Economic Worries Begin to Fade

look forward to? Well, one thing, sorry, you can look forward to is the craziest thing I saw in markets this week. Our tradition which we will end the show with, of course, and a reminder if you see something crazy in markets, uh, see something, say something? Uh specifically, call our what goes Up hotline and leave us a voicemail. Sorry, what's that number again? That number six or six three

two for three four nine zero. So, as Mike said, if you see something, say something, Yeah, maybe we'll play your voicemail on the show. But let's get right to today's show. We've got a first time guest on the show. His name is Mike Schumacher. He's the head of interest rate Strategy at Wells Fargo, Mike, welcome to the show. Thanks very much, great to be here. Great, great and

another guest back literally by popular demand. Um, if your listeners out there, I don't know if you realize this, you can request guests apparently, So this became a new trend in our Twitter feed when we ask for crazy things. Well, instead we have just gotten demands for our other guests. So yes, yes, and so this one goes out to you, Ellie Paname mon Underscore Singe on Twitter, who tweeted at us we demand more, give the people what they want. Well,

we're given it to Ellie Paname. I'm a little susp a'cious about this account. Chris. The profile pictures is a picture Kevin McHale of the Boston Celtics wearing shorts that I cannot describe on a family podcast due to that eighties Arab basketball shorts. Chris being a Boston native, I'm a little skeptical about this, but we're gonna assume this is a real grassroots campug. Nothing to know when I've ever met in my life. Okay, did you believe that's sir?

Not at all? And that voice is Chris Nagy, the executive editor of the cross asset team Man Equities here at Bloomberg and Mike, they're gonna be tweeting to demand you. I'm sure again fantastic. I will not wear funny sorts. So, like I wanted to ask you, you know, we got some inflation data this week. Um, I know the Fed prefers pc but the latest data we got was c p I. I gotta say core CPI two point three percent.

Headline was about two point one percent. At what point do we have to start worrying about the Fed when it comes to inflation. I mean, this isn't the highest it's been at the cycle, but you know, we're we're getting back to sort of that target level the FED would like to see. Inflation took up frankly from Chairman Powell's discussion recently, he'd be thrilled if inflation were two two to three on a core basis for an extended period. Central bankers know what to do with inflation. They just

hit it over the head. So the FED could let inflation run for a while. That would be dandy. So bottom line is, we're not concerned. I don't think the FED is either. So inflation was certainly a hot topic. It came up in many questions at the press conference on Wednesday. One point really stuck out to me from FED chair Powell. He was talking about the so called

Philip's curve unemployment how it relates to inflation. It seemed as though he was saying, we can have a tight labor market, that's fine, but maybe the labor market isn't so tight and we are not seeing extreme wage growth. Did that really resonate with you. Did something from that

conversation stick out to you? Yeah, it's interesting, Sarah. So essentially he's making the case of the Phillips curve with respect to wages is pretty flat, and wage growth actually has been pretty good if you look at the lower segment of the po pulation. So let's say the bottom of wages paid, they're up almost four and a half percent in the last year, which is great, and even the top runners are up almost three percent, and yet unemployments three and a half. Inflation we just heard as

ticked up, but it's nothing crazy. So I think Chara Polo is right when he says we can probably tolerate lower unemployment than we thought in the past without inflation going wild. So the curve is flatter, but not totally flat like the other big news this week obviously, was what appears to be we're getting closer and closer to a trade deal now. To be honest, as we record this on a Thursday, it looks like the latest report

suggests that, um, they're very close. Who knows what will happen in the half hour that we record this, right, have at it, even we deserve it if uh, you know, what are what are yields gonna look like? Though? If we do reach a piece between US and China in trade er, I mean, you know, tenure treasury is now approaching that two percent level. Um, where do you expect

it to stop? If we do get good news on the trade front we've been make in the case, if there's a fairly modest trade deal, which I would call this potential thing, that the tenure treasury goes to to ten maybe two fifteen. And the way we get there is we looked at we're tend stood back on July thirty one, So that was the day of the first fetties. The tenure was too oh two. The next day, you might recall, President Trump put out his tweet really mandating

in all us companies find alternatives to Chinese suppliers. So we think that something like two oh one too oh two is pretty easy to beat. But since that date there's been so much easing by central banks. Would say anything a lot higher than that's probably out of reach. So to ten, maybe two fifteen, if you're aggressive, somewhere in that range we think makes sense. Chris, I want to bring you in here on that topic. So say we do get a trade deal this weekend, all is great.

All of a sudden, you see yields made me move up to ten to fifteen. Is that still a good environment for what are he's going forwards? I mean, there's still pretty low interest rate, right what's not to like? Really? I mean, the one thing you have to think about is that you've just had this gigantic here, and one interpretation of what happened is that what usually happens stock market looks ahead to the future. The market may well

be saying something good about the macro. Backdrop in the question is how much more do you really expect out of stocks right now? I mean, you're going to have year here expecting tons more on top. It's certainly possible, you know, Uh, growth is not twist to fall apart. Earning supposed to be strong, but the question is how

much was that baked in? And something that someone said to me this week and I found very interesting on the trade subject was that even if we do get a trade deal and sure China goes along and buys agricultural goods, things seem like they're moving along pretty nicely. Maybe phase one turns into phase two, phase three per se. The issue is that companies have are already started changing

their supply chains, and that that's pretty expensive. And if they have been changing their supply chains over the past year and a half whenever this all started back in March, wouldn't it be pretty difficult then for companies to start really going back to how it was or not putting money into changing the supply chains again, and that profits could remain print from that point that could then feed

into the global economy next year. Is that anything of the sort that you're thinking of with your team over at Wells Fargo, I'd say a bit. And I certainly take the point that yes, there's probably been some switch over to whether it's Vietnam, Malaysia, Indonesia, who knows, but countries ex China, but probably not anywhere near. So those companies who have not made the switch, who said, gee, we hope this blows over, they should benefit quite a

bit if there's some sort of deal. So I guess the way frame it from a market standpoint is, would there be a decent uptick and confidence almost certainly, would there be a pickup and growth probably, So it should be a pretty good risk on move. Is that if this happens. You know, Mike, we're getting near the end of the year. Obviously, goodness a long one has but there's one hurdle left to go, and that is the sort of funding stress that you often see at the

end of the year in the repo market. Uh, walk us through how you're thinking about that, and really, for the listeners who are not too in the weeds, UH in this market of me being one of them, for example, explain to us why this funding stress happens at the end of the year and what role the repo market plays in it. Yeah, it's been an incredibly hot topic over the last few months. Repost spiked in mid September.

The fed goot very concerned about it. But to back up a little bit, the core of the problem, we would say, and probably most people would agree, is that bank balance sheets are very constrained, capital requirements are tight, they're all sorts of liquidity issues, etcetera, etcetera. So banks probably don't have as much flexibility to put cash into

the repo market as you might think. Now, the way that showed up in September is that something called excess reserves has gone down a lot, and it's probably a misnomber. The reserves aren't really so excess, and at the margin, one extra dollar really tipped the market into a frenzy, and all of a sudden there was simply not enough cash to go around. Now, the FED saw this, every one in the market sought and the central bank response

to a problem is put lots of liquidity into the system. Now, this addresses the symptoms, but not the underlying core of the problem. The core of the problems you need regulatory relief, but that probably takes quite a while. So the Feed is pushing a lot of liquidity into the system. Now, there was announcement not too long ago that talked about doing a bit more of that. So we think the FED is very much on the game. If you will,

there are two schools of thought. We are of the mind that the fedle put enough liquidity in the system to really mitigate big problems. REPO probably goes up somewhat towards the end of the year. It was about five percent a year ago. Right now it's around four. For the turn of the year. Maybe it gets back to five, but we very much doubt it gets to nine or ten,

which is where it was in September. But talking to a lot of clients, they tell me, I get it, But you still may have a case where a number of big banks really don't want to put the cash out, so any amount of liquidity will not be enough. We think that's unlikely, but it's possible. So that's really the issue. In a nutshell, is the supply of treasuries part of the issue, especially on that short end. I mean, here we are, we're running a trillion dollar deficit. UH, investors

are more in the mood for risky assets. It seemed like, seems like UH, those primary dealers having a hard time funding purchases of treasuries. And here we have politicians talking about perhaps a middle class tax cut UH next year. So maybe even bigger deficits. I mean isn't that supply A treasury is part of the story too. It is a big part of the story. So long term, you look at the US budget, the episode of around a trillion dollars, Treasury has to fund it. That means lots

of net issuance. Now the primary dealers have to buy. That's what it means to be a primary dealer. So if you look at primary dealer holdings of treasuries, they have roughly doubled in the last year from about a hundred and fifty billion to about three billion. Now this is just the primary dealer aspect of a bank, it's not the entire bank. So at some point you can say, well, maybe the primaries have about as much as they want they really don't want to have or treasuries on the

balance sheet. Maybe the FED could come to the rescue. This is why Chairman Paul recently got the question, I think anyway about potentially expanding the universe of securities the FED would buy, maybe buying some of these short coupon bonds at dealer's own that sort of thing. So, yes, it's very much the case. The big deficit and heavy treasury supply impact the REPO situation. So should we just expect that FED balance sheet to just keep growing throughout

and and beyond. I mean, I promised not to call quantitative easy. I can't callie, but I mean that balance sheet is it's hard to imagine it's shrinking again anytime soon. Right, we agree with that, And the FED really has talked about making FED funds the primary tool for conducting monetary policy. But QUI seems awfully convenient. Do a little quie, buy some treasury bills, try to help fix the repo problem, maybe expand out the curve possibly if things aren't going

that well. So I think you're right, you probably will see the balance sheet expand. In a theoretical world of asking this just because over the last week, i'll call it, there was some hubbub over the repo squeeze, talking about a potential year end squeeze. Say, theoretically we did see that happen. Could we potentially see fall out to other areas of the fixed income space as well, or would

it be more so concentrated you can see fallout. Repo is really like the grease that keeps the engine moving spinning. So if that really gets clawged and makes it much tougher for clients of any type to transact, and very difficult for players like hedge funds to get short term funding. Not to say it's completely unavailable, but available at really

stratospheric rates, So there could be a lot of fallout. Chris, I feel like the repo market is something equity investors uh pretend doesn't exist until they have to uh cram cram their studies about what's going on, you know, and what you edit and what you read. Uh does this repo all this liquidity to the repo market? I think the um assumption from a lot of people is that this is part of this last of the rallying stocks.

Is liquidity good for stocks no matter what, even if it's in the short end of the Yes, And an argument can be made to things that caught, you know, strain the system, like a gigantic budget deficit is weirdly good for stocks. It's so liquidity provider to the reason. I mean, it's a giant tax cut basically at the back of that, and that's been arguably a huge factor in the background again for the stock market. So these things are are are tail winds until they become headwinds.

You never really know when a giant it's a big nebulous issue for the market. I think people are aware that the US is getting a little over its skis on some of it's borrowing, and to the extent that the whole repot thing is emblematic of that. It's a factor for the market. I would agree your average equity guy, they didn't pretend it doesn't exist, it doesn't doesn't want

to talk about it beyond his capacity. I will say, though, in more and more conversations with different investors that I speak with, liquidity is coming up as a reason for this year end rally and equity. As I asked them what's going on, They talk about the balance sheet, They talk about this not being kiwi. But the fact of the matter is there's more liquidity in the system. And Davis had a pretty good research note on this, and they said, look, money flows to where it's treated best,

and right now it's being treated well. And the equity were I mean, if you buy that last year or so off was the opposite, it was a reaction to power going too far in the other direction that you kind of have to you kind of have to buy that that argument for this year I mean the FED is sitting there, you know, latering liquidity into stockholders hands.

So like it all gets back to what is the biggest risk of all this, of all this, these huge deficits, this huge issuance of treasuries, the FED buying, I mean, is it does it all get back to inflation? As long as inflation stays cool enough that uh, you know, these giant deficits, this giant supply doesn't matter if inflation is low and therefore borrowing costs are low. It's probably not a huge issue with respect of the US budget. And it's interesting how many presidential candidates the cycle of

talked about fiscal restraint. That's right, zero, nobody not and pres and a Trump also I put in that camp. So no one at the top seems super concerned about it. We can come up with risks. It's conceivable maybe there's a foreign buyer strike, But I think you have to ask yourself what else would they buy? Do you really think investors in Japan or China or elsewhere in Asia or Latin America are going to buy a lot of

European government bonds that have negative yield? Probably not. Do you really think that investors who actually need a lot of liquidity potentially and one high credit quality can go too far away from the US. Doesn't seem that likely. So the US markets by virtue of being very homogeneous for one in liquid and also having excellent credit quality, it's a home field advantage. So it's tough to lose that.

