Surveillance: Fed Tightening with Dudley

thrilled that Dr Dudley could join us this morning. We've got a lot of questions built off your important essay al at John and Lisa get to that define the difference between Vulker and brainerd inflation. What's different with this seven eight percent versus a seven eight percent when you were certified at Berkeley. I think the difference is that the inflation that Boker had to fight built up over a long period of time, and so inflation expectations started

to rise pretty significantly. So it's much harder to get rid of the inflation than the inflation we have now. The good news is that the inflation expectations are still relatively well anchored, so that would imply that the Federal Reserve isn't gonna have to do quite as much to push inflation back down your line in your pace this morning. In the late paragraph, Bell, I think it's got everyone's attention, so I'll repeat it for everybody who hasn't heard it

so far. To be effective, it will have to inflect more losses, inflict more losses on stock and bond investors than it has so far. Bill runners through financial conditions and how you gauge financial conditions and why you might believe it stocks for a big part of that. Well, financial conditions are important in the United States, and sure Paula has emphasized this in his prepared remarks because that's how Montrey policy works. So you guys, E commy doesn't

really run on short term interest rates. It really runs on long term interest rates. And the stock market is also important because a lot of people have exposure to the stock market and the level of the stock market affects their wealth. So the Fed has said pretty clearly we need to tighten financial conditions to slow the economy down, to keep inflation and check, and so far financial conditions really haven't tightened very much. The stock market is only

for percent or so off it's high. It's still up very sharply from where it was a couple of years ago. And body els, you know, two point five two point six are still really low, especially when you adjust for inflation. So in my mind, the FED hasn't really accomplished much yet, and if financial conditions don't cooperate with the Fed, the Fed is going to have to do more until financial markets do cooperate. Bill, talk a little bit about the

consequences of this. If stocks are a reflection of sentiment, if they affect the way that people are willing to go out and make purchases based on their household wealth, what does that do to the economy. Are you basically saying that if things continue the way they are, the FED is going to after torpedo growth to a potentially

recessionary degree. Well, the Fed right now is, you know, markets are pretty confident in the FEDS program because they have the FED kicking the flirture rates up to about three. That causes the economy is slow, and then the Fed reserve eases policy in two and we have a soft lanning live happily. Ever after. I don't think it's gonna be that easy because because the markets are so confident in the FED, the financial conditions are still quite buoyant.

Financial conditions are buoyant. That means the FED has to do more because it's slow down the economy. Also, a soft lanning is very very hard to achieve when the unemployer rate is so low. Uh the soft lanning examples that Paul has cited in nineteen n n where all examples where the FED tightened and the economy slowed, but did not slow sufficiently to push up the unemployer rate, the unemployer rate and all three of those episodes kept declining.

I think at the in the current environment, with the unemployer rate at three points six percent and wages running well above outrate consistent with two percent inflation, the Fed's gonna have to tighten enough to tighten financial conditions enough to push up the unemployer rate. And when the FED has done that in the past, it's always resulted in a recession. That's not their intention. They'll go for a soft lantic with their chances of pulling off are very

very low. Do you think that rapidly reducing the balance sheet bill will be enough to achieve this sell off that you think is necessary in order to enact some of the tightening that the FEED is that trying to achieve. Well, certainly we'll work on in the right direction. Obviously, quantitative easing help pull down long term meles, and I think if as a reverse course, that should push them up.

But we don't know by how much. Uh, we already know what the FEN is gonna do, and markets haven't really moved very much, so uh, you know, I think it's just a big wild card in terms of how much will the quantitative tightening do the FENS job for them.

I think the big point I would just make it's just it's very unlikely uh that a year from now we're gonna be at this level of bonds is low and this level of stock prices this high, because that's probably not sufficiently tight financial conditions to do the FEDS job for them. Bill parts. The difference is inflation comes down of the importance of goods inflation coming down own versus service sector inflation coming down. Well, obviously both matter.

I mean, I think where the Fed's expectations is that goods inflation will come down quite a lot over the next year because the composition of demand as the economy reopens, will shift away from goods back to services. And the fact that some of these supply chain disruptions, for example, the auto sector will gradually get resolved, and so car prices, for example, will be weaker. Use car prices a bit weaker,

but the services sector. Inflation is going to be a lot more persistent because that's really about labor costs, and we're seeing that labor costs are going up because the labor market is unusually tight in the current setting. But one time, FED officials when they're in the state talk a lot. You just have now, well, it's unpleasant to be a FED official and talking about how you have to tighten financial conditions to push up the unemployee rate.

You don't want to talk about putting people out of work. And that's not, obviously the deliberate goal of policy. The deliberate goal of policy is to keep inflation from getting out of hand. Unfortunately, one of the reasons ways you have to do that is to is to generate enough slack in the labor market to keep inflation in check.

And that's just an unpleasant conversation to have. So with what the FED set officials talk about is how we have to keep inflation in check so we can sustain this economic expansion and keep the most number of people employed. And that's true too. What they're not telling you, though, is that how difficult that is to pull off. Built a clinic as always, and we appreciate your time this morning.

Built down that the former New York Fed President and of course, amongst other things, now a Bloomberg opinion columnists. The title of his pace this morning tell me if stocks don't fold, the Fed nates to force them, let's get right to it. This is too important of a conversation and it's truly extraordinary. Evel and Farcus and her

family are out of Hungary. They know the experience of moving out of continental Europe over to America, where their tour of duty at Franklin and Marshall College and then her PhD at the acclaimed Toughs University flood your school. What is fascinating is in her public service to President Obama. She is now on the same page is John Bolton. That is extraordinary. And Evelyn, we had John Bolton on the other day and both of you say, get over it.

We're not going to start world War three, discuss what America can do amid this fear that we have that O MG, We're gonna have World War three. Well, I mean, I think tom to the point that what what I've been arguing and I and I had a Washington Post all that about this, and I've been running around, Um, I guess like John Bolton, not with my mustache on fire, but my hair on fire, trying to explain that we

shouldn't let Vladimir Putin deter us. Yes, unfortunately he has used chemical weapons and he has a lower threshold for nuclear use, but he does not want war with NATO. So we should really calculate the risk that we are willing to take in order to protect civilians. And I think me and several colleagues of mine who are national security and foreign policy experts, we signed a letter saying that the administration should not dismiss the idea of a

humanitarian no fly zone completely out of hand. And what we're trying to do there is say, do not rule things out. We to be agile, and we need to understand that we may need to do more, take on more risks to save lives. And so I'm worried as we move into the next phase of the fighting, that we aren't thinking enough about how to save lives. We are providing additional military support and that is really important and that should continue. I look, Evelyn at the path forward,

and we are shocked by these atrocities. I don't want to get in the debate of the war game, but I want to know from you how a Pentagon, or the Pentagon in Germany, or the Pentagon in France, how they respond the horror that we've seen. Well, I think everyone is horrified, and the question now is what can

be done. In the past, even even in brutal wars like the Balkan Wars in Bosnia, I lived there after the war, we have had international agencies in their providing humanitarian assistance and trying to prevent the kind of massacre that happened in Buchan and elsewhere. And I would like to see some of these multilateral institutions like the Red Cross taking more risk, maybe going in with armed escort.

They were held back more than twenty four hours from rescuing citizens, innocent civilians from Mariopal just this past week, so more needs to be done. Certainly, other countries need to be pressured to put pressure on Russia to allow for civilians to be evacuated. But unfortunately, what we see here is that Russia is purposely trying to slaughter civilians. It's part of their their effort to try to break the will of the Ukrainian people and the government. Evelyn,

how do you see this ending? Well, of course, I'm hopeful that the Ukrainians can frankly take back their territory and beat the Russians on the battlefield. I don't think sanctions are going to destroy Vladimir Putin's intentions here, I mean his his his aggressive foreign policy will continue and sanctions will take a longer time to have an impact. So really it will be determined on the battlefield. We if we can provide sufficient or or enough I mean sufficient,

I don't like the word. But if we can provide the military means necessary for Ukraine to push back the Russian military, there's a chance that they can regain their territory. Other than that, there's a compromise potentially where the Ukrainians might have to give up some territory, but I don't see that happening anytime soon. In a personal question, your father has been definitive on the collapse of the Hungarian aristocracy and the time from another place, even before Stalin

and Hitler. I am fascinated how you believe we can laying to the Russian people that Ukraine doesn't need denazification. You live, your family lived Nazification. How do we explain to them that we don't need to denazify. Well, this is a problem. I mean, the Russian government has a lot of control over its population through its monopoly on

the media. That they do have a lot of internet saturation in Russia now, and so some people can get alternative news and truth, but that's also being increasingly squeezed out. And yes, my family I was born in the United States, but my parents both fled Communist Hungry and as a child I went back to Hungry to visit my grandparents.

I spent summers in Hungary. I know what it's like to live under communism when you can't speak the truth, and being told as a ten year old to be quiet because I might get my grandparents in trouble, and by trouble I understood it meant jail and something pretty serious. So, um, you know, the Russian people, we don't really know exactly what they think even when there are polls that are taken, those are probably somewhat suspect. But unfortunately the brandwashing is

pretty effective. It's going to take, frankly speaking, the Russian soldiers coming home or not coming home, for the Russian people to start to figure out what actually they their government is doing in their names. So, as I said, the home front in Moscow in Russia proper is not really where the war is going to be determined. I think it's really going to be on the battlefield evident. Thank you, as a wife said, you want to get seven and focused that the former Deputy Assistant Secretary of

Defense Dr. Cassidy. Bill Cassidy is from Louisiana. He is a force in Baton Rouge win the vote in two thousand twenty. Senator Cassidy, thank you so much for joining this morning. Before we dive into the clear and present, Gou Jing, I need to talk to you about the distance from Detroit and the Democrat big Dingle and John Dingle out to Kalamazoo on Root ninety four and Fred Upton. Fred Upton retired yesterday almost in tears from the Senate because he's being pushed out by the Trump part of

the GOP. You live this. You had a nice re election in two thousand twenty. Can you comment on the GOP vendetta against those that said we need to impeach the president. Well, first, Fred was redistrict in a tough way. He lost three hundred fifty thousand of his base voters. Now there are some of the party who are mad at folks like Upton Matt of folks like me who voted for impeachment. Uh, that's just the way it is.

You do what's right and you live with it. And I think Fred is incredibly proud of the integrity that he showed with that vote, with the enthusiasm that we hear, and suggest that the Republicans may take the House. Indeed, the Republicans may take this Senate. What does the new majority Republican Congress need to do day one? Yeah, day one, we need to have to We need to start going after inflation. Inflation. Inflation right now is being driven by energy.

Uh cost both direct the cost of the pomp on your fuel build, but the indirect the inputs to the fertilizer, the go to the crops. That's a lot higher now as well, I proposed an operation warp speed. Just like we took the vaccine and within ten months had something predicted to take two to ten years, we should take a regulatory kind of let's get all together and figure out how we can increase supply and decrease prices for US and our allies within ten months, if not shorter.

We can do that, but we need the regulatory agencies. We need an operation warp speed. Seneca, where do you see this fitting into eventually moving away from less of a reliance and fossil fuels. Yeah, so right now, believe it or not, there is a regulatory uncertainty for renew doubles. There's a regulatory uncertainty for carbon capture utilization sequestration. So what I'm speaking of is not just oil and gas.

It is also the ccus that Louisiana has been waiting for Regions six E p A in Dallas to get off their duff on our application since October of last year. So excuse me, senator, are you saying basically that it could just be a regulatory fix that could plug the hole, that could plug the gap in some of the supplies that we're seeing, at least in part stemming from Russia. It could be a regulatory fix as well as regulatory certainty. Um. Right now, it's death by a thousand cuts to fossil fuel.

So why are you going to invest when OPEC may decide to collapse prices and you're left with regulations which etcetera, etcetera. So my point being that if you could have regulatory certainty, have a little bit of capital injection to kind of commit the federal government, yes, you oil field service providers, we're not going to leave you out hanging bankrupt, then

we could rapidly improve, increase production, Bill cassidy. You on the high ground on this and today it's gonna be big oil that's gonna talk about price gouging and that. But you live it in Donaldsonville, Louisiana, with CF Industries the largest nitrogen fertilizer company, I believe in America maybe in the world, I'm not sure on that explained to

us how the people in Donaldsonville aren't price gouging fertilizer. Yeah, so natural gas is a feedstock for fertilizer UM, and so if your inputs rise, then it's going to increase the cost of the final product. Now there's also the ability to ship. There's also other aspects of the logistical supply chain. Obviously, it costs more to maintain your plant, costs more for labor because of general inflation. But that's

just gonna be a little bit of a gap. Now, you could sell it below prod ice in which some middle person is going to buy it and then sell it at the market rate, but in somewhere there's going to be a markup. Senator, amid this soup of information, the soup of concern around gas prices, how concerned are you or how upset will you be if you see oil companies post bang gangbusters up profits in the next earning season, Well, you want to look at the reason

for their profit. Um uh, let me just say that. And if they're going to use that profit to turn around and invest in the new um fields that we need in order to increase production, well isn't that a good thing? And let me point out about I don't know, a year ago, people had to sell their oil at a zero below zero price. There was no storage, They had to pay people to take their oil. So there's always going to be some rises and falls. What you want to see those the capital investment that long term

creates more certainty in terms of our fuel supply. Senator Bill Cassidy, if Louisiana said it, thank you for being with us today with Michael Collins. He's a pie jum. And what's cool for our global audience is the state university system of New York. And in my ute, everyone knew the most prestigious math program was if you could survive it at Binghamton, New York. Michael Collins survived mathematics at Binghamton, which is a big deal when we were

growing up. He's senior portfolio manager again, pijam, Mike Buried in your mathematical note, is the economic bet of pijum that the wage spiral or the wage worry, including what Bill Dudley saw in the last hour, May ebb away. Do you see evidence of that yet? You know, we're just started to see Tom the wage growth uh and the labor market growth start to flatten out here UH and maybe start to roll over. You see it in hours worked in the in the report we got on Friday.

So so I think you have probably passed the peak rate of growth UH in wage certainly the peak rate of inflation. I would argue as well. You're going on calculus on it's like lyle Brainer did yesterday when she talked about the rapid pace. Let's call it the second derivatives of in these markets? How do you actually prosecute bond management given the rate of the rate of change

right now? Yeah, Well we all know, Tom that the markets really do focus on second derivatives, right, and it's it's the change that really matters more than the stock right. When it comes to quantitative tightening, for example, you know a lot of people will look at well, the balance sheet is nine trillion, so it goes to eight and a half. What's the big deal? Uh, it is a big deal. Right. When the Fed embarks on quantitative easing, you see a super high direct correlation with asset prices

going up. So what we're contemplating in our shop, Tom, is when they do unitative tightening, do you get a symmetrical um pull back in asset prices or is it more measured as the Fed tries to um signal that quantitative tightening is watching paint dry and it's on autopilot, and it's it's not going to be a big impact on the markets. But I do worry that it will result in much tighter financial conditions. So let's since you

walked right into the big debate of the day. It does quantitative tightening cause higher longer term bond fields or lower ones? Yeah, it's the opposite of what everybody thinks. Right. By the time they start the quantitative easing, right, typically rates have plummeted, your your inner recession. Uh it's a big risk off. And what happens when they start buying bonds rates go up because what they're trying to do is get inflation higher. And it's going to be the

exact opposite when they do quantitative tightening. The markets have already priced in. Look where rates are, right, Look where inflation expectations are, they're kind of peaking here. Uh So by the time they start tightening policy through through rate hikes and simultaneous quantitative tightening, which we've never seen in our lives. Right, this this kind of quick reversal of monetary policy on so many fronts. I think you're going

to see a peak and rates at that time. So a peak and rates at that time, are you buying tenure treasuries at this point? Saying two point six looks golden over the long term. Yeah. I mean, fortunately we had we had cut duration earlier this year and we were we were short uh duration marginally in the US and just really in the last week or so, we've we've covered in most of that and we're kind of flat duration. I mean, there there can be a better

entry point. I mean, personally, I'd love to be you know, long duration at some point over the next you know, a few months or a few quarters. But for this at this point, we're just kind of waiting for for the right entry point, uh and it will come right and it typically comes right around the time the Fed starts fighting policy aggressively, and they really haven't started that right and they're going to start in earnest really soon, Michael.

The movable feast, which is the terminal yield or the terminal dot plot as an ex exist and also a level what's the level of the tenure yield and how far out is that terminal yield right now? Yeah, it's really fascinating time to to look at what's happening with forward rates, what the market is pricing in the markets are basically pricing in a funds rate right now and like a year or year and a half of close to three and a quarter now, right, so three hundred

basis points almost of incremental hikes. But a year and two years and three years after that, the markets are pricing in almost a hundred basis points of rate cuts. I don't recall ever in our life FED has FED, hasn't even started or has just started hiking, and the markets are pricing in a hundred basis points of cuts in in the out years. And I actually think that's a pretty brilliant And I called up the parlor game.

It's just to me, it's just absolutely idiotic. But what you just said what I find fascinating, And this goes to what Bill Dudley was talking about an hour ago. Is the idea of in a year and a half, what does your world, seriously, what is the PGAM insurance asset management conservative money world do if you get that magnitude of change over eighteen months. Yeah, well, I mean that's that's based probably our base case, Tom, that you're

going to have growth slowing. I believe we're already at the beginning stages of what could be a pretty significant level of demand destruction from higher inflation. And now you're seeing higher rates and tighter financial conditions, I mean mortgage refinancings are plummeting, mortgage rates are pressing against five percent this morning. I mean housing has become basically unaffordable for for most of the people in this country. That is

tighter financial conditions. Growth is going to slow. It's just a matter of how much and how fast. But certainly in a year, a year and a half from now, we could be in a very different world where the FED is pausing on rate hikes and maybe even contemplate

and cuts. So what you do as an investor you try to take the long term view, knowing that in three and five years, Tom, the funds rate is going to be back to zero, right, the tenure will probably be back to one at some point over the next five years, So you want to take advantage of that, capitalize on that, on that capital gain you can get by being along duration. Tom, I just want to be cleared. Did you just call the parlor game of trying to

game out FED policy into the future? Idiotic? Is that right? I agree with Michael Collins were in an absolutely original place. I just I was talking to uh. I think it was a quantist this morning about Richard Timberlake of of Georgia. Timberlake never wrote about this. Meltzer never wrote about this. Anna Schwartz never wrote about this. This is unheard of

territory and what we're moving toward. And Michael, this is what you were picking up on the idea that at some point the feed is going to trigger a downturn. You're going to see growth materially slow down. The question is will it be something controlled or will it be a dramatic downturn, something that's a recession that's sooner than expected. Deutsche Bank came out and so they expect a recession

in the United States in do you agree? Do you think that that's looking increasingly likely as we look at what the FED has to do to get markets basically to believe them. Yeah, I think the probability of a pretty significant global slowdown, and you're already seeing it, you know, in big parts of the world in Europe and China. We got p m I s out of China below fifty today and and the US just cannot you know, be an island of prosperity onto itself. So you will

see global growth slow. The question is what does the recession the recession look like and I actually am pretty constructive on this one, right, And if you look at consumer balance sheets, you look at corporate balance sheets and the liquidity they have in the profit margins and the and the wherewithal to kind of withstand some weakness here. This is not going to be a big business or

consumer led contraction. I feel like it's gonna be almost like two thousand and two thousand one, where you get a big correction and asset prices possibly uh and some some pain in the markets. But but you know, back then, you hardly saw consumers spending uh, you know, go down at all. And maybe it's that kind of mild recession or big gold global slowdown. Mike, you are just awesome. I'm miss sitting around a table with you, Sir Mike

Collins there of AJM. Mike, thank you a well time meeting with Lindsay pigs a chief economists of Steve What. We're thrilled that she could join us this morning. Lindsay, I got to get to May four, and I guess there's the hides of March, but tell me about the IDEs of April. First, I got to get to April fift What data matters for loud Brainer, Jerome Paul, and Lindsay pigs Uh. As we try to get to the IDEs of April, I think, first and foremost, the FED

is going to be focused on inflation. Inflation is the driver of the fed's new more hawkish position, and it's inflation that's driving this forward pathway for rate hikes. The FED telling us now that the consensus is for six additional increases potentially coming in fifty basis point increases. That new position, that more aggressive pathway is driven by inflation.

So as prices continue to rise, be that lingering pressures from the supply chain disruptions or new upward pressures from the Russia Ukraine conflict, that is what is going to determine the pathway forward for the federal funds race and goods and services. What is the distinction in moving from seven to a survey to eight point three percent? Is that a goods umph or a service umph? Oh? I think it's both. I think we're seeing price pressures in both. I think the FED is washing the fact that prices

are no longer transitory. They're now broad brain, excuse me, broad based across nearly every sector of the economy, and that is sparking fears that we're moving closer and closer to a wage price spiral where prices rise, pushing wages higher,

pushing prices higher, etcetera, etcetera. And so the FED is very much focused on capping inflation, starting to imply that second derivative decline, meaning a still positive pace of price pressures, but a slower pace, and then eventually moving on to an outright decline in price growth towards that two percent two percent target for the FED. Lindsay, do you think that people are overestimating or underestimating the strength of the consumer right now? Oh, I think people are overestimating the

strength of the consumer. We hear about the consumer being strong, we hear about the economy being strong, and the potential for the FED to undermine this strength in the economy. The economy is not overheating. The economy is not strong. The economy is just moderate at best, and arguably poised to already slow as we're still struggling to grow organic legs in the aftermath of the worst of the COVID pandemic.

Consumers are still very much relying on an accumulated savings as a result of very generous federal programs as a result of a shift in spending patterns from pre pandemic to post pandemic. As we saw an additional and check in many people's mailboxes for that enhanced child tax credits. There were a number of different factors that really build up that wealth cushion, and that continues to support consumers

for now, but it will not support consumers indefinitely. Well, and that was really where I was going to go the time frame here, How long is it going to take before that weakness that you're talking about starts to present itself in earnings in other economic data. Oh, I think we're already seeing the weakness. Even if you look at fourth quarter GDP, which was up near seven percent.

When you strip out inventories and we look at real final sales, you're talking about one point five percent and Q one GDP shaping up to be a significant disappointment, well below two percent. So we're already seeing that weakness now. When I think the bigger question is when do we see that translate into negative GDP? And do think we'll continue to float around positive territory for the next six to nine months, but getting that first outright negative print

by the first quarder of next year. You're looking for a negative print on real g d P by the first quarter of two thousand three. That's correct. I do think at that point the FED will have raised rates enough to choke off domestic growth. Now will we see a technical recession? That's a question for whether or not the FED can identify the weakness and then pull back after a series of bread increases. If they continue to move forward, I do think we go into technical recession.

If they have the wherewithal to pull back, we may be able to navigate not necessarily a soft landing, but a very brief dip into negative territory. And there you are two days in a row. Folks is Lindsay Pegs of pulls forward or Deutsche Bank and Matt Lozettie we're talking about yesterday from late two thousand twenty three. If the Fed bollox is it up, maybe we see a Q one of two thousand dr pigs. And thank you so much for joining yours. 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.