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This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and Amrie Hordern. 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. Matt Miskin of John Hancock Investment Management, writing, if you are not easing your tightening, the bond market has already priced in two point five percentage points in RAID cuts over the next twelve to sixteen months.
If the Fed shoes is.
Less than that, in essence, they will be tightening monetary policy. Matt joined us now for more. Matt, welcome to the program. Have you ever when was the last time you saw a decision this finally balanced twenty four hours out?
I don't remember when.
I think twenty fifteen was the last one that I that I've heard of as a recalling this, but it is leaving a lot of uncertainty, and you know, I think the FED would like to have more.
Prepared kind of communication around this.
And you know what we're looking at is, though not to overemphasize one meeting, one data point. I know retail sales are going to be exciting here in a couple in just about an hour, but at the end of the day, we're starting a cutting cycle.
That's what we know.
We know that inflation has come down a lot and the unemployment rate is rising. Keep it simple, is it relates to that? That means the Fed's going to be cutting.
In argue, we.
Could end this cutting cycle with a two handle on the ten year and frankly a two handle on the Fed funds rate. And that's with just inflation coming down we see a recession. We think, actually we can get a one handle on the Fed funds rate and low twos on the tenure.
Matt, two handles on tens, two handles on Fed funds. Tell me where the S and P five hundred is against that backdrop?
Yeah, So that would be assuming a soft landing, which to us means more chopped.
The problem with.
Wanting more out of the S and P five hundred is the valuations are already at the upper end of the range, so we're at about twenty one times on the forward PE and the SMP, and then we're baking in fifteen.
Percent earning strowth.
So we need earnings growth from here to drive equities. But frankly, there's already baked in massive growth, so it's going to be really hard to get much more out of that. You can make the argument for rotations.
We do like that.
Right now, we're in MidCap for cheaper ideas across the equity market, and we're looking at some high quality cyclicals. But at the end of the day, what we're seeing is the bond market still might have about an eight percent total return over the next twelve months. We think that's going to be really competitive on a risk adjusted basis.
It's a pretty radical thought, Matt, the idea of a two handle on ten year notes at a time where some people are saying it neutral rate is something more kin to three and a half percent. Why do you reject the markets expectations of where the Fed's neutral rate really will end up?
Yeah, I mean starting out with the neutral rate, you know, being around this industry for as long as that in about ten years now.
The neutral rate has always been almost like a.
Mysterious number that can never be quantified or found out. You know, it almost reminds me of productivity in terms of economists. But at the end of the day, it's a cycle. You know, soft landing isn't destination. We're always changing and evolving as relates to economic cycle. I wish you could just stay in one place, but that's not
how it works. If the unemployment rate is changing and shifting like a pendulum to a higher unemployment rate, if inflation is shifting like a pendulum to lower inflation, to us, that means lower rates. And I think one of the things we're anchoring on as investors is still thinking about the COVID era monetary policy fiscal policy disruptions to the global economy as the new normal, and it's not.
That was a massive outlier.
That likely will never happen again, knock on wood in our lifetime. And therefore, if we're back to the way we were pre COVID, why wouldn't.
We be back to a lower rate regime.
And if it's a lower rate regime that's actually good for stocks and bonds. It means lower inflation, but it likely means bonds has more catch up after equities have done so well as a belief.
So it sounds like you're still overweight bonds relative to stocks at this juncture. What could make you flip that given the fact that ultimately this is a pretty benign setup for stocks, given the fact that we spent years talking about how low rates really boosted valuations among equities.
So strategically stocks have done always better than bonds longer term, and so we are just a modest underweight to stocks first bonds. But the biggest change we made in our tactical views is just overweighting higher quality.
Parts of the market.
So on the equity side, we're overweight higher quality markets, technology, US equities, US large your cap versus smaller camp. And then in the bond market, investment grade corporates with about a single a credit quality is about as much credit risk as we really want to overweight. Agency NBS, investment
grade corporates and things we like. We were doing five to six percent in yield just a couple of months ago, and now we're doing four to five, but again on a risk adju a basis, we think that's really competitive versus stocks.
Here, you're not scared of being contrarian. Do you find it uncomfortable that what you're saying this morning is basically what everyone's been telling us now for the last month.
So I hear that a lot, right, So I don't hear that a lot, But nowadays we are hearing that everyone's bullish on bonds, right, and utilities as you said earlier in the show, Jell and around the fund manager survey, the interest rate sensitive sectors, you know, And I look at the pricing note of the market, and I also look at the guts of the market and just cross asset performance. So we've got goal doing great, the end doing great, Treasury is doing great.
Those are all defensive.
Those are all saying, hey, the economy slowing, inflation slowing. Then you got high spreads, it's super tight levels, the SMP multiple is really high, and it's more small caps are starting to do well. We're getting cyclicals out of Europe doing well. So it doesn't add up. That's the part of the consensus that I don't get. If you if you want to say that everyone is more bearish or suggesting more rate cuts, there's another part of the market that is saying that's contrary to that. So I
think you just need to be careful with that. When we look at what's priced in, it's a lot of good news on the risk front, and to me, that just needs to be shaken out here because the Fed can't do everything. They can't just cut you know, it consistently and meet up to these expectations and then you know, support everything that has happened here. So we just want to take a more managed risk managed approach, a more
conservative approach. We're not underweight, you know, we're not underinvested, but that income is a key component and that's to us going to pay off over time.
Matt, just love your thoughts on how a price going into tomorrow and how you think might respond to any given decision. Do you think it's sufficient just to validate market pricing and the dog plot it is not enough? Or does this market need more?
I think that's key, John to your point, because.
They could just say twenty five or fifty, but then it's how do they say on top of that, what we're going to do is the end of the year. So in the June Summary of Economic Projections dot plot, they said five point one on the FED funds rate by the end of the year. That was the mean median that has to come down to some degree or else. So the market's going to be pissed, right, it's overdo it, but it's not going to be happy unless they say, on top of this cut, hey, we're still suggesting cuts
to come. Because again, if they're not easing, they're tightening, and that's okay. If they want to push back on the bond market, if they want to push back on on the easing that's already baked in, that's fine, but they got to know that that's what they're doing, and it's a precarious time to really put more tightening into this market. We would follow the bond market. If you want to create a soft landing, you need that, You need tight credit sprints, and you need the initial jobs
claims to stay low. If you get those three things, you can keep the soft landing. If not, you're probably looking at more risks that come.
Matt, just to sort of underscore one point that you just made about the stock market just generally being pretty ticked off, there is a question about whether this photos or of cares.
It didn't really care.
On the way up, it seems to care on the way down. Is that basically the litmus tests that we're working with.
Well, there is a wealth effect to these things. So you know, consuming at worth through the second quarter hit all time high, ridiculous trillion trillion dollar amount. But that's probably helping the economy, that's probably helping consumer spending, that's helping consumer confidence. And you know, the markets are very thickle and volatile, and it's very difficult for the FED to over extrapolate things because it could change on a dime.
But at the end of the day, they too need to be cautious of being too dubbish because yeah, if the wealth effect becomes even bigger, of housing continues to go hire, that's going to lift inflation. Uh And if stock markets continue to go up. We could be cautious here because of more bubble territories. We've had histories, lessons and lessons of not over stimulating with ultra low interest
rates because it can create bubbles. You know, for us right now cycle wise, we want to protect On the downside, I think their mandate really they're dual mandate. They've got to focus more on employment than inflation, and that's really what we've got to look at. But yeah, they've got
to use the side of their eye. They've always got to be watching for too much speculative nature in markets, and we're coming off some pretty sig significant speculation, but it's still not relieved from the market yet.
Match.
Just to reminder for next time, we curse in surveillance after ours, that's a podcast coming in Q four where there'll be lots of success if you want to cigaretts. Oh yeah, oh yeah, that's you just breaking all the rou Oh yeah, completely.
Let's not get carried away.
Let's just curse.
I'm not missing at John Hancock in Lingo Tobimo writing, the primary risk of a fifty basis point cut is that the market translates the move into a series of fifty basis point reductions that quickly brings the FED funds rate back to neutral, thereby effectively cutting for the Fed and potentially stoking reflation. Ian joins us now for more in It's going to see you, sir, Thanks for joining us, Thanks for having me.
Err.
I want to start with your note from Yes to them. Pick out another quote. Can we expect quote a notably quick pace of cuts in the absence of more meaningful downside in the rear economy, said differently, will the FED simply mark to market the dot plot or our investors in for a surprise, what's your base case?
So I think they should go twenty five. But I suspect that if we go into the event priced with a higher than eighty percent probability of fifty, that there's a really good chance there they move fifty simply to front load the process. Now this becomes tricky for the FED from a communications perspective, because we call what happened
in June. We went into the June FMC decision, they'd already submitted their dots, and so if it is a game time decision we're walking in, we're going to get fifty, but it's going to be hawkish or twenty five and it's going to be duffish.
