A Surprise Dollar Rally Would Be Potentially Disruptive: BNP's Katzive

next year? Will it just be more of the same. Here to answer that question is Daniel Katsi. He's head of FX Strategy in North America for BNP Pariba and he joins us now. Danielle, thank you so much for joining us. Thank you. So what are you expecting for next year for the dollar? Well, more of the same on net. I think by the end of next year

the dollar will be weaker again. But we think right now we're in a period where the dollar is bouncing a little bit counter to that that structural move, uh and we think we have it maybe three or four five percent move ahead of us. For a lot of the dollar pairs over the next few weeks and months before the longer term down trend resumes. Wait, just to make sure that I'm understanding that. In other words, you think that the dollar could strengthen four against a number

of its peers before returning to a down trend. Exactly. Yeah. We think right now the markets under pricing the significance of what US rates have been doing, under pricing the likelihood UH and the and the consequences of tax legislation, and it is generally just under owned. In a world where markets looking for a rates and you'll and you'll yield delivering currencies, Well, what is held back the dollar from posting those kinds of gains recently? I mean this

is not none of this is in new news. No, that's true. I think the market has built up a short position to some extent, and I think part of that reflects this understanding that, yes, the structure, even if you have the opportunity for a cyclical bounce, the big ten percent type moves over the next few years are going to be to the dollar downside. So there's been

a reluctance to own the dollar. I think the market has been reluctant to fully priced in, uh the consequences of tax reform until it actually passes, having kind of gotten caught the wrong way, um, the legislative agenda before and UM. I think there's a cumulative effect of rising front end rates, which is what's been happening in the

US over the last uh two months. The US front and rates have been grinding higher, and this does have a cumulative effect on hedging decisions and investment decisions, which I think is going to only show up potentially over time if the market does can't price it in ahead of time for whatever reason. So, just to put this all into perspective, the moves in the dollar will be

tremendously important to a lot of different asset classes. And I'm thinking increasingly as I talk with investors and analysts that there is a growing complacency that perhaps the dollar will rally a little bit against its peers, but ultimately will remain in this sort of weekend state, if not decline in value over the next year. And I'm just

wondering what happens if it goes the other way. Let's say it does strengthen, how much would it have to gain against its rivals in order to disrupt things like emerging markets. Well, I think it's a very good question. I mean, I think the one thing when I talk to people about what's going to happen next year, uh, the one thing that would really surprise people, as if the dollar moved back to the kind of levels we saw after the election, that that would really challenge a

lot of assumptions about where things are going. We don't

expect that. It's not our base case either. But if I'm looking for the pain trade or the surprise uh for markets in the in the first half, and often we do get surprises in the first few months of the year, it would be the dollar does a lot better that this cumulative tightening that the fed from the FED finally begins to kick in, and that all the things that people talk about, well, other central banks are hiking as well, that that's too far in the future

to really provide sustained support for their currencies, and we get kind of a move to something like one ten and euro USD and yet again not our base case, but I think that would be a big surprise for the market and which challenge UH a lot of different asset classes to to respond. Well. Daniel talking about that response from different asset classes. What does that translate to lower oil prices, lower inflation? It could uh, you know, for if the example I would go back to is,

you know, how things played out in early seen. At that point, the dollar had been gaining a lot, and I think many people in the market underestimated how much feedback that would create into the economy, into um uh, credit markets, energy markets, equity markets, um into the Fed's own thinking um and just you know, remember at that point the year on year rate in the broad trade weighted dollar it got up to about something like like

fifteen percent. It's hard for us to do that now because the base effects just really aren't really the same as they were in twenty sixteen, and or wards of dollars already still, even though it's been weak this year, as you pointed out, the dollars still at relatively strong levels. It's gonna be hard to get as much of a headwind from f X as we got at that time. But even something you know, smaller than that, you know,

does create a lot of feedback into other markets. So, Daniel, how much do you think that the dollar will weakend versus its peers by the end of next year compared

with where we are today. Well, we've been using our long term equilibrium fair value model to try and answer that question, and the idea is that you know, the dollar got very expensive during the period in when FED policy was diverging from policy everywhere else, and over the next few years, as other central banks start tightening and the FED ends its cycle, uh, we're gonna have reconvergence and monetary policies. So we think we could go back

to these long term equilibrium levels. The biggest excrepancies are in versus currencies where the other central bank has been doing QI. So, for example, you're a USD our long term mac librium estimate is one thirty three UM. We don't think we're gonna get there in We think we'll get there by the end of so that'll be a gradual process with ups and downs along the way. By the end, we're thinking one twenty two for euro USD so it's basically getting back to where we got around

