The surprise OPEC+ production cut is pushing oil prices higher and may end up undermining the U.S. Fed’s efforts to cool inflation. Greg Bonnell speaks with James Dixon, Director of Family Office Solutions at TD Securities, about OPEC’s latest move and how it could impact broader markets.
- As investors navigate higher volatility, our guest today says there are three main themes they may want to keep in mind when considering where markets could go from here. Joining us now with more, James Dixon, director of family office solutions at TD Securities. James, great to have you on the show for the first time.
- Thanks so much for having me, Greg.
- Let's start with telling the audience a little bit about who you are and what you do here at TD. You work for the Securities family office, the ultra-high-net-worth group. Tell us about that.
- Sure, Greg. So what we try to do is deliver the full suite of capital market solutions to family offices and ultra-high-net-worth individuals. We do that by connecting with our partners, private banking, PIA, PIC, our TD Family Office, and of course, just directly through external family office. So we really aim to just bring an institutional quality of coverage to the space, something that we feel the space has been lacking for a while.
- OK, so that obviously puts you in a very interesting position in terms of watching sort of everything in the world that's happening and trying to distill it--
- Tell me.
- --down to an essence. So you've got three big themes here. I want to start with what central banks have been doing and trying to tamp down inflation by hiking rates. And I just found such an interesting wrinkle over the weekend that, as we talk about inflationary pressures, they get OPEC in as partners with a surprise production cut. I mean, how does this all play out?
- Yeah, you know, it's been a very, very interesting story. We've seen so much tightening over the last year, far more than we thought initially. And we saw all banks continuously revise their targets higher as central banks across the globe ramped up to fight inflation.
Now we're in this position where economies are breaking, and because rates have just been too high. The question is really, does inflation continue to trend lower like we've seen, or is it sticky? On my desk, we have held the narrative of a sticky inflation theme persisting. In the short term, we do think the trend is lower, even with this OPEC cut. I mean, it's a big cut, over a million barrels.
We think, overall, the inflation levels out around 3%, 4%. And there's a few narratives driving that. I mean, the oil supply is clearly a big issue, and OPEC Plus has made that worse. We also think that we continue to see reshoring of supply chains on the back of COVID. We also think that this remilitarization efforts around the globe on the back of the war in Ukraine is a really big deal.
And this should keep demand for commodities high, and on the back of that inflation. And I think, overall, central banks might actually even be OK with that because if you have a ballooned balance sheet, the easiest way to get rid of your debt is just to inflate it away.
- OK, so an interesting point there, and obviously interesting developments to keep a track on. Now that we've-- for the longest time, all we could talk about was inflation, the central bank action. And then in the recent weeks, something stole the spotlight, the banking crisis, the failure of some US banks, or the whole Credit Suisse situation. Now, what should we be thinking about in terms of that?
- Well, it's interesting. Initially, I thought about rehashing what actually caused this banking crisis. But I think what's more pertinent is, what's next? There was some chatter about a run on A1 bonds after the big write down with Credit Suisse.
But I think the bigger issue right now is a theme that's gaining momentum, and that is commercial real estate. These regional banks have circa 70% of commercial real estate loans. Now, this is a big deal. Commercial real estate has been struggling because of work-from-home policies, a change in the way consumers spend. A lot of it's online now, so revenues are down. Financing costs are up. And at the same time, we have a lot of loans maturing.
To put things into perspective, just this year, there's $450 billion of loans maturing. And the pain doesn't end there. In the years to come, it's around $550 a year. By 2027, that's around $2 and 1/2 trillion in debt that's maturing. And this is a big deal because commercial real estate works a little bit different to residential real estate. These loans are not amortized, so there's usually a balloon payment at the end, whether it's in 5 or 10 years.
And when it comes to refinancing these loans, I don't know how you do it because the bid-offer spread on these buildings is huge. The banks say they're worth one amount because revenues are down, and the owners say they're worth something completely different.
So I think this is the underlying issue now that we are all trying to chop through. Are we facing a balance sheet crisis, or is loose policy going to alleviate the problem we have and we drive on? Certainly, markets seem to be thinking loose policy will be OK.
- OK, so two interesting things. We promised three themes, and the big one, of course, as we plow ourselves through all of this, try to bring inflation down. Live with higher borrowing costs. Worry about some of those US regional banks.
People are trying to figure out, are you getting a recession? If you do, what kind of recession is it going to be? What are the signs that they're telling us?
- Well, it's interesting. Everybody's been pointing to 2s/10s that have been inverted for a while and 5/30s. 5/30s have actually started to steepen again, which suggests inflation is around-- sorry, recession is about six weeks away.
I think we're in a very difficult position. You've got tighter lending standards, which slows growth. You've got weaker consumer balance sheets. So I think the signs are there. I think it's going to be a recession. The question is how hard it's going to be. Is it soft, or is it a hard landing?
My gut says it's probably a softer landing, and just because we believe that China reopening is a big story. And we've seen some strong growth there, and we think that they keep commodities bid, and they could fuel a bit of growth. Is it enough to keep the world out of recession? We don't think so. But certainly a soft landing is on the cards.
- How keen would the central banks be to race back to the rescue? This is sort of the job, but there's been some argument made that as they try to wrestle down inflation, they're going to tolerate, perhaps, a little bit more pain in the economy than they would during other cycles.
- Correct. So we believe that there's not enough priced in terms of cuts. We saw huge hikes over the last year. It started at 25. Then it went to 50. Then it was 75. And we've just continued to see pain in the economy. And all those hikes haven't even fed through into the data yet. So we believe that when the Fed starts to pivot, it's going to be aggressive. They'll have to unwind as quickly as they hiked.
- So with all of this in mind-- and that is a lot-- [LAUGHS] a nice breakdown with what the state of the world is right now, what it means for investors, what should investors do about positioning themselves in an environment like this?
- I've got to be careful of how I answer this one, Greg. What we have seen is we had a look at all the data since the 1930s. And what we have seen is when bonds and stocks sell off in lockstep, typically in the year that follows, bonds outperform stocks.
Will that happen again? We're not sure. If there is a recession, bonds tend to outperform stocks, just on a flight to safety. And if there is a recession, things like consumer staples, health care, utilities, those are the stocks that outperform. For commodities, well, I think you've got to ask yourself if you believe in the militarization theme that we do. Do you believe in the rebuilding of critical infrastructure? Because if you do, then commodities should outperform.