Deep Dive
Shownotes Transcript
At PGM, we actively manage risk today while targeting outperformance tomorrow. So no matter what investment risks concern you most, from geopolitics to inflation to liquidity, PGM brings disciplined risk management expertise that spans 30 market cycles. Our active approach finds opportunities in volatility, helping our clients to navigate risk and achieve their long-term goals. PGM, our investments shape tomorrow, today.
Pushkin. Inflation, high interest rates, an AI bubble, bad sentiment, tariffs, a lousy housing market, and most recently, war. This year, the United States economy has faced all of those things and kept on ticking. Today on the show, what does it take to slow down the American economy?
This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I am Rob Armstrong, coming to you from the center of the universe, New York City. I am joined by the other half of the Unhedged newsletter, Aidan Ryder. Good morning. How did we get here, man? So, I mean, the thing that's most amazing to me looking back is like two years ago, the federal funds rate went from basically zero to
to basically four, four plus. Four plus. We're still four plus. Yeah, and we're still at four plus. And everybody, us included, is thinking, this is going to be bad. At some point, you have some kind of crisis. When you have that big, that quick increase in interest rates...
something's going to crash. Yeah. There were definitely bad things in that period. Yes. Inflation's bad. And we did have little micro scares. We had the Silicon Valley Bank and a couple of other banks blew up.
But the machine didn't break. There was some hissing noises and some creaking, but the machine didn't break. Yeah. I mean, the steady ship U.S. kept on sailing. Yeah. No. So that's incredible. And of course, that came in the footsteps of inflation, which was a whole nother challenge. Yeah. I mean, it had a lot of societal and political impacts for sure. Yes. But in terms of the broader U.S. economy, it continued to chug. It certainly cost the Democrats the presidency. Yes. And a lot of pain and a lot of families that we shouldn't overlook. Yeah.
Measured as a whole, the economy charged through that. And ahead of all of our peers in the developed world. Yeah. And we never went into high unemployment. I mean, that's the ultimate statistic for the economy. We're a kind of four and a bit percent unemployment rate economy still. Other horrors. I remember you and I thinking in January that when Deep Seek came out,
And it had made this for like $12. It had made an AI model that was as good as what Google and Microsoft had or appeared that way. And we thought, good Lord, the AI boom is what is supporting both the stock market, the Magnificent Seven's share prices, and to a real extent, the real economy, because people were shoveling billions on top of billions into data centers and chips and NVIDIA and everything else. And we thought-
Wow, we're going to fall off a cliff here when people realize you don't need to spend all this money. Yeah, but that rut lasted maybe a day and a half. Yeah, it's funny. I remember we were like, okay, we wrote this in a note. Okay, we're going to listen to first quarter tech results, and they're going to tell us they're cutting their data center budgets, and they're reorienting towards something else. Nope. No. Armstrong and Ryder, wrong again. It seems like a streak. Yeah.
Okay. Then while all this is happening, President Trump gets elected and more than half of the country, companies, consumers, investors decide everything is terrible.
I mean, it is a partisan effect, but not totally. And so all our measures of sentiment fall through the floor. Yeah. I mean, like near historic lows and sentiment falling across the board, not just among Democrats and independents who might not like tariffs or the Trump administration. It's Republicans. It's wealthy people, poor people. Yes. The whole gambit. And company surveys where people are like, how's business? They're like getting worse, actually. Yeah.
Every signal from sentiment was flashing red. Not orange, red. Red. And when it's the CEO surveys and the corporate capital expenditure expectation surveys and the hiring expectation surveys, this is the stuff that scares you. Not like asking Joe Sixpack on the street, how are things? I know Joe. He's a grouchy bastard. You can't get a nice word out of him.
But when the companies are saying this, it's a huge deal. 0:02:00.6 S1: Well, we should throw on top of when tariffs hit and consumer sentiment bottomed out, so did international sentiment around the US. Everybody's like, "Sell America, the US is done, we're not gonna buy US equities, we're not gonna buy treasuries." 0:02:14.6 S1: And there was serious talk about whether one of the main underpinnings of the US economy, which is the
The other flip side of our big trade imbalance is a capital flows imbalance. Those two things have to match. The money has to come from abroad to fund our spending. Our crazy big deficit. Our crazy big deficits in America. And there was a real worry...
that that wasn't going to happen anymore. And we started seeing signs of that, as we've talked about on this podcast before, in the market. I mean, like very concerning signs, right? Dollars and yields breaking their correlation, everybody selling off stocks in theory. Yeah. And there was a lot of comments and some actual numbers that suggested international portfolios were rebalancing away from the United States. And ultimately, if that happens...
