Surveillance: 39-Year High Inflation with Gapen

question would be what would stop him? That's wait now and then, well, really not much. I mean you would need a major shift in terms of saying, oh Macron effect on the economy, geopolitical event that that would somehow disrupt um the economy, or risk taking sentiment. But in terms of where the feed is on their on their dual mandate inflation in the labor market, they're basically there.

So coming out of the last employment report with the unemployment rated three point nine, another month of solid employment gains six tenths rise in average hourly earnings, that pretty much meets their bar. So I think in January, at the January meeting at the end of this month, they could very well declare we're at full employment. Yesterday Powell said, we are at or very close to full employment. They've

already told us they're they're on the inflation side. So I don't really think anything stops them from going in March except one of these kind of outlier events. I think they're ready, Michael Gaping, You and I are the only ones that will understand. In two, I have the tiger reigns supreme. So inflations rising up back on the street. Is this the same inflation? Is two? No? Um? So

that was rocky three? Right? So yeah, So the the age of the seventies and eighties inflation was a multidecade period of demand exceeding supply, creating wage price spirals, higher inflation expectation. It was very much a demand driven story, although there were certainly supply shock components to it, with with the oil market at the time. This is is a very different outcome. It's not necessarily from persistently easy

policy over previous decades and expansionary fiscal policy. Obviously we have some of that in the response to the pandemic. We think it's still primarily a pandemic driven story that is likely to ease over time, And as you mentioned in the last segment, what can the FED do about that? I think a lot of this risk management positioning is about preventing second round effects, right, preventing those the impulse today from showing up in a lot higher longer run

inflation expectation. So I do think it's a very different inflation. So how the FED responds to it should be different. And Michael, what's so important here is just a president and his will to survive. What does President Biden do with seven percent inflation? In part talk about that you you get it, you see it, you get it, you understand problem. It crimps real incomes. Households are very sensitive

to changes in energy prices and food prices um. And then you also want to take some steps perhaps to help solve it. Make sure that your Federal Reserve chairman that you're appointing understands the issue and the importance of getting inflation lower. Uh, they unlock some of the strategic reserve. In terms of oil supplies, there's discussions around do you do you reverse tariffs on imports from China? So what can you do to help bring inflation down and stabilize

the situation. But certainly he has to say, we get it, and we understand it, and we're taking corrective measures. How do you get the wrong kind of inflation down while keeping the inflation that they want to see. As we've been hearing from John this morning, the administration perhaps going to be a looking much more at the wage increases and how this is possibly a good thing for the worker. Paint a picture of negative two point four percent real

year over year hourly wages. What does that mean in terms of the wage increases we can expect going forward and the trajectory of economic momentum. Well, certainly, I think conditions in the labor market are are type. We still have roughly four million people sitting sitting on the sideline. Demand for labor is strong. I suspect labor market conditions will remain robust, and average hourly earnings will continue to take hire and then you would hope that some of

the inflation comes down on on the other side. But in the moment, of course, what it means is it bites and crimps real real purchasing power. So disposable income was kind of all the story last year about government transfer payment supporting income. If you start to adjust for inflation. Now, disposable income the last few months has been taking lower, so it might feed in to a little less demand.

And this is where the Fed's messaging has shifted. It used to be we need accommodative policy to keep labor market momentum going. Now what we need to do is stabilize inflation to keep labor markets going and income and purchase power elevated. So it has shifted the narrative from the Fed. Mike. Part of that effort is not just right highs this balance sheet reduction as well informing the analysis. At the moment, it's just a FED speak. Where on

earth is this gummy? We have a balance sheet pushing nine trillion. We're all trying to work on the work out the month on month reduction. Mike, Have you've got any idea what that looks like through the back half of this year if they start this summer, what it looks like into next year? Sure? I think if you if most of us think the balance sheet run el is going to start in the second half of the year, we're in July. You can empower seem to say later

this year. So if you if you look at the mature maturity schedule of the Fed's balance sheet roughly over

the year. After that point, you're looking at let's let's call it about a trillion, and treasuries running off and prepay estimates on on MBS portfolios will give you somewhere around another three hundred billion, So I think you could have at least half of that fifty billion, maybe up to a trillion in terms of how much the FED wants to take out of the balance sheet over kind of the first twelve months, so let's call it six

billion a month. They may need to ratch it up to that level over time, start with their cap that's lower, and move higher. But I do think that they want to get to the balance sheet sooner than later, and with the trillion and a half sitting in the reverse repo facility, I think they feel they can do a lot of draining of reserves without having, you know, a

negative effect on on front end financing conditions. So I think they may try to get a fairly fast pace of of runoff in the beginning and last point, if I can make it, there's about three hundred and twenty five billion and T bills on the Fed's balance sheet. This time. We had almost zero in the last expansion when the FED was doing this, So you may see different run operates for the T bills and the remainder of the coupon issues or the coupon holdings that they have.

You could get a lot of runofs every quickly just by letting TEA bills go. That's a very interesting point, Mike Gape, and thank you Mike Gap, and of Barclay's right now this is very important. Stephen Roach joining a senior fellow at Yale University. We'll talk about the FED

here and what we're doing in America. But Steve Roach, I've got to go back to the heart of your work on Asia, and the fact is you get off Cathay Pacific long ago and far away a Terminal one Hong Kong International Airport, and there was the big Morgan Stanley sign that you personally put up there as you came down the ramp at terminal run. Those days are gone. Your new view on the new China, well, those were the days. Tom. I probably will never go on Cathay

Pacific again. Sadly, UM look like China is UM. Clearly UH embracing a different type of approach to UM. The balance between ideology, policy and economic growth than at any point since I've been covering the tree. Ideology is the dominant force under a Shijin ping Uh. And what has really been disturbing and shocking to some of us is how he used the ideology to go after what had been the most dynamics sectors of the Chinese economy UH,

the internet platform companies, UH and um UH. At the same time he's doing that, he's he's got this income redistribution wealth redistribution program called Common Prosperity, and so it's a it's a twin pincher movement on the dynamism of China. We all know the growth rate is slowed. I'm not concerned about evergrand I think they can definitely manage that. There's zero COVID policy is also very restrictive on a short term basis, but I think they can get through

that as well. I'm more concerned about the medium, the longer term of Jina. I've been positive for decades and I'm much less so today. Stephen, you helped build the modern of Hong Kong. What should be the Western bank response to all this? How does the Western banks adapt and adjust in Hong Kong. Well, being in Hong Kong now UH and in the future is just like being in UM mainland China. There's there's really no functional difference between UH, you know, Hong Kong as a Chinese city

and UH operating in Shanghai or Beijing. So to the extent that Western banks are comfortable operating in Greater China, UH, you know, Hong Kong still has a good deal of attraction to them. I understand that, UM, you know, there's a lot of concern because of the traumatic shift from what Hong Kong had been to what it is right now, but you just have to look at it as another big Chinese city. Stephen, you said you are much less optimistic right now about China as trajectory going forward, and

you have been in decades. Can you play out what the ramifications are at a time when you see inflation is becoming more intriged, that we see supply chains that

originate in China becoming more and more disrupted. Well, the supply chain issue, LISA is clearly critical to UH the inflation outlook, and so much of the global supply chains run through through China that any disruptions there as we've seen have a critical bearing on the supply side of you know, most large goods producing markets around the world. But you know, and I wrote about this, you know a few years ago when I first warned of stagflation. But little did I know what was going to happen

on the demand side. UM. The supply supply side was very fragile, to be sure, but the demand side went into lockdown. And then the post low down snap back, fueled by the FED, who was now desperately behind the curve, UH, really over over strip stripped UH what a limited supply

side could produce. So the result is UM, you know, very high inflation rate UM and the lowest FED real federal funds rate in recorded history of federal funds rate today that is further into negative territory than it was in the nineteen mid nineteen seventies, in early nineteen eighties, when we had a terrific or a should I should say,

a horrific UH inflation problem. So to say the FEDS behind the curve is putting it very kindly, well Steven, to build on that, and to go back to the idea where you said the demand side was rather unexpected in its plays to this elegant maya culpa that you wrote last year in August in Project Syndicate, where you talked about how your call for a double dip recession didn't come to fruition because of this, How do you gauge the forecasting the potential for forecasting errors at such

an unprecedented time, which the FED is grappling with as well, fair point um. Look, you can't even forecast the forecasting errors, Lisa, they're so far off the map. I was just reading an article a few minutes ago about, you know how some of the best uh A of real time high frequency forecasters missed the employment UM numbers last Friday by a factor of two, three and four. You know, forecasting is always hazardous, especially as Yogi told us, when it

involves the future. But this time is ridiculous. Steve Roach Alexander became very close to nailing that forecast at Morgan Stanley and I want to talk, as Lisa mentions about all the miscalls that were made in the pandemic, we need to look forward. You own the high ground on the macroeconomic analysis of saveings. When you hear people talk about we have an abundance of savings, or they talk about we're using our savings up too quickly. How do you respond to what that means for two thousand and

twenty four. Well, I'm looking at it again right now, Tom. What I prefer to look at is UM, the overall domestic savings rate, which is the sum of business, household and government dis savings reflecting these large deficits. I look at it in net terms because I want to take out the depreciation that goes for the wear and tear of capital stock, and so I look at the net domestic savings rate as a gauge for how we can domestically fund economic growth going forward. UH. And you know

it's exceptionally low. It's about running about two over the last year. Ticked up a little bit UH to UH slightly above three percent in the third quarter of last year. But you know that that's less than half the average net domestic savings rate in the final three decades of the twentieth century. So lacking and saving UH and wanting to invest in grow, we have to import surplus savings

from abroad. We run these massive current account deficits to attract the capital UM and that will eventually not last year as I another bad forecast of mine. Uh incorrectly felt that the current account would put pressure downward pressure on the dollar. But that's coming. Hold on, you will see it. Stephen Ruch, we will waite gry to catch up. Ass O white A University, Thank you very much said what was Monday and Tuesday? Gloom gloomish? Gloomish? I like it.

That's a I've never heard that gloomish. It was gloomish. For those of you the want to push against gloomish, what you need is someone who chisels a sixty forty portfolio and says climb on board and made me think, see that's a concision of the Northern Trust Company. And we are thrilled that Jim McDonald can join us and this one. Jim, I love, love, love your research. Note that says the way you can act in this market is to put it down on paper. How do you

get from sixty to equity? Something else? Short time? Thank you for the time this morning. So it really is comprised of three primary bets. We like the emerging the developed markets over emerging markets. So we want equity exposure with robson corporate earnings and relatively steady interest rates. The second pieces that we like the credit exposure over duration, so we like how you bonds over mcgrade. And then the final pieces we like natural resources here for tips

as an inflation hedge. So you had all those up and you get to our belief is that while inflation is the biggest risk facing the markets, that people are being a little superficial in their analysis, so that what really matters is what will inflation lead to earnings problems? Where it will lead to interest rate problems, and right now we're reasonably comfortable on both fronts. Superficial, Paul is cocktail talk for static analysis. I used to be, Jim.

I had such a beleaguered childhood. My mother was at New Trier or one of those schools out there that I would be lectured at the dining room table on static versus dynamic analysis explains a lot, a lot. That was the agony and geek. Hey, Jim, you know, we we got that inflation data this morning right kind of in line with expectations, but a big headline number. How do you think our Federal Reserve is gonna kind of

interpret the data we saw this morning? Well, in some respects they're probably a little bit happy in that it really makes their job very simple. In the March meeting, there is a very very high likelihood that they're going to raise rates and that they're going to take what the market gives them. We think that that's a critical part of analyzing what the Fed's gonna do is realizing

the market does have some constraining impact on them. And I think that actually they're probably pretty happy right now with where rates are because it's so relarly clearing the path for them to start their hip cycle. We're gonna get some earnings starting up in just a matter of days, Jim, I mean, and that kind of brings back into focus for some folks evaluation And how do you think evaluation in this equity market? Do we need these earnings to

really blast through expectations to support the evaluation here? Well, it's kind of funny. The longer I've been doing this, the more I've come to the conclusion that valuations a result of people's actions as opposed to a driver of people actions. We have found no statistical relationship between valuations and one year returns in the equity markets. You've got to go out to five years before it starts to

register in the ten years. It's it's pretty good. The interesting thing about the earning season is we're gonna see really good revenue growth and margin expansion, and that's really what underpens are continued constructive view on the equity markets is one percent margin expansion in this inflationary environment is supportive. Dial up hundred four points sixteen thousand. Excuse me, thirty

six thousand. My eyes are failing me, folks. It's because I'm the only one in the room that actually remembers I have the tiger thirty six thousand, three six on

the nastack up almost one percent. You know, I look at this gym and you allude there to revenues, which to me is nominal GDP And David Bianco DWS was brilliant on you know, we're trying to get back to the golden ratio of one point six percent excuse me, one point six ratio real g d P and a lesser inflation of one one point six to one, sort of a traditional gold ratio of a good economy. What's

your wedeness on that? When do we get back to normal that gives you that revenue impulse in the equity markets well, actually, if you go out five years in our capital market assumptions, we actually don't have that expectation. We think that we're gonna see inflation and nominal GDP relatively comparable. And if you look at what's happening today, we're gonna we're gonna seecent revenue growth in the fourth quarter. That's probably not that that's definitely higher than nominal GDP,

but as a reflection of the higher inflationary environment. But you're talking about four or five years out on an institutional basis or paulse Sweeney's lousy four own k the bait. Excuse me, I should say, John Tuckers, we haven't had the opening of the envelope recently. We have to have that ceremony with John Tucker. But to the under investor Jim McDonald, this is critical. You're talking about a revenue impulse to drive stock market optimism due to an elevated

nominal GDP. Sure that say, it's absolutely what's driving economics right now, and as as we look at over the intermediate to longer term rise and that's where the valuations that you mentioned definitely do come into play. The only thing I will caution and we were similar to others five years ago, and we thought that US equities would only deliver about a five or six percent return annually over the next five years. What did they deliver? Eight? Now?

Four percent of that annually was pre pandemic, and it's because companies did better than expectations and we had some valuation expansion. It's unrealistic to think we're gonna get a further level of valuation expansion from here though. Hey, Jim, in your seventy one percent equities, what's the real core

of that? Are you kind of along the traditional growth names have worked so well for so long, or are you in that cyclical camp again that that's a camp that's worked really well over the past couple of years. How do you think about that as we start up here? Sure? So, I would definitely be much more balanced in two And the reason for that is, well, it seems like value should have another good year because we're having higher interest

rates and a cyclical recovery, et cetera. The Russell one thousand growth earnings expectations are at Russell Value at just seven Now. Part of that's artificial because it's being held back by very strong earnings from reserve releases out of the banks in the market will look through that. So the fourteen versus seven is exaggerated, but it does point out that the big earnings games on the value stocks

are probably behind us. Jim McDonald, thank you so much, State Warm in Chicago, Jim McDonald with a Northern Trust their chief investment strategist BACTI, and Saudi with a snow on this pandemic. Associate Professor Emergency Medicine at Johns Hopkins University. Back to a completely unfair question, but it came up, I think three times yesterday. What is your timeline of when amacron ends? Is it weeks? Is it months? Is it all of two thousand twenty? What's your what's your

scope of the the X axis of a macron? Absolutely so if you look at South Africa, I would have said thirty days. However, we've peaked much higher and our population is inherently different, So I'm really thinking months. I am not thinking that this is going to affect my summer plans um so I remain hopeful. Right then we're gonna get past this peak soon. So seriously, you think I'm acron will be wiped away by the fourth of July. Absolutely, Why do you say absolutely? How do you get to

that certitude? So? I think the fact is that when it peaks so quick clear, we expect the full to be just as significant. Um, we're already seen in New York and in Washington, d C. That there is now a reduction in cases, which you know, it's very very early, but it makes me hopeful. Plus, you know, again we're looking at South Africa and United Kingdom. So United Kingdom of started seeing a tape South Africa from the first

rise in the peak to the end was around thirty days. Um, you know, so the viral transmission cycle here is smaller, which makes us more hopeful that this will end sooner. As we are more hopeful that the pandemic will end more broadly and become endemic. We're left with a health care system that has been transformed. I'm struck by the number of employees who have left the profession about the wage increases that they're demanding in order to stay there.

How much does this healthcare sector look completely different than what we saw two years ago. So I think like the healthcare workforce is just one piece of this puzzle. The health system here in the United States extremely complicated with what is the role of insurers right and how

have they supported the COVID ninating response UM. Now we're also hearing that some insurance are going to start covering COVID tests UM, which I think is helpful right for future pandemics, but it is not going to be the norm. And how will they set up in the future. And what is the power of the health system versus the state versus the individual hospitals in developing your search preparedness plans. I think there is a lot of learning to be

done UM. I think we've talked about series after action reports UM, and hopefully there's a new way of us thinking about how do we how does the health system support in a more unified, utalitarian manner. What's the answer to getting people in the doors at hospitals at a time when we see massive numbers of vacancies that frankly a lot of health executives have said are unprecedented. You know, I don't think money is the only answer. It's very easy to say, we'll just pay you more, but you

need to make this work environment kind of right. Healthcare workers are also human beings. We have the same needs. So let's talk about what it means to be able to have children when you're a healthcare worker looking after patients who are infected. How do we manage sickly, how do we give people time to recover? What psychosocial supports services are available? So it's really not just more money

that is a stop gap measure. We need to look at the healthcare workforce as a whole and think how does this become a place that people want to work and how do we bring back the passion of medicine. Doctor, Can I just squeeze in a final question and go to the statement from Novak Djokovic, the tennis star who tested positive with a PCR test and the following day, on December eighteenth, he went to his tennis center in Bowl Grade fulfill a longstanding commitment for an interview and

photo shoot. He found obliged to go ahead and conduct the interview. He did ensure he was socially distance and war masks except from when his photograph was taken. Doctor, for someone in your industry, right now, how do you react when you hear something like that? You know, I thing there's cognitive dissonance, right? They haven't seen the worst of the pandemic, the worst of the pandemics. That's a nice us behind closed doors. So you know, he treats

it like a common cold. And that is why we are here where we are right because of individuals that make decisions like that. Um. I think my eyes roll over, you know, to be honest, um, and I think, oh, I hope you just don't come to the most problem protest dor good luck, thank you for being with us.

We appreciate it. Dr Batty and Sati there of John's Helpkins University, Melody, I'm sent of Chicago and Aerial Investments, a co chief executive office there, and of course many other werethy items for her Princeton University and around this nation. A philanthropist, of course, I should note with Bloomberg philanthropies as well. But there is a different story. It's a

story that David Rubinstein dives into. And this is the youngest kid of a single mom in Chicago, who, among the struggle of painting apartment wall, said I want my daughter to go to better schools. Melody, I think more than anyone I know in the game, his excelled people have forgotten about her past. Did you explore that with Melody Hobson. I did now, of course, she has not forgotten her past. The youngest of six children, and she

was frequently finding their parents. Her mother was being evicted and they had to basically worry about where the food was coming from. She got a Princeton degree, She became a co CEO, as you pointed, out of arial investments. I'm man already owned investment firm in Chicago, married George Lucas. Now she's actively involved in philanthropy, but also she's the co the co chairman or the chairman i should say, of Starbucks, and is the co CEO of her firm.

I take immense issue with people that say, well, it's George Lucas or whatever Princeton. It's about a character set from her childhood. What did you discuss with her about the best practices she learned enjoying of action in Chicago, Well, among other things, she learned how to work hard, and study and be very loyal. She joined Ariel right out of college and she's been there ever since. She's the only person her class at Princeton who has the same

telephone number they had upon graduation. She hasn't changed jobs. The only person in her class, she said, hasn't changed jobs. David, how is that view from her perspective? Growing up from uh much less beneficial or less wealthy past into where she is now color her view on how companies should operate themselves, on how they should pay their employees. Well, she believes that the companies need to do a much better job of getting minorities on their board and also

minorities in their executive suites. And that's one of her areas of focus. She's also on the JP Morgan board and she with JP Morgan have been making a major effort to have investments made a minority owned firms. But she hasn't forgotten her past. Although she can go out and see anybody in the world today back because she's so well known, and she she did this interview with me when she just flew in from a conference in Dubai,

got off the plane, cleaned up, and then did the interview. Um, then she was off to I think the West Coast. So she's an incredible person. But she hasn't forgotten her pass. Many people who come from or circumstances sometimes they forget their pass, but she does not. She's very close to her family, and she's also very close to giving back to a lot of uh parts of Chicago where she's based, in terms of making certain that people there have better

chances than maybe she hadn't as a young person. David, it's a fascinating time to speak with her, especially as we do seem to be at a pivot point in the economy with a change landscape for inflation. We just get that inflation read and real wages still negative deeply, so some of the most negative reads and real wages year over year going back decades. What's her view on

how to invest in such an uncertain economy. Well, her firm has been a what's called a value investment firm, which is to say they look at companies that are not the high tech high flyers, but ones that clearly are going to do well when the economy is in reasonable shape, are not growing so well. That's what they've been doing for some twenty plus years that she's been there. And her view is you just can't just chase the

high flyers. But she does think their values out there, and and she's a very cautious and very careful investor, and she's not somebody who does travels around the world and tells people, Look, I'm married to George Lucas. Look, I'm very good friends with Bill Bradley. She actually does a lot of hard work and she's very very knowledge about what she's talking about. Aerial investments faces the challenges

of active in my management. I remember as clear as a bell in the early nineties when John Rodgers launched a strange experiment. They have to deal in the new financial world. And Mr Rubenstein, we have to have you comment a new and fresh investment to Citadel Securities, not the hedge fund, but the order flow robin hood part of it. Please discuss Sequoia Paradigm and how they have chosen to invest in Citadel well. Sequoia is perhaps the

leading venture firm the United States. In recent years, they've done extremely well. Uh they have made day with another firm, a one and a half billion dollar investment into the Citadel Securities, a company that that was built by a very very talented person, Ken Griffin. Ken Griffin has run Citadel's hedge fund for a long time. It's about forty three billion dollar hedge fund. But a separate business which is extremely profitable is Citadel Securities, which trades, uh and

clear security trading all over the world. Now, it's amazing how you finessed this. I'm going to stop the show, folks. David Rubinstein here is dropping the the lead line here. Federsham came out of Duke University and did paradigm. What is it like the Duke University could generate a guy like Fred who did coin base, did this, did this and now takes part in Citadel. Well, I'm sure the development people at Duke will be in touch with him very curtly. Um, But obviously we're proud to have people

like that come from Duke University. Uh. Ken Griffin is a gradual Harvard. He came from modest circumstances, did very well at Harvard and trading. Ever since send he's become one of the most successful people in the financial service world. For Shop for Sure, David Show, David join us in studio today, David Rubinstein, of course of Carlisle and an important interview Melody Hobson, who has lived at board member. I should mention for Bloomberg Philanthropies as well. This is

the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course, on the terminal. I'm Tom Keene, and this is Bloomberg