0:00

Forward Guidance is brought to you by VanEck, a

0:02

global leader in asset management since 1955. You'll

0:05

be hearing more about VanEck ETFs later on,

0:08

but for now, let's get into today's interview.

0:15

Happy to welcome to Forward Guidance

0:17

Patrick Sonner, head of macro strategy

0:19

at Swiss Re. Patrick

0:21

is focusing on macro. Patrick,

0:24

welcome to Forward Guidance. How are you? Well,

0:27

thanks. I hope you are well as

0:29

well, and thanks for having me, Jack.

0:31

It's my pleasure, Patrick. What

0:33

is, are you focusing most in the

0:35

macro world? Are you focusing on rates,

0:38

on the economy, and what's your

0:40

outlook for this year? Well, I

0:43

focus on everything that really changes

0:45

the economic inflation rates and longer-term

0:47

capital market outlook, and together with

0:49

the team, look a

0:52

lot at alternative scenarios that

0:54

could be important for the

0:56

insurance industry and institutional

0:58

asset allocators overall. Now, with

1:01

regards to the economic outlook,

1:03

I think there is quite a distinction

1:05

between geography. So if

1:08

we maybe start with the

1:10

US, then I think the macro outlook is

1:12

a pretty decent one overall. The US

1:15

has shown and continues to show

1:17

quite some growth resilience. Many indicators

1:19

are actually suggesting either a pretty

1:21

broad-based bottoming or potentially

1:24

even an uptick in momentum in Q1 if

1:26

you look at ISMs, the

1:28

variety of labor market data, but also

1:30

commercial and industrial loan standards and so

1:32

on. So we might be looking

1:35

at the temporary re-acceleration, but

1:37

I also think that markets

1:40

and analysts have swerved between

1:43

hard landing and no landing, a soft landing, and

1:45

so on. And I think that's kind of the

1:47

theme that we are continuing to see. Now, in

1:50

the Eurozone, I think the situation is a little

1:52

bit different. The German

1:54

industrial complex is pretty

1:57

fragile right now. But

2:00

I also think that one

2:02

shouldn't necessarily extrapolate Germany's weakness

2:04

with other parts in the

2:06

Eurozone economy, because there are

2:08

signs that actually Spain, Portugal,

2:10

Italy are doing reasonably

2:12

well. Now, having said that, Europe

2:14

is in a state of economic stagnation

2:17

and actually has been for over a

2:19

year. So the picture there does look

2:21

a lot more precarious compared to what

2:23

we are seeing in the US. But

2:25

again, if you look at labor markets,

2:28

for example, then, you know, they are

2:30

holding up pretty well, including the Eurozone.

2:32

So it is a picture of, I

2:35

think, relative resilience. But I

2:37

think we also need to recognize that

2:39

several indicators, particularly when you think about

2:41

the optic in delinquencies, particularly in the

2:44

US, but also what we are seeing

2:46

in Germany, just shows that there is

2:49

stress in parts of the economy, and that

2:51

warrants a lot of monitoring going forward. So

2:54

we also shouldn't take the eyes off the

2:56

ball there. And how are you

2:58

thinking about financial conditions? Many,

3:00

myself included, thought when the interest rates go

3:02

from 0 to 5.5%, that would represent a

3:05

tightening of financial conditions.

3:09

And it did. But it seems it

3:11

is a little more complicated than that. And financial

3:13

conditions are not sufficiently tight

3:15

to plunge the economy into a recession, at least

3:18

in the US. How are you thinking about financial

3:20

conditions and what you see when

3:22

you look at the neutral rate versus other

3:24

measures of how tight they are? Yeah, exactly.

3:26

Yeah, I think that is a key question

3:28

that is on top of a lot of

3:30

different people's minds and asset

3:32

allocators. So first of all, I do

3:34

think that the neutral rate has risen

3:37

after the pandemic for a variety of

3:39

different reasons. The neutral rate, I think,

3:41

is a helpful academic concept.

3:43

But I am not sure that it

3:45

is all that

3:48

useful in a practical sense.

3:51

And that is actually why I

3:53

look a lot at financial conditions to

3:55

better understand how loose are

3:57

conditions, how benign is the financing.

4:00

environment that corporates and households

4:02

face. And if you look

4:04

at traditional measures of monetary

4:06

policy tightness, so where

4:08

the policy is compared to estimated

4:10

neutral rates, where real yields are,

4:12

where the real yield curve is

4:14

where the Fed funds rate or

4:16

the ECB rate is compared to

4:18

inflation run rates, then a lot

4:21

of these indicators would suggest that

4:24

monetary policy is pretty tight. Now,

4:26

when you look at standard measures of financial

4:29

conditions and you can look at a whole

4:31

bunch of those, there is not

4:33

necessarily one that's right and the others

4:35

are wrong. But when you look at a

4:37

lot of them, then they do suggest that

4:39

conditions right now are reasonably

4:41

loose actually. And so

4:44

the question is, well, how can that

4:46

be? How can you have what appears

4:48

to be pretty tight monetary policy stance

4:50

while at the same time having relatively

4:52

accommodative financial conditions, particularly in the US?

4:55

I think there are a couple of aspects

4:58

to this. First of all, of course,

5:00

and you know, and many of your

5:02

listeners know that the US is running

5:04

an 8% fiscal deficit this year. The

5:06

IMF estimates that actually the fiscal deficit

5:08

is going to remain at roughly 7%

5:10

for the

5:12

foreseeable future. In the Eurozone, that's

5:14

a bit different. Fiscal deficits are roughly

5:17

3% or so. So

5:19

that explains a bit of the gap also

5:22

in relative growth momentum that we are seeing.

5:25

Compared to last year, actually, the fiscal

5:27

thrust is pretty significant in the US

5:30

and that has contributed to the growth

5:32

environment there. Now, in addition, you have

5:34

a lot of turning out of the

5:37

debt. So there's just a pass through

5:39

and a time lag whereby higher interest

5:41

rates then really eat into the refinancing

5:43

activities of corporates and so on. And

5:46

you know that There is

5:48

quite a bit of a corporate debt

5:50

maturity wall coming towards us over the

5:53

next two years or so where corporates

5:55

will have to refinance actually currently pretty

5:57

benign loan terms at significantly higher rates.

6:00

Though that that is just a matter of time.

6:02

But I think the third aspects. And.

6:04

I believe that is something that

6:06

is commonly a bit overlooked is

6:08

the central bank balance sheet, which

6:11

is you know, extremely sizable in

6:13

many areas and many advanced economies

6:15

of the world that dance suppress

6:17

artificially suppress were longer dated yields

6:20

should be, and as a result

6:22

that inhibits the monetary policy transition

6:24

mechanism. And I think that's something

6:26

where a lot of central banks

6:28

will have to do a bit

6:31

of soul searching going forward. Whether

6:33

this type. Of and this size

6:35

of balance sheet and the composition

6:37

of the balance sheet is really

6:39

warranted going forward. and whether the

6:41

footprint that central banks have in

6:43

markets is really adequate and better.

6:45

That actually doesn't complicates their are

6:47

conduct of monetary policy. Further like

6:49

questions for you so look at

6:51

a financial conditions index. One of

6:53

them is the risk free rates

6:56

are the overnight rate, the tenure

6:58

rate, The. Centre backs have complete

7:00

control of the overnight rate. They have

7:02

a lot of influence over the tenure

7:04

a as well a lot of the

7:06

other variables in a financial conditions index

7:08

defenders or has much, much less control

7:10

over them. I'd say almost no control

7:12

over So that's credit spreads. Investor

7:14

Grade: High yield. Alone conditions

7:17

the equity valuations the value of us

7:19

that the dollar versus other currencies if

7:21

the risk theory has gone so high

7:23

and and is in net tightening effect

7:25

for the financial conditions and x. Y.

7:29

Or the other measures net loose or in

7:31

a what how can you explain for example

7:33

why you're high yield spreads in the Us

7:35

are barely over three hundred basis points and

7:38

tiny conditions in in the banking sector this

7:40

new as have. You. know they

7:42

they were title tell us your that they're

7:44

eating how how do you explain i think

7:47

it's a key question and i think one

7:49

of the the shortcomings or the call the

7:51

odds of finance conditions is that ultimately there

7:53

and antonis in the sense that they drive

7:55

growth but growth also drives them so if

7:58

you have a nominal gdp growth environment of

8:00

in many instances now way above 4%, 5%,

8:02

6%, 7%, then that is a pretty decent

8:07

economic outlook for many firms

8:10

and also households, particularly in

8:13

the context of overall what appear to

8:15

be pretty tight labor market. So I

8:17

think it's difficult to disentangle what is

8:20

the aspect of financial condition that drives

8:22

growth and kind of what the push

8:24

and pull factors are there.

8:27

But I do think that when we come back to the

8:30

influence of the balance sheet, if

8:32

you have, for example, a Fed

8:34

or an ECB that has clearly

8:37

communicated that their reaction function has

8:39

changed and that they have become

8:41

more worried about the left tail

8:44

growth risks as opposed to the

8:46

inflation outlook, which in their view

8:48

has had or has shown meaningful

8:50

progress. While the economy

8:53

isn't slowing down sufficiently at

8:55

that point in time, you

8:58

effectively provide another financial conditions

9:00

thrust that actually allows inflation

9:02

momentum to reinvigorate. And

9:05

if you think about the balance sheet, I

9:07

mean, there are many estimates that actually suggest

9:10

that the size of the balance sheet

9:12

that we are seeing right now contributes

9:14

to a suppression of longer dated yields

9:16

by at least 100 basis points. In

9:20

other words, even the Bank of Japan actually had a

9:22

paper in 2021 that showed that the stock of

9:26

its balance sheet suppresses 10-year JGB yields

9:28

by more than 100 basis points, maybe

9:30

up to 150 basis points. A

9:34

lot of investment banks have done research on

9:36

this also on the Fed side. They come

9:38

actually to a similar conclusion. A policy paper

9:40

from the Bundesbank at the end of last

9:43

year actually also suggested that the

9:45

way that lending standards

9:48

and tighter lending standards are

9:50

passed on to the real

9:52

economy actually changes in a

9:54

structurally higher reserves regime. And

9:57

they have argued that that is actually an

9:59

explanation for why the tightness of

10:01

monetary policy in the euro area may

10:03

not be as significant as

10:05

you would think, given how

10:08

quickly the tightening cycle has played out.

10:10

And I think this is a live

10:12

conversation right now at central banks right

10:14

now, because the ECB is

10:16

looking into the operational framework of monetary

10:19

policy, and therefore it needs to think

10:21

about the size, the structural

10:23

size of the reserves going forward and the

10:25

size of the balance sheet, and

10:28

Fed governor Barr, I believe earlier this

10:30

week, also came out saying that the

10:32

details and the specifications

10:34

of QT are gonna be under more

10:36

scrutiny going forward. So I do think

10:38

that central banks should really think long

10:41

and hard around about whether

10:44

this size of the balance

10:46

sheet and owning 20% in the

10:48

BOJs case, 45%

10:52

of the entire free float of

10:54

the domestic sovereign is really conducive

10:56

to financial market functioning ultimately because

10:58

it distorts the price of risk.

11:01

Right, there's a huge binge of

11:03

quantitative easing in the prior decade.

11:06

A lot of central banks now are doing quantitative

11:08

tightening, as you say, QT, in order to reverse

11:11

that, they are letting their balance sheets shrink, not

11:13

expand. I guess there are two philosophies. One is

11:15

that it's the size of the balance sheet that

11:17

matters. And second is that

11:19

it's the rate of change of the

11:21

balance sheet that matters. Wouldn't you say

11:23

the Federal Reserve's balance sheet is so large, the

11:26

ECB's balance sheet is so large, that is

11:28

the absolute size, but they are attempting to

11:30

shrink it. So what is the solution then,

11:32

just to shrink it more? Anything

11:34

to go faster? Yeah,

11:37

I mean, look, I mean, no need

11:40

to over-complicate it. To be fair, the

11:42

ECB was and has been and continues

11:44

to be actually quite aggressive on the

11:46

QT front if you look at how

11:49

they are approaching a lot of different

11:51

things. But there are also many

11:54

estimates that suggest that reserve scarcity in

11:56

the Eurozone would only start to

11:59

bite if... you decrease the

12:01

balance sheet by at least another trillion

12:03

and potentially two trillion or so from

12:05

here. So there's still quite a bit

12:07

of leeway because again, I mean, we

12:10

have seen just an amazing

12:12

expansion of balance sheets, even pre-COVID and

12:14

then even more so after COVID with

12:16

all the combined fiscal rescue packages. But

12:18

yes, I do think that central banks

12:21

should make an effort to try and

12:24

reduce their balance sheets further.

