Where are markets headed in Q4?

NARRATOR: Welcome to Viewpoint, a TD Securities podcast. Listen in as we draw perspectives from a variety of thought leaders on key themes influencing markets, industries, and the global economy today. We hope you enjoy this episode.

PETER HAYNES: Welcome to episode three of Viewpoint, the TD Securities podcast that looks at important issues affecting capital markets. My name is Peter Haynes and I'll be your host for today's episode. And I'm pleased to be joined by my colleague Moti Jungreis, Global Head of Capital Markets for TD Securities. Moti, welcome to the show.

MOTI JUNGREIS: Thank you Peter. Thank you for having me.

PETER HAYNES: Moti, what I love most about speaking with you is your passion for talking about markets. Today I plan to cover off on a few of the hot-button items that market participants are watching closely as we head into the homestretch for 2021. So let's start with the Fed. At the last Fed meeting on September 22, Chair Powell indicated that tapering would begin as soon as after its November meeting. At the same time, nine of the 18 Fed officials are ready to raise rates next year. Let's take a step back for a second. And can you explain for our audience what is exactly this so-called concept of quantitative easing? And what will tapering mean for asset prices?

MOTI JUNGREIS: Thank you Peter. So quantitative easing is really a form of unconventional monetary policy in which the central bank basically purchased longer-term Securities from the open market. In some cases, they even purchase stocks, especially in Japan. Generally, but not always, they buy these securities using newly created money. Which is why some people are equating it to printing money. But it's actually a little bit more complex than that. Long-term rates being artificially lowered by these purchases, and the intent is to have the lower interest rates and increased money supply filters into the economy and promote growth. The bonds the central banks buy sits on the balance sheet. Tapering is really the process in which the central bank reduces these purchases, and therefore remove some of the support to the market in the economy.

PETER HAYNES: So, your view of the comments that were made by Chair Powell regarding tapering and what might actually impact, in particular, tapering in the US, how that might impact asset prices in your opinion.

MOTI JUNGREIS: Let's maybe talk a little bit about tapering here. So, the Fed had a hurdle. They call it substantial further progress. And that hurdle has been met with the reopening of the economy. So, we've seen hiring, we've seeing higher inflation prints. They also may be thinking about the supply side issues. But that's not something that the Fed can really help via quantitative easing. So, the Fed is set to taper starting November, as you indicated. And really they hope to end it by the end of June 2022. This tapering time frame is actually faster than what most of us thought in the market. And that's why, since the last Fed meeting, we've seen interest rates rise because people are expecting the removal of purchases to be quicker than it was perceived to be before that meeting. However, when it comes to hiking interest rates, I think the bar is much higher. The Feds want to see maximum employment. They want to see inflation overshoot at a sustained level of around 2% or more. We don't think that will happen until maybe late 2023. But the market is thinking that at the end of 2022, the Fed will start hiking rates. Tapering should mean higher rates. Why? Because basically, if the Fed is not the marginal buyer of bonds, other people have to come in and buy the marginal bond. The Fed is not that much of price sensitive, but other investors might be more price sensitive. And they will likely ask for higher rates. Higher rates historically should be somewhat negative for risky assets. Again, it might be positive for some sectors of the market, like bank stocks. But if the Fed can exit slowly and the economy stays strong, then you should expect the equity markets and credit markets to stay on track to continue to be very strong. I don't think that when we talk about QE and tapering, we also ask the question of what happening in the rest of the world, because we talk about other central banks. I think it's important to note with this quantitative easing in Japan, this quantitative easing in Europe, I don't think that Europe can be as quick as the Fed. I think the ECB will continue, probably, on a little bit longer than the Fed. They don't have the same inflation problem that the US have. And they also don't have as much fiscal support like the US have.

PETER HAYNES: So you mentioned the tapering plan is on an aggressive calendar, trying to get it done by June of 2022. When we think about some of the key risks to this tapering plan, is it all about COVID variants or are there other factors that the Fed will consider in terms of its timing for tapering?

MOTI JUNGREIS: It's not just the COVID. It's really to see that the economy is actually moving along. Now, we've seen significant-- and I think we will probably cover some of it later-- but we've see significant changes in the dynamic in the labor markets. And we need to make sure that the economy continues to grow at a fairly healthy pace for the Fed to finish the tapering. There's always a chance the economy slows down. There's always a chance that Delta or COVID re-emerges and creates more issues. So, it's not just a sure thing that the Fed is going to taper and then move on to hike rates. So, we've got to see a fairly smooth sailing from here. And that's why the Fed has always been so careful in navigating these moves.

PETER HAYNES: Well, you mentioned labor a second ago. And everybody seems to have a story these days about labor shortages, despite unemployment rates remaining above pre-pandemic levels. Some pundits in Canada will blame supporting instruments like CERB, even though every major corporation is suffering through supply chain problems, causing prices to rise. And the Fed itself admitted inflation will remain above its target for the next five years. Do you support the Fed's view that inflation currently is transitory?

