#4th IFIS – Geopolitics and Interest Rates by Zoltan Pozsar

Zoltan started the session with the thesis that Jerome Powell will try hard to tame inflation to maintain the central bank’s credibility.

He expanded this thesis as follows:

Paul Volcker, the Former Chair of Fed who tamed inflation during his tenure is considered by Jerome Powell as his hero and Powell in the Jackson Hole Summit did not not talk about asset pricing. Zoltan considers this to be an indication that the ‘Fed put’ is dead for now.. Powell will do more than what Paul Volcker did to keep the credibility of the central bank.  In this process, Fed will over tighten and there is a high probability of recession before Fed changes its stance.

Zoltan is of the view that Paul Volcker was able to tame inflation because of the favourable economic landscape prevalent during his tenure. 1970s saw a decade of big investments into oil so in 1980s the supply picked up as production from those fields started which resulted in softening of crude oil prices. Another factor was that due to the government’s opposition to labour unions during Volcker’s tenure, the impact of labour cost on inflation declined. So, Paul Volcker was lucky being at the right place at the right time to tame inflation.

But Powell faces a different economic landscape. In the past decade there has been big underinvestment across most of the commodities as capital got into growth stocks. Governments are now encouraged to support unions which will push up labour costs. All these factors will lead to a high inflation environment over the next decade.

Zoltan says inflation is a generational phenomenon. Those born in 1970s have grown up in a deflationary world. Next decade is going to be a new era of high inflation for which financial market professionals should prepare.

Zoltan is of the view that the current inflationary crisis is caused by a dislocation in real world and is different from past economic crisis which was mostly related to financial markets and Fed was able to put back the economy on track by Quantitative Easing (QE). But now the real-world conflicts of Russia-Ukraine, USA-China and other such geopolitical risks has resulted in a supply chain dislocation which has caused the current crisis, and this can’t be tamed by QE.

Zoltan’s thesis is that world will be divided into two blocks of G7 and BRICS. Western countries will prioritise reshoring, stocking and arming which will result in huge inflow of capital to build capacities. This is not dependent on interest rates. So next decade is going to be a high inflationary period.

On portfolio allocation, Zoltan believes that the 60:40 portfolio is dead, and he is in favour of a portfolio which has a strong tilt towards commodities and cash.