Surveillance: Dudley Weighs Inflation Risk

and international relations. Find Bloomberg Surveillance on Apple Podcasts, SoundCloud, Bloomberg dot Com, and of course on the Bloomberg William Dudley, writing for Bloomberg Opinion and Yes, the former President of the New York Federal Reserve, has been quite clear in his essays on the path forward, and one of them is that the FED will have to change on inflation.

Bill Dudley and your important essay yesterday, near the bottom of the essay, you made clear this is a FED that needs to be malleable and supple in their thinking. Describe that right now, it's you know, all all hands on deck quick making the economy as stimulative as possible. You got Entrey policy basically interest rates in zero. That's doing quantitative using large fistal package coming. So that's great

for now. We are probably gonna, you know, if the vaccine dissemination works, we're going to see a very strong recovery in the second half of the year. And I think we're gonna see pressure on resources faster than what people participate. I understand why the Fed is doing what they're doing. I mean, they don't want to prematurely change expectations about future Maentrey policy and thereby tighten financial market conditions.

But we have to recognize that if they're successful, they are going to have to change financial conditions, are going to have to tighten. There's only a number of ways to go here, Bill Dudley. But I think the heart of it is a broad public that looks at the fact of inflation is seen in their monthly payments. I would note folks rents down lower here and the last inflation report, and Bill Dudley pros like you looking at the expectation of the expectations of inflation. What are we

expecting right now? What's been interest staying over the last three months or so, is that inflation expectations. If you look at the spread between ten your Treasury note yields and ten your tipsules, that's gone up by half a percentage point, that the tenure break even now is running two point two percent. That's not really very far away

from the Fed's long term targets. So you know, the argument that we had to keep Monterrey policy easy to support inflation expectations that things still already have been mostly accomplished. You've lived in break this though, Bill, would you look at that as a market pricing in the risk of more inflation or actually pricing inflation? Do you see that as the outlook for inflation or just the market pricing

in the risk of it you see outlook. I think it's the outlook because it's about what's going to happen over the next tenuere I mean, I think people recognize that the FED is all in. They're gonna be very accommodative. The new Mont policy regime means that they're going to push inflation above two. People find that credible, and cheer Pole is reinforcing that through its statements, and so essentially the FED is accomplishing its mission of keeping inflation expectations

angry around to present. So, but what I need to understand is what they'd respond to. So, as you remember, Governor King go over the Bank of England, we had inflation north of five and twenty eleven we had it north of three percent. Under Governor County, they looked through it. They used that word transitory. But what's the kind of situation you think the FED responds to in the kind of situation they look through so to speak, Well, I

think they'll look through it. If there's a little bit of a bubble of inflation, you know, the second half of the year, just because you have the surgeon activity and prices go up in some service areas, I think they look through that. I think what they're gonna watch is the labor market. I mean, at the end of the day, inflation is about pressure on resources, and so

I think they'll watch the labor market. I think the thing that's different about this expansion compared to one following the Great Financial Crisis, his households have a lot more abilities spending. Businesses have a lot more ability to spend. There you don't have the kind of you know, overhang of mortgage debt that you had following the Great Financial Crisis. You don't have the So I think that the colomy could bounce back much faster than people will anticipate. Sure,

Polos are absolutely right. There are about ten million people out out of a job, so the unemployer rate understates the amount of slack in the liver market. But at the same time, if we actually do conquer the pandemic allow opening up and getting people back to work. Uh, you know this could this could be a bounced much

faster than people anticipate. I will say. Jared Bernstein of the White House Economic Council did say that people are saving some of that cash that they people say they're going to spend in order to make all of the debt payments that have been deferred. So there could be a little bit of that hangover as well. But it goes to a key point that you're talking about, which is the difference between reflation that a lot of people are saying is what we're seeing right now, versus inflation,

which is what you're seeing we should expect later. And what a lot of people are saying, when do we shift from reflation to inflation? What do we have to see for this to be more sustainable. Well, end of the day, it's gonna be about how long does it take the economy get to get back to four percent three and a percent type of unemployer rate. I think that could actually happen a little bit faster than people think.

Janet Yellen, the Treachery Secretaries, the last we talked about how if we get the fiscal package we could be at full employment next year, so this could happen much more quickly than the Fed's current forecasts. FEDS current forecast, but we don't get back to full employment until three The said doesn't even tighten until after So I think the risk to to the market is that just happened in a more compressed time frame than people are expecting.

But I just want to finish on something important just quickly. We could wrap things up just how the reputation of the Federal Reserve has evolved in the last several years, and how there is now an increasing willingness to focus on society and perceived injustices as well. And I was familiar with the kind of response where a central bank would turn around and say, we can't address inequality with the brunt tool of interest rates, And now the approach

feels very different. That speech yesterday from Chairman pal felt different. Do you sent a change too? And what's behind it? Bill? I think there's two things that are driving. At Number One, current FED policy is benefiting rich people more than more people, right, So it's a FED it is very aware of that and wants to make it clear that that's not really the goal of policy. The global policy is not going

make people more wealthy. We're already wealthy. And the second thing I think is the fact that the last cycle, the FED pushed the one point rate very low and there was no inflation. So the Fed realizes that he wouldn't go further on the labor market than we thought and get more people employed than we thought before, And so they don't want to make the same risk of being too cautious about pushing the labor markets to a high degree of tightness, because maybe they can go further

than they thought. Makes you wonder what it would look like if they have to come back in and hike sooner than people think too. Bill, that's for the next conversation, Bill adupting that former New York Fed president. There's a lot of bulls on technology, but Daniel Ives has been the most persistent, most cogent bull at web Bush on Apple and all the rest of the beasts as well.

Dan i've uh, Dan I've Howard ward the acclaimed growth ga belly stop traffic a few days ago by saying we grossly underestimate the new technology knock on to other stocks? How does the Dan Ives world knock on to the rest of the stock market that leads you to a bullmarket that is underestimated. Yeah. I mean that continues to be our theme, transformational growth themes and cloud, cybersecurity, five

G e commerce. It's still underestimated by the street. We're going through a massive golden age and a rereading for tech stocks. I only think we're a third of the way through, which why we think tech stocks are up another tent this year despite some of these risk off moments that we've seen, even went to Reddit robin hood situation. I look where we are and I want to dovetail dan ives into the conservative tone of the acclaim Mr Ward. Does that enthusiasm fold over into stocks we don't associate

with you, like say the banking industry. But I think what you're starting to see is technology is bleeding into other areas, whether it's on healthcare, whether it's on the fine ends. And I think you're starting to see that and even on some of the dating apps and others. As we're seeing some of these I pos come out. Because right now, investors take a step back craving for growth, and that's why these tech stocks continue get rerated higher.

It's a scarcity value and we're going through so many transformational growth teams, which is why we continue to see a bright green light to continue in tech stocks. Here just going through some of your kills right now, dan By holds six sound zero. One of the holds Tesla neutral and Tesla white, and oh that that continues to be one where you know, we view it as a neutral, but a bold cases twelve fifty base case nine fifty, that continues to be one. We continue to sort of

put the goal posts out for investors. Overall EV we continue to be bullish, whereas one of our key teams over the next years. I also think that Chinese players, Neo x Ping and others or great play is on e V and my view is it's a you know, we're talking a trillion dollar market next three to four years. Tessa continues to be the leader of the pack. It told to me about the supply chain and what's happening in the semi space at the moment. Don Could this

spa production lost, sales lost or sales delayed? What is it? Well? Could that rain on the parade? I think that's really the main question that we're getting. Whether it's across chips on supply chain on the on the car Manufacturers saw A GM said yesterday, I think it's a contained risk

at this point. I think it could crimp growth a bit as we get into the next few quarters, but ultimately I still think the demand continues to be there and supply chain will normalize over the coming quarters, and investors continue to look at forestry treats and that continues to be our thesis on the supercycle with Apple and

everything cook in terms of that playing out. And that's why to me, you know, across the board, whether it's on fangs, on cloud and cybersecurity, we're further bullish come being out of this earning season. That continues to be the theme. Perhaps it's a temporary disruption the supply chain issue, but it's definitely causing chief executive officers to rethink how

they deal with and source their chips. Today, the CEOs of Intel, Qualcom, and Advanced micro Devices sent a letter to President Biden saying, please support the creation of chips, the development of chips on US soil because of some of the concerns having to do with security, etcetera. How much could that crimp their margins if they have to invest that much more on creating a domestic program of chip manufacturing. Given some of these concerns, it would be

a massive shift. And right now, the supply chain continues to be supplanted, you know, and it continues to really be built in Asia, and I don't really see any changes there. But it also speaks to the broader issues that we're seeing with US China. Biden coming in our brands, lowering ratcheting down the tensions with China. But no doubt from a supply chain perspective, I think that continue used to be a game of high stakes pokers. You want to see more in the US, but realistically, I think

that's not going to change for the foreseeable future. Age it continues to be where the supply chain is. Dan, what's the body language under conference calls on use of cash? I mean, everybody's up to their eyeballs and cash. They've got ample cash flow. They're all trying to pretend their blue chip stocks, but they're still growthy stocks from a time long ago. What are they gonna do with cash? I think it's M and A. I think we are going to go to four. They're buying bitcoin, Tom, No, No, No,

that's just tessel. That's just must seriously, Dan, what are they what are they waiting for? It's a tidal wave of M and A that we're going to see him and you see reports and Microsoft pinches and and I think ultimately in cybersecurity and cloud you're going to continue to see many, many marriages because we're going to only of workload during the cloud. Today it's a two horse

raised Microsoft Amazon. I believe you're gonna see aggressive M and A across the board and even financial buyers as well. And it's gonna con Can you drive these stocks higher? Ten seconds? Stand eyes, it's all the time we've got. Can Amazon increase its market share in the cloud from

at thirty four percent statistic? If it wasn't for that company in Redmond, Microsoft, they would be I think right now there's a share shift when the della leading the way in Microsoft any time, we can't let you go. Not yet, not yet, a tidal wave of M and A and some of the big place participating that's got a green light from this administration. Well, I mean, I think you look at fang names, they're going to continue

to be constrained. But you look at Microsoft, you look at IBM, s A P. Across the board, you can see merging of industries on financial and software. I think that's that continues to be the theme here is that you're gonna see really a tide away the M and A. That's where a lot of that cash is gonna go wet Bush down. I'm gonna say so thank you as a wife. Greg Bottle with us now B and P very about this is an important conversation to look at the dynamics of the market. Greg, I want to begin

with the normalization of VIX. Johann has beat me up because to me, this is a huge deal. I got a twenty one zero VIX and it ought to be at nineteen or dare I say sixteen as well? Let's begin with the why why is the VIX unnormalized right now? Well, I mean we'll start with the most obvious response, which is that we had a massively volatile year last year. Not only was the drawdown in March extremely volatile, but

the subsequent rally backup has been as well. So owning optionality paying for premium so far has paid out for investors. Just Away and Greg on a situation with the VIX right now sub twenty we haven't seen it. We haven't seen a post pandemic. We haven't closed below that twenty level. What do you make of that? Yeah, it's been a real support level for the market. But it's interesting you think about the equity spot market, the SMP. The SMP is about fifteen percent higher than where it was pre

the pandemic. VIX is about ten points higher than where it was pre January February last year, so there's much more premium still in the volatility market. Twenty has been a bit of a psychological floor. If we break through that, I think it could drive an accelerated move on the downside. So help us understand this, correct the relationship between the VIX and risk assets and how you expect that to

reconcile it it's all in the months quarters to come. Yeah, So clearly we normally have an inverse relationship between risky assets like equities and the VIX. When equities sell off, the VIX tends to go higher. When equities rally, the VIX tends to come off. But you have to also consider the pace of it. The VIX is a volatility index, so when you see equities moving higher at a very aggressive pace, as we saw in Q four last year, and indeed it's continued at the start of this year.

That can help keep the VIX somewhat supported. So the environment where the VIX is really going to normalize, I think, is when the equity market continues to go higher, but goes higher much slower pace. Greg just to zoomer out a little bit. Perhaps the story of the week is bit coin, but the theme of the year is very much the shortage of assets, the shortage of both dead and equity instruments from people to buy because of the

cash that's been created. In some ways, what we're talking about with the VIX is very much related to that that people want to hedge against declines because they can do so cheaply or more cheaply through derivatives than parting with assets, parting with their equities that they still want to hang onto for this ride because they believe in it. How much is that driving a lot of the action?

How much will that keep propelling equities higher regardless of anything fundamental, I think it's the biggest single drive in the fact we have such easy monetary policy at the time we're expecting a large cyclic l up swing in the second half of the year. It creates a great environment for equity markets. But we have had some very

rapid moves in equities. We've seen some big inflows. Last week in the e TP space, there was almost thirty billion dollars put to work, a three standard deviation inflow for equity markets. And that does keep volatility bid. It does give investors the incentive to and to chase upside through optionality. But if we do see a slowing rate of gain in the SMP, the risk reward of hedging, the risk reward of owning optionality becomes much less appealing.

We've been talking a lot when we talk about equities of the game stop phenomenon and the meme starks, and I'm wondering how much that's representative of increasing retail participation. You talk about the e t F flows, I mean, how much we're getting a capitulation of retail investors that have been sitting on the sidelines for a decade that are finally saying we're all in. I mean, there are certainly a lot of signs of it. You see it in the e t F flows, but you also see

in the option market. There's been an absolute explosion and call option activity over the last six months, and I think this is rational in some degree. We go back to the TMT bubble. If you took your money out of the equity market at the peak, then you can put it in short term rates. What like five guys been talking this morning about where short term rates are now. If you don't have money invested in the equity market,

then where do you put up? I want to go on radio on television now, folks, a little technical with Mr Bible. We can do this with other gentleman from derivatives at BNP Perry bar Greg. I've always felt THET has been ignored, the passage of time of an option and a derivative in your world, has the theta changed? I mean is is theta is a Greek letter? Change the way Global Wall Street does business? Well. I think

that decay is another word for yield. In some ways, you can think of the theater on an option if you sell an option is similar to the yield that you might take on in a bond. So what we saw over the last decade with QUEI and very low rate is that there has been more demand for sure optionality strategies. But Unfortunately, what we saw last year was the flip side to that trade, which is that in a risk of environment, it acts very different to a

classic yielding um safe asset. So what we've seen so far over the last nine months is equity markets have recovered, is that there's been effectively less harvesting of theater. Investors seem less willing to be short convexity, short volatility to take in that yield that you can get from what is a very steep vixed curve brilliant. So if they don't want to take in that premium that yield, as

you say, what do they want to do? Well, at the moment, it's been using optionality to participate for the equity rally. Whether that's to get asymmetry to protect your portfolio, or whether indeed is to do the opposite and inject leverage into your portfolio. That's a buying optionality flow and we've seen more prevalence of that since the pandemic versus the volatility harvesting and the hunt for yield, which is something that I think could start to creep back into

the markets in the coming months. Greg, great to catch you up, appreciate you so I'm always good to see you. Great battle there of bempreparent butt. Thank you, sir. How do you share holes of the Economic Policy Institute publishes and any and all read it? She joins us this morning, Hi, do I really want to die into the history of the moment? How bad is it? Mike McKee just alluded to the worst of oh seven, oh eight, oh nine. How bad are we right now? Within the e p

I historical framework, It's bad. The unemployment insurance claims, the number of people who need unemployment insurance benefits to get it through right, to get through this right now, we're still at historically high level. So we just to put some numbers on that. We are at the forty seventh week in a row where we have had unemployment insurance claims higher than the highest week of the Great Recession. There's all sorts of certitudes wheach here. I don't mean

in a party, but this is really important. There's all sorts of certitudes that are out in the media. Were guilty of that A team surveillance like everybody else. If you could say one thing about the character of the unemployed right now, what would it be that they are people who are out of work through no fault of their during a global pandemic, people desperately need the relief

of unemployment insurance benefits to get through. Until we have a vaccine that's widely distributed, the economy can fully get going again, and we can we can get things back on track. I d We've been sort of hinting at

this broader issue right now. The Federal Reserve wants to run the economy hot to allow the labor market to heal, possibly and hopefully with some fiscal support from Washington d C. But if inflation does take up faster than people expect and the Fed is forced to hike, is forced to stop the rally in the markets, that could cause a big setback in the labor market that will hit the

lowest income the hardest. Can you talk a little bit about the disproportionate effect of a market disruption of something that the Fed could potentially incite if they're forced to hike too soon. Yeah, that's a really good point, and I think the key message here is that the risks of doing too little are far worse for the most vulnerable people, for people at the low middle end of the wage of the wage distribution. Then the FED doing too much. That's really important. Right now, we see a

huge hit that lower middle income people are taking. They're just there's been a massive disruption to their labor market. People are facing massive unemployment. That is a really dire thing right now. And then the longer it goes on, the sort of lasting consequences play out. So if we can get on top of this quickly, that will make those folks really like a lot better off. And then the question is if they do go too far, what

are the risks? And that's easy to pull back. They have levers they can really easily pull to to to keep the economy from overheating. So doing the so I think that's the upshot here. The risk of doing too little are far far greater to the to the people of this economy who who depend on the labor market the most to get through week to week. The risk of doing too little are far greater than the risk of doing too much. And there's a huge pain out there.

It's clear, and the labor market has hit a complete roadblock. We've got now bigger than expected jobless claims. We're going in the wrong direction. We have Drone Powell yesterday as John was saying, it's the ten number. We've got ten million who are a fewer jobs in the market than last February ten percent unemployment rate. If you were to pick out some of the other elements, what are we

doing in terms of bridging this gap? What can be done given how much change has happened in the fundamental labor market, the acceleration to technology, the reduction and manufacturing jobs that we see ongoing that is somewhat independent of the pandemic. Those are really good questions. I think one thing that we're seeing here, unlike any recession we've ever seen before, this this idea of the K shaped recovery

that really is going on. Lyle Brainer, a Federal Reserve governor, had an estimate out a couple of weeks ago that the unemployment rate for workers in the bottom quartile of wages, the lowest income workers, is likely over twenty percent, where people in the highest income, highest wage earners likely under five. We're just five. We're just having this huge pulling apart. It creates just an enormous imbalance. We're really seeing this

recession of this downturn exacerbate existing in equality. So it's just incredibly important we get the relief and recovery people need while we're still in this this sort of dark days of the of the widespread pandemic, until we can get out of that um and and see widespread vaccine distribution get the economy going again. I think this seems to be something about cycles in both the downturn and the recovery. Whether the weakest get hit first in the

downturn and they recover last in the recovery. Now, I'm trying to understand if that's a national order of events, or whether policy amplifies that, especially the federal Reserve, which boost sasset prices almost immediately a markets priced in bank just like that, or whether there's something else going on here that we can address. What do you think it is, Heidi, this You're absolutely right. We always see recessions exacerbate inequality. This one is worse than we have ever seen before,

and that's because of the nature of this thing. It really hit face to face. Services just shut down, and even if they reopened, reopened at much lower rates and so, and workers in those industries tend to be lower wage workers. So you have a ton of people who didn't have a lot before don't have, didn't have a lot build up to fall back on, getting just slammed in this recession, and so that the that we always see those workers get hit harder, but it's just more than ever before

because of the nature of this thing. So it really does underscore the importance of doing a lot to get the recovery back on track. That's what I want to build on though. Is it nature this word nature, just the natural order of events, or is it something about policy that's just wrong because typically that first response, we address the downturn through financial conditions almost exclusively, and financial conditions can address can adjust really really quickly, so if

you hold assets, you'll recover quickly as well. Now I'm just trying to work out what we can do for the next time we have a downturn, the time after that, the time after that, because we'll be experiencing the same thing again and again and again. What's the policy prescription here we need to do. We need to have the FED do everything they can to get the economy back on track. That's going to help people at the high end, but it also really helps people at the low end.

We know that the you know, the FED getting the economy going is a key part of a recovery that adds jobs. Since low income people are more likely to lose their jobs, they're also more likely to gain them as a recovery continue. So that's we we that's a really issue. We also need the Congress to step in with physical part hy do. I want you to know that John Farroll has really provided industry leadership on this because he's from England and he's looking at American going.

You guys are nuts. I want you to go back to Michigan economics, that Graham Letch, what Justin Wolfers is doing there, and and Bessie Stevenson and all that you studied there. You know, you're required a gunpoint in Michigan to take a course like Descartes de kant Okay, philosophy. Do you sense from the liberal bastion of E p I that America is going to change to a more European labor aid construct or are we still going to maintain an arch individualism of every person for themselves? That

is a big question. I do think there is a big there's a shift happening, particularly in the economics field. You see, it used to be a consensus in economics, that interventions in the labor market, interventions in the market were a real drag on the market, they would hurt the very people that they're trying to help. That used

to be conventional wisdom. We are seeing that conventional wisdom really be upended with new empirical evidence coming out that things like minimum wage increases they actually don't cause job losses, that unions are actually really essential to making sure that middle class people get their fair share of overall growth in the We're gonna run out of time here, this is too important in honor of the late Alan Krueger.

Why can't we ramp in a time distance minimum wage increase to get out to sixteen dollars in twenty three cents? Where I believe the horsetoric statistics should be just time. Yes, right that you know you're on it. And so the fifteen dollar minimum wage bill that's now been introduced in the House, well it's in the reconciliation bill, so it you know, it definitely has a chance, and it would ramp up to fift dollars by in five steps. And

so that that you got it. The logic that you're using there is is sort of right where policymakers are I grant to catch up. Thank you, Thank you Ecnomic Policy Institute, Senior economist at Director of Policy. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio