Torsten Slok (Apollo Global Management): "What Lies Ahead for the US Economy Post-Election?"

Thank you, Andre. It's fantastic to see you. Thank you.

Oh, thank you. So let's start the answer to that with the broader backdrop of where we are in the macroeconomic cycle. So the Fed started raising interest rates in March of 2022, and what has been particularly striking is how relatively limited impact that has had on the US economy. You would have expected that when the Fed raises interest rates, that car sales starts to go down — that's not what we've seen. That home prices start to go down — that's not what we've seen. That companies' spending, meaning business fixed investment, starts to go down — and that's not what we've seen. So from an asset allocation perspective, what is the biggest surprise over the last two and a half years is that the economy continues to do so well. In other words, why is it that the US economy continues to be so strong? And there are three answers to that. The first answer is that in the US economy, consumers are simply less sensitive to interest rates going up from the central bank. Specifically, in the US, 95% of mortgages are 30-year fixed rate. So the consequence of that is that when the Fed began to raise interest rates, we didn't see the negative impact on consumers. This has been very different from what we've seen in the UK, in France, in Canada, Australia, almost all other OECD countries. When the Bank of England raised interest rates, as an example, consumers in the UK had to pay more in mortgage payments almost immediately. But we did not see that in the US because consumers are locked in 95% to 30-year fixed interest rates on mortgages. So the first reason why the US economy has done so well is that consumers were simply not as sensitive to the Fed hiking rates as consumers were in other countries to central banks raising rates.

The second reason is that in the US we have an AI and data center boom. This has been very prominent and very strong now for several years, and there are no investors who are saying, 'I'm not building a data center because the Fed just raised rates 25 basis points. I'm not doing AI investments because the Fed just raised interest rates 25 basis points.' So AI has also been an interest-insensitive tailwind to the economic outlook, and that will likely also continue to be the case going forward. And third and finally, we also have had fiscal policy has been very supportive of GDP growth. The CHIPS Act, the Inflation Reduction Act, the Infrastructure Act were policies that were implemented in 2021 with the idea of giving a tailwind to the economy in the areas of building manufacturing facilities for semiconductor production, for solar panel production, windmill production, EV production, battery production — anything renewable energy got a huge tax subsidy. And all those tailwinds, both those things that have actually received the subsidies and also outside of that, things that are in the pipeline, continue to also be a tailwind that has not been interest-rate sensitive. So the first part of the answer to your question here, Andre, is that the US economy at the moment is already experiencing quite strong growth because we have less interest-rate-sensitive consumers, and by the way also less interest-rate-sensitive firms, and we have a tailwind from the AI data center boom, and we also have a tailwind from fiscal policy.

So now to your question, what are the implications of the election? Obviously, we don't know what policies will be implemented, and we're sitting here in basically the middle of November and trying to figure out what might be happening over the next several months in terms of policy implementation. But what we do know is that at least if you talk about and think about what policies have been discussed on the campaign trail, President Trump has now talked about three things. He's talked about taxes, he's talked about tariffs, and he's talked about immigration. So let's in turn think about what are the implications of three such policies on GDP and on inflation. At least under normal circumstances, if you lower taxes, it normally has a positive impact on GDP and it normally has a positive impact on inflation. So on its own, if taxes are lowered — and we can discuss in great detail where they might be lowered and exactly what any packages might be looking like — but if we have lower taxes coming, it would be positive for GDP, it would be positive for inflation, meaning inflation going up. Secondly, tariffs. Normally the textbook would say that if you impose tariffs, that means of course things become more expensive in the US, but it also means that the consumers in the US will probably be buying fewer of those things that become more expensive. So by definition, at least in the textbook, tariffs means higher inflation and downward pressure on GDP growth. And third and finally, if you restrict immigration, and if as President Trump has talked about, if you deport in the extreme 11 million illegal immigrants, which is the number of illegal immigrants in the US, you will, according to the textbook, have that if you remove people from the labor force — remember total employment in the US is 160 million — if you remove 11 million people from that, assuming they all have a job, even if few have a job, if you remove many millions of people from the labor force who have a job, it will have the implication that you will have higher wage growth and you will also have lower GDP growth. So net-net, taking all that combined, and this is certainly very speculative, but lower taxes means higher inflation, higher GDP. If you take at least again from the textbook, tariffs means more inflation, lower GDP. And finally, restrictions on immigration means more upward pressure on inflation and also maybe some downward pressure on GDP. All that combined means that the risks are that there could be some upside pressure on inflation as a result of the outcome of the election. It all depends dramatically on the size and magnitude of these policy areas of what might be done. But I think that this logic that I just ran through is the reason why the trade on the election night, when we just knew just before 9:00 p.m. here New York time, that this was the reason why the yield curve started steepening, that people expected long-term interest rates to go up more, and they expected therefore that inflation expectations at breakevens also traded higher. So what I just gave is an interpretation of why was it that markets were trading the way that they were. But just to finalize, and sorry for giving a very long answer here, but finalize the answer to your question that we just obviously don't know quite yet, but I think that the market reaction up to this point is probably to be interpreted as there are some chances now that we may get some upside pressure on inflation and we may also net-net get some upside pressure on growth. But this all is of course very unclear at this point. But the market implications and how markets have been trading, I think, should be at least interpreted in that framework of what are the implications for taxes, tariffs, and immigration.

Yeah, so one very important backdrop for that is exactly what you're highlighting. So let's first talk about the labor market and then we can talk about inequality. So the labor market has certainly shown on non-farm payrolls some slowdown here in the last three to six months, meaning the speed of job growth has been decelerating, meaning coming down relative to where we were say six and 12 months ago. But if you look at other indicators, yes, I understand that the JOLTS survey of job openings has been coming down in terms of the number of job openings is a little bit weaker. You've also seen the quits rate, meaning how many people are quitting their jobs voluntarily, has also been coming down. But if you look at, for example, what's happening with jobless claims, has remained remarkably strong. If you look at the Challenger, Gray & Christmas survey of announced job cuts, meaning they measure every month what is the number of announced job cuts, that has also remained remarkably strong. If you look at in the JOLTS survey, the survey of labor market turnover, if you look at the layoff rate, meaning how many people are getting laid off, has also remained quite strong. So if I put all that up on this scale combined with a still strong economy, I am struggling a little bit with the argument that the labor market is slowing down significantly because it is simply not consistent to have a view and say, oh, the economy and the economic data is good. Remember GDP growth in the second quarter was 2.8, and as we sit here today, the Atlanta Fed GDPNow estimate for GDP in the fourth quarter is going to be 2.5, and we also had in the third quarter GDP growth was just around three. So net-net, we still have GDP growth that's significantly above the Congressional Budget Office estimate of long-run GDP, which is 2%. So in one word, or a few words, the US economy is good. So you can't say, meaning not you, but the market can, and the Fed in particular has this challenge that they're saying the labor market is not good. Well, how can the economy be good but the labor market is not good? So the first backdrop for your question is certainly that the labor market, it's slightly puzzling that it has been a little bit weaker on some indicators when you still have strong GDP growth and you still have the consensus, according to Bloomberg, according to the Fed, according to our view, the view is that the economy will continue to do well. Nobody is talking about a recession anymore. So the bottom line is this has of course meant that job growth has been strong. And to your question about inequality, it has been the case that we have seen some differences in savings across income distribution, where lower-income households, according to Fed data from the Fed Distributional Accounts or the quarterly accounts, that is the flow of funds where you have now distributional data showing who holds the savings, you've seen that savings have been a bit weaker for lower-income households and a bit higher for high-income households. So that issue of inequality continues to be an important part of the discussion for the outlook, because obviously there are significant issues about the outlook for the consumer. It has now become a discussion of what is the outlook for high-income consumers, middle-income consumers, and low-income consumers. But the bottom line from a macro perspective, with the tailwinds that we spoke about here before, I still think that the broader economic outlook continues to be quite solid, and we should begin to worry about the risk that growth might be stronger and maybe even the risk that there might now be upside pressures on inflation rather than downside pressures on inflation.

Yeah, so the US is obviously special in many different ways, and it is special because it's the biggest capital market in the world. It's special because it has obviously, of course, also a significant defense sector. It's obviously also special because it's a reserve currency for central banks. There are some changes to this; some countries have been lowering, according to IMF data, the holdings of dollars, but broadly speaking, it is still the exchange currency that's used as a reserve currency for the vast majority of central banks around the world, and therefore a lot of trade is happening in dollars, and that also makes the US special. And finally, of course, the reason why the US is also special, and therefore the ultimate answer to your question, is because the rest of the world still continues to see, for good reasons, a lot of opportunities for investing in the US. The biggest example of that in the last few years is, of course, the Magnificent Seven. The rest of the world has piled a lot of money into the stocks and financings of AI, of data centers, of the Magnificent Seven stock prices, because the rest of the world views that the US economy is more dynamic, and the rest of the world views that the US economy has therefore more tailwind to growth and more opportunity for returns for investors because of being more dynamic and because of having the seven biggest companies when it comes to tech, the Magnificent Seven again being so strong as a significant part of the US economy. So the first answer to your question is because the US is special, that means that the US has been able to attract money from abroad, and some of that money has now been going, of course, into financing the US government budget deficit. Of course, we are seeing, according to the Congressional Budget Office today, the budget deficit is 100% of GDP, and the CBO is forecasting that over the next several decades that will grow to 200% of GDP. So it's absolutely correct, Andre, what you're saying, that the fiscal situation does continue to deteriorate, and it does continue to be an issue that is significant in markets, namely who will buy US Treasuries as debt levels continue to grow. That's why my answer to that is that I think we need to look at four different places for whether this is happening. The first thing is we need to look at what's happening in Treasury auctions, because there is no answer to at what level will debt-to-GDP become a problem, but what we should be doing as the debt-to-GDP continues to grow is to look at number one, the strength of Treasury auctions. What are bid-to-cover ratios doing? In other words, what is the amount of money people are bidding relative to what was offered by the US Treasury in auctions? What's happening to tails? In other words, do auction prices come in, the yield levels come in at where the when-issued was trading, or do they come in at a level that is higher? In other words, is demand for US Treasuries weaker? Likewise, we also should be looking at primary dealer participation, foreign participation, all these statistics and metrics in the Treasury auctions is something, and that happens throughout the week as the Treasury holds auctions for two-year paper, five-year paper, ten-year paper. So monitoring what's going on in these auctions, it does take some time, but I think that is still a very important part for really investors across all asset classes. The second thing to keep an eye on, of course, is the risk of a sovereign downgrade. If there's a sovereign downgrade, that could trigger some mechanical sell-offs by people who have to hold US Treasuries only because they're rated AAA. So if the US is no longer rated AAA, that could have some implications. Third, we also need to watch the term premium. The term premium has been going up. Remember, as you know too well, and you and I have talked about for many years, the term premium, of course, is something that we should be monitoring in many markets. But the term premium measures what is the premium that investors need to be paid to buy long-duration bonds in the US relative to buying a trade, say, one-year, one-year forwards where you can roll the trade over and get out of the trade and therefore get out of your exposure to long duration. In other words, what is the premium people are paid to take duration exposure in US government bonds? If that goes up too much, that means that people are beginning to say, 'I need a higher premium to buy long-duration government debt and therefore invest in long-term government bonds in the US.' And finally, the most important perhaps one is what's happening to the dollar. The dollar so far has been very strong, and I would expect it to continue to be strong because US interest rates are higher than what we're seeing in Europe, what we're seeing in the UK, what we're seeing in Japan, and for that reason it attracts money that wants to have higher-yielding interest rates, namely US Treasuries. So for those four reasons and those four areas, I still think that these are the areas that we should be watching and monitoring for whether how long time can the US government continue to grow the debt level. But so far on all four fronts, Treasury auctions are still solid. You have that sovereign rating agencies, of course, still have a AAA rating or the highest rating on US government. The term premium has moved up a little bit, so we're watching that very carefully for signs of more steepening in the yield curve. And fourth and finally, the dollar has certainly also been strong. So overall, so far things are still looking good when it comes to demand for US Treasuries, but we should all be watching in markets very, very carefully what's happening on these four different fronts because these will be the areas where we will begin to see some, if there are some signs of cracks or weakness, where you could have a situation where things could become nonlinear, meaning where in the worst case markets could change their views overnight. And there are a number of situations, of course, in history we've seen that, of course, in Greece more prominently here a little bit more than a decade ago in Europe, where for a long time people didn't worry in markets about the debt level and suddenly they didn't worry. We've also seen that the path in emerging markets, Turkey, Argentina, South Africa, countries that have gone through various debt crises. This, of course, is something that is not unprecedented, but the issue really still is the US is special, and as long as the US is the most dynamic economy with high growth rates, high interest rates, and continues to still have the strong outlook for growth and returns on investments, then I do still think that there will be financings of US government deficits.

So I think that what Jay Powell's response was was very telling for what I think will happen, namely that the Fed keeps on focusing on its dual mandate. The Fed has been asked by Congress to make sure that two things happen. The Fed has been asked to have inflation at 2%, and the Fed has been asked to create full employment. So the Fed would say, and this is what Jay Powell has repeatedly said, this is what our job is, this is what we, as the Fed, are always squarely focused on delivering that dual mandate to the American people. Now, to your question, of course, there's a lot of discussion about what can happen and what might happen and what could potentially happen on different scenarios. But I think that the Fed, and in particular the Fed staff, they will be very, very laser-focused on sticking to the dual mandate and making sure that their job is, no matter who is in the White House, no matter who controls Congress, their job is to have inflation at 2% and have full employment. And there has been some discussion at the highest level, if just ignoring even the Trump election for a minute here, of fiscal dominance, that when you have debt levels continue to grow and the central bank normally takes interest rates up and down as a function of the business cycle, but if suddenly debt levels become so high that if you begin to raise interest rates, then it begins to become damaging because you have to then increase, of course, debt servicing costs when interest rates are higher. So fiscal dominance means that fiscal policy and debt levels dominate what monetary policy can do. We have some version of that in Japan, where debt levels are to more than 250% of GDP, and if the Bank of Japan raises interest rates, it would mean that you would have a significant increase in interest payments. So the dynamics between fiscal policy and monetary policy are getting slightly more complicated, but mainly because of the fiscal dominance risk, namely that if debt levels go up, then that could begin to complicate the Fed's job in terms of how much freedom do they have to raise interest rates if there were to be an increase in inflation. But broadly speaking, the answer to your question is that I think the Fed will be very focused on delivering the dual mandate. And Jay Powell's answer, as you just mentioned, of no, he was not going to leave, I do think that at least it is difficult, given that answer, to imagine that other scenarios, at least in the near term, are more relevant. So I still think the Fed will continue to fight their battle of getting inflation down to 2% and making sure that we keep employment as strong as, therefore, as close to full employment as possible.