Surveillance: Ukraine Risks with Hormats

read Angela's Stent and Elizabeth Economy. On Stent it's Putin's world, and for Elizabeth Economy it is the widely anticipated the world. According to China, her books have been definitive for decades. Dr Economy joins us this morning with the Hoover Institute. Liz, congratulations on the new effort. At the bottom of the book. After the Olympics, after Ukraine, you talk about the China reset.

What is the reset towards the Party Congress? So yeah, the Party Congress, the twentie Party Congress is coming this fall October or perhaps November. Uh Hi Jinping will likely be reselected for his third term as General Secretary of the Communist Party. He has no amassed an enormous amount of institutional authority. Ruthless Lee rooted out his political enemies, whether in the Communist Party or you know, in the broader civil society. Uh, say a word against Hijin Ping

and you will be disappeared for four years or eighteen years. Um. And so this will mark I think the beginning of the third term, uh for Stijn Ping, the third five year term. You know, he's got, as you say, he's got an ambitious agenda ahead of him. Um. You know again robust Chinese Communist Party at the fore from the political system, doubling per capita GDP by five, rostering the p l A. So got to see what he's able

to do. It's all great, But to be honest, you've been absolutely original and saying he's more fragile domestically than we perceive. Do you stand by that absolutely? I mean, I think we can look just back to that first month, second month after the COVID pandemic broke out in China, Uh, and look at what happened on the internet when you had, you know, a week or so of freedom on the internet and you had you know, million people and more

calling for freedom of speech and criticizing the government. Of course you didn't pain went and hunted them all down afterwards. But but I think we have to be uh, sort of a tune to the fact that just because we don't see dissent within the system, that it doesn't exist. Just because he's a mass institutional authority doesn't mean he has the full legitimacy that he would have if he were in you know, an electoral system. Uh. China is as polarized, even maybe more so than the United States,

along gender lines, along ethnic lines. You have the battle between the entrepreneurs like Jack Ma, you know, who are being crushed right now, and the bureaucratic class, and you have this, you know, yawning gap in terms of income inequality. So I think it's you know, we we tend to focus on what she says, this grand vision of China proclaiming its centrality on the global stage. But you're very right to point to what's going on inside China, uh,

and the kinds of challenges that she did. In basis, Elizabeth, doesn't matter if public sentiment is souring on j JM. Ping, or is Jim Ping's predominance over the entire region pretty much guaranteed regardless, And it just matters how hard Hell clamped down. So I think it does matter. Um, I think you know, it doesn't matter in the sense I don't. I'm not predicting that you're going to have, you know, mass protests on the Chinese street calling for the downfall

of Sheet and Ping. But I think where it matters is that if you have enough Headman's white, a really slowing Chinese economy, the international pressures that are coming to bear on China currently right, He's he's you know, created so many of his own problems with regard to countries, for example, in Europe or in parts of Asia. So if you have these headwinds coming, you can have people in the Chinese elite, other leaders who aren't happy about

the direction in which China is moving the country. Right again, this crack down on the sort of what's been the most innovative and creative part of the Chinese economy, right, the fintech sector. Uh, you can have that sentiment that broader of popular sentiment can feed into uh sort of the other leader's claim that something needs to change, that

Chi needs to take a step back. So I think there can be a constellation of forces that could course change, not predicting it, but I think we have to again remain at the possibility at the same time. Right now we're looking at the mounting Russia Ukrainian conflict, and sort of on the on the heels of this, you get this tightening relationship between Vladimir Putin and Chiesi and pay and this idea that if Urashia is somehow caught off, cut off from the Western world, Ji Jumping could come

to his rescue. How close is that alliance? You know, Look, Russia and China have had a long history of working together, for example and United Nations, and and really since two thousand and fourteen, you've seen the relationship become closer. Trade has increased slowly, but Russia remains a major arms supplier to China. They've increased the number and the scope of their joint military exercises. When She Jumping gave a speech in Moscow a couple of years back, he said that

Plutin was his best friend in the international community. UH. And we saw, of course, yes, the joint statement during the Olympics where they basically call for a new world order. UH and so I think the relationship is close, doesn't mean that there aren't problems. Also, I think it bears noting that the China's ambassador to Ukraine last month put peace in Ukrainian newspaper saying that China supported Ukrainian sovereignty. So I do think China would probably come in and

backfill for Russia economically to help out. But I don't think that there's sort of undelivered support for for any sort of Russian military action in Ukraine by by the Chinese. Um. I want to go back to the combination of Angela's stents work at brookings In and your work as well. Angela's stent talks about the risk. Then we end up going back to Yalta in a tripolar international relations where it is about America, Russia and a nascent China. Is

that what China wants? I mean this, China want a new y Alta where it's just a triangulation and that's it. I don't. I don't think so. I think China views, uh, you know, it's rise on the global stage. Um, you know, it's hope is to surpass the United States. I think it looks at as at Russia largely as a junior partner in all of this. I mean, I think the Russian economy is about a tenth the size that of China, and so I don't in many respects, I don't think

that China looks at Russia as a completely equal partner. Um. I think Jing's vision is focused, you know, squarely on the future of China and China's efforts to reclaim centrality on the global stage. You know, it's looking to redraw the map of the Asia Pacific, to push the United States out as the regional hedgemon, to invent Chinese values and policy preferences globally, to the to the extent that Russia supports China in that effort, to the extent that

it bolsters China's efforts. I think China welcomes Russia's support, but I don't. I don't think it looks out at the world and thinks that they are going to be three equal you know, partners sitting around a table, Russia, China, and the United States, as always wanderful to hear from you the absolutely brilliant Elizabeth Economy of the Hoover Institute there right now, we are honored to bring you Robert

Horbett's ambassador Hormats with titament of social advisors. I should say, in his work within various Republican and Democratic administrations, he has tart and feathered as a member of the Clinton clan. But what you don't know is Hormats has eleven thousand, two hundred pages five point six linear feet and the gerald Ford Library from his work with President four years ago.

We're thrilled at Bob Hormats could join us this morning. Bob, I I look at your work over time, and I want to go back to you as a newly minuted freshman at Toughs University. And there was a small matter of the Cuban missile crisis only years before we allowed Krishcheff to save face. How do we allow Putin to save face? Well, I think if there's a way that putentn saved face, sits to recognize that the Russians, as Angela sent has said, have a deep historical affinity for Ukraine.

It's very closely connected to the Russian Orthodox Church. A lot of Russian Ukrainian history are tied up with one another. And Russia perceives that it has a right to have an influence, if not control, over Ukraine. It's part of Russia's notion of having an expanded influence in the New era, just as the Soviet Union did in that region decades ago. I think that the thing that he wants, probably most is a very clear indication, if not a firm commitment,

that Ukraine will not join NATO. How do we thread that needle? That's critical? How do we do that when the Secretary says we want an open door policy. I think you can do it in the way we've done it in the Middle East, in a curious way, and that is you're not definitive about it. You simply say there are no plans and no media plans, and no medium term plans for Ukraine joining NATO without giving up the right of the Ukrainians and a NATO to bring

NATO bring Ukraine Indian NATO at some given points. So you don't make a definitive commitment not to have Ukrainian NATO, but you make it very clear that there are no plans in the immediate future to do so. Ukrainians have more or less said that, and NATO is more or less said that. Man enables him to go back to his people and say, look, this is not gonna happen anytime soon. Don't worry about it. It's probably not gonna happen at all without us giving up the right to

have a joint if it wants to. Based on the diplomat the diplomatic tea leaves that were hearing out of all sides, does it make sense to you that there is a relative complacency in the oil market. No, it does not, because if there's any small chance of an invasion, and Tony blancoln Is more or less said that he thought there was a high probability that would be very disruptive of the of the oil and the gas markets both. Russia is a major supplier the pipeline. At least one

of the two pipelines will probably be shut down. The notion that we would sell oil or gas to Western Europe in an inflationary environment, already in the United States should be concerned enough to be wary of what oil prices would do in the event of war. Well, but there is this argument that Russia does not want that, that Russia wants to maintain its dominance over oil supply

and gas supply to Europe. How much does that get become an overly factored in aspect at a time when Vladimir Putin definitely seems like he has a point that he wants to make. Well, that's one of the dilemmas Russia has at this point, and that is Russia clearly wants to be a major supplier of gas and oil to Europe and a war would disrupt that, disrupt that

quite since severely. Um So if when when Kutin makes his calculations about whether there should be a war, he's going to have to look at the Russian economy, which is no great shanks at this point and UH and and recognize that the oil market which is key to the Russian economy and the gas market, particularly oil is key, and that that would be disruptive and that would send them very negative blow to UH, to the Russian economy which he wants to bolster. So he culely once he

he can't really have it both ways. If he's once have a war, he's going to have to suffer severe economic consequence is and those would come through disruption in the oil mark britiant and tremendous times. You want the shy with us as owis bub homats of tam And Advices. Kelsey Barrel has one of the toughest jobs on Wall Street. There's a guy named Michael. She's got a report too, and he is tough as nails. And that what what that means is pro acuity. We do not talk about

overnight index swaps. That is massive, massive inside fixed income baseball. It's something you'd see in chapter twenty three of Frank for Bosey. Kelsey Barrel joins us now from JP Morgan Asset Management. And what you're focused on is not the spot overnight index swap, but out a couple of years

translate from mere mortals. Yeah. Absolutely, So the oh I asked curve, what it shows us the forward, OH I asked curve is the path for the Fed funds rate not just this year but into And one of the things that is really into resting about the curve right now is it's actually started to invert. So the market is pricing in rate cuts. And this is unusual because, I mean, the economy is still extremely strong, five average job growth per month UM, yet we're seeing these cuts.

And the bottom line is this will continue until the market has proven wrong. They need to see the cut happen. They need to see the economy not breakdown as a result of higher rates. That's the only way you get that higher terminal rate that everyone's talks. So, for you and me, our world stops Friday night at seven pm. That's okay, hold on, I'll have another drink, but I've got to read JP Morgan Weekly Prospects right now. Farole and company are going to publish tonight off the FED

speak today? Can the FED Speak today move your world? Now? I don't think the Fed Speak is going to move the world. This is what I noticed from the minutes. And I know you don't like to read the minutes, but let me just tell you about what what is was not said in the minutes. Right did a research, Tom, she did a research. It's not about what they said, it's actually the words they didn't say. So let me

tell you or the words they didn't say transitory. Transitory is completely gone from the lexicon to the two other words they didn't say, gradual or steadily or measured. They have completely refused to categorize this site. So you get out in front of Bruce Casman now and talking fifty beeves for sure. Yeah, if the market is allowing it. They're going to rock through that door. Well, Michael was there. I caught up with Bob earlier this week, causey he

wants to say fifty. What he said Cowsey was interesting, and I know you two work really closely with each other. It's what happens if we don't get a fifty basis point hike. He actually thinks we get an adverse reaction because the market starts to believe they have not got control of this. What would you look for? Right, So, the market doesn't like to be surprised, and the Fed

doesn't like to surprise the market. And so if the market is pricing in a high probability of fifty basis points, the Fed should take that opportunity to take it as a blessing and go with it. I mean, I think the thing here is that they want the market to follow the data, and the data over the last couple of weeks, we got the CPI report, we got the payrolls report with the backward divisions for the full year. All we're seeing is that the economy is still red hot.

And unless Powell comes out and walks this market back, if the market is pricing fifty basis points the FED should walk through that door. Let's talk about credit strategy. Now, what is it councy? So in credit, we're still seeing some opportunities, but we really do want to start focusing on getting higher in quality and focusing on structures that are shorter duration, so that's things like securitized credit bank loans.

And I'd also like to say, you know, we're looking at e M local this year, which is a really interesting one because you'd think with the central banks on the move, this would not be a good time for emerging market local debt, but actually it's been one of the only areas of the fixed income market that has

had positive returns. And my observation here is that e M central banks, who were hiking like crazy in twenty twenty one, I've actually had the foresight and and the diligence that DM central banks didn't have UM, and we're the ones that were hiking rates now have the cushion and have been able to withstand more of this volatility UM this year with the d M central banks moving

forward Kelsey. Until a couple of weeks ago, the FED has really dominated all headlines with respect to markets, and now we're being distracted or perhaps dominated by the Russia Ukraine conflict. There's been a huge divide into what the FED response would be and what the market response would be should the escalation continue to get worse. What's your view in terms of does it make it more likely

for the FED to go and hike more quickly or less? Yeah, so in the very near term, we know that treasuries serve as a safe haven, a flight to quality. They go to the most liquid point on the curve, that's seven to ten year point. That's what's going to rally when there's a lot of uncertainty. But when I look at the minutes, going back to those minutes, they mentioned geopolitical tensions a number of times, and they only mentioned it in the context of higher inflation upside inflation risks.

So I don't think that this conflict is going to stop the FED from removing accommodation. This is the key concern for a lot of people who are relying on the FED as a put and maybe not explicitly, and they realize that it's not going to be But what is the implication for a market that could potentially be torpedoed by an economy that's slowing in the face of these higher oil prices, in the face of faster inflation, but with the FED that does not respond. The FED

is in a very challenging spot. I mean, we've been saying this for a while and it really hasn't gotten any better. So I think the FED is going to need to watch financial conditions closely. And you know, at this point, financial conditions are still very easy, um. And so they watch that. I know they watch credit spreads UM.

And at this point, although they are wider on the year, UM, you know, there isn't an issue with companies being able to get the liquidity that they need during the Committee expects it will soon be appropriate to raise the target range. The Committee decided to have lunch beginning in February. The Committee will increase, It's all I'm reading. This is more

boring than I expected. Cassie came out with the cold this year, um before almost everybody else, which was the CP will hike this year Council, you said it in early January. Then all of a sudden wake off the wake off the week, everybody started to join in. What changes for the FED this time around? When the e

c B is set to get involved as well. So sell offs in US treasury yields are not generally sustainable unless they're global in nature, because what happens, and we saw this in for example, is that when the FED tries to go on its own, the dollar strengthens, that tightens financial conditions, and the Fed ultimately has to back down. The fact that all the central banks are moving together is very very powerful. So the ECB, sure, you know,

they're they're still a long way behind the Fed. They they want to see wage growth, they have to end quee um before they focus on raising rates, but they're they're going to get there. And then I'll just say the next shoot a job and and you know this is still far out in the horizon, but this is these are the types of things that we're really thinking

about further out in the futures. What happens with the b o J and their yield curve target, What happens when um Kuroda ends up moving out of the position and someone else comes in and we start to see inflation move higher. Because right now inflation there it's still negative, but there's a lot of distortions there, so we do actually think inflation is still low in Japan, but we could be getting closer to positive inflation fairly soon. Corona is the last man standing. What would track him a

wife from all of VISCOUNC. So not in the near term, he's going to stay put. We just saw that the Bank of Japan continued to UH to defend their yield curve target, so they're not in any rush. Nothing is really putting the same pressure on them. You know, they still have negative inflation, whereas they don't need to deal with headline of seven eight percent inflation like the U s has. So they're not going to step away anytime soon.

But when you think about what causes a more meaningful repricing and term premium across developed market nations, you you have to think behind beyond the US, and you have to think about the B O, J, the E, C, B and all of them moving together. Cassie, next time, one pm Friday, we will rate the minutes on blimberg Row Yote you know that read them on surveillance to J P. Muilgan Asset Management. Cassie, thank you very much.

Let us get right to it. Andrew shoots with us, writing a wonderful summary of the Morgan Stanley View and this on cross asset analysis of course of London. Andrew, good morning, What will you write this weekend? I don't care about I'm gonna front run your clients right now. I want to know the theme that you're focused on as you write this weekend. Well, look at Yeah, I think the thing that been very focused on is this idea that the year could really be kind of the

year of three acts or three parts. And I do think we're in the hardest part right now. You know, it's the first quarter where the growth uncertainty is the highest, where the inflation uncertainty is the highest, because inflation is high and it hasn't yet started to come down yet. Where the policy uncertainty is the highest, because we haven't yet had that very important March meeting where the FED is going to give us I think, quite a bit more detail about how it's thinking on policy and where

the geopolitical risk is the highest. And so I think these are still major issues to the market. These are still reasons we're not advising investors to buy the dip, so to speak, but these are also factors that could look very different as we're thinking about you know, April and May, and I think that's also something that's important to keep in mind. Andrew, know how close do you work with Mike Wilson, And over the last few weeks, I think was built up over there is something really

interesting on the growth side. You framed that as inflation first, then policy response to it. The next leg is the growth story in the back half of this year. Just how bad, Andrew do you think this is going to be? Well? I think there's a lot of uncertainty around it, and I think this is where you know, the China policy response is very important, and the fiscal pol the fiscal

story more broadly is very interesting. Right. You have contractionary fiscal policy in the US and the UK, but you're gonna have easing fiscal policy in China on our on our forecasts, and easing fiscal policy in the Eurozone because the recovery fund the recovery fund funds are finally going to get spent. So I think this is a complex picture overall. Morgan Stanley's economists think growth this year is

going to be solid. It's it's going to be be good actually, But I think this is still a part of your word that uncertainty and growth is pretty high and where there's a lot that could happen in a lot we don't know. So again hoping for more clarity on that, but but don't think investors are going to get that clarity maybe until you advance a little bit further in the You so the main sound entry done by the tip at the index level, what would you be buying? Well, I do think this is a market

where you do have UM really diverse. I think vulnerabilities and exposures to this narrative. Right, So so if we take a step back, I think what investors are worried about. Our valuations are high, inflations are high, central banks are behind the curve. But you know, valuations aren't high in

a lot of non US equity markets. UM inflation is not high in much of Asia, and central banks have not been slow to react in parts of EM So I think focusing on cheaper global equity markets, I think like something a market like Japan, focusing on markets where inflation is so we're more bullish on fixed income in China where we think inflation is low and policy is still going to be easing, and even in some of those emerging markets where their way out in front have

been much more aggressive on policy. It's on those markets where we feel more comfortable receiving interest rates, being more constructive on nduration. Most markets were not constructive unduration, but in some of those ems we are. And do do you think that equities really are pricing in the sixth rate hikes that the bond market seems to be pricing in well? On the U S side, we still think

not quite. I mean, you know, the SMP this morning is roughly where our strategists we're we're my colleague Mike Wilson thinks will end the year. So that doesn't imply a lot of risk premium. Again, that kind of reflect the increasing rate risk and the fact that we think real interest rates keep going up. But you know, we think stocks in Europe, stocks in Japan, I think those markets are fine, iff rates are a bit higher. Those

are markets with very high equity risk. Premium is a lot of ability we think to absorb higher interest rates. So you know, those are markets that we think can can end the year higher hired by double digits, and so I think there is a real divergence there. But still in the US assets where we're most concerned a little bit more risk premiums require Andrew, how are you thinking about oil as you take a look at this

call right now? If oil prices stay where they are climbed to a hundred dollars a barrel, how does that change your asset allocation in the in the US and beyond. Yeah,

so there's there's obviously a big debate around oil. Um, we're in the more bullish camp, I mean the more bullish camp, and so our thinking is that demand is ultimately going to be reasonably strong this year, or demand is going to keep increasing because you know, Morgan Stanley is forecasting nominal GDP to increase by about six percent this year on a global basis. That you mean, more oil is used and supply remains very low, and and that supply is going to take a long time to ramp.

It's as as you were discussing in the last segments, it's just not really responding to higher prices in the way it usually does. So strong demand, more limited supply, all of that makes us think that the oil price will be higher. And the curve is also backwardated, so it's not very hard or it's easier for oil to exceed. What's what's currently priced in. Andrew, I've been focused on growth and you mentioned that. I love what you said.

They're about pretty good growth, is what Morgan Stanley says to me. It is the great growth guess of two thousand twenty two. Which of the growth guesses is the market price for tepid growth Morgan Stanley growth or even a surprise buoyant growth. Yeah, So, Tom, I think this is fascinating because I think it depends on what market you're looking at. If you look at the copper price, it looks like the market is expecting very good growth.

If you look at the completely flat U K two's tends curve or the inverted US two's tends curve one year forward, it seems like the market is very skeptical that growth can hold up to interest rate hikes. So I think that there's a lot of this, you know, on a cross asset basis, kind of very different growth being priced in where you look. Ultimately, we think that the market can can price in a higher terminal interest rate that central banks are going to be able to

hike further before the cycle ultimately ends. Um. This is also a case where we do think that the oil price can can rise further to price and more more growth optimism. And on the equity side, I think you

want to be expressing those cyclical exposures. You know, outside of the U S. It's in European cyclicals and cyclicals and parts of Asia where we think that there's more much better risk reward around this idea that ultimately growth will be okay, albeit with high answer Andrew Shakes, As always, Morgan Stanley, looking at for the note This Sunday, The Sunday Stop from Morgan Stanley always the best way to stop in the wait. This is the Bloomberg Surveillance Podcast.

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