Speaker 1: Ye, Welcome to the Bloomberg Surveillance Podcast. I'm Tom Keane
Speaker 1: jay Ley. We bring you insight from the best in economics, finance, investment,
Speaker 1: and international relations. Find Bloomberg Surveillance on Apple Podcasts, SoundCloud,
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Speaker 1: Tony Crosenzi joins us here in our studio, and Tony,
Speaker 1: great to have you with us. Happy holidays and all
Speaker 1: those great things. You know. One of the things I
Speaker 1: like about your notes, as you say, barring a zombie
Speaker 1: apocalypse or a spontaneous collapse and asset prices, uh, that's
Speaker 1: a lot of you know, if this doesn't happen, this
Speaker 1: won't happen. But I'm wondering what would a zombie apocalypse
Speaker 1: look like to Tony Crosenzi. Well, list note was the
Speaker 1: product of pimco's quarterly cyclical form where we look at
Speaker 1: the global economy a year forward and try to devise
Speaker 1: an investment strategy, and Yolakum Fells was the lead author
Speaker 1: to that um. So the zombie apocalypse, of course, would
Speaker 1: be probably a lot of a few things. One would
Speaker 1: be an inflation breakout, which would cause a federal reserve
Speaker 1: to increase its interest rates substantially and change the climate
Speaker 1: for investors substantially. Think about the stock market, it probably
Speaker 1: would be upset by it, and so would the corporate
Speaker 1: bond market. Another asset class. Can that happen? Is is
Speaker 1: it possible for inflation to accelerate, not gradually, but in
Speaker 1: a kind of alerch higher? Is that? You know? Can
Speaker 1: you wake up one day on a Thursday and find out,
Speaker 1: oh my goodness, oil's gone to seventy five dollars a borrow,
Speaker 1: like the Saudist said, But it's not three, It's still
Speaker 1: only twenty. Let's say eighteen. Well, uh. Jacket Yelling a
Speaker 1: couple of years ago wrote a note on inflation and
Speaker 1: called Inflation Dynamics September, and she did a thorough examination
Speaker 1: of what causes inflation, and what she concluded was that
Speaker 1: the most important driver of inflation is not the month,
Speaker 1: the amount of money that exists and this factor of
Speaker 1: that factor, it's inflation expectations, what people believe. So it
Speaker 1: is a very much a behavioral thing. And since most
Speaker 1: people have the view that inflation will stay low people
Speaker 1: meaning investors, consumers, businesses, it's highly improbable that would break
Speaker 1: out quickly. It would take a major change in the
Speaker 1: central bank sphere for UH investors, consumers, businesses to think
Speaker 1: differently about inflation in the future. So, for example, in eighteen,
Speaker 1: what if inflation picked up as a result of the
Speaker 1: US job was rate falling below four percent, which is
Speaker 1: likely next year since it's currently four point one. What
Speaker 1: if the Fed decided we don't care, we're gonna let
Speaker 1: pick up because it's been so low, then inflation expectations
Speaker 1: would build up, and then who knows, it could go higher.
Speaker 1: But that's improbable. The Federal Reserves learned over multiple decades
Speaker 1: to be cautious about letting inflation pick up, and so
Speaker 1: it's not likely inflation will pick up meaningfully for very long.
Speaker 1: But having said that, in your note, you say there
Speaker 1: is the potential for four rate increases by the Fed
Speaker 1: next year. A little bit more aggressive for sure. So
Speaker 1: we saw the Federal Reserve deliver three interest rate hikes
Speaker 1: in t seventeen. Three seems probable next year, and that's
Speaker 1: what the Federal Reserve itself expects. There were inconsistency, so
Speaker 1: and we were discussing this at PIMCO with or an advisor,
Speaker 1: Van Berninki not mean to name drop here, but he
Speaker 1: noted these inconsistencies as well. And the last Federal Reserve
Speaker 1: Summary of Economic Projections is a quarterly report the FED
Speaker 1: produces that shows projections on economic growth, on employment, and inflation.
Speaker 1: There was a big inconsistent here. It is FED projected
Speaker 1: economic growth like we do have two and a half percent,
Speaker 1: but it did not project a meaningful drop in the
Speaker 1: unemployment rate, nor an increase in inflation, nor an increase
Speaker 1: in interest rate hikes. And so something has to give,
Speaker 1: and that give may mean a fourth rate hike, because
Speaker 1: it probably will mean a lower jobs are real quick
Speaker 1: on this, and the job is the simple math. It's
Speaker 1: called the Oakland's laws. Member Nankee pointed out if job
Speaker 1: if economic growth of two exceeds growth potential, which is
Speaker 1: considered one point eight by seven tenths, the job is right,
Speaker 1: by Oaklan's law, should fall half of that FED in
Speaker 1: his summi economic rejections had only a two tenths drop
Speaker 1: instead of roughly four that Okan's law would say that
Speaker 1: it will drop next year. Hey listen, so might Rich
Speaker 1: Clarida beyond that FED next year maybe thinking about doing
Speaker 1: four rate increases. Of course, there's a report out there
Speaker 1: in the Wall Street Journal, according to those in the
Speaker 1: know that the White House has interviewed Mr Clarida, who's
Speaker 1: of course imagining director at PIMCO, and also some others.
Speaker 1: We talked about this on Bloomberg TV with our Marty
Speaker 1: schenk or Um and any insight you can just give
Speaker 1: pim and me, it's just the three of us. Well,
Speaker 1: they would There would only be one announcement, of course,
Speaker 1: of whether or not Rich Claire his name to the
Speaker 1: Federal Reserve, and that would of course come from the
Speaker 1: White House. But I would say about rich and Uh
Speaker 1: that he's expert, he's exemplary, he's exceptional, and these qualities
Speaker 1: are important. Also he's he's very affable and works well
Speaker 1: with people. This is important collegial. Here's his story I
Speaker 1: have from Alan Greenspan. He visited us when he was
Speaker 1: an advisor to Pempico with Newport Beach, and he said
Speaker 1: that when he joined the FED in seven as FED chair,
Speaker 1: that he learned that it it was the most collegial organization
Speaker 1: he ever worked for. For example, he expected staffers PhD
Speaker 1: staffords to walk into his room with competing views on
Speaker 1: the policy, and instead they were working together. This collegiality
Speaker 1: is something that someone like Rich Clarata would contribute well to.
Speaker 1: It's very important to the institution of the FED and uh,
Speaker 1: Rich of course would be ideally suited if chosen. Can
Speaker 1: I just push back on that, I mean, why do
Speaker 1: you want everybody to agree with each other for the collegiality?
Speaker 1: But this is not agreeing with each other. It's not
Speaker 1: it's providing inputs, right, And somebody says don't raise interestsgiality
Speaker 1: in the Federal Reserve sense means healthy discussion. They're all
Speaker 1: working together with their varied points of view. This is
Speaker 1: something that PIMCO knows well. We hold in our quarterly
Speaker 1: forums and Rich Clarence as head of them. Uh. Two
Speaker 1: people attending U in Newport Beach contributing views. It's a
Speaker 1: flat structure where everyone has a voice. One could have
Speaker 1: no rank at all in terms of official rankings. Of course,
Speaker 1: they have high rankings as human beings. Uh. They could
Speaker 1: be vice president of senior vice president, executive managing director.
Speaker 1: Who who knows? The main thing is that it's a
Speaker 1: voice and it's a it's an input. And this is
Speaker 1: something that which absolutely understands quite well. Exceptionally well. What
Speaker 1: about though? Also we know that Rich served as an
Speaker 1: Economic Policy Assistant Secretary for Economic Policy the Treasury Department
Speaker 1: from O two to oh three, So he comes at
Speaker 1: things with an ponomous background, with a financial background, if
Speaker 1: you will, Will comes at it from a couple of
Speaker 1: different angles, Tony, How might that help the FED, particularly
Speaker 1: in what might come in It's also important to have
Speaker 1: a great Anyone who's appointed to the FED should have
Speaker 1: a great understanding about communications. Remember a great line from
Speaker 1: Bamburnanking his most recent book, The Courage to Act. He
Speaker 1: said that he's repeated this to us at PIMCO, that
Speaker 1: that monetary policies on two percent action communication. In other words,
Speaker 1: what the FED says can affect markets and people's expectations,
Speaker 1: and it's important to have an understanding of that, and
Speaker 1: the understanding of economics and monetary policy historically matters too.
Speaker 1: We spoke about this on television a little while ago,
Speaker 1: Carol about how Ben Bernanke understood the dilemma of the
Speaker 1: Great Depression and how the FED failed in the nineteen
Speaker 1: thirties to produce enough money to prevent a collapse in
Speaker 1: the money supply. The amount of money that existed if
Speaker 1: failed by a third according to Milton Friedman, and it
Speaker 1: was a great contributor to the Great Depression lack of money. Uh.
Speaker 1: Bam Bernanke understood that it was that it was importantly
Speaker 1: printed lots of money, just as corroded did in Japan
Speaker 1: and dragging in Europe. Uh. These are very important things
Speaker 1: to understand. Um, that's a big example, but there are
Speaker 1: a lot of little examples about how knowledge about monetary
Speaker 1: policy can conserve a member of the Federal reserved Quite well,
Speaker 1: do you think it's more it's easier to manipulate people's
Speaker 1: opinions now than it was, let's say, in the nineteen thirties. Yes, Um, so,
Speaker 1: then that apocalypse that you describe, where that sudden change
Speaker 1: in people's expectations is perhaps more likely to happen now
Speaker 1: than it was before we had Twitter, smartphones and sevens. Probably,
Speaker 1: perhaps it's not the that the Fed can convince or
Speaker 1: communicate more. Uh. The temple the speed at which things happen,
Speaker 1: of course as faster, but of course the public could
Speaker 1: could have a fear permier quickly. Think of the movie
Speaker 1: It's Wonderful Life with Jimmy Stewart. Uh, there's a scene
Speaker 1: I recall with a bank run. How do people know
Speaker 1: that there's a bank run occurring in that day and age?
Speaker 1: It's simply where it eventually gets around. Today was simply
Speaker 1: the speed at which it gets around is faster. Now
Speaker 1: you just pound the uh, you know, online button, tweet.
Speaker 1: But I mean if you go to a website and
Speaker 1: it stops working and it's your bank, all of a sudden,
Speaker 1: everybody in the world knows that everything's changed, or a
Speaker 1: tweet or something posted on a social website. Absolutely, communication
Speaker 1: is important to central bankers, and that's one of the
Speaker 1: key things that's keeping interest rates low and make causing
Speaker 1: the yield curve to be flat, as they say, meaning
Speaker 1: short term rates are close to long term rates. Is
Speaker 1: the idea that this communication is calmed investors. They don't
Speaker 1: worry and ask what compensate compensation against the risk of
Speaker 1: higher inflation and higher policy rates anymore. Alright, we're going
Speaker 1: to continue the conversation. We've got more with Tony Krissense,
Speaker 1: Pimco market strategist and portfolio manager. I'm pim Fox along
Speaker 1: with Carol Masser, and this is Bloomberg Surveillance. I'm Carol
Speaker 1: Masser along with Pim Fox. We are in for Tom
Speaker 1: Keene and Jonathan Farrell on this Wednesday. We want to
Speaker 1: talk a little bit about the tax legislation. We mentioned
Speaker 1: earlier about Barkley's taking a one time hit from the
Speaker 1: U S tax bill, but expecting to make it back
Speaker 1: to some extent on future earnings. David Burton is with
Speaker 1: the Heritage Foundation, Senior fellow at the Heritage Foundation. We
Speaker 1: find him on the phone from the nation's capital on
Speaker 1: this Wednesday. David, nice to have you here on Bloomberg Radio.
Speaker 1: This tax proposal, we talked about it earlier, not proposal,
Speaker 1: this new tax legislation overhaul, if you will, we talk
Speaker 1: about it earlier. Greatest benefit really is for corporations. Yes,
Speaker 1: in terms of the positive economic effects, the biggest benefit
Speaker 1: is the reduction and corporate tax rate from which was
Speaker 1: a while it sounds like a lot. Um actually puts
Speaker 1: this in the middle of the pack among industrialized countries.
Speaker 1: Will be at about one state corporate taxes are taken
Speaker 1: into account, but until next week, we're literally the worst
Speaker 1: highest corporate tax rate in the industrialized world. So we've
Speaker 1: made progress. Uh. It also contains a number of other
Speaker 1: provisions that are constructive. Probably the most notable is expensing
Speaker 1: for machinery and equipment for five years, so businesses can
Speaker 1: deduct the cost of buying machinery and witment rather than
Speaker 1: having to deducted over many years, five, seven, ten years um.
Speaker 1: There are a number of other positive things in the
Speaker 1: international tax area that will help US headquartered companies, But
Speaker 1: on the individual side, it's not all that much to
Speaker 1: brag about. It reduces individual tax rates a couple of points,
Speaker 1: but for a lot of people that's taken back immediately
Speaker 1: by the repeal of the state and local tax deduction. David,
Speaker 1: do you believe that the economy is doing fairly well
Speaker 1: right now? Yes? I mean it is just doing reasonably well.
Speaker 1: There's plenty of room for improvement, both in terms of
Speaker 1: investments and productivity gains. But also there's a lot of
Speaker 1: people who aren't encountered as unemployed, who normally would be
Speaker 1: in the workforce. Well, do we know exactly how many
Speaker 1: of those people are there and whether that is what
Speaker 1: is tipping the political scales to force this overhaul of
Speaker 1: the tax code. You can get a cent of how
Speaker 1: many people are there by looking at the broader definitions
Speaker 1: of unemployment that the Beer of Labor Statistics put out. Um,
Speaker 1: they put out lots of different measures. The you know
Speaker 1: that what you usually hear on the radio, uh is
Speaker 1: one measure, but there are broader measures, uh that would
Speaker 1: have unemployment up there. I forget the exact number right now,
Speaker 1: it's but it's about ten. Uh. Those are people who
Speaker 1: have not reported in the conventional unemployment rates. But use
Speaker 1: six is what this is called is is uh. It
Speaker 1: reflects people who have gonna affect given up looking for
Speaker 1: work for the time being. Okay, so I'm just trying
Speaker 1: to understand why would you put together a tax overhaul
Speaker 1: plan at a time that the economy, by your own admission,
Speaker 1: is doing pretty well. And you're pointing to all these
Speaker 1: people that are outside the workforce that perhaps aren't counted.
Speaker 1: And yet Uh, if you've got to pass through corporation,
Speaker 1: you're gonna end up paying what tax? But if you're
Speaker 1: actually working for a pay check, as chances are that
Speaker 1: your tax rate is going to be a lot higher.
Speaker 1: How does that make sense? Well, for one, our labor
Speaker 1: force produci patient rate is that historic loads are near
Speaker 1: those loads. This tremendous number of people not working. It
Speaker 1: could be working, and presumably you would prefer that they
Speaker 1: be working and self sufficient rather than uh collecting the
Speaker 1: disability or unemployment insurance. I don't think anybody argues that,
Speaker 1: but I think the question is how do you make
Speaker 1: how do you maintain this sort of idea that this
Speaker 1: tax overhaul plan that reduces You said it's good for corporations, right,
Speaker 1: I mean it will reduce their tax rate, although most
Speaker 1: companies don't necessarily overseas pay that tax rate. Of how
Speaker 1: is the relevant thing you would think is you would
Speaker 1: want people to invest in producing things here in the
Speaker 1: United States, So why not make the tax cut contingent
Speaker 1: on their actual hiring. I mean you can do that.
Speaker 1: You can put all the details you want into the
Speaker 1: tax code. Why just assume that they're going to do
Speaker 1: it or encourage it? When chief executives have already raised
Speaker 1: their hands and said we're going to buy back stock
Speaker 1: and we're going to increase dividends. Well, we'll do some
Speaker 1: of that, and that's fine. The money that when they
Speaker 1: buy back the stock, that money doesn't disappear. It gets
Speaker 1: reinvested somewhere else, and the market determines where it goes.
Speaker 1: It goes to the generally what people believe will be
Speaker 1: the highest return investments. UH. As you probably are aware,
Speaker 1: a tremendous number of US companies have been leaving, for example,
Speaker 1: Onizer Bushes now Belsenburger King Is now Canadian and selling
Speaker 1: down the line. By reducing our core for tax rate
Speaker 1: and improving the international treatment of US businesses, we're going
Speaker 1: to see less of that. We're going to see more
Speaker 1: factories being built in the United States. We're gonna see
Speaker 1: a higher rates of productivity growth. We're going to see
Speaker 1: a lot of positive things as a result of this legislation.
Speaker 1: But I don't want to oversell this legislation. It is
Speaker 1: a shadow of what it should have been. UH. It's
Speaker 1: probably going to result in two and a half uh
Speaker 1: increase in the GDP or the overall size of the
Speaker 1: economy over the next ten years. It should have been
Speaker 1: more up around the neighborhood of ten percent. This is
Speaker 1: going to be a relatively small positive effect on the
Speaker 1: economy as opposed to the transformational, huge kick in the
Speaker 1: pants that it could have been if they've done it right.