the middle of this year. We think dollar end could get UM as low as well as high as one seventeen in the near term, but then back down to one twelve by the end of next year. So a bit of a you know, uh V shape or upside down V shape. You know, I just want to follow up on that, because when you talk about Europe and Japan, we're we're heading into a week of a lot of decisions. We're going to hear from the e c B in the Bank of England, and I'm just wondering, you know,

who's driving the bus here? Is it the e c B or is it the Fed? You know, people talk about Trump and the Trump trade, but is it really that Europe is doing better than expected, that they're going to be forced to start tapering and possibly even lift deposit rates sooner than people are expecting. The market is very sensitive to any indication that these currency central banks like the ECB and the Bank in Japan might be

beginning to exit. Uh So, you see, whenever the ECB says anything even slightly hawkish, you see a big reaction in your U s D for example, Whereas the FED can actually hike rates, and you know, the benefit for the dollar seems much smaller. I think that reflects the Euro's cheapness as always expensiveness, and this perception and over the next few years things are going to be changing.

But you know, what I think, really the market sometimes forgets is that even if the ECB is talking a little bit more about exit, there's still a year away from doing anything really meaningful new on the on the rate front, at least a year away. And in the meantime, if you want to be long euros and hold Euros, you have to pay uh, you have to pay care. You have to be you know, if your your dollar funded, you have to pay a negative rate differential to hold

that position. So that you know, I think it's important to listen to the signal, but not forget that the reality on the ground right now is that policy is still very accommodative in Europe. Yes, the economy is hot, but what that does is create a real downward pressure on real rates. Because inflation goes up in Europe, nominal rates are held stable and real rates actually get get lower, which can hurt the currency in the near term. Thanks very much for being with us. Daniel Katze is the

head of FX strategy in North America for BNP party. Bob. There was an election yesterday in al Obama and the verdict was somewhat surprising. This very red state turned blue for the first time in more than twenty years. Here to talk about what the implications are is Jonathan Bernstein, Bloomberg View columnist, coming to us from San Antonio. Jonathan, thank you so much for being with us. What's your main takeaway from the election of Doug Jones to be uh,

the senator representing the long read Alabama in the Senate. Well, we'll be in the Senate. You know, every single Senate vote counts, and there's a huge difference between having a fifty two majority as the Republicans did you know still do until he gets went into having a majority. You know, the Vice President Pence has already had to break ties

six times because Republicans couldn't keep all fifty two together. Um, you know, all else equal, Republicans would have lost all six of those votes, and we're gonna have more of that in the year to come. Well, Jonathan, maybe just go through some of the list of the defeated Todd Aiken, Richard Moredock, Christine O'Donnell. This could have been the Republicans time, but something happened. Yeah, you know, this is yet another

time where a tea party or an extremist Republican got nominated. Um. You know, before Steve Bannon was involved in politics at all, this was happening, and now it happens even more with Bannonite UH candidates, UM, and they're they're nominating people who they should give away seats. Alabama, this should have been a lack election, even with the president very unpopular overall. Alabama is a very Republican state. They should have won this,

but they nominated somebody who was a terrible candidate. Well, so, Jonathan to that point, how much is this an idiosyncratic issue that had to do with choosing a bad candidate and how much is it a harbinger for next year we get a whole slew of midterm elections. Well, it's in some cases both. Um. The three things went into the victory for Doug Jones the Democrats. One was that Roy Moore has always been unpopular in Alabama. He's won, but he won by much less than Republicans typically one

in his previous statewide races. The second was the scandal um which came up after he was nominated. And the third was that Trump is just a very unpopular Republican president. So it's idiosyncratic of the specific things that happened with more but it's not even astocratic that Republicans have made a habit of nominating these terrible candidates, and every time that happens, they give away a seat. They may wind up doing it in the Senate races in Nevada and

or Arizona. So, Jonathan, I want to press you on that one point. You said that this has to do with President Trump being very unpopular. Does it? I mean, can we really gauge that this had anything to do with that, because ultimately, if Roy Moore was unpopular, he was unpopular, and yes, Trump added his support at the end, But is this really a referendum on him. It's not something to a referendum. It's not the people you know in Alabama said I'm going to vote against more because

of Trump. But having an unpopular president of your own party depresses enthusiasm within the party. Voters are less likely to turn out the other party is more enthusiastic. Um. You know, that's what produced a landslide for Republicans against Barack Obama and funny ten and um. Right now, Donald Trump is about twelve point percentage points less popular than

Obama was at the same point by years ago. Jonathan, you make the point in yours and one of your most recent columns, you talk about how Florida's Senator Marco Rubio and Utah's Senator Mike Lee had an amendment to expand the child credit. Just tell people exactly how that played out and what that informs you of. Well, you know, that was an interesting case where you had two Republican senators who had an amendment that they wanted to push.

