Disappointing 1Q for European Data, Santos Says

doesn't have to be bad news for risk assets. In when yields searched through three pc, the equity market delivered one of its best years of the ball markets so far, with a gain of almost thirty percent. So why could it be different this time around? I want to bring in Vince Reinhardt b and Y Mellon, chief economist and chief in investment strategist, and it's always great to catch up with you. Just walk me through that. What it could be different this time around? We actually don't say

that in my household. This time is never different. I think I think the story is is the Fed raising rates and seen as raising rates for the right reason, i e. The economy has got momentum, the equilibrium, real federal funds rate is rising. Think about it. Think how you describe the last six FED actions. When you consider

the policy renormalizations last year and into this year. They got good press, they said Fed confident about the expansion and raising rates and and renormalizing policy, still keeping an accommodative in that environment, equity market can do pretty well.

The difference this time around, though, if there is a key difference, I would say, looking back at verses now, is that back then, Vince, the two year note was fifty basis points and now it's two and a half UM and two and a half is pretty much where we started the year on the tenure. That's what we have seen, an aggressive repricing at the front end of the curve. Could that be what sort of spouse out

a different story for risk assets this time around? Well, the reality is we're walking up a path of FED tightening, and so we're a hundred twenty five basis point higher on the funds rate. In that environment, the yield curve is gonna flatten. Is not necessarily threatening to economic expansions. In fact, it says that people think the FED will be slow to raise rates, not particularly fast. It doesn't have to meet impending doom. And I don't think many

people on this program think that. In fact, the last time we have an inversion on the yield curve pre crisis, it was a couple of years before things really rolled over. So it doesn't have to mean anything immediately bad is

going to happen. I think the story for me, Vince, is something that could happen in markets where the front end of treasuries gets attractive enough that it competes for capital in a more significant way with things like equities and credit as well, whether it's investment grade or high yield. Do you see that story kind of materializing. Well, we're seeing that in money more gets. That's part of the reason library spreads are so wide, right ted spread or

library oh I s uh. Those spreads have widened a bit in part because if you're a corporate treasurer and you see a nice, safe, risk free short rate as high as it is in such a long time, why do you want to take on risk? Uh? And so if it can happen at the front end, it can

happen for for out maturities. But we're not there yet, and and so I just wonder what this means for financial conditions because for so many years the Federal Reserve has been able to hike interest rights now very slowly, very gradually, and financial conditions haven't tightened until really recently. Does that put the brakes on the Federal? Is that what the Fed ultimately wants to see. They want to see higher right interest rates and and some high conditions

along with it. That's the desired policy outcome. Right, you can't slow the economy unless you've tightened financial conditions. And if you think the economy has no resource slack and is growing faster than the potential you want and modestly slow the expansion of aggregate demand, you do it by tightening financial conditions. Listening to Bill Dudley last week, that's what he was talking about. We have noted three quarters of an average I believe it's three point one percent

or two point nine percent economic growth. Do you model it b n y melon A sustained three g d p Uh No, Because in the in the long run, we're anchored by the growth of aggregate supply. We have an aging population not increasing that fast, and for some reason in another we're not adding much to power work in the long run. Uh. Sure, I think that that's because that maps directly on what they think the equal

abrim real federal funds. Right, long run growth is the attractor to everything, and we talk about the cyclical behavior of the economy relative to that trend within this is it my conversation at the i m F with the head of Treasury for Norway they lowered their target rate from an oil and duced two point five down to the conventional two percent. Is there any constituency, given that attractor of lower potential growth to bring the rate under

two percent? Is there any research vision that we ought to go to one point eight percent target rate on inflation? Actually, the most of the research would say in terms of inflation, you'd go the other way, because when you lower potential output growth, you're probably lowering the equal broom real rate. And the lower the equal Broom real rate, the closer that zero bound phenomenally. So in fact, this should be an argument for raising for Goose. So it's it's chair

and Paul the new ultimate Dove. I don't see him going there because two percent has been locked in the central bank discussion since when the FED talked about quantifying the inflation call. It might I point out this excuse me, this time is different, John, we got trillion dollar deficits. I mean, there was this book a couple of years ago, roll goffin what was her name? I believe, I believe

we were described as Reinhardt. And there's some there's some research since the Carmens that what they say, that's going to be the part of the conversation, and that's about financial depression, governments with big debt like inflation. So we may lation not because of j. Pale. I don't want to get you in trouble at home or out in that beautiful porch you've got. But the basic idea your Vince Reinhardt is Carmen Reinhardt and Ken Rogoff said when

the deficits get to a point, things change? Did they change? With the T word? Are we at a point? And not speaking for Carmen Reinhart, but Vince Reinhardt's work, what's a trillion dollar deficit mean? Do you? Okay? Another favorite factory about out of the world economic outlook, if you look across advanced economies at their debt level in in two thousand seven, the ones with big debt were the ones that perform much more poorly. That is a problem deficits or a problem that will be pushing up on

interest rates over the medium and longer term. That will be a scene anchor on the value of the dollar, and it will create the incentive for a little bit more inflation. Well, let's talk about the dollar just quickly. Vin some the dollar rebounding over the last five days, a bit of a pause in today's session. What do

you make of that? Because a lot of people's investment decisions have been sort of being on the premise, particularly the M for anyone that's getting that exposure to the M currencies, on the idea that at the best the dollar is going to get weak and at worst the dollar is going to be stable. It could be a real pain trade if we get an unwind if that position and what what do you see happening? Yeah? I think you're right. It does feel like a crowded trade,

isn't it. And the problem is you could be right in the medium and longer term and have your head handed in before that. We we view this as as as just the different forces near term, medium term, medium term. The list is pretty daunting about why you want to hold dollar assets, I e. Current accounts, the budget defice. It's big dad an attitude. Uh, that is basically contrary to internationalism. We're ruining their safety nassat value. That's probably why you have a medium to longer term view of

the dollar depreciate. Before that the Fed is kind of tighten more than people think that that tends to appreciate. It been great to have you with us. Thank you very much for joining us. B M. Y Mellon Chief

Economists and Chief investment Strategists. Tom big theme in Europe at the moment has been disappointing economic data, and that disappointing economic data continues with the German business confidence and umber coming through this morning the EFO and it extends its drop over the last several months and through the year after peaking at the back end of To Talk Europe. Gabby Santos, Gabrielle Santos, JP, Morgan Asset Management, Doble Market Strategist,

joining us around a table in New York. Gabriella always grab a catch up with you. You've just been to Europe, so walk me through your vacation and whether you see and improving European economy because it's not coming through in the data at the moment, we do see it very much in improving European economy. It was interesting to see that the dynamism, the energy, the enthusiasm I was just in Portugal last week. Um. But to your point, it has been a disappointing first quarter for European data, and

I would separate that into two factors. The first is the survey data, things like the p M I, which have moderated significantly over the first quarter, but those have been signaling growth that was that was just not realistic. Right three and a half percent g d P was being signaled. That was not going to happen, unfortunately, So the survey data has moderated back to reality. And then the second pieces, the hard data has disappointed as well.

So we do think that first quarter GDP is going to come in closer to one and a half, but we think that's due to probably temporary factors, which was the weather, the intense flu season, and that's likely to revert already in the second quarter. Just in terms of had a bond market is capturing capturing this story, Gabriella, we have this front end story two year buns versus two year treasuries the spread is now north the three

hundred basis points. It is so so wide. I think that's a record wide, a new one as well that's been delivered over the last week. How much longer can we keep this divergence between what is happening with the ECP in Europe and the Eurozone economy and the Federal Reserve in the United States and the US economy, Well, I think they're they're marching to the beat of their

own drums. Right. The US certainly has a lot of confidence on both the growth as well as the inflation outlook, and so it's going to keep its trapped for four rate HIGs this year, are probably even for next year as well, um and even probably some further rate HIGs

as it continues winding down its balance sheet. Meanwhile, it doesn't seem like President drugs in any rush, especially after the soft patch in the data that we're speaking of in the first quarter, He's probably gonna want some conform me shin that that was probably a bit temporary grid. And that's kind of what I'm thinking about the moment when the treasuries can continue to slow grind high with yelds,

and whether the European bond market can remain anchored. Do you already see a bond mark at a global bond market? Whet the US treasury market can almost decouple from everything, counsel, It's not actually likely. Well, I think what's interesting is not necessarily the two year yield um and that gap, but perhaps the tenure yield. Right. So, last week, as a tenure yield started marching higher higher in the US,

it did so around the world as well. Right, So there was something that was common, which was this idea of higher oil prices, higher inflation um, as well as confirmation that probably the soft passion of first quarter growth was temporary. How do you deal with the bias that we're JP Morgan, we're genormous and we saw that clearly seriously in Mr Diamond's letter. People forget the scope and scale the company, and that institutional and client urge to

only own the top two companies worldwide. There's this man sub urge comfort in big. How do you fight that every day at JP Morgan to actually look at mid caps well, comfort in big and also comfort in just one's uh area of comfort? Shall we say? There's there's always this very intense home bias, right, rather we talk depending on whether we talk about equities or fixed income.

So that's something we talk a lot about, not just size of companies, but also geography as well, and I think that's becoming ever more important, especially for our US clients, right, which were in this environment where the US was the only house in the block. It was okay, you can get away with having a home bias. Probably not so if we fast forward the next ten years, that's probably not going to get you to your goals. You have to have some Europe, you have to have some Japan,

you have to have some in well. One quick question, do you have to have cash? I think cash is becoming much more of an alternative now than it's been. Perfect year, yields are higher, right, it's it's kind of broadening your opportunity set beyond just equities and fixed income. You can add cash, and you can add commodities. Right, So your your opportunity set has become a little bit broader this year and over the next few years. Santos,

thank you so much a champion Morgan Asset Management. John, I want you to bring in one of the best people we have on foreign exchange, Elsa Lignos RBC Capital Markets. Yeah, they glob ahead of FX strategy, joining us out of London. After a brief rally in the dollar that stretched to about five straight days, a real retracement of an ugly

seventeen a tiny retracement of a massive move lower last year. ALSA, What do you make of the move in the dollar we've seen over the last week and how sustainable could it be. It's interesting because it's come along a backdrop

of higher yields but also lower equities UM. And that's something we've done quite a bit of work on in the past and looked at what happens in that kind of quite unusual environment where you see a twin bond and exerty sell off UM, and actually it turns out to be a pretty strong environment for the U. S. Dollar. That's not to say this necessarily gonna last. We saw something similar in February and it reversed, but if it does continue, then it should be a pretty good environment

for the dollar going forward. So also, correlation and causation obviously two very different things, and the correlation between yields and the dollar over the last week had many people scratching their heads and wondering whether rate differentials are starting to matter again. Was it that or was it just pure risk a version that was driving a bill into the dollar. It's hard to put it down to risk a version when you look at the performance of dollar yen,

or even dollar Swiss for that matter. Good point, So it does seem to be something more US dollar specific. So can rate differentials be the deciding factor as we

go forward from here? Because if you look at the spread at the front end between Europe and the United States are so it's such a yes that you're a dollar should be a whole lot lower than it is right now exactly, And and that's broken down for some time and has had a lot of people scratching their heads, Which is why I think it's interesting that this move appears to have been driven more by the back end. Um. This doesn't seem to be a kind of traditional vanilla

rate differential story. Um, it does seem to be a little bit more about the kind of bond equity interaction. Is the dollar so big, so dominant that flows don't matter? Elso I bring this up with the backdrop of a week Swiss franc which a lot of people will say, are Russians moving money around and sits in and I get that, But can the dollar move and flows or is the dollar dynamic all about rate differentials? Absolutely, the

dollar can move on flows, I know. I think we saw that most vividly in January, where we had a huge dollar move um and a lot of people were scratching their heads. I mean, I heard any number of reasons for why the dollar was so weak in January, but not many of that must stacked up by evidence. So you know, there are certainly times when people pile into a position, whether that's long dollars or short dollars um, and you get this huge outside moves that go well

beyond what rate differentials a learned would suggest. But that doesn't tend to last. And we've seen that since February the dollar has actually been relatively stavor So what is your I want to be clear here before we go through the rest of this. What is the RBC call and dollar? So if you look at our forecast, we actually have some dollar strength into year end, not a huge amount, but our year end forecast for year a dollar, for example, is one eighteen UM. That's probably a lot

weaker than many in the market would have it. Um and but this selective. You know, we we don't have dollars stronger across the board by any means. Yeah, I mean, and that describes against the ambiguity out there. Is there a trade right now? Or is the street flat? I mean, what's the bet and dollar right now? It's been fairly

mixed it too. Recently, we've you've seen some evidence if you look at tourn Over and estimates of ton Over, we've seen evidence of investors getting more interested in relative value trades. To be honest, Um, so we've seen euroene pick up from kind of late January. More recently, there was a lot of interest in the cart crosses and sterling crosses. I think that reflects the fact that people have kind of given up a little bit on the US dollar and started looking for value alting. Yeah, I mean,

I see that, John. I can't put it out the way grabs on the screen. But Bloomberg has got a high falutint series called O V d V which shows me the bets on any given currency pair, and it's remarkable how symmetric and even eurodollar is right now. That's so if we do get a recovery in the US dollar, is sustainable one and this continues. Where are we going to see the most pain? Oh, it has to be

an emerging market. I mean that's really been one place where you know, you just have to look at dollar max for example, to see the pain that can be caused in just a few short days. Um, you know, dollar max was just trying to lower and lower and lower through librwery March makes one of the best performances year to date, and in the space of three or four five days at all reverses. So you know, I think that's where you've got to be most cautious, the

highly positioned em currencies. Yeah, and speaking to a lot of fixed income investors that want to play the e M local currency story and they want the effects exposure, there seems to be this real comfort taking the effects exposure in emerging markets alside. So I just wonder what are you advising clients around the MFFX now and has it changed over the last few weeks so a that time, strategists has actually been quite cautious on a lot of

these currencies since the start of the year. Um, you have a lot of political risk coming up, both in Brazil and in Mexico with elections coming up this year. The problem with these currencies is that they're very expensive to short. You know, like you mentioned, fixed income investors take the currency risk because if you were too short, if you were to hedge the currency, you would be left with very little or any yield pick up at all.

So UM, I think it pays to just be a little bit more careful with these very very heavily positioned DM currencies like max, and perhaps look for opportunities in areas which are less positioned, like Asia or email. To John's point, how do you play oil? I mean, we're whatever price, sure you want to call all of a sudden, seventy five dollars on Brent crude is a that's a hello quote we get to eighty, you know, essentially nobody called that, but ELSA. How do you play long oil?

So one that we like, it might be a little obscure is long KNOCKI stocky two scandy currencies one against the other. Um Norwegian corona obviously exposed to oil. Swedish corona UM clearly not. And it's also a central bank play. So you know, they're all trades out there. I means, oh, use an email Sarah from Cincinnati. John Ferrell emails in a nacky stocky and and soca. She says she's g she says, you know she's quick. I'm looking at it. Okay.

So so you're your based on your basic idea here is to go long Stockholm on there or about longslo. You're going longslow long slow shorts dot com. Yeah, yeah, Okay. Eliza MARTHINUSI joining us now Bloomberg's managing editor for finance in Europe and joining us on the phone. Really great to have you, Eliza, and just walk me through what we've learned about the new CEO and how the management

is slightly taking shape at Deutsche Bank. Yes, John, I guess what's interesting about disappointment is that it's another Deutsche Bank Lifa, much like the new CEO as Christian serving and you know, principally with exposure to the domestic businesses. So there seems to be a bit of a pattern emerging in terms of the new leadership. Now, so what next for this bank? Because every single morning, whenever there's a Deutsche Bank story, it's usually the most read story

on the Bloomberg And guess what it is again? As Deutsche Bank considers cuts to the Investment Bank and the presence in the United States. Eliza, where is this going and what are they looking at more specifically for their next move? Well, I guess what we're hearing now is that this project Columbo, which we have reporting about for

a few weeks, is gathering pace. And so this review the Investment Bank and a closer analysis of where it is that they're making money and where it is that they perhaps ought to be treating is now coming to an end. And the picture that's emerging is that the US equities business use cash business is perhaps one where you know they will be retreating. As I was just talking to Anthony, and Sparta's at least Sparta's like in the alps of New Jersey. It's sort of outside New

York City. Farther moved from Sparta by the way to the flat lands of New Jersey. He's now in the pine barrens. Something like that. You got read by John mcpheez. How many bodies are there in for Deutsche Bank in New York, I mean, how many people do they actually when we say at cash equity and all that, how many bodies are involved? Well, what we know from from some of The analysis that Toby Anus have done is that they include employee about ten thousand if I'm not mistaken.

Really yes, but of course not all those will be in the equities business, and not all of those will be in the cash equities business. Um, what is that's jargon? Excuse me, time for a jargon alert with Eliza martin Newsy what's cash equities? What does that mean? So that is the trading of plain vanilla shares as opposed to the dating in, for example, derivatives that might be based on equities. It's like stuck, like IBM, you know whatever

the trading do they do that from London? Then? I mean, what I don't understand is are they going to get out of the equity business? How can you do that? Well, we have seen players, you know, other banks that have retreated from the trading of stocks and certain regions. That is not unheard of, I mean. But the question that will remain is how much of the other business you're able to maintain. You can no longer go to client and say I can offer equity trading across the world precisely.

What is the track record of other banks that have said we're getting out of this business because it's a it's a money loser. What's the track record? What we don't have as a clear track record of someone with such a presence pulling back. So, I mean, we've seen it in smaller players, but we don't have the track record with you know, a leading global farm pulling out of the bigger equity market. What do you see in earnings coming up? We've seen Banker and he's coming out.

What is the state of the the EU banking the command your attention? So what we're expecting, based on what the analysts has been crunching, is that there will be an even wider split between the Europeans and the U S firms particular errors such as equity trading. Um. What we've seen so far is that you know, ub asked that reported yesterday did a little bit better than people expecting. Having said that, they did so by ramping up the

risk taking their equity business. So one of the key matches, they're the value at risk more than doubled for equity trading. So it seems that the you know, they're trying to find ways to maintain that market shire Lisa, thank you so much at Lisa Martin News you're running all of our EU bank coverage. Just fabulous. It is wonderful to have with us. Now Michael Mayo of Wells Fargo Securities, and we're going to rip up the script here and

do something a little different. Michael Mayo, I think this is great to walk through the gossip of a bank and in this case City Group, But I really want to outline who these people are in their paths to this moment, and of course looking at all the speculation of what Gary Cohne may do or not do. Let's begin with one of the great gentlemen of the business, which is Michael O'Neill. I first knew him like a

Bank of Hawaii. He goes back to Continental Illinois, who was the present chairman of City Group, And what did he do for Mr Corbett in the bank? Well, just to put perspective on this, Tom, I am in Chicago for City Groups annual meeting. I go there to ask questions. It's the only chance one a year chance to ask questions board members. When their answers uh they can be held publicly accountable to So. Mike O'Neill was one of the grandfathers of bank restructuring. He was a master at

ensuring adequate capital allocation. He was actually the chief nancial officer at Legacy Bank America, as you said, Bank of Hawaii, he was the CEO, and he's been chairman for most of this decade at City Group. So he's overseen an effort by City Group to not have the situation like they had during the financial crisis, you know, for the next generation. And so the de risking at City Group

has been excellent. Uh. They've discarded some inefficient businesses and City Group is on a much stronger foundation, you know, facilitated by him, certainly implemented by the management. A chairman

drives the board. Would you suggest within the speculation and that he pushed out Mr pandit years ago, you know, Tom, I think I was on your show some of those times, and you know it was my view that City Group needed a new CEO, and it was also the view of many investors that City Group needed a new CEO

at the time. And so I think, you know, Mic O'Neil, chairman of City Group, you know, listen to the thoughts of investors and made up the town of mind parts for us what a chairman does versus an operating executives such as Mr Corbett Mike Mayo. I spend time with Mr Corbett at Davos on a panel. He is the buoyant football player from Harvard and folks I should point out that Mr Corbett is actually the real deal. He's not some kid that happened to play football. He was,

by all acclaim, actually really really good. What's that relationship between a chairman and an operating bank officer handling two forty people. Well, Tom, I'd like to point out this is an exception among the large bank. City Group has a separate chairman, as you say, Mike O'Neill versus the CEO Mike Corebat. And this is a big issue of governments, not just for banks, but for all corporations. Do you

need a chairman? What the chairman does? It's an extra check and balance on behalf of investors to ensure that the company is pursuing sustainable growth. Certainly City Group is the poster chopped. What can go wrong? You saw that over the last Well it's for the twenty year anniversary at just April six of the creation of City Group in its current form, and the stock is down. So if any bank, if any firm needs an extra set

of eyes, it probably would be City Group. And the role of the chairman is to ensure the strategy is adequate, to ensure there's good succession plans, and to ensure that you're not taking excessive short term risk to get management paid that comes back and bite you later on. Can Jamie Diamond do both jobs? Well, look, that's best in class. JP Morgan is best in class among the global bold bracket banks, and so you know it's working. Look a question for governance though, is can at work not only

under Jamie Diamond? And it is, But can it work under the next CEO at JP Morgan or Bank America or any of the other large banks. Let's turn to Gary Cone. Do you believe the speculation that he could be asked or assume the duties of chairman of City Group. Well, Mike O'Neil, chairman of City Group, has mandatory retirement at the end of this year. That will be my first question I asked at today's annual meeting at City Group. So one option is to promote my corbette chairman. Another

option is to find somebody on the outside. Gary Cone seems available. There's other people the ex CEO of US Bancorps Richard Davis, Harvey Schwartz. But it's, you know, it's the board's imperative to do their homework, to look at the talent out there and see if they could benefit by somebody else. So why not Gary Cone or someone else like that to be chairman as city group? I'd like to hear their thoughts on And this is what I wanted to get to folks with that historic walks

through we just did. We got the time this morning to do this right with Mike Mayo at the meeting in Chicago. Mike was fascinating. And I say this with a immense respect for Gary Khones public service to the nation. How do you move from the operating hands on goldman sacks guy two chairman duties? Does everybody do that? Or or is that too much of a hurdle for Mr Khane to do? I mean they got to start somewhere.

They all started as a tough operating officer like Mr kohone, So is he eminently qualified to be chairman like well one? That thing I have Tom is, you know, we published our questions for the meeting today and asked large institutional investors. These are the largest owners of City Group in the other banks. What other questions do you have? What are your thoughts about some of our ideas And one of the ideas was, you know what about someone like Gary

Cohen as chairman? And I'd say the feedback that we've gotten has been good. So the large investors do this as their day job. I think that which could be a positive addition. Now, having said that, we heard nothing about Gary Cohn and his intentions, but that's one of several people that seemed to makes sense the charts that I do my you know, my normalized charts on the banks back to two thousand seven two eight. Lehman, uh moment,

Come on, they've lagged, they've lagged, they've lagged. Is there an urgency for City Group to really jump start share older return or is this going to be a long slug still from Mr Corbett, Well, look, that's one reason why I'm here in Chicago, Tom, I mean, I'm here for this purpose. City Group has made great progress. They now have double digit return on equity, return on tangible equity.

That's first time since before this nancial crisis. Their risk is significantly less and the stock while it's underperformed this year, it did outperform last year. Having said that City Group has worst in class returns and worst in class stock price valuation. So if that's the case, what is the stock market saying. We think the stock market banking is City Group needs to up the intensity to another degree and you know, hold managements feet to the fire, and

that partly is the role of a chairman. A couple of more questions here, Mike Mayon have got to go tangential to the idea of European bank walking away from the quote unquote cash equities business in New York. I have no idea how you walk away from the equity business in a given geography and maintain the further banking relationship.

Can any bank, including deuts your bank, can they do that? Well? Tom, when I was on your show a few weeks ago, you know, I mentioned Goliath is winning David versus Goliath, and Goliath is winning in capital markets and to the large five banks are really outpacing the next five largest, which are Europeans. And so the European banks, whether it's Deutsche Bank, Barclay's um or Credit Sweeze had single digit r o E. So the way you walk away is if you have very low returns. That's a tough way

to keep feeding a value destroying business. And that's in contrast, frankly to City Group's current returns which are double digit off the gate Morgan Bank, and so the larger US capital market banks are winning versus the European bank. Michael Mayo hugely valuable. Thank you for your time us in Chicago for the City Group meeting. He is with Wells Fargo.

Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio s