Surveillance: How Low Can Rates Go, Foley Asks

with us the morning the price and sensitive bias. This is such a distorted bond market, and if you try and rationalize what's happening with buns based on fundamentals alone, I just think you're wasting your time. I mean, you know what's going to happen in the secondary market. It doesn't matter what price these things are at, there's gonna be a buyer. Well, I do agree with Lisa. I think it was interesting just you know how little demand

there was in this particular auction. But to your point, I think Mario is going to keep on buying both Lemonade plus these German bonds as well as some others. I think perhaps one of the interesting things, or maybe one of the reasons this auction didn't go quite so well as there's you know, there's now a lot more discussion about German stimulus possibly down coming down the pike, and so maybe there's some investors out there thinking they might get you know, a little bit cheaper if they

just hold out for a little bit. So maybe there's a bit of buying opportunity just down the line. Well, but but this, really, John Ry, is a really good point. Is this a tipping point or is this just a typical auction where they can't sell everything and there isn't huge bit discovery issue I think to be fear and I don't follow the sort of the German bond actions as closely as as the US bond options. I don't think it is a tipping point. I mean, certainly, I

don't think the ECB is changing their tune rates. Yield are going to remain very low, So I think this is more likely to be a one off. I suspect if they had another auction it we'd go a little bit better. But I certainly don't think it's a sea change. Do you think that there is an underestimation of inflation at this point? Um No, I don't think so. You know, getting a little bit of inflation here in the United States.

The surprising thing when we had sort of just the mess of expansion of balance sheets and the printing of money from all of the central banks was that you didn't get any inflation at all, And that I think reflected just the sort of the massive sort of balance sheet recession that we had. And I think, you know, having now gone a whole decade and that inflation hasn't

showed up. I don't think there is an underestimate exture of inflation at this point, wouldn't it just to build on the question of least So I just wonder whether the boat has loaded too much to the one side, just in terms of pessimism around growth, of pessimism around inflation. Have we gone too far too quickly to the one side? Um, that's a reasonable point. I think if I was going to say, you know, is there too much pisima pissimism

on inflation, I'd be more balanced on that. But I certainly would argue that on the growth side, arguably, I think people are a little pessimistic. Sure, a lot of the central banks are largely out of room, but there is still a few, you know, governments out there with a little bit of fiscal space. I mean, I think if the monetary authority on the fiscal authorities were to work together a little bit more cooperatively, that we could, you know, see a bit of a bounce back and

growth at a time. John, I love that you picked up exactly where I was going. My concern as I look at the markets is, especially given Norways throwing in the towel on beds on the higher rates, that there seems to be capitulation and a strong consensus building. And whenever there's a strong consensus building, there can be a

widowmaker trade just sitting there waiting to happen. And I just have to wonder, you know, the strong consensus right now, rates lower, inflation, more abound, the ECB, Morrow draggy continuing to buy that lemonade untill he you know, turns blue. I'm just wondering, you know, is there any argument against that? And are we getting to the point where we could see a pretty violent reversal on very small news simply

because there is the strong consensus. I think that there is a chance that you see, you know, a reaction to small news. The problem or the issue, I think is that that the chance of that sort of news occurring is quite low and sort of going back into the past, I can think of the Taper tantrum back

in two thousand and thirteen. I think it was when Banankee started to prepare the markets for the end of the uh FEDS bombuying, and you can go all the way back to where there was that like massive, you know, very sharp tightening cycle. But I think if you look around all the central bankers, if anything, they're more likely to surprise us on the downside as they're not. No one seems to be turning around and talking about tightening, so that that that surprise that you're talking about, I

think it's a very low probability. So without in mind, neck got to get your currency kill in G ten Right now, the dollar, a lot of people were looking for a week of dollar. It hasn't materialized in the way that people thought it would. What's your base case at the moment, we were looking for a week of dollar and as you say, it hasn't materialized, so a little disappointing for us. But for right now we're looking

for more range trading. So for the euro, you know one ten to one twelve through most of the year, Here's here's the thing. If you look at all of the central banks, they're all they're all using the all cutting rates in New Zealand, Australia Fiddle Reserve ECB. They're also not cutting rates as much as everybody wants to. If you look at the market pricing, everybody's out of head of these central banks. So we'd sort of go back a good decade or so and think about the

carry trade. You know, everyone's going down. I don't think the currencies are going to move that fast, So be short the low yielding currencies and and be long that the high yorlding currencies. That suggests selling the Euro, the Aussy and the Qui all against the US dollar stronger US dollarvan Yeah, I think I think in the near to him rangey. But yes, if you're going to see any move, it's going to be dollar stronger and particularly against you know, the growth inside of currencies, so Ozzy

Kiwi and and a lot of the emerging markets. What about of virgin markets currencies. Um, you know, we've seen some excitement there, quite a lot of excitement to the downside or the upside. Argentina, Turkey, so excitement to excitement to the downside, Brazil hasn't been doing quite so well recently. Um. For for for now, I think that probably in the next probably the next few months, we'd probably see a little more downside for um, you know, for some of

these emerging currencies. Although you know, if we get to a point where where yields which are already incredibly low, go even lower, um, maybe some of these emerging currencies do bitter later on. It's great to catch up, Nick Bannenbrook. They're dropping by the studio here in New York. Last FARNGA Securities head of Currency Strategy, join us now, Ralph Price A Bank America Merrill Lynch International Global head of Rage Strategy. Ralph, walk me through what you're looking for

over the next couple of days. It's the events that you've highlighted, I guess from my perspective sitting in London. The one thing I would add that you didn't mention as the CB accounts, because we do also have a lot of question marks about what the European Central Bank will be doing in a light of much more evidence of a slowdown in Europe compared to what the setters had to deal with so far. But that's exactly it.

It's a question mark over whether or not the said cast to qualify what the market clearly took us a very disappointing right cut in July UM and whether UM German Power follows that up with any more elucidating comments in Jackson Hall itself. Are we asking for too much to see that in the minutes later this afternoon, Ralph, Because as we know, it looks like a very divided f m C, and that division could grow a little bit louder when you sift through these minutes a little

bit later. Yeah, I would be surprised that the minutes I used to pre signal anything meaningful, given that the chair is going to be speaking later on, and that the that Jackson Hall will provide maybe a more nuanced explanation of what what the debate is actually well about within the firm, c Ralph. Are you worried at all about positioning right now in rates? The fact that there seems to be capitulation that rates are going to stay

where they are or go lower. I'm always worried about positioning. UM. It's one of the things we do is status, but the absolutely right positioning on our So this has been flagging as being near extremes in particularly for the US for some time. UM. But the when you when you sift through the numbers in a bit more detail, the reason why people are long is because they're looking for hedges. Um.

You know, the equity market remains near their highs. Tenure Treasury notes are regularly flagged as being the most efficient risk of hedge and in our surveys, So that is

one big reason why people are long. It's not that they necessarily actually expect the FED to follow through and all the weight cuts that are currently priced, but they need an instrument to protect them against something going horribly wrong further down the line and ten your notes are providing that hedge at least for now that perspective, sorry, but you said at least for now. And that's actually what I wanted to pick up on, which is, at what point are yield so low and it's positioning so

extreme the treasuries don't provide that hedge. I think we're quite a bit away from that, um in the sense that if you look at what the market pricing for the said Actually it's so if you ask in detail, you know, what is it you actually expect the FED to do what you see is a fairly bimodal distribution. So there's a few, well, the majority of arrestors around actually expect the FED to do what they said that

it would do, which is that mid cycle adjustment. But then there's a very significant minority of investors who fear that the said may have to revisit the zero lower bound than expect great cuts of a Hunland fifty based points or more. When you're face to that kind of bimodal distribution, interpreting what the market is pricing is actually quite difficult because it is essentially just putting a line

through those way two extremes. You know, the world might be okay, it might not um but the fact of the matter remains that if you worry about the FAT having to revisit the zero lower bound, then then you knowes do provide a lot of upside. Europe, I think

is a very different matter. And and to your question about at what point do we run out of out of hedges, well, the thirty auction this morning in Germany clearly was a signal that there isn't actually that much end demand from investors when you're asking them to pay up for someone else to look after their money for them for the next thirty years. Rough you thought on how the yield curve is responding to the easing that is set to come from the e c B and

is coming from the Federal Reserve. Typically, what we'd expect to happen is a ball statement to start to come through the curve in treasuries as the Fed starts to cut interest rates. It's not happening, Ralph. Why is it not happening? Um, It's not happening for a variety of reasons. So UM in the U S. I think what what is interesting about the inversion is not the fact that has happened, but the fact that it took so long.

It is very, very unusual for the yield curve to start inverting after the beginning of the easing cycle, which is what we faced last week. What that is is a very clear signal that the market leaves that the Fed is somewhat behind the curve. UM. So, the the issue we have is that this is not a normal rate cut cycle where the Fed actually deliberately raised rates to meaningfully above neutral, thereby slowing down an economy that would otherwise have been overheating. No, this is any nomy

that was basically recovering, you know, somewhat above trend. Who Um is being tripped up by a global manufacturing cycle that has slowed very materially and therefore is facing meaningful storm clouds on the horizon without actually an awful lot of evidence of weakness in the domestic economy so far, and that results in this you know, very wide distribution

of possible outcomes that is being priced in. But the clearest reflection of that and that hedge demand is basically a yield curve that inverts after the beginning of the easing cycle. Europe is a very different cattle of fish because they'll be dealing with a policy talk kit that is considerably more constrained than the central bank that has buying large run out of ammunition. If we're honest of a perspective, the path of these diosistance is lower and flatter.

So Ralph John has been trying to put me on this spot all morning with respect to that German thirty year auction, and I've been dodging it, I think pretty effectively. But I want to put you on the spot instead. Uh, And you know, basically is it an inflection point. You were saying that the pushback, the lack of demand that we saw seems to be some resistance to accepting losses, essentially to lend money. Um do you think that we have reached an inflection point in German burns now? I don't,

um So. We actually see bundeals lower into your end um and there's a few key UM differences that would tease out relative to where we were in twenty fifteen, where a porten You auction kind of marked the beginning of the end of the bund valley before the bund Tantrum kicked off in Earnest. In April um number one economic surprises actually continued to be very negative, whereas in fifteen we were looking back at at a fairly meaningful turnaround in UM. In the data flow equally, pms remain

at much weaker levels. The economic risks also much more clear and present in the sense of Brexit, in the sense of the threat of water town US, the weakness in Chinese data that has yet to be reflected in European data, and so on and so forth. Relative value is also another key issue, um SO. From the perspective

of an f X hedge investor UM. So if I put myself in the shoes as someone sitting in the US running an f X hedge benchmark, they're looking at ten y yields in in buns, not as minus you know, sixty seventy basis points, but actually as you know, plus one point nine percent plus one point eight percent, providing meaningful pickup relative to tenure notes because of the the pickup that is implicit in the in the FX hedge, whereas back in on that metric, bonds are actually a

hundred basis points of rich relative to treasuries. So from that perspective, I think it's very very difficult to um make the case for a tantrum. I think what would cause a tantrum in buns and and create that big turning point for bund yields is a change in the native So if the trade will ends tomorrow, then yeah, we can sell off obviously, but it has to end

credit the um. If you get a fiscal policy impulse out of Germany, and but that I don't mean what the current constitutional rules allow for, but actually something that most people would understand a fiscal impulse and is something that is big and meaningful, then that obviously could provide

a very different backdrop. If the Chinese were to start stimulating in a way that actually creates positives below the effects for the rest of the world, so infrastructure investment as opposed to monetary policy using and currency deppreciation, then that could potentially also change the narrative. But I think we're a long way away from seeing any of those

things material is anytime soon. So from that perspective, um, you know, you are faced with the risk of unanchored inflation expectations becoming ever more intentioned in Europe, and that's not going to provide a big upsite for for the long end of the curve. Really smart final thoughts there, Ralph Price of their Banks of American mardal Inch, International

Global head of Race Strategy. The narrative just running away with it south that Germany is somehow putting together a package and will preemptively tackle some of the problems in Germany and Europe. At the moment, I don't see it's not happening. I hope it does. The optics are certainly encouraging. It's positive that this is part of the discussion. I hope it happens, But just realistically speaking, I don't see

it happening right now. Let's find out what Jane fully thinks that Jane Folly Rubber, big head of Effect Strategy, joining us now from London. Jane, Let's get started with the German fiscal stimulus. This idea that potentially, maybe perhaps in a downturn, they could abandon their balanced budget policies. How realistic is it that Germany would actually engage in a meaningful fiscal stimulus early enough to stave off a

downturn that is really painful? Well, I mean, you can see from the outside looking in that they would appear to be a certain logic. Germany's budget position, for instance, looks more healthy than it's another large country, So from

that spectives you can see the logic building up. The reality in Germany, however, is that a lot of the fiscal power is localized um and that means that from a practical perspective, it may not be that it may not be very straightforward or simple to actually make the decisions that bring forward a lot of fiscal stimulus. So it could actually be quite a difficult proposition to actually

see through. So there will be more pressure. We've seen Germany, of course, printer and negative GDP growth q and key growth for for the second quarter. If we see another negative print for the third quarter IU technical recession, then clearly that pressure will build up and therefore there will be increased pressure and perhaps more momentum within Germany to

to to ease those fiscal uh per strings. But um, it's not necessarily the foregone conclusion that some of the the commentary in the markets in the last few days, few weeks would lead to believe. I think I'm struggling to understand as we look at the interest rate picture and as we look at what central banks are doing.

Certainly the e c B is preparing another round of stimulus on there, and given the fact that Germany is unlikely to come out with fiscal stimulus, I'm trying to understand the relationship between the monetary policy and the f X rates where where things are actually trading. I mean, at what point do central banks lose power over currency exchange rates? Well, of course, um, it's for an exchange

is not just driven by by effects rates. There is a cause, an awful lot of political influence, and I think this is very much the case in the detail in the in the trance sort of Brexit sort of era. There's a lot of political risk there. Now. You could take in the Eurozone, you could take the Italian situation now and ask the question, well, you know, is that a negative euro fractor? Well, you know the answer to

that is, well, potentially it is. I mean today perhaps because we've seen the markets reactor quite well to the most recent news from Italy, and that's the assumption that there may not be a snap election in the next couple of months, that might be delayed until next year. And therefore, if we're not having a snap election in the next couple of months, we don't therefore have a big budgetary conflict right now between Italy and the EU.

That's potentially further down the road. But it is all about politics, i would say, as well as the economy, as well as infra distrect differentials. But the central banks certainly have a big part to pay play in foreign exchange. And what we have now is of cause a big emphasis on the September ECB policy meeting and a lot of speculation that the the ECB will use and a word that was used in the President in the last week of the Zooker that they could do something quite significant.

And I think that one of the reasons that the euro has been under pressure quite lately is this perception that this isn't all about how much interestrate caps are said can do over the next year or so, so actually about where else and who else could be doing these interest rate moves, And certainly I think the ECB is right up there in the market's consciousness in the

next few weeks. Well, Jane, if they moved to tearing on the deposit rate, it opens a new range of possibilities up for just how low interest rates could go at the u c B. Have you got a base case for that, Jane, on how low things could go for ECB deposit rates. It's it's very difficult to make that judgment right now, clearly, because it's difficult to know how bad the global economy can be and at a

time make those sorts of assumptions. You've got to try and make a prediction on how far can tradeables go, how far can the relationship deteriorate between China and the US overall, so there's an awful lot of what if, which, of course it always are in forecasting, but it does the ECB don't want to use tearing immediately, but certainly I think if conditions did worsen, they may have to.

You have a situation um where we are talking about the potential of quantity division in Australia, where they're talking about in September the Swiss National Bank cutting its interest rates below where they already are and that's minus not

point seven five percent. So you have, um the the discussion about world countries such as Sweden or Denmark have to pass on negative rates to to retail deposits for instance, So that there's there's a there's an enormous argument and debate about how low can this really go and and how effective can these sorts of policies be and what sort of damage can they do in terms of the damage to the models for banks in Europe and and

also for inequalities, weld in equalities, etceters. So there's a there's a huge debate um and certainly you know tearing is out there on the agenda as of a possibility for the for the u c B, but it's very difficult right now to to call the whens and how locan this goes. Just the final question you Jane, you're

a dollar. There was a hope that we finally break out of these really tight, narrow trading ranges, and we just seem to have established a new one in and around one eleven one twelve on the single currency against the green bag. Jane, do you see us breaking out of that range anytime soon? And where's the path at

least for resistance right now? Well, you know, I always tended to be below the market forecast for quite a while on near a dollar, and I've had one ten pencil dinners as a as a as a forecast for the end of this year, and to be honest with some part of parts of this year, and I've I've I've been so far out of consensus. I thought, you know, do I have to change this? But you know, right now, you know, we're pretty close to one ten, and I think we do have to address the risks about potentially

going lower. And I think the answers to whether or not we can break below one ten are very much in what happens to European grows, what happens in terms of the the ECB, and and whether or not the market does continue to believe that we could get that stimulus in Germany or not. Jane, always great to catch out with you. Jane Foley, the head of FIC Strategy at Raumba Bank, joining us Santa the City of London

on global foreign exchange and global central banking. We're so lucky to have with us Brian Hook, us special representative for Iran and Senior Palsy advisor to Secretary of State Mike Pompeio, joining us here in our eleven three Oh studios. Um, thank you so much, representative for being with us. I just want to start with where where are we in terms of the discussion with Iran, with the latest being

this crew tanker leaving Gibraltar. Well, the Iranian regime uses oil sales to fund terrorism, and they use it to fund proxies like Hezbollah and Hamas and the Hoothies and Yemen. They use it to fund their missile program which has done so much to cause bloodshed and suffering throughout the Middle East. So right now we have the Islamic Revolutionary Guard CORES, which is using oil tankers to try to move oil covertly, and this vessel was seized by Gibraltar.

It was unfortunately released and we are now tracking the movements of that tanker to our hard to do everything we can to avoid it from achieving its destination. So what has been the impact on Iran from you know, our efforts to kind of choke off their one of their key revenue streams, that being oil exports. Well, it's been enormously successful. When the President got out of the Iran deal, and may have last year, Iran was exporting

two point five million barrels of oil a day. You may have seen press reports in June and July that showed Iranian exports around one hundred thousand barrels of oil and this um is three percent of the world's oil supply. But we have been able to maintain a very stable oil market because we've done a good job of balancing our national security objectives UH and our economic interests. But um, we have taken places to Iran. We have taken Iran

two places it's never been historically. Oil revenues are their largest source of export revenue, and so much of that is controlled by the Revolutionary Guard Corps and the Kuds Force which is active around the Middle East and all these Arab civil wars, and so by cutting off the oil, we are denying the regime the revenue that it needs to conduct a violent and expansionist foreign policy is the ultimate goal regime change. No, the ultimate goal is a

change in regime's behavior. And one of the ways you can do that. I think it was SISTERO who said that money is the sinews of war. Iran has less money today than it did two and a half years ago, and we took office. The regime is weaker and its proxies are weaker as a consequence of our maximum economic pressure campaign. So if it's not regime change in terms of the actual personnel, but regime behavior change, at what

point will there be enough behavioral change? What's the sort of threshold for saying, Okay, we can relax these sanctions and move forward with some diplomacy. Apart from this, well, the diplomacy option has been open for the last couple of years. The President and Secretary and the Secretary of State had made clear repeatedly that they would like to resolve our differences with Iran diplomatically. Iran has rejected diplomacy

too many times. They rejected the diplomatic overtures of Japanese Prime Minister Abe when he visited Iran for the first time any Japanese Prime minister has ever visited Iran. Not only did the Supreme Leader of Iran reject his diplomacy, he then blew up a Japanese oil tanker for good measure. President McCrone has also um been on the receiving end

of Iranian rejections, and so we're intensifying our sanctions. We are helping Iran to see that the that the costs of trying to pursue a nuclear program, a missile program, and regional aggression are simply too high. So pulling out of the Iran agreement initially by President Trump, many argued that that was destabilizing the region. What is your response to that? It was the Iran nuclear deal that has

come at the expense of regional stability. And if you read the Iran Nuclear Deal all hundred and forty seven seven pages, in the beginning, it talks about how this deal will promote regional peace and stability. Iran used the sanctions relief and spent it on Assad in Syria, on Hezbollah in Lebanon, on its proxies in Iraq, on the

Houthis and Yemen, and on Hamas. And as a consequence, the Iran Deal allowed the Iranian regime to achieve record levels of military spending and record levels of support for its proxies. Since we have taken office, UM, Iran's proxies are weaker. The first year we were in office, Iran's military budget went down ten percent, and then in the

second year it went down twenty eight percent. We have had stories in the New York Times and the Washington Post doc commenting how American sanctions have weakened Iran's proxies. This is a good thing for the Middle East. How important is it to the administration to have coordination and cooperation with Europe? Oh, It's very important. I'm in almost regular daily contact with my counterparts in the UK, France and Germany. Yesterday we had a very good meeting with

the Polish Foreign Minister. UM. We are I think the press has overstated our disagreements the Transatlantic rift that the press likes to report. We agree on much more than we disagree. When I'm in the room with the Brits and the French and the Germans, we share the same threat assessment about Iran, the regional aggression, the ballistic missile testing, the missile proliferation, UH the nuclear program. The world's leading sponsor of terrorism can never be allowed to have a

nuclear weapon or even to come close to it. There's no disagreement there. We have tactical disagreements over the Iran nuclear deal. We have more leverage outside of the deal to prevent Iran from gtting a nuclear weapon then inside of it. That's a tactical disagreement, but we don't disagree on the end state. Thank you so much for being with us. Brian Hook, US Special representative for Iran and senior policy advisor to Secretary of State Mike Pompeo. We incredit,

we appreciate your time. 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 Keene before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.