Three Percent Inflation Looks Likely, Leuthold's Paulsen Says

particular how to invest. James Paulston joins US now. He's chief investment strategist at the looth Hold Group, which oversees about one and a half billion dollars and is based in Minneapolis, Minnesota. James, thank you so much for joining US. I want to start with Risk your Credit because we've been speaking with some money managers who've been saying they have started reducing their allocations to US hiled bonds as

well as more so even in Europe. Europe UH. The list includes Jpmorg and Asset Management, Double Line, uh Alean's Global Investors, Deutscha Asset Management. Do you agree, well, I certainly, UH bonds in general, I would still be underweight. Um. Well, the bonds are I mean bonds could be government bonds, which are haven investment and would be you know, it

would hinge on inflation and growth. But if you have risk your credit, you're looking more at the credit worthiness of companies and also the pretty high valuations that we're seeing in the market right now. Yeah, I would, I would stay overweighted, uh there at least. I think that the risk for that is when do you think the

next recession is? And I don't think that's real near and if it's not, I think in the balance of this recovery, I think the bond investor is going to need a yield buffer because I do think before the next recession comes, we're going to reset interest rates higher. Um. Probably this recovery is going to end the way most post war recoveries have ended, that is in some sense

of overheat. At some point. I do think wages and inflation probably rise above three and um, I think that's going to cause a major reset and the tenure yield probably above three percent as well. And unless you have some yield buffer, whether that be from credit or whether it be from structure, I think it's going to be a very damaging position to be in and just nothing

but high quality paper. The other thing about spreads is typically, although they're tight today, and I would agree with that, um, I think that they probably stay relatively tight until the recession risk gets pretty close. Um. And so even if they don't tighten further from here, um, you could still have excess return and in a buffer against rising yields. Um, even if they just hold at the at the current you know, tightness of spread that they possessed today. So, Jim,

you just said something that was actually incredibly radical. You said that, uh, that you think inflation is going to pick up to that's radical and very different from what a lot of people are saying. What gives you confidence that that will happen? Well, Um, you know, the range on inflation that we've had over the last quarter century almost has been very narrow. It's one of the great accomplishments in the United States is we've had very low

inflation volatility. Not only low inflation, but it's been very low volatility over the last ten years. Now. One standard deviation about the current inflation rate at one is above it is three percent, and blow it is about thirty basis points. It wouldn't take a lot of inflation to shock people that are used to low and stable inflation,

and I think three percent inflation looks very likely. Wage inflation year on year is already least have been at two point nine percent inflation in this year on year in this recovery, we're still hanging at two five Medium wage inflation is already at three three UM. The the

other labor indicators suggest private wage pressures. UM if the unemployment rate, just like the claims number this morning, falling to almost its lowest level of the recovery, suggesting we're gonna have continued job growth, I think it's very likely we're gonna get wages over three. And if we do, I think companies are going to be forced to raise

selling prices, and that puts your CPI above it. One other thing that's at play right now is the US dollar is very close to breaking below a thirty one month trading range. It's been down about ten per year to date, but I think it could If it breaks that range, it could fall even further, which would also put some life back into crude oil and other come o of the prices aggravating or least elevating inflationary expectations.

So right now I'm looking at a tenure treasure yield at two a little bit more than that, but it's down on the year. Given your expectation for a surprising amount of inflation and possibly three UH wage growth. Where are you seeing this tenure yields at the end of this year. Well, I'm not sure this will. All you know happened before the end of the year. Indeed, I think that one of the reasons I'm positive on stocks right now, Lisa, is that I think we're in a

sweet spot with inflation where we're growing. The economy of the City Group Economic Surprise Index has been rising against since late June in the United States, reports have been getting better, but we're not aggravating inflation and interest rates. As long as we stay in that sweet spot, I think stocks move higher. Eventually. If we aggravate those, and I think we will, that could be what ends the

stock market rally as well as the bond rally. But personally, I think that's probably a two eighteen event now, um, but I would get prepared for it, and I certainly wouldn't be hanging out and overweights in a in a two in your treasury because I think the terminal level is going to be probably more like three and a half percent before this recovery is over. Jim Paulson, thank you so much for joining us. Jim Paulson is chief

investment strategist with the luth Hold Group in Minneapolis. One other area that we are watching is in currency is particularly the Euro. It fell at one point the most since December, although it's recovered some of the losses after ECB European Central Bank officials said that they're worried that the Euro might strengthen more than justified by the economic upturn. And with us to discuss is Doug Barthwick. He's managing

director and head of f X at Chapelen and Company. Doug, I first want to just get your thoughts on the knee jerk reaction by the market of selling the euro based on this com these comments by the e c B. Do you think the ECB would and could take actions to devalue the Euro. No. I don't think they'll take access to divide the year. I think this is a really job owning, a job owning effect, and I think that the market maybe has taken it a little the wrong way and that euro strength can be shown not

just against the dollar, but against many other currencies. The euro, you know, trading around this one set four, it's so much lower than one sixty it was back in two thousand nine, or even one thirty seven in September two fourteen. And so when you look at your who does the Europe export to only coming to the US. So if you're concerned about their exports and the strength of the Euro, it may not be just against the US, but certainly

against China. So euro China, which has retraced about of it's high to low going back to two, certainly looks like the euro maybe a little bit overvide or maybe overdone there. But against the dollar, if you were to go sixt one above the loans, they're we're looking at one and the euro. So I think that the euro

still has further moves higher against the dollars. Certainly because while the ECB may be anxious about the strength of the Euro, that's US administration sift with the Trump administration, it's very concerned about dollar strength. But not only is the U S concerned about it, the b I S and the I m F, both around these levels, have said that they believe the dollar to be ten over valued. In other words, you've got the U S and uh, you know, talking against the ECB. No one wants to

have a strong currency. But I think it's the U S that's really in the driving seat here, and that the Euro still is under vied relative to maybe where it should be, and I think that's probably around the level well before we get to the dolls. So do

you want to get your thoughts on the dollar. I just want to stick with the e c B for one second, because to me, the implication here is, even if this is just jaw boning, the e jerk reaction on the part of ECB officials would be to hold benchmark rates lower for longer and to move more slowly as far as removing accommodation in order to keep the economy kind of in this place where the Euro is sort of stabilized, even as as as the economy grows, right,

I mean, because I don't really see what other moves easy B could take. Well, the the CP would have to keep on doing something at a at a greater level than the FED is doing it. Now. We can look at the Fed, right, and I believe that maybe there's one more rate rise this year, and certainly e

CP won't be raising rates. But even if you look at the ten year yields and the US tenure yields are unchanged in the year, but tenure yield let's say for Germany or maybe city basis points higher, So the yield differentials moving more in the favor of Europe than it is in the US. And remember, when you look at currencies, you look have to look at, well, what's the FED doing versus what's the ECB doing. The e c B going forward into two thousand nine is maybe

going to have Bidman in charge. Widman is much more of a hawk and would like to see rates get a little bit higher in the year zone, whereas you may have Cone coming into the FED in the US who's seen as being a dove. And so longer term, we're still looking at the US maybe having lower yields for longer and the ECB moving out of the lower yields. Plus the e c B is now running out of

products they can buy in the market. You know, there's only so much you can buy in terms of big income in Europe, and they begin to really fill their coffers. Already with respect to the dollar, the dollar did strengthen

a touch today after falling quite a bit yesterday. Uh, basically just due to some of the turmoil, particularly having to do with the Economic Council and the CEO stepping away and this idea that possibly, uh, there could be less progress made on tax or form and other policy issues. But I have to wonder what your view is. Do you think that the dollar has further to fall? It sounds like you do. I certainly do. I think that the dollar is going to be on this weekending stands

really going off over the next couple of years. I think that a weak dollar policy are certainly a step away from the strong dollar policy is the new US term. And so based on that, I think that what folks are worried about more globally is not how far the dollar is going to weaken, but just how I mean, what's the pace of that? And I think that when

we get more of a sense at Jackson Hole. But certainly there is a very strong belief and understanding in the US that in order to keep equity markets as bit as they are, you need to have the dollar continue to weaken, because remember, for every one percent that the dollar weakens, that that moves into a half a percent rise in terms of the earnings per share for the SMP five. So as the US, you know, the US dollars to we can buy you's here and per share go up by ten percent. And so that's now

that that's considerable. And still within the US, we still have this issue where you have underfunded pension plans. You've got you know, government engine plans that are sitting there. They're very underfunded right now, and the way the boost them is by having equities boosted. The way to do that, certainly would be to have the dollar week considerably. Dog borth birth Wick, thank you so much for your comments. Dog Borthwick as managing director and head of FX at

Chapter Lane and Company. Well, today Walmart posted its best grocery sales growth in five years for the second quarter of This is really important because the grocery business accounts for more than half of Walmart's overall revenue. It beat estimates and yet its shares are down. To get a little bit more perspective about why and whether this decline will continue, I want to bring in my colleague Sarah

