Surveillance: Fed Wants You To Take Risk, Schutte Says

firmly in the risk on camp. Can you tell me why? Thanks? John, Well Even with three opening being slowing down in key areas such as Texas, you're seeing nationwide that it's continuing and the consumer spending is coming back, that demand has been pent up. So as I persist, we think that the risk seeking and the equity ride could continue. And what do you take away from the still closes that we've seen from the reopening process hitting poles in Plaicus

light Texas. It's certainly concerning, John, you know, especially with Texas being one of the largest GDP contributors to the national GDP. That is uh, it's concerning. But where it really needs to impact is it going to lead to several other states closing down officially re uh re putting in those quarantine measures, and if that happens to us, that's really going to set back the economic recovery that

had been going on since April. And I want to go back to your derivatives work years ago and particularly almost back to your physics and dynamics at Yale University and real simple, what's the bet of the market right now? What's the exposure of the market right now into the summer. You say exposure, You're thinking risk exposure, I'm guessing. So if you think about that, there are people who are positioned for the upside, but it's not this uh you

fork reach for all grab. You still have a lot of people putting on protection and being cautious because, to be frank, you know, March was only three months ago, and it really hurts some investors. On the other hand, you have those that are been piling into the markets. You look at the retail flow. We look at some robin Hood data and you see that people are eager to participate in this rally. So you have two warring forces.

Our view is still that risk one and longer term equities will be higher what's really interesting area and I'm glad you bring it up. And it goes back, folks to what's called a rehedge, where you go out and you have to reset up your belief structure three months out or six months out. Do you anticipate more volatility and equities is institutions and hedge funds have to struggle

to rehedge to reset their bets. We do think that the couple of months ahead will be volatile, and when you look at the dryms market, the term structure on the SMP options, it's looking like we're gonna have some choppes and elevated vix could persist for some time. That being said, what's given us confidence in our equity play is that you see credit spreads remaining rather tight. And even as credit spreads marine tight, that keeps a cap on those equity balls. So it lets us be more

confident telling investors to continue that risk on value play. UH. And yesterday we got the results from the Federal Reserve stressed tests of the US banks. It was actually somewhat surprising, and it came with a possible review further of the capital plans of the big banks later this year. The FED is requiring banks to resubmit those Does that uncertainty

give you any pause about investing in financials? Given the fact that their dividends are capped, they're not going to be buying back any shares through at least the third quarter, and there does seem to be a feeling there could be additional measures taken in the very near future. You have a great point, Linsa, and let me start with the dividends. So they cap dividends and they tie those dividends to the income stream. But I think them being able to pay out mostly the third quarter is something

we expected. You know, we weren't expecting this huge raising dividends, so it's not the worst news for us, and then slashing buy backs and saying no buy back third quarter. I would say the consensus view was mostly no buy backs for the rest of this year, So that was rather expected. What was unprecedented was that they're going to ask for another review a resubmitting of that capital plan in September. But you know, frankly, it's kind of like getting a test graded and getting it back with all

these red marks. If you get a chance to review and resubmit, it could actually help and be something to look forward to in September as another catalyst. Alright, and I just broadening out a little bit. We want to look at the risks heading into November. There was a time when in a political year, an election year, the election would be on the forefront of a lot of people's minds. Right now it seems to be on the

back burner. At what point when we start to see election risk bleed into the market action, I think actually it's already starting to breathe bleed into the market, Lisa. It certainly has been the backburning, like you said, because of the coronavirus and the reopening the economy. But more and more you're seeing this all being tied together. As President Trump is handling the coronavirus situation that affects his popularity in the polls, and as Canada Biden has become

more and more likely to win the presidential seat. It comes into question, what if the Dems take a full sweep. If that happens, the changes in the new economic plan you see from that side, that could come a lot faster than expected. So the domestic political rest to us looks a bit under priced, and we're gonna be watching

that carefully as it develops. It's Tom King. This has been one of these stories that has come on the right down a massive way in the last week the election, just more and more people discussing the potential outcome come November. And I always think that sometimes the market gets like a distracted toddler which can only focus on one thing. And the one thing this market is focused don't come November is the tax cut and whether the tax cut

gets reversed and the Republicans lose the Senate. That seems to be overwhelmingly the single focus of market participants going into November. Well that's maybe the focus of the participants, and maybe that's typical John of elections to worry about the tax ramifications of all Democrat House, Senate, White House as well, or any of the combinations the permutations you can get. But what is so important here, folks about the tax ramifications is all the other distractions as well.

And one of the great overlays here for equity investors will be some form if I'm elected free beer, fiscal stimulus. We may even get two tranches of fiscal stimulus before the election. How does that fiscal stimulus play into the Powell put the ability the FED to prop up equities. I think it helps the power put really and you know, if you've seen how Trim and Power has spoken in the past off M meetings, he's asking for more fiscal aids, saying that we've done this much on the monetary side,

but we need more. So right now where we put it, we think definitely, Uh, it's better than a coin flip to say that we're going to get more stimulus, but in what form looks like it's probably going to take more like a state and local for aid there, but we don't know yet. We're gonna have to see when Congress reconvenes in July, and that's going to help the economic recovery for sure. And thank you great to get you on the program and gotta get you back soon.

Anna hand there of Wells Faco on the secondy market to set up our guest right now, and we're about a perfect guest for you to reframe for the weekend and for the second half of two thousand twenty. There's not much of a data check because there's not much going on. Futures negative too, but I'm going to point out the four decimal points for the two year yield point one, seven, five nine. It will be amazing to see if the two year yield breaks down with the

stability we've seen. Brett shoot, he follows that kind of stuff. He's with Northwestern Mutual and looks at the placement of investment for Northwestern clients nationwide. Brought thrilled to have you with us, and I want to go like c f A one on one, I'd call it as well, let's go to first principles. Why is watching the two year yield important right now? Well, I guess I I bring it back to kind of a lot of the comments on the disconnect supposedly between the market and the economy

and what that means. And I guess to me, as you think about that two year yield, i'd also point out the ten ye yields of point stuff and percent. So the question of why our equities still up, I think is answer a lot by those competing yields, because to me, relative valuation is more important than absolute evaluation. Um Our clients have to put their um our advisa

and to put their clients money somewhere. And when yield to that low, you have a stock market that's more supported, right, and so to me, the yield are gonna stay low for some time, and I think the Federal Reserve absolutely wants to keep them there and they want you to

buy stocks as a result. And that's the difference in my career over the past twenty six years, I've seen a much more active fe are reserved, a federal reserve that cares about where markets are at, a federal reserve that wants you to take risk, and they'll continue to try to get you to take risk and brand your clients. I'm sure one yield enhancing strategy is given where the front end of the Yolk curve is given, whether the

long end of the yeld curve is as well. What do you suggest they should do in an environment of zero rates for the foreseeable future. Yeah, that's the really difficult question, because, um, you know, if you stretch for risk, you can get caught off sides if you have risk on in both sides of your portfolio. And so we do have an overweight to equities. We have tilted it towards that, um, but we're making sure on the opposite side of the equation that we're not taking too much risk.

And I think where people really get caught is where they actually are loaded up on risk on both sides. And so right now, um, you know, given where yields are, we we aren't stretching for yield there, but we are overweighting equities because we do believe the path of least resistance, even with all the virus conversation that we has had, is still higher and so it's always playing off. Let's talk about how you'll overweight in equities if we can.

What is overweight in equities mean? Right now, you're taking the sign of a county on are you adding to to that? In the tips we've seen over the last couple of days, you stay in long the more so co defensive parts of this market, which some people now consider to be solfware stocks. What do you do when you drive a white stocks? What does that look like? So right now we have a foot in both camps, and so when we added back at the end of March early April, we did add more tostick locality, but

we still do have an overweight to large cap. I guess that's more of the timing type of mechanism. I think if you look out the next few years, you will see parts of the market that have underperformed will actually do better as the economy continues to climb or to walk out of this economic value that COVID created. Actually we created this economic valley, but actually broad based social distancing. And now I know there's parts of the economy that are closing, but on the opposite side, there's

other parts that are reopening. And we think a nationwide lockdown is a slim probability, which I think you can bind at with what the fet is doing and not let's not forget that each morning we wake up and we find out that we have better ideas of treatments, um, we we have vaccines that are progressing, And so that would be the ultimate endgame where you would actually see a pretty heavy market rally, I suppose, And I think

that's what keeping stocks afloat. And when you talk about betting on some of the less well loved stocks, like some of the smaller cap or some of the more beaten up sectors, I'm trying to pair that with the idea that the bankruptcy right right now has risen to the highest level since two thousand and nine and expected to continue to increase as even though companies are able to access credit and are propped up by the Federal Reserve, they still are failing given the lack of demand. How

are you avoiding these pitfalls going forward? I mean, if you look historical, I think small caps performed well coming out of every recession, and so I would imagine that if I looked back, I would find that to be the case that there would be bankruptcies rising during the same time period. And so you know, certainly we have active managers. We also do use e t fs, But in general, I guess that's that's kind of details to

the overall I think acid class performance. And I think historically, um, when real rates are negative on the Federal Reserve is trying to keep them there, which they're going to do for some time, and when the economy begins to climb out of the whole um, small caps typically performed fairly well. Uh. And so I don't know if I have a perfect answer for you, um, but I think that's kind of the the detail to the overall ascid allocation and the asset class climbing out of that valley. And let's keep

in mind they've been under your optimism. Excuse me, but your your your optimism very much is reflected by a lot of individuals, and I think you're not alone in feeling that ultimately we will come to the other side. There will be a vaccine, we will get through this and re emerge on the other side in some form in the nazo distant future. What are you baking into that assumption? When do we get the vaccine? Do we get another fiscal rescue package and perhaps a re upping

of the stimmly enhanced unemployment benefits? Sure those things one, I'm not for sure my optimism is shared. So I look at the Bank of America surveys, I look at what hedge funds and pensions fund managers are doing, and I'm not so sure. I see the optimism that everybody's thinks is out there. I look at the American Association of the Individual Investors, I see the Barish survey um and the and then the number of bulls being low.

I think right now, the reason why the market rallies every time there's a dip is because people are waking up and realizing that you may actually get that vaccine which people were skeptical about. If it continues to stretch past the next you know, six months to nine months. I think then my bullish optimism may be wrong. UM, but I'm not for sure, and I guess I bring it back to common sense if we don't go back

to a nationwide lockdown with central banks doing what they're doing. UM. You know, I think the market is at least supported, and I get the benefit of a little bit more of an intermediate term time rise. And then perhaps many of your guests who come on their show get of Northwestern Mutual Chief investment strategies brand fantastic to catch up with you. Thank you Kenley on joining us nap from right. Can don't worry, I'm starting the interview, not Tom. What

have we left from the Federal Reserve yesterday evening? It's unprecedented. UM. I think what was released yesterday was enormous insight about the Federal Reserves, views about the US economy and also the sensitivity to the coronavirus. It also was insights in terms of what the expectations under scenarios of loan losses for the banks and then in terms of return of capital.

But it was absolutely fascinating to see the narrative that the Fed has looking out from today, not only over the rest of this year but one, and there was much more language and scenarios not only to a U shape, not a V shape, but a W scenario where hopefully not we don't from the second prize of COVID ninety. But the FED has been thinking about this and deliberated yesterday. So I think that's important as the economy. Can you

absolutely nail this as you always do. I mean, I was thunderstruck by the language we saw from Randall, course and the rest of the team. Why did they do that? Ken? What's the back story on the why where there was so much ambiguity and mystery out past a September tom It's a great question, And there was two thags. One, they had to have a narrative that linked, you know, over ten years stress tests that didn't look at an economy where unemployment was far greater than their adverse scenario

of ten point three unemployment. Second, we're looking at unemployment that is not likely to recover what job growth in the Fed's view, but over a longer period of time. And that has led to what does this mean in terms of the health of the banking system and what can the FED do? Even though on the tenure framework.

They are strong, but the FED just doesn't know what the outlook is for the rest of this year next year, so that brings in their actions as we know, which is to limit essentially to only dividend dividends but no dividend increase, pullback sevent their capital return, no stock repurchases. And by the way banks from the largest ones JP

Morgan to the to those of the thirty three. We want to continue this conversation with the FED banks supervisors looking at data and look for the capital plans by year, and that's an amazing reference exactly I wanted to go is exactly the idea of what they're going to be doing later on. How concerning is the additional capital plan that the FED has asked banks to read submit, which Alice Williams of Bloomberg Intelligence has said is a broad

negative for the banking sector. Well, we already know in terms of at least what they're planned for this year for dividends and no buy backs. But it brings you back to the July earnings coming up with loan losses, and the projected loan losses on their historical framework was four hundred thirty three billion and when you get into the COVID nineteen scenarios, you're looking anywhere from six hundred

to over seven hundred million, you know. So it's it's the fet is recognizing that banks are going to see, especially in three areas related to commercial loans, credit cards, and real estate, that there's incredible uncertainty about the economy, the labor market, and there's going to be loan losses. So I think the fet of course, is being realistic

to it's a new environment. And even though the even though before March the banks look to be very strong, they're going to be much more conservative than the c suite or the CEOs of the larger banks about their capital can The reaction in markets has been relatively muted. We are seeing Wells Fargo shares down about three percent ahead of the trading day opening, but that doesn't take

away yesterday's nearly five percent gain. It seems like people are pretty sanguine about the measures that the FED has taken. Do you agree or do you think that there is more potential downside for bank stocks? So when you get to that category of capital return, I don't think there's big no surprises here. There is a threshold in terms of computed net income to dividends or the payout ratio, and Wells Fargo may not need it in terms of

their ratio NT. But overall, the market, the equity market and investors see the banks as of really a try the value and and trading at discounts to net tangible

book value. UH. They are the ultimate cyclical stocks in the market, and I think looking beyond the next six months, banks are likely to do much better and given the protection from the FED and their capital requirements, there's not that much more downside unless the loan classes are going to be incredibly higher than even what the FED is projected. One final quick question here, what's all this mean for James Diamond, Brian Moyning and and the rest of the guys?

Mean what you know? Like what how do they respond to this? As they wander into July, their their spirit and comments are going to be about phase two, which is the road to recovery. The first phase was taking

care of employees and customers. Now they have to be bank executives and do the hard work in terms of making sure that they can communicate the strength of their balance sheet, their ability to manage credit risk and their ability really to manage all the businesses, including the capital markets. So they're going to be positive. But uh, you know, given what we've read from the FED. Yet you know today it's really hard for any of these banks to look out and give any ability to project what their

businesses will do on performance by your end. So it's gonna be a fascinating ride for six months, Tom John, you know, just related to the dynamics of the US economy and global how it filters to banks and as investors as we look at the profile of these stocks and also the return we get as investors. Couldn't agree more. Ken really well summarized Kenneth Lee on their CFR right,

Global Director of Industry and Equity Research. This is a joy right now to bring in bread sets Or to stays with the CONSOL on Foreign Relations barely does justice to coming out of Harvard ce Poet Oxford, where he was a young guy and the papers came off the screen. That happens very rarely that somebody writes papers and they come out of the screen. And that's what young Setsor did at a most early age. He served the nation

at Treasury. He joins US today. Tannem bomb fellow at CFR Brad Richard Hass has out right now my book of the summer, The World. It is a wonderful, simple, straight talking book on international relations. What would you frame is the setser future of our international relations? If it's not Washington consensus, what is it? Oh, I'll give you a classic dodge. I mean, I honestly think it is way too early to tell. Uh, the choices that will

frame the post pandemic economic future haven't really been made. Obviously, the outcome here in November matters, but I think there's a still a broad set of policy decisions on trade, on American alliances, on the relationship with China that will be central to the post pandemic world, and we're only beginning,

