- Geopolitical Strategist
United Kingdom, Institutional
Change
The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.
Episode notes
Macro strategist Juhi Dhawan joins host Thomas Mucha to discuss her latest research on the Fed, inflation, and the key macro themes shaping today's markets.
1:50 – Today’s inflation drivers
3:00 – The Fed’s response
5:10 – Inflation in Europe
7:20 – Political implications
9:55 – Recession risk
12:00 – Key data to watch
13:15 – China’s economy
15:20 – The Inflation Reduction Act
19:45 – Juhi's research process
22:40 – Investment impacts of structural shifts
26:20 – Defense and national security
28:10 – Personal insights
Transcript
JUHI DHAWAN: We really need to think about what kind of downturn Europe might face in the winter months should something like rationing have to come into place. That’s hopefully not going to have to transpire, and storage comes to the rescue, if you will. But nevertheless, weaker activity seems to be a given, and it’s really a question of the degree of the weakness that we have to calibrate for coming months.
THOMAS MUCHA: Today’s topic is inflation and the efforts underway around the world to combat it. There’s probably no more important subject right now for US and global markets, for politics and policy, for the everyday lives of people around the world than surging prices, and what this phenomenon means across multiple dimensions. Can the Fed and other central banks get this under control? How long will it take? What are the market winners and losers? And how does war and deepening geopolitical friction play into this? These are just a few of the questions we’ll be exploring today, with one of Wellington’s top experts on the Fed, and a close colleague of mine on the Global Macro Strategy Team, Juhi Dhawan, macro strategist, who joins us today from Boston. Juhi, welcome to WellSaid.
JUHI DHAWAN: Nice to be with you, Thomas.
MUCHA: So, let’s start with the big question. Where we’re headed with inflation. We’ve got rising energy costs. Rising wages. Massive demand pull following the pandemic and other factors. So, what do you see as the biggest drivers of today’s inflation backdrop?
DHAWAN: It’s a pretty complex question. I would say that the roots of the high inflation that we have today have some parts of it embedded from the supply chain bottleneck issues that we have talked about for quite some time in the global economy, have something to do with the Russia-Ukraine conflict, which has had quite a substantial impact on food and energy prices around the world, but also has something to do with the very accommodative fiscal and monetary stance of policymakers, especially in the United States early on. The good news is that some of this is starting to shift. So, the forward basis, I might have some better news to share, but I certainly think that there are lots of reasons why we have ended up where we have today with a very elevated inflation rate.
MUCHA: So, it’s sort of a perfect storm of events then. Some of which, like the pandemic and major war in Europe, that haven’t happened in 75 – 100 years. Within that historical context, Juhi, how do you assess the Fed’s response so far?
DHAWAN: The Fed has been very humble in acknowledging that they made a mistake in characterizing this inflation as transitory at the start. And so, they were somewhat late in their response as inflation started to pick up last year, they kept policy extremely accommodative, and it was only at the turn of the year, and early this year that the Federal Reserve really started to tap on the brakes. When I think about the turnaround, I give the Federal Reserve credit for acknowledging the mistake, for getting down to business, and now really staying very purposeful in its commitment to ensure that they are able to bring inflation back towards their two percent goal.
MUCHA: The markets of course are focused on how high inflation might go and how long it might last. So how do you think markets respond to this over, let’s say, the next couple of quarters?
DHAWAN: If I’m right that we are at peak inflation, and we are going to start to see some signs of disinflation start to emerge in coming months, I think that markets will see that as relative good news, because for asset markets in general, it is important that inflation come back under control. It matters both for Main Street and for Wall Street, so the Federal Reserve’s commitment is a precursor to really sound policy and bringing this back into what should be a more sustainable path going forward. There is still a lot of work to do. The war certainly complicates a lot of this in terms of what can transpire because of spikes in energy or food prices, but we are starting to see some green shoots in a number of areas which are quite encouraging.
MUCHA: Now, speaking of the war. Speaking of the global impact. Inflation, of course, is not just a US phenomenon. I’d like to get your views on Europe, where inflation is running much higher than in the US. Especially given the energy implications related to conflict. So, what do you expect the key macro impacts are likely to be?
DHAWAN: Yeah, Europe is really at the epicenter of the fallout from this conflict, if you will, and it’s because of the very high reliance that several countries in Europe, for instance, Germany, have had on Russian energy. So just as an example, Russia provided fifty-five percent of the natural gas imports of Germany prior to the conflict. We are starting to see major shifts in policy in a country like Germany as it tries to change in a hurry and start to reduce that dependence, but that of course means that there is a very high premium to natural gas prices right now across Europe. This has been further exacerbated by the climate changes that are going on which have resulted in alternative power sources like nuclear not being as effective as they would have been perhaps for places like France, and all of this has meant that energy prices are quite a bit higher in Europe, by magnitude multiples, you know, six to seven times more than what we are seeing elsewhere. And that certainly means that the brunt of the pain, both for consumers and for companies is quite a bit higher in Europe right now.
