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This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and Amrie Hordernt. 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. Let's get to the
view on Wall Street this morning. Russ Coastrick of Black Rock right in the following. While our base case is no recession, the energy shock suggests a moderation in near term growth expectations. Russ joins us now for more. Russ, welcome to the program. You and a team have been de risking where and what.
In Good morning, Jonathan, we've been to you risking across the board. We've really been getting most of the benchmark in our equity positions, benchmarkt duration. We've been bringing down some of the factor risks and the portfolio and there are a couple of reasons for that. The obvious one is we don't know how long this is going.
To go to continue.
I think you used exactly the right word a few moments ago, persistence, and the longer this persists, the greater the risk to inflation the economy. But the other reason for de risking is that there really aren't any hedges in this context. In twenty two, the dollar actually was an effective hedge against the.
Sell off inequities.
Last decade, treasuries were providing some downside when they're concerns about growth. In other circumstances, gold has been working. Nothing is working right now, So really the only thing you can do within a portfolio, other than making some adjustments at the stock level, is to bring the risks down.
I often say in moments like this, the bonds don't work, They make things worse. Yields right now up again by four basis points for US tens at four forty five twos of four percent LEASA and I yes that I spent a lot of time on a week two year oction, a week five year oction followed by a week seven year oaction as well.
Russ.
What is happening that? What's behind those moves.
This to me is actually maybe even a bit more interesting. It's going on in equity market, so it's very easy to understand. You have an oil shock, higher inflation, hit to growth, and what's happening with stocks. The bottom market, I think is more nuanced. Obviously, the bottom market is reacting to what will be an increase in headline inflation.
That said, as you point out, I think most people realize higher energy, not just oil, but natural gas, higher food prices, higher fer fertilizer prices, all of which leads to an increase in headline inflation. But the problem is one that doesn't necessarily flow into core, and two, it is also a drag on growth. And there's happening at a time when the labor market has already a bit solved. So the notion that you just want to keep selling bonds into this, to me, that's less obvious.
And I do think at some point.
If the concerns about growth continue to build, if we do have one hundred dollars or higher oil for prolonged period of time, there is a question about at what points you want to start bringing bonds back into your portfolio as a hedge against weaker growth. Which is going to be another risk we're going to contend with.
Part of the reason why it's been so hard for us to get a handle on when that point is when people should step in and by duration? Is it's unclear exactly what's behind the sellof Is it technical? Is it a question of central banks that are selling what they can to raise money for possible fiscal stimulus. Is it a potential concern for a fiscal response to any kind of slowdown in the future.
What's your take on this. I think it's a great question. To my mind.
One of the things that's clearly going on is a pricing out.
Of what would have been a number of.
Rate cuts from the FED and pricing in a greater possibility of hikes, particularly from the So is the front end of the curve is adjusting. You're seeing that movement throughout all of the yield curve. But again, if we're going to be an environment where hunderdollar oil persists, and I think you all raised a good point a few moments ago, it's not as if oil is going to go back to sixty five the second the shooting stops.
There's been damage to infrastructure, there are questions about how long it takes to open the straits of horror moves, there is likely to be a war premium or a risk premium embedded in oil for many, many months. So if you're going to have that period of prolonged higher energy and all the knock on effects, you've got to start to bring down your growth expectations, most of which we're high coming into the year, and at some point that probably does suggest bring you to ration up further, which.
Is something that I know others, including JP Morgan, has been thinking of doing this doing given all of this and given what we know in terms of the prolonged conflict, do you think that right now we're facing a market that is over complacent when it comes to the growth shock that's coming down the pike.
I don't think it's overly complacent, because they do think you've already seen a fairly significant adjustment.
I also believe that at least in the US, I think.
The situation in Europe is certainly more serious, giving their exposure to higher energy prices.
I think the US can probably.
Survive eighty or ninety oil still have a year when growth is positive. Of course, the difference is going to be that we're not going to get, or we're much more less likely to get the type of above trend growth that investors were expecting just a few months ago. And if you look, what the equity market has been doing is actually responding to that. The rotation that dominated back in late twenty five early twenty six was all
about the broadening out. You bought cyclicals, you bought value, you bought international stocks, you bought small caps.
To my mind, those trades.
Were predicated on above trend growth. As you start to price that growth out, you're seeing a reversal of many those trends. Investors have been looking for more defensive parks in the market, and interestingly enough, they've also been looking at tech, at least on a relative basis, is holding up better in a world which economic growth is.
Not as much of a tailment. Stay with us more Bloomberg surveillance coming up after this. Let's talk about europe Global central banks facing the thread of higher inflation as energy prices saw the ECP navigating mixed signals, with some policymakers ready to act fast, others urging caution. Join us now to discuss as an ECB Governing Council member, and the National Bank of Beolgium. Governor Pierre Funch, Governor, Welcome to the program, sir. Let's just start with the nature
of this shark. From your perspective, Is this the kind of shark that a central bank should look through?
