P&L: Could See Mid- to Low-90s for the Euro-Dollar in 2017

SoundCloud and at Bloomberg dot com. This is shaping up to be one of the most challenging years ever for analysts to come to concrete predictions for Doug Ramsey, c io of the Lootold Group, just came out with their new Green Book of market research and it's It's an extensive book of forecasts and expectations for the year ahead. Doug, just from the outside, how difficult was it for you and your team to come up with a base case

scenario for next year? Uh? Well, the the issue, at least I guess with coming up with a forecast at this point in the cycle is that it is a very mature economic and stock market cycle, and valuations are are very high. I mean, forecasting is dangerous I think at any point in the cycle. But you know, the one phase where you might have a higher degree of confidence would be early Bowl market. You know, we're unemployment rates are still high, but coming down, valuations are still reasonable,

FED liquidity is still plentyable. We've got really none of that today. We have a very low unemployment rate. Someone say we're at full employment. Valuations are historically very high. We think second only to the tech bubble years, uh in terms of peak valuations. And UH so we're we're reticent to make a let's say, a full year forecast, but we do have a fairly high degree of confidence that we will see higher highs at least during the first half of the year. And it really just has

to do with the internal strength of the market. And I think, you know, animal spirits are a sort of becoming rekindled here with more pro business talk coming from the incoming administration. I think you know, that combination of uh confidence being rehabilitated coming up from from pretty uh skeptical levels and uh and just the action in the market itself had us bullish for you know, at least

the first half of the year. Doug Ramsey, can you just broaden the conversation a little bit by telling us about market breadth and what that's showing you Sure, what we developed a pretty simple indicator, just that we tally each time the SMP makes a new bull market high.

So the latest was Tuesday, And we look at UH the spirit indices and indicators like the New York Stock Exchange Daily Advanced Decline line, new high within the last week, UH, Dow transports, UH small cap stocks, financials, various cyclical indices. I mean, all of these are also poking out to

new all time highs. And just I mean, the history of bullmarket tops going all the way back to the nine is that the final peak in the Dow and the spinal peak and the Blue chips is actually a pretty lonely event where it's really just those two indices

and very little else standing at a new high. So I've just got to believe in a bullmarket that's lasted almost eight years, that we're going to have a topping process that is going to be you know, spread out at a minimum over you know, let's say, four to six months. So one thing that I noticed in your green book was that you said that rising rates aren't always a death now and this is of very interesting point.

It flies in the face of some commentary that we've heard recently, including double lines Jeff Gunlack coming out and saying that, uh, if if treasure yields keep rising to the degree that they have been for a bit longer, that's going to put pressure on the SMP five hundred. Why do you disagree, Well, I think there's an offset.

I mean the fact that we're getting back to numbers and we're not there yet, but you know, if we if we break above the three handle on the tenure bond yield, I think there's going to be of course, you know, that's increased competition for the stock market, but there's sort of a countervailing confidence effect that hey, that's that's a bond yield figure that sounds normal to me all of a sudden, And even if we get short rates, let's say above one per cent, I think, you know,

they'll just be a sense that, hey, you know, the rate environment, the policy environment is being normalized, and I think there's confidence that goes along with that. And even with the in the cycle, I might and we've already had a pretty impressive It was an eighteen month stretch of rising bond yields and rising stock prices from the middle of twelve to the end of thirteen. The tenure bond yield went up a hundred and fifty five basis points.

In the face of that, the Spuh. Since this bond yield rally started in the summer, the SMP is only up six or seven percent, so there could be a ways to go. I'm sort of reticent to put a number on it. You know, where does uh what's a high enough yield level to inflict some pain on the stock market. But I think it may be as much as a point higher from here, I mean three fifty three sixty um could could be a challenge. So I

think it's always away. Well, Doug Gramsey, as you speak, the tenure yield topping a two point six percent, The dollar continues its strength against the euro one oh three seventy six, also strength against the pound sterling at a one four. What does that tell you about the appetite for US assets? Uh? Well, it's it's strong. Uh, there's no question about that. I mean, the dollar strength at some point, I mean sometimes I wonder if that might be uh a negative stock market trigger. Prior to the

