Surveillance: Fed Messaging With Kelly

Premier League, certainly doing better than the Tots. And David Kelly, you know, well, there's the yellow card in the red card, and what you look back is to your Catholic upbringing all those bees and sees you earned an attempt to a pink card. You do a mid year review and you've got a pinkish a plus tone to the American economy. Well, yes, and and this latest out of exam results I think will if anything improved that we didn't see GDP move up.

But what we did see as inventories actually felt even more in the first quarter than initially reported. And what that means is you get a big inventory bounce in the second quarter along with everything else, and then obviously seeing unemployment claims coming down towards four hundred thousand, there's a lot of improvement there. I also very much like seeing this growth in capital goods orders, so investment spending

looks strong. So this is really an economy that is just you know, growing in terms of momentum, and you know, I think it just does poison pose a question, why are interest rates not higher given how strong the economy is? What's sixty nine? Um it is someone mysterious. I mean, it seems like the fixed income markets are believe the

very devilish tone coming out of the Federal Reserve. But um, I don't know that they should believe the Federal Reserve in this because I think when the data change, particularly you get those higher inflation numbers, and provided the economy continues to recover through the through the fourth quarter of this year, I think the Fed is going to change it too, and it's gonna taper a little earlier than they expecting. Things, going to raise short term rates a

little earlier than many people expect. So I do think we'll see higher long term interest rates by the end of the year. It's just surprising we haven't seen more so far. You just said you think they'll raise interest

rates sooner than most people expect. David, when is that, well, I think what they're going to do is, first of all, I think they'll start tapering bond purchases at the start of next year, or maybe even in December of this year, and I think they'll have to raise a federal funds rate either at the end of two maybe the December meeting in two or else the January meeting in three. But right now their forecasts, they don't think they're going to raise the shorter federal funds rate until four at

the earliest. I think that's just not realistic, given you know, the economy is basically going to be fully healed as far as we can see from a macroeconomic perspective by early next year, and that just doesn't justify rates at close to zero. David. How much does the FED policy really hinge on what type of spending plan the US

government decides to pass? This idea that we're looking right now, under the Biden's new budget that was just released, or at least as reported by The New York Times, the total US debt held by the public would rise to a hundred and seventeen percent of the size of the economy. One. That's what Tom was talking about earlier. Can the Feds start to taper, we're starting to talk about borrowing that

much more money in the near term. Well, well they'd better because you know, we need to figure out how do we finance that at normal interest rates, Because for as long as you keep interest rates are close to zero, you're distorting everything in capital markets. You know, you feed good businesses, but you allow bad businesses to stay alive, allows speculation to run rampants. So it's very important the

federal reserve normalizes. And if that means that the federal government has to be a little bit more picky about what it spends money on, that's probably a good thing. So I don't think the federal reserves should get scared by the level of the debt. Frankly, they're encouraging this growth in debt by keeping rates so low. Well, but

we're are normal rates at this point. I mean through every cycle we were talking about before that that rates have come lower and lower, and the more debt you incur, the slower growth is so some people, including HSBC is Stephen Major says it's a natural path of interest rates. If benchmark borrowing costs should be lower for the US government just based on that slower growth trajectory. Why is that not the case. Well, I don't think it should

be the case. I think it's it's been caused by by a federal reserve which is really flooded the economy with liquidity. And the key thing is that flooding with liquidity doesn't actually stimulate aggregate demand. I think this is what they've missed all along. That's why big reason why the last expansion was so slow. But what's a good level of interest rates? A normal level, it's got to be a positive long term real interest rate. If you lend money in the long run, you should get a

positive return after inflation. If you borrow money in the long run, it should because you expect to invest in something that will generate a positive return after inflation. If you don't have an economy that's operating that way, you've got to only that's heading in the wrong direction. And

so I think at least positive real rates. So that means tenure treasury eels well above the rate of inflation, which you know, even by the FEDS measure is close to three percent year over year based on the numbers we're gonna get tomorrow. Dr Kelly, I want to take your JP Morgan work in dovetail with your work at Putnam years ago with the iconic Bob Goodman who was the great optimist, and that is in the sum of

the David Kelly analysis. Are you worried about the gloom of jump conditions given what we're doing with our fiscal and monetary policy new theories? Maybe see to the pants approach or do you see a smoothness where investors can say this will work out, will get to the other side of the bridge. Well, I don't. I don't lose much sleepover because I think it will take a long time for the for any crisis to unfold if we

