Hello and welcome to our latest video MacroMemo.

And we’ll cover a number of subjects. We’ll talk about currency weakness, or perhaps more precisely U.S. dollar strength and the cascading effect that’s had on other countries. We’ll talk about some very acute problems in the United Kingdom.

We’ll discuss the war in Ukraine and some updates on that front. We’ll take a look forward to China’s National Congress, which is held in a couple of weeks, at least as we record this. And lastly, we’ll just run our way through some of the more interesting and relevant economic data.

Let’s start though with the currency market. And so amid considerable financial market weakness, there have been big currency moves. And the euro has fallen below par with the dollar. That constitutes quite a significant depreciation over the last year.

The British pound has also fallen sharply. It got fairly close to par with the dollar. It didn’t quite get there, but nevertheless is also much weaker. The yen has depreciated more than the rest, in fact, and is enormously soft compared to where it was just a year ago. And even the Canadian dollar is a little bit softer versus the dollar than it was.

And so a lot of currency movement. Some of it is specific to these countries just mentioned. A lot though is ultimately U.S. dollar strength. It takes two to tango in currency markets and so the U.S. dollar has been actively strengthening at the expense of these other countries.

And so why is the U.S. dollar so strong right now? It’s not a valuation story. Dollar is already arguably overvalued by a number of metrics. It is more to do with, I think, first and foremost risk aversion. And so as markets are scared, we see people seek out safe havens. So a lot of money has flowed into the liquidity and the relative perceived safety of the U.S. dollar.

It’s also fair to say that the interest rate story has favoured the U.S. We’ve had a very hawkish Federal Reserve. There’s been a lot of rate hiking there. Plans for even more rate hiking. At least initially there was more reluctance in places like Europe, and especially in Japan, to deliver significant monetary tightening. So investors like those higher interest rates they can obtain in the U.S.

There’s also arguably, at least so far, been a little bit of extra economic resilience in the U.S. And so we still see signs of softening in most countries, but the U.S. maybe a little bit less than some of the other countries. And so that’s been relatively attractive for currency speculators as well.

Now when a currency strengthens, it means that that country has lost some competitiveness. Its products then seem more expensive to the rest of the world. And so that is a real issue. Often it would be a central concern, but at this point in time it’s not one the U.S. is complaining about because a strong currency also helps inflation.

It helps to keep inflation from getting too high. It helps to—I suppose in the present context—pull it back down. It means, at a time of particular financial distress, that money is unlikely to flee your country. It’s more likely to come in. And that’s a helpful thing. And so the U.S. policymakers are holding their nose, recognizing that the competitiveness hit isn’t ideal abut nevertheless the advantages are bigger than the losses.

And so unlike for instance in the mid-1980s when the Plaza Accord saw countries in a coordinated fashion seek to weaken the U.S. dollar, we’re less likely to see that now because the U.S. probably wouldn’t be onboard with that story or that outcome.

Instead, we’re seeing the weak currencies—we’re seeing Europe, and the UK, and Japan, and even China—begin to intervene on their own in different ways to support their currencies. We’ve seen some stabilization in the currency market as a result of that. But in the meantime, these currencies are a lot softer than they were.

The reverse of the U.S. is to say that those weak currencies are adding to inflation in places like Europe and the UK, which is not desirable right now. But I think equally it’s worth keeping in mind many of these countries do need a somewhat softer exchange rate than they’ve previously had.

You think in particular of Europe and the UK, and they’ve lost a lot of competitiveness because of the cost of heating, and electricity, and natural gas there, which has soared far more than in other parts of the world. They need a weaker currency to remain competitive on the global stage.

And so I don’t know that we’ll see a full rebound in these currencies, even when the strong risk aversion that currently dominates fades. And so these currency changes could prove fairly enduring. And currency volatility likely continues for the foreseeable future.

Okay. Let’s shift over. UK problems. And so we’ve had a number of quite acute problems in the UK specifically. A sharp, sharp jump in borrowing costs over the last week or so. A big drop in the pound after a long, less aggressive decline in the pound. And as a result of those moves, there were some problems with leverage British pension funds and some problems with certain mortgage lenders. And the government has had to step in and lend a helping hand.

And so it’s worth asking, why did this happen? And what are some of the implications of it? And in terms of why it happened, well, I mean it was something that did build over time. And you could argue the UK was one of the weaker countries out there running big current account deficits and suffering a loss of competitiveness via Brexit and so on. So it was already vulnerable.

But then ultimately a new tax cut plan was announced by the new British government. And under normal circumstances, the market might have lapped up the notion of tax cuts, and growth positive, and pro-business, and so on. However, arguably that sort of seems less appropriate at this particular juncture when the central bank is trying to do the opposite thing. The central bank is raising rates to slow the economy, to snuff out inflation, and tax cuts would essentially just further ignite inflation. And so that was a big part of the concern. Also the British fiscal situation isn’t great. And so this would add to the debt and so on. And so it mapped its way into interest rates.

And so that’s essentially the concern that markets had. Bond markets initially panicked. We’ve seen some reversal since as essentially the central bank has swooped in to the rescue. So the Bank of England is now responding to these problems on a temporary, emergency basis. They are buying a lot of bonds to limit yields.

The government has cancelled part of the tax cut, though they are pushing forward with the rest of it. There’s been some pulling forward of an announcement of debt reduction plans for later, so to suggest the government has some fiscal plan.

But the bottom line is the central bank is actively intervening. That’s what’s keeping rates down. Rates may well rise again as soon as that intervention is done. All of this does damage to the British housing market. It does damage to the British economy. So the outlook there is even a little worse than it was as of a couple of weeks ago.

One thing that spun out from that, by the way, is the observation that bond markets are becoming more fiscally sensitive again. And so really the way to think about this is that under normal circumstances when governments borrow more money, they’re forced to pay a slight additional premium for the privilege of that borrowing. They have to attract additional lenders and that needs to be done via a higher interest rate. And that’s the historical norm. That did not apply though for most of the last decade. The last decade was a period of ultra-low interest rates.

It was a period in which central banks were buying up a huge fraction of the debt stock. And so interest rates weren’t very sensitive at all to rising borrowing costs. And we’re now in a position in which that has changed. We’re in a position in which those borrowing costs are proving much more sensitive. And so going forward, that’s an important lesson. Perhaps it’s a lesson of particularly acute relevance to the UK where debt levels are high and the country is more vulnerable, and so bond markets are especially sensitive. But to the extent we may fall into recession in the coming quarters, to the extent governments may want to lend a significant helping hand, bond markets may not be all that keen on that. We could see countries punished. We could see some borrowing costs go up.

Let’s turn to the war in Ukraine. And so the main narrative is one in which Ukraine is starting to gain the upper hand at least in terms of territory. And so gaining ground as opposed to losing ground, which was the dominant theme over prior months. And so that sounds quite positive.

ß Russia though is responding via escalation. And so recruiting more troops and threatening a nuclear response, which is not something nuclear powers have historically ever done. They’ve held what could be described as sham referendums in Eastern Ukrainian provinces so as to claim that they are now parts of Russia and so that even more aggressive defensive tactics can be used.

And Russia has also, at least in theory, sabotaged certain pipelines that natural gas was previously travelling through. So this war is not done yet. It is escalating. The uncertainty goes up. I think ultimately the risk of nuclear attack is low, but it’s not quite zero. And so that is a real risk that at least needs to be fretted about a little bit.

ß And from an economic standpoint, sanctions continue. The potential for more economic damage certainly does exist. For instance, there’s a real chance that Russia could limit its oil exports to a greater degree than it is right now. So still economic damage there as much as perhaps some of the war headlines seem more positive than negative.

Let’s turn to China’s National Congress. And so this is a big political meeting beginning on October 16th. And I guess the main story is one in which despite some discontent within the party, it is likely that President Xi is reappointed to an unprecedented third five-year term. So that is the most tangible outcome from this meeting.

Because of that, it’s likely that many of the key pushes China has engaged in over the last decade will continue. And so the government will seek to gain more measures of control over the Chinese population. More restrictions there for Chinese people. China will likely be even more assertive on the global stage. And China will continue to pivot back towards favouring public institutions over private institutions.

And I must say, none of that is great for economic growth or for financial markets. Elsewhere, China likely continues its zero tolerance policy through to the spring, at least that’s what the pundits are thinking. Get through the winter wave, should there be one; get past Chinese New Year; and then perhaps more seriously reopen. There are scenarios in which that happens sooner, but it seems more likely to be in the spring of next year.

The property market should be in focus given recent problems. China could reintroduce a growth target. Some think it could be a 5.5% growth rate, though I do wonder if they may struggle to hit that kind of growth rate going forward. And we’ll likely hear some of the key economic themes reiterated, including focusing on common prosperity, which is a comment on reducing inequality, upgrading China’s manufacturing capacity to keep moving up the value chain.

And supply chain security, which is a common theme in a lot of countries these days in the context of food and energy, making sure a country can be self-sufficient or close to it. But also in China’s case, more self-sufficiency in semiconductors. And so this is something the U.S. has been cutting off access to highly sophisticated semiconductors and that is a focus for them as well. And decarbonization.

So let’s look to those meetings. Let’s see what comes from them. They will in some ways set the stage and set the tone for the next five years in China. And China matters a lot to the global economy.

Let me finish with a few quick economic thoughts here. And so I would say the economic data still coming in mixed. And so in a U.S. context, for instance, happy news out of weekly jobless claims, which continue to fall, and so suggesting the labour market in the U.S. is holding together quite nicely.

Conversely though when we look at the very important ISM Manufacturing Index, we see that number plummeting. We see new orders in employment now consistent with outright declines in the future. We see a third-quarter GDP print that might be only very barely positive. And so I would say we’re getting some signs of a stalling economy, but it’s not universal yet, and at a minimum it doesn’t seem to be a recession just yet, though we do think that’s more likely than not.

I think the other economic comment is just there have been a number of tragic hurricanes to work their way through the Caribbean, and the U.S., and to some extent Canada. And so, of course, the greatest focus should be on the loss of life, and the property damage, and these sorts of things. And there are estimates of $40 billion to $70 billion of property damage in the U.S. and into the hundreds of millions in a Canadian context.

There’s also a temporary GDP hit. Companies can’t operate when they are shut down, or when there is no electricity, and so on. And so there will be a very significant hit for Florida. A fairly slight one—maybe a 0.3 percentage point hit—in the third quarter to U.S. GDP. But the story with natural disasters is: and then you rebuild, and then the economy even moves a little faster than normal. And so I guess in the end it doesn’t really change the trajectory over the next year. It’s an inherently temporary effect.

And that’s it for me. And so I hope you found this useful and interesting, and I wish you well with your investing. And please do consider tuning in again next time.