rising rates. I mean, it's become very strong. Uh. I wouldn't be surprised to see the euro dropping into the nineties, I mean mid to low nineties over the next year, mid to low nineties for the euro dollar. I just think when you look at uh the strength of the US economy, and again it's all relative. It hasn't been a great recovery, but it's certainly been far superior to

what's been seen anywhere in Europe. So a simple way to get Europe competitive shy of the EU in the euro itself um coming undone may just to be to get that currency rate a lot lower, and and they're benefiting already. You can see it in the performance of the European multinational stocks. We've got to leave it there, but thanks very much. Doug Ramsey, chief investment officer the Loothold Group based in Minneapolis, uh I think that's a

good headline, isn't it. That the euro dollar might trade in the nineties, maybe even in the low nineties over the next six to twelve months. That would be a huge game changer. Already Europe has seen some advantages from the weaker euro with respect to more trade and more exports. So this will be a very interesting dynamic in the year ahead. But we're trying to imagine what the effects of the United Kingdom's brecks vote will have on wages.

And here to tell us more, as Mark Gilbert Bloomberg View columnists joining us from our London bureau, Mark Gilbert, thank you very much for being with us. I note that the pound right now trading at one against the US dollar, and there have been treasury papers i believe from the Chancellor of the Exchequer and the Bank of England showing that Britain could lose up the sixties six billion pounds a year if it pursues the hard Brexit option.

Tell us what's going on, Well, we had the vote in June, the referendum, Brits decided they wanted to leave the European Union, and you can some of the situations since then. In one word, it's uncertainty. If you look at the pounds on a trade weighted basis this year, it's down about fifteen in total. It's rallied seven percent from the October below. But when you've got a weaker currency like that, what you end up with is important inflation.

And if you look at all of the forecast for what consumer prices are going to do next year, we are looking at a faster inflation rate. So you've got the Office for Budget responsibilit to an independent body here that kind of marks the government's homework. It says that the Bank of Englaan's two percent inflation target will get met, probably in the first quarter of next year, and then inflation will continue to rise, studying out at about two

and a half percent. So that's a direct consequence of the weaker pound, which in turn has been sparked by this decision to leave the EU by Brexit. You know, one thing that I'm struck by is that, you know, inflation has been the holy grail of central banks for years, all of a sudden, now the UK is getting it. But this seems to be bad inflation. It doesn't necessarily translate to higher wages. What are we seeing in terms of UK wages and the ability for consumers to buy

goods that are increasingly becoming more expensive. Well, so far this decade, inflation has been banged on, averaging two percent, exactly at the Bank of Elian's inflation target, but in recent years it's fallen off. If you look at what wages have done this decade, they've only been one point eight percent, So Britains have effectively had a pay cut for the past decade. That arguably is one of the

sparks for for Brexit. You know, this argument that all of the benefits of economic growth have gone to capital rather than to labor. They lead into a bit of populism in a lot of countries, and so arguably that's

part of what the motivation was for voting Brexit. Wages though, have not tended to move with inflation, and if you look at the forecast going forward, as I said, inflation expected to accelerate, but wages are respected to stagnate, and by the end of next year the Office for Budget Responsibility thinks that inflation will once again be faster than wage growth and that people will be getting a pay cut again. Marcus, there are a debate about different sectors

of the British economy. For example, those workers in the agricultural sector, there's a report that they might actually see wage increases. There's certainly places where you're seeing labor shortages, and so if we close the door to immigration, which is one of the consequences of of Brexit, then you'll only see price pressures in the agriculture industry where a lot of immigrants work. If you look in the construction

sense sector workers in their plumbers plasters. They've been enjoying really really good pay growth for several years now because we still have a construction boom, particularly in the southeast of the country. But those sexual gains will help the overall picture for wages according to the oh B r um And indeed, there's a question as to how fast inflation the Bank of England will tolerate. It says it