Well, that's of course the big question, and we know the textbookcase is for looking for if you're confronted with the supply shock. Now, in the meantime, we have the episode of twenty two, and in twenty two we were a little bit late and reacting. We had team transitory. We're not alone. I was maybe one of the first governors to be concerned about the fact that inflation might might go up further than what we had in our models.
So now we're there, we have again a supply shock, and we have to decide how to react to it. We should not overreact. I think so far we were able, I think to communicate the fact that we would react if need be, but that we were not going to rush to do anything that would would be looking like overreaction. But anyway, I mean, we have to Twenty two is different.
We have the textbook and we find we need to find a middle way between what we have in the textbook, which is we don't react, and the experience we had in twenty two. But in twenty two, of course, there were a lot of bottlenecks in the system, very tight labor markets, you had a lot of fiscal support coming out of the COVID crisis, and that's not the situation we're in today. The labor market is a bit weaker
in Europe. So we will have to find a good balance between the textbook situation and again what we experienced twenty two.
The governor, does that give you more time? Does that give you more time? And it's April too soon to know what kind of shock this is to understand if you should look through it or react to it.
Well, if the conflict is mainly over by April, then I guess we will be closer to what we have in our baseline. We just made some projections over the during the last weeking of the Governing Council. I think the base case that we produced was still relatively benign. Inflation was moving to a peak of three percent but not only yearly basis, and then going down quite quickly to two percent. On the basis of that, it's not
clear that the reaction would be warranted. Of course, we were doing the projection on the basis of two hikes that were priced by the market. But I would say, you know, if we're if we are still close to the baseline, that it's not clear we have to react. If we move to what we call the adverse or the CV scenario, then we have higher inflation and certainly more persistent in the case of the cvere, and then my guess would be that we have to do we
would have to do something. But even then I think we need to make a distinction between reacting so that real rates remain stable or reacting and increasing real rates. So if you believe that core inflation is going to go up for a period over a year, you may want to react, and the first tike might just be
adjusting to this higher core inflation. And then there is a stage if the shock is bigger and you have significant second round effects, which is of course a big part of the uncertainty, where you might have to to tighten as such, And I would still make this different hiking as such, if core inflation is going up, might not be tightening. And I'm not talking about you know, a spot real rates, but say, over a period of one or two years, depending on what's our review of the world is.
Governor, it sounds like your more patient, potentially than some other members on the ECB. I'm thinking, for example, of a recent interview that President ECB President Christine Leaguard did with The Economist yesterday, saying that the ECB would have to respond in a force flow persistent way if inflation looks set to sit well above it's two percent target for an exodent period, most people would agree, but she said even a more modest overshoot could call for a
measured rate move. Do you agree with that that if inflation does not look like it is poised to go down to two percent, say by the end of this year, that it makes sense to signal to markets that you're serious about containing inflation by making a hike.
Well, if I gave the impression that was not aligned with Christine Lagad, I'm sorry for that, because we are completely aligned, or I'm aligned to her with her you, but I was just discussing the case where by the meeting of April the conflict would be over and then honestly, it's still something that is relatively probably relatively benign and we might have to react or not, but that's not,
you know, a difficult situation probably to deal with. My concern is, of course, and the concern of many people and of the market, is that it would not be over by by April, or maybe not even over by June. What I would like to have is a better mapping of the scenarios that we are making to actually the conflict lasting until April or until June, that we have a better mapping of our scenarios and basically the meetings of the Governing Council. But it's moving fast. So one
meeting is April, another meeting is June. If the conflict is not over by June, then we are, you know, most probably way above our baseline and that would probably warrant some some kind of react.
Governor, do you think that the ECB is hamstrung by the fact that it is a single mandate FED dealing with an inflationary shock The FED looks like it's currently prepared to look through given that there is a serious growth hit on the other side that is potentially going to transpire.
Well, in a way, it makes it easier because if you have only one objective, you only look at one target, but we always insist that we have an objective over a medium term horizon. So we do integrate the impacts of the shock on growth, and to the extent that the impact of the shock on growth would be to some extent deflationary, I don't think that's the base case, but of course we would have to take that into account.
But it's taking into account the impact of the shock on the real economy and then the repercussion in terms of whether we're going to be faced with second rounds effects or not. If the economy weakens fast, then the second round effects might be limited, which might warrant less of a move. And the big uncertainty is, of course the labor markets and the economy is less tight than it was in twenty two coming out of the COVID crisis, with all these bottlenecks in the system. But the economic
agents were surprised by the pickup in inflation. We had known a period of low inflation for a long, very long time, so people reacted as much as we did in a way slowly to the inflation developments. The big thing now we have to monitor is whether economic agents, firms and then workers will adapt more quickly this time to the shock. If this is the case, it might lead to second round effects that will be quote in quote higher ketrist paribus compared to the level of the shock.
If because of weaknesses in the economy in the labor market, firms and then workers don't react fast and basically take the hit, then the case for reacting is less strong.
Final question, listening to you to recap what I hear is patients the prospect of two different scenarios with different responses. What I see in markets, though, is tied to financial conditions. The market doing the work for you already high yields on government bonds, pricing in the prospect of hikes from
the Central Bank over the next year or so. When you look at that, do you consider that an unwarranted timeing of financial conditions given the patients that you've pledged this morning already?
Well, I'm you know, I'm patient today, But in April, if we're still there, I might not be patient. So I don't want to convey the message that we are not ready to act. But I'm comfortable with what I see in the market. But given the uncertainty, the uncertainty is huge, So you know making any judgment today or what we could do in April or June. Given the uncertainty the market signals or reaction will be different next week and the week after next. We have to monitor that.
We have to at least, I mean we should not overreact. I mean, we are not going to control the first round effects of this shock, so we should not even try to control the first round effects. So in this sense we have time to react react adequately depending on what is our perception of what the second round effects will be. But you know, April is not out of
the question. If if by April we have solid evidence that the shock will be lasting and will lead to a big hike in inflation that is likely to have some degree of persistence, then we might have to do something. But you know, we still have some time before the April meeting, and I don't want to take any any bed in one or the other direction.
Stay with us. More Blandberg surveillance coming up after this. So here's the laces. This morning, the President, continuing his post for our interest rates is the confirmation of French chan nominee Kevin Walsh remains on pause. Sona desire Franklin Templeton writing, even before the current shark, I was not expecting any more cuts, but it is too early to forecast rate high. Sonal joins us now for more, Sonal,
welcome to the program. I know so many people in fixed income itching to get long duration because yields have backed up, but they're nervous. What are you advocating for?
So you know, we came in Thanks for having me on, Jonathan, but we came into this year actually a little bit short, and we are moving slowly towards neutral, but I am not tempted to go a long yet. This is essentially when we talk about the two, it's either bimobile distribution or more accurately, there are two tail risks, and we certainly can't predict which of those tail risks comes to fruition if either either one.
Of them i e.
A very protracted conflict or a very short conflict. I mean you can't, you can't actually position your portfolio to either one of those two tail risks.
Son Now, forgive me. I keep harping on this one topic. Why are long end body yields rising right now? And I look at inflation expectations and the break even rates market long term inflation is not taking up, If anything, it's going down. This is a real rate move at a time when people are looking out to the potential of a decline in growth. Can you explain what's going on currently in a long end of the yeld curve?
To me, actually, what the market is doing is really rational. It is anticipating that, yes, there may well be a decline in growth, and the response to that decline in growth is going to be massive physcal eating. You know your prior guest from the ECB, he only spoke about monetary policy. He didn't mention what the probable fiscal response would be if this were to be a protracted conflict.
There isn't a government in the developed world which will probably not react by trying to accommodate some of that weakening through a greater fiscal push. So I think that bond markets are actually behaving pretty rationally right now.
Do we think that we're pushing up against the limits of using a fiscal lever to offset weakness based on the pushback that we're seeing right now from the bond market.
So it depends, Well, that's a useful statement. I don't think we're getting to a limit. Okay, because here's the thing. There is an enormous amount of liquidity floating around globally. There is the ability to finance more bonds. However, at this point, clearly the market is not accepting that the yield is an adequate compensation for the prospect of higher inflation and higher bond supply. But you do find a
market clearing point, So how much can fiscal do. Even automatic stabilizers by themselves will lead to widening fhyscal deficits. So you know the fact that unemployment goes up to unemployment benefits go up, and so you will have a widening the event of a significant slowdown. And I think there's a big difference between what's happening in Europe as I think I think you've mentioned yourself, versus what's happening
in the US. But in the US, for a whole host of other reasons, we're looking at physcal profligacy as we've never seen before. For the last five years, we've seen it, and I see no indications that this is going to go away anytime soon.
So, now what you just said there on FISCO, I think it's really important for multiple reasons. Here's one. Do you think it increases the odds that we'll see second order effects if governments step in and try and support consumers in this moment.
Oh, in terms of inflation. Yeah, yeah, because actually it was the opposite way around. If you think back to the famous transitory period of twenty twenty one, what was really going on in twenty twenty one. We did have very easy monetary policy, but the reality is we had an enormous fiscal splurge in the first quarter of twenty
twenty one as a new administration came in. It was absolutely enormous, and so back in those back at that time, to me, it appeared absolutely self evident as you were going to get demand push inflation, which the FED kept saying was a supply side impact, and eventually, of course, we got the results we got. If you do get that physical accommodation of a shock of this nature, you will get second right of it. Ultimately, let's take an
extreme scenario. Let's suppose that we really are hitting and taking out not just twenty percent, but oil facilities, say in other parts of the Gulf, which is responsible for thirty percent of global oil supply. Supposing you actually do something much more terrible, which leads to a several year contraction. You can't accommodate it because ultimately you need demand destruction, which translates into slower growth.
This is the Bloomberg's Events podcast, bringing you the best in market economics, angier 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 App.