that hiring has just ground to a halt.

So if it weren't for participation falling back by a huge amount, three-tenths in the last report, the unemployment rate would have gone up by three-tenths to four percent, would have totally change the macro conversation. Underneath that headline statistic, the gross flows within the household survey are telling you that folks who are not in labor force moving into hiring fell by almost a record amount. So we're seeing the underlying details of a labor market, which is slowing down. You're kind of living in this twilight between recession and non-recession. The Fed is essentially running, I know this from your convexity conversation. You'll love this, Tracy. the Fed is running essentially a short gamma position with regard to any weak data.

I feel like there's a bell we should ring when someone says gamma. Any weak data that comes out that's material, not like the Empire Survey, which is a few manufacturers in Buffalo. A really material piece of weak data. And the Fed will stop and look around like they have in the past, whether it was at January of 2001 or in January of 2008 and say, listen, we calibrated policy to a different environment that no longer apparently prevails. But the key thing I'm trying to provide you with is it's not just an antiseptic, technocratic reading of the data that's necessary here. You have to play the man and the ball, the man or the woman, but man in this case in Jay Powell, gets to decide when he starts cutting rates. And that's going to depend upon his own kind of personal welfare function of what he thinks is important.

And if he's really averse to a policy reversal and he wants to be that much more sure, it makes it more likely. that they have to do more later on. This was sort of Bassman's point as well about like, if you think about what's driving policy makers, it's probably reputation and legacy. It's a dual mandate as well. I mean, they're genuine. There's no greater public servant than Jay Powell who has spent his entire life around Washington trying to do good for public policy.

I think he genuinely wants to do good. Oh, you were at the Fed, of course. How much does that experience feed into your thinking now? It's formative. It's incredibly important. So I started out my career as a PhD economist and then a professor, and I felt like I learned in the Greenspan era all about how to analyze the data and all about the sausage making of how policy making really gets done. And so having that appreciation for how these decisions really get made. It's not about, you know, the data release here or there. It's coalition building. It's how they're interpreting things. It's forward guidance and so forth. That experience, I think, is. is invaluable, having seen how the sausages actually made, really helps you be able to sample it. I want to talk about some big picture topics, but real quickly before that, as you point out, you know, and the most recent non-farm payrolls report, there could have been a different narrative than the one that was, because while the headline was good, we did see that weakening in

labor force participation. We did see that increase in U-6. Prime Age employment to population did weaken, but whatever, the unemployment rate did hold steady. When does that, you know, it change and sort of people wake up to, as you point out, that hiring is really slowed down? So Joe, listen, what's going to happen is the recession, should it unfold, the way we think it unfolds, will feel like a slowdown even if we're right. So suppose we're absolutely confident that there's going to be a recession at the start it's going to feel just like a slowdown. And the reason for that, go back to the stat I quoted you earlier on, there were 500,000

jobs lost in the two months following the Bear Stearns failure. At the time, we didn't know that. The first print was minus 16K or minus 24K. That month when Ben Bernanke cut by an emergency 75 and then followed it up with another 50 basis point cut, the unemployment rate went up three-tenths, which may not seem like a big deal. Private payrolls were still going along pretty well. The first draft of history is not the ultimate draft that's written in. It's a matter of kind of art and science, good taste to figure out what you should be focusing on. And there's no designer statistic that you can always use, apropos of the point about there's.

There's no way to design some CTA that harvests all the risk premium in the Fed because these things change over time. For example, right now I think it's very important to pay attention to this gross flow finding that across the board hiring is stopped, whether it's in the jolts, whether it's in the CPS or what have you. That's a key thing to be looking at because businesses, tying it to inflation, which we haven't talked a ton about, businesses probably realize they're not going to get margin increases by raising prices anymore.

So how are they going to protect or raise their margins in 2025? The good old-fashioned way is firing people. And I think we're on the potential edge of that, should it be the case that monetary policy remained tight. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report delivered right to your podcast feed.

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We're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. What separates good leaders from transformational ones? I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example executives making an impact on the IHeart radio app, Apple podcast, or wherever you get your podcasts. This sort of reminds me of the argument about war, right? Which is like it's not like suddenly war happens or at least not usually with some notable exceptions in recent history.

But like people who live through World War I or World War II, it sort of sneaks up on you in many ways. And it's only when you look back that you think like, aha, here are the signs. But okay, that was my very clumsy seg into the major changes, the big geopolitical risks, the economic regime changes. What are you looking at? I think it's important, notwithstanding the fact that I said that extracting risk premium on a daily, monthly basis, what have you, it doesn't pay to be a desk general moving pieces around a giant map.

I think it is important to have a general framework for how you're thinking about markets. And I think we've gone through a paradigm shift that's maybe a little bit hard to appreciate. just because so much has happened with the high-frequency macro, with inflation, and since the pandemic. But we see three major forces that have changed. First, we were in an era of the new normal and the global savings glut and Ricardo Caboero's deficit of safe assets. You know what? There's no deficit of now? Safe assets. There are a lot of safe assets being printed by the U.S. government every month. And that new normal for interest rates, the secular stagnation, that Larry Summers gave a name to, something that we all kind of felt but weren't really sure

how to describe in 2014. We're now out of that era in our view. We're in a higher interest rate, higher volatility environment that makes it so that policymakers no longer have the free lunch that they had post-GFC and through the pandemic. There is a real budget constraint on sovereign debt, especially in the United States and some of the other developed market economies. And I think you're past the era of the Fed put because we saw a period of time where Jay Powell could say, listen, we know how to deal with inflation. Don't worry about all the QE we did. And that turned out not to be true. It turned out to be a problem that made the American people more upset than they'd ever been in the post-war period.

So whether it's fiscal policy or whether it's monetary policy, I think we're in a new era that makes it so that there's no longer a kind of non-economic protector of markets. That's a huge change from what we all got used to. You used to be able to go out as an investor and just kind of buy everything. Any strategy was allowed to flourish because ultimately you knew that there was a non-economic actor out, their fiscal or monetary policy to bail you out. And it's at least much more circumscribed now. I think the second one is China. We've all lived in an era, certainly in this century where China has been an incredible source of dynamism for the global economy. And they've taken all of the proceeds of that and recycled it into financial markets.

another non-economic buyer of treasuries. And now Xi Jinping is quite clearly, I mean, he's doing some marketing at Davos with some of his external officials, but he just gave a speech at home talking about economic nationalism. Their goal is to have state-directed capitalism, common prosperity, which is getting rid of some of the tensions that were created in a society that had very robust growth, generating more billionaires than anywhere else in the world, and the national defense. This is not something that we've seen, not something that we're used to and has direct effects on investors because this is de-globalization right there. And I think it's right that you have people like Brad Sester going out and saying, listen, nothing's really changed now. But I think it's a snapshot apropos of what you're saying.

You never really realize when you're slouching into something. Every marginal decision that's being made is one consistent with de-globalization and is going to have, I think, epic impact on markets. And finally, you joked on. one of the podcasts earlier this year, you just need to sound smart by stroking your chin and quoting geopolitical risks. But I'm going to quote geopolitical risks. I think we're at the end of the end of history era. U.S. won the Cold War. Liberal democracy was triumphant. Liberal democracy had a test during the global war on terror, but I don't remember anyone really wanted to sign up

with Osama bin Laden to go live in a cave. It was the case that we were able to win the global war on terror, liberal democracy was triumphant, but now it's not. It faces a genuine challenge with what's going on in these wars. And you might think the wars are just individual points, but they add up to something that wears the whole as much great in the sum of its parts. The unbounded relationship between Xi Jinping and Putin is important. The Biden administration may not have learned this so well, but certainly the BB administration has learned that deterrence doesn't work. Our efforts to deter our adversaries and certainly Israel's efforts to deter Hamas if we found out it doesn't work. And now, so now we face a genuine dialectic fight

of liberal democracy against the forces that challenge it. And you might think, well, you could say that at any time. This sounds like a political science podcast. But it has direct impact on financial markets because there's one empirical regularity about wars. They cause inflation because they're expensive to finance. Joe, I feel like our international relations degrees become more useless by the day. You would think it would be the opposite with all this geopolitical risk. But I remember like, well, I think you would have done it around the same time. It was all like neoliberal end of globalization. It was all Fukuyama and people like that. And yeah, it doesn't seem to have happened, does it? Well, to be honest, I don't remember anything in college.

And it was not because I was like partying like crazy. I just, it's been a long time. Sure, yeah. There's a lot there. Let's talk a little bit more China for a second. In fact, just today, this morning we got some new data out of China. Not great. Population. continuing to shrink. There's this question about like, when are they going to stimulate the economy? When is that big spending coming up? When are they going to have something more resembling a welfare state? Common Brad Setser a theme that allows the Chinese consumer to have more buying power? What is going on in China? Even sitting aside maybe some of these sort of national security or national defense ambitions, et cetera. What is, you know, when you say economic nationalism,

What is Xi Jinping trying to do right now in your view to the Chinese economy? So investors, whether it's in the West or with regard to China, are continually hoping for the Fed put, the China put around the corner. I think it just misunderstands what's going on with China. And I describe clearly he's making an effort to develop the economy through state-run enterprises. Common prosperity is their version of income redistribution and directing things to national defense clearly has its own goals. I think one of the things you learned from history, so shifting from the IR degree to the history degree, is these leaders, these communist leaders, whether it was Stalin or Xi Jinping or Mao, they believe behind closed doors what they say to you in public.

Whether you're looking at Stephen Cottonigan's work about Stalin or Frank DeCotter's work about Mao, whenever they've gone to the archives, they found out what they say in the Politburo that they never thought would be released was exactly what they were saying in public. And Xi Jinping is telling you what he believes in. And therefore, a lot of the templates that people use in order to try and understand China now, I think are, you know, they have some resonance, but I think they're just missing the major point, which is you'll have some people say, oh, it's a balance sheet recession. Or China's on the edge of its Lehman moment, because Chinese real estate genuinely is the world's largest asset class. Those things in some sense are both true, but I don't think it helps you understand what's going on in China. I go back to, and bear with me because this may seem at first like a goofy comparison, Xi Jinping's notion of common prosperity reminded me, I forget when the penny dropped, of FDR's efforts in the immediate aftermath of his effort to stimulate the economy out of the Great Depression.

What happened in the Great Depression in the United States is that we expanded state control of the economy, fiscal and monetary policy were pretty inert, and you demonized any private. success. I asked, this was a good example of using chat GPT. I asked chat GPT to compare FDR's second inaugural address in 1937 with Xi Jinping's key speeches about common prosperity. This was everything you need to know about chat GPT because first it begged me not to do it. It said you shouldn't be doing this. You absolutely should not compare FDR and Xi Jinping. So it spit that out like a furball. But Then when I forced it to answer, if you go and compare a common prosperity speech to that second inaugural, they have the same elements.

And let me tie this into answering your question, Joe, about why this is helpful for understanding Chinese macro now. The essence of the NRA and the Great Depression, the Wagner Act, it was all to suppress competition. There was a perception that competition was a bad thing. And what that did was it set wages above the market clearing level, and what is the result when you have wages set above the market clearing level. Unemployment. Why do you have unemployment in China now? Is it because it's not a particularly dynamic economy? It's still an amazingly productive and growth-oriented set of businesses. It's experiencing unemployment because

the overall price level of that economy is inappropriate. And then in response, you end up with status leaders doing the same thing that FDR did, which is you might have noticed some of the news stories about Xi Jinping sending people down into the provinces. It's the same thing we did. in the New Deal with the CCC, the WPA. I even got a chuckle in December when they said they were going to do fiscal stimulus by flood abatement, which reminded me the TVA. So for me, I go back to the government meddling in the economy like we did in the Great Depression as being a useful template for what's going on in China.