MUCHA: That’s a big number. How should we assess the macro impacts of that?
DHAWAN: I think that the question is, how much of this burden of high energy prices is borne by the government? So early on we have seen a fiscal response where the governments have stepped up and tried to help alleviate the pain for consumers and companies. But as this number continues to ratchet higher, it is unclear whether all of this can be offset in coming months. And so, we really need to think about what kind of downturn Europe might face in the winter months should something like rationing have to come into place. That’s hopefully not going to have to transpire, and storage comes to the rescue, if you will. But nevertheless, weaker activity seems to be a given, and it’s really a question of the degree of the weakness that we have to calibrate for coming months.
MUCHA: It’s hard to separate inflation from politics and the broader societal impacts. So Juhi, how do you think this is likely to play out in coming elections, in the US and elsewhere?
DHAWAN: Inflation is polling as the number one issue in the United States right now. No surprise there for voters. And I think that it’s not a coincidence that the latest fiscal package passed by Congress had the title “Inflation Reduction Act” to it. Politicians do understand where voters’ minds and hearts are, and there was really a determination to try to shore up energy policy in this package with the thought that this really is going to be where hearts and minds are as voters think about who they’d like to have in power in coming years. And I think that this type of concern across the political spectrum in different parts of the world means that fiscal policy probably continues to play a much more active role than we have witnessed in, say the last decades or so.
MUCHA: I want to get to the Inflation Reduction Act in depth in a minute, but before we go there, let’s examine some history. Particularly, the late 1970s and early 80s when inflation was running so high. How do you think the current Fed views the parallels with that past? Do you think Chairman Powell is summoning his inner Paul Volcker here?
DHAWAN: I think a lot of monetary history has been re-read by a number of us in the last few months, and there are a lot of great lessons for all of us in there. Not just Chairman Powell, but many members of the Federal Reserve Open Market Committee have invoked Paul Volcker, but have also talked about the historical experience with inflation, really affirming their commitment to try to bring inflation lower and understanding and repeating the lesson that they learned, which was not to give up on the fight early, but to persist to bring it all the way back down, and not to change and pivot on policy early. And that’s been one of the key messages that was recently confirmed again through Jackson Hole.
MUCHA: The markets aren’t going to like that tough message though. Or will investors respond favorably to this policy? It’s a push and pull issue, right?
DHAWAN: For sure. I think that realistically, markets do well when policy is sound. And so short-term pain, I think would be acceptable to most market participants as a worthy price for reaching a point which actually results in sustainable policy and leaves the US in a much better position for the long term.
MUCHA: All of this, Juhi, muddies the current macro backdrop in the US. So, walk us through your thought process on the recession risk here in the US.
DHAWAN: The Federal Reserve continues to talk about tightening policy into restrictive area. We are at two-and-a-half percent short rates in the United States today with the goal of moving them quite a bit higher, in terms of the guidance that they’re providing, and also a commitment to keep those rates in restrictive territory for quite some time to ensure that inflation comes back down towards target. So that obviously means that growth is going to be below trend, and once it’s below trend and moves quite a bit below trend, the question then becomes of recession. And so that’s obviously where the US is today. I’m involved with the National Association for Business Economics. I serve as the policy survey chair there, and we have just finished the policy survey in August, which I found fascinating for two reasons. Recession and inflation were the two most important topics that came up, and the range of views that came out of this survey from trained economists who serve as panelists on the survey, was truly incredible in terms of the disparity relative to the past. As an example, roughly nineteen percent of panelists believe that the US is already in recession today. About half believe that we will be in recession somewhere between the fourth and first quarter of next year, and there’s as many as many twenty percent who believe that we will not see a recession at all until past 2023. That’s pretty remarkable for folks who do this for a living every day in terms of a disparity of view. And I think it sums up the complexity of data and just how the crosscurrents from the war, as well as what’s happening in China, and the tightening of policy in the United States is making it very difficult to understand quite what the future is going to hold for us.
MUCHA: So, a lot of questions about the future. A lot of views. A wide spectrum of probabilities. Juhi, in this moment of macro uncertainty, what are the key data points we should watch from here?
