Surveillance: BOE Rate Hikes with Davies (Podcast)

and hard place for the Bank of England. And then someone comes out after writing a book with incredible expertise on the history of crises in England, and that is no one other than Sir Howard Davies, who has chair at NatWest Group, an author of this book The Chancellors. Sir Howard, what did you start writing this? I mean, honestly, it comes to such an amazing time of crisis where people are looking for history and anything as a guide. Yeah.

Well it was a lockdown project, you know. I felt guilty in the lockdown, had to use somehow the time that I was saving, so I thought, well, maybe it would be a good point at which to reflect on the history of the last twenty five years, which has been pretty pretty exciting in the UK, and that we had the great financial crisis, Bank of England independence, We've had Brexit referendum, Scottish referendum, and I asked the various chancellors who'd served in this period if they were prepared

to reflect on it, and of course they had time on their hands as well, so in fact they were very happy to talk to me about it, as indeed were quite a lot of officials. So what I've tried to do is to tell the story of the last twenty five years as seen from the Treasury, which turns out now to be quite a relevant thing. I think, Sir Howard, we were talking earlier this week about how the Bank of England raised rates because they were concerned.

The raised rates only twenty five basis points, because they were more concerned about the labor markets softening or perhaps at consumer demand getting crimped and discretionary spell ending. Then they were about the inflationary inputs that continue to create huge pressures on the economy. Was that the right move based on all of those conversations you had, well, I think I was with the three in the minority. I mean it was a six three vote on the monitor

policy committee. Interestingly, of the four external economists, three voted for a fifty basis point rise and one voted with the Bank of England insiders and for the rise. And I was with the three out of the four externals. I have to say because I think one of the problems that we have, and you just referred to it, is that the weakness of sterling is contributing to inflationary

pressures as well. And if you look back at you know the experience of oil prices, and one reason why we're now facing a two pound alter diesel price is because the pound has slipped down to one twenty something, and you know so long ago that we were at one forty. So we are making our problem more serious by the fact that Sterling is weak. And I think in part that is weak because of the perception that rates will not rise as much here as they're going

to rise in the US. Sir, how are you rightly call out central banks for openly claiming that they can't tame inflation but in reality they can. I mean, they have a blunt tool they can raise rates choke demanded drive an economy in through recession. By question for you is is there any way that central banks can do that with out driving an economy into recession, or there are the policy tools at their disposal, or perhaps it's not providing as much forward transparency. I'm curious to hear

your thoughts on that. Yeah, I think what's one got to look at is the time dimension here. And obviously, if you get a very sharp exogenous shock, like an increase on the sort we've had and the war, then you can't expect central bank to deal with that instantly. But in fact, the inflation target formula explicitly recognizes that, and inflation targeting is meant to target an inflation rate

at eighteen months two years ahead. So I think whereas I can accept the central bank saying, look, we can't respond to this immediate spike, that's fine, that's understood, but what they must do is present a plausible path of interest rates which is going to deliver them back to the inflation target in eighteen months or two years time. And that's why I think you need a higher rate at the moment in order to give credibility to this medium term inflation outlook. And I don't think that's where

we are at the moment. Unfortunately, in the UK. So Howard, Let's character script the bit. You've been a member of the International Advisory Council for the China Securities Regulatory Commission since two thousand three. UM there's about two hundred China liftings on US exchanges, I think roughly one point seven trillion in assets. But all that's going on with the lack of transparency with the p C A O B. I'm just curious to hear thoughts on that. I mean,

what is China's approach to all this? Do you think companies like buy do j D? I mean, are they going to avoid having to delist? In your term? Well, the Chinese approaches evidently changing. Up to now, the c s r C, the Chinese equivalent of the SEC, if you like, has had a general policy orientation towards opening up Chinese markets. They established a link between Shanghai and Hong Kong, link between Shanghai and London, and that's been

the direction of travel. Now. There are, however, signs recently, as you say, of the Chinese wishing to pull back because they're unhappy about the influence that external regulators have via a Chinese company listing in other markets. I think it's very difficult to say at the moment where the where this is going to go, And of course for the last two years COVID has got in the way

of direct connections. You know, I remain on that Advisory Council that time chair of it, but we haven't actually had a physical face to face meeting, and it's in the face to face meetings where you really understand what's

going on. So I'm not trying to avoid your question, but it's honestly quite difficult to answer in circumstances where you haven't actually met people for well over two years now, Sir Howard, before we let you go, do you think that the pound is ever going to get above that one mark versus the dollar that we saw pre Brexit? Unlikely would be my guess. I can't quite see why. There are the short term issues I've been talking about

involving interest rates, but also in the longer term. You know, we do have a structural trade deficit and that's been offset by capital flows for a long period of time. But you know, you can only sell the London property market once externally um net if you see what I mean, they can traded amongst themselves. You any sided ones so I don't see quite what is going to push the pound up. Sir Howard Davies, thank you so much for

taking this time in congratulations on writing this book. Jonathan Gollup joins US now the chief US Equity Strategistic Credit Sweets John. Great to catch up this so and thanks for coming into the studio too. You've been constructive on this equity market. It's been difficult. You can't get them right all the time. Walk me through what you're learning is this year progresses and how you're thinking about the future. Now, Well, I think you guys are actually like right on points.

So let's let's start with with Damien's comments. Um, credit spreads have blown out, but there's not a credit performance problem. And what I what I mean by that is you know people are paying there, you know are making their interest payments and and people aren't going bankrupts. And companies have lots of cash and they've turned out, they've turned out their liabilities so they don't have this rollover risk.

So the credit is performing as if we have this incredibly healthy economy, and yet you have credit spreads really wide. And I think one of the things that are going to drive equities higher between now and your end is if we don't have a recession between now and the end of the year, which I think is unlikely. Um, then I think that the credit spreads actually come down because there's not a credit problem, and yet the market

is pricing one. Now there's a second issue, John, which you raise, which is so far you're to date, the market is really discounted a higher cost of capital, not a recession. And people who are saying is a market discounting and earning this problem? This is that not really? I would say though the last week the market is starting to say it's not just a higher cost of capital or higher discount rate, it's actually the damage that the Fed is gonna do. And are we getting a

recession sooner? And there? I think the debate is mean, it's a simple debate. It's hard to figure it out. Is when does the recession start? If you think that we have a recession in six to nine months, the downside from here is substantial. If you believe that the recession is in the latter half of twenty three or further out, then you've got to buy stocks right here because the earnings will come through and there won't be

an earnings problem. Jonathan I wanted to go there, the range, the range of outcomes and just how big the extremes are actually go back to what Andrew Holland Horse said, volatility may prevail now that the market will were price

fed policy based on each monthly inflation reading. How wide is your bear case scenario and your bookcase scenario, you know, Lisa, So we we actually we put out a report yesterday which was like like it was kind of like a wonky report for guys who kind of love like marketing journals, and and it got a lot of attention. We looked

at the dispersion of analysts estimates. So let's say you're covering you pick the stock Microsoft, and are all the analysts you know clustered at a very similar outlook or are they all over the map. The more that the estimates are all over the map, the more it tells you that people are concerned about recessionary outcomes in the direction of economy. And we're seeing that in nine of eleven sectors you are below average in dispersion, meaning that

there's very little doubt from analysts on the direction of profits. Now, where where did the analysts come from this. It's not like they're pulling it out of their head. They're talking to company management, and company management is saying is we actually have a surprising amount of clarity. Things seem okay, we're not seeing stress with our clients. Margins are under pressure,

but a little, not a lot. So it was it was actually pretty surprising to me when we looked at the data, how clean the earning story looks, not only in terms of the earnings being good, but how there's there's lack you know, there's this pretty high level of conviction on both the part of company management of Wall Street analysts. Jonathan, I think, you know, we've seen the two main factors that are driving um, you know, equity earnings expectations, I think a rise in bond yields at

higher commodity prices. So my question for you is the pace d v v V. Are you comfortable with the pace of downward revisions going forward? Do you think it's gonna be accelerate or I mean, are we there yet? So if you look yere to date, the earnings revisions have been have been solidly positive. So let's say at the beginning of this year, if you look at the twelvemonth outlook for earnings and then you do the same thing. Today we're seven and a half percent higher than we are.

So the markets, you know, the markets down or something like that, but you have a positive seven and a half on the earnings and a negative thirty one percent on the stock multiple. So it really says, is we have a problem. Listen, you have you have cash flows, you discount im at a higher discount rate. They're worth They're worth less money, um. And it's so it makes sense to people would say, yeah, but maybe the markets really telling you the earnings aren't good. I don't think

that's the case. I think that what you have is a real downgrade to what you're willing to pay for a dollar earnings, not the other way around. We go to finish on this everything you've said, is it enough to get us back towards five kg on the SMP? You know? You know, I think the answer is directionally yes. You know, I think that right now the market is really oversold if you look at the way that you know, how how intense the daily moves are and how much

volatility there is. The key is that we have to be confident that we're not that the FEDS not driving us into recession. If if if we start to see, for example, the next couple of job reports, if we see, you know, god forbid a negative print where you actually have a loss of jobs or something, well, then the market's going to freak out and you and you're looking much lower numbers. But look at what we've had. The I s M, which is an indication of industrial activity

well above normal. UM. The last job report very strong in terms of jobs earning season, really big beats so UM. I think that ultimately the fundamentals went out up. But I but I will tell you that the last you know, week or so shakes everybody's confidence in a big way. John, I'm just going through the numbers, and I don't want

to beat up on you. You're not alone. I've got Oppenheimer at fifty three thirty year end, you're at forty nine hundred, got Bowski over a Beama at forty eight hundred, got others, Bank of America, Ceveta, who hasn't been constructive, cebsa su Mamonium at the best of times, and she's at four hundred. I just wonder as an analyst, as a strategist John, and you look at this market run away in the other direction. What do you have to do? What should you do? Well? I mean, so you know,

we we actually lowered our our numbers. Um, I don't know, about eight weeks ago a little bit. And when we went back to the you know, to the to the pieces, we're not. The right thing to do is not to forecast the market. It's to say, okay, let's start with the earnings. My earnings, right, are they too hired? Too low? When we went back and tested them, and the earnings if if you know, looked incredibly solid. I mean, we looked at and numbers said if we're gonna make a change,

maybe we should move higher. I mean, the earnings were looking pristine. Some of that is more coming from energy, but but nonetheless, and then we look at the multiple and we and this is why we actually lowered our estimates. Um, is it No? I mean, you have to lower your expectations for stock multiples, for pe s when the cost of capital goes up. Now, if we were to downgrade our number, it wouldn't be because we think that our

earnings are off. It would be because we say, listen, these are these you know that those credit spreads that Damien was talking about before, if they stay wide, then then stocks can't rebound. They have to come in. I had to squeeze that inch on. It's gonna get your perspective. Johnath, thank all of the credit sweez This inflationary bank drop

is a big challenge to everyone in this country. It's a big challenge to this White House too, And I'm pleased to say that joining us now is how to bouchet. The member of the White House Council of Economic Advisors had the fantastic to catch up with you. You guys have taken this very seriously. The Washington Post is out with a story this morning on a range of issues for Postles that you're putting forward at the moment. One of them is imposing price controls and fanning exports of

US energy. And I'd just like to know first up how seriously we should be taking that reporting this morning. Well, certainly, as the President made clear over the course of this week, all options are on the table in terms of energy. Um. You know, he sent a letter this week to oil refiners to say, hey, you all need to do your part, and that was part of showing just how important this issue of inflation and gas prices is to the president.

He understands that this affects the pocketbooks of American families all over the country and is doing what he can to make sure that the prices that people pay at the pump are fair. Um even given you know the fact that we are in the midst of this unprovoked war by Putin in the Ukraine, that his up ended oil markets, leading to shorter supplies and increases in prices.

But one of the things we also know is that refiners are you know that there's a gap, but now a growing gap between how much they are paying for the oil that they bring in and how much they are charging at the other end. That gap used to be about fifty cents. It's now over a dollar. And so that is one of the things that the presidents

focused on this week. And then, as he said in the letter to them, he is willing to use all of his powers that he is available to him to take next steps, but he wants to talk to them first, figure out what they can do together and the less flesh some of this out, and give me some time to do so. If you can, I'll go through it. This is what the President said. Xon made more money than God this year, buying back their stock and making no new investments. A quote from the President. This is

what Excen said. Globally, we've invested double what we've earned over the past five years, a hundred and eighteen billion on New Orleans gas supplies compared to net income of fifty five. This is what the President said at a time of war, historically high refinery profit march is being passed directly onto American families are not acceptable. He's alluding to them deliberately holding back capacity, alluding to price gouging.

You've done the same. Your own Energy Information Administration has reported only recently that the industry was an incredible levels of capacity utilization of over your own Treasury Secretary has said, it's not price couching, it's demanded supply that's largely driving inflation. So have my question to you, and thank you for allowing me to flesh that out, is who's given the president these talking points because they do not add up. Well,

here's the thing. One of the things that we have seen again in large part due to both the pandemic and the war in Ukraine, that putin has been waging has been there have been a capacity at refiners globally has been taken offline. So over the course of the pandemic um here in the United States about eight eight hundred thousand barrels per day we're taken offline. And so the President is saying, hey, can we work together to figure out how to get that back online as quickly

as possible. Is not just doing that, He's suggesting something nefarious is going gone here at the same time. That's that's the politics of it. I hear it. He's alluding to price couching. He's saying, they made more money than God. They're buying back their own stock. They're making no new investments. Yes, they are buying back their stock. Yes, they are also making investments as well. As I said earlier, your own tracery secretary says, this is supply and demand. We're having

a policy conversation. The president isn't He's speaking just about politics. He's trying to make out something that faris is happening in Texas. I've just read all the quotes, direct quotes, which bit of it isn't true. It is not true that the president is having a policy conversation. He is looking at the data and the evidence in front of

him about what is happening in this industry. And what you cannot deny is that the last time that oil barrels were priced at a y barrels hundred twenty per barrel, gas prices of the pump were about now at this same price level. Of course, it fluctuates every day, but now at this price level, you're seeing prices at the pump it over five dollars. There there is a gap there,

and this is what the President is focused on. That doesn't, you know, obliterate anything that has happened in between, and certainly investments have been made, but the President is saying, what more can we do because we need to get this oil supply to consumers at this moment, you know, people can't very quickly change their demand for gas. People need drive their cars to get to work. So he

is focused on what else the refiners can do. And there is evidence that that they are bringing in exceptionally high profits and that there is this gap between the prices that they are paying and the prices that they are charging that is larger than before. So that there's all evidence and that is still about supplying demand. Well, but Heather, let's say you cannot get that supply on in the way that the President would like in the

short term. How worried are you about essentially going against what the FETE is trying to do with dampening demand by things like rebake cards are subsidizing the prices of gas and other goods at a time when the Fed ultimately is trying to get demand to come down. So that is such a great question. You've elevated how this particular economic moment is very tricky because we have so many supply side challenges um as the as J. Powell himself noted, you know, the Fed's tools are blunt and

they are essentially on the demand side. But we have these and we've seen them over the past few years, these incredible supply chain snarls. We're seeing these challenges in large part because of the pandemic, and so that is why the President is that a multi pronged approach to figure out all of the different ways we can attact where prices are too high consumers. We don't have a lot of time left, but just quickly. The point is it's very hard to deal with the supply chain disruptions

and it takes time. So without that really getting remedied in the short term, why is it good not to seek demand come down a little bit. Well, certainly that the President is letting the Fed do their job. But you know, so yesterday the President signed new legislation on ocean shipping. Here's a place where that legislation and the work that the Federal Maritime Commission is doing right now could have an impact on prices that consumers pay for

goods that are being shipped from overseas. So the President is doing everything he can to lower prices, using all the tools at his disposal, and trying to work with Congress to do so. Have I promise to let you go at five seconds left, So I'm going to do exactly as we promised. Thank you for catching up with us today. How do we share that of the Council of Economic Advisors. Stephen Shaw joins US now principal and co founder of the Show Group. Stephen, let's start here.

If I could be a fly on the wall of a meeting between the Energy Secretary and oil executives that's set to happen in amazing Stephen, what you expect will happen in that room. Yeah, I would expect a lot of pushback right now. It does appear that both the industry and the White House are talking past one another.

The White House is has refused. This is the first real outreach that they've made to uh to the industry, and uh, you know, and they've gone to uh some nefarious characters prior to this, and yet they're going to continue to double down and tell us we don't need to drill. We don't you don't need to drill. You just have to raise capacity. UH tell you what capacity is already there at this time of the year. Refinery capacity is that that is extremely high for this early

in the season. So the industry, it has responded. Guest line production is over ten million barrels a day for two consecutive weeks. Crudal production has risen. Unfortunately, at the heart of this is the lack of refinery capacity, and there's nothing anyone can do about that. Here in Philadelphia, we had, uh, the South Gerard refinery that was producing three thirty thousand barrels of crude all a day. Forty percent of that was gasoline. We no longer have that.

You go to South Philly. That is no like refineries no longer there. It's a brown field, so you're not bringing that back. So we've slashed capacity over the last five years. We don't have the same ability. So now we're more reliant on for foreign production coming from Europe and from Houston, and there are guys. Is the real problem, and that's the one thing the administration and I do know. This is what part of what the executives are telling

the Secretary of Energy. We evoke the Jones Act. Now, for those not familiar, the Jones Act is a maritime law passed about a thousand years ago meant to protect the merchant marine industry, domestic merchant marine industry. The problem now here is, since we don't have enough pipeline capacity, we don't have enough refinery capacity here on the East Coast. We need to ship that guest line diesel fuel out

of Houston and into New York Harbor. But the Jones Act says that commerce interstate has to be transacted on a foreign excuse me an American flagged vessel. We simply don't have enough American flag vessels. Stephen barring some sort of change to the Jones Act and frankly some sort of wholesale shift that we're not going to see in time. The tightness of the market has raised concerns the likes of Goldman's Access. Jeff Curry, how much are we looking

at gas prices that will continue to climb? They have been plateauing recently, but will continue to climb throughout the summer. Two levels that we can't really imagine right now. Yeah, absolutely, A hundred twenty dollar barrel oil. Crude oil both in Brenton, w Tah, which is pretty much where the market has been holding to your point, has stated out around there,

but as demand continues to pick up. As we approached the fourth of July holiday, the triple A national average is slightly right around five dollars a gallon at the pump. Right now, fourth of July, we are forecasting five dollars and forty cents on a national average, So there's still more pain at the pump to come. And this is contingent upon oil holding at hundred twenty dollars a barrel. Every dollar oil goes higher, you're gonna look at another to two and a half sent rise at the pump.

Stephen Forward curves are pricing in a sharper price decline in that guest in oil. You know. For me, I'm wondering, do you think that the price rise in oil is stickier than that of that gas and if so, what are the implications for for example, integrated oil companies out of lad Am or the Canadian oil sands companies, all of which are more focused on oil. Yeah, absolutely, natural gas. It is a more seasonal market. You have two distinct markets.

You have the winter in the summer in the shoulder months, you have uh the refill seasons. So at this point, that backudation is telling us that there is not enough supply right now. The month of main June is when we store the most natural gas, getting ready for next winter. Now, this year it has been hampered of course by uh L en G exports of European demand for exports because they too have have to build natural gas. So that's steep backudation. Priceton is telling us the market is clamoring

to get gas into the ground for next winter. Now lest we we had an explosion and a fire at an L and G export facility down in Texas. Now that export facility accounted for about one five of US leg exports. So that excuse me that l G plant is going to be closed now to probably at least October, if not November. So that's a lot more gas that's not leaving the United States that's gonna be set for

domestic consumption and storage. So with that added gas coming to the market, at this point, you're looking at a correction in the yield curve and the backwardation that is, the front month prices have an extremely high relative to back end, but that's starting the correct lower because we've

have all this found natural gas. Now, as far as the integrated oil companies go, uh, look, natural gas is a fossil fuel as well, so it's in the same sites as oil with regard to policy and the lack of policy with regard to promoting of both natural gas production and crude oil production, and therefore it does set the table for continued higher prices and a squeeze on margins for the companies. Stephen, I've got thirty seconds left. I want you to throw a number on it. We're

have five got a gas right now. Gasoline prices on average in American right now by the end of the summer, do you share the JP mulgan view that this is going to have a six handle. Yeah, we're about it. A four tr modeling is at a fourteen percent probability. We see that. The problem now is it's a race. Uh do we see at six dollars which I said is a fourteen percent probability, or do we see such a severe economic down to receive demands, destruction and prices fall,

because that's where we're headed. We're headed for recession if we're not already in it at these high food and energy prices. So yeah, I'll give a four teen percent. I'm on board fourteen percent of the time with JP Morgan and I productive just just four Saint Stephen stay show at the show a crew. If I light JP Mulgan, just on board with them fourteen percent at the time. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join

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