Surveillance: Fed Distractions with Donald

Economists and Strategist at Manulife Investment Management. Francis an easy one. What did you make of that? That's not an easy one, John, because there's a lot of parcel through there. But the main takeaway for me is, yes, we could talk about terminal rate estimates and the pace of hikes, but what

I'm hearing is just more data dependence and myopic. Data dependence can always be dangerous, but it is particularly problematic in an environment where we have weather distortion, seasonal adjustment distortion,

low survey responses. We are in data that is really having trouble setting us a clear signal, at least over the long term, and I'm concerned that We're going to see markets that are overreacting to data points that of false decision, and potentially even a central bank that's moving too quickly and making big policy changes even via communication off of data that I think is going to be very bumpy in the next three to six months. Francis, with a shock that we saw yesterday, does disinflation come

to the rescue? Can we get a rapidity of sharply lower inflation? You know, I think the FED may not be focused on specifically some of those traditional inflation measures, but that rise we've seen in inflation expectations and market based measures, that's what's keeping me up at night. That

is moving in the wrong direction. Now it's countered by inflation expectations among consumers that are still going lower, and I'm hoping that the FED is focusing on those long term inflation expectations, which are coming down quite a bit. One of my bigger concerns is this summer, we're probably going to lose some of the disinflation momentum that's largely going to be base effects. So this downward momentum that

we've seen is probably going to stall. That's when we're going to start hearing those words like stagflation come back, and if we haven't seen some slowdown in jobs by then, a feed that's going to stay hawkish through the summer after what was rot yesterday? Is it walk it back Wednesday? I mean, do you see come out today to the house and change the tune a little bit. The only way we're going to walk back this pricing for the March meeting is what we see in the jobs data

in the next few days. And when I say jobs data, I mean we've got jobless claims, we've got job openings, we've got challengers, ADP, NFP. It's a variable buffet of jobs data that's going to be coming through, and no one number is going to be I think more important than the sum of those stories, especially in an environment

where we're really trying to dig deeper. We got to look at private sector jobs data right now, people looking at job postings on things like LinkedIn, And indeed, if you want to understand what the feed is going to be doing a year or two years from now, which I think is even more important than the March meeting, you've got to be looking at all of the data available and really making sure that you understand the comprehensive

story behind it. Francis, I understand what a bind freedhair J. Powell is and how unique this moment is, and yet the flip flopping of his messages is jarring. It's starring for markets, and it's starring for people who are trying to get a sense of what the compass is for this feder reserve. Do you think that that in and of itself is detrimental or advantageous given that that uncertainty actually creates some of the market conditions that are potentially

tighter than they'd otherwise be. Well, it certainly makes our job a heart or at Lisa because instead of saying, well, they've provided forward guidance and we can kind of rest on all laurels for six months. We have to be a lot more flexible when it comes to the data that's coming in. But there is a lot of short termism in this industry and financial media. When you're an economist, you're always looking for what is the next big story

and I don't want to miss that inflection point. But problematically, we have a lot of data that's moving, you know, two steps forward, one back. It's getting dangerous to extrapolate too far in the future. We have portfolios that are training technically and they need to be moving off of that.

But if you're a longer term investor, a lot of this is noise that's distracting from the signal you need to be focusing twelve to eighteen months or even in some cases, we have to produce five year forecasts to tell us where our strategic portfolio should be positioned over the very long term. And so some of this focus on the FED moving back and forth in a month to month basis. It's not valuable to investors, and sometimes it can actually be distracting in some cases even dangerous.

Where do you think the market is getting the economy wrong right now? I'm not sure the market's getting the economy wrong. Again, it depends on your time frame. So Q one is certainly much stronger than many people expected. That consumer is holding in strong. But the challenge comes back to, and I've heard a lot of your guests talk about this, where are we going to be down the road? And it is very difficult to discount the probability of a recession twelve to eighteen months from now.

So if we're talking about the next three months, sure there's no problem in saying this economy is stronger than we expected in November December. But if you want to argue for no recession, you have to discount almost every single leading indicator that has very reliably predicted a recession later in the year or twelve to eighteen months. You can try to do that. We have a very different labor market, we have excess savings, but for my view,

it's a very hard sell. One thing you can say is that the leads and lags in this economy may be different than what we've previously expected. But I would just really focus on your timelines. Are you talking about the economy in the next three months solid or are you talking about the eighteen months outlook. I think a lot of strategists, including myself, you need to work on really being clear about their timelines for their forecast friends

to send that degree of confidence around each timeline. Do you have more confidence about where we'll be in six months than maybe where we'll be next week after CPI? Oh, absolutely, And I think that's actually the game is what does the economy look like twelve to eighteen months from now? Actually I'm concerned about that. I think it's going to look a little more stagflationary than we'd be comfortable with.

I'm less concerned about a technical recession. We know the playbook to trade recessions, we know what those look like historically. I'm more concerned about eighteen months from now. We've been in a very slow growth environment for a pretty extended period of time, and we have inflation stuck around three to four percent, and problematically, in the inflation that's rested in the system that's still there is likely to be less interest rate sensitive than the inflation that we've managed

to kind of dissipate over this period of time. So this word stagflation, there's lots of ways to define it, There's lots of ways people can talk about it. I think that's going to be more of a theme for us moving forward than we thought it was going to be even just a few months ago. Francis wonderful as always to get your perspective. Great to see if francis down at there of Manualife Investment Management. We're lucky this morning we've got Cassie Barrow from JP Malkin with us. Now.

Kelsie thought she'd get a clean slate come here to speak on behalf of Bob Michael and the team. Then Bob Michael got in there first and said this to focus. Like Cassie, I've got no idea what this is about. But here's the quote from him. He thinks that if we go back to fifty, it would be pretty confusing to the market. I hope they don't do it. I hope they're willing to run a string at twenty five basis point increases. Now, Kelsey, thanks for being with us.

The chairmans open the door to fifty. How problematic is there? Yeah, So if you think about the way that Powell has been communicating about getting restrictive right, there's three dimensions to that. There's the pace, there's the level, and then there's the duration. And what Powell has been doing for months now is saying, Okay, we've hiked a lot, and so don't worry about the pace so much. It's about the level that we get to and the duration at which we stay at that

restrictive level. Yesterday he essentially threw that out the window. That is confusing, And I think the key takeaway is that if we are going to consider re accelerating to fifty based on the data and they are very data dependent. The risk of a hard landing does go up in that scenario, and the yield curve is telling you as much. What we saw yesterday twelve basis points higher on the two year flat on the ten year break evens narrower. The yield curve twos tends getting to minus one hundred.

That is the risk of overtightening that the bond market is picking up on. And that's also why you're seeing very sticky resistance on tens at four percent, which is something we've been watching and saying, Yeah, people are interested at bonds even in this repricing. The yields are there, and the diversification benefits are going to become even more important if the FED is going towards that hard landing Scenariomas agrees with Mike Lee writes this morning about the

importance of the level we're at right now. Does that level indicate restriction? Does that level indicrate not the drama of super restrictive, but that we're finally at levels that really click in. Well, this is obviously the debate. Now we think that we are getting to level levels that are sufficiently restrictive. So last year the thing that I was always quoting was the real Fed funds rate, so saying the Fed wasn't going to stop hiking until the

real Fed funds rate turned positive. So essentially you needed the Fed funds rate to move above the level of inflation. We are making progress on that. You know, if you look at COREPC, it's around four point six percent. The Fed is now expected to get to five maybe five and a half. That's going to be a significantly positive real Fed funds rate. And I think we have to think about the way in which policy impacts the economy. It impacts housing first, then manufacturing, then consumer and labor,

and it's actually playing out in that traditional way. Housing home prices have been deflating for six straight months. Business investment is starting to rolling over. Now what's only left is the consumer in the labor market. It just takes time. We have the patients as long term investors that the FED may not have the luxury of having. In this moment, I was going to say, perhaps patients that the Fed

doesn't have. Right now, I'm looking at a ten year yields of about four percent just under that, and you're talking talking about value in bonds. Are yields at this level on the longer term debt instruments pricing in a soft landing of sorts with rates remaining higher for longer and no crash. Well, I think that with the yield curve this inverted, you are looking at a rates market

that is suggesting the risk of hard landing is rising. Now, where I think the discontinuity is is really more in the spread market, so in credit, so spreads are still on the narrow end of the recent ranges end of history, So that's where I would say more of the complacency is. But I think in the rates market itself, I think you are seeing the risk of overtightening playing through within

the very inverted yield curve. I guess, to put this another way, there's a feeling that even if we get some sort of recession or some sort of landing, aside from the no landing idea that people were talking about for a while, that we're going to have higher rates for longer, and that is a persistent theme regardless of even a crash. Do you agree with that? Do you think that if the FED does crash the economy, we will still end up with higher terminal rates for a

longer period of time. Yeah, so we do think that we're in a new regime, and the starting point of that new regime was the fact that this is the first hiking cycle in thirty years, that the peak of that hiking cycle is higher than the prior one. Right, So we were having higher or lower highs and lower lows for thirty years. That's the bull market of fixed income.

We are now going in the opposite direction. So this is a meaningful shift because the next time that the FED cuts, we don't think it's going to be back to the zero lower bound. So there is some changes that are happening here, but those are slow moving. They're still going to be cyclical shifts in yields throughout our broader structural view that we could be entering into a phase of higher highs and higher lows. Let's pick up on that, because Bob's given it a lot of thought

as well. Calcum in the team. Are you thinking about repeated cycles of that for the next couple of decades. It's the reason to believe we've got tailwinds for it. There are some reasons to believe, and obviously these are are very abstract topics. Things that we're not going to know until very very far into hindsight, but there are tailwinds as it relates to demographics. Here, we think that inflation structurally is not necessarily going to struggle as much

to get to that two percent level. So if you think about pre or pre COVID, but post GFC, it was very hard for the FED to achieve two percent core PC. In fact, on average it was about one and a half percent, So we were remissing it to the downside by about fifty basis points all the time. Now I think you can say maybe things have started to shift because of deglobalization, because of other factors, that it will be easier for the FED to get to

that two percent. You know, we're not suggesting a materially higher regime for inflation and rates, but it is one that is shifting over time. Could be the last thirty years in reverse. Take here, this a magical coming from the team, Cassie Bob. The call here is you guys aren't leverage players, but there's a huge part of the alternative investment in fixed income market that is usual utilizing leverage. Here did they get hammered yesterday? Is there a misuse

of leverage? Right now. So I think the strength of the move and choose yesterday clearly shows that some people were off sides and there are positions that needed to be to be cleaned out. How's the Austria Bob doing, Cassie, you know what, that's the perfect place to leave it, Cassie barrow King asset management. That was golden And Alicia Levine with us right now being why melon she's over there. It's like the bradmon Kim was on her. Well you were talking, show us to jump in, jump in respond

to what we were talking about. This hurt. Look. I think what Powell did yesterday was the right thing to do. The data has been hot, and if he didn't put fifty on the table, it then threatens a further loosening of financial conditions, which will un anchor inflation expectation. So he had to put it on the table. I actually think it was the right thing to do. But now the problem is he's locked in because if they don't go fifty right, it's been a series of locking in.

The FED talks too much. I have thought that throughout this whole cycle there's too much talking, too much talk of disinflation. Eight weeks ago thirteen times, but in the end, by putting fifty on the table in the near term, they're almost forced to go through it. I think a two hundred number on Friday would do it. I want to pick up on Lisa's think of this morning so far. If two hundred k gets it done, it's a pretty

low bar. Was stock so resilient? That is confounding and the question of the year, And to your point, why was Nazak leading yesterday? So let's just point out that even after the price action yesterday, stocks were where they were on Thursday, and the disconnect between the bond volatility and what's happening in the stock market is ever widening

this year. In year to date in twenty twenty three, the market has been remarkably resilient, as have credit spreads, as you've just talked about, which is what's holding up the market here. So I think what the market is seeing is that ultimately that ten years having a hard time over four percent, and ultimately the ten years going to move lower because a slowdown will be coming. The

Fed's going to wind up pushing us into recession. So I get a lot of hate mail about being too gloomy, and people who think that I always a glass half empty in just you know, I should go have a little bit more fun. And so some people will say that, you know, if you take a look at what's been going on, trying and let's try to look at the bright side, maybe stocks and credit spreads are seeing a picture that you know, the rate volatility isn't Maybe there

is this resilience. Maybe that strength is you know, going to carry through even if rates do go up to six percent. Do you buy that? So I do buy the thought that the economy appears to be less sensitive to rate hikes than originally thought. I mean, we are now at four fifty four, seventy five and twelve months. Whither the crisis, whither the great knock on effects? We're nowhere, okay, And I think that surprised a lot of us who've

seen other rate cycles here. So that has to do with the fact that most of mortgages are fixed rate at three percent. People are making the spread on a five percent six months treasury right, so they're actually making money on this trade. But even if the economy is less resilient, the FED will probably have to go higher and will eventually work. It's just going to take longer. The data and the real economy continues to be fairly strong.

You're seeing weakening in certain parts of the economy such as housing. Clearly commercial real estate is at risk. That's flashing a warning sign here, But that's really the beginning of it. It just hasn't happened yet. As long as labor is strong and as long as workers are getting wage increases, which they are, you can keep this going further. So what do you do with the idea of a six percent FED funds rate? What do you do with a fifty basis point rate hike on March twenty second?

How does that change what you buy? So it's a really interesting things. So far cyclicals this year have worked, as have growth, right, and I think that begins to change a little bit. You have to think of this as if the FED has to go to six percent or even higher. It's not our base case, but you have to start opening your mind to the fact that it could happen. Then you start having to see a recession by the end of the year or even into

twenty twenty four. The confounding part of this year is that the recession hasn't happened yet, and it's very hard to predict with the strength we see in other sectors such as the service sector, which continues to hold up the economy, but you have to expect it within let's say, the next twelve months. And with that you do start

asking the question, will cyclicals continue to outperform? And and that's really where you have to go with this, because the defensive stocks have been terrible this year, right Healthcare has been tough, staples have been tough, utilities have been tough, and the cyclicals have ripped. So the question is what happens if the recession really starts to be priced in. I'm not going to mince on International Women's Day. There are many women that have provide leadership, and you have

with bulletproof mathematics and education. I mean, your path here was painful in terms of like lean over the desk. Right now, we are at a moment where we've got massive first and second derivative moves and it comes down to not seeing Teleb's math. The gravity's back, and as Talleb says, you got to have skin in the game, which means all the shadows are out there, all the worries are out there and you study it on a tail with the Plassant distribution. We're not going to go

into the math this morning, but no, I'm not. I'm not going to go into the math this morning. But are we there now where we've got legitimate tail risk of his Hilarion would say, the unknown unknowns out there, Yes, we do. We've always thought that simply because we don't think you get out of a rate cycle that quickly.

I think what's unspoken in this conversation today is the debt ceiling that could change what the FED does rather remarkably and rather quickly as well, and the fact that the US hasn't had a recession in the third year of a presidential term because it's an election cycle coming up. What happens to the pressure on Powell? If we actually get that recession by the end of the year, can he finish the job? I don't think Powell's burns yet. The question is will he be burns in the future.

I think for now Powell's sticking to the Volker playbook, and I think he's doing a pretty good job at it. The question is, if we get that recession, if your unemployment rate goes to three point eight percent from here, which doesn't feel like a lot. You'll begin and he'll be getting pressure from the right and the left. You're just much more diplomatic than I am. Als going to stick with a selection of aiding net fam ymn it. You should point out that, well, an International Woman's Day.

You can be a reporter who says I got a fancy degree from Chicago, but I know nothing about bonds, and through sheer inspiration and perspiration you learn about bonds. What was it like, Lisa Brand was your first day in the bond world? Well, it was in two thousand and seven in August, when the commercial paper market was freezing. Definitely a moment of real tension and drama that people don't associate with bonds. Did you just pile up fifteen books around you and just read FABOZI cover to cover

and the rest of it. No. I called traders and a number of them cursed and hung up, because that was the moment that we were in in terms of the intense feeling. And I do wonder we saw the lack of drama for a decade or more, almost two decades, and here we are in the drama. It's getting very Oh seventy. Someone that knows that is Diane Swank. She's chief economist at KPMG, and Diane, I'm just thrilled that

you are here today. And I placed you in a group with Abby Joseph Cohen of Goldman Sachs now at Columbia University, and of course the wonderful Sally Crawchuk as well, who changed securities research at Sanford Bernstein years ago. And then there was Swank in nineteen eighty five. I think she was out of junior high school at the time, and she was in Chicago landing a job at First Chicago Corporation. What was it like the first day on the job, Diane, I mean out of Michigan. It was.

It was unique at the time, right, it was unique, And to be honest with you, then I went on to University of Chicago as well. But you know, I wrote up The l Escalator and I often described the person I was mentoring in the eighties, and that person was me. And I looked like a man in some ways with my short cropped hair, my male dominated kind of women's suit, and I even had wingtip pumps, which says a lot. Although I refused to wear those I

had bow tie and I took it off. I just couldn't take it anymore, and I put it around my waist, which is kind of me as well. But you know, until I got to step into for me my femininity, my career didn't take off. And luckily that occurred very shortly thereafter, and I had a terrific mentor. You always need someone that is a terrific mentor. And he once said to me, it's not that I'm altruistic, Diane, you make me look good. What do we need to do

forward an International Women's Day? I mean, there's all sorts of cohorts here in debates and that miss Swank, you've lived it. What do we need to do forward to get more women into economics, finance, and investment. What's really kind of a sad commentary, particularly in economics on the academic side. And you know, the bottom line is that we need to all be able to step into our truth and who we are, and that is not allowed

in a lot of these fields. And that's something that I have a really hard time struggling with because it took me a long time to do that. I had to work through two maternity leaves, my son almost died. I was on TV four weeks after I delivered my daughter. I don't wish that for anyone. And the bottom line is we have to acknowledge the biology, and the biology is that women are delivering babies, and you know, same sex couples are able to have children. We have to

support paternity leave and that is really important. We just don't do it. The fact that our female participation rate and our male participation rate among twenty five to fifty four year olds, a group I no longer belong to, is the lowest in the G twenty, which is really the G nineteen because we don't RuSHA anymore. That is really despicable. Our neighbors to the north, Canada as a twelve percent higher participation right among primage women than we

do in the United States. So a tear with some you know, I have a sadness to this day in the fact that I wasn't able to do more and I still got a lot of work to do for everyone behind me. Lisa, why don't you pick it up here? I mean, there's some themes there that are really really trench it and how alone America is in this debate. Well, I want to go to what you managed to accomplish in that time, Dane, which is an incredible reputation and

prowess within the economics field. At a moment that it's highly tenuous, we're trying to put together a lot of real uncertainty into some sort of forecast. What did you make of what Jerome Powell said yesterday on Capitol Hill? Well, you know, I thought he finally stepped into where we knew the FED was and the fact that all the headlines actually reported the same Chairman Jay Powell is really important,

and that is they are data dependent. The data and the narrative has shifted, and that does put a half percent on the table. Now could it change. There's two more key data points coming out before they meet on March twenty first, But I think it's important that he laid out just how data dependent they are and the willingness to pivot. You've got another Powell pivot, and that is that we could get a half percent at this next meeting, and that rates are going higher faster. I

think that's very important information to have. It's one than we've been arguing. And yes, the data has been out there officially since the Valentine's Day massacre of that inflation number we came out, but the revisions to that we're out prior to that, the friday before it, and we're looking at it going, oh my gosh, this has changed the entire narrative. Well is the data that we've gotten

since then? And I think about the ADP data that a lot of people are dismissive of as it confirmed that strength, or is there any sign that perhaps we're going to see some sort of downward revision or some sort of downside surprise in labor market that has surprised for almost a year straight to the upside. We certainly could see some cooling, and I think we are seeing some cooling, and I think the ADP data is now

the way that they've redone it. And I give a lot of credit to Nila Richardson over at ADP for not making it a forecast of the official payrolls data. It is its own data set. But it still shows that there's a lot of strength and wage gains there. That's terrific for wage earners. But to the extent that we're seeing continued upward pressure on inflation tied to demand, which is tied to the wages people earn. That is a concern for the FED, and I think that data,

I mean, we know the month of January. Part of the reason ADP's report was so weak was because it is more sensitive to the floods we saw in California. So people who didn't work the whole week didn't show up as much on payrolls in that week that was the survey week. It was not the same for the national data. If they got paid even a dime that week, they showed up on national payrolls. So I do think we'll see some downside surprises as well as we come

off this unseasonably hot January in many ways. But the bottom line is you need the threshold to get us to the Fed feeling like it's actually got inflation under control and then inflation will not become a more entrenched inflation is very very high. That means their threshold to slowdown rate hikes is high right now, Dan Swank, thank you for joining us today, of course, with kpe MG. Subscribe to the Bloomberg Surveillance podcast on Apple, Spotify and

anywhere else you get your podcasts. Listen live every weekday starting at seven am Eastern on Bloomberg dot com, the iHeartRadio app tune In, and the Bloomberg Business app. You can watch a slow I'm Bloomberg Television and always I'm the Bloomberg Terminal. Thanks for listening. I'm Tom Keene, and this is Bloomberg