MOTI JUNGREIS: There are a few issues here. One, it's not just a labor shortage, as obviously there's also a significant supply chain issues we all experienced in our lives, daily lives are where we have a hard time getting certain products, or prices have been elevated. This is a global issue. It obviously over time will go away, hopefully, but we have to see. And then, of course, we have the labor issues and shortages, which to your point, some of it is because of a program or government program that's really disincentivized people to go back to work. But others as well, is that the pandemic affected all of us. And many of us, and some people have chosen to either relocate their families, focus on just working from home, focusing on maybe taking some time off. So, I think that's part of the equation here. And we need to see that people are, as the economy continues to reopen and some of those programs are being unwound, that we need to see that people are ready to come back to work. And some of those labor shortages are going to like ease. Because if they don't, then inflation is going to be fairly persistent. And if the supply chain issues are not going to ease as well in the coming 6 to 12 months, then inflation also is going to be persistent. So, we ultimately think that things will calm down. But that's, if you like, the big risk here, that things are creating a momentum of their own. If wage inflation start to pick up, that the Fed falls behind. And then we have-- I don't want to call it the runaway inflation, but an elevated inflation for years to come.

PETER HAYNES: I definitely think we're going to be talking more about that particular topic in the next few-- in fact, I think that will be the most common discussed point over the next few months in terms of markets and people's expectations for the future of capital markets. The Fed gets a huge amount of credit, Moti, for how it's supported markets at the beginning of the pandemic through its asset purchases. Which you just discussed about bonds and credit instruments. And as you say in some countries like Japan, equities. These purchases not only stabilized asset prices, but they also acted as a floor for risk-takers to leverage along the lines of the common refrain, quote, "don't fight the Fed." The Fed support continued for an extended period, leading to questions about moral hazard. Looking back in time, the Fed has arranged for banks to save long term capital. In 1998. They saved Bear Stearns, but instead they decided to let Lehman go bankrupt. We live in a populist society these days. We've seen that with the results of recent elections and some of the rhetoric from politicians. Everyone wants a piece of the pie. Moti, are you concerned that moral hazard has become a bit of an opioid for the markets?

MOTI JUNGREIS: So, yes. I think that moral hazard is a big issue. But first let's talk about COVID for a second. Government and central banks, not just the Fed, everywhere in the world, did actually, an unbelievable job dealing with this unprecedented crisis. The amount of liquidity, loans, basically, if you like, saving the economy in a crisis that happened in such a short period of time, a big, big health crisis obviously. So, we've got to remember that that was needed at the time, which was March 2020. That being said, when I worry about moral hazard, it's really on one side, the fiscal national debt that no one, politicians, those call it even the populist side of it, have really now have zero accountability. All motivation right now by politicians everywhere to run a responsible fiscal policy. Because why don't they have to be accountable? Because central banks, the Fed and others, have helped finance these deficits at ultra low rates. So, really, they never get called out to be accountable for, because there's really no emerging debt crisis if the central banks are buying a lot of bonds and helping finance those deficits. So, I think that's one area where I think there's a moral hazard. And that's for the public to choose a responsible government going forward to deal with those growing issues of significant rising deficits and national debt. The other problem is obviously in financial markets. To your point earlier, if we get used to having support from the Fed every time the market sells off enough or every time we have a pending crisis, then we really don't have a free capital market. We don't have price discovery. And we've seen in the bond market. And I think that's a big moral hazard because it really gives motivation for people to buy any material debt without really doing the work or taking material risk. Because the Fed is there behind them. And we've seen it too many times in the last 20 years. To your point, probably started around 1998. But it's happened about three or four times since then. And in my view, it's a real problem for the market.

PETER HAYNES: So just as we finish up here, let's switch gears to a topic that I know is near and dear to your heart. And you've written about this topic several times on your LinkedIn page. And that is the ever-changing world of crypto. You once said in a client call I was listening in on that your view on crypto depends on which side of the bed and you wake up on. On the one side, crypto is real. It's the future bartering tool. And it's going to replace fiat currencies. On the other side, crypto's one big Ponzi scheme with big losses ahead. So, I've got to ask you, Moti, what side of the bed did you wake up on today?

