Surveillance: Central Bank Decisions

with all Spring global investment. He's trying to place a long term perspective on short term and marshal emotions and were thrilled it he could be with us today. George, What is a bond investor to do if I am in fixed income and I want a coupon, do I just as soon yield up in price down? Well, thank you, good morning, good morning, Thanks for having me on the show. It's it's great to be on again. Um you know, as as as Lisa just mentioned, you know, it's sort

of opposite day and markets. It seems, as you know, the market is rallying, at least stock markets rallying as um, you know, as central banks kind of around the world that they're trying to re establish their credibility as inflation fighters and you know, the playbook if you will to fight to fight inflation is is pretty well understood. You tighten policy, you hopefully you reduce liquidity in the system,

that slows growth and inflation comes under control. Now, all that takes time, takes a lot of effort, and what seems to have happened in the last day or so is the Fed. You know, the Fed has basically met market expectations and in doing so, you know, now the market seems to believe that we're on course for a soft landing, that the market knew what they wanted, the Fed gave it to them, and now all we need

to do is sit back. The glide path is set, and we're gonna see slower growth next year and moderating inflation. That's a very optimistic outlook. You know. Our view is that, you know that things are gonna be a little bit more choppy than that. And even Powell acknowledge that this is this isn't this is a totally unique market, and that they're going to watch the economy just like we will,

and they're gonna respond. They've basically told us that their forward guidance is going to be a little less clear going forward. So to use that flight path analogy, you know, it's it's not so safe to move around the cabin. It maybe might take a little bit more. There might be a little bit more volatility. And you're right, Tom, bond investors need to watch this very closely. It's been

pretty benign action in the bond market. Ten Your yields are, you know, up a little They're probably gonna go up a little more, and curves could steep in a bit in here. But we're now starting to sort of play the expectation game. FED hikes are now priced in and the long end has remained anchored, so you have to reach for yield. Sorry, go ahead, but Georgia have to reach for yield. And this is the reason why you've seen such disability and the credit markets as well. I'm

looking at spreads. They didn't widen on the heels of this, of this announcement and more hawkish tilt from the Federal Reserve. This is exactly again, the opposite of what happened in two thousand and thirteen when our markets going to get a little more rattled. Could that happen or is there ultimate faith that FED share J. Powell will step in the moment that there's turbulence and and really try to calm the waters by taking a step off the pedal.

I think bond markets, we think bond markets are a little too sanguine in here. You know, if you take the largest buyer of bonds of certainly uh, you know, treasuries out of the market. As we go forward, you should expect more volatility. Also, the economic outcomes here are not quite as certain perhaps as the market expects. But the one thing that is certain is that, you know, the economy is strong, inflations running high. That is pretty

good for for corporations. And so there's a there's an argument to be made as to why, you know, stock prices are at least holding moving up a bit higher. But in the world of credit and the world of of sort of you know, sort of credit based fixed income, you know, sort of higher inflation is actually a pretty good environment from from a default perspective, default should go down, stay low, go down, remain low as we move forward. And that's that's that's that's a healthy indication you need

the extra income. Diversified sources of income are the best thing you can have in a fixed income portfolio today, and you need that extra income. Number one, you may use it, but more importantly, from an investment perspective, you're looking for opportunities to reinvest. The income yields should go a bit higher. We need to be able to reinvest at higher rates, so we want slightly shorter duration. And then liquidity. Liquidity is really really important in the market.

Liquidity has been great for a long period of time, which is why risk premiums are so low. As liquidity starts to decline, we need to preserve that liquidity and portfolios we need to be able to tactically move when the market shifts. Now all those things come together in a fixed income portfolio, and so we need to protect CAPA in a rising rate environment where the FED is basically given the green light to start tightening policy. As you guys have mentioned, Bank of England saw the green light.

They moved, Other banks around the world they've moved. We're moving into a regime of tighter monetary policy. You know, sort of basic principle of don't fight the Fed is something that people should adhere to. One Taylor Riggs teaches me day in day out that it is about rate of change. And of course we are seeing significant rate of change a move of were boring cost for the United Kingdom yell spike higher across the Guild curve. I mean, you see the six basis point move on the teniest

similar moves. Who're seeing the short term, but we've seen a slight bull stephening of the US yel curve today. What though a rate of change of how much steeper these yel C couves could become and how quickly? From your perspective, So, I think the rate of change has a lot to do with market expectations. And I think one of the reasons that the the the long end of curves are remaining so well behaved is they still

market still sees very strong government intervention. And the market and the and the and the Fed and other central banks have indicated the pace at which they are going to change. Now the Fed increase the rate of change, and bond yield state the same. So there's always sort of this tension between the market and the you know, policymakers is to where is the breaking point? Uh and and the market seems to be comfortable with the rate of change, of the deceleration if you will, of q

E and and not too spooked, spooked by that. If inflation remains much hotter than expected, if it actually accelerates from here, well, then those paces that rate of change is ultimately going to have to change. The rate of change of money coming into the market was like nothing you've never experienced. Back in the rate of change of money coming out of the market tends to be slow and steady until you reach that tipping point the markets

selling you. Right now, we're far far from that tipping point. There's a long runway ahead of us, but we simply don't know, and we're gonna have to see. It does seem like it's more than twelve months away, but again we're gonna have to see. We think you should keep those seatbelts buckled, extra income, shorter duration, and lots of liquidity in your fixed income. Work secuy nicely for me, George,

as we talk about seat belts buckled. George Bowie with us there from all spring, and thank you for the perspective. We now moved to Seth Carpenter, cheat global economist at Morgan, Stanley and South. I want to frame those pushing against the zeitgeist. I think of Priam Miserable at t D Securities who made clear, yes, rising inflation is there, but if it ebbs, it will not dissuade the Central Bank.

And the brilliant note from your colleague Ellen Zentner overnight, who stood aground and said inflation will cool in February or March of next year. What does Jerome Pool Jerome Powell do if we see a inflation I think the real answer is it depends on how much it's cooling. So uh, Ellen's forecast is great, and we think the monthly prints are going to start to come down and you'll start to see it in Q one and more in Q two um. But just coming down isn't going

to be enough. What I took the change in Powell's rhetoric to mean is that he still cares a lot about the trajectory of inflation, but he also cares about the level. Now he started talking about price stability being uh the path to to full employment, and he said there's versions of the world where they would hike even before they got to full employment if inflation was too high. So now we're looking at not just the need for inflation to come down, for them to sort of come

off the boiler a little bit. But also what that level is going to look like. SOE, I'd loved your sense of what happened yesterday in markets in response to this hawk is chilt from a fatal reserve that may be unwarranted to some degree if you do see a cooling off in inflation. We saw stocks rally, bonds rally, we saw everything rally, and people said why. And one theory is because Jerome Powell basically said they would not just halt any purchases right away because they didn't want

to disrupt markets. It would be too difficult to absorb. Is this basically tacit admission that the markets are an incredible call on anything that they do, and that they will not do anything to unduly route royal valuations. Well, I don't think it's quite quite as strong as that. I think Powell was clear that they are going to be cautious, they were not intending to to disrupt markets, and so I think there's probably some comfort taken from that.

I think there's probably a slightly more fundamental version of things, though, which is the whole market started to has already had already thought that that the FED was going to turn hawkish. If you look at market pricing for rate hikes. There's still material probability on a rate hike as soon as March. So the turn to hawkishness I think was not a surprise. The relief, perhaps in part, was that they didn't in

fact get more hawkish than they than they did. I think there was a part of the market at tail, if you will, the distribution that was worried that they could be even more hawkish than they were. So you put together the fact that he he said they weren't going to actively try to disrupt markets, and the fact that some people were probably relieved that they weren't more hawkish,

and you get the price action. How much can we actually glean in terms of a narrative from the market, and particularly the bond market, because right now it is not signaling any worry about runaway inflation or frankly any inflation whatsoever, and doesn't see what the FED is seeing in terms of something new. Uh Yeah, So that I think is the tricky part. Tom mentioned ellen Zentner and

the great work that she does here. I'll highlight Matt Hornback and his team at the point to jet Still, how much liquidity central banks globally or put you know, have have added to markets just how big balance sheets still are, and that's got to be weighing on the long end of the curve, you know, over time. As uh, the FED keeps hiking rates over the course of next year and starts to signal the discussion about balance sheet runoff. Presumably the long end starts to go up from here.

But there they've been very vocal that the global central bank liquidity of provision is weighing on the long end. You of course, that's spent fifteen years over at the FED, and I'm interested. There was a lot of handwringing across Bloomberg and many an intelligent writer saying, look, they there's never been such a signal from the yield curve and we cannot hike into this sort of a flatten yield

curve expectation. But from your perspective, we heard from j Pow saying, look, we are focused on maximum employment, on price stability, and not on some model. What does how much do they care about the yield curve or not. One of my former bosses that the FED was find of saying that the m C is seventeen people that don't agree on the color of an orange. So there's a range of views as to how important the yield curve is. We can just go back to the last

right hiking cycle. The market chatter then was also about the flattening of the yield curve, and they were members of the committee that said they would not vote for a rate hike that would flatten or invert the curve, and there are others that were willing to just keep

hiking along with it. I think what I heard from Powell yesterday as he pointed to strong job growth, he pointed to strong GDP growth that's still above potential and inflation running well above target as as a backdrop for an economy that he thinks can handle some more normalization of policy. So if I want to go to your Princeton PhD. And there's a good guy there named Blinder who's done pretty good in economics and blind one of Blinders acclaimed quotes is, you know inflation is not a

problem when people stop talking about it. When do we stop talking about inflation? I think that's probably some time off, because I think for the regular person, they don't look at the CPI index and take the month on month change annualize it. They they ask themselves, and might paying more to put gas in my guest tank? Am I paying more to buy food of the grocery store? And we could easily see inflation itself come down a great deal, but price levels staying high, especially for the ones that

are most salient for consumers. So I think there's gonna be a long time that the discussion of inflation is in the air. Seth, thank you so much, Seth Carpenter. With Morgan Stanley, it's so hard to make sense of any of this. Biat of her will do a better job than I. She has co head of investment Strategies at Bernstein Private Wealth Management, joining us now Biada. What do you make of the markets shrug to all of these hawkish proclamations. Has it all just been baked in

or is there something that you're gleaning that's a message. Well, what we make of the market's reaction to the FED statement yesterday is the market cares about clarity and communication, and what the market is responding to is that this FED has moved in an extraordinary every way from their talk track this summer when transitory ruled the day and there was not an acknowledgement of the persistence of inflation.

Just one meeting later, the mood has shifted completely, and I think the market just feels confident that the FED is being clear about its communication, being transparent about what it intends to do, and I think that is really confidence inducing. What part of the equity market am I most comfortable in? While I'm going to go with the part that it's not a sector and it's not a stock,

it's quality. Which companies can control the supply chain the best, which companies have an edge in terms of retention of labor assets and attraction of labor assets, and then which companies can exert pricing power. It's not an even outcome. It is very much a stock pickers market because some companies are going to be able to exert that price pressure and really control the supply chain better than others.

It's to of out there, and we see that with both the employment picture and the supply chain picture, and that's not going to be easily resolved in twenty two. What will be the dynamic of margins We really haven't talked about it in the last week, but the bulls obviously taking a victory lap here with a terrific move, but what is your shops say about margin dynamics? Given what central banks are doing, we think there's likely to

be real pressure on margins. We do feel like that's a vulnerability of the market, that's a risk that we have to watch. We're still optimistic about equities because we see earnings growth next year still in the high single digit range. But again, it's going to be very specific to companies on what they are able to control, and

there's not that much that they can control. It's just which companies are taking matters into their own hands, whether it's buying their own planes for logistics and distribution, or real changes on the labor cost pecture. But margins are

a key area for us to watch next year. So can you go as far to say as you can look at industry groups or indeed the way in which you can focus on a value versus a growth stock, or do you really have to be individual stock named by individual stock name at this moment because we all anticipated that at some point value might get its time in the sun. Many anticipating in Europe could outperform us, for example, because they're more value in nature than growth.

But growth can can sometimes help held up in terms of margins, certainly for big tech. Yeah, I look at the market response yesterday in big cap tech. A lot of market watchers really believe that when the FED starts raising rates, growth is going to be vulnerable. And in the end big cap tech, when you look at their defensive modes around pricing and the need for their goods, that didn't happen. So we would not be abanned any growth, but we also would not be ignoring value. We want

to remain balanced across sectors. We want to remain a global investor as well. You can't deny that x US markets are more attractive on evaluation basis. And let's talk about Europe in particular. You've got more cyclicals there, You've got more financials, So as Amicron makes its way around the world, they may be able to emerge first, really opening up the opportunity for more of those value stocks

and cyclicals x US where valuations are much more attractive. Vietta, does it concern you that the consensus is bullish at a time of such incredibly high valuation, certainly on many historical levels. Well, if you look at valuations on the US market at twenty one times with the tenure where it is. It's not that out of line, Frankly, and I think you have to look back to rate hike cycles and I think we've got thirteen of them since

nineteen fifty. The S and P is actually up eight percent on average in those rate hike periods, and that's an important statistic to keep in mind. Again, Why did Actuality have the response they did yesterday and continuing throughout today? It could be okay, right, the messaging from the FAT is going to be the most important part of what happens in twenty two, So we don't look at valuations as incredibly high relative to the rate environment. We come

back to Tina, there is no alternative. The flows into equities are going to continue to be sustained. Um. We think there's tremendous liquidity and excess savings out there to support that. Be out to thank you so much. Out of Kurt with burnste in Private Wealth Management right now parachuting in. Stephen Englander joins us with that question. The number one Cross Rates guy in the world working for the Cross Rates Bank standard Charter. We're thrilled at Steve

Englander could attend this morning. Steve, I want to go Matthew on you what you have the ability to do. Chairman Powell changed the ex excess yesterday he was on the edge of draggy and he tried to pull the discussion out to twenty three and twenty four. What is

the lengthening of the Fed's vista mean for the US dollar? Well, you know, I agree with what Bill Dudley said, and I think that's going to be the eventual outcome, that the Fed ends up being more dubbish and that the uh sort of token withdrawal of stimulus isn't going to

be enough um and the dollar is gonna fall. I think that the you know, circumstances that were likely to find ourselves, say in the middle of next year when rates hikes are going to be on the table, will be somewhat different, and that they probably won't be quite as hawkish as they make themselves out to be made themselves out to be yesterday, Stephen is that basically the Betton markets right now that the FED isn't going to balk and is not going to come through on some

of his projections for as many as three rate hikes next year. You know, I don't know if it's the bed and more kids. But I think looking at the forecast, right, the inflation rates up like half a percent in two and you know, almost a quarter percent, I think, and all you all you have is a quarter percent more interest rate hikes. So you know, for much of the period, real rates are even more negative projectively more negative than

they were before. You know, I think the market looking at this is kind of saying that, you know, they're they're not over the top, And that was the big fear I think going into the meeting. You know, our questions weren't are they going to stick to you know, fifteen billion, the questions where are they going to do fifty? Are they gonna go to zero? And so the market was really scared and kind of was caught, meaning in the hawkers direction, and that was pulling back. So what's

your view on the dollar? Considering that people have the most overweight according to one Bank of America survey, going back to thinking that the dollar will strengthen more next year after what maybe it's biggest annual gain in six years, is it basically premature to make that bet that this is one of the most likely bets to get up ended as the FED is likely to disappoint, as is being basically communicated to us by the market. I think they're likely to disappoint. But that said that there are

two forces driving up the market. With dragging up the dollar. You know, since say beginning of October when is that inflation numbers have been much higher than expected. But I think the market is also underestimating the risk off fact there by COVID first, you know, the spread of delta across the world, and now concerns about omicron um. Both of those together are very dollar positive. We expect both

of them to say over time. So in the short term we're getting bad COVID news and you know, bad inflation news, and dollars still confined some support once that passes, which we think will be kind of at the end of Q one and into Q two. We do see dollar weakness ahead and then extended period of dollar weakness that Donna smile the many had talked about maybe just

planning out slide to your perspective. Then, it was interesting that we got sort of shout out from J. Powe yesterday regarding currency hedged treasury yield, schooling us on the fact that this is why the long end has been so bid because well, once you hedge out the fex risk with you and it's still a great Viye, does that at any point change from your perspective? You know? I I think he was stressing that a bit too much. I mean that, you know, that's something of a factor.

I think in terms of you know, buying dollars. I don't think it's it's an enormous factor. I mean, the real interest rates from the US are really really negative as far as the eye can see UM. And if you don't believe in what we call immaculate disinflation, UM, they're likely to stay negative for an extended period. Steve. One final question if I can, and this goes to your cross right work. How fragile is EM right now? I mean you're the guy that honitors this down to

cross moments. How fragile is e M? Does it hearken back to the fears of stan Fisher of decades ago? Or is it a new em more resilient? Parts of it are are more resilient. I think the investors are looking at Chinese government bonds and and kind of saying, you know, c N Y c N H verry stable yields are high government very cautious in what they're doing. Um. You know, there are other bits and bobs, you know

that benefit from higher oil prices that are doing well. Um. And I think a lot, a lot of bad news is now priced into e M. It's not where we were in September, you know. We I think the market understands the issues that certainly the short term EM is facing. So if we're right that things look better in the sense that we get past COVID and you know, at least the FED isn't quite as hawk as as advertised. There's a lot of room for EM to go up.

But right now everybody is super cautious. Steven Angler in short notice greatly ship adding value with Standard Charter Bank this morning, Paul, it has been way too long since

we've spoken to Shahab john Nus of Credit Sweets. He is outstanding folks, and and and the way I would would would put this is his notes are so dense that the only way you can read him, and I say this with great effects and job is you sit there and you lean in a chair forward, and you have a desk or whatever you're holding the paper on with a pencil, and you read every line like it's the old testament. They are so detailed and so smart.

They they bring me back to Peter Cook years ago with us in Washington, or do you remember the late David Guray, So late David Girl is the same way he would sit there. David would read research and notes like word at a time. That's what you do with the FX strategist of credit sweets Shabab in those paragraphs of detail. What is your number one f X message for next year? Hi? They um, thank you very much

for that. I think in terms of our number one message, it's still to try to stay long the dollar where where possible the price sanction will be will be tricky, obviously and noisy, but the underlying trend is, at least within G tennant still towards the higher dollar. And it might be getting a bit repetitive to say this, but no change from on site. Forget about Turkey, that's its own idiosyncratic story. Where's the big figure opportunity of resilient

dollar weaker em next year? Well, I think, as you said, Turkey is a tricky one. Um. There are other e m s that that that are potentially going to struggle. For example, Mexico is one that we have an ol radar simply because uh, it could be the case that the composition of the central bank changing may create the more dovish slant there and over time degrade the real rates uh support for the Mexican pay. So, so that's

one to keep on the agenda. Uh. And we're still a bit cautious on the C three currencies and maybe even the Russian rules to some extent, given their longer term popularity UM and relatively strong positioning in those at a time when particularly in the C three, there are questions about whether they're central banks are behind the curve at this moment. How about we we had the Bank of England today, I guess surprising some folks in raising rates.

What is your thoughts on sterling here? We've actually been bullish on sterling because we've actually been in the camp that did expect the Bank of Williman to hike, which I know was a was a not very commonly held view, but well it was in our in the notes that you mentioned, we discussed the symmetry in favor of you know, going with that view, given how how little the marko

was pricing in for it. UM. Well, look that the issue with the Bank of England from our perspective is it's one of those central banks that UH still has a symmetric target in price stability target and inflation target. It does not have a mandate, for example, to try to reach full employment. So it's very traditional, I guess in terms of its mandates UM and as we can see from the exchange of letters today between the Chancellor and the Bank of England, the government in the UK

is supportive of this at this point in time as well. UM. So the truth there is that the Bank of England does maybe have more reasons to worry about inflation expectations getting undermined given that mandate than some other central banks. So to deliver a fifteen basis point rate hike, which is not very much in the big picture, and through that signal that they're taking that mandate seriously, I don't think that was too much of an answer for them.

And if you look at longer term rates in the UK UM and but a longer time I am only talking about twenty four expectations for those years barely changed. Because the market knows that the Bank of England has a lot of flexibility UM between now and then to interpret data. However, it likes, particularly with O Macron as early as the February inflation reports. So I think this was not a particularly big ask of the Bank of England to deliver fifteen basis points today. Shure, have you

said it is tough to derail the dollar strength? What in fact could derail the US dollar here? In your opinion, probably the most likely. I think we might have lot up there a little bit of a problem coming from eleven Madison Avenue, the home of credit Swiss. Yeah, well, there we were with some effects dynamics, John and Nison.

What's interesting there to me is do we see obviously the market celebration, the Dow up five hundreds, very close to an inter day record high going back to Thanksgiving, but in the in the VIX eighteen point seven nine. But Paul, what's so interesting to me is does all this mumbo jumbo, this bow tie fancy talk we're talking about, how does it redound on e m There are Pacific

rim bulls who look for a renaissance. Yeah, I'm the Pacific rim absolutely, and I think that obviously it boils down a large part to what happens in China, and of course China has taken a seemingly a more inward looking view of their economy and their growth. That gives some of those folks in Asia a little bit of a pause here, But again that's where the growth has been in the Pacific room, and that where it continues

to be. And we'll see to what extent Europe and in North America can rebound and continue to rebound and reopen here. So there's a lot of play out there in in the currency markets. A few more ministers shot up Jonas as well have after this ECB talk. What will you listen for from the starting with Governor Waller all the FED speakers here, what will you listen for is they try to stagger to January into what is

I'm told a critical merchant meeting. Well, look, I think we can now accept that there's a lot priced in in terms of rate hikes for two um. The Fed itself has validated that with the message that it gave yesterday. UM. So it's difficult now for the market to to look for more at this point near term from the Fed in that sense, I think. So there's two things to

think about. On the doubst side, we are going to be sensitive to any messages around O macron and how quickly any growth slow down link to omcron could lead to a reassessment of two rate high prospects. UM. I don't expect that to come anytime soon because the data is likely to be shown that anytime soon. So that's

more of a Q one issue probably. UM. The other thing to think about, of course, is what could cause the rate curve in the US too to stepend, particularly between two and twenty four or twenty five, where actually you have a very flat curve at this point, So what could make rates uh go higher? Um? Now, the problem there is that the Fed itself is trying to push the market through the dots for a higher view

than what the markets already pricing in. So whether the Fed can say anything to change that at this point, uh, it's difficult. So so we need to try and figure out what the what the tipping point for the market is on that one. So thank you so much, it's been too long shot. I've jealous with us with credit sweeze on a resilient US dollar. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from

seven to ten am. Eastern I'm Bloomberg Radio and 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.