Thank you for that, Megan, and thank you everyone for staying around for our final session of the day. As Megan said, Emily and myself are going to run you through our thoughts for the macro outlook for 2022 and hopefully leave you with some tradeable ideas as well. Let me start off with the big question. I can't avoid it. Transitory or persistent? I'm going to be brief here because you've heard from people much more qualified than me to talk about this. Obviously, you've heard from Alberto, our head of PriceStats. Let me start off with my views on this very quickly. I am a fully-paid up member of team transitory. I'll be absolutely honest. I think we have to properly define the terms and for me, transitory is not necessarily a timeframe. I know it sounds a bit weird, because the word itself implies a timeframe, but transitory to me means that the inflation pressures we're seeing will dissipate on their own without central banks having to hike rates aggressively to crush demand. We have a supply-demand imbalance, but that's driven by issues with supply. We know that. They're supply-side issues. It's not about demand outstripping the potential supply. In that world, yes, central banks would need to act and they would need to bring demand back down. That's not where we are. I think in 2021, what we've had is a double-whammy. We knew we were going to get base effects. You look at the chart here, the dark blue line shows you what happened at the start of the pandemic last year. We knew that base effects would push us up to four, four-and-a-half per cent inflation this year. But what we didn't really factor in was the increase or the problems on the supply side, and they've kept going and so now we're printing over six per cent. Stubborn is not the same as persistent and for me, that's the key issue here. We can see that simply by the fact that it's happening everywhere. If you look at around the world, the Eurozone, the UK, Canada, even Japan has inflation. If Japan has inflation, you know there's something global going on. This isn't about excessive demand. This is about issues with the supply side and central banks can't do anything about that. Hiking rates does not produce more chips in Taiwan, it doesn't unload ships in L.A., and that's the key thing to consider here. Now there is one caveat. Transitory could become persistent, but the only way that can happen is through the labour market. Everyone's worried about this sort of 1960s repeat, and you'll see that light sort of blue area I've highlighted there, the '60s and the '70s. That's a wage price spiral. That's what everyone's worried about and that's really the only form of persistent inflation, whereby higher wages lead to higher prices, higher prices lead to higher wages, and you end up with this unstable system with ever-increasing inflation. This isn't the 1970s. We don't have all-powerful unions, we don't have price controls in the same way, and that's the key differentiator here. Now, for sure, over the summer, we've had issues with supply of labour. We know that. We know all the job shortages, all the jobs that are out there. But that was caused by unemployment insurance that was very generous and went on too long, quite frankly. That's now starting to dissipate. We see on the jobless claims numbers, we saw in the payrolls, participation isn't going up yet, but we see people coming back to the workforce and that will continue over the coming months. It's all very well wanting to change your lifestyle during COVID and think about living in the mountains somewhere, but at the end of the day, people have to pay bills and they will be forced to come back to work. Even during this supply-side constraint and the labour market, our real average hourly earnings are still negative. You can see that on the right-hand chart here. Average hourly earnings is a strong prince at 4.9, but real average hourly earnings are actually negative by 1.2 per cent. That means spending power is being reduced. If real earnings are negative, inflation can't be persistent by definition because you'll see a reduction in demand, because people's spending power is reduced. For sure, these ae uncertain times. We've never come out of a pandemic before, so we're all flying a bit blind here, but the labour market is the key to this inflation question. Inflation could print higher next month. It really doesn't matter if we go up to 6.5 per cent in terms of the transitory, persistent debate. That's all about the labour market and that's the bit I'm watching most closely. The other element that makes me convinced this is going to be transitory rather than persistent is the fact that I think the risks going forward, both in the near term and also, in the more medium term, are to the downside when it comes to growth compared with very, very elevated, still very elevated expectations. In the near term, the first thing, and I don't want to keep talking about it but I have to, COVID hasn't gone away. The fact that we're not doing this in-person is the first clue, but we look at the data now, the Northern Hemisphere is going into the winter months and already what I've got here are charts for the UK and the Eurozone comparing this year with last year. Look, UK case numbers are already much higher than they were