Surveillance: Fed Owes Mea Culpa, Says Dudley

The Federal Reserve owes the world a mia coppa. Bill Dudley, bloom Big Opinion columnist and former New York Fed President, a good friend of this program as well, joined us right now, Bill, let's start there, a mia coppo. What do you want that to look like? I think the Fed needs to explain to the world what went wrong? Why? Why are we having to rage rates on four d basis points this year four percentage points since year. That's a huge amount of taking in a short period of

time and is evidence that the FIT was very late. Um, the FIT made a couple of mistakes. Number one, how they implemented their two percent average inflation regime and they basically tied their hands and said we can't raise rates until a whole bunch of things happen. Number two, they made some important forecasting errors, both on inflation and enter tightness of the livor market. I think you know, doing a mea culp. I think it's important to basically build

the fits credibility for the future. If you don't admit error, how can you be confident that that the central play will make make a whole another mistake next time? But do you think they can do both of that and do something which you asked them to do a number of weeks ago, which is to be much more open about the pain that this country, this economy is about to go through. And I wonder if they do both. You say it enhance its credibility. Do you think it

also invites questions about whether it should retain its independence? Well, I think you wanted the Central Bank to retain its independence because you don't want monetary policy to be politicized monetary policy, Because politicize you're gonna have even worse mindory policy that we've gotten over the last couple of years. Bill. On the flip side, there is an increasing chorus of big names saying that the Fed is moving to make

a policy error. On the other side, by raising too far that a deep recession is not an inevitability, but will be the consequence of them and raising rates as much as they're expected to raise rates. Are you sympathetic to that view? Well, I think that's a logical outcome of being very slow to tighten in the first place. You've been slow to tighten, and you have to do a lot to catch up. If you do a lot to catch up, you may not notice that you've done

more than that's actually sufficient. I think you know, hard landing is very likely because the labor market has gotten too tight. The FED needs to push the unemploying rate up significantly, and that's likely to lead to a recession. I think it's almost inevitable at this point. What's the economic benefit to the FED coming out and being honest and saying what John was pointing out is a very

difficult message to swallow, which is we made mistakes. Oh and by the way, we're gonna necessarily make a mistake on the other side, tighten into a hard landing. What does that give them in terms of credibility that can actually help meal your the cycle. Well, I think that they are not going to say that we're going to take on purpose to generate a recession. I don't think you'd ever expected center back to to say that, but I do think Paul has now endorsed the notion that

there is going to be some pain involved. I think what the FIT has not done, though, is admitted how do we get into this mess in the first place. And I think that's part of the message that the FIT needs to send to Marcus to build their credibility for the future and build credit to you. I remember doing a panel with you and Muhammad Alarian back in June, maybe May of one, and you're both making this point that the FAT needs to appreciate some two way risk here.

Perhaps start by pulling back on que that would have meant maybe going six months earlier than they actually did. Bill, What difference would six months have made, do you think? I think that the end of going earlier is you wouldn't have to go as fast and you have more ability to assess the effects of your actions. Right now, they have to get to take very quickly, and given a lot long legs of Montary policy, this is increases

the risk that they overdo it. If you spread out the Monterey paulicy tightening over longer period of time, you have more time to assess the impact of your actions. You've talked Bill about how you could see a peak FED funds rate north of five percent. The market is coming to your view. You're out front that way right now in the market we have a nearly four point

seven percent terminal rate for next year. Where have you changed your view on where you think the FED has to go in order to bring in inflation and honestly address some of the flaws of the previous thinking. I don't think it's so much that the peak and rates has to be higher. I think the fact is the FED has to hold that peak for for a longer period time. I think the Fed's pop strategy here is not to just keep hiking regardless of what's what's happening

in terms of the real economy. But I think they want to go to a restrictive policy and then they want to hold it there until they see clear signs that's actually bringing inflation down and generating more slack in the U s leavel market. I built one for to catch up a great rate as always, and good have you on the program with us this morning. Built Donte that they form new York Fed President and now, of

course Bloomberg opinion columnists, amongst other things. Shout joins USNAP, chief Global strategistic Principal Asset Management seem a ringing the bout at the nastact today, buzzing for that. I'm sure I always look up, don't you always look up around the open and bound, and people emphatically clap and with their hands even even when it's down, which is always kind of I always find that would if we're down today, when you screaming and shouting, I'm going to clap, You're

still going to clap even if we're down. Okay, opportunities to buy? Is that? Is that going to be your story whilst you're here, the opportunities to buy this on today? No, No, I have to say, I think I think there's there's worse to come from the market. Unfortunately. You know, you talk about we talk all the time about the third about inflation, about growth, and then you're adding all these

additional geopolitical pressures. It's very difficult to find anything to be positive about at the moment, and a lot of these things. I don't think it's fully priced into the market either. Earning seasons. Of course, it's going to be really interesting. We are expecting to see weakness study to really feed through now, um, a lot of the narrative about march and pressures, but also just generally starting to feel the pressure of consumers potentially putting back from next year.

So there's a lot I think to be concerned about convestors. When you say it's not priced yet, out of everything you've just said, what isn't priced, I still think that the recession is not priced right, So I think the market is eventually. I mean, look, it keeps switching every few days, but I think generally speaking, the market is coming to terms with the idea that rates are going to go higher and they're going to stay there for longer. As well. The bit that the market is still playing

around with is this recession. You know a lot of people still thinking that soft landing is possible. We think it's very unlikely. Um And with recession, unfortually does come and exprocession. So which aspects of the market are not

sufficiently priced? Because some people might look at retail for example, they might look at some of the semiconductors and they'll say recessions price there Where is it not or is it even client on semiconductors that has not fully appreciated the depth of this downturn, not just whether there will be a technical recession. So, like you said, I think there are segments of the market which really have struggled,

and semi conductors have have been one of them. Unfortunately, latest news probably suggests that they could be from further down Downblard movement from there. So valuations at this kind of stage, they are instructive, but they're not going to tell the full story. So in the same way, in the last five ten years, we've known that valuations are very expensive, but it hasn't stopped markets from going up. Cheap valuations don't necessarily mean that markets are not going

to go down. Further, I was reading a piece of research over the weekend which was talking about how if you look at some of the AII sentiment, it looks really bearish. People say they're feeling terrible, things are going to go down, and then you look at their actual positioning and they're still pretty invested in equities. They're still actually fairly bullish, at least in terms of their positioning.

What's the trigger to wash that out? So I think I'm not sure if you're going to see necessarily a washing out, because even from today, you know, we are expecting further declines. But the quant the one question that keeps coming up. I've been traveling around the US in the last week. The question keeps coming up. It's like, but when is this flow going to come? When can I start buy right? So that is the question that people are trying to figure out. When is the timing

for them to increase their exposure. And I think at this stage, you know, if we look at historical bear market cycles, your average downfall is that if you're down and you don't think this is going to be like the GFC, then we're more than halfway there. So if you're not already underweight, this is probably not the time to start reducing even further. What do they ask you about Europe when you tow this country? How much do

they hate that market right now? So much? But I understand that, and actually I fully agree with our perspective for the Europe It is a very very challenging time. And I think that what we're starting to see in the US is they are understanding that actually, in Europe this situation is considerably worse um, and put on top of that is there's so many things that we cannot predict. We're not meteorologists. We cannot predict what the weather is going to be. No one in the whole world probably

cann can predict what's going on Putin's head. So with those two incredible uncertainties, despite European valuations being so cheap, this is probably not the time to increase your exposure

when you have those two things hanging of you. You talked about the persistence of this, particularly around rates, that we could be living with this for the next twelve months or so, then that's also a conversation taking place much more sub in Europe now that we could be living with this for more than one winter, maybe too, perhaps even longer. When you start to think about the United States in that respect, ten years ago we talked about the United States decoupling for the mess that was

playing out in Europe. Is that still the case? Would you say say that's still the case? I think it is to some extent. I mean, one of the things that we are studying to fill is that in the US there is this belief that there is a complete decoupling. But of course that doesn't happen. You know, Europe. Whatever European tensions there are, whatever the energy situation is, they

will be leakage into the US. In Europe, You're already seeing this huge substitution from natural gas towards oil, and of course there will be inevitable repercussions for the US as well. So I don't think it's a full decoupling. I think the U s does come out better than Europe sunny, not completely compling. Okay, so wear with me. But everyone who I know is going to Europe for a vacation, including Tom Keane, who's over in Europe right now.

And we're hearing about the negative effect from the strong dollar on US companies, But that's because things are on sale effectively from say European industrial So when is the currency differential a good thing for Europe the way it used to be, say five years ago, when the currency wars were reversed. Well, I think you've already seen some of that play out this summer, which is why you

haven't seen European GDP actually contract yet. If you look at Spain, Italy, all of the southern European countries have benefited significantly from the weak currency and that is going to moderate a little bit some of the downtown that Europe is going to feel. But this is I mean, from an investment perspective for the U S it's one of the key reasons why we've been overweight midcaps Roden

lodge cap. The MidCap exposure to domestic is significantly higher than what you see for large camp UM and you know they've out performed to be expecting to continue to our perform. One theme that we've heard from a lot of the investors who we speak with is it's starting to look attractive to go into longer dated bonds. How much conviction do you have around that kind of view, both in the US but also in places like Europe. So we have, for example, increase or exposure to long

dated bonds fairly significantly in the last two months. UM A couple of reasons. One is that we are, as I said, expecting recession to hit next year, and in that environment typically you should see down with pressure on yields. But like you said, in Europe, there's the added pressure. What are central banks doing there raising rates but they're also pushing down the long end, or at least they're trying to push down the long end. At some point there's going to be some kind of success or at

least it's going to stop any further movement. So if you have to be anywhere in the yield, cuve, I would rather be on the long end than the short land for sure. In the guild market or treasuries, I don't think you want to be in the UK. I asked the question because you're based in London. I just wondered whether you've been buying guilts in the last couple

of weeks. We did not foresee what was going to happen to the guild market, like anyone else, I think UM just generally speaking, the UK, we have the serious concerns about the fiscal story is not going to improve. I think as much as they can walk back, there are certain segments of that political story, the fiscal story, that they're going to stick to. So if you're looking at a longer term horizon, in the UK has worse

inflation problem, it's got a worse growth problem. So if I had to pick one over the other, I would pick the U S Halloween budget. What do you want from there? As an economist, I want them to underwind everything, undwind everything, just go back to having some serious fiscal policy where they're trying to actually balance the budget in the same way that really in the UK, unlike many other countries, fiscal balancing is a hallmark a fiscal policy

for the last two decades. So for them to walk away from it at this time is a very difficult time. In two or three years time, who knows trickled down economics could work. Do you think that everyone in the UK right now you ask them about what's going on with the guilt market, and they just sort of sigh and look at you like, please, can I just disappear right now by the guilt market? Sort of? Someone did buy the guilt market and made a tremendous amount of money.

I just say that when the bank having been stepped, dear, and yields dropped by what a hundred basis points at one point in that day, Which is the reason why I mean to see him as point the reason why the long end perhaps is getting some credence or some conviction on people because they do believe eventually central banks will step in at least for that because of some of the structural issues that require something from without them stepping in. At some point, you'd have to believe bonds

start behaving like bonds go into an economic downturn. People have gotten wrong what that point is though, again and again, and we have seen people change their expectations for how

high yields could go. And at this point, I think there's a feeling of being shaken a bit about what is the base at this point after a world of zero rates for so long, massively zero confidence in a high volatility world, zero confidence, a complete lack of conviction seem with thank you, enjoy ringing the bow, you press a button, right, There's nothing cool about that? Is that just sort of principlesca management should go in with your own balance, just you know, shake things up. Yeah, film

is going to join us now. It feels like euro crisis all over again, except it's different chief economist to acts or investment managers. So let's start there. Let's just start with the key differences between what we're facing now and what we face back then. Well, first of all, at the time, we had massive external imbalances in the periphery.

We had massive current agaunt deficits. So you had an issue with the government, but you had an issue with the way the entire economy was working in the South of Europe. You don't have that now. Of the those countries have really Donald, good Joe and re establishing proper external external position. The other big differences that we have different instruments. The big issue we had in two thousand and ten and ten thousand and eleven is that there was nothing in the arsenal that you could use to

actually stop this. We don't have the the s M, we didn't have an ECB, which after that has proved it's deexibility. So there was this, you know, scrambled to finding institutional solutions in just a matter of month. Now at least we know that we can rely on those emergency mechanisms if things get to the point that we

need to to to use them. And I think the market knows it, and that explains It's one of the reasons why we have unseen, for instance, a lot of contagion moving away from Italy and and and and affecting other countries in the South. We know that the instruments are there. They came up with o MT We're drunk in the summer twenty twelve and the beauty of lantiers. It never got activated, never had to be used. This summer they came up with tp I, the Transmission Protection Instrument.

Is that right, t p I? Okay, when does tp I start to become a real consideration? Fifty basis points to spread right now, I'm just trying to wonder what's the threshold when that starts to kick in. They they've never been clear on this, and they don't want to be clear on this. I'm talking about the CP Obviously

there's a noo full lot of discretion there. And I guess is that it's not just a case of the level of the spread or the level of interest rates, the speed at which things are moving, and so far it's been fairly contained. The biggest issue for me with t p I is actually not of a technical nature. It's it's political. The way t p I has been designed, it's definitely not uh done in a way that would protect the governments against its own mistakes. And that's the issue.

If you could come up with the situation where the market is punishing a state for things which has not even done or announced, then TPI is probably there. If a government is doing stuff which is triggering a sort of rational reaction by the market, then t p I is probably not the right instrument, and then you need

to go to to MT. But so far, at least, the news that we have from Italy, which is the biggest tissue in there, is that the government, the new government we don't have one yet, but the noises we got from the new majority so that they want to be prudent. So if they don't do if they don't make big policy announcement that would make the CB nervous, they could actually benefit from TP and there's a relationship

with the market that you can build on that. I just can hear your voice in my head right now, so I can hear Jonathan you're saying, yeah, you're mind reading because it's very loud right now, and he's saying, Okay, So they're gonna talk about political risk and the peripheries. What about the fact that Germany is the biggest risk right now to the entire European economy and that some of these things. So there you go. So what's the

what's the answer. How is this situation different, both with the political considerations and from just distinguishing from the euro crisis of two thousand ten, considering that Germany is one of the biggest problems, one of the biggest downside risks to the entire economic outlook. Germany is clearly one of the biggest downside risks to the macro story, but it's also the country which is the whitest policy space, and

they are using their policy space quite a lot. I mean, you've seen the announcements that we we had last week from from the German government. The steel can mitigate a lot of the current pressure that they get from from from guys prices with the billions that they are about to spend. So in this case, yes, it's quite negative. Of the last two three quarters. A recession in Germany

is absolutely unavoidable, I think at this stage. But we know that they can deal with this on their own forces, which is not something that we have in other countries.

That's the big difference. Although you do have to wonder how much higher inflation is going to be for a longer period of time given the fiscal response in Germany, and that the political pressure from the peripher regions will say if you guys can have such a big fiscal response, we can too, because you're gonna just let us you know suffer as we finance your deficit by bringing down the cost of your your financing through a weaker euro

a Keyshue. There thing is um whether all this triggers another round of debt mutilization in Europe, which is definitely what we need to see when we have the pandemic. We ended up with debt mutilization. It was partial, obviously, it was the next generation pack, but we did it. I'm a bit surprised and disappointed that we haven't seen more progress on debt another round of demonetrilization to deal with the full out from the Ukraine War. But there's going to be a point where we will get there.

I mean, Europe is always no tiring for for external observers because it takes so much time to get to the right solutions. But I'm quite convinced that if we get a situation where we will see bigger cracks appearing in our fabric, you will see this further movement of demonotization. You will see a clear capacity from the EU as an entity to provide support to the most fragile countries. We've done this with Italy with the next Generation packed fourth standing It's not done to deal with the full

of the Ukraine War. But I really have no doubt that we would get there if it be. Let's talk about the cracks right now. The mystery for many of us the e c P. Why is it not forecasting a recession? How on earth they're not forecast and recession in the euroSign Now I was, I was, I was very surprised, and then I knew. I reminded myself of of of my time when I was in central banking. You probably don't want to be the one, you know,

validating market expectations of of of the recession. You probably don't want to add to the general bleakness in in in in the system by coming up with a very scary, scary forecast. I guess it's part of of what central banks usually do. I notice that in the U s to feders taken an offul left time before saying that yes, maybe unemployment would have to rise to get inflation back under control. Well, it should be the same in in Europe. Central bank very rarely want to be at the bottom

of the distribution when it comes to forecasts. Sure, except that there is a credibility issue that the central banks will go through with the tightening plans they're projecting because casual observers would say, well, you put A plus B together, you get recession. And they're saying no, no, no, A plus B equals roses and lots of beautiful things. So at what point does that undermine the faith that they

will continue with their tightening cycle. Well, they don't deny the risk of the recession to be to be fair, and we we didn't have a super rosy mess age coming from from from from the CB. But they are in a complicated position because and that's a big difference with with the U s um inflation in Europe is

not or is not essentially domestically driven. It's none o our fault to to to to to to to summarize, and we have an ECB which is forced into tightening UH to keep inflation expectations anchored in a situation of massively adverse supply side chalk. It's not an easy thing to explain, especially if we've spent the last twenty years, not just in Europe but also in the US explaining to a stakeholders in the real economy, middles in the markets that you know what central banks have have your

back at this time. No, Sorry, central banks cannot have your back because there's an inflation issue, there's an inflation expectations issue, and central banks are not going to be to be your friend. It's incredibly complicated to explain again coming up to twenty years of military policies which have been explore and they're only accommodative. They're delaying the inevitable, thou aren't they? They have to confront this at some point.

They're talking about raising interest rates. A lot of people assume that by the end of the year, this is the economic situation we're looking at, whether they forecasted it or not, and they keep on hiking as the numbers clearly show this economy is in recession. Yeah. My My point is that if there, I think there's already debate actually at the ECB, which is for now not having

a direct impact on their immediate decisions. Um, they all agree on the idea that no, our monijtory stance with supercommodative, you bring it, let's say, to the upper end of the neutral range, and then this is where the differences appear.

You have those we're going to say, I don't care, I just continue hiking as long as insolations there and others, And I would probably agree with with those who would say, look, once we've brought I would probably see rate at your band of neutral range, let's stop awhile, let's pose, and let's see how things happen. But for the tending, there is an alignment actually of doves and whole around this idea that in any case our stands was far too

accommodative to start with. So I don't expect actually this debate to really trigger, to really have an impact on decisions before the very end of this year. In the meantime, it's you, as as Jo will say, they will keep at it. Are you feeling the pain if you're a dollar parity personally in your first few days of being hit and certainly not the most move all the rule

person on on on earth. But yeah, I've been in New York for two days now, and yeah, you feel you feel that your coffee is much worse it sp It's a shock, Grandma. I took the other side of the trade, going after Europe, and it feels so much better. So isn't it great? Everything's on sale. It's so exciting for Americans going over jail. It's a fantastic time. Please, we we need you, We need Americans. It was there in the summer and every where you went, I just

had American accents Everywhemerican accents pretty much everywhere. Joe Mark, thank you sir. It's going to see it. It's why Maxi Investment managers and I know you're going down to the m F meeting, so enjoy. Bobby Orga can talk to us about energy to understand Manergy Future Senior strategist and executive director and Miszoo. Bobby, you said you're not a big belief in the OPEC plus two million barrel

production cup. What do you mean by that? Well, I think they will see only about one to one point one one point two million barrels and cuts that are actually made in this opeque um production cut deal. You'll see Saudi Arabia cut. They're good for the word United at of Ram rights same thing. But there's a lot of folks in a lot of countries in OPEC that are under producing for size, they're not going to cut production further. Russia is basically around one point three below

the existing quota going into the OPEC meeting. Nigeria was about eight hundred thousand barrels below. Angola was four hundred thousand barrels below. They're not going to cut any further. And a lot of the other participating countries are happy just to stay where they were. They're not going to go out and pull back on production today. Um, They're just going to do their best to stay where they are. This struggling to be where they are, So I would

see I would expect to see Salty's cut. I expect to see you a cut for about one point one million barrels given the lack of spare capacity, bob wire prices not higher demand is really the issue here. I think that's another one that do PEC folks missed a little bit. The problem is not supply, the problem is demand. Um, we are here. The dollar is higher for starters. That is a reverse correlation to the to the barrel to crude oil. Higher the dollar, the less dollar it takes

to make to buy a barrel of crude oil. Uh. China situation is very negative for for OPEC. That's a big piece of the demand puzzle that's been taken off the off the table. So until that comes back, you're not gonna get We're not going to return to a hundred and thirty dollars like we were in March. Um, but you also have the global economy teetering on the brink of global recession here, that's a demand event. Cutting barrels is not going to make a big difference there, Bob.

On October six, the People's Party Congress National Congress over in China is going to kick off, and a lot of people are looking at this as a threshold moment after which perhaps the zero COVID policy could be lifted in some capacity. What would happen if you did see a softening, especially as we've heard pushback from other officials

recently about how unsustainable as policy really is. If you come out and you see that red headline on the Bloomberg terminal, that's going to definitely see the price go up a little bit here. Um, we probably would trade towards if China is on the way back, and if that's a big move in the right direction, we probably will see the market trade towards one hundred dollars. But I don't see it returning to a hundred and thirty dollars where it was at the beginning of the Ukraine crisis.

So yes, that would be um that's a big piece. That would be a big demand construction event. It would be very positive for the market. But um bob. And beyond that, with the FED still likely to increase the situation by basis points next meeting fifty the one after that, I mean, you're purposely pulling back on the global economy. So it's it's going to leave a mark. Hi bubb, Thank you, sirs. Wi bup yoga that f Americus. 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