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Speaker 1: Welcome to the Bloomberg Surveillance Podcast. I'm Tom Keane. Along

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Speaker 1: with Jonathan Ferroll and Lisa Abramowitz. Daily we bring you

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Speaker 1: insight from the best and economics, finance, investment, and international relations.

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Speaker 1: To find Bloomberg Surveillance on Apple podcast, SoundCloud, Bloomberg dot Com,

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Speaker 1: and of course on the Bloomberg Terminal. Long ago and

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Speaker 1: far away, Lehman Brothers was a shop that excelled in

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Speaker 1: the fixed income trading market. When Lawrence McDonald worked there,

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Speaker 1: he made them some money. He went on to do

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Speaker 1: all sorts of other things, including books and of course

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Speaker 1: the Bear Traps Report. But what he's really known for

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Speaker 1: is every once in a while writing an essay we're

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Speaker 1: in a given year, you stop. He did that this

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Speaker 1: morning for the Esteem zero Hedge. Larry. First thing I

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Speaker 1: read this morning as well. I've been talking up Tunisia

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Speaker 1: is something interesting in the Middle East and in the Levant,

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Speaker 1: and you are focused on the fixed income deterioration of

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Speaker 1: emerging markets. We've seen this before, haven't we. Oh, Tom,

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Speaker 1: it's amazing. This period that we're right now is so

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Speaker 1: amazing because once or twice a decade, maybe three times

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Speaker 1: in twenty years, you get a two three four week

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Speaker 1: period where asset prices are moving at an accelerated pace

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Speaker 1: so fast, and normally economists that that are on all

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Speaker 1: the shows they're looking at economic data. But when when

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Speaker 1: risk assets are moving this fast, the risk at risk

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Speaker 1: assets take over economics a difference delivery. The difference here,

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Speaker 1: and this is really important, folks, is a mens esteem.

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Speaker 1: For Lawrence McDonald. While everybody else in the bow tie

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Speaker 1: world was studying economics, McDonald was down at the Brothers

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Speaker 1: for in the casino by the sea on Cape Cod

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Speaker 1: having a good time where he learned how to trade.

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Speaker 1: And as you know, Larry McDonald, what this is about

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Speaker 1: is the bid walks away. You've got a Bloomberg terminal

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Speaker 1: behind you there in your Matt's explain to me right

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Speaker 1: now the character of the bid walking away right now? Well,

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Speaker 1: it's the rate of change of asset price. It's where

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Speaker 1: it be leverage loans, emerging market bonds, UH credit, the

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Speaker 1: fault swaps on banks. So we're seeing just just the

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Speaker 1: the highest acceleration in the rate of change speed. It's

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Speaker 1: literally as fast as COVID, as fast as Lehman, and

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Speaker 1: economists around the world are looking at Okay, all these

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Speaker 1: rate hikes. At the end of the day, credit risk

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Speaker 1: is about to veto the FEDS policy path. In other words,

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Speaker 1: the dollar is so strong it's the global wrecking ball. Uh.

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Speaker 1: The i m F, for example, is owed one hundred

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Speaker 1: billion dollars tom from emerging market countries and the FED

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Speaker 1: is lighting that balance sheet on fire right now. Well,

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Speaker 1: but Larry, I'm trying to write my head around some

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Speaker 1: of the rhetoric, which is incredibly poetic, that describes the

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Speaker 1: moment credit risk is about to veto the Fed's tightening path,

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Speaker 1: that risk assets are taking over for economics. Basically, we're

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Speaker 1: reaching a breaking point akin to a Lehman moment or

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Speaker 1: even what we saw during COVID. Are you basically saying

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Speaker 1: the FED will have to backtrack or are you saying

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Speaker 1: that there is a more more material fissure that's coming

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Speaker 1: that's really irredeemable given where the FED is with inflation. Well,

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Speaker 1: think of you've done a great at least of this morning.

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Speaker 1: Your job when the stress has have been phenomenal, because

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Speaker 1: if you look back on June, late June, the results

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Speaker 1: came out and the media was really celebrating these results,

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Speaker 1: and now here we are not even three weeks later

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Speaker 1: and there's a restatement of those results. That tells me

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Speaker 1: that the regulators uh saw a shock. Um something is

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Speaker 1: really scared the regulators for that type of change in

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Speaker 1: position over thirty days. And if you look at the

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Speaker 1: rate of change in bonds, copper, and um in oil

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Speaker 1: inside a thirty day period, we've never had a move

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Speaker 1: like that without jobs being down like a hundred thousands

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Speaker 1: to two hundred thousand within three months. So it's so,

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Speaker 1: what's the breaking point here? I mean, you talked about

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Speaker 1: emerging markets, you said multiply that by ten, and are

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Speaker 1: we seeing that already beginning or are we not yet

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Speaker 1: even seeing it? And we're just sort of on the

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Speaker 1: precipice of we're seeing the beginnings of the breakage in

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Speaker 1: the dollar in what you're seeing with a Japanese yen,

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Speaker 1: in which you're seeing in certain markets for risk assets.

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Speaker 1: The fan is trying to stop inflation in the United

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Speaker 1: States by promising, you know, a thousand rate hikes essentially, right,

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Speaker 1: I'm just exaggerating, but about fifteen rate heiks, including one

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Speaker 1: trillion of quantitative tightening. The rest of the world is

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Speaker 1: not doing anything in that regard in the developed markets

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Speaker 1: sets up from maybe Canada. So what happens is when

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Speaker 1: the dollar strengthens and you're in Indonesia, an emerging market country,

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Speaker 1: You're trying to buy wheats, you try to buy corn,

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Speaker 1: you're trying to buy oil gas, You're the FETE is

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Speaker 1: essentially exporting information from the United States through the developing world,

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Speaker 1: and they're crushing civilizations around the planet. Larry, I get

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Speaker 1: this one question and before we go, and that is

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Speaker 1: the famous shot of Lehman brothers and they're standing there

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Speaker 1: watching the deterioration of the company, and the Gartment report

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Speaker 1: is up on the guy's screen as well. That was

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Speaker 1: a time of leverage. The optimists are pushing back against you,

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Speaker 1: saying the leverage here is not like it was a

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Speaker 1: ninety eight or in the Great Financial Crisis. Do you

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Speaker 1: buy it or is the leverage just different in different

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Speaker 1: place this time? Well, we behind me. We run a

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Speaker 1: Bloomberg chat tom with institutional investors on the by side

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Speaker 1: in twenty plus countries, so we monitor the conversation. In

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Speaker 1: the last two weeks three weeks, the conversation from by

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Speaker 1: side investors that run billions of dollars is focused on

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Speaker 1: sovereign risk, and that's where your nose has been focused

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Speaker 1: on this week, and so exactly which transferred the Lehman

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Speaker 1: risk from the balance sheets of the banks to the sovereigns.

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Speaker 1: And now the Feds accelerating rates up and they're blowing

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Speaker 1: up the global bond market and that's what's going to

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Speaker 1: stop them. Larry McDonald, thank you so much. Sobrata Rajapa

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Speaker 1: now was suck and joining us here. What is the

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Speaker 1: correlation that matters to you right now? Sobrata, what is

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Speaker 1: the relationship not only in rates but outside rates for you? Well,

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Speaker 1: I mean everything is a correy ad market, right, I mean,

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Speaker 1: the bond heels are all very correlated. What's happening in

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Speaker 1: Europe is definitely impacting what's happening in the In the US,

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Speaker 1: inflation is correlated. It's it's a global phenomena. But what

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Speaker 1: we're really seeing right now is sort of a record

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Speaker 1: slow motion, if you will. We're in the US. You're

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Speaker 1: seeing the steady rise in inflation, prints the Fed acting

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Speaker 1: aggressively as predicted, and then the very sharp inversion of

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Speaker 1: of the yield curve because of that, and the market

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Speaker 1: is starting to price in a much higher probability of

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Speaker 1: a recession that leading to potentially, uh, you know, FED

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Speaker 1: funds rate peeking around three and a quarter three and

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Speaker 1: a half to three point seven five percent, and then

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Speaker 1: cuts being priced in for next year. So this is

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Speaker 1: all very much what you would expect would happen in

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Speaker 1: a scenario like this where the FED is very aggressive. UM,

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Speaker 1: as far as Europe is concerned and Easy Beast concerned,

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Speaker 1: they're in a much toughest spot. Like you pointed out,

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Speaker 1: you're looking at you know, very high inflation, headline inflation

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Speaker 1: because of higher energy costs, higher oil prices, potential rationing.

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Speaker 1: But then on the other hand they have to be

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Speaker 1: concerned about growth as well, because if there is a

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Speaker 1: shutdown of of nursing one, that's going to lead to

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Speaker 1: a significantly sharp decline and growth. So policy there becomes

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Speaker 1: a lot tricky than it is in the US. We

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Speaker 1: need to be building up gas storage in Germany apparently

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Speaker 1: right now we're working it down. This is really problematic, Savantara.

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Speaker 1: More broadly, for the bond market, I'm trying to work

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Speaker 1: out what the anchor of global rates will be. Over

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Speaker 1: the last twenty years. It was Japan, then it was

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Speaker 1: Japan of the e c B and Europe and the

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Speaker 1: button market, and now there are doubts about the policy

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Speaker 1: at the b J complete unknown. When it comes to

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Speaker 1: European debt market, I've got no idea how you forecast

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Speaker 1: European debt yields at the moment, Savanria, how do you

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Speaker 1: come up the treasury call as you think about the

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Speaker 1: global fixed income universe. So to me, at this point,

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Speaker 1: the anchor is the treasury market because things in the

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Speaker 1: US are much more predictable, like you pointed out, than

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Speaker 1: in other jurisdictions. Uh. You know, the Bank of Japan,

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Speaker 1: you have they have eukur controls are in some respects

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Speaker 1: along and it's going to remain somewhat PEG, but there's

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Speaker 1: a lot of pressure on the currency side of the equation.

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Speaker 1: So at some point they're going to have to, you know,

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Speaker 1: move away from the hag in Japan. So for me,

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Speaker 1: what I'm really anchoring our rate forecast is on on

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Speaker 1: on on the tenure and you know trajectory, the trajectory

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Speaker 1: for growth over the next couple of years. Uh, And

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Speaker 1: that's really where I think that it's going to be

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Speaker 1: very difficult for tenny yields. Rives meaningfully from huron given

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Speaker 1: the fact that growth is poised to store on quite

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Speaker 1: meaningfully over the next year with the Fed expeditiously hiking

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Speaker 1: rates over the over the next you know, three to

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Speaker 1: six months, so bad. Let's take that a step further

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Speaker 1: and building what Bank of America did where they down

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Speaker 1: gooded their forecast for the yield of differential and this

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Speaker 1: rever the baseline yields for ten year and thirty year

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Speaker 1: treasuries at the year end and even next year. How

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Speaker 1: low and have you been revising even lower your expectations

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Speaker 1: for those yields based on the deteriorating macro economic backdrop.

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Speaker 1: So our view for for the for treasuries is that

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Speaker 1: tenny yields will peak sometime in the second or third quarter,

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Speaker 1: we might have already peaked, and then after that we

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Speaker 1: have a very steady trajectory of yields going lower from

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Speaker 1: from here on after the third quarter of perhaps ending

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Speaker 1: around you know, two and a quarter to two and

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Speaker 1: a half percent by the middle of next year. So

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Speaker 1: that's kind of the trajectory we're looking at. It is

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Speaker 1: quite a dramatic move lower in yields from where we

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Speaker 1: are right now, but it's all about, you know, the

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Speaker 1: trajectory for for growth after the FED has addressed it's uh,

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Speaker 1: it's you know, raised rates and address the inflation problem

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Speaker 1: if you will. How much is also a hinged on

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Speaker 1: the idea that the FED will not be able to

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Speaker 1: shrink its balance sheet materially beyond perhaps just the middle

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Speaker 1: of next year, because they will have to backtrack in

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Speaker 1: the face of altility, in the face of recession. Yeah,

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Speaker 1: that's a very good question because the whole policy framework,

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Speaker 1: it's very very tricky this time around, given the fact

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Speaker 1: that you know, after September, the Fed's balance it's going

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Speaker 1: to decline at around ninety five billion a month, So

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Speaker 1: that's a very rapid pace of balance sheet on wine

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Speaker 1: starting as as early as as September. So, you know,

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Speaker 1: I think I view is that the FED might be

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Speaker 1: able to raise rates, maybe to get to three and

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Speaker 1: a quarter three and a half percent by the end

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Speaker 1: of the year. But then you're going to see this

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Speaker 1: this the balance sheet run off act as a as

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Speaker 1: a second second order effect tightening financial conditions as well.

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Speaker 1: So it's gonna be it's yet to be seen if

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Speaker 1: they're going to be able to continue to run off

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Speaker 1: their balance sheet after the middle of next year, given

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Speaker 1: the fact that they're going to potentially have to cut

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Speaker 1: rates if the economy slows down meaningfully. Savantra also going

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Speaker 1: to get your views. What a morning for it? What

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Speaker 1: a twenty four savant Jamper of schen What a year

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Speaker 1: it's been? What a few years? I'm sure somebody are

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Speaker 1: screaming at the TV and radio as I say those

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Speaker 1: words right now. Conrado Quadros who the senior economic advisor

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Speaker 1: that bring capital? And this is the conversation of the day.

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Speaker 1: If you're worried about where that's so called terminal rate is,

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Speaker 1: there's three, there's three and a half. John Farrell just

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Speaker 1: mentioned four percent and a given bank, Okay, you out

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Speaker 1: do them all. What happens to us if we go

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Speaker 1: to a bring capital four and a half percent home,

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Speaker 1: maybe we make some progress on bringing inflation down. I mean,

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Speaker 1: obviously the problem of the day right now is is inflation. Um.

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Speaker 1: We've had, over the course of the last two and

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Speaker 1: a half years a number of poor narratives on inflation.

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Speaker 1: Right We started with the COVID's going to be disinflationary.

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Speaker 1: That went for six months with economists and the FED.

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Speaker 1: Then its inflation is going to be transitory. It's only

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Speaker 1: in a handful of goods. We saw on yesterday's CPI

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Speaker 1: report that Um, it's neither transitory obviously, um. And we

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Speaker 1: have very broad based increases. I mean, it looks to

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Speaker 1: us like underlying inflation is somewhere in the neighborhood of

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Speaker 1: five percent. Now if we look at those trimmed means

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Speaker 1: and medians and steaky price measures. So so the problem

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Speaker 1: of the day is dealing with inflation. Um. And you

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Speaker 1: raise a very important point on that TTERMO FED funds, right,

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Speaker 1: and the the idea here from the Fed is to

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Speaker 1: get policy to neutral and maybe a little bit beyond neutral.

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Speaker 1: But the problem is, I think they're misjudging neutral. The

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Speaker 1: two and a half percent neutral rate is a neutral

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Speaker 1: rate that existed when inflation was still at two percent.

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Speaker 1: We're not at two percent anymore, and it's a nominal rate,

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Speaker 1: so that neutral rate is probably higher, and I think

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Speaker 1: the Fed has got some work to do to get

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Speaker 1: policy tight and bring inflation down the terminal rate four

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Speaker 1: and a half percent. The path to get there is

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Speaker 1: important to understand. Is this a front loading? Is this

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Speaker 1: a rapid rate rise of a hundred basis points at

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Speaker 1: several consecutive meetings or is this a gradual and steady,

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Speaker 1: painful drip drip drip of let's get it up there,

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Speaker 1: because it's not coming down when we look at inflation, well,

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Speaker 1: at least, I think that the Fed will take what

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Speaker 1: the market gives it. And right now the market is

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Speaker 1: giving the Fed basically a green light to go by

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Speaker 1: a hundred basis point at the July meetings. So unless

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Speaker 1: that changes before July, I think the Fed will take that.

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Speaker 1: They have told us that they want to get um

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Speaker 1: as you said, they want to frontload these moves. They

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Speaker 1: want to get the funds rate to what they think

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Speaker 1: is neutral and maybe a little bit beyond. And as

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Speaker 1: I said, I think that that judgment might be off.

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Speaker 1: I think that the neutral rate is probably higher. I mean,

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Speaker 1: if you if you think about it, if you look

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Speaker 1: at the the FED funds right and put it in

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Speaker 1: real terms, it's still significantly negative. And I don't know

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Speaker 1: how we bring inflation down with negative real rates. Conrad,

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Speaker 1: when we take a look at some of the data

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Speaker 1: that we've gotten this week, We've gotten the cp I,

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Speaker 1: we've got JP Morgan earnings, and Morgan Stanley, and now

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Speaker 1: we have p p I and perhaps more importantly, initial

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Speaker 1: jobless claims coming out higher than expected, rising more than expected.

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Speaker 1: Can you put into perspective how telling that is versus

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Speaker 1: perhaps noise and data that has been pretty noisy. Yes,

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Speaker 1: And I think that's the jobless claims are important. It's

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Speaker 1: it's a very high frequency indicator of the labor market,

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Speaker 1: as might point it out. And I think it's a

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Speaker 1: very important point that July is a difficult time to

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Speaker 1: read jobless claims because of those auto shutdowns. And we

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Speaker 1: had an announcement a couple of weeks ago from one

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Speaker 1: of the large auto manufacturers that they're shutting down production

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Speaker 1: until September, and that's related to shortages of parts. UM.

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Speaker 1: But if we take a broader view of the labor

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Speaker 1: market and we look at things like job openings, whether

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Speaker 1: it's the BLS data on job openings or small business

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Speaker 1: job openings for June, which showed fifty of small businesses

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Speaker 1: survey reported a job that they could not fill UM

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Speaker 1: the record high, and we have data on that going

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Speaker 1: back to three The record high was fifty one last month,

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Speaker 1: so we have very high levels of job openings. UM.

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Speaker 1: We might see some pick up in in in layoff rates.

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Speaker 1: But but right now, if you look at the broader

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Speaker 1: data or the small business data, it looks like there

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Speaker 1: are a lot of jobs out there to fill. So

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Speaker 1: as people lose jobs, I think there'll be opportunities to

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Speaker 1: get jobs with other firms. Conrad. Long ago, there were

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Speaker 1: research reports that would come out and there was a

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Speaker 1: young Turk named John Riding or you have a nudding

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Speaker 1: acquaintance with that would write about tumal like I remember

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Speaker 1: this very clearly, waiting for Elliott Platt's book and all

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Speaker 1: of it and all the research from Bear Stearns and

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Speaker 1: d l J and such. Are we back there now?

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Speaker 1: When you look at the correlations out there, the deterioration

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Speaker 1: and e M two stents spread in a heart beat

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Speaker 1: down to twenty seven basis points an hour ago. Are

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Speaker 1: we getting that kind of tension in the global system? Well?

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Speaker 1: I I think one of the things that we're trying

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Speaker 1: to adjust here is to a market that is UM

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Speaker 1: is more on its own, it's less being influenced by

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Speaker 1: by the FED in terms of UM its balance sheet. Right,

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Speaker 1: so we have the FED that's begun the process of

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Speaker 1: normalizing the balance sheet I think that that's had very

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Speaker 1: important implications for the functioning of markets UM and and

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Speaker 1: it raises other issues right in my opinion, the we

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Speaker 1: can look now at the FED shift and it's it's

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Speaker 1: monetary policy framework to flexible inflation average targeting and say

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Speaker 1: that that's been a disaster for price stability. But I

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Speaker 1: also think the other issue we have to deal with

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Speaker 1: is we've had over the last fifteen years or so

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Speaker 1: a shift in the FEDS reserve policy, and this relates

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Speaker 1: to markets UM and the first FED has shifted to

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Speaker 1: an ample reserves policy, but with tight regulations on bank liquidity,

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Speaker 1: and I think that we're going to have some stresses

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Speaker 1: to deal with as it begins to reduce its balance

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Speaker 1: sheet as forward funding rates are now a lot less

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Speaker 1: certain If you think back to late May and you

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Speaker 1: told all that so for for example, would be two

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Speaker 1: and a half percent at the end of July or

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Speaker 1: approximately that, that would have been a shock, right, So

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Speaker 1: there's a lot more uncertainty and funding rates UM. The

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Speaker 1: FED is pulling back on on the size of his

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Speaker 1: balance sheet, and aggregate liquidity is still very high UM.

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Speaker 1: But we've learned over the last few years that liquidity

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Speaker 1: doesn't necessarily get to markets that needed, and so we've

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Speaker 1: had these these policies we had to blow up in

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Speaker 1: the treasury market in March. I mean, these are some

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Speaker 1: of the issues that we that we still have to

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Speaker 1: deal with, and I think we think are still out

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Speaker 1: there given the FEDS reserve policys. Thank you so much.

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Speaker 1: Let's take what we see in the correlations of the

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Speaker 1: market and go to the single correlation for Washington, which

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Speaker 1: is no one's getting paid anything given this high inflation.

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Speaker 1: It's the real wage reality that all of Washington faces.

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Speaker 1: Andrew Blacker has spent years looking at this. Ec ten

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Speaker 1: told him at Harvard years ago, guess what jobs matter?

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Speaker 1: The wage matters. He is with Investco, his global head

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Speaker 1: of public policy, Andy. What is the urgency this time

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Speaker 1: around of a horrific negative real wage. Well, politically it's

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Speaker 1: it can be deaf um for politicians. So right now,

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Speaker 1: we talk about the economy always being the most important thing. Well,

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Speaker 1: inflation is a major part of the economy that talks

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Speaker 1: about how people actually live every day. And so with

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Speaker 1: this latest spike to nine point one percent and us

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Speaker 1: not seeing the top um soon enough for the November elections,

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Speaker 1: I think it can have a real impact on what's

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Speaker 1: happening in the midterm elections. I guess the suits and

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Speaker 1: ties will tell us that a higher unemployment rate is

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Speaker 1: good for us right now, explain that to the American people.

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Speaker 1: How does Mr Powell, frankly, how does President Biden sell

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Speaker 1: a higher unemployment rate is good for you as we

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Speaker 1: bring inflation down. So, of course you give me the

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Speaker 1: tough task here, But theoretically, thought would be a higher

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Speaker 1: unemployment rate would actually soften wage inflation, and which can

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Speaker 1: be the core of inflation, so that they're really focused

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Speaker 1: on getting down inflation for and if you're just looking

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Speaker 1: at it from an inflation perspective, it could be good.

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Speaker 1: But but the other side of it is it's an

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Speaker 1: economic downturn potentially, So um, they are really trying to

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Speaker 1: walk that fine line. And as you've seen, you guys

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Speaker 1: have been talking about, you know, we've had the seventy

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Speaker 1: five basis point increase, we're looking at the full point

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Speaker 1: um this full hundred basis points. This is this is

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Speaker 1: a tough place to be right now, and I'm just

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Speaker 1: glad I'm not working at the FED to try to

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Speaker 1: navigate this. Meanwhile, in the here and now we're trying

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Speaker 1: to parse out the rhetoric of President Biden and some

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Speaker 1: of his associates with what they're actually are planning to

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Speaker 1: do with respect to going after companies that they are

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Speaker 1: accusing of price gouging. I'm thinking of oil companies, for example.

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Speaker 1: But I'm wondering who's next. Considering the fact that places

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Speaker 1: like airlines are not increasing capacity in the face of

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Speaker 1: increasing demand, how much is this going to be a reality?

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Speaker 1: Is their meat behind some of these threats versus just

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Speaker 1: simply lip service. Well, there's only meat behind the threats

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Speaker 1: if there's actual um mouthfeasance. So I mean that remains

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Speaker 1: we've seen. Look, the administration right now is in the

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Speaker 1: toughest of all world. They have high inflation, they have

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Speaker 1: a potential recession on on the on the horizon, they

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Speaker 1: have people really feeling the pain, and so they make

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Speaker 1: they need to make sure that they are out there

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Speaker 1: looking at every level they can, pulling every level to

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Speaker 1: help make things better. And so whether it's going to

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Speaker 1: Saudi Arabia, which we you know, we've heard that may

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Speaker 1: not be about oil, but we know it's a big

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Speaker 1: part of it is oil, or whether it's going after

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Speaker 1: UM companies in the US. They're trying to pull every

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Speaker 1: level to make it look like they are doing everything

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Speaker 1: they can for the American people. And when they have

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Speaker 1: no more levers andy, they say, look to the FED.

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Speaker 1: They're going to do everything. It's their job. How politicized

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Speaker 1: right now is the FED? Well, the reality is the

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Speaker 1: Fed's been politicized for some time. And I don't want

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Speaker 1: to go too far here here, but I mean we've

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Speaker 1: gone from a dobbish FED, who many people think relate

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Speaker 1: to the inflation UM acknowledgement maybe saying it was short

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Speaker 1: term UM, to now where they are really kind of

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Speaker 1: putting on the gas to raise rates. And and to

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Speaker 1: say that politics didn't play a role in both being

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Speaker 1: dubbish at the beginning and now being hawkish, I think

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Speaker 1: would be missing the point. And they so well set

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Speaker 1: that any flock of that, even Meskan. This is the

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Speaker 1: Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays

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Speaker 1: from seven to ten am Eastern on Bloomberg Radio and

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Speaker 1: Bloomberg dot com, and of course on the Terminal. I'm

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Speaker 1: Tom Keene, and this is Bloomberg.