ANDREAS STENO LARSEN: Welcome to the Real Vision Daily Briefing. It is today, Friday, May 27th, 2022. And I'm Andreas Steno Larsen. And I'm very happy to host my first version of the Daily Briefing here. Today, I'm joined by Raoul Pal. How are you doing, Raoul?

RAOUL PAL: I'm fantastic. Look, I'm really pleased you're doing this, this should be fun. It'd be great.

ANDREAS STENO LARSEN: It will be great. Raoul, it's been another, I'd say decent day for risk assets today. NASDAQ is up, I think 3%-ish. Crude oil is trading above one $119 a barrel, and we still have bond yields flatlining or even falling. To me, this may be a hint that markets have started to look past the inflation scare and look towards growth instead. What do you make of all this that we see in markets this week?

RAOUL PAL: I think that we need to be careful because theres month end rebalance. We were told it was going to be huge. I had technical signals that said the market could bounce on a shorter-term basis, like daily stuff. My weekly stuff still says there's more downside, so I'm not sure whether this becomes the false hope, or it feeds on itself. Who the hell knows? But there's a massive rebalance going on, which is why it's all squeezing. It's a long weekend in the US. So, everyone had to jam the order book in today.

So, the question is, does it sell off after Memorial Day? Does it continue to go for a bit and then sell off? Or was that the low? It feels that I've looked at past episodes of all of this, when the Fed was pivoting or the economy's weakening, bond yields tend to come down further before that happens. Because we've only just really pivoted. Sure, breakevens come down quite a lot. But yeah, bond yields themselves have only just started. So, I feel like it's too early to have the celebration of the Fed are going to pivot and everything else. But I think that's all coming.

ANDREAS STENO LARSEN: Yeah, I think that's the million-dollar question right now, whether the Fed will pivot this year. And if we look at the most important data point that we've received today, in my view, the core PCE prices, I actually think that we have some compelling evidence that inflation is starting at least to flatline, or even outright fall in year over year terms, right? We are basically past the peak in year over year terms, if you ask me. What do you make of the inflation picture and the consequences for the Federal Reserve when you watch these data prints out today?

RAOUL PAL: Yeah, look, I agree with you. And I've been following what you've been saying on Twitter. Look, I think the inflation peak is in just the year-on-year comps, let alone structural inflation, I think the year-on-year comps are going to be we'll see inflation come down pretty sharply. Now, I also think there's massive demand destruction going on in the economy too. When I look at monetary conditions, not just using the Goldman Sachs index, but if I add in-- if I use the rate of change of mortgages, 2Y rates, oil, gasoline, and the dollar, that's the largest monetary tightening in all recorded history that's underway.

And I've put a piece out and Real Vision today, it should come out shortly, about some of this stuff. And I think we have the potential to set up to see negative inflation next year, I think the one thing that needs to happen for that to occur is for crude oil to fall. It doesn't have to fall a lot. But then the year on year comes by March of next year, crude oil is going to be massive negative year on year.

And that's not going against the crude oil story, which is the structural supply issue. It only has to trade lower for a period of time down to 70 bucks, 80 bucks. And before you know it, the inflation number absolutely collapses. So, I'm with you on that.

ANDREAS STENO LARSEN: Yeah. And we've even had a member of the Federal Reserve committee out saying that there is a possibility of a pause from September and onwards. And of course, the market will look at such comments and try to get a grasp of what's going on within the Federal Reserve. Are they already now pondering whether to pause a lot?

But one thing I wanted to touch upon when you mentioned the word demand destruction is to which extent various asset classes have priced in this ongoing demand destruction that we're currently faced with? Because I think that's a very fair assessment of what's going on. And I made a chart earlier today on the relationship between equities and the ISM manufacturing index in the US.

RAOUL PAL: About 47 right now, it's pricing.

ANDREAS STENO LARSEN: Yeah, exactly. So, the interesting thing here is whether the recession is already called by equities, first of all, and secondly, whether bonds will follow. What do you make of that?

RAOUL PAL: Well, like you, I map out a ton of these relationships, equities, copper, inventory sales, a lot of the forward-looking stuff, all is recession. Some of them are severe recession, anything that has monetary conditions in. PPI inverted, but suppose as I say, it lags, that's putting the ISM at 30. So, it feels that most of the risk assets have priced it, there are two that haven't, pretty much only two. One is oil and one is bond market.

So, the bond market has been following basically oils rates of change more than it has anything else. And I can understand that because of the inflation fixation, but I think that that evaporates. And we've seen a very similar setup, I've done a lot of historical analysis of these, what causes the Fed to change path.

So, I started with 1974. 1974 was very similar to now. We had a supply issue in oil, which was the Arab oil embargo. We had prices rise, CPI was rising, the Fed were hiking, the dollar was rallying and then growth collapsed. And the ISM went from 56 to 30 in four months. That's what I'm getting in my data to suggest it's possible.

The next one was 1984. And the Fed cut in the middle of that with inflation still up. Theyve cut as soon as the ISM touched 50. Same in 9084. Same in the 2000s. Same in 2001. Same in 2018.

So, I think that the key thing here is if the ISM comes below 50, they start to worry about the jobs mandate. And we're already hearing the tech companies saying we're going to lay off people. Amazon said they were wildly overstaffed. So, the last shoe to drop, it happened in 2018, 2001, and I think it was, yeah, obviously in 1974, was the last shoe to drop was the oil market. I think that's the comp as well.

ANDREAS STENO LARSEN: I even saw, referring to what you said about tech companies, the Swedish company, Klarna, laying off people with a prerecorded message this week. Whats going on there? But I think you're absolutely right that we've seen a peak in employment already now as well. Or at least we're starting to see the early signs of a slowdown of the employment cycle as well. And we know that cycle lags a lot of the indicators that we've already touched upon.

I think the key question here, Raoul, and I wanted to pick your brain on that topic as well, is whether the Fed will be more hesitant in pivoting due to the fact that we are still running clearly above the inflation target. What do you make of that discussion?

RAOUL PAL: Yeah, this came up at the roundtable. There's a narrative which is, well, if inflation is still high, we need to see it coming down to 3%, or whatever before they do anything. I went back and checked every time in history. That never happens. In 2001, they were cutting all the way through from oil going from $100 to $140. 2018, they were cutting, they paused and had cut with the oil price coming up.

Most of these examples when you go back, in fact, even the 1970s, inflation was still going up and oil was still going up while they were cutting. In 1974, they were cutting from about July and really, inflation didn't roll over till early next year. So, I think it's a red herring. I think they will focus on inflation, but theyll realize that demand is the bigger driver. And as soon as demand starts showing that it's coming down, i.e., the economy starts shrinking or heading that way, that's when they pivot. And that was 2018 in a nutshell. ISM touched 50, they stopped.

ANDREAS STENO LARSEN: Yeah. And obviously, if you want to front run this development within the Federal Reserve, then you need to be on the watch for a couple of triggers. Maybe the most important trigger for such a reversal is the growth cycle. And we basically agreed it seems that the growth cycle is headed down clearly. But the second trigger that you will look for is probably the peak in inflation. And we may have seen a peak in inflation in year over year terms, at least I think so. So, are there anything that holds you back from saying that now is the time to bet on a more dovish Fed via buying bonds?

RAOUL PAL: No, I bought bonds. I bought 2Ys and 10Ys, because I don't know whether the curve steepens or flattens, because it always gets a bit complicated. In 2018, it flattened first, then steepens, then went negative again and then went up. So, I don't know. But yes, I don't see any reason why not. And the bond markets telling us this, that A, growth is now slowing, and inflation is coming off.

And it's a very simple. Why I love bonds is people in the bond market have one job, to look at two things, growth and inflation. While in the equity market, you need to look at all sorts of stuff, including human sentiment and all of the bullshit that goes along with equities. But this is really simple. So, the bond market usually gets this bit right. So, it basically got rid of inflation itself by going up, without the Fed actually really being involved and jawboning. And my guess is it's going to start pricing out growth and inflation really fast.

ANDREAS STENO LARSEN: In your monthly update, I also noticed that you're talking a bit about demographics. And when we talk about bonds, I think it's very triggered to avoid debate on demographics. So, throughout this recent rally in interest rates, I've received a lot of pushback when I've tried to tell a compelling story to people that over the three- to five-year horizon, demographics still matter for interest rates. Can you maybe walk us through your thoughts on demographics going three, five years forward?

RAOUL PAL: Yeah. So, if I look at the demographics of Europe and the US, but let's focus on the US, the baby boom cohort is what, average age of 70 now. Some of them are in the workforce, particularly in part time jobs, there's some full-time jobs in the workforce. They're coming out of the workforce, and to have to go into retirement. So, firstly, retirees tend to own more bonds and equities, because you don't want your pension falling 50% in a recession.

Secondly, if you don't know how long you're going to live for, and you've got a fixed amount of capital, you tend to be careful in how much you spend. I've seen my parents go through this when they retired, their spending went down a lot. The consumption of that cohort goes down. But they're also saddled with debt. So, that dynamic tends to create lower growth.

And I look at the labor force participation rate, and you can extrapolate it going forwards. And basically, it's the trend of GDP, it's the trend of inflation, it's the trend of velocity of money. It's the trend of pretty much everything of our economic lifetimes. And it's driven by this old cohort. And so, that means that it's almost impossible to generate inflation for extended periods of time.

You might get it from a supply issue, you might get it from some demand issue. We had a bit from China in the 2000s. There's a new demand source in the global economy. I don't see that right now. Sure, there's some ESG infrastructure spend, that could do something a bit. But I don't really see it. The onshoring, the reonshoring of supply chains, yes, maybe. But the flip side of that is none of those factories employ people, they employ robots.

Go and look at the test of factories. It's incredible how few people they need. And so, I just see the relentless rise of technology. Plus, this old demographic cohort, that's going to take another 10, 15 years to work its way through. It can only generate slower economic growth over time and that needs the central banks to run negative real rates because of all the debt that they've done to offset it. And, yeah, I haven't seen anything in the picture that's changed that.

There is an argument that some put together that they're going to release their capital and spend it all and that's inflationary. I just don't see it from the behavior of all the retirees. When I lived in a beach town in Spain, it's full of retired people. And that they start-- my dad went from buying 50-pound bottles of champagne to fighting in the supermarket over with his friends who could find the cheapest Spanish cover, could they find a decent one for three euros?

Now, that's the mindset when you have a finite pool, and you don't know how long you live for. So, it's really important demographics.

ANDREAS STENO LARSEN: Yeah, I have to agree with that conclusion. And it brings us to the discussion that has been ongoing, I guess, for the past year or so, whether we are entering a 1970s scenario again on inflation. On demographics, I think one key change since the 1970s is that we haven't got that roaring comeback of the labor supply that we had in the 1970s. Women entering the job market, etc. That made for a whole different climate when it comes to structural growth compared to what we see right now.

And when we're talking about demographics, I actually did a study on demographics across regions recently. I would actually argue that the demographics in the US look decent compared to the demographics of Europe, and in particular China. So, let's touch upon that a bit. Because if you look at the demographic projections for China, they look absolutely awful.

No matter whether you ask the World Bank, the UN or if you try to come up with projections of oneself. What do you make of the current situation in China and the spillovers to potential growth in the Western world, both short term and also over the medium term?

RAOUL PAL: Yeah, look, China cannot be a driver of economic growth in the way that it was in the past. We think of like, you talked about the 1970s, there was a double demand shock of everybody hitting 30 at the same time, buying their first house, first car, having their first kid, all of that stuff. And women coming into the labor force. That was the biggest demand shock in history.

China came onto the world stage and globalized, massive demand shock for the economy. It was great. They've rebuilt the economy. But the problem is, with an aging population now, your trend rate of growth collapses. And they know it. Now, you can try and use technology to offset it. But it's yet to be seen whether we can do it, because nobody's done it at scale.

Japan has not managed it yet. And they're probably the world leader in robotics. But that's what you need. You need a robot workforce if you want to raise productivity per capita if you don't have many people. So, it's a really interesting thing. Maybe that does happen. But China itself doesn't have the economic growth that it has, doesn't mean it doesn't have the economic power, because they did make a lot of progress in the years leading up to now.

So, it depends how smart they are with it. But it does also slowdown-- a lot of Southeast Asia has the same demographics. South Korea, Taiwan, Hong Kong, they've all got old populations. And so, Southeast Asia is not going to be the engine of growth. And it hasn't been. As you know, you look at the chart of costs beyond talent, they've just done nothing for decades now.

ANDREAS STENO LARSEN: Thank you for answering. This year, I had a debate with for example, Darius Dale whos also a regular on Real Vision on whether China could be the dark horse in a positive sense on growth this year, because they basically had the opportunity to reflate the global economy again, if they basically flooded markets with liquidity again in China, but they've refrained from doing so. They are only saving domestic markets, it seems to me that they're not interested in trying to save the global momentum. So, not even from China, we won't even get positive signals on growth from China in my humble opinion.

RAOUL PAL: No, credit growth in China year on year is turning up now finally. So, it's a stabilizing factor. As you said, they're not doing unlimited QE or anything that's going to rescue everybody else, they rescue themselves. I think you're dead right there.

ANDREAS STENO LARSEN: Yeah, exactly. So, by the end of the day, it's hard to come up with a positive story on demand growth over the coming two, three quarters in my view.

RAOUL PAL: Hes a question for you, then. I'm going to ask you a question is, the other the counter argument to our view is that there's a structural problem with commodities. Now, my thoughts on that is, yes, but year on year rate of change is what matters. So, it's very difficult for the oil price to have the same impact, because it needs to double and double again. But how do you think through that argument? That people say, yeah, you don't get it. Inflation is here for much longer.

ANDREAS STENO LARSEN: Well, I basically think that you're betting against gravity if you think that the oil price will keep inflating the CPI index overall, as a consequence of what you just depicted on the year over year growth rates declining in the natural state. But I think there is a compelling argument in terms of the supply side of commodities, in particular in Europe.

I'm born and raised in Denmark, still live in Scandinavia. And it's fairly easy to see from the current ongoing debate amongst politicians that we're actually willing to pay a lot to get rid of our connection to Russia when it comes to natural gas and resources in general. And therefore, I think there is a larger willingness to accept inflation within the population compared to usual. So, that could of course be a gamechanger when it comes to the supply side of that particular asset.

RAOUL PAL: Yes, but you destroy the demand side. Because if commodity prices and inflation run high and wages don't follow suit, then all it means is Andreas spends less on fancy bottles of wine on the weekend.