Here's What Just Happened to the Stock Market and the Economy

a couple episodes. And meanwhile, against that entire background, the news is actually happening. The Fed raised rates by fifty basis points and the markets crashed. They did not have they weren't. They had some rough days, that's for sure. Crash okay, crap okay. The market went down and then the market had some really rough days, and particularly tech growth, that kind of stuff, it's just continues to get absolutely killed.

We also had a jobs report. We're recording this what is speaking of being really tired and out of it six, recording recording this base six. We also got a jobs report today which seemed decent. There is a lot going on right now. And yeah, like we were at this conference, I kind of feel like I missed a lot of it. I almost wish I was just behind my computer the

whole time. Yeah, that's a very Joe thing to say. Uh. Well, one thing that was interesting to me, so I was actually at a like a credit market panel right when the Fed raised rates, and I got my phone out and I started videoing the audience because I I thought like, maybe the headline would come out, right, something would change in the room. Absolutely nothing happened. I mean, the fifty

basis point increase was well telegraphed. But the really interesting thing was we didn't even really get much of an iediate reaction in the market. It wasn't until the next day on Thursday that everything started happening. Market stored on Wednesday, I think the NAZAC was up like three percent, and I was like, oh, coaches, clear they took seventy five bases points off the table, maybe policies, some signs of inflation turning a corner, and then the markets tanked. We

have two great guests this time, excellent commenters both. I want to welcome to the show. Luke Cowa. He is an allocation strategist at UBS Asset Management, as well as Neil Dutta, head of economics at Renaissance Macro Research, and I think it's Neil's first time on the show, which is amazing because if we've known Neil Neil for years and I've been big, big fans of his work. So, um, thank you both for coming on the show. Neil, that's right, you haven't been on odd Lots before, is that correct?

I haven't, Joe, what took you so long? I know, I know it really it's a shameful but big week and you're one of the names we needed to call, so hopefully that makes up for it. But let's start with you, like, what's going on? What's your read of everything?

Put it in two. I think the the economy is fine, um, you know, I think obviously if you look at just the total hours worked so far this year, um, it's running around three to three and a half percent, so aggregate hours worked, So if you assume underlying productivity growth of you know, conservatively around one percent, I think underlying economic growth is around four to four and a half.

So I'm not particularly worried about the economy. But clearly, um, there's an adjustment that's happening with respect to the interest rate outlook that's been going on really all a year, and I think that's having some predictable consequences on equity markets. I don't know what happened. One day, I mean, the feed signaling something in the market rips, and then the next day the market tanks. I mean, it's it's it's

a very bizarre sort of situation. But were generally speaking, what I can tell you, and what I've learned throughout the years, is that, um, you know, the economy is a much slower moving entity than the financial markets, and ultimately good economic news can help can help turn the financial markets, and UM, you know, my sense is that whatever so off we have seen, um and tightening the financial conditions we've seen isn't going to have a significant

impact on the economy. I mean in the sense that relative to what's baked into the consensus. Remember, the consensus expects a slowdown this year. That's what's priced in. If you look at the blue chip consensus, it's at two point three for this year, the Feds at to eight. So you're gonna see some slow and when when the economy slows, there'll be some days where the news comes in good and some days when it's not UM and uh.

And you know, in my mind the data hasn't really deviated from from that UM, you know, trajectory really one where or the other UM. And it's good to put a gun to my head and say, you know what, do you think growth is going to come in stronger than one that consensus is for QO. My guests would be probably yes. So there's a lot to unpack there. And before we do, why don't we bring in Luke?

And I guess two questions for Luke? But one do you share Neil's assessment of the economy that he just described? And then two, what do you think happened between Wednesday and Thursday? What was the trigger? Because it feels like that's what everyone's trying to figure out at the moment. So, you know, a couple of tough ones. First off, as a default, I I think Neil is a great person to defer to on the US, on the US economic

outlook in particular. And now comes the ship you set him up all right now, Now now you're gonna show no. I I completely agree. All of the data, basically, all the data we've got recently on the US confirms the idea that the US is decelerating, but to a level that's still consistent with nominal growth that's far superior than what we got last cycle. The problem is that just like that simply doesn't matter right now, that simply is not the the proximate uh mover of resentment of risk

appetite right now. And what's even more concerning is it's very difficult to tell what actually is. So I know one phrase that you know, Tracy loves to use, as you know, flows before pros, just this idea that you know, money moving even from you know, potentially you know, unsophisticated investors can run over the more sophisticated crowd. Right now, the flows are the pros. So it's it's more of

the story for me about flows before pros. But pr O s E. There's no story we can use that is going to adequately explain why risk appetite changed on such a dime between Wednesday afternoon and uh and Thursday morning.

There's there's nothing that does it. So what we have to do, as I said, allocators, we have to take a step back and say, well, you know, there's there's really three big risks we see on the table one is kind of fed tightening, which is going to be you know, possibly if it's if it's too much, it's bad for growth, bad for risk assets. If it's too little, it's probably just you know, bad for risk assets, financial

assets generally. Uh, there's the Russia's invasion, which is just creating kind of persistent supply issues and threatening to exacerbate kind of some of the negative supply commodity price issues we've seen way on forward consumption. And then there's China, which is both the you know, a supply and demand issue.

And I think that's one thing that did spook people a little when the when the Chinese you want depreciate it a bit there because it's like, okay, well, if China's supposedly you know, everyone thinking is about to go on this decent credit old school stimulus, but smaller binge as as the public health situation improves or if they're kind of more durably moving to a consumption driven model. Well that doesn't comport with it with a lower currency

at all. Uh. The lower currency comports with the trying to be the the demand sinkhole for the rest the world and stop all of that up. So that's you know, that's something that's concerning. All three of those risks are still there. And what we have to do when markets are this volatile are demand a higher merchin of safety.

But take a step back, increase our time frames a little bit and think about what are we pretty confident is going to be working in a year from now because rates volatility is so high, macroeconomic uncertainty is so high that trying to really nail that one in three month call seems like, you know, not something we should be devoting as much of our energy and our risk capital to. Right now, I want to zoom out for a second, and I want to start this question with Luke,

and then I want to get Neil answer. But I want to zoom out because yes, we don't know what happens day to day. It's hard to tell a story. But if we zoom out a little bit, obviously these incredible tech boom that we've seen, or the growth stock boom, it's clearly I think it's safe to say like come to an end. I mean, it's a credible contraction. Hundreds of billions of tech wealth lost for a lot of

people like this is something they've never seen before. We've arguably had like a twelve year tech bull market, tech bull market and growth, Like what if the big story about this rotation and the turn? So I think the big story does have a lot to do with the with the macro environment, ak that the moving rates and

the moving rates volatility. I think that's something just on a on a correlation basis, if you kind of plug in what you think should be moving stylistically based on what rates are doing that you know rates are to a certain extent driving the bus before before you go, just real, just real quickly. For people who don't understand it, we talk about this link a lot. It's like rates are going up, so you sell Facebook or you sell arc.

It's not intuitive. Can you just walk through for listeners in a sort of brief form, like why there's this connection between rates or rates volatility and the sort of like violence of the tech market sell off totally? So I think there's some some competing explanations. I'll go with my my preferred and it has less to do with like the has less to do with the along duration

discounting stuff. This is this is more about I think generally speaking, rising rates are a function of an environment in which nominal growth outcomes are you know, expected to be improving and are you know, fairly firm. You can you know, equival about that now, given how much of it is is related to kind of negative supply shocks potentially. But that that's a kind of brief shorthand for why

should rates rise. Rates should rise because things are good, and things are good enough for central banks to remove stimulus, and you know, that's a generally speaking, you know, an okay environment for growth. If growth, if economic activity is doing well, then you don't need to focus on kind of the things that might be revolutionary or innovative or be you know, turned from a who knows what it

was into a verb like gold. Uh, ten to fifteen years from now, you can focus on Okay, I know that energy companies are able to produce x oil with X margin and they won't be producing more than that, so prices are going to stay within X range and that looks very good for me right now, and we prefer that to speculating on something that might or might not be good ten years from now. So that's that's my preferred explanation of how rates kind of effects the

the growth versus value argument or spectrum there. So that's that's that's the headline story there. But I also think there's there's a broader issue both related to growth, but also related to the idea that the kind of the there's a bit of growth convergence to be expected as you as you come out of COVID. And I think this is something that you know, you've covered a lot Joe in that just the kind of the pandemic premium both in multiples is is kind of come back, but

it's coming back in earnings as well. And when you have more and more tech companies talk about kind of you know, right sizing staffing levels or things like that, that to me translates into environment in which growth companies are no longer prioritizing growth. They're turning on some other tap, but it isn't growth. So it's a bit of a stylistic change that the group itself is is undergoing right now.

And you know, when when they're style drift within a cohort, that might get investors to question whether the you know, whether the thesis they've applied to the group is is still valued valid, And that's you know, something we see as an ongoing process right now. I mean, Neil, I mean I'm curious your take on that. I mean, You've

been talking about the reopening a lot. I've had a million ibs with you where you point out that like Peloton is going down and Planet Fitness, the actual jim or people go and work out in person, has been surging. I'm curious sort of your take on the same question of this sort of like bigger shift that we've seen

in markets really since I guess November. Well, I think, I mean, I think a lot of this just comes down to the policy response, right, I mean, the policy response following the financial crisis period was not particularly robust. I think you could say, and as a result, Um, you had a very very um you know, not weak, but just not particularly strong phenominal growth environment. I think we were basically hovering around four four and a half percent for years. UM. So that kind of kind of

churned the wheels of a very steady recovery. UM so things are always getting better, but we never really had that that v shape recovery. And and so as a result, I mean, in that kind of environment, growth is not widespread and so you have, you know, performance in the market's kind of narrow to a you know, specific group of companies that can you know, drive growth in that kind of an environment. By contrast, I think in this period, we had a very robust response. Um. I think, you know,

through a myriad of sort of fiscal support programs. I mean, the government was basically able to deliver you know, a hirement mum wage to people without actually doing it legislatively. And you know, the Fed basically put both of its feet planted firmly on the accelerator. And so you know, I think that's been one reason why, um, you've had such a strong uh nominal growth backdrop, and so growth is more widespread and so as a result, it's not

going to narrow to a handful of mega cap tech names. Obviously, the pandemic is important, as you mentioned. I mean I sort of pose that question to our clients as well as like, what if what we're seeing is really just the last gasp of the of the pandemic unwined? You know, I mean, I think it's more to it than that.

But you know, I mean remember back in I mean people were making the argument like the stock markets are just whistling past the graveyard, and in reality, I think the stock markets were actually following up a script that made a lot of sense. I mean, if you look at online retail sales, they were very strong. Guess what those companies did really well and a twenty and by contrast, brick and mortar retailer didn't do particularly well. Restaurants didn't

do particularly well, and and they were punished. So it wasn't like the market was just you know, you know, turning a blind out all these things. I mean, the market, frankly, I think was evolving the way you'd expect. And you know, now, um, a lot of that's working in reverse, right, and that it's probably better for the economy, but it's it's not necessarily the best thing for some of these, uh, some of these trades that had been put on over the

last number of years. You mentioned financial conditions at the start of this conversation, and this is something that a lot of people are talking about as well, this idea that the Fed has explicitly said that it wants to

tighten financial conditions. And one part of tightening financial conditions, or one component of financial conditions, one of the things that hadn't moved that much or tightened that much was stock so I guess my question is how how is the FED thinking about stocks at the moment, or how do you think the FED is thinking about stocks? I think they're probably encouraged to some degree that the multiple

has come in quite a bit. I mean, obviously the earnings backdrop is quite strong still UM, and I believe projected earnings have continued to go up UM. And so you know, I think they're they're probably looking at the sell off inequities as as a good thing. Obviously, if if demand is running really hot and financial conditions ease more, that means that demand is going to get even stronger, which means that their inflation outlook will deteriorate in their mind, right, So, UM,

I think they welcome some tightening and financial conditions. And as I mentioned, I mean, the financial conditions tightening that we've seen so far is not enough in my view to really UM send the unemployment rate meaningfully higher. I mean, you know, we can talk about the folks over at Cameo laying off some tech workers, UM, but you know, I just don't see it as as a as enough

to really um weigh on the unemployment rate. At at best, the unemployment probably flattens out in response to this tightening of financial conditions over over the over the back half of the year. But you know, I think in my mind, I mean, the FED welcomes the tightening UM, and and given the kind of inflationary environment that we're in, UM, this sort of idea that there's this you know, put out there that the FED will have your back. I mean, the strike price on that put is a lot lower

than it used to be. UM. And that's again it goes back to this idea that UM, you know, in previous episodes when the equity markets were were faltering, the growth outlook was faltering quite substantially as well. I don't think that that's as compelling this time around, and in an environment where inflation is still high. UM, I think it's really a no brainer. As Powell mentioned this week,

their goals aren't intention right. So Luke, I want to bring you in on this point because I mean, to me, the FED never explicitly said that we want the stock market to go down, I mean, for obvious for obvious reasons, but they said financial conditions need to come down. The only thing in the financial conditions induseaes as I mentioned that had been staying up was stocks? Why did it take so long for the market to sort of accept this message, because it it did feel like Neil just

put it as a bit of a no brainer. Yeah. I find it interesting in that, you know, stocks were you can argue they still might be, but since more or less early February or late January, stocks have been kind of stuck in a boring range. You've just been going from the you know, the bottom to the top of that range. I think it was more about the

inertia with that. I also think it had to do with, you know, despite all all of this, and despite a you know, pretty big rerating early in the year, earnings have been coming in, You're quite quite fine at the guidance outlook might be getting a little a little more dowurd in part because the strengthening of the US dollar. There's your financial conditions right there um, as well as you know, headwinds related to to China and Ukraine. But I think I think it was a lot of you know,

complacity about the about the range we're in. But our view was that as we were getting to you know, around those levels around top of range, that you know, those those are good places to be selling stocks. What became more challenging is like when we get to the bottom of this range as we had lately, like does

it still make sense to be underweight stocks? And the view there is that, you know, although we've had multiple compression, a lot of it, we've had multiple compression at the index level essentially to pre COVID levels, we also have

rates more than a hundred basis points higher. So your your layman's equity risk premia would suggest that you're still not being compensated enough for the risk that either the FED over tightens, that China is a persistently larger drag on the global growth outlook for longer, or that's kind of supply constraints So Twain, it's Twine Twain who's adorable. Um, yes, you can hear how adorable he is. Uh but yeah so, or or you have essentially you know, Russia, your grain

exacerbating supply constraints there. So you know, our view, though has been even at the start of April, say when you had you know, stocks doing pretty well, even then you still had dollar at you know, highs of the year, tenure yields at highs of the year, mortgage rates rising.

The kind of tightening that's going to show up more in the forward outlook is going to come much more from what's happened, uh, you know in mortgage rates and the kind of knock on effects to housing than it will from the SMP five hundred going from fort hundred

to forty two hundred. So in terms of the FED tightening, the type of financial conditions that matter in a way that kind of influences the forward growth outlook, A lot of that, you know, we'd are he was in place even before kind of stocks woke up to the idea that you know, can't sustain these kind of mall the polls at at these kind of rates. With the growth outlooked at you still positive, but slowly you know, on

the mortgage rate back up. I mean, I think it's worth pointing out that this is a highly unusual housing market, and I think Luke would obviously agree with that. Certainly Twin agrees with it, um. But what what what I will say, UM, is that when as economists business economists, when we talk about housing, we're really talking about three things, right. I mean, it's residential investment that's what is booked into

GDP and Residential investment is really three things. It's sales, which is broker commissions, and then it's construction and housing renovation spending. Those are the three things that go into residential investment, and the broker commission piece of it, or the sales piece of it, that's only a fifth okay. The rest of it is renovations and construction. So what I think it's important for viewers to know is that even though rates are backing up, residential investment, the likelihood

is is that it's still growing. It's still contributing to GDP. If you look at the gap between housing starts and building completions, there's still a yawning gap. That means mechanically that units under construction will continue going up. Okay, And as as units can under construction keep going up, that means construction spending will keep going up, which means that residential investment will keep going up. And to the extent that rates have backed up, and that's creating some spatial

luck and effects. You know, you can make a pretty compelling argument that that, you know, people that wanted to move, maybe they spend more money on their existing home. Um. I mean, I certainly think that's consists of a lot of the anecdotal stuff that I'm seeing here in my neck of the woods. But you know, look, I mean, I get why Luke is so concerned. He's a potential

first time buyer. That's not everyone. For for most people, your real cost of shelter is collapsing because your mortgage rates are fixed and everything, and your mortgage, your your mortgage monthlies are fixed. Um. You know, we know that adjustable rate mortgages are not nearly as substantial in terms of a share of dead outstanding as they were back in the uh oh four oh five period. You know, so your real cost of shelters declining for most people.

So it's not you know, as I said, I mean, yeah, the rates back up. Yes, that's an unambiguous negative, but I would be a little bit careful about extrapolating how much that's gonna do to to overall residential investment, which

will still be in my mind to sending in real terms. Yeah, hey, I'll definitely agree with you know, someone was asking me because I've been I've been pretty optimistic about the economy, but it's hard to get a little more pessimistic, and they're asking me why and I said, you know, I'm

essentially the modal millennial. I thought I was convinced that this cycle was going to be the one where I got into home ownership, and you know, now I'm no longer convinced, and you know, extrapolate that across the economy now, I'm now I'm a little less less optimistic. So I I, you know, I do agree that this could be certainly a case of me over extrapolating my my personal circumstances, and definitely agree Neil's been kind of quite rightly being in the drum that there's a lot of pent up

production coming coming to housing in particular. But you know, uh, the counter factual of you know, rates having not done what they've done due to the kind of the FED signaling a quick and expeditious move higher in rates as it would have been a definitely a brighter environment both for home prices and for for first time potentially activity going forward on both ends. So again I think it's you know that the counter factual is seems also clear.

Can I ask about one area where another area where I think you guys disagree a little bit and correct me if I'm wrong, But I think Luke at this point in time is more barish on what's going on with China and the Chinese economy. The Neil is Um, could you maybe explain your, I guess, your respective thinking around what's going on in China. We've seen, you know, parts of the country basically shut down because of COVID

zero policies. We've seen some supply chain issues and things like that, and there seem to be varying opinions about how much that actually matters for the global economy, how much of those troubles are going to be exported to the rest of the world. So why don't we start with with Neil? Sure? Tracy, Well, I'm not I don't consider myself an expert on China. UM. I try to stick to my knitting. But what I will tell you is, UM, it's hard for me to see conditions in China getting

substantially worse than they are right now. And so for me, it's about what the blowback is to the US economy. UM. And so you know, my sense is that the situation in China can't possibly get any worse than it is right now. UM. And you know my senses that it gets somewhat better from here. UM, and that'll be a tail end I think for UH for global demand and will help loosen supply chains. So that's sort of how I'm thinking about it. Luke, Yeah, I think, I think.

I think my main difference is that just there's a somewhat at a degree of caution warranted. And it's kind of almost similar to the inflation story. When inflation surprises to the upside for so long, so long, so long, UH, and forecasts are are slow to adjust, then the burden of proof is is higher. On the other side, the burden of proofer thinking inflation has come down UH should be higher because you've been kind of beating over the

head with the mistakes of the past. I think that's very much the case right now from a global macro perspective. In terms of in terms of looking at China, I think, uh, you know, pretty much everyone could point to five or six forward looking catalysts that would have inspired a lot of optimism on China over the past you know, five or five or six months, and it's been the kind of the story of Lucy pulling the football away from Charlie Brown each time, whether it's the underperformance so large

that you know, forward performance should be good. Hey, you've got the China's Party Congress coming up in November, you're probably going to get kind of firming of growth and the stock market ahead of that. Or hey, coming out of the Beijing Olympics, you should really see this kind of you know, this end of blue guy policy, this pick up in industrial production in a way that kind of supports and uh and underpins the real estate market.

A lot of these things can still happen, but I think that the thing is when China has kind of consistently disappointed on the macro side, and a lot of cases through through no fault of its own, but in a lot of cases through policy responses that global investors do not have a lot of visibility into. Then I think, you know, the threshold then for saying, hey, China's decisively turned around should be higher. It is something that you should approach with a little more caution, even if you know.

I would tend to agree with Neil that you know, the six months, twelve months or things better or worse? Probably better, But how bad can things get in you know, two to three weeks in China. I think we've seen in the volatility in the and that market, things can move quite abruptly to the downside, so you know, it's I think it's a case of why not be a little a little late to the China upside surprise party, right?

I mean I would just point out though, that I think it is worth pointing out that outside of China, emerging Asia looks quite good. I mean, if you look at UM you know, for example, the p m I data outside of China looks pretty healthy. If you look at mobility data outside of China, it's been up into the right, so factories and the rest of Asia are open.

A lot of final assemblies already leaked out of China, which could be one of the reasons why the supply chain effects of this haven't been as onerous frankly, I mean, at least on the US economy. I mean, the the impact of the delta variants spreading all over Asia was a lot worse on for for US. UM, you know, producers delivering goods to consumers here than what we've seen lately. So um, you know, I think if the US, I

mean the way for me. I remember, guys, I'm trying to bring it back to the US because that's my right, that's I'm trying to stick to my knitting year, and my sense is that China will re accelerate. I mean, whether that happens in one month, two months, six months, it's going to happen. We know that Europe is frankly a lot more connected to China than than the US is. I mean, the Europe is a very large, open economy

that does a lot of trade with China. So if China is improving, it stands to reason that Europe will as well. Um, I think that's a story. But that remember that dramatically, dramatically undercuts this idea that the US isn't going to go into recession in twelve to eighteen months.

You want to call for a recession in the US at a time when China and Europe may be accelerated, That to me is ridiculous, Okay, And so um, we're obviously not going into recession this year, and so I think that's something to keep in the back of your mind and that maybe you know, I mean, this is this is why again it goes back to what we've talked about earlier to start the program, right, is that

it's a very bizarre period for financial markets. I mean, the moment the bond market basically priced the recession probability out is the very moment the stock market started pricing one in. Well, actually, so I want to actually talk about US assets again and start with Luke, because obviously

a lot of people are looking at their portfolios. Maybe they're looking at their floral one case, maybe they're looking particular at their target date retirement funds, and they're obviously sitting on a lot of losses so far here today. And what's when, you know, we talk about financial markets being weird, Woods New is not just that stocks are down because stocks sometimes fall, It's that the bond portion

of people's port folios it's also down. What for what used to across the last several years performed as this nice hedge stocks go down bonds go up is not working? It stocks down and bonds down because of the rate increases. What does that do, Luke? How does that change the thinking of portfolio management? When the sort of these asset allocation models that worked extremely well one part goes down while the other part goes up are no longer working.

First off, if you're in an environment where more things aren't working, it's you know, it's gross down it's not being it's you know, not taking large tilts in in anyone direction. It's kind of it gets back to a uh more of a risk control and prioritizing relative value environment. That's that's step one. Step two, though, is expanding the kind of the range of possibilities. And one reason obviously why bonds have been doing so poorly is because commodity

prices have been doing so well. So are the is that both as a kind of a defensive ballast in portfolios as well as kind of the you know, the the structural growth opportunities, particularly in in the industrial metal space that you know, commodities are still a good place to be right now with kind of questions about demand. It's not necessarily something aggressively adding to at that at the moment, but kind of on a on a forward

looking basis, you know, think of it this way. It's almost it's almost incompatible to think inflation is going to normalize all the way to two percent and that we're going to have the necessary investments in developing commodities and in using them to support the green revolution that we're able to get you know, some semblance of energy independence.

Those two things seem barely incompatible. Uh so in in that kind of environment that that augurs for more of a structural increase in allocation into commodities, which have been a very unloved asset class for for such a long period of time. So that's something that's helped offset the you know, the correlation. The correlation go to one environment that we we bound ourselves in. Well, Neil, I mean obviously you know we're talking about mortgages earlier, but where

can rates go? Can they keep going higher? I mean, we particularly at the long end, you know, you know, I think so, um why, I think we're in a strong nominal growth environment and um, you know, look, I mean if you think about where rates were the last time, I mean, the FED ended at two point three seven right too, I think it was a twitter quarter or two and a half that's where the funds rate was, and we were in a four and a half percent nominal growth environment at the end of and of FED

promises to well not promises, but they're guiding for something like that this year and will probably be I mean, you know, let's say inflations around three to three and a half percent. I think real growth will be around three, right that maybe a little bit more. Um, so you're talking about something north of a six percent nominal growth environment. So if you're gonna ask me, do I think equilibrium

funds rate is higher? Yes? I do. Remember it wasn't that long ago where the feed thought when they first started doing this, you know, the SEP, the Summary of Economic Projections, they thought that they thought equalibrium funds rate was four in a quarter, four in a quarter. With debt service ratio is a lot worse than they are now, with UM, Labor markets a lot more sluggish than they are now, with business investment a lot weaker than it was than it is now. Oh and by the way,

households are sitting on UM you know, an excess savings pile. Uh, you know, over two trillion dollars and US hitting the most favorable demographic patch that we've seen in our careers. So yes, if you're gonna ask me, do I think equilibrium rates are higher? The terminal funds rate is highed? Yes I do. And that makes me crazy. Um, you know,

so so be it. But you know, I mean, I think in the near term there's probably some opportunity for fixed income, right, I mean, you know, it's it's one of these funny things that you've seen, right, It's like it's not risk parity, it's risk parody. Um. But you know, but I I do think, I mean, look, there's I don't think there's much more the markets can price in

for the FED right now. UM. And I think that probably you know helps um, you know the soft landing, the softish landing case that that the FED wants to tell um. But I think whatever pause we see, um, you know after they get to neutral is um. You know the next move after that is going to be additional hikes. So to like to piggyback somewhat on a Neil set what Neil saying, and you know, for right now, right in our stances that you know better to be neutral the long end, just by virtue of you know,

how much has been priced in already. But one thing that's clearly different this cycle versus the last one is that the global nature of central bank tightening and what that's doing to global term PREMIU. So you know, starting in you have the you know B O J really cranking up, que, you have the E C B B O E joining not too long really cranking it up. After that this cycle that's essentially all going in reverse.

And even in the face of a uh, you know, a pretty big shock to you know, potentially real incomes and growth, the e c B is is telegraphing a move out of negative interest rate policy. This is this is something that is you know, clearly a clearly going to push global term framing a higher and and has the lots If you go back to Leo Brainard's speech about quantitative tightening in early April that a lot of people were focusing on, is you know, this is something

that's going to drive you know, global bond markets. Well, boons have underperformed since that period of time. We're we're in an environment where the fact that the e c B is is kind of uh signaling what it's signaling, and it seems that every day there's a kind of pulling forward of of some kind of e c B related tightening messaging. That's what's driving still the busts and

global bonds. So if you if you look at lately and one thing that honestly I found a little bit confusing in the aftermath of the FED is that US bond volatility, implied volatility hasn't really calmed down too much, and it might be that US bond volatility can't calm down because of what's happening across the pond. I have what is perhaps a dumb question, but can everyone tighten at once? I mean, I know everyone can technically tighten

at once, but does it have the same impact? Because back when we were easing many many years ago, we used to talk about competitive qui and sort of competitive devaluations and things like that. So does it have the same impact if everyone is doing this at the same time.

I would argue that because like last time, you had a much more focused impact on the US, because essentially, you know, the the US was the only one tightening dollar up, and then you have dollar up also kind of exports tighter credit conditions to the rest of the world.

So we we have everyone going this time, but the dollar is still with a lot of strength, and largely it's still like very good growth differentials and the kind of possibility of more left tail economic risks in Europe and China that's still you know, exists to varying degrees.

But you know, I would think conceptually, in theory, an environment where everyone's tightening is on net kind of is less tight than than the than the counter factuals that it's actually easier to go if it's synchronized rather than if it's kind of one country and particularly US centric. Yeah, I mean, the one thing I would just say, I

I would tend to agree, I guess. The one thing I would add to that is, you know, when you look at the dollar performance, um, you know right now versus you know, let's say back when when you know, the like Stan Fisher was making speeches about what the dollar impact is on GDP growth and inflation. Um. You know, what's interesting now is just I guess, is the differentiation that I'm seeing in some of the in some of

the dollars performance. I mean, obviously, the dollar back then was like rattying against pretty much everything in um, you know, and and here it feels like it's more like d M related. I mean, so, so it's obviously the dollar is very strong against the euro, it's very strong against

the end. But if you look at some of the emerging market commodity currencies, I mean, to Luke's point about how all commodities have done, those currencies are actually hanging in there, you know, UM, and that's been something that's been a bit different, um than what we've seen you know, saw before. So I just think that that's interesting. But generally speaking, yes, I think it's much easier on the FED if everyone's also hiking. I know, we have, uh,

just a few more minutes here. You know, again, people are looking at their portfolios. Obviously we've talked about it a ton, tech and growth getting clauvered, etcetera. Luke when and you know you're talking about okay in this environment, maybe the answer is commodities exposure. It's sort of like the one thing that's breaking the all correlations go to one.

But you know, when I look at some of these tech names and SPAC names and all this stuff, I just see like a complete like in some cases it's a much bigger massacre than probably people are ever imagining. And people stocks down in many cases for brands that people know, what would be the conditions in which one would start looking back to this area that's gotten hit

so hard. What would be the sort of either macro conditions or flows uh that you look for to say like, okay, maybe this has been enough and start start looking for opportunities. So the and the difficulty and so doing just as as a starting point is the fact, you know, if you go from a you know, a hundred P to a fift P, well not not exactly. So that's that's

that's a bit of a challenge here. What would what would kind of warrant it is a is a larger pricing of recession risk, certainly so right now in terms of like if you look at what's the you know, what's the the hump in the in the euro dollar curve or anything, it's it's not it's not material. It doesn't suggest you know, traders ascribing a lot of odds to a material cutting cycle from the FED after this

kind of quick series of hikes. If that were to grow larger at the same time as you get at the same time as you get kind of more visible slowing in UH in the US and the global economy as well, you know, that would be that would certainly be something goods demand clearly coming off the boil, and it to be to be fair goods demand, you know, in in terms of PC basis like hasn't really done too much for for about for about a year now. You know, that's something that you know should be should

that side of the you know, economy slow more. That's something that's going to I would suggest, probably prompt investor

attention to turn back more to two growth names. But it's I think the fact that it hasn't happened yet is one of the one of the signals along with the euro dollar curve, that you know, there's not a lot of recession risk being priced right now, and that's that's something that's odd to think about, as uh as stocks being as volatile as they are, but I think that's something to hang your hat right on on right now.

In terms of looking at the forward outbook New Yeah, thanks Tracy Well, I would just I mean, look the the equity markets, UM, the setup really does look very much like a late cycle type of dynamic. Now, obviously there can be multiple sort of market cycles within a broader economic one, UM, but if you look, I mean, for example, defense defenses are outperforming cyclicals. We've seen utility

stocks better bid, staples better bid. Um, We've seen you know, significant sell offs and discretionary I would just say that there's only so long that the markets can price in a late cycle dynamic and then not actually have it happened in the economy. So if you're thinking about something like strategic asset allocation. My view would basically be to use rallies and defensive positions as opportunities to add to cyclical ones, because I do think that's probably the next

leg of the market cycle. Um So, that that's sort of that's sort of how I'm thinking about it. When I when I look at the broader economy, um as I say, I mean bringing it back to to the U S economy, there's really you know, my concern dial is not particularly um high. I mean, it's it's sort of interesting to see like sell side analysts tripping over themselves to see who can pencil in the highest recession

probabilities over the next two years. But you know, in my mind, it's really no harder than it normally is. I mean, what would actually decline if you were to have a recession like housing is we're talking about how we don't have enough cars and we don't have enough homes. Um So, what goes down commercial real estate that's already as low as it could possibly be relative to g D P um So, I mean it could be I

guess you could make the argument of durable goods. But even there, you know, things like motor vehicle sales have basically, you know, as a share of of consumption, they've they've already kind of reverted to trends. So you know, I just don't really see it. I mean, what are we gonna talk about the great, the great household furnishing recession of It's just it just doesn't it doesn't make a

lot of sense to me. Um. And that's why I say, if if you're if you're in, if you're asset allocating here, um, I think we're at a point now where it's probably it's it to me it makes sense to pick up some of these, uh, these cyclical names that have been quite beaten down. And as I say, I mean, this is something that Luke pointed to early here. But if you think about the markets, it's been three things, right, It's been the FED, It's been Russia, Ukraine, so the

situation in Eastern Europe, it's been China. Okay, So like take each of those in turn the Fed. The FED, in my mind, is going to be less a source of instability for the financial markets over the remainder of the year. I mean, Powell has basically given us forward guidance for the first time in a while, right, I mean basically fifty basis point moves, followed by there's a little bit more certainty in the FED outlook than there

has been. And uh, you know, we talked about China. Um. I think I even got Luke to acknowledge that China will look better in the next twelve to twelve months. But if China is looking better in the next twelve months, um, than Europe will too. Right. So those three areas that have been beating down the markets and creating this sort of instability and volatility that we've seen, I think that's likely to abate. So that's why I say, if I had to make a market call, that would be it. Well,

you guys are great. Just could go on a lot further, but we got to leave it there. Neil and Luke so much appreciate you coming on odd loads to help us understand what's been I mean, we say it's been a busy week, but really in extraordinary year so far overall. So thank you for coming on and helping us make sense of the world. We're we're gonna stay on and keep thicker. And yeah, just please record it then send us the audio. Thanks so much. Guys, that was really fun.

Thank you. You know what, that conversation made me think this is gonna be a meta point that we could get to the substance. The best sort of discussions are between guests who agree on a lot and share a lot of the same premises, but disagree on a few key things, like you have to sort of like share a common like assumption about how the world works. Those are the best conversations, right, But because otherwise it's often two people talking past each other exactly right, and that

was not they were not talking past each other. Well, I gotta say, I can't believe we hadn't had neal on before. But he's great obviously, and Luke. Every time we have Lucan, I'm so proud because Luke used to be our colleague and I just love actually, you know, he used to write for our team, and I love the fact that he's now a guest on all thoughts talking so knowledgeably about Macro Yeah, a little tier, yeah, thinking about Luke's trajectory. But yeah, no, I thought that

was really helpful. I mean, so many like interesting points. I mean, you know, it's Luke brought this up that I hadn't really thought of. But you know, it's interesting for all of the double dip or not double dip, but like soft landing, hard landing fears like actually so far, like the classical recession signals. And they talked about the euro dollar curve, like the market is not really pricing one in yet, right, it seems like stocks have overreacted

compared to fixed income. But the other thing, I mean, the other thing I keep thinking is just how I don't want to say obvious, but yes, obvious is the word. How obvious it was that there would be a correction in stocks at one point because I mean, the Fed we spoke about this. The FED hasn't explicitly said it wants stocks to go down, but it talked about tightening

financial conditions. And then you know, for years we're talking about valuations were frothy, that this was something that was going to start reverting once interest rates start hiking, and then lo and behold they did, right, Like I think, the surprising thing it's never easy in real time to make trade, so it's never like, oh it out here comes an easy trade. But I would say the sort of surprising thing is if you look at this sort

of narrative of what happened this year. It's kind of straightforward. Inflation picked up and the Fed said, Okay, now we're going to go in a hiking cycle. Oh and ps. The way that we control inflation just through financial conditions and we're going to like it's a part of those and the stocks are like a key part of financial conditions. It was it was the obvious trade. Just teleport me back to November or January when Defense started pivoting, and

I could have been I could have been a genius. Yeah, I guess it's like the timing aspect is the most mysterious of all of this. And why you know why we saw a rally on Wednesday after the hike actually happened, and it wasn't until Thursday that stocks started dropping off. That's the only thing that remains something of a head scratcher. Yeah,

the week was super weird, thats for sure. Yeah, it was, um, shall we leave it there, Let's leave it there, let's go take a break and you know, let's head into the weekend. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Wisn't all. You can follow me on Twitter at the Stalwart. Follow

our guests Luke Kawa He's at l j Kala. Neil Donna isn't technically on Twitter, but I think he often contributes to the handle of his Renaissance Macro and they're at ren mack l C. Follow our producer Carmen Rodriguez at Carmen armand follow at the Bloomberg Head of podcast francesco Leedy at Francisco Today. And check out all of our podcast Bloomberg onto the handle at podcasts. Thanks for listening.