Euro Weakness vs. Dollar Strength with Rosenberg

thirty year at three point two percent, Jeff? Because unless you're gonna trade it, you're gonna get stuck with a pretty low yield for a long time. And if you are going to trade it, you have to find someone else that's willing to get stuck with that low yield. So there's a couple of perspectives there, Pim. And it's a great question. It's a question we get a lot, but you're seeing the reason why people want to own

that thirty year on a day like today. Duration having something in your portfolio that moves in the opposite direction of risky assets like equities is really the reason why people own that. So it's less about the absolute level of yield. You're not really thinking about the thirty year

treasury is an income source. You're thinking of it as a stabilizer, and on days like today, it's really showing its value that it goes up a lot when risk goes up, and people own it in their portfolio for its diversification value more than its absolute level of yield. Would you sell it if you own some thirty years in your portfolio, I mean, would you sell some of

them today and take advantage of the turmoil? No? No, we're not going to think about sort of the thirty years trade as as as a trade or the thirty years treasury as a as a trading strategy. This is really about portfolio construction and building porto is that are resilient over longer time periods. This is about what's the right percentage allocation in my portfolio two equities to my

risky assets. And then given that percentage that's relevant to me in my life cycle of investing for my risk tolerance, I can add some diversification in terms of adding some thirty year treasuries, and I'm holding that portfolio concentration relative to my equity allocation. If I then decide I want to de risk my portfolio because I think, like events today Italy, it's showing me there's a lot more risk in the world. I want to take the risk out

of my portfolio. Then maybe yeah, I take the risk out of my equities, and then maybe I don't need that thirty year ballast as much. And hey, one of the areas we've been talking to investors about, look at what you can do in the front end of the US yield curve today. You can get three three and a half percent yield in some attractive investment grade areas of the market. Maybe that's why I sell my thirty

year because I'm getting rid of my equity risk. That's a d risking of the portfolio moving into more like cash and cash equivalence. That's a very different kind of strategy talking about the overall portfolio, not just looking at you know, these one day moves. Speaking of these cash and cash equivalence, how do you anticipate all of this volatility and emerging markets in Italian credit, in Italian bonds

all over Europe? How do you anticipate that ultimately impacting the FED decision process and the front end of the curve, because it seems the front end is likely to experience a lot of interesting activity throughout the year. If this becomes a big problem, yeah, and and that's really the the key point to your question is is the if

how big of a problem? And by problem. From the Fed's perspective, what they're gonna be thinking about is does the Italian political risk rise to the point of affecting the real economy outcomes in the US? Does this event cascade into changing people's views on their investment, on their spending, on their con fidence. Right, And the FED thinks about that in terms of what they'll measure as financial conditions, this is a financial conditions tightening, meaning it's making it

harder for companies, individuals to produce real economic activity. Now, where the FED had been where the markets are, is that financial conditions have been very very accommodative. So this is a movement upwards from very very loose financial conditions, highly accommodative financial conditions, to a slight tightening on the margin that reduces maybe some of the odds, but at this point probably doesn't dislodge the FED off of the path of three to four hikes. Maybe it reduces a

little bit of the four hike scenario. Markets are pretty much priced for three and that's where I think you'll see this sort of settle in for the front end of the curve, Jeff. If the dollar continues this, uh, this path of of strength, right, I mean one fifteen

forty five against the euro. Not only are is everyone going to be able to afford to go to Europe for a vacation, but isn't that going to just raw even more funds into the United States And you're going to end up with this kind of cycle that chases its own tail. Yeah. So you know, the strength of the dollar is another kind of source of tightening financial conditions, because when the dollar is stronger, it makes everywhere else in the world harder to finance their debt. Remember, most

of the world's debt is denominated in dollars. So strengthening in the dollar is good for us, good for the European vacations and as as you just mentioned, but it's bad for most of the other countries in the world.

So I think what you're seeing this morning is a little bit more about euro weakness than it is dollar strength, because it's about increasing the odds of some disruptive political events showing up in Europe, but certainly dollar strength on the back of the older story, which was we have a better growth story, we have a better interest rate

differential is another headwinds to global investing. And so when we think about portfolio construction, we think about global equities, for example, this is a little bit of a headwinds we think about emerging markets investing. You know, first and foremost it's a currency risk, and so the currency risk showing up kind of brings some more attractiveness back into

the US markets. Okay, so you hit on a really key topic, and I think that is currency risk in the dollar, and I'm looking at your strategy and you've got sort of this neutral view on emerging markets. Talk us through how you see that playing out, how you see this dollar strength playing out in emerging markets, and where you're still finding opportunities in that space. Yeah, so the emerging market view is really changed for US a

lot because of this shift in the currency outlook. So what you had had for a very long time was relatively benign emerging market currency volatility in an environment where the yields that you were getting for taking that currency volatility by buying the locally denominated currency, debt was relatively attractive upwards of a hundred and fifty even if we go back further two hundred basis points above treasury debt, when treasury debt was very low. Now, more recently, what

have we seen. We've seen both sides of the argument towards local currency move against the local currency view, which is currency volatility is higher, so the risks to currency are much more apparent, and the extra yield that you're getting relative to the hard currency alternatives has narrowed. So that's shifted our emerging market focus a bit matt back towards hard currency alternatives, where hard currency spreads and yields had moved up, making them more attractive relative to other

credit alternatives where you're not taking the currency risk. So that's the shift for us. It's still it's a neutral view because it's an overall portfolio wide view because we're overweight emerging market equities on my colleague side of the equity side, so we're taking the risk more on the

emerging market debt equity side then on the debt side. Well, just to that point, Jeff, I mean, isn't this the time when you hear the word crisis, shouldn't that make you smile as an investor and say, okay, let's figure out how to take advantage of this opportunity, because it's not about people liking you, it's about helping people make money. And if you've got a crisis, you try to figure

out a way to take it vantage of it. Maybe don't go into all whole hog, but you know you have you find something that might be mispriced, well, it absolutely does if you have risk budget for that. Now, Unfortunately, as we go into these markets, one of the things that we see is a lot of people were very

long risk. So crisis is is good if you're a contrarian investor, which meant that two weeks ago, when everybody was very happy, you were saying, well, I'm going to take risk down and and and the reason why you do that is so you have opportunities to add to risk in an environment where risk is going up. That's for very high frequency kind of trading type strategies. I think the broader, longer term message of crises is it's a reminder that markets have risk. Merging markets have risk. Uh,

stable markets have risk. It and to review your portfolio to say, is this the kind of allocation, the kinds of waitings that I'm really comfortable with. One of our big themes for two eighteen relative to seventeen is seventeen was a very low risk environment. It was the lowest equity volatility ever. Now you're seeing it much higher. Thanks very much, much appreciated, Jeff Rosenberg, black Rock Chief fixed income strategist. He's a pro when it comes to radio

as well as fixed income. Much appreciated. Joining us now to talk about issues such as China trade and after t p P as well as other international issues is Stefan Selick. He is the former Undersecretary for International Trade for the International Trade Administration. He is currently the managing partner of Bridge Park Advisors. Had a career that spans not only UH international relations but also Bank of America Mary Lynch, where he was executive of Vice chairman. Steff,

thank you very much for being here. Um, let's get your thoughts right now on the state of trade talks between the United States and China. What do you believe is actually going on? Well, you know, the Secretary of Commerce, willbur Ross is headed there at the end of this week for some follow on discussions um UH to um UH deal with a whole host of issues, including the UH tariffs UM that have been discussed, and so I think it's going to continue to be fluid in ongoing.

What I don't expect to see, PHIM is some big grand bargain coming anytime soon, because these are complicated issues they're going to take time to address, and like in most diplomacy, I think you're going to see incremental progress and not um uh some panacea. Speaking of incremental progress,

what incremental progress would you expect? Right, So, not a grand bargain, but are there specific product areas where you can see true resolution within the next six months even twelve months At the well Gina, I would hope it would be the exact opposite, because if I think if they focus on specific products and have a shopping list,

that they're fundamentally not getting at the right issues. So great if they get China to buy more soybeans they already buy twelve billion dollars of our two billion dollar crop. Great if they buy some more l G. But frankly, this is a commodity product that we're likely to have sold to another market anyway. What they should be doing is focusing on the important structural issues like the joint venture requirements, the investment restrictions, UH, the theft and counterfeiting,

counterfeiting of intellectual property. And so unless they get at those structural issues, I'm fearful that actually that not much long term progress will be made. ZTE Corp. Is it normal for a specific company to garner so much attention within the context of trade talks UM, Well, PIM, you know, they were bad actors and they got caught red handed,

viole eating our laws. In fact, this happened when I was the Under Secretary of Commerce in two thousand and sixteen, UM and we, as you know, UM had sanctions on countries including Iran and North Korea, and as a result of that, they were prohibited from including US products in UM UH there products that they sold to those countries, and they went ahead and did it, and they went

ahead and did it knowingly. They got caught, they paid a fine, they agreed to certain measures, and in fact they didn't follow up on what they had agreed to do. So now this is coming back and apparently now rather than close them down, there's going to be an additional fine of over a billion dollars. There's going to be a forced change of management, and there's gonna be some

real stringent oversight um going forward. Um. That is separate and distinct from this issue of using those telecom equipment products to spy on US companies. This is really just a matter of law, and I think it's gonna I think it's a going to play out over the next few weeks. Stuff. And you have some really strong opinions on this focus on the bilateral trade deficit by the administration and how that potentially, I guess presents a sort

of false argument. Maybe you can talk us through that focus and how it should shift to really achieve any meaningful reform. Yeah, I mean, Gina, I think first of all, thinking of our trade deficit as a scorecard, it just makes no sense. Um. Uh, it is not. And then in fact, the deficit, our trade deficit is caused by a whole host of things. But it's not caused by our global competitiveness. It's caused by investment and savings rate in respective countries, and it's caused by, um, the fact

that the United States is the world's reserve currency. I would also add to that to your point, focusing on that deficit bilaterally with one particular company makes no sense. I mean, you run a trade surplus with Bloomberg every month when they pay you, and you run a trade deficit with your dry cleaner every month when you pay them, And so thinking about this that narrowly is a mistake. And I go back to UM, not using it as a scorecard, but focusing on the real long term structural issues.

And at the top of that list are going to be issues that we have with China, given the importance and size of that economy. Do you believe we're going to get a renegototiated NAFTA. Well, UM, it certainly is not proceeding UM as smoothly as one would have hoped. UM. I'm not particularly fearful PIM that UM we're going to withdraw from NAFTA because the consequences I think would be

UM profound and severe. I think the administration has heard from companies in industries across the United States as well as our farmers and our ranchers how important the Mexican and Canadian markets are to them. Uh So, while I think it hopefully gets UM modernized, because this is don't

forget a twenty five year old agreement. UM, I'm fearful that the asks at the current United States Trade Representative has put in place Representative Trade represent It of Lightheiser are so aggressive that it's unlikely to be able to get resolved in the near term. And as you know, we also have both our and their political calendar. They have an upcoming presidential election on July one, we have

our mid term elections. So my fear is that this gets pushed out into the future and the can gets kicked down the road as opposed to making the sort of progress that we should have been able to make with two of our most important allies. UH and friends, thank you very much for spending time with us, being with us this morning. Stefan Selga he is a managing partner of a Bridge Park Advisors, former Under Secretary of Commerce for International Trade, giving us some detailed information about

how trade talks are progressing or alternatively not progressing. Dean current It is the chief executive officer for Macro Risk Advisors. He joins us here in our eleven three oh studios and I want to welcome, of course, all of our Bloomberg listeners. UH, in Boston one oh six one Boston, Newburyport and UH in Washington six, San Francisco and one serious dean. Are you panicky or are you celebrating? Well, I don't think it's the reason yet to PANICUM him.

I think you make a really good point, which is there are more often than not these events tend to be more idiosyncratic to a specific asset class or region. We've seen these types of UM risk golf events in you know, a particular area UM start to get priced in more broadly into let's say, US stocks, but then ultimately fizzle out. UM. I think the market's trying to do its best to sort of probability weight the potential

for UH something to get transmitted more broadly. So I think that's that's what you're seeing, is that the sell off in US equities and the rise in the VIX are UM some discounting of potential future outcomes. UM. That being said, I certainly woke up this morning and was quite alarmed by just the size, the sheer magnitude of the move UH in Italian sovereigns, the massive sell off in bank stocks in Europe. UM. If you're not an

expert in Italian politics, which I certainly am not. You look to asset prices to tell you about severity, and this is certainly UM. The asset price move is telling you that people very much care about what what's happening

is the situation unfolds. So when you think about that feedback loop, if we if we very much care about UM what's happening in Europe, and then it will ultimately impact the US equity market, how do you navigate that both short term tactically in long term UM in your strategies, Well, I think the first thing is and and so our firm ACAR Risk Advisors tends to focus very much on option based strategies and oftentimes clients will look to us

to help them UM design hedging trades. UM Hedging is I think a undervalued discipline, but certainly something that for example, throughout last year, if you tried to hedge, even as the VIX was quite low, you would have been quite early UH to calling calling the risk golf events. So you have to be careful when you get defensive because you can overallocate option premium UH and spend a lot of money in the sideways. And as I said earlier, most of the time these situations have boiled over. But

I think collectively investors, antenna should be risk. Antenna should be up at this point. Um, we certainly have a situation which the U. S economy continues to do well. US corporate earnings are are the foundation of asset prices. But at the same time there are these complex risk cross currents. We've talked about the dollar as a of international vix. I think that can be destabilizing, especially for

e m um and um. You know, you've got at this sort of at a given time, a lot of international negotiation, uh, North Korea, Iran, China with tariff, so there's a lot of stuff happening, and this meltdown in Italian sovereigns I think just adds to the mix of things to be watchful for. Right. So you talk about size factor in some of your work recently and your preference for small caps over large caps, and that's certainly played out very well and certainly in your favorite so

far this year. But it strikes me as really intriguing that at some point if investors are flocking to the dollar, it's a consequence of risk, right, It's a consequence of depleting risk tolerance or decreasing risk tolerance, and yet small caps carry a very high level of risk. Well, ultimately, the dollar rally work to the detriment of the small cap trade, and how do you navigate that? Right? So it's a good it's a good point. We are our favorite of things like i w M as a kind

of placeholder for being long in the market. Uh. Certainly was with the recognition that it's a domestic index. It doesn't have as much This is the Russell two of the exchange traded fund for the Russell two thousand exactly. Yes, um So, because the small caps tend to be very domestically centric, they're not as exposed to a rising dollar.

But you know, your point is very well taken that um if the scenario of a rising dollar is to is what causes a significant risk off event, it's just hard to say that any anything holds up really, really well. Um So, So this was a recommendation for if you're going to be long. Um we and you don't think the dollar is set to spike, and our work on the dollar suggests that we think tactically you can see it continue to rise. Um. But we're staring at these

massive twin deficits. And so from a longer term standpoint, UM, you know, our work suggests that the dot the dot the strong dollar story, while tactically appealing, UM, we just don't see it. Just given the the size of the you know, capital and current account deficits that the US is set to run. You don't think that we can just get people to lend us more money. We can or or they could raise taxes, or you could have economic growth that then increases tax revenue. Uh why I mean,

since we print the currency, why is that a problem? No, I don't think it is a problem. I think that it's just a reality that we've never Uh. If you were to look at a UM a chart of the unemployment rate versus the size of the deficit, we're in no man's land right now. UM four percent unemployment and a trillion dollar deficit. This is these two have never

coexisted before. UM. So we're we're a uh, you know, consumer of of capital in terms of you know, from from a dollar standpoint, UM, and if you just if you look at charge it's over a long period of time, there's actually a reasonably strong correlation between UM the year over year change in the dollar and the size of the of the twin deficit. And so that's a longer term um issue. And again I think tactically, uh, there's certainly a risk that the dollar continues to rise and

it's destabilizing for assetprises. What is market neutral momentum? Yeah, so market neutral momentum is uh. And you guys have built just an incredibly powerful page it's called ft W, which is for factors on blood neither. Well, we're using it, we're benefiting from it. So market neutral momentum is uh, it's a it's a factor. So momentum is what What is momentum? It's it's the winner's right, So it's it's the observation that winning stocks continue to win and losing

stocks continue to lose. What market neutral momentum does is it takes the sometimes the quintile, so the the you know, uh, strongest moment some socks and the least strong momentum stocks, and it creates a long short portfolio. Um. So it's it's got no market beta, it's just got exposure to the momentum factor, which is the past performance. Uh. And it continues to do uh incredibly well. It's embodied in