If it's more expensive to finance our deficits with money from abroad, that causes a serious problem for America's economy. While we're sitting here talking about shocks, it would be weird not to mention the fact that we have a very bad housing market. We had an awful new home sales number yesterday.
And existing home sales are terrible too, because everybody who has a mortgage more than five years old isn't going to sell. So we've got an economy where one of the most important aspects of it, which is what people spend on buying, renovating, owning, selling houses, is basically not working. And then while we're worrying about all this stuff, the Middle East goes to war.
Yes, it does. And not just the Middle East. The U.S. comes straight in. Straight in. And all that isolationist talk. I mean, Janan Ganesh had a great column about this in our newspaper this week that basically pointed out, remember all that talk about how America is an isolationist? Well, there's these 14 B-2 bombers that have a disagreement with that thesis. Yeah. And that's like, you know, Middle Eastern wars...
That's an issue for the world. Yeah. I mean, it's an issue for the world. We should note that markets have pretty much ignored the prospect of Middle East wars for a while. Now, markets ignoring is, of course, the topic of this show. So let's shift to that. Why is it possible that the largest and most important economy in the world can take these like Mike Tyson punches to the face, a series of them, and still be at four something percent
unemployment rate, still we're hearing great things from companies about profits, margins are high. The markets of course are perfectly sanguine about all of this. How is this possible? Yeah. Well, we should note that there was a period of market disruption and concern immediately after tariff. Yeah, yeah. Liberation Day tried to ruin everything. Absolutely. But my point, and it almost worked, but it didn't work.
It didn't work. And we wrote yesterday that you can kind of see there's like this turning point in mid-May where some of the old market paradigms kind of reassert themselves. The market is climbing steadily, not super fast, but slowly. It's actually approaching its all-time high again. Yields are finally behaving. Yeah. And of course, I'm glad you mentioned that because I think that is the most important statistic. All of this stuff happened. And for the last couple of weeks, U.S. Treasury yields, 10-year, 2-year, 30-year, whatever, are falling.
falling, but at the same time as equities are rising. So bonds and stocks are actually correlated again, which was what broke apart after Liberation Day. And then on top of that, the dollar is now sliding alongside falling yields. Which is normal. Which is normal, which was not what was happening, but got everybody concerned in the month after Liberation Day. This kind of started sometime around mid-May. And there's not a clear cause. As you're intimating here, the cause is just like...
The markets have learned that the U.S. economy is super resilient and can look through a lot of these panics. Yeah. It's kind of worth reemphasizing that point that you just made, that the thing that the moment of fear was the moment when you had rising treasury yields and a falling dollar at the same time. Totally. Because usually...
When the treasury yield rises, money comes to the United States to say, oh, that's a good yield. I'll take some of that. And that money coming in, of course, has to change into dollars. That forces the dollar exchange rate up. When that doesn't happen, when basically the credit rating of the United States as expressed by the treasury yield
is getting worse, and the dollar is getting worse too, that's a bad sign. And that has turned around. But let's return to the question of why the American economy is as resilient as it is. And I think what I would nominate as the most important single factor is that...
We came into this as crappy as the government's balance sheet might be. And we probably should have emphasized among the trouble the fact that we have this budget right now. And we'll get back to that. But the household balance sheets...
came in very good. That since the great financial crisis, when everybody tried to buy three houses in Las Vegas all at once and got hopelessly over leveraged, the US household balance sheet in
in aggregate has been very good. So the consumer is not leveraged out of the years, and that really helps support the economy. Yeah. Just looking right now at household debt service payments as a percentage of disposable personal income. So how much of your income are you spending on your debt? Yeah.
It's still below where it was before COVID. And, of course, the fact that the government sent everybody a bunch of checks only improved that situation. And people weren't paying money for things for a while, right? They were kind of stuck at home and buying stuff on Amazon, but not spending as much money as they would otherwise. So there's a lot of complaints, I would say, to be made about how much the Trump and Biden administrations spent basically wrapping the U.S. economy in cotton wool.
But we have experienced the benefits over the last year in that none of these shocks that have occurred has really shaken loose the American households' good balance sheets and propensity to spend. Yeah. And I think another piece of the equation, especially in the last four years in the Biden administration of why the US economy was resilient was immigration. Yeah.
Yes. Right? You had really high immigration. That made the break even your jobs number higher. It means you had a lot of people to throw out the problem of this hot economy and keep things a little bit cooler than they otherwise would have been. Yes. We might have been in a worse situation with inflation. Way worse because wage inflation would have been gone way, way up. So that helped us weather a lot of the storm. Of course, that's kind of ending now. Yeah. And we'll see what that implies for the economy in the coming year. I mean, the counter argument is that
very high immigration has caused a lot of other social problems and so forth. And so that's all out there. 0:02:00.0 S1: Certainly. And inflation in the past four years, even with the economy being "resilient", there's all sorts of other social problems that have gone along with the "resilient" US economy. 0:02:07.0 S1: But from the kind of macro statistics level, immigration kept us out of hot water. 0:02:11.0 S1: Yeah, absolutely. 0:02:13.0 S1: Yeah, yeah. That's really true. Okay, so we have a relatively unleveraged consumer and we have
Some immigration flows that kept inflation under control. We have a pretty big fiscal impulse. And that's sort of where we're getting to with the Trump and Biden administrations wrapping the U.S. economy in wool. Yeah. Right? But, I mean, it flows through to everything. If you have a government spending in the economy, a government that's growing at the same time and, you know, rates are still high, you are able to support liquidity in the markets. You're able to support liquidity within the broader of the economy. Yeah.
It allows you to keep things chugging. So in some kind of broad Keynesian way, the government did its job as the source of demand of last resort. Now, all of that is suggestive of a future problem, right? You can't deficit your way to prosperity. But let's put that aside for one second and we'll talk about that shortly. One thing that really made a big difference that has helped the American economy is
Is the shale boom? Yeah. Right. You know, we are we've talked about this on the show quite recently. We're now the world's.
biggest oil producer, natural gas producer. That doesn't just insulate us from the troubles in the Middle East. That insulates the whole world from the troubles in the Middle East. Yeah, it's a global market. Right? The Middle Eastern oil nexus is just less important than it was. So a little war between a couple of countries in the Middle East is just a much less important
big of a deal than it would have been even 20 years ago. Yeah. It is really astonishing how markets are able to really look through Middle Eastern troubles, right? Yeah. I mean, the market panicked a little, a few times in the past two years as Israel has fought both internally and with its neighbors. But the market essentially learned to shrug them off and the oil market learned to shrug them off. Right. Iran, we thought, would be the exception.
Iran is a huge oil producer, and crucially, it controls the Strait of Hormuz. Yeah, if they'd shut the Strait of Hormuz, which was theoretically on the table, I don't think the oil market could have ever looked through it. 20% of the global daily consumption, that volume, goes through the Strait of Hormuz every single day. Because if you look at a map, right, it's how all the ships get into Saudi Arabia, into Iran, and a lot of the Gulf countries. So the market could have looked through that, but shockingly, even when...
Trump bombed Iran, which would theoretically invite their retribution or would theoretically pull the US into a longer war in the Middle East, which would have implications for the US economy and the markets. Markets not only didn't care, the S&P 500 went up the day after. Yeah, yeah. I mean, it's just important that the war didn't turn into a disaster. Totally. Like on the tree of possibilities that we were looking at.
we have landed on a very benign branch. So far, knocking on all available pieces of wood. We seem to be in a calm place. I think the broader picture we're sketching is the reason the market hasn't been able to recover in the last month is because the US has just proved itself over and over again. And I think the same policy applies to the US economy itself, right? Once you prove you can outperform US exceptionalism or whatever else you want to call that, it's self-reinforcing. It's self-reinforcing. And it's especially self-reinforcing
On the market side of the economy. Exactly. Yeah. I think that's a really important point that the real economy and the market are not really all that separate. There is causal interplay between the two. They're separate, but- They are separate and the real economy is obviously the more important part. But a market shock can cause an economic shock and obviously an economic shock can cause a market shock.
And this incredible buy the dip mentality that has taken hold in US markets, that whatever happens that shocks the market, the smart thing to do is to buy it while it's low. Yes. That is a kind of economic shock absorber as well as a market shock absorber because you don't get that feedback loop going between markets.
the stock market, the bond market, and the real economy. Yeah. But as the resident pessimist of the unhedged people, I feel like we have to acknowledge this might not be sustainable. Okay. Good thing to say. Let's talk about the future now. We've talked about the past and all the shocks.
We've talked about the present, meaning why things are still so strong now. Let's talk about the future. I'm going to give you the stage to be Mr. Pessimist, which is your role in both the newsletter and the podcast. What's scaring you today, Aidan? What isn't scaring me today? So let's start with the American exceptionalism piece that we just spoke about. As we said, it's self-reinforcing. It's a huge benefit to the United States. A lot of people were concerned that...
Trump's tariffs and all those actions were going to be the beginning of the end of American exceptionalism. We think that was definitely overhyped for the month of April and May, right? If you look at data from the Fed, equity inflows, so people buying US equities from abroad were still relatively high and actually rising. And bond inflows didn't collapse either. They didn't collapse. They weren't- They were weak. They were weak and there were two weak treasury auctions, but they continued around flat to a little bit up. It wasn't
It wasn't catastrophe, but it takes a long time, especially for foreign pension funds, foreign banks who buy the bulk of US treasuries to pivot away. So, I mean, this could be the start of a longer term trend and most people we've spoken with who are very well versed in this are convinced that there will be a longer term trend. It might not be absolute chaos.
But it is concerning. It's drip-drip. And especially for a country that runs these huge deficits. Yes. Who needs to have cheap financing. It's concerning. Okay, that's point. Here's the optimistic counterpoint. Please. The optimistic counterpoint is where else are you going to go, people? You want to put your money in Europe?
I wish you good luck. You want to put your money in Japan? I wish you good luck. You want emerging markets? I wish you good luck. I just don't think the alternatives are there. I'm sticking with Tina on this one. There is no alternative. I think that there's probably no alternative right now, but I think there's a case to be made for all three of those things you just mentioned. Japan, Europe, and EMs to rise in the coming years for a variety of reasons. I'll believe it when I see it. Now, the thing that worries me...
As we intimated before, the US is addicted to deficit spending. And at some point, the people who are lending the money demand to be paid more for doing so. The US budget becomes unmanageable.
Treasury yields spiral up and we are forced as a country either into austerity, like growing up and having a more balanced budget, which would cause a recession and a market crash in my view, or we are forced to inflate our way out of our trouble or use some other wicked financial trick to get out of our trouble. And we are playing chicken with that right now with the budget negotiations that we're having. And we're starting to see some like...
fringe financial engineering starting to take place. So we've written a lot about the supplementary leverage ratio, which is essentially broader bank regulation. Allows banks to hold more treasuries. Yeah, yeah. There's this new regulation that's adjusting this bank regulatory ratio that is allowing banks to hold more treasuries. On top of that, you have the Genius Act, which is getting stable coins to hold more treasuries. I mean, there's a lot of things that are starting to happen around the fringes, which could come to bite us. Countries that have financial troubles.
One thing they standardly do is they try to trick private sector institutions into owning more and more of their debt. And unless you are Japan, that tends to end badly. Yeah. And who is to say if it would end badly here? Also, there's plenty of arguments for why you would make some of those adjustments that are not nefarious. Yes. But it's something to keep an eye on. Okay. That is the pessimistic point.
And I will give you the optimistic counterpoint. We still have the best corporate economy in the world. Totally. It's an incredible engine of prosperity, American companies. And if you make even a modest adjustment, the American economy can grow its way out of a lot of trouble. Totally. You don't have to be a saint to...
Fiscal wise, you just have to be less of a sinner and then the corporate economy will get you out of trouble. My one word counterpoint is tariffs.
We don't know what will happen with tariffs. Correct. We don't know where they'll be. Yes, okay. That will flow through to the economy itself. Yes. And there's so many rumblings about what will result. I was trying, Aidan, to end on an optimistic point. We had to send tariffs out. But you just refused. We had to. You just refused. I completely agree with you, but we had to mention tariffs. I want listeners to know that Aidan sits over on the other side of this table and there's like a little cloud over just his head that it's constantly raining.
It's sunny over on this side of the table, and we will be back after a short break with Long and Short. Speaking of alternatives, PGM's monthly podcast discussing trends and strategies in alternative investing. There's no question that Mexico's preferential position in the new trade policy will drive incremental demand for industrial real estate and will sequentially drive rent growth as well.
There's more to uncover. Hear the full conversation on P. Jim's podcast, Speaking of Alternatives. Listeners, welcome back. This is Long and Short, that section of the show where we go long things we like and short things we don't like. Aidan, you complain so much in the body of the show that I'm sure you have something you are long. Yes, I am long impulse grocery buys. I was in...
the grocery store near me. I saw guavas. I don't particularly like guavas, yet I still bought the guavas. Yes. And last night, I made guava jelly, and I'm very happy. I think you are in the world capital of the impulse grocery buy. There's so many ethnic grocery stores in New York City that there is food you've never seen before, crosses your path all the time, and I agree with you, just buy it. I am long...
The Citigroup buy note. I was going through my inbox this morning and there was a research note from another large bank saying Citigroup finally has its stuff together and it's going to start catching up to the other banks in profitability and markets are going to love it again and you're going to make a lot of money owning the stock.
I have been reading literally that exact research note for 20 years from the day I entered finance. And so whatever happens with Citigroup, I wish them well. I hope this note is correct. But one thing I'm telling you is that the Citigroup buy note, it's different this time, will exist as long as Wall Street exists. Listeners, we will be back in your feed next week. Until then, stay cool.
Unhedged is produced by Jake Harper and edited by Bryant Erstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer.
I'm Rob Armstrong. Thanks for listening.