World Economic Update

Wednesday, February 28, 2024
Ronen Zvulun/Reuters

Chief Economist and Head of Global Investment Research, Goldman Sachs Group, Inc.

Co-Chief Investment Officer, Bridgewater Associates, LP; CFR Term Member

Founder and Chief Executive Officer, Exante Data


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations; @scmallaby

The World Economic Update highlights the quarter’s most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy.

This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies and is dedicated to the life and work of the distinguished economist Martin Feldstein.

MALLABY: Great. Good morning. Welcome to today’s Council on Foreign Relations World Economic Update. This series is devoted to the—dedicated to the distinguished life and work of Marty Feldstein, who was a mentor to many of us. 

We have a great panel. We’ve got over, over there, Jan Hatzius, chief economist and head of global investment Research at Goldman Sachs; in the middle, Karen Karniol-Tambour, the co-chief investment officer at Bridgewater Associates; and next to me, Jens Nordvig, founder and CEO of Exante Data, and of a new company which he will tell you about later.  

I think we’re meeting at a paradoxical moment relative to where we were a year ago. I would say that the political and geopolitical outlook has grown considerably worse. Russia’s made gains in Ukraine. Putin has eliminated more internal opponents. Attacks on the Red Sea and the larger conflict in the Middle East. Continuing evidence of unsteady policymaking in autocratic China. And that’s before we get to this scary polarization and dysfunction politically in the U.S. So all these factors are as bad or in some cases much worse than one year ago.  

And what’s more, I would say that the way that the West is handling these challenges is getting worse too. Whether you look at the failure to deliver arms to Ukraine or the growing evidence that oil sanctions, financial sanctions, chip embargoes are working less well than we hoped maybe a year or so ago. But it seems, nonetheless, despite all that, to be a good time for investors, right? You’ve got the world economy in pretty good shape. Stock market indices and U.S., Europe, Japan, hitting all-time records. All of which is a setup for my first question, which is for Karen. Which is, you know, are you surprised by this disconnect between geopolitics and markets? 

KARNIOL-TAMBOUR: You know, it’s interesting because most investors have shockingly little exposure to most of the areas where you see geopolitical turmoil. And the direct first-order consequences of a lot of these geopolitical issues have not really turned out to be that big of a deal for markets. Whether you look at, you know, Russia invades Ukraine, are grains going to be a big deal? Is sanctioning Russian oil is going to be a big deal? We have a relatively resilient world that finds its way around, you know, kind of targeted, limited issues. So they’re not nothing, but haven’t turned out to be a big thing. 

The really big place where geopolitics, I think, is affecting markets and it’s not a disconnect is really in second- and third-order consequences. This backdrop that you’re describing, Sebastian, which I agree with, of a world that doesn’t feel like the world used to feel—(laughs)—is having a lot of impacts on how companies and how governments are kind of approaching the world we’re in. And it’s part of the, you know, higher inflation backdrop that we’re in. So whether that’s government’s really stepping up industrial policy, defense spending, you know, being out there and having a more active role, businesses redoing their supply chains. And so even if there isn’t an immediate problem right now, you look at what companies are doing. And they’re spending a lot to say: I’m going to make sure I reduce my vulnerability to what if ABC or D gets worse.  

And all of that kind of simmering activity is slow. It’s not one big, you know, you have a big attack and a big, you know, disruption. But it’s part of that backdrop of why we’re in a world that, you know, kind of used to have a gravitational pull of inflation towards zero and it no longer does. And that, of course, has a big impact on markets, and is impacting a lot, you know, kind of how markets are behaving. But certainly, markets aren’t pricing in that any of—all these simmering conflicts are going to impact them in a very first order, direct way anytime soon. 

MALLABY: So, Jens, what would it take for something in the political realm to rise to the level of sort of a first order effect not a derivative effect? In particular, if we get closer to the election in the U.S. and Trump is doing well in the polls, I guess that raises questions about lots of more—you know, additional tariffs on China, the Europeans will have to find money to spend on defense if they get worried that the NATO umbrella—the Article Five guarantee is diluted. How would you see politics really breaking through into the market outlook? 

NORDVIG: Well, so I speak to investors around the world every day. And I don’t think I’ve ever seen a year where people are really, really getting ready for the election outcome, like, so many months before the actual election is taking place, right? So when we had the Iowa caucuses that gave a relatively clear result, like, we could start to see little wiggles in the market, right? And it’s extremely unusual to have, like, the market kind of wanting to front-run an election so many months before. So I think there is a different type of focus on this.  

And the reason is that we had such clear moves when Trump was initially elected. Like we had—obviously, the wiggles during the night—but we had an equity move that was meaningful, we had interest rate moves that were meaning. What had a pretty big dollar move in the beginning. So I think investors are thinking a lot about, OK, are we going to have a repeat of those moves? If they think the polls are clear, do we actually need to do the trades early, as opposed to wait until the night of the election when a lot of people got surprised last time.  

But I think that the key point I would make is that I think it’s very tricky to say, OK, it’s just going to be a repeat of a first Trump administration if we get a second one. And I think the key difference is that I think the focus, if we get a second one, will be very much on immigration, right? And I think it’s worth thinking about if we have a totally different inflow of foreign-born people in the U.S. labor force, maybe even deportations, those types of things, what it’s going to do to the labor market.  

That’s something we didn’t think about very much in the first Trump administration. And that could have big implications, especially because the inflation environment is already different, right? So if we have a negative shock to the labor market from those types of things, on top of inflation issues that Karen alluded to that we have now, it could be a pretty big deal and something that’s different from last time. 

MALLABY: OK. So the labor market effects of immigration policies. I’m going to come back to these—sort of a potential political Trump effect on Europe. But before we do that, I’ve got a question for Jan. Which is essentially, you know, how strong does the European economy look right now to absorb some of these potential challenges from the political side? I mean, if you just look at the basic macro, how do you assess it?  

