Surveillance: Central Bank Policy With McCormick

Strategy at TV. And yes, we'll talk about euro and we'll talk about the US dollar. The President with eleven thirty talking about fiscal America. But what I want to talk to Mark McCormick about is the fun and joy when the facts change. I change. And yesterday, Mark McCormick, you got a love note from the Bank of Canada that the facts had changed. What is it like on the t D desk when the facts change, as you

saw from the Bank of Canada. Yeah. Thanks. The interesting bit is, uh, most of us aren't on the floor anymore, so it's uh, it's taking the facts as they come in from work from home offices. But you know what you saw from the market is is what I think people are really focused on is what the Bank of Canada and what the Bank of England have done is they're pulling things forward. And I think what the markets are really focused on is what's the r star, what's

the terminal rate? How do these cycles evolve over the next year, year and a half versus who moves first and who moves fastest? And so what we know right now in the G ten is in orgeous bank the r b n Z, the Bank of England, the Bank of Canada are first and their primary, and the Bank of Canada basically said to start traders yesterday April is

a live meeting. What I think matters for the FX market though, is really how does the how does the rate cycle evolve over the next year, which actually hasn't changed. So I think that's a big dynamic, especially if we look at the Bank of England. Um, you know, we've priced them in the fastest over the last six weeks or so, but again, are you going to see much more than two or three hikes in in a year

and we've already priced that in. So that's a big element of whether or not these moves are sustainable for some of these other currencies. On the central bank trade marks, let's just go through what's been priced in. Bank of England moves first, Bank of Canada follows, then the Federal Reserve EC becoming in dead last. Is that basically entirely

priced in two currency markets at this point? Absolutely, And I think when you think about as well, like the first one in here was an oorgeous bank, So I think you know what you have to think about in the context of this is we've got central banks what we call the hikers. We've got basically growth divergence, which we call the growers. We've got the miners, which is basically your term to trade, and we've also got positioning evaluations.

So those four factors is what's driving effects. And so if you've got a negative view on the terms of trade shock which was bad for Asia and bad for Europe, and a rotation outside of that where we don't get another jump in oil prices in the fourth quarter, then Norway is really kind ofvulnerable environment given how much excess has been priced in and the euro, you know, give or take positioning, Euro positioning short, but euro should be

trading around one fifty on our high frequency models. You basically have an environment here where your O knock could rally, kind of reversing some of that. And you could also see euro Sterling starting to come off the lows because the Bank of England has been fully priced in, and we're actually long dollar CAD because we don't think the Bank of Canada dynamics changes some of those other forces that we're talking about in terms of you know, growth divergence,

terms of trade and what's currently priced in. So mark the short term is easier than the long term, right, the short term is who hikes first as a competition where you kind of have that horse race going on. Longer term, it is a much harder story, and it's difficult to see one economy diverge meaningfully from another when

it comes to growth and inflation. How much is the idea of a flattening yield curve indicating a global policy error that's going to affect the e c B, that's going to affect the region even if they hike glass basically that one central bank cannot escape another and that the currencies are sort of toggling alout around this reality. Yeah, it's a great point, because we've got kind of three

I guess you call them flation themes. You got stagflation, reflation, and you know, the word that no one wants to talk about is deflation. But there is an element here that the bearish flattening of yield curves is suggesting that monetary policy around the world two year front end rates, whether it's US or non US. You know, first, what we've seen is a non US average emerging markets in G ten has ripped about fifty basis points in the last uh month or so. Higher. US yields are are

finally following their up about fifteen basis points. But there's an element here that the worry is bearish flattening is indicative of weakening growth. And you know, you can some curves have flattened. I got to interrupt. This is too too important, folks. We're gonna go Matthew here and I can do that with McCormick x Bloomberg mark. Are you suggesting, for example, with a ten year US real yield, we have a fan distribution of outcomes that leads us to

a persistent, constantly negative real yield. Exactly. Yeah, your skew is biased negatively so your ten year real rate is you know, essentially, if we think about it in fair value terms, maybe has basis points to move higher. But if we go back to the Taper tantrum, we had a hundred basis point move because we had a three standard aviation miss pricing on real rates. We don't exactly mark I did. Again, I don't wanta interrupt, but this

is absolutely critical. Answer the question then, which is simple, with a three standard deviation move, how does this filter through the American financial system? Well, I guess the big part of it is real rates. The plumbing of risk premium and the plumbing of interest rates stays at very accommodative levels. And if you look at it, a global version of financial conditions weighted by global GDP is still the most accommodative it has been in the last fifteen years.

So the the under you know, the plumbing of the financial system. You know, while we're talking about how many central banks have hikes rates and you know where we're

removing stimulus, we are still an emergency stimulus measure. In real rates are still very accommodative for reflation, which is a theme that I think should still probably do quite well in the first part of next year, especially since we're not looking for a FED hike until three, which again would keep real rates at bay as we see short term inflation rising but essentially decelerating into Mark, thank you so much, greatly appreciate it. Mark McCormick with us

here today. Not a mystery. Yes, come appear at a moment. Which is the trophy taker for the Institutional Investors Survey, And I say an insiders, some we say I I, I okay. And I say this with great respect for the late Fred we Gold, who was a great mentor of mind here Bloomberg, who helped invent the Wall Street Journals survey, which separates earnings guessing from more of a thoughtful view of the crops. The I survey Paul a

beauty contest. It's actually a reflection of what institutional investors, how they value the sell side. And as a former sell side analysts, it was the number one goal for an analyst back in the day. I'm not sure how much it's value today, but back in the day it made or broke careers, and it comes back everytog I can't convey. Not for those of you not on Global Wall Street, the sweat factor of this announcement. I was on the phone ones with a winner who had to

go to decide on three job offers. Literally he said, Tom, I have to go. I've got one call and two calls coming in in a biting word. You know, I can't remember what he did. I think he went and sold boords in California. But the bottom line is it's completely, uh uh, completely part of the Wall Street heritage. Dennis de Busher joins US now with twenty two V research for years with Edward S. Himan at ever Cores I s I and he is the number one strategist this year.

Gratulation for institutional investor Dennis on behalf of the Academy, Congratulations, what did you do afterwards? Watch the Knicks? What you do well? One? Thanks so much And to um we know it's not a beauty contest because here I am on the radio show, Dennis, I look at this and it's it's a lot of hard work and it's getting it right on a type two basis, What did you what did you not do wrong? Forget about what you got right? What did you avoid in getting this huge acclaim? Oh?

Thank you? And a great question to a. I think the thing that we avoided was chasing the narrative to jure and providing some type of way to think about how the macro backdrop, and particularly I keep coming back to this, the narrative is changing, and how investors should

think about that. Not necessarily, you know, how they should be focused on whatever is coming out on Twitter or whatever headline is coming out that could indicate some massive change in trend, which is something you know you'll probably be aware of. We're going through the last few days with this yield curve lattening, So going through another one of these periods of trying to help people understand that and how to think about it as opposed to making

some great call. What we didn't do is chase any big change in trend too aggressively. What is your market call right now, Dennis? A good question. So we're biased high in the market, you know, I think we think fair values up at the rage. It doesn't mean we have to it there by the end of this year. Um. The way we come to that is basically, your implied

earnings yield on stocks relative to risk re rates. You assume a little bit higher in ten ure yields and earnings come in roughly where they're expected to come in over the next three to five years, and cash returns to day about where they are. You've got a little bit higher on on the market. Not that exciting of a call, quite Frankly, I think all the interest in the market right now is in internals. That's where we focus.

So it's sectors and factors, and as you guys know, I mean, there's a lot of macro volatility right now, and the narratives are just kind of really you know, exasperating that, and that's creating some opportunities on the internals that we think are very interesting. Dennis, A lot of

folks are concerned about evaluation in this market. Yes, the ten year you know, is at one point five six per cent, so that gives me a little bit of comfort, But you know, I need earnings to come through in a big way, and it's so far in this third quarter they've been pretty darn good. How do you feel about evaluation? How do you think this market is earning its way into the multiple? Yeah, I think it's it's

clearly earning its way in the market. An extend companies are beating, Um, we're on the back end of a profit boom. People really got this p p I verse CPI um spread wrong. I e. If you know CPI is lagging PPI, that means marketings contract. It's just not true. PPI is very possibly correlated with the corporate value add wages legs. So you know we've had a profit boom and we are working into that multiple. From here it gets a little bit tougher. Well, here's the important point.

I was just looking at it today. So I tend ORR yields minus inflation expectations negative a hundred sixty basis points. Real high yield rates on an implied basis are almost close to zero. So I know nobody likes the Tina argument. I like to know that everybody likes to make fun of it. But we look at the cash return and cash flow of these big cap tech names relative to other things. It's the same bull story we've in talent in the last five ten years. What's your five year view?

I want you to go all ever core SIAM is you start two V? I mean, what what what's your five year view on equity ownership? Stock ownership? My five year view is much lower return than the previous cycle. Somewhere in the four to six percent range per year. Okay, Dennis, thank you, so congratulations, thank you so much. It's just absolutely superb greatly greatly. I appreciate it does to prosure with us uh this morning, winning the II survey with

twenty two v research former ever Course Strategistics, Well just amazing. Yeah. So it's you know, it's the interesting thing. It something going out on your own to start your own firm. It's what a better time. He couldn't get a better time to do that after winning the number one slot on II gives you some you know, incremental street credit, as they say. Lee Ferris joins, how do macro strategy for North America at State Street? Leah's a glass half full or half empty as we look at American g

d P at thirty. I think when it comes to g d P um sadday is half empty. I think this was meant to be the big reopening phase, know Q three expectations at the start of this quarter, where you know this was going to be a seven percent quarter, you know, as things really got back on stream, and now we're looking at the meeting of what two and a half percent Atlanta Bed saying point five, which I think is on the low side. But but even so, it's a far cry from where the expectations were at

the start of this quarter. And it really shows well what Delta has done and the supply side con stranger you were talking about what they've done to activity. Are we at a point Lee where and I think of the great Betina Dalton at Fidelity years ago, where all that matters is domestic final sales and that country to country, And here talking about the US that we see the export import mystery and the China mystery so great that all we can fall back on is US domestic final sales.

And then there's a point to that. Yeah, I think that's a fair point, Tom. I think you know, at the moment, we're trying to gauge the strength of the domestic economy, you know, with supply chains, with all the stuff at the ports, with you know, with everything else going on. You know, the sort of external sector of the economy is sort of something we can't control, right, Um.

So yes, I think there is a valid point that we should be looking at final sales to domestics, um, And that's a better gauge of where we are in terms of the bigger picture and the reopening the other stuff. Yet, I mean there's so many moving parts right now in the global economy and the US that that it's hard to really gauge where we are. I don't think we get a clear picture until next year. I'll be absolutely honest with you, Okay, Ley, who is glass half empty? Right?

I mean you look out at stocks, they're hitting new highs. You look out at bonds, they're doing all right. There is a bearish tilt there. Who has it wrong with how bearish they are in term of US growth? Well, lasta, you're assuming there's a relationship between asset prices and the real economy. Surely that broke years ago. Okay, well said,

carry on. So, I mean here's the thing, right, So low growth now more support from policy, you know fed You know you've talked about at the top of the show about about how much is getting priced in in Europe in the US as well, we have virtually two hikes priced in next year now for the US after this this round of sort of tightening in the market over the last week or two. So isn't weaker data

actually pushes out that scenario? And we know that policy has been the big driver of asset prices hold on very low. This is really key. Are you saying that we are still in an environment we're bad news? Is good news in terms of markets. Yes, the longer we get the policy support, then the better of the markets. The longer that policy support is there, as long as the economy is not own through session or anything disastrous.

But but if things are delayed, if we're going on the right path but at a slower pace, which means the policy support persists for longer, still positive for markets? Yes, overall, Yeah, because more policy support. But what you're seeing in the bond market is the anticipation that policy support will not persist for longer. We're seeing a pulling forward of expectations on when the tightening starts across the world. It's already started in some places, and the equity markets still resilient.

So is that not a mismatch? Yes, I mean there's no doubt there's a lot of mismatches going on at the moment. I mean, the fact is, you look at the curve shapes though, right, So we brought forward these rate hikes, but then if you look at the longer end, you would have actually dropped back down. So what we've seen is this massive curve flattening. So you know, it's sort of we're sort of mixed between the two at the moment, insomuch as we're bringing forward these rate hikes

on the back of the inflation numbers. But actually when we look at policy over the long term, we expected to stay easy. Okay, so let's talk about that curve flattening five thirties right now, seventy basis points between the two. Has that been overdone? Yes, I think it's tough, but I think it's more to do at the short end that the rates going up. I think is is the bigger issue. I don't think central banks are going to act as hawkishly as anywhere near as one that the

market is sort of projecting at the moment. Particularly saw the G three, now some of the commodity exporters Bank Accounada we saw yesterday. Yes, they can be more aggressive. They're going to tell wins from these commodity prices in their domestic economies, but commodity import is generally and the G three economies, I don't think they're going to deliver

anywhere near what the markets pricing. So I would say that, yeah, the flattening has been overdone, but it's been overdone because short term rates have gone up too far rather than long end rates coming to it down too far. Very goodly, first, thank you so much, greatly appreciated with State Street had a macro strategy. What we're doing here, away from buying markets should Annigan's is really looking at the tech juggernaut and how it folds over into the rest of the

stock market. Katrina Dudley at Franklin was iconic and federated for her analysis of technology, and we're thrilled she could join us with Franklin Mutual's today. Katrina, I want to talk up to about something is basic c f A one of persistency a free cash flow? Do we massively misjudge the generation of cash and the use of it

for shareholders? Um, If I take a look at free cash it's one of the key metrics that you have to look at at a company in terms of assessing the stability or assessing the stane ability of the competitive advantage what value investors. But we spend a lot of time looking at cash. We take it from the net income level and we look at what are all the people that need to get paid UM, the legacy restructuring charges. Yes.

So there's so many things UM, and so many parts of that cash fold statement that people just completely ignore UM. So I think that people also very much get confused about a resilient net income number and they forget about looking whether or not that is a resilient free cash I love that you're going on Graham dot and cadl me Lisa. That's the iconic textbook out of Columbia from a million years ago. Katrine has read six volumes of it.

Forget about it, move up the income statement and can you partition the tech juggernaut over the rest of American industry? Do we just simply underestimate in this great bullmarket the ability to make profit um. I think in a tech booll market, what people are now really focused on is the sustainability of that profit stream over a long period

of time. And we're also focusing on the role that interest rates and inflation are going to play, because when you have such high multiples of earnings, which a number of these texts stops are trading on, or you have stocked that actually not even trading on earnings, they're trading at thirty types sales, your interest rates become something that's very, very sensitive because on a DCF valuation you're looking at

those terminal values and rising rates and negative for terminal values. Well, Katrina, this really goes to the heart of the question of the US versus Europe, where there's a greater tech dominance excuse me, in the United States versus Europe, and there also is this feeling that there is a different, more stagflationary like kind of headwind facing Europe. Is the cash persistency of European companies different than that of the US.

So the Europe doesn't have the same level of technology companies, but it does have a number of very strong companies there, from a cap Gemini to a software a g U s A P is another big juggernaut. I think you most companies can't function without an SAP supply chain solution. So I think that Europe does have a great constitution of technology companies, but it's not the dominant force or a dominant percent of their markets. What they do have is luxury stocks, which are the tech stocks of Europe.

When you think of the Louis Baton's um, you know, Cartier and all of those very strong brands, and that is the technology equivalent in Europe UM. I would say, however, that those brands have got a lot longer longevity. They've been around for multiple new centuries often UM and so their ability to generate free cash flow has been tested

time and time again. And the stability and those franchises I think is probably something that you as an investor can kind of put away and you kind of wake up in a hundred years and the stock will still be there. Our investors, global investors under estimating the power of a more devish ECP relative to the rest of

the world when it comes to equity performance. So some of the the You've obviously had a lot of hawk ish comments coming out of the b o E, the Bank of England UM and and some commentary out of the FED as well, so people are saying that there's some fish pressure on the e c B. However, from a doubbish side, we've had the Bank Lending Survey which came out recently and showed that there's been increasing pullback

in landing or tightening of credit standards. And you combine that with a small wise endominal yield and we've already starting to see some signs of tightening before the ECB has done anything. So we've got a number of programs the ECB has um they're they're going until March of next year. We're also expecting an announcement in December from the e c B. Obviously they've got their their their meeting today, but we'll get that December meeting, which is

that we're expecting some big announcements. UM. As I look over to Europe, though, let's just compare and contrast Europe with the United States and the positioning of two of the central banks. You know, the the inflation concerns in the US are much greater than that they are over in Europe. UM. And so you know, the supply chain pressures exist in Europe, but I don't think we've seen the same time of tightness in the supply chain UM in European markets. I don't think you've had the ports

as much being an issue there. The second thing is that the labor market is the other element of the inflation equation, and Europe's labor market has been quite sluggish. Um. You know, you just need to look at the German public sector workers. They were asking for a five percent rate or wage hike, and it looks like it may not go through. So you've got I think a lot less pressure in the ecb UM. The economy came out

UM a lot behind the US. I think they're also taking the advantage of that, and they're going to walk to what the FEDS doing and then they lack labor well, talking of inflationary and labor pressures for US companies. We just had Caterpillar earnings crossing the Bloomberg terminal, big surprise

to the upside. They beat on EPs by something like coming in at two sixty to share, and I'm just looking through the press release and they talk about unfavorable manufacturing costs because of higher labor costs, higher free cost higher material costs, and yet sales were really strong. Therefore they were able to offset that or withstand that to some degree. Did we grossly underestimate the ability of companies to do that. I think that's a company by company decision.

I think it really paying so much attention to this. You have rising costs on one side, and I think that we've been overly focused on those rising costs. But companies can handle rising costs if they can also get the pricing for it. And I think that's what you're seeing with a Caterpillar. They have had those rising costs. But going back to brand name, what construction worker doesn't want to have a yellow piece of equipment? That, yeah, exactly,

people tattooed Caterpillar down their leg, you know. I mean, it's just an iconic brand name. And and and in this case, I think you've got the power of the brand gives you the power of pricing. Be careful, cantriner Tim is going to roll up to bloom the headquarters on every week and we're moving the trees around. Continue. Oh now, I'm just distracted by that image in my head. If someone wants to photo stop feel with the tattoo.

But okay, So Katriina talking about maybe supply chain bottlenecks easing all of these things we heard from the automakers as well. Forwards Atlantis b W kind of saying that the worst of it is over. If the worst of it is over, if margins can then expand, if some of these supply chain issues are no longer an issue, does that just mean the bull market rolls on and we can continue to climb higher and higher solely on the basis of earnings. Even if growth starts to slow. UM,

it growth starts to slow, but earnings keep going. You're right, the market should continue to appreciate because it is very much a reflection of the only earnings of the companies. UM. In terms of the supply chain, I think what we're seeing is the early parts of the supply chain is starting to get a little more room in them, and that will ultimately work its way all the way through

the supply chain. UM. But there are a number of parts where there's still weak there's still tightness, and you know, some of these are are so interconnected. So think about logistics call UM. You know, we used to when we were short on components, we'd have freed them into the factory and that would speed everything up. Well, because we haven't had flights, we don't have belly space, we don't have the ability to do that. So UM, I think that some of the logistics stocks costs will be new

higher for longer. But I think some of the component prices, You're right, I think we've been able to build a little more buffer into it UM in terms of you know, and so the question is if you've got companies that have gone out with the pricing equation on our you just need to cover my higher costs. The risk on that pricing creation there is that the companies get pushed

back on the other side. So I think you've really got to understand the stickiness of those pricing increases, because if they're not sticky, you will not get the earnings growth that you wouldspect. Contrina, thank you for the clinic. Contrina dudly with Frank the mutual today as we look at use care. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live week days from seven to

ten am Eastern. I'm Bloomberg Radio and I'm Bloomberg Teleiver 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