Inflation Expectations Are Too Low, Kroszner says

Pal at the moment? Hi, John, Yes, I think power is trying to retain optionality, is trying to retain flexibility. There are a lot of uncertainties out there. You know, We've had the tax cuts, so you've had this new term boost to growth. We really don't know if that's going to affect long term growth. We also don't know how the whole trade war thing is going to play out. So I think what we're hearing from Chair Powell is

for now, so the next couple of hikes. But you know, I was struck by the fact that he is not pushing the theme of a higher our star or a higher neutral rate. He actually brought up the neutral rate a bunch of times, but he's saying there's a lot of uncertainty. Second point, he's not pushing the idea that I think is embedded in the dot plot that the

FED is going to go above neutral. I think that is I would say the single biggest risk factor, uh for the equity market is the fact that if the FED does go above neutral, they're going away from the narrative of of normalization to actually tightening. But chap Owl is not really pushing on these themes. So that's why, uh, you know, I would say the rates market is essentially priced for that outcome. Um. But but I think that's he's really trying to, uh, to keep up all his options.

Let's explore this concept of the neutral right though, What is the neutral right? How close are we to it? So you know, if if you look at the dot plot, it's anywhere from two and a half to about three and a quarter percent, we really don't know. It's it's immeasurable. I think what drives the neutral rate is essentially long term growth. So what drives long term growth, it's it's

labor force participation and its productivity. Now neither have moved, and I think this is the big puzzle in economics why are these factors not moving? And so if they're not moving, then our star is actually much lower. So I think you know it's it's a it's a big issue for the rates market. They are plug ins. A. Can we make the plug ins given the new lower terminal rate which is a mystery? Right? And B can we make the plugins given central bank balance sheet dynamics

which are a mystery. We have two major mysteries. I cannot not say that we do. I think the balance sheet one is the one that most people think that the FED can continue to run the balance sheet down. I actually think that the equilivalent level of reserves is much higher than what it was pre crisis, and so at some point next year, the FED is going to have to deal with the fact that banking reserves will become a binding constraint, so they'll have to stop balance

sheet run off. At the same time, if they've hiked a couple of times and we'll let's say two and a half three on the first rate, I think they'll have to stop the hiking cycle. This is really important. Back up again and say what's going to happen in a year with a balance sheet choice at given bank reserves. That's advanced. Mumbo jumbo. Explain it in English. So what's happening is as the FED lets the portfolio run off,

access reserves in the banking system do decline. Now, if you look at pre crisis, access reserves in the banking system was zero. So I think a lot of people believe that the FED has a long way to go. Access reserves at about two trillion. If you look at the primary Dealers survey um in May, they actually asked primary dealers what is the equidible level of reserves, and primary dealers about five billion. I think it's closer to

potentially one and a half trillion. So you've got three four billion of reserves that can drain, and then at some point banks are going to demand these Where do they drain? To the swamp in Washington? Where do they So it's an accounting entity, that's a fair point. It's so as the FED lets the portfolio run off, so they let these treasuries mature, it's an accounting entity. They essentially reduced the level of results. Do you know I've never passed John an exam on debits and credits? You know?

I I When she says an accounting entity. I'm like, I'm like the ultimate D plus student. How did you pass the cf A? It was a miracle clouds. I went to the Rigs School of c f A training. It was the clouds parted. I mean, I just barely and you slipped someone a few hundred dollar bills? No, no, I did not. But but the bottle of the eighteen

year bottle of Scotch. It was a Saturday in July in Charlottesville, Virginia, and I expressed that Johnny Walker Blue Down, there was this a dark knight on the in the seven sties. Yeah, it was. It was gonna imagine seventies, you know. But seriously, you know this is really advanced. This is a really grown up discussion with Priam, Mr john and it's about the mysteries of these flows. And even the smartest people Johnny have no clue what's going

to happen over the next eighteen months. They can guess. Yeah, I want your guests on how the fed response of this yield curve inverts lights this year. So I think it it depends on how it inverts. If it inverts at this level, I think the market is going to

have to price cuts in twenty or twenty one. I think that will absolutely terrify the fair because then the FED is going to say, well, the market's pricing in a policy mistake, and it's not if the Fed is going above neutral, which is why I say, if it inverts that, you know, three and a half percent, then the FED is going to say, yes, we did go above neutral, so therefore we have to ease. But I think an inversion or even flattening here, I think is going to worry the FED. Now. I do think that

they're trying to push back a little bit here. They're saying, look, the curve is flat because of the long end. But you know, in our analysis, we actually find that the curve is very fair. If we are heading into the neutral rate, the market is saying stopped right here. I find it really interesting the white people view the yield

curve and come to different conclusions. I think some people look at it and think about whether it's a symptom of something that's happening with the business cycle, and then others look at it and think, what are the consequences of a inverted yield curve flat yield curve? Regardless of whether it's a symptom of anything, because there will be consequences for maturity transformation, just credit formature, um, there will be consequences for how people at risk and what happens

to risk sinking capital. Aren't they the bigger concerns prayer there are? And so this the sole cause and effect issue is key. I would argue, you know, right now the market is essentially priced, or the or the rates market, or the yield curve is pricing in this lead cycle behavior at some point of the curve does become flat. I actually think it has broader implications across the discasses as well as maturity transformation. You know, if you can buy two your notes at to sixty, why take on

more risk in any other product? You know, when cash has yield, that's pretty attractive. You know, there's your trade warheage. Essentially you don't need to sell any stocks. You can just buy some front end treasuries. So I think that's where the flat cove does matter. So I would say, right now, what it's signaling is FEDS about to end

the hiking cycle. And this is where the inversion becomes scary because if the fens is no, no, actually we're going to hike until three and a half as you and voted cove, which I think will actually be self limiting because that's going to spook the ful no idea what you said strategies. Let's talk to the congressman from Corning glass Works, Corning, New York where they make all

that miracle glass. It's in our cell phones. Tom Reid is from the District, New York, which is under the Finger Lakes of New York State, and of course he is a former mayor of Corning and we welcome him today. Tom read Corning glass Works has gone through like fifteen lives since Stu Bend Glass. How is glass Works doing up in Corning. You know, they're doing really very well right now. They always have an uncanny ability to yes, look over the horizon and develop the next product that

becomes a huge driver for them. And you know the guerrilla glass and the fiber out They're doing very well and they've got more opportunities coming down to five part. It's amazing compared to that photographic company up northwest, up in Rochester that's had some challenges over the years. Tom, I've got to go to the business that's usual right now.

You were a Democratic district. You are now a Republican district, and you're caught in the middle of all the emotions of the president and of course at double negatives and all that. What do you hear from your constituents and what are you gonna do in the next couple of days. Is you listen to your Republican president. Well, you know obviously that the president has done very well and are part of New York States, that he did very well

in our district in the last election. And I'll say the sense I get as I go around, as the silent majority is standing firm with him because they appreciate the disruptive approach that he's bringing to Washington, d c. Into putting American interests first and everything he does in regards to trade, new policy, foreign policies. And from my perspective, it's resonating still with people back home. Then this is critical lot of horseheads high school. Your father served the

nation in the army. He was, I believe, in Korea up against a communistant at the time, Soviet threat. How do you take your constituents uh support of the president and dovetail with what we saw in Helsinki. I think everyone worldwide wants to know what does his court constituency do with what happened in Helsinki. You know, I, you know, as I've always said that if there's an issue I disagree with the President on, I will express that, and most of the time I do it privately. But on

this issue I disagree. I think with the President in regards to the Russian relationship. Russia is an enemy, is an adversary, but even with your adversaries and your enemies, and this is what I do appreciate about the president do in Helsinki is reach out to your enemies and see is there a common interest where we can align to address issues like North Korea, like Iran, like Syria, and the Middle East immigration catastrophe that's coming as a

result of that destabilization. And so from my perspective, that type of approach to Russia is the more appropriate approach. And I think you know, the President as heart is trying to do that, but obviously that was not comfortable with the agreeing with him in regards to the embracing Russia as a true ally and a true front that they are not. And Tom, I don't think you were alone Jonathan here and I just want to jump in and focus the conversation now on the trade side of