DHAWAN: I think on the upside, when we think about energy prices and food prices, if we were to see these come in because of, say, some resolution on the war, or because of demand problems elsewhere in the world, because we are seeing weakness in China; we are seeing weakness in Europe, this can actually help alleviate the pressure on the Federal Reserve from an inflation front and also bring real income gains for consumers preventing a recession. So, this is the possible upside case that some people want to think about in terms of what could change the trajectory.
MUCHA: So, there’s a good news story out there?
DHAWAN: There is a possible good news story out there. On the downside is the fact that we have a very tight labor market, and wage gains are quite strong, and the Federal Reserve would like to bring the trajectory of inflation back towards two percent on a sustainable basis, which probably requires restrictive policy, and when policies tighten as much as the Fed is tightening at the pace that it is tightening now, typically downturns result, and we should think about it in those terms.
MUCHA: Yeah, you mentioned China earlier. We can’t have a global economic discussion without considering the state of China’s economy. So how concerned are you? And how do you see that impact playing out around the world?
DHAWAN: So, the Zero-COVID policy in China has had a huge detrimental impact on activity in China this year. But in parallel, there are also concerns about the Chinese property market that have been bubbling for quite some time. This has meant, in some ways, that there has been weakness and demand coming from China, and it has also in some ways perhaps suggested that some prices of commodities, which could have been yet higher, are not as high because China is such an important player, and that weakness in demand has actually helped alleviate some of that pressure. I would almost describe the situation, Thomas, as that of rolling recessions. We started to see the weakness in China because of its policies. We started to talk about problems in Europe because of the elevated inflation that came as a result of the war, now we start to talk about problems in the United States. So, you see how the weakness seems to go from one region to the other as we go forward. The good news from the standpoint of China is that inflation is not a concern in that country, and that does allow the central bank to ease their policy, which they have been doing for a little bit of time. We also have a very important congressional meeting coming up in China, and that, again, could result in some fiscal efforts coming through, which could also be additives. So, while the news on the ground has been of weak growth in the early part of this year, there are some indications that policy is starting to react, and that could provide some signs of stabilization later this year.
MUCHA: Yeah, certainly. The economy in China is at the forefront of policymaker minds ahead of China’s National Party Congress in October, and so that makes sense to me that they would be focused on fiscal. Which brings me back to our earlier discussion about fiscal spending here in the US. First on the Inflation Reduction Act, how are you looking at it from an aggregate perspective? You know, impacts on GDP, on taxes, on debt. I mean, do you view this as a big deal from a macro perspective?
DHAWAN: I do view the Inflation Reduction Act as a big deal, from a medium-term context of what this can do for reducing emissions in the United States for the green transition in the United States, and for really some of the commitments that President Biden had offered in his election campaign to help the United States on its path of decarbonization. So, the actual dollars being suggested, we’ve seen something like US$370 billion being put in place for climate-focused areas, and I think the big thing here, Thomas, is to know that for the first time there’s certainty of this funding for a period of ten years. And I think that’s what makes this stand apart from other prior fiscal periods where funding might have been provided for a year, maybe for two years. But to offer this kind of certainty of ten-year type of funding really is going to give a boost to clean energy technologies, in not just established areas like solar or wind, but also to some nascent areas like carbon storage, or hydrogen, which are not yet cost-competitive, and which might actually get a boost out of this.
MUCHA: Well as you know, I’m a close follower of climate policy, climate action. I’m delighted to see anything that has substantial efforts to move us in the right direction. But you know, on the negative side of this, you know, there are some inflationary costs associated with the energy transition. So, do you think this bill is likely to reduce inflation on its own, or how are you thinking about that impact?
DHAWAN: The concentrated push towards decarbonization that is taking place globally, because we’ve talked a little bit about Europe and its energy transition which will get another lift towards renewables because of what’s going on in China, where there’s also a concerted effort towards decarbonization, all of this suggests that resources might have a greater inflationary impulse in the coming few years than might have taken place otherwise. So, you can argue that there is a little bit of an inflationary impulse from that. Where the bill gets its name of inflationary reduction really has to do with the fact that some taxes were raised in this bill, and in aggregate, the US deficit is projected to actually decrease by US$300 billion over the next ten years. That in itself is an act that really talks about the self-financed nature of this, so that there wasn’t further fiscal expansion, which could be considered inflationary.
MUCHA: Ah, gotcha. So, that’s a pretty significant move. But there are some critics who say the US is still behind Europe, still behind some of our allies. How do you think this bill, and in the general direction of the climate thinking from the Biden administration, how do you think that’s playing with the allies? And do you think that this will increase collaboration on this issue?
DHAWAN: The Biden administration has certainly done more than past administrations in this area. Our allies are certainly going to feel like something was delivered by this government, and that certainly is a plus. Realistically, what determines the speed of movement is a commitment, certainly by governments, and by countries, and the population within to move towards decarbonization. But I would argue paradoxically with what has transpired with the Russia-Ukraine war is that those countries or regions which are short on resources, or which are importers of energy, are probably feeling a more pressing need to find alternative sources of energy, and therefore might accelerate their path towards alternatives, than say a United States needs to. Here, it is really the fact that we are as a nation blessed with natural resources that makes our path perhaps more dual in nature compared to other places.
MUCHA: As they say, all politics is local, but so too all policy is local, as well.
DHAWAN: That’s right.
MUCHA: Juhi, I’d like to switch now to some of your longer-term macro views, also some of your thoughts about your research process which is a key topic of this podcast. So you know, what’s your overall worldview? Or if you will, what’s your philosophy that gets turned into a research process?
DHAWAN: I think it’s really important to think in global terms, first of all because the world is so connected today, what happens in one part of the world has so many ripple effects, and I feel blessed that we have such a fantastic team which works well together, and we can analyze things together and bounce ideas off of each other, and really push each other to understand the implications of what happens in one part of the world, and how it’s going to influence other places. So, an important part of my research is to do the local work, and then spend a lot of time on that interconnectivity, because that really influences the types of investment recommendations that that I eventually make.
MUCHA: So, putting all those strands together then, do you think we’re in for structurally higher, more volatile inflation? And if so, what does that mean for asset prices, the cost of capital, liquidity, and all these other general market dynamics that investors care so much about?
DHAWAN: I do believe that the global economy is transitioning towards somewhat higher and more volatile inflation. I stress the words “somewhat” and “volatile” because I think that policy levers that different countries are going to be utilizing are different than in the past. And this emphasis on fiscal policy, for instance, relative to monetary policy is a key difference in my opinion. But there are also demographic factors that are pushing this. We are seeing real scarcity of labor starting to become an issue in so many different parts of the world, something that was not obvious in the last ten to twenty years. Much of it is demographically driven, and so these are pretty irreversible changes and shifts that take place and can make a difference. As fiscal policy comes to the fore and monetary policy starts to recede, I think the big liquidity tailwind that asset prices have enjoyed in the last decade or two also starts to recede. And that has a lot of implications on the types of styles of investing, types of stocks or sectors that can do well in the market. But, you know, quite honestly, I also think about it in real simple terms for most folks. Cash is an alternative today. It has not been an alternative for a long period of time. It’s a different equation when you start to think about it in those terms relative to where things have been. So, a lot of very profound shifts taking place that matter for markets.
MUCHA: Yeah, these are profound shifts; they’re structural; they’re going to be long term. I mean what’s your sense about either asset classes, regions, or sectors that might be the winners or the losers here? You just mentioned cash, but you know, what are some others that might end up on the positive or negative side of this?
DHAWAN: If I’m right, and we see the unleashing of a really strong capital investment cycle across the developed world, as a result of supply chain becoming more localized, or regionalized, as a result of energy security gaining prominence, as a result of more fiscal spending coming to the fore, I think many old economy stocks that have been left behind for a long period of time might start to gain some traction in the upcoming decade. I also think that we are in this period where it will be very important to become more cognizant of valuations, something that has not happened for a period of time where it was growth at any cost, if you will. And so, the type of stocks that do well, the types of returns that we think about, and the kind of securities, can be quite different in the upcoming decade than what we’ve seen in the last.
MUCHA: That sounds exciting, from an investment perspective. You know, one of these other big structural shifts, obviously, is also one of my favorite topics, geopolitics. You and I spend a lot of time together on our respective research agendas where there are plenty of intersections. So, I’m curious for your perspective on how rising geopolitical risks, the big shocks that we’ve been seeing the past couple of years in this space, from Russia to China to Taiwan and beyond, how’s that shaping your research and your analysis?
DHAWAN: Thomas, I feel and I’m not saying this because we’re having this conversation, but it’s truly the case, I feel so blessed that we have the resources to actually have a dedicated expert like you on the team to continuously drive home the importance of these geopolitical shifts in the global economy. It raises questions like, will the dollar stay supreme? If Russia doesn’t want to trade in dollars, if China in the future perhaps may decide to change its relationships with other countries, it’s the kind of question that we take for granted today, but when we think about the types of geopolitical shifts that are taking place, it makes us question and ask difficult questions of companies in which we are investing by saying, tell us about the concentration risk of your factories, or tell us where you’re invested, or what kind of relationships exist in those countries where there might be some very important research and development that’s taking place for a specific industry? So, I really believe that the world is getting more complex, and understanding these shifts matters much more than before in order to make really sound investments in the future.
MUCHA: Yeah, it truly is a brave new world, and again, these are structural changes; they’re long-term changes. We could have a three-hour discussion on just this one point. But I’ll just pick one aspect of this, which is defense and national security. And given these changes, given the challenge geopolitical backdrop, the US, along the Europe, Japan, China, all sorts of other countries are ramping up military spending. I think we’re in agreement that this is likely to be a key macro driver for years to come. So, you know, how should we all be thinking about sort of the downstream effects of secular higher national security spending and ballooning defense budgets? I mean, is this a positive from a macro perspective, is it a negative? Is it a little bit of both?
DHAWAN: I’m going to take a little bit of both. In pure economic terms, you could say, building walls against each other is never good, and free trade is or was a strength of the global economy, and sort of, fewer the barriers, the better it is. So, this type of spending indicates an increase in inefficiency, which you can argue means, if you will, in some ways, lower profitability in the future.
MUCHA: And higher inflation.
DHAWAN: And higher inflation in the future. It has been a very unequal path up until now in terms of who has spent on defense, or how the world has gone about thinking about some of these issues, and it is important to see many regions starting to take on their responsibilities very seriously in this area of really wanting to ensure that they themselves are independent in their spending. So, I think of it in those terms as saying, that that’s a good thing that we are ensuring that security is not something that we take for granted.
MUCHA: Yeah, I do think it’s one of those things that was taken for granted over the period of globalization, right? This whole movement towards integration at the global economic level was underpinned by a strong defense and these alliances that were rooted in national security. We sort of got away from that, and I think we’re moving back towards that, and it’s going to have a lot of important long-term investment implications for sure.
DHAWAN: Hundred percent.
MUCHA: So, I’d like to begin to wrap up our conversation here, Juhi, with a few questions of a more personal nature as we do on this podcast. We try to get to know our analysts a little bit better in this format. So, first thing is, we all like to read. We’re all voracious readers looking for new ideas. So, can you recommend a book that has influenced your views or your thinking and that might help us make sense of this shifting macro environment?
DHAWAN: Given our conversation in the early part, I’m going to pick Monetary History of the United States, by Friedman. If I think about all that is transpiring this year and what we’re seeing in markets as valuations are being compressed, as interest rates are starting to rise, as central banks bring in liquidity, I’m really reminded of the old adage of fundamentals, and going back to that, and that book I think is a great read. And for those who like alternative sources of media, I think there’s a set of videos on fundamentals by Hoover based on some of this now.
MUCHA: It’s good to go back to basics when things are so in flux, isn’t it?
DHAWAN: For sure, for sure.
MUCHA: So, Juhi, you clearly have a very important job at the firm. So, tell us a little bit about how you got into this position, how you got to Wellington, and what your experiences at Wellington have been like.
DHAWAN: Thomas, I consider myself to be in a very fortunate position of having worked at Wellington now for almost twenty-eight years, and it’s been a remarkable journey, cause I came out of graduate school, I got my PhD at Brown University, and was really just looking for a private sector position, and Wellington at that time was just starting its plans to globalize, and looking to expand its macro team. Call it serendipity, but this job pretty much fell in my lap, and I’ve never looked back in terms of the opportunities it has afforded me. I started off with one country, the United Kingdom, as my coverage. I had the great privilege and anxiety of covering Europe through the sovereign debt crisis. I’ve covered countries as diverse as Australia, and now get to cover the United States. Perhaps all of this really speaks to why my mindset is extremely global, and why I think it’s always so important to connect the dots, to try to get to as sound an answer and conclusion as possible.
MUCHA: So, Juhi if you weren’t a macro strategist at Wellington who specializes in the Fed, and the US and global economies, what other career could envision for yourself?
DHAWAN: Thomas, you know that I’m originally from India, and I would dearly like to start up a nonprofit there for underprivileged children. I think that what we can accomplish for kids today who don’t even get two square meals, but the opportunities that can be afforded to them with some basic education, with the ability to be clothed and have food and just in a safe environment to learn, I think that I would find that incredibly rewarding to see that come to fruition.
MUCHA: Juhi, that’s a great answer, and I hope one day you get to realize that dream.
DHAWAN: Thank you, I hope so too.
MUCHA: Once again, thank you, Juhi Dhawan, Wellington Management macro strategist, for being on the podcast and really, thank you for everything that you do for the firm.
DHAWAN: My pleasure, always.
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Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced September 2022.
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