Yeah, Welcome to the Bloomberg Surveillance Podcast and I'm Tom Keene Jai Ley. We bring you insight from the best in economics, finance, investment, and international relations. Find Bloomberg Surveillance on Apple Podcasts, SoundCloud, Bloomberg dot Com, and of course on the Bloomberg It's one security, it's one number, the ten year tracery and three percent. Just what is so important?
If there's anything important at all about a psychological line in the sand that hasn't been crossed in more than four years, we can bring in now Carl Weinberg, high frequency Economics founder who joins us in New York. Car important or not important at all? Oh, it's it's psychologically important, I think. But I'm hard pressed to argue that the gentle rise we're seeing in bond yields over time is
really making a breaking force on the economy. With inflation sizing up to be around I don't know, two and a half percent or thereabouts, you're looking at half a percent real rate of interest on ten year bonds. That's not going to do the job that the Fed has to do of slowing the rate of growth of jobs in the economy. Carl would you describe this as grant you Although we were close to two percent just back in September the two year no that yields doubled in
in less than a year. We've had a real real re price across the curve over the last six to nine months. Yeah, I see, I see what you're saying. And for markets, is a good bit of volatility in there that we haven't seen in a long time. And that's certainly an issue for the markets. But speaking as an economist, which unfortunately is the limit of my abilities, we're looking at really long term yields that still have
to go higher in order to break the economy. What's more important at the moment, Carl, as far as you're concerned in terms of what's happening with the debt market. Is it the supply the amount of debt issuance we get even more through this week as well? Is it a cross spective inflations down into bubble away the price pressure finally started to come through. Is it something else? What is it? Well, it's yes and yes the both of those questions. I mean, the market should be thinking
about inflation risks. It's it's not here now, But the laws of supply and demand haven't been repealed. The labor market keeps on getting tighter, and is by colleague Jim O'Sullivan suggests, unless the labor market stops getting tighter, it's going to reach a point where it is going to
trigger some wage pressure. And as far as supply is concerned, while we've all been reading about the the US deficit and the impact that the tax cuts on it, that's got to be weighing very heavily on the market, especially at an auction time like this. Well, much of that issuance has come at the front end so far. Colm, I guess my question to you is, at what point do you start to consider these yields as sort of
a restriction against the general economy. You say, not now, but looking at where short term interest rates, that's got to take a fight at some point, Yes, at some point it does. Right now, though, the indications that that we're looking at and that the Feder looking at, just that it's not biting very much. We're seeing the sentiment
in disease looking quite positive. We're seeing the Fed remarking that financial conditions are still quite easy, with the stock market being so strong, so profits being good, so overall, it doesn't seem to be biting just yet. How do guys like you draw fiscal debt and deficit economics into all your monetary and international swirl. Where does it fit in algebraically, where does it fit in geometrically, or just
simply where's it fit in in reality? Well? I think reality is the easiest place to put it, because as economists you have to have a free floating anxiety about this business of running up the fiscal deficit at a time when the economy is so tight, stimulating the economy, when labor is already in scarce supply relative to demand, of pushing an economy that's arguably at the peak of its business cycle. That's what the I m F told this this weekend. That's what jam O. Sullivan is telling
us in his high frequency e CAN mixed notes. Um. So, the overall the question is not so much what happens right now, but what's going to happen when the cycle turns? And that's inevitable. You nailed the thing here, Carl, is we take the net present value of what we think is going to happen to debt and deficit out there, and we pull it back to the present to the current chronic trillion dollar deficits plural of the United States of America create a present moment of angst or not.
I think at this point they create concern about angst rather than angst itself. But you know what they say, the fear of dying is worse than itself. You know that's NIGI. That was way too excessential. Help me, Jo. There was a fantastic time EF report and I'm sure you guys discussed it when I was a wife from the studio. I lost weight Tom and within this report, Oh you weren't here. I wasn't here. Did you miss me? Were you interviewing with Arsenal? I was interviewing with Arsenal
for Vengus Jol. I was in North London. I thought it was winder. I got in trouble. Did you get in trouble? I imagine you're going in trouble for saying that and a few other things as well, Um, Carl Weinberg. Within this IMF report just showed where debt to GDP ratios are going to be over the next five years for the world developed economies and standing alone with the United States, it was the only debt to GDP ratio that the IMF forecasts to increase over the next five years.
How significant is that, Carl, I'd share the I m F is concerned that the US that the g d P is going to rise. It seems to be affordable right now in good times, there's lots of savings out there. But if the business cycle turns sour, it's going to
become more difficult to finance. So I think the risks are clear, and the I m F has done a good job of seating them just looking at some of the risks now though, and as far as the next downturn is potentially concerned, Carl, I see the United States and its fiscal position increasingly exhausted before the next downturn. And I see the Europeans, the euro Zone in the European Central Bank increasingly exhausting their monetary policy options before
we reach the next downturn as well. Out of those two situations, an exhausted fiscal position in the United States, an exhausted monetary policy position in Europe going into the latter years of this cycle. What are you more concerned about Europe the United States? Well, I think that in Europe sluggish economic growth and subpart economic growth isn't news, alright, it's yours become accustomed to underperforming in terms of historical standards.
We've had a little bit of a blip in the last few quarters, but net net GDP growth has been rather slow. I think a slowdown in the United States from the point where we are right now, from this overheated condition that we're moving into after this fiscal stereo. We're assuming in Jim's forecast that the U. S economy is going to get a blip from the tax cuts that we've seen and from this regulations that that that
that expires in the new year. You see, the thing about fiscal policy is you have to keep on increasing it just to keep it steady. You have to spend more and more each year in order to keep the same impact on growth. And once this blip goes through, the growth is going to go back down ten yor yield three percent. Just in your head, car with your decades of experience, at what tenure yield do we go? Oh,
there's just a psychic there's that glimmer that shift. Are we close to that or is it distant like four or five from another time? And place. Yeah, well, I think Jim and I have maybe slightly different views on all of this, But speaking for myself, I look at about a hundred points above inflation as being a level that is a breaking level for a long term yield.
So if inflation is going to run a two to three percent, then we could see long term yields in the three to four percent, which is being still neutral. Carol Weinberg, thank you so much. I freaking say economics. Just really good to get. Great person, John. It was great to have Dr Weinberg on the set with David Pearl of Epic Investments, like two different worlds. Just this
world class character with us right now. For those of you on Global Wall Street, for those of you grinding away for the c f A exam usually June one dish and this year later, this is a clinic of the morning. David Pearl it Epic Investments where they manage money. He and Bill priests Um are basically iconic on the study of free cash David Pearl, what do we get most wrong about free cash flow? When you see c f A s or NBA's blather on about it, What
do they most get wrong? Well, first, the concept of free cash flow is you know, everyone is used to this idea of earnings, but earnings are an accounting measure. It's not like a law of physics. It's not immutable. It's a game like baseball. If everyone plays by the rules, you can compare company A to company B. No one plays by the rules anymore. Companies use ProForma earnings, estimated earnings. We call it earnings before expenses. They do whatever they want.
You can't even compare this year to last year in most companies. Whereas cash is real, that's how you run a business, and generating cash is how you grow a business. That's how you pay for new people, build a factory. Then what do you see among the technology people. When you hear people say, oh, the social media guys and technology guys, they think they play by a different playbook. But does Amazon is one example, generate a lot of
free cash flow? Yeah? So Amazon only generates cash in two areas that we can really see, which is the cloud and uh, you know that's under intense competition, but a great business and third party fulfillment where they don't own any of the inventory, they just mail it to you. So otherwise their free cash flow is pretty negative. Their profit margins are actually lower than Whole Foods, which was
a you know, not successful food retailer. So the answer is no. And the point about um Wall Street is some companies just get rewarded for growth, and Amazon's one of those, and as long as they can grow faster than expectation, it goes up and no one seems to care about profits. You know, Netflix is the other major fang company where growth is very, very high, and frankly, they're losing about three billion dollars on let's say sixteen billion of sales. That's just not good and it doesn't
look like that's going to change. It's actually going to accelerate that laws. So Netflix a company with high cash burn, Tesla another big company we all know of with high cash burn. What's the catalyst for change and changing the way investors perceived these companies as to what is successful and what isn't. Is it high rates um At some point for Netflix and Tesla will be because they are running out of money. I mean, Netflix will have to raise money in six months to nine months at the
rate of cash burn. And Tesla has the same issue where now you know they're debt is trading at eighty five to nine d cents on the dollar, and they're paying five percent, and as rates go up, this becomes a ownerous task to keep financing a company that's going to continue to lose money. Amazon is sort of self funding, God bless them. They also have something that's unusual in accounting.
It's negative working capital because we all pay them up front when we buy something, and they pay their vendors whenever they feel like it, so they get an instant loan. So anyway, for a lot of these companies, there is a huge difference between earnings and free cash flow. Netflix earned sixty cents this quarter and lost three d million dollars. Is your research or are the opportunities rather, I should say, in mid cap and small cap or there's the free
casual arbitrage if you will, in the bigger companies. Uh, It is actually both. It depends on your point in your uh your capital expense cycle. So for industrials like Boeing or even smaller companies or cable companies, if you spent ten years egging holes in the ground, if you're a cable company, you're Boeing developing the seven eight seven, you are at the point right now where you're starting to make money like crazy. So Boeing is now selling
an airplane at you know, three million dollars. They are getting cash, but they have all this non cash amortization and depreciation built in, so their free cash flow per share is higher than their earnings per share, and it's going to be accelerating that gap. So Boeing looks a lot cheaper on free cash flow than it does on earnings. Now, what's your enthusiasm? Just one final question, what's your enthusiasm
on the market. I mean you're walking in to the acclaimed investments and saying, let's put it to work, let's go, go go. So if you're if you really are an analyst they bottom up stock picker, you're feeling good because most companies are having a great year and it's probably going to continue because of tax reform with lower tax rates, repatriation of cash if you're Microsoft or Google. But the macro is the scary part. The big one on the horizon is trade, which has been talked about every day
and today you know a little more favorably. Trade could derail it all. So with a proviso, were bullish. David Pearl, thank you so much. With Epic Investments. Uh, this morning, Tom Percelly with us with RBC Capital Markets have been talking wage dynamics, of which he is especially good. Tom. I want to really focus here on investment by corporations. We've got a tax cut, We've got this that we just hit on David Pearl with Epic Investments, their legendary
and free cash flow analysis. Are they putting any of that money to work actually like investing in American hardware? You know? So I love this question. Um. I would tell you that I think the pieces are are in police for that to happen. Um. Whether it actually happens is a slightly different story. But but let me let
me let me give you something to think about. Um So, for starters, if you look at lending standards for commercial and industrial loans, um, they have eased, and that has been true now for a number of quarters, and that tends to lead actual lending. UM. So I would tell you that's that sort of piece one here. Here, here's
the other thing to think about. I'm not a U. You know people talking about this idea of animal spirits, right, I mean you're you're you've obviously talked about those countless times. I have a hard time really sort of embracing the notion of animal spirits because I can't I can't touch it, um. And because I can't touch it, it's hard for me to sort of model that. UM. But I've I've sort of come to religion on this idea a little at
least a little bit recently. I've I've done a bunch of corporate board meetings, UM, you know, just to sort of give them my view on what's happening from an economic perspective. UM. And when I go in, I've I've been struck by UM how uh. You know, elated is maybe too strong of a war heard, but there's a genuine, a genuine sense of UM, positive vibe coming from the idea that we have lower, lower corporate taxes, regulation might
be scaled back. And what's interesting is I don't know how to model it, but I know what I'm seeing, and I'm seeing this sort of generally better attitude towards the backdrop, and I get it. You know, when we talk about repatriation, we all talked about it in terms of, you know, companies are going to use it for buybacks.
Dippen ends. Um, I just think you know what I've been seeing recently, I would tell you, and given the fact that fundamentally you've had this improved in living standards, I wouldn't be the least bit surprise of something that
gets siphoned off and use for capex. Okay, I agree with all that, but I still don't understand how a corporate officer or CFO does a net present value analysis with the real rates the fiction that they are do you are we anywhere near where a responsible financial executive can actually do the math that they learned in school. Yeah, Well, here's the thing, and here's part of the here's part
of that math, the equation. I think people forget where cash flow is doing because it's true that if if you know, the net present value of of of anything is going to deteriorate if we simply rise, that's true, that's always true. But what if cash flows increase? Yeah, then if your rate rises, then you're left with the same net present value. And I think I think none of the stuff exists in a vacuum, and everyone wanted to,
but that is simply not the way that the match. Well, but the FED, the FED exists in a vacuum, which is, by definition they have to be reactive given the data. Carney, Draggy and the others clearly are waiting and waiting for inflation. We're different. I'm told we are going to see inflation. Our audience says they see it in Cleveland, CPI and some of the more service sector laden indicase. But is
the inflation there for Powell Act. It's enough for them to act in the way that we expect them to write, which is to say, seven more hikes between now the of nineteen. Are thinking, I get much more aggressive than that. UM. Again, I think you know we've sort of were cut short a little bit earlier. UM, And so it won't be labor that at this point on a Monday you can do that. But I think that there's a really sound argument for not only our base case to come to fruition,
but even a slightly more aggressive fed than that. UM. If this idea of that the consumer and I'll just pick up on the thread that I left out there in the first segment. If this idea that the consumer is now all of a sudden going to start to feel a little bit more emboldened to take on more credit, UM, that's a that's a that that's a that will goose up consumption um. And in the that scenario, again, all in the context of what we take even before that,
this idea that wage pressure is a building. Um. Yeah, I think that there's a real sound argument for the FED to be a bit more aggressive, but again that that that's not our base case. Our base case is that the FED will go seven more times from now in nineteen at the end of nineteen UM and and I don't know that you can expect, uh, materially more aggressive than that. What GDP is linked to your seven
rate hunts. Roughly, it's make American great. And the president has succeeded without question, you can say the presidents has succeeded into the mid terms and frankly into the beginning of the presidential twenty twenty to deliver three percent g d P. You know, again, I'll leave that to other people to sort of figure out whether he did his job or or not. But the reality is we're going to get three percent growth UM. And you know, I
don't I don't think that's particularly heroic. I mean, going into this year, we have two and a half percent as our base case uh. And then on the back of the tax cuts, um, we basically threw in an extra few tents three tenths to be exact, and then you get another tenth from from some CAPEX bill. So we're officially we are two point nine percent, so and round numbers three percent. So yeah, I mean, I think that's it again, low hurdle to get there, Okay, very quickly.
One of the thought Tom perc and that is with all the time PERCELLI chat, I'm hearing it just assumes dal are stronger rates, up growth, up dollars stronger. It's not happening yet, does it happen? So what I would say is this, I think when you think about the dollar, I think what you have to keep in mind is you know which cross are you comparing it too. So let's just pick on europe um. And here's the reality behind europe Um. Europe is has stabilized and relative because
this isn't the idea. I think a lot of people forget and relative to what we had been experiencing in Europe, which was, you know, sort of like people worrying about this worst case scenario. That is a major win from a European perspective. So I never thought that the dollar would really be able to sort of advance in any material way on the back of the relative improvement in Europe. I think that's a really important idea. So yeah, I think it's reasonably expect some dollar strength, but I I
wouldn't get I wouldn't take that idea too far. Tim for Solly, thank you so much, greatly appreciate it all this morning, RBC Capital Markets and really original wage growth work about eighteen months maybe two years ago as well, Kitchos of Society General. We recalibrate before May first, Kit when does the dollar go up? The big shock in your world over the last number of weeks has been dollar weakness. Is this lift that we've seen tangible? Do
we finally see reversal? Higher rates, better growth, stronger dollar? Is it for real? Uh, it's it's trying to be for real. We need to go a little bit further, and I think we need to get tenure notes decisively to hold through three in a way that doesn't cause you know, equity Marcus to go into retreat, the FED to start getting worried. Um. I think you know, if
we're going to see the US get interest rates support again. Um, it's got to be, you know, a durable shift higher and expectations about West terminal fet funds are and right now I think we're doing enough to give heart to some dollar balls and to make some of the dollar bears. And that's the majority of the market, but pretty anxious. What I mean if it does reach if it does reach over three for the tenure, should you buy it treasuries?
I would be quite tempted to buy some terms, if you know, once we settled down there, I would get very tempted if we started seeing volatility pickup and an equity market start to sell off because I don't think there's much inflation out there, and I don't think the FEDS changing its long term path reamb. What matters is is the FED going to start moving its estimate of our star of neutral real rates? So we're going to change any of that? Or is this just just noise?
A spring comes around after after a poor first quarter. Tell us about what's going on with energy markets and how that affects your outlook. I know, I look, I'm not a big expert on on oil. I think it's going up because it's being squeezed where it will get open bar before it's done. But if if we get some station just because we see, you know, a spike up to a new range and oil, and then all prices find a level and go flat, I don't think that changes the longer term inflationary story a jot. It
doesn't feed through in a durable way. The question on inflations were about what happens to wage growth, um, not what happens to all prices in a short period of time. And I don't think all prices are going to run away we I think that's you know, the the elasticity and supply globally is I well understood enough, not by now. So we may be moving to a sustainably higher range, but we're not going to a hundred bucks. I I okay,
we're not gonna go to a hundred bucks. But within your reading and as you say, you're you're away from well and yet dollar denominated, etcetera. Are we at a point where the nuance of five dollars a barrel matters? Or have we sort of had the jump fifties sixty all of a sudden to brent seventy three dollars a barrel? Is the effect or impact of the move in the past, or is it to come if we go five dollars higher. I think it's in the past. Unless we start suddenly
talking about breaking outwards. If we're going to settle at seventies something where we were sixty something for the last year, and then we've come from from these lower levels, then you know, unless you unless you change that and talk about it, you know, a sustained move to something different than I think this is. This is just the back end of the move, which may include a little bit of an overshoot before we finally settle down, but the move itself is basically done. Kit Are you at all
surprised by what gold hasn't done? You know, I mean, no, I'm not. I mean gold. You know, it tends to get somewhat more marginalized. But the big story that always supports gold is is going to be super low real yields and real returns on on on financial assets and concerns about inflation that come with that in a low inflationary world, and slightly higher slightly higher yields on treasuries than you know, there are there are things to buy
other than gold. So gold has remained reasonably well supported in the big scheme of things. But right no, there's no reason to be find a hole in the ground to put all my money in gold anymore. And now on Monday we go technical with kiss kit jokes, we go into the granularity of the Swiss franc kit. We've got to move weaker Swiss franc. Bunch of it is the nuance, the speculation, the speculation, the speculation that the Russian rich people are pulling their money out of Switzerland,
whatever that may be. Is this a time where you get brave and go against the trend and go strong Swiss franc I tell you I think against the Euro, the Swiss Frank will strengthen if you're all the breaks down through through one and a half and I think we'll flush out. So the big mover in looking at the Swiss franc is what is happening against the Swiss
Frank against the Euro. We've taken that from We've taken that from really from from one oh eight a year ago to one one twenties and level we broke down through in the big surprise when the peg broke, we've touched it and we're reversing. If the Euro loses its mojo here, then I won't be shut of the Swiss Frank against anything. Kit the stronger Swiss Frank hasn't hurt the Swiss economy. No, the Swiss economy is not sensitive too much. You know it hurts Bits and his nice people.
But know the you know, the goods that Switzerland exports are not price sensitive. Um, it causes some concern because it's given them falling prices, negative inflation that that causes some concerns and negative interest rates, which Swiss savers really don't like at all. You know, they're up in arms regularly against their central bank about that that. Old folks who live in Switzerland aren't happy. But um, you know
we we don't. We don't go I don't know skiing in Switzerland or bank Swiss pharmaceuticals or beauty products because because of the price, that's not what's driving that decision. Thank you so much, greatly appreciated with society general. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keene Before the podcast,
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