Surveillance: Fed In Tough Spot, Lacker Says

to Lacquer and now to Barkin. The Richmond Fed one of my favorites with the wonderful Tom Humphreys on the history of our economy. It's had a wonderful leadership, including under Jeffrey Lacker, the former Richmond FED president joins us. Now, Michael, it's a different fet, isn't it. Well, it's a different fat, It's a different economy and we have learned a lot and now we have an do reaction function for the FED,

which is where I'd like to start. Jeff, you have expressed some reservations about this new policy of letting the economy run a little hot till we can average inflation, because you've expressed concern that that could unmore inflation expectations. Do you think that the Fed, in particular J Powell, over the last couple of weeks and with his address on Friday, maybe UH put a little bit of those concerns to rest by emphasizing the fact that the Fed

is going to stay focused on inflation. UM somewhat, but I think UM, I think the Fed's in a tough spot the UH the danger that they face from this inflation surge. UM, we have inflation on a six month basis higher than it's been since nineteen three. The danger is that that persists. Rob Kaplan was talking on Friday about the then to which businesses were reporting that they expect these supply constraints to continue, but then beyond that

getting embedded in inflation expectations. And I think that's the real key risk that UM, the FED is running these days. So I was glad to see that Powell addressed that in his remarks on Friday. He's and he's done that elsewhere as well as trying to assure the public that yes, if inflation persists at a high level, we have the tools to deal with that. But it's it's somewhat like I'm a friend of mine likinged it to um, you know, dr telling you you have gang green in your leg

and don't worry. We have the tools to deal with it. But it's you know, the tools are the amputation kit and they include a big saw. So it's what we went through in the early eighties to get inflation down was exceptionally painful, and that's what motivated those of us who over time have advocated a more preemptive policy. The Fed's moved away from that and it's strategy statement last year.

The risk it runs is that that shift last year UM is sort of a kin to going off Breton Woods, and and that it it gives people the license to believe that there's an entirely new regime in place now with regard to inflation. In terms of tools, one of the papers presented on Friday at Jackson Hall suggested that our star, the level of interest rates that would be neutral, is much lower than it had been. So does the FED really have tools? Can they raise rates and cut

off inflation without sending the economy into recession? And I think they very clearly can, and um, you know, more to the point, I think they can nudge up the polar expected policy path um, you know, over the coming year, and I expect they're going to have to do that to keep inflation expectations contained. Um So, I think they

have the tools to combat it. I mean, it's the blunt we haven't used them in a long time, but um yeah, I think the FED has the tools to do that if they well, let me put it this way, can they go back to jaw jaw to paraphrase Winston Churchill and job owed uh the economy into place? Or is it going to take action to get wall streets attention? Now?

I think I think actions have always spoken louder than words in this Throughout the seventies, the Fed um loudly proclaimed it's uh opposition to inflation and it's desire to have inflation be lower. It just didn't take the actions to back that up until Volker in one started letting interest rates rise and engineered the recession that that brought inflation expectations down. Jeff Lacker, Tom Can, good morning to you. You mentioned the preemptive nature of a theory and that

Richmond has led on that. I think of the late Marvin good Friend with a cause for concern over inflation, the whole shadow Open Market Committee. What we saw out of Carnegie Melon as well. Where did the inflation Eastas get it wrong? On your watch? So, I think that the stability of inflation expectations coming out of the recession UM was a bit of surprise, I mean a bit. Um. They were a bit more strongly anchored then I and

several others expected, So the upside risk to inflation didn't emerge. Um. I'd point out um at the same time that UH inflation doubs were also also missed it. They were afraid of dramatic sag and inflation. Jeff, this came up, Jeff,

this came up over the weekend. And this is a critical question in defense of the inflation Easta's the idea that the reason we didn't see the inflation is we just moved the inflationary impulse over to an increased asset allocation and an asset battle of sheet inequities in real estate, all the summer properties. Mike McKee can't afford. Sorry about that, Mike,

