Surveillance: Supply Shocks with Singh

and of course, on the Bloomberg terminal. This next guest is one of the smartest minds on markets, but also the most experienced with both the private and public sector, having just come from the Council of Economic Advisors to President Biden. DLive Saying, who is now currently the Chief Global Economist at p JIM also former Deputy National Security Advisor for International Economics for the Biden administration. DELI, but I want to start with this question around increasing protectionism.

I will get into some of your expectations for inflation, etcetera. But this idea of the Inflation Work Auction Act and what we're hearing out of Europe this morning of potentially trying to entice technology companies to come to their own shores, do you think that this could ignite some sort of increasing reglobalization or deglobalization that we already see in effect. Good morning, Lisa, Well, let's put step back and consider

the global backdrop. We're in probably the most intense period of great power competition since World War Two, and it's in that context with repeated supply shocks COVID, but also the war in Ukraine that major economies are saying for critical goods like semiconductors, like pharma, for electric vehicle batteries as well, and some of the foundational technologies like AI and biotech and robotics, UH that that we want to have more prioritization on resilience that are, and more supply

chains geared around geopolitical alliances rather than just global efficiency

and rather than just prioritizing more inventories. So I think the re orientation of supply chains it's real for critical goods and foundational technologies, but there are ways for the US and its allies, particularly in Europe, block rate in terms of getting resilience against a shared set of shocks that worry US using a similar set of tools, and then ultimately, since this is a multiplayer, repeated game, taking actions that leave both the US, Europe and our allies

better off. There's a political aspect of this leap, but there's also the economic ramifications of this in terms of higher costs. Can you dovetail your view on how the West will deal with this, how the East will deal with this, and how this really affects your inflation outlook. Yeah, so there's a there's a negative branch of the probability tree in which this kind of supply chain where your orientation leads to more frictions, lower economies of scale, lower productivity,

and as you just suggested, higher costs. But there's a positive branch as well, which involves a race to the top. So that would mean more public investor spent, more indigenous innovation, more development of our respective labor forces, and higher growth potential, higher productivity, and diffusion of those games broadly. That's that is the that is the question that's now playing out before us. UM. The US, as you mentioned in the Inflation Reduction Act, is taking steps to boost bolster our

own growth capacity. Europe is doing the same, Uh. And we have to manage this process very carefully and also consider how China and other countries that may not share our same objectives play their cards. UH. And this is going to take years to play out, and I think as economists, UM, I am I am putting my bet that this is ultimately going to lead to a net higher trend level of inflation and a lower trend level of growth. But I say that with relatively low confidence

because these are early days. Well, which raises a question about your fundamental belief that central banks will exercise restraint, that they won't as rates as much as perhaps they say they will, simply because they don't want a hard landing?

Can they do that in the face of some of these structural inflationary aspects that seem to be present, and a lot of people seem to be acknowledging that they have to I mean, they have to acknowledge that we're living in a world of repeated and profound supply shocks from the intensification of great power competition, which means more use of economic statecraft, from a very bumpy transition from fossil fuels to renewables, from this supply chain re orientation

that we're talking about um and from less diffusion of technology. In that context, they are fighting the battle of their professional lives to maintain their credibility on fighting inflation, and so they have no choice but to execute on their on their mandate that's what we're seeing, and I think it will ultimately lead to an overtightening by central banks in a context of repeated supply shocks and thinning simple buffers.

So I expect a bumpy road ahead. But there's the overtightening risk relative to the undertightening risk and allowing inflation to run too hot for too long and damaging the economy in that way. Is the recession necessary to get the job done? Well? Look, uh, central banks are doing what they can in this context, and we have a labor market and balance in this country. Unfortunately, labor supply is not coming back as fast as any of us would like. Labor force participation rates are about a percent

or two below the pre pandemic level. We're seeing a fall and net immigration, and so the Fed feels as though all it can do to cool services prices x rents is to slow down labor demand and to get nominal wage growth back in the three and a half percent territory, which if you assume one and a half percent productivity, would be consistent with a two percent target. Now, if you're just the risk is this, if you're just relying on the spot inflation data to guide how much

further tightening is necessary. You're likely to do too much because we're talking about more central banks tightening faster than we've ever seen in modern economic history, and because of the spillovers and because of the lags, this is not a process that's likely to end well. As you were just discussing kind of structural issues that are going to keep inflation more elevated. Should the Federal Reserve be thinking more seriously about not targeting two percent? Is that too

low for the world we live in now? Well, the problem is you cannot change the goal post when you haven't won the game, and so changing the inflation target from two percent to three percent when you haven't achieved your objective would be a serious risk to the Fed's credibility.

But I think the facto UH if we get to a core inflation level of let's say, below three UH and if that, if that decline in inflation is driven mostly by cecyclical factors, in other words, the FED is done when it can, then I think the fact could probably accept a higher level of inflation as a way of making up for decades of missing the inflation target. To the downside, I don't think they would announce this officially, but I think in a practical sense that's where we'll

probably endout. Delia, pat Is, gasoline and crude prices. Factor into your expectations for next year and the fact that it's going to be a bumpy ride, given that we've seen an incredible rally, or at LISA at least if you look at it from the other side of you've seen incredible decline in oil prices, in gasoline prices. But next year, not only will China come back online, but the US is planning to start refilling their strategic petroleum reserve. How does that sort of factor in to what you

see transpiring. Yeah, I think it's dangerous to extrapolate too far what we've seen over the past three months in terms of the decline of energy prices. Look, we don't know how the war in Ukraine is going to play out. We don't know what kind of supply shocks are still in store from Russia. We don't know how OPEC plus

is going to handle its own production of energy. We don't know how the competition for a finite level of l m G globally will will also play out between Europe, Japan, UH Korea, and now you mentioned China, and so I think there are two studed risks in the energy market. And as a consequence this is he had another uh potential headache for the FED to have to contend with as it tries to get inflation back to target. I would not assume that the only component of inflation that

we have to worry about is services prices experence. I think food and energy prices are still very much a prominent risk going in the next year, deliv saying of PGM, thank you so much. The market seems like it is testing the results. So I guess it's a question of whether Kuroda or whoever his successor is come midway through, is going to be forced to just abandon the policy entirely. Two things. Some people think that he's actually going to have to rip the band it off himself because he

has the credibility and a successor will not. The second thing is, yes, they came in with an unannounced slew of bond purchases, but they didn't purchase twenty year bonds. Yes, it didn't purchase thirty year bonds, which raises questions about whether they're basically saying we can't control this one and we're gonna let it step and but let's start there. Mark Tendler is the perfect person to talk about that Chief Marget strategy to Bannckburn joining us. Happy holidays, Mark,

Happy New Year. Let's just get your view Mark on why the dollar is weakening continually even today versus the end, despite what seems to be a reaffirmation if yield to cove control by the Bank of Japan. I don't really quite see it their way. I see that the Bank of Japan SU tried everybody, of course, but in the bay since then the dollar is at making higher highs, and even today it's holding above yesterday's low against the Japanese end. I think yesterday is low. It's just a

little bit lower, about one thirty three forty. I think that matters, right A lot of people sort of. I think the attitude is don't want to be bitten by the same dog twice. The Bank of Japan SU pried us by the time of the move, and think a lot of people are on guard that they're gonna do

so again. I don't think so. I think that the fiscal policy and the strengthening of again in the last month or so on a trade weighted basis is going a lower inflation in Japan and take pressure off the b o J to app again at least in the first quarter. And that first quarter is important because the swaps market shows the market expecting rates to go positive. Remember the overnight rated that minus ten basis points the market. The swaps market is showing a positive rate by the

end of Q one. I think that's just exaggerated because again people don't want to be bit by the same dog twice. That was all excited for like an SNB moment from the Bank of Japan, and this was so much smaller. Even if it continues, do we ever get that mark? I don't know. I mean, I think that Japan is a tough situation. You know, it's not just

that Corona is somehow idiosyncratic in its policies. But you look at what the bigger Japan's forecasting next year lower inflation below two percent, and the market expectations on far are on far from that. Japan had a stringle population, it has a it has like structural issues that are weighing on inflation. I think that's the challenge. And you know, earlier this week Japan recorded its third consecutive decline in industrial productions. And the last thing I quickly say about Japan.

And I know we all focused on COVID and China, but I think it was Wednesday. There was Tuesday that Japan reported a record number of fatalities from COVID's not over yet, And I'm not, of course, I'm not a medical doctor. I don't know these things, but just seems to me that we're still getting a bit ahead of ourselves in the story. Uh. You know what's struck me yesterday or over the last couple of sessions. Is the strength of the pound? Or is it the weakness of

the dollar? I mean, we were at thirteen fifty three on the Bloomberg Dollar Index in at the end of September, and we hung around there for six weeks. We've now come down. The pound, of course, broke down below parody at least I saw a pharaoh tweet that at one point, so I believe it's true. And now we were up to a dollar twenty five? Uh right now? Is the uh pound strength? Is a dollar weakness? Have we seen,

um the the the peak for dollar? I think we've seen a piece of the dollar that you know what I think was happening was at the end of September. Uh. You know, people, I think they're just talking exaggerating what was happening. We actually the capital striking. Get the UK. It's about to enter a five quarter recession according to the Bank of England and the government to trust government

the side, they have some fifth cloop stigulants. That seemed to be a good time for fifth book sigilist capital struck and you know the Encomige magazine was talking about brittlely and I was on tom Keane at the end of September and people were talking about the UK's an emerging market economy. And I think that kind of mentality, that kind of sentiment often corresponds to an extreme in the market. And I think that's what we've seen. I mean I had I had anticipated a move towards one

twenty then one five. We've stopped about fifty on stirving. Uh. And this is where I am only the dollar in the big picture. I've seen the dollar and have a huge setback here and QUE four and oftentimes by that I mean nine out at nine out the g ted currency that's the only one that not in there is the Canadian dollar all appreciated by voy Thane five percent. It's the dollar Hear and Que four After such a big move, they technically indicator a bit over extended to

the dollar on the downside. So I'm torn between thinking the dollar has turned lower and the short term technically indicated telling me the downside has been exaggerated. So I think there to happen Heared short of early and early next year is the market is going to reprice them the possibility of a fifty basic point height by the FED at the next meeting on February first, and I think that's going to get the dollar the technical correction well.

And of course, something that the Fed may have to consider longer term into three is whether or not there's going to be a reinflationary impulse coming from a reopen China once they get past this current surge in cases what you mentioned a moment ago, Mark, how are you viewing that through the lens of the Wan, and so

a couple of things. When I think that it's hard understand how the Chinese are able to do this, and I do this, I think be able to maintain a fairly stable currency, I sort of see them right now, given a turmoil in China itself. I see them why they have a very stable currency and they be able

to engineer that. But I think that I think that the Chinese currency really trapped the Euro and the n right now broadly speaking, and I and those two currencies, I mean, I think the euro is clearly going sideway.

We're holding just above the toy a moving average which you haven't really broken below for a couple of weeks now, and so I think that the I'm looking for the dollar to regain at seven level against the R and B. I think that this idea of you know, we heard this early last year where Chinese pp I, Chinese producer prices was the lead indicator for usd P I, I

don't think so. I think things that really matter here, and I think you should see this very clearly, for Power of Talks were easily watching his service prices in the US, and these core service prices have very little to do with from Cown and Charina. I get think that the challenge for up in the US is that many people keep minding to blame other countries for our problems,

whether it's China, whether it's mops off, whether it. I hope you mean in Vietnam, and I think most of our problems that really get home grown, well, that's probably not the most popular. He's just basically you can blame whoever you want. It's a smart handler and Fanning Brand

have a wonderful new year. Joining us now as someone who has intensive knowledge understanding the labor market for the Federal Reserve, joining us now from the Brookings Institute, Stephanie Aaronson, Director of Economic Studies there, I do want to start there, do we have a true understanding of just how tight this labor market really is and how much wage pressure is driving things in a way that perhaps flies against this sort of moderation inflation that a lot of people

are expecting. I think we've definitely seen a slowdown in the labor market. Um. I don't think we've seen a lot of increase in slack. But it's clear really the case that changes in payroll employment have come down. Firms are adding jobs more slowly. Vacancy rate has come down a tiny bit, although it remains very high. So I think we have some sign that things are moving in the right direction, but it's very small. Claims, for instance,

have been largely moving sideways in recent weeks. So I think it's a bit too soon to tell exactly how much help the feed is going to be getting from the labor market. We're listen, fifteen minutes away from the last initial jobless claims reading of every time they come out you say they've been moving sideways. People kind of shrug their shoulders. They don't really care. They think that honestly, this is messy data that doesn't matter anymore. Do you disagree?

I think it's not the clearest signal. The truth is that there are a lot of workers in this economy who are not eligible for unemployment insurance and that has

decreased the signal that we get from the data. And it's also true that the data are noisy, but we've never had a recession without the claims data going up, and so while on a week to week basis it might not be that helpful to look at the data, I think that if we started to see large increases, that would clearly be a sign, and if we don't, then I think that that's also a sign that the labor market isn't deteriorating very much. Well, and in theory, Stephanie,

it needs to do so. If the FED has any hope of getting inflation under control, unemployment is just going to have to go higher. The question is how high does it need to go and how high will be tolerated, not just by the Federal Reserve but politically as well. What do you think that level is. I mean, I would be surprised if we don't see the unemployment rate go up to at least around what the FED is expecting, maybe four and a half um percent, could be five

per cent. But I do think that there are factors that are pushing down inflation, as we just heard, and so the FED is going to be getting some help. Uh. For instance, the housing markets already cooling a lot. We know that the rent data only show up in inflation with a long lad simply because of how the data are constructed, and so that means over the next six

months inflation is going to be coming down. The goods prices are already uh starting to rise less quickly, and I'm hopeful that the change in policy in China is also going to reduce pressure on goods prices. Of course, it will also be trying to know what happens with energy prices, since that has a date factor two. So I don't think the labor market needs to do all of the work in this case, but certainly I do

expect to see some deterioration, some increase in slack. I think we're all basically asking Stephanie Is for your guestimate of NEHRU, right, the non accelerating inflation rate of unemployment. I never exactly remember, but the idea is, and um, cath Rooney Vera yesterday told us her guest was four point nine. If you don't get to that level, um,

we're still looking at inflationary consumer forces. So if it's four point nine percent and the FED only pushes unemployment up to four and a half or three point seven, now that just isn't good enough, right for an economy that has what se of of of of its inflation driven by services? Don't you need to get it higher than that? Shouldn't it be five and a half percent?

I mean, I think if it's true that the neigh rut, as you said, is four point nine percent, then I mean, the higher the unemployment rate goes, you know, the less inflationary the environment is. Even if we don't really exceed the neigh rut but certainly you'll get the most bang for your buck once but unemployment rate is above that.

My own estimate is probably that it hasn't written risen quite so much, uh maybe more in the neighborhood of four and a half or four and three quarters, So I'm not seeing the need for a unemployment to rise quite so quickly. But again, I think it depends a bit on how much the FED, how much help the FED gets from some of these external factors as well.

I think you know, there also is some evidence that the vacancy rate is falling even without much of an increase in unemployment, and part of the reason that the NEHRU seems to be higher is that there's been a deterioration in matching of firms and workers, and a declining vacancy rate is a sign of an improvement in that process of matching of firms and workers, and if that comes down substantially, that will help ease the tension a lot,

even without our seeing a big increase in the unemployment rate. So Lisa's son has a thesis that deglobalization um that we've seen as a result of the pandemic is driving up prices as well. That that's inflationary. It's just his theory, rightbody else's literally the consensus theory. Are you just talking about the carry on? I mean, I've been wondering about

this to Stephanie. I was looking for pickleball paddles over Christmas, and the Chinese paddles on Amazon or ten dollars, But if you want to buy one that's made in America, it's like a hundred and fifty bucks. So that's a huge delta. How much is deglobalization really happening and how

much of an effect it doesn't have on prices? I think for the long term, it's hard to say now whether we're going to really see a sustained deglobalization, whether the types of policies that the Biden administration is trying to implement are really going to shift a lot of production to the US, where indeed it will be more you know, more expensive. But it's clearly the case that the US benefited significantly from China's accession to the w t O and trying to really becoming sort of the

factory of the world over the last into years. Goods prices actually we're falling for much of the last twenty years and that you know, helped out the US on

the inflation front. And I think with the pandemic, the deterioration in supply chains clearly that you know, ameliorating effect has faded, and I think it's going to be the case that over the short run, you know, deglobalization has been a factor in boosting inflation over the past year or so, and it's likely to continue to be going forward, although again, as I said, goods prices have been rising

less quickly and I think some of that effect is fading. Stephanie, do you have any confidence in the models anymore or do we have a sort of feeling that this is unchartered territory and there's a new level of uncertainty around economic projections. I think certainly uncertainty is very high now. But I think one of the ways to think about the world we're living in today is we were in

a regime where inflation was rising very slow. You know, inflation was low and very stable for about twenty years, and in fact, you know, a lot of macroeconomic variables were showing less volatility. Growth was less volatility, there was less volatile, there were lower inventory swings. You know if this was the time of the so called Great Moderation, and I think, you know, we had a set of

models for that. Now we're in a different state of the world where we're buffeted by increased shocks that you know, economy is more volatile, inflation is more volatile, and it seems to be we're in a regime also where you know, it's just more inflationary. We actually also have models for that state of the world. Uh, you know, we were in that state of the world in the late seventies and early eighties. So I think that if you is knowing,

you know which state of the world we're in. I think one thing that's going to make the FED job tough going forward is as inflation comes down, they're going to have to figure out, are we going back to the more you know, quiescent, calm state of the world that we experienced from the mid ninety nineties until the pandemic, or even if we have low inflation, are we still

in this more bottle state of the world. Stephanie Aaronson of Brookings, thank you so much, a dear Denny, president of your Denny Research joining us right now, and I want to start with a d in version of the yield curve. To me, this has been one of the least talked about, most important aspects of what we've seen. What's your take and why we've seen this sort of unwind in a way that's been very unexpected. Well, historically, the you curve inverted at it's widely believed it's inverted

because it's predicted recessions quite accurately. I think there's a step before that that has been widely ignored, and that is an inverted yal curves typically signaled that something was gonna break, there's going to be a financial crisis, and that crisis would morph into an economy wide credit count where even good borrowers couldn't get money, and that's what

caused the recession. This time around, we've had some financial crises and the crypto market and in the SPAC since a lot of the ARC stocks, and yet we really haven't seen an economy wide credit crunch. I mean, clearly, credit is very difficult in the housing market, and it's getting harder to get in the auto market, but it's not the kind of credit crunch we've we've had in the past, and therefore I think we're probably more likely to get us a soft landing out of all this.

Just to sort of put a bow on it, are you saying that this time around year old curve inversion does not signal recession. I think this time around its signals falling inflation. Um, it doesn't necessarily imply that a recession is coming. As you know, this has been the most widely anticipated recession of all times. You might recall that even at the beginning of the year there were

people are saying that we're actually in a recession. We had two negative quarters in the first half of the year, and and the Bears were very happy to announce that that was at least a technical recession. But yes, I think we're not going to get I'm sorry, that is a technical recession, right, Well, I mean it was. I mean, for for one thing, Uh, I always say any number that doesn't support my story is either wrong or is going to be revised. But I mean, those numbers could

easily be revised in the positive territory. They were barely negative, So I don't think we can really characterize that as a recession. Certainly, the index of coincident economic indicators show no recession whatsoever, there are an all time record high in November. On the other hand, the leading into caters are scaring everybody because they are pointing to a recession early early next year. So if there's gonna be a recession, is going to be soon, and that's what the market's fear.

What is the impact though, add of four hundred and fifty basis points of tightening in one year, I mean, what about the long and varied lags, When do they come home to roost? Uh in a market where we already have like a trillion dollars of leveraged loans, which is more than double what we had in two thousand seven. Well, the answer to your question is this widely because that's the big concern, is that there will be a credit crunch and just just wait and we're gonna see it

early next year, by the middle of next year. Uh So, it is certainly an issue. But the other side of the of the coin is the economy is a lot more resilient, the financial system is a lot more resilient. The banking system is in very good shape. A lot of these bank executives have been saying a recessions coming, and yet their loan portfolio continues to grow, and they

really aren't setting that much aside for loan losses. So looking at their balance sheets, there's sort of a contradiction between what they're actually doing, which is lending money UH and not provisioning for losses, and what they're saying. So

I think the banking systems in good shape. The consumers actually in good shape, with obviously some concerns about some credit quality issues and the auto market for example, but all in all, wages are likely to rise faster than prices in three UH, and so I think the purchasing power is going to be there for consumers. And as we all know, the labor market remains strong and likely remains so well to that point. And if you have a consumer that is going to be able to keep

up consuming and spending and in theory fueling inflation. Are all of these things good because they raise the prospect or maybe the probability of a soft landing. Or are they bad because if the economy holds up too well, the federal Reserve is not going to be able to do its job. Yeah. Honestly, that's the sort of problem that bulls are having right now, is they almost can't win. If you get an economy that's too strong and belies the idea of a recession, well then the fens gonna

have to raise interest rates a lot more. The key is that kind of narrow path where inflation comes down quite quite a bit more that is widely and expected. That's the camp I'm in. Uh. You know, we're seeing used car prices continue to plunge. We're seeing actual rent inflation coming down right rather dramatically. We've seen energy prices

moderate quite quite a bit. I think we're gonna see three to four percent headline inflation on the consumption deflator this year, and I think it's going to happen pretty early in the year and ease some of the concerns about inflation. As you know, all these price indexes that are coming from the regional business UH surveyors are continuing

to show moderation. Well, if we're talking about some those inflationary pressures coming down, therefore cost pressures coming down, input cost pressures for companies, and consumer demand that is still holding up fairly. Well, is there much too much doom and gloom about the earnings story next year? Well, you know, we're all debating soft landing versus hard landing. I think there's a like I'm realistic here. I mean, I'm not going to tell you there's no uh no risk of

a recession. I think there's at risk of a hard landing and a sixt likelihood of a soft landing. The market seem to be kind of flipped the other way where they're more concerned about a higher probability of of of a recession, but nobody's talking about no landing. I mean, the reality is the second half of the year, after some weakness in the first half, has shown growth rate of two to three in real GDP with the consumer spending, with capital spending holding up pretty well. It's been a

rolling recession. It's rolling through the housing market, it's rolled through retailers uh, and it may roll through some of the other sectors in the economy. But altogether the economy is holding up. There's really no landings so far in the economy. If it's gonna land, if soft or hard. All the forecasters that are bearish are saying it's gonna happen pretty early next year at any of your Jenny research. Wonderful, wonderful to get your perspective. A lot to think about

This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am 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 In. This is Bloomberg