Fidelity Connects: The global macro view

Jurrien Timmer, Director of Global Macro

April 17th, 2023

Jurrien Timmer discusses his thoughts on what’s moving the markets around the world and what may
come next.

Last week we saw a lot of the United States big banks coming out with earnings. With the earnings
story starting to pick up, what should we be looking for?

• The markets gone nowhere since last June, I think the markets been in a trading range for 10
months and I know a lot of us have been waiting for this shoe to drop.
• We know how inverted the yield curve has been and historically that has a perfect track record
of foretelling recessions.
• Generally speaking, we're in an earnings slowdown or even a contraction. The first quarter is
expected to come in at -8%, second quarter -6%.
• We are still making new all-time highs with revenues in a very steady way, with the caveat that
inflation is eroding those nominal numbers.
o This is an economy that continues to chug along.
• The employment report showed an ongoing expansion, the unemployment rate is only at 3.5%.
 • The chart above shows the unemployment gap, so the unemployment relative to what is full
employment, which is around 4%.
• You can see that we are near the strongest parts of the cycle.
• In the bottom of the graph, you can see that layoffs are rising, but they're not skyrocketing and
most of the layoffs are in the tech sector.
• My theory is that the economy is just less rate sensitive than it has been.
o Some of the banks like SVB, Signature Bank, and first republic bank are rate sensitive as
they were seeing deposits flow out while they invested those deposits in lower yielding
bonds.
• So, it's not that the rate picture is not hurting the economy, but it's hurting what seems like
isolated pockets of the economy.
• Most people in the States have a fixed rate, 30-year mortgage and the vast majority of
outstanding mortgages today were issued in 2020 and 2021, when rates were super low.
o The average consumer with a mortgage is not really feeling the rate pinch either.
• Many corporates refinanced their debt and termed it out for longer periods during that low-rate
period.
• A lot of the economy has become immune to these sharply rising rates and so that's my guess as
to why the yield curve is not biting as quickly as it has in the past.

Are homeowners that are entering the market getting used to higher rates? We do know that these
are not all-time high rates.

• Yes, we have in the past and 5% - 6% is not the 10% - 15% that it was in the early 1980’s.
• The math of home affordability does kick in because home prices rose significantly during
COVID and on top of that, we’ve had rates go up.
• The cost of buying a home has doubled, at least a few months ago when rates were at the
highest point.
• It's not going to deter anyone from buying a home, but they just can't buy as much home as
they did before.
• The real estate market in the U.S. has frozen as they don’t want to give up a 3% mortgage and
then take on a 6% mortgage unless they must.

Looking back at what’s been going on in the markets, we’re going to be looking at rates, and
comparables going back a year on many different fronts whether it’s liquidly in the market or the
earnings story. The comparables are going to be interesting but can we focus on Quantitative
tightening and if were reacting or not?

• The Fed is effectively running its needle in terms of having provided liquidity to the banking
system while not pivoting on its policy of rising rates and shrinking its balance sheet.
• The chart below shows the Fed funds rate, the gray bars is the system open market account that
sets the part of the Fed where they do QE or QT, and then the purple bars are loans which is
right now the BTFP (Bank Term Funding Program).
 • You can see that program ballooned when SVB went under, but it's stabilizing and doing so well
that the Fed continues to shrink its system open market account, as well as raising rates.
• The expectations are about 50/50 as to whether they will do one more 25 basis point rate hike
but no matter what, the market expects a pretty rapid pivot after that.
• My sense is that the Fed is trying to prevent structural inflation from happening. This is because
it realizes that this was brought on in part by temporary price shocks because of COVID lock
downs and in part by a very loose monetary policy.

What are your thoughts on the trajectory of the U.S. dollar and the drop off in the value recently?

• There's a school of thought out there that the dollar is losing its reserve status, and it's going to
crash in some hyperinflationary ball of flames which I don’t think will happen.
• This line of thinking has been around forever, but the dollar is clearly weakening.
• The chart below shows what we call the terminal rate which is the expected highest rate that
the Fed will get to.
• You can see that it spiked to 569 when Jay Powell gave his testimony in front of Congress, and
then it collapsed after the banking run with SVB and now it’s sort of recovered a bit.
• It's just below 5%, which means that the Fed is expected to be pretty much done for the cycle
and the dollar is testing its lows.
• The reason the dollar was going up in part was because the Fed was tightening policy much
faster than other central banks.
• Now that the policy divergence has been resolved, it makes sense for the dollar to go down.
• Once a cyclical downturn is in place, it tends to persist for a while, so I would ride this trend out
for a while.
Do you have any concerns around the U.S. real estate, particularly around the offices story and the
commercial real estate story that we are hearing a lot about right now?

• There’s a big story in office real estate and commercial real estate as tenants are handing back
the keys and renegotiating for less space at a lower price when their lease comes up.
• This is a problem if you're an owner of commercial real estate, REITs, or any kind of flip, you
know, collateralized mortgage obligations and things that are commercial mortgage-backed
obligations.
• When you think about problems in the economy, commercial real estate is one. The other one is
the smaller banks, which are again seeing deposit flight.
o You could see a credit crunch among the smaller banks.
 • The slide above shows the Russell 2000 which are the smaller companies in the U.S. stock
market.
• You can see that part of the market is barely off their lows, so there are the pockets of risk.
• These risks are well known right now but I don’t believe it is the same as the subprime in 2007.

What are your thoughts on gold and bitcoin?

• Gold, commodities, bitcoin, and non-U.S. assets in general all benefit when the U.S. dollar goes
down because they’re priced in dollars, and it creates certain themes into monetary inflation.
• I continue to be bullish on gold and Bitcoin although it is down at $29,000 today, but it's not a
coincidence that it is going up as the dollar is going down.
• The theme and reality of debt refinancing at very high debt levels in the coming years is not
really discussed much.
• I do think that bitcoin and the gold play are a reflection on that as well as the weaker dollar.

Do you have any final thoughts on what we need to watch closely?

• Earnings and revenues because that gives you a sense of the top line.
• We all know that the bottom-line margins are coming down because inflation is eroding
earnings.
• Pay attention to any word from the Fed in terms of the expected pivot, I do think that the
market is over optimistic.
• It does highlight a disconnect that the market simultaneously expects earnings to hold up, while
the Fed pivots in a way that it would only do when you have a recession.
• Those things make sense individually but not at the same time, so if the Fed does end up
pivoting, it becomes a be careful what you wish for scenario.