Surveillance: Economic Cycle With Crescenzi

the epicenter of your round. Look with you in the team right now, can you just walk us through how you thinking about the world around us at the moment? Well, we we When we talk like to talk about the Yiel curve and Yel curve movement speaks this idea of a fast moving cycle. Does seem like the economic cycle is moving at warp speed. Think about it. We're probably at mid cycle, meaning look at the unemployment rate. Fo

what is a late cycle condition. Of course, a nonemployer rate that's lower, and that lower rate could be achieved the full employment next year. So that's a fast moving cycle. In fact, the Federal Reserve is projecting that the unemployment rate will be in the mid threes by the end of next year. So for investors, it's important to be

on your toes. It's the simple way you're saying. It's important to be active with the portfolio management, to be thinking more about security selection a region, regional selections, etcetera, uh, etcetera. But then it is a fast mood recycle. One final note that the gield curve again, it's it has flattened recently, and that's something that happens later in the cycle because the Federal Reserve is raising the short term rate, which pushes up it yield relative to the long term rate flattening.

That's where I want to go to Ston spread this morning. Eighteen basis points, Tony. Where it is a two year yield that matters to you? Were at zero point four four percent? Just you're just in your mind, Tony. Where's the two year yield a tip point or a critical point? For Chris Enzi, Well, the two year relative to other yields matters a lot, and it's just that the two

year will tell us about the two year window. And we know that the markets looking at shorter term interest rates and forward interest rates like Euro dollar futures is projecting at the Federal Serve will increase its policy rates sometime next year, perhaps as early as June. The markets penning in several interest rate types. But the other these two extraordinary things about the two year to ten years spread.

One is the fact that the spread started to flatten earlier in the cycle than we have seen since the nineteen eighties. And then in the last three cycles, the last three recessions, the spread between the two and the tenure no was is why these three basis points. In other words, the markets were patient about the idea of Federal Reserve interest rate hikes. It thought that industrate highs were somewhere on the distant horizon, and so long term yields had stayed high. Um But now so this this

is the peak. This time was one fifty, so it's half the level of the previous cycles. Was to cut

to the chase. The second part of the extraordinary part of about the yield curve two cents spread is that the tenure yield it's projected to be low, and on Bloomberg of function through new Bloomberg uses f w c M it shows forward interest rates and you see the market is saying that there's a benign story to evolved unfold over time, that interest rates probably won't get up two and a half presented as far out in these forewers, as I look at the table calling it ten years

plus well but tony just to sort of tie this all together, then what is the message from the yield curve? Is it that the market that the economy can't necessarily handle too much tightening from central banks? Or is it just that the margin is going to naturally be narrower because of this ceiling on longer term yields? He said, those are probably the conclusions that most would draw from

it now. But perhaps forward interest rates are wrong. Perhaps the market, the consensus and that's uh embedded in these forward rates is wrong and thinking that the twenty tens uh it will be uh repeated in the twenties. But the twenty tents is probably the wrong analog for the twenties. There's a lot going on in pimco's secular outlook. We talk about speak to transformations, for example, becoming more digital, more inclusive, more green. Those are the three major transformations

we see. All those things could We're not saying they will result in faster growth, and simply doing the math, if if economic growth is four percent, as the FED projects next year and PIMCO projects as well, then looking at the next five years, even if growth is two percent of subsequent four we'll still have a rate that's about two and a half. So that would be a lot better than the twenty tens, simply just by that math.

And so it's possible the growth is faster and these these forwards are wrong, and therefore race will go high. We're not suggesting that race will go materially higher. In fact, we would say we may turn to certain old normal conditions, but with new neutral characteristics, which is to say that, yes, Lisa, that the battles are can't raise its interest rate too much because of deadloads and certain other factors. Tony, we're out of time. Haven't even got the time to plug

your book. Gotta let you go, Tony CRISCENTI, thank you. Gonna catch up as a white right now. This is an incredibly important interview for two thousand twenty two, and indeed two thousand us on fired again. The bears have been vanquished here, no question about that. But a recurring theme that we have on surveillance is look to Asia and look to the true growth there. Gabriela Santos with

JP Morgan joins us their global market strategist. Gabriel, I love how your essay dovetails into what I'm seeing in the new Foreign Affairs magazine, which is China. And you define a new China. What is the new China? That's right, Tom, And in a lot of our conversations with investors, China keeps coming up time and time and again as really an area of growth in portfolios, and I think it's much more about a conversation about Chinese markets more so

than than China's a comedy going forward. I see the new China really being about one that stresses the quality over the quantity of growth um that also prioritizes other objectives in addition to growth alone, such as reducing an equality and energy transition, a development of capital markets, and

also in China that has new areas of emphasis. So this year has been all about the areas of pressure in the new China, but there are also areas of emphasis like domestic consumption, technological infrastructure, and the energy transition. And it's interesting our investors still believe China's investible are looking at this point in time as an opportunity to yield that allocation to China over time. Is there somewhat

capitalism or at least their experiment. Is it endogenous more so to China, or does it readound out across the Pacific Rim and all of Asia. I think we do have to remember China has a very particular political and economic system, and we see that at play this year. When China does decide to pivot and to do reforms and regulations, it does so extremely quickly, and that is a feature of China. It does lead to these moments of volatility. We see these thirty plus percentage corrections every

three years or so in China. It's a feature of investing there. It does come with higher volatility, about double the volatility for Chinese equities versus the S and P five, But you do get other benefits. You get the potential for higher revenue growth and these new sectors of emphasis, and you get extremely good diversification benefits. It's working against you this year, China's down eleven percent while E m X China is up ten percent, but it can also

work in your favor, like it did last year. So net net, we still find it helps to boost risk adjusted returns and that's very unique to the China onshore market. Real are you concerned it all about the political ramifications in the United States toward investing in China. The idea here that there is a changed relationship between the two nations and that if companies or even investors move into China, they could be susceptible to risk at home in terms

of regulation. So we we do see in surveys in the US as well as actually in a lot of countries around the world that's increased in unfavorable opinions towards China. Um and I think that's honestly a feature of the next century, this competition between China and the rest of the world. Well, we talk to our investors about is that whatever you may think or or not about China

and it's political system, you can't ignore it. Uh. You can't ignore it in terms of the size of its economy, the size of its markets, with the second largest equity and bond markets, um and you also can't ignore it in terms of the risk adjusted benefits it can provide portfolio.

So maybe an investor decides that investing in China is not for them, But I think as a fiduciary, investors need to prove that they thought out the benefits that they're leaving on the table, and that they've well documented the reasons why. Meanwhile, graby Ella, the question of what happens in China directly bleeds into the supply chain disruptions

that we continue to see. How are you sort of engaging the activity level there with when we'll start to see some of the inflationary pressures from supply chain disruptions perhaps start to abate a little bit more So, we've clearly seen a deceleration in China in the third quarter four point four point nine percent GDP down from seven point nine. That deceleration can continue a bit longer in the fourth quarter. Part of it is re lated to

the pandemic. China is the only country that continues with this zero tolerance approach to COVID, so localized restrictions are still going on in China, and that can affect up some production and some consumption of services. But more than that, I think we're learning that this deceleration in China is a feature, not a bug, of the new China. It is about lower quantity growth much more about quality. So structurally, we'll continue to see a decline in things like property, infrastructure,

low end manufacturing, energy intensive industry. The floor on Chinese growth is much much lower, and I think that's something that investors need to internalize and adjust lower their expectations and then we can move on and focus on the opportunities. Gabrielle Santos, thank you so much. With JP Morgan this morning, let's go down and look at TS vodka. We can

do that in Texas. We do that with Regina Mayor joining us right now, boy out of Energy at KPMG in a true force at Rice University in the Baker Center. What are you open question? I rarely do this, Regina, but you're so good, I'm going to ask it. What is your single point of study on a hydrocarbonage in America? What's the mystery for you into two thousand twenty two. Yeah, so let me try to boil it down, because I think what we're suffering from is a systematic and prolonged

under investment in these long cycle projects. That is what it takes to bring well and gas to the market. We see demand continuing to grow the I e. A said it will be sion barrels per day uh and and others are saying it will be pre pandemic levels. We have tightening supply because countries are starting to worry about energy security, and countries you can are buying cargoes almost at any cost. So that's driving up all of that against the backdrop of a expectation of a cold

winner hotter summers. So we have a crude oil up six over the last six months, natural gas over a lot six months, and I think it gets worse before it gets better. That's what I'm thinking about. Well said. The reality here is for the last twenty years on a hydrocarbons technology has saved us. Do you and the engineers at RICE and KPMG, do you assume there is new and improving technology or is this as good as

it gets as we produce oil. I think technology will always continue to surprise us, and I never doubt the ingenuity of the industry and in particular the shale players. But what we've had is investors driving different kinds of behavior, and so your public shale players are sticking to the narrative of we're gonna delever the balance sheet. We're gonna

return strong dividends to our investor base. An OPEC plus, which can release more supply, is enjoying this eight plus dollar rally to rebuild their government coffers because they've been suffering for budget deficits over the last eighteen months during the pandemic. So yes, technology can definitely play a role, but not in the short squeeze where we're in today, Regina. This is definitely a global story, but it's also a

very US story, in particular Cushing, Oklahoma. I was taking a look at a bunch of the stories about how much of a supply shortage there is there, how much the inventories have gotten depleted, and how that is distorting markets dramatically. How much is that driving a lot of the rally that we're seeing frankly globally, but driven from the w t I crewed. I think w c I definitely is playing a key role because everyone's watching what the shield players are doing. But I think there's a

Cushing story in all the global markets. You know, we saw in the gas prices spike ten times ten x in the UK not not too long ago. There's again an energy security story. There were of natural gas supplies into the European continent come from Russia. So when we look at tight supply choke points like Cushing, like some of the systems in the North Sea, even what open plus is going to do, those little bubbles create the overall geopolitical story and drive a global commodity price that's

really extraordinarily healthy right now. One is hundred dollar barrel of oil. Do say at the end of this year early next year, as many people are predicting, I think that's where we start to see probably pretty significant demand destruction and probably where we start to see more increases in US activity, which can be a swing producer and we can return to being a swing producer. Aretist seeing rip counts that are up almost uh double from a

year ago. And while the public shail players are sticking to the investor narrative, the signs seeing a lot more private shail activity uh and and more oil and gas development and production coming in the Permian and elsewhere in the US. How do you respond to market strategists, to Wall Street types with a vector to ninety dollars or even a hundred dollars of barrel? How do you respond

to that? As an academic. Well, I think, I mean it's a it's a real economic challenge, right, I mean that's what the underlying value of the of the commodity

is today. And I think that's where we have to look at what's going to happen in Glasgow and cop How do we accelerate the energy transition, how do we address energy security and how do we ensure that the market forces keep energy affordable and reliable and a planet that's consuming more and more, you know every day as we continue to grow with within the oil here, the overlay has already been gas. I remember the the the

Exxon transaction. Everybody had to get into some form of net gas and the rest of it as well, after an a dark after accidental petroleum. What's going to be the synergy that we're gonna see in American oil? What's the next combination that just has to be done? Well, I think you've seen those combinations already, tom So. I think there's a lot of consolidation around shale assets in the u US, which will help because scale, as they say, shale means scale and that will help from a cost perspective.

So even if oil ultimately comes back down to below forty, we can still be profitable with those larger players. And you see the international wild companies pivoting more to have a more diversified portfolio in the energy transition. Some are betting more on carbon capture and storage, others are betting more on hydrogen batteries, others are betting more on renewables.

So I think you'll start to see a bifurcation of the traditional energy company strategy with sort of the new energy company strategy, and that will help balance the power needs that the planet has today. You know, as we pivot into the energy transition, Regina and Top twenty six

will be very interesting to see. Regina. Before we let you go, there's been a dilemma for a lot of investors that want to move towards more E s G type strategies, that want to seem like the good guys investing in greener energy, and they have missed out on a rally that's been dramatic, And a lot of analysts have come on this show and said, you invest in

oil companies, you'll do great. How do you sort of see that developing in terms of investors both getting the returns but also being able to sleep at night with how they're putting their money to work. Sector took a beating last year that I didn't think was necessarily warranted. So I think there's definite upside. And for those of us that stayed in our only guests uh come out

of equities were doing really well in our portfolios. But I think what I would say is investors need to have a balance and don't count out the energy industry. We have to be a key part of driving into a lower carbon climate. If we're not at the forefront of driving that, then I don't think that we are able to achieve a two degree C at one point

five degree C scenario. So I encourage investors to look at the bigger picture, don't demonize one side versus the other, because we need an all of the above strategy to get to the climate goal objectives that we have together. So don't just look for what sounds green in the short term. Look at a balanced portfolio because fossil fuels and hydrocarbons have to be a core part of the underlying part of the portfolio for for a substantial period of time, and we will reduce the carbon footprint of

those hydrocarbons. The industry is committed to that. Regina, I've a really enjoyed listening to you. Thanks for being with this. Regina Matther of KPMG Tony presents you joining us now markets trying togist and portfolio manager at Pimco Tony. This cyclist moving so quickly, that's the story, the epicenter of your round. Look with you in the team right now, can you just walk us through how you thinking about

the world around us at the moment? Well, we we when we talk like to talk about the Yiel curve and Yelk curve movement speaks this idea of a fast moving cycle. Does seem like the economic cycle is moving at warp speed. Think about it. We're probably at mid cycle, meaning look at the unemployment rate four what is a late cycle condition. Of course nonemployment rate that's lower, and that lower rate could be achieved the full employment next year.

So that's a fast moving cycle. In fact, the Federal Reserve is projecting that the unemployant rate will be in the mid threes by the end of next year. So for investors, it's important to be on your toes. It's the simple way you're saying, it's important to be active with the portfolio management to be thinking more about security selection a region, regional selections, etcetera, uh, etcetera. But then

it is a fast mood cycle. One final note that the gield curve again, it's it has flattened recently, and that's something that happens later in the cycle because the Federal Reserve is raising the short term rate, which pushes up if yield relative to the long term rate flattening. That's where I want to go to Ston spread this morning. Eighteen basis points, Tony. Where it is a two year yield that matters to you? Were at zero point four

four percent? Just you're using your mind, Tony. Where's the two year yield a tip point or a critical point? For Chris Nzi, Well, the two year relative to other yields matters a lot, and it's just that the two years will tell us about the two year window. And we know that the markets looking at shorter term interest rates and forward interest rates like Euro dollar futures is projecting at the Federal Serve will increase its policy rates sometime next year, perhaps as early as June. The markets

penning in several interest rate types. But the other these two extraordinary things about the two year to ten years spread. One is the fact that the spread started to flatten earlier in the cycle than we have seen since the nineteen eighties. And then in the last three cycles, the last three recessions, the spread between the two and the tenure no was is why these three basis points. In other words, the markets were patient about the idea of

federal reserved interest rate hikes. It thought that industrate highs were somewhere on the distant horizon, and so long term wields had stayed high. Um but now so this this is the peak this time was one fifty, so it's half the level of the previous cycles. Was to cut

to the a chase. The second part of the extraordinary part of about the yield curve two cent spread is that the tenure yield it's projected to be low and on Bloomberg of function through new Bloomberg uses f w c M it shows forward interest rates, and you see the market is saying that there's a benign story to evolved unfold over time, that interest rates probably won't get up two and a half presented as far out in these forewas as I look at the table calling it

ten years plus well, but tony just to sort of tie this all together, then what is the message from the yield curve? Is it that the market that the economy can't necessarily handle too much tightening from central banks, or is it just that the margin is going to naturally be narrower because of this ceiling on longer term yields? He said, those are probably the conclusions that most would draw from it now. But perhaps forward interest rates are wrong.

Perhaps the market, the consensus and that's embedded in these forward rates, is wrong in thinking that the twenty tens uh it will be uh repeated in the twenties. But the twenty tents is probably the wrong analog for the twenties. There's a lot going on in pimco's secular outlook. We talk about speak to transformations, for example, becoming more digital, more inclusive, more green. Those are the three major transformations

we see. All those things could We're not saying they will result in faster growth, and simply doing the math. If if economic growth is four percent, as the FED projects next year and PIMCO projects as well, then looking at the next five years, even if growth is two percent of subsequent four we'll still have a rate that's about two and a half. So that would be a lot better than the twenty tens simply just by that math.

And so it's possible the growth is faster and these these forwards are wrong, and therefore race will go high. We're not suggesting that race will go materially higher. In fact, we would say we may return to certain old normal conditions, but with new neutral characteristics, which is to say that, yes, Lisa, that the battles are can't raise its interest rate too much because of debt loads and certain other factors. Tony, we're out of time. Haven't even got the time to

plug your book. Gotta let you go, Tony Criscenti, Thanks, thank You's gonna catch up as Elwise. 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,