Surveillance: Red-Hot Inflation (Podcast)

where our listeners and our viewers are at. Forget about FED talk, forget about real inflation. How do we withstand a nominal inflation rate of eight point six percent? Well, Tom, I think this is exactly what you end up getting when you run the anomenal economy hot at double digit growth rates on average since the bottom of the business cycle in two thousan and twenty. Any look at historical

experience will tell you that. And unfortunately for households, if we look at the May data, the proxy phenomenal income out of the Jobs Report, which is essentially just wage growth, hours growth, and employment growth sung together annualized it at about ten percent, all of that being eaten up by inflation. With today's report, that's where I wanted to go, Mike, And that's what I was watching was real average hourly wordings, both on an hourly as well as a weekly basis.

On a weekly basis, it is now the most negative that it's been in data going back to two thousand and six, negative three point nine percent in terms of how far behind wage inflation is falling behind the actual stuff we buy every day. What does this do to your growth outlook, Mike, Yeah, I think unfortunately, you know, we're dealing with a little bit of a stagflationary environment here, at least for the month of May. So obviously we've had intensifying shocks and in food and energy prices. So

hopefully at some point that will reverse. But you know, as Mike McKee went into, this is an inflationary process that has been broadening and deepening out. So you've got pressure on rental inflation. That's a significant portion of the CPI. If we look at services inflation excluding energy, that six of the c p I. It's running it more than

double the average of the last business cycle. So it might be a bit of a fool's Errand here to just assume that if crude oil prices back off all of a sudden, the magic wand is waved in the inflation problem simply goes away. Mike, we thought that we had seen peak inflation. We had not. We now have an even higher print, that is a new post high. Is eight point six percent the high high water mark?

Or are we going to see even higher ahead? Well, I think we're probably pretty close to peak inflation on a year over year basis, But none of that may matter for the path of FED tightening and the bond market and equity market valuations, because if inflation eases from here but still stays very high, then you know that is not an environment where the FED just moves to the sideline sidelines and we see some kind of huge revaluation and expensive equities that dominate the pulpit cap of

the s and P five hundreds. So there are some macro commentators making kind of bizarre arguments, at least from my perspective um that aren't focused sufficiently on the nominal GDP backdrop, which is still way too strong. Aggregate demand is still way troops too strong, so the FED has

more work to do. And the fact that if inflation eases, but is settling in at rates that are several times the Fed's target acceptable inflation over time, and that's still going to be a problem for the bond market and the problem for the Federal Reserve all And you know, Muhammad ali Arian, who was on yesterday with John Farrow, said, um, if you think we're going to have a recession, sure,

inflation is going to come down. And I'm paraphrasing here, but that's not what you want to see, right, That's not how transitory inflation should be affected. So is that the way we're gonna see it? Well, Matt, I think unfortunately eventually that's where we probably end up. But the critical discussion is timing there. So I don't think that we're in a recession now, and I don't see a

recession this year. I think the reception will come after the FED gets itself into a restrictive monetary posture, and

that's going to take some time. Consider this fact, forget the backward looking numbers that we just got, as shocking as they are, the FED funds rate relative to five year expected inflation is still below two hundred basis points minus two d basis point, and that is below the trough of the last business cycle when you had very slow growth and you know, in in very weak realized inflation, and so this FED is still behind the curve, and that is going to create a situation where these underlying

drive inflation like services and rents and wages are likely to continue accelerat well, Michael Dart, that's right where I wanted to go, because, frankly, folks, the most important inflation data of the day after this shock is at ten AM with a five year, five year forward Michigan statistic. Michael Darter, what are the ramifications to the to the the economic zeitgeist if we get the five year Michigan look to break out above three percent, to break out

of the inflation level of two thousand six. Yeah, I think the f O m C would take note of that. Um. You know, those measures are are a bit stickier than the bond market break even measures, but you know they are elevated marginally relative to their averages of the last cycle.

And we start to see a any kind of what looks like a breakout, I think that would create a lot of consternation on the f O m C that these high headline inflation numbers are bleeding into longer term expectations and you know, I think the FED would be alarmed by that. Michael Darta, thank you so much for the insight. Michael Darta, m CAM Partners, and can't say enough about his linkage of the equity markets into what we see in economics. This was scheduled before the inflation

report and the importance of it. David Harrow, of course always looking at price change across America, but far more. We've tried to get David harrowin of Harris Associates to speak of EU banking. It has been an absolute shock and David, I've got to start with credit suites and the view back I'm gonna say fifteen years or so before the Great Financial Crisis of two thousand six, and it is has been an abject value trapped and an abject failure. You've been directly involved in this. You have

been patient, David Harrow. Have you run out of patients with the gnomes of failure in Zurich? Well, not at this stage yet, because there has been wholesale changes at the bank, from the board to the management down, and I think we need to see what the new people who are involved with the bank, both from the Executive Management Committee and the Board of Directors can do too

during this round. There is inherent value within the business, and I think these people should be given a chance to try to create this value and sustain this value. The bank trades at about a third or book value, so that the object now should be stabilization and then growth after stabilization. And they can't do it. Someone else asked to do they have a Swiss Are they not making tough decisions because they know this government has their back, that Zurich will be UBS and that Zurich will be

credit Suite. I would hope not. By the way, I'm a believer in free market capitalism. Then there shouldn't be any protection. If they can't do it and someone comes in to make an acquisition to all our parts of the business, I think that should be allowed to happen. Now. There's taught that if someone does bid, they will give UBS a chance to do some kind of a deal combination. But I would certainly hope that is not the case.

Is Europe even ready for big cross border bank m and A. I don't think you can here across a border bank M and A in uh Europe and a wide scale until some of the rules and laws are changed. At some point this may happen, but you still have fragmented banking markets, which it makes it non conducive to

cross border. I think there is a possibility for some an isolated on an isolated levels and basis, but at this stage you still need regulatory evening out that would make it more conducive to cross border M and A. On the other hand, a company like Credit Suits has a huge private wealth management business which is now bigger

than their global markets investment banking business. And for any big global bank that wants exposure in this lucrative area, you would think Credit Sweets would be in an attractive asset. I gotta ask you about um China because every morning it seems like futures lately have are driven by the idea that China may um get a little bit lighter on tech companies. Yesterday there's a report that Aunt could revive its I p L, although that's been kind of

pooh pooed. I see that you own a stake in Process, which in turn owns a stake inten cent Right, what's your view on China tech now? It does appear that we've hit peaked regulatory initiatives in China. As you know, over the last year or so, they've been increasing a regulatory scrutiny and the Chinese tech sector, so the whole sector has been kind of hit. We also owned some Ali Baba as well, and both these sectors have been hit.

But we believe that even with this additional regulatory scrutiny. Now, keep in mind, what's happening is these businesses around the globe have grown much faster than the regulator's ability around the globe to regulate them. In China's kind of taken a first staff. But what we have seen what appears to be statements from the government that we're getting getting to the end of the regulatory initiatives. And then you even saw in the case of ten Cents, lots of

games that were approved this week. This is one of the things that they were concerned about, uh withholding game approvals, uh, you know, for the various reasons. So we are starting to see regulatory relief or at least movements by the government that the worst is behind the sector. In Meanwhile, these are really well run, world class tech companies that

trade a load double digit multiple. David Harrow, thank you so much too brief a visit, but we've got so much going on in inflation, David Harrold Harris associates there. Jonathan galub is having a difficult Friday. He's a credit squeeze and of course their chief US equity strategist, John, I've got to get out in front of your research note.

Will you amend your targets this weekend for Monday trading? No, we won't amend our our target and I think you know our call all along is that the inflation is going to be stickier at a much higher level, and we've been recommending companies that benefit from higher inflation. So

the two ways of thinking about this. Today's report is bad for the market in general, but there are certain companies that hold up better or worse in a higher inflation environment than others, and that's more focusing John Goda. What's so important to me here is the behavior. And I don't mean to hearken back to the fossil dim that I am in the nineties seventies, but let's look at the deck of cards. We've got the worst bond

market since time began. Price down, yield up. We've got these inflation numbers today, the FED parlor game that we're going to see out to the end of the year. What do you in the credit SUITEZ Securities research team field corporations will do. And my estimation they have to rapidly act even into June and July and make the plans that they thought they would make come October. Am I right on that? You know, Tom, I don't think

you are right on that. I think that I think the companies in a very high nominal GDP environment, which is what we have, the underlying eco out of me for all the recession concerns is fine. Revenues are rip roaring strong, and so bigger companies in this environment have tended to do a bit of a better job at being able to make maintain costs. But profits are really high. The thing which is getting smacked around, um are the stock multiples, not the earnings. And that's important to think about.

So what kind of multiple do you think is right for this market, especially if the FED has a terminal rate of three and a half percent. Well, first of all, I think that the FED is going to and I think this is going to lead to dialogue that this this conversation that we were having over the last couple of weeks. Can the Fed pause in September. Well, we know that the answer to that now is no, UM and the said probably has to move beyond three and

a half percent UM. But we still have a you know, we have a very powerful earnings environment, the revisions, the you know, the kind of the analyst adjustment to the earnings. With all discussion that we've been having about weak earnings, they're going up almost every day. So um, we think that the market so how much how much should investors

be paying for forward earnings? You know, if you if you look at a corporate bond yield, which is what your discount rate, it's not Fed funds, it's still you know, still something like five percent, which is a low number. So we think that stocks are attractively valued at these levels, and we would be going in the level of concern in the market is we think is much higher than the than the underlying backdrop. C IBC report and this is Catherine Judge reporting from c IBC Toronto, and folks,

I think this really sums it up. C IBC calls US inflation report read hot, and they go Matt Miller right to the heart of the matter which McKee alluded to, which is shelter is the most gain since two thousand four. We've been hot highlighting this today, folks from Senator Mansions Charleston, West Virginia to Senator Miller's uh suburb north of New York. I mean, Matt Miller, this is nothing that anybody already knows.

We are aware of this. I mean, if you look at the what's it called the SMP core logic case Shiller, we should really ask Bob to shorten that. If you look at their twenties city index UM and max it out, we're at a level that towers over what we saw in two thousand four, two thousand five. So in terms of the absolute level, it's just unbelievable. The amount of appreciation to seeen in the house prices. John Gala with

credit sweets with us here. John, you talk about the animal spirit of nominal g d P. But at eight point six percent headline, is there a point where the inflation price change part of nominal absolutely overwhelms actual economic growth? You know? It's that's like the the ultar bit the ultimate question, the the like Like I said, before the earnings are fine, the stock multiple is in five multiple points. Is a decline in stock multiples this year. Today's news,

taken by itself, should push the multiple down. The market, you know, the futures are down something like one in a quarter percent on this news. That is perfectly that's exactly what you'd expect to happen. But the market has already you know, adjusted, you know, enormously for this inflation environment.

So I think that the market probably is has taken all the bad news into account already, which is one of the reasons why I'm not as concerned, not because this isn't a good report, but because the markets already discounted a ton of bad news. And most importantly, you know, a red hot and you're just talking about the c ib report. A red hot economy does not equal recession, and this is a red hot economy, not a recessionary economy. John Gallup, thank you so much. Right now, Ellen Wall

joins us. I can't say enough about her book, Saudi Inc. It is a window into the layers of the Ebon Sad family, the heritage of the family, and most importantly, the new family. She's senior fellow at the Atlantic Council. I guess Mr Biden will visit Riot. It's not formally announced yet, but there it is. Ellen is well when he visits. Can there be a belief that Saudi Arabia can adjust the price of a gallon of gas in America?

I think that if you if you have that belief still, you need to re examine your your belief system, because Saudi Arabia does not have the ability to change the price of a gallon of gasoline like that unless they do something so incredibly drastic um and at this point, even with demand way it is and with other producers and you know, kind of falling off a cliff, even if Saudi Arabia put another two million barrels a dave oil in the market, I don't think we would even

see that much of a drop in US gasolene prices. The hope and prayer here, Ellen is a redux of OPEC one, OPEC two six, And there was a moment in night six were oil cratered. Can we relive that? Well? Um, we could. I mean we almost relived that in um. If you remember in in March of win just as global oil demand was cratering, Russia and Saudi Arabia both kind of opened their taps, so uh and and saw in April and May of that year an incredible amount

of oil just slotting the market and crashing prices. I don't think that we are likely to see a redux of that in this case, unless there's some sort of major shock to the global economy that that causes demand to create. At this point, we're so tight in supply, and um, there's enough Russian oil that has been off the market. There's a question about whether it's really coming back or not. I think that it's coming back a

little bit more than people think. But still demand has just been so high, and with China reopening and demand expected to go up there, it's really just it seems like there really isn't enough oil in production now in the world to get that to get these prices down significantly. And then when you throw in uh, you know, the situation in Ukraine and Russia, it's just that it's just

a recipe too for prices to keep rising. Ellen the people who say this is a policy error and we should have been investing more in fossil fuels, if there were some sort of change in policy that would encourage more investment. How long would it take before those barrels would actually come online to ramp up production. So it would definitely take um some time. You know, we're not Saudi Arabia. We don't just have spare capath city that

can come online that quickly. But it's not as slow as it would take in other areas, because there are shale oil resources that can come online, you know, within month, two months, three months, things like that. UM. Longer term, though, we would need a lot of investment in big long term projects, say in the Gulf of Mexico and other areas that could pump a substantial amount of oil that would bring down prices in the long use of her you'd have that. Why would why would those executives want

to do that kind of investment? I mean they've been vilified, um by not only this administration but by the US Congress. Um. Why make that kind of long term investment when you know that policies and regulations can change on a dime against you, precisely. I mean, this is this is the question.

You know, if you're an oil and gas executive and you're responsible for making decisions about the health of the company, returning value to your shareholders of Coorse, you're not going to want to make any of these long term investments because you are concerned that any project that you invest in could just either get shut down by government regulations or for all you know, they're finally going to issue the methane regulations and you're just gonna have to spend

a huge amount more money to comply. That uncertainty I think is really keeping production from increasing. On the flip side of Ellen, how much can some of the renewable sources of energy start to offset fossil fuel usage in a way that is more material in the near term and frankly expedite that transition. But I don't want to be a downer about wind and solar, because I think they are great technologies and they're improving all the time.

But if you look at the amount of energy you get from renewable energy and you compare it to the amount of energy you get from breaking down a hydrocarbon, you just can't compare it. It's it's not you need so much more of these renewable sources in order to compensate for hydrocarbons, And we're at a point where energy use is still increasing, and so all of the renewables that are coming online are helping to to create that to offset that new demand. Forget replacing old old sources.

Oh well, very quickly. Here I have a moving average of inflation adjusted brent, which tells me that when we get up to a hundred forty a barrel, things change, how our behavior change? If we see brent move on up to one and you know what, you know, if you'd asked me a month ago whether we get there, I'd say, well, one forty is a long way off.

Now it doesn't seem so far so far away. I think that if we hit one forty brent, we're definitely going to see um a lot of people and also businesses to making decisions to u not you know, not expand and maybe cut back on production. We're already seeing businesses say that depend on troleum products. We saw Lulu Lemon earlier. This Week's say hey, we're raising the prices of our products because they are made from petroleum, and

patroleum is just that much more expective. So it's not just relying on energy, it's also every business that uses oil products. Now you're seeing Ellen will thank you for the brief on oil with the Atlantic Council. Can't say enough about weekend reading with Saudi and as well. This

is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. Eastern on 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