MOTI JUNGREIS: So, I woke up alone right in the middle. So, that's what was set in itself. But I could choose which side I'm waking on. But I think that if we started, maybe, go back a second and say, well, one thing is clear. China has told us what side of the bed they are and they obviously went last week and effectively banned crypto. And that should not be completely dismissed. Some people tried to dismiss it, but this is the second-largest economy in the world, 1.4 billion people, who basically said, we think that crypto is basically a Ponzi. Like let's call it whatever they want to-- how they looked at that, they've decided that there's too much risk associated with cryptocurrencies. So now, when I look at crypto right now, I think there's three or four areas that you have to look at. We've got Bitcoin. We've got what I would call the networks, which are the platform, like the Ethereums of the world, the Solanas of the world. Then you've got an area that has a like thousands of tokens, where I think it's basically pump and dump schemes and fraud and hype. And you've got also the NFT space, which I'm going to ignore completely right now. So, if I look at Bitcoin, let's look at Bitcoin as the first because it's very definitely been the interest of many people. What is Bitcoin? We're basically saying, let's create a virtual gold, an alternative to gold, a virtual one. Where it's going to be traded everywhere in the world, there's going to be a fixed supply of that so you can actually create demand or decide what it's worth. It's really it's whatever buyers and sellers decide the price. So, there's definitely growing adoption on it, and growing acceptance on that. There's been a lot of derivatives around ETFs whatnot. So, I think that's an area where you can rationalize the need to exist. And the only thing I would worry or I would warn people about, unlike precious metals, where we only have four on Earth. There's only four precious metals on Earth, and yes the supply grows a little bit every year. Crypto, no one is stopping anyone from creating Bitcoin 2, 3, or 4. And they might actually be better, but still have the same supply constraints. So, really, why Bitcoin? Why not something else? And I think that that's something that investors always have to keep in the back of their mind. For now, Bitcoin has definitely been the leading cryptocurrency, and it's getting adoption. But a few years down the road, it could be something else. Third one, which is as I talked about those thousands of tokens that, some of them started as a joke, some of them started just as a hype, where you have promoters, celebrities, and others promoting a token that has no purpose and for the sole purpose of a pump and dump. This is not different than in overseeing 100 years ago or more, we call it the bucket shop, the boiler rooms, the mining stocks, penny stocks, pump and dump. All this is really the same. It's again, another unintended consequence of a lot of money in the system right now. And I would say, and I would argue, and I would advise everybody to stay away as far as possible from those. But the most interesting part of crypto, the most interesting space in crypto, is really those new like technology-driven blockchain platform that are really trying to decentralize the way we do business, whether it's finance, or it could be gaming, or other industries. And I think that's a very exciting space. So, for example, and I'll give you an extreme example. But think about a world where collateral is decentralized. And it's managed on a smart contract, where as soon as certain criteria are met, the collateral is moving around anywhere in the world, instantly. What I mean by that, and I'm going to use an extreme example, but it's one that can make you think, is that say, that you can have a dentist in Australia giving you, Peter, a mortgage on your house or a loan against your car in Toronto. Where, based on predefined rules, your house and the car are posted as collateral. And if you don't meet the rules or you miss a payment, the house almost automatically gets registered to the Australian dentist using smart contracts and decentralized registry. And this might sound like a very extreme example, but you can see where the opportunity is. And you can see that if we move to a world like this, the impact that it will have in the financial world, the impact it will have on banks, on the movement of capital globally. So, I think this is a space that I think we all want to watch. It's interesting because it could also have been a technology company that have done it. I know that necessarily it's a crypto, but it's ended up being under that space. And we've seen the rise of Ethereum-related platform or Solana, which has seen its price, the token price, increase 100-fold in the past year. And I've talked to someone who really understand crypto last week, and his view is that Solana is going to be bigger than Ethereum. So, you basically have this quite exciting space that is a very interesting, full of ideas, and with a lot of innovation that can definitely change the world. But obviously with a lot of risk. The overall space is one that's moving really, really quick. I think all of us can agree that unless you're a real techie, it's really hard to keep up with the changes. It's really hard to keep up with the lingo. But it's a very exciting space, even if only 5% of the things, or 1%, even if only 1% of the project that people are working on in crypto are actually going to work at the end, they have the opportunity or the potential to change a lot in different industries. Obviously in finance, in particular. And that's why I think the whole space of decentralized finance, it's known as DeFi, is exciting and one that we cannot ignore. Anyone in capital markets cannot ignore. And we have to make sure we follow it and be on top of it.

PETER HAYNES: I agree wholeheartedly with what you've said, Moti, and I find myself climbing up that curve and constantly being behind what's going on in the crypto space. One of the reasons why the governments, perhaps like China, are concerned about Bitcoin and other cryptocurrencies is the potential loss of relevance of their fiat currencies. In the same sense as you talk about decentralized finance, or DeFi as they're calling it, regulators worry about their loss of control over capital markets. Do you think at the end of the day, though, Moti, that regulators-- and you're seeing this a little bit in the United States right now-- are going to slow-play crypto regulations and make it very difficult for those crypto companies, or the decentralized finance to allow things like stocks to trade on decentralized platforms?

