WKLY - What Tightening Financial Conditions Mean For The Global Economy

2023-05-17 14:27:00 ET

Summary

• The impact of aggressive rate hikes on economic growth.
• Have central banks turned a corner in their fight against inflation?
• Are central banks still in control of the process as financial conditions tighten?

Tightening financial conditions are raising concerns about the health of the economy, and the ability of central banks to rein in inflation in a controlled manner. Greg Bonnell speaks with Brad Simpson, Chief Wealth Strategist at TD Wealth, about the state of the global economy.

Transcript

Greg Bonnell: Our featured guest today says there are three big questions on his mind when it comes to the state of the global economy. Joining us now to discuss, Brad Simpson, chief wealth strategist at TD Wealth. Brad, always great to have you on the program. Welcome back.

Brad Simpson: Thanks. It's great to be here.

Greg Bonnell: All right. People-- I love when you can number things. Three big questions on your mind. So let's break down the numbers. It's been a lot of central bank tightening. I understand this is the first thing on your mind.

Brad Simpson: Yeah. And you know, something from the last segment you just said is that it's a lackluster market today. You know, like every second Monday I do this kind of global conference call through our system and one of the things I've said is, the financial markets right now have this lackluster feel to it? Which, if you think of all the things going on, and really markets are really, really quiet.

Greg Bonnell: I got accustomed last summer to these wild swings. The slightest bit of information about inflation, you're up 3%, down 3%, now it just sort of seems to be a bit of a...[OVERLAPPING SPEECH] Brad Simpson: And it seems like, one of the things we're always talking about adapting and evolving. And a lot of the -- it's almost that we've gotten to the point where we're so used to big things, and we're just getting used to this endless array of big things that are impacting, like actually quiet, level markets surprise me. And it does. And I think, I guess, the start is that I think you'd be remiss no matter how many of you look at it, is that inflation is still the thing that you've got to put front and center. And, you know, and in a news cycle you kind of want to go, OK, we've heard about this a bunch of times and then let's move beyond this.

Greg Bonnell: That machine is hungry. It's still about price pressures.

Brad Simpson: But the bottom line is, is that this thing is more resilient than, really, what would you, I would say that most people and I would say our first thoughts, really, were on this. So I think it behooves us to come back and go, let's keep on this and let's look at this. And then when we do look at, when we do that, it is getting-- it is getting better. We are seeing both CPI and PPI numbers that came out last week, which are showing that the efforts by the central banks are starting to tighten things up. Inflation is continuing to come down. You look at the US Federal Reserve Board, they are now at 500 to 500 and a quarter. So lots of rates increases.

And their last increase of 25 basis points, came out and said, well, kind of surprised with everybody saying, you know what? We're going to take a wait and see attitude, let's get a little bit slower on this. We saw the Bank of England come out-- and they probably have some more to go, but their language definitely started to change and say, we think that we're starting to get a grip on this. You look over at the ECB that kind of said, look, we're going to stop doing this at 50 basis points a clip, starting about 25 basis points a clip. All of that starts to point to a more positive trend for inflation.

And so with the Central Bank kind of started changing their tone, I think there's a ways to go, but without a doubt that I think we could probably feel that -- yes, I know there's a lot. When I go to dinner parties I can hear the fear of it still. And it's understandable. But it's -- that fear is starting to slow. And it probably should, because I think that a lot of the conversation we'll go to from here is that, in many ways, financial markets have almost turned and said, OK, well that's dealt with. Where are we going to go to next?

Greg Bonnell: Is the wild card here, I mean, economic growth? The whole point of all this aggressive tightening, get inflation under control. And they said the byproduct of that, and not even the byproduct, the whole point of this, is we're going to slow the economy a little. Are we getting the signs that they're actually doing that? Because some of the data that comes in sort of surprises me.

Brad Simpson: Yeah. I think that's, I think, one of the things that we really want to look at with this is that when you start working through the economy, and again, sometimes I feel like, boy, the things that you folks are looking for, how can you look at the world in this way, right? But the only one way to really slow inflation down is you have to start taking on your economic growth and looking where that is. And so, if you sat back and looked at the global economy and you said, well, let's start out and say that unemployment is at 3.5%, that's the lowest it's been since 1969.

Now, I don't think I'm the youngest-looking guy in the world. I was born in 1969. That was a few years ago. So despite the fact that we're starting to see-- we saw some numbers come out last week that did show that inside of the labor numbers are starting to slow. 3.5% is really, really employed.

So the two big things I think you got to look at when you're thinking about where this global economy is going, I think the starting point is employment. And I don't think anybody could argue that this is a softening sign here, but what we look at that people who are employed, the other side of this is looking at the consumer. I mean, right? These two kind of go hand-in-hand with one another.

As we start to look at what's going on inside of the economy, what we see is that we all know what happened with the Silicon Valley Bank ( SIVBQ ), and then all the offshoot from that. What we're seeing inside the economy, both in North America, seeing in Europe, is we're tightening up credit. And credit makes the world go round. Money makes the world go round and the ease of money going on with that. So one of the measures we use is financial conditions.

And so I think if we did-- went back in time and looked out, I think I was here in August, about a year and a half ago, and one of the things we were talking about was that the central bank came out was looking at easing of financial conditions when they were trying to tighten. And Jerome Powell just said, that's it. Done.

Greg Bonnell: In that Jackson Hole speech?

Brad Simpson: Yeah, that Jackson Hole speech.

Greg Bonnell: He laid it down, yeah.

Brad Simpson: So if you look at it that financial conditions have gotten tighter and tighter and tighter and tighter since then. Then you look at senior loan officers coming out. So this is flat-out mid-level bank people going out and having their boss tell them, listen, don't send any money out there. Well, that is small, medium-sized businesses, they are starting to show that this is getting tighter.

So, usually when you start to see this happen in times past and see the tightness of these levels, they've usually been a pretty strong indicator that you're late stage, getting closer to a recession, lot of signs that you're going to look at a changing labor environment.

Then if you look at that changing labor environment, you kind of go over the consumer, you can look at the consumer in North America, you can look at what they're spending on restaurants, look at what they're spending on clothes, and you know that-- every time I walk in to go get some shirts or something, I'm amazed at how much is on the shelves and how much sales there still are on these type of things.

You kind of start putting all those pieces together. It's an economy that, while looking good, if people start worrying about their job, people start taking a look at it and saying, look there was about, roughly, about a trillion and a half dollars of surplus capital on people's balance sheets in the US. And that's the largest consumer in the world. We think that's about down to $500 billion now. That's a lot of spending, but that's a lot of spending that they've gone through quite quickly. So I think that the people's wallet's getting tighter and tighter.

Then you look over-- and then you look over in Europe and you're starting to see things slow. You're looking at the big tailwind that everyone was kind of counting on was China would reopen and be a big tailwind.

We've seen some numbers, they are not so strong either. All of that points to, we have a healthy economy today, but there's no doubt this is one that is slowing as well, which will really help take care of the inflation. It's also going to change the dynamics of the market environment, as well.

Greg Bonnell: When we think about that, that's what the central banks want out of all of this.

Brad Simpson: Absolutely.

Greg Bonnell: Will they stay in control? They're getting what they want apparently right now. Does it get out of their control?

Brad Simpson: Yeah. I think that's one of the things you have to look at is these are the things that we know and these are the trends that we can follow. Let's start and look back and go, OK, we're confident that we've been able to contain the banking crisis so far. But this is a "so far." And so I think that that is still a potential risk that is out there. I think that, and all the cousins of that, that I think we're well-aware of.

And I know we published a paper a couple of weeks ago about commercial real estate, and we wrote about this pretty extensively in our portfolio strategy quarterly, one of the effects ultimately could be, in many areas of commercial real estate it's pretty tough sledding there right now. And if you look at it in through that lens, that has potential, because an awful lot of that lending is kind of in that mid-sized banking sector. If you want to talk about small and mid-sized businesses, most of their access to credit is coming from the mid- and small-sized banking sector. All of that starts to point to real potential problems down the road.

You start looking at some of the hiring patterns from some of the small and medium-sized companies that are really starting to tighten up there. So that one I think is still-- I'm not saying that there's an inevitable break out there, but I think that could get ahead of central banks and things that they just can't stop the momentum on, would be one.

And I think the second one is, which I'm going to guess we're going to probably dig into a little bit here, this debt crisis is a real thing and this isn't something that a central bank can solve. And that has the potential to have a lot of downstream impact that I think, quite frankly, there's a lot of lawmakers in the United States that don't have the financial background to understand just actually how big of a deal this potentially is.

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