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December 13, 2022

2023 Global Economic and Market Outlook


Headshot: Joyce Chang
Joyce Chang | Managing Director & Chair of Global Research, JPMorgan Chase & Co.

Joyce Chang delivers an overview of global economic trends to watch heading into 2023 and beyond.

In the near term, Chang sees a mild recession taking effect in late 2023, with a true “soft landing”, as identified by the Federal Reserve, being unlikely. She notes that overall cycles may be shorter, with a likelihood of 4-year recessions rather than the historic 8 or 10, and markets that rally faster to regain losses.

Included in the long-term outlook are remarks on China’s slowing growth, regions that could benefit from supply chain shifts away from China and nearshoring, and the political divides in the US around ESG (Environmental, Social, Governance) projects and investing.

Richard K. Green also fields questions on the US housing crisis, how rapidly rising interest rates could affect regional banks and nontraditional finance, the implications of a global aging population, and more.

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- My name is Richard Green. I'm director of the USC Lusk Center for Real Estate. And it's my pleasure to welcome you to the final Lusk Perspectives of the year 2022, and we're going to have an appropriate way to end it, which is a wrap up what's happening all around the world. We got some actually kind of nice news this morning about inflation, so I think our guest will maybe spend a minute or two at least talking about that. But mostly about just what's happening in global markets and how it's influenced in the economy. We are very pleased to have Joyce Chang with us this morning. Joyce spoke to us in person toward the end of 2018, so about four years ago now, before the pandemic came along at a time when, if you Google supply chain, if you looked at Google Analytics, the number of times you would see the word supply chain come up in searches was a very, very small number. It has since become a very, very big number. And she has a remarkably integrated view of how the world operates, the world economy operates. She was trained at Columbia in Princeton. She started her career as a graduate student. She just told me at Solomon Brothers back when it was really Solomon Brothers, has now been a managing director at JP Morgan Chase for about 30 years, is in charge of the Global Economics group there. And Joyce, thank you very much for being with us again today.

