Surveillance: Ban the Phillips Curve, Says Sahm

She is the head of Global macro research at Boltic, so she's one of those top down people. UM. Kathan, thanks so much for joining us, coming into the studio and cold, dark and wet New York. Are you from Miami? I'm from New Jersey, but I live in You live in Miami, which would probably rather be in Miami. I'd rather be there as well. So what do you think about? UM, you know this conundrum. We're at a point where it doesn't seem like a recession really is even priced in yet,

and that's pretty crazy given that everyone expects a recession. Yeah, I think we're already beyond talking about recession and everyone's talking about recovery before recession. Has actually happened, and something Kayleie mentioned it's all about inflation. Yes, it's about inflation, but for me, it's all about the labor market because the labor market remains so strong and five six um increases in salaries are not commensurate with a two percent

inflation target. So my view, and you and I have talked about this previously, Kaylee, is that the FED knows, in my view, that it has to get unemployment higher, and that it's horrible to say. Um. But by the way, we're gonna talk with Cloudy Asam a little bit later. She of the Psalm rule, and she thinks that's a mistake to to to think to argue that, you know, the Phillips curve um still alive and well, and you've

got to push up unemployment in order to pull down inflations. Well, I'd like to hear her view on where the NEHRU is right now. Um, I think it's around four pot. You know, we're at three point seven. So so for the natural level of unemployment, if it is in fact four point nine percent, anything below that is in fact inflationary, So we're we're what's her view on wage price spiral? UM?

You know, if we look at and I'm writing these questions, look at history UM and unemployment move of of that amount has never not coincided with an economy already in recession UM. So I think that's important to note. The yield curve is pricing in recession. We know that, but

there could be a normalization next year. And my thing is, you know, everyone's talking about how the ft isn't gonna cut, But if you look also at history the past four team monetary cycles, the last hike versus the first cut, that timing is much shorter than you think. It's on average four months. Okay, so maybe historically that is true. But if you listen to the Federal Reserve and Chairman Pal now, they are saying we are not going to

do that. We are talking higher for longer. We are not giving up until inflation is back to our target, which right now is two per cent. So even if inflation is cooling, we are still far far away from that. What gives you the conviction that the Fed is actually not going to tolerate the weakness in the labor market and in the broader economy as they say they will, and have to make that pivot well, I think it's going to have to come down to how far the

labor market rules over. So I think unemployment goes to four. That's the neighru you know, it's hard to estimate, but thot seven in unemployment. So I do think the FED needs to force the labor markets roll over because their supply side forces and their demand side. We all talk about both of them. The supply side forces are improving. You know, used car lots are packed now, I've seen prices come down considerably. She knows us hearing what you'll respond to passively. I know you love um. So, so

I do think supply side forces are improving. Um, you have China reopening, which you guys are talking all morning about, especially you've been up so early. Um. But demand side really hasn't taken that hit yet. By the way, we also got a one point seven trillion dollar omnibus in my notes to talk about as well. So we do have inflationary impulses, but that's going to aggravate the demand side, which hasn't yet rolled over. Consumption is still pretty good. Um,

it's been very resilient. If you look at Conference Board that's been very resilient and that has a very strong correlation with the unemployment rate. So if unemployment moves higher, Conference board consumer confidence drops, you get a rollover in consumption. UM. People are still spending even though inflation is very high.

It's because they have jobs well. And when people are still spending, and maybe they're doing it by leveraging up more So, now all that pandemic stimulus money and savings built up has evaporated it essentially. But what does that mean for corporate earnings? Because in theory, if people are still out there spending tolerating higher prices, you're going to be able to continue passing on your higher input costs.

And in theory that would mean margins hold up and profits hold up, so you have nominal growth and inflation. So I I do think that next inflation is going to come down. I do believe in a recession. I've I've been out of consensus on that since virtually the beginning of this year. UM calling for recession is the

next phase of the economic cycle. Stagflation to recession was my outlook piece for twenty two UM, and I do think that that that we could get earnings having to be revised lower UM and nominal growth in in my view, yeah, it's positive, but real growth. Next year I have at minus zero point four percent, so that's year every year, So I have three quarters baked in of negative sequential

annualized growth in the US. I just want to make one point to the consumer, because savings rates have fallen substantially. I mean, we, you know, during the pandemic, shot up to you know, record highs for American savings rates and now we're you know, over twelve percent and now we're back down to about two percent on savings rates. But I was talking to Mike McKee about this and he pulled up bank balances. I've got the index in there if the controller wants to bring that. Bank balances are

still holding pretty high right now. They started to roll over a little bit, but they're still pretty fat. So the US consumer shouldn't be counted out quite yet. There you see. And you can find this on your Bloomberg terminal for those listening on Yes, absolutely sorry if you're listening on radio. Let's just say they build up big time during the pandemic and we show this um and they have held their pretty well. However, Kayley points out, you know, credit card debt is starting to climb again,

the consumers starting to leverage up. How do you take this all into account with and put it into your investment strategy? What are you doing right now? Are you still defensive? And when do we find an inflection point when you really can turn around start investing again. It's a good a good thought. I'm still defensive going into next year. I still like energy utility staples. I still

I think you still have to remain defensive. But once you do get that change in UM in the labor market, I think that's where the market drops a bit further. I think we could go lower in the smp UM and then I think we start talking about the FEDS guidance turning a little more devilish. So I am in the camp where UM the labor market determines how quickly the FED could stop talking about higher for longer? And yes, the Feds all in now, but the policy mistake has

already been made, all right. Katherine R. Nuvera of Baltic, thank you so much for joining us in studio. How are you getting back to Miami? What airline are you flying? Oh? Gosh, thank god, not Southwest? But I'm not not not far better spirit, oh Man for tall people like you and I that's very complicated. Yeah, it's difficult, and I don't envy you. That I want to bring in right now

Cloudy Assam, founder of PSALM Consulting. She's a former Federal Reserve economist and one of my favorites because Cloudy, I can see, Uh, you care about people in your work, which is something that doesn't always come through an economist research. You also went to Dennis In University, but I feel more like you're an Oberlin person. So I want to talk about the recent column you wrote banned the Phillips curve and the idea or uh, is it banned the

Phillips curve? Yes, the idea is that to get inflation down, the FED has to push unemployment up, which I guess makes sense because otherwise how else do they affect sticky services prices? How is that wrong? And what should the FED be doing differently in order to, you know, in order not to destroy the lives of working Americans. So I think what a big US two, which has been extremely disorientating. Right, We've had fifty year low unemployment, We've

had forty year high inflation. It is time to put at least to scrutinize the rules of thumb like the Phillips curve that have been used by macro economists for a long time, to think about what's that trade off. The low unemployment just means that people have less money to spend. Most Americans, it's their paycheck, right, And low unemployment means that people all the way up and like

working up into the middle class, they have money. That is, that's not a bad way to think, baby about the tradeoff when it's all demand driven, right, A lot of stimulus checks, a lot of money, big wage increases. But honestly, we have a pandemic, it is still affecting China other parts of the world, and we have a war in Europe, so that you really shouldn't use the Philip curve. It's a really nice rule of thumb. It would be great if it worked and helped the Fed calibrate everything. But

come on, like this is a lesson. At this point, we are in uncharted territory and thus we gotta think we got to dig deeper in terms of what the Fed does. So how else, because inflation also is I mean, Ronald Reagan, I'm sure one of your favorite presidents Um described it as like an armed robber or you know, a boogeyman um that really steals from especially the working classes.

And it's very high right now. And then if you look at the non accelery Inflation rate of Unemployment NEHRU UM, that shows that when unemployment is below a certain level, it's gonna be inflationary. Right We were talking with Katherine Rooney vera earlier who said that unless you get up to four point nine percent, these low levels of unemployment are inflationary. Do you disagree with that? The NEHRU is a made up number. I mean, it's with a lot

of judgment and data. But running up until COVID started the Federal Reserve, most of the macroeconomics community was like, this thing is broken. In many ways, the Federal Reserve showed they have no idea what NEHRU is. Despite a lot of effort, it moved consistently downward after the Great Recession because unemployment kept going down and down and inflation

did not spike. And we really don't know given all the disruptions in the labor market, particularly the massive drop in the labor force participation, it hasn't come back that affects the unemployment rate, the things that we have looked to as signals as a way to think about what what is this equaliberate like, what would normal and sustainable look like? It's really hard to know what that is at this point. Now you gotta do something, and I think this is where the FED has to get back.

Leaning into the data. We have seen inflation coming down without wage growth really slowing, and so that tells you there is at least some relief that comes without the Fed pumping high interest rate increases, fast interest rate increases into the economy. It's time to be a little more action and really look at the early stages of the data. It takes a long time to get to consumer price inflation.

On the subject of consumer price inflation or really just inflation generally, the FED looking obviously the PCs a flatter and the idea of made up numbers, or at least arbitrary numbers. Two percent it's what the FED said its target at. Granted it went moved to average inflation targeting, but still that's what they're striving for. Something like that two percent number. Is that no longer a number fitting of the new world in which we live. In post

pandemic post or still ongoing more in Ukraine. If we're looking at structurally lower labor force participation, structurally higher energy costs, should they be rethinking two percent. It's far too early to have that discussion, and I think, honestly it it muddies the water, and it makes the FED fight even harder to get two percent. They are extremely concerned about

a quote unquote credibility. I mean, I'm not sure who right now still questions the FED is going to fight inflation, but I guess they're out there, and there is still a path as we come out of the pandemic, as the supply change, as the rotation and the in the economy from goods back to services happens, we have a path back to two percent. It's far too early. That's a conversation for maybe this time next year, the middle

of the year after. But it's I don't see any reason for the FED to be moving that two percent target if we get back to something that looks kind of sort of like normal. On the other end of this, well, they couldn't even get two percent before COVID showed up. Okay, fair enough, but it raises the question of especially as you mentioned China, how it's still been shut off from the world. It led to a lot of supply chain

issues that were very inflationary. Now it's opening back up rather rapidly and the surgeons dealing with currently aside in the medium term, in theory, that's going to mean more demand for commodities, could be a few of inflation. How do you filter that back into your thinking about the trajectory inflation and how monetary policy has to respond to it.

And that's not the only thing, right We've got a one point seven trillion dollar omnibus, you've got deglobalization, which has to lead to at least some inflation as well or at least less disinflation. M hm. So absolutely what's happening in China and reopening as a wild card. And we know that the FED has very limited tools to deal with commodity price inflation, the energy inflation. We still have a lot of food inflation and that is not something that interest rates are going to chip away at.

And you know, what's happening in China is extremely um disruptive, tragic as they're trying to reopen, and every time COVID came back was in the United States or big waves globally. It set us back in terms of getting back to normal. Right, this has been very disruptive as things closed down open

back up. So I totally agree on the commodity space that that could be a tough one and that that was a lot of the problems that FED had a lot of the inflation um concerns of the past year when we had the big spike in energy prices, particularly gasoline. So yeah, we are not out of this. There is a path back to something that looks like normal and

the United States. On the globalization, I would be very careful about taking the last few years, which have been extraordinary with a pandemic and a war in Europe, to project big structural changes. That takes time, fair and it's very difficult to do. Claudia, you know, for years now, income inequality has been on policymakers radar, and you could argue that that's what drove the big populist forces that

we've seen um globally. Has the pandemic made income inequality worse or have we made any progress in pushing back against that we during the pandemic. So in what we've seen so far, the fiscal Paul, let's see the labor

market coming back strong. That made a big difference for you know, the bottom fifty, middle class on down because for the first time in many decades, we have had a job full recovery and that really makes a difference for the vast majority of people now that and and so you see in wealth inequality data that the increase in what you know, families bottom have in the bank, it is it is enormous relative particularly to after the Great Recession. So we have done some things to narrow

that inequality now. I mean, the top is doing well right even with some correction right now in the stock prices, and our our billionaires out there, I mean they really got their recovery came fast as usual. And yet this is I think it opens up some big questions. It's like, can our economy handle a job full recovery? And we need to have those So there's a lot to figure out why this caused so much disruption, and yet we really did help people who haven't gotten a lot of help. Claudia,

great having on the program. Thanks so much for joining us. Really love reading your research and your pieces. Cloudy Assam. There of some consulting talking to us about maybe UH, the FED should look at things a little bit differently than UM it typically has. I think, UH, for Tesla, for big tech, for crypto, it has been an annus horribilis,

as the Queen would have put it. Well, you know what, I got that from Christina Hooper she joins US now chief Global Market Strategists at Investco UM and Christina, I guess you got that from her, Majesty, Queen Elizabeth, But she wasn't talking about stocks and bonds. What does three look like? If we've had, you know, the pandemic leading into incredible inflation, and the war in Ukraine making it worse, the FED hiking us UH into maybe a recession, how

does look any better? Well? I think that after several extraordinary years, and when by by extraordinary, I mean extraordinarily bad and traumatic, UM, what we're getting to is a more normal environment UM where we're likely to see UM the FED ease what has been a dramatic level of tightening. So I don't mean ease per se, but UH certainly down shift its tightening and ultimately hit a pause button.

In the first half, probably the first quarter of UM, we're likely to see inflation continue to moderate significantly in te so something of a return to normal. It's not going to be an easy transition UM, but I suspect that is going to be a lot more normal than the last three years, but normal of at least the last decade or so. Christina has been leadership by big tech and stocks being able to fly high because money was free and with low borrowing costs, it's okay to

have a higher multiple. That is not really the world we have lived in two and in theory, that's not going to change incredibly quickly. So just using a stock like Tesla as an example, how much more do you think those stocks need to deflet? How much more devaluation could be coming for certain pockets of the equity market. Well, clearly tech is under pressure. UM, the high valuation areas of the stock market are under significant pressure, and that

doesn't change overnight. In fact, when we get to more of a risk on environment, as global risk appetite grows, we're likely to see a movement towards UM, lower valuation names more cyclicals. I don't think this is going to be a time where we see tech rebound dramatically because raiths are so much higher. Now we will go through an adjustment period. Um, we've already started that process, and we could see more of that in But again it's going to be a more normal environment, which means we're

unlikely to see outsized gains by tech. Um, we're really unlikely to see big gains by stocks in general. But I do hold that hope and I believe strongly that we're likely to see a positive, uh single digit return environment. For example, the SMP fire, you know, Christina Yester, we were talking with Matt Merlely and Miller tay Back and he pointed out, we're looking at I think seventeen point three times earnings forward earnings on the SMP five hundred

now since World War Two. In any recession, if we do get a recession, valuations have dropped to fifteen before the bear market ended and turned around. Do you expect that we could fall that far, because that would put us, you know, at thirty or maybe even below before we can turn around and climb back up into the end of the year. Well, we have to keep in mind that this is a very compressed economic cycle, so things

are moving a lot faster than they typically do. So I think We're going to see a number of different forces converge at the same time, so we will have that headwind of downward revisions to earnings. I mean, that's a given. We haven't seen that priced in yet. But having said that, UM, we also have a market looking ahead to the potential for the FED to cut rates by the end of the year, and certainly just hitting

the pause button will take pressure off risk assets. So I think that we could actually see earnings downwardly revised at the same time, we could potentially see UM as the year progresses, UM some movement towards multiple expansion. Okay, so that's all on the equity side, Christina, But we know that, or at least we have heard that, there are now alternatives to equities. Those have emerged. Tara, right, Tara Tara? I think Tara Tara. I didn't never, I

was never sure about, but I'll say Tara. Okay. So, however, you want to pronounce the acronym t A R A rather than Tina t I N A, which was there was no alternative for equities. It seems that that world has now changed. How are you viewing bonds into the new year, and how much you want to be allocated in that asked class rather than into equities. That's a great question. And of course fixed income had an annus

horribilious in two as well. UM. That's part and parcel of of what we saw in terms of a dramatic um tightening cycle on the part of the FED and other central nights. So where we find ourselves is today UM is looking out on a year in which we're unlikely to see much more in the way of rate high certainly relative to what we saw in two. That

gives some breathing room for fixed income. At the same time, we've seen yields go up significantly, UM, making as as you pointed out, many areas of fixed income quite attractive. I would focus on investment grade credit UM as we see this struggle between a risk on and risk off environment. UM. The the level of of the maturity wall is pretty low right now. UM. We don't see a lot of debt maturing in the next eighteen or so months. UM,

so this is a good environment. Companies are fundamentally more sound in general than they were in the last significant procession we went through, the global financial crisis, So this is a very different environment. UM. Now, as we transition through the year. As as UM we get through a downturn in the economy and look forward to an economic recovery. That might be a time to increase a risk appetite and move towards high yield UM. But certainly right now,

investment grade credit looks very attractive. Al right, Christina, thanks so much for joining us. Really appreciate your time this morning, especially during a holiday week. Christina Hooper, they're talking to us from invest go out of Connecticut. Let's go though and focus in on the airline. Helene Becker joins us right now, senior research analyst at Cow and Helene, thanks so much for coming on Bloomberg again. We just talked to you last week, but since then there have been

thousands and thousands of cancelations. As as Madeline says, we're not close to getting back on track here. How is it right now, especially for Southwest? UM, good morning. Yes, we are not close. Southwest is not close. Everybody else is pretty much within what I would call their normal course of doing business. UM. The cancelations are relatively low.

Southwest accounted for more than eighty percent of all cancels yesterday and UM for them, they're Um, They're just they're just behind the curve here and they probably won't get caught up until the weekend at the earliest. Well, and we have seen modeling from analysts over its city that talks about a three to five percent earnings hit for the fourth quarter. But I'm wondering what kind of signal this is on the longer term operational health of Southwest

beyond just what is ongoing currently. If something like this could happen at this scale for this long, does that just mean they're ill equipped to handle weather events like this? I mean, what went wrong here that could go wrong again. Yeah, they had a confluence of a lot of events. So you had the weather and it moved across country, hitting

Denver and Chicago particularly hard. UM United and Isn't Both of those locations didn't get hit quite as hard, but still impacted UM For Southwest though, I think in Midway there was a lack of the icing fluid. Then they had an issue in San Diego with fog, they had ice and Dallas, so so everywhere they were they had weather, and the worst of it is their systems are just not equipped to handle it. Historically, Southwest underinvested in I t in in technology and UM this is has come

back in the past to hurt them. They were investing aggressively this year. That was one of the catalysts for we thought for the shares later this year is the new scheduling system for employees was coming up. But one of the issues UM we saw yesterday was UH an aircraft with a bunch of flight attendants dead heading to

a city. UM. But the crew working the plane was short of flight attendant and according to the pilot on board UM, any one of those other flight attendants offered to work the flight, but they couldn't get through the scheduling to say, hey, we're here, we'll take it, and so Southwest canceled the flight. They're doing what should be automated by hand. UM. When you have six thousand flights a day, and and you probably shouldn't, you should probab

they have two thirds of that. UM. It's not that I don't have enough people, it's that they don't know where their people are, so they have to reset the entire Essentially, it doesn't make much sense because I understand that the weather is very bad in some places. My buddy Kareem just showed me a picture of his parents house in Buffalo and it's completely snowed under. On the other hand, Helene, I'm forty nine years old. It's snowed

most winters of my life. You know, this happens in the winter months, and an airline especially should be prepared for it. Has Southwest management learned any lessons? Will they invest? Will they you know, stock up at midway with some d icing fluid? Yeah, so sometimes they get caught out. But you're you're absolutely correct, And I think people have a right to be really angry and um and annoyed because, to your point, this is almost they should have invested

years ago in the stems and they just didn't. Um. Well, do you change your opinion on the stock lane because you liked Southwest before this? Yeah? No, I don't think we do. Uh. I think that as the shares um will are reflecting the disaster that's befallen them. I think you'll see the impact you mentioned the three to five percent. We think it will be in the hundreds of millions of dollars range. They're doing everything they can, for example,

refunds a hundred percent of your cash back. They're offering to buy tickets on other airlines if you can even find a seat. Um, So consumers should totally keep their receipts to submit them to the airline. And then I suspect in the first cutter will see them heavily discount tickets to encourage people to try them again and um. And then this investment, I suspect they'll do everything they

can to speed it up. And you're right, there was a fuel shortage at one location, but we're seeing sporadic fuel shortages around the country, and airlines are tankering old where they where they need to. Um. But but I think the other part of what Southwest needs to do in the short term is cut back their ambition because even though they've hired enough people, um, not everybody is fully trained. So the school house is full as they work through this and and get back up to speed.

Um that I just you know, Kaylee and Matt, I just don't see how they get by with another storm like this without super investment in in systems to to improve things. Yeah. Well, clearly something's got to give because there are a lot of people, including the Department of Transportation, who are not excelled by this episode. Laine Becker of Cowen Thank you so much as always for providing us for insight. Absolutely and 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 In. This is Bloomberg