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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. For the broader market, Here's the view on Wall Street this morning, Andrew Sheets of Morgan Stanley writing, lowering interest rates into easy financial conditions raises the odds of a more speculative boom if growth does not weaken. Andrew joins us now for more, Andrew, let's talk about what that means for credit. Multi decade
tights on investment grade high yield. Near the tides of the year, Andrew, We're starting to see that speculative move start to build.
Yeah, thanks, good morning. So look, I think you are starting to see early signs of it. And again, the Fed has a difficult job. The FEDS at a difficult position, but it's certainly taking a risk by lowering interest rates and saying it's still going to lower them further despite inflation being above its target other measures of growth holding up large government deficits. And I think importantly some very
easy financial conditions. As you mentioned, spreads are in your multi decade tights, equity valuations are in your multi decade highs.
And I think.
Importantly we're starting to see M and A activity really pick up. We're seeing IPO activity pick up, We're seeing more signs of corporate confidence. So while those levels are still low by historical standards, they're certainly moving towards more activity.
And that's a trend we think continues.
How does that.
Square andrew with the idea that we've gotten some negative economic news in terms of the nonfarm payrolls report, some of the jobless claims data, albeit somewhat.
Noisy, does bad news equals bad.
News when you start seeing two reading labor market?
Yeah?
So I think this is what's so fascinating about the data at the moment is that you do see in labor market data and some other kind of traditional early cycle indicators, you really do see some weakness you everything from the jobs market to heavy truck sales, but you also see some other data that looks a lot better.
You know, GDP tracking measures are holding up, retail sales have held up, and I think a really interesting one is if you look at commercial bank loan growth in the US, which is, you know, kind of one of our favorite credit cycle indicators to follow.
It's accelerating higher.
And that's before we get you know, the expected deregulation of the banking sector, which we think is coming. So I think the FED is taking the view that look usually the labor market is the most important cycle indicators, the most important driver of sessions. It's part of the
Fed's mandate. That's what we're going to focus on. But the data is generally mixed, and with changes to immigration and other policy, there are a variety of factors that could be distorting the labor market in unusual ways.
When you put this together, it sounds like, Andrew, there's a greater risk of upside to the economy the idea of a reacceleration. There is some sort of downside, the idea that you could see a real further deterioration in the labor market. What's the implication of how far that can go. People have talked about bubbles, people have talked about already tight levels and credit. People have talked about
the idea of a steepening yield curve. Where do you see the potential mispricing of such a reacceleration.
Yeah, so I think there are a couple of factors.
So first, I think, certainly for the credit market, the market that myself and my.
Team follow most closely.
You know, of those two tails, the weaker growth scenario is I think the much worse tail than the more speculative boom scenario. That boom can take some time. And I think importantly, you know, we're still I think in the very early innings of the type of M and A activity that we would expect if things really pick up. You're still below average in terms of levels of M and A adjusted for the size of the economy or adjusted for trends.
So there's a lot further that that can go.
And I think for as much as we rightfully focus on higher levels of optimism, say among retail investors, corporate optimism, corporate activity levels have not been elevated, and I think there's more room to go there, So companies that benefit from from M and A transactions some of those advisors. Those are stocks that my colleagues on the equity side
are more positive on. And I also think kind of importantly there are you know, this is a market that is still providing a discount to things that are small or more cyclical on the equity side in a way
that's not true on the credit side. So again, I think this dilemma that the credit market has is that if you believe that things could get a lot better, there are lots of small, cyclical, more levered stocks you can buy at large discounts, But in credit we're often already pricing those things at twenty year thirty year lows.
So Andrew, we at a space right now with the FED is cutting into what you view as a reacceleration of growth.
So I think that there's a number of data that's suggesting that's a real possibility, and again that it might not even be a reacceleration of growth, but just if growth holds up, you know, just of growth is kind of stable, then the FED cutting into still above average inflation and rising inflation, the FED cutting into these already easy financial conditions and then I think also really importantly the FED cutting into what looks like a really historic
boom in capex. You know, the amount of spending that we at Morgan Stanley are expecting from the AI Data Center revival growth is just enormous. You know, it's in the neighborhood of three trillion dollars we think between now
and the end of twenty twenty eight. So again, these things might not be you know, three percent GDP type of numbers, but if the cycle can hold up for longer and extend for long longer, there are these There is this kind of dry tender of potential for m and a potential for more strategic activity, potential for more CAPEX that could kind of heat up conditions in our people.
Stay with us.
More Bloomberg surveillance coming up after this, Divisions on the Federal Reserve, clouding the fence communication as FED share.
Jay Powell is said to speak tomorrow.
Kristna Giller of Evercore ICI writing the active debate for policy going forward will be predominantly within the twelve who see more cuts in twenty five, not the seven who do not. Krishna joins us now for more Christna welcome to the program. Let's just start with that division of the Federal Reserve. Just how material is it and how different is it to what we've seen in years gone by.
So I think we learned two things at the meeting just gone First, that this is still Powell's committee. He can still muster majority support, particularly although not disclosed among the voting members, if you guessimate whose starts or who's for the policy path that he prefers. And that's market risk friendly because Powell is on the more duvish side
of the committee, the more preemptive risk management side. But there is this large block seven Fed officials who don't see any further cuts after the September cut this year. So the question is what influence will that seven have on the debate. My sense is not that much. I think the debate will mostly be among those who see their need likely to cut rates further, but will be debating exactly the economic conditionality in cadence rather than that
block of hawks. But you can't completely dismiss the seven no cutters.
Christ And when you started talking about the Federal Reserve, point to add that this was Chairman Pal's feder Reserve almost like it was his committee, is it too early to begin pricing a post Pal fared.
So I think the market sensibly, in my view, is looking at two different time horizons in a different way. Right through the end of this year. Indeed, e've been through really at the end of Q one, early Q two to the very end of Pal's term. I think Chair Pal will continue to drive the committee. I think there is a lot of loyalty to Powell, and I think that the divisions among the central group, while they're there for sure and amplified by these political strains, I
don't think they're very very deep. I think most of that core group would agree with Powell that you want to be stepping rates back to a more neutral setting thin and that if the labor side continues to look quite weak, you want to do that in a timely manner. So that's the success of September October, the Sema Cutz versus perhaps if the data were to pick up, then you might slow down that process. Separately, the market needs to look forward through the end of next year and
beyond and ask what might change under new leadership. And I think when you look at the market pricing through the end of next year, you very clearly put some weight on the prospect of a more dovish shift in the FED reaction function as new leadership takes over.
Krishna, has this market adequately appreciated just how duvish this central bank already has been. The idea that they're cutting at the most aggressive pace going back to the nineteen eighties when we weren't in recession. I mean, this is really an unusual type of paradigm. Given the inflation has remained above the two percent target for more than four years and is expected to remain above that for the remaining.
Upcoming two years.
I mean, at what point is this market not appreciating how hot this FED is already running the economy.
So I certainly agree with you that this is a quite unusual set of circumstances. I think it's important to caveat that in two ways. First, the FED is not cutting rates to at least under Powell. It's not contemplating cutting rates to what the FED at least would cons a stimulative territory. What they're talking about is removing what they estimate to be the remaining restraint in the economy.
That's the roughly seventy five basis points of restraint between where we were on the eve of the September meeting and a spot neutral setting that might be in the zip code of three and a half three and three quarters separate from where the long term neutral rate by lie when things settle down to equilibrium, which many still see at the FED as more like three percent. So
you're talking about removing restraints, not providing stimulus. The other thing is, of course you're seeing, i think, under Powell's leadership, and of course with a pressure intellectual pressure from Waller and one few others, the FED taking a view that maybe they should be at least to some significant degree looking through that current elevated inflation because it's to a large extent reflecting the pass through of Tariff's c enter prices, and of course, from a textbook sense, at least you
want to look through that first round mechanical tax impact if you like, it's a bit like a sales tax in that regard, and you want to be focused on where you think the underlying inflation dynamics are going, what risk there is of inflation persistence, And you know, if you look at wages minus productivity, if you look at a lot of the services, particularly the more market based services.
You look at expectations, the news on that second round inflation dynamic is reasonably constructive, but I certainly still take your point that the FED is cutting onerous management grounds into what maybe the early stages of a cyclical re acceleration. I think the market is going to want to see more evidence on that birming inactivity and if it's passing on to affirming in the labor side too, before it
really starts to trade that. But if you were to see that, then I think at a minimum, people would start to pay more attention not just to these three cuts, but the prospect that when the next chair picks up the cutting baton, we might well be in danger of overdoing it.
Let's say the FED cuts rates and long term rates also decline. Will that help housing affordability? Will that help with this sort of declining trend and inflation that is hinged to the housing market, frankly, which has kind of gotten slack.
Well, So certainly I think if longer term rates were to come down from here in an appreciable way, then obviously that would lower the classic thirty effects type financing costs, and that would certainly help buyers at the margin. I'd actually work a little bit more on price than on quantity in a number of cases, but certainly it would
be good for housing, good for housing stocks. I think in the absence of that, what we're likely to see is more people moving to fund at the front end through arms, because, of course, as the front end rates, the FED sensitive rates do come down as an opportunity potentially to finance the front end rather than financed through the classic thirty year. I don't think that there is a huge amount of scope for ten year yelds to
come down further from here. If we are indeed in the early stages of at least cyclical stabilization and possibly even cyclical re acceleration, and my hunches, if that's the path we're on, then the ten year year will be higher six or twelve months from now, not lower, and with it, of course, than those conforming loan rates. With
respect to housing and inflation. I get the point you make, and it's a something one about the relationship between home construction and ultimately you know, oeer rent and those other housing services related components on inflation. I think that's right. I still think overall, though higher longer term interest rates will tend to restrict the economy in aggregate across all the sectors and put downward pressure on inflation and vice versa. If the tenure goes down.
Stay with us.
More Bloomberg Surveillance coming up after this. Counsei Parau of JP Morgan Asseid Management, writing the low higher low fire labor market is keeping wage growth moderate, allowing the feder ease policy in twenty five basis point increments over the next two to three meeting. Calci joins us now for more. Calci Good Mornic, Good morning. It's kind of the easy piece of this, potentially the next two to three meetings. Then it gets hard. What's the call for twenty six?
Yeah, I think we're in a critical juncture right now as it relates to the direction for the US economy beyond the next three months. So there's kind of two ways that this could break. On one hand, you have the labor market, which is clearly weakening.
I think it's not just supply. I do think it's a demand.
But you have growth data that remains fairly robust and guidance from Corporate America that suggests a lot of optimism.
So you have kind of two ways that that can resolve.
One way is that the growth data starts to catch down to the labor market data, and the labor market data is the signal. The other scenario is that the labor market data is about to stabilize, the FED is going to cut rates, easy financial conditions are already there in the background, and in three to six months, or you're looking at companies that actually want to restart their hiring plans, continue their capex, and we could be looking at a FED that doesn't need to cut rates anymore
and an economy that is operating above trend. So right now we're subtrend. I feel pretty comfortable with where we are now and the carry and credit we have in our portfolios. But there's still a lot of uncertainty about which way the economy breaks in the next six to twelve months.
What's the market pricing? Which way does the market believe that this economy is going to break.
I think the market is pricing that the economy is going to break more towards continued expansion and companies that after a period of pause, start to reinvigorate their activities and start and that labor market weakness that we're seeing is temporary. And the way that I see that is I like to look at the what.
The market is priced in terms of the Fed, and.
I think the way to look at it is you look at the median and you also look at the most hawkish and the most dubbish. Right now, for the next six to twelve months, the market is priced up somewhere between the median dot and the most dubbish dot, you know, so still reflecting the fact that the balance of risks for the Fed is more likely that they
cut faster than they don't cut it all. But then if you look at the longer term trajectory for the FED funds rate, it kind of looks like we sometimes call it the Nike swoosh, because the policy path starts to turn up.
And if you look at what the market.
