Surveillance: Fed Pause with Dudley

columnists and so much more. Bell great to catch up with you, sir. I just want to reflect on something we heard about five minutes ago from David Rosenberg pushing back against this idea that inflation will be stickier on the way down. Bill. I know you listen to some

of that conversation. What did you make of it? I agree with Dade that inflation is going to take a longer time to corral, and people think, I mean, people are focusing so much on the improvement in goods inflation that was well expected as as a time he has opened up the composition demand shifted away from goods back to services, So of course whose prices are gonna be weaker, But services inflation is really high, and the labor market is still really tight. We're still having job gains well

above what's consistent with a loosening labor market. So the Fed's got a lot of work to do. I think the big thing about what the next you know you're is gonna look like it's really it's really in the fense control. The FED is going to keep policy tight enough for long enough to get inflation back down, and you know, the outcome we get for the economy is gonna depend on how how much that actually hurts economic growth.

I think there is gonna be a recession. I think it's gonna last quite a while, but it's not gonna be a dangerous recession in the sense that the FED can relent at any time uh and end that recession, which is very unusual compared to past cycles. This is not a recession that has been driven by you know, uh, financial instability. Is not gonna be a recession driven by you know, household and corporate balance sheets being over extended.

It's a recession that's clearly induced by a tight Monterrey policy regime, and so the FAT can end it when they think that the time is great. Given the strength that we've continue to see in the economy, and Evan Brown of UBSS Management was talking about them seeing it sustained through the first half of next year. Do you think the FED could go even higher than you previously thought in terms of a benchmark rate, I'm thinking the peak is probably in the five to five and a

half percent range. Just for what you for the point you just made that the news will probably be stronger for longer and will be very hard for the FED just to stop if we're still, you know, at an unemployed rate below four percent and underlying inflation still running you four percent or higher. So I think that it will get a series of smaller rate hikes, but that will probably push us up above above five percent. But clearly the feds of strategy here is they're stressing the

longer rather than the ever higher. So I think once we get you know, five and a quarter five and a half, I think they'll they'll relent and they'll just si sit there and wait for that restrictive Monterrey policy to slow the calmy down, generate more slack in the layer market, and that will gradually put both wage inflation and services price inflation down. This is what FEDE officials have been saying, Bill, I mean, this is basically pretty much in line with what they're saying. The market is

not buying it. They are still pricing in rate cuts by the end of next year. What does the FED have to see to start becoming less restrictive, And I don't mean that with respect to keeping rates where they I mean actually lowering them in a significant way. Well, they have to be highly confident that they're gonna be able to achieve their two percent inflation object doesn't mean that inflation you have to be at two percent when they finally reliant, but they have to be highly confident.

Highly confidently mean means that they have to see significant slack developing in the labor market that brings down wage inflation to the three or four percent range. And they need to see the inflation pressures be much, uh, you know, much less persistent and broad as as they are today. So they need to see probably inflation in the sort of three percent range headed down, uh. And once they once they've accomplished both of those things, then maybe they

can start to relent. But I think it's gonna take away some time because the commie still has a considerable for momentum, and it's it's going to be sustained by by by the past inflation that we've seen. For example, so security recipients are gonna get eight points seven percent increase in their checks come January, and they're gonna go ahead and spend a bunch of that money, and that's gonna keep moving along, and that's gonna make it hard,

really fit to restrain things. But you wrote yesterday on bloom Bag Opinion that the FED shouldn't rate his inflation target. He said changing the objective now would be bad for the economy and for the central banks and credibility. But I did wonder when that will got published. I wondered why you wrote it. You've really worried that they might

actually go through with that next year. Well, I wrote it because I'm being asked about it all the time, Uh, And so I thought that I should write down what I think the ant right answers. You know, the argument for raising the inflation target really sort of two potential arguments. Number one can't hit too so let's make the objective a little bit easier. That's that's obviously not a very

good argument. The other arguments a little bit better, which is, we have a higher inflation target and the peak in a short term interest rates during the cycle will be higher, more room to ease when when recession hits, and so they'll be less risk of being pinned at the zero

or bound for interest rates. I think that risk, though, has diminished considerably because the peak in church and rates this cycle is probably gonna be about five percent, So the Federal Reserve has plenty of ammunition to cut rates uh in environment where there where their inflation target is still two percent. So I think this idea that the zero or bound continues to be this huge risk. Uh And and there's a big constraint on Montrey policy. I

think that's overstated at this point. But Bill, how concerned are you that the Fed will not have the same resolve in the middle of next year to keep rates where they are if we do see the unemployment rate going up but we do see the US entering into recession. Well, I think the Committee it will be interesting to see whether the Committee is united twelve months from now as

it is today. I think Chera Paula means what he says that he because he wants to behave in a way uh, that he's not like Arthur Burns, so he doesn't have to be like pauled Loker. But whether you can keep the rest of the committee along with him. As the unemployer rate goes up and the trade offs between the two two objectives of the FED prastability and maximum sustainable employment become more in conflict with one another. So I think we don't know the answer to that.

I'm hopeful that power will here in the day. I remember when inflation was sub two percent and people were talking about raising the inflation target than do you remember that you should raise it to three about because then there'd be more ambitious and people would believe they're committed to getting inflation high. Then they might hit two. Remember when they were also talking about free money and of modern monetary theory. We did that too crazy times. Bill Dudley,

thank you. I appreciate it as always alongside Lisa Brabbit's Sam Jonathan Pharaoh, together with election of a bm Y and Madam. Great to have you with us in a studio. And Leah, what is more important the FED speak or the data? So so I think it's the data, and I think it's precisely the Pabor data, because the FED has explicitly targeted the labor market here as inflation has

remained higher and stickier and not transitory. They've been talking about the labor market trying to get rid of job openings, the beverage curve, which is the Jolts data, and then of course you know the wage data. And I think if you don't see softness in either of those two reads, it's going to be difficult for them. Are you saying that good news is bad news in the labor market data. I hate to say that, but we're back to this world.

I mean we're back to the world where a softer real economy will be more pleasing for the FED and means that whatever their target is five to five and a quarter five to five and a half is still the right target. The issue is if you get no softness in the labor market, and let's face it, we haven't seen any softness in the labor market in the aggregate data, then we're going to have to go higher because in the end, every FED hiking side goal ends when the FED funds rate is above c p I

and we are not there yet. What are you thinking that Fed funds is going so we're going to get some real economic projections in the next FED meeting. At the last FED meeting where we had an SEP, which was back in September, they pushed the twenty three dot from three point eight to four point six. I think most people, assuming it goes to five is their scope

for surprise. There there is some scope for it to be a little bit higher than that, just because, as I've said, the services, the services inflation is not rolling over, and the sticky services inflation is not rolling over. So while headline is and clearly the goods inflation has peaked and coming down hard services has not. And that's six c p I so I think there's room to go higher.

I think as you get higher on FED funds, you're going to see a wider dispersion and you're going to see some some conversation in the f O m C about where we go from here. The I think the easy part of the hiking cycle is in a sense behind us after this December meeting, and after that you're gonna start getting some dissents. What do you think is going to be the bigger surprise for markets if we get softer than expected jobs prints or stronger, hotter than

expected jobs prints. So I think the biggest surprise would be if we got hotter here. How we were having really high um and that number of announcements of of layoffs and yet and yet it's not showing up in the aggregate data at all. I mean, those those Thursday morning new claims data are hitting new lows, are you know, barely moving off of off flows. So it's not hitting the data yet. So I think if the if the numbers were hotter, it would it would be a surprise here.

People are talking about short and shallow and we've been talking about this all morning. What is the consequence of this type of recession? How long will it last? We were just speaking with Bill Dudley, who agrees with the idea of a longer and shallow type of recession. Is that an okay scenario for risk assets? So that's a great question. And this goes back to the difference between

the real economy and risk assets. So even in a shallow recession, you can still have SMP earnings declines of and I'll just point to a two thousand and one is a great example of that. Risk assets did not do well even with a short and shallow recession, so there is still risk here. And in the end, this year was about rates and multiple compression and and and the correlation between the you know, the bond and equity market, you know, the worst being since n one, that this

is the transition year. Next year is okay, Now your rates are higher, what does it mean for the real economy? And that's I think we really have not priced in. I'm not the only one saying this, but it is true that the earnings really are too high and not essentially reflecting five basis points of tightening within ten or eleven months. I mean, we've never really hyped this fast and we haven't seen the effect yet. So that is that is down the road and that is short to come.

Let's talk about leadership. Is it early to talk about potential leadership for next year or not? So in a funny way, we have started to price in a recession around June, then against September, and now we're starting to price in a recovery. We haven't even gotten to the recession. We haven't even gotten to realistic earnings numbers. So I

don't think it's too early yet. I mean, there are certain sectors, there are certain companies that are just beaten down and left for dead, okay, And and that is where you can go shopping for for your stock. Like, we think the bond market is going to look much better next year simply because all the work was done this year. And historically, if you look at the ten worst starts to the year in the bond market, you have a positive year the following year. And it makes

sense if you think about it. I mean, it's related to the rolling over and the and the inversion of the yell curve which you mentioned the two thousands. Some of those names were left for dead for a long long time. Can you help me understand what should be left for dead for a long long time? So speculations should be left for dead, right, So anything where it's multiple of revenue or you know that no earnings, that

that will be left for dead probably forever. And I would suggest there'll be some consolidation in those areas, but that's not something to look forward to because there's many of these assets still have a ways to go. We're not there yet. Left for dead is when you're down from the peak. So if you're in a speculative asset or a speculative name and you're hoping for you know that it's going to you know, the market will stabilize one day, you actually still probably have to go on

the downside. Here, what percent of the overall market cap of the SMP is that speculative sort of quadrant that's going to be left for dead? I don't like so I'd say, my I think it's about it's about ten percent. Here, it's about ten percent. I think that some of the biggest risk we've talked about this is the large cap

names which are still trading at higher multiples. You know, in the end, when you get a multiple compression year and you get the ends of of the of the you know, exuberant on the valuation side, you have to bring value investors back into invest in these growth names. And some of our favorite growth names are still trading at pretty high multiples UM. And so the top the top of the market still has risk. Here you can see it and how how the overall market and the

aggregate has has has traded. The Dow versus the nasdack, the Dow versus the SMP, and the SMP is overly weighted. Top ten names twenty nine of the index a lot of those names are still not cheap, and they're still expensive. I think Tom Peter to talk about the talk about but it's it does make sense though, Uh it does. I think that I think that it is a good point going forward. Then do you think that the potential for contagion is off the table considering that we still

have potentially more wash out to go here? So I think there's still a risk of sovereign debt issues in Europe. I think we are not through this winter. We are not through the nat gas problem of this winter, and then after this winter there's a summer and another winter, and I think the markets very shortsighted in piecing this through and who's going to be paying for this and how it's going to be funded that these are not

easy questions. And I think this is kind of an issue that's been left for dead because it's been a warmer than expected autumn in Europe and so the reserves are high. But again that's a one winter story. We don't have a plan yet moving forward, so I think there is some risk there. I think the contagion risk

is lower, but not dead yet. I think that the bitcoin blow up is likely to be contained there clearly with some counterparty risk, but I don't think it was a big enough asset for it to have huge reverberation. I agree with you in Europe, have you got to think about why the reserves are where they are? Not stream, We're going to have the same ability to build up those reserves through next summer. Doesn't seem so, doesn't seem

so right now? What do you do? Also in an economy where the inflation is coming from something completely out of control of central banks and even a policymakers because it's being it's getting difficult for them to source enough natural gas from enough places over the longer term with contracts that aren't necessarily ten or twenty years. They worry about expectations, They worry about a second round of effects of inflation, going into wage negotiations, those kind of things.

That's a tough spot for the Europeans. It will be next year as well, based on where people think the energy market's going. Have people priced out some of that bear case though? For Europe? Based so much traded I mean how much around look, I mean the most you know, the most exposed asset over the last decade has rallied enormously. So you know, risk assets are back on and the the the recovery is getting priced in, and the question is is this a bear trap? Right? Is this too early? Um?

Everybody likes picking the bottom and everybody thinks they have the turn. I just think that the net gas, the funding, the sovereign debt issue all related in Europe is not over yet. And the wage issue, as you point out, we have a wage issue here. Let's talk about the reil strike. Okay, really quiet? Well, if if if rail workers were really concerned about a deepening recession, they probably wouldn't be fighting for higher wages the West Coast. Next,

That's what I'd be asking. The sports negotiations, did they break down? I wonder if you're interested in a five part dollar bond sale from Amazon at Licia, I wonder if that gets your cut? And that headline just crossing the Bloomberg Team USA? Did they get it done? Later? Did they get it done? Team USA? Such an exciting game? Yes, there we go a white man and that's conviction. She's fired up, so excited. I'm gonna yes, I'm going to

say yes to joining US NAN. Please to say, is Evan Brown had a multi asset strategy at Upssset Management even always fantastic to catch up with you and the team. Let's just start with the core theme for you guys, which is that you think investors are going to be surprised by how resilient this US economy will continue to be, perhaps deep into three even you can you walk us through the y and for how long you think we

might be surprised? Yeah, so, I I think the For one, we're in an environment where you still have a lot of excess savings on household balanties in aggregate, so we know that those excess savings are are dwindling somewhat for some of the lower earners, but the biggest spenders in the economy are higher earners. We still have a very tight labor market for those lower earners, lower income earners um plus. And I think this is a very big deal. A big decline in gasoline prices that's going to be

a big support for the U. S consumer. You've got a Social Security adjustment, costs of living adjustment that's gonna effectively boost incomes. The States have a lot of excess savings themselves, and there's direct support for consumers coming coming through there. So, so what we're talking about is a reasonably healthy economy despite all the rate hikes that we've seen today. Can you beat a stands constructive on ann X? Yeah, I mean I think as inflation comes down, that's going

to weigh somewhat on on earnings. But I think a lot of that is known, right, A lot of that even if you haven't seen analyst expectations come down as much. Everyone's talking about recession, everyone's talking about earnings coming down, and so the surprise is that they hang in there. Right. We're not talking about a boom in earnings. They're definitely coming down, but we are talking about them just I'm

hanging in and at this point that's probably enough. Do you think we could see the outcome fore flipped from what people are expecting, which is a good first half and a really bad second half. It could be because I do think that the the tightness of the labor market can continue, and that's going to keep the Fed on edge. There's a lot of narrative right now that, Okay, the Fed's gonna do another fifty basis point basis and

hYP and more or less be be done. But if the labor market is staying tight, then there's a bias that the FED has to you know, kind of extend to do a more a few more basis point. Can we get to a five and a half six percent expected terminal rate? I think we can, and ultimately, you know, that can be the thing that makes the economy crack down the road. But it's too early to trade that right now. What does that mean in terms of the

bond trade? Given that so many people hid out in the long end, does that mean that that could be fine for now and we could see that work for another couple of months, But if we go to a five to six percent benchmark FED funds rate, all of a sudden that trade gets blown up. Yeah. I think that's I think that's right. I mean, I do think a lot of the bond rally is a result of people kind of short covering. Everyone's been short bonds for

a long time. Uh. And I think a lot of it too, has been the round trip that we've seen from from the UK transitioning from fiscal stimulus coming from the Trust administration to now SUNAC and fiscal austerity. So that's putting downward pressure globally on on yields. But all of that is kind of played out and now and now we get to the point where you know, growth is okay, inflation is sticky, fed might be doing more

than people expect. And then right out there you have the Bank of the Japan right which which at some point next year, probably in the first half, is going to be adjusting. And even if that's kind of known, that's really the last anchor that there is on bond yield. So I think almost even psychologically, that's going to be injecting some term premium and bomb markets and perhaps leading to a renewed sell off and uh in duration. Even if that's the case, where does that leave the dollar?

Trite because I pick up on cable you mentioned the UK that went from one oh three fifty intraday loads of the year on September one, twenty right now. Similarly, we've had a turnaround in europe dollar as well at least, and that don't the strength can kick back into Yeah, I think it'll it will kick back in, but not to the same extent that that we've seen for the bulk of this year. And the reason being that Europe, you know, the we all know that they're in recession,

are about to be in recession. They're going to be bouncing back. In fact, you're already seeing the confidence measure, consumer confidence, business confidence measure statilize and in some cases turn. So you should get on a forward looking basis, a little bit of bounced from from your China. The path is bumpy bumpy, leaving zero COVID, but the destination is reopening.

I mean they're going to have to reopen in order to make sure that the economy uh just doesn't completely fall apart, and that that the government has the tax revenues to actually kind of uh pursue their policies on on common prosperity and redistribution and the like. So the current situation is unsustainable in China, and so we'll pick up there. So if you're getting, you know, more support from Europe, more support from China, it's not just a

US riven economic story. Having final forecast, we want from you. Team USA against Iran two pm Eastern time. What's the score? The US is going to win to one. That's you can count on that, and we go Ubs. You see, Ubs likes to play ball. What was pimcom about earlier? They're playing a different baseball Banter joining us with silk Is, the head of European f X strategy over its city said,

it was great to catch up with you. Let's talk about what went right, or rather what went wrong for some of these calls around sterling, which is now pushed through one twenty. Well. Look, I think first of all, there has been a fandom in the reason in the sense that there has been the pricing out of the excessive risk premium UH related to the fiscal policies that

we're basically announced back at the end of September. And the second thing, you know, during that period there was an enormous build up of sterling shorts UM and given the fact that we are now in an environment of relative dollar weakness, sterling has pushed higher and you get the unwinding of the sterling shorts. As far as I mean, if you want to get the direction of sterling, it wouldn't be looking at cable, because cable it's going to be the mirror image of what the dollar is doing.

It's got to bet at the dollar around one, I would be mostly looking at euro Sterling, and you know, I have to say, I'm quite surprised that it's still hovering around eight six, So you would reload sterling shorts but against the euro yes, absolutely, But the the the trigger point for me to do that is that I think we need to reach a point at which positioning, especially by their speculative community, is reaching relatively neutral levels.

We're getting quite close used to that if you look at the SFETYC data as well as our proprietary in this is UM. But I'm quite confident in that call for yours certainly higher. How much are you trying to move away from the dollar just in general in terms of your crosses, your pairs, simply because the dollar story

has been a so dominant and be so unpredictable. UM. I think to twenty three is going to be a year in which relative value is going to make sense from a trading perspective, and I think by far the biggest thing is going to be the housing market on the back of very strong monetary policy tightening. One needs to identify the places where housing markets are most vulnerable, UH and in US at least in Europe if you look, Sweden and the UK are by far the most vulnerable ones.

But aside proble, and I'd like to add that as far as the dollar call is concerned, I have to say that I'm inclined to believe that we're an inflection point in the dollar. It's the FED, and it's also the elephant in the room, which is China inflection point to a week or do a weaker dollar. Yes, I think if you identify the state the different states of the world, what really matters for the dollar is basically what the Fed is doing, but also what global growth

is doing. And I think the market is sniffing that. Basically, the genie is out of the bottle. As far as China reopening is concerned. So what you think happens with China? What's your basic case? Do you think full reopening? Well, it depends what you mean full reopening. I think there is going to be a very gradual reopening because it's not in the authority's interest to do it overnight and

very very quickly. Um, there are a lot of political sensitivity is in that respect, So I think there's going to be a very gradual reopening. We also have the very comprehensive property package, which is putting a floor underneath property prices, which will really some consumption impact by the wealth effected potentially is going to start putting some upside pressure on Chinese imports. But you know what it's it's I think the genie is out of the bottle as

far as China is concernant. What do you think the best China proxy is to push that view through? You're

a China You're a web side. And the reason for that is at the initial stage of the gradual reopening, you're going to see an increase in inputs by China, which means that you're going to have a deterioration in the current account of China, and on the flip side, you're going to start having a positive impact on the car account for Eurozone and in general, everything that basically increases activity from China and Asia more generally is going to be good for the euro So e're China, I

think is it would be my best trade for expressing that. Can you pair this into what you were talking about earlier about the housing market and how that dictates the future of certain nations New point of Sweden and the UK transit walk us through how a very weak housing market, what kind of deterioration you're expecting to really bleed in

to currency weakness? Well, as far as them a direct impact, that's a direct impact into economic growth and therefore there's direct impact consumption and there's direct impact therefore two central bank decisions. We at the Bank of England is very much aware of the properties in the housing market and that's why it puts a lot of weight and growth right now, and that is why it seems a likely at least to us that it's going to validate market expectations.

Now why these places are much more vulnerable. I mean in the UK you have to understand in vast comparison, uh within in in a great difference with the US, where here you have thirty year fixed rate mortgages. In the UK you have two year, five year a fixed rate mortgages, which means that every point in time you get a bigger, big percentage of the population going out that refinance. So you know, just compare it. You have had about two to an a half percent mortgage rates

in the past ten years. Right now you're potentially going to gravity to six and a half to seven. So it's going to be a major major hit. It's gonna be very so you're seeing the numbers already. UK market approvals. Yes, I think the lowest sense COVID nineteen. How bad do you think this is going to get and has a market in the UK? My view is that it's going

to get very bad. And the other issue that the UK is are facing is that it's actually facing a more structural problem into the inflation outlook compared to the rest of the world. And the reason for that, um, you know we've said that. I think it's to a large extent related to Brexit and and as a result of this, it will put the Bank of England in a much much more difficult spot compared to other central banks. It will be faced with a structurally higher inflation and

a much faster deteriorate in economy. Governor Bailey speaking a little bit lightly this morning ten am intent time, yeah to the House of Lords. How much does he discuss the ramifications on the housing market that could be decimated but not just because of interest rates but also just because general economy And did Goldman Sachs moving of Theirs

of London to Milan partly because of this? But look, I think what was really imprecedented was in during the last press conference by the Bank of England, Bailey actually said, um, I hope that the market is getting the message and mortgage rates are going to go lower after an interest rate hike. I found it confusing from the bank aving that at times I I don't know visit Akisss City, it's quite to cash up set. Thank you wonderful. 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 relation Jan's 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 Bloomberg m