12:27

My current read of the Federal Reserve

12:29

is that that seems unlikely.

12:32

If anything, I mean, they're trying to stop quantitative

12:34

tightening. Do you go back to reducing quantitative tightening

12:36

and then having a flat balance sheet?

12:38

So if that is true, you tell me about the

12:41

ECB. Is that a stimulative

12:43

force for the economy if central

12:45

bank balance sheets are to remain somewhat large?

12:47

I think at the margin, yes. I think

12:49

it's too easy to just say, well, you

12:51

know, it's a big stimulation because as you

12:53

say, it's a question of the level as

12:56

well as the rate of change. And as

12:58

we discussed before, it depends on the fiscal

13:00

deficit, the corporate capex spending and these types

13:02

of things. It's too easy to just say,

13:04

well, you know, central banks as a result

13:06

are are stimulative, but at the margin. Yeah,

13:09

I do think that that's stimulative overall. What's

13:12

going on with the European

13:14

central bank? Because, Patrick, earlier you

13:16

said the Federal Reserve's central

13:19

banks switch from talking

13:21

about only the right-tail risk. That's

13:23

got no inflation, we re-accelerate and we go back

13:25

to the 1970s. Now they're

13:27

talking about a balance of risk. They're aware of

13:29

and they're making public statements about the left-tail risk

13:31

of recession that indicates they might

13:34

try and loosen financial conditions by

13:36

lowering interest rates, returning to a

13:38

more neutral stance. And that is

13:40

basically that bullish for financial conditions.

13:43

Tell us about that's going on, the European central

13:45

bank. I admit I haven't been paying nearly as

13:47

much attention to the European central bank, the ECB,

13:49

as I should have. The last time I sort

13:51

of did a deep dive, I remember they were

13:53

so confident that there would be a recession in

13:55

all of Europe that they were making infographics about

13:58

rain clouds. And there was there was. like rain

14:01

and thunder coming on the European economy. What's

14:03

going on now? Well, I also

14:05

believe the reaction function of the ECB

14:08

has changed. And there were several governing

14:10

council members coming out in the recent

14:12

months, including some of the more hawkish

14:15

members that have said that the

14:17

next step is going to

14:19

be a rate cut and therefore have tried

14:21

to tee up markets to price in such

14:23

an expectation. And so the

14:26

reaction function, I do believe has

14:28

changed on the back of what

14:30

the ECB thinks is pretty meaningful

14:32

progress on the inflation front. I

14:35

do think that whether they

14:37

are ultimately able to follow

14:39

through with the rate cuts really

14:42

depends on the labor market and

14:44

the wage outcomes that we will see over the

14:46

next couple of months. In

14:49

Germany, for example, the construction

14:51

unions, the union for construction

14:53

workers, is demanding

14:55

pay rises of slightly above 20%. Now,

14:59

of course, that's part of a negotiation tactic.

15:01

And typically, what is demanded initially is not

15:03

what gets settled and so on. But even

15:05

if we assume that they get 5%, 6%,

15:07

7%, then, of

15:10

course, that in and of itself

15:12

is not necessarily representative of other

15:15

sectors. But if other sectors also

15:17

see 5%, 6% wage increases, then

15:21

it just becomes very difficult to make a case

15:23

that you'll be able to return inflation

15:26

to close to, but below 2% on a sustainable

15:28

basis. So

15:30

I think the rate cutting cycle, to

15:32

a large extent, will depend on what

15:34

the wage negotiation outcomes over

15:36

the next couple of months will show.

15:39

What's your outlook on interest rates? Where

15:41

is the European rate, overnight rate, right

15:43

now? What is the price

15:45

into the forward curve about how much the

15:47

ECB will cut? And your

15:49

probable range, is it above, below,

15:51

or pretty similar to the market's

15:53

range? The OIS curve right now

15:56

for the ECB prices around

15:58

105 basis points of copy. until

16:00

the end of the year. Given how

16:03

precarious the economic outlook

16:05

of the euro area is, I think that's

16:07

roughly fair. And I also think it's roughly

16:10

fair that there are more cuts being priced

16:12

out in the US simply because there appears

16:14

to be on an absolute

16:16

level more strength, but also on the

16:18

relative level in terms of momentum that

16:20

the economy has. So I think that's

16:23

roughly fair, what we are seeing right

16:25

now. And of course, once labor markets

16:27

start to loosen, if they do, I

16:29

think we also need to recognize that

16:31

labor market adjustments are often non-linear. And

16:34

I think we also need to respect

16:36

that when we think about the rates

16:38

outlook, longer data deals, but also the

16:40

central bank policy rate. Central banks, obviously,

16:43

when they provide forward guidance, then they

16:45

do that taking everything into account. But

16:47

I think it's also clear that they

16:49

will change their minds as the data

16:52

develops. And I think should we see

16:54

cracks in the labor market, then the

16:57

central bank won't continue to

16:59

say the inflation threats are so

17:02

large, and they will try and provide

17:05

at least less restrictive stances going

17:07

forward. So 105 basis

17:09

points of cuts to you, does that seem reasonable?

17:12

Is your range in that ballpark, or more

17:14

or less in what? I would say so.

17:16

I do think even if things

17:18

go well, and we do see a

17:21

little bit of a bottoming in European growth momentum,

17:24

then there's also scope to price

17:27

out a bit more, maybe

17:29

not to the same extent as what

17:31

we're seeing in the US right now.

17:33

But I think it's roughly fair. And

17:36

at the end of the day, whether you hike or

17:38

you cut rates by 25 basis points or more,

17:41

that really doesn't move the dialogue that

17:44

much. Like Gold

17:46

did, Bitcoin is establishing itself as

17:48

a macro asset that potentially helps

17:50

hedge against the government devaluation of

17:52

your money. Finally, you can easily

17:54

access Bitcoin in a low cost

17:56

ETF with the Vanek Bitcoin Trust,

17:59

ticker Poder. Search the ticker

18:01

HODL in your brokerage app today. Visit

18:04

vanek.com/hodlfg to learn more. That's vanek.com/hodlfg. Now the

18:06

disclosures. Investing involves risk and you could lose

18:08

money on an investment in the Vanek Bitcoin

18:10

Trust, also known as the Trust or HODL.

18:12

The value of Bitcoin and therefore the value

18:14

of the Trust shares could have climbed rapidly,

18:16

including to zero. You could lose your entire

18:18

principal investment. For a more complete discussion of

18:20

the risk factors relative to the Trust, carefully

18:22

read the prospectus link below. Thanks,

18:25

let's get back to the interview. Patrick,

18:27

now I want to connect two things.

18:29

We're talking about the level of overnight rates,

18:31

the short term and then the long term. In

18:33

the US and much of the world, we have

18:36

an inverted yield curve, so short term rates higher

18:38

than long term rates. That's quite unusual

18:40

and it often has preceded a recession. At

18:42

least in the US, I mean, the track

18:44

record is actually pretty good if you look

18:46

at the three months, 10

18:49

year. Is that worrisome to you? In

18:51

other words, that's short term rates. The long

18:53

end of the curve is telling you rates

18:56

should be lower, but the central banks

18:58

are keeping rates higher and that is

19:00

too restrictive. Or, and maybe one kind

19:02

of escape route is if central

19:05

bank balance sheets are so large, it's actually

19:07

sending a distorted signal because the real 10

19:09

year rate should be higher. It's just that

19:11

they're suppressed because central bank balance sheets own

19:14

so much of the bond market. I think

19:16

it's probably a bit of both to be

19:18

honest, but then again, the yield curve inversions,

19:20

they have had several false

19:22

positives in the past. So for me, it's

19:25

just another indicator like many other

19:27

indicators. So I think one needs

19:29

to evaluate the totality of indicators to

19:31

make a better judgment of where we

19:33

see things. But it is interesting that

19:35

if you look at typical

19:38

lead times of the inversion to

19:41

when a recession happens, then

19:43

we are still in that timeframe.

19:45

Now again, if I look at

19:48

the totality of indicators in the

19:50

labor market, ISMs, a lot of

19:52

different data aspects on the

19:55

economy and on inflation. It doesn't look

19:57

like we are in a broad based

19:59

recession. least, although certain segments

20:02

of consumers probably do feel quite a

20:04

bit of economic pressure right

20:07

now. But the yield curve inversion

20:09

in and of itself is not

20:11

a reason to have a recession.

20:13

Having said that, I obviously recognize

20:15

that it has a pretty decent track record

20:17

in the past, and so I'm not discarding

20:19

it either. But I think

20:21

it's just another indicator that you need to keep an

20:24

eye on. Patrick, so we've done a

20:26

nice tour of the macro world. Can you

20:28

tell, how does that inform the work that

20:30

you do at Swiss

20:32

Re? And if you're, like

20:35

Swiss Re does, managing a very large

20:37

portfolio, it's not just about what your

20:39

base case is, it's about those tail

20:41

risks. So basically, tell

20:43

us how you're thinking of applies to your

20:45

work at Swiss Re. Yeah, totally. So as

20:47

mentioned, I and the

20:50

team, we establish the longer term

20:52

capital market assumptions that flow into

20:54

the strategic asset allocation of the

20:57

group. And we also provide the

20:59

economic and interest rate assumptions that

21:01

are used in the asset liability

21:04

management process, and also flow actually

21:06

into the pricing of insurance and

21:08

reinsurance contracts. So the views and

21:11

the forecasts that we provide, they

21:13

actually matter quite a bit for

21:16

the balance sheet. We also provide

21:18

alternative scenarios that can be strategic

21:20

in nature, if you like. So

21:23

we use them to evaluate our own business

21:26

strategy in these types of things, but they can also

21:28

be regulatory in nature

21:30

where we look at stress tests,

21:32

what would our liquidity and solvency

21:35

position be like if

21:37

such stress tests were to become reality,

21:39

and would we still be

21:41

doing well? So if we think

21:44

about what is going on right

21:46

now with inflation, recession risks, and

21:48

so on, I think that is

21:51

really important to think

21:53

through what the implications could be.

21:56

And I think one of the things that

21:59

is really important important for insurers to think

22:01

about is not only whether

22:04

inflation is going to be structurally

22:06

higher going forward, but also whether

22:08

inflation is going to be more

22:10

volatile going forward. And actually,

22:12

this is not even a hypothesis because

22:15

that is what is priced into medium

22:17

to longer dated CPI options right now.

22:20

It's really interesting that if you compare

22:22

medium term CPI options right now in

22:25

the US, then the median

22:27

expectation has come down, so towards

22:29

2.25%. But

22:33

the distribution of outcomes that is priced

22:35

right now is actually a lot wider than even two

22:37

years ago. And so when you

22:39

think about portfolio construction, the

22:42

very basic principle

22:44

of portfolio construction with the efficient

22:46

frontiers, basically you have an expected

22:48

return, you have expected volatilities, but

22:50

you also have expected

22:52

correlations, which are typically informed by

22:54

a past correlation options and so

22:56

on. And if you do have

22:58

higher inflation volatility going forward, then

23:01

I think a lot of investors

23:03

will need to think about whether

23:05

their investment portfolio is

23:07

really fit for purpose because you will

23:09

have much more frequent correlation

23:11

changes between asset classes. And I

23:13

think it's really important for investors

23:16

to think through what are the

23:18

alternative scenarios? What could the correlation

23:20

regimes look like? What is the

23:22

inflation regime overall? And how does

23:24

that affect the balance sheet? And

23:26

are you able to withstand these

23:28

changes? Are you able to hedge

23:30

what you can hedge? And

23:33

so on. And I think that's

23:35

a really key aspect of what we

23:37

help do, obviously, with a variety of

23:39

other teams at Swiss

23:41

Re. Thank you. And why

23:44

is inflation volatility so

23:46

salient for a large portfolio and

23:48

for the insurance business? You

23:50

talked about the correlation assumptions between assets.

