CHRISTOPHE OLLARI: The fixed income market is sending a very strong message, which is the neutral official rates from the major central banks is far too wide. The ability of the central banks to answer the way they did it in 2008 is very limited. What has been the main, the main takeaway over the last 10 years? The disconnect between financial assets and the real economy, it's not about GDP. It's not about inflation, it's about these markets are extremely addicted to Central Bank answers.
ROGER HIRST: In Raoul's recession framework, one of the key elements is going to be the performance of central banks. Can central banks in any way stave off a slowdown and prevent a slowdown turning into recession? And if there is a recession, can they do anything about asset prices and hold them up? It's a key point and with all the central banks providing significant liquidity over the last 10 years, can they still do that? And can they still have an impact? Or is it already too late?
Our guest, Christophe Ollari, from Ollari Consulting has been looking at the central banks. And he believes that central banks are in a new paradigm. And its central bank liquidity is going to be a key element. And he thinks that perhaps the central banks on this occasion being preemptive. I'm very interested to hear why he thinks that is the case, and how it's going to be different this time from when central banks have provided liquidity before but have failed to prevent bubbles from bursting and asset prices from declining. So, this should be a really interesting conversation to hear about the central banks and the central bank paradigm, and whether they can stop the global slowdown that we are currently experiencing from turning into something more sinister.
Christophe, great to have you back on Real Vision.
CHRISTOPHE OLLARI: Good morning, Roger.
ROGER HIRST: We're here to talk about recession week. But what I really wanted to chat to you about was Raoul's been talking about a thesis, a big thesis of which one of the key elements in that is going to be the role of central banks, and whether central banks can provide liquidity. What I wanted to chat to you about is that when I look at the market, I see all the yield curves, and I look at the 2s, 10s which is trying to turn higher, didn't quite go negative, but we did go negative on 3-Month, 10-Year, and obviously, 5, 30s turn higher last year. So, in combination, all these things are saying we go negative or we turn higher, recession comes 12 months later. And there's a whole bunch of other indicators out there, which are very, very similar. So, it's suggesting to me that recession is imminent.
Now, the chats we've had, you think that the messaging from yield curves might be slightly different and that we're in a new central bank paradigm. Could you maybe explain to us what your view on yields and messaging from yields is and how that ties into this discussion and argument that you've been having about central banks that goes back well over 12 months?
CHRISTOPHE OLLARI: Sure. First of all, I never ignore a message sent by the fixed income market. I really think that whatever the message is, it's a very key signal that we have to look at very carefully. We know that PGFC, the usual flattening of the curve and inversion of the curve, especially the inversion was resting at least a quarter and the subsequent steepener was a very strong signal that the recession was imminent. Is it still valid? I've got a reservation which is very simple. It's when you've got 13 trillion of negative yielding at fixed income instruments, I'm massively convinced that it is impacting the shape of the curve one way or the other.
Where do you have duration, liquidity and a semblance of CB in the world, the US Treasuries market. So, basically, I'm massively convinced that the flattening of the curve and this equation, the equation of the risk premia is as well consequence of these need for duration and the need for a fixed income liquidity.
ROGER HIRST: So, what you're saying there is that rather than the bond market anticipating a recession, what you're effectively saying is that the global pot of bonds have gone negative have forced foreign investors into US Treasuries or the US bond market and the notes and the Treasury market, and their buyers of these instruments, which has been pushing yields down. Now, wouldn't some people say, well, okay, but it's the similar thing, because the Europeans are seeing a slowdown, which is the reaction from the central bankers to force them to negative rates. And so, what we're doing is we're just transmitting the slowdown across the Atlantic and eventually, while the messaging is the same, is that not a valid argument?
CHRISTOPHE OLLARI: The fixed income market is sending a very strong message, which is the neutral official rates on the major central banks is far too wide. So, it's anticipating a very meaningful action from the central banks to move option rates more in line with what I call the new paradigm which is very subdued inflation and very poor growth. One way I look at it, I've created what I call the Major Central Banks Official Rates Index, which is an average of the seven major central banks rates. So, the Fed, BOJ, ECB, Bank of England, RBA, Bank of Canada, [inaudible], and I plot it against the Chinese GDP growth. And it's staggering, it's just the correlation is very strong, meaning that we have moved into a new paradigm, which is what I called the flatlining environment, where in fact, central banks have to move lower their neutral rates.
ROGER HIRST: So, we've basically seen a global convergence of GDP into mid to low single digits, because remember, you used to have a double digit EM and you had three in the US. Now, everyone's between one and five, or one and six, or whatever. So, you're seeing that convergence, but I guess, in terms of the sequencing, because everyone's seeing it slow down, is pretty much clear. We've clearly got a manufacturing slowdown. And people see the slowdown potentially morphing into a recession.
But then the key question for the central banks, or the central bank impetus here is, does a slowdown become a recession? Can central banks stop that? Or if we get to recession, let's say, it's a CapEx recession in the US, can we have central bank's act in a way which prevents equities or risk assets from selling off so that a shallow recession doesn't turn into a significant global deflationary event or a depression or anything like that? How does this new paradigm with central banks come into that and prevent the sequencing from falling in those lines?
CHRISTOPHE OLLARI: I think that when you look at the- for example, PGFC, we went into the massive downturn with official rates at 5% to 7%, with the balance sheet almost empty, with low deficits. So, there was room to in fact to kick-start the economy and to basically save the world. We are not going to a real downtown, and there is no way to omit that. It's not only on the manufacturing, it's broad based. Even if the services activities are quite resilient, but you see just like yeah, creeping under the surface, some imbalances which are very concerning.
We are going into the downturn with official rates in low 2s. Two major central banks with negative interest rates. 14 trillion of balance sheet. So, basically, the ability of the central banks to answer the way they did it in 2008, is very limited. The problem is, they can't afford a burst because they don't have the meaningful tool to address the consequence of a massive downturn. So, they will need to be very preemptive. And that thing that this is the message we have this year.
In fact, last year, what did central banks have tried to do? They tried to rebuild monetary policy ammunition to be able to address a potential recession. They realized that there was no room to rebuild those ammo. So, this year is a big shift, which is all about you know what, we can't rebuild the monetary policy ammunitions so let's try to avoid any burst at any cost. And this is what they are doing, they're going to try to be very preemptive.
And what is interesting is they know they will not be able- I think they have no illusion about their ability to kick- start the economy. I think they have no illusion about their ability to boost real inflation. So, these mandates are quite an illusion. So, they are focusing on what they can do, which is keeping the financial conditions as loose as possible.
And that was the message of the Fed yesterday, to be honest. When you look at their minutes, they know that they can't backtrack, because backtracking would mean just like a massive unwind of the 2019 risk parity euphoria, which were the main achievement of 2019, to be honest. So, I think that they have to focus on- they have decided to focus on loose monetary financial conditions. And to keep the term structure as low as possible. And this is the best way to deal with the mess they're burdened at the end of the day.
ROGER HIRST: And people often look at the central banks and say, okay, what we're actually saying here is don't fight the Fed, that used to the Bank of Japan and the PBOC, et cetera. But then people say, well, hang on a minute. In 2000 to 2003, the day they started cutting rates was pretty much the top of the market, I think had four days of euphoria similarly, in 2007, and you can see perfectly that the equity selloff is exactly in line with the rate cuts. You're saying that in those occasions, they delayed too long. And on this occasion, they're preempting it. And some of the moves that we're seeing in yields, which you could extrapolate forward and say, recession coming actually, those moves in yields are anticipating central banks trying to prevent the slowdown turning into a recession.
CHRISTOPHE OLLARI: When you look at PGFC, we had four main episodes '95, '98 with preemptive rate cuts from the Fed, they managed to engineer a soft landing of the economy. And the equity market just rallied. 2000 and 2007, far too slow to cut rates. The equity market just sold off even before the Fed cut. We are, again, in a different paradigm. We are post-GFC, and I really think that what has been the main, the main takeaway of the last 10 years, the disconnect between financial assets and the real economy. It's not about GDP. It's not about inflation. It's about these markets are extremely addicted to central bank answers. If they come and put another few trillion of liquidity in the market, I think that's the disconnect we have at the moment with fixed income just plunging, diving and equity market rallying can last through the fall.
ROGER HIRST: Is there a danger that- the central bank activity, if you- let's say, take 2016 as an example where whether we got a Shanghai Accord or not or whatever, we had China putting liquidity in theoretically Shanghai Accord, the Fed would relent. And I always call it the top that never was, 2016 look like the tops of '07 and 2000 but it never turned into anything worse because central banks came together. And they all agreed to put more liquidity into the system.
Today, we've got central banks in a little bit more of a beg their neighbor mentality, clearly with the trade war. I'm not sure the PBOC is going to necessarily agree with the Fed this time around. And the ECB is in a messy place. Will they be working independently? Or will they clump together? Because that seems to be the key here if you got to miss that.
CHRISTOPHE OLLARI: To be honest, for me, the cornerstone of the current dynamic. And I think it's very important that you go back to 2016. Because what was the most important part of 2016? It was a concert deductions between the central banks. And we ended up with- between March 2016 and June 2017, something like 2.5 trillion of cash injection. But even more importantly, you have the Shanghai Accord which was meant to put pressure on the US dollar, this will not happen.
How can we have a concerted action on to weaken the data in the current growth inflation and trade uncertainty. You really think that- you know what, you're putting tariffs on our product and we are going to be foolish enough to shoot ourselves in the foot and to let our currency appreciate, obviously not. So, we are in a competition between the central banks to out-dove the doves to do more than the neighbor. Because basically, they don't have many ammunitions so when [inaudible] of their strategy is to weaken their currency.
And you're just exporting deflation. And this is a zero- sum game. And I think that it's quite interesting that even if we are in a trade war, which is a currency war, the G7 preset FX vol is at all- time low. Because you have a spike and what the central bank is doing is just sitting the spike to bring it back lower. So, in fact, it's a zero-sum game.
ROGER HIRST: So within that, you were talking about the doves have to out-dove the doves, and as we talked about earlier, one of the worst parts, and some of this whole central bank framework is that Europe is in a mess, it's a basket case. And the appointments of Christina Lagarde or the nomination of Christine Lagarde to lead the ECB is a tacit acceptance. They probably got to do more than just monetary, they got to get the fiscal side going as well.
So, can we go through to the central banks, what can these central banks do? If they're not going to work together, they got to work aggressively themselves. Europe's not got much ammo, what are they going to focus on?
CHRISTOPHE OLLARI: So, before talking about that, Roger, I'm going to just add on something on the why I think that the central banks will have no choice to do more. It's because at the moment, their fiscal expansion tool is very limited. And for various reason. In the US, we have a political gridlock, which mean that I don't see any bipartisan support for some infrastructure [inaudible] ahead of the elections. The Dems would never give a gift to Trump. And to see him potentially boosting the economy.
In Japan, interestingly enough, they seem more obsessed to rise their consumption tax at the moment harder than doing any program or fiscal expansion. In China, we know that the deficits are already 11% of the GDP, and therefore, it's already a very liberal system. So, the room to do merge right now is very limited. On top of that, the transmission channels of liquidity are compelled.
And then you have Europe. So, Europe, for the time being, I don't see that fiscal expansion is coming in a very short term, because anything with Europe takes time, and you see that, you know the mass records, and you've got the legendary German Budget [inaudible]. So, I think that the nomination of Lagarde is a very strong signal. But again, it's going to take time.
So, in the meantime, what the ECB would do? I think that more rate cuts, I think is going to be very limited for one reason, it doesn't work, and you take the risk to damage even more the banking system. I would either- a very interesting post over the weekend by Deutsche Bank, but it's not- Deutsche Bank is not in your [inaudible] story. It's the overall European banking system, Japanese banking system, or Swiss banking system, which is not very surprising considering that the three central banks are already in a negative interest rate policy.
So, I think they're going to do more QE, they will just- in the meantime, they will just keep the term structure as low as possible. Because it's an easy way to deal with the debt burden for the time being. You're just using the debt servicing, and basically, doesn't cost too much for the different European countries.
ROGER HIRST: So, Europe's stuck in that one area. You said the banks- what they will do will probably see the banks continue to underperform because the banks have to. But it's a death by 1000 cuts. So, it might take X number year. You look at the overall banking sector, the whole thing's on its knees. It's at the 30-year lows.
CHRISTOPHE OLLARI: And just on the banks here, Roger. I find mind-blowing that we don't even realize that the banks are supposed to be the provider of the engine of the real growth. And not only they have to fight with negative interest rates, but on top of that, they have to fight with the post-GFC regulations. So, basically, it's you can- we always go back to the same topic, it's post-GFC, we thought that MV = PQ will work. But M is not the issue, the real issue is V. And we still haven't addressed the issue.
ROGER HIRST: And if you just go through M versus that equation, if you just explain it for the-
CHRISTOPHE OLLARI: Just the fact that if you increase the monetary, basically, base, it will end up by boosting the real economy and the output. So, to make it very simple, why it didn't work in partnership seeds, because we just flooded the market with a new cash, but the cash never went where it was supposed to go. And one of the reason is the banks just didn't- were not the transmission channel they were in the past.
ROGER HIRST: So, basically, a low velocity of money and basically, became a misallocation of capital.
CHRISTOPHE OLLARI: And on top of that, you have also the debt burden, which is impacting the money velocity. And it's interesting to see that since GFC, when you take the global amount of cash injected in the system divided by the global GDP, it has collapsed, which means that even one extra dollar cash injection by the central banks equal less than $1 of real GDP created. So, we are already, to some extent, reaching the limit of the monetary policy stimulus. But they know that, the purpose is not to boost the economy because they knew they can't, it's to avoid a burst.
ROGER HIRST: So, it sounds like the ECB is relatively impotent for the next 12 months, it will do more of the same but more of the same means death by 1000 cuts of the banks. Does that mean that the Fed has to do the heavy lifting? And they're still tightening their balance sheet, they're still running it off. Do you think they going to stop that soon, as well as cut rates? Are they literally going to come back and say okay, we're going to do QE4, and we're going to get rates the frontend back down