MOTI JUNGREIS: 100%. I think the problem that this space is facing, it's the problem of the opportunity. So, regulation for this space is a good thing. I think everybody in that space, unless you're trying to fraud or pump and dump, I think appreciates that the best path forward is regulation. The problem is how stringent? Because if we're going to go to China route, then it's a problem. But anyone who thinks-- and it's interesting because the people who launched Bitcoin or the original theory behind Bitcoin are the purists, if you like, were looking for a decentralized world. It's not going to happen. I just don't see a scenario where the US government tomorrow morning is going to be OK giving up the US dollar and everything that it means. If you look about the last 50 to 100 years, the main way for the US to dominate the world economy, and not just the world economy, but even through military, is the role of the dollar in the financial market, the strength of the dollar in the financial markets. All of our payment system, the SWIFT system, is all based on dollars. You want to have sanctions on Iran? You're only able to do that because we're using the SWIFT system in US dollars. The second the US gives sovereignty or gives up on the dollar and embraces a Bitcoin or any other cryptocurrencies, that's the end of the US as we know it. So, I know that some politicians right now are playing nice. There is definitely hype. It's maybe a populist view, it's popular, they don't want to be the party pooper because so many investors and people are trying to get into this space. And as I said before, there are areas that are very interesting and innovative. But to think for a second that we would allow any-- any open economy and democracy-- will allow something that's unregulated and decentralized. That as I said, someone from Australia or from China can have as much control. I think is ludicrous. So, someone smarter than me said that crypto will be banned as soon as it becomes too big. Because basically right now, although it's going a lot and it's safe to call it $2 trillion market cap across the tokens, it's still manageable. It still doesn't really affect the real economy. It still doesn't threaten the Fed. But once that changes, you will see aggressive steps against it. And I think China is doing it because they see it, and they see it. They see it coming. They obviously have an interest to control their economy and social order and social structure much more than, say, Western societies. But let's not kid ourselves. Western societies that are going to protect themselves as well if they felt that this was a threat to their sovereignty, a threat to their currency, a threat to their independence.

PETER HAYNES: OK, Moti, just as we finish here, I'd be remiss if I didn't get you to give us your predictions. I know you don't typically shy away from having a view on the market. What is your view for-- I'll just put you on the spot-- where is the S&P going to close at the end of the year and where will the 10 year bonds in the United States be at the end of the year? And then also throw in, as you're an old currency guy, where's the dollar at the end of the year? Canadian dollar rate versus the US.

MOTI JUNGREIS: All right, wow. Interesting. So a lot of stuff. So, let's assume that the economy is going to continue to chug along. And let's assume that there is going to be tapering. And we already had a big run up in equity. So I would say that what we're seeing in the last few days is decent theme that could continue into year end, which is basically, growth stocks are going to struggle to continue to outperform. The value stocks are going to be OK. They might not rally as much or not, and I think so you might end up, say it's going to be a flat market from here to the end of the year or, you know, up and down small. There will be increased volatility, mostly because of the Fed and the expected tapering. And data is going to become more important because you go back to the first question, are we going to tighten in '22? Are we going to tighten in '23? That will have an impact on the equity markets. If US 10 years ends up the year I'd say 175, which I think is not a bad prediction, then, as I said, it would be harder for equity markets to charge ahead. But the market has proven itself that it's a buy on every dip. Retail investors are still dominant. Again, if they go back to work and trade last, and again that might take some foot off the gas from those equity markets. On the dollar, so obviously if you think of higher rates in the US, higher yields, strong economy, then the dollar, generally speaking, will perform well. That being said, if you think about Canada and the Canadian dollar, I think we've seen oil rise, commodities continue to do well, and the economy here is doing well. There's more talk about rate hikes here. So, you could see a scenario where once we get through this a little bit of an equity correction here, the market stabilizes, the Canadian dollar could actually outperform into year end. And so, maybe I think we're close to 127 1/2 as we record this podcast. If I had to choose 122 or 132, I'll probably go to 122. And 122 again, means strong Canadian dollar, weaker US. In that context, I see Canadian dollars kind of outperforming the rest of the G10 world, as long as we still have elevated natural gas, oil, and other commodities and a economy here that's gathering momentum. As to your point, CERB coming off and people are going back to work. So, I think that's maybe not a bad theme for the last quarter of the year.

PETER HAYNES: Well, if we're going to be seeing a strengthening in Canadian dollars, that should be good for those of us that are some day hopefully able to cross the border into the United States. And that will obviously be a big catalyst for, I think, continued developments between the two countries. So, we can certainly hope someday that the border will reopen. Moti, thank you very much for your time today, as always. Very passionate about markets. Really appreciate you jumping on our podcast here, and look forward to speaking to you down the road where we can judge whether or not your predictions were correct

MOTI JUNGREIS: Thank you very much, Peter.

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