Surveillance: Fed's Balance Sheet With Dudley

Dudley has done a public service this morning. I believe it's a two part essay for Bloomberg Opinion, and it's essay today is a tourtive force of clarity on what we're doing moving from four trillion to seven trillion and indeed out to a possible ten trillion dollar balance sheet of our central Bank. Every ECON, one on one student should be required to read the Dudley as he built. Dudley, congratulations on the clarity that we've known for years from

your work at Goldman Sachs. What is the singular distinction of what Chairman Powell needs to do forward with the presumed ten trillion dollar balance sheet. Well, what it means is we're going to have a lot of access reserves in the banking system allow of deposits in the banking system. Uh, and that that's going to create some anxiety that that

that that fuel is going to lead to inflation. What are the implications the implications of when the fit by treasury securities and mortgage backed securities is the added amount of reserves and bank deposits in the system. The reserves have already doubled. Second implication is that that forces the private sector hold more cash and deposits than before. And the third implication is that the sense of private sector may not want to hold all that cash and deposits.

That encourages them to move into higher riskier, higher yielding assets, and that pushes up asset prices. It does not, however, need lead to in lation because the fact can control credit demand by raising the interest rate that pays on reserves at the appropriate time. I will take your singular distinction that the FED can control this fear of inflation. And certainly, folks in two thousand and eight we saw the inflation nieces just dropped by the low inflation that

surprised them. What I would point out, though, Bill Dudley, is all of our listeners and viewers on this simulcast understand the phrase, there's no such thing as a free lunch. What is the price of a distortion that is a ten trillion dollar balance sheet? Well, I mean, I think there's a couple of things. Number One, obviously, this has implications for financial asset prices, and so defend withdraws this liquidity that that's going to have some consequences for financial

asset valuations. The second consequences of the FED is actually taking some risk in its balance sheet. I mean, if you think of the FED right now, it's a lot of long term assets financed overnight, and that's fine when

in short term and rates aired zero. But if you run the clock ahead a few years and the set has to raise short term interest rates, you have a situation where short term, the cost of the other set of paying interest on reserves could actually exceed the returns on its portfolio, and so the FED could actually start to lose money. Bill you said, when the FED starts to reduce its balance sheet, when the FED starts to

raise rates. Can the Fed ever do either of those things? Well, obviously all depends on the paths of the coronavirus pandemic and also how the economy response to that. I'm assuming that a few years from now we'll be back to a more normal economy, and when we when we're back to a more normal economy, will also be back to a more normal level of interest rates. Bill, we just got data showing that June is on pace for the fastest pace of issuance ever for US junk bond sales.

What are the consequences of the debt being occurred by corporations, not to say the United States of America as a result of the FEDS policies. Well, the shore run, it means people have the cash and resources to stay in operation in the long run. Obviously, there's limits to how much that people can take on, so there's a risk of servicing that dead over the longer term. I mean, the set is worried about today and tomorrow and next week and next month. They're not so worried about what's

going to happen in five years from now. But you know there will be a hangover from what we're experiencing today. I look, Mr Dudley at all that we've gone through, and I would suggest this was not in your textbooks at Berkeley years ago. It is unorthodox. Do you have a confidence in the belief of all of the smart people like you to get this fixed, even if we're

working off original theory. Well, we've never gone down this particular path before, so I think Tom yet to be a little bit cautious and say, we don't know how this is all going to turn out. That said, it's certainly better than allowing the economy to sink beneath the way it's gonna have a full flown depression. So I think what the FET is doing is appropriate, but we don't yet know how this is all going to play out over the long run. Bill Dudley, I give Chairman

