Surveillance: Fed & Inflation With Crescenzi

our Kane. It's complex, and you've got to read the fourteen thousand pages of stagums written by Tony Kriscenzi to understand a little bit of it. We don't have the time to do that, so we'll talk to him instead. Chriscenzi a pintel Now on where we are, Tony, there are two groups. The FED is organized. The FED is providing stability and the overnight market surge we've seen in Rebo is no big deal. There's another camp that says, Bologny, the world's fallen apart, which is a bringing chart upbread

for TV and on radio. All you need to know it's a spike like you've never seen. Think about Jeff Bezos going up in space. That's what the spike looks like, Tony, what's it mean? Well, it's as if the FED wrote its recent framework on disappearing inc to some. Because the FEDS new framework released last August said that it wouldn't raise this policy rate until the inflation rate had gone above its two percent target for some time. It hasn't really done that for some time, and so hence the

idea of disappearing INC. This is the spike we're seeing in rates. Of course, relates to the FEDS communication. And I should add that Bembrank is an advisor to Pimco has famously said that FED policy is two percent action communication. It goes to show how how strongly markets take the word of the Federal reserved. And certainly UM they were taken very strongly. So so the rising rates to just to sum up UH, I would say that it's as if the Fed is UH put the inflation cop back

on the beat. It wanted to regain control of the inflation narrative because the public's hype over inflation had gotten too high. The fact got spooked. That's what it says, and it'll probably be good final words Tom on this UM. It'll probably be good for the equity market, for the credit markets, private investments, including real estate, because it looks like it will uh rain in inflation fears, but it

made in fact. But Tony, this is really important. If Chrisensi's telling me that FED got spooked, that's really really important. What about the responsiveness, the male ability, the dynamics, the elasticity of trillions of dollars. I don't understand the theoretical model of what that money does. It came from this pandemic. Well, we see seven fifty billion of it in a FED repro facility. There's still a lot of money slashing around. And it's the reason why the Federal Reserve raised a

few official polls. Just should say technical policy rates that it attracts it has. Its official policy, of course, is around zero. But it does things to tweak behavior in the money markets. And last week it raised two specific rates by five basis points because so there's so much money floating around that it was putting downward pressure on money market rates called commercial paper, etcetera. And three month bible, which reached an all time low of thirteen basis points

last week. And so there's still that money still is out there so to speak, and it won't be removed for a long time. Remember, the FED is still purchasing billion dollars new securities per month. In other words, it's printing another one billion of money each month. It will do so into next year, and it won't shrink its balance sheet for a wild Why because it's going to reinvest the principle and interest payments it gets on the mortgages it has. And the Lisa, I don't mean interrupt, Tony,

but this is so damn important, Lisa. What's so important? And Mr Senz just said, is that phrase for a very long time? I mean, that's really what the markets arguing about. Yeah, the the issue here is that people are trying to extra plate forward. What the trillions of dollars in excess cash slashing around that Clearly banks and the FED are struggling to know how to handle what

the ramifications for this will be. Salton Posar of Credit Suite writing in a recent note that by paying trillions in reserves five basis points, the FED just planted the seeds of the next liquidity crisis. Tony, do you agree? No? For one, markets understand the Federal Reserve's reaction function, which is that if there were a liquidity problem with that, the federals would stand up and inject additional liquidity. This is something we learned after the g FC, the Global

financial crisis. There was some doubts about whether the FED would stick to it in two thousand and thirteen when there was a so called tape attention. When there's a fear are like now that the FED might remove its monetary accommodation. That fear subsided over the years, and look today, Federal reserves communicated an idea that the markets didn't believe in previously. Yet the reaction was not much of a reaction.

It's it's rather tame. Uh. You're not seeing meaningful movement in global markets from this, i e. Downward movement in equities, credit and our jump in interest rates. And so it's a rather benign notion related to the reaction function the idea. So this notion that there isn't enough liquidity to the liquidity crunches, uh, not not happening in my idea. What one quick gut notion though, to think about is the idea of chaos in periods when UH credit cycles end.

After two thow we all saw that credit instruments did not trade well. And this relates to the breakdown the so called principal agent model, which is that there's so many dead securities in existence that when the investors go to sell that the system can't handle those securities because

there is no intermediary to bid for them. So that's where there's a liquidity crunch in financial markets in debt securities because of the problems in the broth the principal agent model, and Tony that sort of speaks the so called paper tantrum type of model, particularly in credit, because it isn't traded in the same kind of way as a full faith and credit government debt of the United States.

Here we are, though, with two year yields moving and as a number of analysts noted, people expressing the hawkishness heard by a number of the FED members in markets, but not, as you point out, in credit, we are not seeing the stress in risk assets. How do you make sense of this? Well, first, I thought the first thing I came to my head when you said that is corporate profit story cash flow. What investors care about bond investors ecuting investors is cash flow. A bond investor

is about getting his or her or its money back. Uh. And the earning story is quite good. In fact, we think the the equity that investors should be overweight equities today overweight credit. The story and equities is that the earnings will grow near thirty percent this year, and most projected we would project as well that earnings will grow tem percent next year, tem percent the year after that.

The Federal Reserves communication, if anything, will elongate the economic expansion by team tapering, I should say, bringing down inflation expectations, inflation fears the type that might have truncated the the economic expansion. And so the story is looking good. And again I mentioned I refer back to the notion of the Fed's reaction function. Most believed that the Federal Reserve would step in and take action if, in fact the

knockts got into trouble. Tony, I wonder about the renewed as Ben Rom calls it on the m Live blog. Hey hey, Tony, good to talk to you. He says, there's a renewed quest for duration, and I wonder if that just point to market expectations of real volatility coming back in rates. Looking out several years and into so called forward rates, one sees that and even out five years that the market consensus is that interest rates of course, the you OC curve will be in the low twos.

In fact, that's down twenty basis points in the past week or so. We would say that the sixty forty model is alive and well. Returns have been quite good this year, called it seven or so. We still believe in the hedge value of high quality fixed income instruments. And I said earlier that we prefer to be overweight credit, overweight equities, ovoid private assets including real estate. But that's

not a very balanced portfolio. We would say then that the way to balance that is, of course through the use of aition having fixed income up in a portfolio because in the long run of adverse scenarios will affect treasuries in a way that benefits portfolio while the other instruments don't fare so well. So so we believe in the head value of treasuries and and the still big

believers in that's a shock, you know, I was. I've been terrified to check my I r A over the last couple of years as we continue to hear that the sixty forty model is dead and gone. Why was that and and how come you think it's it's healthy and surviving well. Thinking first of the returns for the year,

which are quite respectable. UH cent or so is a fair return, and it's very difficult to surmise that in a quite adverse scenario that longer term treasuries, and then this has been demonstrated in the past week, would not

fare well in an adverse scenario. So last week a microcosm, perhaps when the Dow Jones Industrial average was following five points longer term treasury yields with falling uh and this is the sort of behavior we would expect in other adverse scenarios, and that could be prompted by numerous things that are difficult to predict, but we do believe that

investors would move in that way. I should add finally that the reach duration is a global story, and this is obvious in Germany where yields where you are, where yields are still in negative territory, and also in Japan, of course, where the near zero all the way years

practically correct. So the the reach for duration, the need for it is still high, and I should the final final note is in sixty models because of the performance of equities, if anything, is likely to be some adjustments by large pension funds and other investors following it into fixed income, especially given some of the volatility of thank you so much, thanks this morning. Right now, all of

this market action dovetails into the banks. There has never been a crisis like this in the career of Gerard Cassidy. He's with RBC Capital Markets and joins us right now.

He has seen this before. Angst and handwringing. What does all this uproar, Jerry mean for the big banks, tomm You're right, We've been through a number of different cycles and each one has a different side to it, but this one it's quite interesting because we've not seen this low rate environment persists for so long, particularly on the long end of the curve, with the likelihood of inflation heating up two levels possibly we haven't seen in over

twenty five years. So the industry right now is grappling with an excess amount of liquidity caused by the quantitative vizing by the Federal Reserve. As you know, Tim, they're balancing defense balance sheet now is over eight trillion dollars, and that's up from four trillion prior to the pandemic, and that's got into the banking system, which is weighing

on their margins along with this rate environment. You know, I looked your right and we were talking about thirty or four dollar lobster roles because we were coming on with Gerard Cassidy of Portland, Maine. And I guess the question is, when you see a pullback in JP, we're going of eleven percent or other selected Cassidy stocks, is it time for Gerard Cassidy to load the lobster boat.

I think it is, Tom. In fact, this pullback is a great opportunity for investors to buy bank stocks, whether it's JP, Morgan Chase, or Bank America, earning the large regionals like a PNC or Truest. And you're right, Tom, if you believe that the U. S economy is truly growing at six or seven percent and throwing three or four percent for inflation loan growth historically, Tom, going back to the nineteen forties, it's carlat it's a nominal GDP growth and the low growth hasn't shown up yet because

of the liquidity of corporates and consumers. But over the next twelve months, we do expect to see loan growth with the growth in the economy the way it's projected today, at least that this is so important, you know, Grizzel pro like Cassidy who remembers that a lobster roll was three dollars forty And I'm sorry, the fact of the matter is he's looking at twelve months, not twelve hours. Tom. I love that your priority right now is a lobster roll.

I am right there with you, Gerard, talking about the liquidity beyond perhaps the beverage of your choice to accompany a lobster roll, but rather the liquidity in the financial system. You talk about extending loans. The idea that there's three point nine trillion dollars of cash of reserves at the Federal Reserve versus pre financial crisis of forty six billion

dollars on average, a complete magnitude change. What is the trajectory of getting that money into lending at the same time people are drawing down their deposits and actually spending that cash, perhaps taking that cash out of the banks and into the economy. Now that that is the key metric, and it's you're very observant on the numbers, and I would suggest that that's what the banks want to do to the banks. As I try to remind myself and investors,

banks are in the business to lend money. They want to lend money to qualified borrows, and in right now the demands not there, but as the liquidity is used up. And remember, the consumer has a number of benefits that are expiring in the fall. For example, if you're a student and you're deferred your loan payments, that expires in the fall. So I think you're gonna find people are going to be used up their stimulus payments to help

with their monthly cash flows. And then we're revolved back onto credit cards, which were starting to actually see so maybe they are buying those lots of roles Tom the thirty ft dollars. Maybe people are buying lobster roles. I wonder if companies are going to start buying other companies, because he asked the consumer balance it's looking pretty healthy, but companies have a lot of cash on hand as well.

And Jamie Diamond last week and talking about the fact that okay, yeah, trading isn't going to be as great look to M and A as a driver. How much of a growth catalyst do you think M and A

will be for these banks. And you know, and that's a real good question, and I think it will be a real driver because as corporates become more confident that the U. S economy is out of the downturn that we experienced last year, do the pandemic, they will have more confidence to either build new plant or equipment or go out and buy a competitor to become more efficient.

So we do see that as being one of the accelerants to loan growth, along with regular corporate loan demand, you know, the building of all the new green initiatives, whether it's electric vehicles and other things, those two are really demanding corporate borrowing. And that you will pick up

as again confidence comes back into this economy. How much does your buy banks call get threatened by a flattening yield curve as many people now are looking at the consensus call as being of that continuing No, that that is a risk. I I don't disagree with you whatsoever. If we're chatting here a year from now, in the ten year government bond yield is a hundred and ten basis points or a hundred and twenty basis points, and there's more talk of the FED raising shorting that that is,

that would be a very challenging bank stock environment. I don't disagree with you, Jerry, I don't care what I care about drug Cassidy is Connecticut or a main lobster role? Are you gonna go with a butter sauce? Or in honor of your colleague and crime, are you gonna go with the Mike mayonnaise Like a good main guy. You gotta go with the butter sauce. Time with the nice I p A and we'll we'll call it a day.

Butter sauce. I never thought, Lisa, I'm absolutely shocked. Really yeah, just think he was ice called Mike Mayonnaise and the whole thing. No, butter sauces is far superior. Okay, thank you. I learned something finally today on the show Gerard Cassidy of RBC Capital Markets, truly expert. We didn't even have time there to go for his single best buy within the south Side and ben Emma's was booked. We said, yeah, okay, great,

seven a slot. Is wonderful that Ben Emmons with us on this Monday, and then things blew up on Friday. So this is a genius booking of Benjamin Emmons and mentally Global Advisors with an important research note over the weekend,

what'd you right? Yeah at him, I was looking at the dynamic of the of the curve on Friday, and you know it speaks to that you get guidance actually through the dop lots, which was different in the twenty thirteen when the fat actually didn't do that and yields jumped, and so the opposite effect that happens on the long end of the UK that says, okay, maybe these future right acts are sufficient to control inflation around that two percent. So the market is given some credibility on that front

to the FAT. But as also lot of technicals at work, and you probably have talked about with Tony, you know, dis positioning that took place prior to all this flattening ever seen was really predicated on that market expecting as this is folks, this is what we do when we invented surveillance. This was a couple of months ago, when we invented surveillance, we said what we want to do is get a short term guy like Chriscenzi on the show and then get a long term guy like Emmon's

as well parachute in the Chriscenzi's market. Long term, people like you and frankly Jerome Powell, what do they think of trillions of dollars in the Kresenzi space, overnight repo and the rest of it. So it's not only substantial, but it will continue to compress short term interest rates over time. As much as you want to communicate that you're going to raise rates, you can't have expected to yield to jump all the way out to this projective

rate that the fetest put out. I think it's more like a very slow normalization and markets are no notice actually because we've experienced this in two when we were eating slowly with the two yields over time, I think that's what you can expect um. Whereas on the low end of the U curve it's this dynamic. I think of a technical positioning and the fact that you know, maybe these rates are sufficient to keep inflation the future under control. All right, So if it is technical, are

we almost through with the technicality? Ben are we moving into a period where perhaps long ends along end of rates can possibly rise on the prospect of less fed accommodation. I think we said that the weights communicated this same compared to twenty thirteen. Is that you know, we were missing guidance own rates in twenty thirteen. And if we have this idea now that okay, it's gonna go that trajectory, you take out some of that rish premium out of

the low end. At the same time, to your points, probably there some scope for rising long term rates as new data comes in and surprises still to the upside. You know, let's face it, we have an economy that's really strong. It's not normal to have rates at these low levels. Um, it's as we talked about a few weeks ago. It looks like this loca it so I would think an explay Rover report, even the core PC data comes out this week, surprise to the upside, probably

a catalyst for rates to somewhat normalize. Again, back to inside the race where we came from, Ben, did we already get the taper tantrum? Was that what March was? Maybe Caylee, but um, you know there's a definition about the state potenttrum at Antoni thirteen. It was really a communication that confused markets and led to this repositioning on Okay, we didn't really expect you to go this fast with ending quee and then moving to rate acts maybe in the future. So and that respect, the FED I think

has done a really good job controlling that aspect. But I think what the markets were not expecting last week was to see this dog blot shift. And I think what really having on Friday was just completely recalibrating what we saw in March, where you know, the expectation for rate acts were the same as they are now today, with now the difference that the markets understand what the FED is potentially planning to do, including you know, working

towards this the start of the tapering process. Well, Ben to Kelly's point though, isn't it surprising that you're not seeing a bigger wobble and risk assets given the fact that people are starting to think about tapering sooner. I think it's a two two things going on at least that because yes, stapering means you know, removal of accommodation over time, but we also have to discount of fact

that the fet is still super accommodated. Fact we will continue buy on twenty billion dollars a month, which by the way larger than in when it was like eighty five billion. So so we're going to continue on that pace for at least a number of months, if not longer, until that tapering actually happens, maybe presumably in two So you're looking at a balance sheet that's going to extend beyond nine very quickly, around of time, very quickly. Here, what do you need to hear from FETE officials in

the coming days, including today? I think you want to hear that what they've put out as as projections is a what we call bullish forecast. They're looking at the economy will be protected. Here again, this surge of inflation and this forecast that they put out on dop plot has always been considered to be an individual that a's re emphasized right. They are still at the starting phase of considering future organization. Thank you so much for Medally

Global Advisors. Jane Foley joins the rubble Bank. She's been dead on And what's so important, folks, is there price targets are moving. I mean the idea of you get a price target and a cup of coffee later you're halfway there? What do you do with your movable feast of FX targets? Jane, how ugly is this ben and how do you adapt and adjust rubble bank on a Monday morning. Well, to be honest, you know, my my one month target at the end of last in the

middle of last week was at one twenty. I haven't changed that yet because we could have a little bit of price adjustment. But I do think that the dollar is going to remain strong, certainly into the rest of this year and certainly this summer. I mean, there had

already been a lot of focus on Jackson Hole. Maybe that was going to be the meeting where the Fed became in a more hawkish but I think what we saw last there's a clearly really surprising market, and what we've seeing now is a huge amount of dollar positioning just being squeezed out here. Well, the dollar position has been squeezed out. I got a little static on the land. We're gonna keep going with Jane Foley, see if we

can get that. That's you know, clearly, that's what happens when the micey the wires over the weekend released seven thirty and the mice coming and working the wires as well. Jane. You know, I look at the Pacific rim play just as something that we haven't talked about today away from the majors, and there's just been this idea of better economy,

Pacific RIM excellence. If I get a strong dollar, I can't get Pacific RIM currency strength, which wins out well, I think in the short term it's going to be the dollar. But you know, what the Fed has done last week does potentially allow other central banks to put a different slant on their policies. But since if we consider you know, the r B A, the r B

and Z, those economies have been pretty good. They didn't really died that much last year compared with other detail economies, they've had really strong rebounds um and yet the central banks, or particularly r B A has remained pretty wish. Not so much to the r B N s A. But you could argue that now that the dollar is strengthened and their currencies have come off, that this could really open the door for other central banks to be a

little bit more hawkish too. Now you could potentially apply that same sort of logic, maybe even to the Bank of Thing or maybe even to the ECB. To what extent does this open the way for other central banks to to subtly change their turn Now we're not necessarily expecting the shocks that you've we've seen from the FED.

And we look at the the Ye curves in the UK and look at the Yo curves and in Europe and Germany compared with the US over the last few days, we haven't seen that much movement, but you know, it could mean that we will see more central banks been brave enough to come out and being a little bit more hawkish because they don't need to fear that their exchange rate is going to start zooming higher. Well, and

that's on the developed central bank side, right Jane. And when you look at emerging markets, the Bloomberg or the m S c I E m f X index right now hovering around its lowest level in a month, obviously on the losing end of that dollar strength equation. And we know that emerging market central banks have been raising rates, they have been tightening policy. They are trying to combat rampant inflation. When you look at the legs of Brazil and Turkey, are they going to be able to provide

enough support to their currencies? Well, you know, I think at some point we've got to look at the various different emerging markets in their own given their own fundamental capacity rather than look at the group as a whole, because some are better positioned than others. But clearly, you know, in terms of there being a stronger dollar, in terms of there being a FED who's a little bit more hawkers than than than it was before, that is clearly

bad news for the whole all of em. But we still remember that, you know that the theft has still being accommodative at this point. Is it's just a little less commoditive than before, but still accommodative. So from that point of view, there will be still value in some emerging markets, but it will be the investors that are able to, you know, put apart the different em countries and look for the ones that can still offer value. Gene. Of course, we're getting the Bank of England decision later

on this weekend. Right now, I'm looking at a cable rate one thirty eight or so. It is the pound is the strongest performer in the G ten space today. What is your base case for the pound? Well, you know, we have seen obviously Sterling come back against you. We stole in the last couple of days. That's not the same sort of story that we've seen in Sterling against

the euro. It's we've still really very range bound and although it's it's it's moved a little bit, it's still towards the end of the lower end of its range. Now the Bank of England, as you said, is clearly in focus, probably not going to be that much or offer, but I think the market's always expecting that chief Economist whole day is he leaves the bank this month, will come out with some hawkish parting remarks that I think the market positioning for that. But I think there isn't

going to be any particular surprises over the summer. But later in the year we could have a little bit more taping from from the Bank of England, so we need to watch out for that. But that assumes, of course that the slowdown and reopening the economy in England and doesn't impact confidence so too much that we still carry on and see some see that the remainding reopening of the economy take place in July. Jane Fowie, thank you so much, greatly appreciate it, and tumultuous day. This

is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am. Eastern and Bloomberg Radio and Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And abscribe 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.