Surveillance: Markets with Wu Silverman

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I'm Tom Keene, along with Jonathan Farrell and Lisa Abramowitz. Join us each day for insight from the best and economics, geopolitics, finance and investment. Subscribe to Bloomberg Surveillance on demand on Apple, Spotify and anywhere you get your podcasts, and always on Bloomberg dot Com, the Bloomberg Terminal and the Bloomberg Business app.

What is around a table? And we were Silverman, no idea if you went to First Republic when Right Spot Congratulations had a disy strategy. OBBOUC Capital Markets. You've got a great phrase in your notes, Aman, wonderful to see you in person. By why you guys, you said this the paddling duck market.

What's that?

That's the market we're in right now. I mean, we got this chill, cool duck hanging out on the surface, furiously paddling underneath. And that's the equity volatility bid. You know, we don't see it in VIX headline. VIC is really low, right, but the reality is VIS call open interest, that demand for volatility going higher is at all time highs.

I'm speaking when Nacim Tolb in I like three or four weeks, and we'll go to the tails immediately. And you make it real clear in your note that there's a tail irregularity here. Everybody's focused on the left tail. Tell me about the right A tale of optimism.

Yeah, so the tale of optimism does not exist. You know, I've been visiting kind of clients in Europe and Canada, and the US consensus bearishness across the board. It's really overwhelmingly so. And so you get to this point where you have to ask, you know, the right tail is so underpriced. Is there a possibility of a congressional miracle?

Woa.

This is actually going against the consensus in a big way. People have come on the show again and again and said, nobody's pricing actually a debt ceiling debacle where you end up with some sort of default, except perhaps in the one month t bell market. Are you saying that's not true, that it's actually aggressively being priced in the equity world.

Yeah, So here's the nuance, Lisa. What is happening is essentially the volvatility market is saying the tail has to wag the dog first, meaning we have to see action in the equity market, which means a draw down before we see some sort of action in congress. Does that mean an actual default, maybe not, but it's definitely going

I love this idea that the common the market is people not willing to make a move by selling what they own, but they're doing it all through derivatives. So, based on pairing those two, what is the most underpriced reality right now? Is it this upside surprise or is it something else?

The most underpriced reality right now is the idea that this debt sealing situation actually gets resolved quicker and easier than we think. That is not what is being priced in the market. Folks are very very well prepared for a debacle, and so if we don't get it, it would be very interesting to see all these hedges roll off. You know, that is not being priced.

So sometimes there's a big difference between ideas and execution, and it frustrates people at home, and you speak to those people, those people in the market. If I wanted to position for a so called up crash, your language the language other people use it as well, before I get the downdraft and the tension. Because ultimately we're acknowledging and you've alluded to it. Do you need to get the crisis before you get the solution, or get very

Yeah?

You know, And that's the tricky part. I think right now it becomes Look, if we get the draw down right, so the market move happens a little bit, then that upcrash scenario becomes a little bit more expensive because we've already taken that down hit. So in some ways you do have to start placing it right now. The good news is it's relatively inexpensive. One of the reasons, and I've been saying this to investors, the reason VIX looks

Every crash in the hindsight is about opacity. I didn't see it coming. It was a mystery, the cliches, the shadows in that nineteen eighty seven, nineteen ninety eight, et cetera. What's the biggest mystery for you right now? Where's the dearth of information? To me?

The most fragile part of this market, tom is this problem of breath. So one thing I looked at that I think is really interesting is if you just take S and P consensus price target on Apple right now, that that sharp ratio is negative on Apple, meaning you're actually better off in cash. If you assume expected rate of return of the S and P of the Apple price target, then you are an Apple. The breadth of the market is so heavily weighted and it's very fragile.

Is that sharp ratio adjusted because of the velocity of the risk free rate? You know, had no risk free rate for three years, we have exactly doing it, and pop, there's the risk free rate tumbling. Do you have an accurate risk free rate?

There's a belief.

Do you have a belief institutionally in a risk free rate forward?

Yeah, so we're assuming a risk free rate right now of just you know what we're getting on cash right now. So obviously that could go down. But if you just take from last year to this year, it going from about one percent to almost five percent across the board. Obviously all equity sharp rashes decline, but also your forward looking price targets are declining.

I just want to follow up in one thing that you said, where you said it's very fragile because of a very very narrow depth. How much does that suggest to a downside shock versus an upside shock or does it not matter. It just suggests there will be a break one way or another. It will be significant.

I think the biggest thing to watch right now is if the market decides that megacap tech is not a safe haven, because you could actually get financials ripping or industrials ripping, and it wouldn't matter on an S and P level. You could actually see the index level trade down right because the heavy weights are the ones selling off.

The action happens beneath the surface most crowded trades B of A. In the survey, what the indications short banks, long tech, top two traits, top two traits identified by people in that survey ex and.

The lack of breadth is what the phrase I used, choiceset there's no choice set out there now. I could run a prospect to structured institutional portfolio, John, because you have to have X number of ideas in the portfolio, and there's not enough ideas out there right now.

I just think this is fascinating, this idea that you could get a better than expected economics shift, whether it's the debt ceiling or whether it's data, and all of a sudden you end up with index level losses because everyone floods out of the very narrow range of stocks that have really been driving all the games.

I mean, Amy's with us for the entire hour.

We got to talk to about the scenario you're coming out of an edtheim in two point eight percent inflation.

No one's prepared for them.

Nobody told me about that.

Face it is trying to suggest it.

Amy, Thank you, thanks wonderful to say it. Griats a seal in person. I'my with Silver, theman that of BOMBC Capital Markets.

Right now to drivers forward in Washington. If I was to say all this, it would be maybe Tom that's off the mark. But when Libby Cantrell writes about pearl clutching in Washington, you pay attention, and it's make a modo double A's and Tiffany's strands of pearls down there.

I love how you do that pearl clutching in Washington.

Is Margaret Smith the ghost of Margaret Chase Smith down there theears right now?

Yeah? Yeah, I mean there. I think there there's been quite a lot of hysteria pearl clutching, if you will, regarding the dead ceiling. But you know our view, and I think to your or your earlier conversation, certainly the mood music is positive. We would argue the mo mune music has been actually quite positive for for quite a while. I think the contours of a deal are absolutely there. The details just to be filled in the fact that they have Silanda Young, Steve Richet Orcutty. These people are

That seems to be the conclusion of so many people down Wall Street. You need to get close to a crisis before you get a solution. Why are you taking a slightly different well.

I think, well, again, and John, I've just been looking at the political incentives here for several months, and nobody has any sort of political incentive to even get that close to default. I mean, if you look at sort of Speaker McCarthy's hand, I mean, he doesn't necessarily have a very strong hand going into these negotiations. He only has a four seat majority, meaning he can only actually just lose five members in order to to sort of

The peddling duck is going to pass.

Gating sort of this morning has been quite something.

One of the reasons why I love to speaking with you, Libya is because you have incredible experience working on Capitol Hill. You understand the political wranglings that go into getting this done. What do you think the contours of this deal will look like? What changes will really take place?

Well, look, I think very importantly is sort of the semantics here. So President Biden will characterize this as a budget deal associated with fiscal twenty four spending, where Speaker McCarthy will characterize us as a debt seiling deal. I would say that's a distinction without a difference, and from a market's perspective, But what we're expecting is that there will be some recision of the COVID unspent COVID money.

There just kind of an irony here. If the market is expecting latility and expecting to have to respond eventually and not expecting a deal, do you expect market volatility in response to a deal that you see as soon as this weekend?

Well, look, I think that we have to talk about which market we're talking about, because of course the fixed income market, which where PIMCO manages most of its assets, has reacted right. There has been a dislocation in the treasury bill market. There's been a big risker version around the bills that have expired closer to the X day. We saw that in the auction most recently in terms of the yields, and so we already are seeing some

Don't tell your work with a Pimcok call in Newport the idea that we're at a five percent general statement on short term paper, do you guys believe we're coming in?