How's act. She's a retail columnist, a Bloomberg gad fly bloombergad Fly is a fast commentary section with a smart and analysis of breaking news. Sarah, what was your take when you saw there sort of tepid X diectations going forward paired with this pretty impressive performance. Yeah, Look, I think Walmart is doing the right things that needs to

do for the long term. What investors seem to be skittish about was the fact that this third quarter guidance wasn't quite as high as they hoped it would be. But Walmart is in a position right now where it really needs to spend big if it's going to in a serious, full throated way take the e commerce fight to Amazon. And so if it's not spending this money um and pressuring its profits, it's hard to see how three, five, ten years down the road it's a viable competitor in

the digital space. So how much money is it spending and where exactly is it spending? Yeah, it's spending several billion over the next few years, and a big part of that investment is in supply chain. What it wants to do is to have fulfillment centers that are more state of the art so it can get orders to people more quickly. And it's also experimenting with different kinds

of tactics for reaching shoppers in a more profitable way. So, for example, on millions of items now Walmart is giving you a discount if you buy the item online but pick it up in store. That's a more profitable transaction for them, and so they want to reward that. You know, I have to wonder Walmart's not alone in shelling out as much money as they can to try to boost

their online operations and their uh digital distribution. I'm wondering if a things are getting a lot more expensive and because of the demand from Walmart and Target and everybody else, uh, and and be whether they're behind the times already. I mean, we were talking yesterday about how if they didn't impress today, it was going to be a really rough next two quarters.

Do agree, Yeah, So I think there is something to the fact that they are a little bit behind the curve here, and they probably should have been making these investments, uh, quite a bit earlier. But at least they're trying now, right, And I think it's also encouraging that they're thinking creatively

and inquisitively. I mean, we've seen them pick up jet dot Com, They've also bought the Nobo's, They've bought Modcloth, and their reports out there now that they might be looking to buy birch Box, and so at least they're they're thinking in different ways about how they might boost their e commerce muscle by bringing in sort of acquahiring, right, bringing in some different talent to help them think differently

about this problem. One other problem that I am facing right now is that the margins are much smaller on online sales for Walmart just simply because, uh, the amount that they have to pay to fulfill the order and process everything is higher at this point. If they're trying to move more of their business online and they make less money from it and they're spending more, Uh, this equation doesn't seem that rosie. That means they have to make it up on volume. Do they address that? Not

that specifically. But I think the hope is that as over time things get better on the profit ability front, because theoretically, once you have a network built out right, once you have these supply chains that have all the right fulfillment centers excuse me, they have all the right technology and place once you're not building those from scratch, that you can start to have some you know, more scale benefits there, and that's sort of a similar argument

that Amazon makes, and the investors seem more convinced when Amazon makes it right, We're plowing all this money into building out our supply chain and that will benefit us on the back end. And I think Walmart is hopeful that the same thing will happen for them. And Walmart still is very much a brick and mortar operation, and there were were a lot of complaints in the past few years about shelves being unstalked, about staff being inattentive.

Do they talk at all about better kind of operations within stores as well as what the increase in wages that they did deliver has done to their bottom line

and what they expect going forward. Yeah. So they've said for the last several quarters that they've seen improving customer score when they survey them about the experience that they're having in stores, and that likely reflects that they have made all these efforts on making sure stores are better stucked, making sure produces fresher and deploying staffers in the right

way so that you're getting good customer service. So they have now had twelve straight quarters of positive comparable sales, and I think almost the same number of straight quarters of positive traffic to the stores, and so that's a good sign that some of those investments are working for them. You know, I'm struck by what you're saying, which is which is wise? You know, I mean, at some point they're going to have to spend, so they should spend sooner than later. Uh, And yet it's just the shares

are just not forgiving. Investors are not being forgiving right now. Do you think that they will come to some kind of uh Kumbaya moment where they say, you know what, we believe in you, or do you think that they're going to sort of go into a show me mode

for the rest of the year. I think there for at least for the short term, there could be a little more show me, because it's hard for me to see how just in the next one quarter or quarter after that they do something that really meaningfully changes their narrative to investors on this question of profitability. Um. But over the long haul, if they really continue to deliver this strong e commerce growth, uh, maybe investors will start rewarding them for it. Sarah Hols like, thank you so

much for joining us always a pleasure. Sarah Holsing is a retail columnist at Bloomberg. Gad Flies are fast commentary group. You can find it at Bloomberg dot com, slash gad fly, on the web or on the terminal at n I space Gadfly Go. Yesterday was a pretty big day, uh, in turmoil Land. For politics. We have President Trump generating controversy after his press conference and some comments from Republicans, and then you had the disbandment of the Council of CEOs.

