Surveillance: Oil Feedback Loop with Currie

court at Golden Sachs's Global head of Commodity Research. Jeff love your note where you really go into the price theory off the dollar of your commodity space. You have something that I would suggest one of our listeners and viewers don't understand commodities year to date in Japan up fifty year to date in the United States. Up. The dollar matters, doesn't it absolutely. That's why we titled the

piece of Dollar dominance UM. And the main point there is as the US hikes interest rates faster than the rest of the world, you get a divergence in global interest rates UM, which then in turns puts upward pressure on the dollar. So funding costs in dollar increase and then people d leverage dollar denominated assets in commodities are one. I don't care if it's a financially held one or

a physically held one. You'd rather liquidate that and hold cash paying five percent, then take the risk of that. And then what happens, deflation sets in and dollar denominated assets. That deflation then increases real US incomes, which then puts more upward pressure on interest rates, and so it's at US negative feedback loop. Take us to supply and demand then, and I guess we could go to the next OPEC

meeting if we really wanted to. But do you throw general equilibrium study of oil out the window because of this excess dollar move? Really good question, and I keeps me up at night. And here's the way I'm thinking about it is, let's go to the definition of UM inflation too much money chasing too few goods. You have two conditions to get inflation, too much money and too few goods. We still have too few goods. The oil

market is in a deficit. Inventories are low. But what's happening money supply is shrinking, and so that's taking the price level and driving it down even though you still have too few goods. So you know, we look at the fundamental picture our base cases, it's going to continue to tighten as we go into year in and particularly you take out the spr barrels. Um, you get stabilization in in China, oil, the gas substitution in Europe. Um, this market is gonna get tighter and tighter as we

go into the winter months. Um. So if we we need to see some stability in money supply or in the dollar in terms of thinking about that liquidity issue, then those fundamentals can press higher. But I think right now you need to really separate what's happening on the money supply side and what's happening on the fundamental supply and demand side. One aspect of the story, Jeff that's gotten a bit lost in the recent turmoil turmoil and

worry about a recession is possible capacity to produce. And there was a story out today talking about how OPEC plus may actually cut its production at its next meeting. How much do you expect something like that, not necessarily in response to the price going down, but in response to a lack of capacity to continue to produce at levels that they're doing now. Well, I mean, if their data dependent, if they're going to cut production. They're doing it because they look at the market being in a

surplus and that's what made sense. But in terms of thinking about the overall capacity, that should affect longer term prices, which is one of the reason why we're bullish long dated long term oil prices. If we can, you're out of capacity, which means you have to forward invest, and ultimately that's what you know can solve this problem. But to attract that capital, you need higher long dated prices, which is why in our note we recognated recommended going

long long dated oil for precisely that reason. What about natural gas? And I know it's a hard pivot because it's a different asset class, but we're seeing a bit of overlap here as Europe faces a winter of discontent where they're flat on their back. Where is the extra margin of supply going to come from for Europe at a time when the US is exporting more than it ever has and it's facing some constraints with production there. Well, I think the answer to that is, look, domestically, you're

gonna get it through weaker demand. You know, we're barished European natural gas going into January and February and see it trading blow a hundred euros per megawatt hour. Why, I like to point out, no one ever gets hit by the train they see coming in the sense that you know, the disruption happened in August, so you were able to make adjustments by reducing demand, industrial demand, destruction,

making substitution into two other fuels. Um. So we believe, you know, barring an absolutely freezing cold winner, they're gonna get through this winner. Prices are going to moderate. But longer term you have a problem. To get to your point, Um, you know, you have to, you know, come up with supplies, whether it's through exports of l en G or domestic investment or substitution in other fuel. So longer term you've

got a problem in yourype. Jeffrey, unfair question, but it's unfair Thursday, What is the optimal price of a barrel of oil for OPEC? Well, if you look at where where the equilibrium price should be, um, you know it

should be somewhere in that dollars a barrel. Um. Given the fact that that's we're probably the cost structure in the U S. Why don't we know it's got to be somewhere in that vicinity because riggs were rising when we were above a hundred, and since we've been now below that hundred ninety US call it around a hundred. Rick counts in the US are coming off. They've been they're off about riggs over the last three to four weeks, which is telling you're getting down in these levels. You're

now below the equilibrium price. So somewhere in that, say, ninety five hundred dollars of arrel seems to be where the markets functioning UM. And we also look at you know, that's where our price target is in four que a hundred dollars about UM. And you know, the potential for upside around that I think is substantial. Going back to the point that, uh, you know, we're out of spare capacity.

Jeff wantedful to hear from you. It's been too long, Jeff, carry that of Thank you, buddy, wonderful us a white thank you very much. Our team is committed to bringing you voices within this crisis. And there's none on policy and economics more competent in this world than Michael Spence, the Laureate of Stanford, New York University and of course chairman of General Antics Global Growth Institute Professor Spence, thank

you so much for joining us this morning. I want to go to another time and place in your ute, when you were studying with John Hicks long ago. Let us go, folks to nineteen eight one and William Grider's classic The Atlantic Essay on a very young David Stockman. The whole thing is premised on faith. The inflation premium melts away like the morning missed a great battle over the conventional theories of economic performance. David Stockman in the

middle of reconomics. Michael Spence, the tumult of the last forty eight hours seems like a Reaganomics redux, is it? It looks like it, Tom, But I don't I actually don't think it is so both Um, Ronald Reagan and Margaret Thatcher. We're dealing with a situation in which you had embed inflation uh, but also you know, uh kind of stagflation pattern, low growth, and they were basically trying to remove the constraints and obstacles to higher rates of growth.

That that meant cutting back government uh and cutting back you know, unfortunate and dysfunctional regulation. I think this is a completely different situation we've lived in the you know, liberated economics world for a long time, and we're actually going in different directions. So uh, you know, I mean, policies are always context specific, but but I don't think this is an analogous to that situation. So then what situation is this? What is the policy prescription for the

United Kingdom are quite frankly China or any others? What is the new Spence prescription? Well, it starts with recognizing that, you know, for a whole variety of reasons, we we have quite suddenly shifted into a supply constrained world. So you know, growth strategies based on expanding demand don't make any sense. I mean, I think that's the core of

the mistake that's been made in the UK. You just don't cut taxes if the supply side can't respond, especially if you're fighting in the central Bank who's trying to get you know, nearly out of control inflation back under control. And then at that, you know, I see, I think you have to face the fact that in the short run we don't have any choice the supply side agenda that we really need, you know, reversing the productivity trends

isn't gonna happen. Overnight. So the central banks, who are a little late to the game but in an awkward position, just have to, you know, deal with the inflation thing by trimming back the demand side as best they can

and as delicately as they can um. But then the rest of the agenda should be focused on real supply side can straints, both domestic and global um and there are a lot of them, aging populations, you know, fading, deflationary pressures from the emerging economies, UH diversification and global supply chains, the energy transition in Europe. I mean, the list is very long, and I won't bore you with the whole thing, but but you know, that's the situation that we have to bottom line is we need a

productivity search without that or to get there. There is also an issue with how do you fiscally arrange a situation where deficits are not easy to finance anymore? How concerned are you about the inability of a lot of nations to finance some of the developments required to increase productivity, required to increase growth in the face of inflation that

is persistent. I'm very worried. I mean, you know, one of the one of the other sort of constraints that that you talked about before, Lisa was a rising levels of some and debt, you know, and in a rising inflationary environment. You know that that that on in many countries,

maybe the United States is uniquely an exception. Um places fairly superior constraints on the kinds of investments that form a portion of you know, sensible growth strategies, you know, supply side oriented growth strategies of the type that we you know, the bills we passed recently in the US. So I think that's, ah, you know, essentially a reason why why we may not be able to dig our

way out of this whole. All that pass well to your writing, recent writings on investment, sir, And I'm going to assume that Chad Jones Berkeley to Stanford was a Michael Spence disciple. He's got the definitive book on post solo productivity. And that's all great. But the answer is we need capital deepening. How do we do that? Well, I mean, you you make sensible choices. So the first thing you do is you don't do is cut revenues, right, I mean, you know, if we're going to get out

of this, we all have to pay a price. The politicians have a tough job convincing people, that's right. But basically, you know, we have to finance the investments we need to get out of this and that means probably um some at least holding fast on the tax situation, if

not increasing them. Michael Spence, thank you so much in honor to have you with us today from always Stanford and New York University in great Atlantic as well coming to us from Italy at today right now, and this is a joy as we continue to bring in to gather in people. As John mentioned, Dr el Arian YenS Nordvig with us yesterday. I thought Allen Ruskin was wonderful

with Deutsche Bank. Right now, Carl Weinberg, chief economist high frequency economics and far more out of the Lawrence Klein wing of the University of Pennsylvania with real world work in the rooms. Is these things get worked out? Carl, you nailed at this morning by saying, look, it's liquidation of bonds for cash. How will politicians respond to the threat of liquidation of bonds for cash? Well? I think good morning, Tom, thank you. I'll try to live up

to your introduction. Um, you know what the government can do, is the government can give people a better reason to hold bonds, a prospect for thinking that inflation will come down and that will bring down bond yields, a prospect for thinking that the public finances are stabilized that will bring down bond yields. Prospect for thinking that once inflation is under control and growth will be able to resume,

that will bring down bond yields. But right now we're not getting any of that in the UK um at least not in the judgment of the markets as we're plainly seeing. And whether it's right, wrong, good, bad politics, it nonetheless seems to be the market's reading it as

bad economics. And how much is the Bank of England's response kind of the playbook for a lot of central banks going forward in terms of both hiking rates, keeping the front and high and buying bonds to basically monetize a fiscal response, to monetize what the policymakers and government are going to be doing without completely upending the economy. Hi, good morning, Lisa. That's that's all the right questions and

it's hard to know what the answers are. The Bank of England has done a good job of convincing everybody that inflation is rampant, and whether I agree with that or not, or that's what the market believes and that's what the market expects. So having convinced the public, having generated expectations in the public that there is a true inflation problem and that the right answer to that is hiking rates, the Bank of England really has no choice but to continue to deliver the remedy for the problem

that it's defined and continue to raise interest rates. And it's going to have to raise that by a lot. If you look at their own inflation forecasts, which again they aim to convince us are accurate forecasts. Right, real interest rates are nowhere near real positive alright, let alone high enough to break the economy. And now add to it the fiscal stimulus they have to in order to deliver the promise, in order to play out the scene that they have set, they have to deliver much higher

interest rates and it won't be until they do. I think that the market will find the equilibrium price. Carl, Have we reached the limits of deficit financing? Well, certainly in the case of the UK, we have to say that the market isn't buying what the government is selling in terms of the amount of debt that it believes it can finance at this time. You know, in the longer term, you know, we're all dead, of course, but in the longer term we can probably borrow a lot

more than we are right now. But to amp up the game at such a rapid pace under these current circumstances, which is to say, an opposition to the stated policy goals of the Central Bank, ignoring if you will, the advice of the Central Bank governor and his committee and his economists and his analysis, all right, and going ahead and ramping up spending anyhow, that seems to be a movement pushed beyond credibility. Carlinberks have NBO and of course

Daniel Jurgen wrote this up beautifully and commanding heights. You are at the Bank of Montreal doing debt workouts on disasters in Latin America. What does trust anomics to look like? How do they get from what everybody believes as a theoretical train wreck to whatever the outcome is. How do you get the reaganomics too? How do you get the trusts snomics too? Well, Thomas, I'm sure you've mentioned many

times over the last couple of days. The Reagan administration cut taxes like mad and ran up the federal deficit like mad in the early days of its administration. By the time we got to the end, they were raising taxes to pay for it, and all of the promises of supply side economics and voodoo economics or whatever you chose to call it didn't seem to work out. So I suspect that someday there will be a day of reckoning in the UK where they will have to unwant

some of this. But it's pretty clear from the Prime Minister's statement that that's not going to happen this week, or next week or the month even after. Okay, I'm gonna we gotta continue this. John Farrell jump in here. You're the guy from Britain as well. What does the committee do under your odd government in Britain? Within the market is going to dictate that some potentially over the next few weeks, And Carla is right for the next

few weeks at least. I think a lot of people don't see list trust changing our mind at the moment, Carl This operation from the Bank aving that goes until the middle of October. The concept we're all talking about now, Carla's fiscal dominance. Walk us through that concept. Carlin, how well do you think this Bank of England can push back against it? Well, the Bank of England, John, as you know, has unlimited resources. It can raise interest rates to a million percent if it wants to to achieve

its goals. It's said what it wants to do, it's said how it's going to do it, and I don't think it can or will back down. M On terms of the government, the government has limited fiscal resources. If it gets into a battle with the Bank of England over whether the economy should be stimulated or not not, the Bank of England will win. It's a question at

what interest rate do we have to get there? The risk, the big risk, and John, I know you're conscious of this, very much more so than I am, is that the government gets fed up with the Bank of England and starts to restrict its independence. On that day Sterling will go down the tubes and on that day go yields wolf story levels that I dare not even contemplate. And there was a whisper of that in August, and they tried to address it as soon as they took out

of account. Fantastic to hear from me, said as always Kyle, wind back. There of high frequency economics right now and this is a huge joy to know. The team that Neil Sauce of Credit Sweez put together decades ago at Credit Suietz included the giant dominic constom now over at Missooo and still at Credit Suetz is Ray Ferris. He only high ground on Pacific rim analysis and also were in exchange in London for the shop. We're thrilled that the chief economists of Credit Suites joins us this warning.

I'm gonna cut right to the chase, Ray, and this goes into your foreign exchange of that ground yesterday was original. What is the original solution for the Prime Minister. Well, look, I'm thrilled to be here. I've been a long time listener to the show and it's it's great to be on. But I just wanted to address the elephant in the room.

That is a fantastic bowtie. I love it. Um. I think it was said a little bit earlier by one of the guests that you know, the UK increasingly needs to be viewed in the context of an emerging market sort of situation. Not that they're going to default on their debt, but the economy has lost a nominal anchor for the system, and that's I think why investors don't want to hold bonds and they don't want to hold

the currency. The fiscal agent looks like it's a little out of control and the Bank of England isn't stepping up to the plate to regain control to establish that nominal anchor by saying that we don't care what happens on fiscal We're going to control inflation. What needs to happen here is the Bank of England needs to step in. They need to be aggressive with their next rate. Height could be better if they move before November, and they need to signal that they will do more after that.

Markets are pricing very high rates as the terminal rate. They don't have to get there if they acts. You have a huge credibility with Asia and with China, with Japan, and you come out and calculate one point six global growth for next year. Are we pricing for that? No? I don't think we are, certainly not in equities um the way we look at equities and I wear two

hats of credit. Swiss I'm chief economists but also the chief investment officer for the America's About three weeks ago, we went underweight in our investment Wealth Division equities for the first time since two thousand and thirteen. That's really a huge move for us. And when we look at equities, we think, as we just published yesterday our new economic quarterly, the worst is yet to come was the title, And it's all about the fact that nominal growth is going

to slow. Financiing costs are going up, and wage growth, the persistence of a lot of costs you know, are going to be there for another few quarters, so profits are gonna get squeeze. Margins look too high, consensus earnings look too high. To that point, right, Let's go back some of the data that we just got. The initial jobless claims of a hundred and ninety three thousand, It

was the expectation of two hundred and fifteen thousand. You hear the FED saying they want to see a little bit more slack in this labor market, or even a lot more with the projection of four and a half percent of an unemployment rate possibly by next year. How far away are we what kind of Fed funds rate. Do we need to get to the type of slack to the loosening of this labor market required to bring inflation down? Oh? Absolutely, The Fed is going to be

angry about these numbers. Um, we've got a forecast of one and a half percent, but well, really, uh, four and five aids for FED funds as a terminal rate. But we stress we don't really know where this thing could peak, and the the there's an asymmetry still in

the Fed's reaction functions to the top side. They have shown that they aren't going to ease just because numbers get or turn a little bit less hawkish, just because numbers get a bit better the June July CPI data, and they will respond aggressively if the numbers, you know, aren't so nice the August CPI data. So could they hike beyond what the market's got priced, you know, the four and a half percent for terminal rate next year? Yes?

Do they? I think just really dislike the idea that markets have got a cut price for two thousand twenty three and are they going to continue to argue against that? Absolutely? Right. We saw from the Bank of England the conundrum that's becoming increasingly global conundrum and perhaps may face this fedure reserve, which is when do you reach the breaking point? And

then how do they counteract that? From a financial stability perspective, What is the break point when it comes to real yields which we saw hit one point six percent just a few trading days ago. Where is the breakpoint for this market and then for the Federal Reserve to have to step in on a stability stance. Well, let me

identify three different things here. The first is that one of the key reasons I think real yields are going as high as they are back into positive territory is that balance sheet strength in the United States, especially within the housing sector, is the best that it's been in depending on your metric, anywhere between twenty to thirty years. The Fed has to push up yields much more than we were fought a year and a half two years ago to actually slow the system down, and that's kind

of what their claims dated. The second thing is, I'm here in Dallas. I was meeting with a lot of retail corporates yesterday and when I asked, are we in a recession? Everybody in the room put their hand off the key thing here is there's a dichotomy in this economy. The good sector, the cyclical components housing and goods already

or in a recession. Services is doing just fine, and that's where you're getting this continued labor force growth, now some real income growth, and the vet's just gonna have to keep pushing against it. Fishures deteriorate on negative one p SMP futures, a fix out two big figures thirty two point to three, not through the highs yesterday, but the stress is out there off of the good news we saw on claims. Ray Ferris, I want to speak to you about the US economy and the FEDS path forward.

If we get a real rate out to two point zero five percent, which is my calculation of maybe great financial crisis average before the crisis, I should say, do you suggest they need to overshoot on the real rate to really turn things around? Or can they go to

just above two percent and stabilize sit there. We think that they're going to be able to Our base case is they're going to be able to pull off a tiny bit of growth, and a lot of that is because of this balance sheet position that households are in. If we're going to go into a recession in the next you know, twelve to eighteen months. It's not going to be because we're forced into it by financial distress.

It's going to be because consumers choose to retrench. But with this type of employment growth, they're probably not going to do that. Do we have to get the you know, now very fashionable vacancy to unemployment ratio down a lot to get wage growth to come down? Well, history says no, vacancy unemployment doesn't actually forecast wage growth very well. So we think it's gonna be a tough fight. If that's probably gonna have to go to four and a half percent,

They couldn't go a bit above that. But you know, we've got employment growth, pay rolls coming down to a hundred and fifty or so by the end of the year early next year, and then, you know, I think the risk is maybe we go a bit softer gradually that will pull down wage growth. Goods inflation is gonna come down. Looks like housing on a forecast basis has already peaked. Services are gonna be a problem for a while,

but they're gonna edge off. So we're optimistic that by the end of next year, the FED is gonna be much closer to where it wants to be without necessarily having to pull the economy into a recession. Right Tom, I's gonna send you a sign both side. How would you like that? From Classic I can't wait. I'll make it happen right fast that I cut a swat. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us

live weekdays from seven to ten a m Eastern. I'm 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 and this is Bloomberg