Hello and welcome to our latest video #MacroMemo. As usual, there's quite a lot to cover.

We'll talk about a turnaround of sorts in the U.K. We will discuss the completion of China's National Congress, which only happens every fifth year. And so we'll talk about what that means. We'll talk about Taiwan and risks of war and so on, which has been a front and center geopolitical risk for some time now and of course, relates to China.

We'll talk about the economy and inflation and where those two stand as key drivers of the economy in the macro environment going forward. And we'll also take a quick look at the U.S. midterm election, which is now imminent in the next few weeks. And lastly, just spend a moment on how human development as measured internationally has progressed or not over the last couple of years.

And so let's circle right around to the start and we can talk about the U.K. economy and the turnaround that's occurred of sorts there. And so what I mean by that is that we have a new British Prime Minister, Rishi Sunak, who replaces Liz Truss, who was there for less than two months. A new finance minister preceded Sunak and is in place as well. And essentially the prior administration had proposed, in retrospect, ill-advised tax cuts that were set to increase the U.K. fiscal deficit and debt at a time when rates were rising and that was arguably not ideal, and simultaneously was set to stimulate the economy when the central bank was trying very hard to do the opposite thing, which was to slow the economy and cool inflation. And so markets weren't keen on that. In the end, it caused the downfall of the government. There is now at least set to be a new government in place and markets are quite pleased about that. In fact, the British ten year yield declined by a third of a percentage point on the very day of the new Prime Minister being announced and indeed the currency market is feeling somewhat better as well.

Now, that's not to say that British challenges are over. Inflation is still higher there than in most places, and there is more interest rate hiking that is needed. And the economy is set to do unfortunately worse than in most parts of the developed world. And the challenges include very high natural gas costs, as with Europe related, of course, to Russia, Brexit consequences are still spilling over as well, and the list goes on.

And one way of thinking about the idea that there are some fairly significant reforms needed in the U.K. is that the British current account deficit is huge and that is to say the U.K. is spending a lot more than it's producing, or consuming more than it's producing, which is to say it's not in a long-term sustainable position.

It is going to need to at some point reorient its economy and adjust and stop living beyond its means, essentially. And so there is still hard work to be done, but it seems perhaps that this administration might be able to do a more credible job of it than the last administration.

Okay, let's move on to China. And so really on two fronts. We'll start with China's National Congress, which has just concluded. Every fifth year China has this event. And really it's an opportunity for the president to give a speech and for some formal lining up of who's in what position among the most senior politicians in Chin, and President Xi has been consolidating power for the last decade. He's been in power now for ten years.

At this point, there really aren't any serious alternatives or opponents left, particularly at the highest level in the Politburo. And so he's essentially positioning himself to all but surely be president for another unprecedented third term, and that will be formalized in March of next year. And in terms of where China's focus is right now, well, it doesn't seem to be the economy, despite some economic stumbles.

Instead, it's very much upgrading the military and foreign policy and foreign security, and with Taiwan, of course, very much in focus there. No change to COVID rules. So China is still pursuing a zero tolerance policy. We think that likely ends in the spring. No change to housing policy. China's housing market has been tumbling, arguably necessarily. It just went far too high.

But nevertheless, that weakness isn't being offset in any way. And I should say, and maybe just by virtue of a lack of attention on the subject, but we are increasingly worried about Chinese growth over the medium term. It's quite slow right now. I think that's a given. But over the next 2 to 5 years, I'm wondering and increasingly starting to think that we need to forecast significantly less growth than was once the norm.

And you may recall China's already been slowing for quite some time. It used to grow at 10% a year, then it grew at 8% a year, then 6%. I think absent the pandemic and recent political developments, you might have guessed five and a half or five for the next number of years. But I'm starting to think we need to forecast less than 4% growth coming out of this pandemic.

And that is because China's leadership simply isn't focused on maximizing the economy. The priorities are greater control over the population. It's on foreign policy. It's regaining state control over the economy and pushing aside the private sector. And in theory, all of those things actually are not good for economic growth. And when you add on top, the idea that China has some housing excesses likely take quite some time to resolve and some demographic challenges, and just the general observation that China is becoming, again, more totalitarian and that isn't historically good for economic growth – it seems to me that we need to expect fairly limited growth from China. It may no longer be the superpower in a growth context that it once was, and that has repercussions for all of us. China has driven a third of global growth over the last several decades, and it may not be able to do that to the same extent going forward.

Let's pivot from China, but not very far. Let's talk about Taiwan for a moment. And so this is simply one of those geopolitical risk discussions. And so inevitably, there are all sorts of problems and risks in the world. And usually these things don't manifest into outright disasters. So keep that in mind as I talk about this. But nevertheless, you know, Taiwan is in play right now and China and you could say the U.S. are both speaking more aggressively and more assertively about Taiwan.

China is still very much intent on a reunification, as they call it, with Taiwan. In fact, the latest speech by the president spoke to this. They would greatly prefer, of course, it be a peaceful reunification, but they have suggested they would not shy away from a non-peaceful reunification if that proved necessary. Now Taiwan is distinctly not interested in this. Taiwanese poll show Taiwan very much prefers to stay a democracy and to stay independent.

The U.S. has been more assertive on the opposite side from China, that is to say it has said explicitly it would defend Taiwan. It used to be implicitly, and betting markets are assigning something in the realm of an 8% chance of a lethal confrontation between China and Taiwan by the end of this year. So not a big number, but neither 0%.

Some analysts are claiming China is pulling forward plans to unify Taiwan. And hard to say just how real those are or aren't. But the risk arguably has gone up at a minimum. And I guess really the only thing of real value we can say is, if something like that played out and there was a conflict between the U.S. and China, that of course is a very bad thing.

