Surveillance: El-Erian Sees EM 'Perfect Storm'

start that same transitory. How much of a challenge are they getting from the recent incoming data? Massive? Drawn and thank you for having me a massive challenge. I think anybody who looks at what's going on will tell you that unless you embrace the analytically meaningless phase of persistently transitory, which I've heard persistently transitory, this inflation around is not transitor.

We should take it seriously and central banks should move quickly to contain what could be something that ends up being more than just an inflation problem, but a growth problem. Mom. It's how small is that window to wact to make that change? Is it there? John? But it's getting smaller. You've heard me say this for the last five months. Um. The longer you wait, the harder it is to deliver

a orderly adjustment. I think this notion that Andy Heldane introduced last July of a handwake you turn what you want to avoid central banks doing this handwake you turn um is a risk that we should factor in, and indeed is being factored in away from the from the Fed right now. Mohamed. One of the more interesting aspects of the price action we talked about the lift in markets following people bringing forward their expectations for rate hikes for the end of asset purchases in the middle of

next year. Now we are praising in potentially to rate hikes by the end of next year. Is this basically a market endorsement of a more hawkish FED that has previously been communicated. Yes. I mean the market is telling the feed two things. One is get going with tapering, we can take it. And two is you're not going to be able to separate cleanly tapering from waight hikes. And again, look at the numbers today, look at p PI in China. This is a very hot inflation environment.

And the longer the central banks wait, the greater the risk and the market realizes this, and it's starting slowly in the fixed income space to price that in. Mohammed, what do we What would you say to people who argue that there is a self correcting mechanism here, that higher prices will slow growth, will slow demand, and that you'll actually right size without the FED interfering and curtailing growth that needs to hit some sort of acceleration pace so we can get out of the hole. I will

tell them that in theory you're right. In practice, we haven't seen it work too well. Um, it's a very finely balanced because this is about demand destruction. That argument is about demand destruction, and when you destroyed them on there's a lot of collateral damage at unintended consequences. So in theory, in a textbook, it works fine. In practice

we often overshoot and end buck in a recession. So this is not something that I would like to try as someone who cares about the well being of Americans and especially those who are lower income, because they get hurt the most in that sort of world. Mohammed, you joined the International Monetary Fund in three This is back, folks, when the New York Jets are actually good and you spent a good fifteen years there, Dr l Arion, you saw all of the revolution and the different crises, but

nonelikely oddity. Now, how important is it for the I MF to distance across the nineteenth Street northwest? Does the I m F need to dialogue breakaway from the World Bank in the coming weeks and years? No, On the contrary, um, you need really good I m F World Bank collaboration going forward. We have a structural issue. The development countries are particularly vulnerable and the two institutions working together can

have a huge impact. What the IMF has to make clear and has been making clear, is that the data integrity issues aren't about the IMF. No one has raised questions about the I m S data integrity. This is an issue that relates to doing business report at the World Bank, and the IMF data integrity is as high

as it can be. Right within this crisis, are we at the point where marginally we finally give way voting and governance power from the European nations of Breton Woods over to selected emerging markets per two, really an Asia. So we have had this governance issues repeatedly, Tom, You and I have been talking about it for decades um. The governance and representation of the IMF, while it has evolved, still represents the world of yesterday and not the world

of today and tomorrow. And what we're seeing is little pipes being built around the I m F and the World Bank because other institutions are deemed to be more representative. So so that is an urgent issue and Europe has to take the lead on this issue. Mohammed. We talked about this great divergence this week because of the I m F. Let's talk about that a little bit more

from a central bank perspective. We've had interest rate hikes from Chile, a big one in the last twenty four hours, I think a hundred and twenty five basis points, Colombia, Mexico, Brazil, South Korea. Mahamm. Do you think something biggest building care from emerging markets that could spread to d M from e M. So funny you say that because I'm drafting my next ft op ed and it will be on that.

I think that there's a risk for developing countries that they have the perfect store and that means massive cost push inflation imported, especially for commodity importers, lower global growth as China and as the US slow, and then on top of that the risk of reversal in financial flows, and that's why you're seeing the central banks tightened way

before the FED Titan. So that risk is there, and it's meaningful because I go back not just your word dispersion, John, but to what Peter Governors, the head of research, called dangerous dispersion. You do not want to enter a world in which the low income countries risk being knocked off the convergence process. So yes, there is that risk, and it's something that we should be keeping an eye on, and it's one of the unfortunately underdeveloped themes so far

at the FUND. I think that the IMF did a great service by introducing this notion of dangerous dispersion, and we should pursue it further. So have it. Let's pursue it further a little bit more. Right now, it's one thing to be focused on the spillover risk. You know how this works. Often DM doesn't care until it effects d M. What's the one big thing you focused on right now? So I'm focused on how capital is responding.

Because the good thing for markets, and you're seeing it again today, is that the behavioral conditioning of the marketplace has been to buy the dip. It has been incredibly successful strategy, and we still see residual buying the deep inclination. And the one thing I'm really focusing on is can we understand the behavioral conditioning of the marketplace and how

that's going to evolve. We know the economy. I don't think anybody can doubt that we have an inflation issue, that the Fed in particular is late to this issue, and that we risk a disorderly tightening of policy. I think most people see that as a risk. What we haven't yet understood fully is how the conditioning of markets, the behavior conditions of market can change Mohammed. If the Federal Reserve does, in fact hike twice come next year,

what does that do to emerging markets? How much more pressure does this put on them, given how much they've already had the high rates to compete. It depends which one, Lisa, and that's why we're going to see massive differentiation. Some countries have the financial resilience to cope with it and have the policy flexibilities. Others don't. And that's that's a very important message for emerjoring market investors. So far, they

have benefited enormously from simply writing the liquidity wave. We've entered a phase right now where you need a lot more granular analyzes and you need to be the old type emerging market investor, understanding that ultimately you do get contagion, and you've got to be able to differentiate between those who recover quickly and those who constitute nonrecoverable mistakes. Mohammed, we miss you, we miss you. We want you back

in America. I understand there might be a free seat at the Federal Reserve soon, so maybe we can work something out. I'm joking, you don't work work. Tom said about mom Mike. I'm in the UK and I love my momake, do you I do? I love momake. It is an acquired taste you're not. Thank you very much for being with us. Muhammadalarian, Thank you very much. John. I understand you understand how sensitive and woke Adam posing is. Will find out how boke Adam posting is in just

a moment. Larry Summers, the former Treasury Secretary Lawrence Summers saying in the last twenty four hours the following, Adam help us out with this one. I'd love you reaction. Quote, we have a generation of central bankers who are defining themselves by their wokeness. Goes on to say they're defining themselves by how socially concerned they are. Adam open one for you. What's your reaction to that. I don't think that's fair. Um, if you want to worry about wokeness, yeah,

there's universities you can worry about. There's various individuals. But the central bank is not stomping on alternative voices. It is not saying you can't worry about inflation because we're too worried about unemployment. There's open debate. I just hosted Raphael Bostic, Federal Reserve Bank of Atlanta President, at Peterson Institute earlier this week. He gave a speech that sounded

relatively hawkish. He talked about inflation expectations, and at the very end I asked him about inequality, and he gave the same answer than most members of the f O m C would. It's entirely right for the Federal Reserve to do research and draw attention to the inequities in the society. Monetary policy has to be focused on the aggregate output, aggregate inflation. The really important point that Adam.

Whether they have the souls or not to address it or not, it sounds like President Bostick doesn't think they do. Do you think they're Are some on the FED the belief they do and ultimately want to do something about it. I think those on the FED who care about these things deeply, and that's most FED people. But if you think of the various FED presidents, there's a lot they can do in their districts. There's issues of bank supervision.

There's issues of redlining and housing where the FED played a huge role first and ignoring it and then drawing attention to it. There's issues of education, there's issues of documenting and putting out there what are the disparities. But no, I don't see anybody on the FED Committee who thinks that you're going to use monetary policy to solve inequality problems.

And the point is you can worry about inflation and argue about whether or not inflation is getting out of hand without talking about people's motivations and assuming some kind of soft headed dr pos and you have the enjoy every day of working with Olivia Blanchardi wrote about the unlikely but not impossible the modern inflation dynamics were in He made worldwide headlines eleven years ago talking of a four scent inflation. We're there, but this is very different,

isn't it? Yes? And no, Tom, I mean Olivier and his co authors made headlines a gad ago calling for a four percent inflation target because the two percent inflation target for Nankee, Michigan lau Bak and I and others had pushed didn't take into account enough the zero lower bound and us not having effective monage. So have we

committed the experiment? Professor Bluntchard talked about, no, because the Federal Reserve and the Congress have not said, hey, inflations up, let's rat let's grab that and say, now that we're here, let's raise the target. Myself, Joe Gagnon at Peterson Institute, we've been out there saying three plus now is the time. Just like you said, So, do we need to resume shame? Do we need a bullet regime change right now to rephrase our generational belief and two percent inflation and say hey,

this is the new normal? I perly think yes, because it's not a regime change, it's a resetting of the target. One of the problems that we didn't foresee when we put in place inflation targets was we assumed It's in the books that we wrote. We assumed that you would be able to reset the target as economic knowledge and circumstances change. We've never seen targets get raised for inflation targets. It's like an exchange rate. Once you said it, you're

scared to move it. And so, as I've said to you, I think before Tom, but I'm glad we're talking about this right now. We should be opportunistically reflating. We should be saying, okay, inflation is now above three percent, let's re anchor it there. So what do you say to people who argue, maybe not stagflation, maybe slugflation, that basically this will slow growth and that prices will come back down naturally. Why do you say that that is not the case, that we're in a regime change, and what

data are you pointing to? Well, just to be clear, I'm saying we're not yet in a regime change. A regime change would be either a fundamental structure shift or the Federal Reserve upping the target. What I do think is happening is we've got so much accumulated weight from these generations of central bankers who were hardly woke and paid too little intention to unemployment that you see the ten year bond. No matter what fiscal and inflation happens,

inflation expectations don't go up. And we saw this in Japan and we've seen this in the Euro Area. It should be a two way bet that there's some variability and inflation expectations, and that gives you the flexibility to cope with the kind of destruction. I'm got to jump in. What you're saying is so so important. You think that the way they should communicate this is not by making up excuses for it, just by saying this is what

we want to see. Is that right? Yeah, we're fortunate enough to now have a bit more headroom from the zero lower bound. We're fortunate enough to have enough inflation space that the economic adjustments to the labor market need to be done. There was a great paper at Jackson Hole this summer talking about how you get better labor market adjustment when you have loose policy, which is what

I said back in ninety eight on Japan. You should be opportunistically reflating and raising the inflation target and consolidating what we got, and then if that means the ten years up a little bit, the yield curve steepens a little bit, and there's two way risk on inflation expectations. That is a win for the economy. That is a win for the Fed, except that the bills are getting bigger and we have to refinance debt. How much is

this a concern? What is the threshold for the ten year treasure yield that the US economy can tolerate given the deficit? It's the ten year yield doesn't have a single threshold. I'm sorry to be pedantic about this, but this goes back to blanch Yard, right and others. It what's counts as our minus g the differential between what interest rate you're paying and how much the economy is growing. And if the economy is growing at the rate it's now growing, the interest rate is going to be lower

than that. I'm not gonna worry about it. And if the interest rate starts moving up a lot and looks like it's going to stay up, then I worry about it. I do not ink a lasting multi year shift the three percent is going to ruin the Yelker, so let's let's conflate this. Blanchard and other sticklets has mentioned it often our minus gs k that interest rate as it's

related to growth. If the growth there, everything's okay. Do you believe that what we're misjudging is a technological overlay which is going to give us better productivity, better growth, so we don't have to sweat our minus g No. I think we're misjudging the extent of the R risk, the extent to which our can jump. I'd love to have G jumping. I'd love to see a product. Do you model and with all your work at Peterson, do you model G jumping or do the inflation nest is

completely underestimate the our dynamics. I'm not quite following Tom. What we what I think what we've seen is that over you look back at the data, if you've got a large economy with a stable government and issuing that in its own currency, are states below gene most of the time if you look at US or Western European or Japanese history, you get are jumping usually when there's a political problem, and that's where I worry about the US.

Not some thresholders was being mentioned you worry about it because when it stops being critical credible you're here in Washington, stops being credible that we can pass debt, that we can pass, excuse me, a budget that we can raise taxes if necessary, that we can get out of from the stupid debt limit. When that stops being incredible, that's when our jumps. So won't you speak to Secretary Yella

now and everybody else managing this in real time? To Lesa's important question before, you don't have a concern about the combined the some of our debts right now and the trajectory of them. In response to Lisa and that question, what I always say is it matters a hell of a lot more what you spend it on and how fast you spend it over time than the level of how are you doing at that what? How are we doing it constructively? The January package was was overshooting. That's

a place where I agree with Umbers and Blanchard. The January package was too much handouts. But what's in the investment packages that are now under consideration of Congress would be well smith. That was the argument that Larry was making, though that pushing that forward would take all the oxygen out of the room to enable us to push this one forward. And ultimately that's what we're bumping up against

right now. And I'm what's amazing about this moment for me and for people that love this material and love this content they're students of it is to hair from someone equally as talented. Muhammada Ain earlier in the morning, taking the other view on all of this. On inflation, Adam, the question I often ask people, it's what's the towel? What they need to see to say, you know what, maybe I'm wrong about this. What would the towel be for you, Adam? For me, the tell would be one

of two things. Either that we get no real wage growth over the cycle, meaning that we keep having inflation outplace wage growth. That would say, okay, this is all for not and so you might as well just go with this harder money as possible. The other tell would be a large jump in real rates excuse me, a large jump in long rates. Now, I think, what's going on with my friend Mohammed and others sister already missing the tell that should have told them to reconsider look

at Japan, look at us. Their views do not explain and cannot comprehend why rates stayed so low for the last fifteen years. Next time we need to get you one together. Anamuscrites to catch ups as always Adam Poston of the Peterson Institute. A bit off our radar in this week of international economics, but now we dive full into it, and it is good that we can do it.

VIDR Gaspar he has Fiscal Affairs Department Director at the i m F, but that fancy title barely describes the respect for the balance sheet worldwide that world leaders have. For the gentleman from Portugal. We're thrilled you could join us in our studios. Welcome a Bloomberg reader for having me. I want to go to the issue at hand, and I know you do not speak for the managing director

that would be inappropriate. But to your fiscal model. You talk about strengthening the uncertainties that are out there within our fiscal process. How does your I m F prove through your department, your pH d s it's data integrity in the coming weeks and months. How do you show, not tell data integrity and analysis integrity is absolutely core

for us. I'm very proud of my colleagues in the Fiscal Affair Department, and we have a very robust process to ensure data integrity and the soundness of our analysis. It involves both our department but also other departments that in the review process vet our data, vet our forecasts, vet our analysis. I think that we have one of the most robust processes of vetting in the world, and

we're always striving to improve. For example, the Independent Evaluation Office reviews how we conduct our business, makes recommendations those are addressed to management, their analyzing the board, and we make constant progress in the way that we produce data and analysis. The joy of what we do here is we just said, Adam, pose it on from the Peterson Institute with the spirited conversation of our fears of inflation,

and that devolves right over to fiscal affairs. In the balance sheet, Can we have a normal discussion of inflation given the excess balance sheets we have from this terrible pandemic. The uncertainty that we're facing has exactly to do with the pandemic. As you put it. The fact that we have these locations in the balance between supply and demand is creating bottlenecks in specific sectors and price spikes that may last for a while while the economy rebalances and

makes its transition to a new growth path. In a situation like that, central banks, if inflation and inflation expectations are well anchored for the medium to long term, should look through these transitory price spike and conduct monetary policy with a steady hand with fiscal affairs. The leaders of these institutions, and frankly, world leaders are going to turn to you with the overarching question, can emerging markets do better in crisis now because they have better fiscal affairs?

And it does fall back into the governance of the I m F and the World Bank and other institutions. G Seven twenty is well, can you report through your research that emerging markets are more fiscally sound now than they've ever been. Emerging markets, like all country groups, are very etro genious. Inside We point out two risks of divergencies into recovery and inside the country groups. Probably the most ectro genious of all country groups is the emerging markets.

We emphasize very much in the fiscal money sor that you just quoted the importance of strengthening the credibility of public finances. We recommend to all countries that they should maintain or build the credibility of their physical frameworks because it pays off. How does it pay off. It pays off in terms of better financing conditions for the treasury. It pays off in more flexibility to get financing when it's needed. It's therefore a precious insurance mechanism to have

in times of stress like COVID nineteen. Then there's China. Explain to us from your chair the transparency of China and your observation on the speculation and real estate in China and what it does to their fiscal structure, both government and private. Let me focus on the issue of public finance transparency in China. We have published preliminary estimates on the base of the Global Debt database that covers

public debt, nonfinancial corporate debt, and household debt. And one of the challenges that we face in the case of China is looking at what is exactly public sector debt, what is non financial corporate debt, that is private debt Given the role that state owned enterprises, given the role that local government's financial vasia, you're confident in that trend parency right now or at least a trend to improving transparency.

I believe that the Chinese authorities have been improving transparency and they have very committed to improving it further, and we look forward to work together with the Chinese authorities to do just that. We are out of time. We have an exceptionally busy day in New York with bank earnings and such. I'm pleased to report to you, sir,

the American banks are profitable. I hope that will make make the day better at the I m F. Peter gaspar whether us he is with the I m F and truly has changed our worldwide debate on the balance sheet and on fiscal affairs. Kenna Lean is with us, and Kenn I want to go to the power point, the Fraser power point, and I want to make real clear. What sticks out to me is the challenge to narrow the return gap. What does that mean in English? What means?

First of all, City Group shares are still trading lowest in terms of price to that tangible book value at a discount. So the market is looking for catalysts. It's not necessarily just uh normal operations, but what do you do with disparaged businesses around the world? Particularly in Latin America and Southeast Asia. They did a bit of that two quarters ago, but the market or even Mike Mayo is looking for some bigger catalysts, which is really, how

do you streamline this bank? Uh? Jane Fraser's management consultant background no different than James Gorman. So the wheels are spinning, but you know, I think it may have to wait for investor day later in the year. It's not gonna happen today on the earnings call. But City again is a lagger to the other banks which have a much bigger focus in North America. That's the big difference. Ken.

I want to dig a little bit into this increase year over year in equity trading revenue, far beating estimates when it comes in at one point to three billion versus million dollars. John was saying earlier that analysts were expecting what do you make of this at a time when banks are trying to tow the line between taking on more risk, appealing to regulators, and at least showing that shareholders that they can drive revenue going forward. Well,

there's two parts that. First of all, we don't like to look back, but it was a week quarter last year. City has been actually hiring like crazy last year into this year in equity trading, so I think that speaks to thetent um in terms of regulation. We're fine, you know. It's the risk measure that banks are taking was telegraph of course with the June FED stress tests, and they came through and flying colors. Um. So I'm not too

concerned about equity trading. But the key here is what moves these stocks is recurring revenue you and return of capital. So you don't want to take outsize risk or into the level three assets of derivatives because you have to put more capital to it. Morgan Stanley understands us. Most of the banks understand us, you know. So it's calibrated. It's not trying to head it out of the park like we saw right before the financial crisis. Can on

belf of all of us to Team Surveillance. Thank you so much for your time commitment here from c f R A this morning. It's really world class analysis and these important and very large banks. The popular narrative is to do the work, and UBS has done the work. For some real caution. They have made a how shift to optimism not your level continues with us their senior US equity strategists, Nady, I want to talk about what we see in big tech in those surprise maybe we

see it in other sectors as well. And that is the idea of the issuance of new debt still with lower rates, still with low real rates. That moves right over to use of cash. We have use of new debt to be used in use of cash for shareholder by back. Do we underestimate that trend? We do underestimate the share of the power of sharehold of buy Box. You know, we have seen been a pick up in

five bucks announcement this year. Actually buybacks announcements are on case to be near record level as we saw post the last administration UM corporate tax reform or relief, and so historically by Box has added about two basis points to EPs growth and so that could be a real tail one as we get into two and corporation return more cash and shareholders. Madame Leguard spoke today in Washington the years being Central Bank President of the second round effect?

What is the second round effect for corporate officers right now, adapting to the economic cards they've been given. I think that corporations have to continue to manage at the expense side. I mean, we saw some of that coming through the banks um this this morning and yesterday, and in terms of concerns around to pick up an interest rate and just give me an expenses um. We also have to watch that from a wage road standpoint, we're seeing a

pickup in wage wrote. That is something that we're closely watching because that that does tends to be a lot stick year, and we know a lot of people are sitting out of the job market for potential increase in wages. One of the most interesting aspects of the optimism that we're feeling this week is that it comes in tandem

with pricing in rate hike sooner rather than later. Right now, the expectation is for at least one rate hike next year, and potentially two or more in two thousand twenty three. How much does that fly in the face of this five thousand SMP call of years by the end of next year, we're looking for rate highs to begin in early three. And now, of course a lot of this is going to be dated dependent. You know, obviously everyone is watching inflation watching and recovery in the job market.

And also watching for a potential real celebration in economic growth. We don't think that the FED will move to preemptively. We think that the FED will people are cautious obviously, will get tapering up asset purchasing program later this year. But we are looking for ray tipes in three. Even if rate tip gets full forward by one one high in twenty twenty two, we still don't think that that drills the equity market store ry. What about two and

what's the breaking point here? I think that if you start to see two or three ray tipes in twenty twenty two, that will be a cause for the market to take cause. Obviously, then people will become concerned that the FED might be moving to aggressively. As we know, like historically I said of the most recent procession, most recessions have been caused by any sort of FED, a FED mistake, and so that would give us some pause

think that policy error here. Not even well, we see combinations transactions that are simply about the drell did word synergy. It's been sort of quiet this year. I would suggest, as we come out of this pandemic, is everybody going to get the urge to merge? I think so you could see a potential pickup and M and A activity. I think that companies have been more on black because there are is a lot going on in Washington around

corporate towns. Form what does that really look like? Hopefully we'll get more details in the next month or so, and I think that will have a better position companies to look to do M and A in twenty twenty two. Companies are flush with cash. Valuations have moved up as well as companies share prices, and so companies might also use that as a way to acquire the companies. And Nadia, I love catching up with you tonight. Now different it's going to hear from you. UBSA is Nadia level. They're

on a security market. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine a m. 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,