This is the Bloomberg Surveillance Podcast. I'm Tom Keane, along with Jonathan Farrow and Lisa Abramowitz. Join us each day for insight from the best and economics, geopolitics, finance and investment. Subscribe to Bloomberg Surveillance on demand on Apple, Spotify and anywhere you get your podcasts, and always on Bloomberg dot Com, the Bloomberg Terminal, and the Bloomberg Business App. We get perspective from William Dudley. Bill Dudley describe transitory on the
way down. I don't understand that. How do we have transitory disinflation?
Remember, goods prices went up dramatically because during the pandemic people bought a lot more goods and bought a lot less services as they stayed home. Now we're on the flip side of that, they're buying less goods more services. So goods prices are very weak and earned me very weak for a while as people have managed their inventories down.
But once that comes to an then goods prices will level off, and so the benefit to line inflation from following goods prices will be over and you'll be stuck
with what's happening in the services side. Look, I think this is a very good report today and the FED should be pretty cheered by this, But I don't think it changes what they're going to do at the July meeting, because they that they're looking at the totality of the data over the last three months going to the July meeting, and the reality is the commy is still doing quite well. We had two percent growth in the second quarter. If you look at the Ladd FED GDP now tracker for
the third quarter, it's at two point three percent. So the e commy really hasn't slowed down enough to make the FIT confident that they're going to see that slack in all their work that they that they want. What I think this does do is opens up the question is could July be the last one? And that's certainly possible, because you know they won't they won't move at the meeting. After July. They'll take a break, just like they did this last time, and then we're going to get to
November first. Well, it was a long time between now and November first. I can imagine by that point it's possible that they'll see enough news that makes some confident that they've done enough, so I think I think the November rate high is really up for grabs at this point.
Bill, you talked about how disinflation might be transitory and that there could be a reinflation once the base effects are stripped out, and especially as real incomes continue to rise at a faster pace as inflation comes in. What do you have to see to believe in the disinflation that it will hold and revert back to a sub two percent inflation norm over the longer term.
For me, it's all about the labor market. I want to see slow down and pay one plant growth. I want to see you rise in the interplaying rate, and most especially I want to see further moderation wages. So labor markets too tight, then you're not gonna get inflation back down in two percent.
That's that's the key, Bill Dudley, thank you so much for joining us. Your commitment of Bloomberg surveillance really really appreciated. William Dudley, writing for Bloomberg Opinion, of course, a former
president of the New York Fed. Thanks to zero Hedge, they had out yesterday a Michael Gape in production That is a chart from Bank of America that showed the fan distribution of our American inflation, where we could see the surprise of a normal disinflation back to the two percent level, or maybe something stasis three four percent, or dare I say we could even see sticky inflation and arise as disinflation moves a lower A lot of confusing trends in math. Michael Gaban joins US NOW head of
US Economics. Michael, what's the key determinant of how disinflation unfolds?
I think, I mean just I think it's catching on with what Bill Dudley just said. Does the labor market soften enough to give you confidence that services inflation will keep inflation running around two percent? So for me, it's about broad based disinflation across services. Yes, we should get some payback in goods prices, we saw that again this month with used cars. But can we get a combination of disinfl in services so beyond shelter? I agree with you.
I'm not sure ourline Ferris fell eight percent on the month, But is it broad based enough to make you confident that the new trend or we're back to our prior trend of roughly two percent?
What do you make of what Billaudly was just talking about, Michael, that you can't see this ongoing disinflation unless the labor market cracks, unless you see a bit more loosening in what we see in the job space.
Do you agree with that?
Do you think we need to see that pain in order to create a subsistence in this low inflation.
I do agree with it. Now, it doesn't necessarily mean the FED keeps hiking. I agree with the narrative of I think the FED will hiking in July. I're if we're posting point two's on core from here, it'll call into question what they have to do after that. So they may stay on hold. They may be reluctant to cut until they see more evidence that the labor market is imbalance, that supply of labor and demand for labor
are more imbalanced. So that argument may be more about how quickly the FED cuts or when it cuts, than it is how high the FED goes in the near term.
This is an interesting distinction because Bill Dudley has been pretty hawkish in terms of the FED having to do more in order to get inflation under control, and yet he just came on and said, this is a great report and this may be the last rate hike that we see from the Fed this month. They may not go in September. That brings us to November. A lot of data in between. Is that bullish or bearish for bonds? Is that bullish or bearish for the idea of how long the Fed can hold rates at a high level?
