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This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and am Marie Hortern. Join us each day for insight from the best in markets, economics, and geopolitics from our global headquarters in New York City. We are live on Bloomberg Television weekday mornings from six to nine am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen, and as always on the Bloomberg Terminal and the Bloomberg Business app.
Joining us now is Amanda Liner of a Black Rock.
Amanda, a difficult time for the Federal Reserved to.
Be meeting, given that their dueling risks seem to be their double mandate seems to be very much increasingly in conflict.
Do you think we're going to learn anything at all this week?
Good morning, Thank you for having me. That's the one thing that we are focused on. I would say the Summary of Economic projections has the potential to give us some incremental clarity on their reaction function. We think on the margin it will reflect a more challenging growth inflation mix. But keep in mind this is just the median of all of the different committee members. It's not actually a cohesive projection from the committee, so we need to kind
of discount that. What we are most focused on is what would be the scenario analysis the reaction function if the dual mandate comes into tension. A few months ago you started see Chair pal Beth Hammock talk about that being on the radar. I think the incremental news it has become, as you alluded to, even more challenging with the geopolitical situation, So that would be the hopefully the one nugget that we will be looking for is how
would they navigate that backdrop? What would they prioritize. The SEP already reflects an unemployment rate of four point four percent for this year, so we know that they are baking in some weakning in the labor market. How much weakening would we need to see in order for their posture to change.
Earlier this year, there was a feeling that any inflationary shock from tariffs or trade tensions in general would be transitory they even use that word, or even short lived.
Now there's a question of the dual shocks.
You have the terror for risk, and then you also have potentially some sort of oil shop that is persistent.
Even if it's not.
The closure of the strait of removes, there is this feeling that there's going to be a higher premium. How much does that complicate things and create a more sort of long lasting inflationary impulse.
I think you nailed it.
It's not just the inflation data, but inflation expectations. So even though they're navigating to core PCE, which would exclude energy, if we do have a rise in oil prices that is sustained, does that alter inflation expectations for consumers and could not cause them to react. I would say there's kind of two fold impacts that we see from this geopolitical backdrop. Its one, should there be higher U premias and corporate credit? And then two are there actually sector
specific implications if there are sustained supply chain disruptions. We haven't seen that yet, hopefully we don't, but those are really what we're focused on. And then the magnitude and the duration of that has yet to be seen. Even when the FED was I would think casually using the word transitory, when was that back in the March meeting? It was also CAVEATD with the healthy dose of we're
not quite sure really where this is going. I remember that meeting very well, and so I think they're even hesitant to say that they'll be able to look through it. I think they're just raising the possibility that maybe they can look through it well.
To the point of credit markets, again, it's another thing where we see spreads widen a little bit and then not really react that much. Where you have seen some weaknesses in the junkiest part of the market, is the risk real there? Could you start to see defaults pick up in that area?
Sure, So two things I would say, our conversations and really since early may have focused on two sided risks exactly as you noted, widening episodes have been short lived, and actually the common refrain from a lot of investors is, oh, I wish I would have taken advantage of that. More So, that's a very real risk, and so we're very focused on the two sided risks.
Where we are trading carefully.
And have been are those kind of left tail pockets of the market that we're already under pressure before the economic data deteriated. So, for example, US Triple c's had interest coverage below one time's already last quarter, it's rebounded a bit. That was before the economic data deteriated. You see that in pockets of the leverage level market, you see it in pockets of private credit. So that's really where we need to focus is saying, Okay, let's not
be too defensive. There's a real opportunity cost to being under risked. But at the same time, if a company was already having trouble growing into its capital structure, or a sector was already having trouble navigating this environment, nothing on the horizon's going to make it easier. And so
that's really I think where we are are mindful. I will add, though the high yield and leverage learned default rates have been quietly creeping for the past year and a half and it has not derailed the performance of the speculative grade parts of the market. So I think what that's telling you is it's the smallest capital structures that are defaulting. It's oftentimes repeat defaulters, and that is by definition priced into the market.
Well, if we do see I said, that falls in between that dual mandate and they can't take action and they can't cut and rates do remain elevated, does that start to spread well.
Actually, somewhat counterintuitively, it's probably going to support the yield base bid for corporate credit, which has been a really powerful technical force. I would say the yield based buyer has exhibited some patients on and off, so they're sitting it out sometimes. But in general, structurally higher interest rates coupled with okay growth, even below trend growth, that's not a bad recipe for corporate credit. That would probably bring some of that yield based demand in off the simelines.
This is also part of the reason why we like selectively moving down in quality. You were talking about the volatility and the treasury market. Kind of one of the understated differences between IG and highyield is high yeld as a shorter duration market, so you're kind of less exposed to those swings and treasuries, especially at the long end.
Just real quickly, here is the private credit market exposed to for selling based the fact that you're seeing endowments of universities looking to raise money, not for selling.
Illiquidity is a feature, not a bug, of private credit. What I think that is reflective of as a multitude of factors, and I think it's a positive that actually folks can make acid allocation shifts over time when they need to with liquid assets, but it's not a liquid market by design.
Amandal Adam of Blackcroc, thank you so much for being with us as always.
Right now.
Aaron David Miller of the Carnegie and Townment for International Peace joins us erin. I just want to get your sense of how realistic it is for the calls for de escalation to actually resonate with either not on Yahoo or with Iran at.
A time or both of them seem to be really digging in.
Great question, Lucia, thanks for having me.
I think it's completely unrealistic and detached from the current reality for three reasons. The Israelis want to destroy as much of Iran's nuclear program as possible, but they're going to have a very difficult time doing it, and they have escalation dominance and their superiority and political superiority. There's absolutely no pushback from anyone in the region, Europe, from the United States, from the Trump administration for the Israelis
to stop. As one Israeli general put it, retired, we're playing soccer with the Iranians, but they have no goalie. The Iranians having invested five trillion dollars into this nuclear program, having been embarrassed and humiliated to a degree that is unprecedented problem in the history of Islamic Republic.
Are not going to yield on this.
How deep their ballistic missile inventory is, what twenty twenty five hundred ballistic missiles. They can keep this up for some time, and the Americans, I think, are faced.
Trump administration is faced with a dilemma.
He does not want to answer this war, but he cannot stop it. It reminds me of Lennon Johnson's description in the Vietnam War of a hitchhiker in a Texas hailstorm. I can't run, I can't hide, and I can't make it stop. Question for Trump, for all of this, I'm not sure Trump wants to make it stop.
Well, that's actually something he's hinted at, this question of maybe they have to fight it out and just complete it. From that perspective, what is the ultimate goal though, Erin, I mean, given the fact that you just said that, as one general told you, Israel is playing soccer and Iran has no goalie.
But what's the ultimate aim?
Is it regime change?
How do they achieve something that actually can be sustainable for the entire region.
I mean critical question.
Have you told me on October eighth that eighteen months into the Israeli Hamas Warren Gaza there will be absolutely no sign of this conflict debating, I would have said, you basically are a bad analyst. The fact is the Prime Minister in Gaza has identified.
Total victory as a goal. I think what he would like to do.
His aspirations would be regime change on one hand, and number two deploying the United States if he can to do what the Israelis cannot, which is to destroy four though and really make a not a dent, but a major crippling of the Iranian nuclear program, which would set it back at least at least two years. So I think right now there's no reason for Ninitaannao to stop.
Ballistic missiles in Israel are very problematic.
I mean, the Iranians are launching, maybe ten to fifteen percent are actually getting through and striking. But you've seen Ethan reported, you've seen some of the damage. Twenty four Israelis killed. I think the public will endure this for quite some time. So right now I see absolutely no way no off ramp, no possibility.
And then you, of course raise the.
Question is what, in fact would a negotiation, other than cessational hostilities, what would a negotiation between the United States and Iran produce? Two months of negotiations produced an impast and I think your writings are in no mood frankly right now for compromise erin.
I hear you saying that there is not a likely off ramp in the near term. But for investors, what can we watch to look for any signs of de escalation or escalation from here? You know, what are the key points that you are looking for?
Right?
I mean d escalation I think right now is not in the cards. I think there's a really good chance that we'll be in for weeks in It's the escalatory possibilities that concerned me.
This is your guys business, not mine. Would concern investors as well.
And escalation, I think could occur in one of two ways. Number One, Iranian ballistic missiles actually end up surging and you end up.
With a mass casualty event in Israel.
Scores hundreds of Israelis are killed or wounded.
The Trump administration.
Under those circumstances, Congress are going to be hard pressed, I think to enter the conflict, and the second path escalation, or maybe there are three. Second path escalation, would be a bad decision in the part of the Islamic Republic to go after American assets, US forces in Iraq, Syria or obviously forces thirty to thirty five thousand Americans that are deployed in the Gulf, and they have many short range ballistic missiles, thousands of them that could produce that.
The third possibility is that the Iranians try some sort of asymmetrical strategy in which they go after Israeli interests abroad Jewish interests abroad in a terror attack. I think that's a back door that would also probably bring in in the United States. But again we've watched over the course of the last eighteen months. We've steered clear of the one thing that investors worry about, the one thing I would worry about, the one thing the region worries.
About, and that would be a major regional war.
We've avoided that this is bringing us. The longer this goes on, the greater the chances of an escalatory cycle, an Iranian Saudi conflict and a US conflict, which would essentially push oil prices, probably well in excess one hundred dollars.
Aron, just quickly, here one thing that the market keeps focusing on that could catalyze that kind of regional lord be shutting down the streets for moves. How realistic is that given the fact that to anger everybody in the neighborhood, I mean, the.
Rinians could probably close it, and the Americans would definitely open it.
But again we're talking about a.
Prolonged delay, filled with uncertainties, all sorts of exit ramps of an unpleasant nature that is going to make this extremely unpredictable.
Aaron David Miller of the Carnegie Endowment for International Piece, Thank you so much.
For the insight. Here's eldest the Federal Reserves today meeting kicking off tomorrow. The f ONEC widely.
Expected to hold rate steady but update its economic forecast, giving markets a clue about how officials will handle tariffs, inflation and more. Joining us now for that potential scenario analysis is Steve Verstudo of Mizuho.
Steve, great to see you, Thank you so much for being here.
Just before we.
Get into what the Fed does, I want to bring you into the debate that Kelsey and I were having earlier. How important is it that in the risk on Friday and today you are not seeing bonds full faith and credit rally.
I think there's a number of things.
A people have questioned the dollars reserve currency status, people have questioned a lot of interesting information about where people are going from a global perspective in terms of investing in the United States.
The reality is we haven't seen much.
Okay, so yeah, the dollar is down a little bit, but on a DXY basis, it's still very, very healthy. Under Joe Biden, we were at ninety on a DXY basis, and we're talking about ninety seven ninety eight.
Now, what's the big deal?
The reality is, when you look at most markets, there's very little impact of anything. And I think this goes to the fact that there is no systemic risk in the economy.
There is no balance sheet related risk.
There's excess liquidity, there's excess global savings, and there's a lot of oil floating around in the world. And I think when you put all of that together, you can easily see why Marcus are just sitting there saying, Okay, we've tried to sell off several times.
I've tried to rally several times. We've had eight recession calls.
Since twenty twenty two. None of them have worked. Let's just get on with life.
So you're essentially describing a bit of an equilibrium where everything is just.
Kind of at this steady state.
And so that gets me thinking about this concept of the neutral rate, which the FED estimates in the dot plot, and they're going to do another.
Crack at that.
That neutral rate has been taking higher, It's about fifty basis points higher over the last year, but the Fed still thinks that the current level of policy is restrictive.
What do you think.
I don't think the current level of policy is restrictive, having for quite some time, I think the FED rate cuts last year were a disaster. I think trying to repeat that again this year would be a bigger mistake.
I think when you look at a two.
Percent real greater growth in the economy, an inflation rate that's running about two two and a half percent, you're looking at four and a half percent neutral rate from a nominal FED funds rate perspective, And to me, where are we right now four and a half percent? I think we should be ending the year closer to five percent, because I think inflation will be three percent.
And I think the only reason why you haven't seen inflation from tariffs coming.
Through is because in this environment, while there's negotiations going on, a lot of CEOs are sitting there saying I'm not going to be the first one to move to raise prices because I don't want to lose market share. I pre inventoried a lot of stuff. I've got time, I've got opportunity. Let's see how this plays out before I'm make any decisions.
Well, we would certainly agree with you in terms of the inflation assessment. We also took a look at that and said, yeah, I mean, you're not going to get negative goods prices on goods prices month over month on a persistent basis. But I do want to kind of drill into this idea of goldilocks and how long it can persist this equilibrium, particularly on the labor market side, because what caught my eye last week was continuing claims which continue to rise. Use just those cracks under the surface.
Do you see those as a concern? Is there anything there for the FED to be worried about claims?
And continuing claims on a forward moving average or at exceptionally low levels. When you look at the covered employment there, even at a lower level, there's no risk whatsoever in this labor market.
And I think that's the key.
I think if you're looking for one market where there's potentially a movement out of equilibrium, it is the labor market. But that is only a move towards a tighter labor market. Okay, once you get this tax cut done, and this tax cut I think will be bigger than anyone still currently thanks, I think you don't wind up seeing what a much tighter labor market and much greater push on inflation. And therefore I question whether or not the Fed's going to get the so called two rate cuts out this year.
So you think that maybe the Fed's not going to cut.
Is that kind of your call?
Hour call has been the Fed shouldn't cut whatsoever, And therefore we believe the Fed won't cut.
So there's a question here about longer term bonds and how that really bleeds through at a time when people have not seen this as a haven, and there's been a real question about the inflation risk being priced in or not. And I'm just wondering do you see yields going higher from here with questions about US assets as a haven as well as potential that's only exacerbated potentially by inefficiencies and oil shocks that might come up along the way.
I mean, I think we're supposed to get to five percent on the tenure note.
I don't think that's a disaster.
When you look at what's happening in the boj market, for example, they're having a significant amount of problems.
There is yields rise in Japan.
You look at Europe, European rates probably aren't going to go up because Europe's a mess, and Christine Legard doesn't think she needs to cut interest rates and she does, so I think you've got this situation. Well, I'd rather buy Europe because Europe's more likely to go into deflation than by the US, where we're likely to have three
percent inflation. So I don't think we have to get beyond the macro into this geopolitical concern about solvency and sovereignty and all this other garbage and reserve currency to explain what's happening in markets. What's happening in markets is you're reflecting relative interest rate differentials based on relative inflation differentials and.
Relative real growth.
And there's nothing that's mysterious about this.
It's traditional macroeconomics.
So we're continuing to work through one big, beautiful bill that's going on underneath all of these headlines that we've been dealing with. And I was curious, you know, the way I think about deficit expansion is there's deficit expansion and then there's fiscal impulse.
So some of the improvement or.
Deterioration in the deficit is a function of just extending the tax cut was isn't necessarily a fiscal impulse. How do you differentiate between the two?
And you mentioned.
Already that you see the risk is actually to more fiscal impulse and more deficit expansion from here.
Yeah, no, I agree with you.
I mean, if you were just going to extend the tax cut alone, you would not have a major positive impulse into the economy. But we're not going to do that. And I think the interesting thing is all this stuff is going on, and the bill is working its way through the system without the political without the news oversight to it that it would normally deserve to get. And this is what happened when suddenly the House passed the bill.
Okay, when it came out of committee.
In the House, so many people walk up, Oh my god, it's not just extending, you know, the Trump tax cuts. And I think, you know, this is part of the process of how the bill is getting done as quickly as it is. And I still think their game plan is to get it done by July fourth and have it implemented by October one.
So they could have a full year of real.
Tax cuts coming through the economy going into the November elections.
And I think that's the game plan here.
I think the game plan is teriffts of the diversion to get the tax cut, tax cuts are the reason to get the midterm. The midterm is to get to what they really want to do, which is.
Drain the swamp.
Well, this is what we're going to try to focus on as we parse through all the different risks that are coming up and dominating the new stever Shudo of a zooha, thank you so much for being with us. Back to our top story for market, it's a fourth day of fighting between Israel and Iran, raising uncertainty for energy markets. Ellen Walls of the Atlantic Council, writing, if Israel can take out Iran's ability to produce gasoline, diesel
and provide electricity, the situation becomes significantly more dire. If the regime cannot maintain control through the use of force, it will likely fall.
Ellen joins us.
Now, Ellen, thank you so much for being with us, and we are just getting word from the Prime Minister of Benjamin Natan Yahoo that Israel is on the way to destroying Iran's nuclear and missile threats. Do you have a sense, Ellen of what the endgame could possibly be?
You know, it's interesting because I think for Israel, the real endgame is just to take out all of the Iran's ability to threaten them, so the missile sites, the nuclear sites.
I don't think that.
They're really aiming for regime change. I mean, they don't want to participate in that. I think that there's also the understanding amongst them and also amongst US policy makers that what would take its place, and sometimes.
Uh, the a lack of a regime or a power.
Vacuum could be even more dangerous. I mean, you know, there's the IRGC is probably the strongest entity in Iran, and so if you know the civil government falls, It's possible the IRGC or what's left of it, would take over, seeing that they have you know, control of most of the use of force there, and that could be you know, potentially a worse situation than they're in now. So I think there's a very delicate balance here between causing you a widespread destruction.
If you're going to take out you know, multiple.
Fueling stations and you're going to take out multiple refineries, then you're going to essentially, you know, send around to the dark ages for a period of time, and things could really fall apart at.
The individual and city level.
So I think that they're they're really, i think, working more towards taking out the military capabilities as opposed to trying to say, foment widespread destruction.
Allen, A lot of people have talked about the idea of some sort of broadening out of the conflict and embroiling a greater number of countries in the region in this war.
I just wonder, who's Iron's friend.
Why is there anyone or is there anyone coming to Iran's defense in any capacity, or are more of the nations on Israel side, or just frankly don't want to get involved in any way, shape or form.
So I think that in terms of say friends, I think that Iran has potentially has maybe some strategic allies that could be useful in maybe arguing Iran's case in a diplomatic situation. So take China for example, China buys a lot of oil from the Iran.
Relatively they're Iran's largest customer. But because Iran.
Buys that oil and they accept Chinese currency, they have to spend a lot of that Chinese currency on good.
And services from China.
So China does a lot of business in Iran, and
China doesn't want to see this situation fall apart. If, in fact, it gets so dire that there are threats to Chinese ships or oil tankers that are heading for China, you know, coming out of the Persian Gulf, and that's not just Irani and ships that could also be ships coming from Saudi Arabia, from Krewate, from other oil suppliers, then China is definitely going to exert the full weight of its economic might internationally and on Iran and say, okay, you know you've got to cut a deal.
This has to end.
You know, this is not worth threatening our you know, economic relationship Russia likewise. In fact, we saw Russia saying, now, hey, we want to We're ready to, you know, facilitate negotiations and we'll accept all of your uranium Iran, which you know, is kind of an.
Interesting offer from Russia.
But they're definitely, I wouldn't say they're necessarily on Iran's side. They're not going to come e them in the event of military catashph but they would definitely be there to support them.
In a diplomatic sense. And I also think, you know, you've got Saudi Arabia.
The Saudis definitely aren't best friends with the Iranians, but relations have certainly improved, and I think the fact that you see them essentially quiet is really almost.
A sign of not support.
They definitely would like to They're more than happy for Israel to take out Iran's nuclear you know, nuclear arsenal and nuclear reactors, but they don't want to see Iran completely devastated.
That's not a good situation for.
Them, you know, like a power vacuum in the Gulf is not going to be a good situation for the Saudis, or for the Amortis, or for anyone else. So if it gets to that, you are going to see them standing up, and I think trying to support the regime ellen.
Whenever conflicts arise in the Middle East, concentration quickly goes to the strait of horror moose and the likelihood of it being closed. Is that the right thing to be concerned about? Or is there a scenario or you get what's happening in the Red Sea where you get one a few tankers attacked and that's enough to convince insurance companies that it is not worth trying to ensure ships going through the street.
So it's interesting. I think there are two points there.
I do think that we're a bit stuck in this old paradigm from the twentieth century where we all is in the West need oil from the Persian Gulf, and we all remember, or at least those of us who were alive, and then remember the Iran Iraq War, and there was a tanker war and both sides were Iran was trying to prevent certain tankers from leaving the Golf, and certain tankers needed basically US military escorts in order to get out, and that caused havoc with oil prices.
So I do think the straight up Room is a very important waterway, But if you look at the traffic patterns and the way that ships go around there, there are other ways to traverse the straits that don't involve going through Iranian waters.
So if it did threaten the security of ships there, there are workarounds.
They're not that easy and would take some time to work through, but it is absolutely possible. The other issue though, is that, like you said, that can Ron actually do this. It's not clear that they could physically that they could physically close the straights. On the other hand, they could cause enough trouble that insurance companies are going to raise their rates through the roof. Now, does that make it impossible for ships to go No, people will pay, but
oil prices will have to go up. Customers will have to pay more in order to compensate for that insurance rate. When you look at the Red Sea, that's a little bit different because there is an alternative route you can go around Africa and a lot of you know, large ships are equipped.
To do that.
So, but with the straight Ufore moves and the Persian Gulf, other than a couple pipelines that are able to get oil and other products out without going through the streets.
There really is no other way out.
So for a rock cut, some Saudi oil, Bachrainy oil, there's no other way. The UE has a workaround and so modifications could be made, but there's nothing else they can do, so they're going to just have to pay the higher insurance rates.
Ellen Waalds of the Atlantic Council, thank you so much, as always for your insights.
This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics, an gio politics. You can watch the show live on Bloomberg TV weekday mornings from six am to nine am Eastern. Subscribe to the podcast on Apple, Spotify, or anywhere else you listen, and as always on the Bloomberg Terminal and the Bloomberg Business Out