Strap yourselves in... it's going to get bumpy

Chris Conway

Livewire Markets

There is no way to sugarcoat it, we're in for a bumpy ride. That's according to Charlie Jamieson of Jamieson Coote Bonds.

Charlie equates the lag effect of economic policy and interest rate tightening to turning on a garden hose and the water taking some time to come out the other end. 

The water doesn't arrive as soon as you turn the tap on and, if you turn the pressure on too hard, the water will burst out violently. Like economic cycles, each tap is different - how much pressure is too much? 

It's both an apt and terrifying analogy. If Charlie is right, things are likely to get worse before they get better. But it does not mean we need to panic. What we need is to be armed with knowledge, understand the different scenarios that could play out, and have a plan for how to manage said scenarios. 

In the following Expert Insights, Charlie explains why he thinks volatility and uncertainty will remain, why a global recession in 2023 is likely, and why energy is an important swing factor for the fate of the global economy. 

Note: This interview was conducted on Wednesday 12 October 2022, and is an excerpt from a broader interview with Charlie, the rest of which can be seen in this wire

Edited transcript below

Chris: Charlie, you talked a couple of months back about the central bank pivot and the fact that it's probably still some ways away if it's even going to come at all, and that heightened volatility and uncertainty will remain. Has anything changed since you passed that view a couple of months back? Has it gotten worse?

No, I don't think so. I mean, the thinking here is that it's very difficult to pivot and that's generally meant to cut rates and do QE if inflation is still at five percent. That's only going to electrify inflation again and we're right back facing the same issues that we were facing 12 months ago. So, to put those support mechanisms that have restored and made the cycles really fast, it's a lot harder to deliver this time. Now, and that doesn't mean they won't do something, but the problem of course then resides that if risk markets move too far and too fast, it does accelerate activity again and that's not what the central banks are looking for. Because that doesn't deal with inflation in full.

So, we just think that the safety net is a lot lower. Now there is a safety net, obviously, we've seen that from the Bank of England in recent weeks, where markets become chaotic and disorderly, they do need to get in as the lender of last resort and say, no one will pass this mark. 

But that mark's been a hell of a long way back from where we would have otherwise expected it to be in previous cycles. 

So, I think that in terms of the way that asset markets perform this time, rather than being really V-shaped - in that it's gonna be really bad and then the central banks will come in and then it's going to be really good, so you've just got to ride through it - it might get a little harder and it might stay a bit harder for a while. Because they're not going to allow things to re-accelerate. They'll stop the decay.

So I guess the thing that we're probably looking for as a pivot is a halt on rate hiking, and the markets will try and rally a bit on that. But what will probably occur, is that earnings will still be pretty ordinary. 

We've still got to face these much higher interest rates as they kind of permeate their way through the economy. 

There is a long lag effect to those actions and so, you know, we've really been hiking interest rates so fast, it's a bit like turning on the garden hose and nothing comes out the end of the hose you're holding in your other hand because it's got to run all the way through and then it just chaotically explodes.

Given that, as you mentioned earlier, these are the most violent rate hikes we've seen since '94, they come at a time when people are carrying a lot of debt. 

Yes, mortgages are still pretty affordable in the context of history, but the debt loads are enormous in the context of history. 

And they, those two, must marry up and find a reasonable equilibrium. So, we know everyone is facing lower discretionary spend moving forward, so we do expect that will bring the economy to a much slower rate - and probably into '23 towards a global recession, as we move through that moment.

Chris: I love that analogy there, Charlie, of the garden hose. Is that the reason why you think we can't have a soft landing because it's going to be violent as we move through this process?

Yeah. Sadly it is. I think what we're doing at the moment is, we're adjusting things and then saying, oh well, we haven't done enough, because there's nothing observable yet. And the reality of it is, is that it's really compounding up, and will come washing over the economy pretty substantially. We know already that we've got seven percent mortgages in the United States, and those key residential markets have really curtailed materially. Similar in China. We're starting to see that, sadly, for homeowners in Australia.

Now, we're still in a great position versus where we were a few years ago, but the issue is that the rate of change is materially negative now and there's nothing to materially address that for a little while longer.

So we do believe that, as we said, once those rate hikes do feed down through the system and discretionary spend is tightened, then we are going to see the job market start to cool and we'll see some layoffs. And at that point, you know, confidence is already very low, but it probably gets a bit lower and it can be a little grim. 

And clearly, economic activity will dampen as a result of that.

We're also at a time where we're not fiscally, in a kind of procyclical manner, trying to address that. It's really been a reign-in on all fronts, be that fiscal, monetary, and from a liquidity point of view, with the reduction or reversal of QE to now become quantitative tightening. Quantitative tightening is an interesting one. 

The Bank of England managed to stay in that quantitative tightening mode for 24 hours until they started quantitative easing again.

So we know that that's a difficult thing to achieve at a time where interest rates have been ratcheted higher and the like, but yeah, we do believe that a hard landing is somewhat inevitable. I guess our thinking in that is that, and - I mean, we'll never know the full motivations and the nefarious actors at play - but Europe has a very difficult energy winter ahead of it, and that is again, a tax on consumers at a time where they're facing so many of these negative issues.

Seemingly, we think that Putin would want to put himself into a negotiating position where, he's got to test the resolve of European leaders, to see how they're going politically, as their citizens are literally freezing, and that has to be a good negotiating position for him to then get to some outcome if that's what he wants. The way that things seem to be set up is that, that that's a bit of a certainty and we know that Biden has to restore the Strategic Petroleum Reserve, he's drawn more than 200 million barrels out of that, I think it was 740 million to start with. Clearly, it is there for these types of moments, but it does need to be restored.

If that is to occur, kind of coming into that winter period, where the premium for energy is already very high, then we could face pretty catastrophic kind of economic outcomes into next year.

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Chris Conway
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