Surveillance: Financial Conditions with Dudley

On the day of the Federal Reserve meetings, we had Richard Clarato with us, the vice chairman, former vice chairman, and also William Dudley of course a former president of New York Fed as well, and we are thrilled Bill Dudley you would find on your date calendar to come back and join us. Here is we reset into January. What will you glean? And I know what you're gonna

tell me. You're not gonna rely on one data point, but what does the data point of January twelve the inflation reports signal to the Fed where possibly they will have three data points lined up marking some form of disinflation. Paul have been very clear that to chief success he needs to see moderation of goods prices, which he is seeing moderation of services prices excluding housing, which he's not seeing, and more slack in the labor market, which he's not seeing.

So he's only achieved one out of its three goals. So the thing that focus on is what's happening to the services inflation excluding housing because we know housing is going to come down with a lag. And what's happening in the labor market. You know we have you know less player e poloyment increase. We need to see pyroll gains of fifty thousand, seventy five a month. We need to see an increase in the unemployment rate on FUNT to generate and a slack in the labor market. We

need to get inflation down in the services sector. You were expert with on this at Goldman Sachs with a guy named McKelvie in a young Turk names hot Sis and the bottom line, I love Bill, what you're saying. We need to get from two hundred thousand plus down to something that's the run rate of fifty seventy thousand non farm payrolls. When we do that, where does that dearth of job growth come from? I mean, there's no evidence out there on how to get from there here

to there. The main phrase I'm trying to talk like him at Bowden, but I'm going down in flames. How do we get from here to thar? Well? What the feed is said that that we need tighter financial conditions. We need tighter financial to getations to slow the economy down so there's less demand for labor. That's why Pollen is the press conference last week with basically pointing out if financial conditions ease and the Fed Reserve is gonna have to do more. The Fed is targeting financial conditions

because that's the mechanism that slows down the economy. When sponds rally and stocks rally, then that just mean there's more for the Fed to do. Bill. I've been confused by the market response after we got the latest Fed meeting. There hasn't been a real increase in bond yields and there is still priced into the market a lower terminal rate. Them with the FETE is saying that they are going to do How do you understand that? There's two possible explanations.

Number One, the market thinks that the Federal blank once the unemployer rate starts going up. So the market is basically saying that the FETE doesn't mean what it says that they're saying this to try to talk tough, but when the going gets difficult, the federal fold. That's one possible explanation. I don't believe that. I think Paul is going to do what he says. And number two, they may just have a more benign view about how fast inflation is going to come down. I think the market

is overweighting the improvement in goods price inflation. We knew goods price inflation was going to come down for two reasons. Number one, the switch in in the pandemic has reduced the demand for good versus services. And two, we knew that some of these supply chain disruptions we're gonna normally. The fact that used car prices are falling out was don't surprise anybody. At the same time, people point to the fact that credit card receivables are going up, people

are borrowing more. It indicates that the cushion is getting used up, and there will be a music stoppage at the beginning of the year that people will stop spending, and perhaps they already are. How do you push back against that and say no, there is actually more momentum, more dynamism behind that that this bed has to curb. Well. One aspect of good price inflation going down is the oval inflation rates lower, so people's wages go a bit

further than they were before. And as you said, you know the excess savings is coming down, but still there's no about truly and a half money of savings above what you would expect the situation to be if we hadn't had those large fiscal transfers. And finally, there's gonna be a lot more income for people caused by indexing. So look at Social Security eight point seven percent increase coming next month. It's a hundred billion dollar increase in

federal spending. All those people are going to go out and spend that money. What kind of recession do you foresee given the outlook that you're talking about, given the fact that if gasoline prices rise, you end up with another situation at a time when suddenly the momentum is waning. I don't expect every set quiet yet. I think the economy still has considerable for momentum. If you look at the Atlanta ft GDP now forecast for the fourth quarters,

it's in the two to three percent range. Uh And I think that the conno will continue to grow through the first quarter. I think the recession, when it finally does occur, will be mild because the federal reserves in control. This is a recession if it occurs is completely induced by the FED to generate more slack in the labor market. That means, once enough slack in the labor market has been produced to bring inflation down, the Fed can relent.

Uh short commentious rates are gonna be around five points, so plenty of room for the FED to cut rates to stimulate the economy when the time comes. This is one reason why I think the stock market is still pretty poyant giving the fact that likely because they see the other side. Bill. This is why we love to have you on, I mean, the idea and this is

so important, folks. I knew that we were going up eight point seven and social Security, but there it is Dr Dudley quantifying it and showing that it's a return and Bill it's almost like, you know, I expect Wayne Angel to be on after you. We're almost like back to the sixties and seventies with an observation like that, is this good old demand pull inflation? I mean, is that where we are we got our social Security check,

let's go spend it and prices go up. Well, novel GDP is on a strong trajectory, and the FED needs to take that novel GDP growth, which we've been running around nine percent over the last year down to about three. That's a big job for the FIT to pull off. Bill Dudley, thank you so much. Lisa Bramlinson. Tom King

was one of the stars of Wall Street. She is definitive on E s G. I'll try to get some questions in on that after a really brutal year for E s G. But we speak with the head of US Equity Quantitative Strategy at Bank of America, Sevita Supermanian joins US as well. Sevita, You've got a very cautious view, a defensive view for two thousand twenty three. My statement is corporations will adapt. How will the corporations adapt to your caution to husband and to husband free cash flow?

You know what I think they're already adapting. And what we're seeing is that companies are spending on automation to replace you know, kind of expensive labor with machines and uh, we're actually seeing the seeds sown for a strong productivity cycle. The problem is it takes a little while for all

of that to come to fruition. I think companies are also adapting to geopolitical risk as well as you know, supply chain friction by reshoring and then you know, just a little on the E s G, a little sprinkle of E s G here a lot of One of the biggest reasons that companies are moving plant and property and equipment closer to consumers is to reduce travel related

emissions risks. So there's a lot of reasons that companies are, you know, adapting to this environment by reshoring, spending a little bit of money on you know, a better set up in the future, but it costs money in the near term and that's what we're worried about over the next twelve months. Stuart Kaiser over at City Group is in the same camp I'm in that when you get Sevita Subramanian gloom, your choice set gets smaller and smaller.

Our index funds going to get hammered in the next twelve months versus active, more narrow less diversified securities analysis because there's just not that many good ideas out there. Given the Sevita gloom Look, I'm not gloomy on everything, and I do think that there are parts of the market that are worth uh really kind of gaining exposure to. I mean, the problem is when everybody is gloomy, the chances are that information is more priced into the market

than it has been when everybody is really excited. So so I think that it is time to avoid being an indexer and get active. I completely agree. There's a lot of reasons for that. I mean, in our quant work, we're noticing that dispersion valuations is that almost extreme highs and extreme historical highs. So what that means is there's a lot of alpha to be made by just kind of playing mean reversion of valuation UM. So that's one reason.

The second reason that I think that indexing is going to underperform active for you know, one of the first years in a very long time is that you know, the index itself is still very top heavy in long duration high growth. You know, tech TMT kind of the old leadership that did really well when interest rates were falling to zero, the cost of capital was free, and you know, any company got funding to do whatever it wanted. I think we're moving into an environment that's more rational

and you really need to sift through and pick the winners. Um, you know, kind of figure out the winners from the losers and sevida that seems to be more energy and financials ironically, rather than tech and discretionary and TMT. That's something that you talked about, the sort of flipping of

the risk premia, which I loved this concept. How much does that take into account the likelihood of some sort of recession, of the fact that yields would be coming back down and the potentially oil prices wouldn't raise as high arise as as high as people think. How much does that still support a narrative of financials and oil companies outperforming. Look if rates come back to zero and if oil companies flood the market with supply, I'm gonna

be wrong. I just don't think either of those things happen. Over the next twelve months. Oil companies finally have capital discipline and they're more focused on returning cash to shareholders and meeting their E s G goals then turning back

the you know, drilling and extracting more oil. They have completely pivoted from flooding the market with supply I'm not talking about just the constraints on energy from the war in Ukraine and talking about something that's been in place for the last several years, which is oil companies in the US are not They're not motivated by increasing supply. They're motivated by pivoting to green and their CEO CEOs at energy companies pay themselves not in alignment with production goals,

but in alignment with E s G goals. I think this is a very different sector than it has been Financials. I mean, even if rates flatline, I think financials is a sector that has morphed from being this toxic credit sensitive sector of two thousand seven to a sector that has lower earnings volatility than the SMP five hundred, a sector that has better balance sheets and it's ever had in the history of its existence, and can actually amp up its div it end, you know, amidst an economic slowdown.