And let's talk about resale sales and how that might influence things. Are you saying it's not that that data point dependent, it's that that data point could shift market expectations so close to fifty they won't want to disappoint.
Them only if it's really weak. If it comes in stronger, it's not going to be part of the analysis because we already know that the consumer remains and relatively strong footing. But if we see a negative print, particularly in that control group, that probably tips the scale to fifty.
What are we pricing in right now?
In the rates market? We've heard a lot of people disagree around this table, some people saying it is accurately pricing in about a forty percent chance of recession, which is the baseline for bank from America the fund manager survey that just came out. Other people saying price is in a much bigger tail risk of something that's negative.
What's your take?
So when I look at the futures market, what I see is the market expects us the FED to get back to neutral, but not end up cutting into the one handled territory. So that implies that at least from a monetary policy perspective, we're still in a soft landing narrative.
Now. Ten year yields close to three point fifty.
Suggests that we're in verse of economic downside over the course of the next two or three years, which I certainly agree with. But I do think that the soft landing narrative can probably survive this year, particularly if the FED is a bit proactive, and even if we see a little bit of weakness towards the end of the year, the market will still think that it's a love.
Do you not buy the argument that they're just trying to get back to neutrals, they're not increasing their restrictiveness. In other words, does that hold less weight for you when you don't have clarity over what they believe the neutral right to actually be.
Well, one thing we know is true is that as realized inflation decreases or a year over year basis, that means that real policy rates are more restrictive. So given where we are in the cycle, they need to cut rates just to keep the prevailing level of real rates as high as that are.
And if we get a softer retail sales print and we have the FED coming or the markets pricing in fifty more notably not on an I edge really starting fifty, but the FED comes out in US twenty five, what happens to the market.
I think it all depends on how Powell spins it, and it all depends on what the dot plot tells us, because recalled that in June the twenty twenty four dot was a five. Twenty five was four point one. If we look at what's priced into the market to simply mark to market, do we have to get to three percent? And so if the Fed says, okay, we'll go into neutral, that gives us a three percent and they do that
via the twenty twenty five dot. I think that the market doesn't sell off as much as it would otherwise.
You mentioned the risk of stoking reinflation or reflation Bill Dunkley yesterday, formerly the neo Fed right and Bloombag opinion.
He thinks they should go big.
He thinks they will go big, and he asked himself this question, do downsound risk to employment outweigh upside risk to inflation.
I'm going to address you with that question. Do you think they do well? They certainly did throughout the bulk of this cycle.
Now we're at the point where we have seen the unemployment rate materially increase off of.
The cycle low.
The conversation about whether we're overdue for a spike higher and on the unemployment remains very valid. In effect, what the Fed is doing is their changing monetary policy for the second half of next year, not for the current data. So it's the trajectory of the prevailing data, and it might make sense to go big early with the expectations that they can solve next year's problem.
We keep saying the FED, but when we're talking about the FED, we're talking about a group of individual policymakers who apparently have some different views on where we are at the moment. And I wonder tomorrow, when that decision drops and we talk about the decision twenty five versus fifteen, then we go for the forecast, we'll just be talking about medians. Will that mask a great divide on a cephalem C?
I think that we also might see a descent.
There's nothing to suggest that everyone needs to vote in for twenty five or fifty, So I think that that could be another way to communicate to the market that it was a knife edged decision and it's uncertain going forward.
Do you think that there's a chance of a seventy five basis point rate cut because of Elizabeth Warren?
That's really not been top of mine recently.
The reason why I had is because we were talking about it earlier, and as someone who's in this market, I wonder sort of whether people actually dismiss this, whether it's actually harmful to the functioning of the Federal Reserve, or basically just noise with people trying to get their voices heard.
I think the I think the latter point. I think that they're just trying.
To be part of the micro conversation and it's not going to be particularly influential for the FLMC.
I love that you got last it a site noise for you to continue this conversation. Joining us now, Islurina Ruchi of t row Price Plurina, let's get to this data. It seems to have settled absolutely nothing about whether we go twenty five or fifty tomorrow afternoon. What's your base case now?
So I would say that what we discussed here in the past is still valid, that the FED is data dependent, not data point dependent, And so I hope when they sit in their deliberations today and tomorrow, they'll look at what we've seen in the economy over the last three months.
I would say, before the quiet period, we.
Didn't have an indication that they wanted to start this cutting cycle with a big cut. But it seems like perhaps we don't have as good a sense of how the FED is interpreting the labor market data as we should, And so I think into the decision.
It's really essentially a coin flip.
And I don't disagree with market expectations here. I do think that the FED perhaps is looking at the fall in vacancy rates, at the recent uptack in the unemployment rate, and the labor market differential from the consumer side of the data, and saying, Okay, the labor market is really slowing down, and perhaps we are a bit behind the curve, and we want to take some insurance cuts early in the cycle. So I think it's completely possible that we
get a fifty basis point cut tomorrow. And I do think that the Summary of Economic Projections is probably going to show that the dot plot has one hundred basis point worth of cuts for the year as a whole. And I think if you consider how the market deals with uncertainty, perhaps from the FMCS perspective, it makes communication easier. They start with fifty basis points and then the market can expect that the November and December meeting a couple of twenty five basis point cuts.
You mentioned the SEP. Let's start there and we'll unpack the rest in just a moment. The so Many of Economic Projections was last published on June twelfth, and that is super superstow. We're going to see some major revisions to that one. You mentioned how the median dot would come down and show in basically one hundred basis points of cuts for this year. Can you walk me through twenty twenty five? Where's that median doll for twenty five.
Right? I think you're absolutely right.
We're going to get a much more doavash dot cloud than we had in June. Just a reminder in June which had only one cut for this year. So the INFORMC has really changed their assessment of the economy and of the cutting cycle for next year. I don't expect changes. I think they're going to still have four cuts. It would be a very doubbish surprise if they fully embrace market pricing and show four cuts this year and six
cuts next year. It's a risk to my view, but I do think that's shifting to eight cuts over the next fifteen months or so. It's already a very douvish move from the side of the fat. And then if you consider where they had interest rates at the end of the cutting sete, I think essentially what's.
Happening is they're not changing.
Their idea or their view of the destination and the long run rate.
They're just bringing.
Those cuts forward because the cooling in the labor market and inflation is happening faster than they expected back in June.
Just to sort of build on that, there's this feeling that later this year it'll get that much more difficult for the Federal Reserve to project out some sort of path with potentially some different fiscal proposals they could come to the fore that could very much affect inflation. Do you expect that to be sort of hinted at or suggested discussed by a Federal Reserve that has hinted about the deficit as well as some other government programs.
I do expect that the f Y and C and Powell in particular, during the press conference will be asked this question. I think they will stick with their mantra here that they take fiscal policy as given.
I do think, though, they.
Are sure assessing risks around their outlook as with regards to what will happen if we have tariffs across the board. I know that we've had tariffs in the past. It's a one off shock to the price level, but we haven't had sustained high inflation at these levels for quite some decades, So what will it do to inflation expectations if you have another shock to prices?
So I think this will be part of the deliberation.
I do think that when they get asked directly about it, they're not going to comment. But for me, I think, even setting aside fiscal policy uncertainty, I do have a more benign or optimistic interpretation of data, both from the labor market and activity then the market seem to have. And I do think if the FED front loads cuts and eating in financial conditions, that it's setting up the economy to perform quite well later this year and at
the beginning of twenty twenty five. And I think this will put forward some challenges to them bringing inflation down to two percent.
Is there any chance that there's a risk that this could set up the economy to, besides doing quite well, potentially reaccelerate inflation Marena.
I think this is the key risk that people are not talking about anymore. I do think there is too much certainty priced in the market that the FED is going to bring inflation down to two percent. And when I look at the progress we've made so far on goods disinflation, A lot of that has been driven by dollar strength by week, import prices, improving supply chains. I don't expect that impulse to help the FED quite as much.
I get the idea that globally commodity prices are soft because we have a China slowdown in the picture, But we're seeing signs of gold and copper picking up, and I think that's basically a precursor to global commodity prices perhaps picking up, and that's not good news for the FED cutting interest rates. The market is pricing more aggressive cuts from the Fed than say the ECB Bank of Canada or buy at the moment. I think that's going to lead to some dollar weakness as well.
So I'm not very.
Optimistic that the disinflation in goods is going to be sustained. And I think we're going to have more volatility when it comes to domestic services prices.
And rent inflation.
So too much uncertainty, and my view is priced in with regards to bringing inflation down to two percent.
We've got to leave it there. We appreciate your insight got into the Federal Reserve decision tomorrow Loriina Richie at zero Price. This is the Bloomberg Sevenance podcast, bringing you the best in markets, economics, angiopolitics. 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 bloomblog Terminal and the Bloomberg Business out