Surveillance: Fed Credibility With Dudley

with the timely essay at this morning. It gets us to Wednesday, but far more gets us to the new new and the new theory. Bill, I want to go back to Berkeley, and I've always had such a respect for the interesting faculty that shows a University of California, Berkeley over other institutions. And it all wraps around a theory of belief of behavior, and that wraps around this strange word credibility. What is the character of the FEDS credibility in a time where we're making it up as

we go. Well, there's a risk to their credibility because one, inflation is higher for longer to inflation expectations are starting to rise, and three they sort of bound bound themselves in terms of you know, when they can actually raise race.

They said they're not going to raise rates at all until theyve hit two percent inflation, hitful employment, and our confident inflation is going to stay above two percent in the future, inflation expectations get an anchored, that's going to push inflation up even before we get to maximum sustainable employment. So they could be in a tough spot. Be in

a tough spot. But take it back to like the history of Ike and Grain, or maybe the social economics of Brad DeLong and the other young turks out at your Berkeley Here. Again, we're making it up as we go. With the debt dynamics that we have. Now, what is the theory that you would propose to maintain this valuable, this precious credibility. Well, I think the FET should be a little bit more flexible in terms of when they're

willing to raise long term short term industries. Uh, if inflation expectations truly become an anchored, that's a problem for actual inflation, and I would think that they would have to react to that. The current regime where they don't do anything until they reach maximum sustainable employment in their mind,

might turn out to be too late. How concerned are you bill to that point about recent consumers consumer confidence surveys that show that consumers expect inflation to be materially above the Fed's expectations over the next three to five years at a time when this is also dampening their optimism. Well, the New York Fed publishes a household survey of expectations about inflation, and the most recent reading is really quite

uh disturbing. The three months inflation expectations are now up to four percent, which is essentially double what the Fed's actually targeted. Great, So, how concerning is this too? I mean, the idea is that can sumers don't always get it right. However, this does signal a credibility issue beyond markets for the Federal Reserve to address. Well, the key questions whether people trust the FED. If people trust the Fed and trust the Fed's forecasts and inflations, expectations will come back down

as inflation moderates. If people don't trust the Fed, inflation expectations will stay high, they will push up inflation, and the Fed will have a have a problem on scenes. So do you think that the market could potentially have a problem or a disruption if the FED does not signal tapering soon enough, Well, I think the FED is

going to say single tapering pretty soon. I mean, I think that this meeting they'll probably reinforce the idea that they're making progress towards their goals, setting up the notion that taper infected to be announced at the November f MOC. Meaning so, what is the effect of the senior age of the US dollar on all of this philosophy and calculus? We are different with the US dollar. How does that

make Chairman Paul's press conference different on Wednesday? Well, having the dollar as a reserve currency allows us to attract the foreign capital on very attractive terms as long as we have credibility. If people start to doubt the FEDS commitment to a stable inflation over time, you know, then the dollar would start to weaken, and people that if that went on for a good period of time, then people might start looking around for substitutes to the US dollar.

But you have been a great optimist on this, you you know, within the body of the William Dudley work. Frankly, Bill, I'll take it back to Goldman Sex. You've been a great optimist on the institutional strength of the American system. Do you maintain that that institutional strength is there with

the fractious Washington that we have. Well, the thing we have going for is number one, we have a very deep and liquid capital market, and to the FED has done a good job keeping inflation and checks, so we have credibility with the rest of the world. As long as we don't mess up our economy. People are going to be willing to continue to use the dollar as the reserve currency because there aren't really great alternatives, you know. I look, Bill, we've got to get back to the

markets here as they are. Challenge futures a negative eighty one. But Bill, to me, it is just a FED on a massive ex post basis will wait and wait and wait. We're mentioning Alan Meltzer of Carnegie Mellon earlier. I think of timber Lake and the Georgia School, and the answer is, when in doubt, wait right. Well, I think it depends on what the risks are. I think one thing that we will see this this week is the dot plot.

The forecast of interest rates in two will probably show more people being in favor of rate hike in two and then may reduce the concerns about the FED being late, but you face down the risks out of China many times on the f wem C. I'm thinking of the summer at I'm thinking of early as well. If we were the FED looking at the risks that are playing out at the moment building in China, how are you processing that, digesting the moment. But I'd love your insight

on that. I think your experience is really valuable on this particular top peg Well. I think you know that the Fitter Reserves certainly understands that China's an important player in the global economy of the China had had a hard landing that would have very serious consequences for the

rest of the and and for the United States. I think at this point it's really premature to reach that conclusion, though, that Chinese have tried to tighten things up before, and when it starts to actually affect the rate of growth and employment, they tend to ease off on the brakes, and I think that's what's going to happen this time

as well. How do you think the Chairman will approach that issue in the news conference this Wednesday, Bill, I think he'll just say that we take the world as it is, and obviously we're updating our views about what's happening in the rest of the world as things unfold. So I don't think he's going to make a strong statement about his views about how China's gonna unfold. Well, but do you think Bill, for example, if there is a draw down like sum are expecting Mike Wilson in

particular Morgan Stanley, what does the FED do? Do they not taper at all? Well? I deviously, if things happen in a way that change the economic outlook in a meaningful way, then obviously the Fed world just course. But at this point they're not going to react to, you know, small market moves and then defer the tap tapering on

that basis, they have to change their economic focus. That's why the summary of economic projections this week is also important because it's basically tell you what the FED thinks about how the economy is like to evolve, not just in one and twenty two, but also twenty three and twenty four. Bill, this Fed is a different Fed than the one that you are a member of in the sense that it's balance sheet is bigger and the stakes are higher should there be a disruption, because their ammunition

is just limited. How much does a nearly nine trillion dollar balance sheet tie their hands going forward in terms of how much ammunition they can really deploy. There's no limit on the size of the FED reserves balance. They can make it much bigger than it is right now. I mean, it's obviously we're not used to having a balance sheet of this magnitude. There's no actual limit on

how big balanction can get. Bill You've been very vocal, you know, with the public responsibilities you've had over the years. I really value the Bloomberg opinion essays as well. What is the great research mystery now? If you're lined up with the people like say Vincent Reinhardt of the time of green Span, if you're lined up with the young PhDs at the FED, what's the research idea now to

you that bears immediate and further study. Well, the biggest connunter we have right now is how tight is the US labor market? On one hand, we still have part fall from where we were in February twin twin. On the other hand, the number of job openings at a record level. So is is layer market loser? Is a living Okay? Well, you went right to my third round. I'm gonna go there because of your heritage here with Goldman, Saxon, Berkeley, Bill Dudley. Do we have a clue what the overlay

of technology is on our labor share and our labor dynamics. Well, the labor market is obviously changing in a pretty rapid rate way, and obviously the COVID pandemic accelerated that transformation. So I think it does raise questions about, you know, the level of uncertain we have about the layer market. I think the level of uncertaining about how the labor market right now is unusually. But we've got to leave

it there. An important topic, important conversation got into Wednesday, looking forward to that decision, a news conference this coming Wednesday. Build don't think that Bloomberg opinion columnist and senior advisors to Bloomberg Economics and former New York Fed President. It is the volatility that Lori Kvassin has been wasting for the OBC Capital Markets head of U Security Strategy joins us right now, Laurie, is this it is this the set up, the beginning of it, at least that you've

been waiting for. I think it very well could be John. I mean, you know, looking at the futures this morning, this is the first time in quite some time that we've had a real meaningful break and I think if you talk to investors, UM, the fear is starting to become palpable, and ultimately, we really do need to see a break in institutional investor sentiment and positioning to get this pause that ultimately refreshes UM. Look, you know, we've

been talking a long time about this. You know, we've talked a lot about the deceleration and the rate of change in SMP earnings growth time and time again. Coming out of a recession, it typically leads to a pretty meaningful pullback in the stock market. Um, it is natural for this kind of pullback to happen, and we've got a lot of a lot of other catalysts besides slowing earnings growth that are starting to perk up to help

catalyze that downward move. So look, I am actually somewhat hopeful that we can just go ahead and get this done and get this out of the way and then move on. UM. I never want to see a down market, but I do think that this is just a natural part of the process. When you come out of a recession, that you have to have this digestion period. What is the overbought nature of the market right now? Of institutions,

what's the character of their confidence. I think that it is a hope that some of the pressures we have on the market and earnings growth, in particular on the inflation side, the supply chain side, that those will be uh resolved sooner rather than later. I think there's also the idea that we are heading into a strong economy again next year. I think at the end of the day, investors have to ask themselves what's the risk of a recession? It really is that simple. Is it yes? Is it no?

If the answer is no, you are but typically better off sitting around waiting and buying the dip. It's really only when a true recession fear builds in that institutions will take that positioning down and move to a more defensive posture. LORI, when do we know that it's the

dip to buy? I think that we've got to watch the sentiment indicators very closely, Lisa, and you know, we actually had one take a very good step in the right direction last week, which is if you look at the a AII Retail Investor survey that comes out every week. The net bullishness dipped to about minus seventeen percent, So we saw bears pick up pretty quickly, and we also saw the bulls just absolutely collapsed. Now that's one week of data. We really need to see that hold for

four weeks on the four week average. But typically when you get below ten percent minus ten percent on the four week average, that's a very good bye signal for the market on a three and twelve month forward basis. Now that's just one side of the sentiment puzzle. You also have to look at what institutions are doing. And the CFTC data, which we get weekly, is showing us that we're still sitting around all time highs. If you look at SMP five hundred contracts, if you look at

aggregated smpach are broader US equity market futures positioning. So we need to see that institutional positioning come down, and we probably need to see a little bit more damage on the retail side for a few more weeks. Laura, you'll call forty year and forty nine hundred year end

next year. What it's fed policy fit into this least it's home bringing it up this morning once they could be interesting given what we're seeing on the screen this morning, what's the FED call that goes into that forty next year. So the FED call really impacts two things. Is one our assumptions on multiples, and second are are how we want to be positioned for the broader US equity market.

Like I think, a lot of the damage to the market itself, John was done back in the spring when you saw all the economists around the street clamor for the FED to start sending those tapering signals, and back then we saw small caps really start to underperformed large caps. We've also seen the value trade take a pretty big hit if you look at two que performance. That is important because if you look back at the last tapering episode, we saw markets actually ultimately continue to climb, but the

risk trade took a hit. So value underperformed and small cap underperformed. That's that's I think one issue. But the other issue, frankly, is that if you look at the FED balance sheet, it's really enabled multiple expansions and the post financial crisis era. So if you take the balance sheet expansion away, you don't get any more multiple expansion. That's really gonna be earning strongth griven market going forward. Laura, I'm I'm in a complete sweat here this morning with

futures where they are now. We're in the SPX of four point one draw down. I mean a crisis is it in the VIX? Isn't even at the thirty We're at twenty five point one four. When I decide to load the boat, which sector has the most combination of persistency and velocity into two thousand twenty two. So I'll say the two sectors that I'm gonna be telling people to buy this week are going to be financials and technology. You've got a big pillar of the value trade, big

pillar of the growth trade. I think as we as we come out of these you know, sort of shorter term concerns on the market, I think the value trade will do well again. And I think the financials trade, it's cheap um, it doesn't have supply chain issues that things like industrials have. That's gonna be your cleanest, purest way to play that value pop. But longer term, what we do know about the FED, and so let's move

away from tapering and start talking about hikes. But typically the FED hiking cycle does end up killing the value trade as well. We see that time and time again. UM and I think longer term, when we start to see economic growth decelerate back towards kind of trend like levels, you want to be in the growth trade, and tech is probably your best way to play that. LOI thank you.

Going to catch up as always Lori Kavassin or obviously Capital Markets head of US equity Strategy Andrew Holland Horse drives for the conversation with City Group, their chief US economists. And maybe it's a slowdown Q three, a pickup Q four, and then it's a complete mystery. What is the most mysterious part of the mystery known as economic two thousand and twenty two. I think if there's one big mystery out there, and maybe the most important mystery also, it's

what's going on in the labor market right now? How serious are these worker shortages? How long will they continue? Forth? So we know that we're in an economy that's constrained by the supply side, and the big question is how significant is that constraint and how long will it be? With us? Well, the constraints there, and it wraps around a consumer as well the consumers linked in and supply constraints and particularly linked into the challenges and prosperities of China.

How do you link American consumption of the economy into the dynamics we observe out of Hong Kong and Beijing. Yeah, it's interesting, Tom, because if you do the kind of direct effects that go to three decimal points, yeah you get, yeah, you get, you get relatively relatively smaller numbers. The the the issue, of course is that if you get a general risk off in financial markets, a general concern and financial markets, then we find that global economy has become

much more correlated. We saw that post two thousand eight, for instance. So you always have to watch these global risks, even if when you kind of run the numbers on these things that the direct effects look relatively small. Well me through the China issues right now, then as far as you see them, Andrews the anot of dice. If you're at the Federal Reserve and they faced this a few times over the last ten years, risks coming out of China, how don't they face this one dawn this

time around. That's what's so difficult for the Federal Reserve of course, as the Federal Reserve, you aren't controlling primarily what's happening domestically, and your monetary policy should focus on domestic issues, but you have to take into account any exogenous shock, right, whether that be concerns about the dead ceiling, which you were just talking about, concerns about what's going on externally. So I think that's what FED officials are

trying to navigate here now. I think they deal are in a pretty good place because we have very accommodated financial conditions right now, So they'll probably still be confident in proceeding towards tapering, but you know, as always with the FED, probably leaving lots of optionality, lots of contingencies there in case something happens down the road. They're not going to set themselves on a preset course. Andrew, A lot of equity analysts are very focused on whether supply

chain disruptions are transitory. That's one of the key aspects with margin pressures. Does the FED really care how long they last? Or is that not the inflationary input that they're really focused on. Is it more just the labor mismatch that we're seeing. So I think it does matter

the tightness that you're seeing in product markets. If it continues for a longer period of time, and we're talking about things like semiconductors where this could be continuing into mid two towards the end of two, that's gonna put continued opward pressure on prices and that can push up inflation expectations, and then the FED becomes concerned. But really, again, I would go back to the labor market because ultimately, in product markets, you can expand capacity, you can expand supply.

What it's harder to expand supply of his workers because there fundamentally and fixed supply. So so I think that would be my concern if I were a FED official. Andrew, I'm still trying to understand why it is that the FED is continuing with a hundred billion dollars of purchases,

how it directly feeds into the labor market. Basically, is this a statement saying that the FED has not successfully divorced the idea of taper from raising rates from tightening, and that they will not be able to do that no matter what their communication is. So I think you're not alonely, so I think there are even some FED

officials who are with you. That are looking at what's going on with very low levels of interest rates, house prices that have increased very dramatically, and saying, do we really need a hundred and twenty billion a month of asset purchases? That is it really doing something for labor markets right now, which is the mandate where the FED

is still trying to make progress. So I think there real there are real questions about the kind of marginal benefit of doing continued asset purchases at this point, which is why they're being papered down now. In terms of separating paper from tightening interest rates, yes, I think we're gonna hear from Chair Powell these are separate issues. But remember FED officials don't want to raise interest rates until they've fully tapered purchases. So I think there is a

sense in which these can never be completely disconnected. It it's still a hawkish movement or a less dubbish movement. Maybe we should say to wind down the purchase plan and it does set you up for rate heights down the line. Andrew the linkage here of the great Alan Meltzer of Carnegie Mellen back to your U c l A. I mean, come on, it's a huge deal. You were throwing the two volumes Alan Meltzer History of the FED and said, yeah, I'll read the introduction, give me the

History of the FED right now. And the answer is they wait and wait and wait. There's data dependent now they've ever been right it. So those those volumes are on my book shelf. Tom. I can't say whether or not I've read Oh good. I can say I have not read them. And I told that the professor Meltzer wants go. But but I think that is what the fedest trying to do with this flexible average inflation targeting. The whole idea is we're gonna wait until we actually

see the inflation emerging, which we're seeing now. Now maybe it's transitory, but we're certainly seeing those numbers now, and then we're gonna wait until inflation expectations are moving higher. And we have seen those expectations move higher. University of Michigan five to ten. Your expectation sitting around three percent. Some of the other survey based expectation measures also higher.

So that that is a sense in which FIT officials, relative to their prior policy, that they're essentially trying to be behind the curve. Relative to where they would have been historically, just because it's been so difficult to get inflation higher. Now, when when they start raising interest rates, that would say that they should have a lot more confidence in continuing to raise interest rates because you've essentially waited for inflation to run a little bit stronger, for

inflation expectations to pick up. And I think that's why they're thinking about, you know, another eighteen months or so before they're raising rates. You're really waiting until you're you know, towards the end of two or the beginning of Andrew. How does the dot plot help them achieve us objectives this new approachrim question. I'm not sure that every feed official would feel that it does help them achieve their objectives at this point. I mean, we're gonna get four

dot in the summary of economic projections. We think it's gonna be around one point six percent. Now for for the market, of course, this is out in it's a median. Right. When I say one that's comedian is going to be a wide dispersion, I think, well, you'll you'll really hear Chair Powell doing is saying, look, these are far out expectations, they're contingent on how the economy performs and market shouldn't be kind of reading these is literally what the FED

is going to do. Lisa Alan Meltzer would have screamed about the dots. I know that for certain, and we wouldn't read about it or listen to it, clearly because nobody else here has actually fully read his occupents. I will say, Andrew, just to sort of tithe this altogether, and to move from the dots to the real world.

When is September actually starting? What's your sense looking at the real world data in terms of how long the reopening has been pushed back by the delta very and by the concerns that we're seeing slow some of the service sector reopening. So I think you're definitely seeing that in the travel sector. That's where it comes through most clearly if we look at where we thought not really only domestic travel, but also international travel, which has just

clearly been held back by this. And we're hearing from airlines about canceled flights or flights that are pushed out. Now some of that may be only pushed out a few months, but of course that's contingent on what the public health scenario looks like. A few months from now, so that's very clear. And travel. Outside of travel, we're actually seeing demand holding up relatively well, and a lot of the growth that's being pushed out of Q three and Q four comes back to those supply side issues.

If you look at you know, only thirteen million auto sales in the month of August at an annualized rate, much lower than expected, and that's purely a supply issue. At some point that semiconductor situation will normalize, that growth will come back. But then as an economist, the question is is this you know, Q three growth that's not happening and moving into Q four. We're pushing this out into two at this point. Andrew, thank you. Andrew Hell and host on the Week Ahead, The Year Ahead, City

Chief US Economists. The issues trying to get back to normal, lasist told to back school is getting coming back to normal Summon, as we're saying for the first couple of ways to school, is trying to get back to normal. That's difficult, it is, and the testing continues, and certainly it's a really constructive Let's go to Amber to Susan now we are hugely advantaged to speak to her right after this announcement with Johns Hopkins Bloomberg School of Public Health, Amber.

This has been expected, but then there's more to come. What is more to come now? Is it just more study, more testing? Well, we have been waiting to see the data and children, so this is really exciting to see the beginning day to come out with an infectious disease. It's very hard to stop transmission without also vaccinating children because they can continue to spread it. So everything we know about the biology, it starts COVID to suggest that

it would likely be effective. These vaccines would likely be effective and told in But this is the first data and it's uh, it's important to figure out the right dose. We need to look through all of the data that's provided in the trial. But this seems like a really exciting development in the right dose. What are the side effects that you're worried about? What are they studying for in terms of side effects? Is it simplistic like heart

inflammation or is it much more subtle? Well, the great thing about a trial design is you're open to any side effect, even one of those you might not have expected. Right, So, um, all the same side effects that are seen in adults would be monitored, but there might be other side effects and children and those would be captured with the reporting system. So these trials have considered different doses. Sometimes with children they need the same dose as adults, and sometimes it's

a smaller dose is the right dosing. So UM, this data that's been released today looks like it's for a smaller dose and it's shown to boost and a body responses and not have high side effects. So we'll have to wait and see what the what the other dosing sc also their death, but I'm sure that information will

be submitted for consideration. Amber. What's the time frame from seeking emergency approval, from releasing this data for the first time to emergency approval and actually getting kids aged five to eleven vaccinated? That's a great question. Last time it took around a month UM, so that is very fast um for normal processes. So it might be a month that it might even be a handful of weeks UM since this builds on previous data for similar vaccine, same vaccine,

different does UM, but definitely not this week. It would it would take boots. There's also the issue of the complicating factor of booster shots and the idea that supplies now have to not just meet the millions of kids would be eligible, but also people who might be eligible for additional shots. How does this sort of work out in terms of prioritization and supplies that are currently available. Yeah, there has been there have been planning around that at

that point. Um. If the booster demand for boosters hit at the same time as the emergency authorization for children, UM, there might be you know, slight challenges getting an appointment for further short term um, like we saw with earlier rollouts for a week or two. But there has been a lot of planning. We have a good amount of vaccine, so that would be that would not that situation would not last. We definitely have enough vaccine to extend to

children once there's a new new emergency authorization. On a Monday morning in September, as we move inside with a bit of a chill, what is a trend of vaccination in the country. I mean, we had a benchmark of one million a day. It dipped down below that, it came back. Where are we on vaccination right now? Dr Susa, Um, you know it's very slow. Um. I I don't remember the exact number this week, but it's you know, less than a percent of Americans every week getting vaccinated. Were

it's a slow proportion. We are getting additional people, but but the progress has been very slow now for months, UM, so that people who are currently not vaccinated there's not as much appetite. But there is a you know, interest by many a younger individuals who have not yet had the ability to get vaccinated. So I think once this data is reviewed, if emergency authorization is given, it's clear that there are many parents and children interested in vaccinations.

So there might be some parents who are hesitant about using a vaccine that is being used under emergency youth authorization for someone young as five. What would you say to them, Well, the reason that it hasn't been available for children is because we've been waiting for this data. And so, you know, I think I certainly have confidence in this process. And uh, the data seems strong from what the headlines have said, but it will have to

be fully reviewed. If the f d A grants emergency Youth authorization, UM, that means they're very confident um in its safety and utility and UM every parent will have to make the decision. But we know that the mild side effects associated with a vaccine, if any and the majority of people have no side effects, um, you know, pale in comparison to all the other outcomes were seen. So I expect there'll be many parents very interested in

the vaccine village doctor, thank you. We do have to leave it that we appreciate time this morning on an important story. I'm the Associa that John's Helpkins University, Bloomberg School of Public Health, Professor of Epidemology. 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