I think it's a really interesting sector right now, Savida. Where do we pivot to after next year. Let's say it's the reset year where we understand whether we've seen peak inflation and the trajectory of inflation. From there, are we moving to a lost decade one of slow grinding returns for fields remain higher, or are we entering a new bull market that has legs. Look, I think that we're in an environment where we're moving from just simply

price appreciation to total return. And that's been our thesis for for the last couple of years. I mean, if you look at the last ten years we've had, you know, very most of the returns of the S and P five have been from just capital appreciation, like less than fifteen percent of returns have been from dividends. I think we're moving into an environment where fifty percent of your returns are going to be from dividends, are going to

be from price appreciation. So it's gonna be not as exciting from just buying a stock and watching it go up, but it is very exciting from the idea that companies could actually increase their dividends. Um your total return profile could be that much better than bonds. I still like

stocks more than bonds for the next ten years. And you know, Lisa, one thing that I think is good news, so I'll end on a positive note, is that our you know, our long term models were very negative on equities at the beginning of this year, but the good thing about this correction that we've seen in the market.

The good thing about valuations coming down is that the setup right now is spitting out something like five percent returns per annum over the next ten years, rather than negative returns that we were seeing at the beginning of the year. So yeah, I'm not going to be great as the twenty tens, but it's going to be better than than negative. Sevita, thank you so much. Sevita Subermannia

and the Bank of America Securities here this morning. We've got to get her back on to talk about the new e s G. Right now, we're gonna spend four minutes with Matt Brill of Investco on a day job, and then we are gonna wander over to his good experiences at the World Cup, he greets us this morning for those of you on radio, and I don't what did they say, the blue and the blanche. I don't even know what the language is here to Argentina with

the blue and the white Jersey met bro. The bond market needs to win next year after a horrific two thousand twenty two. What is the path to total return next year in debt markets? He good morning, Tom, Yeah, it was. It's been a very challenging two thousand and twenty two. I think the the I G index is down about UM, but the coupon is materially higher going forward, and yields are a lot higher going forward, so you know,

the look at the starting point is good. Um. We think that for two reasons you tend to not have back to back negative years for fixed income. The first is that obviously a higher yield gives you a greater break even it or buffer going forward um for volatility

and for spread and interest right widening. But to that, the higher cost of debt generally is a burden on the economy, and as you have a higher cost of debt, it starts to slow the economy and makes things uh, it makes eventually the FED cut, which we do think is is certainly in play the back half of three. So pretty good starting point. Um. He got a goodfferent painter of this year, but I do think the technicals will be very good for a G next year. UM

at these higher yield levels. Let's talk about the pain. I'm looking at stocks and I'm just asking myself, is that it with down almost on the SMP year today? Death thirty one on the nastack A little bit more on that. I look away spreads this year, Matt, and I'm just asking myself, is that it is that the price that we have to pay for four hundred basis points worth of tightening and nine months? And some people say, yeah,

I think that's it. Others Matts say no way, You're not getting away with blown up ten years a decade worth of easy central bank policy with these numbers. What do you say back to those people? So so, I won't speak to the equity markets, but I'll speaking to the fixed in compartment. It's it's the worst year we've ever had. So what you say is that it? I mean we were down over at one point and that was just an absolute catastrophe and things that never anybody

ever would have thought could happen to that magnitude. I don't think, Um, we're very few people were calling for a down year in the bondom market. Um, so you know, I think that the readjustment has taken place. Um, when you type, when you hike for inner basis points in less than nine months, UM, you know it's gonna it's gonna leave a mark. And that's certainly is what happened. But I do think we're much better in balance at this point. And you know, we're talking earlier whether the

FED hikes one, two, or three more times. You know, I'm kind of more in the camp of the hike in February. I do think they'll hike again in March, but that's that's probably it. So we're of the way done here. Um So, I think, you know, the floors has sort of been set and the worst is certainly behind us. Although credit spreads are pretty much in line with averages, are they pretty pricing in a recession as well? Or are they pricing in something much more mild? Yeah,

so it's it's the tail of two markets. If you just look at spreads, the answer is no. Um here where the thirty basis point range on spreads that is already the fifty basis points wider on the year, So it is a pretty material and move wider. But they've been cheaper about thirty of the time over the last five years and about of the time over the last ten years, so we're not pricing it intercession. If things were to significantly slow down, credit spreads likely would happen

go wider. But if you look at yields, yields aren't that roughly the nine percentile over the last decade, So all in yields are still very elevated, and you are getting paid, in my opinion, to take on credit risk. The question is are you Are you better off in treasuries? Are you better off in credit? Matt Brill dressed in Argentine is blue and white. You were in cutter from

many many of these games you experienced at firsthand. The World Cup in four years will address New York City and also with Investco Atlanta is well other cities across this nation. What should we look for in four years after what you experienced this year? Well, this was the World Cup on like any other that you could have it all in one place. But um, you know, I just think there's gonna be a hot ticket here in

the US. And we've got a good young team. I'm not sure we're gonna get a new coach or not. I'm not gonna get in that conversation, but I think we like we will, got a great core of the team, and I see it in the youth ranks. Everybody's talking about this World Cup. Everybody wants to go to it. I was able to get six games in four days over in Guitar all at face value. I don't think that's gonna necessarily happen. Ever here in the US. I

think it's gonna be the hottest ticket. Everyone's gonna want to be a part of this World Cup, and I think it's gonna be, you know, a fantastic time here in North America. I gotta mention it's in Canada, Mexico as well. Very cool, Matt. I've been thinking about the same thing, buddy already have Can you imagine how expensive it will be if you don't get those tickets? Hit coverage in Atlanta? Well Pharaoh today, Oh and Matt brill White down in Atlanta. Why can't we just do it?

I'll pay it. We can do if you gotta go run, you gotta go to Mexico, go to Canada, you know coverage, Lisa and I will stay home and watch, you know whatever. Right now, we are going to get a brief on the holiday festivities with one Tea Haynes. Terry Haynes as founder of Penge, and we welcome him again this morning. Terry, we're all distracted by football in the holiday season, etcetera. Is Washington shut down yet or are they actually pretending

work this week? Tom, You know Russ never sleeps in Washington, and uhh no, they'll be working all week putting together what I hope are the final touches on a full year spending bill. They've they've been promising that that will happen, so it probably will happen. But otherwise that'll be a

bit help us here. With all the knowledge base you have of the ten people it takes to make a run for president, which people are percolating the hardest, besides the obvious names to make a dash for the presidency, which are hiring all the people you know at that octagonal bar at the Willard, Well, most of them have been hired up already, you know. And you you've saved

me some time by going through the usual names. There's a lot of usual names, of course, starting from De Santis and going through Vice President Pence, Governor Haley others, and uh, you know a lot of those have already staffed up and briefed up, you know. The uh. Back in the eighties, Uh, the man who became Bush forty one was thought of as being slightly insane for starting his his campaign the three full years early, but ever since then it's been that sort of uh, that sort

of staffing up. So you know, everybody's jockeying for position, and they have been for some time. So we'll start to see them break cover earlier in the new year. How much pushback is there in the Democratic Party for from Joe Biden running again? We had we had seen over the weekend a number of reports talking about how he's beating up his social presence, particularly in some of the networks that don't have political advertising allowed. What do

you take for that from this? UM? I take the largely that the president intends to run for reelection and the party can't identify a good alternative. There are a lot of voices in the party that say that the president should not run again for a variety of reasons, age being the age and the bridge being the two major ones. But in point in fact, there's nobody around that's going to be able to command, uh, the ability

to continue to attract progressives. UH. And you know Biden has been essentially running the progressive agenda as much as possible UH and also appeal to centrists and UH, he's making a case that that's what the midterms showed, and so they're they're all kind of reluctantly follow the falling

in line on this, I think. And Terry, one of his hallmark policies had to do with oil prices, uh guess, and the fact that he released as much as he did a record amount from the Strategic Petroleum Reserve over the past twelve months. Now we're hearing that in February, they have plans to start refilling it. How is that going to affect the connection between gasoline prices and sentiment and political popularity if it reverses some of the price

drops that we've seen. Well, I think, Uh, the president is not particularly popular as as as everyone knows, and isn't going to you know, magically become more popular his his popularity still hovers around forty depending on which polls you like. And uh, you know, so refilling the Strategic Patroleum Reserve, frankly, as policy is a very good thing because there's a great concern about how low it's gotten.

But you know, it will have a detrimental impact on gasoline prices, uh during the during the winter, and uh, you know that's going to be difficult for a lot of people, So you know, they're trying to balance here as best they can. But now that he's gotten pass the mid terms, I think you can say he's he feels a little bit freer to to to re engage and reinflate the spr Terry, what you're betting that the President of the United States will run for a second term? Uh?

I think probably. Uh. They've They've given every indication that he will, assuming he's physically able to do it. I said, I see no no reason today why you won't. Very good, Terry Haynes, Thank You's isn't he Yeah, he's It's completely wired in and he's got some serious credit thirty years ago. I mean, he's been through this a few times, unlike a lot of other people out there. 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,