Surveillance: ECB Adds to Fed Gloom

and of course on the Bloomberg terminal. The single headline, John, I see and this will be good to get into, Jeremy stretch out of g t FX at C I b C is what they do which we don't do, is they go out three years to two thousand twenty five and there's a miraculous conception of inflation plunging. There's no other way to put it. From an eight level down to a stunning two point four percent. That is

optimism of a certain level. Jeremy, stretching all your years of central bank watching, Can they get out near three years and look for an inflation and disinflationary trend? Is the ECB publishers today or is that wish for thinking? Well? I think it's interesting that the CB are still anticipating the inflation will still be above their target threshold by

the end of twenty twenty five. I wouldn't have been surprised that the ECB felt it would appropriate, or at least the ECB staff had attempted to try and find a narrative that allowed the inflation profile to get back

to target. But clearly because of the upward revisions that we've seen in the profile that both this year and next year, it is going to be very very difficult to see or it's going to be a very tough ask for the ECB to be able to force or drive inflation with pressure down without probably a greater degree of economic dislocation that they're currently pricing into their forecast.

So I think, but perhaps a little bit too too ambitious to optimistic contems to the growth trajectory, and if if we are going to see inflation falling back, it is going to be a very much a challenge that is going to have to be met by probably a more aggressive policy reaction than the market has been or certainly we have been considering well. Yeld declimbing in response to that, particularly the front end of the BUN market.

Your German two years up by eleven basis points to two, the ten years up by eight or nine basis points on a ten year right now to a round about two percent two point zero two percent. For give me for throwing so many numbers at the war, but I do want to go through the inflation projections again from the u c B. We now see average inflation reaching eight point four percent in twenty two before decreasing a six point three percent in twenty three, with inflation expected

to decline markedly over the course of the year. These are still really high, Prince Jeremy. Just to go through core and their projections there projected to average three point four percent in twenty two point three percent in twenty five. That's headline. When you strip out food and energy, that's projected to be three point nine percent on average in twenty two and then rise to four point two percent

in twenty three. Can we just talk about that clip, High Jeremy, that they're looking for in core inflation through next year. Your thoughts on that and just how far they can push the terminal rate given what you expect

to happen with GDP on what they're looking for as well. Yes, that's right, I think that, I mean, I think you know, when we've you've obviously been talking a lot about the FED projections over the course of the last twelve hours or so, and there is a real dichotomy in terms of the inflation profiles that we're seeing from those requisite central banks, and the pace of the moderation in terms

of the Eurozone is very very glacial in effect. And of course, as you quite rightly say, those core inflationary pressures are going to be pronounced over the medium run, and that is going to be a real difficulty for

the for the European central banks. So I think in the context of some of the discussions you're having after the FED last night, is that who has the greatest potential policy problem with policy dilemma than I think in the ECB definitely falls into that remit because of course, as we know, there are those fragmentation risks as well.

So it's going to be very difficult to see how the ECB is going to be able to square the circle by trying to tighten policy but without creating significant degrees of uncircaity against what is still a backdrop of

very lated and amplified core inflation repressures. And they do can see that the Euro Area economy may contract in the current quarter and next, So there is a hint at that recession, although not necessarily coming out with the same kinds of prognostications as the Bank of England also talking about food and underlying inflation, Jeremy is the e c B, which I think it was a lot more interesting in terms of the statement than the Federal Reserve.

Is the ECB just sort of getting ahead of what the federal have to deal with and recognizing a stickier inflation for a longer period that goes beyond what the markets are currently allowing for. Yes, I think that's true. I think we are going to see core inflation proven to be remarkably sticky. So yes, we can see headline inflation repressures gradually easy if we are correct in assuming

that those energy forward curves are correct. But core core inflation, in terms of service driven inflation, I think is going to be much more challenging to drive out of the system. And it may well be the case that we see many central banks facing difficulty to really squeeze core inflation back towards target thresholds over a two year four past arizons. So in a sense, that's why it's still interesting that the CB are still struggling to get back to their

target threshold even in year three. And that just underlines that inflationary pressures I think are going to be much more pronounced and stickier, particularly if we're going to see wage growth remaining relatively elevated because of still relatively tight lego markets, even if we're seeing a moderation in macro activity. What a challenge. Jeremy Stretcher C I p C. Thank you. I'm already leaning too. January twelve. Well, you know we've

got a job jobs report January six. I believe it is, but but I'm sorry, I'm already going to January talk

to get another look at inflation. Someone doing that as well as Jonathan Pingle, chief you US Economics that you be as security Jonathan, I gotta study for you in your academics from years ago, and that is simply, is there any history of any central bank modeling and getting right a major three year disan flationary trend the FEDS trying to do it, and in technical this morning the e c B has elevated up inflation for this year and they go out to a nirvana in two thousand

twenty five. Is there any predictability to that exercise? Well? Thanks, Tom, thanks for having me. First of all, Yeah, forecasting inflation is hard. Um. I I think that has been proven, um, in spades in when we look back at history. You know, getting this exactly right on the way down is probably going to be as hard as getting it right on the way up. Um. When I think about the central bank experience, UM, you know, you've had some immaculate disinflations

following World War Two. Is is one example. UM. It was certainly the case the Chairman Green's band seemed to be, you know, kind of ahead of the curve and the productivity gains in the mid nineties and the disinflation that that led to. UM. But you know, let's face it, a three year, two year, even one year head inflation forecast at the moment um, it is pretty difficult. UM.

And in some respects UM. You know, I think the FED has been dealt a better hand than the e C BUM because they are getting some data in hand that starts to look like there is some real disinflation coming. What do you make though of how much of this disinflation really stems from some of the more variable areas, which include gas, natural gas, gasoline, crewe products. Well, you know, in the US. You know, certainly the energy um, you know, the energy prices moving up and down, UM, you know

has played a role. But you've also got um a number of components of inflation, like you know, use car prices that you know, you know exploded higher in new car prices up UM, and we're already seeing use car prices fall two percent a month the last few cp I s. So UM. It is a lot of our little components. And you know, what goes up, you know,

could come down quite quickly in the US. I mean, you know, in Europe and the Eurozone, you know, the reasons to think inflation might be a little stickier than the USUM, particularly if the Fed does engineer and increase UM in unemployment UM. You know, in the US that does typically prove somewhat disinflationary, even if you think there's

a flat Phillips curve. You know, in the Eurozone, they don't have quite the same flexibility in their labor markets UM, which you know, could also lead to sort of more persistence UM in the Eurozone relative to the US for inflation. Although the e c B did come out with perhaps an even more hawkish statement than the Federal Reserve in terms of how much higher they revised upward their inflation expectations for this year, for next year, for the year after.

From your vantage point or the balance of risks, have they changed when it comes to both the FED and the ECB in terms of either going too far or not going enough. Before it was not going enough. Do you think now it's more evenly balanced? Oh? Yeah, No, I definitely, I think it's more evenly balanced. Li Sa, No, it's a great point, um. I mean, you know, we actually are expecting a pretty weak U S economy in

the latter part of three. You know, that's both because households are exhausting their excess savings, which we think is going to you know, start to bind for more household and restrain consumption. And and on top of that, we're just gonna still pile the mounting effects of you know, what's been a very rapid tightening cycle. The e CV is a little bit further behind the FED. There they are playing some catch up, um, but there as well, you know, they are facing a tough economic outlook as well.

So I do think these risks are becoming more balanced. Are we in neutrality? For rates? Yeah? In the US are we in neutrality in terms of the central bank ballet, So I would actually I mean, I you know, chure Pal yesterday said he thought policey rates were in restrictive territory. I would agree with that. I mean, there's a pretty big margin of error for whether or not, um, you're

really at neutral. Um. I don't mean to interrupt, but just because Jonathan, just because of time, this is really important. What is the single variable of our mystery about that collar around neutrality? Is it inflation? Is it jobs? Is a g d P? Is it just we don't know? Well, I mean we just don't know. I mean it's also a longer run concept. I mean, you know there's a lot that goes into the neutral rate. It's our demographics are productivity growth, thank you, um, but it's you know,

pinning it down in real time. It's your Powell's explained. Can he come on again? And I disgust that was great? Are you suggesting that the Yeah? I mean, Jonathan, thank you, that was brilliant. What he absolutely nailed there, which drives me nuts, is all it's like the dots, all this gazing and Pringle nails, the demographics nails the technology we're living in we don't understand, etcetera, etcetera. Jonathan panofs. But we can sit on the bank aving it for longer,

Bioll meats. We're going to do that now with that shop Bettia, Deputy c i Owe the fixed income at Newberger Berman a show first to you, just your reflection, your thoughts on what we've learned from two central banks

in the last twenty four hours. Yeah. I think the the overruning message is that the time of central banks being able to hike rates without an impact on the real economy and real growth, which was a lot of the story of two thousand and twenty two, that's over and we're now transitioning to this environment where central banks are divided over how do you wrestle with inflation rates which are very high but likely to come down and the future trade offs to growth And you know this,

This dissension and the collared descents on the BOE really just put an exclamation point on it, which is there are some individuals that you know, think and want to conduct policy more on a forward looking basis us where others are still view the risk management attributes of policy making is we've still got to be very dependent upon inflation, and this is the debate that's going to be at all the central banks for for next year. How do

you invest around that? How do you take the messaging and use it to to really create some sort of thesis based on the fact that a lot of other people are discounting at wholesale and say the data will be what the data will be, and we don't buy what they're selling. So I think the biggest investment implication is is fixed and convolatility is going to go down. Um. You know, you look at this year from low to high, the US tenure moved in about a three hundred basis

point just under a three hundred basis point range. We're probably heading back to something next year where you know, we're going into this environment of slower hikes, fewer hikes. You know, I think consensus is broadly correct on that. But what that means is expect ten uere interest rates in the US to move maybe in a hundred hundred and fifty basis point range. It's going to be a

dramatic reduction next year. And what that means is that income high quality income um it's going to be more volatile still on a day to day basis, But ultimately you invest on the idea that with less volatility you can earn income and high quality income, and you know, in a lot of fixed income markets, and you stay position.

You have some positions on that, some of the more devish um uh, you know, central bank views that inflation can fall in the growth impact um that that that could play out and lead to some higher returns and fixed income next year. A shark is we approach neutrality or approach restriction? Is it easier to have confidence in a portfolio of fixed income? I mean, now that we're here, is it easier to prosecute a portfolio and hold a portfolio? Yeah?

And I think the biggest driver of this, and Powell's actually I think been quite articulate on this, which is three big drivers of inflation. You've had goods inflation, housing inflation, and then services x housing. If you go back three months, all three of those were rising and who knew, who knew when they were going to stop. Um Now we're looking at goods prices in you know, mid to high

single digit deflation. We're seeing some you know, higher conviction that over the next six months housing prices are going to come off but it still leaves this issue of

the third which is the services ex housing inflation. But we've transitioned to this environment where call it two out of three of the big CPI categories, we have a little bit more confidence of we know what the trajectory will be there, and that's the key thing that gives you a little bit more confidence that some of the left tail of significantly higher rate possibilities are being reduced pretty quickly. So thanks for being with us today. We

always appreciate it. We'll catch the with you a little bit later in the year. I'm sure I check battier the of new Berger Berman. We have the advantage and particularly after the Bank of England decision today, which I'm gonna call collar descent, those looking for a more aggressive rate move in the was looking for more dubbish rate moves have someone I could only think of. Adam Posen

is the equivalent. John Riding is Chief Economic Advisor to bring capital with Service to the Bank of England, his Bank of England and also to the Federal Reserve System as well, and he joins us now with decades of experience here. What will you listen for from Governor Bailey is he has colored descent, something totally unfamiliar to Americans. Well occasionally have thought there's a bifurcation in these dissenting views.

Two members of the committee didn't want any change in rates, which I find somewhat remarkable and speaks to the devishness of some people on the committee, and on one person wanting a larger than fifty basis point rate high um and then you then you had six going along. So so that what what were the two who were not expecting, not not unexpecting, but not wanting a rate high when the inflation rates running at almost ten percent? Now, what's interesting?

Compare that to the Fed? And you asked what, I hope Governor Bailey sounds like j Pal did yesterday because he, for once, he put in a terrific performance and he kept pounding away at the markets. The terminal rate five point one percent, it's going to stay there for a while. Don't look for cuts until there's clear evidence that inflation

is headed back to two percent. And as you make the point, the markets are saying, well, we're still not even going to price in a terminal funds rate above five. All comes down to inflation. And I think that markets to some degree, are looking for central banks to react as they reacted when economies are going into recession over the last two decades, when inflation wasn't a problem. Inflation is a real problem, and a much bigger problem in Europe. You made reference to the banking in the UK is

a small, open economy. Um, the exchange rate has a really big impact on inflation, much more so than than in the US UM and of course the bank also has to navigate A nice get little update on those troubles in the guilt market back in September forced the Bank of England to begin easing again with temporary quantitative easing.

The day after, they confirmed that they were going to start quantitative tightening the following week, and they had to abandon those plans, which John, let's unpack some of this, and let's start with the nature of the descent on the b O way. The individuals that didn't think we should hike interest rates today, they believe in long and variable lags. They think the cumulatively over the last twelve months, we've done enough already and that's going to hit the

economy next year, We're going to go into recession. They ultimately must believe that inflation is going to be on a downtrend. What would you say back to that, Well, let's use the language that the FED has adopted. Policy needs to be not just restrictive, but sufficiently restrictive to get inflation down. And ask, is a three and a half percent interest rate when inflation is at around nine

and a half percent restrict if at all? Real interest rates interest rates adjusted for inflation are at negative six percent on the policy rate. And I don't know any economic theory that would say a negative six percent interest rate is a restrictive policy setting. So the message and the message to Fed has shifted to now they were late, but they continued easing through the inflation problem last year. But at least now they're they're getting that message out

and and have they done their messaging. They said, it's not a question just how fast we raise rates, That's that's a lesser important question. Now it's how high and how long are we going to keep it there? And I think that they Europe and then the Bank of England is struggling with the how high. I think the Fed's largely got the message right, But then the next part of the message is going to be how long.

And that's where the market simply just don't believe. They believe that the recession is going to lead to lower inflation and that's going to do the FEDS and Bank of England's and the ECB's job for them. And I think with these particularly these supply shocks on energy prices and still horrible developments in the Ukraine, these policy rates. To imagine that a three percent policy rate would be high enough to bring inflation down, um, I just don't

get it. There's also a disbelief, though, just to push back a little bit, that we could go from eighteen trillion dollars of negative yielding debt in the world to one trillion dollars of negative yielding debt in just a couple of months and that nothing will break and then suddenly we'd have this complete regime change that everyone would say that was going to be catastrophic, and then suddenly it would all be okay, and it wouldn't be enough,

and suddenly rates had to go much higher. People don't believe that things can change this quickly without some consequences

that we have not yet seen. How do you push back against that, Well, you're actually right I mean something did break back in September, which which was the guilt market, and then you were in an uncontrolled um rise in guilt yields because of the leverage decisions that UK pension funds had taken number of funds in terms of buying UK government bonds on borrowed money so they could also invest in equities to try and catch up with their underfunding.

And what happened was those that that important and why did they do that? Because central banks have kept interesting it's too low for too long and they've been buying the assets and so banks got pension funds got over leverage. So something did brick and other things may break. The break in the crypto market I think is largely unrelated to um. These these policy issues, but things things will break.

But but if you abandon targeting inflation, which of course in a sense the New York Fed has actually touched on that with this our star star concept, there might be interest rate that might need to be hind for and inflation might break the financial system. Yeah, I gotta ask you a question before we run out of time. I've heard this story before. The only reason you got into came, which is your mother beat math into you. It's well, well, well understands you said at the kitchen

table and said, Johnny, do your your math. Can the time continuum that you mentioned there be a substitute for level? Can the Feds substitute a certain level of interest rates for getting up to a Bullard like excess terminal rate? Yes? I think they can. But the difference between the Fed is that they have policy rates getting clear at least close to if not in restrictive territory, and when the end and planning to get an ongoing process is going to get rates higher, and then they can let those

rates sit. And I think that's where the conversation shifts. I have the problem the banking that the ECB is policy rates and know when you're restrictive, so time cannot substitute for that. I just imagine that. Look up the the articles the Federal on opportune disinflation back in because that is going to be I think that if the February visits that the genesis of framework for the idea that we can just sit at a restrictive rate for a longer period of time to push down on inflation,

and that will work, providing the FED has credibility. I'm providing policy is on a restrictive setting. John, this was awesome. I'll just tell you how great it is to see Mrs Riding in the studio as well. Fantastic, isn't that great? Taka love screen, Love that, John, Thank you, Thank you, John Ryding. Bring capital, France and Argentina. Oh, after the hand of God incident. I've got to go with France. Just can't let that go. Can't let it go? Come that we go back to the eighties. I have no

idea what you're talking about. Okay, So like the voice of God, you don't know what Diego did. No no clue, Get on YouTube and find out. Ridiculous, John, how am I working with her? 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 and this is Bloomberg