The unemployment rate never went below 14 percent after 1933 until we had World War II. So let's hope World War II isn't his solution to his unemployment problem. You know the mistake you made? Asking chat GPT, when you should have asked, you know, there's like a study Xi Xin Ping GPT version. Yeah, the Chinese. Yeah, there's like a nationalistic version of chat GPT in China. And it's funny because I played around with it. You actually, you can't ask it any questions in English. It refuses to engage in English because it will tell you Chinese is a beautiful language and you should be interacting with it in Chinese. So you need to ask that same question to the Shishun Ping thought. That would be a fun experiment. Talk to us about the end of the end of history a little bit more. Incidentally, and it was not planned at all, I'm like halfway through the Fukuyama book right now.

I started reading it about two weeks ago. Setting aside whether it's right or wrong, it's a very interesting book. But why do you sort of talk about what that means the end of history to you and what it means for that thesis or that idea to be coming to an end? So I think this cohort of policymakers, and the mainstream certainly of U.S. policymakers, believes that the post-Cold War architecture either doesn't really demand the U.S. to do that much or deterrence is enough.

But it's evident that deterrence didn't work for Putin invading Ukraine. It's evident that deterrence didn't work for Hamas and then perhaps what's going on with Hezbollah. against Israel. Big question mark, whether deterrence is enough for maintaining the status quo with Taiwan. These are all questions that you have to ask yourself. The end of the end of history for me means, do we have to have a completely different security architecture? In the immediate aftermath of the in the Cold War period, the post-World War II period, we had NSC-68, which said we need to develop the H-bomb, we need to be able to fight two and a half wars, and we ended up not doing

deterrence. We ended up fighting multiple wars in order to enforce the liberal democratic order. I worry that we're moving back into an era where the end of the end of history means that we can't just, as my friend, Neil Ferguson says, talk softly and carry a big stick, that we'll have to actually use the stick. But, you know, you made the point when you're sort of giving the big picture. Like, after 9-11, there was a major military effort and there was war in Afghanistan. There war in Iraq, but there was not some big sudden impulse it felt like to sort of like take the side of Al-Qaeda, regardless of the war itself. And, you know, obviously in Fukuyama's telling, you know, sort of liberal democracy is like the logical endpoint for society. That's the ultimate

sort of the expression of society with the least internal contradictions. And so what you're saying now is like, actually there is competition. There are people and there are countries, etc. I think maybe there is a different way. Listen, surveys of the Global South, and if you don't trust the surveys, just look at what the leadership does, whether it's Brazil or India, they're not taking sides. They're seeing the dialectic between liberal democracy and illiberal tendencies, and they are not so sure about signing up with the post-Cold War liberal order just by revealed preference. So you're seeing this play out in real time in a very important way, even. with allies who we've hugged closer in certain spheres like India. So I think this is a real, you're seeing the manifestation of it right in front of your right in front of her eyes.

How do you express these ideas in actual trades? So all these big picture thoughts, end of secular stagnation, a major change in China's economic and potentially political trajectory, the end of the end of history. How did these actually translate into positioning? So let me give you a case study because you might think these are all. all pretty airy-fairy ideas difficult to figure out exactly how to put on a trade, because ultimately you've got to go to your Bloomberg and pick out a ticker, whether you want to be long or short. Let's take the term premium move last year.

So the term premium in the U.S. Treasury market, which is the extra compensation that you get for owning an asset with longer duration, rose by about 100 basis points from July to October. Did that just rise exogenously? No, that was really importantly influenced by some of the forces that I'm talking about. You don't have the same economic, non-economic actors going out and buying treasuries hand over fist. We were experiencing QT and the Chinese being more reluctant to buy treasuries. We also saw that banks for regulatory reasons and maybe reasons related to the cycle were buying fewer treasuries.

So that was a very real manifestation losing these non-economic actors buying treasuries as a buffer to that big increase in the term premium. Similarly, if you buy into our argument that we're at the end of the new normal or the global savings glut, there now is a surfeet of safe assets, not a dearth of them. You should expect the term premium to go up over time, and you can construct very specific trades for that, whether it's short duration outright, a curve steepener because you want to pair it with a bet that the Fed is cutting rate. So these have very tangible implications for us.

