00:00:02 Speaker 1: Bloomberg Audio Studios. Podcasts Radio News. This is the Bloomberg Surveillance Podcast. I'm Jonathan Farrow, along with Lisa Abramowitz and Anne-Marie Hordern. Join us each day for insight from the best in markets, economics and geopolitics. From our global headquarters in New York City, we are live on Bloomberg Television weekday mornings from 6 to 9 a.m. Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business App. We begin this out with stocks and bonds finding their footing following the first Fed rate increase in some three years. Julian Emanuel of Evercore writing, once the Fed starts hiking, even if it was known to be coming, stocks remain volatile. Julian joins us now for more. Julian, good morning. 00:00:49 Speaker 2: Good morning. 00:00:50 Speaker 1: Volatile upmarket into year-end, is that how you see it? 00:00:53 Speaker 3: We do. We do. 00:00:55 Speaker 4: We think, you know, there isn't runaway upside into year end. Our price target is modestly higher than here. But I think when you look at yesterday and today, what you've done is eliminate sort of the left and right tail fantasies of fixed income traders. So coming into yesterday, there was a very solid one and done crowd. And that was completely taken off the table by Chair Warsh. And then this morning, what we realized is, yes, in fact, all the rhetoric of the last several months about 2% being the goal is firm and it is real. And by doing that and establishing that, you've taken the other side of the equation off where we were getting clients talking about 6% and 7% in the 10-year yield, not happening. 00:01:46 Speaker 1: You stand with now, the long end of the curve. We stand with that. 00:01:51 Speaker 4: Some people that I know, and obviously you had one on the show yesterday, really see value here. And I think the fact that you are being true to trying to fight inflation here, buy the hike, buy the message that there's likely more to come, it provides a value opportunity in the long end. 00:02:14 Speaker 5: Are you part of those people? Are you backing up the truck a little bit when it comes to long end bonds? 00:02:19 Speaker 4: Well, and I think, again, if you look at, if you're in global asset allocator and you look at stocks versus bonds this year, You probably should be rebalancing a little bit. 00:02:30 Speaker 1: It's the stock guy saying buy bonds. That's terrifying. Is that what just happened here? 00:02:34 Speaker 5: Yes, but he doesn't want to say it, which is saying people, some people have seen value. And people have a logical argument. 00:02:40 Speaker 3: No, but think about it. 00:02:42 Speaker 4: This call is more important than it's been in years because the fact is the bond market is more important for the global capital cycle than it's been in years. Because if you're taking pressure off the long end in treasuries... You are taking pressure off the long end in sovereigns. And ultimately, what you're doing is you're making issuance for the hyperscalers incrementally more easy. 00:03:05 Speaker 1: OK, so it's a good thing for the equity market. 00:03:07 Speaker 6: Absolutely. 00:03:07 Speaker 1: Stocks and bonds. 00:03:08 Speaker 2: Absolutely. 00:03:09 Speaker 1: What do you think is the threat to this equity market? Because it has shown remarkable resilience in either direction in fixed income. Yields up, yields down. Stocks have been OK. Stocks again this morning up by 0.8%. What are the developments on the horizon? It might give you pause. 00:03:22 Speaker 4: Well, so again, in our mind, it's this transmission mechanism from $ 100 oil to yields. to hyperscaler debt issuance. And the fact is, to your point, is that credit markets, which in our mind are the things to really focus on, have been. 00:03:41 Speaker 2: Very, very placid. 00:03:43 Speaker 4: You've had a little bit of volatility around some of these issuance announcements, but overall, very, very placid and very, very liquid. 00:03:53 Speaker 1: That's the biggest one. 00:03:55 Speaker 4: And again... For us, it's this idea that even though this last quarter's results were peak rates of growth. 00:04:05 Speaker 2: In terms of earnings. 00:04:07 Speaker 4: We're still on track for a very strong, you know, rest of the year and 2027. And that ultimately, if that story stays, you know, is positive. And frankly, the sort of the AI safety story weaves into that significantly as well. 00:04:26 Speaker 5: Potentially the real tell into the end of the year is going to be the banks. And John was noting yesterday that the banks were falling out of bed in response to this decision. There are a couple of reasons why. The one that appears most salient is that when you hike rates to this degree, issuers of debt, issuers of equity, IPO potentials might sit on the sidelines and wait it out. The volatility introduces extra risk that could curtail some of the incredible capital markets activity that we've seen. Do you see that as a likely outcome of the rate hiking cycle that's underway? 00:04:57 Speaker 4: You could get some temperance in issuing, and that probably wouldn't be a bad thing because when you think about the entirety of the cycle, what you've had over the last year and a half or so is with regard to ai is a mismatch between the investment funds being thrown at the story and the roai and the adoption okay and if you slow down the issuance you actually allow those two concepts to converge in a more meaningful. 00:05:28 Speaker 1: Way stay with us more bloomberg surveillance coming up after this So here's the latest this morning. The Federal Reserve taking on inflation with the first interest rate hike since 2023. The committee signaling more monetary tightening to come. The former New York Fed president, Bill Dudley, writing a 25 basis point hike is too small to have a meaningful impact on economic activity. Bill joins us now for more. Bill, welcome to the program. Before this decision you wrote in your column, you said the case for a hike was crystal clear. Is the case for another hike just as clear? 00:06:11 Speaker 2: Right now it is, unless the data changes pretty dramatically. 00:06:14 Speaker 6: Kevin Warsh basically said that he needs to make financial conditions less accommodative, probably push them into the restrictive side. And he hasn't told us how much you need to do to do that. But judging by the reaction of financial markets, he hasn't really accomplished that yet. I think that he also signaled that this is probably the first in a series by talking about removing a dose of accommodation. That implies that there's more doses to remove forthcoming. And if you look at what the federal funds futures market is pricing in, they're pricing in three or four hikes over the next six to nine months. So the market certainly expects that the Fed's not done. And that makes sense. If financial conditions are accommodative, that's causing the economy to grow at an unsustainable pace. 00:06:58 Speaker 2: You need to do more to make financial conditions. 00:07:00 Speaker 6: Less accommodative to restrain economic activity. What's interesting about the Fed's forecast, it's sort of the immaculate disinflation. If you look at the summary of economic projections, growth doesn't slow, unemployment rate doesn't rise, yet inflation magically sinks back to 2%. 00:07:15 Speaker 2: I think it's going to be a little bit harder than that. 00:07:17 Speaker 1: Bill, do you think we need the demand destruction? And what kind of level rates do you think is necessary to get that demand destruction, to get inflation back to target? 00:07:27 Speaker 6: Well, it's hard to know because, you know, it depends a little bit on how financial markets react. I agree with Kevin that financial conditions are really the way of judging the stance of monetary policy because that's how monetary policy gets communicated to the economy. So if the stock market, you know, ignores the Fed's tightening, if the bond market ignores the Fed's tightening, then there's more for the Fed to do. 00:07:47 Speaker 5: Did you think that Kevin Warsh did a really good job at this press conference, or do you think that he should have illuminated a little bit more kind of how he was thinking about the path forward? 00:07:58 Speaker 6: I think he did a much better job, but he was still very, very guarded. 00:08:03 Speaker 2: No follow-up questions. The answers were very short. 00:08:06 Speaker 6: Didn't really answer the question about where's neutral in terms of a neutral federal fund rate. I think it's an odd concept not to have a view of whether monetary policy. 00:08:16 Speaker 2: Today is easy, neutral, or tight. 00:08:19 Speaker 6: I think you need to have some framing of where you think the federal fund rate is today in terms of whether it's providing positive impetus or negative impetus to the economy. So certainly much better, but still very, very guarded, very, very constrained. 00:08:32 Speaker 5: Do you have a sense that neutral is significantly higher? I mean, that was sort of the implication when he said that they're removing some of the accommodation. Or do you think that that phrase was just a commentary on last year's 75 basis points of rate cuts? 00:08:44 Speaker 2: Yeah, I think neutral is higher. 00:08:46 Speaker 6: I mean, it's higher because we have this huge AI investment spending boom that's pushing up to neutral rate. That's increasing the demand for capital. Now, if the investment spending boom comes to an end, then the neutral rate will probably drop back down. But for the time being, as we're spending hundreds and hundreds of billions of dollars on these data centers … And the chips to fill them, the neutral is going to be higher. And the Fed's got to take that on board. 00:09:09 Speaker 1: Bill, we often reflect on a conversation that we had together coming out of the pandemic. I believe it was 2021. Maybe it was early 22. I remember it was with Mohamed El-Erin at the time as well. And you made the case this Fed might have to go to five. which just sounded crazy at the time because I think we were still close to zero. And they went to five and they had to go further. And Bill, it didn't cause the pain that the Fed chair at the time was talking about in Jackson Hole a couple of years later once he got there, the pain that was required to get inflation back to target. But what is it about this economy? You've alluded to some of it, but what is it about this economy that can withstand these interest rates? Because it's the resilience that has surprised so many people in the face of what this Fed has been doing. 00:09:50 Speaker 2: Well, I think it is financial conditions. 00:09:52 Speaker 6: So we've had huge wealth gains in the stock market, which supports people's spending who hold equities. Obviously, it's not very good for the people at the lower end. of the income distribution that don't have that benefit. 00:10:03 Speaker 2: And the AI boom. 00:10:04 Speaker 6: I mean, I think the AI boom is sort of an exogenous factor that's pushing the economy along. And I don't think the spending on AI is particularly interest rate sensitive. I don't think if the Fed hikes 25 or 50 or 100, It's really going to have much to change the trajectory of AI investment spending. 00:10:20 Speaker 2: That's going to be driven by the returns on that investment. 00:10:22 Speaker 6: And that's going to be determined not tomorrow or next month, but over the next few years. 00:10:29 Speaker 1: If you can't influence it, why do anything, Bill? 00:10:33 Speaker 6: Because you can't let inflation get ingrained above 2%. The Fed's gotten away with something over the last few years. If you told me five years ago that inflation would be above the Fed's target by a meaningful amount for five years, I'd be very concerned about... you know, the credibility of the Fed. But the Fed's managed to maintain that credibility. People still believe that the Fed will push inflation down to 2%. But you can't stretch that out indefinitely, especially at a time when the economy is performing fine, the labor market's, you know, very much in balance, and all the risks are on the inflation side. I mean, I think the worst thing of the situation, the war in Iran and the uptick in oil prices, and obviously diesel oil prices in particular, you know, basically raised the stakes for the Fed waiting. 00:11:14 Speaker 5: Bill, do you think that we would be talking about rate hikes if oil prices weren't where they were? 00:11:21 Speaker 2: It's possible that we might not. It really depends. 00:11:25 Speaker 6: As Kevin Warsh talked about, it's really the distribution of prices that increases what we care about. It's really about the pass-through of oil prices into other things. But I think the increase in diesel prices is really important because it's going to affect things like airfare. It's going to affect things like food prices. It's going to have a lot of knock-on effects. It goes into transportation costs. So any good service that has to be trucked around the United States is that has to embody that cost. So it's not just going to be, you know, in the headline inflation rate. It's going to start to filter into the core inflation rate as well. 00:11:55 Speaker 1: Stay with us. More Bloomberg surveillance coming up after this. Ed Yardeni of Yardeni Research, cutting his year-end target on the S & P to 7,900 from a street-fi 8,400, writing the risk of a downturn have increased. We raised the odds of a bearish outcome from 20% to 30%. Ed joins us now for more. Ed, welcome to the program, sir. You've dialed things back just a bit, slightly less bullish. What's weighing on you heading into year-end? 00:12:30 Speaker 7: Yeah, well, the key point in terms of what I've changed is I'm thinking it's going to take a little longer to get to 8,400. I don't think it's likely to happen by the end of the year now. I think it's more likely to happen by the middle of next year. 7,900 is still obviously above where we are now, so it's still... give us an awfully good year of returns. But the issue for me is geopolitical developments have deteriorated. The war in the Middle East has escalated, and we're looking at higher for longer oil prices, and higher for longer oil prices increase the odds that some of that inflationary pressures from energy will spill over into core prices, as Bill Dudley, your interview with Bill Dudley, excellent interview, indicated. And then in turn, we have not a one and. 00:13:22 Speaker 3: Done situation here with the Fed. 00:13:24 Speaker 7: We've got a situation where we're likely to have another one or two increases this year. And then the bond market's concerning. My friends, the bond vigilantes, have kind of gone wild all around the world. And I'm particularly concerned about the unwinding of the carry trade in Japan. 00:13:45 Speaker 3: The U.S. 00:13:46 Speaker 7: Officials keep putting pressure on the Japanese to increase their interest rates at a faster rate, which makes sense from a macroeconomic standpoint. But unfortunately, we may find out that this leads to more unwinding of the carry trade, which means hedge funds that borrowed in Japan at very low interest rates, when the yen was getting weaker, now will flip around and say, you know, that's that financing is just too expensive now, too risky. 00:14:16 Speaker 1: So, Ed, you gave us three things to think about there. Let's unpack them all. So, you said geopolitics and what happened with oil. You talked about what it means for monetary policy and the spillover to the bond market. Can we just stay on the first one? Does the first one inform the other two? How dominant is the situation in the Middle East? And to the people watching this at home that have become desensitized because it's gone on for seven months and they don't think it matters anymore, what's your message to them? 00:14:39 Speaker 7: Well, look, we're back at 100, and everything was just hunky-dory when we came back down to about 80 or so a few weeks ago. But the problem is that everybody thought that this war... in the Middle East will be over pretty quickly, especially at the beginning of the war when the leadership of Iran was decapitated. I thought the same thing for about one day. Then I thought about it again, and I said, well, wait a second. The IRGC are professional terrorists that are basically running a country, and they've got proxies all over that neighborhood. 00:15:15 Speaker 3: They're not going. 00:15:16 Speaker 7: To give up just because they're getting bombed from the air. Military history shows that that just doesn't work. You need boots on the ground. And so here we are in a situation where we're approaching the midterms, and Iran has a great incentive to create more havoc to keep the price of oil up, because they obviously would like Trump to lose his Republican majorities in the House and the Senate. 00:15:44 Speaker 5: Do you think that stocks are going to take longer to get to some of your loftier goals because of oil prices or because of rate hikes? 00:15:52 Speaker 7: Well, I think it's a combination of everything. The nice thing about being a strategist is it's pretty simple. It's PE times E. It's the valuation multiple times earnings. That's easy to do. Getting it right is the tricky part. I think the E, the earnings side, looks great. The economy is doing great. I remain fundamentally bullish, but even more bullish have been the analysts because the companies have been reporting great earnings recently. So it's all about the valuation multiple. And as you know, as earnings expectations have increased, and I call a FIMO, a fabulous earnings momentum, the valuation multiple has actually gone down because investors are getting a little bit shy about paying for this remarkable outlook for earnings. And oh, by the way, the whole AI story has become a little bit more questionable. That's also sort of being delayed, if you will, or pushed out. And I think that also affects the valuation multiple, because a lot of these AI stocks have very high valuation multiples. 00:16:55 Speaker 5: I want to pick up on something else that you were talking about with John, which is the unwind of the yen carry trade. And you're concerned that it could get kind of messy if you see the Bank of Japan hiking more significantly or responding to pressure from. 00:17:09 Speaker 1: Around the world. What does that look like? 00:17:10 Speaker 5: What gets penalized the most in that type of scenario? 00:17:13 Speaker 3: Well, I think actually we've been seeing it. 00:17:15 Speaker 7: When you look at the global bond route, when you look at how bond yields have gone up just about everywhere except maybe in China, what I think we are in fact seeing is a significant. 00:17:28 Speaker 3: Unwinding of that carry trade. Hedge funds. 00:17:32 Speaker 7: As I mentioned before, they went and borrowed at close to zero in Japan, got the proceeds in yen, converted them to other currencies, and bought government bonds and other assets around the world. And I think that's probably one of the best explanations for why this has been a global route, because the hedge funds took the money and invested it all over the world in areas where they thought they'd get a good carry trade opportunity. And that's that's unwind may not necessarily be over. 00:18:03 Speaker 1: What are the pockets of vulnerability that you can identify this morning for a set heading into the. Where do you see pockets of vulnerability in the market as you unwind that carry trade? Where do you still see him? 00:18:14 Speaker 7: Well, I think the clear tracks or fingerprints of the unwind would be in a coordinated increase in bond yields around the world. 00:18:27 Speaker 3: That's what we've seen. I mean, I think. 00:18:31 Speaker 7: But the BOJ decision up ahead here and what they do will do– if they only do a quarter, then I think maybe that will keep the carry trade from unwinding faster. But if they go and surprise and do 50, that might be more of a shock. So, I think the reaction to the BOJ report will be very important. 00:18:53 Speaker 1: So, Ed, just to get this clear, the more hawkish this BOJ is, you believe the more vulnerable the global bond market is? 00:19:00 Speaker 3: Yes. 00:19:01 Speaker 7: Yeah, and the ironic thing is our officials, especially Treasury Secretary Scott Besson, is pushing them to be more aggressive. More aggressive means they'll be raising interest rates more, their short-term rate more aggressively, and that would obviously strengthen the yen, two things that clearly stimulate the unwind. 00:19:23 Speaker 5: So clearly, just to sort of put a pin in this, Ed, you don't think that this is a good time to be buying long-term bonds ahead of that Bank of Japan decision? 00:19:33 Speaker 7: I wouldn't do it right ahead of the Bank of Japan decision, no. But I think, let's see what happens after that. I do think that looking out six, 12 months or 10 years on a 10-year bond, 5% is going to turn out to be a very good return. But for now, I'd like to sit on the fence the way the 10-year is sitting on the fence. 00:19:54 Speaker 3: It's just kind of sitting in that 5% fence. 00:19:57 Speaker 1: This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics and geopolitics. You can watch the show live on Bloomberg TV, weekday mornings from 6am to 9am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always on the Bloomberg Terminal and the Bloomberg Business App.