Is China Debt “Too Big To Fail?”
During the Winter 2021 installment of PGIM’s China Investment Symposium series, a panel of experts examine the dramatic rise in China’s debt.
The Russian invasion of Ukraine has added another set of uncertainties for financial markets that were already grappling with a host of concerns. For institutional investors, chief among those concerns is that, as inflation continues to rise, the potential impact to global markets and economies is likewise on the rise. At our latest AsiaPac Forum, PGIM brought together a panel of experts to discuss these issues, and how policymakers might react.
Among the topics our panel addressed:
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>> To everybody in the region, good afternoon. To my colleagues, the moderator, and panelists in London, good morning. My name is Philip Hsin. I'm responsible for the Institutional Relationship Group of PGIM here in Asia Pacific ex Japan. I would like to thank all of you for joining us this afternoon for our first Asia Pacific Forum of 2022. I would also like to thank my colleagues across the region for extending this invitation to many of those who are joining us today. Before I start -- before we start here, I would like to just clear up some housekeeping matters. The one -- the first one is that to please input your questions into the Q&A session that you'll find at the bottom of your screen. The second thing is I'll come back at the end of the session to remind you to help fill out a short four-question survey for this event. So without delaying any further, let me hand it over to Kishen, who is our client portfolio manager at PGIM Quantitative Solutions. Kishen, I'll hand it over to you.
>> Good afternoon, everyone. Thank you for, Philip, for the introduction. And I just want to thank you all for making the time. It's clearly a very active and turbulent time in markets right now. Appreciate you all have been very busy today. Thank you for taking the time. As you will all know, the session today is tied toward inflation outlook and the implications of markets. So we will clearly be challenging each of our panelists on those two topics; what are their current thoughts on where the world stands, but more importantly, what are the investment or portfolio indications in terms of where we are today in the market? Now, the most important thing I will be doing is challenging our panelists to put themselves in your shoes as investors in the Asia-Pac region, and really thinking about well, you know, some of the actions they may be doing if they were in your shoes. So sort of look out for that, but that will hopefully be an important question -- important session. Now, before I introduce the panelists, just a brief overview of the structure today. We'll be looking to speak for about 40 to 45 minutes, but as Philip says, I really, really do encourage you to please don't put any questions you have throughout the session. I'll be collecting those and we will make sure we have some time towards the end for -- you know, last ten, 15 minutes for some questions. So please do address those. Now I will -- and it's my pleasure to introduce our three distinguished speakers. We've got some really, really distinguished guests speaking to us today. The first person I'm going to introduce is Katharine Neiss. Katherine is the Chief European Economist at PGIM Fixed Income. Prior to joining PGIM Fixed Income, Katharine was a senior member of the Bank of England, including heading up the International Surveillance Division. We are also joined by Sushil Wadhwani -- Dr. Sushil Wadhwani. Sushil founded and is the CIO of PGIM Wadhwani, PGIM's Systematic Market Group. Now, again, prior to joining PGIM, Sushil was a senior member of the Bank of England. He was actually on the Monetary Policy Committee. And also he had some roles at Tudor and Goldman Sachs, as well as a lecturer at the London School of Economics. And finally, I'm delighted to also welcome Peter Hayes. Peter Hayes is the Global Head of Investment Research at PGIM Real Estate. Peter was also a member of the Bank of England, senior economist there, and also was a lecturer at the Universities of Sheffield and King's. So I'm sure you will agree we've got a great panel for you today and hopefully this is a very opportune time for this discussion. So we're going to kick things straight off and really there's nowhere else to really begin other than Europe. As we'll see, a lot of development [inaudible] is a big conflict in Europe, so Katharine, can I please pass to you to share some opening thoughts around the issues in Europe and the [inaudible] consequences?
>> Absolutely. Good evening, good afternoon, everyone, and it's great to be here, so thank you very much. I thought I would start off really by trying to set the scene in terms of the global economy. We started this year things were already looking a bit more uncertain, ironically, relative to 2021 when with the rollout of the vaccine it seemed pretty clear that the global economy would see a strong rebound on the back of that. And we started this year already with more of a cloud of uncertainty hanging over us, but then really on February 24th when Russia invaded Ukraine, things really did completely change I think in terms of the global outlook. And we now have a situation where clearly there's uncertainty over the conflict itself. There's also a huge amount of uncertainty around the economic impact of that conflict, and of course we continue to have uncertainty around the world of policy in light of this renewed -- this new crisis that we have in Europe. And Europe is very much the epicenter of this crisis, and so I thought I would focus my comments on that, but clearly there are elements of this in other regions around the globe. So I might just start with my first slide, if I may, to really just give you some of the key takeaways that I'd like to leave you with. And the first of this is that, you know, this conflict is clearly a negative shock globally. It's a negative shock for Europe for sure. And the question really is, you know, how big is this negative shock? There are several channels to which the shock can impact the region and beyond. You know, I'm sure viewers are well aware the energy impact, but we also have trade and financial linkages. And then in addition to these channels, I think it is really worth emphasizing that we have these potential amplifications coming through things like consumer business confidence and crucially supply chain distortions which were already, you know, really kind of being pulled at the seams because of COVID lockdown measures. Now, there is uncertainty around how this is going to evolve. And probably a key factor is going to be the state of energy flows from Russia to Europe. And there is still a lot of uncertainty around what that is going to look like, both over the immediate future and beyond. Now, despite what is clearly a negative shock for Europe, when the European Central Bank last met, they effectively told us that they are continuing on their path of normalization. They're wanting to -- it appears, to extricate themselves from these extraordinary measures of asset purchases and potentially even negative rates. So there is an additional element of uncertainty there around how much can we rely on the Central Bank for policy support, and similarly with fiscal it's early days, we still don't really know very much around, you know, how much European policymakers are going to support, you know, individual member states and the region as a whole. So really the bottom line for my comments is that we have an additional degree of uncertainty with the eruption of this war in Ukraine. And that is further magnified by uncertainty around the degree of policy support that we can expect. So those are the key messages. Let me just very quickly take you through just a few slides to kind of bring some of these comments to life. So this chart is just showing you the degree of energy dependence across different European countries, compared to the Eurozone as a whole. And the main thing I wanted to really get across with this chart is firstly that clearly the conflict is negative for the region as a whole, but it is asymmetric. Some countries will be affected much more than others. What's unusual here is that countries such as Austria, Netherlands, Denmark, Germany, countries that have typically been isolated or relatively less affected by European crises in the past are now much more in the forefront. And the second point to take away is that once again Italy is a key vulnerability, and that's always a concern given their very high debt levels, you know, even before this conflict. This is just to bring out some of these amplification channels. So when we think about a shock, we typically think about, you know, what's the direct impact, you know, how energy dependent is, for example, Germany or Russian gas? But then there are these much more difficult to quantify amplification channels to consumer sentiment. We're going to find out more later this week what's happening to sentiment in Europe, but so far we have two indicators, and those are on the left-hand chart. And you can see the latest observations have really died down, you know, as you would expect, given the proximity and, you know, the really, you know, distressing situation around the conflict has really been a hammer blow to confidence. The second thing I wanted to point out is related to supply chain disruptions. The table on the right just gives a few examples. We are hearing growing number of stories of automobile makers, steelmakers, some paper products, that are highly energy dependent and also dependent on other crucial commodities from Russia and Ukraine, starting to make announcements about reducing their production capacity. And clearly that would be a concern for the region as well. So moving to the next slide; this chart is essentially a slide of the level of Euro area GDP. In the blue line is the data, and then we have projections going forward. And what I wanted to draw out in the projections is really, you know, this heightened agree of uncertainty. The top line, which is in sort of light green, is effectively, you know, a very benign scenario. It is actually consistent with the ECB's latest forecast. And I would cast that as really being, you know, a very sort of optimistically benign outlook for the region. The bottom in red is what I would call a severe downside, if for whatever reason -- either it's coming from the Eurozone or the Russians, but that flow of energy really just stops from one day to the next, which of course is a possibility that I think is on the table and it's something that we need to be mindful of. And then of course we have our base case, which is effectively somewhere in-between. And again, just to note, you know, the headline number of close to three percent probably doesn't look that bad. But a lot of that is driven by these base effects, because what you can see compared to the yellow line is that Europe is still operating at a level that is below potential. It's below where it would have been had the pandemic not occur, and the economy had simply grown at potential. So there is spare capacity in the region. And this really distinguishes it from the US macro situation. And then finally to my next slide, and final slide, which just shows you the monthly purchases coming from the ECB in terms of, you know, asset purchases of sovereign bonds. And you know, this is setting out, again, the forecast as the ECB has told us in their last meeting, just to really highlight that in the pandemic, you know, fiscal and monetary in Europe, like in many other countries, the US, the UK, in other regions around the world, really stepped in to help address the economic consequences of that. Thus far, there is a bit of a question mark on policy support. And the ECB, at least, have told us that, you know, their plans are to finish asset purchases before the end of the year. So hopefully that gives a bit of an overview. It is European specific, but I think some of these elements do apply to many other regions, you know, to different extents. But hopefully that's a good way to kind of get started for the discussion and see the lie of the land.
>> Thank you, Katharine, some very helpful [inaudible] thoughts. I'm sure we will get some comments from the rest of the speakers. Sushil, I'm going to turn it straight to you; any immediate reactions to anything Katharine's covered? And obviously, you know, you've had a lot of questions in the registration sessions where we were asked some -- to ask some questions around the US and some comments around the US [inaudible], particularly your thoughts around how all of this is impacting inflation.
>> Well, thank you very much, both Katharine and Kishen. It's always a pleasure to listen to Katharine. I always find I learn from her. So what she said about Europe is really I think quite insightful. But as Kishen has requested, I've got a few minutes to focus on the US. And I have to say that I have spent the last 18 months worrying that inflationary pressures in the US are being underestimated by the Central Bank there. And as time goes on, I've become more and more convinced of that. Now, why is that? I would say there are several reasons why I think defense forecast for inflation over the next two or three years are too low. So the first is I think they are significantly underestimating the pressure in the labor market. There are several wage measures now that are already rising at about six percent a year. That's much higher than the Fed had ever envisaged. And remember that in the US wage settlements tend to be staggered. So this uptick that you see is likely to continue to percolate through the economy. The second reason I'm worried is all along Chairman Powell and his colleagues have told us, "Don't worry, inflation expectations are anchored." This is becoming more bothersome. It's becoming more bothersome because now what you are seeing is that it's not only one- or two-year ahead inflation expectations that have gone up, but that this is now also true of expectations five to ten years out. You saw that most recently in the Federal Reserve Bank of Atlanta's survey measure. You're obviously seeing that in market measures. The third reason that I'm becoming anxious about, you know, further upside surprises to inflation in the US is that the Fed somehow thinks that it's about to effect a miracle. It thinks that it's going to be able to bring inflation down, even though real rates are highly negative, and even though on its own forecast unemployment doesn't really go up. Indeed, unemployment remains below the natural rate of unemployment; its own estimate of the natural rate of unemployment throughout its forecast horizon. So the Fed, again, you know, even though they retired the word "transitory", they are in essence assuming that there are enough transient components in inflation to bring it down miraculously; almost miraculously. So what are these factors that could bring inflation down? Clearly one reason why inflation did go up was essentially the supply problems that you see because of the pandemic. Now, these supply problems, sadly, are going to be prolonged because of the Ukraine shock. But ultimately they will subside. So the Fed has a point that those supply shocks will ultimately subside. The other thing where the Fed is right is about base effects. Inflation last year around this time was very high. You can certainly make an argument as to why some of those components will be weaker this year. So yes, I can see inflation coming down somewhat from these very elevated levels, but I simply don't see inflation going down to -- you know, around target in two years' time in the way the Fed does, unless we see a lot more tightening. Now, the Fed is belated sort of catching up with that, so we went from essentially having very little tightening penciled in for this year, to now having several hikes. And now as of Monday, Chairman Powell is talking about moving even more quickly. I think the word is "expedient". And yes, so they are beginning to catch up, but they are so vastly behind the curve that I fear the inflation cat is out of its bag, and they've got serious problems. Now, if you take what I've said and take what Katharine has said about the risks, the world, you know, looks even a bit more scarier. But I'd better pause there. Perhaps Peter is going to be more cheerful than me.
>> Yes, thanks, Sushil, obviously very thought-provoking and we'll definitely come back to this. Peter, you know, obviously any immediate reactions to anything Katharine or Sushil have said, or any other thoughts on additional [inaudible] effects would be great.
>> Hello, [inaudible]. Well, it's -- there's obviously a number of things going through the narratives, and that leads to just how hard it is to read the data coming out of the pandemic into the shock we have with the Russia and Ukraine conflict. And so you also already had a case that central banks are a little behind the curve because it's just so hard to predict these events. I think the challenge that I've talked about in the past is really to what extent central banks have a [inaudible] which allows them to have the ability to contain inflation; which means an actual understanding not only what's driving inflation, but also how the transmission --
[ Inaudible ]
So you know, it's obviously a time where it's very difficult to [inaudible] to all of this. And I think the challenge that we're faced with when it comes to central banks is really the communication strategy and the risk. And obviously alluding to what Sushil said and what Katharine said, which is, you know, to what extent can central banks really, really take over the inflation questions and, you know, arguably avoid a sharp interaction tendency? And [inaudible] that balance is really a hard one to make. And so understandably, you know, you have got [inaudible] back and forth about, you know, miscommunication. It's not fair. But we clearly are suffering from just huge uncertainties about how this plays out in the next six to 12 months. I think -- and I'll leave it at this point I think obviously that's where investor [inaudible] sits today, and what do I do given another bout of certainty [inaudible] central banks.
>> Thank you, Peter. And that, you know, "What can I do" question is obviously on a lot of people's minds in terms of our listeners. And it takes us very neatly onto sort of what we want to go on to next in terms of portfolio implications. Just a quick sort of summary of, you know, some of the points we've heard. In Europe; heightened degree of uncertainty in Europe. You know, Italy is a particular concern. And there were definitely some certain sectors that are facing the brunt of this issue. You know, [inaudible] in the US, thoughts around the Feds full cost inflation being too low, underestimating impacts of wage pressure, you know, long-term inflation accusations have gone up in terms of five to ten years, and really do the Fed think they're going to pull off a miracle, which is sort of how current forecasts are pictured; and Peter, you know, thoughts around how hard it is to read data, and again, the uncertainty around it. So with that background, I really want to then go on to what I think is on a lot of people's minds, portfolio and investment implications. Peter, I want to come straight back to you. You know, many of our investors have significant real estate exposures. What does all of this -- you know, what impact does all of this have on real estate? What are your current thoughts? What is the team really thinking about right now?
>> Well, there are probably two ways they're thinking about it. So one is what's happening to investment [inaudible]. And secondly, you know, how it slows [inaudible] sector in itself. Let me start by mentioning that second point about the real estate market. What's been a theme -- and of course, when you talk about real estate, I'm talking private real estate. It's a long game. But even though [inaudible] global financial crisis, it's really quantitative periods of time when we haven't been exposed to a lot of uncertainty. And the lessons of a global financial crisis -- certainly in the real estate space, has really -- I feel like the juices and sort of the ingredients that makes this less exposed to some of the short-term volatility you see at the moment. And by that I mean, you know, [inaudible] system, we haven't seen a lot of development activity [inaudible] real estate markets. There were also pockets of oversupply. And I mean, investment is a thing to be focused on what you call "[inaudible] chain space investment. You know, they've really stuck to, you know, mature markets. They've stuck to [inaudible] secure stabilized assets. So if you like [inaudible] a lot of investors to be quite defensive mindset. And you know, we know when [inaudible] about real estate is talking about multifamily [inaudible]. So I like the real estate market is in a really good place. You know, it's a sort of cash flow. But as I mentioned the outlook is obviously -- this is basically where the challenges lie. Historically, when you're in inflation an environment -- so let's say historic -- let's take the last 25, 30 years, which is a different sort of stories before, in a rising inflation environment historically one way [inaudible]. And in fact to the point where, you know, in inflation feeds into real estate, it is protected [inaudible] structurally or even just the way normal demand for space increases. So real estate [inaudible] inflation issue policies. There are other ways of getting around the inflation in a way that these terms are [inaudible], for instance, the multifamily markets, which we have invested focus on. But the difficulty [inaudible] is a weak growth and [inaudible]. And that doesn't bode well. And that's where obviously momentum is starting to look a little bit more fragile. I think investors' sentiment [inaudible] Europe is naturally learning towards more of a false wait and see. You know, it's just a conflict because it's an inflation story which will disappear in the next couple of years; in 12 months [inaudible] leading to a new world order. You've got the regional centers, you've got a hit to global growth more permanently. And that's part of [inaudible]. I think what really is sort of on the minds of investors [inaudible]. And that's -- I mean, you know, Asia in particular, you know, some markets [inaudible] and also interest rates. And that tries to kind of [inaudible]. We know the employment is still fairly good. It's bounced back from COVID. So I think what you'll find is that this year we'll see weakening of transactions activity. Investments will still be focused on cash flows, still focused on income. But the things that liked before COVID, before the [inaudible] accelerated, I think logistics [inaudible] will still continue to be the focus of their attentions. But I see momentum is slowing down a little bit. And some of the stories around retail recovery, return to the office, certainly in Europe, you'll find that those have taken a little bit of a hit, and that's more of a 2023 story the recovery this year. But you know, this is [inaudible]. So this is a good place; loads of cash flow, defensive mindset, obviously some nervousness around pricing. But at the moment there's no real cause for concern. There's no obvious distress that's coming through. So it's sort of wait and see a little bit, you know.
>> Interesting. Certainly, the fact that real estate [inaudible] natural inflation measures. We'll see. It helps its cause [inaudible] in today's environment, but inflation with weak growth is really where this agility may come in. And we might come into some of these topics but later. I want to go on to Sushil to share some thoughts around public markets, you know, across the board, whether it's [inaudible] fixing concurrencies with commodities. Sushil, how do you see the current environment really impacting many of these asset classes? Where -- you know, where are you worried? Where do you see opportunities with these asset classes?
>> Well, thank you very much, both Peter and Kishen, for your simulating views. I actually think that this is a really, really important time in markets. Is it possible to have my next slide, please; because what I want to show is that we're living through what for many market participants is a very unusual period. So for people like myself who have probably been around far too long, you know, when I was working in the markets in the late '80s, we were thoroughly accustomed to periods of high and accelerating inflation. So a lot of market participants were very cognizant of the risks. Of course, we've since been through this very benign period in terms of inflation. And the current inflation shock we're experiencing you can see has sort of been relatively limited so far in the context of history. And in my anecdotal experience, a lot of people are underestimating the harm that this can do to portfolios. Remember, rising inflation can be bad for growth. Rising inflation certainly undermines PE multiples. Think about [inaudible], you know, all the way back in '79, the famous paper, obviously [inaudible] fixed income. And so there are very few places to hide; yes? Now, one of the places where many people have hidden the last 12, 18 months is commodities. And that certainly in the first phase of an inflation cycle is a good place to be; yes? And so it's proved again. So commodities tend to do really well when inflation is high and accelerating. And you'll see that in this picture. As long as inflation is accelerating, commodities do well. However, you run into a problem when commodities start -- when inflation starts decelerating. And at some point, that's going to happen. That's going to happen either, you know, as the base effects disappear or there will be some response to monetary tightening. And it's the second channel that I want to focus on. So clearly, the Fed is belatedly catching up. That inevitably will slow growth. So I completely agree with Peter, the issue is not just that we've got an inflation problem, but we've got a growth problem. And we've got a growth problem partly because of monetary tightening, and we've got a growth problem partly because of the confidence effects emphasized by Katharine earlier coming from Ukraine. Now, that's a very bad combination. And that will over time certainly undermine the returns of the most cyclical commodity markets, which is why you see the phenomenon captured in this picture, which is once inflation peaks and starts decelerating, commodities are not a place that you can hide anymore; long commodities. So what is it that we should do? What we now need in this uncertain environment and this environment where many, many people are not old enough to remember the bad things inflation can do to portfolios, is you're going to need agility. And as a simple-minded example of agility, what my team put together was -- let's just take an absurdly simple benchmark, which is simple trend following, and look at if you use trend following since the early '70s and applied them to commodity markets, what happens? What happens is you can still make decent returns even when inflation is decelerating. So this is just another way of saying is that as long as you have your wits about you and you are agile and you know when you've overstayed your welcome in commodity markets and you're willing to go short, then indeed, this environment -- this macro environment with so much instability can actually be a very fertile environment for returns and for alpha [phonetic] And therefore, for folks like myself who sort of view themselves as macro investors, in many ways this is a great environment, because this is an environment where activism can help; agility can help. But it's very, very important to embrace that philosophy. You know, an ex boss of mine told me that the key thing in markets is to keep it simple; is to either remember whether it's an environment that you want to be patient and longer-term oriented, or whether you want to be agile. I think with the uncertainty that Pete has talked about, this is a time to be agile, this is a time to be responsive. And why do I say that? I say that also because the risks of a recession are now rising. It depends on which region you are talking about, but given some of the things Katharine said, if some of a scenario eventuate, obviously you get a recession. But I think even in the US, the risks of a recession are rising. And we know that recessions represent a very important discontinuity. Alan Greenspan used to talk about how you needed two different econometric models. You needed one econometric model for normal times, and you needed a completely different one for a recession. Because he saw that as an important discontinuity, and he always emphasized it was important to recognize that nonlinearity in relationships. If we do now fall into a recession, then that's going to have huge effects on portfolios. I mean, equities will go down, commodities will go down; you know, the most cyclically sensitive commodities like industrial metals and energy. And of course, [inaudible] will invert. So given the I think meaning for the rise in the probability of a recession, I think it's prudent to begin to prepare one's portfolio for the possibility, or at least mentally prepare one's self to move very quickly if signs of a recession start accumulating. Let me -- Kishen, I apologize if I've gone on too long, but let me leave you with one char, which I think, you know, certainly scares me in terms of potential macro-instability. So this is a chart I've shamelessly stolen from Olivier Blanchard. Olivier, of course used to be Chief Economist at the IMF for sometime; well-known professor at MIT, now at the Peterson Institute in Washington. And you know, he's reminded all of us with how unusual the current situation is. So you've got core inflation at six percent in the US, and you've got real rates really low. And you don't usually get such a pronounced divergence. And the last time you got such a pronounced divergence was obviously in the late '70s, as this picture shows. Now, you know, 18 months ago, I thought we were likely to have an inflation problem and that will have some portfolio impacts, but that we weren't going back to the 1970s. I'm still not sure we are going back to the 1970s, but I have to tell you this feels very much like the late 1960s to me. So what have you got? You've got a central bank that's behind the curve. Tick the box. You've got a lot of complacency about valuations. Big tick in the box. You've got a wall. Another tick in the box. And you've got a very uncertain geopolitical situation. So further shocks could emerge. I think it's going to be really, really important to be flexible in one's portfolio allocation, and be agile. And I apologize for saying "agile" for the 47th time, but I think that's going to be really important over the next couple of years. Sorry, Kishen, if I went on too long.
>> No, not at all; you know, really, you know, very, very helpful. I think clearly, the key takeaway is all about agility and the need to not overstay your welcome, so that's a certain [inaudible] commodities. And maybe we'll come back to some of these in questions. I'm going to send another prompt for any Q&A. We've got some questions come through, which we'll address very shortly. But please do send through any thoughts you have on anything that's been covered. Katharine, can we -- you know, I want to come back to you, particularly, you know, with your sharp thinking about fixed income. Any other sort of perspectives on concerns or thoughts from a fixed income investor's point of view?
>> So maybe just to start and sort of emphasize, I think, you know, some of the comments that Sushil was saying about the US that, you know, clearly, the US and Europe, you know, are -- experienced the same, you know, COVID shock, this conflict now in Ukraine. But yet, I think it is really important to emphasize that the backdrop is really quite different between the two regions. You know, firstly, the impact of the conflict itself, Europe's proximity to the conflict, the fact that Europe is much more interconnected in terms of energy and other commodities to Russia, Ukraine, really makes it a clear negative shock. It's negative for the US as well, but the US is far more insulated. And moreover, the US going into this conflict, as Sushil I think very, you know, compellingly set out was really showing multiple signs of overheating. And again, you know, this is simply not the case for Europe. Nominal wage growth is, if anything, you know, too low relative to the ECB's two percent inflation target. Services inflation last year was lower than it was the previous year; so you know, far fewer signs of kind of flashing red. So again, we are getting a bit of a disconnect there in terms of what's the outlook. That said, and coming back to your question around fixed income, is since the ECB -- you know, when the conflict erupted, I think many market participants thought, you know, "Clearly this is a negative. The ECB is likely to put more weight on the negative impact on growth than on the positive impact of the conflict on inflation." And so we saw a lot of this market pricing of an aggressive normalization path, you know, fall back. But since we've had the ECB's meeting, you know, that's basically done, you know, a complete roundtrip and retrace. And going forward, we are seeing these tighter financial conditions, and we are I think looking at the risk of more spread widening both for sovereign bonds and other credits in the region. But it's difficult for me to imagine a situation where if things really were to deteriorate in the region that, you know, the ECB wouldn't then need to step in and ensure that its setting of monetary policies being transmitted to the real economy that they are there to ensure, you know, the transmission to all corners of the Eurozone. So you know, I think there is a bit of a downside insurance there that, you know, if we look at the past. But in the meantime, as they do seem clear to want to extricate themselves from these extraordinary measures, it speaks to I think what Sushil again was saying, you know, looking for alpha opportunities. It speaks to a bottom up assessment, you know, with that top down overlay of really looking for pockets of value, particularly, you know, high yield, emerging markets, and in investment grade corporates.
>> Kishen, is it okay if I come in just for ten seconds?
>> Yes -- [overlapping].
>> So I just wanted to say I wholeheartedly agree with everything Katharine just said. I think it represents a huge divergence opportunity between the Eurozone on the one hand and the US on the other. And it also actually throws up another interesting potential opportunity, which is the country many of us are speaking from today, which is the UK, which has -- almost always contrives to get the worst of all worlds. So the UK has US tied inflation problems; US tied labor market overheating. And so we have that problem. On the other hand, we have some of the vulnerabilities the Eurozone has in terms of energy price risks. So the UK could actually end up worst off. But I'll stop there.
>> Which is obviously wonderful [inaudible] given the [inaudible] are all based in UK; but no, thank you for those thoughts. You know, where I'm going to sort of round up the formal comments before we go to Q&A, you know, I want to sort of have the last of 30-second, one-minute answer from me too. You know, putting yourselves in the shoes of a senior investor in Asia, what is the one thing I guess is keeping you up at night, the one thing that you particularly are going to be focusing on as an investor, and potentially, the one thing you are first to address in the coming three months; or, you know, what would be your primary sort of points of adjustment in your portfolios? Peter, I'm going to come to you maybe with a real estate hat on, but I don't know if you have any final thoughts on that point.
>> No, I think it really comes back to, you know, what -- I would say from a [inaudible] perspective, if I'm going to say I think the argument is what is the longer-term [inaudible] in terms of trade and [inaudible] across the regions, because you are looking at a region of global growth [inaudible]. So if you end up with a sort of regional sort of fragmentation of what was, you know, before globalized model. So that would be where I would be worried where because it's still [inaudible] interest rate point [inaudible]. And ultimately, if you're a [inaudible], you would sit through this. You would sit through the longer [inaudible]. But then ultimately you're looking at, you know, how --
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>> Brilliant. Katharine, you know, same point, you know, key concern, key thing keeping you up at night, and then key potential opportunity or key thing to address in a portfolio?
>> For me, the trickiest part around, you know, this latest crisis is trying to work out the implications through supply chains of some of these key commodities. It's -- you know, we saw these supply chain distortions, disruptions because of the lockdown. It's clearly, you know, an impact in terms of energy in the region. But Russia, Ukraine are exporters of other key commodities, which individually might not look very important, but you know, are right at the beginning of the supply chain and trying to think about how that whiffles out, thinking nonlinearities where really the system could get so gummed up that it just comes to a full standstill, these are the things that really, really worry me. To just to emphasize that, you know, when economists think about the economic impact of a shock, you can sort of bucket them as, you know, the direct effect, the indirect effect and the spillover. And typically, it's that direct effect is reasonably straightforward to try to quantify and forecast. But where we have typically made mistakes, and that's much harder to forecast and quantify are these indirect and spillover channels. And so just given the extraordinary, you know, situation that we find ourselves here with supply chains, I think that's the bit for me that worries me, but also, you know, there are opportunities, because clearly there's trade diversion and substitution. And so you know, there could be some winners from this dislocation. But trying to anticipate that I think is -- you know, requires lots of number crunching.
>> All right, thank you, Katharine. And Sushil, same question, you know, key thing keeping you up at night, key thing you would address if you were an investor in Asia in terms of priorities for the next three months.
>> Okay, thank you. So it's always hard to follow both Peter and Katharine. But the key thing keeping me up at night I guess is the thing I dread most is I get woken up my colleague in Australia and I'm told that there's been some horrible, horrible escalation in the war. You know, today we've been talking about more mundane matters about the portfolio, but that, of course, is sort of the most feared scenario; clearly, a scenario one fears most. I'm not a geopolitical expert, but that very much is a possibility. But if I now look away from that for a minute, I think we are in a very dangerous environment for portfolios. We are -- we've become very accustomed to this notion, especially since the GFC [phonetic] that, you know, problems happen in the world. But the magicians of the central banks sort it out. And indeed, if you look at the period since the GFC, the portfolio bounces back; you know, retailing [inaudible] and, you know, the world looks okay. So if you're a portfolio manager, you've got your 60/40 portfolio, you look like a hero. Those days are gone. Those days are gone because that was only possible for central banks to do because inflation was low. With inflation as high as it is, with inflation forecasting as difficult as it is, I think that ease where central banks rescued portfolios are over for a considerable period. You're on your own now as a portfolio manager. And you now going to -- and you're going to have to respond to events, take a lot more responsibility. Because you're going to be able to add a lot of alpha if you respond quickly and in a timely fashion to these events. Thank you.
>> Thanks, Sushil. And thank you, Peter, Katharine, you know, for some great, you know, comments throughout the session. I'm going to come to questions. We've got, you know, a couple of really good questions. I was actually -- and this is a great question and it ties in very neatly with a conference I was attending yesterday. A big theme for that conference was, you know, deglobalization, and essentially, you know, given the degree of geopolitical risks out there, could we see a scenario where we start to get fractions in the world in terms of, you know, almost an Eastern and a Western economy? So that's sort of one thing I want to throw out there, that how big an issue is deglobalization? And the second point linked to that is how does all of this really impact, you know, so-called "emerging markets"? How are you guys thinking about allocating to emerging markets? I'll come to Katharine first just for any thoughts on either of those things, deglobalization and emerging markets.
>> Well, I would say that this certainly looked like it was a trend even before this latest conflict. We can think about, you know, Brexit coming back to here in the UK. The Brexit boat wanted to separate from the EU. We had a US election in 2016 where there was a real cleavage between the US and Europe. And it just feels like this latest crisis is really kind of hardwiring this trend going forward. You know, I see it very much -- in Europe if you look at what policymakers are saying, the EU presidency is currently under France and the French President, Macron, has really been sort of banging the drum of European autonomy and sovereignty and, you know, they effectively have announced a new economic business model for the EU coming out of their latest summit saying they would like to extend this into defense, into energy, into food security. You know, maybe it sums it up I think in 2017, Angela Merkel said, "Europe needs to take its fate into its own hands." And I think what she really meant is, you know, we need to be more self-sufficient in all of these areas. And so you know, that is definitely, you know, an inflection point relative to the direction of travel, really, you know, since I was a child. So you know, I think that this -- these events -- they're part of, you know, a trend, but it's really pivotal. Really I don't think I could underscore that anymore.
>> Thanks. Sushil, same thoughts around sort of deglobalization as a theme and the impact all of this may have on emerging markets.
>> Great, and thank you. So in terms of deglobalization, again, I agree with Katharine, it's part of the continuing trend. If you look at the data, ever since the GFC, the world -- we've had deglobalization. It's been accelerating. It's accelerated because of the pandemic. And now Russia, Ukraine will only accentuate that trend. Of course, deglobalization has sinister implications. One is I think it raises medium term inflation. The second thing I believe it does is, you know, essentially, to echo what you just have been saying, Kishen, which is it I think gives you more of a risk premium in terms of EM assets. To me -- listen, I'm not a geopolitical expert, but it looks to me like the world is going to essentially coalesce into two groupings, the so-called people who believe in the liberal Western economic order, the liberal democracies, and then everyone else. So everyone else, obviously the key players would be China and Russia, but you wonder as to whether India joins that camp. And you are then really talking about very, very significant fragmentation. I think a lot of problems. And clearly, flaws into some of these markets, you know, have already been reversing. You know, we've seen what's happened to the Chinese markets. You know, is India next? You've at least got to ask that question. And I think what recent episodes have brought to light is the huge importance of country risk, also the huge importance of political stability in terms of the stability of economic growth, and the reliability of equity market returns. You know, if you go back 20 years, there will people touting the Brits, you know, in terms of economic growth, in terms of a place to be, in terms of stock markets. And look what's happened to most of them. You know, you definitely wanted to avoid the Brits as a group if you wanted to preserve your wealth. And I think that's a lesson a lot of people will absorb.
>> Thanks, Sushil. Peter, I will come to you. And I've got one more question I really want to throw to the group before we wrap up. So we've got five minutes. Peter, any thoughts on that theme around, you know, deglobalization or emerging markets?
>> I want to -- you know, I think the comments by Katharine and Sushil captured the essence. I would just lead to at a -- you have got fundamentally, you know, economic problems in the Western Hemisphere, if you put it that way. You have got issues around productivity growth. You also have issues where maybe since the global financial crisis, you know, companies just wanted resilience against a [inaudible] environment. So you're talking about a global sort of narrative whereby regions are looking at how can they protect themselves if they pursued policies which go against the group. So you've obviously got the issue of deglobalization accelerated a little bit at the moment if the pattern [inaudible] continues. But I think that would be a chase. I would say the emerging markets won't be hit by that, but then you'll also see a lot of chasing for emerging markets and access to markets there or access to [inaudible]. So it will be a change in the way that we've been doing business because of that fact. So I'll leave it there.
>> Thanks. I'm going to come back straight to you, Peter, on this last question. What is the current investiture curve telling us about the long-term nature of inflation? So isn't it currently just a supply shock [inaudible] monetary policy? You know, we're going to finish on inflation. What are your thoughts about [inaudible]?
>> That's a very good question. And it does come back to, you know, the financial market's price [inaudible] short-lived hits to markets. And look, I think history isn't necessarily as useful to going -- just going forward. But then the argument here is that long term we already -- if you like, a lot of dryness behind the interest rates being lower around the Asian population [inaudible]. And it's a hard one to call at the moment. I think we've been talking about here is that it's really -- you can't really rely on those [inaudible] is never good for growth, obviously. But the -- we're saying that there's just so much uncertainty around how long this inflation can persist and central banks chasing the [inaudible]. So I would say that -- I mean, you know, [inaudible], but I would say that those signals obviously, you know, point to a beyond scenario where inflation comes back to its lower [inaudible]. But it's [inaudible]. So yes, I'm not -- no, I wouldn't see that as signal really at the moment.
>> Fair enough. Sushil, any thoughts on that in terms of an inversion of the yield curve and whether inflation is supply shock or monetary driven?
>> So in terms of -- if I take those separately, in terms of the yield curve, it depends on which segment of the yield curve you're looking at. Some bits are inverted, some aren't. And I think it reflects market confusion at this point or, you know, market uncertainty. And I think that there's good reason to be uncertain. We don't actually know whether there's going to be a recession yet. You know, I would have thought it's close to 50/50 in the Eurozone. But I would have thought it's closer to 30/70 in the US at this point. But I think on the rising. So you know, certainly, one reason the U-curve is doing what it is is pricing and recession risks. Now, is it a supply shock or is it -- did we have too much money? I think it's both. You know, you just have to look at the monetary numbers in 2020. Look at what happened to supplies; the demand/supply story. But you know, obviously, we've also had a big supply shock. So both things are going on.
>> Brilliant. Thanks, Sushil. And Katharine, any final thoughts?
>> I'm conscious of time so, you know, maybe just leave it there. But I was very relieved to hear Sushil's, you know, recession risk for Eurozone. I think I would also put it at about 50/50 and less for the US. And again, that speaks to the differences there.
>> Brilliant. Thank you, Katharine. Thank you, Peter. Thank you, Sushil. Hopefully, it's been a very insightful session for you. We really appreciate your time. We're just up to the hour, a half an hour of time. So we'll close there and I'll pass it back to Philip, but thank you for joining us.
>> That's great. Hey, thanks, guys, very much. I know you guys have had to get up early this morning to join us here and keep it live in the Asia time zone. So with that, I thank you very much, and wish everyone a wonderful day ahead. Have a great day, everybody.
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