Surveillance: Curve Flattening with JPM's Kelly

and Mike Wilson on a spike in energy prices. Quote would destroy demantain off you and perhaps tips several economies into an outright recession, the polar vortex. David, you are great, none of us, just none of us. Just the energy prices. I mean there is a risk, of course, uh, if we get in and all out worn Ukraine. I mean, we don't know how far that goes in the the long term implication, it could be significant. But if it's

just tensions higher oil prices, it's not enough. I mean, there's a lot of momentum in the U S economies, a momentum in global economies as we come out of the pandemic there's a lot of pent up demand. So I think the world can handle oil at night you or oil at hundred UM. If it has to handle that and a big war and all the uncertainty that

comes with that, it's a different matter. David Kelly. If we assume buoyant nominal GDP whatever the makeup, is a real g d P in the inflation dynamic as well, how do we fair given buoyant nominal g d P. Well, it helps corporate profits, um, and you know it is it is kind of what it is. I mean, you know, there's a lot of talk about FED policy and the FED being more aggressive, but that's gonna have an impact in later this year, in twenty three. Right now, the

economy is it's gonna be slow in Q one. Those are still gonna be low numbers for Q one GDP. Then it's gonna boom in Q two, and then it's gonna slow as the year goes on. I think that's true for um, you know, inflation is obviously high in Q one, but I think inflation will also fading this year goes on. So that that that's what we've got, and I think the FED needs to just take it easy. Here um in normalizing policy, and don't try to don't think that they can actually fix all of this at

one sitting. Well, do you think that the message from the yield curve is basically saying just that? And it's an important and instructive tool right now for why you think the FED should not move perhaps as aggressively as people are pricing in, Yeah, because I think the yield curve is telling us that the FED is going to overreact and then pull back. Um. And that's exactly what the FED should not do. The FED should do, is

what Mary Daily was saying over the weekend. Be patient, be gradual, twenty five basis points per meeting, next four meetings, get going in the balance, you know, over the summer, but just keep at it um, you know, don't get still get scooped and try to get back to normal rates. But the yield curve saying no, they do. They go aggressive and then they have to pull back when something goes wrong with the market of the economy. It's kelly, this idea of engineering soft landing. Just how wide open

is that window still to do so well? It's bumpy anyway, It's it's kind of like a plane coming in with the wings flap on all over the place. You're wondering, you know, stually have the option going around trying it again. Um, it's it is bumpy because we've got very low growth in the first quarter, booming inflation. But again there's not much we can do about it. A lot of this has to do with just the waves of distortion caused by the pandemic itself, and I think you just have

to sort of play it out. But you know, could we achieve itself landing? Yeah, I mean the economy does seem to have a natural tendency to put out sort of two percent growth per year and two percent inflation per year. There are a lot of years which look kind of like that, and I think we can get back to that. But it's it is looking a little bumpy and challenging right now. Demie Kelly, thank you, sir, as always of JP Morgan as in management. Let's get

to the bond market store. We can do that with about a jamp at the heead of US right strategy at sulk gen so Pantra. I don't expect to have a crystal ball on things associated with geopolitics, risk and military exercises. What I'd like to do with you is try and understand how negative developments inside Ukraine would influence central bank in central banking policy. From your perspective, how

do you think it would. I think it does play a factor because of the fact that you don't want to be seen as aggressively hawkish or raising rates too fast at a time when geopolitics is a key concern. I mean, to me, really the key indicator is the two stands part of the curve that's at our body basis points. So so really, any sort of more hawkish rhetoric, if anything, it's going to flatten the curve because you're going to see this sort of flight to quality, um,

you know, bid on the tenure. So again, I've said this many times before. I think the last thing the Fed wants to do is to raise policy rates too aggressively, flatten out the curve and lead to a recession. I think there's a lot of there's a lot already big into the into the bond market right now. We're pricing in six rate hikes by the end of the year, five of which are delivered before September. So that's a

very aggressive policy path. Already, So I just don't think you're gonna get much more of a hawk is shown from the FED. They're gonna be very very cautious, especially with the Ukraine situation. It's evangel what happens in Ukraine will influence the decision of the e CP in a different way. The spill over to the European economy will be very different compared to site the US. How would you expect the yield curves inside Germany and Italy to

develop off the back of those stories? So so far we've seen sort of a steepening of the of the yield curve in in Europe because of you FED hike, sorry, ECB hike expectations getting priced into the into the market. UM. I think that they're in a very tough situation with with oil being a key issue and Ukraine you know, in their backyard. Um, you're gonna see some of the you know, the rate hikes getting priced out of the market.

I would think if the Ukraine situation gets worse, because you know, natural gas is a very important, you know issue for them. You know, energy prices have gone up quite meaningfully again, you don't, you know, the ECB again doesn't want to be punitive and sound very hawkish at a time when geopolitics is is front and center, especially because of the fact that I think higher oil prices are going to eat into consumer spending, not just in in Europe but also in the US. So I think

central backs are very aware of that. What is your view of this distinction between a flat curve two s tends equal yield or maybe you know, ten basis points spread whatever, and an inverted curve. What is the difference between those two for markets? Well, there isn't really much of a difference per se, right if at these levels your forty basis points away from being being close to zero or inverted. So we're really watching the curve very

very closely to see what signals we're getting. Typically, a flattish curve and an inverted curve is going to leave to slow down and growth in about a year's time or or two years time. In past Federate high cycles, you tend to see that the FED hikes rates you know, well passed inversion. You know, in the last two cycles in the as well as in two thousand and five, the high grades by you know, one and a quarter to one and a half percent after the curve adverted.

This time around, I think they're gonna be very very cautious. They're looking at the signals from the Yeld curve to make sure that they don't tighten policy too fast and slow down the economy, especially since we're the recovery is still very fragile. Looking at the first quarter, where growth is going to be quite meaningfully slower, you're looking at perhaps a weaker retail sales number because of the Homicron variant.

So under those circumstances, I think the FED is going to be, you know, very cautious when it comes to policy, and policy is going to be very measured. Is this environment, however, so bad we're getting more concerning for credit? Yeah, definitely. I think you're starting to see credit spreads start to widen. You're seeing, you know, the fact that the FED is going to be stepping away from the market, especially acid purchases. It's going to be less supportive for industrates in general.

And the talk is that, you know, there's going to be a pretty decent rapid unwind or the balance sheet, you know, sometimes starting in June or July of this year, by the middle of next year. So again, you know, the policy being accommodation being removed from acid purchases is going to impact both you know, tragedies as well as credit products. Broadly speaking, Spandra, thank you as always Sabantra Sampi of sulk Jan on a flat up perhaps maybe

even inverted yield further down the road. In Alex Bordeaux, we are thrilled to have with this practice at at Eurasia Group for so much of the continent of Europe, in Eastern Europe as well. Truly an authority, Alex. What is the diplomatic construction if we choose to contain laddiber and Putin, and if we choose to allow him some form of saving face in the coming hours and the coming days, what does the West need to do well?

I think that the package of diplomatic effort has to include addressing a number of the issues that that Putin has brought forward, and that includes some really tough issues like Ukraine's membership in NATO. I think the comments from Foreign Minister love Robin and Putin's ascent today are a

good sign that negotiations can continue. But it's been pretty clear, especially in the last week, that there's really been not much change for Putin on what issues really matter, and it's this NATO Ukraine dynamic that I think is still going to be very important. So ultimately they have to come to some sort of agreement or understanding on that,

and that's really hard to do in this circumstances. I think, you know, the the chances of a real diplomatic breakthrough have actually gone down just in the last a few days. If we stagger from Yalta to the history of SAE and then to now a new affirmation of what NATO will be, what do you and I and Bremer perceive

the new NATO will look like? Well, what are the interesting aspects of what's happened so far is that, in fact, because of the military threat post to you craigbly seen more cohesion and unity in NATO than we've really seen in a long time, and a lot of that has been directed at countering what is has been coming from the Russian government. I think the diplomatic efforts of the US have have has made towards European countries and NATO allied members has been notable and actually has gone fairly

well so far. So we're seeing a fairly dynamic response there, and I think the question is really it does that pressure then lead to some level of concession on the part of Moscow. The problem in the last few weeks is that we really haven't seen that coming from Putin. Alex won't have to has achieved so far over the last few weeks. Well, they brought the West to the table on some issues that clearly have mattered a lot

to Putin over the years. And this includes Ukraine's foreign policy orientation, and it includes this issue of NATO's presence on Russia's western border. Uh. And Putin himself has kind of, you know, noted that that he thinks that the pressure that's been brought to Barrassons November has actually led to that result. Um. I think for Putin, he's still looking for some type of diplomatic win here. Uh, and that's probably going to involve something more than just getting everybody

to the table. Is going to going to involve some level of concession. And that's where the problem is in the diplomacy. What's his main motivation. I'm talking about Vladimer Putin's domestic agenda versus in his international agenda. I think that there are a number of security concerns that Putin really perceives need to be addressed. Now, I would question some of the you know, some of the underlying motivations for some of that. We've heard of some of it

in his press ofference with Makron last week. Um And but I think that he does think that Russia faces a direct security threat coming from NATO and that he is trying to address that, and Ukraine is kind of a focal point for that. I certainly he has talked a lot about his views of Ukraine and his links to Russia, but I think the security matters have really come through in the last couple of months in his

rhetoric Alex just finally before we let you go. Of course, there is a lot of diplomacy still to take place through the next twenty four hours. What are the kind of words language that you're looking for that would indicate de escalation or perhaps the opposite from Chancellor Shelves or rather anyone else for that matter, through the next day

or so. I think one of the words that we've heard a lot, especially coming from the Russian side, is the basis, Is there a basis for having a significant concrete discussion on European security, and if we start to get signals like that, I think that that would be a good sign. Unfortunately, in recent days the indications have been that that's not where we are. Alex, thank you sir if he writes agree, particularly for that final comment. Right now, Lindsay pag and joins us our first briefing

of the week. The chief economist at Stephen were thrilled that she could join us. Uh this morning, Lindsey, let's just get back to the recalculation. I'm sure you did over guacamole last night on the couch, And that is the terminal rate of inflation, whether it's the near rate out say one year, or a rate farther out. What is the trend that we're heading towards on inflation. Well, right now it seems as if inflation has nowhere to go but up. But as demand a pent up demands

excuse me, it is satisfied. And as we start to see somebody's supply chain disruption smooth and balance is restored, we would expect to at least see that second derivative decline or a slower pace of positive price increase set in by the second half of the year. Giving us a nice downward trajectory that is we head into. And this is really what the FED is baking on. The FED is very much convinced that inflation is near or at peak levels. Do you agree with this? I mean

the arch research, not this weekend. This is a two or three percent? Is a statistic? Or is it four or five percent? What is the path we're going to? Even with FED hopes and dreams, I think we could easily see four and a half percent by the end of the year, and it continued downward trajectory as we go into three. So when we put that in perspective to the FEDS target of two percent, the takeaways that were likely to be well above that target level for

quite some time. But again for the FED, for the market, it's the trajectory of inflation that's really going to set the tone for the expectation of a change in monetary policy over the next twelve to twenty four months. Lindsay, how do you push back against the assertion that inflation is becoming more entrenched? And you can see this in rent prices. You could see this in the fact that cp I came in that much hotter than expectations. That

already were for a pretty hot inflationary environment. Well, remember there's two types of inflation. There's the demand side and then there's the supply side. On the supply side, production costs moved up quickly because of these supply chain disruptions, distortions,

and imbalances. That's the component that the FED was very much focused on, the transitory component, if you remember that language, And we do expect that to ease in the medium term again as balance is restored a clause across the global marketplace, and we're already starting to see a little bit of price pressures ease looking at the p p

I with this week's report expected to ease further. On the other side, you do have the demand pressures, and that's where the entrenchment, the concern of this wage price spiral is really setting in, and that's going to be the component more difficult for the FED to control going forward if in fact, we do see this more entrenched as prices rise across nearly every sector of the economy. So do you see a wage price spiral at this point, given the fact that real wages are still deeply negative

for for some measures, the most negatives is two thousand seven. Well, they certainly are still negative. When we talk about that five to six percent wage increase, it's certainly less impressive against the backdrop of seven percent inflation. But we're still seeing that cycle set in higher prices leading to higher wages leading to higher prices. So the wage price spiral, although still inefficient for workers, has very much set in at least over the previous I would say about six

month period. Lindsay, let's look for to retail sales. We've got a few distractions on a Monday morning, but the key distraction of the week is this measurement of the American consumer is a good math worth focusing on. Absolutely. It tells us the health of the consumer. It tells us the comfortability of the consumer to move back into

the marketplace. Now, if you look back to the third quarter and the end of the fourth, excuse me be the beginning of the fourth quarter, we had sort of this buy now mentality, the fear that inflation was going to continue to rise, so we needed to buy what we needed today because tomorrow it was going to cost more if it was available at all. So what we really saw it was a lot of these metrics pulling

forward traditional end of the year holiday spending. These these measures, though, this momentum is likely to weigh as we look further out into the first quarter. And we already saw that weakness in December retail sales. So if in fact we do see this weakness carry forward into the first part of the first quarter, I think this reinforces the notion

that pent up demand is already being satisfied. Savings through the pandemic are already being drawn down, that trillions and savings has depleted markedly, and this is going to lead to a much more modest pace of growth for the longer run. In the domestic economy. Well, what is your real and inflation call for this year that gets you to nominal GDP. Give us those three statistics that you see real g d P, the inflation out to the

end of the year, and the total nominal GDP statistic. Well, I think real GDP slows to a range of two to three percent, You factor on about a four percent inflation figure at the end of the year, and you have a nominal GDP rate around six percent. All right, Lindsay pigs. One thing a lot of people are talking about this morning is how oil prices might change the equation pretty dramatically and actually could eliminate quite a bit from GDP. How do you factor that in? What's the

choke point for oil prices? I think the fastest way to derail the consumer in the American economy is raising gas prices, is sustained elevated gas prices, and we're already seeing that with double digit gains across the country, with some of the highest prices of course being felt out

on the West coast. And so when we look at the consumer, when we look at the health of the consumer, and we talk about businesses being able to pass on these cost increases, well, if the consumer is already absorbing sizeable price increases and some of these very key categories I eat, energy and groceries, businesses are going to have an increasingly difficult time passing on further price increases if the household ballot sheet, the majority of the household balance

sheet is being allocated to those two categories. So, lindsay, do you have a level of choke point level? And I wonder because I heard some people say a hundred and fifteen dollars in barrel, some people saying it has to get back to a hundred and fifty dollars in barrel simply because of inflation. Oh, I think the consumer is a much more fragile footing than that. I think the choke point would be a lot lower between nine hundred dollars. So we're rapidly approaching or even teetering into

that category already. So I'm just wondering, lindsay just quickly to follow up here this idea of nine hundred dollars of barrel. We're there. Are you saying that at this point, if oil prices are sustained where they are, the US will not be able to avoid some sort of downturn. I think it's very clear that as the economy continues to recalibrate to a new normal level, we are already set to slow markedly from that four and a half

percent range in the second half of last year. I do expect GDP to remain positive, but slow to a range nearer two to three percent, which, if you remember,

is very much in line with pre pandemic growth. We tend to romanticize where we were prior to the crisis, but growth was already slowing from three percent in twenty eight down to two percent in twenty nineteen, and with a moderate consumer, with elevated inflation and rapidly rising energy costs, I think it's a very clear trajectory back to that pre pandemic growth rate of near two to gdp. Lindsay, Thank you Lindsay of Stay Fold. This is the Bloomberg

Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom keene In. This is Bloomberg.