00:00I don't know if you've seen this interview with Isabel Schnabel. Of course she is a hawk on the
00:04governing council, but when you have an ECB hike in September almost fully priced, do we need to
00:10wait for 2027 for another one? I don't think so. As you rightly say, Isabel Schnabel has been
00:16consistently on the hawkish end of the spectrum in the last couple of years, and particularly
00:20since the Iran conflict began. But in terms of the rate outlook for the ECB, I mean, let's look,
00:26it's true that the Eurozone economy has been resilient in the face of higher energy prices.
00:30To some extent, the household savings have clearly acted as a buffer. We anticipated that to some
00:35degree. I think it surprised us and others as well, to the extent to which that has played out.
00:41But we're thinking about price pressures going forwards. There are next to no signs of indirect
00:45effects of the conflict feeding through. So you're going to have higher energy prices obviously
00:49hitting consumers with higher fuel prices. Ultimately, that will feed through to higher
00:53electricity prices as well. But in terms of the indirect effects, things like how is higher
00:58fertilizer prices and how are fuel prices going to boost food inflation? To what extent is jet fuel
01:05prices passing through to airfares? To what extent are some of these power generation costs
01:10diffusing their way through the price mechanism? So far, there's very limited evidence of that.
01:15Now, it's true that some of these effects are lagged. They do take time to feed through. Food inflation,
01:20for example, can take as long as a year to fully feed through into consumer price inflation.
01:25But I think the magnitudes we're looking at and the limited evidence of these sort of indirect
01:29effects we've had so far suggests that price pressures are relatively contained. We've had
01:33some of the survey indicators have started to see some of these price indices fall a little as well.
01:39And the big thing that keeps central banks up at night is the risk of second round effects. Is the
01:45labour market hot enough? Is the economy booming such that workers and firms respond to higher
01:50energy prices by trying to bid up wages in order to compensate themselves for a hitch to their
01:55purchasing power? And I don't think there's very much evidence of that either.
01:57But if you put the second round effects to one side, within energy, and that gas price is more
02:02of a concern now for inflation than oil when it's the European picture? That's right.
02:07Okay. Right. So where's neutral for you? Well, I mean, to be honest with you, we don't even
02:12necessarily think that they needed to have hiked already. And we thought, we've characterized initially
02:19when they hiked, we thought it would be a case of a one and done. That would be all that's
02:23necessary.
02:23That was predicated on the view that we wouldn't get a sustained increase in natural gas prices.
02:28And it was predicated on a relatively optimistic view that seemed to be prevalent at the time of
02:33the signing of the memorandum of understanding that we would get a gradual reopening of the
02:37Strait of Muz. That has obviously come into doubt. And the longer that this conflict goes on,
02:43the longer that the blockade is in place, the bigger the risks are to energy prices. Now,
02:47you mentioned that gas being more important than oil for Europe. Absolutely, that's the case.
02:50And we're seeing natural gas prices rise. Stocks are at a seasonably low level. They
02:56really should be much higher where they are, considering we're coming into peak demand season.
02:59Heading into winter. That's it. So I think the risk here is that you do get higher
03:03gas prices feeding higher electricity inflation and higher food inflation. The question is,
03:09what is the state of overall demand? Is there going to be, in the question for 2027,
03:13is the eurozone economy going to be strong enough to allow to convert those transitory price pressures
03:20into a more persistent price pressure to which the ECB would need to respond forcefully?
03:24And I'm not convinced that's the case. It's true that the rhetoric coming from some of the
03:29governing council members and the stance of the ECB generally, I would say, we can characterise their
03:34reaction function as hawkish. So there's the risk is clearly to what there's there being a one or two
03:39rate hikes. But my base case is that the economic fundamentals don't justify them.
03:43Let's also talk about the US because, of course, we've got PCE coming out later.
03:47How hawkishly skewed are the risks from that print?
03:51Well, I mean, not really. I mean, the print for the PCE deflator is we've already had the CPI
03:57and the PPI data. So we're pretty nailed on for a sort of around target consistent, slightly higher
04:02than target consistent print for the core PCE deflator. So we're looking at a 0.2 monthly gain.
04:08Now, that on itself, taken in context with the weaker, the softer labour market data that we've
04:14had recently, taken into account some of the softer activity data as well, it's just sort of
04:19dampening some of the appetite for a sort of a September hike from the Fed.
