Surveillance: Inflation Control with Harker

McKee Bloomberg Economics and Policy Directive. Also worst questioner of Jerome Paul that we know, and that is they are not just FED presidents or FED governors, but they are real people with true expertise. Patrick Harker is truly extraordinary and a voice for technology at the FED. He is definitive and operations research. He holds the youngest endowed professorship at Wharton in their history. And all I can say, Mike is when the FED needs to understand technology and productivity,

this is the guy they turned to. Well, let's turn to Patrick Harker ourselves, and we should mention that along with everything else on your resume there you are a voting member of the Open Market Committee as an alternate for the vacant Boston seat at the present time. So, uh, Tom does have to pay attention to what you have to say today. Let me start off. I don't agree with him on the question of jay Pal So all right, well now I can take it out on you. Mary Daily,

very firm yesterday. We are not behind the curve, do you agree? Look at risk on both sides. I mean, let's step back. I think it's worth a step back and say, why don't we have inflation running away? It's run two things supply demand. Uh, the demand is something we can influence through monetary policy. The supply constraints people and goods less. So in fact, very little can we do about that. Two things are happening at the same time.

So the question is how quickly, and this has always been the question, how quickly are the supply chain constraints going to leave us? And it looks right now like they're not. They're going to take some time. So slowing down some demand, just what monetary policy does? I think it's appropriate. I don't think we're behind the curve in that sense because we don't affect a big part of why there is inflation. That said, I do think we need to move now to try to control inflation. That

is something I firmly believe. Well, move now, but then move how often after that and how fast that you know the questions out there? The fifty basis points in March of the seven rate increases proposed by Bank of America, Where do you come down on that? So let me again, let me step back from it. So we're going to stop the tapering in March. I would be supportive of point increase in March. Could we do fifty yeah? Should?

We am a little less convinced to that right now, But we'll see how the data turn out in the next couple of weeks, and then when we're sufficiently away from zero, we can argue with above zero d five basis points under basis points. Then we start normalizing the balance she start bringing the balanty down, which of course will also reduce accommodation. So truly a two step process here. Yes, we want to increase the fed country, which is our

primary tour of monetary pulse. At the same time we want to start removing accommodation by shrinking the balance sheet. Both things have to happen in tandem. In my mind, Let's step into March and then build on your comments on the balance sheet, President Harker on March, tell me the data that you are looking at, the data that will influence and shape that decision. A lot of people

de emphasizing Friday's payrolls print. We would all love a deeper understanding of whether you will look at that, how you would process that information given the omicron scare as well, and additionally the data you'd be looking at going into the March cool. Yeah, So you know, I heard some of the common earlier from some of your colleagues or tweet people who have tweeted about maximum employment. I think

we're there. So really this is an inflation story in my mind, and so what we're looking at is the signs that inflation, at least the precursors to inflation, like the supply chain issues, are starting to mitigate. If I don't see that, then I would be for a more aggressive policy. Right now, I think four twenty five basis point increases this year is appropriate. But there's a lot

of risk here. There's risk both to the upside of inflation that is worse than then I would anticipate, but there's also some risks that inflation will start to ease faster than we have anticipated. I think that is a lesser risk and is a good risk to have. But this is where we need to keep flexible with respective policy. We can't define a path right now and just stick to it. We've got to look at the data, and to me, primarily it's the inflation. Can we keep building

on that? Then? Just on the inflation front, do you need to see deceleration into March? It's persistence enough to worry if it persisted at this level, with that worry you enough? Which one would it be? Sure? I mean, I think persistence would worry me, continue to worry me, And that's why I'd like to see some signs whether it's actually in the inflation numbers themselves. Whereas I said in the precursors to inflation that we're starting to see some easy of the pressures on wages or the supply

chain constraints, etcetera. What would you be looking for a president hu Harker to possibly go fifty basis points? You said that, you know, should we that's less clear? Could we sure? Absolutely? What kind of inflation read? I think we're looking at a fairly significant spike from where we are now in inflation. If inflation stays where it is right now and continues to start to come down, I don't see a fifty basis weren't increased, But if we see a spike, then I think we might have to

act more aggressively. Are you concerned about the possibility of a hard landing being dismissed by a lot of feed officials is probably unlikely, and this sort of confidence that they can engineer this. Look, it's always a risk. Let's be clear, it's always a risk. But I think we we actually can do this if we really listen to

the data and act appropriately. And again, my first step in acting approprictly is marked stop the paper, stop the balance sheet purchases, and let's start raising rates by twenty five basis points. You in two two twenty adopted a new framework which made you state dependent in terms of moving interest rates. Is that out the window now? Are we back to forecast dependence? Since policy works with a lag, well, there's always you always have to take that into account.

But I think in this case, if you just look at the states of our dual mandate, we're there, so we need to act. I mean, I don't with there's back to employment. This is one of my pet peeves. Look, we're probably going to have a bad jobs report in in the end of this week. I mean, just because of Omicron. I mean, it's just simply because of Omicron that said, I mean, and the media will saying I'm not criticizing the media here, but it'll say the economy

only created X number of jobs. Now, the economy has created millions of jobs. We just can't fill them. It's a supply constraint and that is not what monetary policy affects. So I think with respect to employment and with respect to inflation, we are there at our dual mandate and that's why we need to act. Well, let me ask you the question I asked Chairman Powell, and that is what is your goal in terms of the inflation rate.

It was understood that you were trying to average two percent over time, but he told me you're not trying to go below two percent, which you would have to do to get an average. Yeah. I mean, at some point we'll go below two would be our guests. But we don't have to rush it. I mean, if we can get it in the ballpark, that's good enough. I mean, the measurement are sufficient where if it's slightly above or below two two and a half the one and a half, I worry less right now where we are it is

clearly a problem. The President Hunter, I want to try and move the dial on the balance sheet conversation because we really don't have much clarity, and some banks on Wall Street are trying out some pretty big numbers. Mattla Zedlia, Deutsche Banks talking about one trillion dollars of reduction next year, five sixty billion in the back half. You're about four hikes. How does the balance sheet conversation influence that decision? Is it separate to your rate high code? Does it complements it?

How does it fit in? Yeah, that's a really good question. So in my mind we have to reassert that the Fed Funds rate is the primary tool of buntary policy, but recognizing that the balance sheet clearly has an effect that ads or removes accommodation. So I would like to get the Fed funds rate up and then start a process of normalization that is like watching paint dry, that

has put it in motion, start reducing it. That reduction will be faster and steeper than the last time we've tried it until of course all this happened, and just because the balance sheet is so much larger. But we put that in process, we start reducing the size of the balance sheet and use the FED funds as the tool that we need to adjust if we need to adjust,

no question about that. Do you think that you will need to sell assets to get the balid sheet down, particularly on the mortgage side, since the Fed says it wants to hold primarily treasuries and you'll be stuck with mortgages for thirty years if you don't. Yeah, maybe, I mean this is something we're actively looking at right now. No decisions have been made on the balance sheet question. It is why where we're going to take our time. We have some time here right now to think about it,

to model it. Uh. Could could we sell assets? Possibly, but right now I wouldn't commit to any of that. Enjoys the analysis. President could just finally from me, do you have a number in mind when you think about balance sheet reduction on a monthly basis, one that would make sense? Can you give us some insights and real time thinking about this? Yeah? Yeah, not yet. I mean

I think we have to let that play out. Like I said the analysis, And what matters to me more right now is that we're committed to doing it, and that we're going to commit to doing this for the long run. That is, it's going to take some time to get balance sheet back to whatever normal is. And I know there's an argument about what normal is, and there should be an argument about what normal is because we're not the economy we were before we came into

the pandemic. So I can't put this precise number on it, but I think what matters now is that we are committed. I can say I am committed to making sure that we start this process possibly later this year or early in twenty three, and then let it run to get back to normal. This is a real time conversation. You guys are looking for tons of flexibility, Patrick, How could just to find a one from me? You satisfied with how the mark it is discounting some of the communication

coming out of central bank right now? You know the markets will will interpret what we say how they want to interpret it, and I think we can be as clear as we can be. At least I'm trying to be as clear as I could be where I think Powerlson should go and I think it's really important that the market participants are seeing the same data we're saying.

We're not seeing anything different than what they're saying. It's all question of interpretation and that we can we can disagree on, but at this point we need to let

the data play out. President Haka of the Philadelphia FETE, fantastic to catch up with you, say thank you very much for being with us alongside Michael McKay, Tom Kane, Lisa Bramison, Jonathan Pharaoh, Alicia Levine with this head of equity's capital market advisory at B and Y Melon Wealth Management, Alicia, what do you see in the corporate space that will

inform the FETE of the tough decisions they have to make. Look, the really interesting thing about earning season so far is that with all the concern about margins and inflationary pressures, actually margins have held up very well in the face of of input costs going higher and employee costs going higher. So that's an important thing because that's what the markets focused on, which is is the inflation out of control? And what will earnings be? Can we project earnings with

inflation is high? And the answer so far is yes. And I think that's why you've seen some stabilization in the market, because the fundamentals are actually coming in better than feared two and three weeks ago. So Corporate America is telling you it's still okay. Um. I was shocked to see the margin number and the aggregate and the company's already reported. So that's that's what's stabilizing here. And the other thing is, let me pay. It's an interesting

scenario for you. So we're all concerned about Russia, Ukraine and oil prices and have have being a hundred twenty dollar oil sort of destabilized markets. Well, what if it's done right? What if we what if the West says, you know what, we're not going to bring Ukraine in to NATO. Putin gets what he wants without, you know, uh, blood and treasure being wasted and oiled all of a sudden has a different kind of a price. And that's the case that I think the big shock worry to

the market is over. And I think that's a very realistic scenario. I'm just going through your sector right down. Some of the style calls just a thematic calls as well by business capital spending coatious on the consumer by Profitable Tank, by industrials, by haalth care, by financials. Where's the energy pace in all this than, Alicia? So we

like energy here. We just think that there's been a huge price shift upwards so far, and with the calls in the market for a hundred and twenty to even a hundred and fifty dollar oil price, I think I think that given the scenario, it may not happen, and we may be close to high as we're not there yet. There's still upward pressure on oil prices here, but I think many of the many of much of the move

is already done. We like energy, we're strong energy. But if we're talking about adding new capital today, I wouldn't add new capital today simply because the move is over and this expectations for World War three in Europe are probably not going to happen. Alicia. The scenario that you're

portraying isn't that optimistic. The idea that we're going to have lower long term run raids in terms of yields, that we have the priced in fed, that we have oil prices that are gonna come back down, and the margin story remaining intact even as you see wage inflation really raging. I wonder how much cost cutting, how much were This really indicates a later cycle type of stage

rather than something that is a resurgent economy. So look, we do think we're mid cycle here, and as you've been talking about all morning, this is dancing on the head of a pin for the FED. It's a dynamic economy.

It's not linear. These are not linear decision ends. But I think the yield curve has told us a lot in the last few weeks, which is, as rate expectations go higher for the FED funds rate and that two year moves higher, the ten year softens, and so we're now in a position where essentially, if the FED moved fifty basis points in March, which is not our base case scenario, you're going to destabilize rate pricing in the market.

And that's the last thing the FED needs to do right now because it limits their hands on the on the out meetings. So we do think you'll get Fed hikes uh March, May, in June, and then we have the FED will have to reassess where we are in the real economy. I think the FED issue here is not so much slow in the economy. It's job is to slow the economy right now because we're frying in oil. It cannot do anything about the supply chain. It can

do something about demands. So that is its job right now to soften the inflation picture because that's its mandate. And if it fails at that, at the mandate, that tends that's not going to be good for the institution. They be looking at a plas want to squeeze this in what is that leaf? The banks tride? So look, we we like financials. We prefer the insurance companies here because the insurance companies will do very well. Again, financials

have moved strongly. We've seen some of the pricing issues. We think this is the year for be selective. I think it's very difficult to play the sectors. You have to play cash flow, you have to play earnings, and you can't just buy. I think the year of buying an index or buying a sector call is going to be very difficult. You have to buy individual companies here with dividends, cash flow, and earnings power. It's a very

complicated year. Yes, we're still bullish, and we do think the Fed cannot go seven times this year, just like the OL curve is telling them that Alicia f B and y Melon Wealth Management. Alicia, thank you. This is a joy. We begin a two hour conversation with Douglas Cass of Sea Breeze here or automby Doug. Let me start out with trading. How was your January? Sea Breeze, which we just started, actually had a modestly up January,

which I could pretty well differentiates us. So your your your note this morning is fascinating and basically a lot of it's about being courageous when the fear is out there? How do you judge the when of that when to be courageous given present fear. I tend to look um at um measures of sentiment, um um a AII investor survey, oversold over what that sort of thing. Doug, late last year, mid to late last year on this program, you were

notably notably cautious slash barish um. And this is the beginning of this year, certainly, you know kind of I think kind of brought that to the four year Is it time to get more constructive on this equity markets? From your perspective, we got a little more constructive, um, I would say about two weeks ago. Since then, the SMP has rallied by roughly UM two d and twenty

SMP points. I know it sounds astonishing, and UM, we're sort of doing it about face now, we're taking advantage of that trading tradeable trading opportunity, which I called it, and I question whether we're in a bear market rally. Investors face a number of dilemmas UH. As mentioned in the previous segment, rates are being raised into a slowing economy multiples UH compression, stag slug flation, sluggish growth, stained inflation,

and hot and heightened volatility seems to lie ahead. And I think the strike on the Fed put as much lower than many believe. So UH it's my view that the odds favor that the rally over the last three days of January and into today may have been a bear market rally UM, but not likely the basis for a new bowl market leg UM. Yesterday I sent M Paul Tom Lisa John Um an important chart that I published on Real Money pro where I've been doing a block for twenty four years, and it's the NASTAC index.

It has cut through the downside of the fifty two hundred day moving averages and even with the remarkable two day rally is only back approaching the resistance of the two hundred day. So unfortunately I suspect januaries. UH. Market weakness was the first shot across the bow. In is going to be a down year? Frequities? How deep is? It's obviously uncertain. What are you doing with with your capital? You mentioned your your hedge fund. What are you doing

with your capital? Are there places to be uh in this mark in a rising interest rate environment, in any slowing economy. We have basically moved from in that long position. UM. And I didn't expect to do it this quickly, Paul, But UM, we take what the market gives us. UM. A walk is as good as a hit, Tom and Um, by the way, thirteen days too, pictures and catchers and the majesty and grace to show up. Yeah, that's a very good question. So there are pockets of opportunity of

a large position in the cannabis stocks. UM. Most of our stocks that were long our bottom up stocks UM. Based upon the bottom up analysis, companies like City Group, Federal Express, an interesting biotech company, fiber Gen, etcetera. But on on the whole, UM, I think that the winds of change are growing stronger, and um that that there are problems. I think that the FETE is clearly committed

a fighting inflation. I was listening to the interesting Fed worser president interview you had, Um, and we're moving into tighter financial conditions, and I don't believe many, especially the bullish cabal Cabal believe that the power will be very hawkish, and I disagree. I'm convinced he's going to stick to his mandates. Um. You know, the FED and its chairman have become very politicized, and Pal is now effectively part of a liberal administration which is justifiably concerned with social

well being for citizens. He listened to any interview that Secretary Yelling gives. You see that clearly, Um, they've continually emphasized recently the pain that the lower classes is going through today and over the last couple of years. So he must be inflation at any cost, and that political viewpoint will likely be matched or more harkish policy. And I don't think this is being understood by many investors do.

I want to talk about the charm of Douglas cast Trading and also writing consistently about big tech is a long term vehicle and you've led that with I believe a discussion on Amazon as well. Amazon, we saw Microsoft deliver, we saw Apple deliver Jim Suva's twenty pages on Apple three or four days ago. Is it whether you believe it or not? As a tour to force of looking out five years, how do you treat for fortress or moat tech is Ben Laylor calls it, how do you

treat him out five years? When the Montreal Canadians finally get good again. It's really tough because the risk free rate of return because of tightening, um, you know, because of the Federal reserve tightening, uh produces a lower value to present value of their earnings. So the opportunity short

term becomes a little bit mooded. But you asked about the long term, and it is remarkable to also use Warren buffets term of a mote their competitive modes of Amazon, Google, will Microsoft and Apple simply get deeper and deeper and are not penetrable anymore? UM. I used to be concerned UH Paul and Tom about the existential threat of regulation, but frankly, any regulation would benefit them because none of the smaller companies or uh, you know, medium sized companies

can afford the regulation. Doug, We're gonna have Google report earnings after the close. How do you think about some of those boy those Mega tex stocks, the Amazons, the Apples, the Googles the world that have been so such good performers for so many investors for such a long period of time. How do anything about those over the next couple of years. You know, you mentioned the moat issue, and you certainly hear people talk about motes when they

talk about those names. What I try to do is identify which which companies um UM are attractive on a longer term basis, create a core position, and then UM try to successfully and unsuccessfully trade around the core position. That's what I do. UM. Now is not the time at the margin to buy the stocks. I am long Amazon and Google, and I booked them well and I

sold Amazon especially well. UM. But you know, the Federal Reserve, as I said, is dancing on the head of a pin and titans and it's tightening into the lattest stage of an economic recovery. And you guys have been talking

about cost savings. UM. A lot of companies are going to continue to cut costs, but we're gonna have a steady drum of goods and wage inflation um exacerbated I think by persistent and sustained supplied change disruptions, and it's going to eat into corporate revenues and profits for for what I call the nifty seven you know, um fang plus um uh Navidia, etcetera, and um. So, I think

we're in a problematic environment. It's funny how Guy's price changes sent him at four days ago everyone was besides himself negative raising cash, and now the SMP has risen by two forty points and they're getting a bullion. And I think that optimism is as misplaced as a pandemism

was a week ago. And I think that also conclude by saying there are bad habits on the parts of many retail and institutional investors over the last couple of years, and I think they're going to continue to be challenged and rapidly replaced by wisdom, a sense of his history, and common sense traits that have lost their relevance but likely to regain popularity in the months ahead. So I see a trying environment, Doug, we got to leave it. There are out of time, Doug cass with us with

sea breeze. This is a joy. Semestian Maloby is a collective, to say the least, with the consulant Foreign Relations, a senior fellow. You know him from work on Mr Greenspan, work on the hedge fund industry, and now he's tackled in a mustard book for this summer. If you're part of Global Wall Street and you feel as ignorant as I do, then you must address Sebastian Maloby and the new and important the Power Law with a beautiful yellow cover. You can't miss this Amazon or at your local bookstore.

On venture capital and the making of our new future. Sebastian, congratulations again, are providing clarity on something mysterious when you started this project. What was the biggest mystery for you of this strange phrase venture capital? The biggest mystery tone was how do you even begin to allocate capital when you are dealing with startups? There are no quantitative guiding guidelines. You can't like, discount the future cash flow because there's

no cash flow. You can't do book to value because there's no book value. What do you have is two legged mammals walking into your office with a dream and so just that share lack of guide post intellectual blank sheet. That's what drew me into the subject. What if I'm fascinating is from the beginnings and you cover so well Kliner, Perkins and all of it in the stereotypes we all hold out to the present day and say soft Bank, and you touch on that later in the book as well.

His venture capital then even remotely the same as venture capital now is represented by soft Bank. Well, soft Bank is a special special case, and so is a special special person, right, I mean he has such a willingness to take crazy risk. Now he blew himself up in the Nasdak collapse. But at the same time he'd just taken that position in Ali Baba, which went from twenty million in two thousand to eight billion fourteen years later. So I think he said of a case unto himself.

Maybe the question is like Tiger Global, Right, that kind of growth equity investing, which didn't exist maybe fifteen years ago, has now become front and center, and that is a new departure for venture capital. Sebastion. It seems like a lot of money has been flooding inter venture capital with the promise that you outline that even if a lot of the investments that you make are does there will be a couple real shining stars that absolutely are torpedo

to the top. Is it different now to find those? Is it harder to find those at a time when the beheemoths of the world I'm thinking the Google's, the the facebooks, etcetera. Are buying up so many startups before

they even get off the ground. Well, one of the cool things about this space is that when you're doing the really early stuff and you're writing a check for five million, ten million, um, you're not going to get the big growth players involved in that that it just doesn't move the needle for them on their huge portfolios. So if you're doing the early stage staff, you have a kind of timeline in your mind of five to

seven years before your exit. Whether the stock market is up or down or sideways, what you know, whatever it happened to get interest rates, who the president might be, it doesn't matter m So you can just basically look for what you think is going to be transformative technology. Yes, you will get it wrong most of the time because that's the nature of the business. It is a power

law business. Since my title, um, but you know, you hope that you will get one or two bets out of ten will be exponentially right, and that will more than make up your whole portfolios. A lot of people are talking about the productivity gap in the United States and in the modern world, and basically we are not seeing a huge productivity boom, and they say, well, this

could potentially change if there's some massive technological shift. Based on your conversations with venture capitalists, you see that possibility percolating right now. Yeah, I mean, I think that you know, the stuff about productivity being down is partially a measurement issue.

When good surprise at zero, as they are with Google Search, for example, it doesn't show up in the of activity numbers um And I think that you know, if you just turn the question around and say, how much do you think your life has changed in the last twenty years, How do you collect information, how do you think? How do you arrive at quiet epiphanies? All these things are fundamentally different. So I have a hard time sallowing this idea that there's been no innovation to speak of in

the last couple of decades. I think I think there really has been. At the end of the book, Sebastian, you have Josh learner of HBS and he's talking about a boulevard of broken dreams. And the huge modern question is it was a small group of people associated with San Francisco and Stanford and it's expanded out to where we want retail individuals and others to take part in venture capital. I don't understand how the little guy takes advantage of the power law. How do they? I think

they don't, is the honest answer. One of the troubling things about the private investing world is that it's it's a game for people who are hands on. They're on the board of the company. They are super involved. They're pretty expert. They understand what the company is making. They have an engineering degree. This is not for amateurs um and I think this private, hands on venture capital type of investment is key to the the progress of the you know, an economy where you have a lot of

intangible capital. We used to have capital goods that you could drop on your foot. Now it's services, it's I mean, it's it's knowledge, it's software, it's intangible. We need the venture capital, but unfortunately the little guy can participate. I'm gonna tend more questions. We don't have enough time Sebastian Malby comes on foreign relations. The book is the power law of venture capital, the making of the new future. And what's important is even and there's a lot of notes.

It's not that intimidating folks on radio. It's a little bit thicker than normal. But all I can say is this will be the definitive Wall Street read this summer. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. 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