Bloomberg Audio Studios, Podcasts, radio News.
This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and Ameri Hordert. 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. So here's the LASiS
this morning. FEN share Kevin Walsh, preparing for his first week leading the Central Bank. Has investors price in higher for longer rates, the former New York Fed President Bill down The writing, the prevailing wisdom is that the Fed will tighten monetary policy later this year. Bill joined us now for more, but welcome to the program. I enjoyed the piece. I just want to get to one important
line in there. Whether it's credible for this Federal Reserve to say the monetary policy is indeed still restrictive.
Bill?
What should time kilm that?
I do think you have to look at the commedy's performers over the last few years we've been at this level of interest rates are higher since November of I think twenty twenty two, and yet the E commedy is continue to grow. We're still at full employment. So where's the evidence that mantre policy has actually been restrictive. If it'd been restrictive, the commoye should have slowed down, the uneployment rate should have risen. So I think the case for cutting rates now is actually very.
Very weak given that bill.
There's a real question here about the housing disinflation that people point to as well as we haven't seen wage inflation accelerate. In fact, you've seen it decelerate. We've seen the worker not participate as much as companies in terms of just their profit margins. At what point does the FED have a right to keep looking at that rather than the overlying GDP growth.
I think you have a right to look at that. I mean, I think the big question is is if is the tax refunds that have boosted people's disposable income over the last few months the key driver. And as we get to July August, September, we'll consumer spending turnover or is the fact that financial conditions are so easy. Is that going to be the dominant influence in terms
of supporting consumption and economic activity. I think the wage trend is something that is positive in terms of those who think that inflation can come back down to two.
Percent, but that could turn.
I think the problem here is that we've been above the Fed's inflation target for more than five years, and there is a risk that inflation expectations do finally become unanchored. In the University of Michigan primary result last week showed that the five to ten year inflation expectations did tick up quite marketly. Chris Wallers focused on the two year inflation outlook two years two years forward that's also moved up.
So I think the FED is concerned that they're starting to lose credibility because they haven't been able to get inflation back down to two percent.
How much is this Fed sort of conditioned by the pre pandemic reality of low rates in a way that has made them overly dubbish to meet the moment and frankly having to reconcile their over dubbish dance with fundamentally stick your inflation as a reality I agree with that.
I mean, I think that if you look at the level of real rates prior to two thousand and seven, the real rate embodied in the tailor roll, for example, it's two percent the fence. Assuming today that the level of real rates adjusted for two percent inflation is one percent. So it's very possible that you know, matre policy today is not restrictive at all because real rates are higher, and there was a reason to think that real rates
are higher. Look at the investment spending boom caused by the AI that's raising real interest rates because of increasing the investment demand in the economy.
The fiscal path.
Of the US is also raising real rates because it's diminishing the supply of savings available for investments. So I think there are reasons. There are good reasons to think that real rates are higher than they have been in the recent past.
When you have Christopher Waller saying that his current policy position is to hold rate study for the near term because policy risks have changed, do you find it interesting? And he was able to look through the potential tariff impact on inflation, but he's not when it comes to the oil shock.
Well, I think they're really the same in terms of both being likely to be transitory. The real question though, is how does it get bodied in inflation expectations? And I just think the FED is sort of pushing the limits of their credibility to claim that trust us that we're going to get inflation back down in two percent when we haven't been able to do it for the last five years. So I think he's getting nervous that they can't sustain this. There's also a big risk here.
I mean, Kevin watsh is coming in. The President wants lower interest rates, so you can see all the elements in place where the FED should know titan rates sometime later this year, and they don't because of the pressure from the President. So the questions about the Fed's independence, how willing Kevin Wortsch would be willing to buck the
desires of the President also way into this situation. So I think that if the Fed's independence was what wasn't under question, then they'd be more likely that inflation expectations would stay well anchored.
So I buildre's an all tension flation expectations right now. Consumers don't trust them, haven't for a while. You see that in the recent survey. They're expecting inflation to be way above their particular target for a significant period of time. But market based inflation expectations, does the market trust them well?
I think if you look at the very longer term expectations, for example, like if you look at the treasury inflation protected securities market versus nominal treasuries five years out, that looks fine. I think the issue is that an accurate measure of what households and businesses think today. And I think that's why Waller brought up what's inflation going to be two years from now for the next two years, and that is started to tick up, so that's not
so far over the horizon. Five years is a pretty long time, Yeah, I can trust if that's going to get inflation down to two percent in five years? Are they going to get it down to two percent by the end of twenty twenty seven?
Is this a recent problem or a problems persistive for some time under chairman Power.
I think it's a more recent problem in the sense that the credibility that monetary policy is restrictive it's really started to finish as e Communist continued to perform. Well, so that's really the you know, if the policy thesis was correct, the policy was restricted, then the Ecomomoyas should have slowed more in the unterplan ratios and.
More stay with us.
More Bloomberg surveillance coming up after this, the US at Iram clashing near the Straight of Homers, even as both sides to have progress on a peace deal. Stephen Kirk of the Council on Foreign Relations right in, the Iranians will not give up their right to enrich uranium, and they want management over the straight Offormers. Steven joined us now for more, Stephen, welcome to the program. Let's run
with those two points. They want to carry on and they want the right to enrich uranium, and they want to manage the Strait of Hollmers. How do we strike a deal with them not backing away from those two things.
Well, that's exactly the point is that the Iranians had remained firm that they have a right to enrich uranium.
They had not given on that at all.
Every time the President has said that the Iranians have agreed to something along these lines, the Iranians contradict those statements. It seems quite unlikely that they will give up their right to enrich.
There might be some way to.
Fudge a situation in which they enrich to lower levels than before they enrich. They move enriched uranium outside the country, but they will maintain that right to enrich. And then when it comes to the Straight of Homus, Luckily for them, the President launched a war on February twenty eighth, and they now have control or partial control over the Straight of Hormus in a way that they never could have dreamed of before. It seems unlikely that they're going to
give it up. They said that there would be no tolling of the Straight of Homus, but there certainly would be fees for service for shipping going through the strait. So I don't think we're as close as the President and others would suggest without either the President capitulating and or the Iranians capitulating. And it doesn't reckoned that the Iranians are in a position or willing to capitulate.
So basically, steve the same thing, just different branding. Would you assess that this morning we are still in a ceasefire?
Well, I think the President and others would like you to believe that we are still in a ceasefire, but Obviously, the United States in Iran are on a hair trigger here.
The Iranians apparently threatened.
US forces and even fired on US forces, and the.
United States responded.
But this is not a return to the kind of high intensity combat that we saw throughout throughout March. Clearly, the President is shying away from a major escalation and is looking for a diplomatic way out, but.
The Iranians aren't going to let him do that.
They have an enormous amount of patients, and they have inflicted a lot of pain on their population, and they're willing to continue to inflict that pain in order to push the President into a humiliating capitulation.
What was interesting over the weekend is in one very long truth social post, the pro talked about sat Arabia and Cutter and how these countries should be joining the Abraham Accords. Is there any room for that to wrap up this conflict.
It seems like the President is aware of the criticism of the deal that's on the table, at least what we believed the deal on the table might be, and is trying to make it look better by saying that it will simultaneously come with an expansion of the Abraham Accords, but the Saudis have held firm and said that they will not normalize relations with Israel until there is an irreversible path towards a Palestinian state. The cut Thuries have said that they will deal with the Israelis, but only
in terms of resolving the Israeli Palestinian conflict. So it doesn't seem to me that normalization is actually on the table. The President is just trying to sell this deal in a way that will make it more palatable for the Republicans in the Senate and others. But I don't think anybody really believes this normalization is on the table.
Sevid, you said they're more palatable to Republicans. This is what's interesting to me is that part of the issue is it more palatable to Israel. How much is the break between both President Trump and the Republicans in his party as well as Natanyahu in Israel.
Well, it seems that there's a rather significant break between Israel and the United States. That's to suggest that the Prime Minister has come to the conclusion that there's really nothing that he can do with regard to the presidence positions on Iran, and that Israel will have to take matters into its own hands. It has consistently said that whatever sees fire the United States, or whatever agreement the United States and Iran come up with, Israel will not necessarily be a party to it.
With regard to the Lebanese.
Front and his Ballad, the Israelis have been taking a lot of fire from his Belah has been using these wire guided drones to which the Israelis have very little response or defense. So you're seeing Israeli soldiers killed day in and day out. The Israels just can't give.
It up there.
When it comes to the Republicans in the Senate, there's been a lot of criticism from from those senators because the deal looks like it gives the Iranians very significant sanctions relief, the ability to sell oil, which removes a significant amount of leverage when it comes to trying to press them to end their nuclear program.
The more you talk Steven, the more I'm a sort of cognitive distance between the two Steves. This morning, we had one Steve coming on saying if it can't happen, it won't. It's not going to be an issue in a couple of months. Everybody needs a straight or from moves open. Then you come on and you're saying essentially that it seems like we're pretty far apart. How do you reconcile where the market is and where negotiators are.
Well, I heard I heard your interview before I came on, and I think this is something that's been happening in the markets from the very beginning, is that there is a belief that there's some magic formula that's going to open the straight or for moves.
I was on with you.
All in April at the time of the IMF World Bank meetings. Then I think there was an expectation that the Strait were to be open in a matter of days. I hated to throw cold water on that at the time, but it was going to be months before this issue is resolved. Perhaps the President Will as a result of these strikes, Will had instilled a little bit of flexibility in the Iranians, but so far the Iranians are hanging quite tough.
Stay with us.
Mulblinderg surveillance coming up after this, So I'm desire Franklin Semples and writing with the Energy Shark feeding into headline. Inflation rate cuts are off the table, so I'll join the snaff for more, So now welcome to the program. If rate cuts are off the table, rate hikes on the table.
So hi John, thanks for having me here. But I would say that raid hikes are on the table in certain circumstances. I think four percent headline innovation at this point is almost baked in the cake for this year, just because of where oil prices and the elasticities associated with it. But I think were if we were to see headline inflation actually start veering not towards four but close it a five year, I think great hikes are on the table. I don't think that happens this year.
By the way, it was funny, So no, when do you think that will happen.
If it happens, it depends on how long this these oil prices remain in place, And if it were to happen, it would be next year. I think this year. I think that even if the conflict were to resolve in the next week or two weeks, I still don't think that oil prices come down significantly below something like say eighty and that's enough to get headline up towards four.
So now an increasing number of people are questioning whether we actually are a neutral or above neutral. Michael Darda from Roth Capital Partners over the weekend, what if the FED is actually below neutral? Mount Lazeti of Deutsche Bank coming out with a piece called over and Short, where we talked about one hundred and seventy five basis points of Rayka saying maybe they went too far. How much are you sympathetic with these views?
Well, I've been saying that the neutral rate is it closer a four than the three for about two or three years now, so I'm happy to see more people coming around to this view. But I completely agree.
I think J.
Powell has described policy repeatedly as being moderately contractionary, and I would see it as being moderately expansionary. And I think four percent is probably closer to when neutral is between productivity growth and the Fed's own inflation target. I don't think you get to three percent.
If that's the case, and all, then you might want to buy the long end of the yield curve if you believe that the FED is actually going to respond to some of this pressure with a great hike. Is a signal that you're taking from the market that there isn't a whole lot of faith that there will be some sort of hiking cycle even if inflation remains elevated.
So here's the thing. Inflation has been elevated for three years now, the FED has been fifty percent above its inflation target, and the FED s cut over that period of time close to two hundred basis points. And therefore we actually have a very dubbish FED, and I think the market is perhaps coming around to that viewpoint. Regardless of who the FED chair is, I think we have
a very very dubbish FED. We've always had one, and I would say that if we look forward, I don't think the market currently is pricing in realistically what long end yules would be. I think four seventy five to five is probably closer to fair value. I think this is not yet the time to go all in on long end yuels. I think we're going to arrange trade a little bit. But the drift over the next several years, I would say is probably upwards, if it's not downwards.
So that's a great point because many people probably argue that actually J. Powell, who was another Trump appointee, could be even seen historically more dvors than Kevin Wharsh. Kevin Wharsh when he was signing his swearing in on Friday and then also gave a little bit of a speech, said he's going to lead quote with energy and purpose, just the way Chairman Greenspan did. Can you glean out what kind of wash FED we're going to say?
I think an orthodox one. I hope to see an orthodox one. It's been close to twenty years we've had completely unorthodox policy from the FED. The first go to is quantitative easy. That is very very unorthodox monetary policy. The FED should not be engaging in the long end of the yield curve outside true crisis, and it is true that they've come in several times when there was a crisis, but they remained in for much longer than
any crisis would indicate they should. Therefore, I think, if I think about green Spans FED, green Span sped FED tried to push markets into valuing risk more appropriately. The FED did not bail us out if long end yields were surprisingly low over the green Span era. I think it had a lot more to do with what was going on in China, petro dollars, the savings glut, and since the since the crisis, the global financial crisis. What we've actually seen is a FED which is almost led
by markets. Everything that's gone on on the long end of the yield curve seems to be driven less by the economy and much much more by FED action, intervention, and a part of the yield curve it actually shouldn't be present.
Some people might say the twothpaste is out of the tube. Do you say it differently? Do you think we can go back to what we used to be.
No, I don't think we can go all the way back near tom but I do think over the next four years, I don't think Kevin Walsh is coming in and he's going to and I don't think see him shaking up markets by immediately trying to reduce the size of the FED balance sheet. But over the next four years, I don't think we'll see a more sustained move in that direction. In the direction of reducing the size of
the FED balance sheet, it is enormous. I don't think that he's looking for the financial instability that an overnight to return to.
But let's say he goes in that direction. I'm not saying we get back to that place, but let's say it goes in that direction, Do you want to own those assets on that bound.
Strey on that so you know, eventually yes, but before that we're only talking about Montreal policy and isolation. We need to see what's going on with fiscal policy here, and that's another piece of this puzzle, and it's not a good one. And that's part of the reason that I would not be jumping in to buy long end
bonds at this point. I think between inflation, between a return to hopefully more orthodox Mantor policy, and a continued fiscal profligacy in the US, I don't see a reason to go all in there and own long end bonds. I think you could opportunistically go in and come out, but I think over a medium term, long en yuels are going higher.
This is the Bloomberg's Events podcast, bringing you the best in market it's economics, and geopolitics. 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.