Surveillance: Stepping on Brakes with Slok

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Well, I do think a very important implication is that then the cost of capital will be higher, The cost of capital will be higher for companies, the cost of borrowing for consumers will be higher, and all that will, of course imply that we're going to have more of a significant impact, at least in the near term, on not only consumption, but also on corporate spy price.

Do we see asset price reduction because they got yield up price down in a simplistic way.

Yeah, because your equacy risk premium model, if you change the risk free rate and you permanently increase that for whatever recent demographics, interdy transition, less immigration, whatever it might be, if you have the discount rate going up in any finance model on page one in your textbook, would tell you that then risky assets are going to become less attractive relatively.

This has been a fascinating week because we've seen the fastest pace of issue once this year when it comes to investment grade bonds, the third busiest post labor day couple of sessions going back to twenty ten. Companies are saying, Okay, rates are going to be higher for longer. We're going to sell debt because you know what, we're going to

Well, I mean, broadly speaking, of course, September is mainly having a lot of issues because the summer normally has relatively low levels of issue. So first there's a seasonal issue why issuance has been so high this week. But the other issue is also that well, we're at the same time in the background seeing that the high yield default rate is actually moving up quite quickly. In the last six months, we're now at least on the Moody's default rate, we are at around four percent.

And if we keep rates at these levels.

You know, every day on the Bloomberg Term and Lucy stories about their companies that cannot get a new loan, companies that cannot roll low on existing loan, in particular for lower rated companies with higher leverage, and especially when it comes to interest covers ratios. Insuest covers ratios, which measure earnings divided by interest expense, is coming down both for ig quite quickly and also for high yields. So it is not the case that all firms just have

Both are the IT and HIGHAL index.

This is fascinating. The spike up that we're seeing in high yel defaults I'll be it from really low rates and I'll be it still at historically low levels when you part, when you pass that out, are you basically model the next six months, the next sex twelve months. Do you end up with an acceleration of these defaults or does it kind of plateau. Are we seeing the pain now as some of the rate hikes come into the market.

Well this is really important because so far the soft landing document is that it has been very orderly the slowdown in the label. Mind, it's been very orderly, the slowdown in inflation. So what's the problem. Well, the problem is that in the background, if you have this increase in default rates, especially in high yield, and remember the high yield industry basically has employment of roughly eleven million

And just across the board in terms of what kind of rate structure is going to be important going forward. As we were hearing from Stephen Major of HSBC in particular that catalyst event. From your vantage point, how does this play out the barecase? Is it some sort of deep recession, is it some sort of fissure in the credit markets, or is this just a recession the one that everyone was calling for earlier this year.

So I do think that it will be a continuation of what we're seeing the FED. They're stepping hot and hot on the brakes, and this is not just about the change in interest rates. This is about the level of interest rates. And as that process continues, if you're on your Bloomberg screen type ECFC, go have a look at what nonvum payrolls are telling you about Q one of next year. The consensus is expecting that non van payrolls in January, February and March will be twelve thousand.

In the last eighteen months coming out of COVID with all the original economic framework that we have, the supply shock, etc. We've had so many things wrong. We got the recession wrong, we got before that transitory wrong, We've got four other things on the red sox. You know, we thought they'd have a good year, it didn't work out and Harry Kane would never leave Tottenham. What right now that's a consensus call. Do you think we're going to sit back a year from now eighteen months ago?

God, we got that wrong.

What I think is truly fascinating is that we did go into this year all of us expecting as shop a slowdown. Then what we saw and because effects as savings in the household sector, this just took a longer time. More people have been traveling on airplanes, staying at hotels, eating in restaurants. The service sector, which makes up eighty pcent of GDP, has just been a lot stronger. So it is a bit ironic that this process of slowing

To move higher.

And just as all these things finally started appearing, everyone said, wow, now we're not going to have more off a slowdown. Now it's just goldilocks and we'll have a soft landing.

So you think goldilocks right now is the thing that we're getting wrong.

I do think that the risk is that this process remembered. Think about what the FED is doing. The FED is raising interests face because they want us to spend less money on our credit casts. They want us to buy fewer casts, they want us to buy fewer homes. That's the whole idea. So we're slowing things down.

Off of Jonathan Spence's classic work, an orbal Shell, published like I believe it was in the Telegraph, is staying corrected if that's wrong. Orbitshell writing on China. What I'm getting out there right now basically is the death of China. All my raiders up, tour stin roll down this morning.

That is a major risk.

And the FED had a working paper a few years ago where they tried to quantify what is the impact on the US of correction in Chinese GDP, and they found a relatively modest impact that a one percent decline in GDP only had a zero point two percent in China, had only zero point two percent impact on the US. But this is now to be tested because China is not only slowing for cyclical reasons, meaning exports are going

But just one of the big counterpoints to the barish argument that you're making is that growth has surprised to the upside and it continues to albeit at a slowing pace, and that companies are still doing well. How do you understand that surprising resilience?

Yeah, well, the nuance to that is that growth and employment has continued to slow down. And also when it comes to our companies really doing well. But why default raised then going up so much? Why interest coverage ratio

Federals to see. It's so slocky in gloom seeing the slowdown continue going ahead.

What would you have to see to change your view?

So what we need to see is essentially the cost of capsule coming down, because the first domino brick in this process of the data that we're all watching across the board is that the FIT has raised the cost of capsule. And as Tom was saying, maybe there are some reasons why the cost of capsule might not be

The Trystan slack with us, it's great to have Steve Major with us with HSBC, and they have Earl Davis with us today with a heritage with BEMO Asset Management in Canada, Bank of Montreal, it's just great to have Earl with us. Earle, I love the pedigreed. It's your fault. The Toronto maple leafs are terrible. You were in Ontario teachers for years. They used to own the maple leafs.

Yeah, I think we'll be higher for longer for you know what, most likely until twenty twenty five. Don't foresee any cuts next year for two reasons. One is all central bankers are telling you that, and I think we have to believe them. The other thing is you see the economic numbers, the resilience. Even though I know you guys were discussing discussing jobs and the decline there, but there's still excess demand for workers.

It's still positive.

So the question is not whether things are declining, is whether they're declining fast enough. And I believe some of the secondary data that we're getting is telling us no. And that means if they're not going to hike too much more because they have to wait to see the cumulative effects of rights, they have to hold on for.

Longer, accumulate US across twenty twenty four to year twenty twenty five, how does fixed income react to a longer that most people aren't predicting like you are.

Well, the interesting thing is we don't believe there's hikes next here. We believe they're a whole next year. So what happens in that environment is that the longer end of the curve starts doing the fight against inflation, you know, and that comes through the market doing the fight against inflation.

So there's two things.

That have to happen first one is the market right now is discounting eases in the two year volondo all throughout next year. I think there's four or five yusas discounted in the US. That has to be work itself out, and that means higher yields across the board. But we believe we'll have steepening before because people are scared of the UAW negotiations. What's the impact of that, because let's say there is you know, for argument's sake, of twenty

We talk a lot about the long and variable lags, and there's a huge disagreement about whether they've already basically impacted on the economy or if they are yet to come. Aside from just the treasury market, when you take a look at credit, are you seeing companies being able to absorb some of the higher rates and all of the debt sales that we've seen over the past couple of days, or is there something else going on that makes you think it's going to bite in a more material way.

Well, they could easily absorb that the debt hikes from where they're refinancing. And the reason why is, let's look at US tenure bonds. Let's say a company issues US corporate credit at what say one hundred above above overnight above ten year yields. They're still earning a positive return.

Down as well, if you do have some sort of wage price spiral. Are you saying, Earl, that we're on the cusp of a reacceleration of the US economy that people are not foreseeing, and that that's slow sort of soft landing and decline is not an accurate portrayal.

It's a great question. The answer is, it depends, and it depends on what the FED and FOMC reaction to that is. You know, it's our belief it's going to be very difficult for them to hike in twenty twenty four because of the election, and I know they're independent, but it does impact popular opinion when politicians are talking about hiking when things are turning. So depends on the reaction function of the FED. If the FED chooses to counter that reacceleration, if it does happen, then no, we'll

Oh that word. But can I pick up on that? They're independent? But I've always struggled with that. Well, they're either independent or they're not. There's no butts about it.

Why is that always I'll give you the butt. Let me answer that question.

Show they are independent, but the politicians Congress, Senate, they could change the mandate of the FED in five years. So they're independent now. But the reaction function in five years in regards to the ongoing mandate, that's that's subject to change.

That's not perfect. Interesting.

Oh you think that might change?

Then I didn't say that. I'll just tell it.

That is in the cards, so that has to be taken into account. Let me look at it.

Rephrase it.

I'm a fixed income trader. I look at net present value, so which means you're cash flows over next ten years. When they font see makes a decision, they have to look at what's the impact, not just immediately but next year, two years, three years, four years, by years. Part of that calculus is what I'm saying, and that's what you have to distill back to ensure that you have longevity in what you do. And that's how we kind of see the game theory of monetary policy, fiscal policy, and

That's fascinating. Oh, thank you, thanks for the explanation. Oh Davis the of BMO Asset Management, pretty good, right.

To it right now. This is an important conversation. Pierre Farragu has been just brilliant and decidedly not an Apple fanboy. He is global technology infrastructure head at New Street Research. Pierre, I love your phrase, the silicon wall. I'm going to give you credit for that, the Faragu silicon wall. That's attention this morning. Is there a silicon wall identifiable between America and China.

Well, I don't think we see the wall yet because China is buying about twenty twenty five percent of any you know, Western tech company or any Western semiconductor companies, so they still China is still a very big market.

By a homegrown chip.

These moves are very important and are setting the foundations for the world in some ways.

And that's that's the way we think about it.

And you know, it took like a few centuries to build them the Wall of China, and it's probably going to take a decade or two to to build the Silicon Wall as well. It's going to take a very long time for China to be able to be more autonomous and for you know.

Their ability to replace Western supplies.

Your note, Pierre, your note is extremely constructive on short term for Apple in China. What is the power this way that Tim Cook has over the Chinese government and over the Chinese manufacturing establishment.

So let's yeah, I think you raise a good point that you know, China has to you know, be very careful to what they do with Apple because China depends on Apple for many things that even more important in the upstream of apples than the downstream of Apple.

That's a very good point.

But even if you take a step back, you know, let's talk about learn instead of talking about team and see what happened. In twenty twenty one, China banned the use of tests like gas for similar like a similar scope of Chinese Chinese officials and Chinese military state owned companies, And how is TESTA doing in China's His day is pretty well.

So you know these bands, the direct impact.

Of this band is very, very like and to be honest, actually invisible. You don't even see it. And so that's the reason why I'm going to be constructive on the situation. You're like, this band is not going to affect that good in the near term. Of course, it's a wake up call for investors. They're like, oh my god, Like this situation with China is not getting well.

And I think the ban is one thing. The one way phone is another one.

And it's not a coincidence that we see the two things popping up in the in.

The in the same way.

So the way I see it, whether it's Team Cook or even mess, these guys have a good ability to engage with Chinese authorities understand the importance of China as a market.

China understands the importance of having.

Them building factories leveraging the Chinese supply chain, and so you know, nobody is going to mess the Apple cart in the near term, but in the longer run, I think you have to keep in mind the second wall is building up, and slowly but surely China is going to get out of the mix of the revenues of an Apple, of the Tesla, of an Intel, of all Western technology.

So at what point are you looking to see how much Tim Cook heads over to New Delhi to Mumbai to really have a discussion about expanding production in India.

Yes, you know, exactly, very similar, very slow moves that are going to play out over years and years. So it took China like a few years, you know, to be able to pull out a chip that could power a phone that could more you know, compete with a kniphone, but still like well behind. And you know, like revenge is a is a dish that is better, that tastes better cold.

And now China is.

Starting to put up is putting up this phone and in a position to start like pushing back on the iPhone, and Tim Cook and Steam are very clearly you know, cognizant of that, and they're making sure they're lowering that dependency on China as well.

So that's that's the world building slowly but surely.

I have to say, this is a frustrating conversation to be having, not because anything that you're saying is frustrating or not incredibly interesting. It's more just going forward that it feels like we have all these geopolitical headlines and then we have people coming on and predicting with really no basis of whether this is something meaningful or something

Yes, you know, I.

Wish I had started a hedge from twenty four months ago, just like buying the deeper favorite geobietic headlines.

And I'm pretty sure we have made a lot of money.

China the Silicon roll like tensions between China and the West. The way I like to frame it is the following. Let's say China is an average twenty percent of Western tech, and let's say in a decade or two from now, in fifteen years from now, China is out of the picture. That means Western tach is going to lose barely a point of growth every year over the next fifteen years.

So yes, you can reflect that in your this year's valuation and things like that and begin to give you.

Like a single digit, you know, headwind on your valuation if you're a fundamental investor. But at the end of the day, it's not a big it's not We are ready for that. And because the market is what it is, every time there is a piece of news, it's massively over reacting on something that is going to play over fifteen years. So yes, I tend to see each of this reaction as a buying opportunity.

Yeah, I'm happy to look at opening that fun with you. Look forward to working together new Stream Research per Thank you, buddy, always great to get your perspective. I'm pleased to say that my good friend on my side, Steve Major, joins us right now glob I had to fixed income Research at HSBC Steve wonder for to catch up with you, sir, We're going to park the football. We're going to talk about this bond market. You are bullish. What do you

Well, a way to start. I think that the list is getting longer and longer. When I look at valuations, absolute and relative valuations, treasuries just stand out. We completed our monthly ass allocation this week, and most of my colleagues have reined in their enthusiasm on other bond markets because they're not attractive. I mean, I'm struggling to find a single em raids market that I want to buy right now. Much of the total turn's come through effex anyway,

And a lot.

Steeven you and ags we see are hardwired the end of the China slow down, the knowledge of China, the dynamic of their GDP. If we do get some form of new diminished Chinese economic growth, is that a disinflationary impulse that assists in driving yields lower fixed income prices.

Up, well, quite possibly, yes, it's it's not good for many markets. I mean, the EEM tends to quite like a soft dollar and a strong China. It's got the opposite right now. So the channels through which China might matter to global fixed income are many. It could be through capital flows, it could be through trade and therefore GDP. It could be through FX, it could be through some form of contagion, some kind of financial stability incident. I mean, there's so many that the list is long, and it

How do you understand, Steve, why we haven't seen yield go lower this year, why they've seen so sticky and persistently so with economic data surprising to the upside that we've we've.

Just completed the most aggressive tightening phase in four decades. It looks like the momentum of the tightening is definitely fading, and I think that we're, you know, we're entering a very important period here where there's probably going to be a handoff from the focus on inflation onto the really colomby data, and it's going to be a slow process.

Are you saying that the risk right now is for some sort of systemic event and that you see one on the horizon versus the upside growth surprises that we have been seeing, which is like a lot of people to say that, really the asymmetry goes to the other side. The growth could actually reignite. And I've heard this even from FED officials themselves.

So the GDP now a is a notoriously volatile series. It's been goosed up by the fiscal loosening, and the trend GDP is still what one seventy five, one eighty. The smart people, I believe recognize that the R star is unchanged from before the pandemic. So the policy rate is more than double what the equilibrium rate is going to be. So it says to me that we are at or very close to the peak in the.

So given that, Steve, where do you how do you place a bet here out a year or two? Are you you know, on a retail basis, are you laddered? Do you barbell? What's the major strategy that's to go press up, yield down?

Yeah, that's now the key question. I've got much more comfortable with just outright long of ten year plus rather than trying to play anything fancy with the curve. If you if you start buying twos versus tens and players steepener, you've got too much carry to overcome, and so so the strategy favors taking duration over yield.

Curve expressure.

Right now, I can't say enough John, how important it is to see a bullet approach from a major bank. You don't see that nowadays. Everybody wants to do ballet fancy fancy CFA garbage and major just says, shut up and buy it.

We're talking about treasury, says Steve. Let's talk about that trade relative to what you expect to happen in the UK in Europe is a similar story, Steve, Or is it different?

Well, the UK might be leading things today. At least happens occasionally, doesn't that. I think for every hundred days, maybe there's five to ten days when the UK and the Eurozone can pull the US around, and today might have been one of those. The front end of the UK got some life into it. Seems like the UK could be at the peak. The data is supporting that, so it's all connected. I just think that at the moment, the relative value between treasuries and boons and guilt and

Stay final question, Top four west Ham. What does James ward Prows have to do to get a call up for the national team?

Hasn't he been great?

What a joy?

Surely he must be on the list.

It's been a joy to watch.

Just snubs by Southgate continuously.

I'll get it, kay. I read the press on this, Henry Wonder and all that, and you guys are vicious over there. I mean, we don't have this.

It's pretty brutal stuff. Yes stuff, Yeah, the tamploid the sports pages. Steve, thank you sir for the update on the bond market and a sneak peak of some of the football chat as Wallow for an England Steve Major of HSBC.

Right now working with Ian Bremer at Eurasia Group is Anna Ashton, director of China Corporate Affairs. On of course this relationship with US and China. We need a brief this morning as well, and I'm going to cut to the chase. I see a lot of hysteria, and we've had some good voices calm us down a bit, take us away from the immediate hysteria of China to clear thing. How are you thinking clearly about the domestic challenges of China.

Well, Tom, it is quite a challenge to be the one who's supposed to come up with the positive take, because you know, China really is facing some serious economic hurdles right now, and they're different from hurdles in the past. The slowdown is systemic, the real estate crisis is affecting

I think.

One of the issues that is kind of separate from the slowdown but also makes it harder and harder for foreign firms to do business successfully, and has nothing to do actually with regulations either, is just the fact that there's more competition in the Chinese market from domestic companies than there used to be.

If I look at the domestic companies, it comes back to the soees, the state owned enterprises like the waves. Every eight years, we're going to de emphasize them, We're going to re emphasize them.

Or that.

What is a relationship of those state owned enterprises now with the nu Xi regime in Beijing.

Well, definitely Shijinping is more of a state sector man. He has definitely moved away from his predecessors in re emphasizing the role of the state and in his you know, pretty firm belief that the state needs to be involved in directing which parts of Chinese China's economy are going to be emphasized and are supposed to grow. But you know, interestingly, that seems to be the direction that US politics is going to a lesser extent as well.

Anna, we had Pierre fergu on earlier and he was saying that he wants to start it or he wished he had started a hedge fund to buy every dip in some of the names that are most affected by the geopolitical headlines in particular about US and China relationships. Souring is this time different.

On the one hand, I would agree with him. You know, how many times has there been a prediction that China was becoming collapse of China? But China had reached the end of its miracle of growth and development. But so I tend to err on the side of China. We'll figure it out, because there have been all of these times in the past when we thought it was different too.

Do you also think that there needs to be or that there will be more of a response from the US in light of the fact that the new development in the Chinese phone was released during the Commerce Secretary's visit to China, And you know, Ramondo is there the timing very much trying to sum the nose at the US government and that there seems to be a much more direct tit for tat.

There's definitely a much more direct tip for tat. And you know, we've seen that play out in a number of different forums in the last few days. So there was Gina Raimondo's statement on Face the Nation about not necessarily wanting to apply the word trust to the relationship or improved trust after her visit, but saying, you know,

All right, go ahead, Well, thank you and I greatly appreciate too short a visit today. Let's do it again, someone we will with China so much in the news and Ashton with us with Ian burmersh to raise your group. Subscribe to the Bloomberg Surveillance podcast on Apple, Spotify, and anywhere else you get your podcasts. Listen live every weekday starting at seven am Eastern on Bloomberg dot Com. The iHeartRadio app Tune In and the Bloomberg Business App. You