This is the Bloomberg Surveillance Podcast. I'm Lisa Abramoyds. Along with Tom Keane and Jonathan Ferrow. Join us each day for insight from the best in economics, geopolitics, finance and investment. Subscribe to Bloomberg Surveillance on demand on Apple, Spotify and anywhere you get your podcasts, and always on Bloomberg dot Com, the Bloomberg Terminal, and the Bloomberg Business App. Julian Emmanuel of Evercore I say calling for the S and P five hundred to end next year at drum roll forty
seven fifty, basically where we are now. He sees a pullback in the first half that will take the index down to thirty nine seventy and then a rally kicking in quote prior to the twenty twenty four election, based on received recession trough and inflation falling to the FEDS two percent target. Julian, I'm so glad to say is joining us now. Julian, you're calling for a pretty big draw down. Does that mean that you're really leaning against what we're seeing right now?
Well, actually, in context of typical raw downs, it isn't really that big, you know, on the order of fifteen sixteen percent, which you tend to see in most years. You didn't see it in twenty twenty three, which is why the Vicks is at twelve. And we had this, you know, incredibly great feeling and obviously we've had a lot of momentum in December, and look, the message we got from the FED was very much and all clear.
The markets responded in kind. But frankly, when you think about it and you go back to July when we had that interim peak at the time of the last hike, in fact of the cycle, there was that diminution of the wall of worry. The wall of worry doesn't exist
right now. And so from our point of view, even if you manage to skirt around the recession, which is certainly possible, and the data doesn't show that we're in imminent danger, but even if you do, there is likely going to be a growth scare time, just because there's so much optimism in the markets right now.
So that's what you think is going to crack it. Bad economic data, that is what you think is going to spur the downside. Not any kind of retlacement about the idea of a FED pivot.
No, the FED is not going to unless the inflation data surprise to the upside, which again it doesn't feel that that's going to be the case, though I would observe that. Notably, you know, oil among other things, have rallied quite strongly the last couple of days, perhaps in response, but no, I think that that based on what we've seen, the FED is likely going to try and be as quiet as it can for the next several months.
Does that mean that it drops out as a driver, because you think about the equity markets, they've been so macro driven for quite a long time. Right now, if the FED really is on hold, maybe starts cutting those rate cuts already priced in. Do we start paying more attention to corporate fundamental.
Well, look, the FED will never disappear in this cycle because this cycle is so unusual. But you know, we'll turn the page to January. We will remember that we will have a government that will be facing shutdown, we will have elections in Taiwan, and we will have fourth quarter earnings reporting season. You know, from our view it's not that big a deal, but bottoms up consensus is
a bit too high in terms of earning expectations. Those will be walked back and then, as has been the case this entire year, the most important thing is not going to be what the news is itself, but the price reaction to the news. And if you think about it, all the volatility this entire year has been almost exclusively the purview of the bond markets. It's been relatively quiet in terms of credit, in terms of equity. We think that's going to change a little bit next year.
So Julia, let's say I agree with you, and I do believe the time now is to get defensive, given where the market is right, what's the best way to do it? Do I want to be rotating into some of those classic defensive sectors like staples, healthcare, et cetera, utilities maybe? Or do I want to be using options? Put your options had on for me? Do I want to be buying puts? I want to be selling calls?
Here?
How do I protect?
So the beauty of what we've had the last number of months is that some of the more classically defensive areas haven't actually been the beneficiary of interest rates coming down and inflation coming down, a lot of other noise, you know, in areas like consumer staples and healthcare there's been a lot of confusion and a lot of fear frankly, around the GLP one phenomenon, and so people have stayed
away from there. But now all of a sudden, we're in a place where, particularly when you think about inflation, input costs into those sectors are moderating, wage gains are starting to moderate, they are going to benefit, and frankly, the work that we've done shows that the defensive sectors, as you said, staples and healthcare and particularly the ones we like, tend to outperform on average from the time of the last FED hike to the time of the
first cut. So it's really a way to play offense with defense.
Well, to get to the second part of Damien's question, beyond just buying maybe defensive type sectors, are you looking to hedge here?
So it is something where particularly if and we say this very much in terms of the retail investor's mindset, is that what you want to do is envision yourself as a buyer down call it's fifteen percent an average type of yearly drawdown. And if you don't see yourself as a buyer, because buying the dips has been a strategy that's worked our entire investment lifetimes. We don't see that changing. Then you want to take advantage of the fact that options are incredibly inexpensive.
Are bond yield's going to go a lot lower in the scenario that you put out?
So I think the bond fields are sort of maybe getting to some sort of stasis because obviously, look, if we do have an economic turndown or at least a growth scare, clearly that's more downward pressure on yields. But on the other hand, there's this idea that there's a secular change in international investors appetite for fixed income and oh, by the way, the Feds still doing QT, so that limits any downside in bond yields.
Just to give you a victory lap, you did call the turn in small caps it's been a rip roaring rally over the past six weeks. Is it time to get out ahead of some concerns about growth?
We don't think it is. And actually it's fascinating because this has never happened for before. In twenty twenty three, you undercut your bear market low in small caps just at that October low, and then less than a month later you had a new fifty two week high in the Nasdaq. That kind of divergence has never been seen before in the entirety of a calendar year, let alone
one month. And so if you think about it, even if you do get a recession, small caps have for the most part already been through their recession in terms of share price performance. And again, similar to consumer staples and healthcare, they're going to benefit from a labor market that's easing. And yes, the consumer still does have excess savings, which we think cushions the severity of any downturn.
Julina Emmanuel of Evercore ISI, thank you so much. Right now, we are seeing in the market a little bit of a lift to basically beyond the year end target that Julian has a forty seven eighty five, up a quarter of a percent. Julian, how much do you think though, that there is enough fear that could get brought in from any weakness to give a drawdown Given that there is so much cash it's going to be pushed out of money market funds as yields go in.
Well, it's definitely going to cushion the blow. But again going back to this idea, yes, we've more or less been promised three rate cuts, but in fact, if inflation does not continue that you know very you know marked at this point downward path, you're still going to have cash yields north of four percent four and a half percent, and again within the context of the last fifteen years, that's still quite attractive.
Join em Manuel, thank you so much. We've been talking so much about the Israel Hamas war that we have lost focus of another war that's been raging, which is Ukraine, and we've been focused all week with respect to whether they can get aid from the US but also from the European Union. Let's get straight to it. This is a really important conversation. John Lieber, Managing director at the Eurasia Group and former policy advisor to Senator Mitch Baccaddel
joining us right now. And I do want to start there, John, considering the fact that it wasn't just the US that failed to pass aid after of lot of Roslenski came to Washington, d C. But overnight the EU as well, also failing to get anything through before the year of the before the end of the year.
Yeah, I mean, but a lot of veto points in it, and it makes it hard to get anything done. But in the US, you know, this is less of an urgent issue that is in the EU, which of course also has a lot of veto points because any one country can stop the aid come flowing for now. Ultimately, you know, this is a much higher stakes issue in Europe than it is for the United States, and probably the Europeans are going to be potentially more reliable partners
than the United States is. But it looks right now like the US is set to punt on this issue, perhaps into January of next year, when further funding for Ukraine will be tied up not only in the Congress's ability to negotiate border funds, but also in their ability to avoid a government shutdown. So this is a really messy ootiation right now, and the outlook does not look great for the continued major flow of weapons and support that we've seen to Ukraine so far.
Well, John, that's what I wanted to talk about, the point that you made that this is a higher priority, a bigger issue with more urgency when it comes to the EU. You take a look at what's happening in the US Congress that debate between more usaid for Ukraine, whereas the Republicans pushing for more border security. Who do you think, what does the compromise look like there, and how does this evolve in January.
I think the Republicans have the upper hand in the debate right now because they have the ability to veto any additional aid, because Speaker Mike Johnson can just say thanks for your effort to the Senate, I'm not putting your bill on the floor unless I like it. There's almost certainly enough votes in both the House and the Senate to pass more Ukraine aid plus more border funds.
The Republicans are using this as a leverage point to hold out for everything they want on the southern border, changing the asylumn rules, creating more ability for the government to deport legal immigrants, and the Democrats are saying, no, we aren't gonna do that. They think this is inhumane and they don't want to treat migrants on the southern
border that way, and they're at an impasse. So I think ultimately the compromise is going to be something like what Biden proposed, which is a tens of billions of dollars in additional aid for Ukraine but the whole a plus the border but the whole thing could fall apart because the two sides just are not close to agree on this border issue, which right now is the lynchpin towards getting a deal.
John, I'd like to shift back to Europe here. I'd like to talk about Hungary. I'd like to talk about Victor Orbon, the Fidez party. I mean, what is going on there? I mean, does Victor Orbon represent the belief of the Hungarian people? I mean, they are holding up the fifty billion odd in funds to Ukraine at this point, they're the only EU member doing that. What comes next?
Yeah, they're holding up the money. But oddly they did let they walked out of the room when it came to the Ukraine ascension talks. So it seems like they're playing. What kind of game he's playing is really unclear right now. Obviously, Orbon's trying to flex some muscle inside the EU and make sure the Hungary's influence is felt, and they're going
to revisit this next year as well. I think that for both of these bodies, this debate is far from over and there's still some more negotiating and horse trading that can happen both within the EU and the United States. But it's hard to say exactly why Orbon's doing things this way. It looks like he's just trying to increase some leverage over the EU for Hungary.
Well, John, Hungary is generally viewed as, you know, the closest ally to China within the EU. I wonder can we read anything into that is China, you know, kind of pulling the strings behind the scenes.
A little difficult to say, especially at this point. I think the outcome yesterday was a little unexpected, particularly on the fact they let the Ukraine ascension go forward. I think that's a sign. You know, that's a long term process. It is going to take many years probably for Ukraine to qualify for EU membership. And it's really difficult to say what China benefits from the EU not funding this war.
I think what China wants is probably an end of the war as quickly as possible, but not necessarily on Russia's terms, which is where all of this is going to end up. If the Ukraine can't get more aid out of its Western partners.
Just to sort of put a bow tie on that, are you basically saying that Russia will win if Ukraine doesn't get more aid.
If Ukraine doesn't get more aid, Russia has the upper hand. They've got the manufacturing capabilities and the patients in long term timeframe to wear down the West. So Ukraine really needs the West to step up here, and if they don't, they will win this war.
In the meantime, we all also are dealing with the Hamas Israel war that keeps going on. But there seems to be a real tone shift from this administration really warning Israel against more kind of indiscriminate air strikes or more broad based military action and more sort of surgical types of procedures going forward. How big of a deal do you think this is?
Yeah, I think as the kind of horrors of what happened on October seventh fade in the public's imagination, the political liability for Biden of the Israeli response in Gaza is growing, and Biden, you know, there's a lot of damage that's already been done for him domestically among the progressive left and young voters, which are both important parts of his coalition. And I think that the humanitarian situation in Gaza is becoming untenable for the United States to
support now of course, Biden's only shifting his tone. The US is still supporting the Israeli militarily and will continue to do so for the foreseeable future. There is a broad consensus among in the United States Congress that Israel has a right to defend itself and it will continue
to do so with US support. But for Biden, this is becoming a political liability, and I think that they're going to start putting more and more pressure on Israel privately and publicly to be more tactical than what they want to do in how they approach this. But that doesn't mean the Israel is going to stop, and it doesn't mean that the is going to stop supporting now.
It just what the US wants to see is that hasten hastening to the next stage of this war, where you know, Hamas is removed and then you can move to a kind of post war period and rebuilding.
Well, John, to your point on political pressure, we're talking about how the Biden administration is handling this, but let's talk about Joe Biden, the presidential candidate. Of course, for what eleven odd months out from the presidential election, you think about these hot wars happening in other parts of the world. How is the American voting public ranking that when they're heading to the polls.
I think the wars are bad for Biden because it gives this narrative to Trump that the world's on fire, and Trump, you know, ignoring COVID, can is go to say, when I was president, we had peace, we had prosperity, we had growing real incomes, there was no inflation, and you didn't have all these wars around the globe that are He's going to attribute to President Biden's withdrawal from Afghanistan.
So as a political matter, the wars are going to play in a pretty major way in the narrative of the US election next year, even though foreign policy is typically not a top issue for American voters, and I think that very much works to Trump's benefit. There's nothing Biden can do about it. He is committed to funning Ukraine if you can, if you can get the money, and he's committed to defend allowing Israel to defend itself.
So this isn't Biden's choice, but it's going to be a problem for him next year if these wars are both still raging in the middle of the US campaign.
John Leeb, thank you so much for being with us of Eurasia. We appreciate the insights joining us around the table. Greg Daco, Chief economist at EY. Do you think that hopes and dreams of immaculate disinflation have gotten overblown and that there is this concern about a slowdown that's steeper than people are pricing.
In well, I think we have to be nuanced when we analyze the economic landscape. We are in an environment where we are seeing slower economic activity. I think there's no denying that, whether it's on the consumer side or on the business side, we have seen a slowdown in terms of the pace of growth, so it's not immaculate disinflation. We've seen the supply come back online. That's helped with the supply the inflationary picture, and we're seeing moderating demand
which is also putting downward pressure on inflation. So it's not immaculate and I think as we look into next year, that's going to be continuing to drive inflation lower, whether it's rent disinflation, slower momentum in terms of growth activity, even wage growth compression, and the fact, let's not forget that the FED is still maintaining a restrictive monetary policy stance. Combine all of those and you have all the right ingredients for a disinflationary environment.
Let's talk about sentiment a little bit, because we've been talking about this morning, the fact that you think about the US consumer and you take a look at these sentiment surveys and it has just been grim out there for years now, and when do you think about inflation. Yes, we're in this disinflationary environment, but the outright level of prices is still much higher than it was. Do we need to see actual deflation to see some of those sentiment numbers that.
You're alluding to the most important point when it comes to the inflationary dynamics. Because we talk about inflation, economists, policy makers, we all talk about inflation, But what matters for the average person, whether it's the consumer or the business leader, is the cost level. The cost fatigue phenomenon is very real. The cost of everything is much higher than it was pre pandemic, whether it's goods, services, labor, inventory,
even interest rates. Everything is much higher, costs much more. That is leading to business decisions being pulled back and being more scrutinous about how much to invest. It's leading consumers to be more careful about how many goods, how many services they buy, even though they're spending a little
bit less. And I think that's the very important narrative that's going to be really underlying the pace of growth next year is how sensitive people are to this higher cost cost of everything environment and how the labor market reacts. Let's not forget the labor market is the key pillar to economic activity.
Greg the dot Pot's calling for seventy five of cuts. I think the market's priced inn one hundred and forty PIFs of cuts. It's pretty big divergence there. You know. Talk to me about the why is disinflation enough of a reason for the Fed the cut rates in twenty twenty four?
Well, yeah, I think the key reason why the Fed will be adjusting rates is because it sees less inflation. Last time I was on the show, I was talking about the fact that we have the holy grail of non inflationary growth in front of us. We have an economy that's still moving forward, but inflation that is moderating. That is what the Fed wants. The Fed does not
want a recession. It wants to see inflation come back down to two percent and become a non issue, a non topic, something that we don't talk about every day on this show or on other platforms. This is really
what the FED is aiming for. So whether it comes to the fed's forecast being realized or the market expectations being realized, I think the truth in the end will lie somewhere in between, probably one hundred and twenty five bases points of rate cuts by the end of the next year, with an environment where inflation is gradually slowing and we don't enter recession. If we enter a recession, the picture in the game is going to be quite different.
Greg off the year, Lisa and I always like to talk about real yields. She likes the five year. I like the ten year. Personally ten year real yield one point eighty eight percent, down sixty basis points since October. How low can real yields go well?
I think that's the key question for next year is going to be what happens in terms of growth momentum, what happens in terms of inflation momentum, and how rapidly does is a FED ease monetary palsy. That is what fetch your Powell and the rest of the FED officials are going to be focused on They're going to be focused on ensuring that real yields don't rise. Dude, do you not want to be tightening in the face of a slowdown in final demand, in the face of a
slowdown in inflation. So they're going to be recalibrating monetary palsy gradually. I think the March rate cut calls right now are a bit extreme. They're going to be making sure that inflation is really sustainably on this trajectory of lower inflation, and then recalibrate to the downside gradually with twenty five basis point increments to start with.
I mean, well, I do want to just bring this to you. New York Fed chair John Williams has been speaking, and he said that the market is reacting maybe more strongly than forecasts show, and also said we aren't really talking about rate cuts right now, as Neil Data over at Renaissance just commented, sorry, but you can't put that toothpaste back in the tube. There is, however, a market response.
We are seeing bond yields rise to year yields rising to about four point four six percent ten year yields spiking upward to about three point nine six percent. This raises a question, Greg, do you think that they are getting concerned about the easing and financial conditions beyond what Jaypowill seemed to indicate yesterday. I think when.
People say that the easing of financial conditions is going to reignite growth and reignite inflationary pressures, I tend to be a little bit more cautious. First of all, as we were just talking, we have to factor in the fact that maybe market expectations are a bit too strong. FED policy communication is going to recalibrate that market perspective.
Number two, it's not for get as we just talked about cost fatigue and labor market developments are going to be the key drivers of economic activity, not so much rates. And then number three, and this is very important. We are in an environment where there is less rate sensitivity. There was much less rate sensitivity on the upside. We should expect to be a little bit less rate sensitivity
on the downside as well. All three factors mean that we have to be a little bit more nuanced when it comes to the economic picture.
Greg Daco wonderful as always to catch up with you.
Happy hollog always a pleasure, Happiologist Greg Daco of.
E Y, Let's welcome in Meghan swib Or. She is director of US rate Strategy over at Bank of America. And this feels how it usually goes. Of course, you have your own pale come out at these FED meetings and then FED speak happens and tend to walk it back.
Yeah.
I think that's exactly right, Katie. We had just such a prominent rates market response to Powell's very dubvish comments here, and so we were actually flagging some of this in our recent publication. It seems like the market's in for a bit of a consolidation here, and I think that
William's comments really endorse that. One of the things, though, that we see born out in a lot of the indicators that we look at though, is we had positioning largely long coming into some of these moves that we got so in rates in particular, that's an area where we can see investors covering profit taking alongside some of these recent moves as well.
Well. I mean, Katie says that I never like to not talk about currencies, and we're talking about currencies here because you talk about currencies. We're talking about dollar yen here. I mean, that's one of your trades, right, you do believe that there's more downside to dollar yenna current levels. But I look at rate differentials and I say, wow, look at those rate differentials. To put that trade on, My goodness, you're going to be bleeding on a P and L basis. How do you put that type of
trade on? How do you play that in the market.
So this is actually something that we're seeing a lot in the FX and rate sentiment survey that we conduct at at b of A. Generally, investors are short dollar, and the way that they're kind of playing this, of course verses against the yen, and we think that positioning
is really quite stretched right now. So ahead of some of these adjustments that we see coming from the BOJ, we think that the preferred way to do this is as in short jgbs rather than play this in the currency market because of some of that stretched positioning that we see.
No, no, I don't disagree, but then you also have I mean, look, I forget about dollar yen. You've got mespacogin, right, I mean, look at mexpaeso. It's one of the few currencies that's really been kind of off relative to the whole of every other currency with the dollar, you know,
because it kind of tracks the dollar. You know, talk to us about that dynamic, you know the fact that you know, you've got currencies like the Mexican pay so that's tend to track the dollar in certain environments, currencies like the Japanese and that tend to track the dollar and risk off environments. How do you kind of manage through that when you're a fixed income investor?
So I think that what the real impetus that we see for a lot of this divergence in positioning is just that conviction about the said path, which is actually another thing that we see born out in the survey,
is that investors are long rates and short dollar. But ultimately alongside that, there is some skepticism around how which is the Fed ultimately going to cut investors generally thinking that if there's one central bank that can surprise a little bit more so to the hawker side versus expectations, it could indeed be the FED. And I think that it really comes down to this message that they've been delivering,
which is data dependence. The market understands their reaction function now that they want to be cutting alongside this progress in PCE inflation, and so that's why we've gotten this such sharp recalibration. But the Fed has really done such a heel turn on this that there's risks that they can do that again.
Well, let's talk about the dispersion of potential outcomes here, because you have the dot plot penciling in what seventy five basis points of cuts next year, then you have the market at one hundred and fifty basis points. Where do you fall in between that?
So we've been long coming into this this most recent rate rally. I want to say the year because we wrote our year aheads in November, but it really has been almost a year and in a month in terms of some of this price action. So we had been recommending investors trade long trade on the five year sector in particular, because that's the point in the curve that cannot just be sensitive to just what the timing is of cuts near term, but also this trough of the
FED cutting cycle. So when we look at market pricing versus the dot plot, what we see is the market is certainly overpricing the extent of cuts versus what the Fed is endorsed. But what we see also on the flip side is that the market's pricing a higher trough of the FED cutting cycle than ultimately what the Fed
is telling us. Right, we look at the dot plot suggesting that the Fed is going to get to below three percent, that's where they think neutral is, But the market's still very reluctant to price that, and I think it really is driven by some of the uncertainty that we still see in the inflation market and the fact that we were not really seeing broad based weakness elsewhere and trying to get a better sense of what is it that's going to cause the Fed to really cut
more aggressively and bring rates back down to something that they think is that neutral rate. So we've been long, we've taken that position largely off because of the the very sharp performance that we've observed, and now we're being a little bit more tactical, you know, managing some of the opportunities that we see headed into next year, but are roughly neutral at this point.
All right, Megan, great to check in with you, especially to get your live reaction to these comments from John Williams that are moving the markets right now. That is Megan Swiber of Bank of America.
Subscribe to the Bloomberg Surveillance podcast on Apple, Spotify, and anywhere else you get your podcasts. Listen live every weekday, starting at seven am Eastern on Bloomberg dot Com, the iHeartRadio app tune In, and the Bloomberg Business app. You can watch us live on Bloomberg Television and always on the Bloomberg Terminal. Thanks for listening. I'm Lisa Abramowitz, and this is Bloomberg