Speaker 1: And let me just point out the Joint Committee on
Speaker 1: Taxation UM, the group within the Congress that really kind
Speaker 1: of figures out, you know, what kind of kick this
Speaker 1: legislation will have. They actually say that it's going to
Speaker 1: be maybe eight tenths of a percent increase to the
Speaker 1: accounty over ten years, so it's a lot less substantial.
Speaker 1: The Joint Committee on Taxation staff basically has a long
Speaker 1: history of underestimating the economic growth effects of any tax legislation.
Speaker 1: That said, you know, I don't want to overseell this legislation.
Speaker 1: It's not going to have magical effects. But David, let
Speaker 1: me ask you. You say that there was a missed opportunity.
Speaker 1: They could have done a lot more. What should they
Speaker 1: have done in your view? Should it have been more
Speaker 1: of an individual tax cut? What? Wow? The biggest thing
Speaker 1: that they failed to do is improve permanently the tax
Speaker 1: treatment of investment in things like factories or technologlogical developments
Speaker 1: on the line. In other words, they did not expense
Speaker 1: capital investment. Uh, they didn't expense structures, they didn't expense
Speaker 1: equipment uh permanently. Uh. They made a lot of other mistakes.
Speaker 1: They kept the capital gains rate where it is. They
Speaker 1: kept the rate on pass through businesses or or individuals
Speaker 1: uh very high and for a lot of people who
Speaker 1: actually see marginal tax rate increases. Uh. So there's then
Speaker 1: I can get into a lot more details, but there's
Speaker 1: a long list of things they did not do to
Speaker 1: improve the tax system, David, If the consequences of the
Speaker 1: overhaul lead to muted growth, in other words, this pop
Speaker 1: that you're describing, or indeed even the stronger economy that's
Speaker 1: being described by the Republicans who passed it, if that
Speaker 1: does not appear, is there a way to put to
Speaker 1: rest the notion that tax cuts fuel economic growth. I
Speaker 1: think it's vertually certain that tax reductions and marginal tax
Speaker 1: rates and reductions in the cost of capital will fuel
Speaker 1: economic growth. That's pretty basic pricetery, pretty basic public finance.
Speaker 1: It's not the tax cuts per se has and do
Speaker 1: its sort of kensy and multipliers and things like that.
Speaker 1: It's the fact that people are economically rational and if
Speaker 1: they can get a higher rate of return, they're more
Speaker 1: likely to invest, they're more likely to work, they're more
Speaker 1: likely to say uh. And so I don't think we'll
Speaker 1: get over that because I think it's almost incontrovertibly true.
Speaker 1: But then the question is how do you do that?
Speaker 1: And reducing marginal tax race is part of it. Reducing
Speaker 1: the cost of capital as part of it. This bill
Speaker 1: or or legislation does improve those things, but it's not
Speaker 1: nearly as dramatic as it could have been, should have
Speaker 1: been as not as as dramatic as it started out.
Speaker 1: They ended up having to keep a long laundry list
Speaker 1: of special tax provisions uh and and various things on
Speaker 1: the individual side. It don't affect by people off because
Speaker 1: there they needed virtually every Republican vote to get it done.
Speaker 1: All right, well, we're gonna leave it there, but thanks
Speaker 1: very much at David Burton. Looking forward to having you
Speaker 1: in the new year and to go over the effects
Speaker 1: of the attacks overhaul plan. David Burton is the Heritage
Speaker 1: Foundation's Senior Fellow in Economic policy on the tax plan.
Speaker 1: You're listening to Bloomberg Surveillance. I'm Pim Fox along with
Speaker 1: Carol Masser. I'm Carol Masser along with the wonderful Pim
Speaker 1: Fox right here on Bloomberg Radio. We are in for
Speaker 1: Jonathan Farroll and Tom Keene. We do want to talk
Speaker 1: a bit about the economic outlook what it might mean
Speaker 1: for FED policy. Joining us right now is Kevin Cummins.
Speaker 1: He's senior US economist at NatWest Market, joining us on
Speaker 1: the phone from I Believe, Connecticut. Kevin, good to have
Speaker 1: you here on Bloomberg Radio. You look at the outlook,
Speaker 1: you look at the economic outlook. There are folks that
Speaker 1: come on and they are optimistic about what's to come.
Speaker 1: They continue to see growth into one eighteen summer. Tempering
Speaker 1: it back, Where are you, hi, Good morning, Well, thanks
Speaker 1: for having me Carol. Um. Yeah, we're pretty optimistic on
Speaker 1: the overall outlook. We think the expansion is going to continue. Um,
Speaker 1: we're looking for growth this year right around two and
Speaker 1: a half percent and to gradually accelerate into next year
Speaker 1: closer to I want to know about automobile sales and
Speaker 1: what what weight you give those to your outlook, because
Speaker 1: it looks as though we are set for the first
Speaker 1: decline full year sales decline since the Great Recession. And
Speaker 1: I know that there are a lot of statistics that
Speaker 1: you know, exclude automobiles, They exclude energy, whether that's inflation.
Speaker 1: But I'm wondering if you could talk about automobile sales
Speaker 1: and how you figured that that flows into the economy. Yeah,
Speaker 1: I mean, obviously, the manufacturing more broadly is an important
Speaker 1: sector of the economy. In particular, autos drives a lot
Speaker 1: of manufacturing UM and as you mentioned, those are set
Speaker 1: to moderate, although more recent months you've seen very strong
Speaker 1: demand in the wake of the hurricanes, which impacted a
Speaker 1: lot of UH. You know, replacement automobiles have picked up
Speaker 1: in the in the wake of that. UH. In fact,
Speaker 1: we're looking for a nice rebound that will get at
Speaker 1: the start of the year a pretty healthy reading close
Speaker 1: to eighteen million units at an annualized rate. So that's
Speaker 1: a very strong, probably unsustainable pace. More broadly, UM, but
Speaker 1: this year we're looking for a closer to about a
Speaker 1: seventeen million unit rate when it's all said and done
Speaker 1: for the twelve months of the year UM, and we're
Speaker 1: looking for that to be pretty much sustained into two
Speaker 1: thousand and eighteen. As the consumers and still pretty healthy shape.
Speaker 1: Do you think that consumer is in healthy enough shape
Speaker 1: to actually buy one of these new cars, because the
Speaker 1: Kelly Blue Book says that the average sticker price paid
Speaker 1: for a new vehicle is nearly thirty six thousand dollars.
Speaker 1: That's up two percent from a year earlier. Those are
Speaker 1: November figures. Yeah, those are big numbers. But uh, you know,
Speaker 1: with the sort of labor market that we've gotten, Um,
Speaker 1: you know, it's the consumers seems to be kind of
Speaker 1: firing on all cylinders as we headed into the start
Speaker 1: of the year. Do you think that they'll be able
Speaker 1: to continue to afford it whether they put cash down
Speaker 1: which is unlikely, but more likely to borrow or lease. Yeah,
Speaker 1: that's kind of the American way. I mean, you know,
Speaker 1: the labor market has remained very solid. If you look
Speaker 1: at payroll growth, we've averaged about a hundred and seventy
Speaker 1: five or so thousand jobs over the last twelve months
Speaker 1: or so. UM. The employment report that we'll get at
Speaker 1: the start of the year suggests that the consumer is
Speaker 1: likely to have have a pretty good uh wherewithal to
Speaker 1: spend h to start two thousand and eighteen. And now
Speaker 1: that you've gotten a little bit of momentum in the
Speaker 1: overall economy as we head into the year, uh, you know,
Speaker 1: when people are reminded U that confidence is high. We'll
Speaker 1: get a reading in that in a little bit with
Speaker 1: the Conference Board measure. But but by all indications, there's
Speaker 1: no reason to suggest that there's going to be any
Speaker 1: sort of pull back from the consumer sector as two
Speaker 1: thousand eighteen starts. All Right, Kevin Cummins, I'm a half
Speaker 1: glassful kind of girl. I'm just going to say that
Speaker 1: I'm pretty optimistic. UM. Having said that, we have seen
Speaker 1: this economic cycle go on for some time. I know
Speaker 1: there isn't a mark on the calendar that just says, okay,
Speaker 1: time for the economy to turn down. But what is
Speaker 1: it that you're watching out for, um to see a
Speaker 1: different twist in this economic cycle? Uh, is a recession
Speaker 1: at all on the outlook for you? UM, not for
Speaker 1: the next day, twelve or so months. I put the odds.
Speaker 1: I mean, normally there's probably a chance of about ten percent,
Speaker 1: and any given expansion that you can uh, you know
Speaker 1: that a recession is going to come. So I I
Speaker 1: put the odds somewhere close to that, maybe ten fifteent
Speaker 1: odds that you're gonna get experience a recession in the
Speaker 1: next twelve months. But you know, there's no real warning
Speaker 1: signs in fundamentals for the economy. As I mentioned, the
Speaker 1: labor market remains very solid. We've seen good uh income
Speaker 1: growth if you look at wages and salaries last week.
Speaker 1: We've got personal income and spending and it showed wages
Speaker 1: and salary growth over four percent, So you know, that's
Speaker 1: a very healthy pace for the consumer. And given that
Speaker 1: the consumer uh AfD account for import growth is probably
Speaker 1: about six or so of the overall economy. Um, you
Speaker 1: know that that right there suggests that your overall economy
Speaker 1: is in pretty healthy shape. I mean, one of the
Speaker 1: more positive things as we head into two thousand eighteen,
Speaker 1: especially in the wake of the UH plan for the
Speaker 1: tax cuts, our business investment, and by all indications, we're
Speaker 1: likely to see UH further acceleration from that perspective. So
Speaker 1: you know, you add that to the consumers part, and
Speaker 1: you're you know, almost or so there. Does it also
Speaker 1: mean no more inflation? And then that becomes maybe problem addict? Yeah,
Speaker 1: I mean, inflation, surprisingly enough has been as soft as
Speaker 1: it is, you know, trending below two percent, and the
Speaker 1: Fed is obviously, uh pretty sensitive to that idea. So
Speaker 1: I think, you know, the overall inflation backdrop doesn't suggest
Speaker 1: that you're going to get any sort of real upside
Speaker 1: risk inflation here, but probably more gradual UH pace of
Speaker 1: somewhere around one and three quarters to two percent over
Speaker 1: the next year or two. Kevin Cumming see is the
Speaker 1: net West as senior economist. Our guest is r J.
Speaker 1: Gallo of Federated Investors, Senior portfolio manager, Head of Duration Committee,
Speaker 1: r J. Gallow. What is a duration committee? Our Duration
Speaker 1: Committee is a group of senior portfolio managers traders are
Speaker 1: Global fixed Incomes CEO Bob A. Strowski, and we convene
Speaker 1: every month and sometimes more frequently to look across the
Speaker 1: factors that we believe are driving us interest rates and
Speaker 1: to set the duration governor that then permeates through the
Speaker 1: intermed and long term bond portfolios or firm managers. So,
Speaker 1: since durations one driver of bond returns, we try to
Speaker 1: bring together minds from across the fixed income group to
Speaker 1: set duration targeting that is then followed, you know, with
Speaker 1: with judgment by the portfolio managers of the various portfolios
Speaker 1: we run. Okay, can you give us an example of
Speaker 1: how the group has changed its recommendation so that we
Speaker 1: understand the mechanism by which it kind of implements these decisions. Yeah. Absolutely,
Speaker 1: Every fixed income portfolio Federated has a strategy relevant benchmark.
Speaker 1: So for example, of the Total Return Bond Fund, which
Speaker 1: is our largest um investment grade portfolio multi sector across treasuries, corporates,
Speaker 1: high yielder, emerging markets, et cetera. Has managed relative to
Speaker 1: the Barkley's Aggregate Index UM. The out index, of course,
Speaker 1: has a duration, and the duration committee Our output is
Speaker 1: to provide a recommended percentage of that index duration that
Speaker 1: the portfolio manager should follow, but they're given latitude around it. So,
Speaker 1: for example, UM, for much of this year, we've expected
Speaker 1: treasury yields to rise, and as a result, we have
Speaker 1: been recommending a duration typically between ninety to sometimes seven
Speaker 1: and a half. So being short your benchmark duration because
Speaker 1: we anticipated as yields rise, being short would give you
Speaker 1: opportunities for relative out performance. When the tax package passed
Speaker 1: and as it was working its way through Congress, what
Speaker 1: did you guys go back to your offices and sit
Speaker 1: down and work and say, Okay, here's what we need
Speaker 1: to think about different portfolios as a result of this.
Speaker 1: What changed? That's a great question, UM. Interestingly enough, you know,
Speaker 1: there's a lot of times we talk about you know,
Speaker 1: everybody's been expecting yolks to rise for for a very
Speaker 1: long time, and oftentimes people focus on the tenure of treasury.
Speaker 1: But if you go back and you look at the
Speaker 1: yield on the Bloomberg Barkley's Treasury Index, which is the
Speaker 1: treasure component of the of the agg UH. That index
Speaker 1: yield was eight basis points um at one. It's two
Speaker 1: and twenty four basis points as of yesterday's close. On
Speaker 1: this calendar year alone, it's risen thirty five basis points,
Speaker 1: driven primarily by the fact that the two years up
Speaker 1: seventy plus basis points and the five years up thirty
Speaker 1: as is the three year up almost sixty. The tenure,
Speaker 1: on the other hand, is about where it started the year,
Speaker 1: So we've had a massive flattening almost a twisting is
Speaker 1: better term of the Treasury Yon curve. The fifth a
Speaker 1: policy change that you just brought up the tax bill.
Speaker 1: You know, we've been talking all year long, what will
Speaker 1: the Trump administration and the Republican Capital will be able
Speaker 1: to deliver with respect to significant changes in fiscal policy,
Speaker 1: to include taxes, to include healthcare UH, and to include
Speaker 1: deregulation and on that last point, the regulation. They've been
Speaker 1: quietly making significant changes UM which arguably are stimulative at
Speaker 1: least in the short run. As businesses feel that the
Speaker 1: administration UH and Washington d C. Broadly speaking, UH, is
Speaker 1: somewhat more business friendly. It's a it's a sentiment builder,
Speaker 1: if you will, and they've been delivering on that for
Speaker 1: a long time. Healthcare, we know what happened there, Uh,
Speaker 1: you know, got closed, didn't change it. Um. And then
Speaker 1: ultimately we felt that the failure on Obamacare would increase
Speaker 1: the probability of a major tax bill being passed and
Speaker 1: signed into law. We felt that the political imperative of
Speaker 1: the somewhat fractious Republican Party between the White House and
Speaker 1: Capital Hill. Um, they all shared common interest and they
Speaker 1: needed to move forward, and we thought the tax about
Speaker 1: would happen to be frank we thought it would be
Speaker 1: signed in Q one eighteen UM. But that political imperative
Speaker 1: was very motivating and it got signed in so. Um.
Speaker 1: The the progress that we expected, in fact did manifest
Speaker 1: themselves a little sooner than we expected. Uh. And we
Speaker 1: do think it's going to be somewhat stimulative. UM. I
Speaker 1: have questions about sort of the content of the tax cut.
Speaker 1: I've heard some of your interview earlier with the individual
Speaker 1: from the Heritage Foundation, and you were asking some some
Speaker 1: of the questions I would ask so UM, but generally speaking,
Speaker 1: I think the short term stimulative nature of the tax
Speaker 1: cut is it's hard to deny. Long term, we worry
Speaker 1: about deficits. So in the near term, the simple fact
Speaker 1: that the deficits will probably go up. UM. I'm a
Speaker 1: believer in dynamic scoring, but I'm also believed that the
Speaker 1: tax cuts don't pay for themselves. History has not proven
Speaker 1: that to be true. That suggests that it's one argument
Speaker 1: for staying short duration. UH. There'll be more treasuries issued.
Speaker 1: Happens to come at a time the FED will be
Speaker 1: buying fewer treasuries. Uh. Supply and demand matter in everything,
Speaker 1: and they should matter in the treasury market. So we
Speaker 1: think that the trajectory of treasury yield generally speaking should
Speaker 1: be upwards. The curve has been a massive twister. UM.
Speaker 1: Don't know if that will last. Possible, some near term steepening,
Speaker 1: in fact, will occur as you see a little bit
Speaker 1: more economic stimulus, as you see inflation slowly building, UH,
Speaker 1: and as you see more treasury issuance with less demand
Speaker 1: from the FAT all at the same time. So our
Speaker 1: view on the tax bill was that this is in
Speaker 1: line with our anticipation that yields should be rising, and
Speaker 1: it was one of the factors we considered in making
Speaker 1: sure that we stayed short, you know, in the nineties,
Speaker 1: if you will, relative to index duration as we got
Speaker 1: through the fourth quarter of this year. R J. Gallow
Speaker 1: Over at Federated Senior vice president, senior portfolio manager and
Speaker 1: head a municipal bond investment group and also head of
Speaker 1: the Duration Committee at Federated. Thanks for listening to a
Speaker 1: Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud,
Speaker 1: or whichever podcast platform you prefer. I'm on Twitter at
Speaker 1: Tom Keene before the podcast. You can always catch us worldwide.
Speaker 1: I'm Bloomberg Radio.