Paul extremely high marks. Everybody grows into the position and the pressure of those very bright lights, and he's I think, really handling much better now the press conference, in the back and forth and the nuances of all this. But the thing that's out there is what if we receive some form of exogen is shock to the system given this balance sheet build up? Are we prepared for the not the next pandemic. I don't want to get all fiery in that, but are we prepared for any kind

of exogen is shocked within our debt markets? Well? I think the FED has shown that they have a pretty wide array of tools to deal with market functioning issues, and I think one of the great successes in the last few months is that we had a lot of market stress in March going into April, and the FED introduced a number of special liquidity facilis that have actually caused markets to return to good functioning. So I think it tells you that the FED still has pretty good

tools to deal with things like illiquidity. The problem I think we have fundamentally, though, is that the pandemic is causing harm to household and corporate balance sheets, and there's limits to what the FED can do with respect to that damage. My favorite quote over the weekend fund manager

called the Federal Reserve helicopter parents for the market. I thought that was pretty apt at a time when you have a lot of worries that are just being absolutely pushed away at the at the behest of the Federals. Or if people saying, put your faith in the FED, don't fight the Fed. The FED has our backs. I'm wondering how concerned you are, Bill that this takes the pressure off of Congress of federal lawmakers to actually pass some stimulus efforts that could potentially get to main street

faster than some of the Fed's programs. Well, I think Cheri Pale has made that same point that it can't all be just about Monterrey policy. The pandemic is causing harm to people's incomes, to their balance sheets, and that's something that really terry policy can't repair by it. So that's why you need fiscal policy stimulus. So, you know, one of the you know, risk here is that people think that the FED is all powerful and basically put

all the all the weight on the FED. And the fact I think that we need more, probably probably gonna need more fiscal stimulus than what we've got to take. Dr Dudley, thank you so much for joining us today. Bill Dudley is the former president of the New York Fed.

An exceptionally interesting and clear essay for Bloomberg Opinion today, and I really anticipate, folks, what I believe is a presume second essay from Bill Dudley on the prescription forward given a ten trillion dollar deficit right now with us and we're thrilled to bring you here for an important conversation on deflation and disinflation. James Sweeney of Credit Sweets he writes, wonderfully direct research reports this out of the

acuity of a London school of economics. James, I've got to start with what was in the literature this week again, which is the what if what if we do fiscal policy? What if we do fiscal salvation? And what if we run out of it before we get a legitimate recovery?

Is that feasible? Is that possible? I mean, with the politics the way they are right now, I think anything is possible with fiscal I mean I could imagine a strong stimulus, I could imagine a temporary strong stimulus that runs out, and I can imagine no stimulus, and that creates a lot of uncertainty for the outlooking both directions. They all look in both direction, and then it sort of it really comes down to that the V shaped idea, and I get I looked at the spreadsheets down we're

going up. We go que three. How big of a mystery is the fourth quarter of this year. It's a very big mystery. And I think that, well, we've got three uncertainties. I mean, first we have are we going to have another fiscal stimulus? We have that extended unemployment help running out on July thirty one, So you're gonna have a big drop in household cash flows at to that if if you don't you renew it um, and it looks like they probably won't. They might extend it,

but not renew it. But on top of that, you know, we have ongoing contagion, accelerating contagion in many states, and could that lead to more shutdowns? Even without more shutdowns, could it lead to people staying home to the extent where we don't have the full recovery, um, you know, the full post shutdown normalization we were hoping for. And then you have the election as well, So UM, I think you have to put large arab bands around any forecast for for the fourth quarter this year and arguably

for the third two. Let's talk about the bounce we've seen as well, James, and how the bounce, the data bounds that we've seen over the last month informs your views about the ladder end of this year. What do you take your wife from the bounds? Yeah, it does not inform my view about the latter half of this year. This bounce was entirely predictable. This is turning the light switch off on the economy and turning it back on again.

It's pretty it's pretty easy if if hours work to go down because they sent this home and then we they bring us back to work and hours work, they're going to go back up, and the data are going to bounce. But it's not answering answering any of the big questions. So you know, the unemployment to jump in this is so so significant. So many people are looking at this data bounce and they're extrapolating out two three Q two for que into what does inform your view

about the year still to come? Well, I mean, I think you can extrapolate this bounce out a few more months, as long as you're seeing people return to work. But further out, I mean, if I'm thinking about the labor market at the end of the year, I want to know how damaged our businesses, How bad are their balance sheets and earning so that they can't hire. I want to know how bad are their sales expectations given that the virus may still be around and a lot of

people might be avoiding certain activity. And I want to know even how much how many efficiencies have businesses found while their workers have been working from home? So some business is maybe discovering that they could rearrange somethings, use less space and fewer workers. And I think all of those three factors are different factors that backward looking forward, looking at a productivity one which could lead to an

elevated unemployment rate later in the year. So I think the unemployment rate is falling now for very simple and simplistic reasons, where the light switches is being dialed back up again. But um, it's gonna be high. It's gonna be a lot higher than three and a half percent at the end of the year, maybe in the high single digits are even higher. Um And and you know, so we've got to really think about all those factors separately, James, Efficiencies is a sort of a dirty word right now

as people look for the second wave of layoffs. How much are the federal reserves policies buoying this market from a main street perspective, keeping some of these businesses alive and can continue to through the end of this year. Well, there's no doubt that the p p P program in particular, which I think of more of the Treasury of the Treasury program than a fit probe him, has has kept a lot of businesses going UM and I think the

FED programs in general have kept credit flowing. You've had this extraordinary issuance in the primary markets, but it doesn't mean everything is good. I mean you're gonna have a lot of business failures and we don't know what the balance sheet damage looks like six months from now. So it's just a very, very big deal when you have the GDP contraction of this size driven by the virus. We've had policy responses which are extremely forceful UM, but

it's even possible that they are not enough. And that's why you circle July thirty one as the date that some of the Cares Act benefits expire. And and this is going to be the next particularly important moment that markets are going to focus on as we've come to

learn what the second half is going to be. Like James, everyone's becoming a social scientist and trying to pass through Google, Google searches and other soft high frequency data to get a sense of what the consumer behavior is going to be with respect to the virus as well as businesses.

What are you looking for? What sort of the early indicators that can give us a sense of just how much business is being suppressed by people's concerns and frankly, how much businesses have to respond by shutting down so that they don't have the extra expenses of being open without enough business to justify it. Yeah, there's different forms of foot traffic data, web traffic data, you know, hours

worked data. I mean, there's a lot of very ultra high frequency macro data that didn't exist just a few years ago, and right now, I would say, survey quite quite a few of these numbers. Um, you're not normalizing, You're you're normalizing very slowly in the states that reopened first, and then the states that reopened later they're slowly normalizing too. And now in the states that reopened first, you have a very sharp pick up in contagion in a number

of them. So I think the best case scenario was the viruses is a little quiet, and you know, you're you're rich hurning workers to work, and some workers are avoiding risks, and therefore you can't expect a normal level of demand. But if the virus is severe been a lot more workers and customers are going to avoid going out, and in those most affected sectors like restaurants and travel

in airlines, etcetera. You know you're gonna have a problem, and so every data point on the contagion UH suggests you know something bad for the second half of the year. James, you made your name with Niel Sauce studying deflation and really pushing against the deflation gloom in Europe, ages and ages Ago. I want you to parse right now the disinflation of America in goods and services. We've had a pernicious decline in price for goods at times fine, but

services have been remarkably stable. Can you model out, given this pandemic and the tough recovery, can you model out services disinflation or even outright inflation? Sure? Well, I mean in the way inflation is measured about to and thirds is services prices, and one third is good. And it's important to know that because you know, most people really look at cars and look at gasoline, and there's their

view on inflation. But the services are important, and you've got things like housing, healthcare, and financial services in there which are opaque, and sometimes the prices are even basically modeled, at least in the short term. Right now, housing inflation looks likely to put downward pressure on overall inflation um, financial inflation, and the others are in healthcare a little bit more mysterious. Um. But this was a huge drop in services consumption, the likes of which we haven't seen

since the Great Depression. And right now we have a much bigger services sector. So you know, we're gonna see headline inflation bounce around zero for a while. We're gonna see core inflation bounce around one percent um. Services are doing some of that work. I mean, there's certain goods like airlines and use cars that are that are doing it on the good side as well. But this is the temporary implications on prices from the shut down and

from the virus. The wrong term questions a little different. The one final question, James, it's just real simple here. If we're gonna model this kind of nominal g d P, should we begin to really aggressively talk about a FED that manages for nominal GDP and not real GDP. Well, yeah, I mean I think really the dual mandate is nominal GDP in a way, because you've got you know, the unemployment rate is the real growth piece and the inflation is the is the inflation piece. So there you have it.

If you're doing both right, You're you're really targeting nominal, just not you know, explicitly. Um So, I think we've had a four percent nominal GDP trends in the US over the past ten years, and hopefully we can get back on it. I think the equity market is trading as if the expectation is we're going to be on

that four percent nominal GDP trend before too long. Um The bond market seems to have its doubts, and I think that that encapsulates pretty well the range of opinions right now on deflation and inflation, a wide range of opinions on pretty much everything right now. James task to catch up with you said as alwise, James Sweeney of Credit sways on this market, this economy, this recovery. Joining us now is he did a bit ago? Uh? Joining us now is the head of the m t A.

Their chairman Patrick Foy joins us now. Pet A hundred and thirty two people within your huge organizations succumbed to the virus. The courage in the heat of this was noted. What will they do? What will the m t A do to celebrate on this reopening? Well? Phase two Phase two is a big step for New York City and frankly a big step forward for the UH for the country. On gladtime that you're gonna be eating in New York City restaurants five days a week. The city needs the

business and the UH and the tax revenue. Throughout the entire pandemic, the m t A UH employees, UH, Subways, buses, Metro North Long our Road, road bridges and tunnels have been heroes, moving heroes. They've done extraordinary work in the most trying circumstances. At one point, UH a total of well over ten thousand employees or under home quarantine. Ten thousand employees have returned to work. The number of employees on home quarantine is in the is in the hundreds,

down from thousands. And tragically, a hundred and thirty two of our colleagues succumbed to the virus at at the mt A, Subways, Buses, New York City Transit, Metro North Long Island Railroad, UH, and UH, and that is tragic. Obviously, New York has been the epicenter of the UH of the pandemic, but the MTA workforce has been heroes, moving heroes, first responders, and essential employees, including fellow transporters. What will be the process of someone on a subway, someone on

a bus not wearing a mask. Wellok it state law to wear a mask on public transit. As a result of an executive order that Governor Cuomo issued some weeks ago, I can tell you that UH compliance by our employees is universal. We have done physical counts on the subways. The original account was a ninety two mask compliance by

our employees. We believe it is now. We've got a robust communications and messaging plan to get the number even higher, and we've been distributing over the last couple of weeks millions of masks to writers who were returning to the system. It is not optional, it is mandatory and state law to wear a mask on transit. Public health officials tell us that the single most important thing any anybody can do in whatever environment they're in, but including on transit,

is to wear a mask. Protects you, it protects your fellow commuters, and it protects our employees. Pet I've been looking at pictures of workers cleaning all of the subway cars twice a day, which is fantastic for anyone who wants to write a clean subway. It all takes money, and your CFO said that it could be as soon as early July, at which point the m TABLE run out of money, will run out of federal funding that's

been propping up the finances. What then if the federals, if if the federal government does not re up that financing, what happens to the m t A. So so at least a just one point of clarification, which is important. Our employees are not cleaning subways. UH, They're not cleaning stations. They're disaffecting them. And we've been doing that since since Mark three. Bob Foreign, our CFOs concern is is well placed.

We're in a dire financial situation. We got the MTA received three point eight billion dollars, was awarded three point eight billion dollars in the Cares Act. That money will carry us through July, will be drawing it down through August. UH. The f t A, at U, S d OT has done a good job of facilitating and expediting that money.

The Heroes The Heroes Act, which passed the House thanks to Speaker Pelosi UH and the support of the New York Congressional Delegation, provides an additional three point nine billion dollars of federal funding. It's obviously subject to Senate approval. It is absolutely critical that the MTA received that money.

We hired McKenzie to do a review of our finances UH and the looking at the revenue decline because ridership is down across the system, expenses her up and also a dedicated package of taxes and subsidies which also accounts for fifty of the mt A revenue in a in a normal year. Mackenzie's midpoint is seven point seven billion dollars, So the three point eight from CARES and the three point nine in the House bill on the Heroes will

take us through. It's critical that we received that federal funding. PA, just real quick here. That distinction that you made between disinfecting and cleaning, why was that an important distinction to make? Well? We we UH. Cleaning means taking the coffee cups out and the refuse on a on a subway car or bus. We've been disinfecting using disinfecting agents since since March three because of the pandemic. We've also been piloting the use of ultra violet sea light on subway cars and busses

were doing that right now. We worked with a Columbia University professor, Dr David Brenner or the Irving Medical Center at Columbia, who's an expert on ultra violet light. He concluded in this innovative collaboration with the m t A and ultra violet sea light kills the COVID nineteen virus.

We've also been piloting the use of anti microbials, which we believe and to be verified by independent laboratories and regulators that it too will kill the COVID nineteen virus and has the potential to do that for weeks and

months after application. That would be a game changer. And the point I wanted to make to our riders is that we are looking at every step we can to minimize public health risk to our customers, answer our employees, ultra violet light, ultra violet sea light, ants on microbials or evidence of that. Pat way pray shot hot work

the city, the whole city does. And I thoughts with the team of the m c A. Patfoy that off the m c A right now, let us turn to what we do, which is economics, finance, investment, and more on foreign exchange than anyone in the world. And we can do that with Jane Foley of Robbo Bank. She's exceptionally attuned to not only what the speculators are doing, but also the commercial banking interests of her Robbo Bank.

Jane Foley, I have to start with the dollar. I noticed today looking at the Bloomberg Dollar Index, which is basically resilience for four years, even pushing into five years of relatively strong dollar. That's been a great miscall. When do we finally see the dollar give way to what

the consensus call is? Is we just dollar weakness? You know something that's a really interesting question because let you say, the consensus called for a number of years has been that we will have a weaker dollar, and finally with the dollar, bears are saying, well, this year, this is going to be the year that we see this weeker dollar because a little that money printing that we've had, Look at all the excel liquidity that we saw at the FED and other central banks add But you know,

I think the answer really will be in risk appetite, because it's not just this year that we've seen, say, a correlation between the dollar and emerging market stocks. This has been going on at least since twenty eighteen, and it seems to me that the answer to the dollar or the dollars the dollars trend will be an emerging market. If the market is confident enough to keep on investing in e M, the dollar will go down. If it isn't, it won't and the dollars still will have this safe haven.

So if we do have another wave, if we do have later on in the year markets really concerned and stock markets got ahead of themselves, well, in sort of instance, the dollar is likely to do well. But if the market carries on being really optimistic and being in this blind stupor of optimism because of central bank money, well the dollar could soften. It certainly could. Jenny's there's another way of saying, don't waste your time looking at rate differentials. Well,

you know, great differentials obviously come into it. I mean they're the bread and butter clearly of foreign exchange. But that they it has changed. So for instance, if we consider for ins as a carry trade, it used to be the days when we used to sell the air and as as the funding currency and by the Aussie But if you look now where Aussie rates are then really not that high anymore. Last year people swapped, for instance, to to to the Mexican pay so as as a

carry trade. But in terms of funding currencies, perhaps now you have a lot more choice. You've got negative interest rates for a variety of different countries now, not just of course at the end, so the market has changed. Interest rates will always be important. But I think what we have, as we all know, in terms of crisis, we have this big correlation where we have risk one and risk off and in those sorts of environments we

have less detail. Well, let's talk about the characteristics of this particular regime just a little bit more, Jane, going into the downturn, the March contraction that we saw not just in the economy but in this market to increasingly the Euro was becoming the funding currency of choice, then it quickly unwound. Have you seen that build up in any particular way that's significant enough that we need to think about more. I think the euro has been significant

this year. Now, We've got to remember that the Eurozone has an enormous current account surpers. Germany has an enormous current account surpers, and what we saw in March when we saw this big sell off in risky currencies and and e M in particular, we obviously saw the dollar benefit, but I would always say I think the Euro held up relatively well against the US dollar. I think what we actually saw was sort of e M versus G ten with with the dollar coming out at the top

of the bundle of of the G ten. But but you're held up well. And then of course last month we had those two pieces of news which I think was significant for the Euro. We had at the ECB really put in its mouth where it's where it's money, where its mouth was, and say, look, we do not want fragmentation, and we do not want the market to think about fragmentation. We're going to buy those peripheral bonds. We're going to stop that sort of talk, which helped

the Euro. And of course we also had that European Commission bunship proposal that was a step forward. Now clearly that's got to be ratified, but we've still got the euro really boid on that. So I think the sort of neutral point for for Euro dollar has shifted tire on the back of European news, and I think that

is significant. Jana, the dollar is still very much the funding choice of many countries, and that's the reason why the feasurers have opened up that swap line and expanded it dramatically in the wake of the dollar crunch that we saw in March. Last week marked the first time that the FED started to taper that and people are expecting that to continue. The demand for dollars coming down. Does that tell you that the dollar crunch is over?

Does that tell you that this could be a potential risk with the dollar surging again, if there is a liquidity shortage around the world. I think it tells you both of those things. I think it tells you at least for now. Yes, the the the the eye of the storm has passed. The middle of the crisis has gone, and things are calming down, and we can see that in lots of different asset crisis too. We wouldn't have stock markets where they are now if we were in the middle or you know, still in the eye of

the storm. But we also know, you know, all of us, we look at our screens every day and we see worry news about the coronavirus in the US, and we see the r rising again in Germany or you know, in Brazil, we see terrible news, and then we know that we're going to face bad economic news as well

over the next few months at the very least. So we all know that there is another wave, and if there is another wave, it will be the dollar and possibly the end in the currency world that well, we'll see still some flows and central banks will have to react again if that does happen. Jane, I got killed this weekend. I lost so much money on the tarts. It's incalculable. Where can I make back money in foreign exchange in the next six months. Where's a tradeable trade

right now in f X? Which pair gets it done? You know what, I think the trade that you might be putting on today it could be very different to the trade that you're sitting on in six months time, and it very much depends as to whether or not we get that second wave or not. If you are extremely confident that we weren't, then yeah, maybe you'll make money out of selling the dollar. But you know, looking

at the Aussi dollar, that does worry me. I think we see the same picture in the Aussie dollar as we see in many stock markets, and we see a lot of good news in that price, and if we see a lot of good news in the price, it clearly means that the market is is more susceptible to it's it's a bad news. And I do think that we've got some retracement to go, potentially a lot of retracement that certainly some retracement in the next few months.

So you know, I would be a cello and rallies of risk currencies like the Aussie and we'll I'd be very concerned about Sterling if we do not get a trade deal soon between the UK and the EU. I think Sterling could be really quite vulnerable. We've got to spend some time talking about Brexit in a not too distant future. James Foley of Rather Bank, I'm sure you can hardly wait week and hardly wait great to catch hell with you this morning. My best to you and yours.

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