Surveillance: Recession Chances with Hatzius (Podcast)

has been about acuity. On this Friday, we're gonna lose the numbers, the many numbers of Jan Hatzius work as team's work, but we're gonna go to one number, which is your queue four number. They've marked down g d P from a sterling one three to sub one. That gives you some of the direction of the recession call. But at the same time, Jan Hatzius calls for a shallow rees session. If we get a shallow recession, you quantify what it will mean for jobs in America. How

does the magnitude of recession work into the dynamics of unemployment. Yeah, let's just be clear that we don't have a recession in our baseline forecast. We do have significantly below trend growth zero point nine percent is only half the long term trend pace, but our our best guess is that will be below trend, that rebalances the imbalance in the labor market, and that ultimately also helps bring inflation back down.

That said, there's a very significant risk of recession. I think it has gone up because it's very difficult to reduce labor demand without you know, the deterioration feeding on itself and then ultimately culminating in a recession. So we're giving one and three chance of a recession in the next twelve months, and it's close to fifty fifty I think over the next But you've got to to cernam floyment rate baked into a two thousand one ish kind of recession. In two thousand and one, it was a

two percentage point increase. That was the bottom end of the historical range. If you look at all of the recessions in post war history, the top end of the range is five and a half percentage points. I think if we do have a recession, it's likely that it

would be on the shallower end for two reasons. One, private sector balance sheets are in better shape than at the end of previous business cycles, and too, I think while inflation was very high, I don't think it's as entrenched, certainly not as entrenched and expectations as it was in

previous high inflation episodes seventies early eighties. Yeah. No, we just got off a couple of weeks where people were ratcheting up their expectations for the terminal Fed funds rate about four percent as of at some point next year, And here we are looking at a huge rally in two year yields. Can you translate the rally that we have seen through an economics lens in terms of what

people are forecasting and whether it's seems plausible in your mind? Well, our forecast is a terminal rate of three and a quarter to three and a half percent. We think we'll get there by the end of two thousand and twenty two. We don't have any additional rate hikes in two thousand and twenty three, basically because the economy is decelerating, is growing below trend, inflation is coming down, and I think

at that level the Fed would probably hold. You're right, we had priced something around four percent, you know, immediately after the ft C meeting or right around the fom C meeting. But I think people have looked at the fact that the economy actually is decelerating and that has led to a reversal of that, and I think fundamentally that's appropriate. But yeah, given the fact that we are see a deceleration, but we're not seeing a deceleration when

it comes to the inputs into inflation. We're seeing rents continue to climb at a record pace. We're continuing to see some of the disruptions to oil supplies and the food supplies that causing some of the price increases. When do you start to talk stagflation? When do you start to talk about a FED that is forced to act despite an unemployment rate that's rising and despite weakening economic data points. Well, I think it's a little bit more mixed.

If I look at the inflation indicators, No question, the last CPI and the rent number there was bad. There was an increase in the long term University of Michigan Inflation Expectations measure. But the supply chain measures are actually getting better. You look at the supply delivery indices in

the business surveys, those are coming down. Um, the wage numbers in two thousand and twenty two have been sequentially clearly slower than the second half of last year, and I think broadly speaking, inflation expectations, look at just the break evens in the bond market are still very well anchored. So I think it's a it's a more mixed picture.

And in an environment where growth comes down to a below trend pace, I just don't think that the FED would, you know, keep hiking aggressively when the economy is already slowing and inflation is already coming down. So yeah, And essentially what you're saying is that when Chairman Powell was speaking on Capitol Hill yesterday saying that our commitment to fighting inflation is unconditional, that there actually are conditions in

which the FED blinks. I think there are conditions where the FED blinks, but it's partly because there's a feedback from economic activity into into inflation. If the economy weakens and labor demand declines, and maybe the unemployment rate starts edging up, then you also just go and become less

concerned about inflation. So I do think the commitment to ultimately getting back down to two percent is unconditional, but they will be, you know, factors other than the current inflation prints that will sort of drive what they do on a on a meeting by meeting basis. While we're talking about the specific year words that your own Powell

has used. I've talked earlier in the show about the tweets Bill Ackman posted overnight talking about how the FED clearly has a credibility problem in the bond market is misreading the Federal Reserve, and what he said is ultimately that comes down to the communication of the chairman. Do you think that Powell and others on the f O m C are are accurately communicating to this market what it is they intend to do. No, I think there

are accurately uh communicating. I think in ways that that that are clear that that they do want to get back down to two percent eventually. They're tightening policy aggressively, much more aggressively than they expected to do six months ago or twelve months ago, in part because inflation turned out to be much higher. So I think at that level it's it's all pretty clear on the credibility problem. I would also say, you know, look at inflation break evens.

I mean the credibility from the bond market's perspective or from the perspective of forecasters of the two percent inflation target, it still seems seems intact. Yeah, And I want to go to Peter Orzag of the London School of Economics and a small banking up in New York. Computer Or loves the phrase glide path, and maybe that's differential equations.

Let's just it's Friday. Let's just stay with calculus. Are we completely misjudging the second and first derivative of core inflation coming in where it may come in shockingly rapidly and we underestimate that? Good news. I do think that core inflation is likely to come down. In fact, if you look at statistical measures of core inflation, like the trimmed means, that has been improving over the last few

few months. It's so little, too early to tell, but the last couple of readings have been more encouraging, and I think that does suggest that over time core inflation is going to come down. And you know, we were at about four percent for core pc core in this case to find us ex food and energy by the end of the year, and then at about two and a half percent by the end of next year. So I don't think it is going to happen overnight. But

I think we're headed in that direct. So when your own poulss we get back to two percent inflation, that's what he's talking about, And Hatzius says Powell will get his wish in eighteen months. Not quite. We're at you know, two and a half, but that's not too far away from two and two and a half. It's TV who's counting, especially if you look at this as an average inflation target. So at some point there will you know whether there's

a recession next year or not. You know, all best guests is not, but there will be a recession at some point, and that will bring inflation down further. I should say, with great respect, I'm busting Dr Horts. Chapter is a huge difference between two and two and a half percent in the inflation game. With Goldman Sex, thank you so much for coming in. Ian Lincoln is out

of Minnesota and the Carlson School of Finance. It is absolutely definitive with a tour of dude to yell as well in Old Court at Beamon Capital Markets and writes absolutely the most dense note on fixed income dynamics on the street. We're Thrilly Goad Jonas and Studio Today. Ian, Welcome to Bloomberg. I'm gonna cut to the chase. Forget about the y axis moving yields. Your note right now

is on the mystery of the X axis. Is Bullard talks about front loaning and that give us the nuance to the pro pro audience of the X axis dynamic, the first and second derivatives of the time change we're gonna see. Well, I think that this is the most important conversation in financial markets at the moment. It's really the answer to the question how can Bullard be talking about a three fifty terminal rate when the reality is that two year yields are trading at or below three.

It really comes down to the twenty four month moving window represented by the two year notes, and effectively, what the market is saying is you might hike now, but you're going to have to start cutting much sooner than in prior cycles. Lee fixed in coming. Go over to Jan Nazis Globen Sex Economics, where he and I talked about core c p I and the idea that we don't have a real understanding of the rate of change of how court c p I is going to come

down do you share that uncertainty, I certainly do. I would add one nuance, however, and that is all inflation is the same at this moment for the FED headline inflation core inflation, they've made no distinction. That's interesting because in the past they would always focus on core inflation overheadline because it was less volatile. But the realities of higher energy prices, higher food prices, and the fact that inflation has become the political touchstone at this point makes

all inflation equal. And I think that will change, but not intel the midterms. And it's peak rates, it's peak yields. Have we already gotten past that? Are we basically out of place where you can say definitively that that is an accurate characterization of what we've seen. Well, that is certainly our call. But I will note that I said the same thing once we got to three twenty. So

at three fifty the logic holds a lot better. But the reality is there's going to eventually be demand for ten and thirty years paper and we haven't seen the key investor classes of Japan or certain parts of Europe really come in and start buying treasuries yet. And when we do that will be worth thirty five to forty five basis points in tens, and that gets you back below three, the curve more inverted and the market even

more worried about a recession. So ian is this supportive for risk assets if the market is going to get more worried about recession and could potentially have to reduce their estimates for margins and profits. So that is again one of the key uncertainties. I would normally say, yes, you have a less aggressive FED, you have lower race, you should have a good set up for risk assets. But this FED is behaving much differently than we might have otherwise anticipated. So we could see a process the

possibility of recession increase. But the FED, instead of having the traditional response just push forward and say yeah, three and a half, we're going to get there. We might push it into a recession. But the reality is it's worth keeping the decades of hard one credibility as an inflation fighter for the FED for this one cycle. Well. Bill Ackman of Pershing Square says the FED already has a credibility problem and that the bond market is misreading

the FED. To quote one of his tweets, he said that the market is flat out ignoring Powell and the governor's commentary. Expect even more hawkish commentary until the bond market wakes up. Who's a sleepy and Bill Ackman or the bond market? Well, I'll tell you this much. If you look at break evens, what you can see is that inflation expectations continue to move lower and lower and lower, and that is a vote of confidence in the Fed's

ability to control inflation and forward and Asian expectations. So one thing can be said, the tips market certainly isn't asleep at the moment. Well and Jim Bowlard, as we said, have said that the tips pricing is pretty much right on at the moment. So as we put all of this together, the market has confidence in the FED ability

to fight inflation. What it has less confidence in is what the ultimate result of that inflation fighting is, how deep a recession will be when and if one arrives in, what is your assessment of that and ultimately what that means for how low we could see yields going. So I think that at this point, part of the conversation that isn't occurring in markets is we're just coming off of a negative real g DP print for Q one, which was negative one point five after revisions. Right now,

GDP for the second quarter is tracking at zero. So if we have a repeat of the higher than expected inflation profile in the US, we could actually dip below zero for real growth in the second quarter, and that would make a recession a very near term event caveat though that's not the same type of recession that the market is talking about. The markets worried about a real recession with higher unemployment, that we actually see an aggregate hit to nominal demand, and that's not where we are

yet in Lincoln party order. If you're on radio and television and lingo to bemo, Capital Markets joins us right now the conversation of the week on fixed income. You and I have never seen these bond losses, and I'm fascinated and I wanted to ask you this question, which is getaway from the nuances. The bottom line is the total return index of Bloomberg Lincoln total return index is negative twelve. How does bond psychology change if people are looking out to two thousand twenty four to catch up

from these losses. I think an important aspect of bond losses in the treasury market is to keep in mind who the major players tend to be. All the people taking a loss. A lot of the people taking the loss are indexed or are or match attempting to match their index. But everybody's been short and so on paper, it's a pretty significant loss, but a good portion of the investment community has fair reason. Come on, what about

mere mortals? They open up their statement from Demo Capital Markets and go they start saying profanity about Lincoln the real world out there. This is a bond market we've never seen. It's worse than Boker's bond market. I think that the person at home opening their statement what they're really going to be thinking in the back of their mind as well, mortgage rates are almost six percent, that might be the problem. So a little bit of pain in terms of the opportunity to invest in higher treasure

yields is one thing. But as the ramifications of the feds tighter monetary policy continue to push through to the the employment and the housing market, I think that's where we start to get worried. Ian how much is your peak yields thesis right now? Hinging on this idea that the inflationary inputs our transitory that we still have this stealth transitory narrative guiding a lot of investors and even

the Fedure Reserve. I think that the peak inflation of the peak rates narrative is actually based more on the hawkishness and the aggressiveness of the FED regardless of how inflation plays out. What we know is that a lot of what has occurred, at least over the course of the last six or eight months, has been a function of distortions created by the pandemic, the supply side on the energy sector and now food inflation is very material. Fast forward to UH this time next year, the year

over year inflation prints will not be as high. That doesn't mean it was necessarily transitory. That either means that the FED was that much more hawkish or in fact

prices moderated just based on demand. Ian While we're fast forwarding fast forward to ten AM, when we get those humish sentiment numbers, is the bond market going to latch onto more the pure sentiment read how how bad it is and what that means for growth prospects or the inflation expectations, and what that means is to whether or not the FED is actually going to have to be more hawkish for longer if that is becoming entrenched in

the economy. I think that the headline consumer confidence figure at record low levels is extremely telling. And when we look at the correlation, it really comes down to gasoline prices and equity performance, and both of those have been going the wrong direction for the there to be any additional confidence. I think that we are going to focus on confidence over inflation expectations because the FED has communicated that they're going to do everything it takes to keep

inflation anchored very quickly. Here do bonds have catharsis? We think about stocks going down, vixiforty, etcetera. Does that happen with bonds? Does everybody sell at the same time? So there does tend to be key moments of capitulation in one direction or the other. And right now, as I mentioned of the vast majority of the market is short treasuries. There will be a point where people wake up and they say, I don't I don't want to miss out on these higher yields. Wonderful to see. You have a

lot of message here onions research. Again, we protect the copyright of all of our guests. Find that research at BEMO Capital markets Ian Lincoln with his It's Tuna Fordam with the futures of thirty Right Now founder and geopolitical strategist Fordham Global uh Uh Foresight joins us right now,

thrilled to have her on this morning. Tina, I want to digress to the British elections in the uproar of Mr Dowton, the Conservative Tory Party leader resigning at five thirty in the morning, London time, and I want to go out far west of London on the way out to Cornwall. And this is not the time of Paul Dark this is the time of now and north of Exeter, Tiverton and lovely Devon, I hopened pronouncing everything correctly and

Boris Johnson was absolutely crushed. What is the symbolism that he was crushed in friendly Devon going back to nineteen Well, it's it's another blow to to this Prime Minister, who nevertheless is you will have seen Tom has vowed to to carry on exactly as he has been. Um, we've had scandal after scandal. The chairman of the Conservative Party, as you've said, resigned this morning and a you know,

sternly worded letter. And yet Boris Johnson doesn't seem to have plans to go anywhere, and that tells you a lot about the times that we're living in Um. There there certainly is no no shame in politics, knows no sense of accountability. And as long as the labor leader Kire starmer Um is not you know, a serious challenge,

Johnson will probably stay where he is. Um. It's you know, defining the laws of political gravity by elections in the UK aren't typically you know, very very much participated in.

Posters will tell you that they're miner importance. But again, in the face of so many crises that this government is spacing, um, how many times can Boris Johnson get on a plane and go see his friend Zeninski in Que when things are looking tough at home, Tina, you point to this political gravity or lack thereof that Boris Johnson has and other leaders may have as well. As we face a lot of individuals who want to be heard about the pain that they are feeling in the

face of inflation. And that brings us to some of the strikes and some of the protests that we're seeing erupt throughout Europe, throughout the world. What is the hotspot that you're watching and what is the consequence both politically and economically that will result. Well, strikes in inflation go hand in hand, and uh, coming out of the pandemic and probably heading into a recession, and with those workers who are on kind of fixed contracts not having seen

a pay rise for a very long time. You know, the old summer of discontent term is being bandied about a lot. Um. You guys were talking about the price of lobster rolls. Um. You know. Similarly, I can say that British Airways is threatening I think meaningfully here in the UK to start striking as soon as school vacations begin. Um, that's going to be very unpopular. But the question is whether it's going to to actually force a compromise in advance. Um.

In the UK, this is very acute. Uh. France also is known to to have strikes and that will recur. And I guess what I feel is there's a sense of helplessness about this for so many public sector and other workers. Wages have been staggnant through the pandemic, and you know, it's just take the inflation focus mines, Tina, we talked about lobster rolls tongue in cheek because this is the least of our concerns. It's basic stables, it's wheat, it's basic meat, it's all of these other uh, basic

groceries and gas prices that are impeding. As Tom said, the lower deciles. How do we look at possible possible fiscal spending to offset some of the pressures that are very real, very tangible, and a big threat, and particularly to the lower income individuals around the world, in Europe in particular. Well, of course, the people most acutely affected are are the very poorest in in Mia and those who depend on on grain supplies that are being blockaded

by Russia out of the Black seaports. UM. And so that's happening in the Middle East, where there are many concerns which I've addressed elsewhere about kind of Arab spring to point, oh and that sort of thing. In developed countries, we don't get riot sort of civil unrest in the same kind of way. We get more organized expressions of popular discontent UM and that means strikes of course, UH

and protests. Governments, having responded with so much fiscal largest during the pandemic, are really going to be expected to step up. And what I think we're already seeing is fuel prices and subsidies for fuel prices are going to come first. Food is a bit more difficult in developed countries, but winter heating, winter fuel allowances and those kinds of subsidies UM in the UK and Europe, I think are just a question of of when and not if. Tina,

we only have about a minute left. But as we talk about the economic pain so many countries are feeling, are we going to start seeing a dissolution of the resolve of the allies to continue to support Ukraine inflict economic pain on Russia when it's inflicting so much economic pain on their own domestic populations in return. Are we

reaching that breaking point? We're not there yet. But at the G seven meetings, the measures that are being contemplated gas rationing in Germany for example, UM, the question of whether Russia just slat out, you know, cuts gases lives to Europe as punishment in what a tactic called coherstive diplomacy. Uh, it's very real. It'll be winter before we see push come to shove on this. But that's why getting the gas storage facilities in Europe filled is crucial. They have

to fight this. They can't give into Russia. I think leaders understand this. Can they communicate to two citizens? The need to make sacrifices is a bigger question because politicians don't like to to take. They like to give. Me Tina ford and thank you so much, greatly appreciate it. With Fordham Global Foresight, this is an immense joy right now. Shop John Knows is global head of ex Strategy at Credit Suite and joins us this morning. And I want

to go to the magnitude of your calls. I want to go week yend well out past one forty and Swiss Frank, We've been watching the last twenty minutes to see if we go through parody strong Euroswissy coming down nicely under parody, and you say, goes further. Why do

we get these magnitude of moves in foreign exchange? What we're seeing the end of the former system of central banks using balance sheets too essentially manipulate where effects rates trade, and as that system frees up or comes under pressure, you're seeing effects rates react to that. In Switzerland, they're much further ahead than where Japan is right now in making that transition. Japan is trying to stay stay the course as long as possible. So that's what we're seeing

reflected in. So are you calling for a Brenton Woods moment? I mean, is it a big enough shift coming off of balance sheet dynamics that it's allah after World War two and what Kains and the others did at Mount Washington. It doesn't need to be as big as that to still have very significant effects for effects investors. Let's let's put it that way. So, for example, in the Euros Swiss cross, it's very easy for us to imagine that cross going down to ninety seven even lower in the

weeks to come. What does it do to a McDonald's hamburger and the baron stuff just down from the credit sweets of office asking for Yeah, it's a good idea to to think about those things. I guess they will get more expensive, but that's not something that is worrying. Yes, and be at this point. So at least so they have top ticks out of twenty dollars for a number two value meal. I'm sure that there is some personal experience worked in there. I can't figure it out, but

I think that's my hunch. Sah. But I wonder how much you're looking at peak yield as we were just hearing from Mike Bell of JP Morgan, and how much does that mean peak dollar? Right? How much are these two measures really trading in tandem. Well, look, it's it's definitely been the case that rate differentials and the US is much higher yields have been helpful for the dollar. But to be honest, I think there's more to the

dollar story than just yields. For example, on the trade side, there's been very big shifts in trade dynamics that really need to be recognized. So for example, right now we have the Ura area with a with a trade deficit. We have Japan moving rapidly in this in the same direction as well, So currencies like the year in the end that historically we're backed by trade surpluses, current account surpluses. The whole energy price shift and in terms of trade

shift has really changed that dynamic materially. And meanwhile, on the U S side, you have record experts at this point there's going to be nearly two hundred billion dollars of just agricultural exports in this fiscal year according to projections from from that side of the story. So when you put all that together, to me, there's more to the dollar strength story than just rate differentials. At this point.

This is a really important point. How does this translate into some of the big crosses, whether it's your oparity or just in general how strong the dollar can get. Well, I think the dollar right now looks strong compared to the last three to five years, that's for sure. But I think if you go back much further, the dollar has been a lot stronger for a variety of reasons. And the key point I would make is it's not the same dollar as the last time you're a dollar

was at one oh five. You know, when you have your own now with trade deficits as a problem, you basically need capital inflows into the year area and on a net basis if you're going to have a current account deficit, and that's something that hasn't been missing. The EU has been a capital exporter for for many, many years. So there's a new value proposition that the Euro needs to offer at this point in time simply to avoid

going down, and I think that's absent right now. Well, let's move from Europe to the island just next to it. We had UK consumer confidence data earlier today showing a record low, the lowest and forty eight years of data clearer concern around inflation, the cost of living, the possibility of a recession. How does that feed through to your view on sterling? We think sterling is still going to go lower. We are looking for a test of one

cable again and eventually a move through that level. The problem for sterling really you still have that same trade story developing that I mentioned for the for the ur area in Japan. It's not like years of a weak pound of created big trade surpluses or very competitive UK exports that just hasn't happen. And for a variety of reasons. Uh, And so you have a currency that doesn't really have

any reason to go up right now. Um, even when you think about the Bank of England, the market is pricing in fifty basis point hikes consecutively for a few meetings ahead of us, and yet the Bank of England is constantly pushing back against that narrative and makes it very difficult to realize what's already priced in. So when you put that those factors on the table, standing is still going to go lower? Sum, I gotta get more questions, Um, you gotta go but you know, please come back soon

as as you can. I got These are some abrupt calls here from Shob Jones. It's a different landscape out there for all of US investors, including Jerome Powell, with a kind of moves of credit, sueez he is talking about. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten AMI 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