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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.
We've got a problem in the UK.
Political uncertainty in the country pushing guilt yields to their highest levels in decades. According to the Times of London. Just moments ago, a rival to UK Prime Minister Kirs Stamer preparing to trigger a leadership contest. Kit jukes of self gen right in the following Increased spending and higher taxes are a given layer that, on top of rising energy costs and falling growth forecast, there isn't much to make anyone feel good about the pound. Kit joins us
now for more. Kit Welcome to the program. Lisa said it yesterday, said it again this morning. Is this the new normal for UK assets?
It's been the normal for a little while.
Now.
We are stuck in a world of governments that don't focus enough on growth and have lots of other things that are more interested in the result of that is you either have you are constrained on spending or you have to raise taxes and you're probably going to be
on popular somewhere in the middle of it. And around we go and the adults in the room is the bond market or the referee is the bond market because funding this requires a country with a massive current account deficit dependent on foreign investors to come in and buy guilt guilt yield spike and the and the government does or doesn't fall and doesn't or doesn't respect the bond
market and get its act together. And we've done this a few times and we don't look like escaping this until someone comes in and says we need more growth.
Okay.
Outside of the UK, investors might not be familiar with names like West Street inc. Anti Burnham, Anti Burnham of course the mayor of Manchester West Street in the House Secretary. There was a moment ago, about ten to fifteen minutes ago we had a report from the Times of London suggesting that maybe the House Secretary might consider triggering a leadership election, a leadership contest and ultimately quit the government in the next twenty four hours. Kid what could come next?
Can you help people understand what the next government, the next leadership might look like.
So it depends on where we go. So we have factions that he's not part of the biggest faction, that's the Burnham faction, but it represents certainly a shift to the left politically. And then if he were to win a vote for example, which is possible but at this point unlikely, you would have a messy kind of situation going forwards from there, where you see what you can do.
If it gets to one candidate turns into lots of candidates, then we see the Mayor of Manchester has to has to find himself a seat in Parliament and that'll take time. And the last round of voting that we saw in the local elections didn't suggest that a lot of people are voting labor at the moment, so that's quite messy.
So it's all going to be quite drawn out. And if we got to an end conclusion, we would still have a labor government, and we would still have a labor government that at the moment is fixated on lots of things that don't include growing the economy more quickly and increasing tax revenues through that method to includes highest taxation or reduced spending, depending on where you sit. So the problem doesn't go away.
How much is this a specifically a UK problem and how much is this a broader representation of the issue facing all of Europe and frankly on the margins the United States with debt levels at a very high level relative to growth and a potential pushback in an inflationary environment from pond investors.
Well, so firstly, we're at the I guess we're at the pointy end of the problem. So the problem starts if the United States is higher yields because people are concerned about the inflation fighting credibility of the federal reserve and are concerned about the size of the deficit, spending on the war and anything else. If we get ourselves into that, then you get treasury yields if you like wandering up to four and we wanted ours up to five, and we can add some numbers.
To each of those.
We have a bigger current account deficit presented of GDP than pretty much anybody else. So we're dependent on foreign investment coming in. We have slow growth and the only thing that keeps our currency stable is having interest rates that are high or higher than the rest of Europe. That doesn't get our growth story at So yeah, if ten youre noteyilds were at two and a half percent in the US, the world would be a much easier place. Unfortunately,
because it isn't. We're the kind of the We're the place where the pain starts being felt, and it's on the UK government. Given where we are, the size of our deficit, the size of our current account deficit to be responsible. The only advantage we have over the United States is we have a very credible central bank, an inflation targeting central bank whose independence isn't in question at all. But but that on that on its own isn't going to be enough to finance the deficits to come.
What would it take kit for you to get bullish on the pound?
On the pound, I'm only slowly, but that the support the pound has is that everybody's bearished, So it doesn't take me much good news to make me optimistic but I would like a government with a clear and coherent plan for growth, and then I probably would be barished because at that margin, if I thought that, you know, that we could put in a program that would have the UK growing one percent faster perannum than the rest of Europe, which isn't which isn't a very big bar
to get over, then then the pound, I think, could.
Could start getting stronger.
But its value in real terms is going is being eroded because we're consistently running higher inflation in the rest of Europe, so it's getting more expensive every day, and that's why nominal terms, the currency is going to have to weaken at some point if we don't turn that around.
