Surveillance: Fed & Inflation with Blanchard

look at fourteen topics. We're not gonna do that, Elsa. I want to look at the one true thing you're focused on, which is your e c B. You've provided huge research over the last decade on e c B. What does Laguard do is there is her degrees of freedom so shrunk down that she has limited choice. April fourteen, So this stage they'll be doing very little. Um, they're setting ourselves up for a normalization coming further in the year. But I think what gets really interesting is what they

do further out. Because the market is pricing hikes and it's clear that's the direction of travel. But the question is how far do we just get to zero and stop? Do we go any further than that. And the reality is that unlike the US where you have this really strong domestic demand, in Europe it's a bit more about inflation without as much strength in the economy. How do you respond to the certitude that they will raise rates, begin to raise rates, or get out front of raising

rates to keep up with the Fed. Well, the reality is they're not going to keep up with the FED, and I think that's what's going to just give increasing support to the your solo as the year goes on. I mean, our call for for euro dollar is still a trough around one oh seven, and quite comfortable with that.

But you know, if I had to look at where the risks lie around that, you know, and less the FED change's course, or you know, something happens to derail the US tightening, and it may well happen later on in the year. Um, if things turn out as market surprised at the moment, we're going to have a really significant meld advantage for the US over the your area by the end of the year, and that in itself will be very meaningful for the currency. So what's a

ramification for the dollar of this balance sheet reduction? That we're trying to game out and coming up with question marks. So I think it's a little bit more indirect than most people perhaps might think, because all of our research historically has found that there's no one for one link between the size of a central banks balance sheet and the domestic currency. A lot of it depends on the status of the currency as a haven or as a

risk proxy. And because in the case of the dollar at the moment it is trading as a bit more of a haven, you do tend to find that if equities sell off, the dollar finds a little bit of a boost um to the extent that the market, like you said earlier, is not necessarily priced for a full one point one trillion of reduction and balance sheet per year. You may well see the weighing on equities and boosting

the dollar as a result. Elsa, you talk about the global picture for the currency, and so I have to go to a philosophical point, especially as you see China start to pay for call from Russia and u N and you start to get this concern, especially as you, as Treasury Secretary Jenny Ellen yesterday said that they could actually actually impose some sanctions similar to what they did

on Russia to China, should they invade Taiwan? How much are you looking at the diminishing of the dollars place as a result of what some people are saying the weaponization of its cloud on the global financial system? Right? You know, a lot of what we've seen with Russia in some ways has been unprecedented. But I think the key task is what's going to take its place. We had a really interesting conversation about this exact topic just a few hours ago with the client talking about de

dollarization and that. Two big obstacles I think for China one is the closed capital account, you know, the fact that they don't allow free, unflanted access to their capital market. It's and the second is liquidity and the ability to hedge exposure via the US dollar or via dollar leg funding markets. So I think until you get a very broadshift on both those topics, you're not really going to

see a proper challenge. Of course, it's going to happen over the next decade or fifteen years, but most investors don't think on that horizon. Also, the bet here is on all these currencies amid massive uncertainty, can you make a big figure bet and dollar or a big figure bet and d x Y or the Bloomberg Dollar Index. Is that even feasible? Now, I've got to say, Tom, we've had a lot of success this year with quite

short term tactical trades. Um. It's definitely paid off a lot better than trying to kind of position for those big, longer term trends. Uh. You know, at the moment, I think we've been watching your dollar kind of bounce around in that range. We obviously have the French election coming up that's attracting a lot more interest and attention. My bias longer term is still for a grind lower, but clearly there's a lot of risks around that. I look at the Pacific Rim and of Lisa mentions China and

the challenges there as well. Is there an opportunity of surprise opportunity in the Pacific Rim here, given the COVID story in China, given sort of a Pacific Rim gloom out there, where's that opportunity? Yeah, it's a really interesting question because actually I see quite a lot of optimism baked into parts of the Pacific Rim. You know, if you look at the Australian dollar, even the new Zealand dollar. We model it based on the usual fundamental drivers two

year yields, commodity prices and so on. And actually for the last few months there's been this big unexplained residual, so a lot of optimism kind of getting baked in to the top side. I do think that as the year goes on, you know, if the FED is really going to deliver as much as it says it will, as much as markets expect it might, Um, then that yield advantage for the US is going to undermine not just the Pacific rim, but global currencies will oddly else.

Before we let you go, you're talking about some of your conversations with clients. What are the biggest concerns for clients right now? What is their biggest worry that they present to you? You know, I think there are a number of questions topics on people's minds. Um. Clearly, you're looking at the situation UK and everybody is sensitive to

the fact that it can worsen materially at very short notice. UM, it's a political decision what extent of sanctions are imposed, and and that political pressure for further sanctions could change. Now beyond that, I think people are a little bit perplex you know, looking at the relative strength of equity markets, for example, and constructing their heads trying to figure out where that's coming from. Granted, you know, I'm talking to

macro investors. Probably if you speak to an ext investor, they feel a lot more comfortable with it, but there's certainly a lot of anticipation of perhaps and weakness further out the line. Thank you RBC. Nobody owns it for almost a decade. Like Elena Paoliakova, when you are at Berkeley and write a thesis on the Dark Side of European Integration, you are a decade out front on the dark side of this war. Professor, Thank you so much for joining us this morning with the Center for European

Policy Analysis. Elena cut to the chase. You nailed this ten years ago. How dark is this war and what does Ukraine have to do about it? Unfortunately, the threat that is Russia we now know. We tried to ignore it and we just can't, you know, in Russian Vida Crimea and then you know invaded Russia's sorry crane's eastern the dorn Bus. We put sanctions on Russia. Obviously sanctions didn't change Putin's calculus, and here we are. This is the most significant, most brutal war since we've seen since

World War two. Um. And it is a dark moment for Europe. Absolutely, It's a dark moment for all of us, even here in the United States. Elena, I've got John Bolton on the right and Elena Farcas working with Obama on the left, both agreement that we weigh over estimate the ability to start World War three. Do you agree with them that we were overwrought in our worries about

the ghosts of nineteen thirty nine? Uh? You know, it is rare to have someone like Bolton and Evelyn, whom I know as well, uh, to agree on this issue. But it just tells you how Um at the end of the day, you know, we are so worried about escalating and worrying about what will Putin do if we give the Ukrainians more weapons, all we can do if

we give the Ukrainians fighter jets. But you know the truth is we can't predict what Putin will do, and we should be worried more about how do we ensure that Europe is whole, free and a peace How do we ensure the United States, Um isn't going to get pulled in with troops and things of the nature into the war, and the best way to do that is to give you know, as a Swarmers could have said, to give the Ukrainians absolutely everything they need to be putin in Ukraine so we don't have to fight him

as Nano in Poland or the Baltic States, because unfortunately, if Putin isn't stopped in Ukraine, there is a very good chance that he'll take that as an opportunity to keep going forward, keep going further into Europe. A leader to the sanctions work at a time when a lot of the opposition to Vladimir Putin within Russia has been squelched, where protests aren't really working if everyone's hauled off to

jail or forced to leave the country. You know, economic sanctions are historically speaking, especially with Russia, have never worked to change the short term military behavior on the ground. You know, looking back at when Russia invaded in ins Crimea, we impose some significant sanctions on Russia, but it didn't change Putins calculus. How do we know that because he invaded Ukraine eight years later. So now we have an incredibly significant round of sanctions that we've imposed on Russia.

We've never tried this before. It's affecting the global economy. The Russian economy is not like North Career orr on It's it's significant and we're seeing some of the effects of that, you know, in grain prices and oil prices obviously, But sanctions are a long term tool in themselves. They will not change what's happening day and day out on the battlefield. For that, we need the military and security assistance.

Sanctions in themselves won't change behavior. And at the end of the day, the elite, the oligarchs, they're close to Prutin, They're not breaking ranks um, They're staying loyal to Mr. Prutin, and I don't think that's going to change. This is a really important point. The sanctions are not helping in the near term when it comes to the day and

day out of the on the ground military actions. If that's the case, do policymakers realized that, Do they sort of recognize that, and if so, what are they doing to actually affect that at a time when they're talking about war crimes. Well, absolutely, I do think there's a recognition that sanctions have a way of taking a long time to work because we've never tried this level of

economic sanctions that country as large as Russia. We're still waiting to see how they will all interlock and play out. Right now, the strategy is too pronged. It's one to make it really hard for Russia to sustain the war effort financially forced Russia potentially to default. This seems to be what the United States is pursuing right now. Close all avenues of financing for the Russian government so they

can no longer pay down on their debts. But you know, they'll have a thirty day great spirit if they even uh, stop payments on their debts. So it's really not a

short term solution. So the second prong of the strategy has to be making sure that you know, we are supplying Ukrainians and what they need on the ground, I mean, and together that should contain Russia if we do it rapidly, if we do what it takes, and if we don't, you know, kind of pursue a very cautious tentative policy where you know, we may do eggs, we won't do why so if we go in full, we give the Ukrainians what they're asking for. We ramp up those economic sanctions.

You know, the war will eventually have to come to a halt by you know, eventually. How many more deaths would that mean? How many more brutal images are we going to see like we've beens in the last couple of days. That's really the where we are right now, calculating those costs, and it's it's painful. It's quite painful, incredibly painful for the people of Ukraine. Elena, Thank you. Elena Polla cover the of the Center for European Policy Analysis.

Olivia Blanchard joins us this morning. Professor Blanchard, thank you so much for joining us. You were just out at Washington University with all of the heritage of Murray Weidenbaum and all the optimism of Washington University and growth. Can you be optimistic about the American economic experiment at this time? It depends which one, but the count one one we're all thinking about is how we're going to basically decrease inflation and get back to to a low level. In

that I'm not as optimistic as as most people. I still think it's going to be viat. I think inflation has a lot of momentum. I think wage golf is you know, there's a very tight labor market. Wedge golf is very strong. The fect is going to have very hard time stewing down the machine and it has to admit that it has to stow the machine a lot. And we don't want a recession. But you know, there's

this term come golf recession. I think that this will have to come with some increasing unemployment and maybe some increasing ways beyond what is currently priced in. With all of your work, and particularly with the firepowered M I T and the seventies you live the dismal seventies and the debate over trenched entrenched inflation. You have a chart at Peterson Institute of the seven or eight year battle to extract ourselves from nine eighteen. Is that our future

out to two thousand? Now it's the past, it's not the future, but it's a warning. Uh. You know, basically what happened is that that just delayed doing what it had to do, and pull Voca came very late in the game and just want at it. But you had to increase rays by first in a hundred basis points to actually get to where he wanted, We're not going to go there with feed is much smart. Facial expectations

are not as bad. But you know, the hope that we can do all this by having rays going to two point five or even three, I think it is a hope, not not in my my book of forecast. The hope is underscored by the mystery of some of the tools that the FET is using. And I'm thinking most importantly of the federals Ers balance sheet, possibly reducing it by one point one trillion dollars over a year.

How much do we understand how this reduces inflation? Well, you know, it's likely to make the long rates a bit higher than they would otherwise be so to the extent that long rates affect activity, that's going to basically slow down again the machine. And that's the way you reduce inflation is basically by making the labor market less type than it is now exactly how it works, I think when it comes to the policy rate, I think we have some understanding of how it affects the economy.

When it comes to quee or QT, now I think were we know much less And if I have a father would denounce some path but not feel that I'm committed to it if it turns out to be the stronger weaker than expected. Do you think we're heading into a period of time where inflation is structurally higher than it has been over the previous few decades because of the globalization and because of some of the shifts that we've seen that were accelerated during the pandemic. No, I

don't think so. I don't think there's any close link to say, between productivity goal for globalized or any of these structural elements and the rate of inflation that the economy has. The rate of inflation can be anything. You just have to to have it flat. You basically have to uplay the economy at for employment, not hotter than that, not colder than that. But you can have any rate of inflation you want. Olivier, you have lived the vogues and the religions of the moment. You and I remember

where the world stopped. I believe it was on a Thursday afternoon at three pm, and we'd all count M one, M two, M three. There's been any number of other religions of economics. What's the religion right now that we need to be aware of that? We need to fear well. I was never kind of in the m one and to m free religion. I always thought that was that

was the religion and not not not not science. I think, you know, the way to think about how much peoples he works is to have to look at the yelk of and so of the of economic activity depends on the short end of the curve, some of economic activity depends on the long ends the mortgage rates and basically the however yield curve the more tightening, Okay, is I think that you know, if I had to choose one object as opposed to say I'm one or I'm two

or whatever, I would say, just look at the yeld curve, and the yel curve, I think is telling us rates are going to go work for a while, then maybe they'll come down a bit, at least adjusted for inflation. Uh. And I think that's you know, that's the tool that the FED has. I mean, the old days it only played you know, at the short end. Now it plays all the way through the yeld curve. But that's the object. I think we have to look at, what's the tool

of real yields. Olivier and I talked about this as the real yields, the inflation adjusted yield anten your treasuries moves to the highest the least negative, I should say, going back to March, Yes, I mean you have to realize that we're still in in an era of very very low bial rate UH. At the short end of the yield curve, bill rates are very large negative. At the long end, they are less negative than they used to.

I think they are getting closer to zero. I think that's what's needed to get the economy going in the long run. We don't exactly know what the long run equilibrium rate, if you want to call it this way, is, but it's probably around zero at this point. So if we were you know, if we are cruising along with no more inflation than target, then I would say zero is probably the right number. But we have before we get there. We have to get inflation down, so we

have to go above zero in terms of real rates. Olivia, We've better leave it there. Thank you so much, really looking forward to your work with the Peterson Institute, particularly on the new inflation level. Professor Blanchard. Right now we hold court with this colleague severta Supermannian head of Equity and derivative strategy at b of a. Buried in your note sa Vida is the mathewiness of your Berkeley, which is followed the money, follow the cash to borrow from Colbert.

It's a cashiness moment. How much cash is our cashiness? Cash? Well, listen, I think that what we're seeing in the in the overall investment landscape is a reallocation towards the short end of the curve. I mean, we've seen it with Wall Street strategists. They amped up their cash recommended cash allocations and took down equity allocations. I think that's actually net bullish for equities, because what we found is that when Wall Street gets barished, that's generally assigned to get bullish.

But when you think about the overall market, I think the reason that you want to buy stops right now is the cashiness of the market. And you know, the good the good news about the government and the FED being in debt is that they passed on a whole bunch of liquidity to consumers and corporate Something like nineteen trillion dollars of cash went from the public sector to

consumers and corporates. And that's good that cash. Like you said, it is going to be worth It's going from worthless right now yieldless to three percent by the end of the year. That's a huge move in terms of the return profile, especially against a backdrop. Well, we don't think that equities are going to return anything close to that

on a on a longer term basis. UM. So, I think all of this conspires to create an environment where some equities are going to do well and those are the most cashy of the equities and um and we can talk about sectors in a moment, but I think that there are a lot of parts of the SMP five hundred that look incredibly attractive from a free cash flow perspective and are also relatively inexpensive versus say tech or you know, high growth stops. At this point, de civated.

That takes us strike to energy. Why stick with it after the massive move we've had here today, Dick with energy. I know it sounds crazy because the set has basically doubled or tripled, but you know, look, if you look at at the world around us, everybody still hates energy, and um what we found in our work is that energy is still a massive underweight, and the average long only portfolio same underweight that we started last year with something close to you know, over at ten percent underweight.

But the sector has basically doubled in its size in the benchmark. So last year it didn't necessarily hurt to be out of the best performing sector. This year, it is probably going to hurt a lot more. And our view is that energy is still incredibly inexpensive, still offers a very high free cash flow, real free cash flow relative to other sectors. Um the free the earnings have kept up with its price moves, and it's it's really a sector that's gotten capital discipline. It's playing nice with

E s G investors. I said this all before on your show. I think energy is now finally investable again. But folks haven't necessarily moved into the sector as aggressively as we would have expected it. And a lot of people would agree with you. You're seeing an increasing number of notes coming out saying that it's frankly, there's an

under allocation to commodities. What about big tech though? And I do want to shift there just because this morning has been the bulls and the bears on Apple, with Dan Ives coming out and saying this is the most attractive time to go all in since two thousand fifteen, and then JP Market actually cutting their earnings forecast for

Apple based on a consumer appetite. Where do you sit on this, Well, I'm not a stock analyst, but I would say that there are parts of big tech and there's a more yield quality, maybe old boring tech areas

that have sold off enough to become expensive. So, you know, I think every week after big moves in the market, what we recommend to investors is to just run a simple screen of free cash flow to enterprise value and look for the cheapest UH tech stops and and they you know, the good ones rise to the top, and those are the ones that I think are are likely to outperform. So look for free cash flow at a reasonable price, because, as you mentioned, cash is king. I mean,

we're moving from zero to three percent on cash. That's all you need to know in this type of a market environment. Soveta just to found a question the index CO year and forty six hundred. Where are we now only have some pages short of forty undred? What are you telling clients about your index co? You know, look, I mean we're neutral on equities. I think the market's going to bounce around a lot. You know, I think it's gonna hit our target a few times this year

and then move higher and lower. It's gonna be a year where I believe there are gonna be opportunities to add exposure to tech, to energy, to areas of the market that get punished by you know, the vagaries of fat expectations, et cetera. But forty s dred to me still seems like a reasonable target. UM I would watch corporate and consumer confidence. If those two measures in the US start to ail and we see capex, you know, expectations start to drop, that's when we would get a

little bit more bearished on ciplicals. But so far, so good to Beta. Wonderful to catch up with you, as always, always enjoy the rating of the research out of Bank

America's vatasive amounting the bit of execuities. We continue with this discussion and a lot to talk about in a divisive debate on the American economy, and there's no one more qualified than Vincent Reinhardt with his heading of economic research at the FED and particularly the Greenspan FED Chief economist at Venerable Dreyfuss and Melon were thrilled at Vince rightin Erica, join us this morning. Vince, A personal note after I finished reading every word of the minutes yesterday.

Who writes the minutes for the FED? When you were at the FED, were you the guy that wrote the minutes? I finned him for the best six or seven years, and was involved in drafting for a decade and a half before that. But the reality is is that a group does it, and that ultimately it's the responsibility of the Secretary of the FOM seat at claus now. But every draft is seen by every person who was in the half m c room for those two days, so

it really is a group effort. Interesting, Vince, let's talk about this interesting economy. We've seen group a massive division this morning. Bloomberg surveillance over glass half full, half empty. When you see claims where they are, what does that signal to you about a fully employed America? The glass is more than half full, and the Federal Reserve is gonna have to uh take a little bit out and that is a difficult pivot that they're trying to undertake

right now. Uh and uh, just you know, what was your conversation in the last five minutes. It's really hard to read the data. It was distorted by the pandemic depression. UH. The the experts have no idea what the seasonals are. You have to really appreciate eight that the information we're getting in real time UH is is somewhat suspect. Vince it.

Do you agree with Bill Dudley that if if we do not see more of US sell off and equities, and if we continue to see inflation run as hot as it's been, that the Fed is going to have a more aggressive action against directly trying to torpedo where

equity valuations are at this point. I wouldn't put it that bluntly, but the reality is monetary policy works through financial markets, and unless financial conditions tightened, UH they're not, they will be removing policy accommodation and putting restraint on the economy. The reality is that the overnight federal funds rate, the policy rate of the f MC, doesn't matter a

whole lot for anything. It matters how it gets priced in through the yield curve and into other financial asset prices, and unless those prices move in a way to tighten financial conditions, the film seeing will not have accomplished UH slowing the growth of aggregate demand to something more sustainable

given the level of where we are. So if the market is pricing in several series of fifty basis point rate hikes in a row from the Federal Reserve, as well as potentially one point one trillion dollars a Federal Reserve balance sheet reduction over the course of a year, then how much further would the Fed have to go in terms of signaling or even rate hikes to actually

tightening conditions enough. Well. Uh, One thing to point out is even those succession at half point hikes imply the real federal funds rate denominal federal fund graded less inflation will still be negative. And that's the measure of policy impetus. So a lot of what the Fed has to do initially is just catch up. And until they have passed the catch up stage, Uh, then it's it's time to

the questions you just did. At a pace of a half point point point over the next couple of meetings, the committee will still have to be tightening well into next year. It's not a fordom. You have maybe lived the FED more than anyone we speak to and from Volker and with all a lile brainers in the uproar two days ago. From Voker to where we are now, is you look at it is the Great Moderation over? Uh? Yes,

I think that's right. We have one way to put it is we've had two generational shocks, a great finding, a pandemic, and uh European war in the space of two and a half years. And that's within a decade of what we have fought was the Great financial contraction. Uh, We've We've added a lot more to volatility. Importantly, the

Great Moderation was the great anchoring of inflation expectation. We achieved what Volker and Greenspan talked about a situation in which households and firms were concerned about a changeable price level in making their decisions. Were out of that range. And we're probably out of the Great Moderation as well. So Vince right at the money question is if the moderation is over? Greenspan invented with you along the X axis this word measured. Are we done being measured? Remember?

Greenspan also produced the policy tightening of that included uh, started with quarters, then put in intermeding actions, then fifties and seventy five. Uh. So I think he was willing to do what was appropriate. I think you're right. I think that being measured at this point, uh has some drawback. I think a better word than measured is predictable. The fact could do a lot, but they could let everybody

know about what they're going to do. A feature of ninety four ninety five that we forget is markets were really volatile. There are a number of blow ups, including Orange County and prominent and prominent hedge funds. So uh, if you have a more assertive and changeable fed to address macroeconomic concerns, we might just get a lot more financial market volatility. To Vincent Ran, how that of dry for cementa Vincent great to catch out with you said.

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 and economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom keene In. This is Bloomberg