I think to lay those out. I look, Brad, at where we are, and after this election, the day after this election, what will be the best practice to resurrect our State Department from where we've been the last administration. Whether it's a second Trump term or a new Biden term, Well, it's a lot easier to imagine the process with a new Biden term. Let by a I have every reason to think that that Joe Biden would pick a very strong,

very well respected secretary of State. But I think Biden has made it very clear that he would prioritize America's ties to his traditional allies, and at least in the first six months, I think that that would be a relatively easy to orchestrate, in the sense that there would be an enormous appetite on the part of America's traditional allies to work more closely with a new administration. The hard part comes when it needs to sort of define

the substance of the new relationship. But you know, there's some pretty obvious things that Biden could do to get relations off on a better foot. I mean, narrowing trade conflicts to focus on China and settling some of the outstanding trade tensions with Europe is for example, a fairly obvious. But there's a question going forward how much we are going to continue with the de globalization that we seem to be talking about at least, if not effectuating over

the past few years. I'm wondering to what degree you're seeing us rejigger supply chains away from China, redomesticate them in a way that a lot of people have been calling for. Well. To be honest, right now, the the data is telling us the opposite story. So there's a disconnect between the discussion of deglobalization and the reality which is right now in some ways the world is more sinocentric.

US production is still down so hindered by the state of the pandemic in the United States, while Chinese production is more or less back at capacity. So what you see is that this is not just for the US. Around the world, UM imports are down, but imports from China are down less than overall imports, So Chinese imports are increasing in market share. And in the past couple of months of US and Chinese data, imports from China have been flat, whereas you know at the beginning of

the year they were down. So I think you know in the first instance that the pandemic and the way the pandemic has moved around the world has at least in the second quarter, reinforced dependence on China. There are China's the global center of mask production right now, and

everybody is welcome in that rise helping me demand. So my my view is that if you really are serious about reducing supply chain dependence, it will take policies that actively promote that outcome, whether that's how the US procures medical equipment, or whether at some other measures that support increased resilience. UH. At the current exchange rate. With China up and running, the natural pressure is actually towards reinforced dependence.

Just real quick, twenty seconds. Would you basically consolidate this by saying that the tariffs have failed so far to reduce international dependency between the U S and China. No, I wouldn't say that. I think you know. The tariffs clearly what the arrists failed to bring production back to the United States, the production the tariffs were reasonably effective and creating an incentive to move some production to Vietnam.

Imports from China would be down about a hundred two d and fifty billion ballpark below where they were before the tariffs. So the tariffs had an effect, but some of that effect is sort of strangely currently being undone by the course of the pandemic and the fact that the Chinese productions and chain got back up and running before everyone else. Brad Setser cfr Fellow, thank you so much for being with us as always, wonderful to hear

your insights well. The joys this year in the past twelve months was to swore right down to Washington, this is pre pandemic and wander into a building and see a wonderfully, wonderfully reinvigorated International Institute for Finance. And this is under the leadership of Tim Adams. He is out of Kentucky. Tim Adams serving the nation at Treasury and took on the wonderful job at ii F, the consortium of all the banks worldwide, truly reinvigorating that important institution.

And we're thrilled the Tim Adams could join us this morning. Tim, how is ii F doing in a pandemic? I mean, I guess you go virtual, but if any of our listeners groups wants to get together, there's nothing like physical intect is there. Hey? Tom, thanks for having me. And that's probably the best intro I think I've ever had. You know, about fourteen fifteen weeks ago we went virtual. We've done forty events over the period of times six

thousand participants, so we didn't miss a beat. We're able to function from home from our basements or garages, our attict. I do miss my colleagues. I'm miss seeing our clients and our around the world, and I look forward to being able to do that, but we're out there functioning every day. Tim, one of the great questions, and there's a stress test in the global issue in European banking and that in the big banks, the ones that you spend a lot of time talking to, is we're all

waiting for consolidation. Does this disease, this virus, this pandemic, does it speed up that process or does it delay the process of global banking consolidation? A good question, Tom, I think in in the short term we're all firefighting. We're ensuring the capital continues to flow to the real economy. But I think once we come out of that, the arresting issue that we need consolidation, I think we're gonna

see it in Europe. We've seen a couple of announcements UH in the Gold States over the last couple of days and large banks consoliday, and we're going to see in Asia and the US has been consolidating for twenty or thirty years in that process will continue, if not accelerate. So Tim, I guess I have to admit not being a banking expert, but I've read a lot of the research.

This morning, I was a little bit surprised that the you know, the Federal Reserve added some new rules that could limit dividends and buy backs because I thought the stress test the banks came through in pretty good shape. I've been told by bank analys and fund managers that the banks are much better shape now than they were going into the two thousand and eight financial crisis. How do you kind of play that or what's what's your

take on that? Well? Yeah, first of all, the said said quite explicitly, where the sources strength for the economy rather than the source of the problem. So very different in two thousand and eight two thousand nine, and in the intervening period, we've raised globally almost four trillion dollars worth capital, So the banks are well capitalized, lending is up, the US deposits are up, and we're channeling resource to real economy. But distress does showed that we need to

continue to husband resources for potential downtime going forward. So it's a sense that this is a precautionary measure, because says I look at some of the big banks that JP Morgan's, the Bank of Americans of the world, the balance sheets look pretty rock solid to me. I completely agree. I think this is being just cautionary. That's the fed's job, and I must applauded to FED. J. Pale and Randy Quarrels another done a remarkable job in this period of time.

It is precautionary. I think it makes the makes sense that the stock price had taken up this morning. We saw the same thing in Europe when similar measures are put in place. But it is time for caution, and this is extreme caution. I applaud to FED efforts. Tim Adams, how is the relationship of our August politicians with the bankers? What was it five years ago? Four years ago we had bankers lined up swearing in in Congress and all

that is the relationship proved a bit. Oh, the relationship is much better and we have a great relationship with the administration also members of Congress. You know, again, Tom, we're part of the solution. We're channeling capital to the real economy. Lending is up, deposits are up. You know, we have visions in place for relief, for auto relief. So yes, well, no, that that's very fair that the Trump administration I think has been very much pro sort

of corporation. And while students that how do you, Tim, and with your wonderful political attun nous, how do you feel the banks will adapt to the protests across this nation that are much more social, Not so much black lives matter, but all lives matter. How will the banks

immediately adapt to that? That's a great question, Tom. You know, if you look at Jamie Diamond, who headed the Business poun Table for the past three years, he among other corporate leaders are looking for ways to promote diversity within their own institutions. We need to reach out to forgotten communities, those who feel that not only economy but socially they've been left behind. We need to do a better job there, without question, and that's made the real challenge before us.

What I find Tim HadAM so important here has There's been some true leadership and indeed governance on this by selected bankers, but it's got to get much broader within banking, even farther beyond the the II F Are you optimistic bankers could do that? I'm optimistic that we can be a part of the solution, without question. I've not a number of some calls this week where the top topic was how can we play a positive role in society? Not just in capital formation and lending, but how can

we be a real agent of change? Yeah, yes, absolutely. One of the reasons folks, I hope this pandemic ends is so I can do a Swarry in Washington with Tim Adams in the ii F. It is an important meeting with a lot of really really good expert discussion. Tim Adams he is the CEO of the International Institute for Finance. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or

whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio