Where Things Stand Now With Inflation and the Fed

I think the headline figure was seven point one percent, which was lower than expected. Right, so a pretty big week, I mean, the story the big macro stories. Everyone's waiting for some clear sign of inflation deceleration. Everybody is trying to figure out, you know, is the FED going to pivot and what PIVO even means, which I think is

a contested word. And so I would say a pretty big leak because, as you say, we got an inflation report, of FED announcement, press conference, all of that, and so I think a good moment to take stock of where we are in these stories, Right, Is this a turning point in these sort of high inflation, interest rate hiking cycle narrative that we've had for some time, and the fact that I've said turning point means that, and the fact that we're doing an episode on this means that

it's probably going to amount to nothing. And I've cursed it, but you never know. We keep the setting ourselves up for the jinks right now, so we have all of our bases covered. But anyway, I think we should just get right into it because we have two great guests, two of the people we most like to turn to on these big macro questions. We've spoken to them many times over the years. We're gonna be speaking with two guests.

Tim Dewey is the chief US economist at s g H Macro Advisors as well as the Professor of Practice in Economics at the University of Oregon. And John Turk, the founder of j ST Advisors and the author of The Cheap Convexity substag, which is a must read. Tim and John, thank you both for coming on. Well, thank you for having us. Thank you absolutely so. Why don't you know, I'll throw a question out for both of you, but like really simple, we just uh, just as we're talking,

wrapped up Powell's press conference. Why do you sort of give us your summary? You know, you start with Tim, but both of you can go of, like, what did we just learn from Powell? Well that's a okay, So what did we learn from Paul? Uh? So, No, No, you know, I think, you know, I think the main thing that that we really learned from Paul is that they are very much committed to this idea that they need to hold rates, you know, at a at a

restrictive level for for an extended period of time. Uh. And then we also know that they're closing in on what they think that level is. And and so you know, what this seems to be coming down to is causing you deliberately causing something that that looks very much like a recession, although Paul Paul always say that it's it's something in the forecast. Which is interesting now because it's gonna create some questions given this disinflationary trend we're seeing

in the data. It's really gonna people are gonna start asking, well, why do you need to create a recession here? Right? John? Yeah? I mean, for me, I think of it that I

took away three key things from today. I mean, I think that one is that they are kind of transitioning from this where is terminal to how long to stay their stage, And I think that that really was I think most put forward by the fact of policy very open to going in intervals starting at the February next FOMC meeting, so that, you know, along with the commentary of the press, commerce doesn't make it seem like they're in the ballpark of what they deemed to be so

fficiently restrictive. I think the second thing is that they are seemingly looking at this at least ex anti as that they want to stay at five around five percent FED funds for a while. And then third, I think the interesting thing from the dots to me. You know, obviously one can point to an interesting PC number, but I think, you know, most interesting to me is that if you look at the real rates for twenty three and twenty four using FED funds and their core PC projection,

it's a hundred sixty basis points for both years. So I think in terms of defining what sufficiently restrictive this sort of vague maybe dynamic term means, I think they gave you a pretty good insight into the level that they seemingly are going to be targeting. That's you know, equates to inflation back and target over the medium term. So this is something that I wanted to ask both of you. But I feel like there are a lot of terms that you know, we throw around now without

really like digging into them very much. I mean, transitor inflation was one of them from last year, and now we're talking about transitory deflation, which is kind of amazing. But can we talk about restrictive, Like, what exactly do we mean when we talk about the FED moving to a restrictive policy that can be for either of you? No, Well, well, it's it's unfortunate that the FED doesn't doesn't seem to entirely know when when they're going to be restrictive, right, So,

so how are they going to figure this out? And it's it's the case that they're looking for this this rate that they think we'll create downward pressure on the labor market, sustained downward pressure on the labor market, and the desire is to get wage growth down in order to really reduce the inflationary pressures that they think are going to persist if if unemployement stays this low. But

but but what is that rate? Uh, you know, I think the best way to think about is is maybe, like like John was saying that maybe it's a a rate of a hundred sixty basis points, but but I don't know if we should have a lot of conviction in that number. Yeah, you know, I think that it is sort of this you know, feel your way around, you know, even in the context of what I know

a message I took away from the SEP today. You know, I think that what I think Loretta Mester actually set up a decent way of thinking about it and sort of these like broad Stokes and in my notes the Climes that kind of called it like the Themester roadmap.