And then kind of the art of it and also the science of figuring out the timing will depend upon the data and what the policymakers are doing. But having this broad framing, you can see how it can translate into something that is, a very real opportunity seen last year. Jason Cummins, thank you so much for coming on Outlots. Fascinating conversation.

Thank you, both. Tracy, can I just say, real quickly, all guests should come prepare to cite as many past episodes as Jason did. Really, that's how you know someone. I really appreciate that. He's done his prep. That's for sure. But I did find that a sobering conversation at a very minimum.

Yes. It reminded me a little bit about the conversation we had with Animal Wong towards the end of last year about why a recession didn't materialize in 2023, but per her argument, it could in 2024. There's a lot there. I mean, to start, I do think his points about the labor market need to be taken seriously. And this idea that, yes, like unemployment, we have not triggered a sum rule. Headline unemployment has remained depressed.

But there were those red flags unambiguously in that last report. We did talk. We have talked about them. We even brought them up with Lail Braynard. There are some signs of a weakening labor market and it can go from weak to bad or it can go from tight to moderately tight to loose fast. And I think that is something to pay attention to. Yeah. I keep thinking back to, oh, again, this was a point that Anna brought up, but the 2001 recession and Jason brought it up as well. But the idea of how quickly things kind of shifted in there.

And to some extent, people didn't really realize it was happening until much later because you didn't see, you know, it took a while for the unemployment to kind of start to spike. But the other thing that I was thinking about, like, it seems to Jason's point, it seems like the wild card here is sort of what happens to corporate profit margins. And what dial companies have to start turning in order to maintain those. You know, is it pricing power? Can they still eke out more revenue from the consumer or do they have to resort to cost-cutting measures? Well, I thought that was really interesting. His point about you can have periods in which the trajectory of economic activity and financial

conditions go in different directions. And so as he pointed out in the immediate wake, I guess, of Bear Stearns, we did see that rally in financial assets, even as already the economy was really starting to shed private sector jobs, at least, to a meaningful degree. Granted, like again, the headline labor market indicators look fine, but there have been those reports of layoffs lately and people starting to wonder what that means. And so maybe it's just about margin padding, et cetera. But there is enough to watch even if like markets seem fine or sanguine about it. Yeah.

To some extent, it feels like markets or investors kind of sometimes it takes a while to internalize the shifts that are happening. But that said, I think there's also there's a human tendency to call like big regime. changes constantly. And we kind of saw it, going back to the intro of this conversation, we saw it in 2023. You know, lots of people were arguing, oh, things are going to be different this year. We're going to have a recession. That didn't materialize. That doesn't necessarily mean that it can't this year. And again, to Jason's point, like the trick here is sort of determining how long and variable those flags actually are. I really liked also his description of like what he does or what he does. And it was interesting to hear. And it was interesting to hear

that, and this is something that does not come up very much, which is the connection between the big picture ideas that he, you know, his three big ends, the end of the new normal or the end of secular stagnation, the end of China's growth at any cost phase in favor of this sort of more domestic focused nationalism and the end of the end of history, the sort of geopolitical call. But it was interesting to hear those three big ideas within the framework of a company that needs to make short-term trades to make money. And how do you sort of connect the long-term macro with the short-term macro? I really enjoyed hearing him talk about that. Yeah, absolutely. I kind of, I always thought of macro hedge funds as like making these big bets on regime shifts. But his point

about like, well, there is that aspect of it, but also a lot of it is more tactical than strategic long-term investments also make sense. Because of course, where does the hedge in hedge fund come from? You have to, you know, be long and sure and you're trying to preserve capital. So that makes some sense. Shall we leave it there for now? Let's leave it there. This has been another episode of the Oddlots podcast. I'm Tracy Alloway.

You can follow me at Tracy Alloway. And I'm Jill Wisenthall. You can follow me at the stalwart. Follow our producers, Carmen Rodriguez, at Carmen Arman. Dashel Bennett at Dashbot and Kel Brooks at Kel Brooks. And thank you to our producer, Moses, Ondom. For more Odd Lots content, go to Bloomberg.com. Odd Lots, where we have transcripts, a blog, and a weekly newsletter.

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