Surveillance: Fed Expectations with Hollenhorst

this year. I have to s Andrew, congrats to you in the whole of the team, because I remember when you first came out with those calls for fifty basis point at every meeting, then definitely five and everyone started to laugh Andrew, and it quickly became consensus. Where are you now going into year? Rand is the rest of the pack on Wall Street talks about a step down of financial conditions, starts to weez, Yeah, thanks so much, Jonathan,

and thanks for having me on. We're you know, for our base case, we still think that the Fed might and somewhat below five percent policy rates, but we would not be surprised by levels above five percent. I think anything up to five and a half percent would not be too surprising at this point, and you know, it really goes back and kind of thinking all the way back in terms of why this Fed has been more

hawkish and why we're getting higher policy rates. That's what you were just talking about it in the European context, we just have inflation data that continues to surprise to the upside, that continues to push policy rates higher. Actually think the Chairman navigates this conversation in the news conference center this week. Given that they don't have the full costs no fresh s EP until December, it's really difficult.

In December, you do have a lot more variables that you can use to try to guide towards a step down in the pace of policy rate increase, but at the same time not trigger a loosening of financial conditions. And I think we saw a little of that last week as the market got excited about the fact that the FED might be slowing the pace from a seventy point hike at this week's meeting to a fifty basis point hike in December. And we think that is what's

going to happen, and that's not necessarily a do wish outcome. You, the hiking fifty basis points is still a larger than usual sized hike. The Fed could continue to hike at those larger sized hike sizes for extended period of time get to higher policy rates. So there's nothing inherently dobish about hiking at a slower pace. What the Fed needs

to do is communicate that, and you're right. At the December meeting there's a summary of economic projections that can show higher dots suggesting the policy rates will move higher. It's really just gonna come down to communication. In the press conference at Wednesday's meeting, Ken Powell talk about slowing down the pace, but still indicate resolve on fighting inflation. What's more damaging for the economy getting to five or five and a half percent and then cutting perhaps six

months later. We're getting to four and three quarters percent and holding it for two years straight, I think, but would be damaging for the economy, and I think to their credit, FED officials have recognized this is to allow inflation to persist levels that are well above target. I mean, you you were just talking, and you know, we're kind of joking about the idea, could we get a three percent,

four percent, five percent inflation target. But implicitly that's what happens if the FED continues to miss on their inflation mandate. If you continue to miss to the upside on inflation, then you embed in the economy higher rate of inflation. And I think we're already seeing some of the costs, some of the uncertainty associated with not knowing how much wages, how much prices will be going up. That's the real

risk for FED officials. And that's why stopping too early is a risk and could imply actually hiking further at a later date. So so you do have upside risk, you have downside risk. It's a complicated scenario. I think the primary risk right now is still the risk that inflation remains too high. Andrew, you said something really important there that by basically undershooting inflation again and again, they're basically communicating the inflation is going to remain higher than

their target. This sort of speaks to what Diane Swank was talking about their projections being fantasy land. How much do you think they've already done that by not really communicating some sort of downturn or something that is more realistic. According to the economists, projections in terms of what kind of pain needs to happen in this economy to get

inflation under control. I think it would be helpful if FED officials concentrated a little bit more on the fact that labor markets likely need to loosen significantly to bring down inflation. It's a very unfortunate reality. It's a reality that nobody wants to be dealing with. But the empirical fact is that to bring inflation down from levels like the levels that we're seeing in the US and Europe

elsewhere involves a significant loosening of the labor market. And that's almost a euphemism for saying the unemployment rate rises. Millions of people who currently have jobs no longer have jobs. It's a horrible outcome for the economy. That is the cost of aation that's too high, and the issue now is minimizing the further cost of that. So I think that's right least. I think there should be more direct communication about the pain that's associated with breaking down inflation.

Andrew A consensu even you're hesitating to say out loud, I'm waiting two around the program, around the table, and surveillance every single morning. And Andrew, I think they've still got to do a better job of communicating this, and it's not for me to do it for them. Andrew, how did they tell us the higher unemployment is a price worth paying to get inflation down. What's the answer

to that. Yeah, it's a very hard message to deliver, frankly, and I think that the answer is to be clear the forthright, to talk about the historical evidence, talk about the theory the theory that we have. You look at the employment cost index last week, up one point two percent quarter on quarter. This is well above a pace of wage increase that would be consistent with two percent inflation. And so I think that's just one indication a very

height labor market that's going to drive inflationary pressure. There's strong theoretical reasons, they're strong empirical reasons to think that that doesn't change without a loosening of the labor market. So I just think that we need to be clear and forthright about that. And and to your point, Jonathan, it is an unfortunate reality, and I think that means that FED officials and others have been reluctant to comment

on it openly. Andrew. We get unemployment from Friday, we get the jobs report in America right now, I'm looking at pay rolls, the survey, the matin estimate about one ninety from a previous two sixty three. Andrew, can you tell me if the year ist progressed, if you sense that perhaps this unemployment rate needs to go higher than you thought it did at the start of the year.

So I think there is a sense that maybe the unemployment rate doesn't need to go higher, but that the amount of restriction needed in the economy may need to be more to get to a higher unemployment rate. So we think that the unemployment rate may need to get to something around five and a half percent to bring down inflation. That would be a lot higher than three point five percent where we are now Historically, it wouldn't

be as high as what we've seen in other recessions. Um. So there is some good news there if you want to see it that way. UM. I think that the the issue is the labor market. Data continues to be very resilient. A hundred and ninety thousand new jobs in a month is going to be strong enough to continue to put downward pressure on the unemployment rate. So we have a tight labor market generating wage pressure that's too high, and that labor market looks like it may be tightening further.

The only evidence of the contrary job openings the Joeld's job openings numbers. Those have started to come down. We get a new reading on that this week, so I think that's going to be important. But overall, low initial jobless claims, there's just a lot of evidence that this is a labor market that has not slowed sufficiently to bring down that wage of pressure. And Joe starts to coming up tomorrow with the SEMs Wealth and then onto the Federals IF on Wednesday, and onto the Pyros report

on Friday. Would awake Andrew, Thank you sir as always Andrew Hollen, host of sitting on the lightest and what they're looking for from this FET this week. I'm going to send you on this right now. The Director of Research Energy Aspects Emorrator. Can we start there. Typically we talk about the near term story, let's get out to next year, just briefly. How vulnerable is the United States now with the SPR at a four decade low. I

think it's the great question. Um, We've calculated this and even before Prince Ample Lizzie said this last week, we kind of highlighted the fact that right now the SPR is actually being used to uh, pretty much influenced prices, whereas its objective was very much for supply mitigation. So remember, the SPR also has legislative releases that was agreed back in twenty seventeen. So that's another hundred million barrels that's

going to come out. Will end the year this year at just below four hundred million barrels about three hundred and eighty. Deduct another hundred from the legislative releases over the next three years. It doesn't leave the administration with much more than sixty million barrels. We believe that they could do without running into issues with the e e S at least requirement to have at least ninety days

of net import cover. Now, of course, you can continue to run it down below that number, but I will can I will say this again and again that this is a time of energy security and running down sprs to influence prices is probably not the most prudent strategy. Do you think it leaves America even more exposed to the whims of opening next year if you don't have SPR, or rather, let me rephrase, if you were using SPR

to offset um supply disruptions, that's very different. But if you're using SPR to just keep a cap on prices, then yeah, absolutely, because we've said this before as well. But if you are going to use the SPR to combat OPEC, that's like turning up to a gunfight with a knife, because it's OPEC has millions of barrels per day of production that they could cut or raise, where the SPR is ultimately a finite volume which also will

need to be replenished at some stage. I'm going to given the fact that there isn't this relief valve of the SPR that potentially could be tapped in a major way next year, and given the facts OPEC plus has that leverage over the US and other nations, are we ever going to see seventy two dollars a barrel kind of price levels where this administration said they would like

to refill the SPR. We don't think so. No. I mean, if anything, fifth of December, when the EU embargo and Russian crew starts, that's when you're going to see the real supply disruptions kick in. Because this is about shipping disruptions, right, We're just having to tie up so many ships now to move Russian crewed all the way to the east. We will start to see some Russian productions shot in

and that's only going to get worse next year. So we just do not see how we get down to the seventies unless and until the economy really collapses and China doesn't actually start to get better, which we expect should start to happen from April next year. I'm ready based on some of the supply disruptions that you're expecting heading into the winter, and we are getting signs that you know, it has been mild so far, but the UK there are just reports that they could see a

colder winter than usual. Where could you see oil prices going and how does that translate to gasoline prices at this highly political moment. I mean, look, we are expecting prices to go towards hundred dollars produced into into the year end and really trade into the hundred and tents and hundred and twenties for most of next year. Uh. And the biggest upside, like you mentioned, is the winter.

Of course, weather is always going to be a erratic, and you know, nobody can really predict weather, but even otherwise, stocks are just very very low. Now you do ask about gasoline, it's a fair question. Gasoline prices in the US have continued to rise because there's so many refineries that are still down, and let's not forget the French strikes that are still ongoing. We're not producing enough. But I will highlight its diesel that we need to be

really worried about. Diesel stocks are at near record lows. We just haven't built over the summer, and that's what we tend to use in the winter if it does get very, very cold. And I think that's a much bigger concern for the administration right now. So we are expecting potentially some form of intervention by the administration, should maybe saying you have to hold x amount of diesel stocks in the New York Harbor before you can export from Path three and Rita. I've got about forty seconds

on the clock. I want to squeeze this in. We've been talking about this now for the best part of what eight months, called it nine months close to and Rita. Have you seen any effort either from Europe or the United States to build out refining capacity in a material way. No, quite the opposite. And it's a great question, because you know, if anything, Europe is talking about windfall taxes on refining um and this is going to be the biggest bottleneck.

Next year. We have a few Midleastern refineries starting up, but after that after we just don't have enough refining capacity to meet all demands. And that right there is the problem. I'm really send thank you, Director of Researcher and as you aspects, thank you. If you get me one, I will do it. Is standing by the head of US Multi sector fixed income as should as at least at FED of aselve on Wednesday. All this chat about a step down. What even the team thinking about when

you go into this November matin. Well, you know, I don't see any reason for them to commit to down shifting on Wednesday. UM. I think that they will let us know that they're considering it. But we have, as you said, John, two CPI prints between now. We're between Wednesday and the December meetings. So what's the point in saying here's what we're going to do, it's time to downshift. I think they're gonna say, hey, look, if we see inflation moderating to some degree, will will We're open to it.

We realized we piped a lot. It's going to take some time for this policy, these this tighter policy to actually have an effect. Um. But as you said, they've the central banks have been wrong before, and they've they've said they're going to back off a bit and then they end up having to kind of go full throttle. So I just don't see why they pre commit quite yet. They don't have much to point to in the way

of inflation moderating here. In the meantime, people are looking long term and they're trying to get a better sense of long terms and short term is so difficult to project. And Brian why scene of Morgan Stanley earlier this morning saying that he likes long dated treasuries because regardless of what they're gonna do, it's gonna slow growth and slow inflation over the longer term to make four percent yield on a tenure treasury attractive. Do you agree? I think that, Yeah,

I think there's a lot of merit to that. I think it depends on your time horizon. If you're a long term investor now, certainly will you have a better entry point tactically between now and the next six months, probably, Um,

But again it depends on your your time horizon. On this nice feature over for the weekend in a Wall Street Journal had about five or six investors being interviewed about three and the opportunities just jumped down from Rick reader FROMO he said, I'm more excited going into three than I've been in a really long time. You hear that a lot from the fixed income team, don't you A lot? I really do. Okay, I hear that also because I lived through the era of people railing and

comployed ero rates complaining we're not getting anything. This is ridiculous. It doesn't make any sense. Now they're getting nine percent average yields on things that actually look better because these companies have preserved cash for those people who have been sitting in cash complaining about low rates. I haven't heard enough from them about saying, yes, we're going to take

take some opportunities here at Lisa. Does that resonate with you what Rick really said over the weekend, I'm more excited going into three than I've been in a really long time. It absolutely does. I mean that was basically the title of our market paper as well. And you know it's to Lisa's point, you don't even need to go to high yield to get interesting yields. I mean, HSBC came with a bond deal last week seventh north of seven percent. It's a four year piece of paper.

I mean, I think they're gonna be paid. You're gonna be well compensated for that. Again, time horizon matters, but over the next four years return, I think that that's gonna I think that's going to be a good investment. And you're just sticking in the investment grade market. There A Lisa, how has business changed? Then? Can you walk

us through that? Just over the last six months, you get the sense that people see the world the way you see the world in fixed income going into next year, this more interest from people that would typically be allocated to equities or somewhere else. Yeah, I absolutely do so. I've been to a few presented at a few conferences, and the interest in fixed income now is is much much higher. It's it's it's palpable. People are excited about it. I think there's still a little bit of nerves, right.

It feels a bit like catching a falling knife here, and so there's a there's a bit of a we want to allocate but not quite yet. So I do feel like there's there, there's the risk. And we've had this a couple of times this year where you get a bit of a rally and then all of a sudden you get alert even tighter because everybody realized, I think, oh this isn't we passed the peak. We need to get in and then it's been past the last year. It's been kind of false starts. Um, But I do

think that that could be the template. You know, everybody is sort of waiting, sitting on their hands a bit, but they want to get invested, but they're not. We're not quite there yet, so when we do, it could be fairly sharp. Um. But I think there's a lot of interest. I mean when you compare fixed income to private markets, when you compare them to other other public markets,

I mean, fixed income is corrected a lot. I mean, it's yeah, my favorite stet right now is uh It's credit of Deutsche Bank, but they basically have the Treasury index going back to sight and I believe this was the worst return since that period. So it just gives you some context for we use the word unprecedented a lot in markets, but I think that's that's truly unprecedented. Truly is Lisa, Thank you, Lisa Homebi that suttis, thank you very much. Gregfied this now chief US policy strategy,

that HF investments. Greg, Let's talk about energy, and that's been a big problem for this White hastroy this year. How is that playing in the mid terms, the lack of a caherent energy strategy in the minds of so many people, Greg, I think it's playing really poorly. A great editorial in the Wall Street Journal, I think it was this morning, all the day start to blur, but talking about how dysfunctional to this energy policy has been.

I mean, Joe Biden just comple aiming about prices, but in reality, one of the reasons prices have gone up is because of his policies. We can you elaborate on that, Greg, because a lot of people think that his policies have been to unleash the spr on the energy market, on the gasoline market, and that's brought down prices. What's the

other side of the story. Well, the other side, Lisa, I think, is how adversarial the White House has been, starting within days of his inauguration when he killed the Keystone pipeline and then he's gone from there, you know, really beating on fossil fuels, coal, oil, natural gas and saying that renewables is the way to go. I think renewables will play a major role for the rest of this decade. But right now we need fossil fuels. Okay,

So that's the case. At the same time, perhaps it's just the coherence in the message from this administration, because they have actually confirmed that kind of view and said we need to encourage investment by some of the oil majors. Where could they be more consistent? What could be the message that could read through better that perhaps the Republicans are giving In your view, well, I'd say probably regulatory policy,

which has been quite restrictive. I think the industry senses regulatory policy that's quite harsh, and therefore the industry is not doing much drilling or refining or shipping. Craig, if they can keep hold of the house in a Senate, what do you think this administration would like to do next? What do you expect to happen? It's a good question, John. I think that because both sides are so bitterly divided, we have to lower our expectations for much but I

do think there's a chance they'll talk about immigration. Everywhere I go around the country, I hear the same refrain, we don't have enough cooks, waiters, waitresses, carpenters, whatever. And I do think more legal immigration is really quite would be very beneficial, and I think both parties might agree on that. Greg. In the meantime, a lot of people are thinking that it's going to be good luck and markets like guid luck, and that seems to be the

feeling right now. Is this going to be grid luck that's good for markets? Yeah? I think so. I think that there's not going to be anything radical, certainly nothing new on taxes, capital gains, the estate tax, the top rate. I think all of that stuff gets frozen for at least two more years. In that kind of predictability is a good story for the markets. What does that do

to our alliances with other nations? And I think about some of the potential for restricted exports of natural gas of diesel, especially in light of some of the up in price that we've seen recently in both of those categories. How much could that really create some longstanding fissures in classic alliances? It could, You can't rule it out. I would say, though, the biggest fear that I would have

in terms of fissures is Ukraine policy. We're starting to see a lot of ads on TV in the last couple of weeks, UH talking about why are we spending this kind of money on Ukraine? We got lems right here. If there starts to become a perception in Western Europe and in Russia and Ukraine that the US is losing some of its resolve on Ukraine, that's a big deal

in a very negative story. Well correctly, prospect of any kind of trade restrictions on energy projects products out of the United States would only exacerbate that in places like Europe. Greg that trial balloon has been floated a few times this year. They haven't gone forward with it. Is that what's holding them back? I guess it is what would push them forward? What would make them go through with a policy like that? Well, I think what first and forward would be a sense of the US economy is

starting to weaken sharply. I don't see it yet. The data looks pretty good. But if at some point next year the US economy is starting to slump, then I think there will be a serious debate over how much we're doing for Ukraine, and the Republicans may lead a fight to give them a lot less. Greg. Thank you. I appreciate your time. Greg. Now doubt we'll catch up with for next week. Greg find of h g F Investments.

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