Surveillance: UK Crisis

and of course on the Bloomberg terminal. It is an historic I MF meeting as well any number of topics to speak to Geita Gopeneth about the first deputy Managing Director at the International Monetary Fund and as I am aggested a GEO with a managing director on the United Kingdom, a meeting with the former Chancellor and with the Prime Minister just a few days ago, I must begin there

with you. Your research capability says what is the best first practice for this fractured government in the United Kingdom, what's the best first for them to get to some form of new stability. So Tom first days the leisures who join you here. We are following the developments in the UK, and of course there are issues which we don't comment on. We do hear that there is some recalibration likely to happen on the policies, but we don't have any details. We'll see what comes next and then

we will be able to comment more on those. Thank you for those comments, and we'll get much more on that, I'm sure from the managing director as well. Folks, I've got to this up here. This is how quickly things are moving at the International Monetary Fund. Released within the hour is a definitive weekend read on how countries should respond to the strong dollar. Gopen Haf pulling an all night or on this. Uh, it's wonderful and with wonderful

charts as well. What I see within your note as you speak of financial amplification leading to instabilities, can the strong dollar amplify the world's risks of ability? So so when you have sizeable movements in the dollar, it has very sizeable implications for the global economy because it's so dominant in trade and finance. But the important thing to keep in mind is that there are fundamentals that are driving these large movements. They seem very quick, they seem

very steep. The differences in the path of monetary policy tightening is one factors. The differences in high energy prices are affecting countries is another factor. So I think this is going to be a bit of a rocky right for countries, but they will have to adjust to it, so they have to use their own monetary policy tools to be able to keep inflation. Roger here about emerging markets. Let me stay with the major countries with you, Dr

gopen Athide. Let's look at the yen experiment. All of this meeting in the world, John Farrell, is transfixed by yen one seven. What is the council of you and your chief economists to the Japanese to extricate themselves from their unique yield curve control experiment. I mean, there are fundamental reasons for that particular divergence that were seeing in

the currency. Japan has decided to stay the course in terms of keeping interest rates low, while the Fed has decided to stay the course in terms of raising interest rates very decisively to bring down inflation, and that, of course is the one of the primary drivers of these different of the fact that the the end has lost value relative to the dollar. Now, of course, over time, monetary policy will have to figure out what the best course is depending upon inflation developments in Japan. But as

of now, I believe given the diverging trends. You know, currency movements will look like they do now with all of your expertise, if Japan capitulates to a more normal monetary policy and yend goes strong one one fifty, just as pick a number out of the air, one, what will that do to the Pacific rim financial system. We have to look into that and see how well it happens in a disruptive manner. It happens in an orderly manner, right.

We always have exchange rate movements all the time. When you have big movements in exchange rates, the problems that come up is when you have phones or banks that have borrowed in multiple currencies and haven't sufficiently hedged themselves, so those get affected. But if you've hedged yourself, I mean, these are movements that you should be used. Because of breaking news in the United Kingdom, we're gonna ask one

more question. I really want to give John and Lisa New York enough time with the flow up news there. I did a careful read of this blog, folks. Again, this blog as the read of the weekend. Look on Twitter. I'll have it out with the I M. S website. Nowhere in here do I see that you were at the Plaza accord. You don't mention the plaza cord. How does a grizzled pro like you respond to the media silliness, the romance back to how do you respond to people

we need another plaza accord? I think we are we that's not where we are. And frankly, when you know the Plaza card worked at all, it was not just because there were announcements on currencies, but there was more signaling of coordination of other kinds of fiscal and monetary policies and so on. So so now, uh, I don't think we're going to have a plaza called anything. What have you learned at these meetings? I'm fascinated how people's time frame is back forty and fifty years, not back

fifteen years. What has been year observation at these meetings and the tension here. I think there is a clear recognition that inflation is stubborn, it's persistently high, and I do think central banks are very careful not to again stumble on the you know the fact that maybe this is all going to move correct itself automatically. So I think there is very much agreement on staying the course.

The second piece is about making show monetary policy and physical policy are consistent and they're both rowing in the

same direction as opposed to pulling an opposite direction. And everybody is concerned with financial fragility in the sense of what could be lying in the dark corners and the shadows at this point in different shadows in two thousand and Thank you so much for Joanny Bloomberg today, Dr Gopen Anthony, I am at first deputy Managing director right now in these unusual times, in unusual interview with Robert jo And he's former governor of the Central Bank of

India and far more at the Boosts School of Chicago has provided two magnificent books of the era. He defined the crisis of OH eight and oh seven with fault lines in is the Third Pillar, which was my book of the summer one year. The Third Pillar has been shockingly prescient about the technological and community changes of America, none of which we can talk about this morning, for

there is only one topic. The topic is the strong dollar what it means for all of our Bloomberg surveillance audience, and you, with the great financial sophistication you have, are watching cash in international overnight lines, which are called swap lines, and the nations that don't have those instruments available tell us your study of liquidity right now? Well, I think this is a phenomenon which is across the board, and you see it reflected in the problems in the UK

right now. What is happening is the central banks flooded the markets with the most liquid asset on earth, which is central bank results tens of trillions during the pandemic. Now they were drawing that cash from those markets. So what happens when they would draw that cash? Banks in the meantime have written a lot of claims on that cash. A lot of people depend on that cash for final settlement. That cash is shrinking and as it is, things are

getting very tight in financial markets. If you look at every measure of liquarity, it is off the charges back to the uh you know, March levels in the United States. Think of what happened in the UK. You have these pension funds suddenly have to make margin calls. They need cash, but nobody's willing to lend them that cash. And so what they do they sell assets as they say assets as follen value and you see the interest rates go up.

I think the problem. There was, of course the government action, but you can think about accidents waiting to happen across the world, including for emerging markets. So let's split this. Let's talk first about the others like the UK that have so called swap lines where there's a confidence to go to the Central Bank of the United States. Is that system working now or do you have a fear

that we could fail with the larger, more sophisticated nations. Well, I think for now, the fedroom Reserve has made commitments to a number of countries. It's the country's that are outside that system which have bigger problems because when they need the cash, what are they going to do? They're gonna sell in their stock of treasuries, their reserves, and that creates a price impact in various markets. Right now,

I think they're managing. But if there is a big sort of demand for cash, as for example in the UK, basically you get must selling you. And I studied Stanley Fisher one O one in the crisis of previous decades, and people here at these meetings make clear they're looking back forty and fifty years. Is EM different this time? Is EM more prepared for these liquidity crisis. It is more prepared, uh, because it has built reserves during the time of easy money. It's seen that story happened again

and again. So the big e m s are better prepared, of course. The small ems and the developing countries not so. And for them, of course, the twin effects of high inflation, higher food prices, um. That's hurting them a lot, higher fuel in food, and so many of them are on the brink this time, not so much liquidity but default. They simply cannot service their debt yet that people. At the same time, Lisa from New York emails in and says, Tom, You've got to ask about yen in the Pacific room. Lisa,

let's do that very simply. Here. The Bank of Japan has an original experiment which is not taught by Randall Crossner at booth. It's original weekend one of forty seven. I've done the math, You've done the math X number more interventions possible at some point that will break it. As I said to Dr Gopenhath, we will see yen and a heartbeat. What did that do to Indonesia? What

does that do to China? Well, any volatility in asset prices creates a problem somewhere now in this case, when the yen strength and significantly it probably helps other countries a little bit. The problem to some extent is of people who have borrowed in in at this point and are thinking this is easy money, we can repay it effectively.

When the again strengthens, that becomes a problem. The bigger problem is for people who are holding uh gps, I mean, think of what happens to them, because supposing uh you know, the part of Japan has to move off its yield of control because it's achieved its inflation objective, how does it move off? It's writing a tiger. It has to move off in small steps. But people, but markets basically accelerate that movement. They know that you have to get off it. And therefore what happens to g g B

s is a big price fall. When when the when the Bank of Japan, it's the time for one more question. Unfortunately they are writing a tiger as the tiger holds their party congress in China literally tomorrow in this week as well, how does China fit into your view of Pacific room and around your India given their absolutely unique covide strategy. Well, I think they're hurting themselves. And the question is how do they move off given that this is so closely associated with President she and it is

created creating opportunities for countries around the Pacific. Vietnam is benefiting as the China plus one India is benefiting a little bit. But the real question is what happens to China after this? How do they find a way to move off this or do they actually buy Western vaccines and start vaccinating their population with the effective vaccines. That's the big question in front of them because they cannot

continue this strategy forever. Dr Rogan, thank you so much, greatly appreciated a former Reserve Bank of India Governor Raman Rajan this morning as well, stated standing joints NOW Chief Economist to Amherst Punt Stephen, you're expecting a U turn, a pause. I have it from this fed anytime soon after that day to yesterday. Good morning, Glyn. I'm sure they would love to, but now now it's not in the cards. I mean, clearly inflation is becoming more entrenched.

The the breadth of underlying inflation right now, um is just very troubling and I think it's gonna be a while until the FED gets inflation under control. Unfortunately, Stephen, as a debt that we got yesterday made do you rethink the terminal rate that the FED would ultimately get to in the cycle. Um, so, my my estimate was already above five percent. I think, you know, I'm sticking with that for the moment, but I think there's certainly,

you know, some upside risk to that. Uh, you know, I definitely think we'll see another seventy five base point move in November, and um, you know, I had thought they would slow down to fifty in December, and I'm gonna, you know, cling to that for the moment, but certainly, if the inflation numbers over the next couple of months come in the way that the last two have, then um, it's not clear to me that they can stepped down

from the sevent basis point hikes. Stephen, what do you make of all the discussion that perhaps we are overlooking the lag effect in the rent component, the fact that housing does tend to operate on a lag and that there may be a decline in the next six months that hasn't yet fed into the data, And so we're going to get it. Even if the FED doesn't raise rates as aggressively, what do you say to people who

really are arguing that perhaps the FED is overreacting. Yeah, well, the research suggests that the lag is from home prices to the shelter cost components of the inflation numbers is about twelve to eighteen months. So I think our realistic scenario here is that maybe rent and owners equivalent rent UH continue to accelerate until around the middle of next year. UM. And that's a long time for the FED to sit uh, you know, to kind of say, trust us, we got

this under control. I think the other point would be that if it were only about shelter costs UM, then that argument UM would be very po awful. But the reality is that we're seeing UH inflation very hot and in many cases accelerating across UH just a you know, virtually the entire UM list of categories within the CPI or the pc inflators. So this isn't you know, shelters one story, um, but it's it's not the only one. And unfortunately the data are pointing to a more systemic issue.

You know, wage pressures are pushing into prices now UM, And I think you know, the the risk is that the FETE has talked about is that the longer inflation is high, the more people get used to it, the more they start to incorporate it into their plans. And that's why the Feds in a hurry, because they're trying to cut that off before uh, it gets kind of set in stone. How many times do we sat here later and said, they've got more work today, They've got

more work today. How much are we getting? Are we catching up to the Bill Dudley version of the world that here yesterday? I mean, but we're there in terms of the market expectation. And then you have some people including Jason Furman out in Twitter saying that perhaps it's even higher than what the market is currently expecting because of the sticky components that are rising at a really

rapid rate. Steven Stanley ms payphon. Steven always wanted for to catch out with you, said Garrick Freeman, US Bank Asset Management's chief investment officers. So, yeah, we are coming off the highs on this early trade. Eric, what's standing out to you? What what do you make of all these wild moves that we've seen in just the last couple of days on the data. Yeah, Nathan, and I think the biggest thing we're focused on is what happens

in the bond market. Clearly we're focused on stocks like everybody else's, but the stock market is absolutely taking it's it's que from what's happening in bonds. And so I think on the back of it was tresh press conference, the thought that you did have a relatively but i'm responsive fixed income says that you know, perhaps there is

a little more calm um uh, you know. I I do think ultimately our bias is an equity prices head lower, not higher over the next call a couple of months, but do expect to see a peer amount of variability between now and the end of the year. How about on the fixed income side, Eric, because you know, we've seen double digit declines across pretty much every fixed fixed income category and and all the fixed income folks that we speak to say that's unprecedented, It's never happened before.

So when I hear language like that, I'm like, I'm just putting all my chips in the fixed income space. I mean, you can't get me lower ken it. How do you think about fixed income? Yeah, I think that Um, you know, it's really difficult to give up with the market giving you right now, which is on six month treasury paper a four point two plus percent annualized EEL.

That's that's capital. That Again, you may have some price risk between now or the next six months, but unless the US government doesn't pay back, which we expect them to, that's a that's a pretty tough thing to ignore. So you know, without question, there is more discussion about the FED becoming more aggressive, and yesterday's data, coupled with the very clear message from j Powell from Jackson Hole, suggests

that the yields likely head higher. But do think that for for investors that can take a staggered view over the next six to twelve months, starting to dip into the front end of the bond curve, we think makes a lot of sense. So that would be a priority for us in terms of what we're doing with that with capital in the here and now. So you're looking at greater recession risk than deeper inversion for the yield curve. Yeah, I think that the recession odds that we would put

are definitely greater than fifty fifty. And uh, look, we think that the catchup on the slowdown is going to really materialize mostly in the first and second quarter of next year. So even though markets are forward discounting mechanisms, we've still think that there is some some economic and some earnings growth concerns that will start to emerge. And again, you've done a great job as a team looking at

earning season as we really kicked that off. And so we think that again this quarter probably fairly benign in terms of actual results, but outlooks we expect to be a little more truncated in terms of enthusiasm from companies. So we do think that the weakness will become most pronounced in corporate America in the first and second quarter of next year, and that would signal a recession to us.

You mentioned earnings, Uh there, Eric, and we're just kind of kicking off the big boys, starting to say, with some of the big banks. Uh. And obviously the forward guidance, as you mentioned, is going to be really key here. Do you have a feel, I guess what's your call here on valuation? Um? I mean, obviously will be dependent upon kind of some of the earnings and the earnings forecast we get. But for this market, is this market cheap.

Yet yes, I would say that it's not yet cheap enough for us to come off what we've had on for some time, which is an underweight position to global equities and most specifically US and European equities. So we do think that the cheap factor is going to likely kick in more as we get deeper into first and second quarter of next year. And so what I mean by that is that we still think that earning his expectations for the early part of next year are just

too high. And again, like you always talked about really thoughtful terminal usage in terms of what you can use in the Bloember terminal to look at the next couple of quarters, next couple of years, we just think that the next two quarters are too high, and so that we think that rationalization is going to be step one. The other rationalization, we think it's going to be the FED staying at a higher interst rate terminal level for

for longer. And so that says to us that yes, things do look obviously less expensive, perhaps we do think they'll get cheaper, So we would not be in a rush to push the valuation argument right now. We'd especially be careful about that argument in Europe. Europe is cheap, but cheap for a good reason. We think likely it's cheaper from here. Well, what do you think is going

to trigger a capitulation in this market? Yeah, and they said, you know, we actually look at about eight different signals across our macro research efforts and we've only seen two or three fire and so we're not quite there. And again we do think that it's going to be a combination of big volume. It's gonna be a combination of I think two things. One company's really coming clean with what next year will look like and then you know, and we hope it doesn't happen, but it's certainly could happen.

Investors throwing up their hands. We have not seen that quite yet. You were right to point out the VIX index earlier. We think the VIX index can can be somewhat of a of a red herring in terms of it's forward predictability. But we also look at the move index and fixed income. That's something that has been elevated, and if we see that elevate on a prolonged basis, that would be a reflection to us that investors maybe are a little too pessimistic. And we may take the

other side. All right, Eric, great stuff. We appreciate you sticking around. Eric friedmans u S Bank Asset Management chief investment officer getting his thoughts on these markets as we really get into the thick of earning season. 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