HATZIUS: I mean, the basic macro, I would still take a little bit more of a glass-half-full type of view in terms of, you know, GDP was obviously weak, kind of close to stagnant in 2023. And that was, I think, because we had a negative impact that lasted longer from the big inflation increase. Because you had not only the post-COVID inflation but also the household energy budget inflation. And that was really weighing on real disposable income. And then weakness in China has a bigger impact on Europe, especially Germany. There are a lot more kind of structural questions around Germany and other European countries as a location for production. So all of that has weighed on the economy.  

But I think now we are seeing some stabilization. Inflation has come down dramatically. And that’s helped real disposable income. And so I think consumer spending is going to look a little bit better in 2024 than in 2023. We’re also likely to see rate cuts from the European Central Bank at some point over the next few months. And that—I mean, driven by the decline in inflation. The increase in rates has actually had a somewhat bigger impact on European consumers than on U.S. consumers, because European consumers have a lot more adjustable-rate mortgages whereas U.S. consumers have overwhelmingly thirty-year fixed-rate mortgages. So that’s been a drag on the income flow as well. That’s probably going to—go into improve. So, you know, I think growth is maybe 1 percent by the end of the year. You know, annual average, I think, is going to be below that. But I do think it’s getting a little bit better. 

MALLABY: OK. So if the glass-half-full view is 1 percent growth, right, that’s a setup for another question for Karen. Because, you know, the German defense minister recently said he thinks defense spending would need to rise to 3 ½ percent of GDP, that’s pretty much a doubling, in order to deal with both the fact that, you know, Putin continues to be super aggressive and the defense umbrella from the U.S. appears to be less reliable. Other people say 3 ½ percent not enough. Maybe you need four. Whatever the right number, we’re in an environment where people are talking about issuing European-wide bonds again. Kind of following on from the COVID experience but doing this now for a common defense.  

And at the same time, you’ve got the U.S. government debt-to-GDP ratio—public debt-to-GDP ratio at—approaching 100 percent. I think it’s 97 (percent). And political polarization, meaning that it’s very unlikely that this debt-to-GDP challenge is going to be managed proactively. So what I’m getting to here is that people have predicted forever, and then to the dollar’s reserve currency status, but maybe we’re reaching a time when Europe’s need to potentially issue more safe assets to finance defense coupled with the U.S. apparent inability to deal with rising public debt means that we should take this challenge to the dollar more seriously than previously. 

KARNIOL-TAMBOUR: Yeah. It’s definitely true that the Europeans are getting knocked from every which way to be strongly, strongly encouraged to be doing more public spending, right? Whether it was last year, all they wanted to talk about was how are we going to respond to the IRA with our own version of this, to now the defense challenges. It’s hard to believe them getting a bigger, you know, kind of punch in the face that they should be doing something more. So it’s a little bit if they don’t do it now, I don’t know when. This seems like the time to really be doing more.  

And from a capital markets perspective, I do think that having joint issuance matters. That it affects kind of how you think about those assets. But I don’t think we’re anywhere close to having a real challenge to the dollar. If you sort of look at—the first thing is that, pre-financial crisis the big people that really mattered in global capital flows and all that were the reserve managers. The fact that, you know, China and OPEC and whatnot were accumulating reserves. And so their decision to, you know, hold too much in U.S. Treasurys was the most significant decision, and a big driver that really pushed down interest rates and created all the excess mortgage borrowing that happened here.  

We’re really not in that world today. There isn’t really a lot of reserve accumulation happening. And reserve managers already, their second biggest market after Treasurys is European bonds. And so on the margin if there’s a lot of joint issuance they could shift a little more, but they’re going to be really cautious how you shift kind of an existing pile. And that’s not a pile that’s growing. The real growing piles are all the different private investors out there in the world. And for those people, you know, they look around the world, they just don’t have a lot of choices that are not U.S. dollar choices, right? So in the debt markets they already have a little more competition with European bonds on the margin, that’s going to make it a little more attractive. But you really can’t invest in debt without buying Treasurys. It’s just the single biggest liquid, most—you just can’t possibly take it out.  

And I’ve heard some extreme conversations over the years, whether it was around Trump election or sustainability, of people trying to say even to imagine a world without Treasurys is very hard to do if you’re a debt manager. And then in equities, the position of the U.S. is even more dominant. And the more you move from reserve managers to private money, more of it’s in equities. And in equities, because of the run up we’ve had, you know, in tech and in U.S. economic outperformance, and the fact that the stock market is just bigger relative to the economy—more companies are listed—if you need to buy stocks, you don’t have any choice. You’re going to hold mostly U.S. stocks, disproportionate to the size of its economy.  

And so I think the U.S. almost has a form of, like, a Dutch disease, in the sense that people who need to save—it doesn’t really matter if they like the U.S. or don’t like the U.S. Just like you may not love Saudi Arabia. You’re going to buy oil if they make it. If you need to invest, you’re going to buy U.S. assets. And I think we’re very far from any, you know, real meaningful challenge that. The U.S. is still getting a disproportionate set of inflows that happen, regardless of how attractive it is. 

MALLABY: I’m going to come to Jens now. I want to just give you a little bit of extra setup here. I’m going to persist a bit with this thesis that Karen is telling me to drop—(laughter)—that we should think about the dollar status in a new way. And I’m going to throw in demographics into this picture. The point here being that precisely because of rising welfare state burdens as you have aging populations, it’s even harder than it would be otherwise to imagine the U.S. political system dealing with 97 percent public debt to GDP without some kind of nasty moment which shocks the markets. You know, some debt-ceiling fight in Congress where, you know, nobody blinks at the last moment.  