I think unbalanced. You'd have to conclude that it's bullish in the sense that we're seeing disinflation in the US economy that is gradually becoming more broad based in an environment where the labor market still is very healthy and
the unemployment rate is low. So again, I think what Bill was saying was if this is the new run rate eight, then yes, it would call into question hikes beyond beyond July, and it might give you more confidence that's a less pain in the labor market is needed to convince and give the Fed confidence that inflation stability, price stability will be restored. So on net, I think it's hard to argue that disinflation in an environment of
a strong labor market, you know, is bearish. I think at the moment that's a bullish view.
Where are you a nominal GDP? I mean, Michael Gaban just simply here, if we go out one year, dare I say out two years? Not that anybody's modeling out to twenty twenty five, but do we get back to some kind of four percent top line GDP? Two percent inflation two percent real GDP?
Probably not until twenty twenty five, if most of our baseline forecasts are accurate. For let's call it gradual disinflation and perhaps a hiccup in growth here in the short run, if growth continues to slow down, you might get you might get something around four percent temporarily, but I think nominal GDP growth is likely to remain pretty healthy until you get into twenty twenty five and inflation maybe is settled down to around two percent.
Or speaking with Michael Gape and if Bank of America and Michael you were saying that if this data does continue, that does seem like a likely case. I just want to get a sense from you on the real wages point. How much does that make it difficult to see ongoing disinflation, that real wages are rising at an accelerating pace.
I think it makes it difficult if you're a policy maker and you're thinking, you know, I need to get demand and supply into better balance. But what I'm seeing as a consumer that continues to want to spend and is getting significant increases in real wages, so it may be hard for them to, you know, again, make that conclusion that we're on a path back to two. It's
about confidence in that outlook. So you need a combination then of actual evidence on the ground that you know, where is the new trend in inflation, for example, is it point two or is this a one off and we go back to a point three point threees are more the run rate or you need a collection of evidence on what the new run rate is, plus where
spending in real wage data evolve. Again, this may ultimately be about the timing of cuts and how quickly those cuts come in, and the near term path for the FED may be more about these prints on inflation. Inflation may dominate whether the FED hikes beyond July, but the cutting environment when they're back to a neutral rate of interest on the other side, could very much be about that labor market story.
Meanwhile, counter programming as Richmond FED President Tom Barkin, who's speaking at a separate event that came out in tandem with the CPI data saying that the inflation rate is still too high, that the FED has been moving aggressively as aggressively as it could against inflation, and talking about
the longer term view. Michael, if we do see the rate hike that we get this month as the last in the rate hiking cycle, how long do you expel rates in the US to remain about five point three percent, give or take, for the foreseeable future.
Well, we have the first cut coming in May of next year, next year, so our baseline still has another hike beyond July, but we've highlighted that that ultimately will be data dependent and we'll have to see how things evolve. Our first cut in an end to balance sheet runoff would be in May of next year. So the debate on the committee is some combination of higher or for longer, and I think they would be inclined to want again. This is about the evidence, the accumulation of evidence and
confidence about restoring price stability. So we don't have that first cut until May of next year.
Michael Gape, and thank you so much, and congratulations on that really informative Bank of America charter. The last twenty four hours. Megan Horneman joins us downt investment Officer Verdant's Capital Megan. Do you change your outlook with this disinflation report?
No, I think this was a good report. I do agree with that inflation's going in the right direction. Disinflation is starting to take hold, But I don't think it changes the move in July from the Fed. They can't take their foot off the pedal yet. There's still three things that they're looking at, and they're not necessarily looking at airline fares. What they're looking at is housing, which owners'
equivalent rent is still slightly elevated. They're looking at earnings, which we've just finished talking about how real earnings now are higher. And they're also going to be looking at the service sector. So those three things they are improving. You can't deny that in the report today. But I just don't think it's enough for the Fed to say we're completely done.
Do you think, though, that there is a greater likelihood as a result of this report, that this raid hike at this month's meeting will be the last.
If this is the trend that continues.
Yes, Let's keep in mind there's a lot of base effects in this report, so we don't want to take one month as a trend. But if this continues, I think this may be the last. But I don't think they're going to be cutting, And that's something that we've been saying for a long time. The market is too optimistic about the path and the timing of rate cuts.
We think they're going to stay higher for longer. They've told us that, and they can afford, especially with the consumers still wanting to spend to take their foot off the gas here.
That said, how does this shift your view on how to allocate your assets at a time when a lot of people are betting that the economy can remain strong even as we continue to see price stability restored to the market.
So we've been taking the opportunity this year with the big rally we've seen across the global equity sector, to start to reduce some of the allocation. We want to get more to a neutral waiting to our benchmark, because we're not while we're looking at a period where the Fed may be near the end of their aggressive tightening cycle, we're not calling for cuts. There is still, as we said, there is still some inflation in the pipeline that.
They have to get under control.
Our bigger concern is that the market's got a little too optimistic about the economy. We continue to see in a lot of these reports underneath of the details that there is significant weakness in the economy and especially the consumer. We've talked about this before, the FED tightening cycle as well as now tightening lending conditions. This takes time to work into the economy. We haven't seen those full effects.
The labor markets now starting to show signs of weakness. This is all negative for the consumer.
So we're concerned about the consumer in the second half of this year despite some of this positive inflation report, because we just don't see the spending that we saw on the first part of this year sustainable.
So to cut to the Chase Magan, I think this is really important. A tep of economy just simply means less revenue for corporations, and that's where the earning shortfall begins.
Right, And this is you know, we're getting ready to start this earning season here in the second quarter. This is the first the it's expected to be the worst earning season that we've seen since the pandemic. And we don't really think that this is completely over from an earning's perspective, I.
Look Megan the step forward here, and I get that this is one report. Lisa's told me that three times today. Maybe you take a smooth three month moving average of disinflation. Did the disinflation vector change enough for you to have to sit down and recalibrate getting to the third quarter?
No, not yet. I still think, like I mentioned, there's three things.
That's what the Fed's looking at, and they have gotten slightly better. But even if you look at the owner's equivalent rent component that was running a five tents on a month of a month basis, Oh, it's slipped to four tenths. Is that enough for the FED? I don't think so. I still think that's a concern for the FED. So I'm not ready to make any changes. We're sitting
neutral with our equity exposure. We have a nice cash position because we are earning now on that, and we're looking for the potential that we could see some weakness of the equities in the second half this year.
I gotta say, Tom, I'm looking at Bespoke Investment. They put out a report saying that at the headline level, there have only been two stronger than expected CPI readings in the last year, which is the fewest and twelve month period going back to November twenty nineteen on a core basis just three stronger than expected monthly CPI readings
that has been the fewest since November twenty twenty. There is a sense that Wall Street doesn't have as much faith in the disinflation as is actually coming through in the number.
This is really well timed that you bring this up, because doctor Dudley alluded to that when he did as Newtonian calculus in English, where we talk about the first derivative, the second derivative, you'd make jokes if you're particular, if you had a hangover from course three to light, you'd make a joke about the third derivative or the fourth derivative. But all of this anecdotal evidence leads to some form of vectors which say the agony of this inflation is over. Then the debate begins.
From an investment perspective, Megan, is it time to get out of CA maybe not go into risk your assets, but lock in yields.
At a higher level data.
Kelly, if we are seeing inflation come in.
And we actually started to do that, recently as well, we moved our duration of our fixed income investments out a little bit, not significantly long at this point, because I still do think there is that uncertainty around the FED. Yes, it looks like they may be able to be done in June, I mean in July, but when it comes to ray cuts, when are they really coming in? And we don't think that's the story until twenty twenty four.
So it's not a rush to run into the long term yields at this point, but we do think you should move out some of those shorter durations into more of an intermediate intermediate duration.
Megan, Thank you so much. Meghan Hartman with Verdant's Capital Advisors. Right now we have a Darta moment. Michael Darta joins us MKM Partners and the chief economists is also disinflation strategist for Roth MK Partners. Michael, data is disinflation in place.
Hi, Tom, thanks for having me. It certainly is in place. So maybe these numbers came as a bit of a surprise to some, but frankly, if you've been tracking the macroeconomy, what we're seeing is a rapid deceleration in nominal GDP growth. Aggregate demand. In fact, we've got some numbers on same store sales going into July that are comping negative now, so nominal growth momentum has really hit a wall here.
And if you just look at an indicator like the ISM Manufacturing Index, their prices paid component has just collapsed and that leads the headline CPI by four to six months. So you know, this rapid rollover that we're seeing in flexible price inflation shouldn't be a big surprise. And we've got a good number on core today. You know, those numbers tend to be stickier because they're tied to contracts and leases, so they tend to lag the business cycle.
But the market, you know, is certainly being lifted on a sentiment basis from that.
So how do you think our Federal Reserve kind of takes in this print we're going to get some PPI tomorrow as it relates to kind of where they want to go over the next several meetings.
Well, I think this is a case of you know, once bit and twice shy, So they obviously didn't have the correct inflation forecast coming into the cyclical upswing, and I think they've already tightened enough to put the economy into a eventual recession. And so you know, the equity market is acting like a soft landing is at hand, and most commentators on your network and others are, you know,
seemingly falling into that camp. Yet historically, if you take a look back at the data, you don't get soft landings. When the FED raises rates, inverts, the yield curve collapses, money growth presides over a drastic in sustained tightening in lending standards and focuses on backward looking information. And that's exactly where we are now. Equity markets, you know, I mean, they can defy gravity for a while. We've had a heck of a rally this year that few people have predicted,
Present Company included. But the equity market is up on a zero earnings growth. This is an entire entirely driven by valuations and long term interest rates really haven't come down if you go back to the October lows of last year, no earnings growth, about a flat ten year treasury yield and a four point multiple expansion. I mean, you know, I think investors do themselves a disservice if they are going to chase a market that's been propped up in that fashion.
Michael Darta earning season kicking off in Earnest Friday with some of the big banks. What are you looking for from this earnings cycle?
Well, you know, we've already got a earnings recession well underway, so we have three quarters now we're the SMP operating earnings have fallen. There's a huge and growing divergence between the GDP based NIPPA profits that cover all US corporations and SMP operating earnings. That's been a late cycle recession bear market flag in the past. And then I mentioned the nominal growth momentum fading on the back of tighter
monetary policy. If top line growth is weakening or especially contracting relative to slower moving cost variables on the wage side, that is a setup for a margin squeeze. So I think we're going to have difficulty going forward. And then we have to ask ourselves why is this equity market performing the way it is. It is simply pricing in a huge turnaround in earnings. Do the forward indicators tell you that there's no there there? And then eventually I think we're looking at lower equity prices.
Michael.
So if you look at the SMP earnings for twenty twenty three about two hundred and twenty dollars per share. A lot of folks will come in to the studio and say, hey, that number could be even closer to two hundred dollars, maybe even south of two hundred dollars. How much earnings risk do you think is still left in this market?
Yeah? I think there is considerable risk. You know, you're running the mill. Recession is going to put forward estimates, you know, down at least fifteen or twenty percent, and then you know the actual trailing operating earnings typically fall more than that, and you've got this big divergence between the economy wide profits now in S and P operating earnings. None of that adds up to a highly confident full
run or risk assets in my opinion. So you know this is you know, I can understand why people are getting more optimistic, because you know, everyone tends to get whipped around by the market. The market has done well this year, but I think we need to take a step back and look at this in a sober fashion.
Unfair question, but I'll conflate the two DARTERA would give me a C minus on this can we say that we're going to get a constrained near four percent nominal GDP and at the same time, does that reaffirm John William's quest for a low our start.
Yeah, Tom, we're actually already there. So the last time the three of us talked, we were talking about gross domestic income and nominal GDP, and the divergence is there, but if you sum that, you know, if you average the two rather, we were actually already there. Over the last two quarters for which we have data, were just below four percent on the average of nominal GDP and nominal gross domestic income. And prior to that, the recovery
average was thirteen percent annualized. So we were in this booming nominal activity environment on the back of very easy monetary policy. Policy has been tightening rapidly and nominal aggregate demand is weakening, and so in that environment, you know, the neutral interest rate is not going to be consistent with a thirteen percent nominal top line number. You know, it's going to be much lower. If we're trending around four and I don't see any pickup, and you know,
we're talking about structural stuff. Really that means supply side. So what is the trend in nonfarm productivity, it's actually zero growth since the recovery started. We obviously didn't have a baby boom, at least that I'm aware of, and so there's you know, there's no improvement in terms of working age population growth. So I don't really understand the story here that the neutral interest rate is going to
be higher over the long term in a cyclical sense. Yes, if you have a boom, then the neutral rate is higher. But you know, again, if there's some long term structural shift, why is the yield curve upside down? Why is money supply collapsing? Why is bank credit collapsing? You know, those questions are just unanswered by some that are making, in my opinion, not very well thought out arguments.
Michael Darta, thank you so much. With ross MM partners. Subscribe to the Bloomberg Surveillance podcast on Apple, Spotify and anywhere else you get your podcasts. Listen live every weekday starting at seven am Eastern on Bloomberg dot Com, the iHeartRadio app, tune In, and the Bloomberg Business app. You can watch us live on Bloomberg Television and always I'm the Bloomberg Terminal. Thanks for listening. I'm Tom Keen, and this is Bloomberg