Is there anything in geopolitics that you think isn't priced in yet, that you see happening in the coming months or years?
I think the market underestimates the war between Ukraine and Russia.
So, things really aren't connecting between what we understand the AI world is seeing and what the real macroeconomic picture is. This sentence I'm about to say will probably get me banned from the United States, but I think China is a real competitor.
What is the thesis where you think you differ most from the market today?
I don't differ that much, but I think I'm more vocal on the debt issue. I think people are playing with fire.
Welcome to another Ponto de Vista, an Invest News program in partnership with Nubank. Today I'm here with Rogério Xavier.
Thank you very much for the invitation, Roberto. I think it's going to be a really nice conversation.
I think a first topic that has been much discussed is global debt. Global debt has been growing since the pandemic. Governments have had great difficulty addressing fiscal issues. Today we have a global debt problem that crosses not only the emerging world but the developed world. And we're starting to see, let's say, some consequences of this fiscal escalation in long-term interest rates. We're seeing what's happening a bit in the United States, and we also see a bit of what Japan is going through. What is your view on the global debt issue, on these cracks that have started to appear in the markets, and how do you think the way out of this will be?
Well, basically I think it's a problem that today, at least, is known. I remember us talking a few years ago and it seemed like only the two of us were worried about this subject, but it seems evident to me that it's not a localized problem, it's a global problem, and today, basically, you're discussing the competition for capital, which in reality, as countries kept borrowing and not addressing the problem, what happened is that you combined the sovereign part with the private issuance part, especially after companies linked to the artificial intelligence sector started accessing the market. So we're approaching almost $1 trillion in annual issuance from these companies that will compete for resources with sovereign nations. So I personally don't see any political will from countries to address this problem. I don't see it in the United States; on the contrary, we're heading in the opposite direction. I don't see it in the European countries either. The main European countries with these fiscal problems have reasonable political problems, especially France. The United Kingdom, poor thing, has been suffering from a political issue for almost a decade.
But what do you think is the endgame, as they say? What is the trigger? Or will there be a trigger where governments wake up and address this? Will it be inflation coming? And also, do you think the long end of the curve, this widening of the long end, already has some relationship with this?
There's a debate today about whether it does or not. I think there are parts that are addressed by the short end of the curve, believe it or not, and parts that are addressed by the long end, which have more to do with fiscal.
Uh-huh. But there's a theme that mixes all of this, which is what sustains the American economy today, which in my view is very much sustained by the AI companies themselves, whether through investment or through the stock appreciation that generated absurd wealth and sustained American consumption, because people are feeling rich, in aggregate. So this issue involves a bit of an art by the American Central Bank, the Fed, trying to reduce some of this exuberance in the capital markets, because the capital markets went 10 times what the real economy did. Now, the real economy needs to catch up with the capital markets.
So, picking up on that monetary policy point you mentioned, one of the things that has generated some noise is the perception that the United States is trying to change the way it conducts monetary policy. There's questioning regarding forward guidance, questioning regarding the market's learning. The current Fed Chair always says the market needs to learn to interpret signals better. The market can't always expect to be guided by the Fed. How do you see this change, let's say, in terms of how to conduct monetary policy at a time when we have so much uncertainty?
So, I think we lived through, at least in my career, the strange thing was forward guidance. In the end, we relied a lot on data analysis and especially trends. I think what Powell is trying to show the market is that there isn't much of this issue of data point X or data point Y. What exists is the direction we're heading. Either we're heading into something that's reaccelerating, generating inflationary pressures, and deviating from my objective, so I need to act. That's why the Fed has been giving a big downplay to the neutral rate, things like that which we talk about regularly. He's much more focused on the trend of where things are going, whether I need to act or not. But again, coming back to that other point, since I think the interest rate level isn't a deterrent for these companies to continue developing their investments, I think we won't be able to... unless there's a real action from the Fed, I don't think there's an interest rate level that derails the American economy, you know? So I think we're going to stay in this pattern. Do a little bit and see it won't work. Have to do a little more. You asked me where the endgame is. I think the endgame in the end is a great global recession. I strongly believe in this, because they're going to rise to such an extent that at some point it will cause a significant correction in the capital markets, in the stock markets. And we can't forget that when the asset market grows, it's not just the assets that grow, the collateral grows too, and the leverage as well, because you can leverage up. So when you go the other way, into a down market, you have forced selling due to all the margin calls, due to the liquidation of collaterals, because your asset became smaller and you have to adjust. So I think the endgame of this is a big rise in global curves, because there will continue to be very strong issuances. We don't address the sovereign part, so there's this competition, they keep rising until one day...
Uh-huh. One of the topics we debated among central banks, I was in a meeting with central banks and it was debated last time, is this thing of having two economies. One is the AI and technology economy, which, as you said, even if funding is a bit more expensive, the return is so high for them that it doesn't make much difference. And on the other side, another sector of the economy that, when funding gets a bit more expensive, has great difficulty achieving the minimum return. And then when you try to address one, you end up kind of killing the other. How do you see this dynamic?
The interesting thing is that if we look at what the market is expecting in terms of multiples, obviously tied to 2027 results, the Mag Seven part isn't that elevated. Where there's a reasonable expectation of earnings growth is basically in the other 493 companies of the S&P. So, in a way I don't understand, the market is thinking that these 493 S&P companies are the ones that will bring profits and sustain the American economy in 2027. I find that hard to believe, but that's what the market is saying.
Okay. Of course. Now changing gears a bit and talking about geopolitics, we have today the China-United States topic, we have a Middle East topic. And I think the market, in the midst of so many uncertainties — the AI topic, the long curve topic, and the geopolitics topic — has a lot of difficulty absorbing so many sequential shocks at the same time. How do you see the geopolitics topic? Is there anything in geopolitics that you think isn't priced in yet, that you see happening in the coming months or years?
Well, first I think this Iran issue — the support Russia and China give Iran behind the scenes in logistics, in intelligence — seems clear to me. I don't think Iran is acting alone there against the United States. So I already see an attempt by China to remove the American zone of influence over the Middle East. It's an attempt, but let's see where it goes. The other thing is that I think the market underestimates the war between Ukraine and Russia. There have been several quite disturbing elements happening near Odessa, there in Ukraine, which is close to the border with Moldova and heading toward Romania. I'm not saying that I'm predicting a Russian invasion of Moldova or Romania, but I think there's a chance of a conflict, at minimum of provocation. And then, since Moldova is a NATO member, that could generate an issue that could really disturb the markets, which is: hey, are we going to defend Article 5? Romania is being bullied by Russia — are we going to do something? I think that's a risk the market isn't talking about, and for me, living in Europe, it's a big concern.
Taiwan and China — do you think that's also a risk the market isn't talking about?
No, I think that risk... and I go, you go too, but I go to China annually, in fact I'm going at the end of this month. And one of the things they told me right at the beginning, when I started, is that the problem with Western people who come to visit is that they think too much with a Western head. [laughter] For us, it doesn't matter to China to take military action. They understand this is a process that will happen naturally, just like Hong Kong happened. They won't need to take it militarily; they will win politically. Time passes, then a more pro-China candidate comes in, it gets closer. And that's a bit like what happened with Hong Kong, right? Exactly. So from my point of view, having followed this evolution closely — very closely — I would be surprised if there were an attack by China on Taiwan. I don't see that.
Taking the opportunity that we're in Asia, let's talk specifically about Japan. When you look at people who have followed the market for a long time, Japan has had atypical volatility, atypical American interventions that have generated uncertainty. When we look at some implied volatilities for Japan, we're talking about two, three times the historical level. And a Japanese government that has been changing, let's say, its orientation in terms of what is my guidance, where do I want to go. Do you think Japan — this uncertainty in Japan, what's happening with the markets — has the capacity to affect various markets? Is it a very localized thing? And how do you see the United States' intervention in the Japanese markets?
No, I think Japan has already changed the global balance. In the end, Japan was funding for everyone, and now Japan realized it needs funding itself. So when you had a central bank that was your captive financier and it disappears, you start seeing problems arising in front of you. So what I see today, which I think is the most central thing we can have in our debate, is the so-called marginal investor. Everyone talks about the stock, but those of us in the market know that what matters is the flow. Ah, the debt-to-GDP ratio is X. It doesn't matter at all, because that debt-to-GDP is already financed. Someone already bought it? I don't need to worry about that guy. I need to worry about it at refinancing time, but what I have to care about is the marginal debt I'm issuing. That's what I have to worry about. Will Roberto want to buy what I'm going to issue additionally? Well, if he wants to buy, at what price will he want it? For what maturity will he want it? What's the elasticity you have with this marginal investor? This figure is the most important thing we should be discussing. Ah, we're in fiscal dominance. No, that's not it. Fiscal dominance isn't a day you wake up and discover you're in fiscal dominance. It's a process, and the way you discover this process is when governments start losing their instruments — what I call degrees of freedom. If you have your instruments, you have monetary policy, you have fiscal policy, but if you can't use them fully, it's because you've lost the degree of freedom. The moment the marginal investor defines your policy, it's already over.
No, excellent. I'd like you to talk a bit. I think fiscal is Brazil's big topic, right? We've been discussing it. I recently even wrote an article about the dynamics — very well written, by the way. It was criticized, but it was actually an arithmetic calculation, right? For those holding long NTNs, I think sometimes it's worth doing the arithmetic. So I'd like you to talk a bit about what you think of the fiscal situation and, again, what is the endgame? Are we going to get out through inflation, are we going to manage an adjustment? Modern economists have been saying a lot that propagating fiscal credibility can help you make an adjustment without having to do the nominal math, simply through the propagation of credibility. How do you see this fiscal unfolding?
Great. Let's go back to the marginal investor. The marginal investor is looking at Brazilian fiscal and saying: 'I don't want to extend duration, I want it indexed to the Selic.' And I see with real concern, in the short term, the capacity and willingness of the government to pay me. So I think Brazil is already on that curve, heading toward a more serious situation from a debt standpoint. So what I see today is this political polarization between two actors, one of whom you already know — he's in government. The other, you have a doubt about, you have no opinion about him, but you have a doubt. That already totally alters the probability distribution of what he might do. So this one here — no value judgment on the candidates — but this one here already has a benefit the other doesn't have, which is the right to the benefit of the doubt. So since I don't know, I have to wait for his actions to say: 'Ah, he didn't do anything, he won't act, so we're heading down a bad path.' The other one has to do something different from what he's done so far, because what he's done so far is leading us to the abyss.
And then getting into the consideration of the candidate in power, what's interesting is how he sees it — even though we're in a political cycle, terms like fiscal adjustment are nonsense, things he really doesn't believe in. And then you have the following possibility: suppose we look at that federal budget and see that the main line item of government spending is interest. Then people look at that and say: 'No, our problem, the cause of all our problems is this line item here, interest. Let's lower interest rates.' If we then reach Galípolo — but let's lower interest rates. Then the guys say: 'But if we lower rates, the exchange rate will go up.' And he says: 'No problem, we'll control the exchange rate.' So I don't think it's a far-fetched view that one day, if the incumbent wins — I don't think that probability is low, I think it's quite high — people will come and say: 'Look, we can't have rates this high, this math is what's pushing the debt-to-GDP ratio up, and we have to cut these rates and leave them there and control the exchange rate.' And then they'll see the harm they did to the country. But first, I think they'll try.
But there's Galípolo. 'Ah, the Central Bank isn't independent.' The problem is that it's independent more or less, because the president will have four directors to appoint. He puts four guys there who want to cut rates. Galípolo can keep voting alone and lose. And the moment he starts losing the votes, he says: 'Well, bye. I'm not here for this.' So, even though there's institutionalism, even though I see President Galípolo as a super well-intentioned person, wanting to do the best for Brazil and committed to inflation — I agree 100% — but he's going to lose. What can he do? I don't think he'll subject himself to that role of staying there with other board members sabotaging him. I think that's even reasonable. So I see a scenario that is feasible, in my view, and that could lead the country to catastrophe — turning a bad problem into a chaotic one.
And the other one is a big question mark. I don't know, I have no value judgment, just because he's not in power. And I also haven't heard what his government plan is. So I don't know what he'll do, because one thing is promises, another thing is action. I need to see the action. So in the beginning, I give the benefit of the doubt. If he does nothing, he goes down the same path.
Uh-huh, agreed. And still talking about Brazil, there's another topic that has been much discussed, which is household debt. If we take the last crisis, let's take 2015, 2016, we had debt, but it was debt that was much more concentrated in small and medium-sized enterprises, what we call SMEs, and there was some debt in large corporates, because leverage was greater than today. Today we have household debt, which is much, much more grave. When we look at the concept of how much people spend of their monthly disposable income on interest, it has reached a level we don't see not only in Brazil but in other emerging countries. We also have the betting companies topic. How do you see this household debt topic?