23:53

What were you referring to there? Well,

23:55

for example, simple stock bond

23:57

correlations, but also correlations of

23:59

alternatives. of alternative

24:02

assets and so on. And the reason

24:04

why this matters a lot for insurers

24:06

is because insurers are through

24:08

the nature of what they do, quite

24:12

inflation sensitive. So when you think

24:14

about, for example, motor insurance, then

24:17

you pay a

24:19

motor claim that can be a repair cost,

24:22

that can be a replacement cost of a

24:24

car. And if you have, for example,

24:26

used car price inflation going a

24:28

lot higher, then that is price

24:31

inflation that you need to pay out as

24:33

an insurer. And the

24:35

difficulty is that this type

24:38

of insurance-related inflation is

24:40

not something that you can hedge on capital

24:42

markets, because you cannot go out and buy,

24:45

for example, inflation options or

24:47

an inflation swap and say, well, I've

24:50

protected the balance sheet because the inflation

24:52

that you have on the balance sheet

24:54

as an insurer is one that is

24:56

linked to motor insurance, again,

24:59

a replacement cost, it can be construction

25:01

costs. If you're more in other areas

25:03

of property insurance, it can be linked

25:05

to wage inflation. And these are

25:08

to some extent linked to the overall

25:10

inflation profile, but they are only proxies.

25:13

And therefore, if you want to

25:15

try and insulate the

25:18

inflation sensitivity of an insurance balance

25:20

sheet, then you need to pull

25:22

a lot of different levers in

25:24

order to be ready to react

25:26

to somewhat higher inflation volatility should

25:28

that occur. Thanks,

25:31

and that's on the insurance front. When it

25:33

comes to assets and correlations, what do correlations

25:35

look like when inflation volatility is

25:37

very low? And what does

25:39

it look like when inflation volatility is high? For

25:41

example, when in the US, inflation went from 0%

25:43

to 9% and back to 3%, what's

25:47

different about that correlation regime between assets?

25:50

The difference primarily comes

25:52

through whether you can

25:55

diversify risk

25:57

across assets. So basically, Usually

26:00

when you have falling inflation, particularly from

26:02

a higher level, and you have a

26:04

rally in bonds, then

26:07

that provides some sort of

26:09

diversification potential for other asset

26:12

classes. Now, typically in a

26:14

recession, you have a rally in bonds and

26:16

you have a sell-off in, for example, credit

26:18

and other risk assets like

26:21

stocks. And that naturally

26:23

hedges part of your portfolio. And

26:25

if you have an

26:28

acceleration of inflation, as

26:30

we had seen over the last couple of years,

26:33

then what happens is that yields

26:35

increase in government bonds. That means

26:37

the prices decline. And at the same

26:39

time, at least during

26:41

that period, we also saw that,

26:43

for example, stocks declined, and therefore

26:46

you had a positive relationship between

26:48

the bond prices and equity prices.

26:53

And therefore, the diversification potential of

26:55

going into stocks and bonds and

26:57

other asset classes is pretty severely

26:59

weakened. And I think if you

27:02

have different levels of

27:04

inflation and, again, different inflation

27:06

volatilities, I think you face

27:09

an environment where these types

27:11

of correlation, the relationships just change

27:13

and flip much more frequently and

27:16

therefore make the diversification process just

27:18

a lot more challenging. So

27:21

how are you thinking about where

27:23

inflation volatility will be? You

27:25

referenced earlier that the market is

27:28

pricing much higher inflation volatility in terms

27:30

of options prices on the CPI. We

27:32

can show that actually, you showed me this, that

27:35

now the range for CPI pricing

27:37

is actually wider now, greater volatility

27:39

than it was in June of

27:42

2022 when the price of oil was very, very

27:44

high and inflation was very, very high. That is

27:46

interesting to me. And so

27:48

we talked about what the market is pricing in

27:50

implied volatility for CPI. What

27:53

do you think it will realize and why?

27:55

Well, I think there are a couple of

27:57

structural factors and aspects. So when you think

27:59

about... a lot of things that have come

28:03

out of COVID, a lot of manufacturers

28:05

and a lot of companies are thinking

28:07

about how can

28:09

we future-proof our supply chain.

28:12

So how can we make sure that

28:14

supply bottlenecks and

28:16

so on don't become a more recurring

28:18

feature similar to what we have seen

28:21

in 2020 and 2021 and that in and of itself could create

28:24

some inflation burst

28:29

going forward. If you look at the

28:32

geopolitical tensions that we are seeing, the

28:34

Red Sea disruptions where you look at

28:38

the Middle East tensions that occasionally

28:40

flare up again, then you do see

28:42

that also from a commodity perspective a

28:45

lot of commodity markets are actually susceptible to

28:48

higher spikes. If you think about the

28:50

net zero transition which requires a lot

28:52

of copper and actually it's not even

28:54

clear whether the copper supply can resolve

28:56

all the demand that should

28:58

come out of the net zero transition,

29:00

then you do see that

29:02

there are a lot of potential triggers

29:05

to force such inflation spikes

29:07

going forward. And I think that has

29:09

been obviously some of these aspects

29:12

were already prevailing before

29:14

COVID but I do think that COVID

29:16

has intensified this overall. If

29:19

you look at how portfolio construction

29:21

works, then I do think

29:23

that a lot of insurers as well

29:25

as other investors really

29:27

need to think through whether

29:29

they are able to withstand

29:32

in their asset allocation large

29:34

swings in inflation and not

29:36

only a structurally higher inflation

29:38

level and whether their diversification

29:41

approach right now actually

29:44

isolates them from inflation swings going forward.

29:46

But whether that realizes or not, we'll

29:51

have to see. But I do think

29:53

that it's good to prepare and think

29:56

through what the implications could be. You

29:58

talked about the stock-bought correlation. So definitely, really a

30:00

lot of individual retirement

30:03

accounts and RIAs, for example, that

30:05

definitely changes if when stocks decline,

30:07

bonds won't appreciate and yields won't

30:09

fall as they did in 2020.

30:12

That is something of a shock

30:14

when the clients open up their

30:16

monthly portfolio statements. What

30:18

about though for institutional investors, particularly

30:20

in the insurance business? Maybe I'm

30:22

wrong. I don't think of insurance

30:24

companies owning a ton of stocks.

30:27

They definitely do, but it's often

30:29

fixed income so that that

30:31

asset can be a match to the

30:33

liability of their. For mostly fixed income

30:35

portfolios, so not so much stocks,

30:38

are there differences there in the correlation

30:40

regime when inflation volatility is higher? Yeah,

30:42

that's a really great question. The

30:44

way we look at this is from

30:47

a total balance sheet perspective. Our

30:49

assets support our underwriting efforts.

30:53

The question for us is whether,

30:56

for example, structurally higher inflation and

30:58

higher inflation volatility.

31:01

What does that mean, of course, for assets

31:03

in and of themselves? But

31:05

also how do they interplay with

31:08

the underwriting activities that we have

31:10

seen? That is what I mentioned

31:12

before. When you have an inflation

31:14

spike, then what ultimately

31:17

trickles down into the books

31:20

of an insurer depends on what

31:22

the underwriting exposure is, whether you

31:25

are mostly focused on motor

31:27

insurance or property

31:29

and these types of things. That

31:33

just really depends. From

31:35

our perspective, we look a lot at

31:37

inflation and the potential implications, of course,

31:39

from an asset side, but also what

31:42

can we do on the underwriting side

31:44

and what are the underwriting and asset

31:46

side implications that you need to marry

31:48

and merge in order to kind of look at

31:51

this topic in a pretty holistic way. That

31:53

makes sense. But in terms of

31:56

correlations between credit risk and duration,

31:58

where normally if... the risk-free

32:00

rate falls, spreads do X, but

32:03

in inflation volatility regime where inflation volatility

32:05

is high, they don't do that. Can

32:07

you give us some specifics on that

32:09

or anything between the, I

32:11

don't know, maybe the inflation

32:13

volatility is high and rate volatility is

32:15

higher. I imagined convexity risk is higher.

32:17

So that figures into

32:19

mortgage-backed security products and stuff like

32:21

that. Yeah. I mean, that could

32:23

be now from an insurance investor

32:26

point of view because most of

32:29

the rates exposure

32:31

is basically used to

32:33

match the underwriting cashflow

32:35

on the liability side. That

32:38

is not that big a deal. If you

32:40

look at the average insurance

32:42

portfolio, then a lot

32:44

of the credit exposure that many

32:46

insurers have is investment

32:48

grade. And therefore, if

32:50

you see, you know,

32:53

large volatility in either inflation

32:55

in rates, in economic outcomes,

32:57

then typically that hits the

32:59

weakest part of the capital

33:01

structure the most, which is,

33:03

you know, high yields or,

33:05

you know, other non-rated debts,

33:08

maybe emerging markets, if that

33:10

spills over there. I can't

33:12

speak for every insurer, obviously,

33:14

but by and large, an

33:17

insurance asset allocation is pretty

33:19

conservative because the allocation serves

33:21

the underwriting strategy that a

33:25

company pursues. I think from an insurance

33:28

perspective, it should

33:30

be okay from an asset management perspective.

33:32

But again, I think the question is,

33:35

how do you react to the claims

33:37

inflation that ultimately you need to pay

33:39

out? And, you know, how do you

33:41

mitigate that? And what can you do,

33:44

including from the asset side, to

33:46

safeguard that? Thanks for that, Patrick.

33:48

Now, tell us about your view

33:51

on currencies and the euro versus

33:53

the dollar. What's your view on

33:55

that and how is it shaped

33:57

by the expectations?

34:00

of how much the Fed will cut

34:02

versus the ECB will cut or versus

34:04

the strengths in the economies and stuff

34:06

like that. So first of all, by

34:08

the way, at Swiss3 currency is something

34:10

that, or the currency risk is something

34:13

that we try to minimize. So, you

34:15

know, ideally we don't have active currency

34:17

risk on our books. So

34:19

that is not something that we

34:21

have, besides obviously hedging activities and so

34:23

on, have an

34:26

outspoken view on. In terms of the

34:29

currency and your US dollar, now again,

34:31

if I look at the relative

34:33

momentum in economic growth and in inflation

34:35

and so on, I do think that

34:38

there is scope for a bit more

34:40

dollar strength relative to

34:43

Europe. But if you look at

34:45

the last year or so, then

34:47

a lot of the changes have

34:49

actually been driven by the real

34:51

differential between the US and, for

34:53

example, Germany and so on. And

34:56

right now it seems like, you

34:58

know, the differentials are not totally

35:01

out of whack. So I think, you know, where

35:03

we are right now is probably

35:06

okay. But where a lot of

35:08

this will ultimately boil down to

35:10

whether the acceleration in inflation and

35:12

PPI and so on that we

35:15

have seen very recently, whether that

35:17

is a bit of

35:19

a data fluke and driven by, you know,

35:21

seasonal adjustments, January effect where a lot of

35:23

prices are re-indexed and so on, or

35:26

whether actually there's something more going on

35:28

and actually, you know, the fundamental inflation

35:30

process is gaining momentum and so on.

35:32

But yeah, we'll just have to see

35:34

over the next couple of months how

35:36

that plays out. But yeah, given the

35:38

precarious situation of the

35:40

Eurozone, I do think that there is scope

35:43

for a bit of Euro

35:45

weakness going forward. You use the

35:47

word precarious talking about the Eurozone. Just how

35:49

precarious is it? Early you said

35:51

just because in Germany it's not looking so great

35:53

doesn't mean that in Portugal and Italy and Spain

35:55

things aren't looking a little bit better, but Germany

35:58

is a large part of the economy. and

36:00

maybe it's more manufacturing sector and people

36:02

say that manufacturing leads, I mean, I

36:04

don't know if that's been true. What

36:06

is your outlook on the European economy?

36:09

It's actually almost

36:12

like a continued stagnation, to be honest.

36:14

I mean, again, the last five quarters

36:16

were overall barely positive. And

36:18

so I think it's not super helpful

36:20

in my view to talk about two

36:22

consecutive quarters and therefore a country or

36:24

a region is in recession and so

36:26

on. Labor markets are still pretty tight

36:28

and I think when we talk about

36:30

recession prospects and so on, we really

36:32

need to think through what

36:36

is the implication of a recession

36:38

on the labor market adjustment mechanism

36:40

overall. And I think

36:43

right now, personally, I thought

36:45

the Eurozone was going to be in

36:47

much more dire shape. If

36:49

I had known how strong

36:51

the monetary policy cycle is going to be

36:53

and so on, I thought there

36:56

was going to be a much deeper setback

36:58

in your area growth

37:00

momentum. So from a relative point of view,

37:02

I think actually the Eurozone has done well,

37:05

but I think the proof lies in the

37:07

pudding and we haven't landed yet. So

37:09

I think it's also premature to declare

37:11

all as well. We just need to

37:14

see. But we all know that

37:16

in many instances in the Eurozone,

37:19

particularly the southern countries now more

37:21

in Germany, the pressure is can

37:23

arise pretty quickly. So at this

37:25

point, I am surprised by how

37:27

well on a relative basis

37:29

actually the Eurozone has managed to eke

37:32

out some growth. But again,

37:34

I mean, this is totally pales in

37:36

comparison to what you're seeing in the

37:38

US. So, you know, I would say

37:41

some some cautious optimism, hopefully.

37:44

Sorry to interrupt. Just want to tell

37:46

you about Blockworks upcoming crypto symposium in

37:48

London, the digital asset summit, which is

37:50

running from March 18th to March 20th.

37:53

Everyone in crypto is going to be there,

37:56

not just the experts and policymakers, but the

37:58

real industry leaders writing the checks. Over

38:00

$800 billion in assets is going to be represented.

38:02

Anyone who's anyone in crypto is going to be

38:04

there, so if you're into crypto and you haven't

38:06

bought your ticket yet, the time is now to

38:09

get your ticket. I would not wait any longer.

38:11

We've got some exciting guests on the macro side

38:13

too, Julian Brigden, Michael Howell, and yes, I can

38:15

confirm at last the rumors are true, Joseph Wang,

38:17

the side guy himself, is going to be there

38:20

too. I'll be hosting a panel with

38:22

these macro heavyweights that you don't want to miss, so

38:24

be there or be square, click the link in the

38:26

description and use code FG10 to get 10% off. Thanks.

38:29

Let's get back to the interview. You

38:32

said you don't put too much stock in the consecutive

38:35

quarter over quarter negative real GDP prints.

38:37

I would say in the US, we

38:39

had that in the

38:42

first half of 2022, and what followed

38:44

was definitely not a recession. The unemployment

38:46

rate stayed below 4% and continued to

38:48

decline. How do you think what

38:50

that means for Japan and Germany and

38:52

the UK, where at least

38:55

everyone is talking about a recession, people on Twitter are

38:57

saying the economy is in a recession, the unemployment

38:59

rate is low, and the stock market is

39:02

not only at all time highs, but

39:04

actively rising. How do you

39:06

think about that? I don't think it means

39:08

much. I

39:11

mean, look, if you have... You don't think the stock

39:13

market means much? No, the label of a recession.

39:17

The label of... I mean, look, if

39:19

you have, let's say, minus 0.2% growth

39:21

in two quarters overall,

39:25

then first of all, we need to recognize

39:27

that national accounting has a lot of noise.

39:29

So maybe it'll get revised away anyway.

39:33

Secondly, if you don't grow for half a

39:35

year, it's not

39:37

the end of the world. I think at

39:39

the end of the day, it really depends on... You can

39:41

have a pullback

39:43

in economic activity in one industry, and

39:45

that can then distort the aggregate figures

39:47

and so on. But I think as

39:49

long as households are doing well, as

39:52

long as the labor market is

39:54

holding up well, I think the

39:56

label of a recession is a

39:59

bit misguided. It doesn't mean it can't

40:02

intensify. I think

40:04

one should be open to that.

40:06

But just because an economy has

40:08

two quarters of negative growth rates

40:10

that are just barely below zero

40:13

without an associated breaking

40:15

up of labor markets and these types of

40:17

things, I think it's just

40:19

misguided to label it a recession. You

40:22

don't think the term recession itself is misguided?

40:24

Do you think that two

40:26

consecutive quarters of negative real GDP

40:29

is not of slowdown if you

40:31

don't have subsequent severe

40:34

adjustments in the labor market? In other words,

40:36

it's all about the labor market and

40:38

consumption. And the national accounts, there's

40:41

a lot of wonky math in there that can make

40:43

things look weaker than they are or stronger than they

40:45

actually are. Basically, yes.

40:49

Okay, that makes sense. Well,

40:51

Patrick, it's been great getting a chance

40:53

to hear your views and hear your

40:56

thinking. When it comes to macro, what

40:58

do you think are some of the

41:00

most common mistakes that people

41:02

who are trying to do macroeconomic analysis

41:04

make? That's a very actually

41:07

profound question. I think there are

41:10

a couple of points. First of

41:12

all, I think mistaking correlation

41:14

for causation, I understand why

41:16

people do that, but it

41:19

requires a lot of effort

41:21

to better know what is the actual

41:23

root cause of something because that then

41:26

allows you to think through what

41:29

the ultimate outcomes could be. The

41:32

other one is often groupthink. Obviously,

41:35

people are influenced by what

41:37

a reputable institution says and so on.

41:40

Even though they see it differently, they might not

41:42

be able to voice that or don't want to

41:44

voice it for a

41:46

variety of reasons. I think

41:48

the other one too is to just

41:51

be open-minded enough. Again, think

41:54

about scenarios. Forecasts

41:56

are useful as an anchor, but they

41:58

are not. the absolute

42:00

end results. So I think, you know,

42:02

if you have a forecast and analysis,

42:05

then it's important to think through what

42:07

the yardstick is, but it's also important

42:09

to think through what are the mechanics

42:11

so that your prescribed

42:14

forecast actually comes to fruition. And

42:17

that is why I really think that

42:19

scenario thinking and so on is just

42:21

extremely valuable to constantly question yourself, you

42:23

know, this is my view, but I

42:25

might be wrong or most likely I'm

42:27

wrong. So what could the alternative reality

42:29

really look like? Yeah. And I think

42:31

once you manage to have a balance

42:34

across all of that, then I

42:36

think you will ultimately become

42:38

a better analyst and

42:41

hopefully you can translate then that also to

42:43

better, you know, strategic decision

42:45

making portfolio outcomes and so on.

42:47

That correlation versus causation point

42:50

is so true. I think often

42:53

people ask, well, low rates

42:55

are stimulative, but actually

42:57

they aren't because, you know,

42:59

during a recession, there tend to be low rates,

43:01

but a recession causes low

43:04

rates, but then low rates can cause coming out

43:06

of the recession and the same term with high

43:08

rates. So Patrick, I just want to say, like,

43:11

when you look at the assumptions about

43:14

soft landing, no landing, hard

43:17

landing, you know, you said you

43:19

don't really like the term recession, so I can't even

43:22

imagine what you think of those landing

43:24

words. They are kind of unhelpful, but everyone

43:26

uses those words. So when you look into

43:28

what is priced into markets, the soft landing

43:30

has become much more dominant view of this

43:32

in the US than it was six months

43:34

ago. I can't say about what percentage view

43:36

it is, but I just, I can talk

43:38

about the rate of change. Like the stock

43:40

market is up, inflation has fallen, yields have

43:42

gone down. Does that make sense to

43:44

you? In other words, the balance of

43:46

risks implied by the market

43:48

makes sense to you. And how are you sort of

43:51

thinking about the balance of risk? So

43:53

the base case is a soft landing

43:55

in the US, but I think the

43:57

two primary alternative scenarios are obviously a

43:59

stack-side. type of outcome as

44:02

well as a recession. And

44:04

I do think that at the current

44:06

juncture actually you can make a pretty decent

44:09

case for both because on the one hand

44:11

you see some sort of reacceleration, you see

44:14

inflation picking up and you know

44:16

you see actually wage growth increasing.

44:18

On the other hand if you

44:20

adjust for seasonal adjustments, if you

44:22

look at delinquency rates that are

44:25

actually from a level as well as from

44:27

a momentum perspective picking up pretty quickly then

44:29

you can also take the other you and say look

44:31

you know this can easily go the other way. I think

44:33

it's important to be open-minded and have

44:35

an action plan for

44:38

when you realize that you

44:40

are going to shift with

44:43

an increase in confidence into one

44:45

scenario versus the other. And

44:48

you know again market pricing has been reasonably

44:51

erratic and analysts have been

44:53

swerving between all these different

44:56

descriptions so I think it's just important to keep

44:58

that in mind. You know how do you react

45:00

from one thing to the other and

45:02

there's also a difference between you know

45:05

what's going to happen in the next couple of

45:07

weeks versus what's going to happen in half a

45:09

year or a year and so on. And I

45:11

think it's also important to not let

45:14

the immediate data and

45:16

the immediate price action

45:19

determine and cloud your longer-term

45:21

thinking all too much. But

45:24

of course you know we will and I

45:26

will update my views as we get more

45:28

information and you know we're all data dependent

45:30

at the end of the day so I

45:33

think it's just about being open to revising

45:35

your view if you see that the evidence

45:37

speaks in favor of one thing or the

45:39

other. Thank

45:41

you Patrick. People can find you

45:43

on Twitter at Patrick underscore Sonner.

45:46

My final question for you Patrick is you had a

45:48

storied career before your work at Swiss Re, you were

45:50

at the World Bank, UBS and

45:53

the Swiss National Bank. My question is about

45:55

the Swiss National Bank. A lot of my

45:57

show is focused on central banking. Can you

45:59

just share? what is the

46:01

mindset of folks who typically work

46:03

within the Swiss National Bank or a central bank

46:06

and having done a lot of work in the

46:08

private sector, is there a different

46:10

kind of mindset between working at a

46:12

central bank when you're working at a

46:15

bank or a other type of commercial

46:17

private financial firm? Yeah, there is and

46:19

hopefully there is because they serve different

46:21

purposes. Look, at the end of the day, if you're

46:24

thinking about a public sector institution like

46:26

the Swiss Central Bank or the World

46:28

Bank, then you are serving

46:32

the people. Now, of course, in the private

46:34

sector, you're also serving the people, but your

46:37

decisions are extremely influential

46:39

for a lot of

46:41

different stakeholders. And that

46:43

can be households, that can be corporates

46:45

and so on. So you need to

46:48

be extremely rigorous and thoughtful in terms

46:50

of how you approach the data and

46:53

what the implications of your actions could be

46:55

on a huge variety of stakeholders.

46:57

I can't speak for other central

46:59

banks, but the people at S&B

47:02

that I met are extremely sharp, they're

47:05

very intellectually curious. And they also look

47:07

at a lot of things in really

47:09

great and fantastic rigor. And the reality

47:11

in the private sector is often that

47:13

the resources are scarce and you need

47:15

to focus on what is most pressing

47:18

for a company or your

47:20

strategic initiatives and you need to try

47:22

and deliver that. So I think it's

47:24

just a slightly different

47:26

mindset. But I do

47:28

think that you can learn a lot having

47:31

been at the public sector in terms of

47:33

how to think about certain things, how to

47:35

think about rigor and how

47:37

to think about There.

47:40

Were go Patrick Thank you so much for coming on

47:42

sharing your your insights and think you have been for

47:44

watching. Thanks.

47:48

For watching, remember to check

47:50

out vanek.com/hodel F G to

47:52

learn more about the Vanek

47:54

Bitcoin. Trust. reminder

47:57

that forward guidance episodes are available on

47:59

all podcasts. apps and on

48:01

Twitter where I post them

48:03

regularly at JackFarlane96. Thanks again,

48:05

until next time.