Good to be with you, Tom Um. So I think, um, what people lost sight of with a huge increase in the Fence balance sheet is that the monetary liabilities it

was pumping in the economy. We're being absorbed by a tremendously a tremendously large demand for liquid assets by the banking system, driven by the bank's natural reaction to what happened in two thousand and eight, but also regulatory um you know, impetus provided for them to hold larger liquid buffers, and that means that, you know, the demand for money is essentially flat at the interest rate on reserves, and yeah, we could increase the money supply a lot until we

start forcing banks to hold more liquidity than they want. And we're we were ways away from that, so the size of the balance sheet wasn't really doing much for the economy. On the flip side of the station debate, Jeff, is the employment picture, and we're gonna get a better read on that perhaps on Friday. If you were still on the Fed, what would you be looking for to determine just how much slack or how tight the labor

market really is. It's a really good question. You know, we had all these debates about what maximum employment meant or what that number was. It's really a long run, long horizon kind of thing. It's like, after all the sectoral reallocation has occurred. After all the matching that has to go on between people looking for another job, what kind of careers are going to be. I want a different occupation. I want to be in a restaurant anymore, and uh, firms looking for where they're going to find

someone with the skills that I need. After that process plays out, Yeah, maximum employment might be a lower unemployment rate we have now, but that takes time, and maximum employment in September of it's really close to where we are right now. We're really close to September maximum employment. We can't we can't get maximum unemployment much above where it's it's going to be in September. So um, I think that you have to keep in mind the dynamic

process in which labor markets. Heal some recent research by Bob Hall and Marianna kudlak Um in that regard is painting a very different picture of labor markets. You think of the unemployment ratist shooting up in a a recession coming down, but you know, uh, it looks like it

just comes down at the same pace every every expansion. Jeff, you were very much an inflation used to when you were on the board, and I'm wondering if you've seen what the current FED seems to be arguing that inflation dynamics have changed, uh, and there is, as j Pal said on Friday, a natural disinflation in the global economy.

I'm not sure i'd buy it. Um what people have been uh increasing the weight they place on um inflation expectations and inflation dynamics over the last couple of decades. I know, you know, early two thousands people thought it was all sort of a backward looking process. The important thing to remember and think the thing people neglect about inflation expectations. People talk about it as if it's some exogenous external force of nature or else some collective psychological

whim or something. It's really expectations about what the FED is going to do in the near future. And so when you look at inflation expectations, that's really credibility of the FED, and that can change. And the process by which that shifts and changes over time is not one that's deeply deeply understood in the economics profession. So Lecker, thank you so much. With VCU and of course the former president of the Richmond FED, thank you, thank you

so much. We've got the perfect guest for you. Kitchens of Society General. We spoke to his people last night and they said he would make an appearance with us, even though his arsenal struggles there. Kid, let me start with the first important question of the week. If Harry Kane and Ronaldo joined Arsenal, would that help? No, we can't defend the goal scoring is less of a problem unless one of them places full back. It's been sport to say the least. Kid, let's get started in a

serious matter here. It is the summer doldrums, but it's not What are you looking for? How do you frame a set up to maybe a more active September in October? I think you know, we have to get away from being driven just by the FED tape of story. Um, so you know the the other currents will take over. I'll be interested, Oh, what's happening outside the United States? Only in the sense that things change if other parts

of the world start to see recovery. If you started to get better data in Europe coming through relative to the States, that could change things a little bit. But but while we're bogged down with this idea of not even when does the FED start to slow its asset purchases down? But what does that mean about when they're done? And what does that mean about when rate rice has come and they're not going to come to three? So hey,

what are we going to do in two? You know, we have to we have to get past that, that whole story. But I think you know, there's there's geopolitics coming up. The comment situation is is is either going to improve or or it's going to become a real economic factor again, so that that's not static. Um and um. You know, the the range of forecasts for Friday's peril numbers over on your side of the pond is huge,

So we will get surprised by this. We we don't have a handle on the place of job creation really, we just guess kit taking a step back, it seems like the market is saying that the taper is a non event. Is that what we're seeing that basically Fed Chair J. Powell has successfully made tapering the one billion dollars of monthly bomb purchases an entirely non event from markets.

It should be. I mean, in a sense, the whole idea of the table was the you know, the FED slows down its asset purchases at the same time as the government spends less money and the needs to issue fewer bombs. So who cares, right, Because what what we've done is we is the United States finance the pandemic with the government handing out checks paid for by issuing debt that was brought by the Fed. Just unwind the process.

Just stop paying out checks and stop stop buying the bombs, and then and then we can get back to discussing important stuff, which is did all these checks create savings? Did all these create checks create demand? Did all these checks create inflation somewhere out there with all these bottlenecks and things like that, And I think that's what we're

going to find out. But the focus is on can can the US government have spent this much money getting the on me to recover this fast from the pandemic without without some inflation that's stickier than the legged than the FED is going to feel comfortable with. And we're going to find that out over the next six months

in a big way, I think, you know. Okay, speaking of being this far from the pandemic, it is interesting that people are saying that when we taper, we have to go faster given how far into this we are eighteen months or so. How are you thinking about a pace of a taper um. Well, you know that the consensus view on tapering is you reduce. You reduce the pace by ten billion each FMC meeting instead of the five billion for treasuries that they did in twenty fourteen,

and that takes a year. Now you could go every month, you could try more. In a sense, it should be possible to go fast because the Treasury is going to be issuing less debt into it, so you're you know, you've got you kind of got things lined up. The only difficulty would be if we started to get seriously worried out the inflation data and the strength of the economy at the same time as they're tapering, and then the bond market is going to struggle and that kind

of catches us where we are. It's really easy, it's really easy to to taper without yields going up if inflation is low and the economy is not growing too fast. But if you if you lose control of the story while you're doing it, it can get pretty messy. So I think they'll I mean, I would go as fast as the market let me go once I started, because it buys me a degree of freedom. But you have

to be market lead. You know, if you if you cut back your your purchases by ten billion one month um and yields back up study basis points in the first week, you know you kind of you go and have a scratch of your head pretty quickly. Thank you so much, greatly appreciated. A good conversation to start the week for me, society General and the chief Foreign Exchange Strategies right now is the most important conversation of the

day and even of the week. For those that are saying, you know, lose the fancy talk, just give me some courage. Robert Doll for decades has done just that, a storied career in the equity markets with cross market global investments, and Bob Doll I love within your research. Note you say, look, we've got to invest in a quote a still good economy. What does stocks do in a still good economy? They

generally go up. Tom uh. You know, a good economy means good earnings and so the path of LEAs resistance has been and likely will continue to be to the upside. That does not mean there aren't flies in an ointment. I can give you a list but the path of least resistance is still higher. Tom. You know that, Bob, the flies an ointment, Let's go right there, because that's how I roll. I mean, honestly, what material fly in the ointment are you looking at that potentially could disrupt

things in a way that people are not expecting. Well, if they're all at the margin. You all just talked about coronavirus and in the delta variant that that that is one. But inside the market, earnings estimates for the third quarter peaked in early August and they're off a little bit. That's after four quarters were right. During the quarter of the earnings estimates kept going up. Brett's the average stock peaked in June. What's that telling us? Its

telling us the markets get a little tired. So I can find flies and annointment are the material ones? Great question, Bob? Can you answer the question for me? Can we get a reflationary cyclical trade if bond yields don't rise? Uh? That's the million dollar question. If you dropped me on the planet and told me everything except where the tangy year and asked me to guess, I guess a lot higher than one thirty something going on the bond market

when the SUP has the same yield as a tenure treasury. Um. Uh, we need to watch that carefully. That has that you has to go up. Uh in my view to have this cyclical trade. To come back on, Bob Dol, you have fought against the pendulum of flies in the ointment for decades. In decades you have said you have to participate in the foundation of that, Bob Doll, is it corporations will adjust? Do you observe and in what way do you observe corporations adjusting into two thousand twenty two. Well,

I'll start look in the rear view mirror. First. If you had told me they're more companies in the SMP five dred that would benefit from COVID, then would be hurt. I wouldn't have believe you wanted to get. But that's exactly what's happened. Corporations are figuring out how to morph. Uh. They're dealing with very low interest rates. Uh. They've learned how to raise prices in environment where pricing power is coming back. They've kept cost down. A labor I think

will be a flying ointment on that one. But corporations have morphed in lots of ways that caused them to print these slin earnings reports. I'll talk about another flying the ointment, just to keep repeating the image on this Monday morning for everybody eating breakfast. I do wonder going forward, Bob, about the potential for higher taxes, and I look to Washington, d C. Pulling together some sort of infrastructure plan. What have you accounted for in your projections and what isn't

accounted for? Right now? Yeah, I still think the path the least resistance for that legislation is that we do have a Democrat reconciliation package following the bipartisan um infrastructure plan, but a much watered down one. Uh. Let's call it two trillion with up to a trillion dollar of tax increases, kind of the plane Vanilla ones, higher for higher wage earners,

for corporations, and higher capital gains. But you know, the Afghanistan thing, uh, does not raise President Biden's political capital get that through. So whatever you thought the probability there, it is lower. Now, Bob Don, what's your target on SMPF hundred. I'm embarrassed to say fifty. Uh, as the thing just keeps going up, I've not revised my target. Let's revise it. Right now. It's a slow Monday. We had to get Riggs on the show for Taylor. Riggs,

