Surveillance: Fed Patience With Dudley

President joins us too. Bill. It's going to catch up with you and I enjoy your pieces and your piece out this morning. It's a little bit technical, but I want you to run through things. When the Bank of England comes out with the rate decision, bank rate means a lot for a lot of people in the UK for business loans, for mortgages. The Fed funds rate is a different beast, and you push him back against the continued use of targeting the Fed funds rate and using

it almost can you just want me through the thinking head? Well? The Federal funds rate used to be important because reserves in the banking system were quite scarce and so banks had to trade the federal funds rate FED federal funds between themselves to satisfy the reserve requirements. That's not the situation today. The banking systems awash and reserves as a federal reserve continues to buy D twenty billion of treasuries

and agency mortgage back securioes. So the federal fund market has become very different, very much much smaller, and much more idiot thing credit than it has been in the past. Motivation for this piece was the fact that the Fed last week had to make a technical adjustment to too short term interest rates the rate they pay on overnight reverse repurchase agreements and interest rate they pay on reserves five basis points each. Why supposedly keep the federal fund

rate closer to the middle of his target range? Why are we tiring the federal fund rate in the first place. At this point, it's no longer an important market. The Fed has the ability to just to paid interest on reserves. Why not Why not ditch the federal funds rate target and just set the interest rate on reserves at the level that's a apropriate with the monetary conditions that the FED seeks to accomplish. Well, that's your simple solution in

your words three words, drop the target. But could you anticipate a communication issue around doing that. If they were to do that this year, I think they could explain it very easily. They would no longer have to make these technical adjustments that I think are more confusing than illuminating. Also, another thing that they need to do is is exempt reserves from the leverage ratio. As they add more reserves to the banking system, that's putting downward pressure on race.

The whole reason why they had to make this technical adjustment to the federal fund to these two interest rates push the federal fund rate up was the fact that they're flooding the banking system with reserves. Banks don't want the reserves because of the leverage ratio, which is starting to bind as a capital requirement for banks, and the example from the leverage ratio, then that problem goes away

as well. And Bill, you're talking about the glut of deposits that you're seeing on some of the bank books, with some banks even saying to their corporate clients, we don't even want your money because it is getting to be excess of just taking a step back. How much is the change that you're proposing evidence that we're going to remain in this environment with a system awatch and cash and the Federal Reserve pumping money continually into it,

even though there is so much cash. How much is it just sort of an acknowledgement of that reality over the near and frankly not even that near term. Well, I think we're gonna be in a system where there's lots of reserves in the banking system for some time to come. First of all, the Fed is not going to stop their asset purchases quickly. It's probably going to continue well into the fall. So the balancy is going to continue to grow. The munt of reserves in the

bankasys we're going to continue to grow. And then when it finally decides to start to normalize, it's balancy. Balancy is so big now it's going to take a long time to get it back to, you know, the one a half trillion of excess reserves that we had prior to the pandemic. So I think we have a system where the interest rate the FED pays on reserves. It's

a primary tool of Montrey policy. Let's acknowledge them. I understand Bill, the argument that the FED wants to continue with their very easy money policy is just comply to allow inflation to pick up and allow employment to get to a better place. However, people have pointed to certain fraud the areas and the mortgage market in particular. Do

you think it's advisable. Do you think that it would harm the progress that the Fed is allowing to happen in the economy for them to pair back on some of the mortgage debt purchases that they make every month. I think it would have an effect more on expectations about future mandrec polls we tell the market the FED has now acknowledged that they made substantial further progress towards their goals, and so people would change their expectations of

the timing of tightening. So I don't think it would be that important in the neurrowness of the housing market. I think it would be quite important as a signal of the Monterrey policy and the timing of tightening. Montre is that the preferred method versus first. I don't think they're gonna do it. I don't think they're gonna do it. I think they're gonna be pretty patient here. What about

perhaps maybe more of an equal waiting taper. I think all December a discussion of five billion and treasuries five billion in b asked. Is that just more of an easy path to go? Well, I think that you have a template from the last cycle, and so to deviate from that template you have to have a really good reason. I don't think they have a really good reason. I think if they deviate from what they did last time just raises a bunch of questions. What are you concerned about?

Why aren't you following the game plan that you followed West? What do we learn from last time around bill? The lessons of the last time we reduced asset purchases and

eventually actually had some balance sheet reductions several years later. Well, I think it went in all fairness, quite smoothly, once the Fed communicated clearly about what's the what's the what's the sequence was going to be, First we stop the asset purchases, we can taper the asset purchases down, then we raise short term rates, and then we finally start to normalize the size of the bounty. So this time

the market has a template to look at. Last time they didn't, and so there's a lot more uncertainty about what the favors are going to do in the last cycle compared to this secle. I think it's one reason why the markets are pretty comfortable with what's the Fed's up to. Do you think that there's two much FED speak at this point We've been talking about how there's very little dissent and there basically is a FED official every hour speaking. Well, there's always probably too much FED sean.

The thing to pay attention to is really the chairman, the vice chairman of the of the Board of Governors, and the vice chairman of the over Market Committee. So how Clarida and Williams, what are you saying, ignore the FED presidents when they go around doing speeches. Yes, I wouldn't say ignore the FED presidents, but put a lot less weight on them because they're just one member of the committee. I mean, the big three set the agenda for the Federal Market Committee. He's not gonna do something

if those three people aren't on board. So it's about weight. Don't ignore the presidents, but don't put too much weight on what one individual president might say, but just how much they influence the conversation inside the Federal Reserve, when you have those f ONMC meetings, when you have the likes of plus official really pushing back at the turn of the last crisis, going through the recovery, Just how

much do they influence the conversation. I think they have any They influenced the conversation because they offer a different perspective, and I think diversity of views is actually important. Diversity of backgrounds is actually important in terms of getting good monetary policymaking. By the end of the day, the committee is gonna go where the consensus is, so someone's always dissenting.

They started marginalize themselves because they're not relevant in terms of figuring out where the where's the committee gonna go U in the future. Right now, there's a lot of disagreement about, you know, when should we start to uh paper asset purchases because people are uncertain about the state of the recovery and how fast will it cut into unused labor resources. There's quite a bit of disagree agreement right now about timing. But the people that matter are WILLIAMS.

Laria and of course Howell, because they're the ones who are going to determine the ultimate timing it's gonna catch up. I so always got to see a great pace to a had a blow Bloomberg dot com and all the Bloomberg terminal built dountly that Bloomberg opinion columnists at former New York Fed President Danny Fledge Flower Target, professor of Economics and former Bank of England Monetary Policy Committee remember joining us. Now. We were just talking about how there

is not much being said that is new. However we make here something in a half hour time from the Bank of England when they release their rate decision. You're looking for a potential policy error. Can you explain, Well, both the Fed and the Bank of England are struggling in the dark. We've never seen anything like this and the best thing is to simply wait and see. Um. So, any any suggestion that they have a clue. I mean people say things that I think we're going to tighten

in three Well, they're just kind of winging. It's I think that the potential area here at the Bank is to say that they're going to start to perhaps um do less quey start sort of stop it by August rather than December, as the economy goes into lockdown. Um, the data really are very confusing. So I think the sensible thing for them to do is to say we're continuing, we're waiting, and we're watching. Two people are going to leave the committee how day, this is his last meeting.

Um Liese leaves in August and we get Catherine Man. So I think the right thing to do is to just say waiting, watching, and and and signaling that they have a clue what they're going to do in the future. I think it would be a major era. Well, Danny, I got to think that all of people are all of the discussion that we hear at of FED officials at a Bank of England officials basically gets shrugged off by markets because until fair FED chair J. Powell speaks,

no one's gonna listen. Basically, he's going to lead the charge globally when it comes to tightening and until he does so, you know, these members on different central banks can say whatever they want, no one will believe them. Isn't that the case? I think that's right, and I think in many senses J palanas that both sound the same.

He's been very sensible. Um, what did I just say, waiting and watching understanding they made a mistake in two thousand fifteen and accepted that and saying, you know, we'll

we'll see how the economy moves. I mean, we've still got to understand what happens in the with the vaccine, and what happens in the in the Southern States in the United States, of course, but then there's all these issues about which firms are going to survive and are people going to change their long run behavior, and that's a risk of the downside. People are going to keep those savings that they have and not not spend them. We don't know, but the risk I think to the downside.

So if you go back to making the potential error people saying, oh, we need to worry about inflation, well what inflation? So the fact that the talk today is the bank deblion worries about inflation, Well it's two point one and we've had two very weird months where the base effects dominated and the slight changes in the last couple of months go away in twelve months time. So everything looks to be transitory and temporary. And the answer

is we just don't know. And j Palace, but I think fantastic and he's just been saying essentially that wait, look and we'll risk bond if we need to. But there ain't no inflation problem despite the fact two point one and that's supposedly an inflation problem with a weird couple of months. Come on, folks, get real, Danny. Do you think we're suffering from a better group think? Yeah? Absolutely, I mean the group think in a way that if

you follow Padal, is to be right. But I hear these these fit governors he held in at the Bank being making ludicrous claim saying inflation is going to take off based upon what wild wishful thinking and guessing that's not credible for a central plan. Danny, That dissents healthy, isn't it even if they disagree, it's healthy to happen. And I think what I've missed over the last ten years, particularly the Bank of England, since Governor Carney came out

with some forward guidance. So let's face it didn't work. But one thing he said off the back of that forward guidance is that it helped to tie the hands at a committee because you've got everyone to agree with one thing and no one could dissent anymore. John, that you and I were just chaffing on this. If you look, if you look at the fit, not a single governor since Greenspan has ever dissented. Governors at the Bank of England have actually not dissent, although whole Dana's cheek economists

has um. I think a real debate is credible and sensible. But I think if you if you realize that we just don't know. Remember, we saw the biggest dropping output ever seen, biggest and fastest dropping output ever seen. And the question is what's the past data where we have past data from the great influenza UM, and we've had you know, so there's there's really not much to go

buy um. So, yeah, you're right, descent quite good. But but in a sense, much of the descent we've actually seen over the last decade has been dissent in error. The reality is that people have argued that you should have raised rates and you've dissented on that side, and it's clear over the last decade every one of those votes was in error. You shouldn't have done that. Big picture, Danny, A lot of the notes that I've read the push for wage pressures focus on human capital, a shift to

e s g. Those are structurally inflationary. Are we in a new inflationary regime. Well, the answer, the answer is go and read the blog written by C. C Rouse, the chair of the c A, talks about Actually the likehood is that the wage data really a messed up and reality is very soon we're going to see negative wage growth. I've got two nice indicators for the UK

how hard it is to understand wage growth. The official data came out this week on wage growth eight point four percent, but we've just had data this morning on the size of wage settlements too, um and so what you have are these base effects and composition effects. It's very hard to understand what's going on. But in wage terms, we've seen the bottom of the wage distribution dropout, and

so we're comparing to a weird thing from a year ago. Um. And so I think the evidence is actually that, um, yeah, there are going to be some bottlenecks, but that's not something you want to respond to instantly. That's sorry. I think that the wage pressure we will see, but I think a lot of it is you know the world is changing a bit. How many more Jata points would it take for you to see three four? Um? I

don't know. I want to see evidence that significant bottlenecks are occurring, and I don't see that in the data. I'm not gonna I'm not gonna say three or four. I would want to see sustained evidence. But I think the wage settlement evidence is pretty good two percent, saying as it's been for the last decade, it's been two to to two. Yes, there are temporary bottlenecks, but what should the central bank do to respond to a temporary bottle? I think of price changes. We saw a big rise

in timber prices. Okay, people don't have to buy timber, and so the price of timber now is halved. So I think we'll we just have to watch an economy recovering from a shot we've never seen before. Danny, just to conclude things someone wrote into me just moments ago, and I think you'd agree with them. The only mistake has been to be too hawkish, never too davish. That's been true over the last ten years. Is that what

you worry about now? I think that's right. I mean, I don't understand how is it an error to sit and wait and watch, just wait, don't, don't, don't do anything more than you're doing now and watches the economy resolves itself. Look look, look at the hawk ish folk who I've been on your programs with many times over the last decade, telling us inflation was going to take off, that's what it was gonna do. You had to raise breack.

Oh that was nonsense. So I think that the error has always been in a recovery, you're tightened too quickly. There's enough really no error to be had in waiting and looking and seeing it. And I think that's what's going on. And we got to see in the UK. The potential is the government is going to withdraw the stimulus, perhaps in September in the in the US, these unemployment benefits are going to go, and then we'll see, we'll

see what how the economy anounces back. But you know, we look, watch and don't make another big mistakes like George olds One did in the UK in two thousand ten. Need we need a round table, don't we with you? Andrew says we need to do that again? Oh no, we get days and friends now we are good friends. We both think brexit as a disaster. Let me go. You agree on He still wants to raise rates, of course, does he? Well, that's what I thought maybe that would

be the optimal man table for a program. What's the discussion that you wanted forever and he wants higher rates. Danny's going to see it. It's going to hear from you, Danny Blanche for dam professor Again, I'm trying former bankingron a Monetary Policy Committee member. Let's turn to Luke UBSS and Management Asset Allocation strategist Mr Kawa, going to see

you a good old friend, Luke. Central banks when they change type baby steps and the baby step that I think we're witnessing over the past week, both with the Fedom Reserve and now the Bank of England seems to be just reassessing the balance of risks around the outlook and also around the outlook for inflation. What's your take on that? Look? John, imagine if your your baby's first step wasn't a first step, if it was you know,

a whole vaulter, a high jump. That's that's the shock kind of the market had to deal with, even though we're talking about things that were only out you know, ine and do require a lot of of progress to be sustained and to be actually realized. So kind of looking at the FED and digesting how that might hit cross asset action. What we're thinking about is kind of the two reasons why German Powell said that the dots

did move up. One reason is that you know economic activity is coming in, so there's more confidence within the FED that the baseline outlook that they achieved and marked that they outline of March is going to be achieved. So on the one hand, this suggests that continued inline data is going to be a force of pressure that continues to pull orward dots. And if you're trading short term interest rates, all you have to do is be more confident than the FED that that economic outlook is

going to be achieved. You can kind of continue to push the timeline on that front. On the other hand, it's clear that the the inflation risk, the balance of inflation risk that jumping too and that thirteen beneficials thinking that the either risk to UH to a core PC are tilted to the upside. That also influences the forecast, the balance of risks, and when they think tightening might

be warranted. So on the other hand, you have what we would expect to see over time, is that the ebbing of these inflationary pressures and upside risk just as these these do turn to be less persistent, to avoid

using the T word, inflationary forces. So kind of putting this together, I think what you would expect coming out of the f l NCY, and this is something we've adjusted to take account of, is that that real yields break even trade off has moved more into the real yield side of it, driving moves in the tenure that of course is going to also have an effect on the dollar. So it's about seeing less widespread dollar weakness

and the scope for that deteriorating on the margin. What I will say is encouraging to say from a risk perspective is that even as we've had you know, a broad dollar rebound in the wake of the f o MC, it's rallying more against the d X Y components than it is against the m f X components. So this suggests this isn't about a kind of a dumping of risk currencies so to speak, or a less positive view

on risk. It's just a reevaluation suation of the FED real yields and what that means at the front end. So Luke, the more we hear the two are in transitory. The more people buy risk assets, exactly as you said, they're going further into a risk in order to get returns. There is a question at what point the Federal Reserve, the Bank of England, other central banks starts to take action just to curtail some of the moves that we've seen.

And I'm thinking of the mortgage market in particular to Tailor's point earlier, this question of the composition of which assets the FED may pair back on its purchases. How much are you looking to the mortgage market to feel some from that as people start to question the elevated housing prices. Well, I think the main reason why the FED at this point is still purchasing in both asset classes because it knows, as we know, that by purchasing mbs,

it's it's sucking treasury fall out of the market. And you know what one of the Fed's goals is to, you know, use asset purchases to a certain extent, to to calm markets, calm market volatility. So I think the the signal from the FED that it's going in either direction in terms of both purchasing less and moving to to raise rates at some undustined but at some inconclusive

point in the future is really just a signal. They will both be that the FED is moving more from a val suppressant mode of purely baal suppressing mode in order to get us through the crisis and get the rebound completely on track, to one where the FED is going to be more a source of two way volatility. I think that's the real reading from that, not necessarily

the nature of the components of the underlying asset purchases. Luke, are you surprised by the cross asset resilience see with equities at record highs, a VIX with a fifteen handle and a very calm and well behaved bond market to to a certain extent, yes, I think the markets have been able to digest this quite well. Uh, the a more hawks than expected FED, And I think kind of when we're looking through what and why what we talked about earlier in terms of the dollar being stronger, real

yields being stronger, how far can that filter out? What's very important lately is that it hasn't filtered out really all the way to commodities. Copper had had a pretty bad move down, but that's kind of alleviated lately. Oil still pushing forward to new highs, so the market is still trading this idea of we're still getting very very good activity going forward. The FED has cut off right tail inflation outcomes. Therefore it's it's safe to buy equities.

In our view, there are there are limits to this, uh, particularly the way that it's been kind of playing out under the surface with with the rotation to growth. That's not necessarily something we want to change us right now. Right now, the equity is at the headline level. We

do think are due for a breather. And if you look at over the past few months, equities have really moved sideways on a global basis and on the SMP five hundred, So we're not necessarily looking for a lot of downside, but think there there will be in attractive potentially to buy going forward in the coming weeks. And this is just to do with the market needing to digest that the second derivative is turning the that is becoming less supportive. Luke always great to cash up. I

promise you we wouldn't tall baseball. We won't as ubs got a call on you. Have you got a country a nation? I I mean I I have to say the Swiss, right, the Swiss? Do you I guess maybe? Why do you have to say this one? Yes? I guess right. You gotta go with You've gotta go with Swiss Switzerland UBSAS and Management assa allocation strategist Luke Kawa, let's bring it Terry heinha we penchi pol he found

rejoined us right now, So let's start there. What we can expect as far as you're concerned down in d C. On a fiscal front, what we can what we can expect firstly is a touted roughly one trillion dollar infrastructure package like what I've been talking about for the last month or so, um of which, as Lisa says, about fifty nine billion is new spending. Brings up a dichotomy for markets. By the way, you'll hear Washington pump high numbers,

but then a lot of it isn't new spending. And that's important to understand the code of the last COVID relief bill, for example, uh touted is two trillion dollars, but only one trillion is gonna get spent this year. The rest of the run out over the next eight years, so you're gonna get that are you going to get much of anything else at this point. I really doubt it. The so called Families Plan, another couple of trillion dollars, I think is going to be very difficult to pass,

even with all Democratic votes. And then what you're into is if you're into spending, which is going to be large leaf flat uh into next year and uh, and you've got the debt ceiling as a as a potential surprise.

But Washington's attention is going to be taken up between now and the end of September, a time in which the House and the Senator roughly and only one out of those next three months, uh, with getting the infrastructure bill done, and otherwise partisan warfare about all the other stuff I just mentioned as we talked about five billion dollars of new spending, Terry, how much political political momentum is there behind balancing the budget, behind raising taxes or

cutting spending ahead of that August deficit ceiling? Oh? None, none. Uh. You know, they both parties talk about debt and deficit when it's when politically when it suits them Democrats did over the four years of the previous administration. But in reality, where the parties tend to come together and as as we've seen, is on spending things. Uh. Uh, COVID is a money spender. The China Bill was a money spender. Uh. Those things are money spenders, and the parties come together

around those things. But most of the rest of it, you know, I think federal spending is going to be largely flat, as I say, But the rest of it, uh, you know, they will they will fight over but but I don't think you're gonna see anything beyond the infrastructure package today anyway, Terry, Where then is the momentum on how we're going to pay for all of this? Oh? Um, we're gonna pay for a Taylor? Uh you know, I you know, the devils and the details on the infrastructure bill.

I I edged up my odds on infrastructure uh the last night, but on the news. But I'll sso give you things fall apart. And one of the details here is that we don't exactly know how they're going to try to pay for it. And they say they are going to pay for it, and they say they're gonna pay for it without tax increases. So uh, there are

not insubstantial uh difficulties here yet. And well, then I think what market see is a deal solidifying, I mean the likeliest scenario here, the markets will see a deal solidifying over the next week, but they'll see wrangling around this deal and passing it out of both houses through the month of July. So there's gonna be a lot of volatility here. And one of the details that will cause that volatility is exactly how the thing is paid for.

And you don't worry about debt and deficits during wartime, When then should we begin to discuss it? Uh? You know the you know, my view of this very simply is that unless unless Washington gets a market signal that uh, that that there's too much debt or too much deficit, Washington is not going to he he to call. You know.

But my favorite example of this is the tax bill, and you know, no disrespect to anybody who put that together, but but you know, understand that the the the redline for Republicans was they weren't going to spend they weren't going to go into depths in any more than one point five trillion over ten years. Now, when you're talking about, you know, how to manage a deficit increase, uh, that's a sign that you're really not serious. About bringing the

depsit down. And that's the way Washington is these days, regardless of party. Yeah, and Terry. If it weren't that way, people probably would be accusing it of not recognizing the reality we're in a pretty low bond yield. Since Tom Keene is not here, I'm going to channel him and talk about how close we are to the two midterm elections. Is this fiscal package that we're seeing coalesce in Washington, d C. Going to be viewed as a win for the Republicans or a win for the Democrats? Yes, Uh,

The answer to that is yes. Uh. By the infrastructure spending is bipartisan. Uh. Members of both parties want to see better roads, bridges, fundamental infrastructure. They all want to be able to go home and say that they did that. Uh and uh. And the you know, the key for me at the same time will be, uh see if they can goose them along more quickly. You know, there's uh.

In my home state of Pennsylvania, there's been a now a ten year long project just to redo forty miles of old interstate And if it's gonna things are gonna take that long, there's gonna be a lot of frustration out there in the world. So one thing that they're going to need to do is goose their states along and make things go a lot more quickly in order to gain the maximum out of political benefit out of it. That's the best way of answering its home King question.

Ye Sterry, Thank you, Sera Hines Fanchia Policy found it that in Washington day sake. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. 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 In. This is Bloomer