This matters to markets arguably because it raises some questions about how quickly President Trump can move on his policy agenda. And here to talk about that is Mike McDonough. He's Global director of Economics Research and chief economist at Bloomberg Intelligence, and he joins us in our eleven three oh studios. So, Mike, how much does all of this actually make an impact

on these policies? I mean, are you getting sense? Yeah? So, I think you know, the the the actual resignation of the CEOs and disbanding of the Council's Uh, that's somewhat more symbolic than meaningful in a way, because I mean I actually said this. I think that no one, Not many Americans, if any Americans could name any successes the Council has had. But you know, as of twenty four hours ago. But it was always symbolic. It was never

anything but symbolic. So this is the extent that it was a symbolic vote of support that gave people confidence. Is now the opposite? Well, you know, like I said that every everyone could now name at least once CEO who's quit from this panel. Where it makes more of a difference is infrastructure is one area where both the Republicans and Democrats needed agree it needs to get done.

They have some differences on how. But when you're going when you're coming out and saying, Okay, this is the infrastructure press conference, I'm gonna do something, you should leave with everyone applauding, everyone joining hands and saying, finally something is getting done. Uh for the press conference to derail as it derailed, and you've basically, you know, shifted from infrastructure to these divisive comments where you have Republicans coming

out and and coming coming out against you. Now you basically have gone from something that should have had a really good outcome to where it's increasingly difficult to see how he's going to be able to get any of his agenda done, and it's incredibly important that he does get some of this stuff done. Infrastructure is needed, tax reform is needed. I don't see how it gets done. And this is maybe the nail on the coffin for

a lot of that. So, but how much was it his agenda to start with, because as you just said, it was Wilkins and Democrats who wanted to come together and come up with some infrastructure plan. I mean, can't they do that anywhere? Or does he have to be leading it? Well? I think, you know, the president has

to lead that sort of. I mean, maybe it's possible some of he gets out of the way and let some of his cabinet handle it, but I mean it's going to be hard for him to get must or any the type of support needed because you know, while I said, both sides agree this needs to get done, they differ on how it should be then, you know, be it from public private partnerships versus how much the government should fund on the infrastructure side, and then on

the tax reform who who should have benefit? Right should it? Well? So on the Bloomberg I think in the past, the past week or so, there was a story about two thirds of economists surveyed. I think that the current administration will get some kind of tax plan passed by the end of the year, but that the effects won't take place until after after the year after, possibly next year as well. I'm that that that ratio surprises me. I think that the idea of there's two things we need

to look at. One is the probability of tax reform, comprehensive tax reform that seems like it's zero percent. It seems like it's been zero percent for a while. Uh. Then there's the probability for tax cuts. That's probably what the economists and this survey we're referring to. I mean, I think there is a chance you could get some tax cuts, but I don't think I would be in the two thirds thinking something could happen. And keep in mind that survey was probably done before yesterday, in the

past weeks, for sure. But I have to wonder how much where I was going with this is how much is this optimism about the policies, uh that President Trump espoused during the campaign. How much has that optimism been baked into markets already and it hasn't been already beaten out that still needs to sort of come out of the market should we really fail to see anything materialized. So I think you saw euphoria fading a bit. Uh

in the rates market. In the dollar equities is a place where you haven't seen it come out as much. And I think that's partially because, uh, you know, it did start to get baked in, but then once people started baking it in after the election, you had a series of better than expected earning seasons, so that kind of helped catalyze the view that that was going to happen.

So I think that, uh, you know, if if you look at the reaction of the market this morning to the rumor that Gary Cohne may have been resigning, I think that's kind of an indication of what could happen if the market sees no hope of any of this stuff getting done. I have to wonder, though, I mean, what is do you really believe that? Do you buy that that that if Gary Cohen were to resign that the market would tang? You have to think about it.

It's it's it's not just meaningful because he's he's the National Economics Council director, he's also the front runner to take over the FED. So the market needs the price in, you know, the impact on Trump's physical agenda. But then it also has to kind of look at, well, what could the monetary policy implications be if he were to actually resign. So it's not just simply saying this is his current job. You have to look at the fact that he is a front runner to replace Yelling in February.

So what impact might that have? Right, He's a he's probably like Yelling, a kind of low interest rate guy. The market likes that. Who could the possible um, you know, replacement B if he were to step down to be the front runner, you know, would it increase the likelihood that Yelling uh stays in the job. You know, these are all questions that the market had to momentarily begin

answering this morning. But an ego boost, you know, it's like if someone someone leaves the whole market tanks, you know that it might be film pretty good fo um. Mike mcdonna, thank you so much for joining me. As always, Mike mcdonna is Global director of Economic Research and Chief Economist at Bloomberg Intelligence in New York. Thanks for listening to the Bloomberg P and 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 Blueberg Radio