Surveillance: Fed Policy With Dudley

essay for Bloomberg opinion on the banks and leverage. It harkens back to the summer of two thousand four is codified by Simon Johnson in his book Thirteen Bankers, when the SEC allowed the broker dealers to become more leveraged bill This is not like two thousand four, where you say these are banks that need to be free from

regulatory restriction. Now it's completely different. Their balance sheets becoming more tight because the feed is buying treasury securities and agency mortgage backed securities, and that's boosting the amount of reserves in the banking system. The banks can't make any choice about whether they're they're going to hold the reserves or not collectively, so that as that amount of reserves and the systems goes up, the leverage ratios for these

banks becomes more binding. How how was Jamie Diamond or other bankers, how are they restricted now? Well, the leverage creation show hasn't bound very tightly for many banks, but it will become more binding as we go forward, as we go from now to the summer, because reserves in the system are gonna go out pretty dramatically. What what will happen at you know, the big banks is they'll basically try to push deposits elsewhere. They basically won't want

to take corporate deposits. They'll want the corporations to take their money elsewhere. That induces, you know, unnecessary frictions in the system for no net benefits. So it seems to me like it's pretty obvious that why don't you just make an adjustment for the leverage ratio to take into account the fact that the fit is driving the amount

of reserves in the system, not the banks. How uncomfortable is it Bill to be arguing to reduce certain regulatory pressures on banks at the same time that we're dealing with the archagus fallout that JP Morgan says will probably cost banks ten billion dollars. Well, remember here, reserves at the Federal Reserve are not risky assets, so we're not

talking about an exemption of that increases bank risk. And if we're really concerned about the idea of you know, exempting reserves and that giving the banks more room, we can offer we can just raise the leverage ratio requirement from say five percent to five and a half percent. On what's left that point is that reserves are not risky and banks can't control how many reserves they hold.

That's determined by the fit. Although moving beyond just this particular point of regulation talking about the leverage ratio, you've talked before about concern about leverage building up in the shadow banking industry, about a lack of regulation in that particular area of financial markets. Do you still see this as a concern and do you see it as a pressing one or simply something to deal with perhaps later on. I think it's pretty pressing. I mean when you think

about what happened last March a year ago. Uh, we've been basically the federal government had to rescue the money market mutual fund industry. Again, we had problems for mortgage reach space. We had problems in the corporate bond space, and we have just function in the US treasury market. So and then more recently we had the arctical issues. So it seems to be like the non bank financial sector is still right for a lot of issues that need to be dealt with sooner rather than later. Bill Dudley,

I need to switch to the present FED discussion. We've been making jokes all this morning about transitory as well. You and I have talked before about the British pretense of short term, medium term, long term. Now we've got a transitory thing. As we move along the X axis in the timeline. Does any of this make theoretical sense? Or we just is kidding ourselves massaging the unknown. Well, the FED is being patient for some a couple of very obvious reasons. Number one, they're not really sure where

full employment is. Number two, they're not sure how fast inflation will rise once they get to full employment, and so they're willing. And number three, they're worried about inflation expectations becoming unanchored to the downside because the FED hasn't been able to achieve is two percent inflation objective for a long time so that change in policy is well motivated.

The risk is that the FED will be late before the FED basically try to tighten monetary policy to arrive at a two percent inflation rate, full employment in the neutral monetary policy all at the same time. Now, they're not even going to start to tighten monetary policy until they're at full employment, inflations at two percent, and they expect inflation to move higher. So the FED is gonna be much slower to tighten this regime than in prior regimes,

and that does create some risks for the economy. But we say it's a risk that will be like, isn't it a commitment that they're going to be Like, well, the question is how late? Yes, I think they are that they are making commitment that they're gonna be, Like, the question is really how late? And then how high will they have to raise short term rates to basically

keep inflation from continuing to accelerate? Now, the risk is I think that the risk is that recession will be uh more more likely at that point because the Fed's gonna have to move not to a neutral madreate policy, but to a tight madre policy. If they're following this new UH framework so bill, this is a huge issue. And I think the most important question we can ask right now FED officials, and we asked it if last check cloud on Friday, is how will they know if

they're wrong on this transit tree issue? If you run the FMC back on the FMC bill, how would you not if you were wrong? Well, at the end of the day, I mean, I think they're gonna look at the bubble that we're going to see inflation this year is mostly due to base effects and some frictional costs. You sort of reopened the economy. They're gonna be really focusing more on the labor market. How many people are still unemployed compared to where we were in March of

two thousand uh and twenty. Right now we have a shortfall of employment of about eight and a half nine million people, and Fed's gonna be tracking that very carefully. As does people get employed, then the Federals start to not focus on the transitory factors driving inflation. But really the one that they are most concerned about is what what point do you get to such a tight labor market that it generates wage pressures that drive up crisis, and FED officials have said that they have the tools

to combat inflation that's higher than expected. Do they have the tools to deal with financial disruption after with this incredible surge in risk taking that has been on the heels of FED policy, What happens if that stopped in

its tracks as a result of FED tightening policy. I think you're raising an important question that when the FED goes from very very friendly to unfriendly, financial markets are going to have an adjustment to make, and the adjustment could be quite severe after such a long period of low interest rates. Uh. I don't think the FED cares about the stock market level per se, but they do care if the stock market were to collapse, and that

would potentially hurt the US economy. So the FED does care about financial conditions in terms of how they feed into the performance of the economy. But the FAN is not going to run to the rescue just because the stock market goes downtown. No. But it raises a question about whether if the if the FED is going to tighten in the near term because they see that things are getting a little bit ahead of their skis, or if they try to take actions to combat inflation, could

the torpedo markets that are already at heavy levels. I mean, do you feel like your colleagues are actively considering that or is that sort of not as significant as just getting the market and the economy back up to speed. I think PA repeatedly has made it very clear that the FED is not going to be preemptive and they're not that concerned about financialstlis. What they're concerned about is getting that eight to nine million people back to work

as soon as possible. That's the focus of policy right now. What that does do, though, creates a risk for markets when the FED has to shift gears and start worry about inflation. That's probably that's probably several years off. In our great debate here, do we still underestimate the wage inflation doesn't move because of the new technological impulses that we see in our economy, Well that could be a factor. I mean, we're running an experiment basically, and we're gonna

see how it goes. And this experiment is, you know, has more uncertainty than usually because we've never had a recovery from a pandemic like this before, going back for more than a hundred years. So anybody who tells you that they know how the economist can perform over the next year or two. I think is not being truly honest with you, because we've never had an economic recovery like this one fuelled by massive mater and fiscal policy stimulus.

So I think it's gonna be very hard to know for sure how fast this is all going to unfold before you go, Bill. An important question Mohammad al Arian asked on Blowing Bag Opinion this morning. Did the FETCH shift policy lines at the wrong time? Do you think they make this framework shift a little bit prematurely? I asked that because I wonder if they have known was about to happen on the fiscal side, whether they would

have made this change. I think they would have made the change in any case, because they were really worried about inflation expectations becoming an anchored in the downside, and because they had such a poor record of forecasting what level of employment is full employment. So I think they would have made the shift no matter what. But I think Muhammad al Arian's pieces is a good one because I think he points out the fact that there are

some risks to this new strategy. The FED could be late and if they fed is late, they'll have to slam on the brakes and now have consequences not just for the economy but also for fun financial market. Looking forward to catching up with you both on that issue a little bit later this week as well. Bill, Looking forward to that Bill Dudley, the former Federal Reserve Bank of New York President, on some of the issues right now. This is a conversation that we wanted to have for

days with the passing of Robert Mundell. You've heard me say that Ken rog Offen others that the line the lineage of our international economics goes back to Chicago of long ago. And Jacob Frankel. We are thrilled that Dr Frankel could join us this morning. He is a course with a group of thirty. Chairman of the Board of Trustees, Jacob. We had a wonderful friday with Ken Rogar, Richard Clarida, and Angus Daton talking about the twentieth century international economics.

When you were writing at Chicago, what did you learn from Mandela Colombia. Well, to begin with, when I came to Chicago in nine, Mandel was a superstar. We were students together. Rudy don't Bush, Michael Mussa, myself and some other people who well, all in a way hypnotized by the way in which he changed completely the way in which the economic profession looked at the economy. I would say that up to that point the world was viewed in the textbooks as a closed economy. Each country was

a unit. Yes, it had some inter inter relationships with other countries through trade, but by and large it was a close unit ran by the policy makers of that unit. Caman deal and said, the only closed economy for real world, but each country within the world. And therefore, you know, in order to understand how the economy works, we need to develop a new approach, which is called open economy

macro economics. It means that you cannot run monetary policy under the assumption that you are a close unit, because after all, exchange rates because of time, and I know Listen wants to get in here. I want to drive this forward to the modern age because you were your work with JP Morgan, with Mr Diamond and the team there, and your work with Group of thirty. You have been the architect of so much of our discussion of an open economy. Is Mr Diamond mentioned in his letter the

other day, does America resist? Does America have a chance to lose our open economy advantage? It depends if it keeps the open economy perspective or if it closes itself. The only way a country can succeed, small or lounge in the intergrated world is by being open to benefit from the better things that other countries do and to and to benefit other countries by the things that we do.

The principles of comparative advantage that we're coined still ages ago by David Ricardo Adam Smith, I'll still valid today, but even more so because capital markets are very inter real. Capital markets are moving by expectations, Expectations are being fed by announcements, and announcements are affecting the economy through the credibility. All of it together means that we cannot afford playing the game of isolationism, and anyone who will try to

do it will be penalized by the markets. And I believe that by now there is greater understanding that when countries are trying to close themselves under the excuse of trying to protect its own citizens, so to speak, as a matter of fact, they helped their citizens because they don't allow the citizens to enjoy the benefits from the world knowledge and technology. Jacob. This used to be a common thought, a common belief, and increasingly it's become less so,

and there's been more isolationism. I'm wondering how much pushback you're getting in from the members that you talk with among the group of thirty to this idea that perhaps globalization doesn't help everyone in the same kind of ways, and at certain things need to be done in a more domestic capacity, especially as we see these supply chain disruptions. Absolutely, but the main lesson is not to throw the baby with the water tub. Namely, if globalization is not perfect,

don't make globalization a passee. On the contrary, ask yourself what's not working. What it was not working was that the benefits were not widely shelled. And this is basically the agenda for governments to make sure that the benefits are widely shelled. That's that's that's the essence of fiscal policy, of transfer of text policy. But it is not the case against opening the window. If you open the window, yes you may get some storms, so make yourself more robust.

But if you close the window, you really miss the smell of roses from the garden. Are the benefits from globalization the same now as they were twenty thirty years ago, given how much pay has evened out, given how much wealth has gotten spread out around the world. We don't have the same China today as we did thirty years ago,

driving prices down. Thirty years ago, we did not know that China will come, and here it came, and you could have said thirty years ago the globalization has already exhausted its benefits by the same talking today, when you look today at the we are, we have and we have experienced now the pandemics. We have experienced now the fact that pandemics did not recognize boulders, that knowledge is an international public good, that the vaccinations are to be shared,

that the mechanisms need to be in place. So by and large, the manifestation of globalization will come from different places in the coming year or years, will be in the ferry, in the climate area, who needs to have the cooperation of God, all issues that do not recognize Jacob Franco. It is such an honor to have you on right now. Is Adam Posen of the Peterson Institute announced the death of John Williamson. I'll be honest, Jacob, I can't think of someone I'd better talk to at

this moment than you. John Williamson was a micro economist who spend all of economics, including macroeconomics, and his founding in nineteen eighty nine of the phrase the Washington Consensus. Jacob, every bit of your work identifies what Williamson wrought. Do we have a Washington consensus today? In honor of John Williamson?

Welcome begin with I really wanted to share other opposing sadness and sorrow and with the death of our trend, John Williamson, the Washington consensus was a concept that was developed about the notion that there was a consensus of what does it take to be a successful economy. And I believe that today we do not have the Washington consensus.

And the reason is that, especially since the Great Financial Crisis of two thousand and seven eight nine, subsequently with the subsequent crisis, seems to be that policymakers in many places of the world have I would say, lost their compass. And if you lose your compass, you cannot have a consensus about a strategy. And I think that The challenge today is again to recognize what are the basic principles that our robust and what are the things that can

be put pushed aside? And I think that consensus we I see. I still think that the issue of globalization, of openness, of making sure the globalization succeeds, of making sure that the benefits are shared, of making sure that the machinery is in place to bring about this sharing of the benefits. This has to be a strong fiscal system, a strong text system, and a very independent, when focused monetaried policy looking at the long term and not just

about the show's working. About Mandeli, he was a false sited economies that could see behind the conor and del poll. He was so successful. And Mandel and Williams and Jacob Franco, we are so honored to have you with us, the former governor of the Bank of Israel. This is an exceptionally important interview. In the last for eight hours of surveillance, we've had terrific interviews on economics and now a must listen, must watch on China ching, which is a JP Morgan.

She's vice chairman of Asia Pacific Banking for the firm and that barely describes her commitment to a dialogue between the Western world and China. We're thrilled that Jing Ulwar could join us. This want to Jing, I want to talk about Hong Kong. I want to talk about it forever changed, How Hong Kong? How much is Hong Kong change? And what does it look like for the JP Morgan

Company in the coming years. Well, Hong Kong. I've been here for many years, and the Hong Kong financial markets are extremely buoyant, as you could see from you know, many activity in the I P O market, many of the innovative companies from China coming to the Hong Kong market to list. In terms of the recovery from the pandemic, Hong Kong actually has done pretty well if you think about it right. Hong Kong is a city of seven

million people all together. I think they have been about eleven thousand cases of COVID since the pandemic began, And these days, I think a pandemic is definitely coming under control. Economic activity is actually returning to normal slowly but steadily. During with your influence, your experience, the breadth of your knowledge of the Pacific rim, do you look at Hong Kong that it will be changed for Western banking or will it be business as usual? Well, so far it's

been business as usual. We're as busy as ever helping our clients among the corporates and also investors. And they remember China has a huge amount of likuti as well. Through the connect program between Shanghai and Hong Kong, shen Jen and Hong Kong. There's a lot of mainland money actually coming to Hong Kong to invest in world class companies. Can we talk about what's happening on the mainland right now? The equity market is really struggled over the last month

or so. What's going on? Well, you know, the equity markets in China have performed differently from the US. The U S indusseries are near all time highs. The China market had done very well up until February of this year. I think this has to do with the liquidity situation in China. As you know, normally the Chinese equity market performance is very much um in synct with the credit cycle.

Now that the mainland authorities are actually typing liquidity because economic recovery is firmly on track, they want to control the laborage ratio. They want to control the risk of overheating. So therefore, as they really raining raining in the credit uh growth, you're seeing some softening of the mainland markets. They had done very very well throughout two thousand and twenty and also into January February this year. I think this is taking a breather, not just reigning in credit.

They're running in some of the big tech players. And I understand you can't do single names, so I do it for you, Ali Baba and Financial very much in the news at the moment ing and I think for people outside of the main land, outside of Hong Kong even I think they're struggling with what's happening with regulation on the ground around some big tech players. These were big themes that investors worldwide wanted to get some traction,

some exposure to. What are you telling them now, Well, you know, despite the recent market volatility, we think the digital economy in China is still alive and well, especially since the pandemic. The digital way of life is definitely not turning back. If you look at e commerce, you look at the sharing economy, you look at payments, everything is growing in a very robust passion. So we believe the medium to a long term outlook for the large

tech companies remains very robust. Although you've got to wonder which area people are going to invest in big tech. Do you find that some of your international investors are more hesitant to invest in Chinese big tech because of the regulatory oversight that does seem to be tightening. Actually, many international investors are looking at China as an asset class.

They find themselves actually under exposed to China. If you think about the next ten years, the Chinese economy is going to surpass the US economy to become the largest in the world. However, if you look at the waiting of global funds in China, it remains very low. So we're actually looking at in the national institutions finding different ways to gain more exposure to China, both equities and

fixed income securities. And on the fix income side, you know, I know, you guys talk about the tenure treasure yield

all the time every day on your show. China is three point two percent on the tenure right now, so that's relatively a track tip for international funds really seeking to get some additional yields could you dovetail the advent of a digital u N into this conversation, the idea that that could potentially lure more money into the nation due to it being on the cusp of more modern technology. Do you view a digital UN as bringing more capital

into the nation? Well, I think China has been very judicious in terms of bringing capital on shore because they don't want too much capital flooding into the country causing you know, bubble concerns, and there's ample liquidity already in China, so I think when it comes to capital inflows and outflows, the authorities are very careful in terms of controlling what types of money comes into the country and what types

of money can flow outside of the country. So we're seeing obviously in a recent couple of years, the gradual internationalization of the Chinese currency. We're seeing the Chinese currency being use of lot more in international trade. But there's a long way to go. You know, in the next ten years, as I said, channel become the largest economy in the world, but the Chinese un is still not fully convertible on a couple account, So it's going to

be a steady journey or gradual opening up. And I do believe in the coming several years, capital influence and outflows will gradually become loosened. Jing. I want to speak about not so much the politics at the moment or frankly the politics of the future, but the reality that business can often lead politics. JP Morgan has been in

Hong Kong for nineties years or so. JP Morgan provided leadership and being in Taipei in seventy explain of business and financials will interlink with our politics in this delicate debate between the mainland and Taiwan. Well, you know, I

will leave the politics to politicians. So we UM as a firm are very committed to the Asia Pacific region, of course, including China and the rest of the economies and UH as you said, you know, we've been in the region in some countries for over a hundred years and this year we're actually celebrating our one hundred anniversary in China. So we're here to serve our clients, both in the national clients who want to do more business in the region, and also UM local clients who actually

want to go global. So we are here really acting as a bridge between East and West, and we're here to facilitate capital transactions both in and out of the region doing some really really sensitive topics. We appreciate your time this morning to comment on some of them. Jingle Rick there, JP Morgan Chase Managing Director and Asia Pacific

Vice Chairman. Tony Rodriguez is with newving with years and years of work, and what's wonderful about in his work it's really been focused on the corporate side and investment grade his tenure of credit Suite of years ago. Tony Rodriguez, you are ever optimistic here about the credit quality that's out there? Do we underestimate the goodness of the balance sheet of Corporate America? Well, good morning, Tom, good to

be with with all of you guys. Um. I do think that there is some underestimation the quality balance sheet. I mean, we are looking at UVINE this year at or higher earnings and cash flow growth. And when you look at what companies did basically throughout was they really fortified their balance sheet. They borrowed a lot, but they

kept a lot of cash on the balance sheet. So we're expecting to see this year, both in the high grade space and the high yield space, is a significant pay out of that debt where you might get one full turn of leverage decline this year in the high yield market, So balance sheets are gonna be very healthy in our view. And from then, from that perspective, you can look at the pricing in the high yield market

and what we certainly think it's pretty full. We think that it's justified by the reality of the improvement in the fundamentals. So I'm going to suggest that something new year to see the gross paid down that we see and we saw it from Jim Suva on Apple where he says they're going to really come in with a vengeance on buybex and div it an increase to see

leverage come in. But then in a high yield space, look at the story right now, you're not in airlines out this morning kicking off the five point five billion dollar high yield bond sale. We've had a ton of supply and the numbers this year is set to get bigger tony and the numbers of one thing. What that money is used for is another And you've touched on this how much of that is just refinancing, But we're seeing the numbers that well indicate something like is refinancing.

So companies have been able to extend out the debt, which is clearly very critical in case you run into some sort of liquidity hiccup and an ability to finance. But in addition to that, by paying down some of the cash that they've built up given all the uncertainty they were facing in now, that really starts to bring

down the leverage. And that's a big reason why we see default forecasts, not only our own, but rating agencies, other street firms bringing them down to numbers in many cases are as low as two percent of faults on a trailing twelve month basis. By the end of this year,

those are almost record lows, Tony. This makes sense when you look back six months, but there seems to be a cognitive dissonance a little bit when you take a look at the one point six trillion dollars of high old dead outstanding in the United States and you look at that it's near a record high that if you look back beyond the immediate pandemic times, these companies still

look highly leveraged. Is there some sort of reckoning that is waiting for these companies past this arrow when they actually have to start paying this down in real time, not just paying down some of the borrowing that they

did during the pandemic times to stay alive. Yeah. Well, when we look at kind of lawn term averages of debt to cash flow and you look at the high market and say maybe it's four to we're and a half times debt to but down market we see numbers coming back down into that range, meaning the long term historical average range. So what that tells us is that the overall high market is really not we don't believe as significant risk of dislocation just from the level of debt.

The dislocation would come really more from a surprise and inflation, a much weaker growth outlook, potentially negative outcomes on whether it's the vaccine or resurgence of COVID more of a

fundamental driver of weaker growth. But from a financial stability perspective, the high market is pretty well positioned in terms of level of debt and where cash flow is and where companies have been able to restructure their balance sheet to extend out their maturities, kind of pushing back any near term maturity wall that is often a big risk in

the market. From a liquidity perspective, tell you just a find question for me before we let you go, marches could be an issue this year, and marches will being focused in the next couple of weeks when we get the onnings as well. On the cost side of things, how closely are you looking at that and right now? So, honey, well, very closely, and we clearly expect there to be some cost pressures, particularly here in the middle of the year as we head into towards the end of the year.

All of the supply bottle next thing. You guys have highlighted some of the initial reopening price pressures. Whether it's from not only a goods perspective, but I also obviously from employment bringing people back in quickly enough to match what we think would be a big surge and services demand. So we'll be looking to see whether that is truly just a transitory short term bulge in those pressures impacting margins negatively, and what the outlook will be for twenty two.

Right now, our view is that the margin pressures will be transitory and in twenty two you get back to an equilibrium level of really still pretty supportive margins. From a depth perspective. London getting drunk on this program quickly, This drinking games taking off isn't it. Tony Drake has moving head fix thing comes Johnny. 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