Surveillance: Fed Tightening with Jones

year approaching four, Kathy, these big buys. Either one of them for you. Well, we like extending duration here. I think it's unsustainable to have the Fed hiking rates at a very rapid rate, doing qt with, you know, the economy slowing. We've had six months of declining ALII, which the housing market decline. Uh. These are unsustainable trends. At some stage of the game the FAD will have to shift and or, you know, we're just going to go into a deeper recession than we may already be in.

And so we do like expanding duration. Albeit yeah, rates could continue to move up, but I think all we're getting is a deeper and deeper in version of the ill curve here. And, Kathy, this cold and extended duration ultimately has to be a call on economy rolling over. Do you have an idea of the pain threshold the Fed is willing to go through? Well, I did mention pain for households and businesses last time and I think there's a willingness to let it continue and and worsen,

particularly Um. I think the Fed wants to see unemployment rise. They won't say that out loud, but I think they want to see Um Labor conditions not as tight as the way that they'll put it, and they want to see wages slow down. Right now, average hour learning is running at five point two percent a year over year. It's leveled off, it's stabilized, but we haven't seen it decline and I think their comfort zone is closer to three percent in terms of wage gains than five percent.

So that is probably what you know. They're willing to tolerate. Um. The question is whether you know whether risk assets can tolerate that sort of pain. Cathy, do care about the DUB plot? Well, we have to write because I put it out there, UM, but it's a moving target. I just look at it as a moment in time. Guesses. I'm not going to take it too seriously. I think it's a messaging tool. Um, simply the FAD will show that they want of hype grades and keep them there

for a long time. But it's a moving target. Kathy, I asked this because there's a question about the credibility of this Fedu reserve, the credibility that they're actually coming up with a thesis that they can follow through on, versus just following the market and doing what the market is dictated day. How much has that shifted your view of how to operate and how much volatility is going to be injected in these markets at a time when the feed is not leading anymore, it is apparently following

much more with the markets already doing. Yeah, I think the fat is in a position now actually following the inflation data, and we know the inflations are lagging indicator. We know that monetary policy works with the leg and so they've shifted instead of saying, Hey, we're on top of this, you know, we're we're taking action, we've got

qt on top of a rapid tightening cycle. Um, they shifted instead of saying, okay, we know that what we're doing will make progress in the future, to reacting to numbers that are coming out today, and that's why the risk is for a deeper and deeper slowdown in the economy, and this is compounded globally. You know, we're seeing this all over the world and that that makes it even more of a problem for people who are trying to look forward and look at what the is saying versus

what the fet is doing. How much conviction do you have, Kathy? You are saying it is a good time to go into duration, and how much conviction do you have that? We've seen the highs were at some of the higher levels for longer term treasuries at a time when you're questioning whether or not we're actually already in a recession, let alone headed for one? You know, we feel pretty confident in moving out the curb. We're not all in buying, you know, thirty year bonds or ten year bonds here,

but we do think that it's unsustainable. We're starting to see credit spreads widen't a bit, the straints in the economy, the strains in the marketplace. Liquidity isn't what it used to be, and so you feel pretty confident that this is the time to start taking advantage of yields where you can lock in, you know, an investment grade portfolio right now. You can lock at fortified percent yields without

taking a tremendous amount of duration risk. We think that that's a good alternative compared to some of the other asset classes out there. Kathy, thank you. They're putting in Kathy John's a child swap on the bond market. Christopher Ryan, partner had a technical mat try strategistic to take us some bad company. Great Co Chris. I mean, we're so close three. I think we came even closer than that. When next, I guess? And just the B L J blank. Well,

I think they have to. I mean when you look at yields around the world, US tends, as we mentioned, our three fifty three. This morning German tens are basically two percent. We've seen UK tens absolutely run away and we sit here and Japanese tenure yields are Bass points. I'm just not sure how much longer the B O j can sustain this cap on yield without losing total

control of the end. So we like dollar yen higher until, frankly, someone breaks, and I think that's the B O j. So whether that's one fifty or one fifty five or some other level, Um, I think we're on a collision course here that ends with B o j capitulating, raising the cap on yields to get more in step with

what we're seeing a around the world. And Chris, if you've thought much about how the dominoes fall from that, if that headline drop that they stepped away from your control, what it makes for Buns, what it makes to try to race? I mean I think the initial reaction is maybe you then you get your blow off in yield. But our experience just has been, I think the historical experience has been, bond yields tend to go up until something breaks, and that's why I just don't think that

we're done here yet on yields. Our view on yields has simply been they're going to remain stickier and higher than the consensus believes until there's an accident, and I'm not convinced we've quite seen that accident yet. And the accident comes with longer term yields rising in addition to short term yields. Possibly what you're talking about with the yield curve control being abandoned in the bank Japan and the ripple effects through the rest of the world. What

kind of downside are you looking at? How do you sort of hedge against that scenario at a time when it could take a lot longer than people could afford to keep that position on? Well, I think it just speaks to our overall positioning here, which is placed ball, go slow, be prudent. Caution is still the word of the day and you know, where you really see, at least the impact of yields is on what the leadership framework of this market looks like. You have yields up

and utilities continue to dominate. So I look at that as a very lead cycle message. You know, when you look at the top of the market, the big stocks, the big weights, the one everyone owns right, a lot of those are already below where they were in June, whether it's Google or whether it's Microsoft. So you know, you see the impact of yields continuing to hit Tech Um and I think that's going to remain the story

until yields peak, which I just don't think's here. So when you look out to what's going to happen in the next couple of months. What I'm wrapping my head around is what's the downside here, right? I mean an accident? How does that ripple through a market when people are saying there isn't the same kind of leverage, you're not seeing the fragility in banks. You have a much more stable base of consumers and their savings and corporate savings. So that's the reason why you have this bid, you

have this range. What's going to break that? Will anything or is that so going to be the reality? You know, I think that's unclear. The narrative or the consensus is that there's no ice to banks or that consumers are in better shape than we've seen. But I'm gonna let the market be the judge of that. When I look kind of a different pockets around the world, I could show you plenty of weak consumer stocks that would suggest, Um that the market might have a very different opinion

of that. Are Plenty of weak bank stocks that would suggest the market has a different opinion to that. So we let the market kind of dictate that. What I think is most important for investors is, you know, the debate on the street is okay, SMP gonna, you know,

revisit or retest or undercut the Jew lows. And the only thing I would add to that conversation is a lot of important stocks already have right when we talk about the top of the market, Microsoft has, Google has Um Meta is back to where it was at the covid loans right. So kind of go down the line and a lot of big names, a lot of big weights have already, I think, started to reflect that risk. Chris lost decades on, unheard of. You can have much

thought to that. That's so recently. When it comes to the UITY market, it's it's funny that that you mentioned that, Jonathan. Earlier in the year we wrote something to the effect of, you know, the most provocative thing we could say is not that the SMP is going to go a ton lower, because I think everyone was pretty bearish, but that the SMP is not going to make much progress for a long period of time. And that's a view that that that that we've kind of embraced here as you kind

of make this transition from que e to qt. I think at a minimum, when you look at the very liquidity sensitive assets out there, new I P O, s, bitcoin, high multiple software stocks. I think those things are done as your leadership. For a very, very long time that's been our view that remains our view. So I think when you look at those, uh, you know, very speculative corners of the market, they are saying, even if the SMP loads are in here, there is no new liquidity

cycle in front of us. The reason I bring this up, and I imagine it's the reason you're thinking about it too, is that we've just blown up a decade of Quei forever and serve and I just struggle, Chris, and we're living this in real time. I just struggle to understand why twelve months of race and interest rates in turn a bit of cute and then we go back to

where we were before. These are big moves. It's not just the Fed, it seems to be pretty much everyone, with the exception of, say, the B O J. I mean, why would it take just twelve months to reverse ten years of that? And then the consequences are, oh yeah, we just got back to the old playbook in about

six nages. I'm with you, I think, to kind of maybe use a little bit of a cliche this, this does look and feel like regime change, and I think that the one chart of the one exhument that speaks to that, it's on the Bloomberg terminal, is that dollar value of negative yielding debt. You know, we went from eighteen trillion dollars of negative building debt as recently as a year ago. It's down to about one trillion dollars today. So if you're looking for regime change, I think there's

no better exhibit of it than that. Is this a resume change when it comes to nominal yield or is this a regime change when it comes to real yields? Are we going to see real yields continue to climb as people price in a very different response from central banks? Well, it's both. And I think the thing about real yields right it's it's it's Um it's somewhat fashionable to say that that that really yields are positive or that, you know, really yield are above one percent, but not not really.

I mean the Fed funds rate is still well below the rate of inflation. So in kind of in any practical sense for savers, really ills are not positive here yet. So I think ultimately, as we've seen in every single cycle going back the last fifty years, the Fed funds rate will overcome the rate of inflation. That's when the Fed has done enough, and I think there's certainly time before we get there. Lisa, are people position for what

you're expecting, Chris, this sort of accident or something breaking? No, I think you know. When you look at what positioning looks like, there is a decade of residual positioning at the top of the market, the big weights that have been so reliable for so long and kind of our viuew is again. Whether it's market up or market down, that's actually less important. What's more important here is this

massive leadership change that we've seen. I'm very reminded of in two thousand two, when the NASDACK bottomed in October. Bow Two right in bottomed with everything in October vow two. It continued to underperform for the next four years. So your price low in NASDAC, I don't think, will be your price low in relative performance. That is the big takeaway from us. The leadership picture has changed dramatically here. Interesting. Hi, Chris, great cold on the end, buddy, and I'm sorry for,

like you, I'll never laugh again. I Will Christopherry let's just take it. Let's get straight to relation of a in the head of equities and Capital Market Advisory at Ben why? Madam Mouth Management, Alicia, how big is the risk that we're heading back towards something like thirty? Look, I think it's it's a, you know, fifty percent odds

on that. We go there simply because, all you're the the equity market has really been following the bond market here and as tenure yields move higher and push through three point point five percent, that's our trigger for another move lower from here. So in thirty nine hundred couldn't hold, which was sort of that last vestige of support where there was a lot of supply and a lot of

trading previously. Technically, when that didn't hold, you know, it was just kind of clear that as you move on yields up, the equity markets are going lower, and and really for good reason, because the top of the market, or high growth and tech stocks, where the valuations will come down as yields move higher. So it's a neat little equation. Unfortunately it's playing out uh, and that opens up downside from here. But as you say that that three sixty six, the June seventeenth below is not that

far away from here. It's not. It's not a heroic call to say that. Anymore, are we pricing in the weakness that we're hearing from the likes of Ford, from the likes of fed x that already are starting to sound some profit warnings? So so, in an interesting way, your conversation about. How does this conversation change right? How

do we move higher from here? It is our view that the way the equity market can climb out of this hole, but it's kind of got it and gotten itself in, is for estimates to finally come down and and for realistically to price in the slowdown and growth, because it's all been driven by yields. Even now, even now, estimates are holding in there. You know, the forward twelve month on the SMP is something like seventeen times and if you take energy out of it it's nineteen times.

That is not a cheap market and it's not a market reflecting a slowdown and growth. That has to happen and I think if you realistically reset growth expectations and earnings then you can begin to bottom. But until that happens wholesale, then I think we're sort of stuck in

this purgatory for a while. So this is the part of the conversation where equity strategists wear their bond hats, because it's all about rates and this is what we've been seeing for a long time, and so you have to come up with a call whether we're getting to peak hawkishness, whether people already pricing in more than the Fed could potentially do. Do you have a call on that? Is that something that you want to game out, or is there some kind of relative trade that seems a

little bit more insulated from those macro guessing games? UH, great question. I think that the risk is actually two more hawkishness here, simply because, if you think about uh, that that CPI print was pretty devastating for the Fed dot plots, I think, and for the terminal rate on the Fed funds Um so that likely goes higher. If that goes higher, multiples get compressed further. But that hasn't

happened yet. So I think there is some thought that we're getting to pe caucushness, but that's not going to move the market now. It's the earnings that are going to move the market and a realistic reset of where we're going in this. So yes, there are relative valuations. Look, in the end, this is a short duration market. It has been a short duration market, same in equities and not just in bonds. So we still like that. Utilities are fine, some staples are fine, safety is fine. We

love real assets. We we are, you know, allocating our clients to real assets because we do think we are in a regime change where inflation remains higher for longer and rates remain higher for longer as a result. And all you have to do is listen to some of the workers strikes that are going on out there, what happened with the rail strike. I mean, these are huge wage increases. This will is a change for the economy and the rates we're going are going to reflect reflect

that going forward. I don't think we're going back to a world where you have, you know, one percent yields on the ten year and let's have a party of by, you know, high growth and they're earning tech stocks. So we're still in that short duration world. And to your question, our bonds an alternative, not on the long end, but on the short end. They certainly are doing better. And whether a four percent yield on a two year is

fully reflecting inflation on a real basis. It is not, but it's sure of a lot better than losing money in the equity market and sh just quickly. What's your time and rising for all of this. It's so well put together. When you start thinking about these issues sticking with us for longer. How much long are we talking? Years? We talked five, ten, what is it? So look, I was trained as a historian and I look at things in big picture ways. In the short term, I think

we get a nice bump coming out of the election. Okay, mid year. Elections are notoriously difficult leading up to it and you never lose money in the twelve month after the election since so we likely have a rally coming out of the election and it could be sustainable because we'll get to that peak nastiness heading into it. Right we have terrible seasonality. Now better seasonality, but at the end of the year. So we're optimistic for how this

year can stabilize and move higher. Looking forward, I think you have to have a more intellectual view of where yields can be and where the market is and where we can grow, and one of my favorite things to do is just look at you know, the top ten stocks of the SMP or the top ten stocks of the Dow the beginning of every decade to see the change of where capital is being allocated and what the growth companies are. And I think you can make a good case that some of these large pap tech is

where the risk is here. Let's just avoid the down, you know, just stick to the SPENCOURAGE, encourage. Honestly, you know, one of the best relation events we management. It's the housing market very much in the forefront as we watch yields rise because mortgage rates have been climbing so significantly. And there's no one better to speak to this to Jonathan Miller, who has decades studying the industry, President CEO

of Miller Samuel. He always puts out these fantastic reports that gives these real deep dives into what's actually happening on the ground. And we're talking about the pain. We're talking about home builder sentiment rolling over yesterday. We're talking about what it means to have a mortgage rate at six percent and you are still seeing bidding wars. Are we underestimating the demand, the strength in this housing market?

Absolutely before the Fed was raising rates, bidding wars in most of the markets we cover across the country where somewhere in the neighborhood of of all transactions, southern California was two thirds of transactions. Uh, there's still bidding wars now. So it's just much more muted. Uh. I think the the narrative is that, you know, you can hear crickets and that is not the case. It's just not what it was and what it wasn't sustainable. But how much

are we speaking about idiosyncratic markets right? I mean the market in Connecticut, for example, very different than the market in Phoenix, Arizona, or the market in San Francisco? How much are we seeing potholes where you are seeing wholesale declines and prices in some areas, particularly the sun belt darlings, whereas other areas are holding in more significantly? I think the the chatter on pricing is more about sellers cutting

asking prices more than wholesale price declines throughout a region. Uh, you know, in aggregate in these regions, uh, because inventory is so low, even with the increases that we've seen, there's a fairly firm underpinning under price. It's certainly you know, I'm not saying we're not looking at some sort of price decline a couple quarters out or, you know, sometime

in but I don't. I don't see this as a correction scenario because the market was wildly overweighted on the demand side going into this and inventory was literally obliterated. You know, a typical market, sub market, might have two hundred listings just before the Fed rate increases. In beginning a year there might have been ten listings, twelve listings. Now there's fifty. It's still sevent below. I mean that's sort of the scenario we're seeing Um in the different

markets that we cover. But just to push back, we're seeing the just the volume of sales drop off a cliff and a lot of times that's a precursor to price drops that are more substantial. Right, it really is a matter of where people are willing to transact, especially if they're all in borrowing costs arising by hundreds of dollars a month. I mean, at what point does that

housing the sales slowdown translate into something materially in price? Yeah, so typically there's an average of about a fifteen month lag between Um sales, sales correction and some kind of price decline. I think what many people get wrong in a market pivot like this is the scenario is external event. Sales activity falls than inventory rises and then, because there's

more supplied, prices correct. But how thing prices are sticky on the downside, that they take longer to fall than they do to rise, and we're in that sort of discovery period right now. But what's different is that supply in general is still relatively low as compared to historical norms. Jonathan, you're talking about how just because rent increases are slowing down doesn't mean they're you're going to see a decline in rents, and you've talked before how rents typically are

pretty sticky, that they don't go down that much. Does that mean that the transmission mechanism of mortgage rates where they are are, is going to be largely ineffective at bringing down some of the base costs like rents, like housing prices, that people are imagining as the case right I I think you know, housing is about CPI and

its owner's equivalent rent. It's not, you know, any kind of correction in housing prices is gonna bear a little impact on our limited impact on inflation, because its owner's equivalent rent. Um. And effectively what's been happening is if you have a slow down in the sales market, Um uh, and largely because of the loss of affordability, with a

spike and mortgage rates. Mortgage rates are literally double what they were at the end of December, and the scenario ends up, Um uh, you're pushing those people into the rental market, which is already tight, which keeps rent elevated, which makes me worry that the that the Fed path is going to be longer than we think in terms of pressing rates higher. How high could mortgage rates go in your view? Uh, who knows? I'M NOT UM. It's funny. About a year ago I was basically saying that rates

should be in the in the fives. That would be a more normalized market. Maybe the sixes. Um, I'm skeptical that they can. They can leave the sixes, but but I still think there's some upward movement going forward. Um.

There's no barring a recession. I mean, you know the idea that, um, the Fed is taking a baseball back to the economy is, Um something that has to factor in housing, since it's so large, and I'm not sure if that's going to be effective just because of the owner's equivalent rent calcula driving rent are keeping rent high. The opposite of rising rent is not falling rent, it's stabilizing rent, in my view, and the only thing that's going to bring rents down is going to be some

sort of profession, at least at this point. Jonathan, twenty seconds. Have we overdone the back to cities trend or is that going to continue? I think it's stays where it is. Pretty it's pretty close to that. Uh, this is this is not returning to the mean sort of scenario. We've been working from home too long for this pattern to go away. Jonathan Miller of Miller Samuel. Thank you so much for being with us. I always love speaking with you.

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 in this is Bloomberg,