I don't know if you follow the whole uh craze of modern monetary theory m M T at all, But um, you know the idea that that deficits don't matter. We've we've spent our lifetimes worrying about the deficits. Crank up that printing press Are they sort of being proven right to some degree? Do you think? Um? At least you know, for example, if you're the U S and your currency is the reserve currency, uh, and you don't have to really worry about a major devaluation in the currency if

you're if you're cranking up the printing presses. Recently, it's worked out. I certainly wouldn't accept that long term. But in a world where yields are generally quite low globally and the US has a reserve currency, the US government can run a pretty big deficit, and right now it's the biggest by far across G ten. It's more than five of the US GDP, and the next biggest one is sort of a tie between Japan and France at about three. So the US is running a much bigger deficit,

no doubt. So going back to the interest rate conversation, but bringing it over to equity is something that did happen this week was that the S and P five hundred financial index, very closely tied to movements and interest rates lately, finally took out It's two thousand seven high. So, Chris, what does this really tell you about how far we've come the journey that it's been over the past twelve years or so, Right, it's sort of the final chapter

in that in the financial crisis. From the stock market perspective, I think you have to look at it as really mainly testament to the power of the bullmarket. The bullmarket insanely powerful thing. Pretty Much everything that you could do to you could throw up in the face of banker to impede bank earnings has been done. All the vulcar stuff, risk taking rained in, and interest rate environments the opposite of what they want pretty much, And yet those stocks

still pulled above all that stuff. They rallied an insane amount from the bottom they fell the most, and they had to rise something like sixfold to get back to a record. So I think it's entirely the rising tide of the stock market, and nothing specific to bank stocks other than the fact that they're part of you know, they're part of the US economy and we're taking part

in their earnings have slowly crept back. Chris, one of the stories that caught my eye from your team this week was this notion that a lot of the strategist on Wall Street are getting bullish towards small caps um Now, is that sort of you know, an unwind of the defensives versus cyclical trade in some degreem Obviously, you know the the SMP is a little bit more defensive than the Russell two thousand. Is that all part and parcel that you think that that makes sense? That there's a

bunch of different ways to frame. One would just be how much more bullish can they get? As we were discussing on large caps or megacaps in the US, I mean, you set a gigantic year, you've run out of positive things. There's actually this dynamic where they've they actually set there to estimates and then the market went crazy underneath them. So all of those pretty optimistic estimates when they set

them now in a percentage basis, look like nothing. This is sort of as something we've we've touched on a few times. So they've run out of things to be excited about. And if there's one thing that strategists are going to perennially do, it's try to be excited about something. Small Caps are the one thing that's kind of about performed this year, and you know, makes sense that that's

what they're choosing. I do have to say there is one quote in that story about small caps that I was a little bit particle of just because one person came out and said that, well, yeah, small caps might take off in the fact that we get a trade deal and all of a sudden they're more domestically oriented and small caps which should do better. But a year and a half ago people were saying the exact opposite, that once we got a trade war, then more domestically

oriented U S docks should do better, and they never did. Yeah, looking for a coherent UH, I would be against anyone like parsing the things that I say week a week on this podcast for consistency half the time. Um, you know Ellie Pennam, he would never cast any down on my my thesis. Uh. Like. If let's turn to Europe a little bit. Christine Legarde made her debut at the ECB this week. Uh clearly she didn't make she didn't break anything, you know, Uh, no major freak outs in markets.