But it's basically this idea is that once the FED gets to a rate that has, as Tim says, you know, sustained downward pressure on the labor markets stain down and pressure on economic activity, they can basically tee off this handoff from below trend growth to slowing wage growth to slowing inflation. And I think that is sort of the sequencing is that they're trying to achieve, and they can only really know which level is doing that in real time.

Of course, they'll have model estimates that will guide them, and we'll, you know, we'll sure we'll see a Coshari blog, you know, following this meeting on what that looks like. But I think that you know, broadly speaking, it's going to be very much informed by the data. And this is something that I think, you know, a takeaway from me from this meeting is that you know, sufficiently restrictive is not a you know, it's it's not an absolute level,

it's a it's a dynamic level. And I think, you know, going into you know, the next two years, staying still may actually include moving, but we can get into that. Let me back up a little bit, because set Us had the FED, let's talk about the day before. On Tuesday, we got that CPI report that Tracy mentioned in the beginning. Core cp I on a month over month basis came into just point two percent headline, obviously influenced a lot by the plunge and oil prices which can only go

so far. I guess just zero point one person, Tim, is this like, when you look at this report, are you optimistic? Are the reasons to be optimistic that this is the start of a sustain in a bold trend or is this noise. Yeah, certainly when I look at the report, I had to be sort of honest to uh, you know the approach I was taking last year, earlier

this year. And you know, when when I saw this inflation numbers started to rise and I saw what I call super core inflation, right, uh, core inflation minus housing and autos, you know, I really started to say, you know, we can't ignore you know, this inflation is transitory. And I'm kind of the same position as right now is that we've seen a lot of improvement in that super core and narrowing of of some inflationary pressures. And so it does seem to me like there has been a change.

Now whether or not that's persistent will we'll find out. But I do think you kind of have to have to take the number face value and saying, yeah, there seemed to be a few of the lessening of inflationary pressures, at least in the near term here. So one of the things that Pal said today was, you know, he was talking about how there's this expectation that services inflation is going to be tough to bring down because the labor market is so strong and wage growth is still

relatively high. And that's the thing that kind of feeds into overall prices. I mean that implies that the FED is explicitly going to be targeting like a softening of the labor market. Right. I was thinking that this is a way you can sort of tell that the fetish hawk is right, is that they're they're they're very much focused on getting inflation down, even at the at the cost of getting unimplanted higher, you know, considerably higher. And you know that's that's I think, you know that we're

definitely trying to achieve here. So inflation is starting to come down. But for the past year or so, we've been told that the reason the FED needs to be so aggressive is because they're worried about expectations becoming embedded. They're worried about a wage price spiral. But the fact that core seems to be beginning to come down, does that suggest that maybe those concerns were overblown. That's gonna

be the question that people start to ask. If core is coming down and the FED sort of backing down to this argument that that we really need to get this this lower level of core inflation services minus x housing down, it's going to cause some some concern about, well, why why is that now the measure of underlying inflation.

Why should we be focused on that and not in fact the idea that maybe we can return to type of environment and the FED doesn't hasn't changed the narrative to to to allow that to happen yet, So I think it's going to be a question that's increasingly important as overall cored inflation if it remains low. I like

two things on this. I think that, like Tim said, it's absolutely right, you know, I think that they're really like two reasons for why, you know, this rendition won't just be the reciprocal of sort of the you know, inflation rising period of late last year early this year.

I think one, and this is why I think the FED is so emphatic on showing us that they're going to be looking at you know, services XO er sort of this like core labor market trend is because the FED knows that the labor market is not a tail when to achieving their goals. It's a headwind. So given the state of where nominal wage growth is, it's much harder to have you know, conviction that inflation is going to settle back at two percent when nominal wage growth

is five and a half. Whereas we flip it to where the FED was, you know, in late last year early this year, it was it was becoming pretty obvious that you know, inflation would be even if there were transitory factors, it had this structural tail when from a

very robust labor market. So you know, in terms of comparing then to now, I think it's it makes sense for at least like in terms of a range of outcomes, for the FED to be more hesitant into embracing this trend disinflation versus them accepting trend higher inflation because the labor market dynamic is feeding into one and not the other. And I think the second thing is, you know, on inflation expectations, you know such a big part of it.

And this is something I think that you know, Powell has been really pounding the table on really I think since June when they made their initial rise to seventy five, is that he said that above target inflation in terms of expectations is not only about trend, but it's about level.

And then from there it's like a ticking clock in terms of in terms of its feet through two inflation expectations, whereas if you allow inflation to remain above target for three or four years, even though it's headed in the right direction, that level can be a nuisance in terms of inflation expectations and making sure that inflation is anchoring a two percent So I think that you know, there are you know, similarities to playing that this is the

reciprocal of the bull had been goods. This is the reciprocal to the bull with rents. But at the margin there are more factors for the FED to be hesitant in this full embrace of the early signs that they meaning, especially because they got burned on that last year too,

So you know, that's there there. This has always been I think, you know, I'm not a risk, is not a risk the likelihood that the FED was going to, you know, was going to hold hold the line here for longer than than than maybe market participants thought appropriate, simply because they thought the risk of budding in flesh and get uncontrol and and Paul reidered that, reiterated that today it was just simply too hot. So I want to talk more about labor and tim This is a

question for you. So right now, the unemployment rate is three point seven percent, And in the press conference, I don't think like Paul like specifically talked about a soft

landing per se. I don't know if you used that term, but he did seem to express some hope that we need to see some weakening of the labor market, but that maybe you could just be a little because all you know, the labor markets really tighten his view, there's all these unfilled job openings, there's a structural shortage of workers. So maybe we just need a little bit of tilt.

What does history say, Can we just get a modest increase in the unemployment rate to like the low floors, or if we start to see that pick up in the unemployment rate, does history say it's going to go up substantially more than that? Yeah, I would say that that the history is is not the Fed's favor here, that that you really can't guide the unemployment rate, you know, three tents or or five tents of the percentage point higher,

let alo point nine right brains higher. So uh, you know, I I just don't think that this sort of soft lending idea is a likely outcome here. Um. I would like it to be right, but to me, it seems to be screaming against what we've seen in the past. Yeah, Tracy, I'm just looking at the FEDS set the Summary of Economic Projections, and it anticipates the unemployment rate peaking at like, you know, hitting four orth three point seven now, going to four point six next year and the year after that,

and then going down a bit. So there's like this idea that we just get a little bit. You know, one person is not nothing, especially the people who have lost their jobs. But you know, the story the Fed

is telling is that the unemployment rate will be contained. Well, this is something else I wanted to ask about, which is, you know, we hear comments from the FED a lot now about how monetary policy operates with a lag, and that to me seems like as big a question shin as the transitory inflation question that we were discussing, you know, a year or two ago, like how long is the inflation going to last? How long is it actually going

to take interest rate hikes to have an effect? Do we have like a good sense of that, Like the fact that we've saw cp I come in less than expected yesterday, is that the a sign that monetary policy is working, is a sign that monetary policy has the potential to overshoot, and you know, cause the recession that everyone seems to be worried about. I think that, you know, broadly, the long and variable lack question is just very hard to answer. I don't think there is a clean one.

I think that there is this assumption that the FED is like talking in central banks broadly, are talking about about long and variable lags in the sense of, you know, well, we should slow down and then wait six months and

you'll have more apparent evidence. And you have seen it across the I mean, the Bank of Canada is recently transitioned from saying that you can feel the monetary policy tightening and just the interest rate sense of sectors and the economy, and now the whole economy is starting to feel it. So I think there's like, conceptually it makes a lot of sense. I don't think that there's like a strong empirical approach to say, okay, you know T minus nine months, this is when we'll start to feel

the whole thing. I think that the way the FED is thinking about long variable aggs, and maybe I'll be more specific to the leadership is I think the way the FED things about long variable aggs as you kind of hope to engineer this, this handoff to pro cyclical tightening.

And what I mean by that is that basically you let the disinflation that's occurring basically raise your real effective funds, right, And I think that the FED is now at the point where the long and variable lags is that now you're starting to see the data at least begin to cooperate with them. There has been some softening, not a lot, but there has been some softening in the labor market. There's definitely less churn, as we can see from continuing claims.

Jolts have come down a lot, the inflation data starting to look a lot better than it did three months ago. And now I think from the FEDS long and variable lags quote unquote perspective is it's about, you know, exerting real positive policy rates across the curve and letting that sort of service. This that the new form or or anchored form of tightening more than you know now what

we've been doing now, which is ratings. I want to go back to the theoretical question about whether some sort of immaculate disinflation is possible, or whether we can have inflation return to trend without a big jump in the unemployment rate. I mean again, just going back to the last few weeks, so we gotta you know, pretty a good November CPI report. We also had that hot wage growth number from the recent Non Firm Perils Report. I mean again, we're pulling out of just very few data points.

Like you, I don't think you could tell a tremendous story from one CPR report, two CPR reports and one wage number in the Non farm Perils Report. But I don't know. It looks to me like you can have both. That you can have this period where wages are growing robustly, where the unemployment rate is low, and some sort of rollover.

What would it take for the FED? I guess my question would be to say, you know what, maybe it's possible, maybe we don't need to induce a recession, or maybe we don't need to see much of an increase in the unemployment rate at all. What would it take for the FED to look at you know, how many more of these cool CPR reports would it need to be before maybe the FED started believing in the possibility of

a soft landing. That's a that's a big question. I asked myself a lot exactly That reason is you have seen some improvement in the inflation numbers, and it seems

like it's almost premature. Right, we had been expecting, and the FED had been expecting, that that improvement would really follow the labor market, and it's coming, you know, it's coming ahead of you know what we see as any any significant loose sing remarket and that the FED is going to be worried, and I think rightly so that you know, persistently high inflation excuse me, persistently high wage growth, if not matched by sufficiently high productivity growth, is over

time going to lead to upward pressure on inflation and upper pressure on inflation expectations. Uh. And that that basically the argument that that wages and inflation are are tied together in the long run, and we could be seen in the short run is all the slippages that that can happen. So you could think of uh, you know, higher wages being resolved through lower margins, right margin compression.

So you know, I think, as you said, it's really hard to make anything any clear decisions off of just a couple of months of data. But you know, the FED will have I think a hardard time selling that story going forward again, If if inflation continues a lot, especially if if the core services inflation numbers starts softened more than that's, that's gonna be something. It's it's gonna be harder to explain. When did we start calling it

immaculate disinflation? I don't know this. Who came up with that? I think like the earliest mentioned. I was curious because this is the second or third time I've heard it just today, But the earliest I can find is actually Matt Klein in his newsletter. Um, it sounds like a summer's thing, I feel like, right, So I wanted to ask about financial conditions as well, because I mean, this

is something that has come up. Neil Kashkari talked about it on on this podcast, talking about how he was happy to see the fall in stocks which fed into a tightening of financial conditions. And of course, monetary policy is supposed to work through either loosening or tightening financial conditions. But in recent weeks we've seen those conditions start to loosen again as bonds are rallying. Stocks have been rallying up until today, it looks like that is down a

bit after the FED meeting. But John, this is for you in particular because I know you were very very focused on the stronger dollar over the summer, and you had argued that the strong dollar would end up doing some of the Fed's work when it comes to tightening financial conditions for it. But now that the dollar in particular is softening and financial conditions in general are loosening, does the FED need to be concerned about that? Do they need to try to move to offset that? That's

a good question. I don't think so. Um, And I think that you know, from the FETs perspective, at least, you know, looking at it in dollar terms or US dollar terms, is it really almost was job done? I mean, we can, of course, you know, add in that China being effectively shut down for a lot of the years certainly helped com under pressure come off. We can also added that the spr a tremendous amount of relief to

oil markets. But you know, I think in terms of the commodity supercycle that was being pitched, the dollar did new or a lot of the right tail in you know, the broader commodity complex and just looking at you know, the Bloomberg Commodity Index it's all from material amount from its highs. So I think in those terms, the FED

has achieved a lot um. I think, you know, thinking about the financial conditions question, and this is one I actually, you know, get a lot because we have had a non trivial move and you know, and looking at something like a Goldman f CIS basket over the last few weeks. I think the way to think about it, and I think the way the FIT is broadly thinking about it, is that f c I s are sort of this this relative term. They're relative to the spot labor market

data and this spot inflation data. And if f c i s were loosening in the context of the inflation data getting worse or the unemployment or the employment stuff getting better, I think that would be at odds with

something that the FED is looking for. But you know, a point that I've been making over the last few weeks, if the f c I s have sort of been quote unquote earned in terms of a slight improvement in the labor market and more than slight improvement in the inflation data, even though it's only the last two months, then I think that's something that it's not necessarily equals like the FED is going to fight where you're going to It requires Powell to sound like he did at

jackson All. I mean, I think the pretty telling thing for me was when Powell came out in Brookings and everyone was expecting him to, you know, beat the hammer on financial conditions, assuming that they loosened too much. He didn't, And I think that part of the reason he didn't is that this is different than it was in July and August, when there wasn't really any compelling evidence that

inflation was following. We actually saw two months of point six is after and the claims moved from that when saw you initial claims reached k W back to two ten basically over the course of a month. And then it was more of a reaction function question how serious is the FED? Is the FED willing to do what it takes? And then Powell came out and Jackson All told you we're gonna do what it takes. That's not

really the question. Now the market is full said we'll do what it takes, looking at you know, either for inflation stops or break even rates. The question now is is how much earned financial conditions can you loosening? Can you have? And that is I think data dependent, and I think that that's I think that's going to be the way that shakes out over the next few months.

So just on this note, and this can be for either of you, But looking at the market reaction today, you know, stocks went up a bit right after the decision was announced and they've come back down since then.

But in terms of the market reaction as the as the data, assuming the data starts to change and evolve, and we do see sustained deflation and maybe maybe even a little bit of weakness in the labor market, is the FED going to be able to continue to convince the market that it is in fact hawkish because that seems to be what it's trying to do, right. It needs to maintain expectations, put pressure on financial conditions and things like that. But is it going to be able

to do that as the data starts to change. I think it gets to to John's point, is that that if the if the data is moving in a disinflationary direction, the market is going to go with that because they're gonna assume that. Sooner or later, the FED is going to catch up to that approach. And it's it's really more problematic for the FED if if the market is

just not getting the FEDS reaction function right. You know, where again there could be some tension here is if the FED is excuse me, the markets are looking at core inflation and the FEDS looking at this you know, this services x housing component would be would be more interesting in a space where there could be you know, room for for confusion. But I think you know, once the data turns, or the markets starts to sense the data is starting, the FEDS is going to have a

hard time you know, selling selling that story. It cuts both ways to if the data firms here, lower prices cause consumer spending to rise um for example, or real terms, in real terms, they could sort of tighten back up financial conditions. Well I joked about this over the weekend, but I don't know, you know, it's kind of only half a joke or half a troll about you know, we've had this big plunging gasoline prices and maybe because

of that, maybe some of that is softening demand. I don't know, But for some people that's like a huge financial shot in the arm. I mean, that's like a lot, you know, that's more money left in the wallet each week and so you know, I think what could cause the data to firm. Maybe it's falling gasoline prices. But sim I want to you know, I want to go

back to something you said. You know, you think about, Okay, what are some ways we could have like a soft landing, And one of them would be if we got some period of like catch up productivity. And we know that productivity I think has been pretty bad. What's your story for why productivity has been bad? And is there a possibility that whatever cause that could flip in some way and then we get a big spike in productivity. Yeah, so to you're measured as a residual you know of

of GDP growth and unemployment. So you know, how how how um you know how confident we are of that number? Should it should always be in question? But it does look like productivity has been weaker this year. And you know, I don't know that anyone has some some hugely great explanation for this. I think that when you kind of run the economy too hot, you run it inefficiently. And that seems to be to me what was going on. You have to you have a lot of turn in

the labor market. Maybe you've got some new new employees, some younger employees, and they're just not as efficient, you know, and and they're struggling against stronger demand, so that that eroades your your relative productivity. So I think I think that's a reasonable story. And then theory could could you know, ease back up if if people got some really breathing room on demand? Right, So, I think you know that's

something that goes on to me. If you want a soft landing, the most important thing is is getting the FED to believe that you can have a soft landing. Um, you know right right now that that's I mean, they're

saying you can have a soft landing. But again we can debate whether or not the rise in unemployment that they have penciled in is consistent with that alcohol and I would say say no. But you know what I'd like to see for soft landing is for the FED to book to believe you fully, they just do not have to keep hiking rates and can cut them sooner than they anticipated. Tim, I want to ask you about

this as well. So, setting aside the prospect of a soft landing, which has now been rebranded as immaculate disinflation, it feels like the big concern or fear for the FED would be significant stagflation, So inflation combined with you know, negative economic growth. What would they do in that scenario. Paul has Has has said the objective here would be

to bring inflation back down to trend. You know, I think that if you had a real stagflationary episode, how the FED dependent would really depend upon what they thought was happening with inflation expectations. So if you had, you know, elevated inflation this year going going into this suppose elevated inflation was was something we're still experienced, and then suddenly the unemployment got rate was rising, you know, the FED would start to think, well, you know, higher unemployment rate

should pull down these inflation numbers. And so so the key in there would be what would have what would be happening with inflation expectations. If the FED could could be confident that that that they can focus on the employment mandate without worrying so much about the inflation mandate because they thought that was going down, then they could you know, pursue an easier policy. But if they saw inflation expectations rising, um, they would they would pursue a

more aggressive policy John. You know, one of the things that Paul was asked about was, you know, we're talking about how many more hikes, but he was asked about cuts. And there still seems to be this tension between what the Fed officials have said and what market pricing have said.

And so you know, all year the fetish like what do you guys even talk about We're not anywhere close to thinking about cuts, or at least that's basically my summary of like it's like, we're not, you know, we're not We're nowhere closed, and yet the market seems to be pricing in rate cuts and not even very far out. In fact, you have an inversion of the three month to year curve, which means, you know, rates in the fairly short next couple of years lower than they are

right now or over the next three months. In some way, like what do you make of this divergence, because it's been a story, I think for several months, this gap between rhetoric and market pricing. Right right now, it's a good point, and I think that there's there's two parts to it. I think that that the and I'll talk about it in stage terms, and the first stage of this was really the middle two q three of this year. Part where the market kept saying is like, Okay, they're

going to be cuts in X amount of time. And I think that was really a byproduct of the market's assumption that given all of this fix think of volatility, given the rapid increases in the federal funds, right that something was going to break, whether it be the labor market, whether it be a financial accident as we saw in the UK, something of that nature would break and the FED would have to unwind some of the things that

it did. And that's why we always, even you know, looking as far back as June, we always kind of assumed that cuts couldn't be more than nine to twelve months away. Um. And I think what is happening now, which is different than that first stage, and I think is actually a little bit more sustainable, is the FED is basically not officially, but you can glean into the

fact that the cycle is almost over. And from the market's perspective, once the market months the FED convinced conveys to the market that palace preferences probably for twenty five in February, then the market has to trade with a percentage chance that marches a pause a very reasonable percentage chance given what is seemingly the trend of you know, disinflation at least through key one UM and then from there the weighting game, the market is always going to

trade the skew that either hard landing or soft landing will happen, and in both of those cases, the feed isn't at five percent forever. You know. The way I've kind of looked at it is is that there's three potentials for next year. There's the no landing, the soft landing,

and the hard landing. The no landing is sort of we find ourselves in a similar world to where we are now, or inflation is to not convincingly on its way back to two nominal wage growth is still five and a half percent, and the FED is just kind

of stuck. The soft landing is that you sort of get into this twenty nineteen world where the immaculate disinflation does somewhat take place, and then you could see yourself as you know, Goldman Sacks Q four forecast for you know, CORPC next year is two point nine, and the FED could feel at two point nine the five five and change is a bit too high in terms of the know how restrictive policy needs to be and that could lead to cuts. And then in the hard landing scenario,

we obviously know that they cut a lot. So from the market's perspective, once you told them that there's really not that many more hikes left, maybe just fifty basis points, the market is going to lean into the skew cuts. It's just a faction of the time. M Yeah, there's there's really nothing that the FED I think can can do about that at a certain at a certain point. So, you know, we've been focused on the FED for obvious reasons.

But John, I know you've been in particular looking at some other central banks, and you refer to the Central Bank of New Zealand the Reserve Bank over there as something of a north star in terms of the read across to other major central banks. You know, it was one of the first to actually start hiking rates. Can you maybe talk a little bit about what we've learned from the experience of central banks x U S. Yeah, No, I mean I think that you know there there there's

been a few interesting examples. I would say over the last few months. I would say that the rbn Z sort of in both ways either in terms of their policy trajectory has been sort of this north star, as you said. But I also think that you know, for me sort of like thinking about the trajectory of the cycle and you know, what is the sort of the next phase of you know, of trading interest rates. Um. You know, I think the RBNC in November was a pretty telling meeting in terms of how the market is

digesting this potential inflection point in the cycle. Because with the happen of the RBNZ in November is that they accelerated their hiking pace from fifty to seventy five from a place that was already restricted. And then in their monetary policy statement and there you know, their forecasts for the economy over the next few years, they said that they see the terminal rate in New Zealand being close

to six percent. So this was a very big rerate in terms of both the actual hiking actual hikes that they did, and in terms of the hiking cycle in its totality and the market's reaction to that, which for most of this year would have been you know, rates at the very front of the curve ratchet higher, actually rates you know, yields increased on the day, but actually didn't make a new higher relative to where they were in October and September, even though given there's new marginal

information and the arbanc he was much more hawkish, and I think many market participants thought of so I think, you know, in terms of where you know, using these leading hours, but also getting a feel for sort of what the distribution is in terms of markets. I think the RBNZ was very telling in terms of, you know, how the cycle, at least the hiking cycle towards the

end of hiking cycle is going to be traded. And I think that you know, broadly speaking, you know central banks around the world now, is that there were going to be in this divergence period where you know, there are central banks they're going to see very clear and obvious signs of growth deceleration, and they're going to be

central banks that don't. And I would probably put the Fed in the don't camp, whereas it's not obvious to me that you know, GDP next year is on track to run it as the FED thanks zero point five percent.

You know, I think, as Joe was sort of cheekly alluding to earlier, is that you know, there's some pretty decent impulse for growth, given that the composition ship is getting a lot more healthier in real terms, and if you can sort of get a little bit less financial market volatility, you can maintain some decent real income growth, which we have sort of scene now since July. Then I think the economy can do you know, pretty well.

Whereas you know, places like the UK, even Canada, places with you know, very high you know, private debt levels relative to GDP and have a lot of or intense you know, floating rate mortgage exposure, you know that those places are going to feel growth in a very different way. In those central banks I think will be quicker to be like listening, we have to be a little bit more two way in terms of, you know, how we approach the cycle. So I think it's gonna be. I

think there are still north start. I think we're entering a period of pretty meaningful Divergence's interesting. I think the economic performance is going to be just very different across the world. So Tim, I have I have one last question aimed at you, but you know this idea and you sort of hinted at it, which is that if you if we were to get more data points like the November CPI report, they indicate, Okay, it looks like

there's a meaningful slowdown. Then regardless of what happens on the labor market, the FED might start to believe it that something is real. But just how are you thinking about the next few months, So we don't have another decision again until February than in one in March, like just like what you talk of through like your sketch for how you're thinking about you know, the first quarter of the first half of next year, right, So I'm expecting a twenty five basis point right hike at the

February meeting. Uh, and then beyond that, you know, getting to you know, the Fed's current terminal rate involves you know, rate hikes of that magnitude in in March, March and May as well. And at this juncture, I'm finding increasingly difficult to see that. First, you know, if the inflation numbers are sticking, you know, sticking on the downside here, Uh, you know, the it's going to be much more problematic

for for the FED to continue raising rates. And then if we you know, over that period of time, we can see some some labor markets softening. Now the interesting question to me now is to help what extent the firming we're going to see in this data over rides any any softening we're seeing in labor markets right now.

And John John mentioned some of those signs earlier. And if those signs stick, I mean, if we are getting a job growth down to you know, uh, you know, closer to a hundred thousand a month, as and as the economy firms, then I think the FED is going to be a hard press to keep keep raising rates after after certainly after March. And that's that's the kind of setup that I'm looking for, is that we see some of these continued evidence of labor market softening that

gives the FED sum room to pause. But they're gonna want to be confident that that that softening is going to continue. So I do think they're gonna want to see the economy slowing uh, and and that the it's it's it's not evident to me that's that's going to happen. So this is a similar question, but directed to both of you. What's the one number or economic indicator that you're watching for signs of a soft landing that will allow the FED to potentially ease up on rate hikes,

and please don't just say inflation. I'll go with one. I mean I think that you know I'll go with I'll go with the C I because I think that that's the way. How will sort of categorize how he sees a soft landing in Brookings? I think the interesting thing about Brookings and I think if you juxtapose Brookings with the SEP is you kind of get to glean into what the FED wants versus what the FED feels

they need to say. And I think the SEP is more reflection of the FET things they need to say in terms of commitment and credibility versus If you listen to Powell's talk at Brookings, you don't get the sense that he truly believes that he needs the unemployment rate to go to four point six to get inflation closer to target. And I think for the FED, the question is going to be at five and a half percent

or close to six percent nonimal wage growth. The FED does not believe that that is consistent with two percent inflation. So to me, the feds chances of a self lending will be to me very dependent on how the inflation data evolves post a lot of this, you know, more transitory noise in in the goods and rent side to some extent. But also, you know, what does wage growth

look like in the middle of next year? And I think that will sort of set the stage not necessarily for how long how many more hikes there are, but how long they stay at this very elevated level of its tim Yeah, I would actually, I mean I don't I don't want to repeat the same thing, but I do think you know, the clearer evidence that that John is right. I mean, in theory, if if wages were to come down, wage growth was to decelerate, and so you know what what work could we see that other

than just the e c I number. So you know one place that could be somewhere it shows up is and it's already declining. Is the quits right, So you know, presume Blue and Paople, you know, quidded job or another job, that the next job has a higher, higher wage. And so even if you've got the quicks right down, you probably you know, get get wage growth decelerated, and something like that could help convince the Fed that they did

not need a recession. Right. So so the theme here is, you know what does the FET need to see to believe they don't need, you know, unemployment at at four and a half or center for four point seven percent, and the answer is is probably, you know, wage growth would be the most likely place that we can help see that. John and Tim, thank you so much for

coming on the podcast. It's always great talking to you and particularly timely conversation to understand what I think is a pretty important moment, a pretty important week in this story. So thank you both for coming on outline. Thank you, thank you a good for having us. Yeah, thanks so much, guys, it's great that great, always great to talk with John

and Tim. I mean, I think that last point from Tim is sort of the key thing, and it's still sort of the big question, which is will other signs emerge that convinced the FED that there can be some sort of durable decline in inflation without a meaningful jumping unemployment. So maybe it's a decline in the quits rate, maybe it's other measures of wages. Maybe maybe it's something with job openings, etcetera. Maybe it's just the employment cost index.

But it does feel like those are the things to watch because look, the soft landing can't be as long as unemployment rate is at three point seven, you can't rule out the soft landing scenario. Yeah. Absolutely. The other thing that I thought was interesting was the idea of the sort of discrepancy potentially between what the market's looking

at versus the FED. Yeah, because that seems like, you know, today might be kind of an example of it, where the FED came out pretty hawkish and the initial reaction at least was stocks went up. They've since gone down, But like you do, wonder as the data starts to change, whether or not that's going to become more of a theme, and whether or not it's going to complicate some of

what the FED is trying to do here. I really liked John's explanation of this sort of seeming, you know, speak of market divergence, of you have FED officials saying, no, we're not talking about rate cuts at all, we're not even done with the hiking cycle, and yet the market is priced, you know, on some level of the market

pricing rate cuts before too long. And I like, you know, the sketch of the three the no landing, the soft landing, and the hard landing, and if you sort of like figure that, okay, the hiking cycle is sort of maybe coming to an end, probably right, we're not that far from the final hike, maybe Fibruary and Marcher something like that. Then at some point, you know, there is some chance the spread that we go into hard landing scenario and

that the FED would have to cut. Yeah, I mean, there are like these kind of weird discrepancies that are starting to emerge from the forecast. So like the PC forecast I think went up, but like the growth forecast when down where it seems strange. I do feel like we talked a lot about the past year is being like difficult for central banks, but I actually think next year could be even more difficult, just because you have

all these different moving parts. And I know you were joking about gas prices putting money back into people's pockets. But like it does seem that as these trends start to change, and you know, maybe services inflation is still going up but consumer goods inflation starts to fall, there is like a weird interaction that could start to happen where like you know, maybe people who work in the services industry are getting more money and so they start

spending more on consumer goods again. Landing scenario. Well, there's like a real possibility. There are so many moving parts, you know. I was glad that you asked that question about international central banks because I thought that was John's you know, the year of divergence. You know, all the central banks have been sort of like rowing in the

same direction, so to speak. This you know, they're all on inflation fighting mode, but in on this point, you know, you have these other countries where the economy is super rate sensitive because so many people have adjustable rate mortgages and so, like, you know, you could imagine Canada and the UK said, really economies really get hit by higher rates.

But if you have this situation like you're you know, you just sort of described or actually the U S consumer hangs in there pretty well because they're all getting a price cut on gasoline and there isn't really that pass through from rates to mortgages the way there is here, and so you have weakness the rest of the world. It also made me wonder it's like, well, does that

mean the dollars get a rise. We don't really talk markets much, but that would sort of possibly be an implication of other central banks feel like they have to cut rates or slow then faster while the feed is saying, look, us consumers are doing all right anyway, all kinds of interesting possibilities for there. Well. I also think the big wild card is what China does here because we've seen

such a huge pivot on COVID nineteen restrictions. Are they going to pivot when it comes to monetary policy and fiscal stimulus as well? Like right, and then the question is, you know, the reopening we have as of right now, West Texas oil seventy seven. Last Friday it was around seventy, so we you know, we're trying to reopening and the gas cut, will that cause oil prices to go plenty of plenty of moving parts to the mac. Yeah, I was gonna say the theme of this episode is moving parts. Moving.

The world is a complicated place, very much, So shall we leave it there? Let's leave it there. 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'tal. You can follow me on Twitter at the Stalwart. Follow our guests on Twitter. Tim Dewey, He's at Tim Dewey. John Turrek he's at j Turk eighteen.

Follow our producers Carmen Rodriguez at Carmen Armon and Dash Bennett at Dashbot, and check out all of our podcasts at Bloomberg under the handle at podcasts and from more odd Lots content. Go to bloomberg dot com slash odd Lots, where we push the transcripts of the episode Tracy an blog. We even have a newsletter that comes out each Friday. Should go there and subscribe. Thanks for listening.