And just for context, where sanctions on Russia have been significantly damaging to the global economy, China is maybe, and this is conservative, 6 to 11 times more important to the global economy than Russia is. And so you can imagine the kind of ripple effects that might emerge in that context, not to mention the fact that Taiwan generates 70% of the world's computer chips.

And you could imagine global supply chains being quite complicated as well. And so, again, not at all our best case scenario that this happens, but it's a risk and it's a risk that's higher than it was. And so we need to do a little bit off of pre-loading just in terms of thinking in that direction, at least in that that's precisely what this is.

And so you're seeing companies think similarly. And so a greater focus on supply chain diversification and companies looking to open operations in India and other Asian and Mexican and so on, locations just in case they were to lose access to their Chinese facilities.

Okay. On from there, let's get into more traditional economic domain. And so on the economic front, we predicted recession for quite a while. For the developed world, that's still unfortunately what we are looking for. We've incrementally increased the odds recently from a 75% chance to an 80% chance for what it's worth. So nothing big in terms of changes, but a little more likely as opposed to less.

We're still seeing a fairly middling depth. I have to say there are very good arguments as to why a recession could be mild. There are very good arguments as to why a recession could be deep. That's why we're calling for a middling recession. They're neutralizing each other, if that makes sense. And so we expect a middling depth recession. And I should admit, we have been actively downgrading our growth forecasts again, that's still a work in progress. That's a sneak preview for me, I suppose.

We're still hashing that out on the investment teams, but nevertheless, really just kind of more properly pricing in a middling depth recession and markets now pricing what I would describe as a mild recession, but maybe not quite enough to get to where to where we think they may eventually end up. I should, of course, say recessions are inherently temporary.

We've also said this one could be more useful than most in the sense of it could prove quite central to helping to fix inflation. It could prove quite useful for helping to fix housing excesses as well. That's already starting, I think. And you could argue there's an inevitability in the sense that the economy is so overheated it has to cool to some extent.

Maybe it would be nicer to cool it over a few years and avoid a recession in so doing. But some cooling is needed one way or the other, and a recession would achieve that necessary cooling and getting us back to a more sustainable footing. So I'm not saying a recession should be celebrated, but nevertheless that it's likely and it may have more silver linings or redeeming values than your average recession.

Let's address inflation for a moment. So inflation is still much too high. Headline numbers have been heading a little lower, though, for the last three months, and that's been nice. But you may have noticed central banks haven't felt all that much better about it. And that's because core inflation is still much too high and inflation breadth is still much too high.

That is to say, just a lot of little things are still moving upwards at a rapid rate. And that's likely why the Bank of Canada, the Federal Reserve, seem inclined to raise rates by as much as 75 basis points again at their next opportunity. We still feel pretty good about the theory behind a turn in inflation that we see central banks shifting, we see fiscal policy shifting, we see supply chains getting a lot better.

We see commodities, I should say – I forgot a fourth item – commodity prices getting better as well. And those were the original drivers of high inflation. So we think that we can see inflation come down from here, including core, including the breadth, but we just haven't seen all of that turn just yet. There are famously lags involved.

And so, for instance, we've already seen wheat and corn and soybean prices come down somewhat. We haven't seen that in the grocery store. Classically, there's a 3 to 6 month lag. And so we're just waiting for that lag right now. Shelter; similar story, even longer lag. In the U.S, it's classically an 18 month lag. We can see home prices starting to fall, we can see rent prices maybe stabilizing there.

Some indicators are falling, some aren't quite yet. We can see that happening. It's going to take a while before that shows up in CPI. Central banks know that, they don't need to keep raising rates for 18 months because they'll know when home prices are turning and that they are turning. But nevertheless, it's going to take some time to turn this. So as we’ve said for a while, inflation can, we believe, become less high. We wouldn’t quite bet on low in the near term – central banks have a little more work to be done – but don’t think we’re into a new high rate environment permanently. There should be some reversal, I think, at a later date.

And then let me finish with two quick things here. One is the mid-term elections in the U.S. As I record this, they are two weeks away. It looks as though the Republicans pick up the House of Representatives. It's a debate who gets the Senate. Right now it's a 55% chance that the Democrats keep it, 45% chance the Republicans get it. I wouldn't say that's inconsequential. It is in various ways.

But nevertheless, the main point is it looks like there will be a divided U.S. government, a Democrat White House, at least a partially Republican Congress. So hard to get some legislation done over the coming years. Do note in terms of items of relevance fiscally in the near term for the U.S., student loan interest has not been paid for the last few years.

That's something that was waived during the pandemic and will be reintroduced at the start of next year. It's a $2 trillion market that we're talking about, $100 billion plus of interest payments that will resume and that could have some ripple effect that could significantly slow the economy.

And my last little item – I’m going in maybe a little too much detail here – human development indices. So we know the economy has ebbed and flowed and fell in 2020 and rose the last two years. It may fall again. Human development measures have generally been more optimistic. For the last generation they went up every single year. And that is to say, when you look at longevity, when you look at education, those sorts of things, we were still seeing the world getting better for people even when the economy occasionally went down.

That stopped in 2020. We saw a decline in human development indices in 2020 and in 2021. Unfortunately so the world did suffer in a very real way. We've seen a subsequent bounce in 2022, so I don't think it's a forever phenomenon. But let's not underestimate the damage that was done both to longevity and to really educational attainment by the pandemic. And that's going to take some time to dig out of.

Okay, I'll stop there. Thanks so much for sticking with me. Hope you found that interesting. And please tune in again next time. Thanks so much.