INSIGHTS

We’re sharing an edited excerpt of our October 19, 2023, Q3 CIO call with co-CIO Greg Jensen, where you’ll hear Greg describe how he’s seeing the biggest dynamics in economies and markets today. He covers the reasons behind the economic resilience to date, why backward-looking supports are now set to unwind and reverse, the upward pressure on yields that will be a headwind for assets, the grind down we expect in growth, and the divergent global conditions that are creating differential pressures relative to what’s priced in. We hope you enjoy the discussion.

TRANSCRIPT
Note: This transcript has been edited for readability.

Greg Jensen
The world’s changing a lot; the world’s super interesting. There are obviously many things that are timeless and universally true, but the degree to which they’re true or the degree to which you have to understand different types of dynamics is important.

I thought it would be helpful to talk about that in the context of what we were thinking pre-COVID. In 2019, we were thinking the world was at a crossroads—that you had gone through, since Volcker from the 1980s, this disinflationary period, decline in potential growth, and we’re in this risk of secular stagnation, as demographics and debt problems continue to play out.

So the question was, were we going to go down a path of constrained central banks and Japan-style deleveraging? We thought if they didn’t move to what we call Monetary Policy 3, if they didn’t move to fiscal policy matching the importance of monetary policy, you’d end up on this continued downward slope. But we faced these big choices that, really, populism had started to push, which are, are we going to actually change the economy? Are we going to end up with much more government-involved policy—deficit spending and money printing? Pro-labor policies and deglobalization would cause a change in the inflationary and the nominal GDP path that we had had before.

So that was the choice that we faced, and we ended up, really because of COVID, on the upper fork. And COVID accelerated a lot of those secular changes, and there’s so much going on. We had a plan—because we were thinking about this in 2018, 2019—we had a plan on how we’d put fiscal policy bigger into our process, how we’d think about deglobalization and pro-labor policies and the impact they’d have. But then it actually happens, and you learn so much through it actually happening.

Going from that picture to the things that are playing out today, so going from that big picture—the world’s changed a lot from pre-COVID, it’s really important, and those changes are having a lot of impact on what’s going on.

The first thing was we had a massive tightening, and the economy has been resilient despite that. And you really have to understand all of the changes in the economy to understand that.

First was the fact that you had a huge fiscal policy in 2020-21 that led to massive improvements in household and corporate balance sheets. You’ve never come out of a recession with households and corporates having more cash than when they entered the recession with—a better balance sheet than when they entered the recession with. The second thing is that the demand spike, due to that excess cash that went onto the balance sheets from governments to households, led nominal demand to be so far above supply that, even as nominal demand slowed, supply was still struggling to catch up. And a large budget deficit expanded without bond issuance, as I’ll describe, and that supported spending in markets.

So those three things really supported the economy, cushioned the impact of the tightening that actually did occur on credit, and netted to a reasonably sustainable growth rate over that period. But as you’ll see, those things that caused that buffer have largely gone away. Credit’s already fallen a lot. It has created that cushion. But the impact of higher rates for longer now is going to be playing out while there’s much less support on the other side.

Now that the easing’s been pushed back and bond issuance is beginning to normalize, upward pressure on yields is creating another round of tightening, which will be a headwind for other assets and, we think, the overall economy. So as a result, we expect growth to grind down as high rates produce a steady drag and past supports fade. And conditions are diverging globally. There are a lot of different ways that people have handled the post-COVID environment, leading to big differences that create a lot of opportunities in currencies and differential pressures.

And finally, to understand this environment, this timeless and universal truth is really important, which is basically this formula—that money plus credit plus income is equal to the spending in the real economy, the spending on financial assets, and reserves. That’s always true, so there’s a timelessness to it.

But what’s actually happened in this period is so interesting in this timeless truth, because things that almost never happen within this timeless truth have been very important. Money went down in 2023. Credit went down in 2023, particularly private sector credit. Public credit went up, so there’s a little bit of a mix there. Private sector credit went down a lot. Normally, public sector credit is reactive to the overall economy. But public sector credit went up even though incomes never went down. Incomes were kind of flat to slightly down in terms of growth rates. Spending stayed strong, even stronger than income, and that was a function of the money that went into financial assets. Money, in terms of financial assets, money came out of bonds but actually went into equities and cash.

And how did you get there, with money and credit falling and income being kind of flat? How did you get enough money in spending for it to continue to grow and enough money to support financial assets? Well, a unique thing happened: the money came out of reserves. The government borrowed money. It didn’t have to get that money from the private sector; it didn’t have to get that money from, essentially, the money sloshing around the economy. It was able to get the excess reserves that were sitting on the Fed’s balance sheet to fill the hole. So the unique ways that we settled in with a collapse of money and credit but not a collapse of spending in the economy and financial assets—and that’s really important to understand and understand how sustainable it is.

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