Surveillance: China Regulation with Miller

We've got to have a really important conversation. I'm sure it's frustrated you through the week that everyone, almost exclusively I say everyone, A lot of people have been overwhelmingly focused on whether this is a Lehman moment or not. You think there should be a bigger focus out swhere. Let's start there, Leland, where well, you you have to start just saying this is not China's Lehman moment. I think everyone's at the point where they're sort of understanding

that there's not major contagient risk here. China has the tools to be able to deal with it. The real signal here is is what she is doing in the in the property sector. Earlier in one and we saw this very clearly in China Beige Book data there was a d risking of the financial sector, much tighter conditions

as the years went on. Year went on. The property sector has been in the midst of a de risking for the last six months or so, which is which has created this uh, much lower growth, much less access to capital. This is this is a paradigm shift for China's growth model. When she looks forward, I think he sees the end of this economic growth model as it

stands right now. There is too much risk, there's too much nonproductive uses of capital, good money chasing bad and so at this point, you know this is investors should be looking at the medium term trajectory of growth, which is gonna be much lower than I think people understand it right now. How much lovely do you think? I've seen numbers in the low fives for next year? What are you talking about? Leyland? Fools three? So what do

you think? Look two is gonna be very tricky because you start off at the beginning of the year with the Beijing Olympics, and you have the Party Congress at the end of the year. There's no way that the party gonna allow bad headlines or disruptions right up into the Party Congress. Which is held twice a decade. It's where she is going to point himself truly president for life and maybe a point of successors. It's gonna be

a big deal. So the questions really beyond because two is a bit hazy in the way that they want to handle that run up. Uh, we're looking at numbers. They can keep them higher for longer, but but but

they're going to have to truly downshift. We're not talking about, you know, a tenth of a point here, We're gonna have to talk about full percentage points going forward in growth because they're not going to have the property sector driver, and they're not gonna be able to simply snap their fingers and transition from investment to consumption because they're not doing any of the structural forms necessary for that right now.

How sustainable Leland is the framework of the Chinese economy to handle a three four percent growth rate after basically hinging itself on that seven eight nine percent growth rate that we've seen. It is absolutely capable. The only reason the Party hasn't gotten away with it is because there's been decades of of of zelotry around the idea you have to have a GDP target. You have to meet

that target. If you just accepted slower growth. Now, look, foreign investors, commodity firms, everyone will be thrown for a loop globally. But China itself could embrace slower, healthier growth. It would improve the dynamics outside China, it would stop the debt build up all of a sudden, capital could go to productive uses instead of non productive uses. It would be extremely important for China, and I think that's

why the Party is doing it right now. The true risk here is that foreign investors just haven't gotten the memo and they they're not expecting what's coming next. Well, let's talk about those foreign investors Leland, because China also was supposed to be in the process of opening its financial markets. Does what She's in pain is doing now internally in China run counter to that it does, and and there's there's there's just a major conflict here. Um

she is facing you know, is faced inward. He is he is doing a huge rectification campaign in the run up to to the Party Congress to to show that the social compact has changed between the Party and the people. Now the party is is not focused on growth for growth sake or creation of wealth. It's there for distributing wealth and making sure everybody is happy and rich. So there's a major domestic focus right now. You know that conflicts dramatically with the idea that you're going to make

capital markets hospitable to foreign investors. So Leland, this goes directly to the question of the dollar bonds of ever Grand. If they perhaps if the regulators in China manage to avoid contagion risks within the population but allow these bonds to default, is there a larger message that it is dangerous and unpredictable to invest in dollar bonds from Chinese companies going forward. Absolutely, the risk of this is shut upward and it doesn't mean that they're going to to

try to screw for an investors. But could they be any clear in signaling where the priorities are right now? You know, if you're investing in in dollar bonds, you are somewhere in the middle to the bottom of the priorty party list forever brand and overall. So the idea that these are sort of non non zero risk investments or or low risk investments, I should say you have to crank up your risk profile for these tools because you don't know how deep these crackdowns are going to

go for the next year plus. And this has been such an important conversation. Leland, don't be a stranger. Stay close. Let's catch up again soon because I imagine we'll be talking about this issue for a while. Leland Mill of the China Book International CEO. Let's talk to Michael Gayford, Barclay's chief US economists. Michael Kelly talked about real yield in this adjustment we've seen in the past twenty four hours as well. Darryl crom talked about the belly of

the curve yield tire on five. So, now, do you think with pricing in hikes a little bit too quickly here based on what you heard in that FED call a little bit earlier this week, No, I think I think, given the first of all, good morning, UM, and thank you for the for the question, I think given what you heard, No, I think you you you are hearing hawkish rhetoric out of central banks, the FED giving you the signal on taper, the Bank of England, you know,

signaling tighter monetary policy may be appropriate. We can debate whether or not we think it's the right policy, depending on how you think of inflation is going to play out and where the risks really are. But I think given the communication, no, I think markets have been right in terms of absorbing the message that that the normalization of policy has started, the great exit, if you will, from these emergency policy settings has begun and and maybe

even accelerating. Well, let's at tank that line of thinking, not the should should, and let's do the will want, what they will do, what they won't do? What do you think they will do? What will that rate path look like through the next couple of years. Well, I think for the for the ft obviously step one is get to taper, and I think there's now a very high bar to to not taper, given given Powell's comments and and the message that they will be done by

the middle of next year opens the door. Whether they walk through that door or not, we don't know. We need to see where inflation will will be. The Bank of England is now set up a situation where the markets pricing in about two hikes over over the next year, and they may have a small majority in order to deliver those early early next year. So it's probably be a coin toss whether or not you get a hike in in the US next year. It's a nine to

nine split right now on on the committee. But I think the FED would argue, yeah, okay, fine, we might get started, but look three years from now, we still think we're going to be below neutral. So it's a it's a blend, and that's why I think a steepening in the yield curve made made a lot of sense. We may get started sooner than than we thought we were just even a couple of quarters ago, but we still think it's it's going to be a gradual cycle.

And and the neutral rate is you know, we're not going to be touching the neutral rate over that whole forecast period from from the FED projection. That's why I think you can still argue for a steeper curve. I want to get a more elaborate ration on the great exit is starting. This sounds dramatic. It is dramatic after years and frankly months of extreme accommodation after the pandemic, and yet we have not seen any major moves in

markets in response. Can this stay or is there a culative sort of response accumulative effect by all the central banks taking a similar type of more hawkish tone at the same time. So I think that's a great it's a great question, and you look and I think there there probably is a day of reckoning at some point that no, we all can't be when when when that ship turns Globally, historically you're going to get volatility. So in your previous segment you talked about downside risk to

China growth. The Central Bank Brazil tightened a hundred basis points. We think, we think Mexico does twenty five next week. The FED is going to be starting tapering, The Bank of England potentially hikes early next year. That's a lot of you know, acute potentially the ship turning in a way that's coordinated globally, and it reflects the nature of the shock of courts, which was a coordinated pandemic shock.

We're kind of past the v in terms of we've gotten that sharp snap back and economic growth growth could be moderating globally going forward, central bank policy could be normalizing. That's not always a great recipe for for markets. So here it's about the speed of that removal against where market expectations are. So far, markets want that and it hasn't been destabilizing, and we'll have to see whether that

balance can be maintained. This is one thing I was worrying about last night as John Farrow was talking to priamsra I was just quietly worrying about this idea of higher yields around the world leading to lower foreign buying of treasuries, and what if there is not substantial domestic demand to keep yields where they are at a time of FED tapering, even if supply isn't that big or is a lot lower than it has been in the past,

could you foresee some sort of development like that? Sure, And in that world, I think what you would be arguing is that rates would have to back up a little bit and would therefore tighten financial conditions on the margin and help to moderate growth in the US. So it's it's a scenario that I think we have to be aware of and and see if that plays out.

That would mean you're going to get more tightening, kind of more effect on on GDP per FED titan if you will, because you're you're arguing rates should be higher all else sequel given that net shift in demand for treasuries, Michael, I want to talk about the consumer because in just the last couple of days, we've heard more and more about supply chain issues companies are facing, one of them being Costco, who last night says we're going to have to raise prices for items on our shelves by three

and a half to four and a half percent. To what extent is the consumer still going to be able to tolerate that if we aren't getting significant wage inflation. Well, I think I would argue that I think we have enough, say ammunition in the pipeline for the consumer to keep spending going despite what could be potentially higher prices on on some goods. So we still have a lot of excess saving that's out there on household balance sheets. And and we still think there's going to be a lot

of employment growth. So as you know, income generated from labor markets isn't just where wages are, but it's ours work, it's total employment. So from an aggregate perspective, I still think there's enough momentum there to household spending, say, clicking along at reasonable rates, even though yes, there's certainly underlying price pressures now that we didn't have twelve to thirty six months ago. So I think we're still comfortable with where the U. S. Consumer is, So let's talk further

about employment then, Michael. Obviously you still have a persistently lower labor force participation rate. You're starting to see those additional benefits rolling off, but you aren't seeing the subsequent increase that many were expecting when you remove that incentive not to work. What do you make of what's going on in the labor market right now and how structural these issues are? Yeah, so I think this is the literally the big unknown for for the US recovery. Does

that participation rate rebound? Is it a permanent exit from from the workforce? What I make of it. I think there's a lot of factors keeping restraining employment and restraining a return to the workforce. I still think, you know, we can't really parse it all out because there's a lot of moving parts here. I still think the number one important reason that's stabilizing labor markets is fear of infection and infection risk. And and I know that's been a well worn you know wheel at this at this

stage of the pandemic. But if you look where hiring came off in the last employment report, all these are in hospitality, all retail, outside of those hiring was still pretty good. So I think if we want to return, you know, and if we want to understand the structural outcome in the labor market, we have to you know, we have to get a control on on the pandemic. It's it's simple to say, hard to do, but I still think that's the driving force. We've got to get

you out of the basement. Mike. We're actually back in the office three days a week now, so we're getting there. How do you how do you split it, Mike? You do Monday at home, Friday at home? Is that how it works? A longer weekend varies. It varies depending on whether we're seeing people, you know, face to face that is actually happening. Again, it depends whether I have interviews with with my friends on Bloomberger and not as well. Very cool, Thank you, Mike. Right, a catch up Michael

Kaife and there Francoli's chief US economists. We're not talking about a Lehman moment. We're talking about the removal of some of the dynamism of global growth from the China slowdown. Mike Darta really covers everything on the intersection of global economy, the global economy through the lens of the United States joining US now MK, I'm partners chief economist and macro strategist. I want to start there. How much would a material

slow down in China's growth affect the United States? It's a great question, you know, we don't know off hand. It really critically depends on how much contagion there is. And so if we listen to what that Chair Powell said this week, if financial conditions and credit market conditions were too tighten drastically, uh, that's you know, that would essentially deliver the same kind of headpoint is if the started to tighten much more quickly than expected. So far, however,

that hasn't really happened. So viewers can watch a few different indicators to keep tabs on potential contagion. One is just the performance of the high yield market in the US because it's very sensitive to liquidity and growth shocks. So if China goes into a tail spin that's likely to be highly destabilizing the global growth. You'd expect the high yield market spreads to wide widened pretty considerably. Nothing

doing there so far. Now that can change, but so far we don't really see any contagious spillovers, flor whatsoever. But Mike and I need to say this because it's always bad to say this time is different, But this time is it different because of the feds involvement in credit markets and frankly because of the backstop that we've seen. Yeah, that's a great point, and I think that's exactly why we're seeing the stability in the high yield market that

we are. There's essentially three point eight true million dollars of foam on the runway, and that's not balance sheet foam. That's broad money, spendable assets deposits in the financial system, and so because of the FED actions, I think that's exactly why we're not seeing the contagion. But it also means that there's a lot of support for aggregate demands to continue running pretty hot in the US even with

these setbacks around the globe. So it's a it's a good point, but I think the high yield market can still still gives us the signal that there is a tremendous amount of liquidity and spendable assets in the system, and that means that the US business cycle probably keeps chugging along, even if ever Grant does a hard based plant here, which seems highly likely. Mike, let's talk about

the intersection of US monetary and fiscal policy. Greg Valier, who's a policy strategist, just publishing his note a few minutes ago talking about the fiscal drama happening down in DC, surrounding the debt ceiling, infrastructure spending, and he said it will look so dysfunctional that the Federal Reserve may have to wait until winter and the resphiscal clarity to begin tapering its asset purchases. Do you agree with that? I don't agree with that. I think Paul was very clear.

He essentially said in his atension, we've all but met the threshold for tapering, which is simply a substantial further improvement in labor market conditions relative to where we started the year. And you know, so the fiscal policy deliberations are going to continue to unfold. I think the FET is still on course to start the taper, you know, this November, unless we get some really shocking data or a big financial market accident, which so far has not occurred.

So those two things, I think, rather than the discussions that are going in a going on in Washington, would be the only potential snaxt but highly unlikely. I think we're on autopilot here too, to see the feed begin a taper in November that likely concludes mid year next year. Just keep in mind that tapering means they're still adding

money to the system. That that's balance. Heat will likely expand by half a trillion dollars or more over the course of the fall through the middle of next year if they do it, a fifteen billion dollar tape for per month, that is pretty unusual with an economy rapidly closing in on full employment. If we just look at the trends and what's happening to employment ratios and the unemployment rate, and so I don't think physical policy is going to be as disruptive of forces as some seem

to believe. But you know, we'll see how it goes next year. Okay, well, let's talk about you were mentioning the data there. Obviously, October eight is going to be the next big one with the September jobs report, Palace set in his news conference, I just want to see decent growth. You know, it doesn't have to be anything stellar. Is it even possible that what happens on October eight changes the equation for November or is that now kind of setence don't. Yeah, highly unlikely. I think it would

have to be a pretty dramatic misrelative to expectations. It's always possible, but I think it's not very likely. So either something like that or some very sudden uh financial market storm um taking place in so far and we're not really seeing that even with all the pressure on ever grand in Chinese debt market. So I think, you know, set in Stone might be a tiny bit strong um. But I think kind of life has to a taper for for sure, pretty much all but in the bag Mike.

Yesterday we had on Danny blanche Flower of Dartmouth and he called the current field of economics guess anomics, since we have no clue what is happening basically in our visibility is very low. He was saying that it's a mistake for the feeder reserve to be tapering at all because the underlying trend in labor markets is actually weaker and that frankly, the lack of participation has been a high concern. Do you agree, I would have to say

I actually disagree with that. Um. So if we go back to the last cycle, and we look at where the labor market is. When the FED taper starting in came you worry of announced at the end of twenty thirteen, the unemployment rate was considerably higher about you know, hundred and forty basis points. Uh. The primate employment to population ratio was lower by the same magnitude a little bit

more actually, uh. And if you know, even if we look at this criteria, the FET is now saying it wants to be more inclusive in terms of focusing on the labor market. We look at African American unemployment rates or Hispanic unemployment rates, we're in a much better shape now than we were back then when the FED started

the tapers of the beet is already waited longer. And even if we look at these super core measures of inflation, right so if you listen to the people that are in the temporary transitory base effect camp in terms of saying,

don't worry about this high headline inflation. Right now, if we look at the trimmed mean PCE deflator, the median CPI, the employment Employment cost index, those are all run hotter, not massively, but you know, I would see materially then they were when the FED started the taper in the last cycle, so the Fed's already desitioned itself behind the curve easy to be the last cycle relative to the labor market and relative to even these super pore measures

of inflation. So I would have to disagree on that score. I think, if anything, that FED is probably going to end up behind the curve here, because we could be rapidly reconverging with not just full employment, interesting casually beyond full employment by the you know, by the mid mid year next year, the end of next year, before the FED even gets up that geral lower bounds. That final point is so so important, Mike, it's so important. We'll try and talk about that through the morning, Mike Dae

to that of MKM Partners, Mike, thank you. Sir Patrick comp Strong joined the SNAPLIBI Wealth Chief Investment Officer. Let's start here, Patrick Poth at least resistance high or LOWA for this equity mark, Kid, I think it's going to continue to be higher. I think queue is going to slow down. It's not going to stop over the next nine months, but it's going to be tapered and that suppresses volatility. So I think we have a bumpyard grind

higher potentially. But while we've got massive liquidity you saw one point three trillion in the FEDS reverse repo yesterday. Um, you've got negative real yields at negative point nine percent, and you've got very significant earnings growth forecast for the next few years. At the double digit earnings growth still is the consensus expectation. While those three things are in place,

it's hard to see equities having a sustain sustained sell off. Patrick, Yesterday, people were saying that there was a reaffirmation of the reflation trade, as you could see from higher yields in tandem with higher equity prices. Do you agree that there's been some shift or was it just choppy as people tried to make sense of all the headwinds and tow wins. Yeah, I'm not even sure if it's a change in inflation expectations. Is it's a change in basically what the Treasury has

to yield. So you've got the Fed who's been buying a hundred and twenty billion of bonds every month and that's going to slow. And if you look at inflation break evens, they're largely unchanged over the last few days. So I think the path of the tenure yield moving higher is actually a slightly less negative real yield, and you have to incentivize buyers to take those treasuries that the FED won't be buying, and I think higher yields

are needed to that. Okay, So Patrick, let me just pick this apart because you mentioned that real yields of taking higher were now around negative ninety basis points. You talk about three pillars that support equities, one being real yields, which are still steeply negative. I'll give you that liquidity, which, as the FEDUS said, it's going to start winding down, and then earnings growth. So when you look at companies like Nike and FedEx over the last week, how nervous

does that make you. I'm actually avoiding the companies that are the price takers and basically they're selling to a consumer that they can't massively change their prices, but they have input costs that might be admissed. So companies like that, I think, with the bottlenecks the world's experiencing right now, you're probably best search thing away from them long term. Probably this is immaterial short term or for the next quarter or two quarters. You might have some hit to margins.

I like to own the companies that are forcing those companies to have margin mrs. Basically so the mower, Mayor's tap eg Lloyd's shipping companies. They're able to charge whatever they want right now, there's so much demand for shipping and there's so much few vessels. Um. The other side of things, the semiconductors. You've heard it from all the auto companies. They can't produce as many cars as they want,

and it's going into handsets, television, refrigerators. There's a chip shortage, and I think companies that produced them, the machines that make those chips, so SML, Tokyo electron Land Research, They're set for years of pricing power and very strong demands appatriate. That sounds maybe that you think these issues will persist. To own the equities for a significant period of time.

Perhaps makes me wonder how you'd reconcile that cold, that position in the equity market with another coal on syte Monitory policy, did those two things stack up? Um? Well, Monetary policy, we've got the dots that indicate interest rates will becoming in a couple of years, but it's the charity he's going to make those decisions, and there's going to be a massive turnover in the FED over the

next eighteen months as well. About voting members changing, I think there'll be eight new voting members over the next two years coming in. So I think the QUEI the tapering will happen. I think that's in the cards already. The interest rate hikes, I think those are a little bit by in this guy. I think those rates will

only happen if the economy is very strong. If we do have inflation, hopefully it's a good kind of inflation coming from demand rather than the bottle next I'm talking about, but monetary policy, you even have some pressure if it is a stagflationary inflation. The FEDS got got a good handle on how to deal with that, and I think Bank of England the same kind of thing. They're looking at those things that a strong demand let inflation is

something they're equipped to deal with. A stag flationary environment would be a lot more difficult. So Patrick, just to building which I was talking about, this is an important distinction to bet on supply chain disruptions lasting for a prolonged period of time, but still feeling bullish more generally on stocks indicates that you do see an acceleration in in other areas, including wages, to offset those sagflationary trends. What do you have to see in the data to

confirm that view. You need to see continually higher wages. You need to see people coming back to the workforce and entice back into the workforce with the higher wages. The n f I B service show a massive problem for American companies that basically filling job vacancies, and that's the biggest problem most of them are setting right now. So I think higher wages reduced margins, increases spending power

of the consumers. So for me, I'm very confident there will be higher wages and that will provoke hard demand but also impact the profit margins for some companies. Patrick, I'm sure you heard at the top of the show there John and Lisa arguing about why we have to care at all about the dead ceiling in the song and dance going on down in Washington, d C. When you have to make investment decisions, do you care at all?

I've almost written it off. It's basically thank you if it's a long dog at this point where you can only make the bell so many times, and the dead ceiling. It just it's there. It's gets addressed when it needs to, and it's seems to be a bit of an overhang, but it's never been in an event fit miss. It's really been material Patrick. Thank you, Sir, Pantrick calm Strong, Chief Investment Office Set. This is the Bloomberg Surveillance Podcast.

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