Surveillance: Recession Risk with Berro (Podcast)

that we do. It's about housing. Let us take four days across four FED meetings of two thousand twenty two and look at the mortgage, the thirty year bank rate fixed mortgage, and the yield has gone up three point seven three percent, four point four seven percent, jumping up to five point five zero percent and on the six percent which Julian Cornado note last week, Kelsey Barrow joins US now with JP Morgan as well Lincoln the JP Morgan World of bonds, yield price dynamics into real estate

in the third year fixed mortgage. Yeah, absolutely, So if you look at the FED funds rate, it's it's risen a hundred and fifty basis points. But the third year fixed mortgage rate has risen by double that three hundred basis points all the way to six percent UM, and we already are seeing the impact on the housing market from that move, and we will continue to see the

housing market decline. But I think what's really important to note about this move, this move in financial conditions, is it's been so severe that in any other scenario, the FED would have paused. The reason that they haven't paused this time, despite the fact that mortgage rates are up three hundred basis points, is that the inflation environment is just not letting them. And I think what really spooked them UM last week on Friday is that University of

Michigan sentiment Yester. Yeah, absolutely, he mentioned the University of Michigan sent meant tipping up, ticking up. Now, what we do know about the University of Michigan sentiment data UH and the University of Michigan inflation expectations is it's very correlated to gasoline prices, and some of that increase in gasoline prices is out of their control. So they're putting themselves in a very difficult situation, but one where they're

clearly saying we're going to prioritize inflation overgrowth. I mean, Lisa, one of the stories here is oil has only gone eighteen on brent. I mean, we barely had a pullback, Lisa, in oil, and it isn't necessarily translating into a pullback at the pump because gas prices, refined goods are not getting cheaper because of a lack of refineries. How does this really bleed into credit, Kelsey, has been a question that we talked about with a lot of investors yesterday.

They were seeing the prospect of wider credit spreads, of more credit losses kind of being implied despite the fact that you don't see near term maturities. Do you agree that it's the up and quality trade going to higher rated debt or do you think that there's some value given the eight and a half per that yields and high led Well, clearly financial conditions are tightening and the risk of recession is rising. But if you look at current default rates, obviously they're very low. They need to

normalize somewhat. But corporate fundamentals are really strong, and companies have done a number of things to set them up for an environment where we're not particularly concerned about credit losses. They've done things like increase their cash, reduce their leverage,

and also turn out their debt. So if I look at the high old market, for instance, less than six percent of the market is maturing in two or three So there's not that much sensitivity UH in the high old market, which has become much more higher in quality

than it has historically to these higher rates. Now, I think that there is going to be volatility, and what we're focused on this summer is increasing the liquidity of our portfolios because the one thing that share Powell didn't talk about in the press conference was q T. But QT is happening. We're seeing massive moves, and we want to have the liquidity to sell it when it's expensive rather than need to buy it um when when there's a challenge. Lisa is quote unquote increasing liquidity the same

as go to cash. Well, Kelsey, that's exactly what I was going to ask. How do you do that? Is is it with E T F S, is it with cash or is it with the securities that are most traded? I mean it is dependent on the portfolio. If you think at the very baseline we're thinking about, you know, going from off the runs to on their own treasuries,

getting out of tips and into nominals. You know, things that are going to have less ability to be intermediated when markets are quiet, when people are going out on summer vacation, and things are more likely to trade more volat with more volatility um. So essentially the bond market has gotten much bigger, and dealer balance sheets have not risen to the same size to accommodate that, and so we want to be prepared when people need liquidity to

be able to give it. This is shocking to me, Tom, and really a reversal of what we've seen for so long when people were seeking out illiquidity. We are looking at the prospect of a fed driven volatility cycle that we have not seen in a long time. And credit I'm just looking at the the you know that I've been to Kelsey. This has been a crusade of mine is we're in a bond bear market and nobody's talking

about it because nobody's used to it. And the answer is, if I look at the Bloomberg, the Barclays, a Lehman Total return US aggregate bond portfolio, these are double digit losses, right. Absolutely, what's the plan? Absolutely? There's the two sides to that coin. Right, You've seen massive losses, particularly in long bonds. The moves and yields. You know, if I look at the move over the week or the move over the month and you compare them to the last five years, these aren't

just two standard deviation moves. These are four, five, six, seven standard deviation moves. I mean, it's just incredible. But then on the other side you have the yield the new starting guild. If you were to invest fresh capital now, that is a lot more attractive, as Lisa mentioned, and a half percent on US high yield is very attractive and it's consistent with the long term returns um in the equity markets as well. We round up the digits

negative in the US aggregate portfolio. Kelsey get the work, Kelsey Barrow. Where this is JP Morgan Asset Management as we dive into it with Andrew Chase, he's chief crosssset strategist. Hit Morgan Stanley really coalescing in mathematically statistically as his Brown University math of what the total, the whole view is and the summary Andrew is simple. Morgan Stanley thinks like Joe Stiglett's growth matters tell me why growth matters. Yeah, thanks,

thanks Tom, and it's it's great to be here. So I think this is a backdrop where the FED is shown that it's going to have to be very data dependent over data that it doesn't necessarily have a great deal of control over because the actions that it's taking now, is you discussed earlier on your program, are not necessarily going to do anything about gasoline prices, airfares over the next month or three months that are driving these inflation

surprises that share Powell mentioned. So you have a situation where I think the FED is somewhat captive to the incoming inflation data that matters a lot, and then the growth outlook is also very uncertain. I think the FED acknowledge that uncertainty. I think you know, we see it in our own forecasts, where there is a lot of

different data point of different trajectors for the economy. Where we come out of all of that is to try to be relatively defensive, to try to keep positioning light as you continue to have a number of cross currents going on here. And it's amazing to me that we talk so much about the prospective recession and yet we've hardly talked about Dan grinning earnings. I beank channing with

Deutsche Bank on yesterday. I think it was the first time I've spoken to someone on Wall Street and equity strategist who is actually cutting their earnings expectations, first time in a while. And I know that you and my Wilson have been on telpodes story too. What do you make give that that we haven't had the warnings from corporations, we haven't seen the straight down great earnings in a

way that would match this recession conversation. Yeah, Jonathan, I think this is what's so fascinating about what's going on is I think that's exactly right in terms of the next thing to focus on. You know, when when we think about the market, in particularly the US equity market, you know, my colleague Mike Wilson thinks the market has generally adjusted to the rate rise that we've seen roughly.

What it has not adjusted to is earnings downgrades, which you usually get when you've had this sort of reduction in financial conditions, when you have had these sort of risks around growth, when you have the declines in p m I s that we think are likely. So I

think that's now where the rubber meets the road. There there is a scenario that's more positive than ours, where the companies are continue companies are able to continue to earn profits and and hit those consensus numbers, and in that case, the market could stabilize around current levels if they cut earnings as we expect, and then we still think that there's some downside risk here, and it's too early to try to enter the market, Andrew, which is

the reason why perhaps you're looking elsewhere. I was kind of surprised to see where else you're looking Japan. Why, based on the fact that you've seen that the end appreciate so significantly and a lot of people expect that they will eventually the Bank of Japan will eventually have to follow its fellow developed market central banks. Yeah, that's a that's a fair question. So it's pretty apparent that that every major global equity market in the world has

its own particular challenges. We just discussed the US. Europe has active ECB hiking, it has the war in Ukraine, China has the challenge of a zero COVID policy, and Japan also has very easy central bank policy that's increasingly disconnected from the more hawkish policy elsewhere, but we think for the moment that's one of the better challenges to have. We think the Japanese market is not priced for the

end appreciation that we've seen so far. We think that that if the end were to stay around one thirty five, or move higher, move weaker, that would result in earnings upgrades at a time when other regions can be seen earnings downgrades. Japan is derated significantly. It's not nearly as

expensive versus history as some other markets are. And we do think that the Bank of Japan will stay patient a little while longer because the inflationary pressures in Japan not not only aren't a severe right now, they've been so much lower for so much longer than the US. So when you talk about creating some sort of ballast to the portfolio, I understand the bet on Japan to some degree. However, there's got to be some bigger pool of securities that have to come from a place like

the United States or like Europe. If you don't like stucks right now because of that earnings uncertainty, how much conviction can you have around the long bond at a time when the Fed is going really aggressive yeah, no, I think that's that's one of the challenges. I mean, I think this is an environment where are overall exposures

gross exposures. Investors should be trying to keep those lower and to stay more liquid because as we've just seen over the last twenty four hours, the price action can be extremely volatile, it can be extremely harder to manage those risks, and there's large amounts of uncertainty. So I think keeping you know, lower exposures generally in this environment makes a lot of sense. I think it's trying to look for kind of relative value, putting more relative risk

into relative value strategies than than directional strategies. At the moment, as I think we are seeing a number of instances where relative value is working despite the volatile environment. And then it would be something like oil, which is an asset that we like, where you have an inflation hedge that pays you quite well to hold it given how

backwardated that oil curve is. And so that's the way to generate some yield wall also providing some protection and to just to kind of five thirty four hundreds still the number for you guys on SMP. Yeah, that's where that's where we think the risk reward starts to look more compelling. Okay, shakes that Morgan Stanley. Some downside still to come then for the team over a Morgan Stanley. Andrew sets the working closely with Mike Wilson, of course,

and Morgan Stanley too. It's right now, Andrew Sliman joins us senior portfolio manager, Morgan Stanley, someone who was inequities, someone who was congenitally long and optimistic, except maybe he's not. He joins us. Now amid the gloom, Come on, Andrew, the gloom, there's blood on the streets. Do you load the boat here? Uh? You know, Look, I think there's an opportunity coming. I just think it's too early. It's the stock market. Regardless of your view of the economy.

My view is basically, the stock market's got a hard time with tenure where it is given the multiple from that remains on the market until we get resolution in terms of interest rates and inflation. I just think it's too early to get aggressive. But you know it's out there. It's just it's just too early. Amid the loom. What is a lesson on use of cash? We saw d E Sha go after FedEx. They've amended. We saw targ

with a big dividend increase as well. How does use of cash change given the gloom that's the Bremo like gloom that's out there. Well, it is interesting that you know you are seeing companies increased stock buy backs. You know you're seeing insider buying. So I think there is some reason to believe that the collapse in earnings won't be there. Uh, And I think that's a lot to do with inflation. Frankly, that companies can pass along there

there you know, inflationary costs to the consumer. The question becomes will they may be able to maintain the margins or will consumers push back before their costs come down? And right now that has not happened. So companies feel pretty good about their business and they're raising dividends, buying backstock. That's what's happening. Aroun Now, we haven't seen the collapse in margins that many of the bears and predicted. So Andrew, let's say that we do get a continued sell off

as many people to expect. Is the real yield, not only the nominal yield, but the real yield in the United States resets to levels that we have not seen since two thousand and eighteen and earlier, depending on which measure you look at, When are we there? When do you start saying we have baked in the depth of the pain? Let's go well, I think first of all, timing, you know, it would be nice to be a little bit later into this summer because I suspect another seventy

five basepoint increase will cause further catharsis. It would be nice when you guys are out having your burger and y over or whatever you said top, you know, if the FED were to you know, ease up, I think that would be good. So timing first Number two is where did the market go if it gets down you know, it's sixteen times forwarderings, if we start to see fourteen times you know, in the you know, kind of mid

three thousands, I think that would be helpful. Or if you saw rates back off to uh closer to three percent, which clearly is not happening today. We're starting to see some inflationary inputs we can, but certainly not oil, and that's there's too much, too many things driven by oil prices, so inflation backs off, rates back off or the market comes down to a multiple that's more reasonable with three

and a half percent. I think those are the two scenarios, and I suspect all that will happen going into it later this summer. I just think it's too early, so you remain defensive until then. Andrew, what does it mean to remain defensive when you have to be fully invested? Yeah, I mean for me, look, I think we want Okay, So number one, what's amazing is you know what is working here today? Energy utilities, defensive stocks. Those are late cycle stocks. The market has told you that we're into

a you know, a slow down. The way you position as long equity managers, make sure that you aren't your beta isn't above the market. Make sure you have plenty of these defensive stocks and energy. The however, though, Lisa is early cycle is a consumer sucks and those have

been absolutely crushed. There are a ton of opportunity in consumer stocks, and as I said before, when the consumer sentiment is at an all time low, you have to stand up and say, huh, the rate of change at some point is going to be uh, you know, positive. And I think those are the types of stocks you want to start to prepare do the analysis on because I think that's the next what I would call the next fat pitch UH is to move into more of

these early cycle stocks. I just think it's too early. Andrew. Are you saying that it might be time to think about fighting some of the energy move then? After the months the running we've seen in energy stocks? Yeah, well so, Jonathan, what's Here's what's interesting. So the utility sector through May had outperformed the SMP by base points. You to day utilities are fading, right, So they have faded going into June. So I just wonder whether we're going to look back

and say we were in a recession. We're already in a recession, and the playbook would say, then you want to start to fade the late cycle. If you tell me, Jonathan, their recession is, you know, end of the year, next year, Oh, that is too early to sell energy. It's too early

to begin to reduce the defensive. If you tell me we're in it now or it's happening, then yeah, I want to get you know, I want to start to fade those that if we were in a recession and let's say it was right now, whatever that means what

kind of recession would you be expecting. I see that our world gets run around all the time, would be expect Well, well, we're uh, you know, the problem with the d procession right now, right now is you're not getting the fundamental drop off that the big earnings destruction. Now It's what scares me is you're starting to see some of these financial issues like Swiss bank raising rates.

You know, my contention has always been ultimately, uh, you know, something unfortunately, something breaks in the system and a kind of perverted not a very nice way of saying about a dead body floes to the surface. That's the kind of thing that you know, Marx bombs in you know, recessions. But I you're right now, as we said, if it is going to be a shallow recession because we haven't had the drop off in fundamentals to the magnitude of

a deeper recession. Andrew swimming Nuance for you as always certain to catch out with you from Morgan Stanley Investment Management. Right now, a gentleman from the Republican persuasion and from Arkansas, french Hill joins us on Uh, this aut economy. French Hill, I believe in Arkansas, you have a three point two percent inflation rate. You are the Kings of Chicken. Chicken is in ascendant in this nation because of the price

of beef, etcetera. Can things get any better for Arkansas? Well, Arkansas consumers tom good morning or really hurting from high gas prices. Were a rural, rural state. And when I was in private business before I came to Congress, I had many employees in my company that drove almost an hour every day to work. And so gas prices are really hurting our families. They woke up Monday morning and Little Rock to crossing the five dollar mark on gas. And so inflation is the top thing I hear about

when I'm talking both the small businesses and families. And the second thing, and this is the irony in the economy. You're a percent right. The second thing that's brought up is quality workforce. Trying to fill these open jobs in business? Well, do you fill them by raising wages? I mean, what is the prescription? It's the oddest thing, folks, All this day to day crisis we're reporting on, and yet the joy of a fully employed Arkansas, Right, how do we

solve this conundrum? Well, first, I think Arkansas spending a lot of time, and I've contributed in every way I can, both in my business career and now in Congress to better workforce preparation, better skill training for those coming out of incarceration, those coming out of high school, those still in high school, to make sure they have a path to the pursuit of happiness that's not a college degree. So we've got to do more workforce preparation, and believe me,

our state and our counties are doing that every day. Secondly, I think there's a real issue with getting people back to work and you raise pay and let me give you a quick example from Central Arkansas. Amazon has recently come into a little with one point three million square feet purchased, opening up their major logistics operations and they're offering about eighteen dollars as a starting wage there. So that is also really disrupting that full time, forty hour

a week person that's at a starting career. So you're seeing rising wages at the bottom in Central Arkansas. Congress been how crucial is it to increase immigration to the United States and open up some of the pathways for people to come in At a time where you're talking

about such a labor shortage. Yeah, at least, it's such an important question, and it's been something where America has been stuck for a number of years of trying to do that in a smarter way by doing more merit based immigration policy as well as clearing the decks on people who have been waiting ten years or so with

a professional degree waiting for a permanent residency status. So we let about a million people in legally in this country every year, it's something that we always look at rebound on seeing that on the legal admissions, I would think more merit based admissions would be good to get our our markets more in line with the talent that

we need. Yeah, Congressman, how difficult is that for some of your fellow Republican congress members to swallow considering the fact that for so long there was a discussion about reducing immigration or limiting much more substantially. I mean, how much are you representative of the mainstream of the Republican

Party versus an outlier? Right? Well, thanks for that question, because it all centers on the fact that just as we're seeing every day here record numbers of people crossing the Southwest border illegally and So the for years lease of the idea was if we can achieve border security, border control, or is our Secretary of Homeland put it the other day operational control, which they don't have, UH,

that would open up the day. I think to modify a lot of our internal immigration policies, and that's what we need to do. French Shaw out of Vanderbilt years ago, I know you still have your Jerry Ford whipping inflation now button. You know is a smart banker guy that you can't fix inflation. Joe Biden can't fix inflation. Even Elizabeth Warren can't flick fix inflation. What do you need

from Jerome Powell to fix inflation? Well, Tom, I think he took a bowl move yesterday, putting the Fed on record that inflation is UH their enemy number one right now. Considering we have such a surplus of job openings, we have a very strong labor market. So the seventy basis point move I thought was a bold one. He knows he's behind, Tom, You and I've lived through this for many decades. He knows he's behind. He wants to send the signal that the FEDS committed to not letting inflation

expectations get entrenched UH incorporations and pricing. And in the meantime, I think clearly we have to do everything we can to get the supply chain open by unleashing America's power to get people back to work, supply chains open. And this, as you say, not an easy task. That's why they call it the anguish of central banking. Tremendously difficult right now, Congressman, always fantastic to hear from you. French Hilda with the lightest in d C. And this is the Bloomberg Surveillance Podcast.

Thanks for listening. Join us live weekdays from seven to ten am 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