Writing about macroeconomics has always been my passion, so it’s good to be back at it again after what felt like a long break: It’s been almost six months since I wrote my last weekly piece at my previous employer (on the topic of negative interest rates). I then spent most of my “gardening leave” before joining PIMCO reading, traveling and organizing my move from London to California. Yet, now that I’m up and running in the Golden State and at PIMCO, it’s high time to start writing and publishing again. Why? Writing helps me to organize mythoughts and (hopefully) identify flaws in my arguments. Publishing allows me to benefit from your thoughts and arguments, but only if you push back and challenge me whenever you disagree – so don’t be shy! Macro Perspectives will appear at the beginning of each month, and I’ll also start writing a more frequent, shorter column on our PIMCO Blog soon. I look forward to hearing from you.
As this is my first piece for PIMCO and many of you either will not be familiar with my earlier work or may have simply forgotten about it during my six months of silence, let me first explain my framework for thinking about the global macro outlook and how it fits in with PIMCO’s approach and views. I’ll start with three general points about the framework, and then become more concrete about how it links into the current outlook for the global economy and markets.
Macro thinking: three key elements
For starters, I strive to simplify macro matters as much as possible, even at the risk of the occasional oversimplification. Simple is beautiful. I believe my bias for simplification goes back to what I learned decades ago in my econometrics classes: One should always aim for a parsimonious model – the simplest plausible model with the fewest number of explanatory variables. Also, I admit that Tiki Küstenmacher’s “simplify your life” mantra probably also rubbed off on me: While writing, I often whisper “simplify your macro” to myself, and I constantly try to find simple catchphrases to describe the state of the world and express my views.
Actually, this is something PIMCO has been doing for a long time: Just think of the simple, elegant and powerful New Normal concept that was coined at PIMCO’s 2009 Secular Forum to describe the prospective post-crisis macro environment. The term has become common among policymakers, commentators and market participants alike. The same holds for PIMCO’s more recent The New Neutral thesis – the idea that the neutral rate of interest is much lower than in previous cycles, resulting in a shallower hiking path toward a lower terminal rate once central banks decide to escape from the (somewhat magnetic) lower bound. Following the company’s 2014 Secular Forum, PIMCO identified and described The New Neutral as the natural progression from The New Normal and it has since been largely endorsed by markets and commentators.
Secondly, global trumps local when it comes to explaining important macro trends. The globalization of trade, capital, people, ideas and information flows means that global factors are now so much more important in driving local economies and markets than in the old days of limited mobility:
- For instance, it is difficult to explain the prevailing very low inflation rates in virtually all advanced and many emerging economies with domestic factors alone. Of course, if national central banks and governments try really hard to screw things up, they can still produce either high inflation or deflation. Yet, by and large, lowflation has not only gone global, but also is driven mostly by global factors.
- The same holds for bond yields, particularly at longer maturities: Explaining, say, the low level and the gyrations of 10-year government bond yields in the U.S. or Europe – or rather, the term premium embedded in yields (i.e., the component not explained by the expected path of short rates over the bonds’ lifetime) – is not easy without considering global factors.
Thirdly, I’ve always found the distinction between, and the interaction of, “secular” and “cyclical” forces important in understanding and forecasting the economy and markets. As analysts and investors, we have to distinguish between (1) the longer-term destination, the secular trend, and its drivers and (2) the often winding path toward that longer-term destination, the cycle around the trend, and its shorter-term drivers. At the same time, it is essential to recognize the interactions and feedback loops between secular and cyclical trends and drivers:
- For example, a prolonged period of depressed demand and sluggish cyclical growth can easily morph into lower long-term potential growth via weak investment, a deterioration in idle workers’ skills, lower labor force participation and dwindling animal spirits (you will probably recognize the “secular stagnation” story).
- Conversely, strong secular headwinds, say from deleveraging or slowing population and productivity growth, will likely weigh on cyclical forces and increase vulnerabilities to shocks. This is why, given the headwinds emanating from the financial crisis, I had dubbed the current global economic expansion that started in 2009 a “BBB expansion,” where the triple B stands for bumpy, below-par and brittle growth. I think this expression still applies in what is now Year Seven of this global expansion, and you can see easily how the BBB expansion is related to The New Normal and The New Neutral.
Of course, PIMCO has long internalized and institutionalized the secular/cyclical framework by holding a Secular Forum each May to form a view on longer-term trends and drivers, and three Cyclical Forums in March, September and December to debate and agree upon the likely path of short- and medium-term gyrations in economies and markets. (The secular timeframe is typically three to five years, and the cyclical is six to 12 months.) Importantly, we don’t view the two as independent of each other – secular trends often have a bearing on the cyclical and vice versa. Put differently: Yes, the long run is a sequence of short runs, but long-run forces can alter the short-run path.
