This is the Bloomberg Surveillance Podcast. I'm Tom Keene, along with Jonathan Farrow and Lisa Abramowitz. Join us each day for insight from the best an economics, geopolitics, finance and investment. Subscribe to Bloomberg Surveillance on demand on Apple, Spotify and anywhere you get your podcasts, and always on Bloomberg dot Com, the Bloomberg Terminal, and the Bloomberg Business App. This is the Interview of the Day on rates. Ian Lincoln is
watched across all of global Wall Street. At being on capital markets, he writes incredibly terse, dense notes on the dynamics of fixed income. He joins us this morning, I got eight ways to go here, one single sentenced. Friday you call most influential jobs report of twenty.
Twenty three wide.
I think that the relevance of non farm payrolls on Friday simply can't be overstated. The Fed has achieved what they wanted to, at least thus far in terms of moderating CPI. Now the question is have they overshot on the jobs front. We know that jobs are cooling, We are expecting a relatively benign The consensus, I think is one seventy for headline non farm payrolls. But we do have that joltz print and the quits rate within that
is very troubling. It's now down to two point three percent, which was the average between two thousand and eighteen twenty nineteen, so we're back to kind of the pre pandemic norms. So what happens for the macro outlook if we get disappointing jobs print?
What concerns you most? The number or the speed the right of change?
I think that if I were given the choice between the outright level and the rate of change, I would say we're in the right We're at the right pace. We're just getting to levels that are far more concerning. So I would go with not the rate of change yet, but the outright levels.
And if the levels and the rate of change suggests that the Fed's work is getting closer to being more fully accomplished, obviously there's still a long way to go. The move in the two year yesterday was suggest that that has run perhaps too far. Did we see the peak already? We hit that north of five percent, stayed there for a little bit, and now we're done.
So a lot of that comes down to whether or not the FED is able to avoid cutting rates throughout the first half if twenty twenty four, even potentially avoid cutting rates until the beginning of twenty and twenty five. Now, I don't expect that that will happen, but there's a contingent in the market that thinks that higher policy rates are going to be in place for the foreseeable future.
And if that's the case, we're going to see two year yields back up above five percent again, which we continue to view as a pretty attractive buying opportunity.
But when we're thinking about how the FED is going to be thinking about deciding whether or not to cut rates next year, is the bar for that even higher than the bar for them to hike again, given how this that has been conditioned by the mistakes it made earlier on.
That's actually a great observation. What I would say is the FED has already signaled that they plan to cut rates by one hundred bases points next year, but they're going to allow the QT to run off in the background or to continue shrinking the balance sheet. And so what they're doing is they're reframing the conversation around rate cuts being a response to a slowdown and rate cuts
being a recalibration closer to normal policy rates. So I think that they've given themselves a fair amount of flexibility for the year ahead.
And all anybody wants to know is for you to frame the real rate. The ten year real rate we got up to two to two point zero, I've got some numbers above that, which so the real stress is bracket the real rate right now where it could come back down to that level. We're now at a one point eight, three, eight four whatever, and then bracket up. What frame that for us?
If I were to put a range on ten year real yields, I would put it at one sixty five two fifteen, and that's well within what the FED wants to see.
Okay, But if the two fifteen, I don't mean interpret this is so important. If we pop to a two point fifteen, what does that do to the greater American financial system?
I think that's when we start to see strains in equities, in risk assets, and it becomes a much bigger burden for the overall business community.
Let's put it all together. There's clear dividing line between the kind of data this FED appreciates wants to see it's objective and what you think is undesirable. And what a sense from you is that we're creeping towards the latter and moving away from the former. Now, if that's the case, isn't the ten year treasury and you'll mind a screaming by right now?
The tenuere treasury, in my mind is a screaming buy. I think that from here the path forward phenomenal tenure yield is going to be lower. For two reasons.
Well, slow down, I got to take notes and screaming by.
For two reasons. One, the Fed's credibility is being re established as an inflation fighter, and that will put downward pressure on break evens. And one of the reasons that real yields are where they are is because break evens haven't repriced higher. Think about Jackson Hall. They're holding the two percent inflation target. They're doing everything that they can to convince the market that they're here for the long
haul in the battle with inflation. So if we believe, which we do, that there is still a six to nine month lag of monetary policy actions hitting the real economy. The second half of this year is going to be pivotal for the effectiveness of what Powell has been attempting to do.
So is he saying load the boat on the ninety seven year Austrian.
Not quite like that. Make some money here, and I think we've got to put some numbers on it. Difficult to do, I know, but I just want to understanding a better understanding of the direction here on what you're looking for right now? North of four percent? We got through four point thirty in the last week or so. What are you thinking about three? Could I go to a two hand or what kind of numbers are you thinking about?
I think that we do get ten year yields back to three percent. I don't think it happens this year. I think that that will be a first half of twenty and twenty four event. But we can easily close in a range of three fifty to three seventy five by the end of this year.
And that's not just monetary policy dependent either, it's fiscal as well. Treasury still issuing a ton of debt. We have a deficit spending that we need, that we need to fund. How does that factor into this equation.
I think that what primarily sets the outright level of treasury yields are the global macros of inflation and growth. The incremental supply considerations will lead to concessions in and around the events themselves. And frankly, the market knows that there's a bunch of treasury issuance coming. We have that largely priced in. The Treasury Department has been very clear in their signaling, and still we have ten year yields at four fifteen, not five point fifty.
I look at this, and I just look at what will break. Torsten Slock is out this morning with a spectacular look at aling's market has changed, and there's the debt servicing costs up up, up up, But we're also making more in our coupon up up up. Mister Slock takes it back to nineteen fifty nine that this market is out of wack. Do you sense that as well, that your world's that.
Out of whack.
I do think that there is a significant mismatch between the primary buyers of treasuries and the incremental players. The people who are fundamentally adding treasuries, whether it's a major central bank or an institutional investor or they're really generally starting to look at these levels as attractive buying opportunities, especially once we have some degree of clarity from the monetary policy side, the incremental investor people playing for a quick two or three week trade I think are a
lot more aggressive on the bears side. So there does seem to be a fair amount of mismatch.
And it's going to say and I apologize, We'll run with that headline of with diapex up at words in your mouth, But then we got financial media for you ailing a female capital mouth case.
He wasn't a Jackson hole. He should have been. He would have done the thirty one mile paint Bush Divide hike goes way up in the thunder there at twelve thousand feet. Doctor Carpenter darkens the door with many years of experience at the Federal Reserve System, Seth Carpenter is with Morgan Stanley. You have to Carrell Zettner when she's not in some trout stream trying to catch trout. What is the Zetner mood? Now the Morgan Stanley recession meter. Have we just discarded recession?
So I wouldn't say that we've discarded it wholesale. There's always a risk. As I like to say, bad things happen to good economies all the time, Tom, But you know, since the beginning of this hiking cycle, we've tried to say a soft landing is the most likely outcome. The economy is not going to go into recession as a base case forecast. In so far that view hit has come true. I mean it was not, I have to say, the most popular view with our clients three months ago,
six months ago, nine months ago. On the other hand, things haven't slowed down quite as much as we thought it would either. Mike was talking about the GDP data. The Doward revision sort of pulls things sort of along the slowing line, but it's still a pretty punchy number. Two point one percent is above I think most people's estimate of potential growth, so we still have a ways to go. We still think there's more drag from monetary policy in the pipeline, but inflation's coming down. Job growth
is slow, and we'll get another print on Friday. Our number is I think around one fifty five for private payrolls, so that'll be another tick lower in terms of job demand. We saw the Jolts data that had a market reaction as well, so things are cooling off a bit, but they're not cold.
The hallmark of Morgan Stanley economics is invented by Stephen Roach and Richard Berners. Everybody fights like cats and dogs. What is the point of conversation around the desk and Stanley? What's the thing everybody's arguing about?
Gosh, right now, I have to say, every corner of the world has its own quirky story. I mean, I think we for us in the US, there is definitely the slow down, the soft landing, but boy, the data are surprising to the upside, in very stark contrast. On the other side of the world, I'm always in conversation with my team in Asia China. We had come into
this year pretty bullish on China. The first quarter was super strong, and now things have slowed down a great deal, and so the question is when do we get enough of a policy response from Beijing to pull things back in So that's where those are two of the main topics where we're really debating.
Yeah, and we've talked about China a lot in recent weeks because it just seems like piece mail, one thing after another, they're doing things to try to stimulate that economy. Just to return to your soft landing thesis and the avoidance of a recession. Are we really talking about a recession entirely avoided or one that potentially is just pushed off, just delayed further out into the future as we think about these lagged defects kicking in in a way they have not yet full.
I mean, I think that still remains a key question for us. We still think it is a recession avoided. That's been our view for a long time. The troth, though in terms of economic growth, does seem like it's got pushed off a little bit. We think things will come down further from here. And there are things besides monetary policy that are a downside risk for the rest of this year. I mean student loan moratorium that has
gone away. If you look at the Treasury's daily Treasury statement, you can start to see some of those inflows going. So that could weigh things down on Ellen's team. Sarah Wolf is our consumer specialist and she's been all over student loan debt repayments as a really key downside risk for the fourth quarter. So are there still risks of a recession? Absolutely, there always are, but we don't think that's the main story. That the labor market slowing, But still resilient.
Yeah, in October, that's definitely going to be something of concern. Two weeks before that though, actually, just two weeks from tomorrow is when we're on watch for United Auto Workers strike. How are you thinking about the labor movement in particular the power of these unions to ask for things is audacious, to use their own words as a forty six percent payhike. What does that signal to you about still the supply issue and the ability of workers.
To demand for So, I think it's definitely something that's going to matter a lot. It's going to have We already have one strike in the books, right the screen Actor's Guild and all of that, and that's going to have an influence on Friday's jobs report, and so we're going to have to try to read what the underlying
trend is and data. So I think the first part of it is going to be not to be hopefully avoid being confused by swings in the data because of if there is a strike with the auto workers, what that means for the numbers. But yeah, I mean you've got a question of how long are they on strike? How much does that disrupt production? If they are we know that the auto industry was one of the last ones to be able to catch up to supply chain disruptions. Now we're starting to see auto prices fall, so it's
a real mixed bag. I think we're going to be trying to watch very very closely. We're going to pull in our equities analysts who cover the auto indus tree to see sort of where production is going. But for now, you know, I don't think it's easy for us to forecast whether or not the strike will happen your Princeton.
A guy named Bernanki wrote a really important paper, Bernanki Del Negro on our Star. We missed you at Jackson Hole. Give us the carpenter our star. De Should our audience pay attention to it? Or is it economic babble distraction?
It's a little bit of both. I mean, it's hard to avoid the relevance of the concept of our stars. So how high is the level of interest rates that's neither stimulating the economy nor putting a drag on it. That's got to be fundamental to everything about the economy. But in real time, at any specific point in time, knowing where that is with any precision is borderline impossible.
The statistical models that lots of my academic minded colleagues use are really really, really sophisticated ways of showing off how much matthe you know. But at the end of the day is all they can do is say, we know where the current level of interustrates is. Let's just look is the economy accelerating or decelerating, and then we make an inference about whether we're above or below our star. So I don't think there's a whole lot there that
you can judge for sure right now. Over time, if the Fed keeps the policy rate where it is now and the economy not only doesn't slow, but it starts to accelerate a quarter from that two quarters from now, you gotta have a view. But the same thing could be said there could be extra residual push coming on from fiscal policy. That doesn't tell you anything about the permanent level of our star. That just says, right now, there's more demands.
Thank you to Peter Sheer for attendance right now, Head of Macro Strategy Academy Securities. Peter, did your journey in the markets? Did it change yesterday with a Jolts report? Not?
Really, It was more or less in line with what we're looking for. Is basically the FED is looking for an excuse not to height. So they're going to be looking across a broad spectrum of data, and I think the one area that's going to disappoint is jobs. I think they are going to be downward revisions. You mentioned a bunch of other parts of the Duet report yesterday. The higher's rate continues to drop down. There's been this dichotomy that the hire's rate has been off very strangely
low relative to job openings. I think that's going to catch up, so it's jobs slow down. I think the Fed's going to have the excuse to do nothing. And then it's going to become a question of you know, where all the economists, including myself, we're looking for a recession this year, going to turn out to be right or not.
Okay, Well, as we talk about whether or not you turn out to be right. If the job market is slowing down, if we're starting to see the growth deterioration happen, but inflation is still too far above where the Fed would like to be, which they say still is two percent, what do they do then?
I think the key word is they say is still three percent. I'm not sure it's really three percent. I think they're going to be looking for excuses to delay. So I think we get ten year yields back to four percent, and then we're going to need significant either jobs data, you know, consumer sales data, real you know inflation dat again, because they're already trying to downplace some of that saying they're seeing it finally trickle into the
housing market. So I don't think they do anything if they can avoid it at all.
We talked about the housing market the last couple of days. Home prices in America totally distorted by the rates of the last two years of record lows and the rates more recently a two decade highs pete. Is that something they can ignore? Can they ignore the distortions of house prices given their contribution to shelter and what might be elevated inflation for maybe the next year or.
So now, I think, sadly they're going to have to. Partly, this is very location based. So when you look at where the homebuilders are doing, and they've been very successful, they're building homes and areas that people are moving to, right as people continue to leave California. Maybe Illinois's Illinois moved to other states. That's what they've been able to take advantage. So I think we're seeing a very regional economy,
particularly on housing. I think the FED is just going to have to give this time for people to either get forced to move, choose to move, figure out what they're going to do with their mortgage rates. So it's problematic. Again, I think this all goes back and we're not you can ham home on this. They were so slow to react. They allowed this bubble to create itself. They should have
reacted much sooner, much earlier, done much more. Unfortunately we're here, so I think this is just going to take time to play out.
Unfortunately, your view sounds like high for longer. Ian Lingoln of BIMO came on this program moments ago, Pete, and he said ten year treasury yield ten year treasury screaming by He thinks yield goes down to three percent. He indicated that, and these are my words I'm paraphrasing here, but ultimately Pete, his characterization of the data was this isn't desirable. Some of this is undesirable. Maybe things have gone too far. Pete, What's the counterpoint.
To that one. I'm definitely worried that he could be right. So I think we get to this four percent of the tenure, I think that's good for stocks. Then I think we actually get to three point eight percent. As we start moving lower, it becomes negative for stock because people have to start repricing in is there a potential recession risk? My outlier on the inflation story is really India. I'm watching India to see if they can generate some growth, what happens with China. So if we get in I'm
not really worried about domestic inflation. I think we're seeing enough slowing down both in the goods and the services market. Inflation is not going to be domestically generated. It's going to be something happens with India or China that could set us eye off that way. So I'm kind of into an inflection point right now. I'm very comfortable yields lower down below four percent good for stocks. As they go much lower weak for stocks. Then we'll see how the data plays out.
Peter Overlay on this. The Geopolitical Matrix Academy is acclaimed for putting a geopolitical tinge on my investment. Is it steady as she goes? Or do I need to worry about geopolitics in the next year.
You know, I think we need to worry about geopolitics. Certainly what's going on with Russia, right, Putin clearly showed his hand when he was willing to kill the person who went against him. So don't forget what's going on between Russia and Ukraine. But for us, the real story is still China, and I think people are underestimating China's desire to start selling their own goods, their own brands and possibly denominated and wand mostly to emerging markets countries.
When we sit here and examine China day, they are clearly experiencing trouble. They're going to do some things to fix that, but I think it's going to have to be pushing their brands globally.
Well, Peter, to your point on China, I was really struck by the research that came out in the last twenty four hours by our own team here at Bloomberg Economics talking about China's property sector as being both too big to fail and too big to save. They say the government could the government step in and rescue the sector when looking at the options, it suggests the load would be too heavy to bear. Is China in a position right now to flex on anything.
That's a great question. So how we're looking at China is I think they are going to cram down on the rips. So I think as this property sector resolves itself, they're going to try and protect what's left of the middle class, and it's going to hurt the rich. But I think those are all relatively weirdly short term problems. The real problem that they face right now is one no one really wants to produce in China. Right People are moving their production out of China. That is not
going back. It's political, it's too long term, so they're not going to be this factory of the world old any longer. And clear that one, Chinese customers don't consume the way American customers consume, so their ability to develop a real domestic economy is weak. They're going to have to support that with the housing market or the real estate market there so people can spend, but they are going to have to look to selling their brands offshore. That's the only way they're going to be able to
produce enough goods to keep people employed. And I also worry, and I think our geopolitical team always cautions us. Right when things are good in China, they are less likely to flex their political or military muscle. As their economy weakens, they do something like that, just like we saw Pudin do well.
Pay bad folks do bad things. What kind of bad things are you thinking about?
You know, I think Taiwan's off the table. It's not going to be that. But look for them maybe to flex their muscle in some other regions of the world where people care less. Look for them to continue to expand through their Belt and Road initiative, more access to ports, more access to these countries who are failing to pay
on that. And I think you're going to start hearing more and more trade occurring and want and that's something people kind of I feel in our denial because we're getting a lot of anecdotal let when we talk to companies, they're being pressured to do some contracts in one it's very small mostly I said, the emerging markets. But this was not something anyone was talking about two years ago.
So I think this trend is there, and I think US companies are going to have to take a real stock of Hey, do we have exposure to selling our products and emerging markets? Because China might become a real competitor, and still we deal with that well.
Pet I want to talk about that just one step further domestically in China. How are US brands going to compete on the mainland in the domestic market given the kind of things that we're discussing right now.
I think it's very difficult. I think everyone still has this. It's impossible not to look at a billion customers and say, Wow, if I could just reach a fraction of this, I'll do well. I think the regulatory hurdles are going to remain extremely high. I think China is not really going to be friendly, so you can go there. But I think you want to put in limited intellectual property, limited resources,
because that's not the wave of the future anything. I think you're supposed to be figuring out what do we do with India? India is a much more compelling case to me right now than trying to figure out how to sell into China. Clearly, this friction is ongoing and the reluctance for them to do business with US is.
Increasing, So Pey, I've got to raise this question, and forgive me for bringing single names into it. You can answer it directly if you want, you can dance around it, but it's got to be said. What does it leave Apple? What does it leave Tesla?
You know, I think we're already seeing some of those companies move their supply chains develop around this, right, So they're looking at that, and I think that's been stage one of this. I think stage two is going to be how do we protect our brands in some other countries. So I'm I think companies are now maybe a little bit behind as a whole, but dealing with the China issue. And I think what they've got to get ahead of is what are we going to do with the rest
of emerging markets? As China becomes potentially a competitor of low costs, you know, they're going to flood the market with their low cost, maybe lower quality goods, and that's I think what we have to be thinking about. So I think companies have done a decent job adjusting to China. I think they were slow as a whole, but that's going to be really the next phase is adjusting to Chinese competition.
Before we get ahead of that, Let's get ahead of this idpig just around the corner. I've got to go to Mike McKay in a moment. Pete, what are you the team looking for from ADP today Claims Tomorrow Payrose Friday.
I'm looking for weak numbers and whether it's in the headline numbers or more importantly, even the revisions, because we've seen pretty significant revisions lately that people have somewhat ignored. I think it's just going to kind of really solidify this view that we are the best for employments behind US.
Peter, thank you, sir Cheer of Academy Securities joining US NATS market. It's how city of portfolio manager at all Spring Global Investments Market big deaf gags yesterday. Are you still constructive on this equity market in America?
Yes, I think we'll have a strong finish to the year, maybe more moderate returns than we've had year today, but still positive return because the economy is still pretty strong.
Margie, I look at where we are on free cash flow. In the heart of the matter is there's a generation of people that don't know the rate structure we're in right now. You and I have lived it. Can corporations generate free cash low and dividend growth from it in this interest rate environment.
Oh yes, because I think interest rates is just a small part of their costs. If you look at companies since a financial crisis, they have restructured their balance sheet, locked up fixed rate, low rate money, and so I think they're really rather impervious to these increases in rates. I think that's one of the things that's fuzzled to FED. But I expect they'll continue to maintain profit margins.
I like the idea of impervious as well. If I'm a CFO, how do I change my issue ince given this high environment? Do I extend out duration? Do I stay short? Short? Short? What do CFOs actually do in a real rate environment?
Well, I think most of them have already done that. For the last five years, particularly in the high yield market, we've seen more than half of all the issuance being to extend maturities, pay off bank debt, refund or pre refund issues coming due in the next couple of years, a so called maturity wall. So I think most companies really don't have the need to borrow new money. They have enough liquidity on their books to handle their own needs.
Well, when we talk about the companies and they're borrowing needs and just their financial position. Marguie, what is the default cycle actually going to look like when they to this point have remained incredibly low. There is growing calls for a soft landing. You seem to think that everything is still looking relatively strong here. Does that mean that there's not that much risk in risk of your debt?
I think, particularly in the public high yield market in the US, that market is going to continue to have very very low default rates. Right now, the default rate in the US is a little over three percent. In the loan market it's higher, it's over three and a half percent because a lot of the poorer quality issues
financed they are rather than the high yield market. But as I said, most high y old companies were very prudent in the last decade and they simply extended maturity and they've improved their balance sheet, and so the quality the high old market is good, and I think defaults will stay low. That's why yield spreads have stayed pretty narrow.
The market. Isn't there a day of reckoning next year? If this Federal Reserve isn't cutting interest rates for those companies that pushed out that maturity will termed out their debt. Don't they have to start reissuing in twenty twenty four.
I think most companies have a couple of years too before they have to worry about liquidity. So I don't think there's a real risk that companies aren't going to be able to refinance. And once again, is there access to money rather than the cost of money? I think at the margin, not that many corporations are going to need net new money because of maturities in the next year.
With that in mind, if higher interest rates aren't going to buy corporates in America anytime soon, doesn't that just extend the cycle marketing keep rates high for even longer potentially?
Well, I think it keeps the economic cycle going. And really, I think the puzzle has been where's the recession? And there's no recession in sight because everything in the economy in the US is really pretty well balanced. People aren't affected by this big increase in short rates. And really, right now the ten year is what four and a quarter, maybe you'll drift up to four and a half. Those aren't exactly the sort of rates that choke off economic growth.
So if I've got a nice pull of cash right now. Should I be worried about the reinvestment risk and the road or should I just sit there in a two year and te bills and relax and know that rates are going to be there next time I need to reinvest that money.
Well, I think it's likely that we'll see short rate well, certainly much higher than they've been for the last decade of year zero. So yes, I think they'll be much
more of a return for investors short term oriented. But really, if you say the yield to say five to five and a quarter or something like that in risk create assets and the cash flow yield of corporations is maybe five and a half five and three quarters, that says to me you're better off taking the volatility and looking at equities or high yield bonds, which have a lot more to offer than short term short term rostree assets.
Maggie, Thank you, Maggie Biteu of o Spring Global Investment.
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