Surveillance: Yellen on China & Recession Risk

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That conversation can commence Right now Bloomberg's Amrie Horton sitting down with the Treasury Secretary Janet Yell, and Amrie I would see you.

Thanks so much, John Yea, We're very pleased to be joined by Jersury Secretary Janet Yellen. You join us now from India where you're meeting your counterparts. It's the G twenty finance ministers and Central Bank Governor's meeting. And really the cloud around this meeting is the fresh data we got out of China today. Beijing slowing momentum in their growth city is talking about the growth target being at risk.

Well, you're talking about the slow growth number from China, Is that right, Anne Marie?

Yes, correct, So I think.

China has seen slower growth than they expected upon opening up from COVID. Consumer spending has been relatively weak. It looks like consumers are more focused on building back their savings buffers, and so growth has been slow in As you know, youth unemployment is quite high there. So I think the Chinese are concerned about sluggish growth in their economy.

But what does this mean for US growth and global growth overall? Is the soft landing in the United States sill your base case scenario?

Well, many countries do to depend on strong Chinese growth to promote growth in their own economies, particularly countries in Asia, and slow growth in China can have some negative spillovers. For the United States, growth is slowed, but our labor market continues to be quite strong. I don't expect a recession. I think that we're on a good path to bringing inflation down. The most recent inflation data we're quite encouraging

Okay, So it sounds like soft landing is your base case, and you don't think we're going to see a recession. Yesterday when you were speaking to reporters, you talked about this de escalation with China, and you rolled out lifting tariffs as part of this de escalation with Beijing.

So what is on the table?

You know, several years have gone by in which we've had COVID lockdowns, especially in China, and very limited contact between senior officials in the United States in China, and we now have a new economic team in China that we need to establish relationships with We need to get our relationship back in a more stable place, put a floor under it, and try to promote better understanding between our countries. So I recently made a trip met with

But when you're looking at de escalating, we're trying to figure out what we'll be left on the table, because what it feels right now is the administration is actually just amping up when it comes to potential tit for tat with Beijing. There is the outbound Executive Order that potentially we could see as soon as the end of July or this summer.

Could that be a place pulling.

A punch from the outbound Executive order, maybe making that a little bit more toned down.

Could that be a place you could de escalate with Beijing.

Well, first of all, I want to say that what we're doing is not TIT for tet. What we're doing is putting in place controls that are designed to protect US national security and in some cases to address fundamental human rights abuses. And we do intend to protect our

Madame Secretary of the National Security concerns are so important. Jake Sullivan called for this outbound of executive order two years ago.

Why is it taking the administration so long?

So we are looking carefully at outbound investment controls, and they would serve as a complement to the export controls that we have in place to make sure that we've covered all the channels by which technologies can be transferred to China that we think pose national security concerns. I explained to my Chinese counterparts that if we go forward with these, they would indeed be narrowly targeted. They would focus on a few sectors, in particular semiconductors, quantum and

It sounds like it's already done.

Is the administration have it finished and is just waiting for a good time to release it.

We want to make sure if we do this, that we get it right, and we've been working on the details.

If we do go ahead, and there.

Is a good chance that we will, that we would put out along with the executive Order and notice of proposed rulemaking so that the public would have a chance to comment on these proposed controls, and we would receive a wide range of public input before finalizing anything that we do.

Madame Secretary, you obviously have a lot on your plate when it comes to re engaging with China and your discussions. They're just off this trip from Beijing. I'm curious how difficult the dialogue is going to continue to be after the revelations about the Chinese hacking of your colleague, Secretary Gina Romundo.

So I do have concerns about hacking of US government officials or private individuals or companies, and I know the United States has expressed those concerns, but we intend to continue to deepen our discussions with China to increase our engagement. It's especially important to explain what our motivation is to avoid misunderstandings that can lead to necessary, unnecessary and dangerous escalation.

When did you learn about the China email hockey.

I'm curious if you had a chance to maybe bring this up on your trip to Beijing.

I believe I did not know about that in Beijing. Wasn't one of the things that we discussed.

I also want to ask about what's happening on the ground, something that I know is very important to you, and this comes to debt relief of these developing countries. There has been this push from the US administration to use the Zambia principle for other countries like Ghana, but that's not getting.

The broad support it needs in India. On the ground.

Amongst other G twenty finance ministers is China the hold up here?

Well, we designed the G twenty designed something called the Common Framework, which is a set of trough principles and processes to deal with unsustainable DIBt situations.

And we would like.

To see countries that apply to use the Common Framework get rapid relief from their dit that they need in order to grow and be able to attract investment and undertake IMF programs that can help to stabilize their economies. And the few cases that have applied to use the Common Framework, including Zambia, have taken far too long. The process has been onerous and it's taken a very long time to get debt relief. We are pleased that China has become China, after all, is a major creditor of

Madam Secretary, thank you so much for your time today live from India at the G twenty Finance Ministers and Central Bank Governors meeting. And safe travels to you as I know you're heading off to Vietnam next.

Let's push it out and talk about a federal reserve for July and beyond. The former FED Vice Chair Richard Clarda saying market bets for rat cut in March makes sense. JP Morgan's Calsi Barra writes in this raightcuts will need to be preceded by a more material way can get the labor market tom while we are seeing softening under the surface, we will need to see a further slow in job creation or a sharp pick up in layoffs the cause the FED to shift away from the concept of higher for longer.

Joining us now, Kelsey Barrow fixed income portfolio manager that barely describes your duties with some Michael over JP Morgan Asset Management. Boy, Am I glad you're here. First of all, have you people changed tone, duration stability, the Fabosi curve out rather Fobosi out there. You'll give all the different metrics you use. Have you changed that view given the news flow of the last ten days.

So I think the biggest data point that is impacting our view has been the recent inflation data. I think what we've seen there is increased confidence that inflation is coming down, and it's coming down faster than the FED projects. The FED has a forecast of three point nine percent for core PC by the end of the year. We think they're going to get there, and we're going and they're going to go even further. Inflation is going to

Look at this and I say, Okay, what's the tactical response, like do you barbell, do you ladder? Do you shift your ladder out picking up greater duration? What's the do right now?

So we've been looking at the fixed income market this year.

It was a great trying to frush at Bob's watching, So.

A great question. I think all morning.

I've been hearing you guys debate soft landing or hard landing, right, and what does that mean for fixed income? Well, the good news is is that regardless of a soft landing or a hard landing, if the FED is at the end of the cycle, bonds are going to outperform. So you look at the last seven rate hiking cycles, including the ones which were soft landings, that's nineteen eighty four

Matt hombachmore ca and Stanley agrees with you, says Bonnie, Dips and bonds. Can we talk about the potential limits of a rally. Some people think maybe yields won't fall that far that quick. I know that you and the team are looking potentially for three percent across the whole curve. Can you help people who are listening to this right

Yeah.

To us, what we're seeing is not that there are limits to the rally. There's actually limits to the selloff. So if you look at the ten year yield so far ye're to date, it's not able to sustainably trade above four percent. So if you look back, we had a peek at four and a quarter in Q four of last year. We tried to retest that four percent level in Q one of this year. It failed. We then tried to retest four percent again in Q two

So later cycle, considering end of cycle by core fixed income. Treasury's rarely got that. Why a high yield spreads near the ties.

Of the year.

Yeah, So it has been a grind tighter for credit in general. And so we've been looking with our high yield analyst about what is going on, and there are certainly a lot.

Of cross currents.

So if you look across the sectors, right, you're hearing different things across every sector. Every sector is kind of operating in its own little cycle. From the chemicals or technology in high yield not so great, right, then you hear from leisure and hospitality and people can't stop traveling. Everyone on my Instagram is in Europe this summer. I mean, it's incredible.

That's funny, mind too.

There you go.

And so what we're seeing ultimately though, is that in the absence of a material weakening in the labor market, you're seeing that people just want to get that spread and they just want to get that yield.

And on top of that.

We've had very little issuance in the high old market, so the technicals are really there for that grind tighter. And what we found historically is that high old spreads really don't blow out until the recession is actually here, so this move is not really that unusual, but it really has been a grind.

Do you still see a recession though? I mean, is it incompatible to see the strength that we're seeing that's underpinning this euphoria that we felt last week and the tighter spreads, as John was mentioning, is that compatible with a steadied grind lower in inflation?

So we do see a recession still in the horizon. We have seen strong labor markets, but it's really important to understand that the labor market is a lagging indicator. So the unemployment rate bottoms right as the recession starts, and the unemployment rate doesn't peak.

Until a recession is ending.

So what we're looking at is the leading indicators, things like gross domestic income, which is softening below the surface, hours worked within the labor report which is also softening. And we're saying the five hundred basis points of rate hikes that have already occurred, they're not behind us, they're still impacting the economy.

With John's point, we're seeing spreads right now in hiled bonds at the tightest levels going back to April of twenty twenty two. This has been an incredible grind. If credit is a leading indicator, is saying that we're not going to get a recession, We're not going to get a default cycle, and all systems ago when you look

So where I would disagree is credit being a leading indicator. In fact, credit highield spreads don't actually tend to blow out until the recession is actually upon us. So just because risk assets are doing well now doesn't mean that a recession isn't on the horizon. So for us, what we're doing is we're for focusing on a high quality fixing come portfolio.

So that's investment grade over high yield.

Another sector we really like right now, agency mortgage backed securities. You can get very attractive valuations there. You get a lot of the spread without a lot of the risk.

Kelsey. Most people in the equity space think the bomb markets three guys in a room with the slide rule and the fact that the opposite is true. It's much bigger, much deeper, etc.

But at the.

Margin, bonds can move off equity valuations. Are bonds competing now with equities? Are people buying particularly credit corporate quality bonds versus owning equities? Now do you observe that?

Yeah, we absolutely do observe that. So what we're seeing is that people are taking this opportunity to pick up the yields that are historically attractive. So if you look back, real yields, for an example, are at their highest level in fifteen or twenty years, and this is not an opportunity that comes around very often, particularly in an era where the Fed has had to go to the zero lower bound multiple times in the last few decade.

What are you guys going to say an issuance? I mean, I mean, I know you take the call that Bob Michael. What they do, folks, is when the issue bonds, here's some big fancy company. They call four people and one of them's Bob Michael. He's out at lunch watch in Liverpool. So you get the phone call. Are you getting phone calls about bond issuance right now?

We are?

So there is a little bit of a bifurcation between the markets. So, as I mentioned, high yield has been a market that has not had very much issuance. On the other hand, you have investment grade market. It's fully open and there is issuance taking place.

Kessie Love it as always Cassie Power of the of JP Morkan Asset Management.

Joining us. Now I've experienced David balin Cio at City Global Wealth. David is not that we've been here before. To me, it's absolutely original. But what is the character of this bullmarket?

Well, it's a bull market I think born of a variety of things. Number one, a lot of exceeding expectations. You know, we had started the year expecting that there'd be an energy crisis in Europe that didn't happen. The banking crisis, you know that you've discussed this morning, didn't turn out to be a banking crisis. Growth turned out to be better than expected. And ultimately what we saw

Do you have enough combined information from your securities analysts to say yet that we have a better ANUE growth line because of a better nominal GDP?

Not really, Tom.

You know what our view is that next year we're going to be you know, one half of one percent highering GDP in the US. It's going to take time for momentum to build. We consider this to be like a rolling recession. So if you imagine that a sharp procession would have a be like this and last for six months, we think this recession is probably a fifteen month length and it's just like a solid, shallow trough.

In the meantime, David, you said that you're raising your allocation to global equities. Where, in particular, when did you start to make a more meaningful shift on the heels of better than expected data.

We've made two emerging markets moves.