Is pricing for the long term, the market is actually slightly above the most hawkish expectation for the FED funds rate in the long term, and that reflects some of that longer term optimism around growth prospects that has kept yield structurally higher in this environment.
So what you're saying is actually really interesting.
The idea that long term rates potentially could go higher in a reacceleration trend, where you're saying suggests maybe that's not the case. Maybe that long end rates right now as they are, even with yield curf flattening, are already pricing in that reacceleration. And actually, if you get some sort of real deceleration the labor market, you get a bigger rally.
Is that what you're basically leveraged too.
Yeah, I mean, I think that speaks to the asymmetry and the value in owning jury. So I would say that the path for the market is priced for the FED in the short term is you know, priced fairly to the trailing data. But where we still see that there is valuation opportunities is in those long dated forwards where they are very elevated. They are pricing in a lot of optimism. And then on the other hand, you know, a lot of people have been concerned about the structural
supply demand dynamics in the treasury market. You know, are there going to be foreign buyers coming in? So far, we've seen that the demand for fixed income is there. The other concern has been around the mix of treasury supply, and you know, and that's not even just a trend
in the US. You know, the long end has had question marks around it across most developed market government bond markets, and what we're seeing there is signs that debt management offices and the Treasury in the US are actually probably going to be more active in terms of shifting the issuans to where the band is, which we see still in the five to ten year.
Belly of the curve.
Kelsie, can you give us some more detail on that.
What has the Treasury've been doing more recently that's enabled this market to reject the supply fears.
What have they changed?
Well, they haven't actually changed anything. It's about market sentiment around around those things. So one is that you've seen very strong auctions generally.
There's been a few exceptions.
There's a pretty poor tips auction last week, but generally the nominal auctions for the long end have gone very well. The other thing that has shifted in terms of perception is, you know, now we have the roadmap for fiscal we have the one big beautiful bill. We kind of know what we're going to be collecting in terms of tariffs on an annualized run rate, and we can kind of feel at least more comfortable. The depth sit trajectory isn't great, but at least you know we know where it's headed.
And then you know, while the Treasury hasn't done anything dramatic, they are doing buybacks on the long end, and we do think that over time they will be able to keep the long end supply stable. If not, maybe shrink it as a share of issuings and you'll see the bill issuings as a shares is going to actually be able to rise.
A little bit.
Stay with us more Bloomberg Surveillance coming up after this. Vina Krishner of Marcleak's writing, we've increased our year end twenty six price target to seven K from sixty seven hundred. We expect us TACH valuations to continue reflecting constructive investor views. VI who joins us now for more good Monarch, it's going to see sir, Good morning, John. So up, great to the outlook. Let's start there. What's underpinning that view at the moment for you in the team.
A couple of things.
First, you know, the first half has been much stronger than what we expect it from an earning standpoint. Two, if you dig in and see what's driving that. It's tech in financials, which is over fifty percent weight of the market, and the revisions for that actually are improving. And now we're in the cusp of rate cuts, which
incrementally are of course positive for the market. Right So I think when you put and then don't forget that global growth, if anything, is stabilizing, and US will exit this year economic growth by our economist estimate, it's closer to around one point eight one point nine percent range.
Which is pretty healthy.
So I think while there's a lot of talk about you know, valuations being extended, which I don't necessarily agree with, but right now, if you see what is holding the market, it's three things. One is the AI narrative is still very much intact. Two, we are in the cusp of you know, fat cuts to three let's see what happens. And three we're entering a period of strong seasonality. That's
more of a technical sort of phenomenon. But that said, we do believe that all that is priced in and our hard time seeing how the market can keep grinding higher. But then if you look past the serial into next year, we do see earnings improving ten percent, and we do see you know, the market going in the range of seven thousand, seven eight hundred. That's an upside and base case rate.
Let's break it down earnings and valuations. Yeah, I just want to sit on valuations just for a moment. You said, I disagree there extended. Yeah, so time of the source of that disagreement.
Yeah.
So I think the tendency is to look at the aggregate multiple, which by historical standards looks high.
One is, you know, we've done.
Work and it shows that over the last fifteen years is a structural increase in multiple three SMP. And this primarily function of the domination of tech, which has been faster growing, higher quality earnings, better margins, and higher multiple.