Do you see uh much of a change of the guard there or is it sort of steady as she goes in Europe? It's a change of Luguard. But there you go right into that. You did, Thank you. I thought she was very smooth. She's a super seasoned politician as we know, so as far as being able to present and get a message across, she might already be

the best central banker on day one. That's quite possible, just given her personal experience as far as policy goes, I would agree she didn't say much, but didn't really have to. E c B is starting a review next month that'll go on a good chunk of the year, just like the Fed is doing a review, so that gives some cover. And the e c B has already been so easy for so long it's hard to see

a radical shift getting easier. Maybe a little bit on the margin, maybe the deposit rate goes from minus fifty to minus sixty, but probably the better avenue is to do a bit more q E. So we don't see a huge shift on tap right now. But at this

point we just don't know enough about her views. You know, one story we had out after her press conference was there was a discussion h the forehand about the negative effects of negative yielding debt um So they are listening to sort of the complainers out there, the pension funds, the banks, the US. I'm curious how you've been in

this business a while. Would twenty years ago, would you have ever guessed a we'd see uh, negative yielding debt, and where do you see it going in that whatever X number of trillion dollars of negative yielding debt, it's bound to come down, I would guess, right, Negative yielding debt is not something I would have foreseen or probably anyone really years ago, and yet here it is, and it's huge. It's whatever the number is today, thirteen fourteen

trially and some some crazy numbers. So we suspect when the history has written about negative policy rates, they'll be deemed to be a pretty poor idea. It doesn't seem to us they've worked a ton. Again, we prefer the Quei avenue if a central bank is going for non traditional policy, and KIWI has a really disruptive effect on banking systems. So it seems, especially running in Europe, which

is very banking center, that it's gone super negative. US hasn't done that, all right, So before we get to the craziest thing, Chris coming back to you again as a shameless plug reporter and editor on your team. Low Wing has a great story coming out this weekend and it's about the best sharp ratio ever. So I was hoping you could maybe give us a little bit of

a preview. Well that, yeah, that's a great start. That's just looking at the basically volatility adjusted uh return in the SMPP hunter, which means so if you're an asset and you bounce around ten percent a day and it's an incredibly jarring ride, then it's less of a big deal in a way if you if you cover a hundred, if you double say, because you know the moves have been so big, you could just as easily have fallen by half or fallen by this is the sharp ratio

means that it's just a steady climb. It's measures the steadiness and the slope of the climb. And what you found is that this year of this decade, the one coming right after the financial crisis, the one where everyone was like stocks are dead, you can't touch stocks, is the best decade on record as far as we can calculate a Sharps ratio, going back about eighty years. Uh, this is bigger than just a little bit, bigger than the tech bubble. The tech bubble was much bigger return,

but much more volatility on the way up. You look at the charts of they're crazy. The moves all look like a year moves this year just incremental couple, Yeah, a couple of meltdowns. But uh, for the most part during the last ten years, pretty much steady climb without

a hell of a lot of volatility. You know what I thought, speaking of sharp ratios, I was curious, if you take a triple levered stock fund, what would you guess higher sharp or lower sharp than the regular by far lower higher, my man, So, Mike and I were on the e T F Trillions podcasts this past week and Mike stopped talking about leverage GTS. He's all all about it. If you bought the triple levered q q Q four thousand percent return, okay, because some insane return

in the decade. In the decade, right, well, that's it. Your numerators higher than your denominator kind of. I feel like it would have gone to zero a few times. You know, if you're bullish stocks, go go big or go home. You know, if you never get stopped out, that's pretty crazy to kick it off listeners at home. I do not really recommend that. It's just just a discussion point. We don't recommend anything. I just wanted to get the trillions et f listeners riled up about some time.

Maybe they'd hate listen to the show. All right, So I guess the sharp raisio for a levergy TF is pretty crazy. But Mike, what's your actual crazy thing this week? Okay? Do you guys might have noticed President Trump was a little angry recently? They noticed that, Yeah, what do you think he's angry about? Chris? Alright, like the kid who hits the climate cheese? Like that kid, that's true? Like, what do you think he's angry at not thrilled about

the impeachment thing. Yeah, he's angry about that stuff, but he was really angry about toilets. He's mad at how often enough to flush at toilet. He came out and he said, people are flushing toilets ten fifteen times. I don't look, I don't know anyone who flushes needs to flush the toilet fifteen times. Granted I do not travel in the same social circles as President Trump, but it

got me. Uh, you know a lot of people making jokes about this, but as sort of the equities background, it made me think, well, are we gonna have to replace our toilets now because of President Trump? And what stocks could benefit from that? So I went I did some research, some some research on toilets. Uh, sure you really enjoyed that research. Good. A good website to start if you're curious, flush guide dot com. A lot of this comes from them. The hottest toilet in the country

American standard. It's not American, it's made in Japan by a company called Lixel. And actually the second biggest toilet maker is a company called Toto. Also Japanese also probably make Trump mad. So I was figured, all right, someone's got to be buying toilet stocks after this comment, right, not really, Lixel down about two percent since Trump said this, tote up one percent. So I thought, well, what could it? What could it be about? Toto and they sell You're

not gonna believe this, Sarah. This is the craziest thing I've seen in a while. Their Neo rest and X two dull flush toilet list price thirteen thousand dollars. You're going to be right, but it's the Yeah, look, it's a thing of beauty. It looks like Steve Jobs designed this thing. And you know what's crazy. I never thought that we'd be talking about toilets on this show for a couple of minutes at a time. Yeah, I can

go on who you can, I can tell. But Trump would love this one because it has technology known as the Tornado flush, two powerful nozzles that create centrifugal cyclonic rest in action. Now but here listen, is more effective in one flush than most toilets are with multiple flush. Trump, if you're listening, I got the solutionary fixed amazing, unbelievable, unbelievable. Chris,

did you come prepared with anything? Well, I was just gonna bring up the crazy Walmart Cocaine Santa and that's it, And moving on, switters Matter something that depicts snowman Santa sitting in front of snow with the crazy eyes and the snow is arranged in little white lines, and I don't think it's called cocaine step. But then the caption is, Oh, it's going to be a white Christmas. So this thing lasted like twenty minutes before they were forced to pull

it because of popular outcry. Possibly yes, possibly appropriate. The ugly sweaters are a big thing around the holidays now, I think that's yeah, big big stimuls see economy. Alright, Sarah, what do you got? So did everyone here see the original video of the Tesla cyber truck when they were going to throw the ball at its mass the window. Huge mistakes. So there's another video that's now making its ways around with the Tesla cyber truck and it's uh.

Elon Musk himself decided he was going to take out one of the prototypes to go eat at Nobu in Malibu, California, and there's a video of him on TAMZ. He's leaving in the cyber truck and at the very end of it he knocks over a sign, makes an illegal turn the wrong way. Um So, once again a video of the Tesla cyber truck making its way around the internet. But at the same time, Tesla stock is trading at the highest levels in a year, so maybe all the

publicity is good. I'm a contrarian on that cyber truck. I think it's going to sell. Well. Yeah, it looks like something you find on the moon. It looks amazing. It really all right, Mike today, warry about our gimmick. Here the craziest thing. I was thinking about this, and it's very difficult to top the funky Santa, the toilet or the truck. But we come, we come prepared. I will throw out that. I think our president tweeted something like a hundred times this past Sunday. It was some

crazy no, a hundred times on Sunday. I'll put that out. Just think about the interval between tweets. What correction I was waking time was tweeting? It's pretty high? Is that all original tweets? Does that include retweets? Are you getting pretty deep? I don't know that. It's the important information that we need to know, sir. You gotta tweet more I do. I I can't even match one hundred. I could maybe tweet a hundred times in two years. Maybe I gotta I got to step it up. Work to do,

We've all got work to do. Well. One guy who tweets a lot is Ellie Panamey, who's I actually know who this person is, and he's gotten about two thousand more air time than well, he got exactly what he wants. So with that said, Chris Nigi Mike Chumucker, thank you so much for both coming on the show. Thank you What Goes Up. We'll be back next week. Until then, you can find us on the Bloomberg Terminal, website and

app or wherever you get your podcasts. We love it if you took the time to rate interview the show on Apple Podcasts so more listeners can find us. And you can find us on Twitter, follow me at therapont Seck, Mike is at Reaganonymous, Chris Nagi is at Chris nag one, and you can also follow Bloomberg Podcasts at Podcasts. What Goes Up is produced by over Foreheads. The head of Bloomberg podcast is Francesca Levie. Thanks for listening. See you next time.