Stay with us more Bloomberg surveillance coming up after this. Seth competenter of Morgan Stanley writing disinflation resumes in the second half of the year, allowing the Fed to cut rights twice in the first half of twenty seven. Seth joins us now for more. Seth welcome goes be over. Chicago thinks we've got an inflation problem. Do you disagree? I don't disagree.
You know, our baseline forecast, as you just showed, is that inflation should start to trend down. We do think we're around pete tariff effects on core goods inflation, and that should start to come off. I think we got a sign of that from the CPI data just just yesterday. The way you just had the clip with Kevin Hassett pointing out that historically energy price shocks like this have gone through the headline but not to core and then
it ends up being temporary. So if everything goes according to that baseline plan, then then the inflation problem isn't as bad as it might otherwise. Look, however, and this is I think a really important however, we're in a really really unusual situation here. The FED has missed its inflation target for over five years. To the upside, we're still about a percentage point above target. That longevity of
the inflation myss. At some point, I don't know when, probably starts to affect the psychology of consumers in terms of what they expect and what they accept for prices. It probably starts to affect businesses as they're setting prices trying to understand how much they can or can't pass through costs.
We don't think we're at a tipping point, but I.
Do believe that the risks now are heightened relative to history. This energy shock has proved to be very difficult to forecast, and I think it's an open question right now how temporary is the energy shock. Our baseline assumption when we did our forecast was that we would get some resolution, We would get oil prices down to call it ninety
dollars a barrel at the end of the year. So coming off the peak coming down, we could easily be wrong there, and just the headlight headlines overnight show that there's all sorts of risks that there's prices stay elevated.
Seth.
I's the inflation data we've had so far within the report of yesterday, are the elements within that that do give you pause that maybe you think could become a bigger headwind to your base case.
So you know, we saw, for example, in core, we saw a rebound in shelter inflation.
We were expecting that.
I think a lot of people were expecting that that looked like there was noisy tick down in that category. And so the tick back up makes a lot of sense as long as that's all it is, is sort of a bump in the road along the same trajectory we were on before. It's fine, but you really have to start to wonder is there something else going on in core at the fundamentals of the economy are actually pretty solid.
We've got an unemployment rate that's pretty low.
The last jobs report showed that the weakness in hiring we had very much seen last year has probably bottomed out and start to pick up. So I think we have to be on heightened alert. But I wouldn't say there's any single component that's sort of standing out.
Is this truly an oil price shock if we stay where we are based on inflation adjusted fuel prices over.
History, Well, I mean, I think that's that's a good question. If you compare where we are now to say, twenty twenty one twenty twenty two, where we ended up following the Russian invasion of Ukraine, nominal prices of oil are not as high right now as they were then, And then if you compare it to the average price level, so the CPI index, it makes it seem like less of a of a price shock now than it was then. So in that sense, you know, it's a bit more mild.
And that's the reason why we maintain our constructive baseline view. I think the challenge here and the risk is what happens a week from now, what happens a month from now, what happens two months from now. My colleague Martin rats Over in London, who's our commodities and energy specialist, has great charts about what's going going on with US exports, and US exports of distilled products like gasoline. Inventories are coming down being shipped away just as we're about to.
Get to prime driving season.
So if there's no resolution, if we still see this shortfall in terms of supply flowing to the global market in a month or two, could we see physical shortages where things are just running dry. I think that's a real risk that everyone should consider.
SETH.
We also are looking, as John pointed out earlier, to cheer economy, where you've got the AI trade and you've got everything else in The AI trade seems somewhat independent of some fundamental macroeconomics and is fueling a wealth effect that keeps consumers spending. At what point has the traditional channel of disinflation broken down because of the AI cycle that's been super imposed.
On top of it.
I think that's a great question.
And as we wrote our Midjiar outlook and we were thinking about various scenarios, those are the two themes that we matter. What's going on with the energy shock and then what's going on with AI. I think there's no
two ways about it. In the short run, AI boosts aggregate demand, boost aggregate demand for investment spending, for construction, and then the wealth effect that you're talking about is absolutely critical to keep upper income, upper income and higher wealth household spending, and they're the real drivers of what's been going on. Will that lead to more fundamental underlying inflation you know, so far not clear, but I think
there's another risk. And so what we try to illustrate is what happens if we are you optimistic but not sufficiently optimistic, and consumer spending actually picks up from here because of the wealth effects and because broader hiring seems like it's stabilizing. What if that spending, along with the AI spending, allows businesses across the economy to start to engage in cappex spending.
So far it's only been essentially AI capax. What if it's.
Broader that kind of aggregate demand scenario where things really pick up from here, that's the scenario you need to really see the FED shift gears start to think about hiking interest rates, and as you pointed out, I think earlierly the market starting to put some probability on that outcome. I really do think we want to pay a lot of attention to where that generalized demand in the economy is going, because it could lead to that scenario of the FED hiking.
Stay with us more Bloomberg surveillance coming up after this. Here's the take from Terry Weisman of Macquarie Rights in the following There seems to be a divergence between a high year end inflation outlook and a FED that is expected to keep the policy rate on hold through year end. Terry Johns snappermore Terry good Mornic. How do we reconcile resolve that tension?
Well, it's going to have to be with a policy move.
I suspect the Federal Reserve, unfortunately, is going to meet in June, and that feels like such a long time from now, given how much inflation data, how bad the data has been in the last two days. But ultimately it's going to have to be with some recognition that a certainly an easing bias is the wrong thing to do. I'm shocked that they haven't removed that already. In the April meeting, J. Powell hinted that they would, But even
that doesn't feel like enough right at this point. What's enough enough is probably moving towards a right high and being explicit here and even signaling that through a tightening bias at the next meeting.
I think that's appropriate.
Look, I think at the heart of the matter here is that all wars are inflationary. You can go back to the US Civil War, you can look at World War Two, you can look at World War One. You can probably even look at the Spanish American War. I haven't, but I'm guessing that it was inflationary. The Vietnam War certainly was. Why are we shocked that we have a war and we have inflation?
If this FED does not move to a tightening bias, what is the market response likely to be?
Well, I think we're already seeing it. It's the long end of the curve. It's the presumption that they don't do something soon, they're going to have to do a lot more later, that they have to nip it in the butt.
The longer they wait.
The longer, we're going to see the long end of the curve they yields, and the long end of the curve move up and the curve effectively steepen. That will not be good for housing, let's say, it will not be good for other sectors in the economy that are sensitive to the long end of the curve.
But that's exactly why the FED needs to start moving.
I think by signaling that they will high rates, you will stabilize, effectively stabilize the long end of the curve they yield at the long end of the curve, because you'll be singing to the market, to the market that we're dealing with this issue, that we're not going to delay it and ultimately have to raise rates a lot more in the future.
Arkably, some people would say that typically these price increases are transitory. They don't want to curtail the slowdown that you're seeing in certain sectors of the economy. Do you think that it would become more of a liability if they signaled at least staying on hold for a longer period of time. Do you think that you would see a dramatic weakening in the dollar. Do you think that you would see the bond vigilantes come back, Yes.
I do.
I mean, it depends on the tone that they use when they submit that they're going to keep it on hold for a very long time.
I don't think.
But that in itself is a commitment, right, that's the problem to say that you're going to keep it on hold, and definitely is a commitment to keep it on hold. And if the market continues to show us that inflation is going to be high, that is not going to seem like enough. I'd rather they err on the side of doing a little bit too much at this point.
And I'll tell you why.
If you look at the if you look at the inflation swap curve right now, it is not predicting that inflation is going to come back down to even three percent by the end of the year.
In fact, I suspected after the numbers this morning it's higher than that.
It is also predicting that in April that's already in the main inflation print, we're going to get something on the order of four point three percent for CPI year every year, very high. So the market is already very doubtful that the Fed can get this under control by effectively pricing in a forward curve for inflation, that this is not converging back down to anything.
Near the target by the end of this year.
What does that confidence that we do converge to taka? Where does that confidence come from after they've missed it for five years?
What does that confidence come from?
Well, it's going to have to come from a much more explicit commitment on the part of the FED to tighten if they need to to put a priority on priced ability. Problem John, of course, is that we don't have a FED share incoming FED cheer who has made that sort of commitment in the past. This is part of the problem. And by the way, this is this is part of the reason why we might not have seen a.
Neutral bias in the April meeting.
It might be that too many members of the FOMC were too deferential to the incoming chair and not as opposed to the opposite. That's very possible, and I suspect that Kevin Warts is going to have a problem, certainly a bigger problem now he needs if he's going to try to convince the rest of the members of the FOMC to keep rates on hold. I think some of them are going to want to move that bias towards Titan.
This is the Bloomberg Seventans podcast, bringing you the best in markets, economics, angier politics. You can watch the show live on bloomblog 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 bloom Black Terminal and the Bloomberg Business app