big cap text tech stocks. It is Facebook, it is Netflix. UM, you know, it's it's the beheamoth that continues to underpin a lot of the market capitalization growth in US equities. So UM, this has done what up nine percent so far this year. It's tremendous. This this and this is a portfolio that you're running right now. No, this is this is a factor. UM. We we would argue that momentum just because it's been so good to people for so long, UH is one of the risks that UM

investors are vulnerable to. UM when you look at the allocation, for example, the passive strategies. Last year, Vanguard took in three sixty billion dollars of new capital. I mean, even Jack bo Goal is saying this is this is insane UM. But Vanguard, UH just does not read the newspaper. They just buy Apple because it's the biggest stock. So indexation is largely a momentum strategy because it buys the winners, right that have the biggest caps. Thanks very much for

being with us, Very illuminating, much appreciated. Dean Current is the chief executive of a macro risk advisors and risk I think is going to be the word of the day risk when it comes to Italian debt. UM. Diane Swonk is our guest chief economist for Grant Thornton. Diane, if you were in Michigan, you were paying over three dollars a gallon for gasoline, as many people are in

the country. Do you believe that that is going to show up in what people are able to put away, because we're gonna get and personal spending numbers later on in the week, Yes, I do. In fact, our analysis is that the depending on how long these higher gas prices at the pump linger we do know the Saudi Arabia has started to turn this picket back, or at

least promise to turn the ticket back on. Even as much as we're seeing production in the US, it just simply can't make up for what Saudi Arabia has in spare capacity. And so our analysis is that we've already eliminated much of the tax cuts with higher prices at the pump for middle and lower income households. Those um tax cuts average when you get into the middle income

households about eight hundred dollars per household. About half of that's being wiped out already by higher prices at the pump. For low income households, the lowest wage earners, their tax cuts are only four year dollars a year, so of

course they've already seen major loss in earnings. And what's really important is with the higher prices that the pump is, it also affects things like housing, mobility, people's ability to take higher paying jobs because anything a gain in terms of paycheck gets wiped out in terms of how far

they have to dry and higher commute costs. So we certainly are crossing our fingers that saw Arabia will go through and actually continue to turn on the pickets and bring those prices back down and it will show up at the pump over the summer, so that we can get people in the jobs they need to be in and not have to turn down higher paying jobs because

it's eating away in their commute costs. Diane, I just had a pleasure of reading your note No Place Like Home, in which you review the prospects for the U S consumer, of course mentioning gas prices as a critical component as well as income. But the one other thing that you dive into quite a bit is how much consumers are starting to tap into their homes again to support their

spending patterns. Wantn't to talk us through a little bit about what you're seeing in home equity lines of credit growth and how the consumer is utilizing credit markets once again to sustained spending. Well, up until now, that's great at the question, and up until now we had seen people doing cash out refinancing to do remodeling. And this is where a lot of areas baby boomers and older homeowners Gen acts homeowners are now adding and remodeling and

repairing their homes instead of trading up. That's also leaving us with short supply, but they are investing in their homes again and they're doing it by tapping into either the cash out refinancing or now home equity lines of credit which are coming back. The good news is there's more safeguards and there ones where and that is that you can't take out more than you know leave yourself

with less in your home in most cases. Although that said, it's interesting is even though there's been a change in the tax laws which limits the deductibility of those home equity lines of credit to actually remodeling and putting money into your home, the signs are seen on the street and actually published one without the bank's name on it, right in the middle of Lasle Street in downtown Chicago.

The advertisements were for a third honeymoon, a trip to your rome um, you know, braces for your kid band camp.

It was really sort of a flash back to two thousand and five and the idea that you would use your home as an a t M. And what we don't know is how easy credit conditions are going to get, not by the banks per sale though they're trying to make up the fees loss to refinancing which have now fallen, but also more importantly to the shadow banking industry, which so far hasn't been really aggressive in the home equity

line of credit market. But once they can't get those refinancing fees, and we have seen mortgage applications are not what they could be because we don't have enough supply in the market and prices are going up fairly rapidly. That could see a flip flop and you could see many more people tapping into it. We're already yet very low rates on the saving rate. When you see home equity lines of credit go up, that's going to push the saving rate even lower. It's at three percent right now.

The record low is two point four percent, which we hit in December because of all the insurance and sort of rebuilding after hurricanes. But that was the lowest rate since two thousand and five. When you look at the general risk of this evolve incredit landscape, banks getting a little easier on credit allocation, particularly with respect to Holmes, the consumer leaning on credit a little bit more, saving less. What are the trigger points that make you really concerned?

Right because we said, we tend to talk about, oh, these things are changing, but it's not a huge risk. It's not going to push us into recession. At what point do you say, okay, this is it. We've gotten to a point where we now really need to worry about home equity. Is it rates are a certain um level or is it outstanding debt reaches a certain level. Is it the unemployment rate that shifts? What are your big triggers for the employment rates? A lagged leg an

indicator in defaults is something. So far they've been pretty low, with the exception of vehicle default and student defaults. And student defaults have actually come down off their highs. But um, we don't know what's out there, and once we start, you often get teaser rates on these home a rate lines of credit, right, and so the first year you're fine. But what we'll really be watching for is a year from now is what happens as those rates flip, and we will likely have a much higher rate in how

much is that can to stress these homeowners. Also, I think it's really important is that we watch very carefully how much people move back into flexible rate mortgages instead of fixed rate mortgages. That seems completely counterintuitive to go towards shorter term interest rate mortgages when rates are going up,

but that's exactly what people do. You know. One of the things, having been in credit for nineteen years of my thirty year career in a bank, I used to always warn our credit people as the best way to die is in debt, because it means you've gained the system and you've lived beyond your means your entire life. And that's what I always worry about, is the accumulation of debt. And we're doing it even though we're not at the highest levels relative to income that we've seen

since such crisis. We have taken off that access debt. We're at two thousand three levels. That was still a peak prior to the housing build up, and we had already taken on too high a debt build up before the housing bubble. Diane Swunk, Can I just shift your attention to one of the pieces of information are going to get when we look at the labor report, which is the prime age male labor force participation rate, how

many people are actually working. Can you give us your thoughts there and whether you believe that this is a structural trend that is going to have really nasty implications for the economy. It's a great question. It's one of

the ones we moost worried about as economists. We have seen us come off the lows and participation from the crisis, but we're still on a downward trend since the peak and prime age, particularly as you pointed out male labor force participation, but also women um women's labor force participation among that fifty four year old group is now lower in the United States. In Japan now they include more

part time women workers. But these are things we really worry about because as we are not able to bring as many people back from the sidelines because of chronic problems like the opioid crisis, a huge erosion in skills, people who have just simply not been invested in in terms of their human capital, their education to work the kind of jobs or working today, and all the burden to train is on individual employers. I see it with my clients every time they're biggest challenges, they train people

and then they get poached. And these are people that they're paying signing bonuses to their increasing their wages and their paying for their training. But unlike higher level education things like an m b A or things like that, where a company can sort of require you to pay that back over a period in time, if you train a trucker to be a trucker, they can be taken

away from you overnight by a competitor next door. Well, and this is also something that if you take a look at what's going on in Italy, they also have matched the United States for low mail primates participations. Exactly good company there in Italy, right, Yeah, I know this is really serious, and you know, the things that we worry about is how much of it is structural and how much of it is cyclical. The cyclical component looks

like it's you know, starting to play out. We really are bringing some of those people back that got hit hard as but you know, could come back into the labor force. But this is a real issue going forward because by if we eliminate immigration, and we are cutting immigration quite dramatically, it's already down legal immigration is already downed quite dramatically from a year ago. That's the administration's desire.

If you eliminate immigration, by just the aging of the labor force and the natural trends, this sort of structural trend we see in labor force participation by men in particular, gets you to a contraction in the labor force by that's only two years away. That's something we want to avoid because we really want to re engage these workers on this hideline. We want to We don't want to

lose people. The open word crisis has so many collateral damage, but that's only one of many things that are affecting incarceration rates, are infecting prime mail participation, all of those things together. There are fixes, but there's no sound bite fixes. And a good economy alone does not lift all boats, thank you very much, Diane swonk Is. The chief economy is for Grant Thornton. Thanks for listening to the Bloomberg

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