will tolerate inflation over target for a while. If it's appetite for for for that faster inflation proves greater than people expect, then the impact on wages could be even greater. So I'm trying to expect to understand this. Today the Bank of England decided to keep its interest rate at a record low level. UM. If the BOE decides to raise rates more quickly than people are expecting in response to some of this higher inflationary pressure, will this caused

the power and to appreciate significantly? I mean, is that is that under the Bank of England's control even well, like like most central banks, they say they don't target the currency rate. Certainly, the the European Central Bank says the same. The Federal Reserve says the same. If you look in the futures market, there's about a thirty six percent chance of higher interest rates by the end of

next year, so not even at fifty. So the market is definitely expecting the Bank of England to stand pat through next year, and that's in line with it's with its claim that it will it will allow faster inflation for a while to compensate for the slower consumer prices that we've seen. Guessing currencies anyone's any you can't make money guess and occurrencies. I don't think the pound historically, whenever it's had a fall of this kind of magnitude, it's tended to stay at that level for quite a

few years. We had in nine we had a similar collapse in the pound after we left the exchange right mechanism. Pound weakness is something that I think that the economy is just going to have to cope with for the rest of the year. You know, we had news this week Lego is going to raise the prices of plastic bricks by five as a compensation for what they've seen in the weakness of the pounds, and most kind of

increases for imported goods. I think you're going to be something that we're going to see more of as the months roll by. Mark Gilbert, thank you so much for joining us, Mark Gilbert Bloomberg view calumness coming to us from London ground zero for Brexit and all of the developments that are coming with respect to inflation, wages, and price increases. We're going to try to imagine what is going to happen next year in the bond market. This

is the big question, the big mystery. I want to bring in Eric Stein, who is going to solve this mystery for us? Eric Stein, co director of Global Fixed Income at Eaton Vans. Yesterday, the Federal Reserve decided to raise interest rates by a quarter of percentage point that everybody was expecting. What people were not expecting was that the Fed increased the projection from to rate hikes x

here to three rate hikes six here. So, Eric, do you think that we are just going to see three rate hikes next year or do you think that there's even a possibility of even four. I certainly think there's a possibility of four rate hikes. You know. I think what's interesting about yesterday is a couple of things. First, off. The dot plot almost never goes um up in terms

of rates. It always goes down. We're actually we're debating this, uh in our eating Vance Global Macro Team research meeting today. There's actually been one time that one dot went up if you go back to two thousand fourteen, but generally dots come down. So now we saw the first dot just just just just backing up. The FED dots are the individual FED member projections for where benchmark rates will

be over time. So when people talk about the dot plot, they're talking about sort of, uh, that projection, and it moved upwards. It moved from to rate hikes applying to rate hikes at three right hicks last yesterday, Yes, exactly, and so it moved up from two to three. What I was expecting was that it was gonna that was gonna happen, but at the March meeting, not here at

the December meetings. So to me, that's very symbolic. And what Chairwoman Janet Yellen said when she was asked at her press conference was that some maybe a few members had incorporated the potential fiscal stimulus from the incoming Trump administration and other regulatory and tax policy changes that could be pro growth as well as some things that could potentially be inflationary, but everyone hasn't incorporated that yet. So they FED also raised their growth projection from two to

two point one. They lowered the unemployment projection from four point six to four point five. Marginal changes. But if the growth in inflation out look picks up, as I think it will and the markets they're telling us that it will, I think the dots could also go up. So I think three three rate hikes is certainly likely. Four as possible. Look, maybe the market can't take it. There's no guarantee that happens, but I think four hikes

is certainly on the table in two thousand seventeen. Eric, some of those thoughts might disappear in twenty seventeen because they're not going to have the same members of the f O m C. And indeed, Janet Yellen's and I believe, expires in February of eighteen. So what do you see in terms of any change in the disposition of the FED? So I I you know there. I do think it's gonna be very interesting to see how the Trump administration

fills those vacancies that are there's a couple. I think on the governor's side that are currently open more will be open. As you mentioned, Chair Yelling's term as Chair ends in February of eighteen. Actually her term as governor goes farther, but typically I don't think it's ever happened that someone stayed Honors chair when they're UM, when they've when they stayed on his governor, I should say, when

they lost their their chairship. So I do think Trump will a point at the margin, maybe more hawkish members UM than you would have seen, let's say, under Hillary Clinton administration, that being said as much as Trump in the past is criticized yelling for keeping rates low to boost the stock market. You know, if we're gonna spend more money and we're gonna have more debt, lower rates

are are are make that easier. So I wouldn't expect super hawkish members, but I would expect maybe more hawkish, more monitorius, less Kinsian members appointed to the Fed under our Trump administration. You know, how dangerous is the possibility that right now the consensus and markets is completely wrong, that U that rates will potentially even not not benchmark rates, but but treasury yields, particularly the ten year, yield comes

down in the first quarter of next year. If you know President elect Trump's team doesn't necessarily come forward with specific plans or runs into some issues convincing Republican leadership in the House and send it to come on board with him, what is the risk uh for for a very serious uh rally that could also spur a pretty serious sell off in other markets. So so that's certainly a risk. Look when when Trump got elected, which is now what five weeks ago, I said, Look, the distribution

of economic outcomes has widened. I think the modal outcome has gone up, but the distribution has widen. That's still that still remains. Let's say he can't get those things past. Let's say then we get a bunch of tweets and trade protectionism will definitely get a bunch of treats. We'll definitely get a bunch of tweets, but we'll get if we get trade protec action, is um and some other of his policies that I don't think are so strong that I think the baseline for the markets and myself

is that those will be somewhat muted. Then you could have worst economic outcomes. You could see a rally in the bondom market. I do think many of these policies, though even some of the bad ones like trade protectionism, are inflationary, some of the good ones that are pro growth also might be inflationary. So I think we will get somewhat of an inflationary impulse. And I think that's why the Fed moved from two to three hikes in

their so called dot plot. Eric Stein, thank you, portfolio manager co director of Global fixed Income for Eaton Advance, helping to manage three hundred billion dollars of customer assets. He is based in Boston, home to Bloomberg. Thank you very much for coming in and spending time with us. All Right, we are a FED day plus one, and here to tell us more is Joe Davis. He is the chief global economist for the Van Card Group. Joe, thanks for coming into the studio. Thanks for having um.

So maybe you can just explain a little bit about the vanguard response to the rate decision and then maybe connect that with what you see happening in and then markets as well. You know, so what what we noted the clients, we we we we applauded the decision. Um we were anticipating this year, phim that actually the federal reserve UM through the course of seventeen was actually going

to be at least about one UM. And so what I think we saw yesterday was a little bit of building confidence in in the outlook, something I think that quite frankly was warned six months ago UM And so I think I don't think we're gonna see very hawkish activity by the Federal Reserve. But I think we have taken out at the margin this this and this deflationary

tale that we were concerned about. Okay, so we might have taken out the disinflationary the deflationary tale, but are we setting ourselves up for gangbusters growth, incredible inflation, a departure from the new normal? Is this the end of the bond bull market in the beginning of you know,

clear sailing ahead. It's a great point. So paired with that with those comments, is I think we have to appreciate where where we should be right as you can best estimate that and our estimates say where the tenure treasury, which is a key benchmark right now, and we were we were two point five zero as if you can measure that precisely this time last year and we haven't changed. So we were skeptical that the world, we believe the markets in the world was to the bond market was

a little too pessimistic by the summer. At the same time, you are being too PESSI well, we all have. I just like would be careful of not being let animal spirits get out of control. I mean the equity market, if you, if you do the math, is pricing in closer to four percent real GDP grow for twenty seventeen. I think that's highlight unlikely. So I think choose somewhere in between. I think we're actually closer to fair value if you look at say the shape of the Eel

curve and the treasury markets, credit markets. But but you know, so if we would see maturial creator move, I think we'd be careful. Okay, you say if we see a material greater move, we should be careful. I was actually just gonna ask you Jeff Gunlock of Double Line Capital that came out and said, if you start to see much higher yields on the tenure, even up to three percent, that's going to start to pressure some of the riskier assets.

Do you agree, yes, I mean, I think even before to look at the at the three percent on the tenure treasure would be looking at the US dollar. I mean, we're already a point with which I think we'll we'll be hard pressed to see a further acceleration to manufacturing sector, which again the global economy was rebounding from its law

before the election. So I think if you can take that into account, if we see another ten percent rise in the dollar versus the basket of currencies, we will see, you know, further pressure on some of the import prices and on some of the growth. So I think there's a natural limit to how far we can go, and at some point twenty seventeen we could very likely test what that limit is. I think would be shocking to see a further acceleration across the board in the financial

assets that we've seen in the past thirty days. We'll glad you mentioned financial assets because this headline coming from the Federal Reserve that big banks are seventy billion dollars short of the debt needed to weather failure. Maybe talk a little bit about the financial sector and the increase in rates and what this means for their future. Yeah, I mean, I think, you know, if you take a broader step back. And you know, I think one of

the actually the hallmarks of the U S economy. One one of our thesis for while the USC was going to remain resilient over the past several years, was with the repair of the balance sheets, I mean on the consumer side, household side, clearing in the banking sector, which gets other parts of the world, we have not seen

this similar progress. So that aside. You know, obviously the flight near the old curve before recent before more recently was putting some pressure um and so it's nice to see some steepness in the OL curve that clearly you've seen in the financial marketing, equity prices um so. But again it's not all smooth sailing. So I think in one sense, you know, I think I think history will show this, this very strong concern of new normal stagnation

was a little bit overdone. At the same time, we're starting to enter the world of some talking about a sickle gold strong recovery, and I think we have been burned over the past four or five years, and I think there are still some structural forces at work, and so I think the truth is somewhere in between. I think right there in the markets were sitting right at that sort of fulcrum, and so we just which is which is fine. It's it's good that we're more balanced, um,

but we can't get too carried away. Earlier this week, the Treasury Department's Office of Financial Research came out with the report talking about how concerned they were about corporate debt in the US, the explosion of the market, which is increased in size by more than fifty since the

end of two thousand and eight. And they were talking about how, uh, while big financial firms are stress tested, the mutual funds and the pensions and the insurers which own a much greater proportion of the debt today may used to are not stress tested. Do you think that the corporate debt market holds some concern or poses some kind of significant threat to financial stability? Really not. I mean I think you know, particularly we're going to talk about,

you know, from the SA management industry. I mean that's concerned around um, them being systemically important or having that sort of risk in our minds, just it's just overstated. I mean, in many ways it's a pass through entity. I mean, you have to look at the mismatch. If there is any between assets and liabilities in that sense,

it's not the case. I mean, we have seen deterioration in corporate health right um, outside of the financial greater increase in in some debt, although part of that has to be compared to the c ANI landing which we've seen. So part of this has been a financing remix commercial and industry. Yeah, yeah, so we have this excuse me for the nomenclich but yeah, so there's something that's been a refinance in which in the zero bound, very low

industry environment, I think has been natural. You know, our biggest concern on the corporate debt market has actually been overseas in the emerging markets. You know, non financial private sector debt has increased significantly UM and in various you know, government agencies around the world think tanks have called that out.

So that that's if there's a pressure point in terms of corporate leverage, it's the emerging markets that I think, you know, so you know, we just have to monitor and to that point, I mean, the as you talked about earlier is the strongest that it's been since two thousand and three. Uh. If this is not the time when emerging markets corporates are going to feel pain when is yeah and you know so yes, and I think we're go and we've seen that already in some repricing.

I think, you know, however, in the market, I think it's some of this um um but it but it may be lost over the next six months as we have continued prospects for potential continue US dollar strength. Is that you know, emerging markets today are not emerging markets in late nineteen ninies. I mean, there's one or two potentially that you that you could zero in on, but everything from foreign reserves to to to some better balance sheet measures and and and and level of certain financing.

It's different and so at least they're not all in the same bag. And so I don't think we're going to see a set of rolling crisises um, but we will see some pressure points. Thank you so much. Thank you. This is a very interesting time and you've had a lot of interesting insights. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at iTunes, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm out there on Twitter at pim Fox.

I'm out there on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio