Bloomberg Audio Studios, Podcasts, Radio News.
Hello and welcome to another episode of the Odd Lots Podcast.
I'm Joe Wisenthal and I'm Tracy Alloway.
Tracy, we're here in Jackson Hole.
It's nice to be back.
It's really nice to be back. So this is the second year we've come to the Big Kansas City FED Economic Policy Symposium, and I think it's fair to say, you know, we heard Powell this morning, there's a certain era of like victory.
Right, Yeah, the vibe has shifted. I think last year there was a little bit more I guess comfort with the idea of inflation coming down, at least compared to the year before. So remember two years ago was the famous Powell speech here in Jackson Hole where he stood up and he basically said there's no way we're going to get inflation down without a degree of economic pain, i e. A pickup in the unemployment rate, job losses,
that sort of thing. And now fast forward two years and he basically announced that it's time for rate cuts. And it wasn't a victory lap necessarily, but he sort of walked through how and why he thinks inflation has come down without those job losses.
That's right, and of course we've seen that tick up in the unemployment rate, not through big layoffs however, so there's not been a major degree of cuts. But the other aspect of that is, like, you know, there was some expectation that to balance the economy achieve the inflation mandate, there would have to be some loosening of the labor market. But what he said, and I think it was the second line of the whole speech, is we don't want
to see anymore we're good ones at this point. The risks to the labor market are what we're primarily concerned with, and we do not need to see any more weakness to be confident that inflation is no longer a major risk.
Yeah, so the focus has certainly shifted from upside inflation risk to downside labor market risk. But this opens up a whole new set of issues and things that we need to discuss, and I guess everyone's going to be focused on a slightly different set of economic indicators going forward.
Right, So now the question is like, okay, if you accept that the primary risk for the FED and Paul s edit, so it is is now protecting against further weakness in the labor market. What does that look like? Because yes, we know now basically for certain data rate cut is coming in September, but there are still all types of questions about the size of the cut, how
many cuts, the sequencing, et cetera. And from a market perspective in particular, I would say this is actually still a very live and open question.
No, absolutely, and the other thing that's happening, and we should get into this. But the FED has said so many times that it's data dependent now, and so if you say you're data dependent and you're really focused on what's going on in the labor market, then that's like a combination for everyone to be watching that next jobs report as an indicator of whether or not we get twenty five or fifty BIPs, or if it comes in better than expected, maybe you don't get a rate cut at all. I don't know.
I guess nothing is locked in stone.
Everything is possible.
Anyway, I'm very excited. We have the perfect guest today, someone that we have had on odd lots several years ago talking about similar stuff, including I think it was a discussion about how you even ascertained the neutral rate of interest. But we're going to be talking about the question of what will this rate cut cycle look like that we're all expecting. So we were speaking with Peter Williams. He is the managing director of macro Research and Central
Bank Policy at twenty two V Research. Previously he had been at the IMF, he was at Evercore. He lives in Bozeman, Montana. He just sort of drove down here to meet with us, do some fly fishing here in Jackson Hole, and also meet with us. She was not in the room, but Tracy and I weren in the room either. So we're all reading this speech. So Peter, thank you so much for coming on out locked. It's nice to meet you here. It's nice to see you here.
Nice to meet you guys. Nice to be down and.
We an intermitted person right before it was the first.
Time we got We had to meet on a fishing boat ramp.
Not so bad, Yeah, not too bad. So you've been writing even prior to the speech this morning, talking about like, okay, the rate cut cycle is clearly coming into view. How do you begin to think about the question? You know, twenty five fifty both seem kind of live at this point. How do you start trying to ascertain like what this looks like.
Yeah, so I think you know the starting point is, you know, Powell says, obviously we're getting some cuts. They're starting soon. I would say, while Tracy wants to keep every possibility open, they're going to cut in September, and realistically, in the vast majority of cases, they're also probably cutting
in November and December two. I think just penciling in some degree of front loading, because when you're in a risk management mode usually you move a little bit more aggressively than when you're in just kind of minding the
base case. We were minding the base case in like twenty seventeen, twenty eighteen, policy was slow gradual the last three and a half years, right since COVID hit in different ways, you've been minding the extreme tales in both directions, and now we're starting to worry more about the downside.
So you know, maybe base case from listening to thegitality of FED speak besides just Powell kind of still sounds like a fit a twenty five, but especially if the labor market data comes in a little bit softer than expected. All eyes on this sort of August payroll print for sure, but also the job was claims data as well, sort of cumulating over time. Yeah, I think it's a fifty certainly seems very possible and maybe even prudent. But I'm also not the guy in the room making the decisions.
Well, just on that note, are there pros and cons to twenty five BIPs versus fifty BIPs? So, for instance, maybe you want to be early and proactive, so you cut by fifty bases points. But on the other hand, I might imagine that there would be some investors or some people in the market who think, oh, the Fed's really worried about the labor market and that's why they're cutting so dramatically in September. It seems like there are benefits and all so downsides for each of those moves.
Yeah, I think at this point, with Powis saying that we're no longer really worried about inflation on the inflation expectation side or labor market driven inflation, the case for sort of not fifty to some extent, like not pretty aggressively front loading, you know, largely boils down to sort of institutional inertia. They tend to move relatively slowly unless you're in the midst of a very deep financial crisis
or something like COVID. You know, these mid cycle adjustments, at least hopefully that's what this is that we've had before have tended to be relatively gradual and small in nature, so like you don't often get these very large drops
and rates in relatively stable times. But against that is, we know rates are very high, we know interest rate sensitive parts of the economy have been struggling for a year and a half or two years now, and so the case sort of against fifty feels more of like an institutional one and sort of a desire not to spook market participants. But like we all kind of see the same data. If it is a little bit of private data we don't see, but we see the big data.
We all see the employment report, we all see claims,
we all see inflation. And if you're just looking at that data, it's sort of harder to make a case that you shouldn't just front load, you know, the initial part of the rate cutting cycle, and then from there you can kind of move into like weight and see mode or just pause, see what happens in twenty twenty five, But at least early on payback, some of the hawkish insurance they took out in late twenty two and over the course of twenty twenty three, and you can be a bit more level set.
You know, every cycle is different, But what do past rate cut cycles generally say about the way the Fed approaches it. I mean, it's different because the economy more or less seems fine. There is not, certainly not a consensus that we're in a recession currently. We're not in a financial crisis currently. But what does history say about how rate cut cycles work?
So you basically get two versions. There's a sort of mid cycle correction which ninety five, ninety six, ninety seven, ninety eight around LTCM and then arguably although people might have different views, instead of twenty eighteen nineteen yeah as well, and those tend to be relatively moderate in sort of cumulative size, like seventy five maybe one hundred basis points.
And then on the other hand, you ever sessions, and these are basically the two varieties of rate cutting cycles we've had in the sort of modern, kind of post vulgar era of FED central banking. And so I think even now it feels a little bit different because compared to those prior periods. You know, the assumptions about where interest rate should be in the long run, especially from
the Fed's perspective. I think market participants probably thin they're a little bit higher, but from most people the Fed, you know, the comedian still says two eight, and we're sort of looking at a pretty large gap to that compared to a lot of those other prior mid cycle corrections. So you're, you know, you're seeing a somewhat different sort of base rate on how far you might normally expect to cut. So the sample size of history is in a somewhat structurally different world.
Yes, So the other thing I've been sort of thinking about, and it's kind of remarkable about the current cycle, But you know, just a week or so ago, I think on August thirteenth, Bostic for instance, was talking about how the FED needs to see a little bit more data before it decides on rate cuts. And then fast forward.
To literally ten days later, yeah.
Exactly, he was talking about the potential for a fifty basis point cut. And then today at Jackson Hole we see Pow come out with an extremely ubbish speech where he puts the emphasis on the labor market and says we don't want to see further weakening. What happened in this sort of like two week period, Well, I.
Think part of it is for a lot of the more hawkish committee members, you've seen better inflation data. You know, the Q one shock looks a little bit farther in the rear of your mirror. Now you have relatively more confidence. And while we haven't gotten that much more marginal labor market data, none of it looks dramatically better, Like jobless
claims have been pretty well behaved. The last couple of weeks, maybe had these very large downside revisions to sort of trend NFP growth from April twenty three to sort of March of twenty twenty four, and it just makes the economy look a little bit more like it's been enough
funk for longer. And so that probably helps you reassess, like what your view on the medium tournament is, and if you're a little bit less optimistic about the steady state of where the thing should be headed, maybe you should be a little bit more proactive and trying to cut off some downside risks there because you've a bit less buffer in that sort of a world.
Does the first move tell us something about what the second move will be.
Yes, more so if it's a fifty, I think because either if you'd to fifty, I would say realistically, either the August employment report was pretty bad, so the direction of the economy walks worse. If you're still trying to head off something really bad from happening, you'll be more
aggressive with it. Or if the August employment report was fine and they still go fifty, then that tells you something about the reaction function and their desire just to be a little bit more proactively cautious in trying to
get rates down. So I think there if you see a fifty in September, realistically you should expect that, like the reaction function at least through early twenty five is going to be relatively more duffish than otherwise, whether that's pusis the data itself, or just the way they're seeing the world.
The other thing I've been thinking about the last time, or the first time we had you on all Blots, it was to talk about our star or the neutral rate, and since then, certainly this year, our star has kind of fallen out of favor. So I think the Bank for International Settlements came out and they were talking about it's better to base policy on observable inputs, like the actual data, rather than unobservable models. And I'm trying to figure out, like there's so much talk about data dependency.
Our star is kind of out of fashion, but is it still alive and well and sort of in the background of Jackson Hole And we're just not talking about it because it's no longer fashionable.
It's certainly not the operative concern for policy, right, Like, you know, if the primary motivating force at this point is like we don't want to see the labor market fall apart, powerful this stuff this morning, this is what's driving it, And you know our star maybe helps you inform like how restrictive your current policy stance is, but on like a quarter by quarter or meeting by meeting basis, you just know that rates are substantially higher than they
were a few years ago. Looking at rates in ceative parts of the economy, you know they've growing up, been doing great. Overall economic activity has done surprisingly the wall over the last couple of years, and suggests that our star has probably moved up some post COVID for sure.
But you don't really want to base Paul, you have like a very uncertain structural variable and say like, oh, we should only cut you know, fifty basis points because we're going to do a much higher our star because you can only solve those sort of longer run problems a little bit in the future. But like if you accidentally create a recession, that's a very persistent problem you
have to deal with four years after the fact. So it's sort of like different horizons for risk management, siness, the kind of.
So we know that the sort of our star is this sort of in economics that you can't directly observe it, but we believe theoretically exists that there is some rate that brings the economy into balance. What is the sort of economic explanation for why that changes over time? And just to add on to that, like why in twenty twenty four do economists believe it's higher than say it was in twenty eighteen.
Out of that, I think in the sort of post GFC decade, you had, you know, a banking system that was having to sort of you know, re solidify its balance sheets. There was a lot of new regulation about the banks making them kind of de risk. You had fiscal policy that after sort of the Obama Ryan deal was in much more restrictive territory given where the sort of business cycle was, and you had, you know, sentiment generally speaking, like on a corporate perspective, was just quite
subdued for a long time. Afterwards, you'd had this massive shock, and I think a lot of these very persistent but not necessarily permanent forces were dragging it down. You used to have like longer run forces like productivity and demographics that are sort of weighing on our star. But all of this sort of persistent but not permanent stuff has now sort of faded out, especially because the post COVID experience was the exact opposite of all those things. It
was massive, fiscal policy was very loose. Financial conditions, it was an absence of spending restraint on the part of households and the government were large.
So the other noteworthy change between this year's Jackson Hole and last year is last year, even though the trajectory or the momentum overall on inflation was good, it was coming down. There was a lot of talk about the idea that, well, there's always the possibility that it comes rearing back, and this could be the nineteen seventies all over again where it comes down dramatically and then it spikes a little bit later on. This year, it feels
like there's not much talk about that. There isn't even that much talk about inflation expectations being embedded, like all of that seems to have gone in the rear view mirror and it's all about the labor market. Do you think consideration of the return of inflation is warranted here? Should there be more discussion about the potential for inflation to come back.
Over the medium term? I think, you know, post COVID and especially you know during the contrast with the sort of like post GFC era, you know, inflation, that trend in inflation seems like it has moved somewhat higher. Trying to pin it down seems like kind of a fraud endeavor, but it certainly moved higher. There it was it was
sort of substantially too low after the GFC. Now it's preps a little bit too high, but it's not so high that it's obviously a problem for the FED, because I don't think most people notice if core PCE is two and are quarter percent or two percent or one point nine. Realistically, as long as like the labor market is okay, and that's sort of a world It like adds a little bit of a bias towards policy over
the medium term. And they've definitely been you know, some structural shifts post COVID that seems somewhat inflationary, but in general, at the moment, it's not really the operative concern as we had into like twenty five or twenty six. If the economy really reheats, that could be a problem down the road, but that's a problem for a very optimistic view of the world two plus years from now, not today.
So in Q one of this year, we did get warmer than expected data. You know, one point that we was talking about there are a lot of people thought the rate cutting cycle was going to start in March, and then we got that warmer than expected data to
start the year, and then they had to push that back. So, okay, what if we have like another period just to you know, for whatever reason, some component or something, you know, let's say Q four does run on the warm side, and they feel, you know, there's some let's say, questions emerge about whether they should continue the rate cut cycle in the face of this data. You know, let's say the job's coming strong and suddenly things look warmer in the
short term, not twenty twenty five, twenty twenty six. What are the costs for the FED if the rate cut cycle is you know, sort of aborted so to speak, I mean, or if they feel, you know, it's like you're like, you know what, actually, we don't want to be cutting rates as fast for whatever because the data does not come into way they expect.
Well, if you get surprised by the data, you should respond to it. And I think fundamentally the issue that I've had with a lot of some of the FED speakers recently is that they're sort of premising this notion on doing the appropriate thing now about something that eventually down the future could maybe be a surprise. Yeah, and like, you know, some part of policy needs to be consistent over time, but you know a lot of shocks happen
in the economy. It's always evolving. And I think the notion that like, you can't do something today for the most predominant risk because you might get a little bit of a surprise direction a year, for an hour, six months from now.
People really do talk about this. They like there's like, oh, the Oh, the worst thing that would happen is they have to backtrack or something. And I'm trying to understand, like, okay, if that's so bad, what exacts is so bad about it?
I think there's a fear that by changing your mind, maybe you you know, elevate risk premium, you make markets a little bit less certain.
But I mean we did just see massive drama in the market. Yeah, because of like a reconsideration what the FED was doing.
Yeah. True, It's just I think, you know, the worst thing rather than not respond, you know, if you're worried that like you might have to change your mind, but it's much worse to not respond, I think, you know, fundamentally, Like yes, maybe it shifts you in a little bit on the margin of like well we should do a little bit less because of the medium the inflation story or something. But the softening in the labor market, you see,
power was very clear, Like that's in the data. You can interpret it in different ways, but like the labor market is back to normal, maybe even a little bit soft. And if you're worried about that as the sort of dominant kind of breaking things risk because you know, presumably once recessions start, they get going pretty darn quick. That's something you really have to sort of trunkate away pretty quickly, like, okay, it didn't happen, Well, okay, that's fine. You can sort
of move on. It's like, you know, you buy a bunch of insurance for your house and then like the wildfire doesn't come. There are worse fates.
I mean, I still think it's a pretty big shift. Post financial crisis, it was very much about forward guidance and sort of trying to pin yields to where you wanted them, and then I think it was twenty twenty two it moved to the data dependency very very short term. It does feel to me that there's a downside here to saying that we're going to react to every data point, especially when there's still big question marks over the quality
of the data. And we just had that BLS revision that everyone was talking about.
So the way you sort of robustify against that is you still have to have some sort of forward looking view on a policy relevant horizon. Six or twelve months out is typically when you thing like monetary policy can really impact the sort of top line kind of macro data, right, So you have that sort of view, but you're updating
it relatively robustly as the new data comes in. But the problem, especially over the last year and a half, is that different parts of the data have been telling you relatively different things, so you sort of have to average between them. And the more you get into like a sort of risk management driven mode, maybe you'll pay a bit more attention to the most pessimistic parts of the data right now, the unemployment rate perhaps, or you know, if everything else holds up, well, you might shift the
signals you're paying attention to. If that theory you had about the unemployment rates sort of spiraling doesn't come to pass, then you'll pay me put one more weight on the activity data or the NFP data. Despite the revisions that just had still looks okay, if not fantastic.
What do you think about like the efficacy of cuts, because okay, for a while, there was questions about, well, what are the efficacy of rate hikes because they didn't seem to be doing much for a while, and they certainly didn't impact the labor market as people had anticipated, and various stories everyone has their mortgages locked in or yes, it affected the economy, but only in like real estate and like auto loans or you know, much of the
economy is not rate sensitive and how long are the lags, et cetera. So it feels like, to some extent, we need to have that version again for the cutting cycle and what we expected to do. So from your perspective, like let's just say the FED goes fifty or twenty five or whatever. In your view, how does that transmit to putting that floor under activity and how quickly?
Yeah, I mean, some of it is just ratifying what's already priced in markets. You know, they have pretty strong assumptions about cuts over the next year and a half or so, So to some extent, you still have to do the thing that's priced in, even though like yep, you know, long term rates to people borrow it may not change that much. But I think a lot of it also has to do with a sentiment shift on the part of what call them like wes, financially sensitive
firms and households. We're just seeing headlines about FED rate cuts sort of changes the tenor of your business and maybe changes some decision making because this comes through in a lot of surveys. You know, to an extent that often kind of surprises you when you're reading them, but there's a pretty large amount of attention paid to just the headlines. Yeah. The headline is the Fed's going to get your back starting in September.
Yeah, Tracy. Speaking of the surveys, there were a lot of specific comments the last couple of months, I think, in like the Dallas FED Manufacturing survey of business owners specifically saying like rate cuts please, or we expect things to be good assuming they're rate cuts. So people are paying attention.
Yeah, although they were kind of saying the same thing a year ago as we I mean, we were talking about the VIBE session and some of the stuff you read was like, it's an absolute disaster the FED cut. Right now, Peter, what's the most interesting thing that you're watching now when it comes to the Fed and monetary policy? We've had the shift that some people were expecting, the emphasis moving from inflation to the labor market. What should we be on the lookout for now?
I hang in the short run, it's sort of rate sensitive spending because if you're perhaps a little bit worried about the labor market and how activity data is going to shake up with rates having been so high for so long and like maybe things just tip over on there. In accord, you need to see that sort of rate sensitive spending in the economy start to kind of recover
and rebound there. You know, the housing data has been relatively soft so far to start the summer since market rates started coming down, but as you sort of get through into like later this year and into early next year, you really need to see that rate sensitive spending part of the economy start to rebound because if that doesn't happen, to Joe's point a bit ago, the efficacy of police on the downside, in addition to the upside, becomes a bit more of a concern, and you worry that the
Fed might not have the economies back in the way we all kind of assume right now.
Peter, so great to meet you in person and run into each other here. And Jackson Hall, so thank you so much for coming back on outlaws.
Thanks so much.
Great to be back again, Tracy.
I thought that was very helpful. You know, they're obviously going to be a number of questions here, but one thing that is in particular I thought was interesting was this idea that like whether they go twenty five or fifty will tell us something more generally about like the reaction function and their sensitivity to weakness, what twenty twenty five might look like, and so forth.
Yeah, it does feel like it's a new regime, and we're going to learn a lot to your question, which I thought was excellent about out the transmission mechanism of the interest rate hikes. That's going to be something interesting to watch in reverse as well, right, like, okay, well, now we're cutting to boost the labor market. Is it
actually going to work as intended? Or are we going to get all these existential questions as we did when inflation was high, and you know, there were lots of hikes and we were wondering whether or not they worked totally.
You know, there was a really interesting paragraph in Powell's speech where he's like, why did inflation come down? And the thing is he said there were essentially transitory factors that took longer than expected, and there was the rate hikes that depressed demand, But he didn't assign like a percentage to either one, So we don't really know, and so you have to figure on the way down, we really are going to be having all of these same conversations, except in reverse.
We should just record all the or rerun all the au thoughts episodes in that verse backwards.
No, you know, it's like if the story was like, oh, the households and the lack of thing and that's why it's not working, well, then what's what are the lower rates going to do to put that floor underneath activity?
Well?
I did notice also he didn't mention it by name, but there was this idea of the beverage curve in there as well, and so you know, job openings have come down without having mass layoffs. But he didn't really explain why that had happened. It was just like, you know, we thought that this might be a possibility, and if it happened, then that would be the key to a soft landing. And now it's happened. But he didn't really
go into why. So I suspect there are still a lot of unknowns in how the economy is functioning.
And he said that too, which is that people will be debating these questions until long after we're gone, which is like how extraordinary the last four years have been will be you know, in the same way they're still writing papers about why the Great Depression happened. They're going to be writing about what happened from twenty twenty to twenty.
Four, so something to look forward to.
Yeah, all right, covering it?
Shall we leave it there?
Let's leave it there.
This has been another episode of the All Thoughts. I'm Tracy Alloway. You can follow me at Tracy Alloway.
And I'm Joe Wisenthal. You can follow me at the Stalwart. Follow our guest Peter Williams. He's at Peter D. Williams. Follow our producers Carman Rodriguez at Kerman Arman Dashel Bennett at Dashbot and Kelbrooks at Kelbrooks. Thank you to our
producer Moses Ondem. For more Odd Laws content, go to Bloomberg dot com slash odd Lots, where we post transcripts, a blog and a weekly newsletter and you can chat about all of these topics as they're doing right this second twenty four to seven in our discord Discord dot gg slash oud lots.
And if you enjoy odd Lots, if you like it when we go to Jackson Hole to cover what policymakers and central banks are talking about, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is connect your Bloomberg account with Apple Podcasts.
In order to do that, just find the Bloomberg channel on Apple Podcasts and follow the instructions there for listening