Surveillance: Powell Crushes Pivot Hopes, BOE Hikes

Huo America's don't fantasity catch up with you? Say one morning for it, Let's just start with yesterday and that news conference. Number one takeaway for you, Tom, What was it? Um, Well, the main thing I thought so was actually at least they started to introduce the idea that the cumulsive effects of Monterrey Titan to dates are going to have to be considered. So there's some sense of mutual and the measure of restrictiveness that's uh in place, and it's going

to be in place as affords are realized. So I mean that was the main thing. There's a there's a shift in narrative. I absolutely agree it's important that they raised the you know, the peak funds rate versus September dots. But you know that that was that's been going on for a while anyway. So the main thing for me is a new narrative. If you like dominic you know

yesterday and folks, you can get it from Missoo. There's a single classic constant paragraph in there where you say this is faith based central banking and they risk a textbook type two error something. Laureate Michael Spence talks a lot about tell us about the certitude of FED policy butterersed up against the potential for error. Well, I mean the problem is, um, we don't really know where neutral rates are in the sense of producing or being consistent

with price stability. You only observe that after the event. So we can look back at historical data. And because we don't even have that much data going an you're going back maybe twenty years. Uh. You know, the neutral rate you know right now, based on that backward looking thing, would be around one percent. But we could be in

a new regime in which case neutral rates are higher. Uh, and so by by those old metrics that the FED is definitely super restrictive, but they may not be restrictive enough. If you are you know, if the neutral rates is in fact higher and understanding why neutral shifts is very important, and there are lots of behavioral things that could be going on there, their structural things that are going on

in demographics and globalization that could be shifting neutral. So in some sense, you know, the question is what does a central bank do in this environment? Uh? And I would just suggest they have to be a bit cautious at some point when when they know that on old metrics they're super restrictive, perhaps they need to sort of just take a pause, recalibrate, you know, a way down a couple of meetings in the course of four before they decide if they need to carry on raising rates.

So it would be a kind of a pause that refreshes a tightening cycle. Or maybe everything will fall into place and they'll say a few you know, with think good this, We've done enough, and then maybe they've done too much and they have to scurry back the other direction.

So that's the issue Dominic we were talking earlier. At the beginning of the show, John asked, is there any reason to be bullish right now in equities because you've got the FED chair basically coming out and in so many words, not being particularly happy at seeing any kind of rally in the face of this inflation and the need for tighter financial conditions. What's your view on that.

I mean, where could there be room for bullishness amid an absolute rebuttle of any type of devilish pivot well as hard as be bullish on anything, to be honest, either either bonds or equities. Um. The the issue for equities, I think really is down to a hard landing or soft landing. If there's a hard landing, you definitely cannot be bullish on equities. They have a good downside in earnings, and you know, we would suggest at least another sort of ten maybe even downside in price on a sort

of hard landing. The other problem you've got is even with a sort of softish landing, that the route to to a soft standing, as we've always argued, is anyway through margin compression. So it's it's earnings coming down. It's just that you don't have to have a massive cost reduction on top of it, which would involve you know, really sort of shutting down sort of businesses. So it's

very difficult to be be be bullish. I would just say that you could do a weighted average of soft versus hard landing outcomes right now, by the way, we're not already getting any sense of any landing uh and, but you can do a weighted average and you could say that, you know, fair value perhaps is around you know,

thirty six hundred. That's kind of where we've been working to uh And and if the if the clouds clear and the soft landing looks like it's sort of taking hold, then then you've got upside you know, up to around four thousand or sew on the SMP. So that's the way I approach it. So, yes, it's difficult to be bullish, um. But you know, maybe if you're in the soft landing camp, you can sort of use some of this weakness to accumulates, uh cover some shorts perhaps and maybe sort of look

for some kind of upside down the road. Certainly difficult to be in that camp right now, Dominic custom, thank you sir. From the yesterday. Somewhere in the vicinity of two thirds of the way through the FED discussion, there was a modest note from City Group and they framed out a five percent two year yield to discuss that when he Caesar joins US now global head of credit strategy at credit sites. Why how does your world change if the two year yield moves from four point seven

zero percent to five point zero zero percent? What actually are we going to live with a five percent two year yield? Well, it's good morning, Tom, thanks for having me. I think that the conversation around a five percent yield, both in the front end in the two year is important as well as in the long end of the curve with a ten year, where we've had a lot of clients asking whether we're going to I know about helloween?

Is it like a hell? There we go, only disappointed that we could only buy ten thousand dollars worth of those ibons for his future savings. He's really set on buying a monster truck for himself when he's older, so hopefully we get there. But clients have been really focused on what happened if we hit these five percent levels, both in the front end and in the long end.

And I think that the two percent ten year yield or the five percent to your yield discussion is really important from kind of a credit risk perspective, whereas the to the five percent ten year yield is really important from a duration risk perspective, and the performance and credit portfolios this year has been equally negatively impacted by both credit and duration risk. So clients are trying to figure out, Okay,

which bet do I take? Now? Do I say a recession is coming, extenduration and things are going to be okay? Or alternatively, am I going to just get whipsot again with the ten year going to five percent? In your world winning? And this is not the world of our listeners and viewers. How do you link the two year yield move up with what we see in the new library? Oh I s the f R A O I s

through fifty beeps this morning. This is all less of arrant, folks, But all you need to know is in Winnie Caesar's world, yields up? What does that mean to you? How do you link them? So? Yields up has a lot to just do with market liquidity functions and really what has been happening with depository institutions and less smooth functioning in

the treasury market. More broadly, we have seen over the course of this year as the Fed really started to do q q T and then kind of amped up its bond roll off, the treasury market liquidity has eroded pretty considerably, and this has been particularly true in the front end of the curve, which is why we're seeing a lot of just really challenging movements on the wide work side of things and in just the front end of the treasury market. Given the volatility that we've seen

in benchmark rates. How much can you get behind this assertion by JP Morgan's Bob Michael yesterday on Bloomberg TV with John when he was saying that investment grade debt really is the ballast that sort of come in the storm to hang on to despite some of this underlying volatility. Yeah, so I really respect that view. We've been very constructive

on US investment grade debt. With all in yields at six percent in US i G. Historically, that's actually a level where you can buy high yield and perform pretty well in portfolios. So to have a cohort of companies that are much stronger fundamentally at a six percent yield

feels really good. I think that what's really tripping investors up is the percentage of spread that contributes to that all in yield is much lower than it has been for the past ten years, just because government treasury yields are so much higher, So investors are really trying to wrap their head around how much credit risk can I take and feel comfortable with. I love this six percent

all in yield. And what we're telling investors is the I G universe has a lot of flex in their liquidity in their balance sheets in order to whether a

continued economics deceleration. When you've given all of this though, how much do you have to look at some of the technicals right this question of the l d I concerns over in the United Kingdom, perhaps not in the same form, but forced selling from some big institutions that have been hit with massive losses, some of which and I'm talking about the private debt and the private equity

world might not have been realized yet. Yeah, So the liquidity side of the conversation is really interesting, especially because one of the top things we heard from investors coming into this year was we're reducing our allocation to us I G. We're reducing our allocations to USI yield. We realize that yields are going highler we realize that policy tightening is upon us, and where people were going floating rate affort classes, clos leverage, loans, private credit, private equity.

So there is the potential that we continue to see kind of this re rack in terms of asset allocation. But the benefit to us I G and high yield is a lot of investors started their years underweight those asset classes, and so there's a pretty good case to be made that they should be rotating into something else. The question is how much liquidity do they kind of preserve or put on hand at the beginning of the year instead of putting all their eggs in the eon

basket or in the private credit basket. When you when we look at short term paper, and I guess we've got to look to December as well. Does the FED parlor game and the FED speeches that we're gonna get I can't imagine what they're gonna be like here in the coming days when when we look at the speeches, does that actually affect short term yields? Are they now just a beast out into two thousand twenty three to

stay elevated. I do think that what the FED governors end up saying over the neck a few weeks is going to be important. We've seen why what we've seen a lot of volatility in the terminal rate that's priced into the Fed funds futures market just in the past twelve hours or so now at a terminal rate well above five percent, about five point one eight percent. We're going to be very focused on the conversation around lag effects and kind of the appropriate case of tightening here

on out. Do you know, I don't mean to interrupt winning, but this is just absolutely critical. Do you think various and sundry FED speakers will talk back what we heard from Chairman Paul yesterday. I think that there is the potential that there will be more of a focus on the lag effects and a slower pace of rate hikes from here on out. Whereas said share Powell was very much focused on kind of that overall higher destination in

terms of Fed funds. I think that the pace and kind of the path to get to that destination is still highly uncertain. There's still a lot of economics data to come from now through the end of the year and you know, let alone into next year. So I do think that the Fed speakers are going to be focused on that lag effects between policy tightening and actual economic impact, because when we talk to our analysts that

credit side to cover all of these companies. They're definitely seeing some signs of kind of transition in terms of inflationary pressure and also transition in terms of expectations for next year, which indicates to me that there is some deceleration in inflation. There is a deceleration and growth, and the FED kind of needs to acknowledge that, and that the pace of tightening needs to be much more reconciled with kind of the lagged impact of policy tightening on

actual economic conditions. When I say thank you, when I says with credit science, yea. Now we talked to Jeffrey You, senior market strategist b and Y Melon as well. Jeff, I don't even know where to begin other than I think an emotion of our listeners and viewers is the system near breaking? No, it's not in the UK, but dare we use that p word unpivoted? There's a key line here. There are clear signs of the cost of living crisis taking hold on on economic activities, suggesting more

gradual approach was warranted. An overtightening in policy, right, They are worried about overtiping. They're worried about hitting the afterburners. At exactly the wrong point in the household cycle. So some doubts are creeping in, and I think that's where we are. This is really very different from where the feed is right now. Actually everyone else is different from the feed is right now. You look at lugs earlier today and it looks like Europe is starting to put

it away. We'll rather pull back. Well, that's exactly where I wanted to go, Jeff how Am, Which is this really representing a sea change among central bankers? The fact that one committee member on the Bank of England's committee did vote for a fifty basis point high another one twenty five basis point how much is that the descent that you can increasingly see around the world that will eventually filter back to the Fed. So it is only going to start to increase some starting in Europe. Again,

we saw it Norway today. It didn't seem like fifty basis points was on the table, even though you know that was where the market was. And now we're going to start to only see increasing descents of not pursuing things as aggressively the Fed. However, um so I think

you mentioned this early in the program. You know our dollar, your problem that is going to take quite a bit for them to start to worry about international conditions, because from the US's point of view, it's about tightening conditions in the U S. U S. Economy is still doing well, so there's no obligation for the FED to take into account wider conditions. How long can this last, Jeff? How long can this divergence where the dollar is the pre

eminent trade and continues to strengthen. Is that an entire kind of trade? So it will last longer than markets expect, but more crucially, from from a positioning point of view, it will last longer than markets hope. Right, So there will still be repeated efforts a pricing of FED pivot trade through equities, you know, through bonds, you know, through effex, you know, through the dollar and the like. But I think there's still a few more rounds of disappointments some

to come. We look at the where their terminal pricing is, you know, right now it's going up, whereas everywhere else now it's probably gonna start coming off. Jeff. We've been discussing whether you should be trading growth expectations or rates

when it comes to the Euro. When it comes to Sterling at least it's been building on that in this conversation too, based on what the bank having has just said, it's that positive news for Sterling that they're pushing back against the higher terminal rate that would have actually hammered growth over the next couple of years. Um. I think initially it's not to be frank because the markets still working off rate differentials between the b o E and

the Fed. UM So now that correlation needs to snap back right after the mini budget and kind of trashed it. So if that correlation and dust stop back now, then on a cable point of view, you know, then no Sterling is going to struggle. But if you think of that not as type policy, if the household is going to get some relief and then growth is gonna be slightly better in the UK compares the Eurozone compared to stand Scandinavia than relative any traits and that that could

start to come through. We just look at intro European divergence. But the dollar is still going to ragn supreme at this point. Getting a bonus around Tom with Jeff you how case that just stick with Jeff you Bmy manager Dan McKee was a force on Wall Street. He went off to a gentleman named Corner point seven two and is the chief US economist for point seven two, and I daresay the New York mets as well. Dr mackie

joins us this morning. Dan McKie, the Governor of the Bank of England, just framed out a two year recession. America is different. How different is the United States from the turmoil of double digit inflation we see worldwide? The main difference, Thomas, there's just a lot more momentum in the US economy. You know, Europe and the UK are dealing with a much bigger rise and energy prices and there,

you know, they have a war on their doorstep. The US has a lot of momentum, especially in the service sector, and we think that's why, you know, jobless claims are staying well. We don't think the unemployment rate's gonna rise soon. The momentum in the service sector is going to continue. The great hikes are slowing things like housing, but it's not having an impact on services, and we think it will take a long time to happen. Dr mackey, you were weaned at Stanford off of John Taylor and other

elites do their rules work now. Does Oakland's law, the beverage curve of Lse that Jerome Powell mentioned yesterday, and the Taylor rule of Stanford? Are those operative theories now? Or we flying by the seat of our pants? I think, you know, those rules can give some guidance, but but really the face not having had hasn't dealt with the pandemic before in the post pandemic era. So those rules can give the FED some idea of where to go,

but it's really a different environment right now. How do you understanding the productivity levels that are not recovering at any kind of real pace, and this idea that we don't necessarily see any decline in a number of people who are getting jobs. How do you understand this at a time when we're hearing anecdotically, anecdotally so many companies laying people off, reducing some of their workforce through attrition.

I think what what has happened is that not long ago most companies were having trouble finding workers, and especially in that service sector, which is seventy one percent of US employment. There's no reason they're going to start laying people off immediately. Um, you know, they're they're looking at business, there's still the ship from goods to services spending happening, uh,

and that's bolstering a service sector and eployment. UM. The productivity numbers I think are also being weighed down by what I do think is an understatement of GDP in the first half of this year. Um, it doesn't make sense that employers are adding five jobs per month while the economy was contracting. So I think that's eventually going to get revised to something more in line with what gross domestic income was was telling us. But in any case,

productivity is is pretty weak right now. Do you think that the labor market is an accurate reflection of some of the pain that's being felt to the market. In other words, is this really the metric that the Federal Reserve should be targeting right now to understand the progress that they're making and bringing down inflation. I mean, I think the labor market is an important step in the process of bringing down inflation. Now. The thing, one thing I would mention is that much of the inflation we

have isn't directly tied to wage of inflation. You know, we all know about the supply chain problems, the you know, the goods price surge that we saw during the pandemic and afterwards. But I do think way growth and the labor is high enough and the labor markets tightened enough that it is a force on inflation right now. So the FED ultimately does need to slow it down, but I think it's going to be difficult for them to

do that. Doan Mackie dominic constum, you know, when you are Barkley's and a Deutsche Bank dominique constum says, this is a FED that is super restrictive. Do you agree. I wouldn't say they're super restrictive right now. Um, you know, they are raising rates quite rapidly, so we are getting into restrictive territory and you are seeing them having any effect. The housing markets clearly clearly contracting at this point, so

their their policy is working in that sense. But I do think that they're dealing with a different environment now, where you know, you do have still reopening that's happening in the service sector, and that means that you're not going to get the service sector contracting in the way that it often does during a recession day. We just want to know if point seventy two has done any modeling on what would happen to the Queen's economy if Aaron Judge went to the Mets, if you modeled that

out yet. I'm working on it, but no I haven't. He's working on it. T K. That's a scoop. Jan, We got you know, you gotta have Mr. We gotta get Steve Cohen and you on the show together. Dean. I think you can provide cover for us to talk to Mr Cohen about this. I mean Aaron Judge, Texas Rangers, Aaron Judge, San Francisco Giants, Aaron jud Dan, Steve Cohen's

gonna let Judge go to the l A Dodgers. It's an American no no comment, point seventy things like ready to pull at the back of the LA Honestly, don't blame him. Thank you, Dane. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten AMI Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine AM for in site 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.