Surveillance: Fed Day with Citi's Mann

the Economy Division. Great to have Katherine with us on the program. Catherine, just looking ahead to the FETE decision later, Let's jump straight to the Q and A and the summary of economic projections. What if you got your RYE on this morning? Well, I think the real question is whether or not there's going to be more dispersion in the summary of economic projections because we're already hearing talk what we have for some time now, especially since the

last meeting. UM more more vocalization by some of the federalis or of bank presidents, um that, Uh, this march towards seventy or a hundred basis point cuts, which is what the market is, this marches is really not a

done deal. And uh you know, they've been saying that, I think because of their concerns about the consequences for leverage and for spreads UM, and and they're not they're not in the majority for sure, but they can voice their concerns about the strategy UH through the SMP, and that UM will generate greater dispersion in the U SMP.

How difficult does it make the job of Chairman Pound to communicate how much of that is compromised by this dispersion in the summary of economic projections that you forecast and the descents that we've seen over the last few months. Well, I think that that he he could UM use this greater dispersion and the descents as evidence of the complexity of the situation that the fedoraries are faces in making

its decisions UM. Because the fact of the matter is, if it this was obvious as to what to do, there would not be dissents, there would not be dispersion, and there wouldn't be vocalization by other bank presidents about the range of concerns UH that and data that they are looking at. So you can turn this towards a the complexity the challenges here is what we're thinking about

here is what we are weighing. Different of our bank presidents weigh it differently because that's exactly what they're supposed to do. They're supposed to be representing their district. UM. So you can turn this away from the uh single voice of the FED too. Why there is this dispersion, doctor Man? Is this a meeting? And as I said, folks, this will be an historic meeting given all the economics that Katherin Man follows every day, along with the finance

and banking of the repo debate. Is this a meeting where this FED will be more focused on the clear and present danger than trying to game out the future. Well, the clear and present danger UM affects your trajectory in the longer term, so you can't really separate the two of them. UM. And so they have to be both

responsive to the current environment. UM. Particularly, they have to recognize that if they don't do what the market expects them to do, there will be financial turbulence consequences, and that that that financial turbulence does feed through to the real economy. And the question is how much does it feed through? And I think the different ones of the bank presidents think differently about how much passed through of turbulence to the real economy that we need to worry

about it, that they need to worry about um. And that's why you're ending up with these different views of of the situation and also the extent to which financial turbulent is a necessary part of the adjustment towards a more normal rate in for the policy rate. I'm gonna put out a chart on Twitter. This is one of the repot charts we look at with the yield up at three. We don't I know the charts work on Radio Beautiful. You'll see him first on Twitter. I'm Bloomberg

Radio John. To be clear, we don't have a quote yet for this morning up or down from the three point nine three statistic of yesterday. We'll get that a little bit later this morning. A little bit later this afternoon, there will be a news conference and a smart journalist perhaps his name will be Michael McKee, will put his hand up and he will ask the chairman a question

about what has been happening with overnight rates. And Catherine, I just wonder how the chairman puts this in plain English, and how he puts the response to the Federal Reserve in plain English as well. Well. Again, I think he has to go back to the to the word complexity. Um. It's a very complex system. Um. And the market can be very reactive, and the Federal Reserve responded um. And so you know, it's a it's a situation that that he's not going to be able to put it into

plain English. I mean, I think he may use the plumbing word because it is kind of a matter of plumbing. Plumbing sometimes gets stopped up. And when when that happens, uh, you know, the water comes out in places that you didn't expect. And I think that's what we're seeing here, and the plumbers came in and fixed it. Okay, Catherine Man, thank you so much, greatly appreciate you stopping by through this important FED day. Doctor Man, head of economics at

City Group. As well, we have the right guest, John Farrell, long ago and far away. Um. He would throw pieces of chalk at students that didn't get at Boston University as professor of finance for the as you that don't know, Bu's finance program is truly world class, sounds people, So he will it is gruesome and he will now explain the repot market Why did you begin, John with the

grilling of Jack Ablin. You know, I love about this program sometimes when Tom tells me what to lead with and then allows me it's this is about as far as you go when you just you know, it's on a shortly ship. Want to black Hawks hockey, but we're not going to do that. Why don't you Jack Camplin, Let's introduce the guest properly, Jack Camplin, Crescent Wealth Advises, founding partner and see Io. Good morning to Jack, Good morning. Let's begin with this issue. Just walk us through it.

What is happening? Well, I mean it's a simple matter of shortage of overnight cash. The question is there is no single source that that we can look at to say where did this cash go? Um. Some of it perhaps related to the fact that the world expected the Federal Reserve to lower interest rates this afternoon, so they possibly put rates they put their cash out longer dated. Some of it may relate to the corporate tax payments

that are due UM. But the fact is that there was a shortage of overnight cash and as a result, I think we saw the overnight rate spiked to nearly seven percent yesterday. UM FED has come back and injected cash into the system. UM. And for right now, I'm not really putting anything more into it. I think it's just a supplied demand issue. If it were to persist, then perhaps there's a trust issue that we have to concern.

A lot of fact is going into this company is pulling cash from money market funds to pay tax one of them, the government selling treasuries at Gloody treasuries, a scarcity at dollars, all of that stuff coming together. Some people are looking at bank cash reserves declining and ultimately contributing structurally to what has been happening not once, but three times over the last wealth months. Jack, just wocus

through that. Why it's so significant? Yeah, I think that um, you know, having the cash reserves available UM is part and parcel of the bankings, you know, keeping the banking system operating. UM. And I think having clients that are you know, drawing on that cash, um, you know, is is putting us strand on the system. I know it's

not Boston University, but we gotta assume it. Come Loudy Holding Court here from Villanova and Finance Angela Mantalotis, who wrote, with our jury is the brilliant explainer on all this, and the single sentence from mantalotis is the idea that the repo market is twenty three percent the size of the treasury market, and in the last crisis they were the same size. We have regulated ourselves to a smaller plumbing liquidity market, haven't we. Jamie Diamond says, we're constraint.

We we are. Although I think the FED has expanded the number of dealers which then that can borrow directly from the FED. So I think what they've done is while the size of the market has diminished, the number of players that can go directly to the FED has We're going to see more of these interventions by the FED, like yesterday and presume today as well. Yeah, so I think that there there are some offsets, But you're right. I think the market has has shrunk, and I think

it you know, too many investors. This hearkens back to the find you know, the beginnings of the financial crisis, when we were having liquidity upsets, um the auction rate securities and all that that we're part of, you know, the funding crisis. Uh, this isn't a trust issue. I don't think it's a trust issue. I think I think it's right now, it's a supply demanding equity issue. Pretty much everyone says this isn't a trust issue. Yeah, I

don't think it is. I think, you know, like I said, I think we'll let it play out and if if, if we see that, uh, the overnight rate is in the threes a week from now, then you know, we'll re reassess. What are the chances that the FED needs to stop building up the bounty sheet again. Well you know that's you know, that's a slippery slope. But it

looks like they may have to do that. Um. I I suspect, you know, and I've been saying that they've created this nanny state for corporate America, UM with the low rates and low overnight rates and low you know, tenure rate. UM. You know, nearly ten percent of US companies listed our zombie companies right now. And the question is which way does the FED want to go continue to ease and just pander to this issue, or get

tough and try to reconcile Jack. Nobody cares the Cubs lost to the Reds last night for two What is this about? The Cubs have to be in the playoffs, the Cubs are holding on by their fingernails. Um, I'm hopeful they'll be in a wild card game against the Nationals and perhaps they can the Fed can use Wrigley Field as a collateral. John, That's what we'll do, Jack Evelyn, great to see you. Advisors love it. It'd be very cool. I love it. I could see him there. I love

American football. That's a joke. So it's so easy to get you guys. So what is a mid cycle adjustment? Stephen King joining us now HSBC Senior Economic Advisor. Stephen, just help us answer that. What is a mid cycle adjustment? And is that what you expect? Well, we had them in the past. We had one in the mid nineties, one that came after the Asian crisis as well, which is sort of time. It's whether they're kind of a poolse to refresh as more reduction interest rates that doesn't

lead very far, keeps the economy going. You have a kind of soft landing, and then everything sort of motors back up to too normally if you like. The The evidence though, is that most times when the said tries to achieve one of these mid cycle adjustments, it discovers that actually it's got a a late cycle problem because it ends up cutting interest rates much more than it

had originally expected. And that's partly because you end up with a significantly weaker economy than they had originally anticipated. Is that what you expect to happen here, Steve, is that your base case on how this plays out? Well? I think at the moment it's difficult to look too far into the future of HSBC had a couple of rate cuts coming through today and then in October. There's a possibility of stuff happening next year that we're not

forecasting it currently. But I think one of the big debates about the U S economy is is how late cycle is it. And there are a couple of things that I think the said would be worried about. One of course, slope of the yield curve and inverted yield curve or flattening yield curve is often in would signal of a downswing to come UM. And the other thing they might worry about is the fact that the unemployment

rate is so incredibly low UM. And when you've had a low unemployment rate, it sounds like great news, but often it can be a sign of wage pressures beginning to build. Maybe a squeeze in margins may have an impact on capital spending, and all those things might be issues to the final issue, of course, is the fair worrying about the sort of geopetical situation, and in particular that the trade war between the U S and China. To your book of eight years ago, is it a

grave new world? I mean, shouldn't we be optimistic about stunning unemployment rate resilient US economy relative to everything else? Are we going into this press conference? Is a grave new world? Well, the good news is that the US has done better than other countries on unemployment UM and

so on and so forth. That they're not such good news as the US has a problem which has been shared in other countries too, which is a productivity growth has been incredibly low UM, and that's given you a kind of a situation where unemployment is low but wage growth is very, very weak in general, and people have felt that they've been left behind. That's particularly true of

the number of different American regions. So although you have on the surface evidence of an economy that's doing better than others, there are a lot of I think weak links within that economy is one reason why I think the US has become more protectionists, trying to explain why it has these weak links. And of course one narrative of SUMILARI is to blame somebody else, whether it be China,

Mexico or elsewhere. Stephen King, I just put out a charter on Twitter Radio you'll see it first, Bloomberg Radio worldwide. You see it first, charts on radio. Well, there's a lot going earlier, and Stephen King, it's something I've never seen.

This is a custom chart from our Ira Jersey of the repo market is the size of the treasury market, and as you well know, Dr King, basically we fell off a cliff in two thousand nine where we said we're never going to repeat two thousand and seven again, and the size of that repot market is back to eighteen eighty one nine eight zero. Have we gotten ourselves into trouble because we have shrunken our markets hoping never to never to repeat two thousand seven two. I think

there are some difficulties out there. The repose situation currently I'm not so sure about. But I think that one thing that has happened is that the combination of zero rates q E and so and so forth has definitely lifted financial asset prices a long long way, even though underlying excellent performance has actually not been that great. That a little gap has opened up between financial hope and

economic reality. And that gap, I think is something which yeah, it's sort of it's created an obvious problem for central bankers. You think, well, have we just created another bubble in the attempt to dig ourselves out of the hole that was created by the global financial crisis. When we get QT, where does the financial hope go? Um? Well, QT doing because you're trying to sort of unwind the addiction that

has been created on on the continuous easy money. But as we've seen from the fair, it's proved to be perhaps her a more tortuous process than they themselves had

originally expected. And they think one lesson, it's like a Japanese lesson in one sense from the experience of the last two or three years, is that even when central banks, including the fad of trying to return to some kind of monetary normality, they've really struggled to do it because each time they've done it, they've had to reverse much

more quickly than people had originally expected. You go back a year or two, everyone was saying this is going to carry on raising rates for a long period of time. Suddenly with a handful of months, they're going into the can tire. You the reverse direction and the one sense they're being dragged down by events elsewhere in the world, where, of course interest rates Europe, Japan and some that's still absolutely at rock bottom. Stephen, I want to pick up

on the issue with Europe right now. There is a big focus on monetary policy impotence. So many people come on this program and say this is what I think the central Bank will do. Now, let me tell you why it won't work. Olivia blind Shut of the Pitterson Institute for me of the I m F. I'm sure you know him. While Stephen was out on Twitter over the weekend and he had a really nice little sweet storm and I just want to bring you one line from it. I suspect we may be close to the

reversal rate, Stephen. How important is that concept right now and how close are we to it in some big economic blocks. So in Europe this is a particularly important issue. So it really works on the basis that the more negative interest rates go, these official interest rates go, the more difficult it becomes for banks to be significantly profitable.

And one reason for that is that banks, for all sorts of social reasons more thing any house, finding very difficult to offer their customers negative nominal interest rates um, and so the consequences that they end up paying too much to fund their own institutions, and their profit margins are in never to be squeezed. As a consequence of that,

I know that squeeze comes through. It means that effectively the kind of the monthly plumbing doesn't work quite so well because in the old sort of textbook, ex a palls near the central bank cuts interest rates a bit um and one being cut, you know, you end up with the stimulus coming through in terms of bank lending, but the banks aren't making your money out of it. And actually the bank lending doesn't pick up in the

way that perhaps the center bank would normally expect. So it's a kind of peculiarity associated with the fact that cash ultimately offers you a zero interest rate in nominal terms. So the more negative you go, the more attractive cash becomes um. And you can quickly move in certain circumstances to a sort of weird economy where cash dominates. If we reached the constraint of the limit, I should say, rather on a calculus basis, if we reach the limit of what global q E can do, I think we're

certainly in a situation of diminishing marginal returns. Okay, But if we reach the limit, I mean, is that what we've learned at the last fourty eight hours Now, I think you can do more QUI if you wanted to. There's no sort of specific limits on it. The issue, I think is the effectiveness of it UM and your montar part. He works a lot on people's expectations. If they sort of believe it's going to have an impact, then it become more confident, Asset prices rise, all the

sorts of usual things kick in. But if it turns out that people are no longer convinced that KIE works, it may be that you do quite a lot of it, but not really much really happens. I course, that was exactly the Japanese experience over the course of the last ten and fifteen years, that KWIE did not deliver the economic outcomes that some people have predicted. This has been wonderful. Stephen King, thank you so much with h just extraordinary

time today and it's too very third. Thanks Step as well. It is always a joy to speak to Austin Gulsby, but it's a particularly joy after Professor Gulsby turns at the Booth School to his analytic finance stem eligible brethren, including John Cochrane, Douglas Diamond, Luigi's Dallas, Eric Swick, Robin Roging. I mean, all these guys at Chicago are completely analytical, and you know that's where googles be turns when he's

got to explain the repo market. Professor Goolsby joins us this morning, Austin, we're all brushing up on one in two day paper. What do macro economists how do they adapt and adjust to that short term paper market? That analytical finance at Booth schools legendary on Well, uh, thanks for having me back on first of all, um, and I think everybody first we were all starting to have flashbacks and nightmares. Oh god, is this how it begins? But I think most people that I have been talking

to their view is in a crisis. Every correlation goes to one, as they say, and the fact that this is just one little market and it's not spreading thus far to others. Um, that means that that it maybe hopefully doesn't have a grander meaning. You have been wonderful about linking academic theory into the application this afternoon at this press conference. How much is the chairman and the proxy of Vice Chairman Clara and the others. How much are they making it up as they go versus foundational

economic theory. That's the uh, that's always the magic balance that the that the FED here has to strike. I kind of think moments like this are always the danger for any policy maker, and you could call it on monetary policy, or if you were thinking about fiscal policy the same thing, that something strange happens, and you could incidentally destroy your credibility going forward if you say something in passing like, oh, we think there's no problem. This

is a minor matter. You know circa Ben Burnankee when they asked him about sub prime housing and he says not, Now, this is a very limited thing and it's not going to spread. If the facts end up proving them wrong. Um, then people are going to conclude either the chair and the system they didn't understand the theory, They didn't know what was going on. If facts prove them right and they get up and say this is just a technical matter, it's just in one market, don't everybody, you know, pay

no attention, keep walking. If they say that that proves right, then essentially nobody will remember it. So I kind of think days like today are a no wins scenario for the for the FED. So, Professor, you know, as we await the FED decision this afternoon, Now, there's a school of thought out there that says, as we get to the grinding ever lower rates, that incremental rate cuts by the FED just are losing their effectiveness um to really

impact economic Outlook, what is your thoughts? Yeah, look, I agree with that. I wrote a little piece summarizing that, uh point of view, and I think it's quite accurate in the following sense. In normal times, forget about the runway length issue. That in a normal recession, as you face the recession, the FED would cut rates four hundred, five hundred basis points. That's the normal recession fighting move,

not all at once. But you know, over a relatively short period, there's not four or five basis points to cut, Okay, so that's short. One runway problem is one thing but the second is even the same size cut. Normally, some of the bang for the buck of say the investment impact or the mortgage refinance impact, is that there's some pent up demand for investment that people are saying, well, I would go build a factory, I would go buy a car, I would go refinance my mortgage. But I

want the rates to come down a little bit. And so when they cut basis points, you get the normal impact plus the pent up demand. But there is no pent up demand because rates have been low for so long that there's nobody who's like, oh, well, if the rates would go down basis points, I'll refinance because they would have already refinanced. So I think people are putting too much weight that the FED can save us. Either. The FED should do what they're doing, but they're you know,

they're not. If we start going into recession, um, if we start escalating the trade ward and driving both those economies down, the FED cutting rates by fifty basis points is not to alter that. Austin Michael Spence, you may know him. He's not even passing knowledge at Stanford, one of our great educators and a Nobel laureate. Now it's a school in New York, Austin called New York University. Professor Spence wrote a jewel in about two thousand and ten.

It was my essay of the year. And when we regulate, there are things that are obvious. Let's call them a type one construct, and there's a type two construct, which is a little more sophisticated. It means you gotta be careful what you wish for. Did that happen in the repo market, that we have overregulated ourselves into inelasticity and into a limited choice set for banks under shock? Did we overregulate and we got a nudget back a little bit?

I don't know. I I take the point, and it's an important point about regulation in general, that the false positives versus the false negatives um viewpoint. I don't know if that's what the story is here. I think it would have to be spread You would have to see this spread out of just the one narrow market for exactly think that it was caused by some regulatory things. That's so important. You've heard that twice on Professor gouls

Be here in this conversation. The idea of it's discreet to the repo market and again to be clear, folks, we have an improved market. Uh. This morning we thank Austin Gules We, of course, a former chairman of the President's Council of Economic Advisors for President Obama. A Shingle out at the Boost School at the Chicago Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer.

I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.