Applying the macro framework: the three gluts
With this general framework in mind, here’s how I’ve been thinking about the global macro outlook for a while: It is driven by the interaction among what I call the “three gluts”: the savings glut, the oil glut and the money glut. While the global savings glut is likely the main secular force behind the global environment of low growth, lowflation and low interest rates, both the oil and the money glut should help lift demand growth, inflation and thus interest rates from their current depressed levels over the cyclical horizon. Let’s look at each of the three gluts in turn.
The term “global savings glut” is a simplification, of course. Ben Bernanke coined the term a decade ago to describe a situation where an excess of global desired saving over global desired investment depresses low long-term interest rates. Ten years later, it is fair to say that the ex-ante savings/investment imbalance is even greater and the global equilibrium real interest rate even lower – recall that the equilibrium (or natural) interest rate is the rate that brings saving and investment in balance as the world’s ex-post saving must always equal the world’s ex-post investment (unless capital is allowed to flow from or to Mars). Why is it, to simplify further, that everybody wants to save more but nobody wants to invest? There is a host of reasons, but these may be the most important:
- History: The financial crisis casts a long shadow on consumption, saving and investment behavior.
- Demography: People want and/or have to save more for a longer retirement period as the retirement age has not risen along with life expectancy.
- Inequality: It is rising, and the rich save more than the poor.
- Technology: Many new industries have low capital needs, and disruptive technologies make investors in old industries reluctant to commit capital for a long time.
- Necessity: Many emerging market countries have aimed to reduce their capital imports and slashed investment spending following the 2013 taper tantrum.
Due to these factors, the global economy has been suffering from adeficiency of demand, both investment and consumption demand. And, as I described above, weak demand for a long time slows potential growth as temporary turns into permanent joblessness (via “hysteresis”) and weak investment dents the growth of the capital stock. This implies that the real equilibrium (or natural) interest rate in the world is probably negative. And if governments fail to fill the demand gap with fiscal stimulus and central banks cannot push real rates significantly negative (due to the lower bound for nominal rates and low inflation), the economy remains lethargic and central banks have to blow pretty bubbles in the financial markets in order to avoid even worse outcomes. As you may have noticed, we have now arrived at the core of Larry Summers’ “secular stagnation” thesis, which is actually very similar to (though not identical with) Ben Bernanke’s “savings glut” thesis.
Before you get too depressed, let’s introduce the oil glut, which became so apparent in the second half of last year and has recently reasserted itself after a temporary rebound in oil prices in the spring.The oil glut helps to mitigate the depressing impact of the savings glut on consumer demand by shifting income from oil producers, who have a high propensity to save, to consumers, who typically spend most of their income. As we have seen in the U.S. over the past few quarters, the immediate negative impact on investment in the oil sector may initially outweigh the positive impact on consumer spending as consumers are slow to spend the windfall gains from lower gas prices. Yet, for a net importer of oil like the U.S., the effect on aggregate demand from lower oil prices should remain positive over the cyclical horizon, and consumer spending in the second quarter in fact picked up nicely from the first-quarter lull. True, the very recent further decline in crude oil prices still has to translate into lower gas prices, but once it does, consumers will start to react.
Enter the third of our gluts – the money glut – which has been fueled by the impact of both the savings glut and the oil glut on central bank policies. The savings glut has long forced central banks to try to push real interest rates lower toward and ideally below the negative real equilibrium rate – mainly through zero or even negative policy rates, forward guidance and quantitative easing. And the oil glut, through temporarily depressing headline inflation and damping inflation expectations further, has led to a doubling-up of these efforts –witness the wave of central bank easing steps around the globe since the start of this year. We expect more monetary easing to come, particularly in China and in many commodity-producing countries, so the global money glut, which is already increasing due to heavyweights like the European Central Bank and the Bank of Japan executing their asset purchase programs, will swell further.
Global implications of the three gluts
To conclude, what is the combined effect of the three gluts? First, expect global growth, inflation and interest rates to remain much lower than in previous cycles over the secular horizon, reflecting the impact of the global savings glut – this is the core of our New Neutral thesis. Second, look for a pickup in global economic activity and inflation over the cyclical horizon, reflecting the combined effects of the oil glut and the money glut. And third, expect bond yields to rise moderately from current levels on the back of the cyclical recovery and in response to the Federal Reserve embarking later this year on a long but shallow hiking path toward a New Neutral interest rate of around 2%.
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