Surveillance: Inflation Picture on Weak Side, Hooper Says

in Japan an important election over the weekend. The short answers Abe wins again joining us now Robert Feldman of Morgan Stanley MUFG, their senior advisor in Tokyo. H he is definitive on Japan and their political economics. Robbie, thank you so much for joining us again for at Tokyo. What was the character of this victory for Mr Abbe? The victory was a little bit stronger than I had expected. He has now again got a very strong majority in

the Upper House. At the moment, he does not have the two thirds he would need to amend the constitution. There's been a little bit of talk about one of the center left parties may be coming along, but he has all the votes he needs to get major economic legislation through if he chooses to do so. And that is the issue that I think markets are going to start grappling over the next month as they see him redo his cabinet, to see who he appoints, see what

the policy priorities are. That is the issue I think is before investors. Now, who votes for Mr Abe? I mean, does he have the support of Iowa, is at the support of New York City? What is the character of his supporters? Well, his supporters are broadly small business um uh, the general public uh, the sort of center right, and a little bit of those who are focused on say

agriculture or other industry interests. But I think another very important new support for has come from young people because Primeister obb is the one who pushed and achieved the

lowering of the voting age to eighteen. Moreover, if you look at the voting results on some call it litmus issues between call it left and right, such as constitutional reform, what you see is that it's a much larger share of older people who are on the left wing and a much smaller share of young people who are on the left wing, although obviously there are some so I

think that's also an important characteristic to look at. Probably we got him back, I don't know, six years to Shinzo Abe, the Prime minister that's talking about sales tax hikes. Are we finally going to get this sales tax hike one and two? What do you expect the fallout to be? Uh? Well, the answer on that is almost certainly yes, because he said as part of the election that yes, he would the hike the tax as has been all ready legislated,

and so he doesn't. If he does nothing, and that would be hard to redo at this point, then the tax will go up on October one. The negative impact of the tax, I think will be significant, but not nearly as bad as it was in two thousand and fourteen. At that time, they not only hid three percentage points, but they also made a revision to the social security system to take back some of the over indexing that had allowed nominal pension levels to stay where they were

despite deflation in the economy. So all that took about three percentage points out of the out of GDP. This time, they're only doing two percentage points on the consumption tax, and they've already passed some measures to ease the burden, partly in some spending areas that are really necessary, like better education things like that. So the negative impact will probably be smaller than it was last time, but not not tiny. So, Robbie, that's domestic policy. That's the tax hike.

Let's talk about what I don't think has got much discussion here in the United States, the trade dispute between Japan and South Korea. Just frame that for our listeners, Robbie, what is going on between Japan and South Korea right now? Well, there are a couple of things that are going on. One is that a few months ago, the South Korean Supreme Court made some rulings that were inconsistent with Japan's interpretation of the treaty, and so there's been a lot

of back and forth on that. In addition, most recently, I think was July one, Japan decided to to take UH South Korea off the so called white list for the export of certain dual use items. These are items that can be used in the manufacture of nuclear weapons um UH. Now, also we've seen from Korea a couple of statements from diet members UH that some of these materials over the last four years actually have been diverted

UH to or sold in non approved ways. So from the Japanese point of view, this is an issue of national security of great worry to the South Koreans. UH, they don't believe this or they don't believe it. They think it's much more oriented towards UH call it tit for tat retaliation and might be political, etcetera. But I

think there are two issues here. One is that those of us, you know, regular working stuffs like us, don't understand the chemistry of what's going on, the difference between an extraordinarily good quality of this sort of material and a pretty good quality apparently like night and day. So that's one issue. And then there's probably some information that most of us don't have, like what happened to those exports that kind of got out of hand? Why did

it happen? Are the matters? Are the methods that these companies have to control experts? Are they actually sufficient? Moreover, when you think about those things, there is a huge incentive among the Security Committee not to let information go public because if they do, then some of those sources might be might be compromised. So it's very difficult for investors to really know what's going on here. Dr Felman, Thank you so much, greatly appreciated for the Morgan Stanley

m U f G in a Tokyo. We are thrilled to bring you know Peter Hooper, who is a Deutsche Bank They're global head of economic research. Really just set the tone here. Dr Hooper, thank you so much for being with us. I love your headline off your note. Will the first cut be the deepest? And this goes to almost the inertial impact of a rate cut cycle. Is it biggest early on or is it bigger is you add on rate cuts forward? Good morning tom um.

You know, certainly the debate has been um uh whether whether to go big upfront, fifty and done, or or make it a little smaller and uh cuts over time. We we are still expecting several cuts this year. We think we'll get a total of seventy five basis points. That that does assume that things get a bit worse on the trade front and uncertainties continue there. But it certainly is not It is not a picture that says you need to be aggressive up front. We don't agree

with that one. I mean, the economy is okay, um. There are a number of reasons why we expect the committee to want to cut rates um um. But but I mean the case against fifty, I mean not cutting deep. The committee committees, you know, committees mixed on this economy generally, Okay, we're not too far from neutral, and cutting a lot could overshoot. There are a number of other factors in there we can talk about. Well, one of the factors to me is the reaction functions. Since we're at the

lower bound. I mean, I know, everybody wanders back to you know, everybody's got their analog they like to look at. But those analogs aren't with negative interest rates. Those analogs aren't with near zero percent rates and certainly zero really yield rates as well. Does does your do your dynamics work here like they've worked before. Well, yeah, we are close to the zero bound. We're I guess nine basis

point cuts above it. One could argue, yes, you definitely want to go aggressively given how close we are to zero, if there's a serious risk for the economy. We're not in that situation. We're not at a serious ritt. We're not at the point that would warrant doing doing a lot extra up front right now. I think the basic reasons for cutting rates. Now, Yes, we have some we have some risks on the global front. Yes, we have some uncertainty on trade. The going to continue to fester

most likely. Uh. And we have an inflation picture that's a little on the weak side, and I think the Fed wouldn't mind seeing inflation move a bit above two. So so the risk to to going further below neutral, if you will, are not high. But it's not a case of hey, we're we're on the cusp of a downturn here, we need to act aggressively. That just isn't the picture right now. Paid a lot of pressure from the President this morning through Twitter on the FEDA reserve

needing to act. Does that complicate things just optically month end? You know, you know it? It does? I think. Um, the Fed, I mean left to its own devices. If if, if we didn't have the mixed economic picture and everything else, I mean the Fed, the Fed is going to move policy based on where it sees the economy. Um. If the economy we're not in the picture. Uh. Pressure from

the administration of anything I think is counterproductive. The FED does not like the impression that it seems to be growing, that the monetary policies being run out of the White House. Uh, this, this is counterproductive, I think, and it well one factor that to my mind argues against fifty. You don't want to act aggressively because says, okay, the Feds jumping when the way that jumped, and that that's that's that's bad

for perceptions about independence. Peter. One final question the idea of how business will react to the first second, the third rate cut. I mean, do they act or are we at a point where they don't change investment plans off of more accommodative policy. Well, I guess you know at this point basis point cut is doing at least something to to bolster financial conditions. Um. Yes, if you wanted to really give financial conditions a boost near term, you might want to argue doing more than more than

the market expects. But I think we're we're a bit below neutral. I think everybody every little bit helps in terms of supporting financial financial conditions. Um. But the bigger, the bigger issue is what's what's going to be happening. The trade policy for that is the main drag, that

is the main factor holding back business right now. We've got to leave it there, Peter, Hooper, Thank you so much for the briefing out of all of economic research at Deutsche Bank this morning and with us now Brookes Sutherland joining us on the industrial space as they call it, this will be a two hour conversation right now, two hour conversation on industry. It's oh the rage right now. All sorts of smart people are in the value in

the the trade manufacturing gloom gloominess of industrial. Who's gonna win this battle? The earnings are terrible, crew or those that are buying deep discount value. I don't really know where the deep discount value is at this point. I mean, I think one of the things that's interesting to me is just how much some of these industrial stocks are up going into earning season. And I think that's why you saw really big disappointments at the likes of CSX.

I mean that stock was up going into earnings, and then when you have them come out and drastically cut their record about honey well, I mean, honey well, the gloom there you wrote about the gloom. I'm looking at it as you beautifully stayed as you always do, Brooke. They lifted organic revenue sales vision. That's not gloomy, is it? So the thing about that, so they did raise their organic revenue guidance for the full year, but the second

quarter actually came in way weaker than analysts. I'm not buying it for ninety days. I'm buying it for one year, two year, five years, twenty years. So the thing I understand. The thing it gives me pause about Honeywell is people typically think that they are just being conservative and there's upside to their guidance and they have the opportunity to raise down the road. And this to me does not feel like they're trying to set the bar low so

that they can beat it. It It feels like they have legitimate reason to be concerned to be cautious here sixty Honeywell's business is shorter cycle, so they don't really have that much visibility to how well it's going to turn. Um sound like a cell side analyst. I'm just trying to be, you know, properly this morning, get us all in trouble. So so when it was honey was like a twenty times earnings whatever. I'm not even going to mention the name of the company. It's a vanilla um,

it's a vanilla industrial company. Good morning, Cleveland, Ohio, and they're trading it like fourteen times earning. Are people comfortable on this stuff just because it's cheap. I mean, I think it depends on the name. I think aerospace is still a really safe place right now. I think you saw that with Honeywell eleven organic sales growth in their aerospace business. I think we're going to get numbers tomorrow

from the United Technologies. They're going to reflect similar growth there in their aerospace business, and I think that gives people confidence um in that sector continuing to be robust

for the time being. But you look elsewhere, particularly at some of the shorter cycle markets, you just see you know, ground swells of weakness there, and I think that should make you nervous and make you feel like maybe some of these stocks are not quite cheap enough, especially if I think about three M, which is also reporting later this week, and I think, you know, expectations there are that we could see yet another guidance cut, which would bring us, by my account, I think, to five in

the past year, which would be you know, a rough start for that new management team. I mean, I look at three M as a separate beast in itself. What a difference in relative performance versus other industries. It's really rolled over there from two thousand and eighteen early as well. Let's go back to the railroads, you know, the transports. I've had more doubt theory conversations I think in the last ten years. I've in the last week and a

half c Sex as an example, the airlines. I guess this bundled ugly thing called transports is that the transports of of of my mother and your grandmother. No, I mean, I think it's interesting. I think you're right you think of this as a very sort of old school industry, but it can be a linking indicator for for where we're going, just you know, in terms of measuring demand.

And Bloomberg News came and Creees actually did a really interesting last week where he compared the Transport index to FedEx and so FedEx has obviously that it's share of issues, and but it's also exposed to international markets, so it can be sort of a proxy for the trade war versus railroads, you know, just by nature of their business

are more domestically focused. So if you start to see the railroad sell off, that could be an indicator that you know, what, the domestic economy is starting to loose steam, that maybe we're starting to see this weakness spread into America. So it's sort of an interesting proxy for the what's the correlation of railroad prices right now to trade war Trump? You know, the whole thing not very much because they're

so domestically focused. I mean, to the extent that the automakers are struggling because of the trade tensions huge A huge part of the railways business is moving the cars, and so that's been weak for them. Um, you know, lately, they've struggled a lot on the intermodal front, and intermodal is sort of your typical consumer goods that can be transported via either truck or rail. So part of that's the trade war. But the other part is that the

trucking market is weak right now. The prices are down, there's a lot of capacity there and so they're starting to see some of the pain points there. But you know, they sort of last a lot longer than names like FedEx Um in terms of volume staying up. But the other saving grace for them is they've all been under these easy efficiency cost cutting plants, so their margins are going up even though volumes are coming down. So what's your focus into this this earning season. I mean, which

company is sort of the Brooks Southerland one. I've really got to dive through well ge always, but they're industrial yeah, oh yeah, I mean at this point they've gotten rid of all the consumer facing businesses, really wound down the finance arm um. You know, I don't know if that so much as a is a key, you know, indicator of where the markets are going. But I will say that company, more than anything, is very vulnerable to swings and interest rates, just given the size of their unfunded

pension liability and then their long term care insurance balance. Um, those are very sensitive to steps down in interest rates. And now we've got one more question for Brooks Southerland. Of course we have to do this, which is she is our surveillance movie mean, scarlet food is our celebrity Loadstone Brooke could never touched scarlet foods and cyclopedic knowledge of Hollywood, but you didn't go right there on movies anytime you were you were one of the one eighty

three million dollars in Lion King this weekend. I was report. You know, I have to say, it sort of lacks something for me. I don't know if it really added value to do the c g I lions. I just maybe I'm too old school. I liked the old cartoon version. You can see more emotion with the cartoon animals than you can realistic looking lions, if that makes sense. But they did have a c at the movie theater. Selling point was scars suitably scarry. No, it was much more

faded it was. I mean, it took me a while before I even found the scar on his face, and it was it was more Was he a more modern sensitive scar now the classic cartoon? No, it was still just as Um. There's a lot of violence, a lot of regicide and um, I don't know what the word is for uncle's side, but that is uncle's side. You just the basic ideas anyone with a with a dog at home. I was lifting them up this weekend doing this Simba routine. I mean, you know, the torture of

dogs at vet Bill hated it all weekend. We're doing a Simba routine with Vett Bill all weekend. You know. But dude, well, it's just like three star, four star, five star. I would give it sold three and a half that experience. It was fun, take me back to my childhood. And the air conditioning was good, the popcorn was good. Yeah, what wait a minute, what the popcorn cost? It was a lot. It's a lot. And it also comes in this like industrial size that basically like you

could feed a family of six. So thank you so much on Industrial America with lots coming up UM as well, this is a wonderful moment for me. Jonathan porteris as a King's College, and I can tell you that in all my conversations in the United Kingdom on the oddity of the constitutional ballet of a disunited Kingdom, he has been hugely valuable. Professor Porters joins us now from King's College. Your mathematics at Oxford maybe prepared you for this moment. Professor,

what is the mathod? What is boris Johnson's mathematics? When he becomes prime Minister Johnson? What is his calculus? Um? So the big question is that Jonasan could really go one of two ways. UM. The first is to UH is to say that um a no deal breaksit would be bad for the UK economy and perhaps more importantly, from his point of view, bad for him politically. Um, and that therefore he needs a deal with the EU. UM. And that essentially means the deal that is already on

the table, the deal that Theresa May has negotiated, possibly rebadged. UM. I think what UH in American politics is referred to as putting lipstick on the pig UH and then UH and then trying to sell that to the UK Parliament and then to the to the British people. So he could go that way. UM. The alternative is to for him to say, as he has done in the campaign, that Theresa May's deal is dead UM, and that if the EU want a deal, they're gonna have to throw

it out and start again. You have said that's not going to happen. UM. If he goes down that route, and that seems to me the most likely one, then the most likely outcome is that we are headed for no deal, that the UK Parliament will stop him from going to no deal, and that we will have to have an election to sort it out. So that obviously is a very high risk gamble from Mr Johnson to take, but it is really the logical consequences so far. Now. Mr Johnson is no stranger to changing his mind when

he decides it it suits him. Um, I don't think anyone would describe him as the most principal politician in in UK politics, so he's quite capable of doing a U turn. But at the moment, the logic point to US heading for no deal UM, and US having a general election relatively soon within the next six months to to decide whether or not that's through it we want to go. So, Jonathan, is there any sense yet it's been you know, several years now of what a hard

Brexit really would look like for the UK. Um. Well, I think we have a much better idea now than than we did about what a hard break it would look like. And we know that some of the worst potential impacts of a hard break of a no deal Brexit will not materialize. So UM. In technical terms, if nothing at all had been done, then planes would stop flying between the UK and continental Europe for example. That's

not going to happen. Uh. There are some legal fixes that the EU has put in place UNI laterally to ensure that planes will keep on flying, UH, trucks will keep on rolling UM. And on the UK side, we've made contingency plans so we can avoid things like shortages of medicine and so on. So I don't think the idea that, as was technically possible at one point, that that what the the UK would literally be cut off from the continent and that there would be a quick

descent into chaos with widespread shortages. I don't think that is very likely. But there will be significant economic disruption because the one thing No Deal clearly does mean legally is new tariffs, trade barriers and custom controls bete queen the UK and continental Europe UM and given the degree to which multinational companies have um European ied their supply chains over the last forty years, relying on the complete absence of any such borders or controls, that is going

to be pretty disruptive. So you'd expect to see rises in prices, probably a fall in the pound, um, possibly some localized disruption and shortages of some things. Although I don't think it will be as bad as some people claim we do, but it will not be. It will be bumpy, it will be disruptive. So, Jonathan, I know in your list of potential outcomes here you did not mention my favorite, which is the second referendum. Is that

as there are no momentum behind a second referendum. Um. I I think that the second referendum is a certainly a possibility, but we're not We're not We're not there yet. Um, it is possible, I think, I do not think the there is. Some people have suggested that Boris Johnson would indeed do a complete cynical U turn and decided the best way out of this bind in which he'll find himself in is a second referendum. I think that's unlikely.

I think it would be politically suicidal for him. But one possible outcome of the election that I've suggested is likely. If there is an election, it will be between parties on the one side and the Conservative Party led to Boris Johnson and then breaksit Party led by Nigel Farrens who want a quick no deal Brexit, and parties on the other side, the Liberal Democrats and Labor who are

broadly going to be committed for a second referendum. That election is very unpredictable, but if it goes one way, then you could have a second referendum. So the second referendum is certainly on the agenda in a way which it wasn't a year ago. Is the nation exhausted by this. Do they look at this as a tipping point where Prime Minister Johnson will come to the rest? You will, Larry the Captain, Life will go on And are we at a tipping point of a constitutional crisis? Um? I will.

There is certainly a very widespread mood that we are that Brexit has been a complete mess. The government has made a complete mess of it, and everyone wishes your a large proportion population are very bored with it and wish it would somehow go away, uh, and that they could forget about it. The problem, and this is why it's such an interractible problem, is that none of the

options on the table we'll make Brexit go away. The idea, the attraction for some people of a no deal Brexit is well, okay, then we'll be out, it will be sorted, We'll have this clean Brexit. But the fact is it won't because there will be all sorts of things. It isevitably we will end up back at the negotiating table with the EU trying to work out what to do about all the resolved issues about tray, about transport, about exit bill, about citizens and so on. Equally, even if

there is a second referendum. Uh, that's not going to bring back the country back together either. And there is a very large sports of population we will see that is a betrayal and overturning the first reverendum undemocratic and so on. So unfortunately, well, I think there is a very large portions of population will like one way or another, rate it to be over with. It's not going to happen no scenario under which we don't continue to be

talking about. It'll keep us, it'll keep us employed. We look forward to seeing you in the green at Westminster again. Jonathan Portis at King's College, thank you so much for perspective away that that's the best word intractive. Yeah, And of all the people I run into there, he's the clearest speaking about the permanence of this, which I find fascinating. Yeah. Yeah, I think, you know, as he mentioned, there may be you know, another election here that we needed to sort

this out. 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,