It would have increased the child tax credit, and it would have they would have raised the corporate rate a little bit or you know, not lowered it as much to make up for two senators in a fiftiest majority. They didn't have the cloud by themselves to force miss mcconnald to make a deal. Now, some people criticize them. They could have still tried to They could have found

a third senator. But now with a fifty one already nine two senators, any two senators, Republican senators could go to Mitch mcconllull and say, I'm not going to vote for this unless you give me my amendment. That one. You know, it seems like it's not a big deal, one out of a hundred, but in fact, it makes it easier for different small groups to be able to get their way in the Senate, making it much more difficult for the Senate to get anything done for the

Republicans in the Senate to get anything done. So, just going forward, what sort of the strategy for the GOP, how are they going to frame this? Well, you know, there's what they need to do is to find some way to improve the two things, to find some way to defeat uh these Bannon type Tea Party type candidates who are terrible candidate, who are giving away seats. They haven't figured out a way to do that. Um, they had thought they did. Mitch McConnell thought that they were

making some progress in that in the nomination season. We'll see what happens as goes along. The other thing that they need to do is find some way to make Donald Trump less unpopular. You know, good luck figuring that one out. I want to thank want to thank you very much. Jonathan Bernstein. He is a Bloomberg View columnist and previously political science professor at the University of Texas

at San Antonio. Fascinating, fascinating election yesterday, and the turnout was really interesting, and that was definitely something that people are to be watching. Is uh is the Democratic Party galvanized? What will it take to galvanize the Republican Party in the same kind of way for the mid terms. Yes, technology alone cannot save your business from cyber attacks, so says our net guest. Chris Young is the chief executive of McAfee, of course, previously purchased by Intel, and he

joins us here in our eleven three oh studios. Chris Young, thank you very much for coming in. What do you mean by this? Technology alone isn't going to save a business from cyber attacks. So technology is really important and obviously putting together the foundation for security for any organization, but you have to have an addition to that, a culture of security across your organization. This is really important.

Security has got to be something that everybody from your employees, your partners, your executive staff, as well as your board, all parties involved, have to make sure that security is a priority and it's something that's part of our consciousness and inside of any organization. So that culture is critical to augment. Also, you know, augment what you're doing with technology, all right? When you walked in here, I asked, ingest,

do you live in a constant state of paranoia. And you were talking about how you would never plug your phone into a public outlat outlet because you don't know who's on the other side of it, And I have to wonder, I mean, I operate by going around thinking, are there that many people out there that are trying to fleece me? Are there? In reality, the number of the number of people who get you know, hit a hit in these in these situations are pretty small from

a mathematical perspective. But the problem is, you know, cybersecurity and cyber attacks are getting more pervasive. The numbers are going up every year, um, and it's something that everybody has to pay attention to well. But I guess from a corporate standpoint, have the number of attacks increased exponentially and have they gotten more and more sophisticated to the point where uh, companies are facing daily barrages that they're having trouble keeping up with. So the answer to that

is yes. I mean we see literally, if I was to show you any chart and pick it an attack type, literally every attack type is up into the right in terms of absolute numbers that we see, Um, we've got If I was if I was able to show you a presentation. I've got a presentation that I do that shows the last thirty years of cyber attacks. One of the things you see is that no individual form of attack actually ever goes away. They all change, they more

if they get more sophisticated over time. And now what we're seeing a lot of these guys do is there actually combining attack types to come up with new attacks that you that a lot of those of us who are defending have a hard time conceptualizing because they're completely different approaches to UH achieving your mission, so to speak, if you're a cyber attacker. Well, and it seems as

though they're also combining the fruits of their labors. For example, there is a database that's been reported of about one point for billion user passwords has been discovered on the dark web, and this is data that is UH taken from LinkedIn, MySpace, Netflix, a variety of other sites. And the comment is that none of the passwords are encrypted, and they've already tested them so that now they can be sold through out the world. This is really a

big business, isn't it. It's one of the reasons you have to change your password frequently. I know For some people they feel that's annoying to have to change their password. But it's back to that culture of security. Security is everyone's responsibility, whether you're the person on the street or the CEO of an organization, whether you're in the business like we are at McAfee of protecting people, um, or whether you're there the person who answers the phones here

at Bloomberg. Everyone has to take responsibility. So how much have McAfee's profits gone up. We've we've we've been a successful business. As you know. We just spun ourselves out of Intel earlier this year in April, to be exact, and we've you know, we're one of the largest independent cybersecurity companies today. UM, we are, you know, we're I like to joke internally that we're um, we're kind of

like a startup, but we're actually quite large. You've been in the business for for several years and it's something that, uh, we're very proud of. What do you actually do? So we're we provide cybersecurity products and services across consumer markets as well as commercial markets. We serve governments and businesses. UM. We provide products, we've got services, we do a lot of protection and at the foundation of everything we do

is really strong threat detection and helping stop threats. You you recently made a purchase of a sky High UH Networks and this has to do with cloud computing. Are there specific risks associated with so much data and corporate activity moving to the cloud where the people involved may not even know where the data resides. They're absolutely, they

absolutely are. If you think about where the world is going in the future state, it's going to be a worker in any any organization is just gonna be They're gonna be on some device, They're gonna be accessing applications and data that are in the cloud, potentially in a public cloud environment, and that's going to be the way

the world is going to work. And so we at McAfee, you know, have decided that together when we close the transaction with sky High, which happens in the early part of next year, will now be able to provide that end to end security from you know, kind of the devices that users are working with all the way out through the applications and data that are in the cloud.

Where Skyhis establishes established themselves as a leader, we think that's the future of where the world is headed not only from an I T perspective, but the cybersecurity models got to operate that way as well. Just quickly, what's your biggest fear with respect to some kind of massive data breach? UM? My biggest fear when it comes to attacks is is you know the impact on um, you know,

on major systems. You know, like I, for example, at a conference a couple of years ago, I had Ted Coppel come and talk because he wrote that book called lights Out on you know, an attack, potential attack on the power grid. UM. So I do worry about those things. I think those are real issues that we have to wrestle with, and I think there's a lot of infrastructure

that needs to be put in place. I think there's a lot of process and a lot of back to my cultural security, a lot of prioritization that has to be placed on the cyber security model in and around those critical systems. I do have to say, though, when you change your passwords so frequently, it leads to people writing down all their passwords in one place, which could just just then get hacked. I'm just saying before you could use a password manager, that's true, I guess you could.

You could get more tech savvy Christian. Thank you so much for joining us Christians. Chief executive officer of McAfee, based in Santa Clara, California. I hope that you are okay with the wildfires. It's supposed to be a quiet time of the year for municipal bond issuance, but preliminary numbers indicate that at least nine billion dollars worth of muni debt is expected to be issued during the week of well this week December eighteenth alone, actually next week,

but we're already ahead of ourselves. Now. This is according to out of that we've compiled here at Bloomberg, and that is more than double more than double the average issuance during the last two weeks of December. You have to go back to nineteen eighty five to find these kinds of numbers. Uh. And here to tell us a little bit about this and other things involving the world of interest rates and yielding bonds is Rich Taylor. He

has fixed income client portfolio manager for American Century. They're based in Mountain View, California, and he helps manage more than forty billion dollars in fixed income assets. Rich thank you very much for joining us in our eleven three oh studios, your thoughts about muni bonds in this this sort of wave of issuance that's that's coming. Is this uh directly related to the tax overhaul bill? Yes, I think it is. Pemin Again, thank you both for having me,

and Merry Christmas to you and yours. Um. Yes, Uh. Normally as December is a very low supply month, usually around six seven billion, but as you know, we're getting probably closer to fifties sixty billion this this month alone. Uh. That is still being readily absorbed due to the increased demand. But it is really issue where is trying to move up their issuance. Normally that would come in January February in advance of this what may come out of this

text form bill. So um, we do expect supply to drop off dramatically in January February, but right now we're getting a big flood, so aside from the tax plan which is still up in the air, although there is the expectation that Center Republicans will present a bill, possibly some kind of final form or draft early next week. Um. How are you arranging your portfolio heading into next year? Any big allocation shifts. Oh, that's a great question, and

I think what we're expecting. You know, we don't have a whole lot of clarity yet on the bill. I think the biggest thing, that's what we're trying to do is get in advance of it. If we get a tax MP advance for funding elimination, that's of the market. So what we could see if the bill goes through and its current status, you could see a fifty percent reduction in taxes at muni bonds. So that would vastly change these sort of demographic of the supply because right

so we are going along that route. And also if the state and local tax deductions get eliminated, that would certainly potentially change the way the nature the structure of the way state and local governments issue bonds and also their ability to race time. But you're not actually changing your allocation around this here, not at this point though, because we don't have enough clarity left to know what the bill is gonna ultimately look like. So one thing

that I'm wondering. You know, a lot of people come in here and they say, we're in a pretty good environment. We're not expecting any big hiccups next year. Very few people are predicting a recession of any sort gradual tightening, but the central banks are all petrified at the markets and disrupting anything. Um, there's a lot of risk building. How concerned are you about that? Very concerned a matter of fact, that is my number one certainly said, I'm

glad you asked that question. Is that really? Since so eight, what we've seen is bond investors have and and understandably so. Uh. They're primary, if not soul objective in their bond portfolios has been to maximize yield. We're a low interest rate environment. We're no longer in an environment where you can if when if you're tired, you can clip a coupon and not touch your principle. And now and now obviously you know you can't. You can't live the twenty three years

from time and I wanted two percent a year. So what investors have done in the last several years to get that There's only two ways to get that yield, duration risk or credit risk, and pretty much everyone has done it by loading, loading the boat and their portfolios on credit risk. And now credit spreads are so tight and evaluations are so rich, you're not being paid for that risk. So what scares me is that as long as we're in this goldilocks low volatility environment, that's fine.

But if we get if and when we get the next big equity market correction or when Bolatili increases the high correlation between the credit markets and the stock market, I mean that the stock market goes down, the bond the credit market is going to do the same way with it. So I'm concerned that investors have far too much credit risk in their portfolios. Is not enough diversification. Well, does this mean that they're now going to uh lavish

themselves with a duration risk to add to their credit risk. No, not, especially now if you've got the curve that's flattened so much, you know, throughout this year, and if it gets a little bit more flat uh going forward. I think it would be a big mistake at this juncture. If the Feds can continue to slowly renormalize rates and if inflation starts to creep up a little bit more uh and also with FED balance sheet restructuring that could actually take

longer rates up a little bit. So I think staying intermediate, saying in that four or five six year area makes the most sense. But just being modestly overweight credit risk and and and not not make really the sole objective of the portfolio to be maximizing yield. So do you feel like your portfolio has pockets that have excess risk

that you in another environment would not be comfortable taking. No. A matter of fact, we have anticipated this for quite some time, and we have one of our hallmarks of the way we met it's fixing come money in American century is to seek diversified sources of return. We don't want duration, or credit risk or sector allocation being a big concentrated risk. The flip side of that is that returns are likely to be lower. That's right, and the well the world has to we have to assume and

expect lower returns. What are the returns that you're expecting returns? Uh? You know this year core bond funds have been getting where three, three or four percent. I'm thinking maybe two to three next year. So that's the big get right to two to three percent returns all in returns, price and coupon for core bond funds that are about half investment grade corporates and half covernments. That would be the lowest performance in a long time in a very long time.

And again that's exactly right. And that and the thing is is achieving those maintaining decent returns and decent yields with an appropriate level of risk. And that's the biggest, that's the big that's job one for managers and investors. Well, just to report this headline from the associate depressed that House and Senate leaders have reached a tax package deal.

We're awaiting the details, of course of that deal. You know, rich the Uh, the issue that I that Lisa and I speak about every now and again has to do with automobile loans and that has been something that has offered yield to yield start investors. But ninety day plus delinquency rates for auto loans is up to about ten percent. That's the highest since the first quarter of Does that

Does that give you any pause? It does? And interestingly, UM, within the asset backed sector allocation our portfolios, we have gone the way of sort of issued regular auto loans and home acuity and credit card loans because again they're very rich as well. And we've gone into some more esoteric areas like fleet and rental cars, UH, and also time shares. You know, the rate on a on a time share ask back, there's you know, ten elve, so we can get some very nice yields, and that's a

market that's been fair the untapped at this point. So we when it comes to asset backs and kind of mortgage credit area, we uh shy away from your traditional asset backed areas because that does concern us and also evaluations. Thank you so much, really a pleasure to hear what you have to say. Rich Taylor, fixed income client portfolio manager for American Century, which is based in Mountain View, California. Thanks for listening to the Bloomberg p m L podcast.

You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio.