Surveillance: U.S.-China Talks with Blackwill

dot Com, and of course, on the Bloomberg Terminal. Robert Blackwill a senior fellow at the Council on Foreign Relations and Bloomberg opinion columnist Robert Let's stout here, how do you convince a foreign country of the responsibility that comes with great power? Well, I don't think you convince a foreign country or most any of uh, buddy else by hectoring them or constantly lecturing them. I hope the President will begin the conversation with she by essentially saying, UH,

we have a problem here. Uh. We may see the situation Ukraine somewhat differently, but we both both want to first have a cease fire and then find uh an equitable way to end this war. And I hope you'll start like that and not start with your on the wrong side of history or uh with threats. It seems like, Robert, we have a superpower on the global stage that has a very different interpretation of the responsibility that comes with power.

And Robert, I wonder if this is something you see repeating again and again over time, or whether a situation evolves within China where they start to change, they start to change their approach. Well. Uh, First of all, Uh, I wouldn't put it quite as you did. Uh. China has a different interpretation of its vital national interests than

we wish it did. And essentially, I believe the Chinese leadership things that the United States is determined to stop its rise, to contain it, if you will, and they see everything through beginning with she that optic. And so what we have to do, I think is, first of all, while of course remaining strong and resolute and defending our national interests, we have to try to persuade them that isn't the case. And that's the context in which this

conversation will have happened this morning. I would remark that yesterday the Chinese government issued a statement saying they hope that this conversation, which will happen in a little over half an hour between the two leaders, will be an opportunity to try to begin the improvement generally of the U. S.

China relationship. So I hope that's in fact the perspective the President has, while of course making the points that China UH will if it seeks to support Russia to get a on the sanctions, will UH itself have a serious cost. Ambassador, do you think that it's realistic for China to want to send weapons, to want to send military support to Russia. Well, again, we don't know, I

believe whether that's actually happened. We have a leak from or lead perhaps even on the record from the U. S. Intelligence community UH that Russia asked for UH such weapons. We don't I think, have a leak of what the Chinese response was. But certainly if it makes a decision to UH supply Russia with weapons in the context of this war, it will be a further, very serious blow again on US China relations, the most serious one in many,

many years. Ambassador. I noticed a line in one of your recent Bloomberg opinion pieces that released stuck out to me. Russia will remain a threat so long as Putin leads it. China will remain a challenge irrespective of its leader. That is a much longer term view, And how do you think the immediate need to focus on Eastern Europe detracts from a longer term strategic pivot towards China towards Asia. Well, my colleague Richard Fontane and I wrote a recent uh

op ed for Bloomberg exactly on this subject. Uh. There was a bipartisan agreement in Washington one if a few one might say, sadly UH that uh United States should reorient its foreign policy toward Asia. That of course, has been turned on its head by the recent events in Ukraine and the brutal Russian invasion of Ukraine. Now I think without any doubt, we're going to have to moderate that, uh,

that pivot to Asia. It will be slower and less encompassing because we have to first stabilize Europe along with our allies, and that will mean more US troops in Europe forward deployed in the Eastern Europe. And we have to I think, do more in the Middle East. Uh. Since the Obama administration Middle East frenzy, United States have been uh convinced we're leaving the Middle East. We have to disabuse them of that notion. And it's only if we can have stability in the Middle East and in

Europe to a much greater extent than at present. Will we be able to make a full fledged pivot to Asia. We'll be just a fund of question from me looking ahead to next week and the talks. You've been inside government many times, you understand the inner workings of events like this. You need to arrive in Europe next week with some deliverables for the President of the United States to meet with foreign leaders next week, and what do

you think they would be. Well, first of all, we have to what happens between now and then, and Russia seems to be escalating. Uh. They attacked the viv for the first time overnight. UH. If that continues, and let's keep in mind the danger of Russian use of chemical weapons against Ukrainian cities, then obviously there will be an escalation in our reaction. But I think the primary in the absence of that, the primary UH presidential objective will be to keep this alliance together UH to UH UH.

And it's been remarkable. I think most people did not believe the alliance would act as resolutely as it has to this tragedy. To keep them together and to prepare for UH next steps that Russia putin might take in order to further the destruction of Ukrainian cities. Incredibly incredibly united, Robert, We're lucky to have you with us this morning. Thank you, sir Robert Blackpool. There on the talks between China and the United States. My Shoemac of the global head of

Race Strategy at Wells Fargo joins us. Now, Mike, if you've been surprised by how much weight we've had it to the front end of the yield curve, and he surprised to some degree how easily we've shaken off some of the comments of this fed this week. I haven't surprised. It's been just amazing, frankly, to watch the action at the front end of the US and it's it's driven by so many factors, have fed other central banks to degree in The inflation outlook at the front end has

been incredibly volatile. I'm sure you'ld up a time and we thought they the people on by our expectations, there's not much. The curve is starting to get messy, Mike. Seven year year olds above tens saw a bit of that, with five threes almost coming there threatening to do that yesterday morning. The yield curve is starting to invert. It's flatter at the long end, twos tens twenty three basis points to thirties. Let's call it fifty two down four

basis points today. Again, how do you think that evolves in the coming months, Mike, it's flatter still if you look at the forward grades. Johnal Price, let's say twos tends to be completely flat and three or four months something along those lines, I think you could actually invert before then. We've been telling clients you've got to think outside the box of bit here. This is an incredibly unusual situation. The inflation backdrop as you need in the

last thirty or forty years. It's possible twos tends inverts to the tune of fifty basis points or more by the end of the year. But as far as the path forward flatter, more painful for a lot of institutions. So, Mike, a lot of people are wondering whether an inverted yield curve still means a recession. And I'll go a step further. Does an inverted yield curve in and of itself cause

a recession? As we were talking about the potential earlier today, what's your view on this, I'd say no to both lisas. So there is a very good relationship between curve shape and future economic growth. Let's say prior to the financial crisis. Since then, central banks have been so active buying on so you've really broken that way. So the ability of the curve shapeless, say to predict t DP growth out twelve months eighteen months sets diminished a lot, So I

wouldn't worry so much about the predictive power. But I think the second question is really interesting in terms of does a flatter curve felt cause recession? And it probably contributes in particular when you think about the financial sector. If your basic businesses barley along and you say, well,

what can I do? Or you want to I want to borrow along, you want to lend short more flipping around, you can't really do much of the curve is flat, so that intermediation function doesn't work for it well, and I think that takes away a lot of profitability opportunities for banks and even for the shadow things. So flatter curve is tough for financials and therefore it's tough for

the whole system. And there's also an additional yield curve that Tom Saturas of Strateigues, who was on our show earlier this morning, was talking about that if you see the FED funds rate get higher than that two year rate, that that actually hurts the people who need it the most, and what you get is a causative effect on main street.

I'm wondering from your from your perspective, whether you agree with that, with you think the FED should back off from raising rates as much as perhaps they're talking about and lean more heavily on the balance sheet. No, I don't. Actually, when you think about the let's say the inflation backdrop right now, it's terrible. And I think if you talk to most people out there in the US, and we all do this in our daily lives, inflation is everywhere you can't really avoid. So what the FED needs to

do very simply to step up and fight inflation. That's very abundant from an economic perspective, it's very far from the political perspective. That's what the FED needs to get done is to fight inflation. Put that genie back in the bottle. So he needs to raise the funds rate a number of time acts. You can't focus simply on the balance sheet. Balance sheets a nice add on, but

it really has to leave the FED funds in my opinion. Well, let's talk further about the balance sheet, with which Jerome pal did not really get to do much on Wednesday. Maybe he will more next week when we hear from him twice, but he basically equated that runoff to the equivalent of a hike. How do you view it, Mike, Yeah, I think the FED struggles in terms of that equation. From my perspective, it's a little bit different. Basa will

compare apples to bananas, doesn't take that much sense. But what the balance sheet does, in our view, is really addresses risk appetite very directly. So if you think about the basic trade during the year of quantity of easy, and it's pretty simple. When in central banks buy more bonds and you're supposed to buy more stocks. That's worked

really well. Now if you flip it, you'd say, well, okay, if the FED and other central banks are reading in the balance sheet, that's probably a pretty big negative for risk assets. So I think that stands out and the FED can take some froth out of that market. The other thing I suspect the FED and other central banks are trying to accomplish is to limit that neel curb inversion limited that flattening. So if the FED backs away from buying tenuere treasury, it's twenty of your treasuries, etcetera.

You should all else equals. See those yields go up, so that should help limit the downside from the flatter curve. Well, if you say QT could be a sizeable negative for risk assets, do you think risk assets are appropriately pricing that? I suspect probably not. I think that when you look at the risk asset landscape right now, it's been driven primarily by the overall idea that yes, central banks will tight and that's a bat then and secondly it forced

the big commodity spike. So balance sheet probably is number three, and at least from my perspective, I think that the risk markets have not fully priced it. So which was asked to which risk market? Excuse me? It is a Friday is most underpriced for this potential risk. It's hard depending on onely. So, but when you think about risk appetite across the board, I'd say I would focus on

the central banks and the most involved QT. So the FED probably leads the way, followed by banking with Banker Canada. So within those markets, whether it's high yield bonds of equities, tough to sort of parce those differences. But I would go to the dice or parts of risk. So within markets do you want to focus on and you think the risk is more susceptible to the high end? I think it is the the assets that typically the higher data most likely to be most impacted by this cut

back and balancy. The reason why I ask Michael is because there's a lot of disagreement about how much momentum there is in the US economy, withstand the potential for two point eight percent FED funds rate, withstand some of the rate hikes that you and others are saying is absolutely necessary in order to curtail what you see as

dangerous inflationary pressures. So at this point, do you think that the FED can actually orchestrate a soft landing at a time when they're diverging viewpoints and diverging data points underpitting the economy. It'll be very difficult to pull off the soft landing, I think least so it was always going to be a challenge when you think about the massive amount of stimulus in the system, over the last couple of years, both monetary and fiscal, the rebound from

COVID on top of that commodities play. That's an incredibly big ask to talk about a soft landing, so it was always going to be tough. I think it's gotten much cover. The chance of it happening probably is following by the day. So it's a fifty fifty. Maybe it's probably not much better than that. All right, Mike, We've talked to out risk assets, we've talked about the bond market. Can I just get your thoughts quickly on the dollar, which, in light of everything we heard from the Fed this week,

is heading forward its biggest weekly declined since early February. Yeah, we think that's a mistake. We're actually valuables and it's interesting. You can think about this from two perspectives. Really, if you look back over the last the last couple of years and also just over the last couple of months, the dollar has emerged as the top safety, so that should be a win if the Ukrainian situation intensifies, which

seems likely over the next month or two. And secondly, if you focus on really only meat and potatoes types of things in effects it's interest rate differentials, and I would say that the Laiciam Marbue there's more potential for the market to increase its expectations for hiking from the FED than there is from the ECB, probably from the Bank of Angels that also should benefit the dollars were

actually very positive in a stollar right now. My Shoemaker, thank you fantastic coal earn this year on the pond market. My Shoemaker there of last f commits, Sky joined us now chief research strategist to Alpha Simplex Katy three this year. Can we just work through that? What would happen if they try to raise the FED funds to three percent

this year? Oh, that's a hard one because the truth is I would love to do that and raise the FED funds rate to three percent, but that has repercussions and it needs a little bit of balance in terms of not affecting growth and causing disruption in the market. So I think the Fed is probably choosing to be a little bit more conservative and kind of ease into this new decision and how to actually move into a

regime of raising rates. So I think there's a difference between what might one might want and what is actually achievable, um in sort of short order, achievable without the disruptions

that you talk about. Is this basically the modern form, the new form of a FED put that they will move much more slowly than perhaps they would want to, simply because they do not want to incur a huge losses and the equity markets, yes, because I think the challenges Remember, as rates rise, we have sort of industries

that have more duration exposure. We have potential tightening of credit, we have other issues that could cause businesses to be a little more squeezed with higher rates, And so I think the challenge is balancing between not affecting growth and encouraging encouraging good economic practice, but at the same time not disrupting the market. I mean traditionally, whenever the market has been faced with the rate hike, we usually have

sort of a sell off in some way. So I was pretty impressed that the market was relatively calm this week about this decision, but maybe that's because everybody knew it was coming well. Impressed though, at the same time, Katie, we did see a changed tone from a FED chair J. Powell, even indicating balance sheet reduction as soon as May. I'm just wondering are we actually reacting to the words? Are

we actually reacting to the press conference? Are we reacting to the FED that we have known over the past ten years, which is one that is beholden to a certain common markets. Yeah, I mean that's a good question. I mean, I think we've been asking the same question all last year. Are we ever going to see this

type of move on our side? What we do see is sort of the technical signals that show that rising rates are coming, and sort of the trend themselves really sort of has been indicative that we're going to see these rising rates in the long term. I think the real challenges them sort of shifting regimes and sort of being more actionable. And I think that's something that we really still have to see and I think you indicated that in the sense that we've kind of seen them

being a little bit more complacent in this area. UM. But I think when you're dealing with inflation at the level we're seeing right now, the pressure is going to come from a lot more places, um, and that will push them more. Katie. The market's knew coming into this year about those inflationary pressures and the likelihood of tighter monetary policy resulting from that. What it couldn't have anticipated

was a war in Eastern in Europe. Do you think the market is still under pricing the risks around both of those things happening simultaneously as we see the smp F I founded coming off it's best three days since November. That's a good question because I think most people are asking themselves this right now. But the truth is, from our cross asset perspective, we really see that some of the trends going into the Ukraine crisis really just extended.

So what that means is we saw an extension of current themes, inflation theme actually extending even further, and we

had massive moves, particularly in the energy markets. So some of us are thinking that there may be some consolidation at this point, meaning that some of the concern and some of the supply chain issues are priced in UM, but there is still definitely room because as you know, geopolitical uncertainty is very difficult to predict, and things can change quickly and in different directions than we would like UM.

So what I would say is we may not be pricing it all in, but that may be just because it's hard to know how to do that, Kat just quickly just finally on the FED, if we can finish there. At least when I were talking about this with Tom earlier this week, this felt like the December FED mating what cham and Pau said everything he needed to send the news conference, and people didn't really listen to it, and then they reacted to it when the same thing came out in the minutes, as if the minutes was

some kind of hawky surprise. Do you think was setting up for the same kind of thing again? Oh? Yeah, I mean to be honest with you, I wish I knew the answer to that question. I think most people are really sort of in a period where they're not reacting much right now. I feel like the market has moved already um. And the key question is does the market already anticipate that um? And so I'd say that we're seeing some consolidation, some of the positioning kind of

coming off for certain trades. Interesting suggests that people, so you saw that flattener kind of turned into a steepener a little bit this week, which means that people had betted on this move or a bet on this move, and now they saw it. So there's a little consolidation. What I'd say is short term respite, a little bit of back and forth, and then more focused on the next time we have an opportunity for hike. Kenny, Thank you Kenny Kaminsky of Alpha Simplex. Christian Majo joined us

now the head of Portfolio Strategy of TV Securities. Kristen, can we start there with Saudi Arabia over the murder of Kashagi? You remember people stepped back from Saudi Arabia and then they were back in React twelve months later. This feel is different for a lot of people. Do you agree with Blue Bay there that line that Russia will be in the isolated wilderness for a long time to come. A regime change in Russia is probably a

prerequisite for reinvestment for many. Yeah, I think I agree with that statement that two situations are really different because the solely case was against one single person, while here we're talking about a whole nation and I'm talking about Ukraine being involved. But there will probably be some money coming back, probably some money will not leave at all.

But the problem is, even when you remove sanctions, um, what's the reputational risk of being associated to a regime that by many as being considered to be a murderous and genocidal one. So, Christian, what is the contagion risk to other emerging markets, given the fact that this isn't going away, certainly not in the financial world for a long time. Well, first of all, we see contagion right

now through conversion and through UH commodity prices. Commodity prices were already on the upside, but they are definitely um getting pushed much higher because Russia is a great commodity producer, energy, agricultural medals. So that's not going to go away immediately because we have just too many supply side disruptions involved in this conflict. Then you can have default, the Russian

default that everybody is talking about, and that's another risk. Well, but the market views that as a lesser risk today than it did yesterday. Christian on the news that Russia sent that a hundred seventeen million dollar payment to JP Morgan, who then sent it on to City. We don't know where it went after City, and yet we've seen Russian CDs coming in substantially. Is the market being over confident? No,

you're right. The point is, UH, what you're talking about is to coupon payments that were due a couple of days ago, so they were already paid um with some delay, which is not a very good sign. But we have numerous more coupon payments and redemptions coming to UH in the rest of the year and over the next twelve eighteen months. So they and the thirtieth of March we'll see another couple of interest payments worth about hundred and

ninety million dollars. So the market will be uh, you know, holding eyes for it's breath for quite some time every time these payments come. Do Christian. In the meantime, I wonder how you think the global pool let's say central bank reserves and the denomination of them it's going to evolve in the coming months. If you are a central bank after a leader of let's say, a state with questionable leadership in the eyes of the West, what you would do with your dollar reserves right now? We are

you're quite right. First of all, I wouldn't want to be on the bed side of of the US that has weaponized the international reserves in a way of um, you know, freezing dollar assets. The first the first the first point is where do I diversify my reserves into into euro, but the Euro is also subject to the same risks. Then you can go into Raminbi, but Rominbi is not really a currency that you can just yet use for international payments. Uh So it's um, it's a

bit of a conundrum. Maybe goal you can be in physical gold, but that's not as liquid as currencies. So wherever you go, you know, the dollar is the global reserve currency and forty good reason. Christian. Do you think that there's still is a very real risk going back to the Russian default scenario, that the payment could get stuck in the pipes? I mean this has been something that we've been talking about. We really haven't seen this before.

Are there bigger implications for this? Yes, that's uh, that's probably the biggest risk because Russia is demonstrated to have at least for now, willingness to pay. They definitely have the capability to pay until they drain cash available in these person accounts. The question is it even a default if a payment doesn't reach the bond holders, not because the the doctor didn't make the payment, but because there

are restrictions and international sanctions. I think this is completely charity territory and you will be very controversial, but the risk is very real. Christian, We've got to leave it there. This is a fascinating conversation. We'd love to continue it with you. Christian Macha, the of t D Securities. 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, and this is Bloomberg