04:23OK, because the bets have been up and down when it comes to a September hike.
04:27Yes, it's been a bit of a roller coaster, hasn't it? I think that we had initially ourselves,
04:31I thought the September hike was most likely outcome, but always contingent on the July and August
04:37data releases. And it just turns out that ever since we had the July FOMC meeting,
04:41things have sort of been playing into the doves' hands.
04:43Well, partly because, of course, of Kevin Walsh's communications.
04:47Well, yes.
04:47We're going to hear from the chairman on Friday at Jackson Hole. Do you think that he
04:51needs to give more clarity on the reaction function of the Fed and his views on inflation
04:57to restore credibility to the Fed? Or is Fed credibility just fine in your eyes?
05:03It's a bit of both, really. In a sense, it's a storm in a teacup. And it's like the big
05:10commentary we all had about whether Fed independence was under threat from Trump. And a lot of column
05:15inches was devoted to it. I'm sure a lot of interviews on this program were devoted to
05:19discussing that issue. And generally speaking, it doesn't amount to a huge amount. Similarly,
05:23with the credibility of the Fed being brought into question by a bit of a flop at a press conference
05:30from Kevin Walsh, it's probably overstated the significance of this.
05:34So, just a rocky start, maybe? A rocky start, maybe. But, I mean,
05:38what makes me only slightly marginally concerned is that, of course, it is a longstanding view of
05:43Kevin Walsh that he's not a fan of great transparency and markets want transparency. So,
05:48to the extent that he wants to manage market volatility, it makes sense for him to come out and try
05:51to
05:53give markets a little bit more in terms of what he's talking about, in terms of what inflation
05:57measures is he talking about when he's talking about inflation pressures more generally. We want
06:01to know – in the past, when we were talking about inflation targets moving, that was a question of
06:06central banks potentially moving the goalposts. With Kevin Walsh, it's a question that there are
06:10multiple goalposts and we don't know which one he's shooting for. And it would be really good if he
06:14gave some indication about that. The problem is, of course, Jackson Hole's theme is about financial
06:19innovation and about payment systems could be a bit of a snoozefest. But there's a chance,
06:26there's probably a likelihood that he says something interesting.
06:28But what about Scott Bessent's credibility, the Treasury Secretary wading into the bond market?
06:33You've been the voice of reason. Does he have a credibility problem, would you say? Because
06:38you've had the likes of Citadel saying that what he's doing is financial repression.
06:44Oh, right. Okay. So, two things here. On that last point on financial repression,
06:49let's be clear, I don't believe he's doing financial repression at the moment. Potentially,
06:52we're at the beginnings. So, what he's actually doing is debt management, I would say. So, this
06:57buybacks of issuing short-dated bonds to buyback long-dated bonds on such a small scale, I think,
07:04is a relatively minor technical debt management issue. I think moving forward into Q4, they might even
07:11change the issuance such that they, again, skew it more to shorter-dated bonds, to bills. But I
07:16still classify that as debt management. When we're getting the Treasury and Trump coming out and
07:21demanding that US financial institutions have to start hoovering up more Treasuries, or when they
07:26start talking about potential regulatory changes in order to force them to do so, that's when we're
07:31in a world of financial repression. So, I don't think we're there yet, even though I do accept that
07:35we could look back in a year's time and say this was the beginning of a move towards financial
07:39repression. But I don't think we're there yet. The broader point you have about Bessent and
07:43a credibility problem, it comes back to the difficult, sticky situation that the US finds
07:48itself in the Middle East. And clearly, Bessent has been put under pressure to have to come up
07:53with something. The military means has not been sufficient to bring about the change the Americans
07:57wanted in Iran. Therefore, the onus is having to be taken up by the Treasury Department and what
08:02they can do with economic warfare. The latest announcements about the economic D-Day really doesn't
08:07add very much to what's already in place. Iran is already heavily sanctioned. It's
08:11largely an economic pariah. It's under blockade and its exports are largely stopped. So, further
08:17economic sanctions are, one, unlikely to put on much more economic pressure, and two, likely to run
08:24on all sorts of problems with managing the relationship with China, with whom the Americans, of course,
08:28have a famous meeting, a much anticipated meeting in just a month's time.
08:32Exactly.
08:34So, I'd say it's less of a credibility problem, it's just sort of symptomatic of the
08:39wider geopolitical problem that America is dealing with in the Middle East.
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