Surveillance: Fed Needs To Act Soon, Darda Says

With us is Michael Darta of m CAM Partners. His work particularly on demand and supply dynamics across the greater economy out of Wisconsin or near legendary for such a young guy, and we're gonna talk to him now because he is an outlier with Mr Kachola Coode of Minnesota on what a FED needs to do. And Michael, your basic theme is it's not a FED in a static environment. In this is dynamic economics and cultula quota is correct. They've got a cut because it's a moving target right

now for the FED on real rates. That's exactly right, Tom so um By new by doing nothing, the central banks are doing something. They're actually allowing monetary conditions to tighten. Because if you have a big shock to confidence in the neutral interest rate collapses and central banks stay steady with the policy rate. That's effectively a tightening of monetary policy. How do we know that's the case. Look at the

bond market, Look at inflation expectations. They're plunging. If this were a first order textbook supply side shock, inflation expectations would be going up as real rates fell. That is not what's happening. So yes, the first order effect is a supply side shock from the coronavirus, but the second order effect can be a monetary shock of central books don't respond to this and a timely enforce beautifully explained.

But then go to the x axis and take the part wi differential of the time function across those first and second ordered functions. The answer is nobody's talking about the sequential path of when the disinflation clicks in. Is it weeks, months or do we have to wait quarters for the evidence for them to move. I said this last year when the FED was presiding over an inverted yield curve, and my view was they really need to act sooner rather than later, and much more forcefully rather

than in a tepid fashion. The longer they wait, the more they'll have to do in the less effective it will likely be because they're allowing a situation in which the neutral interest rate is moving down. You know, this happened in two thousand and eight when the FED got so distracted fighting the financial crisis they forgot about monetary policy. The neutral interest rate collapsed through the floor. The FED

was late, and nominal GDP one off a cliff. By definition, if you have a nominal GDP shock, monetary policy failed. So the first order of business is to avoid that. Come Mike. What I hate from you though, is that the most important thing for them to do is manage financial conditions. Is that what I'm hearing? Well, financial conditions are sort of you know, it's a bit of a slippery concept, and you know that's a byproduct of of a of a monetary shock taking place, and most people

end up looking at the stock market. You know, a lot of these financial conditions into seas are a little strange because sometimes they have interest rate levels in them and conditions than ease in the models of you know, discount risk free rates fall and that may not actually be the proper way to to think about this um But if you have inflation expectations moving lower because you've had a shock, and that's associated with risk spreads widening

and now a big plunge in equity prices. Yes, you can define that as a tightening in financial conditions, and so to stay neutral, policy rates need to come down. That's my point. By doing nothing, central banks are doing something. They're actually presiding over a typing of monetary conditions, and that's how you end up creating a situation where, um, you know, the coronavirus actually can morph into my recession.

How the lower rights cascade through an economy like the United States that could face a supply shock and demands shock as well in this environment, which is very very unique, it's a health situation, a public health situation. How the lower rights cascade through the economy, Well, the markets are

already doing it. But if the Fed does not follow suit, and it's holding its policy rate above market rates, which is what's happening now right, we've had a reinversion of the of the yield curve, the entire curve, the short dated curve was already inverted coming into the year. Now the tenure yield is plunged back below the FED funds rate and and the t build rate um So that tells you that the Fed is actually holding interest rates

at levels that are too high for the economy to survive. Now, you know, some guests will come on here and say, oh, that doesn't matter. The yield curve doesn't matter anymore as an indicator. But take a look at business cycle history, and this is not something you want to play Russian

roulette with right now. If you look at the FED funds futures market pricing in almost four rate cuts by the end of January, to your point, just to put a number on the diminishing inflation expectations, the break even rate over the next five ten years has fallen to the lowest sixteen one and a half percent, now well