And in the meantime, the same demographic argument applies even more strongly in Europe. And that’s why Northern European economies, which have had this political resistance to issuing tons of public debt, again, have put that aside, because they need to borrow to pay for aging. So you’re going to have more debt issuance in the countries with debt capacity in Europe, which would mean more assets for people to hold, and more risk that the so-called Triffin dilemma, you know, ends up finally biting in the U.S., and you have some kind of crisis.  

JENS: So I’m happy to comment on that. So, like, when we had the U.S. credit downgrade, again, over the summer, right? And it coincided with U.S. yields rising above 4 percent, right? I certainly got a lot of questions about, OK, can we please, you know, redo the debt sustainability calculations? I’m sure you’re getting these questions all the time as well, right? And we can do those debt sustainability calculations. And you can certainly come up with some scenarios where things look very concerning, and so forth. But I think—for the next couple of years, I think the counter argument is related to the point that Karen made, right? That we’ve had a number of years where portfolio managers have been incredibly focused on big equity exposures, right? Lots of portfolios have massive equity exposure, right? There’s actually a lot of big portfolios around the world where the debt percentage is quite low, and there’s plenty of capacity, if yields are attractive, to actually add to that bucket.  

So think we’re sort of in a transition phase where, OK, you can do the long-term analysis, and U.S. fiscal deficit of 6-7 percent of GDP doesn’t look sustainable long term. Certainly not if demographics kick in and the growth rate lowers. But we do have portfolios that, for probably a multiyear period, have capacity to absorb a lot more debt. So I think it’s pretty hard to trade that.  

And then just one comment on the on the euro aspect of it, right? So we had negative interest rates in the eurozone for a number of years—call it from ’15 to when we had the rises here after post-COVID, right? And the one thing I thought was interesting, when we went from negative to 4 percent, it was very hard to see that reserve managers actually added to the euro exposure, right? We have IMF data that shows the share that central bank managers have in euro. And it got down to twenty, right, and it has stabilized around there. So they’re not that sensitive to these things. They’re kind of deciding what to do with these reserve portfolios, perhaps on longer term parameters. So it’s hard for me to see them sort of get very excited about something that, to them, would be more tactical, probably. 

HATZIUS: Yeah. The other thing I’d add to this is that if you look at the U.S. deficit, the federal deficit, you know, significantly larger as a share of GDP than five years ago. The flip side of that has been a big increase in the private sector surplus. So it hasn’t—it’s not being financed from abroad, but I think it sort of speaks to the idea that there is, you know, elasticity relative to increases in yield. And there is a decent amount of capacity for investment there. That’s not going to, you know, last forever, but I think at the at the moment it is kind of helping finance move relatively smoothly.  

MALLBY: So, Jan, moving away a little bit from the geopolitical questions, it could be argued that the market optimism of the recent month or so—longer than that maybe—is, even in economic terms, on thin ice. Core inflation is back up to an annual rate of 4 percent. You know, some people say that the economy’s strength is such that you would expect inflation to be breaking out, even if there hadn’t been the COVID surge and de-anchoring. So, I think as you’ve written, the Fed’s path of rate cuts is going to be pushed back a bit. But I don’t think you believe this will impact markets. Talk us through that, Jen. 

HATZIUS: Well, the part I agree with is that the timeline for Fed cuts is later, clearly. I mean, we thought it was March. We now think it’s June. And the communication’s been pretty clear. And some of the data releases, both on the inflation side and on the—on the payroll side, are—obviously have something to do with that. But I have a much more optimistic view sort of fundamentally. On inflation, I don’t think 4 percent is the right number to put into your head about the current inflation trend. Yes, January was a—was a big number. You know, 0.4 percent on core CPI, probably something similar on core PCE. But there are some one-off factors that I think are not representative. 

One was—and we flagged this in advance—a January effect in a number of categories where prices get reset once a year. And in an environment where inflation is still higher and there’s been some pent up demand for price increases in areas like healthcare, for example, that resulted in big increases that were not adjusted out by seasonal adjustment. And, number two, you have this weird increase in owners’ equivalent rent, which is my least favorite category of the inflation indices. It’s a price that nobody pays. It accounts for 34 percent of the core CPI, 13 percent of core PCE. So, pretty big. And that is very likely to come down dramatically. So if you look at the three, six or twelve month rates of core PCE inflation, even with an estimate for January, is going to be—those all between 2 and 3 percent. And I think that’s more—that’s a more reasonable estimate of where the trend is.  

Also, as far as the labor market’s concerned, yes, we had a very big payroll number, once again, in January. Again, there are some seasonal issues around that. But the unemployment rate’s been between 3 ½ and 4 percent for the last two years, or slightly above where it was pre-pandemic in February 2020. The jobs-workers gap has continued to come in, job openings as continued to come down, the quits rate is back actually slightly below where it was prior to the pandemic. So I think the labor market’s been rebalancing. Even in the strong growth environment, we’ve been rebalancing the labor market, the inflation trend has come down significantly, I don’t put much weight on the—on the January number.  

So with all of that, the path to rate cuts, you know, given what Fed officials have said, if we’re moving towards 2 percent we will cut rates, you know, the path to rate cuts I think is still there. The timing—you know, there is going to be an impact on markets from changes in the timing. Certainly, on the rates market. We’ve seen a meaningful impact on the rates market. I think on the—on the equity market and risk markets more broadly, you know, if the timing’s a little bit later rather than a little bit earlier in a decent growth environment, I don’t think that’s dramatic. Now, if this disinflation thesis had to be thrown out—if what I just said for the last several minutes turned out to be wrong—then, of course, that would be a much bigger threat to markets. But that’s not my expectation.  

MALLABY: I mean, just to underscore this quickly with a follow up, I mean, you’re really saying that the perceived hit to the Feds reputation as of, say, two years ago, when inflation was really high and the Fed was perceived to have been late and there was a lot of quite doomster-ish talk about, oh, you know, 1970s and all that—you think basically that cloud has gone? The credibility is back, the trend and inflation is down, it’s Goldilocks outlook? I mean, I’m not disagreeing. I’m just saying it’s remarkable.  

HATZIUS: Yeah, I mean, I’ve never agreed with the—you know, the talk about how the Fed had completely lost its credibility. And I think even if you looked at the time at market measures of credibility, for example, around long-term inflation expectations, they were very anchored. So markets never bought into the idea that the Fed had completely lost the kind of anti-inflationary plot. And but there were some doubts. There was obviously a lot of criticism. Short-term inflation expectations were higher. Yeah, now all those things look much more unambiguously encouraging, I’d say. 

MALLABY: Karen, let’s switch to China. Sentiment has grown extremely negative, probably for pretty good reasons. Property past, negative demographics, incipient deflation. But one thing we do know about China is that policy can execute a U-turn faster than you might imagine. So as you watched the sort of COVID story from, you know, total lockdown to radically rapid reopening, that was a pretty dramatic U-turn. And so one thing that might, I suppose, switch around is the government’s stance towards its willingness to provide stimulus. But just more generally, do you think that sentiment may have overshot on the negative side for China?  

KARNIOL-TAMBOUR: I mean, I think that sentiment on Chinese economy is bad for a reason. It’s justifiably bad for a reason. And that all indications from the Chinese government is that they remain very committed to only doing the kind of stimulus that is aligned with their political goals, which is too narrow to offset the huge tide of problems that they have. So, you know, you’re kind of in a tough spot if you say: I don’t really want to give money to households and encourage consumption. I don’t really like a lot of the different industries. There’s a lot of people I don’t want to see gaining any strength. I don’t really want too much currency weakness. There’s just a lot of stimulus they’re not willing to do in the middle of a huge property bust. And they’ve decided the one thing they do want to do is win on certain types of manufacturing that they think will really help them in this, you know, kind of global competition, particularly with the U.S., but on kind of more high-end technologies.  

What that is doing is that they’re willing to throw a lot of money into creating capacity in certain manufacturing areas where there isn’t actually particularly demand in China for those areas. And so in terms of the rest of the world, and you’re starting to hear this a little bit even coming from U.S. officials, what they’re doing is basically dumping capacity on everybody else. Because they’re saying, the way we do feel comfortable stimulating is by creating this excess capacity in these kinds of manufacturing industries. Now, basically, for many years when China was stimulating, you know, through the roof, and, like you’re saying, Chinese policymakers prove they could get whatever they want done, they did it in a way that the overcapacity they created was internal and really couldn’t be exported.  

So it doesn’t matter for the rest of the world if a create lots of buildings no one’s ever in and lots of roads to nowhere. It doesn’t affect any of us. If anything, it’s actually inflationary for the rest of us, because they’re using all these raw materials, and they drive up the prices of raw materials. But all the deflationary excess is kind of stuck in China. Now they’re dealing with being stuck with all that deflationary excess. And the new extra capacity they’re building actually can be exported. So if you’re Europe, you know, you’re showing up and, you know, are being bombarded with, you know, cheap EVs, and solar, and all these things that the Chinese are willing to throw money at. They don’t care, you know, if there’s any demand for it. That’s actually deflation finally being exported to the rest of the world. And it matters from that perspective.  

The last thing I’ll say about just how negative sentiment is that it’s a little hard to read sentiment on China because if you look at their assets, you’re not just getting a true view of sentiment on China, right? People’s view on holding Chinese assets is highly, highly colored by worrying about political interference both from Beijing and from Washington, and not letting them hold those assets. And so if you look at what kind of risk premium is built into, like, Chinese stocks, it’s probably way more than what people actually think is going to happen in that economy. It’s much more colored by a view of even if Chinese growth is great, is anyone going to let me make any money holding a stock in China? Maybe there’ll be great outcomes and I just won’t get any as a stockholder? And will Congress come in and say, these are not assets I should hold? So it’s actually harder to get an objective read of what investors think because of those issues. 

JENS: Can I make a quick comment on this? It’s OK to say no. 

MALLABY: I’m going to—OK, I’m going to say no, because I’m going to ask you a different question. (Laughter.) Shh. (Laughter.) And we’re going to bring in members to join the conversation after this last question. Time for one thing I want to get to, and I think you want to get to. Which is sort of the question of, you know, the way technology, and specifically probably AI, could affect the outlook. I’ve, you know, peppered people with a lot of depressing negative questions, as is only fitting for the dismal science. But let’s end on an upbeat note. AI, LLMs, application of AI to drug discovery—are there things on this list which you think are going to affect the way the macro economy behaves? 

NORDVIG: Absolutely. So I’m in the unfortunate situation that I managed two companies. And one of them is an AI company, and the other one is Exante Data. So I feel— 

MALLABY: Yeah, stop complaining. You’ve got two hands, so it’s fine.  

NORDVIG: (Laughter.) But it’s—we’re definitely going through a revolution of sorts right now. And from a macro perspective, right—I used to work with Jan Hatzius at the Goldman Sachs economics department, right? There’s one thing I’m doing now that I’ve never done when we worked together. That is, like, when a company reports earnings, i.e., Nvidia, I actually think it’s relevant for the macro economy, like, what—how big those data center numbers are, right? Because, like the data center line item in their earnings, which is almost entirely AI compute, right, is now so big that if you scaled up those numbers, up with those companies that invest in those compute, they also have to invest in staff to actually direct that research. And the numbers are really big. 

And I see it from a day-to-day basis. When we interact with people in big U.S. financial institutions that are really keen on having, you know, generative AI as their big strategic push, right? They’re definitely investing, right, but it’s also clear that the timing of when these investments are going to actually deliver a product—like, I’m not talking about OpenAI and these video tools that we can all see very tangibly. But for most businesses, right, these are investments that are being made with a goal of launching product maybe at the end of this year next year, 2026. It’s a pretty long-term process. So it’s something that’s going to be with us for a long time.  

And then there’s some really complicated question that relates to, OK, how is it going to impact the macro economy, right? Because it’s a type of technology that is so concentrated. Like, there’s certain companies that have the data—the huge data set that is needed to do this training. But not that many companies have that. There’s some of the Google projects that we’ve seen launched officially now in the last few weeks. And then you go and read the press release. How many people built it? The Google team was thirty people, right? So we have a type of investment, right, where the amount of money that is invested is extremely large, the amount of compute that is invested is extremely large, right? But the amount of people that’s actually involved is not very big. So thinking about the impact on the labor market and the economy, I think you need to think about it from a different perspective than we’ve done with these other kind of big leaps in technology in the past. 

MALLABY: Great. Well, so let’s open it up. A reminder that this is on the record. And so if somebody’s got a question. Ah, I can see Tara, great. Right in the front. 

Q: Thank you so much. Tara Hariharan from NWI Management.  

I just wanted to bring up two geographies that hadn’t been discussed so far in this panel. The first is, of course, Japan. Assuming that the BOJ does move in the spring to get out of negative interest rates, do any of you anticipate a big shift by Japanese institutional money out of overseas investments back into Japan, considering we’re already seeing significant inflows into the Japanese stock market, for instance? And the second question, which is of course my obligatory question I ask every year, emerging markets. How is the situation now? Especially given that the prospect for the Fed cut cycle has been, you know, pushed back a little bit compared to where we were thinking of it early last year? And also the situation in China has worsened, although some may argue that EM ex China could be positioned to benefit in the process. Thank you.  

MALLABY: That was two questions. OK, so Jan, do you want to one of those? 

HATZIUS: Sure. I mean, I think on Japan it depends on, you know, what, what’s the destination? If you’re moving from very marginally negative to very marginally positive but that’s it, then I don’t think it necessarily has a big impact on flows. Although, frankly, I probably look less at flows than, you know, either Karen or Jens. So I’m not really very qualified to speak about it. But I wouldn’t expect a huge shift, necessarily. And economically, I don’t think there is need for a big increase in interest rates slightly in positive territory. It seems much more likely because, I mean, the inflation outlook in Japan is still sort of at or below 2 percent. Will probably be back below 2 percent by the end of the year for all of the different permutations of core, and Western core, and global core, and new core inflation that they—that they publish. So that would be my expectation. That it will be kind of anticlimactic. 

On EM more broadly, yes, Fed—aggressive Fed rate cuts in 2024, especially in an environment where the economy still holds—the global economy still grows strongly, that would obviously be great for emerging markets. But if it’s not aggressive cuts, if it’s sort of more delayed cuts, maybe a little bit of cuts in the U.S., you know, that’s still an OK environment. Especially because there’s a pretty strong case, I think, in many emerging economies independently of what happens with Fed policy to bring down rates. And, of course, we’ve already seen some rate cuts because the emerging economies outside of China and outside of Asia had huge increases in inflation as well. And those increases in inflation have also abated. We’re now back to levels that are much closer to the pre-pandemic level. And so I think there’s still some room for central banks in emerging markets to responsibly bring down interest rates gradually. And that should still be a—kind of an OK environment, in my view. 

MALLABY: Tara, one of the emerging markets that, of course, has been on a tear is India. My favorite factoid about emerging markets is that in 2023, Indian retail investors bought more than 85 billion options, which is nearly eight times the volume purchased in the U.S. And the average holding time for these contracts was less than half an hour. I don’t know whether this is sort of Robin Hood mania arrives in India, but I was struck by that.  

Let’s go to a question right there. 

Q: The panel has all said that— 

MALLABY: Please identify yourself. Sorry. 

Q: Mark Rosen from Advection Growth Capital. 

The panel, you’ve all said that in the short term, U.S. debt and deficits does not seem to be any kind of problem. But for investors that are looking longer term over the next decade or so, is, you know, 7 percent debt deficits per year, debt rising, is that likely to be a problem in the longer term, in the next five to ten years? Or is it an issue that really we shouldn’t worry about? Japan has gone to 250 percent debt to GDP, or whatever it is. We really shouldn’t worry about U.S. debt and deficits at all? 

MALLABY: Do you want a crack at that, Jens? 

NORDVIG: Sure. I can start. Yeah, so when you—when you look at a 7 percent of GDP deficit for a multiyear period, it’s obviously highly, highly unusual. What’s going on? The level of debt is going up in a pretty dramatic fashion. It’s helpful that we have growth that is still surprising to the upside. But I think the question I’m getting all the time is the question that’s linked to the dollar’s reserve currency status, right? And we have—every few years we have a wave where people, like, come up with, like, a new reason to hate the dollar, right? And when I worked at Goldman Sachs, it was the U.S. current account deficit that was too big. That was back in 2006-2007, right? And in 2023, it was the—you know, the freezing of Russian reserves in dollars was going to be the demise of the dollar. Nobody would want to hold dollars after that. So there’s always a new story, right?  

But if you look at how the dollar is trading, it’s trading incredibly resiliently. So I think really the key issue to think about, OK, can we have some kind of real turn, a real crisis dynamic that comes out of that is very much a function of whether investors around the world see an alternative, right? So the narrative that was told last year was that, OK, now we have the freezing of Russian reserves. There’s going to be a lot of countries that’s going to gravitate away from United States and they’re going to go to China, right? And the reality is that the exact opposite have happened. If you look at the capital flows in and out of China, there is a very, very persistent selling of Chinese bonds by all kinds of foreign investors, right?  

So the bottom line is that it’s just very hard to see, OK, what is the alternative to the capital flow that has been coming into the U.S.? So once that—until that alternative emerges, the dollar can remain strong, irrespective of all those issues that you rightly point out. And it’s going to delay when there’s any kind of, like, real fallout from that. And I think that’s still the environment we’re in. 

KARNIOL-TAMBOUR: Can I just add on this topic? I think that you do have a structural shift to needing structurally higher interest rates in the U.S. And, you know, what do you look at the size of that deficit and kind of think out number of years, as you’re doing, and sort of saying, look ten years out, you also have to remember that in a lot of these cases, like Japan running huge deficits and in the U.S. the last twenty years, you had very big buyers that were noneconomic buyers. First it was the reserve managers. It didn’t matter what the yield was, they just were going to buy U.S. Treasurys anyway. And then it was the Fed, or in bank—Japan, the BOJ. So these are very, very large buyers that are kind of structurally there, regardless of the interest rate, and created a world where the interest rate could be lower than, you know, it otherwise would be, because they’re just going to keep pushing it.  

I don’t really see a path for the next ten years where we get a large noneconomic buyer. And so the things you’re balancing is, well, there’s a lot of borrowing. Then, you know, Jan made a really important point that outside of the government, there’s not a lot of borrowing. So on net, there isn’t as much to finance. But that’s going to change. That’s not—that’s a today thing. It’s kind of a leftover of the fact that we had to have all this deleveraging. So it’s actually very highly unusual to be at this stage of the cycle where the economy’s strong and everything, and no one’s borrowing but the government. That’s very unusual. But it means that if we keep stimulating, and the Fed does lower interest rates and whatnot, that’ll change through time. So you’ll have kind of a pie of how much needs to be financed.  

And you have to get through, you know, this point that was already been made of people who just haven’t seen debt in a long time. Jens made this point and he’s right. So they’re going to keep moving back into debt just to kind of rebalance. And they’re seeing yield levels that are interesting for the first time in a long time. In the U.S. context, you have a public pension that’s supposed to make 7 percent a year. For many years it was just kind of ridiculous to say they’re going to make 7 percent a year, because rates are zero. So what does that even mean? Does that mean they’re just supposed to go crazy and take lots of risks? How do you make 7 percent a year? 

Now they can say, I can basically buy a government bond, maybe take a little bit of credit risk, and I’m pretty much there. So you’re still going to get these flows to say, OK, at these levels this is looking more reasonable. But you add it all up to say, if you look out the level at which we’re kind of going to normalize is just going to be structurally higher. And that also matches the fundamentals of higher kind of gravitational pull of inflation from zero to 1 (percent) to more, like, 2-3 (percent). And a real interest rate—the economy doesn’t need—for many years, the economy needed extremely low real interest rates to get any activity going, coming out of financial crisis. We don’t need that anymore. Now, that could get out of control. But I think more likely, we’re just looking at a world of structurally higher interest rates than you had for twenty years. 

MALLABY: You want to comment, Jan? 

HATZIUS: I agree with that. I think we are going to be in a higher interest rate environment than the, you know, post-’08 period, which was, you know, a long period of balance sheet adjustment. And now that’s behind us. So I agree. 

MALLABY: Let’s go over here. I’ll come to your neighbor next. 

Q: Oh, yes. Next? 

MALLABY: Go ahead, and then we’ll— 

Q: Oh, yes. Thank you. Daniel Gilmer CFR term member, Pfizer, Incorporated, Rockefeller University.  

So, Karen, you opened up the time speaking to how there’s relatively less exposure to a lot of these geopolitical crises for a lot of the investors today. And then, Sebastian, you mentioned as well that there hasn’t been the response that one would hope from many countries of power to many of the crises that are currently occurring. Do we expect that to shift as these crises do impact investors even more? That it will have more of a political force to actually be more productive in the solutions that are posed? And if so, what might that look like over the next year, as some of these crises continue to spillover? 

MALLABY: Wow, that’s a difficult question. 

KARNIOL-TAMBOUR: I think investors have sort of gotten extremely concentrated in the U.S., and worried about being too far outside of it. To give you a sense of how crazy I think it is, investors are under-allocated to Japan. And so you’re basically saying, what are the big markets of the world? You’re, like, there’s United States. People got a lot of that. There’s Europe. People have a decent amount of that. The third biggest is Japan. That is starting to feel like an exotic, this would be really diversifying if you get into Japan kind of conversation to have with investors. So it feels like we’re far from the—Russia experience was traumatic, right?  

The Russia experience of a market that kind of seemed OK on the investment horizon, and within a day became a completely you cannot have in your portfolio. And the shutting off of China increasingly, you know, has been not as formally as Russia, means that, actually, the investment universe has shrunk in a way that there’s more nervousness. I mean, if I go to something not as extreme as China or Russia, look at a place like South Africa. And you basically say, wow, there’s so much pessimism priced in South Africa. Like, nobody is there.  

And I can tell you a hundred reasons why South Africa is in terrible shape. It’s not good to literally have blackouts such that you can’t run your businesses because you can’t get enough power. Very, very bad to be in that situation. But there’s so few people in those markets that all it takes is, like, a little bit of outperforming disastrous expectations and you’ve got a pretty good asset. And so I think you’re just at an extreme in allocation. 

MALLABY: Question right there. Yes. 

Q: Niso Abuaf, Pace University. 

My question is about the nexus of fiscal and monetary policy. If we look at the U.S. yield curve, five years on it’s basically in equilibrium around 4 percent. It’s the short term that seems to be in disequilibrium. Given that, why is the Treasury doing most of its funding at the short end of the yield curve? And, moreover, will the Federal Reserve be under pressure to reduce interest rates because of the fiscal and monetary nexus?  


HATZIUS: Well, why are they funding mostly at the at the short end? I mean, they are funding—they’re always funding a lot at the—at the short end. But it’s certainly an argument for, you know, shifting out a bit more. I think that—I think that’s right. In terms of what the Fed—you know, what it means for the Fed, I mean, it’s a reflection of the fact that most investors believe that the equilibrium nominal interest rate isn’t 5 percent, but, you know, somewhere between 3 and 4 percent. And so that’s why the longer-term rates are lower. 

Is that, in and of itself, going to get the get the Fed to normalize? No. I think you also need to see, you know, inflation continue to come down. If the trend in inflation has come down—is going to come down, then they will normalize. They’ve clearly said that. In fact, back in December Chair Powell said that they would start moving the funds rate down well before inflation gets to 2 percent. And it now looks like maybe it’s not that far before inflation gets to 2 percent. But if you do go to two, then they will be cutting. That’s very—that’s very clear. I mean, that’s—even the more hawkish participants in the—on the FOMC have made it clear that they will be reducing rates if inflation gets back to 2 (percent). 

MALLABY: There’s a question, right there, at the back, please. Yeah. 

Q: Thank you. David Ekizian with Mitsui. 

Any perspective on the current levels of U.S. consumer credit card debt, and what that might mean for inflation going forward and economic growth? 

MALLABY: Credit card debt. Could you pass the mic just in front, to the left? And we’re going to come to you in a second. Credit card debt. Who would like to take that?  

HATZIUS: I mean, it grew a lot about a year—you know, a year to a year and a half ago. There was a sort of surge in credit card—in credit-card debt. Actually, it hasn’t moved very much. I think a lot of people have pointed to deterioration in some of the credit quality measures, especially towards the bottom end of the income spectrum in credit cards and auto loans. And there clearly has been significant deterioration over the last, you know, year or two.  

It’s important to keep in mind, though, that this is coming from really exceptionally low levels. I mean, we had such low levels of delinquencies and charge offs in this post-pandemic, very cash-flush environment, where households had much bigger checking accounts including, you know, below-average income households, that what we’ve seen so far, I think, has been a normalization. And at least, you know, what’s going to happen going forward is going to depend on what happens to the economy more broadly. But I can tell you that under our forecast, things kind of stabilize at these more pre-pandemic levels that are much higher than a couple of years ago, but not high in an absolute sense. 

MALLABY: Another question here. 

Q: My name is Andrew Gundlach. 

I wanted to go back to the dollar. It kind of reminds me of one of my favorite movies with Peter Sellers, Dr. Strangelove: How I Stopped Worrying and Learned to Love the Dollar. (Laughter.) But, Karen, to your—to your fascinating point on the idea of U.S. having Dutch disease from a portfolio allocation perspective. In the short term, the structural reasons for higher rates, to what extent can they be offset by productivity gains, that have been anemic to date but may prove to be higher with AI? That’s the short term. But in the longer term, the U.S. is a 50 trillion (dollar) equity markets out of 100 trillion (dollar) worldwide market. Sixty-odd-percent—65 percent weighting in the MSCI World. The world that you’re making me think of—because markets tend to be natural monopolists, right? If you fast forward ten years and you have a 200 trillion (dollar) worldwide equity market, why can’t the U.S. be 80 percent of that? What is the natural breakage on the maximum weight of the U.S.? Higher capital returns, better treatment of money, better liquidity, et cetera? How do you think about that longer term? 

KARNIOL-TAMBOUR: Yeah, on the productivity question it’s a major wildcard, and something that a lot of people are trying to figure out, including myself. So far, there’s not a lot of signs this is going to happen super quickly, but it could surprise us all. You know, I’ve been really digging into where has AI actually already increased productivity? And so you look at things like, you know, computer programmers, right? Like software developers are clearly multiple times more productive. Or what’s happening in anything, that’s customer service-like. And it’s big. It’s really big in those industries. But it’s just drowned out by the shape of the whole economy. There was probably a more or less unlimited demand for software developers ahead of this, and so you’ve kind of increased productivity in this little area that just had kind of a limited demand.  

And the what’s happening in, like, more customer service, it’s as big as when you shifted lots of jobs to India, you know, X years ago. But those jobs today compete with hotels and hospitality and restaurants. And so you’re not yet seeing, you know, any kind of macro impact because it’s happening gradually. My best guess is this productivity thing, it’s going to be—just like the last round of this, where we exported a lot of jobs abroad in manufacturing and got more productive in manufacturing, and over a multi, you know, two-ish decade period, took about 10 percent of the U.S. workforce and replaced it. And over a long period, we could say that was a really big deal. And it certainly affected our politics a lot. But very slowly effect on markets, kind of barely showed up in the macro stats. My guess is you’re about to go through a repeat of that with AI. Maybe it’ll be 20 percent of the workforce and not 10. So we’re going to look back in 20 years and say that was a huge deal, and a big deal politically, and displaced a lot of labor force. But it may not be a big kind of macroeconomic event in quite the same way.  

And on the same question, I don’t know. There may not be that much of a natural limit. If you kind of look at attributing why has the U.S. stock market outperformed so much, it really is not one thing. It really is, you know, they do a better job returning to shareholders, they’re doing a better job capturing market share, they’re doing a better job with margins. It’s not only one sector. It’s not only tech. There’s a lot going on. One of the fastest ways that could close, and you’re seeing a little bit of this, is there’s a degree to which, because people just put money in the U.S. and that’s the index, companies are starting to realize, wait a minute, if I listed the exact same company in the U.S., I think I would command a higher valuation. That doesn’t really make sense, right? That really shouldn’t be happening.  

So companies are starting to say, maybe I’ll just list in the U.S., even if I’m not even a U.S. company, because I’ll just get a higher valuation. So there’s a world where, you know, when people put money into the U.S., they’re increasingly not putting it into U.S. companies, because that’s just where people want to list. But it could have room to run. These things do tend to reverse somewhat. That said, back to the dollar point, even in a world where the U.S. is not the best equity performer in the next 10 years—because it really might not be for the simple reason that all that outperformance is now in the price and so expectations are high. Like, I think that U.S. companies are going to have better earnings than most of their counterparts, but that’s very much in the price already. So valuations are still better outside the U.S. That still would be a very gradual rebalance with most of the new money still coming into the U.S. because, as you’re saying, they’re starting out two thirds of MSCI World. And you cut out everything people don’t do anyway, like tiny countries, three quarters of the money. 

MALLABY: Yes, right in the front. Yes, coming up. 

Q: Thanks very much. Chris Turner at Warburg Pincus.  

Related question. Performance in major developed markets equities, very good. Strangely though, there’s kind of depression in the IPO markets, the ability of young, smaller companies to create capital in the equity markets. There’s corporate spin offs and things like that, but there seems to be a paucity of the ability of newer companies to find capital in the equity markets. However, Karen, as you reflected there’s an abundance of private capital. Is that the answer? Is that the offset? Or are any of you concerned about that, at least to me, kind of apparent dysfunction a little bit in the structure of developed market equities? 

KARNIOL-TAMBOUR: I think this is about a pace—the pace at which public and private valuations are catching up to one another. There’s still a lot of private money that went into deals that, despite the U.S. good stock market performance, still look to rich relative to the prices they were done at. So there’s not a lot of enthusiasm to go acknowledge those losses. So if you’re in the private capital space, you’re kind of seeing all of your LPs stopping to give you money. Saying, wait, wait a minute. First of all, I used to have only a little bit of illiquid assets. Now, like, half my assets are illiquid. Turns out, it’s actually difficult to manage illiquidity. Maybe I should start thinking about that. I can’t get out of these illiquid places where I have losses. So they have a lot of capital, but they can’t get more. And they don’t really want to recognize the losses. And so there’s just—it takes time to—public markets reprice quickly. And that’s a great thing. And private markets take some time. 

MALLABY: Yes, right here. Lady, right there. 

Q: Thank you for some—giving us a lot to think about. Bhakti Mirchandani from Trinity Church Wall Street. 

I have two questions. One is just on, you know, the prevalence of asset-light companies. If that makes the next credit crisis worse because recoveries are lower. And then the other one is on the backlash against ESG. To what extent does this have a real impact on the investment world, other than inconvenience? 

MALLABY: Jens, do you want to talk about— 

NORDVIG: What was the first question? 

MALLABY: The prevalence of capital-light businesses—asset-light, capital-light. 

NORDVIG: Well, we can talk—we can talk a little bit about what happened in the banking system over the last, call it—call it a year, right? So it’s a year ago since the Silicon Valley Bank situation started, right? And that situation was a little bit special, right? And now we’ve had another mini-concern about New York Community Bank, right, which related to commercial real estate, which is at the core of a lot of the credit tension that we’re having now. And the amazing thing about it is that there’s a lot of people who are extremely pessimistic about what’s going in commercial real estate, right? And those people might be totally right. But nevertheless, if you see how the passive flows and so forth are behaving, we literally can’t see any instability in deposits anymore, right? So people have gotten comfortable, that the banks able to handle these losses and, you know, equity investors will take the losses, and so forth.  

So the banking system and all the data we track in the banking system really doesn’t point to any kind of, you know, acute tension, right? So those losses are going to be written off on a long term. So I think, obviously, for credit investors it’s really important how you think about those exposures. (Laughs.) But from an overall macro perspective, it will be pretty surprising to me if this is something that’s going to, like, you know, create a big shock in the near term, drive the Fed, and these types of things. 

MALLABY: What was the second question? Sorry. 

Q: ESG. 

MALLABY: ESG—the backlash against ESG. Anyone want to talk about that?  

KARNIOL-TAMBOUR: Yeah, happy to. I mean, I think the biggest thing that’s happened is that you have less capital that is kind of committed to funding pro-ESG assets, at any price, because of directives, you know, kind of from the top. You still have a lot of capital that has some degree of ESG thinking embedded into it, because a lot of that’s kind of gotten written into governance. But there’s a lot more discipline around at what price and whatnot. And on the flip side, it’s happening at a time where that pressure’s being put on policymakers, right? And so things like the IRA are also changing what’s the mix of subsidies and incentives to actually make pro-ESG investments be higher returning. So you’re less likely to get kind of capital sort of throwing itself at the greenest thing because it has to, and you’re getting more disciplined to see where are the opportunities? 

MALLABY: Final question. I think you had one. Yes. 

Q: Given Karen’s argument about the increased Chinese government investment in manufacturers, and the dumping the impact of that—and I think that also has a political signal to the manufacturing area, go ahead and manufacture and dump. Is that an argument or is it not an argument for a higher—strong, high tariff policy with respect to China in the United States and in Europe?  

NORDVIG: Definitely. Like—yeah. 

KARNIOL-TAMBOUR: Definitely. I think the Europeans— 

HATZIUS: I think that’s going to be the impact, yeah. I mean, Europe—in Europe very likely. And in the U.S., I think it depends—obviously, a lot depends on the outcome of the election. (Laughter.) But, yes. 

MALLABY: Well, that was an easy last question. You got unanimity. (Laughter.) You united us all. Thank you very much. You’re a united, not a divider. Thank you for joining today’s meeting. Thank you to Karen, Jens, and Jan. And there’ll be a video and transcript of today’s discussion on the CFR website posted shortly. Have a great day. (Applause.) 


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