have a crisis. But where I don't believe in modern monetary theory, I think it's nonsense um and I think in the long run, the key thing is if you spend, if you run big budget depths, and if it actually helps the economy, then this level of debt will cause the economy to blow up. It's your modern monetrade theory only works if it fails to actually achieve any improvement in human welfare. So it's it's it's it's a bad idea. I think you've got to try to get to normal

interest rates. If you set interest rates at the correct level, then the economy will operate optimally. David always going to get here for you, don't hold back, David Kelly that if JP Morgan Asset Management, the chief global strategists right now, Peter Cheer joins us from Academy Securities on what we see in the markets, Peter, it's the question we've all been yammered about. But you're the pro Why are yields moving given our fiscal stance, our fiscal numbers. I think

there's three things. One is the fact continues to buy a lot of debts, so that's offsetting it. We're seeing corporations able to defease their pension plans so they are net sellers of equities to buy debt. And then I think just no one really believes that either we're going to get the fiscal stimm Tho said, it's full extent because that bipartisan feeling is gone. And also quite frankly, no one really seems to believe that inflation is going to be anything but transitory. I do think it's going

to be persistent. But right now the market hasn't seen inflation for so long that they're downplaying that potential. I don't think the number one question has changed that much. Pay When it comes to a treasury sell off, How self limiting would treasury market set off big? How self limiting would it be? I think it would be very limiting. You know, when we go back and people want to talk about a paper tantrum, you see much much different positioning.

All you even have to do is look at some of the e t f s like an l QT, which is along dated investment grade bond t LT lawn dated treasuries. They've all had significant outflows, so they market is much more prepared for a tapering type event. And if the that needed to, they had things like Operation Twists that they could pull out. So I think we can get to two percent on the tenure of this quarter, But it's going to be a struggle and nothing's going

to gap a lot higher. It's very much under control at the moment. Do you think we could see a cycle high and I know it certainly days and it's hard to make the scalpaid, but you can envision a psycho high of two on a tenure. I think we're ultimately going to push up towards two and a quarter two and a half percent, but that maybe later this year, next year, and that's only once I think this inflation story becomes embedded. And I'm a little bit suspicious about

what China was saying today. For example, I do believe China is working towards that shift to a domestic economy, so they care less about providing us with cheap exports. So I think there's all sorts of inflation stories out there away from this commodity rise that people aren't talking enough about. And we'll start focusing focusing on the summer.

So what does that mean in terms of investing? This idea that there is a sort of a self limiting factor to the treasury UH sell off that could potentially happen, And yet we do have price to perfection when you look at certain aspects of credit markets and when you look at certain slices of equity markets, where are you seeing value? You know, I think it's going to be about a domestic growth story, right, we are going to

see supply chains shift. I think there's going to be a real push to help build up our five G and anything that we're kind of on that tech side competing with China, look for infrastructure spending and a real domestic focus. So I think that industry is really exciting. I think you're gonna see a push to bring back a lot more healthcare, you know, medicine's pharmaceuticals that can't be all sourced from China given this kind of level

of friction and competition. So we're gonna see that brought around. That's gonna change supply chains, change where things are, you know, made. I think that's the real opportunity figuring out what this economy is gonna look like in two years with this push towards sustainability, with bringing back some of these industries, and that's where the real opportunity is going to be. Peter, the full faith in credit space is not so much

yield but the price. There's somebody bidding on this paper. Now, you mentioned the government in the US government in as well. Do you see within your macro economics that the foreigners will walk away and all of a sudden the price will drift down and yield will drift up. I think we're actually a okay on that even when foreigners are stepping away, which is become a little bit more likely

given that we have the worst negative real yields. I always get confused talking about negative real yields, but you can actually earn more on an after inflation basis in Japan right now, probably even in Germany, which seems bizarre given that they have word lower negative yields than usum. But it's that real yields. I think it goes away, but there's just so much support from corporate pension plans, from pension plans in general, from retirees. I don't see

it getting out of control. People are too positioned for it to get out of control. And finally, the FED has a lot of tools that it can bring out if it starts seeing that risk. So I think we see yields go higher, but it's more of base deepening and it's relatively gradual and it's not going to be an impediment for stock market either. Get back to New York City. We need to can't s up it's gonna hit from me, sir, account of my security's head of

MACROI strategy. This is with our question, our conversation of the Day on the state of the American economy, high frequency economics, Rights, brilliant sharp notes on global economics, interest rate dynamics, and with Reveala Ferouki Rights on the American economy. She joins us this morning, Reveal, I've really been looking forward to this. You move from a ten percent boom economy down to something in the vicinity of five percent economy.

When you and Karl Weinberg look at that sudden shock of deceleration from a boom economy, what are the inertial forces we're gonna experience as we slow down? Good morning, Thank you for having me. So, you know, there are a lot of dynamics and play over here. What we're looking at right now is you know, peak growth rate, which we expect to be around ten percent in the second quarter. But after that is where the uncertainty lies. We don't really know what a post pandemic economy looks like,

what we expect as a decederation as these fiscal measures expire. Uh, and you know, if there is a lot of uncertainty about how the labor market proceeds from here, and I think until we get to that point, until we get to say September you know, there is a lot of uncertainty surrounding what will happen in the second half. It's it's an interesting dynamic because we can't really say that we're going to go back to a two percent or whether we're going to keep above potential. What we'll see

class officers do. How will corporations adapted adjust to a decelerated economy we've never witnessed before. Well, I think, you know, there's been a lot of preparation for this. It's not like this is going to be a surprise. We don't expect to grow at a ten percent growth rate. That's you know, it's not exactly possible without uh, you know, continued support from fiscal and monetary policy. So I don't think this is going to be a shock. It's just

going to be an adjustment. And again, we are still looking at a pretty strong growth rate with a lot of uncertainty surrounding that. Outlook, Rubella, let's talk about taper, and I just talk about talking about Kathy Joe and said yesterday I came on and she said that actually the bond market is responding logically to taper talk, which means yields down price higher. This is now when people are expecting. They were expecting the FED to allow yields

to climb. Yet the indication is that if they taper some of the stimulus, it leads to slower growth, Which is is this time different or we're going to fall back into that traditional paradigm. So what we're really seeing is, uh, the confidence in the FED right and what they're doing and what they are messaging. That is what this is all about. So if the FED wanted to avoid a taper tantrum, this is exactly what they're accomplishing, and the

messaging has been actually very good so far. I was surprised to see mention of tapering in the minutes, but it seems to me that that is exactly what they're doing. Is is really preparing for a range of possibilities. If things are stronger than expected, that the markets will expect that the FED will start talking about different But if things are not, then you know it's a more delayed process.

So it's really uh, I do think it's different this time, and I think what what the feds objective right now is managing expectations and they're doing a great job with that. We keep talking about how boring it is this week, and how it's even boring amid a pivotal moment in the economy. What are we looking for? What are we waiting for to determine the trajectory of whether it's very hot or whether it's a little bit cooler than people

are currently pricing in. Well, it's all about the consumer, it's all about the labor market, it's all about incomes. So what we're seeing right now is the effect of what has happened so far, and what we have to consider is that we are starting We started the third quarter on a very high base, so even if we had very little progression, we would have still seen a very strong growth growth rate, which we expect to see now. Now what happens beyond that is a very different thing.

We saw a huge deceleration last year because when fiscal measures expired, But this time around we will be in a different situation, hopefully because the labor market will have made progress and we have made a huge proggress on the health front. So while there's a lot of uncertainty, you know, our focus remains on the labor market. Because if you think that is the FEDS focus as well, they would rather tolerate a little bit of inflation for a little bit of better outcome on the libor market.

I mean reveal. I know you don't want to talk about this, but you know I don't want to get you in the Carl Weinberg time out chair. Let's link Carl's work together with your work. And that is the trade deficit, the fiscal deficit as well. Do you see any relief there? Do you just assume an expanding trade

deficit to GDP a stable or expanding fiscal deficit to GDP. Well, if you think about the trade deficit right now, what we're seeing are imbalances, right, I mean, the US economy is open to the European economy is getting there, not quite there. So therefore you have, you know, goods deficit in the record. I do expect some adjustment back as other economies reopen. So I don't expect that this trade deficit issue is going to be us, you know, it's

just going to persist. I do think we're going to see adjustments, but uh, you know on the on the on the fiscal on the deficit side, uh, budget deficit side. I do think that what happens with these negotiations is very important, and especially when we look at you know, the Widen administrations push that this is not going to be a deficit finance. This is going to be uh, you know, this is going to be paid for. So

you know, there's a lot of uncertainty. But I do think that we could come out on the other side of this, you know, maybe not as in bad a situation as a lot of people are expecting. Before we let you go over about two hours away from the initial jobless claims that we get every week, increasingly they are going down, and yet people say that they're very noisy and markets tend not to trade off them. Are they basically useless as any kind of indicator at this point?

It's it's really I mean, we we still follow it, but they're like you said, there is a lot of noise in the data. It's really surprising. It's puzzling why we would see four thousand people get laid off each week, and you know, these filings what we are looking at

is the continuing claim sample. They are also you know, extremely high, but we do see value in it, you know, in terms of the you know, it's a high frequency indicator, but I do play less less weight on it because of the fact that it doesn't really seem to be connecting right now with what's happening with the economy. Okay, of high frequency it can almost the chief US economist.

We've gotta leave it there. We get lucky with a gentleman from Arkansas on the second Congressional District, the Republican French will joins us on four or five other topics, which you discard to talk about six trillion dollars, a trillion here, a trillion there. Congressman Hill, I want you to go all ever dirks and on us and give me forget about modern monetary theory, give me the modern French kill theory about how all Americans adapt to a hundred sevent total debt of g d P ten years out.

Can we do this? Tom Lisa, good to be with you. We haven't seen that since the end of World War two, when America was fifty of global GDP, and that debt way over g d P was a result of fighting and winning a world war. Now we have embedded deficits for all the out years from our social safety net systems and by government growing as a percentage of GDP. I don't believe it's sustainable, and my biggest concerns are the potential for creating inflation once again going back to

high inflation expectations. Secondly, the value of the dollar connected to that obviously, and the ability of servicing that debt as interest rates inevitably rise from their historically below zero level today. Other than winning in two thousand twenty two, what is the appropriate Republican response to this budget is proposed? And again I don't mean the one year fiscal budget, Congressmen,

but the idea out ten years. What's a cogent GOP response. Well, look, starting in nineteen before the pandemic, as you will recall, the budget for discretionary spending was essentially flat. In fact, it declined in real terms. So Congress has the ability to control discretionary spending and better reform our mandatory spending

programs like Medicare and Social Security. And we need to come back to reality after the pandemic, Tom focus our spending, target our spending, reform our mandatory spending programs, and in my view as a House Republican, not expand the role of government in our daily lives, which this budget does in spades. There is a question though, about useful spending and the idea that sometimes if you spend, you generate more growth. We saw that certainly from the nineteen nineties

and the Clinton era. We've seen this over time. If you borrow, you can actually generate a more positive future. What is the distinction between good spending and bad spending right now? Well, first of all, I think there's a rational level of spending too much, too fast, on two

on too many things that are not rational spending. And you look at the nineteen nineties, President Bush and President Clinton had some modest tax increases, that's true, but you also had the peace dividend as the Soviet Union unraveled, and it allowed President Clinton to work with Congress to balance the budget by the end of the decade. And they did that through reform, including mandatory spending programs and

and other social spending. So again, it's targeting, it's reformed those programs, it's look at ways to build our country. And when it comes to infrastructure, that would be a rational spending of public money that needs to be done in a targeted way, with a principal focus on things

that are really in need of repair and reform. Inflation has been an interesting debate, and that was one of the biggest arguments against running the deficit this deeply a lot of people have come out and said they're worried about inflation. Has become a bibararity sort of polarizing debate in Washington. How much inflation are you looking at that would be too much? I mean, are you looking at specific thresholds that would create a problem for the economy. Well,

we have sharp increases in commodity prices. You look at lumber being the worst, perhaps, and President Chairman Pal hopes that these are transitory. But other members of the Open Market Committee, like President Kaplan of the Dallas Bank, are concerned that if this gets out of hand, we will once again to get into a nine seventies inflation expectation situation where instead of trying to cut costs and improve productivity at businesses, we just raise prices and suggest that

up and down the supply chain. If we in bed that, we're in trouble on inflation. If we don't, it's transitory. The french Hill, one of your charms is you actually have fairly close selections, unlike so many other people in Congress. French Hill fifty Joyce Elliot in the last go around, Republicans are gonna win in two thousand and twenty two. A lot of experts tell us here, you're the kind

of district that's critical for them to sustain themselves to victory. Again, what do you need to do to get your district to take a more conservative stance? How do you sell that to America? Well, look, I think Americans are so rational. We operate off the kitchen table, We operate around our companies with our employees, and it's about using math and rationality. And we think borrowing money at the rate the Biden administrations proposing it and expanding government is not really a

shared value by most American families. So I think it's tugget targeting tom and budget priorities, and that's what we need to be focused on, is we come out of this pandemic. French show, thank you so much, greatly appreciate it. From the second Districts. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten AMI 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.