Surveillance: Fed Tightening with Luzzetti

side and then do acute published research. John Farrell, no exception here in the last couple of weeks is Mr Hooper and Mr Lozettie have looked at the movement that we will see and particularly the rate and rates of change that we will see. John arery happy to say that Matt joins us NATSA on Matt Loozettie at Deutsche Bank.

Mantless start that the workout going into the weekend with Peter Hooper, the race that the Fed needs to do more, this argument that we still experience longer variable lengths with policy. They already behind the curve and how much more do they need to do? Sure? First, thanks so much for having me. Certainly we did argue that that is behind the curve now, and I think that's mostly a byproduct of the rapid improvement we've seen, most importantly on the

labor market front. I think it's important to remember that as of June of last year, we were at five point nine percent unemployment, So the unemployment rate has formed by two percentage points basically over the past six months, but then very much so on on inflation and in

terms of the wage data that we've seen. So I think given the very rapid developments, the very rapid improvements that we've seen both on the labor market front and high inflation, uh, the idea that the Fed should be at their current policy setting, which is zero interest rate still adding to the balance sheet at this point, with an economy that has satisfied their dual mandate goals and very strong growth, there's there's definitely a disconnect between those

two things at the moment. You've put some numbers on the balance sheet reduction five hundred and sixty billion this year, a strong tilt towards bills once TRILLI and more in three. You also equite balance sheet reduction to interest right hikes. The total draw down of the balance sheet through the end of twenty three amounts the somewhere between two and a half and three and a half twenty five basis

point increases. Matt, Can you help us understand whether that balance sheet reduction complements the right hikes you were already calling for or replaces them. Sure? So, I think the interesting thing from our own forecast is we we've brought rate hikes forward at the same time that we were building in a faster drawn under the balance sheet. So at this point, our our baseline is that they had

grades four times this year March. You know, given all the FED communications, given the data, seems very very likely in terms of liftoff at this point. Uh and we've we've had four hikes in addition to that balance sheet wind down that we've seen. I think there's been different

views within the committee on this. We've heard from people such as Mary Daily, Governor Waller, Jim Bullard, all those officials who actually want to I think actively substitute doing more on the balance sheet and doing less on the on the front end. We haven't heard as much from FED leadership share pal John Williams on this uh Leo brainer.

But but I anticipate that the rest of the can Make Committee will want to set the balance sheet, allow that financial condition tightening to happen as a result of that, and do what they need to on the front end, so not really actively substitute between the two, but at least realize that both of them will be tightening financial conditions. Matt, why do you disagree with Peter Sheer who says this

could just be the FED job owning. So I think, you know, perhaps there is some part to that, but but I think the the economic reality is we have very easy financial conditions. UH. The unemployment rate is below the Fed's view of nay room, inflation is well above target and they expected to remain well above target UH,

and wage growth inflation expectations. The broadening of inflation pressures suggest that the risk starts the upside on inflation, and so in that environment, UM, I think it'd be surprising simply for a central bank to to jaw bone their

way towards tightening monetary policy. I think that actual tightening needs to take place both via the front end via policy rates UH and also via the balance sheets, and I expect the FED will deliver on that this year and one reason why your research has been so original, Matt is you try to game out the effect of quantitative tightening on markets, which has been a moving target and frankly has a lot of people questioning what the

ramifications will be. How difficult was it when you came up with this call of two and a half to three and a half rate hikes by the end of that would be the equivalent of what quantitative tightening would exact onto the markets. Sure, I think it's very clearly an uncertain one and it's one that the FED still

grapples with. We here in the minutes, I'm still discussioning discussing the effects both of QUEI and qt UM, and so I would highlight first, I think that there are lots of uncertainty around this, but we do have a lot of research. We have the FED owned staff, research

from the Board and some of the regional feds. We've done a lot of our own work, UH, And it kind of interestingly and and thankfully I think, clusters around a certain range of estimates which suggests that call it six fifty billion, give or take UH of qt we tend to equate to one rate increase, and so the draw down that we expect at the end of next year, we think is material in terms of the tending that has two and a half to three and a half

rate hikes. As you mentioned, Matt focused Landau and Peter Hooper have beaten into you a respect for history. Let's go back to Paul Vocer seventy nine, where fifty basis points wasn't under debate. It was a major emergency, including an emergency October move, and they moved rates in four or five months from ten and a half percent out

to fifteen and a half percent to break inflation. Now that's not happening right now, But what is the price to the Greenspan credibility that's been earned over decades if we jump fifty beeps? Now what do we lose? Sure?

And if you go back to that episode, and then then even later, we had a change in the monetary regime looking at money supply rather than then focusing on interest rates, and so there was a sense in which you needed to shock the system at that point to get it inflation expectations back down into break the inflation psychology here, Uh, you know, we do think that fifty basis points move is possible at some point. At this point, it does not seem the most likely case for March

from my perspective, at least for two reasons. One from FED officials. We were hearing from them, even the more hawkish members like like Waller not supporting Governor Waller not supporting a fifty basis point hike at this point. But also if you hear you know, certainly Chair Pal talk about tending policy at this point, that is testimony last week.

He basically said we want to move from extremely accommodated to somewhatless accommodative UH and officials are saying they want to do it in a way that really does not disrupt the labor market. And so I don't think you've seen a shift in communications or a shift in thinking or public thinking from the Fed which suggests that they need to really actively tighten the monetary policy to reign and demand. I think possibly that that may change at

some point, and that would change. I think if we get clearer evidence that inflation is not coming back down this year, clear evidence that the labor market continues to tighten UH and perhaps you know, I think inflation expectations they will continue to rise, could be a big part of that. I was going back and forth with Dr Lary and at the University of Cambridge this morning. Matt and we were talking about the extrapolation of all these markets w I r P function and all that. Nobody

in history cares about that. It didn't happen really until the Bloomberg game began, the parlor game began. So this is a FED that's going to get on a path. Why can't they say we're gonna raise fifty beeps and then we're going to sit on it. That's what they used to do. Why can't they do that again? Sure, so I think the idea of raising fifty basis points

and then sitting on it is a difficult one. I think one to communicate the market reaction to going fifty basis points and going fifty basis points in March, I think we'll simply pull forward the entire tightening cycle and may actually reduce the flexibility and scope of what they could do moving forward. And so I think from that perspective, you know, a forward looking market will not take the FED um as saying we're gonna pause from here and

wait and see how how things happen. We will see I think more significant tightening As a result of that, I think to your point, though, we are in a world where forward guidance is curtailed and I think it's

limited in its effectiveness. UM. And you know, looking back the past two tightening cycles, we had one where we had both where uh, the end point was pretty well known, the pace of rate hikes was well known, the starting point was very well known, and that damp and volatility markets were able to I think very clearly anticipated predict where the Fed was going. I think the most important point from my perspective about this cycle, uh, is that that it's gonna be far less predictable. You know, we

are talking about fifty basis point rate hikes. We are thinking of real scope for the FED moving at every meeting, they're drawing down the balance sheet more aggressively. So this is something that we haven't seen in markets, you know, for several decades in terms of the pace and the extent of tightening of our relatively short period. That final point,

that is the importent one. Mattlazetie a Deutsche Bank. Matt, great work over the last few weeks, right work walwise, but particularly the last week the research has been outstanding. Matt Lazetie a Deutsche Bank. Andrew Sheets is at a Brown University, staggered into Morgan Stanley one day and everybody leaned forward. He's the kind of guy who writes a fourteen page research report and has fourteen people writing with it.

He coalesces in all of the Morgan Stanley view worldwide, from Mike Wilson over to economics and Ellen Zettner, Mingui and the rest of them. John, what's great here is his mathiness gives you a really interesting opinion. Andrew shakes his with us right now. Andrew, great to catch up with you, said, why is this the where the index stars to struggle? Yeah, great, it's great to be with you.

I think you have a couple of factors that are coming together that that we think will drive us index underperformance. And and a lot of that goes back to the point that Lisa made about real yields, that that real yields did not rise last year. That was a surprise given how strong the recovery was the rise of inflation. We think the really yields start to rise is this year, and that really yield rises both more pronounced in the US and the US market is more sensitive to it.

So we do think US earnings will be relatively strong. We think the U S economy this year will be relatively solid, but the valuations need to come down like they've come down in a lot of other markets, and we think that leads the US down to perform. Andrew, this is an important distinction. Is the underperformance driven by FED policy or is it driven by margin compression from

the inflation that we're seeing from wages and other input costs. Yeah. Thanks, We think it's more by FED policy, or more specifically by the market pricing in a more realistic real interest rate and more realistic discount rate over time. On the margin front, it will definitely impact a lot of individual companies that it will definitely drive idiosyncratic risk for companies that do not have pricing power. But for overall earnings this year, you know, our estimates are are kind of

near consensus, a little bit above consensus. So from that basis, it's hard for us to argue that that margin disappointment at an overall index level is the big problem. Instead, it's it's more the valuation in the discount rate and the Jenna Martin Adams at Bloomberg Intelligence Equities just publishes on this and she says margin scrutiny in the United States is front and center. Your lead sentence is you're away from American stocks and you're towards Europe. I believe

in japan stocks as well. Won't they have the same margin scrutiny, the same margin pressure. Well, so it's it's fair that I think some of the issues are our universal rising commodity prices, tighter labor markets. But I think two factors are at work. First, in aggregate, we are you know, less worried about that margin compression overall, that we still have a very strong nominal GDP growth globally next year. We think nominal GDP in in both the

US and Europe is six seven percent. That's a that's a pretty strong revenue backdrop that should be somewhat supportive of margins. And then also I think especially for your up you know, my Colligram Sector, who who's our European equity strategists, notes that consensus expectations they're just look very low. That that the market is not expecting much out of European companies, which is under understandable. European earnings have disappointed

for a long period of time. But we think that bar is so low that it's just gonna be very easy to clear, even if our growth expectations are a little short of what we think. And I could take that comment, those few comments and just look back maybe five ten years, and they just sound like the same comments I've heard over the last decade when it comes to Europe, Andrew, you know that what's new about this? Sure? So you're absolutely right. You know Europe is underperformed for

a long period of time. I think it's supported for us to step back and think about why it has underperformed. It's it's not that the US is outperformed because the FED has been active. I mean the c B has been buying bonds, that the Bank of Japan has been active in the market. The reason the US market has outperformed has been because it's had superior earnings growth, or at least that's been a big part of the story.

I think something that we think is is different this time in Europe as we think the earnings can actually come through that. We think we have a much stronger commodity environment, which helps Europe. We think we have a stronger economic recovery in Europe with a very strong consumer I think you have a better political backdrop in Europe than you've had at many points over the last five years.

And you have a much better relative valuation argument of Europe relative to other regions, especially in the US, than you've had over a lot of the last decades. So kind of putting all those factors together, that's why we think it can ultimately do it what it hasn't really

done much over the last twenty years and outperform. If there is a devish surprise from the Federal Reserve, if they see the move in real rates, if they see the repricing and they say, wait a second, we're perhaps getting a little ahead of ourselves, and they push back next week, and they push back in the months to come, is that a risks case to your scenario? Do you see that reversing this trade and actually making US equities

more attractive? Yeah? Thanks, I think that's fair. I think if if the Fed does blink as uh maybe maybe as you describe, I think that would make investors, you know, more constructive towards towards US assets. UM, it would probably weaken the dollar, and we have moved to a neutral dollar stands. But look, I mean the part about that that's interesting is can the FED do that credibly right?

Because we still we're still in a window where inflation hasn't come down yet, where inflation is still quite high. And so you know, if if the FED is more debbish, but the market thinks that it's too soon for the FED to make that pivot, and that causes longer and yields to rise. The market thinks that that the FED is just going to have to catch up and do more later. That might not necessarily be be good either.

So you know, I do think that the FED is probably a tougher policy predicament than the E s c B or the Bank of Japan, and that's one of the reasons why we think equities and those markets can ultimately outperformance. You interesting, that's the kill andrew S. Thank you said of more. Can Stanley enjoyed the rate over the last few weeks coming from the TAB and all of that reset. Yeah, right now, Leslie Falconio has to

deal with this. Senior fixed income strategists for the Americas at UBS, We're thrilled you could join us this morning, Leslie. We go from Morgan Stanley and as Lisa mentioned the resurrection and maybe it Shinnali mentioned the resurrection and fixed income as well. Right now, I think it's priced down

yield up. That's my analysis. Where are you on duration? Well, I mean we've embarished for quite some time, and I think what we're seeing right now in terms of indistrates, we thought we would see in the fourth quarter of twenty one. And I think the key is that this

is being driven by a rising real rates. I mean, the setender yield was at one seventy back on November and I think it's important to remember that also, you know, we we do think interest rates are going to rise, but you know now that we get towards that two percent, and given the bearish indicators at the market has already priced in whether it's qt the FED tapering, you know,

and you know, new risk into the marketplace. As we enter a new year, you've gotta pause for a bit, and we don't think over the longer term, it's necessarily a bad thing to start aft costing here. So this is the concern that some people have, including Peter Sheer, that perhaps the FED is just job owning, trying to get people to move and then they won't actually have to make the moves that would then potentially break the market. So they get to a certain point. According to Jim Bianco,

where do you stand on this point? I mean, do you think the Fed cannot come through with the rate hicks currently priced into the market. Well, the market is pricing in, you know, about four rate hikes and we're probably about three to four as well. We also think that they're going to start q T as sort of a process to continuously tighten financial conditions. I mean, but we definitely leaned towards the longer type of you know, uh,

financial conditions tightening. We think the trauma rate goes higher. We don't think it's gonna be a fast and done. You know, the market going forward is only pricing in you know, a few rate hikes in three. We think it extends out more. And you know, we do think that they're probably four rate hikes this year, but you know, going forward, I think it's gonna be a little bit long, get them more people participating. Do you think that the

market is underprising the impact of QT? You know, I think I think that the risk of QT is it goes quicker and faster, right, or more or more faster, hiring faster, But what do you think about what the primary markets were actually showing in terms of what they expected for QT Most of them really didn't even thin would happen until three. So I think the market is actually reacting quite well given that they pushed it for you know, known to know exactly where that sort of

normalization will be in balalty to reserves. But I do think the market is fairly prepared for it. Leslie, thank you as a white Lets con a UBS Global Weath Management. David Rubinstein Peer to peer conversation tonight at nine pm and Mr Rubinstein joins us right now. Darren Walker really interesting character here in a changing philanthropy, David, What did

you learn from him? On the new philanthropy? While Darren Walker, as somebody who has the head of the Ford Foundation, has has as much impact on the philanthropic world as people who are worth billions of dollars giving away their own money, because he's really transformed a lot of philanthropy and what he's done at the Ford Foundation and also

by influencing a lot of other wealth well known philanthropists. David, what's important here as you do these peer to peer conversations, and they never dovetail as nicely with the news as they do today. Darren Walker was at UBS, That's where he did some of his banking and maybe raised his first actual tangible wealth. And we see ubs today move x on out of their climate funds. The Ford Foundation and others many that you are directly related to are

having the same discussions as well. What did you learn from Darren Walker about how to manage E s G in the new philanthropy? Well, for those who don't know Darren Walker, what he did is when he became the head of the Ford Foundation, he said, I'm going to basically focus the Ford Foundation on one principal thing, inequality in our society. And so he got rid of a lot of the other things that the Ford Foundation did, but he also influenced other things like E s G

and other areas of inequality. So he's a transformative figure. Came from poverty, raised by single mother in Texas, went to public schools, came to New York to be a lawyer and then a banker, but ultimately he society life was more important if he would spend time giving back

to society. Rose up as you mentioned, to be at the Rockefeller Foundation now the Ford Foundation, and he really is a charismatic figure who I think influences almost everybody he comes in touch with because he's so passionate about the things he believes in. So I wouldn't be surprised if somebody would say that he had an impact on the UBS decision, because he has an impact on so

many things in the philanthropic world. David, I see a connective link between Darren Walker and your Priority week's guest Melody Hobson, basically in that career trajectory in coming from poverty and actually coming to a place of incredible respect, power, and frankly monetary largess. I'm curious whether their perspective on the modern American dream has changed in our new moment, whether it's more difficult for people to come from that type of background and get to the place where they

find themselves today. It's an interesting question. Generally people would say, well, if you have um Darren Walker on your show and you have Melody Hops on your show, this shows how people are rising up from minority backgrounds and poverty. But they would say that actually a situation is probably worse than it's been before, because the level of income and equality has gotten much worse as a result of COVID, and the number of people who are below the poverty

line is actually increasing. So although you can see Melody Hobson, you can see Darren Walker, and they're great examples of people rising up from modest circumstances, the truth is, they would say, and I would say as well, that probably the problem is worse than it's been in many, many years because of growing income in equality United States and the chances of more and more Melody Hobson's and Darren Walkers are probably reduced. That's an unfortunate, uh and unfortunate take,

and one that I do hear a lot. I am wondering, David, detailing this into the corporate picture, and from your position at the Carlisle Group, I'm wondering whether there's a similar type of worsening in the outlook of smaller companies, particularly in the face of some of the inflationary pressures and the supply chain disruptions, the labor shortages. We've heard about how some of the bigger companies have been more flexible in dealing with them, and smaller ones are struggling more

what's been your on the ground experience of that. Well, we've become a tale of two cities, really, or a country of two cities. Because the large companies, the Carlisles of the world, and the Microsofts and so forth, we're all doing reasonably well, and our employees are doing reasonably well.

But companies that have blue collar workers, that have uneducated workers who don't have high school degrees or college degrees, people who have a lot of companies have a lot of people that really are not well paid, well educated. They are really falling behind, and many of those people are being laid off because of COVID and other kinds of concerns that that some of those employers have. So the better known companies in the United States are actually

prospering reasonably well. Clearly nothing's perfect, but they're doing reasonably well. I'm more worried about those people that are working at food trucks, at at at walmarts, at uh drug stores or things like that. Many of these people are laid off relatively quickly. They don't have a lot of to

fall back on. So yes, if you if you watch television and you watch business news, you'll see a lot of wealthy people talking about how good the economy is in some respects and how many billions of dollars certain people are making. But if you talk below that line, I think we have some real challenges in the country. David, I must ask your observation of a new phrase, the new defenses, which are the huge big texts in their massive balance seats, and we saw that at work yesterday

with Microsoft with a sent billion all in transaction. Tell us the power of the cash that these behemoths have. We've never seen anything like this. We've never had come and ease up until recent years, had cash hordes. If I use that phrase um of a hundred billion dollars or more so. Microsoft I think has about a hundred and fifty billion dollars of cash, so they're using for this transaction maybe half of that. But Google UM has enormous amounts of cash as well, so does Facebook. Obviously,

Apple has an enormous amount of cash. We've never seen anything like that's in corporate America before, and I think the companies are increasingly under under pressure to do something with it, either give it back to the shareholders through dividends, which they are often reluctant to do or to make acquisitions. So I think you're gonna see much more of this cash used because I think regulators increasingly are saying and members of Congress, what do you need all that cash for?

If you if you have that much cash, maybe you're charging too much, Maybe you're a little bit uh too strong. Is it a Silicon Valley conceit? Is it a conceit of a generation behind you? Well, there are a lot of people who work in Silicon Valley, and I like a lot of those people who feel that they are masters of the reverse. There was a phrase that we offer no and you have that much cash. If you've got a hundred fifty billion dollars a cash in the bank,

pretty much, I think you can do anything. So I think humility is not the greatest virtue of some people, um in some parts of Silicon Valley. We've got to leave it there. David Rubinstein, Master of the Universe and a member of Carlyle and of course his interviews peer to peer on Bloomberg with Darren Walker. Looked for that tonight. Very interesting. Seven. 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 two.