Yields will come in and.

Frankly benefit Washington as well, where five percent becomes a three point eight percent shield.

Yeah. So I think that you know, our view in general in terms of of the FED and the economy is that the threshold for the FED cut is going to be high. We think that the FED is going to have to see sustained economics and a sustained economic slow down before they before they start cutting. So I think we disagree a bit with where the market pricing is.

To do it.

When was the last time we got today this sit around the table together? How many years?

In the last two weeks.

And just started to pick wonder back up. I've said that a few times this morning. It's happening.

Getting back to the office. Are people getting back to the office there?

I mean, we've been never left for a very long time.

Ever left.

We never laughed, Thank you, John, That is actually correct.

Lilly Cantrell of Pimco.

Debtlimit talks between President Biden and congressional leaders intensifying. Mike Schumacher of Weils Faker and the team have got this to say. At the moment, our economics team is skeptical that a sweeping debt seiling agreement will be reached over the next month to suspend the debt scening for one to two years. A short term punt, Tom, I think that's a kick the can that buys more time for an eventual sweeping agreement is the higher probability outcome in

To see a punt their giants American football. That's when you're down three downs in the fourth down, you.

Can is that the guy that comes on just to kick the boat.

Just to kick.

They used to have a rule he could be hit by the people coming in, but now they have goals to protect them. OK.

So you think he's good. He's just kicking the boat.

Yeah, nice the punter.

We called it Jemmy. Goalkeepers would love that job. They would ex Premier league goalkeepers would find that so easy.

A CIS Sports report. It continues in this plot as well, saving us right now, Michael Schumacher joins his global ahead of macro strategy at Wells Fargo. The courage is defined in your research note, Mike, is that you are long duration. You're saying get out there, own bonds. Yields will move lower. Discuss given the debt ballet in Washington.

Yeah, that's the only time it's tiresome. But it's not going away quickly in our view. Yeah, we still look for the market to panic a bit more. It's interesting, you can talk about the market, but it's really the markets here. So the treasury bill markets in full throat of panic mode right now, you've got yields on May bills that are low threes, yields on June bills that are called medium five. So an enormous gap there. But treasury bonds tenure treasury three to fifteen neighborhood. It's been

What on a year basis is long duration? Is long duration five years? Or is it twelve years? Or dare I say it's an Austrian pre sought fifty years? What's long duration?

Now we're not going to Austrian here. Let's keep it to call at the tenure and the reason I say that, certainly it's the benchmark. But when people want to move a lot of risk globally, that's where they go. They

I keep thinking about this paddling duck market that Amy with Silverman was talking about, because it seems very difficult to get our hands around with respect to the debt ceiling. And then some of these company profits that are coming out, these company earnings that are coming out as we get retail sales. I'm wondering if you could weigh in on Paul Donovan's point that companies are really expanding their profit margins and consumers are only just now starting to push back,

Yeah, it's really interestingly soon. We think we characterize inflation right now as stubborn globally, you think about it country after country. Canadian data came in high yesterday recently Australia hiked surprise the markets. You look at the UK, inflation and data are pretty unpleasant, especially on the wage side. In the US, I'd make a similar argument. So, yes, inflation's come down as it come down nearly as quickly

How much shouldn't you actually just go into some of these companies though, with pricing power, If they're able to expand their margins, it doesn't really matter a lot of the other potential issues because they're still able to make bank because consumers aren't pushing back that much.

I'm going to leave the more the earning discussion in why colleague Chris Harvey. But when you think about it from a macro perspective, it does point to more inflation as far as we're concerned. That's the big takeaway I've been focusing on recently.

I looked like a where we are in May, and what it just simply comes down to is we're all baffled in a tight collared range. How do you know when the caller's over in which way a given vector goes. What's your experience on that?

Yeah, we can see gap ye types of moves, Tom, We've seen it a few times this year, certainly around the Silicon Valley Bank. And I'll give you an example. So dollar yen was one thirty six exactly seven something like that on March eighth, call it went to one thirty. So call it a four to five percent move. That's a big move. Not as big as the type of move we had last year, but they were more secular. But something like that that happens in a week or two in a super liquid market, that tells me we

I look at.

Finally got those results from TJX. Let's get to them. Thank you, sir as always on a bond market from wels Fanca, My Schumacher there.

Michael Gapan joins us now ahead of the economics at Bank of America Securities. I like the idea of the last resort. They really don't want to cut rates. What does history tell us about when they do cut rates?

History would tell you that the housing sector would bounce back quickly, all the sectors that have been in trouble recently would bounce back strongly. But history tells you the fed's cutting rates for a reason. They're either achieving their goals on the inflation side in this case, or there's been a stronger downturn in the economy and policy is shifting towards helping activity recover. So typically when the FED cuts, there's a reason for them to be cutting.

They keep pushing back on market expectations for cuts. And Andrew Holland Horrice of City Group has kind of been out alone saying that this FED is completely underestimating how much the inflation is out there, and they need to keep hiking, even potentially in June. Do you see that as an increasing likelihood based in the data that we've been getting.

Yes, we've been saying that a hike in June can't be fully ruled out. There's obviously a lot of hurdles we need to get over to make that decision. But I would still put a hike in June or July at kind of the thirty to forty percent range that the data on net is still pretty strong. The Fed has an upward bias, and if it probably needs to see two to three months worth of evidence to make that decision. June is a pause at the moment, But certainly I think you can you could get to a

As Tom described this market and this economy as excruciating, he is not wrong. I'll give you an example. We get these retail earnings home goods clearly seeing a downdraft, people not buying home goods as much, whether it's Home Depot or TJ Max. But then if you look at makeup. If you look at food, if you look at services, that's all continuing to blossom. And even these companies pass

Yes, I think so that in the FED is we all know the Fed's not out there saying, oh, we need to engineer a recession to break the back of inflation. Right, They're saying we need to lean against the wind. So it's not all up to us, and so we're just trying to put policy in a quote modestly restrictive stance. That means you can get i think, rolling slow downs across certain parts of the economy where any downturn would look more, say you shaped than it would be shaped.

Study in school, Michael, that statistics for the modern age started about nineteen forty seven. And one of those series that we have in the Bloomberg and Sherman Greenspan loved it was he all in augmented unemployment rate, which is six point three percent right now. It's a gloomier statistic, and you know it speaks a lot to the tension of unemployment. We are two point two standard deviations to fully employed on that statistic going back sixty seventy years.

We're not.

I don't think the feed is either. So I think you're you're in a situation where some sort of they land this right and you get a higher for longer outlook. But I think in general, the need or the desire or the want for cuts sooner than later is a little misplaced. There are certainly past to get those cuts. I'm just not sure they're as close to baseline as people are thinking.

I mean, lista, what's so important here about the oddity of a pandemic and all the other dynamics we talk about all day. It's people like Michael Gaban with huge credibility and earned credibility, are looking at quote, other factors involved and we want your own power to fix our other factors involved, and he doesn't have the tools to do that. It sounds completely irresponsible.

So there's that issue. And then there's also the other factors involved when it comes to the actual pricing and markets for rate cuts, which include most people saying probably they're not going to cut rights this year, but if there is some sort of crisis, you could get some

States, Well, the economy certainly has shown great resilience, and you're right, there's spillovers from debt limits, there's concerns about regional bank funding models and so forth, and yeah, those could propagate in ways that are very unhealthy for the economy. But that's unlikely. The data shows that the stress and the regional banks appears manageable. To your point, though, I'd also I'd just like to affirm or amplify what you said.

That's true.

That's been true in every tightening cycle, and you need that in order to bring inflation down. So in some ways we're a little bit bipolar. We know we want the FED to raise rates to moderate activity to bring inflation down. We all know that's good for the economy in the long run. But when the pain of that shows up, we all want the FED to run to the rescue and fix our own individual market. That's not what the Fed's there for.

So I want to bring to you something that we heard yesterday from Austin Coolesby, who is talking about immaculate inflation. I said that people who try to talk down that concept of immaculate disinflation are perhaps fooling themselves because there was an immaculate inflation and so there, yes, there could be immaculate disinflation. That's actually part of what we're seeing what would you say to that.

I'd say that's part of the story.

So if you go back and you think that some of this was excess demand and some of it was a supply shock, the immaculate disinflation can come from cleaning up the supply, the adverse supply shocks and the resumption of normal supply. That should help bring inflation down on its own. But to Tom's point, the labor market is as tight as it's been in my lifetime. If the labor market's cooled down, it's cooled down from exceptionally hot to as tight as it was in the past prior

Michael.

I want you to look at the global purview of of America, the great work that you and Ethan Harris are doing.

And that is I see unsettlement.

I see the Turkish election with Turkish lerier coming out obviously regularly with the uncertainty of two weeks. I see Argentina where the blue dollar Argentina pays. So is something you and I have never witnessed You've done this at the IMF as well. This morning we have Ecuador dissolving their parliament. There's just seemed to be that early nineteen ninety eight tension out there, little butterflies flapping, if you will, to use a worn out cliche.

Do you sense that at Bank of America?

Not yet. I would add maybe the election outcomes in Thailand, for example, is yes. I'm sorry, no, no, But it's a good point that there is a series of elections where there's been some surprises and still some momentum and populist candidates. The message there is still one of potential

Is Jerome Powell's central banker to the world until all these butterflies out there with tensions.

And realities, Whether he likes it or absolutely yes.

I think it's a way under played, Lisa. I think you know the actions that we're looking at the United States, including tangentially this debt ballet.

Were going through.

Talk about well, Alicia Levine was talking about that if the Fed does hike rates in June, what happens to the dollar? And then how does that sort of disrupt the rest of the world in their economic policies, Because it's interesting.

I mean doctor Gaban's entourage folks, they said he can't talk the dead ceiling.

I mean when he came in, he just said, you know, it's not going there.

Well, apparently it's like passing a kidney stone comment like that.

That was perfect.

Well, we've had a lots to do in law and order, We've done sports shows, and now we're doing Doctor Kildare. Yeah, I go so, Mike, Michael Gabon, thank you so much. Bank America securious. Christopher Merinack joins us right now. Chris, you know, it's an honor to have you on and thank you so much for your coverage here through this crisis. At the bottom line is we're all watching. This is

I was surprised because I think that they had enough liquidity to stave off the first couple of days. I think that it was a challenge to understand how many more depositors we're going to be behind on that Monday, Tuesday,

I don't want to dwell on this because I just think it's theater and soap opera and that's not the purpose of this show. But there is a large part of America that would suggest the Senator from the Commonwealth of Massachusetts is onto something here that the suits and ties should return the bonuses should they.

Well.

In my opinion, the bonuses were made in twenty twenty two and twenty twenty one for just normal business. I think that there could be some penalty for the lack

Chris, I'm looking right now at Western Alliance shares at more than eleven percent in pre market trading as people get a sense that deposits are coming in the door. They're reporting this now on a weekly basis because it's good news. Pack West shares also up about eleven percent. I understand that off a very low base, but still, do you think that this is right, that deposit strength in one bank really suggests stabilization in the entire regime.

I think that's accurate.

I mean, we have seen much more stable deposit flows from the weekly FED data all throughout this saga since March, so deposits are down four and a half percent year to date. We're down six and a half from the peak in twenty twenty two. The reality is we're normalizing in terms of deposits and funding mix in the industry. I don't really see big disintermediation. It's only a short term indicator that money market funds are up and deposits

West and left Western Alliance back.

I think the market's trying to ascertain that, and I think there are positive days ahead for both of those companies.

Let's say things have stabilized, Chris, you talk about the pretty massive distortion that occurred when you did see all of these deposits. I think trillions of dollars flood into the system all at once. There is a question of where those deposits were deployed. Was it commercial real estate? Was it loans to companies that might be faltering at this point? How much even if there is stabilization, there is still a very big problem on the books of some of these regional banks.

So we really saw loans grow very little in twenty twenty and twenty twenty one. It was only a twenty two that loans started to grow and a lot of the growth came in mortgages, it came and seen eye loans, and it did common commercial real estate. But I think it's been very muted in terms of the pace of growth in the past year. So we've seen overall loans up about seventeen percent during this timeframe.

And beginning to use the deposits.

What I find really interesting is that loan to deposit ratios are seventy one percent today for the industry, up from sixty at the bottom, and that compares to a long term average since the early seventies of eighty two percent, and we were I think around seventy six seventy seven prior to.

The pandemic, so we're still coming back.

I don't think the leverage in the industry has anywhere near where it used to be.

Chris sellside By, Outperform, Single, Best Buy, whatever the ballet is is up twenty up to thirty percent. You basically have a double or more than double on some of these selected.

Banks right now.

They're going to go into this year, next year, in the following year. Am I right is smaller institutions describe how their share price does a double off a bank that's going to be smaller than it was in twenty nineteen.

Sure, so it starts tom at tangible book value. So if you look at tangible book at seventeen to eighteen dollars a pack, West, that company is trading at a willful price to book today.

It can come back. We think book is actually going to rise.

With retained earnings, so that ratio comes off of the twenty five to thirty percent level and heads towards fifty and then eventually sixty and seventy and Western Alliance is a slightly higher stock, but still at a discount the book by a pretty meaningful way.

And that's why we could come back as well.

This mirror is two thousand and nine when you had stocks like Fifth Third and the old sun Trust and Huntington Bank that are trading less than fifty percent of book and then they end up raising capital for TARP at a higher level, and then they traded much higher at the end of two thousand and nine.

So you know, we've seen this movie before.

The volatility is very high today, but it does work both ways, and we think banks are going just going to continue to put one foot in front of the other have a profitable second quarter, we think that the overall mark to marketing she is going to start to weaning slightly. It's not going to resolve itself all the way because the FED hasn't lowered rates yet, but it is getting better each quarter.

Are they going to be smaller institutions or do they grow at some factor of American nominal GDP?

Sure?

So for the pack West and Western alliances, I think that they will shrink somewhat because the deposits are lower than they were at the end of March and certainly at the end of.

Twenty twenty two.

For the rest of the banks, I think you're going to see them more flat to growing at about one percent. I think that if we have a recession and GDP contracts, obviously I think you will see a little bit of.

Contraction, but I think it's very modest.

You know, the liquidity in the industry is very high, and it's better today than it was when this began in March. So I think the banks are in a really good spot, and I think there's still credit demand and inflation tends to be good for business because customers need to borrow more as they have a higher price level for their goods.

And services.

That's said, Chris, I do wonder, especially if you say you'd put some of the blame with the regulators, that they perhaps and I'm extrapolating here, I'm putting words in your mouth, so please feel free to correct me. They didn't stress test against a massive rise and rates to the same degree that a lot of people say that

I disagree with that because I think there's lending opportunities all across the spectrum from community banks that serve their customers really well and are a key piece of the puzzle for giving advice. I think as you move up to mid size and larger companies they can do the same. All of these banks have good capital and good reserves. I think they could use more as we go through the cycle. I think some banks will raise capital to kind of create a sign of confidence, perhaps fill in

There's no question that there's a credit crunch today.

I just think it's going to be a more measured approach, and overall leverage in the industry is very low today.

Christopher Vernick, thank you so much, and thank you for the many appearances through this crisis.

He's with Jennie Montgomery and Scott.

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