Surveillance: Richard Clarida Is Ideal for Fed, Crescenzi Says

those great things. You know. One of the things I like about your notes, as you say, barring a zombie apocalypse or a spontaneous collapse and asset prices, uh, that's a lot of you know, if this doesn't happen, this won't happen. But I'm wondering what would a zombie apocalypse

look like to Tony Crosenzi. Well, list note was the product of pimco's quarterly cyclical form where we look at the global economy a year forward and try to devise an investment strategy, and Yolakum Fells was the lead author to that um. So the zombie apocalypse, of course, would be probably a lot of a few things. One would be an inflation breakout, which would cause a federal reserve to increase its interest rates substantially and change the climate

for investors substantially. Think about the stock market, it probably would be upset by it, and so would the corporate bond market. Another asset class. Can that happen? Is is it possible for inflation to accelerate, not gradually, but in a kind of alerch higher? Is that? You know? Can you wake up one day on a Thursday and find out, oh my goodness, oil's gone to seventy five dollars a borrow, like the Saudist said, But it's not three, It's still

only twenty. Let's say eighteen. Well, uh. Jacket Yelling a couple of years ago wrote a note on inflation and called Inflation Dynamics September, and she did a thorough examination of what causes inflation, and what she concluded was that the most important driver of inflation is not the month, the amount of money that exists and this factor of that factor, it's inflation expectations, what people believe. So it

is a very much a behavioral thing. And since most people have the view that inflation will stay low people meaning investors, consumers, businesses, it's highly improbable that would break out quickly. It would take a major change in the central bank sphere for UH investors, consumers, businesses to think differently about inflation in the future. So, for example, in eighteen, what if inflation picked up as a result of the US job was rate falling below four percent, which is

likely next year since it's currently four point one. What if the Fed decided we don't care, we're gonna let pick up because it's been so low, then inflation expectations would build up, and then who knows, it could go higher. But that's improbable. The Federal Reserves learned over multiple decades to be cautious about letting inflation pick up, and so it's not likely inflation will pick up meaningfully for very long.

But having said that, in your note, you say there is the potential for four rate increases by the Fed next year. A little bit more aggressive for sure. So we saw the Federal Reserve deliver three interest rate hikes in t seventeen. Three seems probable next year, and that's what the Federal Reserve itself expects. There were inconsistency, so and we were discussing this at PIMCO with or an advisor, Van Berninki not mean to name drop here, but he

noted these inconsistencies as well. And the last Federal Reserve Summary of Economic Projections is a quarterly report the FED produces that shows projections on economic growth, on employment, and inflation. There was a big inconsistent here. It is FED projected economic growth like we do have two and a half percent, but it did not project a meaningful drop in the unemployment rate, nor an increase in inflation, nor an increase

in interest rate hikes. And so something has to give, and that give may mean a fourth rate hike, because it probably will mean a lower jobs are real quick on this, and the job is the simple math. It's

called the Oakland's laws. Member Nankee pointed out if job if economic growth of two exceeds growth potential, which is considered one point eight by seven tenths, the job is right, by Oaklan's law, should fall half of that FED in his summi economic rejections had only a two tenths drop instead of roughly four that Okan's law would say that it will drop next year. Hey listen, so might Rich Clarida beyond that FED next year maybe thinking about doing

four rate increases. Of course, there's a report out there in the Wall Street Journal, according to those in the know that the White House has interviewed Mr Clarida, who's of course imagining director at PIMCO, and also some others. We talked about this on Bloomberg TV with our Marty schenk or Um and any insight you can just give

pim and me, it's just the three of us. Well, they would There would only be one announcement, of course, of whether or not Rich Claire his name to the Federal Reserve, and that would of course come from the White House. But I would say about rich and Uh that he's expert, he's exemplary, he's exceptional, and these qualities are important. Also he's he's very affable and works well with people. This is important collegial. Here's his story I

have from Alan Greenspan. He visited us when he was an advisor to Pempico with Newport Beach, and he said that when he joined the FED in seven as FED chair, that he learned that it it was the most collegial organization he ever worked for. For example, he expected staffers PhD staffords to walk into his room with competing views on the policy, and instead they were working together. This collegiality is something that someone like Rich Clarata would contribute well to.

It's very important to the institution of the FED and uh, Rich of course would be ideally suited if chosen. Can I just push back on that, I mean, why do you want everybody to agree with each other for the collegiality? But this is not agreeing with each other. It's not it's providing inputs, right, And somebody says don't raise interestsgiality in the Federal Reserve sense means healthy discussion. They're all working together with their varied points of view. This is

something that PIMCO knows well. We hold in our quarterly forums and Rich Clarence as head of them. Uh. Two people attending U in Newport Beach contributing views. It's a flat structure where everyone has a voice. One could have no rank at all in terms of official rankings. Of course, they have high rankings as human beings. Uh. They could be vice president of senior vice president, executive managing director. Who who knows? The main thing is that it's a

voice and it's a it's an input. And this is something that which absolutely understands quite well. Exceptionally well. What

about though? Also we know that Rich served as an Economic Policy Assistant Secretary for Economic Policy the Treasury Department from O two to oh three, So he comes at things with an ponomous background, with a financial background, if you will, Will comes at it from a couple of different angles, Tony, How might that help the FED, particularly in what might come in It's also important to have a great Anyone who's appointed to the FED should have

a great understanding about communications. Remember a great line from Bamburnanking his most recent book, The Courage to Act. He said that he's repeated this to us at PIMCO, that that monetary policies on two percent action communication. In other words, what the FED says can affect markets and people's expectations, and it's important to have an understanding of that, and the understanding of economics and monetary policy historically matters too.

We spoke about this on television a little while ago, Carol about how Ben Bernanke understood the dilemma of the Great Depression and how the FED failed in the nineteen thirties to produce enough money to prevent a collapse in the money supply. The amount of money that existed if failed by a third according to Milton Friedman, and it

was a great contributor to the Great Depression lack of money. Uh. Bam Bernanke understood that it was that it was importantly printed lots of money, just as corroded did in Japan and dragging in Europe. Uh. These are very important things to understand. Um, that's a big example, but there are a lot of little examples about how knowledge about monetary policy can conserve a member of the Federal reserved Quite well, do you think it's more it's easier to manipulate people's

opinions now than it was, let's say, in the nineteen thirties. Yes, Um, so, then that apocalypse that you describe, where that sudden change in people's expectations is perhaps more likely to happen now than it was before we had Twitter, smartphones and sevens. Probably, perhaps it's not the that the Fed can convince or communicate more. Uh. The temple the speed at which things happen, of course as faster, but of course the public could could have a fear permier quickly. Think of the movie

It's Wonderful Life with Jimmy Stewart. Uh, there's a scene I recall with a bank run. How do people know that there's a bank run occurring in that day and age? It's simply where it eventually gets around. Today was simply the speed at which it gets around is faster. Now you just pound the uh, you know, online button, tweet. But I mean if you go to a website and it stops working and it's your bank, all of a sudden, everybody in the world knows that everything's changed, or a

tweet or something posted on a social website. Absolutely, communication is important to central bankers, and that's one of the key things that's keeping interest rates low and make causing the yield curve to be flat, as they say, meaning short term rates are close to long term rates. Is the idea that this communication is calmed investors. They don't worry and ask what compensate compensation against the risk of higher inflation and higher policy rates anymore. Alright, we're going

to continue the conversation. We've got more with Tony Krissense, Pimco market strategist and portfolio manager. I'm pim Fox along with Carol Masser, and this is Bloomberg Surveillance. I'm Carol Masser along with Pim Fox. We are in for Tom Keene and Jonathan Farrell on this Wednesday. We want to talk a little bit about the tax legislation. We mentioned earlier about Barkley's taking a one time hit from the U S tax bill, but expecting to make it back

to some extent on future earnings. David Burton is with the Heritage Foundation, Senior fellow at the Heritage Foundation. We find him on the phone from the nation's capital on this Wednesday. David, nice to have you here on Bloomberg Radio. This tax proposal, we talked about it earlier, not proposal, this new tax legislation overhaul, if you will, we talk

about it earlier. Greatest benefit really is for corporations. Yes, in terms of the positive economic effects, the biggest benefit is the reduction and corporate tax rate from which was a while it sounds like a lot. Um actually puts this in the middle of the pack among industrialized countries. Will be at about one state corporate taxes are taken into account, but until next week, we're literally the worst highest corporate tax rate in the industrialized world. So we've

made progress. Uh. It also contains a number of other provisions that are constructive. Probably the most notable is expensing for machinery and equipment for five years, so businesses can deduct the cost of buying machinery and witment rather than having to deducted over many years, five, seven, ten years um. There are a number of other positive things in the international tax area that will help US headquartered companies, But on the individual side, it's not all that much to

brag about. It reduces individual tax rates a couple of points, but for a lot of people that's taken back immediately by the repeal of the state and local tax deduction. David, do you believe that the economy is doing fairly well right now? Yes? I mean it is just doing reasonably well. There's plenty of room for improvement, both in terms of investments and productivity gains. But also there's a lot of people who aren't encountered as unemployed, who normally would be

in the workforce. Well, do we know exactly how many of those people are there and whether that is what is tipping the political scales to force this overhaul of the tax code. You can get a cent of how many people are there by looking at the broader definitions of unemployment that the Beer of Labor Statistics put out. Um, they put out lots of different measures. The you know that what you usually hear on the radio, uh is one measure, but there are broader measures, uh that would

have unemployment up there. I forget the exact number right now, it's but it's about ten. Uh. Those are people who have not reported in the conventional unemployment rates. But use six is what this is called is is uh. It reflects people who have gonna affect given up looking for work for the time being. Okay, so I'm just trying to understand why would you put together a tax overhaul plan at a time that the economy, by your own admission,

is doing pretty well. And you're pointing to all these people that are outside the workforce that perhaps aren't counted. And yet Uh, if you've got to pass through corporation, you're gonna end up paying what tax? But if you're actually working for a pay check, as chances are that your tax rate is going to be a lot higher. How does that make sense? Well, for one, our labor force produci patient rate is that historic loads are near

those loads. This tremendous number of people not working. It could be working, and presumably you would prefer that they be working and self sufficient rather than uh collecting the disability or unemployment insurance. I don't think anybody argues that, but I think the question is how do you make how do you maintain this sort of idea that this tax overhaul plan that reduces You said it's good for corporations, right, I mean it will reduce their tax rate, although most

companies don't necessarily overseas pay that tax rate. Of how is the relevant thing you would think is you would want people to invest in producing things here in the United States, So why not make the tax cut contingent on their actual hiring. I mean you can do that. You can put all the details you want into the tax code. Why just assume that they're going to do it or encourage it? When chief executives have already raised their hands and said we're going to buy back stock

and we're going to increase dividends. Well, we'll do some of that, and that's fine. The money that when they buy back the stock, that money doesn't disappear. It gets reinvested somewhere else, and the market determines where it goes. It goes to the generally what people believe will be the highest return investments. UH. As you probably are aware, a tremendous number of US companies have been leaving, for example, Onizer Bushes now Belsenburger King Is now Canadian and selling

down the line. By reducing our core for tax rate and improving the international treatment of US businesses, we're going to see less of that. We're going to see more factories being built in the United States. We're gonna see a higher rates of productivity growth. We're going to see a lot of positive things as a result of this legislation. But I don't want to oversell this legislation. It is

a shadow of what it should have been. UH. It's probably going to result in two and a half uh increase in the GDP or the overall size of the economy over the next ten years. It should have been more up around the neighborhood of ten percent. This is going to be a relatively small positive effect on the economy as opposed to the transformational, huge kick in the pants that it could have been if they've done it right.

And let me just point out the Joint Committee on Taxation UM, the group within the Congress that really kind of figures out, you know, what kind of kick this legislation will have. They actually say that it's going to be maybe eight tenths of a percent increase to the accounty over ten years, so it's a lot less substantial. The Joint Committee on Taxation staff basically has a long history of underestimating the economic growth effects of any tax legislation.

That said, you know, I don't want to overseell this legislation. It's not going to have magical effects. But David, let me ask you. You say that there was a missed opportunity. They could have done a lot more. What should they have done in your view? Should it have been more of an individual tax cut? What? Wow? The biggest thing that they failed to do is improve permanently the tax treatment of investment in things like factories or technologlogical developments

on the line. In other words, they did not expense capital investment. Uh, they didn't expense structures, they didn't expense equipment uh permanently. Uh. They made a lot of other mistakes. They kept the capital gains rate where it is. They kept the rate on pass through businesses or or individuals uh very high and for a lot of people who

actually see marginal tax rate increases. Uh. So there's then I can get into a lot more details, but there's a long list of things they did not do to improve the tax system, David, If the consequences of the overhaul lead to muted growth, in other words, this pop that you're describing, or indeed even the stronger economy that's being described by the Republicans who passed it, if that does not appear, is there a way to put to

rest the notion that tax cuts fuel economic growth. I think it's vertually certain that tax reductions and marginal tax rates and reductions in the cost of capital will fuel economic growth. That's pretty basic pricetery, pretty basic public finance. It's not the tax cuts per se has and do its sort of kensy and multipliers and things like that.

It's the fact that people are economically rational and if they can get a higher rate of return, they're more likely to invest, they're more likely to work, they're more likely to say uh. And so I don't think we'll get over that because I think it's almost incontrovertibly true. But then the question is how do you do that? And reducing marginal tax race is part of it. Reducing

the cost of capital as part of it. This bill or or legislation does improve those things, but it's not nearly as dramatic as it could have been, should have been as not as as dramatic as it started out. They ended up having to keep a long laundry list of special tax provisions uh and and various things on the individual side. It don't affect by people off because there they needed virtually every Republican vote to get it done. All right, well, we're gonna leave it there, but thanks

very much at David Burton. Looking forward to having you in the new year and to go over the effects of the attacks overhaul plan. David Burton is the Heritage Foundation's Senior Fellow in Economic policy on the tax plan. You're listening to Bloomberg Surveillance. I'm Pim Fox along with Carol Masser. I'm Carol Masser along with the wonderful Pim Fox right here on Bloomberg Radio. We are in for Jonathan Farroll and Tom Keene. We do want to talk a bit about the economic outlook what it might mean

for FED policy. Joining us right now is Kevin Cummins. He's senior US economist at NatWest Market, joining us on the phone from I Believe, Connecticut. Kevin, good to have you here on Bloomberg Radio. You look at the outlook, you look at the economic outlook. There are folks that come on and they are optimistic about what's to come. They continue to see growth into one eighteen summer. Tempering it back, Where are you, hi, Good morning, Well, thanks

for having me Carol. Um. Yeah, we're pretty optimistic on the overall outlook. We think the expansion is going to continue. Um, we're looking for growth this year right around two and a half percent and to gradually accelerate into next year closer to I want to know about automobile sales and what what weight you give those to your outlook, because it looks as though we are set for the first

decline full year sales decline since the Great Recession. And I know that there are a lot of statistics that you know, exclude automobiles, They exclude energy, whether that's inflation. But I'm wondering if you could talk about automobile sales and how you figured that that flows into the economy. Yeah, I mean, obviously, the manufacturing more broadly is an important

sector of the economy. In particular, autos drives a lot of manufacturing UM and as you mentioned, those are set to moderate, although more recent months you've seen very strong demand in the wake of the hurricanes, which impacted a lot of UH. You know, replacement automobiles have picked up in the in the wake of that. UH. In fact, we're looking for a nice rebound that will get at the start of the year a pretty healthy reading close to eighteen million units at an annualized rate. So that's

a very strong, probably unsustainable pace. More broadly, UM, but this year we're looking for a closer to about a seventeen million unit rate when it's all said and done for the twelve months of the year UM, and we're looking for that to be pretty much sustained into two thousand and eighteen. As the consumers and still pretty healthy shape.

Do you think that consumer is in healthy enough shape to actually buy one of these new cars, because the Kelly Blue Book says that the average sticker price paid for a new vehicle is nearly thirty six thousand dollars. That's up two percent from a year earlier. Those are November figures. Yeah, those are big numbers. But uh, you know, with the sort of labor market that we've gotten, Um, you know, it's the consumers seems to be kind of firing on all cylinders as we headed into the start

of the year. Do you think that they'll be able to continue to afford it whether they put cash down which is unlikely, but more likely to borrow or lease. Yeah, that's kind of the American way. I mean, you know, the labor market has remained very solid. If you look at payroll growth, we've averaged about a hundred and seventy five or so thousand jobs over the last twelve months

or so. UM. The employment report that we'll get at the start of the year suggests that the consumer is likely to have have a pretty good uh wherewithal to spend h to start two thousand and eighteen. And now that you've gotten a little bit of momentum in the overall economy as we head into the year, uh, you know, when people are reminded U that confidence is high. We'll get a reading in that in a little bit with

the Conference Board measure. But but by all indications, there's no reason to suggest that there's going to be any sort of pull back from the consumer sector as two thousand eighteen starts. All Right, Kevin Cummins, I'm a half glassful kind of girl. I'm just going to say that I'm pretty optimistic. UM. Having said that, we have seen this economic cycle go on for some time. I know there isn't a mark on the calendar that just says, okay,

time for the economy to turn down. But what is it that you're watching out for, um to see a different twist in this economic cycle? Uh, is a recession at all on the outlook for you? UM, not for the next day, twelve or so months. I put the odds. I mean, normally there's probably a chance of about ten percent, and any given expansion that you can uh, you know

that a recession is going to come. So I I put the odds somewhere close to that, maybe ten fifteent odds that you're gonna get experience a recession in the next twelve months. But you know, there's no real warning signs in fundamentals for the economy. As I mentioned, the labor market remains very solid. We've seen good uh income growth if you look at wages and salaries last week. We've got personal income and spending and it showed wages and salary growth over four percent, So you know, that's

a very healthy pace for the consumer. And given that the consumer uh AfD account for import growth is probably about six or so of the overall economy. Um, you know that that right there suggests that your overall economy is in pretty healthy shape. I mean, one of the more positive things as we head into two thousand eighteen, especially in the wake of the UH plan for the tax cuts, our business investment, and by all indications, we're

likely to see UH further acceleration from that perspective. So you know, you add that to the consumers part, and you're you know, almost or so there. Does it also mean no more inflation? And then that becomes maybe problem addict? Yeah, I mean, inflation, surprisingly enough has been as soft as it is, you know, trending below two percent, and the

Fed is obviously, uh pretty sensitive to that idea. So I think, you know, the overall inflation backdrop doesn't suggest that you're going to get any sort of real upside risk inflation here, but probably more gradual UH pace of somewhere around one and three quarters to two percent over the next year or two. Kevin Cumming see is the net West as senior economist. Our guest is r J. Gallo of Federated Investors, Senior portfolio manager, Head of Duration Committee,

r J. Gallow. What is a duration committee? Our Duration Committee is a group of senior portfolio managers traders are Global fixed Incomes CEO Bob A. Strowski, and we convene every month and sometimes more frequently to look across the factors that we believe are driving us interest rates and to set the duration governor that then permeates through the

intermed and long term bond portfolios or firm managers. So, since durations one driver of bond returns, we try to bring together minds from across the fixed income group to set duration targeting that is then followed, you know, with with judgment by the portfolio managers of the various portfolios we run. Okay, can you give us an example of how the group has changed its recommendation so that we

understand the mechanism by which it kind of implements these decisions. Yeah. Absolutely, Every fixed income portfolio Federated has a strategy relevant benchmark. So for example, of the Total Return Bond Fund, which is our largest um investment grade portfolio multi sector across treasuries, corporates, high yielder, emerging markets, et cetera. Has managed relative to

the Barkley's Aggregate Index UM. The out index, of course, has a duration, and the duration committee Our output is to provide a recommended percentage of that index duration that the portfolio manager should follow, but they're given latitude around it. So, for example, UM, for much of this year, we've expected treasury yields to rise, and as a result, we have been recommending a duration typically between ninety to sometimes seven

and a half. So being short your benchmark duration because we anticipated as yields rise, being short would give you opportunities for relative out performance. When the tax package passed and as it was working its way through Congress, what did you guys go back to your offices and sit down and work and say, Okay, here's what we need to think about different portfolios as a result of this.

What changed? That's a great question, UM. Interestingly enough, you know, there's a lot of times we talk about you know, everybody's been expecting yolks to rise for for a very long time, and oftentimes people focus on the tenure of treasury. But if you go back and you look at the yield on the Bloomberg Barkley's Treasury Index, which is the treasure component of the of the agg UH. That index yield was eight basis points um at one. It's two

and twenty four basis points as of yesterday's close. On this calendar year alone, it's risen thirty five basis points, driven primarily by the fact that the two years up seventy plus basis points and the five years up thirty as is the three year up almost sixty. The tenure, on the other hand, is about where it started the year, So we've had a massive flattening almost a twisting is better term of the Treasury Yon curve. The fifth a policy change that you just brought up the tax bill.

You know, we've been talking all year long, what will the Trump administration and the Republican Capital will be able to deliver with respect to significant changes in fiscal policy, to include taxes, to include healthcare UH, and to include deregulation and on that last point, the regulation. They've been quietly making significant changes UM which arguably are stimulative at least in the short run. As businesses feel that the administration UH and Washington d C. Broadly speaking, UH, is

somewhat more business friendly. It's a it's a sentiment builder, if you will, and they've been delivering on that for a long time. Healthcare, we know what happened there, Uh, you know, got closed, didn't change it. Um. And then ultimately we felt that the failure on Obamacare would increase the probability of a major tax bill being passed and signed into law. We felt that the political imperative of the somewhat fractious Republican Party between the White House and

Capital Hill. Um, they all shared common interest and they needed to move forward, and we thought the tax about would happen to be frank we thought it would be signed in Q one eighteen UM. But that political imperative was very motivating and it got signed in so. Um. The the progress that we expected, in fact did manifest themselves a little sooner than we expected. Uh. And we do think it's going to be somewhat stimulative. UM. I have questions about sort of the content of the tax cut.

I've heard some of your interview earlier with the individual from the Heritage Foundation, and you were asking some some of the questions I would ask so UM, but generally speaking, I think the short term stimulative nature of the tax cut is it's hard to deny. Long term, we worry about deficits. So in the near term, the simple fact that the deficits will probably go up. UM. I'm a believer in dynamic scoring, but I'm also believed that the tax cuts don't pay for themselves. History has not proven

that to be true. That suggests that it's one argument for staying short duration. UH. There'll be more treasuries issued. Happens to come at a time the FED will be buying fewer treasuries. Uh. Supply and demand matter in everything, and they should matter in the treasury market. So we think that the trajectory of treasury yield generally speaking should be upwards. The curve has been a massive twister. UM.

Don't know if that will last. Possible, some near term steepening, in fact, will occur as you see a little bit more economic stimulus, as you see inflation slowly building, UH, and as you see more treasury issuance with less demand

from the FAT all at the same time. So our view on the tax bill was that this is in line with our anticipation that yields should be rising, and it was one of the factors we considered in making sure that we stayed short, you know, in the nineties, if you will, relative to index duration as we got through the fourth quarter of this year. R J. Gallow Over at Federated Senior vice president, senior portfolio manager and head a municipal bond investment group and also head of

the Duration Committee at Federated. Thanks for listening to a Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keene before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.