do your revision right now. Al there we go. We're making news. Bob Doll, thank you so much. Dollar, I love it, Taylor Dollar, cross Mark pretty cool joining us now. Peter Truowittz from the London School of Economics with all of his good work over the years at the University of Texas at Austin, and Professor Trubowitz. We talked to Afghan experts. I want to talk to you about United States experts, and I go back to your landmark politics

and strategy. Do we have a strategy in foreign policy that gets us out to say, two thousand twenty three a year before our next election. Well, Tom, it's good to be with you. I would say we have the beginnings of a of a strategy. I mean, really, what's been going on for well over ten years at the United States is in the process of reassessing and adjusting strategically and internationally. What that means is moving more of its energy, it's time, it's energy, and its assets to

East Asia and domestically. I think the principal challenge that has dogged three administrations. Is UM rebuilding or renewing the social contract, which has really been badly damaged by the country's failure to keep international openness and social protection and balance. This is the challenge. Afghanistan doesn't really change that, but I think it kind of draws our attention to it

in a kind of more focused way. UM. As we wind down this chapter and UH and hopefully the United States begins a new one, I look Peter at a new strategy, and it just seems to be all of the ghosts that the looking back. We look back one year, we looked back, two decades, we look back three wars. Which are you looking back to to find perspective? I'm

not actually looking back at wars. What I think about is I think about I really do think we're in a period where the national interest is being redefined, and it's not being done in the news cycle. It's being

done over an extended period of time. So I look back at periods for the historians out there, UH, like the eighteen nineties and the nineteen twenties and the nineteen forties and the nineteen seventies where the United States readjusted, recalibrated, change the balance between international and domestic stick interest and and that's what I think we're in the middle of.

And I think it's very hard to see. You have to be able to kind of bracket it, step outside of it, and get some distance looking at it from ten thousand feet rather than from from a hundred feet, And right when you're in the middle of something like what's going on in Afghanistan right now, it's very hard to see that. But I do think that's what Biden wants,

perhaps trying to get out he is having trouble. That's where I wanted to go because right now we're looking at an agenda in Washington, d C. That is almost solidly Afghanistan. I mean, I was watching the Sunday talk shows and the political shows are all Afghanistan at a time, and we're heading up into the debt ceiling debate. We're heading up until uh this question about infrastructure and getting

it past. I mean, did this just accomplish the opposite? Yes, I think that's you know, they said, that's the great irony and all of this. One of the reasons that Biden was so keen to get out of Afghanistan was to focus more attention on domestic problems and the messy, costly withdrawal from Afghanistan has basically only increased the political risks of failing to deliver on that front and the difficulties of getting it done because he's now open and

vulnerable to attacks over Afghanistan. You heard it yesterday, people calling for impeachment, Lindsey Graham calling for impeachment of Joe Biden, you know, and and we'll hear more of that in

the coming days. I think, Professor, are our allies rethinking our commitment to them, and I have Taiwan specifically in mind, so you know, I think that is going on, although Frankly, Teller, it's mostly on my side of the Atlantic over here, and I don't mean the UK, but also in Europe there's a lot of people who are very piste off about not being sufficiently consulted about the operations with respect to the withdrawal. I hear much less of actually from

our allies in East Asia. So why is that the case. I think it's because they know that the goal behind this, at least the international goal, is to shift the focus to East Asia, to China and more broadly, and that's a concern on this side of the Atlantic on on, you know, in the European theater, Peter, Are we actually going to see the US remove involvement from that region or are these drone attacks that we're seeing going to be ongoing and then the need to put more personnel

on the ground in order to get intelligence. Then all of a sudden, did we really get out in the first place? Well, I mean, you know, who knows. But I think we're gonna see now because of the terrorist strike again that killed you know, US service um men and women, We're going to see the Biden administration invest more time and energy in this. I think they really cannot afford to see this kind of thing happen. It

really can't happen on their watch. Whether or not it can be done over the horizon, that is, with drones and some special courses, I think that's the goal. I do not think there is a huge push anywhere for more kind of boots on the ground, big time with nation building the United States. American people, when you look at the polls, they're piste off about how the withdrawal was handled, but they are not upset about getting out

of Afghanistan. Peter, Thank you so much. Peter, Trubois with us the London School of Economics Professor of International Relations that 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 keane in. This is Bloomer