So that's one.
But the other thing we do is you've got to unpack the market and we take some other parts approach. In other words, we look at Big Tech, rest of tech, and rest of SMP. So if you look at Big Tech's trading right.
Now at about twenty nine times, right, looks high.
Fine, it is true, but it started the year at thirty one times.
They posted earnings about twenty eight percent.
They increase their operating marke their net margins by over two hundred basis points. The beat numbers by eleven to twelve percentage points. That's one Rest of tech is trading around twenty eight times. Now that's a tad high for rest of tech, but if you remove some extreme names like you Palenteered, those sort of highly valued names, it's more reasonable. And in fact, the software part of it has got sold off because of a lot of concern about AI disrupting the business model, so we in fact
think there's an opportunity there. And then last motion, the rest of US and PP we just call broadly sixty percent of the market. We really see it as a function. We have a good model for that, which is a function of where rates are, where in creation is heading economic growth Based on that, you're training it on twenty times, that's fair value. Remember just a few months ago the
ten year was at four and a half percent. Now we're we're struggling to crawl, you know, to how around the four percent range.
So I think that's reality.
So in other words, I'm not suggesting it's cheap, but I'm saying it's not a rich market, it's a fully value market.
How predicated is this call on further rate cuts by the Federal Reserve on the idea that yields have peaked and are headed downward.
It's not predicated on that, but it's supported by that right because earnings are also improving. So we do see earnings actually improving next year, not a lot from this year, but call it around ten percent. But where the tenure absolutely happens. Is that fair value talked about That definitely
gets impacted by the way the ten year is. You're always concerned about the correlation of rates and equities, and I think what we have found is that we get worried when the tens breach four and a half percent and start heading towards five percent. But it's a very distinct negative correlation we've observed over a very long period of time. On the flip side, and it's already low,
then you're concerned because the destabilizing impact of deflation. Right now, we're in a sweet spot where we have some amount of inflation which is not necessarily bad, which actually strengthens the ability to do some pricing on the pricing power front. We have economic growth which is moderating compared to twenty
three and twenty four, but still relatively robust. So and you have corpid earnings where with very strong and most importantly what has happened is the tariff effect, which you can be estimated has proved to be a little less worse than what we thought. It's probably got pushed out
a little bit. But companies are figuring out, and most importantly, based on the transcript work we have done, it appears that in their guidance they are already taking into consideration the mitigation steps, and so the guidance is relatively safe at this point.
This is so much optimism I can't even standard. I will just take one issue, this idea of seasonality. Everyone said that September was a bad season, it's always a bad month. Well we're up more than three percent and it's poised to be the best September going back to twenty ten.
Has seasonality broken.
Well in the recent year as it has?
You were last year it was the same story August and September was pretty good. Historically it's bad, but I would argue that why just seasonality?
Now?
Everything is long term relationships were broken quite significantly post COVID. You have a negative yield curve for a long time. In whatted curve, did we have a recession. No, we had pmis in the negative territory. Did we have industrial session No? Did earnings collapse for industrials?
No?
Right, but it doesn't mean they're not us. So a lot of relationship which we thought existed are.
Simply not true. Right.
And it doesn't mean that you shouldn't worry. It just means that, you know, if you say this time is different, you've got to take it in.
Blocks and see you know what next? What next?
Right now, at least for the next twelve to eighteen months, we don't see significant catalysts for destabilizing where we are right now.
So do you find policies like H one B, visa's the terrors they're still being legislat it in courts when it comes to AEPA. Do you find DC policies supportive or they headwinds next year?
No?
I mean one of the biggest concerns this year has been the level of policy uncertainty. But what is amazing is that the market is learned to look past it and to see, you know, the extent of rhetoric, how long it lasts, goes on. I mean, you saw even the HU and B thing, we had data shifting over the weekend right, first the use of modraconian and then they came back at clarified that you know it's one
time and not for renewals and things like that. So I think policy and is certainly something we have to learn to live with. What we have to watch out for where it oversteps acceptable boundaries of the market, right, And so that's where I would actually watch the rates market more for that to see if and when the discomfort is there. I mean to talk about deficits is the biggest concern right now?
Right? And what is your tenure doing?
It's oh, it's not up right, so it doesn't blet me actually come down. So I think you start looking at those things and say that to what extent is the magnitude policy and certaintly going to hurt the market, and so far I think it's it's a risk where it's not an overwhelming risk thus far.
If any What's amazing is what you said about earnings
for next year EPs revisions. It's been a huge focus of this program for quite a while now that we've had this step down in payrolls growth, massive step down in payrolls growth, and maybe it's been building for a whole lot longer than people realized, and you're still seeing this step up in earning revisions, which makes me wonder just how relevant this is, which is an uncomfortable conversation for anyone following this right now sitting at home saying, well,
it's relevant to me, it's relevant to everyone.
Everyone needs a job.
But at the moment we're seeing that tension just grow get bigger and bigger. How relevant is the payrolls number to the broader market and to ornics?
You know, it is.
Relevant, and that's why talking about you know, this market is highly bifurcated.
That's why I said, if you look at where.
The earning strength came from, it came from just two sectors, Tech infinancials.
And that's where the divisions have been.
If you looked at the best of the eight to nine sectors, ninety percent of them had negative operating leverage, in which their cost growth was faster than the sales growth. So to we should not allull ourselves into thinking that everything is hunky dory across markets. It's not right, and that's why we're paying attention. That's why you know, in our outlook, when I'll take some other parts approach.
We are a lot more bullish on.
The tech front, and we are very positive on financials, but compared to consensus in the street, we're a lot more on the rest of the economy. So, you know, how does the rest of the economy get impacted by all? This is important And to your point about the labor market being I mean, your tech companies are laying off people by the thousands, but their net margins have improved by two hundred basis points and their earnings are off
the charts racial basis. When you say things are rich, it's kind of one and the range is one to one point six.
So what are we talking about.
Do you think the tech sector can continue just to try it on an island, it can just be its own base, this big ceclar thing, this detached from the cyclical story, or do you think when they do finally face a cyclical test, people might be surprised by just how resident they might not pay.
Well, they will face a ceclitical test. It's not happening in the next eighteen months, and we do more work lookout for that.
Bas doing some excellent work on that. But the interesting thing is.
The text impact now is spreading across a rider cross section of the economy. So for example, when you talk about even big tech and all the cape spending, it is not just the big hyperscalers right now. It's gone into utilities, it's gone into component manufacturers, it's gone to industrials.
So it's spread. So to the extent that.
Tech is negatively impacted in terms of the scale of the business, it will percolate.
To some extent.
So yeah, it's a mixed back, but look out, I think probably we should come back and talk it.
Well, I look awf your research piece before you go. We really wanted to squeze in. If you're on small cats, we've had this massive rally. You've talked about the lack of broadening cap for earnings revisions. Small caps have rallied almost exclusively on a rerating of the race cycle or the rate cuts, the repricing of that over the last site two months, since early August when we first had that really weight you like payrolls report.
Are you seeing anything beyond.
The ray cut story to justify the rally we've had over the last seven consecutive weeks.
For the first time, we are, and let me paraphrase that we've been negative and small casts for the longest period of time, right, and it's not worked for the last two decades.
I still am very skeptical.
I think it's more of a rental trade or a
tactical trade rather than a long term strategic trade. The reason I say that is, yes, rate cuts have been one of the huge booster for them, but if you start looking at the SML, which is the more profitable portion four hundred art companies from the Russell universe, we were surprised to see that they actually had some modest sales decline but managed to post pretty solid earnings top of that, and their divisions have improved and actually their divisions have gotten slightly better than the.
SMP outside of tech that portion.
So I think there is some fundamental strength which is going consistent with the recent rally. I just worry you whether how long it's going to last, especially for things like tariffs, which have not fully shown yet. I think it's going to percolate over the next few quarters. Business Wise, there's less flexibility. The other thing is, you know, with the tenure coming down and front end rates coming down, with a lot of floating rate debt, they do benefit in the short term.
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