Surveillance: Fed Cycle with Mike Wilson (Podcast)

strategist over at Morgan Stanley. Mike covid a weekend and Tom and I talked about it. You use that word dream this equity market streaming. Why is that dream misplaced? Well,

we don't know exactly. If it's dream, it is always dreaming. Mean, the equity market is tends to be forward thinking, like most markets, but particularly equities, and I think what you know are The phrase we used was really just trying to imply, Look, we had this wind though of opportunity for equity investors where rates are coming down, and you

can interpret that a couple of different ways. You can interpret it as if the FED is close to being done and they're gonna be able to pose or pivot before the next recession arrives, and that window is always positive for stocks. So the equity market is trying to get in front of that pivot. I think it's premature, to say the least. I also believe that by the time they do pivot or pause, probably something bad has happened on the growth side. And that's really our core views.

So look, we're we're always open minded. We don't get too dogmatic with these These rallies can happen at any time. But then we go back to our framework, and our framework suggested risk we work now is pretty poor, right, given our view on growth and given where rates are at this point. Mike, the new new what you've been leading on is a divide between service sector kind of equities and goods kind of equities. How sharp is a

divide between Caterpillar and Apple Computer? Well, I mean, I think, I mean, you make a good point on the services versus goods, but you also make a point that there are different types of goods, uh, that some are more expendable than others. And you know, this is exactly why we've skewed ourselves more defensively, meaning we we like companies that have things that you must buy or you know, not not luxuries but necessities, things you need for everyday life.

And and that's those are the kinds of stocks have been doing well because why because you know, the volatility in their growth is not it's not that volatile, and they can deliver on the earnings during this period when uncertainty is going to be higher and we're gonna get a payback in demand for all these things that we over consumed in the last twelve the twenty four months. And I think it's pretty obvious that that's just playing

out now. Mike, You've gotten the playbooks so right this year, and you deserve a real congratulations for pin pointing to where we are in the cycle and how we see rallies and then retracements. Where do you see the trade what it comes to energy at this point, given that it was one of the big calls in the first half of the year, the inflation protection at a time where now we're looking down growth fear is really reigning supreme. Well, those are nice comments, but energies in one area we

completely botched. So I mean, I'm not sure I'm the guy that asked, but look I mean energy, we were not overweight enough. We own a few stocks in our portfolio, and we were basically neutral. And I think that energy now is vulnerable from an equity standpoint if and this is a big if, if you take the view that a recession is sometime in the next twelve to twelve months. And it's just been our experience. And the thing I'm most worried about, Lisa is that you know the commodity complex, uh,

technically and what it's telling us it's not good. I mean, we're seeing demand destruction across the board, some of that, you know, when some of the base metals and things like that's dude to zero code policy in China, which could reverse in the fall potentially. But the charts don't lie, and they're telling me that we've seen the peak in commodities and if we're gonna have a recession, then they're

probably going lower. So I would we're continuing to be neutral and energy, and quite frankly, I think people are probably a little bit too long at this point. Mike. How much do you take the pushback that you I'm sure you here, which is the earnings have been than expected. You see ongoing resilience. Yeah, there are potholes here and there, but for the most part, companies are to use Tom's phrase,

adjusting and adapting and moving forward. No, I mean the company and US companies are really good at managing earnings okay, but they're not good at doing is forecasting earnings over the course of twelve months plus. That's been our experience, particularly at major turning points. And so you're right, they've

done a good job of managing the quarters. And so what ends up happening is that you know, the bar gets lower, they jump over the lower bar if I say it's better than expected, and then you know, it's kind of a drip, drip, drip lower. You know, we we do a pretty good job of forecasting twelve twenty four months out of macro, not at the micro level

so much, but it informs us. And what we're seeing is that it's this drip drip drip is going to continue for another two or three quarters, and they'll probably be more of a drop as opposed to a drip if it's a recession. So like I think the another words I'm saying is I think that don't get mesmerized by the very near term data on the on the earnings because you know these number these numbers are man it Okay, that's that's why they look may be better

relative to the managed numbers. And when you're looking out twelve months, you just have to take your own view at these turning points. You can't rely necessarily on kind of what companies are saying or what the community is saying. You need to take a view. And our view is very clear the orange revisions are going to be much

more negative of the next two to three quarters. And when we've seen for the last two years, and Mica got to squeeze this in, what do you say to people getting mesmerized by the bond market move we've seen since the middle of June. Well, that's one thing we've gotten right. We've been very bullish on bonds, as you know, John, thinking that you know, the markets might have been infatuated with inflation. Of course, when it became obvious and the FED and that was really the story in Q one

and up until about May June. And at that point, we you know, we think that was the time to pivot away from that and start thinking about what's growth gonna look like. So we think the bond rally makes perfect sense in the context of our fire and ice narrative. We're staying long the long bonds, and uh we think it's great hedge against the nequity portfolio. Right now, Mica also to get you on to show this small thank you,

Sir Mike Wilson, that of Mark and Stanley. As Mandy's chief equity derivative strategist at Credit Sway Securities, Mandy joins us right now here in New York. Mandy, let's start there. How do you play a peak in real yields? Sure? I get this question a lot um, you know, and the two the most traditional way people look at it is either do you go a long tech or do you go along gold? Because those two have historically had

the most inverse relationship with real yields. And in my view, I think going along gold is a much better play um for a peak in real yield rather than Tech. And the and the key here is, you know, real yield could be going down either because of a dovish FED or because of rising recession risk, right and and for tech, if it's rising recession risk, that doesn't bode

well for tech as a cyclical sector. So for us looking at upside and gold, and you have seen in the derivatives market more to mean for upside in g LD option for example, to play that up peak in real yields. Lisen Saunders was with us twenty minutes ago just put out on Twitter the Dallas trimmed inflation statistics,

something Chairman Powell watches carefully. The first derivative of this over one month is stunning three point zero three point one and then an explosion in the Dallas trim from five point two on to a ginormous six point nine. How do you fold inflation into a conventional derivative strategy and equities? Sure, so I think a couple of ways you can look at it, so you can play it through uh you know, um bond et s right. So looking at for example, we've been recommending people look at

upside place in TLT, which is longer dated bonds. And the view here is that the Fed actually will remain aggressive in trying to curb inflation and as a result increase recession risk. And that means actually the back end of the yold curve goes down because that's much more a function of inflation and growth. You can look at it through hybrid options or equity options that are contingent on rates. So there are different ways and you can

play it. But I would say, you know, in my view, um, the market has it wrong that the feed is gonna pivot. I don't think inflation is going to come in that quickly. Um. You know, Powell has said that he needs clear and convincing evidence that inflation is falling back down to the two percent target. I don't think that we're going to

get that anytime soon. Mandy, how much conviction just to sort of zoom out here, how much conviction it has this rally had behind it from a derivative's perspective, How much have people closed out their bearish bets on the US economy, on the U S stock market in particular, as the market rally the most in November. Well, first

of all, what bearish bets right? So I would say one of the defining characteristics of this sell off on the first half of the year is that we've seen very very little hedging in the derivatives market, and that contributes to, you know, the relatively lower levels of VIX v VIX, all the measures that we track and options and part of that is because we've seen already very significant deleveraging d risking in terms of underlying positions of

people selling at US stocks going into cash. Now over the past week we have seen some pick up of upside call buying, but certainly not significant enough. So I don't think this is a high conviction rally of anything. I think this is much more a bearer market rally. And when you face the kind of headline risk that we face today, this event that could take place a little bit later this morning speak below sea landing in Taiwan and the complete unknown as to how the Chinese

will respond to it. What do you say to clients when they killed you about how they should manage this situation? Sure, so on the topic of China, clearly a lot of headline risk in the near term, but actually the much bigger risk, and what I've been emphasizing over the past few months um and in terms of the outlook for China, outlook for global economy is China's zero COVID policy, and

that's going to have a much bigger economic impact. It's gonna have a much bigger market impact than whatever happens, you know, in the next twenty four hours on the geo political front. And the key here is that you know, if you talk to investors, most people still expect China to pivot from the zero COVID policy because of the economic cost. And my view there is, if you listen to she, if you listen to the top Chinese leadership,

they're very ideologically committed to zero COVID. I do not think in a politically sensitive year such as this year for China, they're going to abandon zero COVID anytime soon. Um. And I think that's just gonna mean a bigger demand shock for global growth, a bigger demand shock for commodities. And I think that, you know, that's one of the reasons why we've been pretty barished on commodities as of late. Thank you, as O Wise from Credit Swasi. Halene Becker

knows about jet Blue. She put a reaffirmed outperform on jet Blue yesterday. She is at Cowen and she's as of this morning going to have the good counsel of Mark McCormick. As t D says, they will take out Halline Becker's cow and that will be a good match Mark McCormick and a Laine Becker and Mr McCormick joins US now global head of FX Strategy TV Securities. Let's start with square one mark, what's the dollar going to

do in the next year. I think in the next year where we all will talk about the peak dollar story. That's really not where we're at right now in the next couple of months. But if we look where we are in extrapolate pass this year, it does look like where we have the conditions of the peak dollar, which is Feds cutting rates and global economy can be recovering. We know the euro Zone is is slipping into a recession, but all of those factors should likely turn by next year.

So I think that is the big forecasting stories, the turning of the dollar in the next year. There a risk adjusted basis, including geopolitical risk adjusted, which is the currency flat on its back where the greatest week dollar opportunity is. It's still again, we've talked about it a lot. Really, yeah,

it's it's the Yeah. An evaluation perspective, if you think about why the dollar could peak, if if the feed is cutting rates next year, and if you think about and talk about the yield curve of the U S yield curve is inverted now, So if we if we think about the slowing conditions of the US and we think about how much yen has moved from fair value, fair value for the end is somewhere in the in

one ten, one fifteen. So if we think about the reversal of the dollar, the d X, Y the euro still has a lot of cyclical problems to deal with, but you know, the big driver of what's pushed the end weaker, it's been global rates moving higher and the oil in the terms of trade shock and if you've already mentioned on the oil side, like we're expecting oil

prices to be lower next year as well. So the combination of those factors peak higher rates and essentially a peak in the terms of trade cycle, which has really been challenging for Asian currencies for the last six months, those reversals would help us see dollar again move back closer towards fair value rather than you know, trading at the massive preview we see it now is that regardless of where risk sentiment is any given time mark, is

this a risk off trade that now works? So is it just more broadly a tried that's gonna works through the end of the year because of the dynamics that you described, Well, the risk off helps, and I think the risk off helps because it's pushing yields lower, and I think that's it's an important combination in what we're starting to see is the FED had articulated a bit of a focus on growth. We know that they're not there yet, and it's too early to trade this as

a durable theme. Um I still I still think the near term we gotta be buying the dollar against most major currencies, even the Euro and European currencies. But if we are talking about the next six months to a year, the conditions are changing where u S data is deteriorating, and again in a backdrop, it doesn't have to be risk off, but we're not going to see this persistent deterioration in terms of trade. Where oil prices are in a hundred and a hundred twenty dollars in barrel, we

are talking about oil below a hundred next year. That will be very positive for the Japanese trade balance, which would also be good for the European trade balance as well. So, Mark, let's say that the FED doesn't pivot. Let's say that the FED does continue to raise rates, and that you start to see, uh, some concern about having to go further and uh and perhaps faster than people are expecting. And I think about Zoltan pose are over at Credit Squeeze talking about a five to six percent FED funds

rate eventually in order to get inflation down. Does that eradicate the idea of peak dollar and you start to forecast a much stronger dollar to come. Absolutely, we are not playing, you know, with our baseline as a five six percent terminal rate. So right now you can even see we're we're a bit more hawkish and where the markets currently price, which is why we like the dollar. Now. If we're talking about a five six percent terminal rate next year, then absolutely we talked about risk off, we

talk about a global recession. Uh, this reinforces where we've been the last couple of months, which is a global demand shock. Plus the FED offering the dollar is like the world's key safe haven. If you think about three factors that have like we're assets that have done quite well in the last three months, it's energy prices, Chinese equities,

and the dollar. Like that's really all there's been. So the dollars offering the properties of relatively higher yield and a decent you know, relative beta to a declining global economy. So if we're talking about a five six uh FED terminal rate, then the peak dollar story will not persist. Mark, what you has conviction trade? Right now? I still think it's the it's the end crosses. I know we've moved a lot in the short term, but as you mentioned,

I think some of the European crosses look honorable. If we're talking about just this week, I think Sterling, we've got the Bank of England sterling in downside. I think it's quite attractive. Euro Yen down downside is quite attractive as well. We'll give us some numbers on this. My head spinning, Mark, give us some yen you know, John, take notes please, I'm I don't I lost my surveillance pencil.

Give me a yen number like short yen. Now as to what so, I'd say right now, if we if this week in general we are expecting better the U S data, so I think we get a dollar again reversal up to about say one thirty three, there is a good fade point. So again, if we could see another half percent move higher in euro yen um again, I think we're going through one thirty as well, so I think that would be a good short term set up.

And then a year from now, are you to one twenty, which is students two standard deviations out or canyend strengthen that to a one fifteen. We still have Yen kind of coming in around one twenty is but again in the backdrop that we we had discussed where we do see the terminal right probably three and a half to four rather than five to six. Uh, that environment we've white bullish for the end, particularly for oil prices and the terms of trade shock, which would yeah, that would

start to reverse. John, does this work for my four oh one k? Mark can relief to you that foreign exchange is no longer boring. It would be great if the regime didn't change every week. But yeah, it's got a lot of in terms of how you people care about effects. I Mark gonna catch out Matt mccomack, it's a d We've got a lineup of things to talk about with a good John Writing, Chief Economic Adviser, Bring capital.

He joins us this morning because be the tops starting out their season, what ac Milan is going to do, and of course his Preston North End playing is Wigan or Wegan. We played Wigan Athletic the Latics and drew uninspiring performance. Nothing. Nothing. That's our soccer talk for today. Just because there's so much going on. I want you to talk John writing right now about the Phillips curve. This ancient from another time and it has to do

with the time of beverage. The economist at l s E. I want you to link in the Phillips curve myth with the raging debate over the beverage curve in the efficiency of our labor economy. Well, first of all, I was born in the same year that Professor Phillips pend his article on the Phillips curve, so that makes me

an ancient thing from another time as well. Um. And that that curve was was really a description of the behavior of the labor market over a period of a hundred years or so, and it was hijacked um by people like Paul Samuelson and solo in the US to

make it a theory of inflation. And Milton Friedman said, it's it's not it's not going to be stable, and he that was a very prescient article because what he said is workers will find trip in the higher prices eventually to the wage bargain, and they will add more in the Phillips curve will breakdown. That's exactly what it did in the nineties seventies. But now we're back in an environment where for the last twenty years or so, inflation was so low that nobody took it into account,

and so the Phillips curve re emerged. And now, um, the question is how much unemployment do policymakers think they are going to have to engineer? Can they engineer That's the heart of the matter, John is, Can any central bank, whether in the United Kingdom or the US, engineer a labor economy. Well, here's the problem. They want to create some slack and that Philip's curve thinking is very clear

at the FED right now. They want to create some slack in the economy without causing a recession, which means growth has to be between potential growth, which they thinks around one eight percent one point nine percent per year, and zero otherwise the economy is in recession. Now US just clear up again, the economy is not in recession at the present time. The economy created two points seven million jobs we've got in the first half of this year.

We've got another job support on Friday. But as Pal said, it's a very narrow path. And if the Fed is going to make a mistake, given that it's let inflation out for the first time in three decades, it's going to make a mistake by raising rates too much, and that inevitably is going to result at some point in recession. Not imminently, but as the three month ten year curve flattens, that recession signal starts to emerge when we when we get close to zero a year out. So I think immerged,

you know, engineering a soft landing. And this latest debate, the beverage curve, the relationship between vacancies and unemployment. We get the Jolts data, the job openings data later today, which gives us a new reading on job openings. There are almost two jobs per unemployed person. This bait going on right now. Can the Fed deflate the demand for labor in the economy without pushing up unemployment a lot

because there's a lot of job openings. Uh. And you know, there's quite a raging debate going on between Governor Waller on the one hand and Larry Summers, on the other hand, trading blows uh, while I gave a speech on Friday and Summers published Engineering Forward Yeah, basically saying that Waller's soft landing paper had errors after Chris Waller came out and tried to slap down their previous piece. So basically

a tit for tat and academic journals. The other big debate is how far the FED will have to go to engineer some sort of softening in the labor market, what it will take. And you have some people saying we're close to the terminal rate, perhaps even FED share J Powell hinting at that, and then you have the likes of his olden posar over at Credit Suite saying, more likely we have to get to I have to six percent because of how entrenched some of these inflationary

aspects are. Where do you stand, well, Lisa, As you know, all through last year, I was warning you that inflation was going to be the problem, And when we discussed the FED making a mistake, we discussed the FED doing too little in one not too much in two. Now what the FED has to do now is a consequence of the mistake they made last year by continuing to ease, continuing to buy assets all through last year as inflation

picked up. So I don't think Pal signaling the what the market is reading right now, which is the FT's not going to raise rates as much as this, and he was signaling very much. The best guidance we can give you, to the extent we can give you guidance, is the forecast we gave you the so called SEPs in in June, which was three point four percent at the end of this year, three point eight percent at the end of next year. Now we're two years, we're almost talking about them. It's a long way away from

from that guidance. So from n where the market surprised in an interest rate above inflation of about three quarters of a point on average for the next ten years, it's just about taken out that so called positive real interest rate and that tightening in the economy and yet not really factor back in inflation. And I think that's too easy a choice. Either the Fed is going to have to hike rates and get policy restrictive and that's higher than the market is currently thing, or we are

going to have a more protracted inflation problem. And right now, I don't think the markets shall lined up in a sensible manner of having relatively low inflation break evens and a relatively low terminal rate. Given the not only the US, but the global scope of this inflation problem, John throw into the mix what we're seeing right now with Nancy Pelosi expected to land in Taiwan in about two hours.

This question of whether the safety bid is to go into short term treasuries or even treasuries at all, if they could potentially increase inflation, and if FED is still going to try to fight with the market is assuming in terms of a pivot. How do you see the response going forward to this type of risk. Look, I think the FED has made it clear that beating inflation is job one and probably job too, and then other

things come after that. At the present time, and the luxury that the FED has had in the past to respond to geopolitical events like for example, breaxit um, and to respond to market events, and to respond to the unemployment rate and so on was because inflation was so low. Now we have inflation that in CPI terms is nine point one percent. While the July number will probably show a bit of relief because of the decline in gas prices. It's by no means to show it that we've even

seen the peak in inflation yet. John. What's so important to John Farrow is the thing of University of Work and Robert Skodolski. We've got people doing political economics like Lord Skodolski, and at the same time we're talking about engineering the economy. Is if there's any evidence we can engineer an economy, I find that insane. And someone go

a step further. There's clearly some policy bus here, some political bias which is shaping some of the analysis taking place at the moment, John, which I think we all find increasingly frustrating. The simple way to frame this is soft landing versus hard landing. John, which Camper you went? Ultimately, if you had to choose a sign right now, I

think ultimately it has to be a hard landing. The the runway is just too short to carry on the airplane analogy to to bring this down on a on a soft landing, given how narrow the gap is between a potential recession and UH and growth at the economy's economic potential, and it's not that the FED tightening causes the inflation as such. What it is is when the public's expectations of inflation are built in sufficient gentle that

those expectations are inconsistent with the policy timing. Now, the one good piece of news that the FED has is that the tenure inflation expectations from US households from the University of Michigan is at two point eight percent. Now, we don't know how good to survey that is. It's only five hundred people, and it was at three point three percent in June. And I don't believe long term expectations bounce around as much as they do. But that's

the key thing. If the public believe the inflation increase is going to be transitory, then I think the debate we should be framed between is it going to be a mild recession when it eventually comes probably late. Is it going to be a mild recession or is it going to be a deeper recession. And that's the key thing. We have to watch inflation expectations, because the more entrenched

inflation expectations are, the deeper the recession. Is just the public beliefs about how the economy is going to unfold and the Fed's intention of what it's going to do about the inflation rate come into conflict. You know what I'd love to do just listening to the umage survey being conducted in real time and see what people say on the phone calls Tom, can you imagine where do you think inflation is going to be in five to ten years? And how people respond? Have they ever called you,

John Ferrell, They've never They've never called me. They've never called Lesa about every three months at Lesa's anchoring that number? Much much? Oh yeah? And there go to no, I've never been. I've never been surveying. How much time do we have with the writing command seconds Premier League? I mean John who looks good at approved John Writing, who looks good in the Premier League community shield? Liverpool three

Matchester City once. So I think those of us Liverpool fans are thought, well, it's going to be probably gonna be City season with the with the upgrade the I think Liverpool is going to give him a real run for the money again. Down to the last weekend. There we go. We begin this season Premier League coverage, team coverage, Bloomberg Surveillance with John Rode his season kicking off this weekend. John Riding of Bring Capital thank you sir. This is

the Bloomberg's 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