below the two percent target of the Federal Reserve. I'm wondering, if the Federal Reserve comes out and confirms market expectations for this many rate cuts, do you expect longer term inflation expectations to go up? You know, that is a great question, and that is basically the problem. And and so you know, we came into this crisis with you know, already low inflation expectations. Why is that the case? A lot of people say, well, the FED tried to raise

inflation and couldn't do it. Are you trying to raise inflation when you raise rates eight times and cut the balance sheet by half a trillion dollars when inflation is only a two pent of the time, which was the rate hiking and monetary tightening environment. So the FED is a tremendous amount of credibility and keeping inflation low but not in raising inflation to ur above its target. And

now we're dealing with limited ammunition. And if you go back to FED New York FED President John Williams speech of you know a year or so ago, in an environment where you're in the vicinity of the zero lower bound, preserving ammunition is exactly what you don't do. That's a way to fail. You want to move sooner and much

more aggressively, or your actions may be totally inadequate. And to your point, if they do move now, if it's twenty five basis points, you may not see a big recovery and inflation expectations, but it's certainly better than than doing nothing, in which you know these expectations could continue to roll over. Recession risks are elevated, they were still elevated coming into the year, and now they've they've moved

up even more so. Afraid when I listened to a lot of other commentators, they're just simply missing the boat on this telling you know, the fed not to not to act, not to panic. No, in this environment, you actually move aggressively and sooner rather than later. I Mike got to catch out with your Mike data of m camp fount is, let's get the view on the straight show. We Stave Lighting joining us on the phone. City Private Bank Global Chief Investment strategist, Stay fantastic to have you

with us. Walk me through your message for clients on a morning like this morning. What do you tell them? Well, look, I think it's just getting through the initial message that the success that China seemed to have in slowing down the coronavirus gave a false impression that this could be

contained to a regional event. So what we learned over the weekend with for example, just to start of this Italy and Korea, but going from a very small number of infections to something that was more in love with vir bologists had thought that this was not going to be containable, right, that there would be widespread it's not infections, but but certainly exposure to the virus that that changed

this from a regional story to a global one. And so therefore some of the economic effects, the disruption effects that we've seen in China, which were been very severe, um, but some of that that we would see in other parts of the world. So that's the thing. This is a much larger than simply regional uh disruption effect, but it's going to be something that's much more widespread, and that's going to mean greater uncertainty about the economic outlook

and greater depressing effects uh in economies. UM, you know, just trying to avoid uh, the dispersion of virus for the economy. So our outlook has changed from the economy, UH, and what we would think, you know, earnings do, what you know activity in the economy does, and uh, therefore

what financial assets would do. Here for a while, so Steve walk us through that the idea of the economic effect and how you price that in and how you measure that against the market effect where there seems to be fear being baked in that does not seem to be abating this morning. So figuring out exactly how to measure this is not something that's going to be to

be easily done. I mean, we're just going to assume that travel transport, uh, that those industries will see double digit declines uh and in very similar to what you might see in a severe recession. But this much more, very deliberate. Um that this is like having you could almost say, like a national strike effect and r big industrial activity or natural disaster that that's probably going to happen a bit over time, and in region by region,

country by country to predict unpredictable way. What I heard just talking about really about what economic data points you can look at, and honestly, very little data outside of perhaps from the China data. But but this is much more than a China story. Um, very little data is going to reflect any of this. Yet. I think some of the consumable commodities are the things that you're going to say that, look, we have to use this or will it will show up in storage. Those types of

commodities will be used for tracking real come activity. Stave. How would you respond if the Feds down to the signal they make a move in March? So far little signal of that whatsoever. I'm just interested in trying to get my head around how investors would respond to a central bank willing to step back in because so far seeing little signal, little sign of that coming from the e c B, all the Federal Reserve, how would you respond to that stage positively? So they're not in an

easy place. And and clearly they would be correct to say that a monetary policy response, which has long labs in terms of its impact on the economy, UM, is uh not something that's going to sort of cure a disease. At the same time, what you have to think about is what if they don't move and um, if the Federal Reserve or other central banks would stand in the way of a market adjustment right, um, and keep policy rates higher than the market is looking for, then they

create an artificial tightening. Um. And you know what we have to think about. And if you want people to look over the valley, UM, it's that, Yes, if the Federal Reserve eases, it probably will be easier too long. It's not going to tighten when the when the impact of the coronavirus is over. But in a way we

need that. Um. We just simply say, well, let's suspend the Fed funds rate for a while um and lower borrowing costs and on the way out of this and certainly doesn't stand the way of an adjustment and financial conditions. That's that's less severe than what otherwise would Stephen Whiting when you look at your expertise, which is linking profits

in into market performance and into economics as well. What if I'm fascinating is what portion of this slowdown and revenue revenue growth, earnings, flat earnings, negative earnings, whatever it is, what portion of that will be recoverable down the road? Have you in City group done any work on that, yes, and and it's it would tend to be a large part of it. And exactly when is not clear. Um, But again if you are so, so, a couple of things need to happen. Now some of the pale risks

that you can talk about again have increased. That credit would negatively affect the economy even in a scenario in which the coronavirus dissipates. That that is what central banks should want to avoid, and that's why fiscal policymakers need, um, you know, disaster relief, right, that's the kind of thing that happens in a great, big natural disaster. Um, you need fiscal easing to address weak creditors. I think China

will do that, for example, very easily. I think that other authorities should be considering that when the time comes, they think that they will. And if you do that, then you don't really damage economic potential, this longer term ability to recover. And you know, again we you know, ideally, um, there's some break in as virus, and then people have short memories and suddenly they go back to travel, purchasing things that they would otherwise, and economic activity can normalize

pretty fast. Always great gay thoughts stay wanting their city Private Bank global chief investment strategist, speaking as we do any credit group chief economists, typically constructive. We usually drained the drama and the hyperbole from the conversation with Eric, and I look forward to doing that now. Eric. March twelfth, the ECB convenes. What is the house view on that meeting as things stand from your perspective, Well, good morning, yeah,

I I don't think they're gonna do anything. Christine Lagat said according to the Financial Times that that so far they haven't seen any things that would have sort of a material longer term impact. Uh. Now it's not on their website as far as I can see, So I'm not sure there's been a big discussion inside the ECB. But but I I I it's clear that Europe is going to take a serious hit on growth in the first quarter. But there's a big question what a sense of bank can do and what the e c B

should do this earlier. So my guess is that we will get some some wording on being nervous or watching it carefully, but but no action. He should follow up paric what kind of policy leavers do you need to pull it in an environment like the one we're going into. Well, that's a very good question. Number one. If it's a supply shock, which it is predominantly U, there's really not much you can do. If you are, for for a reason,

the virus shotting down movie theaters. You can put any amount of money or or credit to people, they will not go to the movie theater period, right. So it's so if it's a supply shock, there is not much you can do apart from providing liquidity to companies so that don't go bust. If that takes two, it turns into bad loans. The problem potentially in particular in China but there's also there is also a demand side, particularly in Europe where a lot of of of restrained traveling.

Now we started to come into place, and some of that travel may take place may if you had more money on your hand. I cannot doubt it. So this comes down to potentially supporting the market a bit, and there it is balance sheet expansion rather than interest rates. You need to use um. But we're not there yet. Eric.

What's the likelihood of a global recession from here? I wouldn't put a percentage on, but it's if you if you record it technically, if you will, then it's I think it's very high now because China is going to take a big hit in the first course. Also, our very sort of preliminary guests is that you're seeing something like a growth rate of maybe half of what you had coming out last years or maybe three. This is a coincroal five percent drop, but they're about then that

automatically it's into Europe with a bit of a negative number. Small, but then you have the European effected itself and the US also. I mean, may I say here from Europe on one word on on the US, yes, to fall look good, but it was all this knit export effect, right, that complete right, right? The number so the US is a lot weaker than people realized. So so yes, high probability. Now that's a really important observation on the dynamics of

exports and imports. Eric Nielsen. One thing we've missed this week or talked less about with the market news and of course things front and center, is the effect on em UniCredit has a real Eastern Europe and Southern Europe feel as well. I've got Turkish lira out, the new weakness, six point to three, Brazilian relics, etcetera. What are the knock on effects of this pandemic and the knock on

effects of the big economies onto the lesser smaller economies. Well, it's a good question, tom, and and it's and it's significant, right, I mean, And and here's the ublem we're facing is it's too effect. We are shutting down businesses in the in the big or the G seven economies and China, and that by definition has this spill ful effect. And then there's the financial monet effect, which it comes with this move to safer assets. We saw your dollar now

is coming back a little bit again. But we have seen them generally speak speaking risk conversion coming on. Look at how your credit for example, and that hits the e merchandise as for example. You also pointed out so this this would be an accelerator out there. Unfortunately, Eric great to get your viewers aunts olwise, Erry Nelson, there only great a Crow chief economist calling son potentially botannical recession.

This is the interview of the day. If you need a synthesis of what's going on, and I will advise you that. If you need a reason to sign up for linked In, it is James Bianco of Bianco Research l l C. What's the l l C man, It's like only fancy people that the people that go to Wrigley Field do that. Jim Bianco with us right now, his feet on LinkedIn is a must read for Global

Wall Street and of course is good research as well. Um, I just did the mathematics gym, which I usually don't do, and eighteen down bear markets twenty four thousand, two hundred, bear markets twenties three thousand, six hundred. Are we going to get there? Are we going to a bear market? You'd almost have to say that we are, and I wouldn't even be surprised if we were to see it in the next day or two at the rate that

this market seems to be plunging right now. I think what we need to understand is that, first of all, if the market made a mistake or is making mistake, it was after it sold off in early in late January on the in the original cornervious spheres. It rallied to new highs by February. That was the mistake. So it has to correct that, and it has to now price in a new era. I think I'm with Scott Minored. This might be a bigger deal than the financial crisis.

This is a change in the way that the global economy is going to work. There was a serious break that just happened. We're not going back to the way we used to work pre January with the global but we get viruses end, Jim, Yes, but not the attitude that it will bring won't end. We're going to deglobalize, We're going to change things. We are not going to have a collapse. We're not going to have a great depression.

Let me put it to your market terms. The S and P was trading in a forward rate pe ratio of twenty before this virus hit. It's going to trade at attendant Fife ratio coming out of it. It's not going back to that heavy twenty growth and that optimism that we're going to have this booming global economy like we had before. We're going to deglobalize. That's going to mean to pull big things back from China. That's gonna bean more inflation, that's gonna be more friction in business.

That's what the President Sanders is gonna come in. He's gonna eliminate the terroiffs like first eight he's in office. You know, things that we can't predict, they're gonna happen. And I'm not saying we go to twenty multiple or twelve multiple. That's our job. But I am going to say, on a medical basis, there's an ample history that viruses end. And you're saying we can't go back. No, I'm saying we can't go back to a p e sky is

the limit um global economy. That's where we were. I'm saying we're gonna go back to a little bit more circumspecte maybe a twelve pe if you will, economy. That's enough to knock down the stock mar not not a great depression, but we're going to take the starch out of this market right now. That's what you're seeing the market do an immediate rep. Markets don't explain, they don't complain, they say, oh, I got it wrong, new era, let's just reprice the new era. That's exactly what we're seeing

happen in the market right now. Now there's a possibility it's getting it wrong. And getting it wrong means China comes back and we go back by this summer to thinking how do we continue to close every job in the United States that we can and send it to China. We go back to that attitude, which is lower cost, faster growth. We'll get back to the highs. But I think what we're seeing in the market saying we're not

going back to that attitude. This is a new era that we're going into, not a disastrous era, but a new era of slower growth, a more circumspect kind of world. Hey, Jim, can you give us a sense of the delta you're thinking about, because you know, we were already thinking about a lower growth four longer in terms of global GDP, and you know one to two kind of what do you think the new era might be post crisis. Well, I think that there's two steps with it. First of all,

we have to get through the crisis. The immediate thing that's going to happen in the next two weeks or so, we will find out if this virus does start to spread widely in the United States, that is a palpable fear and we see widespread school closures and disclosures like we've seen in other countries. If that happens, we could see an immediate contraction of GDP in the second quarter. Now, if and if that does happen, coming out of that, you're going to get attitudes a lot more conservative then

you would if we don't see that. So I do think you're going to get conservative attitudes, but they could be a lot worse if we have to go through what say Japan is going through South Korea is going through. Right now, Jim Bianca with US Bianco Research, let me do a day to check here quickly. We're a negative six plus on the UH out on negative for fifty trading here. We are open for business twenty five thousand, three fifty one in the Dow SPX, decisively below that

three thousand level. The VIX went out forty seven I believe it was forty one point one six. Now on the VIX the action was in the two year yield down to a point nine one handle. Again, we've had a bounce here in the last number of minutes. Uh

and uh, I'll just mentioned oil for thirty three. Jim Bianco, you show this on LinkedIn today within your good research, which has been our theme of the morning, which is gaming FED prospects and Marianna Cucho Dakota of Minnesota and Rochester and Michael Darta MKM Partners and Bob Michael JP Morgan sit enough. The FED has to act because even if they staypat with disinflation, they're tightening in an indirect manner. Do you agree that the FED needs to get out

front of this. Yeah. I think they need to get out front of this in one of two ways that there talk of. We have to wait to see the data. Uh. Jim Bullard's speech that was released a little while ago, he's the dove. I'm not ready to move just yet. Smacks of them hiding under their desk and shell shock.

And they need to recognize what the markets think and that there is something significant that's happening in terms of the attitudes of the global economy, in the U S economy, and start to at least acknowledge that they don't have to move today. But I think that they need to

at least acknowledge that something significant is going on. And eventually, yes, I'm with them that if this economy pulls back, the act of doing nothing is a tightening and that they will have to think about moving down with the economy. And kind yeah, I want to bring this up. It's amazing how I missed the stuff. You know, I'm supposed to be all wired up. You know, I've got four log ins and on all the upper east side dims out when I come in the morning. But I missed this.

And thank you to Ian Shepherdson free of AMIS and all at Pantheon. They mentioned the Bloomberg Financial Conditions Index. I call it the Michael Rosenberg Index, which was many standard deviations ugly in two thousand and eight. We're nowhere near that. But we've really come in from a positive benign financial conditions we're now down one standard deviation. I

didn't know that it's it's starting to the data. It's just migrating end a week towards a point of Oh, really, Jim, do you think the federal you think there needs to be some type of fiscal stimulus on a part of the US government if this gets uh, you know, more widespread in the US. And again we have it. It's been very limited in the US to date this virus, but to the extent that we see similar migrations that we've seen in some other countries. Do you think fiscal

stimulus may be needed by the government. Well, don't do it. I mean, there's no doubt that they will attempt to do it, and especially if it if it migrates into this country, the fiscal stimulus might just be combating with the virus itself and what they'll um, what they'll have to spend at least in terms of testing and identification and trying to mitigate the slowdown in the economy and

the like. So yeah, I think they will not. A question is will it be effective, because what you've got going on now is an immediate supply shock that could also turn into a demand shock if the virus comes to United States. I don't think we've ever seen both at the same time to this degree, which is what the risk is that we face Jim. Thank you so much,

Jim Bianco. And again, folks, I can't say enough. First thing you sign up for on LinkedIn after Paul Sweeney's glorious site is Jim Bianco is just really extraordinary out on LinkedIn with Bianco Research LLC is well. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcas as you can always catch us worldwide. I'm Bloomberg Radio