The first one was to Brazil specific allocation there, and then subsequently about a week half ago, we added emerging market debt to our portfolios. We really want everyone to think about their cash position a lot, and to think about moving from cash and taking some duration risk now you know, five or six year duration risk.

Capture the yields that you're getting.

In your money market fund today for the next five to six years, and in emerging markets, if you don't take a lot of credit risk, you can actually get you know, yields of seven to eight percent, and that to us is very attractive. If we expect inflation in fact two and two and a half percent next year, how much.

Is that really predicated on the idea of a dollar continuing to weaken.

Well, last week was a very important single and you've touched upon this in your conversation today. I mean, the dollar really took a move once inflation the inflation print came out last week, and I think that's indicative of what the world's expecting, right, the US is a much more active you know, our central bank than Europe does.

I'm told the public is pushing in against sixty forty. David Baal into sixty forty work in twenty twenty four, in twenty twenty five.

I'm really back in love with sixty forty. Tom. I think that investors have to think about it this way. You're getting paid now for the first time in a very long time to hold a medium duration bond portfolio. If you can make as you know, five percent or five and a half percent doing that for five or six years, or you want to take more risk.

You can really you know, earn some.

Terrific yields and emerging markets and in private credit, you should be doing that right now. Because that is going to have diversification as compared to your equity portfolio.

And the second thing.

People have to be mindful of is that they need to think about the value that they're getting their portfolio. So I believe we're in a recovery in twenty four, a more meaningful recovery.

You want to have small and medium sized stops.

You want to diversify into areas even like China right which are countercyclical, which you A're treating it incredibly low values, and for the reason now, but ultimately you've got to be forward looking in your portfolio construction and diversification really is the only free lunch that you get on Wilson, and we think we need to see more of it less you are centrist, David.

One final question and quickly unfortunately David Balin, are we clipping coupons or can we actually own that debt portion for total return?

I really think it's the right now. Actually, I think you can get it for total return. You're being paid a lot of money to you know, if you can capture three or four percent real interest rates a year and a half from now, that is an exciting prospect relative to where we've been for the last eleven years. So I do think it contributes meaningfully both to risk reduction and to the total return tom and we're emphasizing

David, i' just think for a lot of people that have been trapped in cash this year, and I say trapped in cash only relative to the gains we've seen elsewhere in the nastak and the S and P five hundred, if they're going to come back in they feel fall less chasing big tech. What do you say to those people.

Well, we have to divide that up, right.

So first of all, our clients have been sitting there for ten years waiting to come back into the market. So there's always this idea that you can outsmart the markets, right, you know, And so the difference between now and anytime in the last ten years is that you want to capture a real yield, right, and you need to do that now because when we're talking about it. In three or six months, this opportunity may go away with that much cash on the sidelines. In terms of the whole

But you don't want to time this the.

Situation and say, oh my goodness, it's all over now, because we've had this movement in technology. The type of change we're talking about with artificial intelligence affects every industry and every company, and the adoption of it is something that we're going to be monitoring and looking for those companies that actually become more efficient maintain their margins, or drive revenues as a result of AI's you know, sort of rapid acceptance.

Babe of City David, thank you.

Tom Mischel joins us now. He's the chief executive officer of KBW, Keith, Buryett and Woods Stifle Company, and he understands this American banking system truly like no one we speak to. Off the market, off the March shock, the Keith, Friods and Wood index, I'm stunned by this. Off a dead cat bounces up all of four percent off of the middle of March shock. I thought it would have done much better. Why are the broader indexes of banks? Why is it lagging?

It's lagging mainly because the market's unsettled about what the earnings is going to be for the regional banks and for the banks, and there's a reset underway. The first reset is around net interest income and what's happening with deposit costs. I thought it was very interesting that when you looked at the big bank earnings on Friday, which were actually pretty good relative expectations, the stock still went

Could you have us understand just the size of those banks when you come out of a number like that twenty percent drop, it's.

All the way through the industry, all the way through the down.

It's large, just up and down.

So just if I were to talk about dynamics, if you're just a spread income lender alone, you have more pressure. But don't forget we think this second quarter is going to be a very difficult quarter for investment banking. They did maybe a smidge in better than we thought, but still, let's just say down twenty percent at least a year over year. Now we're seeing green shoots and investment banking. That's only about half a dozen or so companies, but

Have you been surprised by how quickly we've left behind the events of March April time.

I am, which is good and bad. It's good because the American banking industry is really resilient and these were idiosyncratic risks, and I think we've proven that. But at the same time, we need the right reform. And actually in the last quarter I did testify in front of Congress, and I was urging deposit insurance reform. Instead we're getting capital increases, which I think are going to create unintended consequences and be a whole nother dynamic.

How idiosyncratic, though, was it? And I asked this at a time when a lot of people are studying commercial real estate, including the Saint Louis Federal Reserve, which accounts for about half of all loans on smaller banks balance sheets, And we're looking at a potential record of maturities maturing commercial real estate loans this year? How do you dovetail that into future weakness that we could start to see in this earning cycle?

So and I remember the last time we're on, we talked about this. So we have a commercial real estate research group, and higher rates are going to hurt commercial real estate values everywhere in the country, but the ones we're most worried about are the cities and the cities where they have the big properties. That's where you're seeing the biggest stress in terms of occupancy, in particular, where

Nine percent.

That's a big number for a bank after you think about all the equity that's already in those projects, So that's pretty big. So we had a regional bank that we took around in New York recently to meet investors about a forty billion dollar bank. Their median commercial real estate loan was a million dollars and almost none of it in a city. So we feel better about that.

The last time you were on, we talked a lot about consolidation. You did expect a wave of consolidation among smaller banks. Do you feel differently now that evidently the crisis is over and everything has changed, or do you feel like we're going to see an ongoing turn of consolidation that hasn't yet transpired.

I think we're going to see consolidation a because it's just been the trend for the last couple of decades. Then you ask yourself, why would that happen, Well, it would happen because the costs of regulation continue to go up, and one way to be able to afford it is either to have more scale or to merge with a bank that already has it so that way you don't have to build it yourself, and that makes the system

Tom Mischelle, all of us on the racket have a bank we just follow. I'm not going to mention the bank, but it's a pure mediocrity of a small bank and it's called bank X. Bank X in the last ten years has delivered two point two percent shareholder return and the least twenty years, bank X has returned one point four percent twenty years. Are these guys not put out of their misery because they're protected by an umbrella of

Well, I'll tell you what's interesting is in some cases there may not be a buyer. There's a chance there may not be a buyer. And as technology continues to evolve and there's less branch traffic, for example, some of these companies may find there's just not the buyer.

That's so what do they do?

What what does Bank X do in their twenty year garbage mediocrity kept a float not by KBW, but kept a float by government regulation.

Well, and I think the other thing is that should that company need capital, because that's say they have a bad loan or they need to make an investment, investors are going to look at that and an industry where where investors don't have strong incentive to invest. If the if that company, and I think this applies to any industry, but if there isn't a return, they're not going to have the access to the capital that the government and the regulators would like. You need a healthy industry up in.

This is a uniquely American thing, John, Hey, this is just I'm sorry.

And the big thing is so you know, and I get a lot of questions saying, hey, other countries have five or six big banks. You know, we have four really big ones. It would be great if we had fifteen to twenty five big ones, and then you'd have really good choice and really good competition, and then some of those local banks will still be critical to their local communities. I think it's that middle. I'll give you another number, the ninety seven percent of the banking industry

I got thirty seconds when you went in front of Congress. Did you get the impression they wanted to make sensible policy or just punish this sector?

I would say the majority, not the entirety, but the majority was they were thinking about steps that they could take. But I felt as if they were going to address issues that weren't solely Silicon Valley and other bank failures, and the chances for unintended consequences were high. And I think you really got to because if you push too hard, you're going to benefit the non bank industry, and I think we could be headed in that direction.

Tom Mischa, thank you guys. I've KBW Maney response the question not so much very often on Tom Love it as always just want.

To be with you.

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