- Thank you very much, Richard. It's great to be with all of you today. I thought it might just be easiest to walk through a PowerPoint presentation I have that goes through the key variables we're looking at with respect to the global economic and market outlook. So I'm gonna share, we're gonna share a slide deck with you and really talk you through the forecast we're putting out for 2023 and how we see the risk around the baseline. Now, I have to say that we published our year ahead, you know, sometime between Thanksgiving and December 1st. And already we've seen such a strong market rally that, you know, we're almost at some of the targets we had been calling for at the end of 2023. And this is a theme that I will come back to, is that part of it is we are in a period now of much shorter cycles than we used to think about an expansion and a recession being, you know, eight to 10 years. I would say it's half that amount now. And we're seeing much higher macro volatility. You know, I do see a scenario where both higher inflation and lower growth are here to stay, or are the results of just the amount of fiscal spending that has, you've gone on since the onset of the pandemic. But I would call this a period of regime change. And I think we talk about regime change in really five different areas. So first, there is just the end of the great moderation, a period of higher inflation, even though today's surprise was softer than we had expected. And by higher inflation, I don't mean runaway inflation, but I think the question is, is three the new two or is four the new two? The second regime change is really the market transformation. It is just the growth of passive investment, the size of the asset classes that ballooned during zero interest rates and the change in market structure where just the lack of liquidity has meant that we have much higher volatility in these cycles. And it's the speed of change, not just the change that I think the market is grappling with right now. The third regime change is the US-China relationship. And we do see this as really the key geopolitical risk, even more so than Russia-Ukraine. And you know, something where we will continue to see these tensions endure. And I think that, you know, we still see, even as China is going through what we see as a structural slowdown that, you know, China will reach the size of the US economy sometime in the next decade, you know, in the 2030s. And the fourth regime change is the energy transformation, the energy security problems that have, you know, coincided have made this more complicated, but just the investment needs as we look at the energy transition and what those effects will be. And the fifth is actually the political changes, the rise in populism. So a period of real regime change. And now let me walk through our forecast. So if we turn to the next slide, what you can see is that, you know, we have always thought that the global economy is not at an eminent risk of sliding into recession. But if you look at this, global growth has been weak this year. There's no major region apart from the United States which has come close to returning to its pre potential, potential path for GDP. So a shallow recession has become consensus, but we can also see is that some of the adverse supply shocks are fading fast. There is disinflation that is going across the globe that's playing out as well. But we still see a world where we are going to be pushed into restrictive territory with the Fed pausing not until 5%, the Bank of England, the ECB will have more significant, you know, growth weakness, I think at the start of this year. They're probably not going to pause until four and a quarter percent and two and a half percent respectively. So I think that, you know, the message I would say is that we've had an inflation drop which is substantial but not sufficient. And what we are looking at next year is if you take a look at the US outlook after contracting this year, 2% is far of a recession. But if you look at the second half of the year at zero growth, we're really looking at a mild recession in the second half of next year. At the same time, Europe will be coming out of recession and you can all see that, you know, in Japan we actually have, this is one of the very few times where if you look across the developed markets, the first half of 2023 Japan growing faster than the rest of the developed markets. But a big move you could see in GDP growth downwards, inflation upwards over the past year. Turning to the next slide. So what I would just caution is that, you know, I would not call this a soft landing. And what we've actually laid out is just a probability tree that looks at just the risk of the scenarios, because I think the story through the first quarter of the year is fairly well telegraphed. You know, inflation will have peaked, the Fed will continue to hike, but we'll probably pause by the end of the first quarter, as will many central banks. And you do have this disinflation trend from the peak. But going from 10% to four to 5% is the easy part. The harder part is, you know, can they actually get closer to target? And next year we have the core US inflation still around 3%. We don't think that it will go back to 2%, but a mild recession. As we see the weight of 500 basis points of Fed tightening, also the excess savings that households have been accumulating, which was 2.1 trillion at the end of next year will be used by the second half of the year. So our baseline is slip sliding away. It's a mild US recession late in 2023, which in many ways is central bank induced and the rest of the world growing at a subpar but positive pace with the first Fed ease to come in 2024. I know the market has been signaling a pivot later in 2023, but we think that that will actually, you know, be something that will take a longer. I think the Fed is inclined to over tighten and to keep more of a hawkish bias to anchor inflation presentations. But there are risk around this scenario. You know, one is that, you know, we have a pause, but the pause is not successful and inflation continues to be, you know, above target to a degree that the central banks need to tighten more later. The soft landing scenario is not one that we wouldn't rule out, but we only give that a 20% chance. And we do see this as, you know, being one where, you know, the market in many ways is pricing in a soft landing over the last couple of weeks. And we would just caution that, you know, we do see more risk to growth as you go out to 2023. Turning to the next slide. So you can see the drop in inflation. And what you can see though is the differences between core goods and core services. And we still see core services inflation being, you know, quite elevated through the second half of 2023. But we've seen big drops and with the moves, we've seen the NWTI and oil prices in food and energy prices coming down from the peaks that we saw in the first half of the year where the inflation was highly elevated. So we're off the peak of inflation. But if you look at where core services are settling in particular, that's where we still see more risk around the scenario. You know, and the numbers that came out today, you know, I need to say they were a surprise. You know, we had actually been looking at a forecast, you know, that would be like, you know, 0.3. You know, so significantly higher than what printed today. And I think that the, you know, we saw was a bounce back in rent inflation, but a reversal of the other components that was bigger than we had thought. But rent inflation is very important in the US forecast. This is more than one third of core CPI, and we do see that being quite elevated still through next year, at around, you know, six to 7%. Turning to the next slide. You know, you can see just the breakdown of inflation and you can see shelter, you know, at 7,5%, you know, still in our forecast, but other components that have come down very sharply. And you can see that expectations actually for 10 inflation have remained relatively well anchored, you know, and they've been, you know, really sort of insensitive to some of the realized CPI inflation, but they've been very sensitive to commodity prices. So seeing the move down in oil prices, that also has contributed to, you know, softer inflation prints than one would've thought with the move we've seen in oil prices, which has been significant from the peak levels we had reached earlier this year. Looking at the next slide. So just to put the US, you know, economic outlook into one snapshot. But what we do see is, you know, very strong growth this quarter, still one and half percent growth in the fourth quarter of the year, but a slowdown, you know, as we progress through 2023. And you can see an increase in the unemployment rate as well. And I do think that on our recession risk, this is the key risk that we're monitoring is that you will see that some of this labor market tightness and the wage pressures that have come with this, you know, are ones where the Fed will, you know, continue to have to sort of, really monitor labor market conditions as a, you know, really look at how much tightening is necessary, what is necessary to sort of, you know, bring inflation back into check. So, you know, you can once again see just the difference between core goods, core services, inflation and where shelter comes in. And you can also see that this is beginning this tightening of financial conditions to really weigh on CapEx and business survey CapEx expectations. Turning to the next slide. Just to focus on what is happening in the Euro area. Well, I think at the end of this year, a lot of people expected that China would be recovering and that Europe would be going into a deeper recession. We've actually seen the reverse. The China numbers this quarter look, you know, really fairly dismal, whereas that you've seen that the slowdown in Europe was not as dramatic as what some people would have thought just given that the energy dependency on Russia. So looking at the fourth quarter, we do see, you know, a negative 1.3%, you know, contraction, quarter on quarter, still staying negative through the first quarter, but a recovery by the second quarter of the year, but then still growth that is below potential. And we have taken down the potential growth forecast over the past year. We have US growth, potential growth and only 1.4%. We're really looking at whether China could be closer to two and a half rather than 3% potential growth as we look ahead at their demographic problems and some of the ways in which the structure of the economy is changing. So it's a period where there is still a, I think, revision of a lot of the baseline assumptions we have used over the last few decades on global growth and global inflation. So, you know, we've told people, if you used to think about 2% growth, 2% inflation, think about, is it one and a half percent growth and is it, you know, three to 4% inflation? We used to talk about treasury yields at sort of three and a half to four and half percent. Will we over the next decade really see that real yields need to reach two and half percent or about five and half percent phenomenal treasury yields. But a European recession, which is milder than what many people would have expected. Turning to the next slide. And so the Fed's tightening cycle we think will draw to a close, you know, in March, paving the way for lower yields. We have the 10 year treasury at the end of 2023, so pretty much where it is right now, 3.4%, and we do see a steeper curve going forward. But, you know, we have some big changes. We've talked about the Fed hikes, but you know, we've seen very few episodes of quantitative tightening. The last episode of quantitative tightening was much shallower than originally forecast. So we do have this now programmed in on autopilot, and you will see that some of the G4 central bank balance sheets will begin to shrink in 2023, but it's a fairly small change that lies ahead. Turning to the next slide. And most central banks look like they're complete this tightening cycle by the first quarter of the year. So that's the part that I think the market has already moved forward the pricing, pricing a Fed that's on hold, central banks are on hold and a disinflation trade. The question is, is it going to be sufficient enough? And that's where we, you know, really have our doubts for the second half of the year and whether the growth trends will begin to come down. Looking at the next slide. You can see that the quantitative tightening that lies ahead is also more synchronized, you know, and that the inflation expectations are better anchored than what we've had in previous cycles. On the next slide. So let me talk now more about the risk ahead. We've had a lot priced in disinflation. Will the Fed go on hold? You know, has the worst of this all passed? But the second half of the year becomes more complicated because remember the questions that we came into this crisis with. Excess household savings will be used up by the second half of 2023. But we're also looking at balance sheets that, generally speaking, seem to be in better shape than they have been during past periods where we've talked about recession. But you can see, you know, the US spent, you know, around almost 20% of GDP. So of course it wasn't an eminent recession, you had this massive savings cushion. And if you look at where we are right now, you know, you've taken down that cushion a tremendous amount this year. We think it will go back to, you know, more towards the long-term average trend, not below average. And you can see just where it was, you know, by the second half of next year. The household fundamentals actually, we look at the chase credit card data across every income level, high income, middle income, lower income is actually higher than it was in 2019. So the household is in much better shape. And what we can see is that that really has contributed to some of this disconnect we saw over the last year that consumer spending continued to rise, even as consumer confidence came down. And you can look at the household debt ratio measures and what you can see is that the debt service ratio is one that you know is, and the debt ratios are ones which, you know, compared to, you know, history are sort of, you know, are still, at manageable levels. Looking at the next slide to talk more about the market outlook. So this was a year where it was really for bond markets, you know, historically the had year, and you can see just the, it wasn't just the performance, but just the outflows and the change in AUM, the high yield market, you know, nearly 10% of AUM down, sort of the lowest amount of issuance that we had really seen since the global financial crisis. And you can see that actually even with the equity market sell off, that the inflows into equities and passive investment sell held in. In emerging markets, it was really a fairly devastating year with respect to the bond markets. But you can see for the bond markets, this was a historic year with respect to the outflows and the underperformance. And that there has been still, you know, passive money though, you know, going into the markets, particularly into the equity markets. Looking at the next slide. When we take a look at a US recession and we ask what's priced, what could the drawdown be? What kind of recession, what shape, what is the timing? So I do think it's a mild recession. I think it's late in 2023. And if we look at previous recessions, what you can see is what the drawdown has been, and we've had a substantial drawdown this year, 25%. We've had drawdowns during past recessions that are anywhere from really averaging 20 to 50%. But you can see that this time we did not have the US corporate spread widening that we've seen during previous sell loss to the same degree And if we take a look at the default rates that lie ahead, they remain fairly modest, you know, two and a quarter percent for the high yield market next year, even for leverage loans, less than 3%. And I think, you know, the key message I would say is that more of these problems will become apparent in 2024 than properly in 2023. Just the amount of government spending that occurred, you know, provided a cushion and during this period of zero interest rates, many corporates were able to really reprofile their debt. Looking at the next slide. So we do see though a sharp reduction in the earnings forecast in the next year ahead. And that's what I think will, you know, play out in a way that we did not see this year. And we see this in the Eurozone and in the US, the UK in particular, whereas China will have a reopening trade. We see China's EPS growth actually going up right now. The emerging markets, you know, coming back, you know, into more of a recovery. And many of the emerging markets countries have actually started hiking much earlier and are done with the tightening cycle much earlier than the developed markets. You know, like Brazil for example. They will begin to actually be able to ease interest rates in the second half of the year for some of the larger emerging markets countries. So, you know, not a cycle that's necessarily synchronized with the emerging markets countries. Looking at the next slide. I wanna talk longer term. So that's the near term forecast, you know, that we've had in many ways, you know, a big cushion because of the government spending. That means that we will have a milder recession. but slower growth to come, higher fiscal deficits and somewhat higher inflation. And a lot of people have asked us, you know, where do you see this going over the next five to 10 years? And so what we've tried to do is really lay out in this chart what we think are secular forces and structural drivers for the economy over the next decade and how these factors have changed over the previous decades. And we do see that higher yields do lie ahead. So we're out of this, you know, of zero yield world. And I think we will be completely out of it by the end of the first quarter of the year because we do think that the Bank of Japan will abandon yield curve control, YCC and yield move, and that rates will move into positive territory there. But we looked at these 11 structural factors, the demographics, the climate investment, corporate profits, de-globalization, macro volatility. And we really tried to gauge, does this point to higher yields or lower yields. So economic growth being lower yields, but climate investment, the corporate profits, margins coming down, de-globalization, macro volatility, the amount of fiscal debt, all of this we think means higher yields ahead. And this is why we think yields could be around 2.5% real yields. Looking at the next slide. You know, so some of the lessons learned from the global financial crisis and why we're at where we're at is that, you know, you had to go bigger and faster with the packages and that's what the government did. If you look at the way in which fiscal policy and the central bank balance sheet was expanded. And looking at the next slide, you can see that, you know, if you take a look at this crisis, what I mean by the speed and the velocity. After the global financial crisis, it took 34 quarters to close the output gap for developed markets. And we're talking, you know, three years as opposed to nearly nine years in the cycle. That's what I mean by cycles being half the life that they were, market rallies being much more sudden and market sell loss being much more sudden. But you can also see on the bottom chart that we do see potential growth coming down across the board, you know, whether it is developed markets or China. Looking at the next slide. So let's talk about the fiscal cost of all of this. So we do have that the federal debt is projected to reach 110% of GDP over the next decade, 185% of GDP by 2052. And if you, the congressional budget office uses 3.8% for treasury yields. If you use our five and 5% nominal treasury yields, 2,5% real yields, you come up with debt service that's 1.5 trillion higher for the US than what CBO is projecting. And you can see that the stock of negative debt has plummeted, the fiscal debt has reached historic highs. So that is a regime change. This is a big regime change. Looking at the next slide. I wanted to really focus on China because as I said, we see the US-China strategic competition as being really the key geopolitical risk to watch. Look, you know, the US sensitivity to China's growth is much less than the rest of the world for an emerging markets economy, for a commodity exporter, every one percentage point change in China's growth takes about half a percent off of global growth. And for a commodity exporter, it can be as much as one to one. But China's growth is slowing because of the demographics. And this square slowdown is significant. You know, we think that, you know, you could be looking at it two and a half to 3%. And the trade wars, it's more than a trade war. It's really a tech war about the supply chains. I do think that with what the US has been doing on industrial policy export controls, made in China 2025 is not gonna come to fruition. I think that is actually a serious, you know, issue, you know, with respect to what China's ambitions had been for made in China 2025. Nevertheless, just given where US growth is going, where China's growth is going, we still see a point where there is catch up with the US sometime over the next decade, even at these lower growth rates that we're talking about. On the next slide. But you know, de-globalization is not yet a reality. What I would say though is that big government is back, that's what the fiscal spending has done. But we've seen that exports have continued to grow, US foreign direct investment into China actually hit an all time record in 2021. And when you talk to the businesses, there's a real disconnect between what business people are saying and what the government is saying. So even though the government has talked about friend-shoring and nearshoring, what we see in the business community is record FDI, trade that's continued to grow. China's export growth is now flatlining after growing 30% in 2021. But you can see also that the main four China component, multinationals have a very big market share in the China market itself, domestically, not just across, many different product lines, whether it is, you know, home care, you know, consumer appliances, as you can see in the chart of at the bottom. On the next slide. What you can also see though is that there has been, even if the macro numbers have not changed and deglobalization is not a reality, there's been a sharp deterioration in US business sentiment towards China. And you can see that, actually if you look at this chart, has your company moved any segments of its supply chain outta China in the past 12 months? You know, 24% say they have, and some of this has been to the US, some of this has been to other locations. Now the key reason for this is not geopolitics, it's actually been the COVID shutdowns. And so as China reopens, we need to see how much of this actually really does move because you know, I think that China really sort of is now looking at, you know, two policies they had in place in 2022 and how they sort of, you know, deal with this going forward. And that was zero COVID and also the no limits in supporting Russia policy. Now I think what you're seeing is that China is trying to figure out the right way to sort of move away from these two policy lines and sort of move on so that it doesn't, you know, have global growth collapsing. I think the slowdown in growth has really, you know, affected the thinking in China. You know, the targets five and a half percent, we have growth this year at 2.9% for China and only 4% next year. On the next slide. So how easy is it to move the supply chain? I would say say that, you know, China has a number of advantages that other locations do not have. You know, first of all, it has the infrastructure, it has the scale and it also has a trained labor force with 12 million engineers that graduate per year. But we're seeing some movement, and I think particularly on the value added technology. So made in China 2025 I think is at risk. We think in five years by, you could have 25% of Apple products manufactured outside of China. You know, it's only 5% right now. But some critical product supply chains are very concentrated, very, very difficult to move. So who are the beneficiaries? On the next slide. We've taken a look at this, Vietnam on small components has been a key beneficiary. There's a lot of talk about India. And I think India will benefit from the China plus one. We want China plus diversification. They do have a demographic advantage, as does the Ossian countries. Vietnam, the population that's under 30 years old, but we haven't seen quite as much movement. The biggest change that you could really observe has been to Vietnam. But it's brought up the whole question about whether there will be more regionalization, you know, of the supply chains. And we've just tried to map out just the size of these markets by region. And then we've looked at Mexico in particular because Mexico has a moment right now where they could take advantage of this. You know, they have a US-Mexico-Canada free trade agreement. Unit labor costs in Mexico are actually lower than China right now for the first time ever. And the currency is cheap right now. And when we talk about countries that did a lot of fiscal spending during the pandemic, Mexico was criticized for not doing enough, but it's spent only 1% of GDP. You compare that to the US spending 18% of GDP or Germany spending 37% of GDP. So there is a question on whether Mexico will be a key beneficiary, you know, for some of this move to Nearshoring and friend-shoring. On the next slide. You can see the portfolio investment has taken a big hit and there's a huge difference between doing business in China versus being a portfolio investor in China. Doing business in China, it's not easy to move the supply chain. US companies still want access to China's market, and that's the same for Europe as well. But if you're a portfolio investor, this is where we've seen real outflows. And you can see this both on the bond side and on the equity side. And we just competed the process of putting China into the indexes for the government bonds at the end of 2021. I'd say about 250 billion of inflows that went in, about half came out after the Russia-Ukraine, you know, after the Russia-Ukraine war because many investors basically said that, look, in a rising yield environment with the threat of secondary sanctions, more volatility in the Chinese currency, I mean picking up a hundred basis points, 150 basis points isn't enough. Whereas that differential had been like 300 basis points previously. But you have seen a real change in the way that questions are being raised about China by portfolio and foreign direct investments. Although the foreign direct investment numbers don't affect that yet, the portfolio numbers do. On the next slide. And you can also see real differences between Europe and the US. So a lot of people have said, well, well Europe sort of stay aligned with the US and sort of the anti-China, the US-China tensions. And this was a very interesting survey that was done. And when you ask, you know, Europeans, who is the most influential player on the global affairs now, you know, nearly two thirds say it's the United States. But if you ask five years from now, many of them say that China will be ahead. And I was just in Germany recently. But you can see that, you know, they have just approved for the Hamburg port, you know, the contracts with China. Also 5G, they have a huge dependency on , which I think is very hard to unwind as well. So I don't think that I do call it US China tensions because I don't think the rest of the world will necessarily take the same path. So that's Europe. But if you turn to the next slide, which is emerging markets, and the next slide, which is emerging markets, like for forward one. China's largest creditor to many of the low income emerging markets countries, it exceeds, you know, the bilateral creditors, other bilateral creditors, the IMF, the World Bank, but it has a tremendous amount of influence and through Belt M Road also owns much of the ports and the infrastructure for many of the low income emerging markets countries that also own a lot of the natural resources. And the next slide you can see that, you know, the world has, we've gone through this world a great moderation where you had cheap labor and abundant natural resources to now real fears about, you know, demographics, rising labor costs, and also scarcity of natural resources and this energy security with the focus on energy security. And one thing that I don't think gets enough attention is that, you know, the world is short commodities, but China is not. China has been stockpiling them, you know, really since 2019. And when you look at rare earth for clean energy, it has a monopoly which is built over 30 years. But even things like global copper, global aluminum, China holds 95% of global copper, 77% of global aluminum. So they have on many strategic resources sort of stockpiled commodities in this Bretton Woods 2.0 world. On the next slide. Get a lot of questions about Taiwan. Do we think that China, Taiwan, this conflict is going to escalate? And I don't see that as, you know, a near term. I think there will be quite a lot of noise from the GOP Republican house on China. Kevin McCarthy has said he's going to form a select China committee that looks at the origins of COVID, intellectual property rights and other issues. But I do not, and but I think the lighthouse, which is separate from the Congress has been very clear that they don't see the eminent threat. And I think that in China's case, we don't see that as being something that's eminent either. In any event, it seems to me that, you know, if Russia's military capabilities were overestimated from day one, I think China realizes its own military, you know, capabilities are probably something that they're still investing in. But the other point I would make is that there are many other ways that China can impact Taiwan without having to talk about use of military force. And that's because the export and trade relationship is, you know, so intertwined and you can see that like nearly half of Taiwan's exports go to China. So there are many other ways in which Taiwan could be impacted that you know, don't require use of military force. On the next slide. I wanna just head from China and say a few things on just energy security and ESG. We've seen, you know, everybody pledging and sort of making long-term goals for net zero, you know, targets so that there's been a rise in this over the even emerging markets countries trying to articulate some of these targets. But you can also see the challenges on the next slide. On the next slide, you know, just that there's investment need that we are with demand recovery, inflation, sluggish investment growth. Our estimate is that for the large global oil companies, their CapEx needs are probably around 750 billion to the end of the decade even just to meet demand. And so we're seeing sort of the flip sides of this. They're the goals, but the lack of investment also has made a big impact on the markets over this past year, and put the focus on energy security and looking at just what the missing CapEx needs are. And on the next slide you can see that the US is finally now coming up with its first real US industrial policy to address this through the inflation reduction act and the bipartisan infrastructure law, which really does put, you know, a focus which is, you know, 570 billion from the IRA, and then even more that is coming and investing in the power grids and EV from the bipartisan infrastructure law. And on the next slide. So you can see that we do think we're in a period where even though we've seen softer commodity prices, it is more of a structural upcycle for key commodity markets. And that includes, you know, agricultural commodities, because we've seen that food security really is at a breaking point in many of the emerging markets countries. So even though we've seen softness in the numbers recently as inflation has come down faster than expected, you know, we're still looking at inflation numbers that are far away from target. And we do think that commodity prices also like this volatility is going to stay with us. And on the next slide, we are seeing the anti ESG movement also picking up. And 20 states have put in anti ESG policies. But there's four new Trifectas, meaning that the state, the congress, the house and the Senate all have the same party, four new Democratic trifectas where you could actually see sort of a mix of policy. Some states have put in, you know, like California, you know, pro ESG requirements. But you can see that this last year, the tide really turned with 20 states putting in anti ESG policies. And on the next slide. And this really shows you the divide on climate change on political lines. We see the, you know, 65% of you know, of republicans, 65% of Democrats see climate change as a top policy priority. But you ask republicans the same questions only 11%. So that polarization is playing out at the state level as well. So on the next slide. Just a snapshot of the growth and inflation forecast, but let me just stop there and just see if there are questions.

- Joyce, a bunch of questions, and if you don't wanna answer any, just say so. But I wanna just, I'm gonna start from the, toward the beginning of your presentation on rent inflation and what an important contributor it is. And one of the things that concerns me is of course as a result of the Fed policy, projects, residential projects that pencil a year ago don't anymore. And there are also issues with even projects that are currently under construction, getting takeout financing for them that will fully pay for the construction loan. And so this is going to have a negative impact on the supply of housing for at least a couple of years. And so that seems to me to be counterproductive in that it'll push up this very important component of CPI, which is rent because we don't have enough houses as it is and this means we're gonna have even fewer houses for at least a little while going forward. Do you have any thoughts about that?

- No, I agree with you. I mean that there is a real structural problem on housing. So I don't see it as like a traditional, you know, property crisis. I see it as an affordability crisis. So we have the home price appreciation index risk coming down 5%, but we think that many of the challenges that we're facing are actually due to the demographics, just the millennial demand versus where inventory is at right now. So, you know, I very much would just like agree with your assessment that it's a great affordability crisis that really lies ahead. So this year US home prices declined by about 10% peak to trial as we saw mortgage rates go up. We've seen the biggest affordability challenges since the 1980s and we think we're gonna see another 5% decline in 2023 for housing prices. We think mortgage rates at the end of 2023 will be at about 6% and that's based on the 3.4% for 10 year treasury yields. And so if you do something like assuming wage growth of 6%, this implies that home prices can decline by like 13%, which is higher than our forecast actually. And this points to some of the structural issues that you just have a shortage. So if you wanna to see the affordability levels return to 30%, you know, there's risk to the downside on this. A couple things we've looked at though, you know, 80% of borrowers have a mortgage rate of 4% or lower, and are largely locked into their homes. And you know, so they have low fixed rate mortgages and this should keep supply, I think more muted, you know, because people are just not that willing to move while demand stays lower. And that means like the home price growth, I think you could have limited home price growth, you know, well into 2024 as a result.

- So I wanna talk a little bit about the speed at which the Fed has raised interest rates. So the federal funders rate hasn't risen this rapidly since I think it's 1987. And I think about how one of the things that killed the savings and loans in the late 1970s was a very rapid increase in short term interest rates. And you know, for banks like JP Morgan, you're largely hedged against this sort of interest rate exposure, but for regional banks, that's not true. They just don't do it. And they have tended to, because of, you don't have to put any capital behind treasuries, they were making money off the spread on the yield curve and so they were investing in 10 year treasuries, for example, that may have been paying 2% interest. Well, you know, now that the federal funds rate is well above 2%, that sort of puts them in a pickle it seems to me. Do you see any sort of systemic threat arising from regional banks having this balance sheet mismatch issue at the problem?

- I don't see a systemic threat, you know, really for the banks in part because just like the capital requirements and the stress testing that has been done, you know, for not just the major banks but for a lot of the regional banks I think is an, you know, a different place. So I don't see that as being like a systemic issue with respective global financial stability. But I do think, you know, and this goes back to the mortgage market, one of the key things to watch is that, you know, like more than half of the mortgages now originate outside of the traditional banking system. And when we have looked at just the risks that have played out right now, a lot of them have just been in, you know, areas that are out outside of traditional finance, you know, like crypto and a lot of these risks. So I worry more about that aspect of it than I do about what is happening in the traditional banks, even some of the smaller regional things. But I think the, you know, I think we're also sort of, you know, close to, you know, being at sort of the peak. I mean we do see that, you know, the Fed will go on pause by the second quarter of the year. the question is, you know, as I said is, is the pause successful? Will inflation come down enough? And so inflation coming down by half was not the hard part. And at what point does the Fed say that, look, you know, we're not gonna get to 2%, but 3% is okay, we can live with somewhat higher inflation, but that there's a big difference between 5% versus 3%. And that's where I think it becomes, you know, much trickier and probably much more of a second half of 2023 issue to look at.

- Okay, I'm gonna ask you one more question then I'm gonna take a look at the audience Q&A. But I found it interesting that you saw demographics, your team sees demographics as something that will push up interest rates. And guess the story is labored shortages mean that there'll be wage pressures that need, that the Fed is going to lean against or that markets are gonna lean against. So a story I've been telling for a while, and maybe this is not true, but is one of the reasons Japan has had deflation now for basically until recently for nearly 30 years, is you have a very old society that's growing even older. And what happens is old people get scared of running outta money and so they spend less and less of it and there's evidence that that's actually true. And so while there certainly is an issue on the supply side from the labor point of view, on the demand side, and you can actually see it in data. When people retire, for example, they're spending drops pretty precipitously. So if you could tell us a little bit more about why your team sees demographics as something that's pushing interest rates up.

- Yeah, no, I think that, you know, there's a way in which you can really sort of debate this, but we look at a couple things. So part of it is just the higher spending requirements that you and the wage, again, it's the structural issues on the labor market that you also, you know, have mentioned whether it is in the US you know, that it's immigration policy or even in the EU, that it is mobility and Brexit and that just sort of higher labor costs, higher wage inflation. But the other thing that we have really taken a look at is how much is sort of also embedded in a lot of the entitlement spending as the demographics increase. And so I think demographics is one where people can say, look, is it really lower yields or is it higher yields? But when we've looked at the overall fiscal spending that is necessary. And when we've looked at some of the labor market dynamics, which are we think going to continue to drive wage costs, you know, higher, you know, we put it in as, you know, higher, but it's a debate. And this is probably the area where we get the most sort of questions on how do you look at this? I also think it's hard to compare some of the dynamics in, you know, so you're right, older people want to save more. The question is like how much, how much of that is sort of going to be discretionary just given what the pressures are. And so I think Japan is like sort of a little bit of an unusual case that also try to extrapolate to globally, but I think the US one thing that we look at very closely is really just, you know, the healthcare and entitlement costs that are also associated with the demographic changes and what will be necessary.

- Well it it's along those lines. So my wife is a physician and she says, something has to be done about this. The healthcare system rewards procedures too much, which adds to costs and there are actually ways to bend the curve, but that's a whole other, but we're gonna have to, I think we're gonna have to do it.

- I agree with you. I think that this is one where the demographics mean that it will have to be addressed just given the way the dependency ratios and the costs are, which are quite unique in the US compared to looking at anywhere else in the world.

- So Michael Banner has a question and I am, you know, Michael, I'm trying to understand the question. So it's with how will these trends, especially housing stress impact the 30 billion pledge to close the racial wealth gap? I think this is referring to a pledge Jamie Diamond made at some fairly recently. I don't know if Joyce, that that's a question that you'd be prepared to answer.

- No, at JP Morgan there's been a real focus on affordable housing. So actually, and there's, you know, if you look at some of just the recent news that's come out, it's been really looking at targeted areas where they can actually build affordable housing. I mean, so like we look at it as a great affordability crisis that you need a more affordable housing supply. So that's where really where, you know, the focus has been with respect to, you know, so just targeting certain areas where there's just a lack of affordable housing and concentrating that also on making sure that there are ways in which there's better accessibility to getting access to housing.

- So I am curious, I was looking at your chart about countries think will be more influential five years from now, the breakdown by country, and I saw France and Italy in particular think the US is going to lose its mojo relative to China. And I'm just, this is a, maybe there's a little bit of sly humor in this question. Doesn't France always think that about the United States, or maybe the French are hoping a little bit that five years from now the US won't matter quite so much? I'd just be curious if you look contextually whether they've always been saying, yeah, they have a lot of power now, but they won't sometime.

- Yeah, yeah, so this survey, and I would recommend that everybody takes a look at, it's a Trans-Atlantic Trends, and it's put up by the German Marshall Fund and I'm a trustee on the German Marshall Fund. So I've always looked at this and it's a really interesting survey because it also asks like who will be some of the weakest digital powers. And the Europeans themselves put themselves in as being weak in the digital powers area. Like if you look at just sort of like, you know, technology and just how they are perceiving their own competitiveness. So I think that, you know, look, France has actually become our central trading hub in Europe since Brexit. You know, there has been a move of just sort of part of the workforce to Frankfurt and Paris. So I think there you, and even like when you look at things like, you know, like I show that slide about China and its external being the largest external creditor, it still is that the Paris Club is the one that organizes, you know, a lot of these discussions. So I think you're right. There is a way in which France, you know, has at least from a policy framework point of view sort of seen itself as, you know, sort of having, you know, a role that has just historically been there. But I thought it was interesting looking at the, as we talked about Europe's relationships with Europe, you know, Germany, they went to Germany the Schultz and 12 business CEOs went to China recently. So is really the message that it's a change in business or is it business as usual? We've seen a lot of the contracts also, you know, continue to go through, you know, in doing trade with China. And I think that German, I think there had been talk about whether Germany and France would go to China together and they didn't. So I think there's a, the separation is something that is deliberate. And I think that's one thing that China will look at. I mean, how united will the stance be with the US, you know, on China policy? And that's where I don't see that unity, like even though there has been this unity of Russia Ukraine, I don't see that extending to China nearly as easily given what the economic ties are. Just in practical terms.

- So you said something, in teasing your remarks, you said something about populism and its impact on economic outcomes. And I don't think you got far enough into your slides to really talk very much about that, but I am very curious as to your take about that. So if you could give us a minute or two on that.

- Yeah, well I think you were, you've actually seen that the most is on the ESG. we have seen that just, you know, what had been, you know, that the states are demanding a safe in the United States and you know, the difference between California versus Texas, versus, you know, West Virginia is very big. So that's where I've seen sort of more of the polarization when you look at just, you know, the views on energy security and climate change and even the way that state policy is evolving depending on the political party, but it's not just a US trend. You know, what I would say is that, you know, even if a the populist party does not win the election, it's now an institutionalized force. So we used to think about like, if you were center left and center right, it really wasn't that many degrees of freedom between the two. Now it's really, you know, really quite vastly different policies. And even if they're not the ruling party, you know, what that contingency wants and the size of that contingency is that cohort is, you know, much bigger than it had been during previous cycles.

- So as you may or may not know, the news came out a day or two ago that Los Angeles is no longer the largest port in the United States. New York, New Jersey is. And one of the reasons for that is LA has become a very clean port with policies in place that make it more expensive, just considerably more expensive than even New York, which is a much dirtier port. And so I guess does that this put a place like California at a competitive disadvantage or ultimately will the other places follow because people who live near those ports don't like diesel emissions either. And you know, this is, so like if you're on one side of the ESG policy debate, are you at a competitive disadvantage or ultimately is, are everybody gonna say, yeah, kind of we gotta do this? Do you have any views on that?

- Well, I just don't think this is gonna be linear at all. But one thing I would say just on why we think we're in a higher inflation regime is that, look, if you're no longer selecting who you do business with based on the lowest cost, you're selecting it on a circle of trust, ESG climate change goals, you're gonna have higher inflation. So I don't think 2% is coming back just generally speaking, but you can see the differences at the state level that, you know, I mean like in Texas they've been very much, you know, local in that, you know, like putting boycotts on some of the institutions where they feel that just their policy on fossil fuel is not tenable for what the state priorities are. So I think that, you know, will everybody eventually go the same way? They may, but it may take much longer, right? I mean, it already seems like these goals are decades away and nobody really knows how to measure this. We have not gotten very far with data standardization or a definition for ESG that everyone can agree with. So I think you're gonna see, you know, much different, you know, and the state's really, no matter what you put in. So the point I would make is no matter what you put in at the federal level, the states have the ability to challenge this in the courts and they're exercising that. So if previously in a period where it wasn't as focused on energy security, the states weren't doing that, I think you're just going to see more of that going forward. And even though it's barely a red trickle, it just seems to me that the noise level on this has, you know, moved up. Now, the private sector though, has actually, you know, been moving ahead on its own because your shareholders are demanding it, your younger employees are demanding, you know, that momentum at the company level. But I see at the state level, it really is a rise in a level of activism that we had not seen, you know, 18 months ago.

- So Joyce Chang, I could talk with you for a lot longer, but we are at the top of the hour, so we have to let you go, and I know you have other things to do with your day. Thank you very much for a very action packed hour.

- Happy holidays to everybody and all best wishes. Thank you.

- Take care. Best wishes to you too.

- Thank you.