the story. I think many people agree with you that they're happy that someone has come along trying to break up the status quo and take a new approach to get some different outcomes. I'm just wondering what kind of outcomes you're hoping for here, Tom, Yeah, what we're looking for it's just an equitable thing field, a fair plain field upon which we can trade on the world marketplace. So you start with our our family friends, so to speak, Canada and Sick though, and you look at a deal

that hasn't been negotiated in decades and renegotiated modernized. So there's issues of digital commerce, there's issues of access to their dairy markets in regards to Canada in particular, and I think at the end of the day we will be able to work that out because we are so aligned and we're such a close friendship with Canada Mexico, and all we're looking for when we go onto the world stage outside of Canada Mexico is when we take on China, that we all recognize the unfair trade practices

that China engages in. And when I say we am talking about all the countries of the world to send the message to China. You can't steal our intellectual property, you can't require the investment standards of just having Chinese

ownership and businesses. They're you're hollowing out countries. You're taking away countries ability to compete fairly, and that's that's to me, is what we're ultimately looking for in this trade So but I think it would be quite easy on the international stage to build there are the coalition to really address what is happening with the Chinese. But unfortunately the

President has trying to do everything all at once. Do you think trying to do everything all at one to run the risk of isolating allies when perhaps there is a better option to go at China try to get them to address these trade issues. But do that and do that alone and get your allies on board. You know, I appreciate that, but that has been tried for decades and kind of that slowgo grow, glacial type of approach

to trade policy. What the President has done doing is sending the message the trade policy of yesterday has come to an end. From America's perspective, we're going to disrupt it. And when you when you do that, clearly now your adversaries in those relationships understand that you mean a different game, You mean a different side of business that you're going to bring to the table. So that's what I think

is going on here. You have terroriffs affected less works. No, I mean, obviously any type of trade war is gonna impact you know, they have obviously a world stage they operate on them. But then also are agricultural communities, so we're all sensitive to it. But at the end of the day, the message I send to my to the trading partners to stay at the table, negotiate these things out. Stay at the table, don't walk away if you if you think you're gonna walk away, you're only going to

prolong this dispute. Stay at the table and negotiate this through. Well, we're gonna negotiate it through. But do we need to do it bilateral and so adversarial or can we find a more multilateral path? I mean, essentially, Congress and reader, we back to the nineteen thirties. Smooth, Hollie, Well, I think you know we're not to to the nineteen thirties. And my humble opinion, we all recognize we're on the world stage. The world consumers was outside of America's borders.

So what I think to see is, you know, we we can do bilaterally, can do multilateral. But the bottom line is we will negotiate like you saw with South Korea, for example, in regards to modern Night and some of the provisions there to make it a little fairer for American interests. You know, you stay at the table, will work this out, the bilateral, multilateral. I think there's an

appetite to get this taken care of. Tom last question, big tax package passed by the Republican Party in Congress, and there are some people concerned that the trade push could be the doing of the stimulus that we could get for the US economy. Do you see that offsetting the tax story? Now? You know, I don't see that.

In regards to the numbers that we're seeing, the economic growth numbers, the job growth numbers, the confidence, the consumer confidence numbers, those are all good indicators that you know, this type of short term disruptive anxiety and fear I don't see having a long term impact on the economic growth trajectory of America. And from that perspective, I think we're in a position that you just continue this growth

and keep writing it up. Tom Read, thank you so much, greatly appreciated that he is with the twenty three district Republican in Upstate New York. This is just under the finger Lakes as well, Tom Reid on a number of topics. Right now, let's switch gears and go to a steam gentleman who has never had a Schmitz in his life. That with be Randall Krasner on finance in our central banking as well. Randy, All, my radar is up. Everybody's

telling me it's boring, boring, predictable, boring, boring. And you know that's when you get your tail deviation. That's when you get your three standard deviation. Shock. Are we there? I don't think we're quite there, but I think you're exactly right. It's only when you don't expect it that it hits. I mean, think back to early February. Everything was the smoothest, this the simplest, the easiest, and suddenly a new piece of data came out and the markets

were in tumult for for a few weeks. Randy, I want to give a shout out. You can use their research work at BOOST Schools Chicago. Deutsche Bank I think has done beautiful Peter Hooper like work on the dynamics of the yield curve and central bank balance sheets. His the uniqueness of q E and then to QT his given us a wrong picture or snapshot of that twos

tend spread dynamic. Well, I don't necessarily think wrong, but I do think we have to be open to these These data are not the same as what we typically have had and so and the circumstances are different, and so to just say, oh, well, in the past, you know this flatness always meant recession. I think we have to be open to the possibility that it doesn't because

of all these other interventions. Do you think there are consequences though, that come about from an inverted yield curve, for instance, maturity transformation, What happens with credit in the economy, what happens in terms of seeking capital just flooding to the front end of treasuries. Do you have those concerns? Randig? Well, well, clearly people are not getting compensated for waiting thirty years

rather than waiting overnight. I mean the difference between overnight rates and tenure rates in the US is you know, less than much less in a percentage point, that's not much much compensation for that. So obviously they're not given incentives to to wait, and that can have consequences as exactly as you said, for where money flowing in different ways than would be typical with a more steep yield curve.

So regardless of what the reasons are for the flatness or perhaps the inversion later this year, you'd have to think, Randy, there are consequences that come about from that that the Federal Reserve should be taken now to solve. Well, again, it actually gets back to what's driving the flatness. So is the flatness being driven because people expect the economy to be going down in the future, or is it because they expect so little inflation have so little worry

about the upside to inflation. I think it's more the ladder, and in that case then the yield curve isn't necessarily telling you such a negative story. But it's hard to know now, you know, it's always easy exposed to say, oh, well, no, of course it was because things were going over the cliff. But it is true that the inflation expectations are pretty low. And the expectations of inflation spike seemed to be very low. I think they're probably a little bit too low for

my taste. Finally, Wednesday Math with Randall Krasner. Randy, there's the idea of linear fed raises rates step by step, inch by quarter point inch, and the fact is quadratic, which is an exponential function, Folks. The fact is is we raise rates more, you begin to get more profound, more quadratic effects. Do you know where that moment is or is that something that you feel your way towards.

It's something that you definitely feel your way towards. Our models are not very good at sort of pointing out those inflection points. They're pointing out those turning points. Most models, even if they have some nonlinear elements. As you're you're describing, and it tends to be very very smooth. This is one of the reasons why the FETE is wanted to go at such a gradual pace so that they have time to figure out if something's going wrong. And I

think they've been pretty successful at me so far. What you just heard there from Professor Krauser, Folks is profound. You have to go along the path and monitor what happens because of the danger if you get it wrong, as you it up towards a neutral rate and even a restrictive policy, not that we've had that in a zillion years. Randall Crosser, thank you so much. With the University of Chicago, they're both school and of course a

former governor. The putters are Terry Haynes joins us now with abcre I s I and we will digress from policy. Here was someone qualified to speak of the double negative? He is out of Oberlin, which is a school that takes immense pride and it's English curriculum. Just to get through I'm serious, folks, the core gut English one twenty three introduction is Shakespeare is a thing of legend it Oberlin. Did you take introduction to Shakespeare? Terry Haynes, I did not, Tom.

I was a what they called then government and now politics and religion, major double major. Well, the religion of the double negative has come front and center and the rhetoric of Washington with your years of experience down there, what's the follow on from what we observed yesterday? Is it a one off event that drifts away into the August heat, or does it have any permanent substance to

Republicans in Washington. Well, I think it does. You know the uh, Yeah, there are plenty of times the Congressional Democrats didn't agree with President Obama. The Congress's uh, in the same majority as the president, always find themselves in

these sorts of pickles. I think the the immediate fall out of interest to markets, though, is that I think Republicans are going to feel a little bit free or about trying to challenge and again when necessary and guide when necessary, the the policy of the United States government on things that are either directly related such as Russian sanctions and the like, uh, or weapons sales and things

that are indirect uh. And and that includes trade because I think the what I've been saying for about a month now, and I continue to see signs of it this week, is that Congress is thinking about starting to take back some of its trade related powers that had longer US Okay, that's important. How will they do that? Particularly butt of stuff as the clock to the mid terms, can they take how do they take power back from

the executive branch? Well, it's in in uh. The stuff is never easy, but in the been a technical sense, it's easy. The what you have is a situation where you know, the Congress patitutionally has the tariff power. It has given some to the president for national security purposes, for you know the three oh the three oh one,

the purposes that are now being used for intellectual property. Uh. What is what is the merger as a proposal is the idea that Congress has to pass the DRINT resolution to approve the use of the president's use of trade powers, tariff powers on national security on matters related to national security. And there was a fairly meaningless resolution that came out

of the Senate last week. But there are signs from particularly from the heads of the trade committees, Senator Hatch and the Senate Congress, from Brady in the House, uh, that they're thinking about pushing that. And uh so you know this is clearly meant as a warning to the administrator. And and so Congress can pass the statute to do

your direct question. Congress can pass a law and actually tuck it into the spending bills, tuck it into a bunch of different places and essentially dare the president de vito and over that, which I probably wouldn't do with the news flow and I'm not talking just about the upper over hell Sinki and all that. I'm talking about the trip, know, you know, England, Helsinki. But even before that, who's got the upper hand in the to the election

discourse Republican legislators or a Republican president. Who's got the upper hand right now? I say the I say the legislators in no small part because the legislators are up for re election, and the legislators will calibrate, uh, their own responses. I mean, they're their own political calculus will in many cases different from the presidents. These are all these are all local elections. Give an aspect to which this is gonna be a referendum on the president, but

that's that's usually not the dominant aspect. What we spoke to Tom Reade district in our Corning, New York Corning Blasters talked to him this morning and he said just what you said, which is, yeah, it's like there and he doesn't agree with the president on what's happened the last few days. And then there's this huge but you know, we're going to continue with this hugely pop or policies within the Republicans. Congressman Reid said the Republicans silent majority.

They haven't wavered, have they? No? I think they haven't. And and uh, Congressman Reid, who is a very smart member and a very smart politician, I think makes it an important point here. The way I would put it is that the Republican Congress and President Trump have always been in a coalition government. When they agree on on pursuing big things together as they did on tax they

can be very effective. But when they disagree on things, which they do quite often, those things aren't gonna gain traction. And you know, you have seen a lack of cohesion on lots of lots and lots of difference issues from from spending issues to uh uh, to immigration and a bunch of other things. So you know they you know that. You know you're not putting words in Congressmen Reid's mouth, but you know these are people that don't think they're

being let around U those at all. They think they're you know, it's their agenda as much as the President. Terry Haynes with I s I with us right now expert on policy. If the Republicans keep the House, and I don't know what the polling is right now, but let's suggest that would be a modest surprise. What's the first Wednesday of November big policy prescription for a Republican Trump, a revitalized Republican House and assumed Republican Senate. What's the

next big thing after they win the election? Today? Let me let me do a sentence to set up today. I think the likeliest and we're a long way away, as you know, from the election, but today I think the likeliest outcome is that Republicans pick up seats in the Senate. It's a very favorable environment for them. They're mostly Democratic seats up the House. I think they scrape out a win, but they probably lose some seats, and

they already have a very small majority. So I think what you've got in November UH is a is a tiny Republican majority. But you know, even if there's a Democratic majority, it's tiny. What you're gonna have is a largely muddled uh ability to do things in Washington was

such a was such a small majority. And what you're gonna see, I think, is an emphasis on the second tier issues that went nowhere this year, and that includes things like infrastructure, things that can be guaranteed to get some some bipartisan buy in things that are will be very popular across the base. Uh, and I think that's

where they pivot to Terry. Thank you so much for the briefing, very informative with all that's goin on as nice to walk away there for a moment place from I would not not I cannot, John, did you study double negative? It's a school. 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 Keene before the podcast. You can always catch us worldwide.

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