this time last year. Now, for sure, vaccines work, so hospitalisations and thankfully, deaths are much lower than at this time last year, but high case numbers still impact activity. Eurozone chart is even more worrisome. Exactly the same pattern as we saw last year, and already we're getting limited restrictions coming in Austria, coming in Holland, coming in Germany. Again, we're not going back to full lockdowns. We don't need to because we have a lot of people vaccinated. But it still impacts activity. Now people will say, well, that isn't happening in the US. Well, it's starting to. You look at the chart for the US here, we're bottoming, we're plateauing and we're starting to move up. I think over the next couple of weeks, we're going to start to see some big numbers coming again in the US. We're going to see those COVID cases start to rise. Why would the US be different from the rest of the Northern Hemisphere? Vaccination rates in the US are lower than anywhere else in the G10 and if you look at the bottom ten States in terms of vaccinations, it's barely above 50 per cent. Cases will come back in the US. We won't have lockdowns, but it impacts activity and when you've got lofty expectations with Q4 and Q1 as well, that's going to impact. Looking further ahead, the other thing that worries me about next year is the fiscal cliff. We're not talking about this enough, so the top chart here is from the Brookings Institute. They estimate around four per cent, fiscal policy added around four per cent to GDP this year. Next year, it's going to remove about two-and-a-half per cent. The bottom chart shows you, I went back to 1930 and looked at every, the change in every budget deficit since then, because that's the sort of thing I do because I'm not very interesting. Anyway, I went back to 1930, looked at all the changes in budget deficit since then. 2022 will see the second biggest fiscal cliff in history. The only one that was big was 1946 and the other one that's comparable is 1947, an eight per cent reduction in the fiscal stimulus next year from ten per cent of GDP to two per cent. Even 2023 makes the top 12 as well. That means the expectations for growth are next year are unrealistic. When we look at this chart here, spot the odd one out. 1946, 1947 both saw negative growth and yet, we're expecting four per cent in 2022? No. I don't think we'll see negative growth next year. I'm not expecting a recession. But we're not going to see four per cent growth either and I think that's something we have to consider when we're thinking about the path for inflation and also, for policy moving forward. The final element here to consider is what does the post-pandemic economy really look like? Once we are through it, what changes are going to stay with us? What's going to be the difference maker? In terms of the consumer, I think there are two main things. First one, work from home. Whether it's hybrid, full work from home, whatever, I think what's becoming ever-clearer is, more people are going to be working from home for more time than they were pre-pandemic. Think of it this way, if all of us work one day a week from home more than we did pre-pandemic, that's a 20 per cent reduction in footfall in city centres during the work week. 20 per cent less people in coffee shops, sandwich bars, bars and restaurants. If you're working from home, you make your own sandwich for lunch, you make your own coffee, you grab a beer from the fridge at five, or earlier if you're having a bad day, two o'clock, 11 is my record, but don't tell my boss. That was a bad day. Regardless, you're spending money at home or not spending money at home. Work from home is deflationary. Leisure and hospitality employees ten-and-a-half per cent in the US workforce, not all those jobs are going to come back. The other factor, the other element that's going to stay with us is online shopping. Retail employs ten-and-a-half per cent of people in the workforce as well, and these two sectors are two of the lowest or the two lowest paying sectors in the US economy. Remember the Fed's mandate about maximum employment for all, the Fed is intent on reducing inequality, on seeing wages and participation rise for all sectors. These are two of the lowest paying sectors. They employ 22 per cent of the workforce together. You can see on the chart on the left, retail was already shedding jobs ahead of the pandemic. The move to online. Well, what have we seen over the last 12, 18 months? That's accelerated. Look at it this way, retail sales sectors, so on the X axis, a change in retail sales since January 2020. Huge numbers, up about 20 per cent since then. On the Y axis, number of people employed in those sectors, so what you see is a huge increase in retail sales, but for most sectors, a reduction in the workforce. Sure, online has hired more people, but their sales are up nearly 40 per cent and they've hired about seven per cent more people. Look at clothing, 15 per cent increase in sales minus 15 per cent number working. This, people will go back to the shops to some degree, but retail has invested in the infrastructure for online, websites, logistics in terms of delivery. Not all those jobs are going to come back, and this makes that labour market return, once we get over the big numbers over the next few months during 2022, it could take a lot longer than people think. Now the one caveat here is this wall of money we talk about for next year. This pent-up demand that's coming. Well, yes, true. But as wherever with these things, the aggregate doesn't tell the full story. It's very, very unequal. If you look at the bottom 50 per cent of households, liquid savings, $3,700. They've barely gone up during the pandemic. Even if you go up to the 90th percentile, we're looking at $18,000 saved. Again, not up significantly during the pandemic. Top ten per cent, top one per cent, sure, but they're marginal propensity to consumers. Lower, they're already buying what they need. Maybe more lavish holidays, but that's probably going to be overseas anyway. The wall of money, yes, there's some truth to it, and this is why I don't think we get a recession next year, but not as much as people think. So what does this all mean for developed markets? First take away, the Fed don't need to rush the taper. There's a lot of speculation they're going to bring it forward. We're going to finish before June. I think there's a 90 per cent chance they finish in June. We keep it 15 billion a month, we finish in June. If there's a risk though, if COVID takes off again, the numbers disappoint. It could actually get pushed out, but even if we stay at June, the punch bowl is going to stay fairly full. Liquidity remains ample. At least through to Q2. We're still going to get some chunky numbers coming in from the Fed and that I think is the important thing to consider when you're thinking about the next six months or so. What about on the rate side? People need to calm down. There's far too much priced in. About a month or so ago, we had 500, 600 basis points in the next two years for the G10. We're now at 1200 basis points. That's far too high. If I'm right on inflation, if I'm right on growth disappointing, these numbers have to come down, people have to calm down. What does that mean for the dollar? I'm still a structural dollar bear. It's been a tough ride, particularly over the last couple of months, but I still believe that with the US, what we're seeing now, the current account deficit is widening out and funding of the current account deficit remains key for the dollar. The US funds a current deficit through fixed-income inflows. Overseas investors buy US debt, but look at the chart on the left. When they do that now, Eurozone and Japanese investors I've highlighted here, they can do it hedged. You mean ten-year treasuries, you hedge in the three month. This is what you earn, around one per cent over and above the domestic risk-free rate. So if you can hedge and earn that, why wouldn't you do it? And they do. If you look at the chart on the right, this shows you our fixed-income hedge ratio. You can see it peaked in early 2018. That's when those two lines on the left-hand chart went negative. You couldn't hedge any more, because if you hedged, you paid everything away. So hedge ratio went down from then through to the pandemic. DXY is on the right-hand scale inverted, as the hedge ratio comes down, you buy fixed-income, US fixed-income unhedged, the dollar rallies. Since May of last year, what we're seeing is that hedge ratio start to rise, because the lines on the left are positive. If that's the case, the dollar has to go down. It's ignoring it right now, it won't continue to ignore it. I still believe over the medium term, the dollar is in a downtrend. I expect Euro/Dollar to get back to 1.20 in the first half of next year, and I still think we can see 1.25 in Euro/Dollar next year. Dollar/Yen, I fully expect that to 1.10. I wouldn't be surprised to see it as below 1.05 next year. What about overall markets, risk markets? What are real money telling us? They're buoyant. Sentiment from real money is still extremely strong. Our behavioural risk scorecard looks at real money flows and measures sentiment plus ten. Very strong reading. Hasn't been negative since September, early September, but the chart on the right is even more interesting. This tells you, this is the number of consecutive days since that BRS was less than minus four, and minus four and below, that's a real risk-off signal. That's when real money are really scared. It hasn't happened since July last year. It's the second longest run we've seen of consistent non-risk averse messages. Money talks. Liquidity floods in. FOMO, fear of missing out. TINA, there is no alternative remain the main drivers of investment activity, and that's still where we are and where we're probably going to stay, I think, for at least the next six-to-nine months. But having said that, not all risk rallies are created equally. There are two different risk-on rallies. You've got the fundamentally driven one, better global growth, more optimism. Then you've the liquidity one, the QE era one. Just to highlight the differences. Here, the first one is the 1990s, you can see we haven't got carry data for the '90s, but you can see EM equities, we saw a pop in SNP in the last year, but pretty much they all rise together. The one in the early 2000s, another fundamental rally built on debt. We found that to our cost eventually, but look, everything rallies. Equities, EM equities are on the right-hand scale, because they outperform so much, but then look, you've got EM carry, DM carry all performing well. Let's have a look at the QE era. This is where it's different. Equity's still fine. Look at carry. QE 3 did nothing for DM carry and EM carry, and then we look at the pandemic QE, it's even dropped EM equities, and certainly on the carry front, nothing to report. Why? Because a fundamental risk rally when growth is accelerating globally, things are more optimistic, investors seek out opportunities in growth areas, in what we traditionally call high-risk. EM and commodity export is in the G10 space. If the risk-on is purely driven by liquidity and you don't have that growth optimism alongside it, it's a different story and that's where we've been. Why is that important? Because when we look ahead to QE running out, there are still opportunities in higher-risk assets, and actually in G10 FX, there's opportunities for divergence. We had some this year. There have been moves in G10 FX this year. But in 2022 when the focus comes off equities from my belief, Q2 onwards as the money runs out, what you'll see is divergence. We've got a lot priced in, some more realistic than others. Where are the unrealistic? It's my homeland, it's the UK. The chart on the left here shows you, of G10 currencies in terms of growth from '20 to '22, 2021 and '22. On the Y axis, the rank of one-year inflation, one-year interest rate expectations. New Zealand, strongest growth, most priced in, fair enough. Norway, second strongest, next most priced in, fair enough. Look at the UK. Second worst growth. Only Japan is lower. Yet, we've got as much priced in as Canada and more than Norway. Makes no sense and that's why sterling is my favourite short next year. Long Euro/Sterling, short Sterling/Aussie. Real money overweight all sterling crosses, and that to me is something that presents opportunity for next year. But there's probably more opportunity in EM and for that, I'm going to hand over to Emily.
Thank you so much, Lee, and it is the perfect segue into emerging markets, especially since there are some opportunities there, but they've been slightly more difficult to come by, and definitely when we look at where we stand right now headed into this next year, we're at a point where investors are pretty underweight their emerging market asset classes. On this scatter plot in particular, we've highlighted FX. How the behavioural risk score that Lee mentioned before of positive ten on the flow side and overweight risky assets in general, that hasn't translated into overweight holdings in EM or even really significant inflows into EM. Both of which should be better right now based on where we've been. As I look into 2022, there's a few things that I'm watching, and the two big ones for me are 1) the growth fears that Lee has already talked about. We've got a theme going there. And the second being local political stories, which looking ahead to Chile's election this week and also, seeing everything that's gone on in Turkey over the last month, it's become increasingly hard to get clarity on those key local political issues. Really, we'll focus on the first one. How does growth look for EM into next year? We'll start off with, it's not great. Growth is certainly going to be hard to come by in 2022 and the countries that are able to find that growth are going to be the ones that stand to benefit, particularly in the FX space. Over this last year, what we saw in 2021 was that a lot of countries had revisions higher in GP expectations, as this graph on the left shows. The bounce back that was aided by vaccine efforts and also exports, the pent-up demand reopening, all of that contributed to the delayed bounce back in EM this year. Next year is going to be a bit more difficult. First of all, we're starting to see that expectations are being revised down slightly and notably, being revised lower in a lot of parts of Asia, which I'll talk about more in a second. Additionally, a lot of the re-bounce back that was fuelled by vaccines this year is going to have trouble going into next year as we start to think about boosters and what the future is like in this new post-COVID normal. Those issues are going to be front and centre, particularly for the emerging markets where vaccines have been harder to come by. The other factor that's going to be hampering growth is on the policy side, and this chart was actually from my presentation back in June where we talked about how in 2020, we really saw this extraordinary policy response on both the fiscal and monetary side. That was beyond what we had seen after other recessions. Now interestingly, this time round though, the quicker than expected response has led to a quicker than expected recovery and now we're headed into this normalisation period at a much faster pace than we would have expected. That's certainly coming through. This slide is looking at both the monetary and fiscal side in emerging markets. On aggregate, there are thousands of basis points of hikes priced in over the 19 major emerging market countries, over this next 12 months. That's significantly higher than the G10, although certainly less countries in that grouping. Then at the same time, we're seeing that the fiscal policy is becoming less expansionary. As we look across the board, most of the big government responses were in 2020 and 2021, and most emerging market countries don't have that same space to continue those fiscal efforts going forward with things like the infrastructure bill in the US or other programmes in China. That same response mechanism won't be there going forward. Add on top of this, in particular if we zoom in on China, historically, China has been there to provide support in these areas of crises for either globally or for emerging markets, where we've seen Chinese pull the levers of policy in China to better accommodate global growth. This time around, we don't have an offsetting force from China, either through monetary or fiscal policy. Instead, both right now are relatively tighter as Chinese authorities tend to be looking to address some of the more longstanding issues and pursue better growth at the sake of all growth. Now the really interesting part for next year for me is going to be, when we do start to see this transitory inflation come through, and obviously, Lee and Alberto have both really talked about how much we're watching and waiting for this base effect that's going to come through this year, as things eventually start to normalise, and we know it's going to come. The problem is right now is that emerging markets have had such a dramatic response upfront to the crises, and that's understandable. Certainly, in emerging markets, we know that inflation expectations tend to become more quickly engrained and also, we know that currency weakness has contributed to some additional price pressures this year. Additionally, the market's been less patient. The idea that Lee has highlighted that the Fed has room to wait, that hasn't, same impulse hasn't been there for EM central banks, and actually we've gotten a lot of hikes so far. What happens then when these inflation numbers start to come down, as they inevitably will? This graph is using PriceStats to help forecast going forward using average monthly measures when we start to get to that point, and see the base effects come through, along with the visual, and in places like Brazil, Turkey and Chile, we're all going to end up seeing lower inflation next year. This leaves us in somewhat of a tight spot. Back in June when I was here, we were talking about looking for the countries that were going to be able to normalise and being able to ride that wave. What we've seen in reality is that actually the correlations between FX and rates has been somewhat weak in emerging markets as of late, and really countries that have normalised super quickly, might be getting ahead of the curve while others are set to be left behind. Within the emerging market space, as we look into 2022, we're really looking for countries that are able to walk that really delicate balance between reducing accommodation and controlling inflation while also not sacrificing too much growth. It's a really hard position to be in. There's a few countries that appear to be ready to strike that balance, sort of thread the needle from our perspective. One of those is Mexico where the central bank of Mexico has been reducing accommodation at a steady eclipse of 25 basis points, while watching inflation to see if it comes down. This is in contrast to the likes of Brazil where the Selic rate has gone up exponentially along with increases for expectations going forward, perhaps even at 200 basis points the next meeting. While expectations for growth out of Brazil next year have drastically fallen, potentially even towards looking at recessionary area based on some forecasts. Alongside that in places like Indonesia, we do have room for the Indonesian central bank to be a bit slower in their approach. Inflation hasn't been over the top and hence, they have a bit more of a slow but steady approach looking at, we think removing accommodation headed into the middle of 2022. This is in contrast to India, where it looks like the RBI might be behind the curve a bit, given that the oil prices that we've seen so far this year, India being a major importer of oil, and also the pent-up demand being released. That all set to start to change the tide in inflation coming forward this year. The last one to highlight is South Africa where we also have seen relatively muted inflation, given the fact that we are, that they do have a slightly higher inflation target. SARB has been able to be slow and steady in their approach as well with expectations maybe starting this week, maybe not. We're looking at those countries, but either way, the take away seems to be that across the scatter plot here, definitely there's a lot of variation within the EM complex and investors are picking and choosing based on flows and holdings. With that, I'm going to hand it over to Megan for the Q&A session.
Thank you, Lee and Emily. It's always great to hear your thoughts. Now we'll go into the Q&A. Again, thank you, those of you who have already submitted questions and also, please continue to do so as we go through. Lee, this first question I'm going to direct at you, and the question is, if labour is key, are there insights on how the disproportionate loss of jobs for minority groups, such as women, could contribute to US inflation, economic growth or dollar performance?
It's a very good question. I think in terms of growth, etc., if those groups stay out of the workforce, then that hurts growth. There is no doubt about it, and this is something the Fed is very, very cognisant of and this is why they have the goal now of maximum employment for all. I think the way to think about it as well, particularly for the dollar, is if these groups are slower to return to the labour market, they're slower to find jobs, and I highlighted leisure and hospitality and retail, that employs so many lower-paid workers. If those jobs don't come back or they come back much slower than people think, that's going to keep the Fed on hold for longer. Have to remember, they now have this dual mandate where actually, you would argue the labour market is seemingly more important to them than inflation, as long as inflation is reasonably controlled. I think yes, it's key for the dollar. You can't look at aggregates in employment. You have to look at the whole premise. I don't think, I should have said, I don't think the Fed will hike next year anyway and I'm not convinced they hike in 2023, but if those sectors of society most damaged by the pandemic come back much more slowly, that gets pushed out even more.
The next question, Emily, is for you. Does the case of rising inflation in Brazil portend issues for other EM central banks?
Yes, the Brazil case has been really interesting, and this is one where we do have PriceStats series and we have seen it rising pretty significantly over the last few months. When we look at what that means for other emerging markets, definitely it's hard to make a one-for-one comparison to any emerging market country just given the differences between them. Certainly, it does show that central bank policy is maybe not always the best way to look at these kinds of inflation issues. Certainly, in Brazil, they've raised rates a lot and yet, what we've seen is that inflation has still continued to creep higher, which that just gets at a little bit to what Lee pointed out at the beginning of his talk. That essentially, this is a global phenomenon and it's based on global factors. All of these supply-chain issues are global in nature and won't be fixed until the underlying issues of the pandemic are addressed, and that's made it more difficult for central banks. They certainly don't operate in a vacuum and in this case, there's even more factors that are outside of their control, which makes it hard.
Maybe a follow-on question to that is, do you think at some point, higher EM rates will be a positive for EM currencies?
Yes, we are waiting for that moment, and I guess that gets to when the PriceStats series, we're starting to see that decline into next year. We will get to a point where EM real rates come back and we start to have carry again in EM. Right now, it's not yet quite enough to compensate particularly on the rates side, given that inflation is so high that real yields are still low. But on the currency side, we're looking at rates of northward of ten per cent in Brazil, in terms of the Selic rate, and when you have that impetus, it does make it hard to go short EM carry currency. At least, that's one less negative in the picture.
Lee, this one's for you. How would a new Fed chair, whether that be Brainard or someone else, how would that impact your outlook for US monetary policy?
Well, I think it's come down now to a straight choice between Powell and Brainard, if everything we've heard is right. If it changes to Brainard, doesn't change my policy. If anything, Brainard to me is a bigger dove than Powell. I mean, if that was possible. She is a bigger dove than Powell, so as I said, I don't think they're going to hike next year anyway and I'm not convinced about 2023 yet either. Brainard, I think the market would push out rate-hike expectations with Brainard, and I think she is seen as more dove-ish. She is more focused on or really buys into the idea of maximum employment for all. I think Powell does, but Brainard's one of the architects of that, that framework, so yes, to me, that would be a marginally dove-ish shift away from Powell. Personally, I think Powell deserves to keep his job. I think he's done a great job, but this will come down to politics and we'll find out in a couple of days, but it wouldn't change my view on the Fed materially at all.
Okay, great. I think in the last 20 seconds or so, Emily, this last one's for you. What do you think the transition to the low-carbon economy, for example, phasing out of coal, what impact do you think that will have on EM countries and are there certain countries that you think have greater risks?
Yes, it's definitely going to be a difficult transition and something that we have seen coming for a while, but the most recent panel has brought these issues to the forefront. We have an increasing number of ESG metrics that we're looking at over at State Street Associations. All of that, applying that to a country perspective would be my preferred way of looking at it for now. But it is going to be difficult, particularly for the countries that rely on oil exports, like the likes of Columbia, Russia, all sort of coming into the cross-rays of this new direction going forward.
Well, thank you. We're at the end of the Q&A now. Thank you again. You guys have given us some great thoughts and insights, and so thank you for your time.