Speaker 1: Hello, and welcome to What Goes Up, a weekly markets podcast.
Speaker 1: My name is Mike Reagan. I'm a senior editor at Bloomberg, and.
Speaker 2: I'm Katie Greifeld. I'm an anchor with Bloomberg Television and
Speaker 2: a cross auser reporter.
Speaker 1: And this week on the show, while the Federal Reserve
Speaker 1: raised borrowing costs again this week, taking their benchmark interest
Speaker 1: rate to a twenty two year high. At Mane on
Speaker 1: Wall Street, believe the Central Bank is either finished or
Speaker 1: very close to being finished this very aggressive rate hike cycle.
Speaker 1: But what about the recession that so many were convinced
Speaker 1: would result from the Central Bank's aggressive fight against inflation?
Speaker 1: Was that just misplaced pessimism or is the downturn still
Speaker 1: on its way. We'll get into it with our guest,
Speaker 1: who is an economist at a major investment firm. But
Speaker 1: first I got a question for you. Yeah hit me,
Speaker 1: And I know you went to college in the Philadelphia
Speaker 1: area at Haverford. I assume you sampled the cheese steaks
Speaker 1: in Philadelphia at some point, and you're.
Speaker 2: Preaching right, No, I've never had a cheese steak. I
Speaker 2: feel like I'm immediately killing our banter. Our top of
Speaker 2: the show banter. But I've never had a cheese steak.
Speaker 1: You've never had a cheese steak?
Speaker 3: No, It just.
Speaker 2: Something about the strips of meat never appealed to me.
Speaker 2: I do eat, I'm not a vegetarian, but just did
Speaker 2: not fill out my boat.
Speaker 1: Oh man, all right, all right, that's fair. So your
Speaker 1: answer is none of the above, Na, not applicable?
Speaker 2: I said, yes, what would have happened?
Speaker 1: My tradition here is to ask Philadelphia area guests what
Speaker 1: their favorite cheese steak joint is. And I'm going to
Speaker 1: tell you right now, Katie, If our guest this week
Speaker 1: actually is a cheese steak eater, I think I can
Speaker 1: guess what his favorite place is. And this after never
Speaker 1: have met him, never spoken to him. That's how good
Speaker 1: I am. All right, you ready?
Speaker 3: All right?
Speaker 2: I'm excited.
Speaker 1: Now let's bring him in. He is Joe Davis. He's
Speaker 1: the global chief economist and head of the Investment Strategy
Speaker 1: Group at Vanguard. Joe, welcome to the show.
Speaker 3: Oh thanks for having me.
Speaker 1: All right, Joe? Are you ready to be blown away?
Speaker 3: Yeah? Let's go.
Speaker 1: Your favorite cheesesteak joint is Larry's Steaks on fifty for
Speaker 1: fifty fourth I believe it is and city line on
Speaker 1: Hawk Hill? Am I right?
Speaker 3: Not bad? Not bad?
Speaker 1: Did I get?
Speaker 3: It's not my favorite?
Speaker 4: So I grew up outside of Philly, but I went
Speaker 4: to college in Philadelphia proper. So Larry's is a great one,
Speaker 4: particularly after midnight because being in college, they're there.
Speaker 3: It's a good cheese.
Speaker 1: Joe Is, I believe you might be our first Hawk,
Speaker 1: our first Saint Joseph's University hawk on the show, which
Speaker 1: is exciting for me, my whole. I've one of six kids.
Speaker 1: Everyone in the family went to Saint jose but me. Yeah, yeah,
Speaker 1: it's crazy.
Speaker 4: Well, how is this so if you're from Philadelphia, you
Speaker 4: know a rivalry of Saint Jose's.
Speaker 1: Villanova r Oh, absolutely yeah.
Speaker 3: So that's where that's where my daughter's going next year.
Speaker 3: So we're gonna have some family tensions.
Speaker 1: Oh yeah, boy, you're at your let you're gonna let
Speaker 1: her back in the house.
Speaker 3: I don't know.
Speaker 4: My son's at Penn. So we got the whole. We
Speaker 4: have almost the entire Big Five. So yeah, long lived Pilly.
Speaker 1: Three fifths of the Big Five. Well, Joe, let's get
Speaker 1: down to business. Then, you know we have the fed
Speaker 1: uh statement and press conference today. You know, the vibe
Speaker 1: I'm getting is not too many surprises. You know, we
Speaker 1: got the quarter point rate increase, so the FED funds
Speaker 1: target's now five and a quarter to five and a
Speaker 1: half percent. Anything shock you today or surprise you at
Speaker 1: all about the statement or what Jerome Palell had to say.
Speaker 3: No, I mean, nothing's really surprised me, Mike.
Speaker 4: I mean again again, I think the big, open ended
Speaker 4: question is the same question that we were facing at
Speaker 4: the beginning of the year, and that really is how
Speaker 4: much work, if at all, there needs to be done
Speaker 4: from the Fed, which really brings to the heart really
Speaker 4: the essential question, which is how restrictive are they today?
Speaker 4: You hear Chairman pal saying they're restrictive.
Speaker 3: By any measure. The question is how much? Because if
Speaker 3: you can.
Speaker 4: Get a handle on that, then you know how much
Speaker 4: both inflation will fall and how much economic damage may
Speaker 4: be done over the next six or twelve months. So
Speaker 4: I think that's still the open question that we were
Speaker 4: facing the beginning of the year.
Speaker 2: Something else that I wanted to ask about, though, was
Speaker 2: the fact that just stepping back from you know, will
Speaker 2: they won't they? In terms of rate rises, it's been
Speaker 2: striking to me how there's been so relatively few descents
Speaker 2: on Chairman Palell's watch. This was another meeting that was
Speaker 2: completely unanimous, even though in their words and the FED
Speaker 2: speak that follows every big decision, there seems to be
Speaker 2: some disagreement. You never see that in the actual votes.
Speaker 2: I'm wondering if that's something you've noticed as well.
Speaker 4: That is a good point, Katie, I have noticed it.
Speaker 4: I think that if you know, going forward, we may
Speaker 4: see greater disagreement. Certainly there's probably more healthy disagreement in
Speaker 4: the actual discussions when they're making decisions rather than the statement.
Speaker 4: But I think I think they've been I think Chairman
Speaker 4: has been able to navigate that with more of the
Speaker 4: first appause, you know, the last meeting and now being
Speaker 4: a more data dependent phrase because you do have you know,
Speaker 4: a healthy spectrum of those wanting to go a little
Speaker 4: bit further and those thinking on the FED that they've
Speaker 4: done enough. So I think that's also a somewhat of
Speaker 4: a testament to his leadership being able to navigate that.
Speaker 4: But I think from here on out, I think that
Speaker 4: the probability of having you know, some modest descent could rise.
Speaker 2: Do you think at all that it sort of muddles
Speaker 2: the message coming from the FED that there has been
Speaker 2: unanimous votes up until this point. And the reason I
Speaker 2: asked is because I was listening to Andrew Hollenhorst from
Speaker 2: City on ATV immediately after the decision, before the press
Speaker 2: or after the decision, saying that basically they sacrifice clarity
Speaker 2: in having a completely unanimous vote, especially after what we
Speaker 2: saw in June where they decided to skip but they
Speaker 2: signaled more raises to come. Is that something that that
Speaker 2: irks you at all, something that muddels their message? Or
Speaker 2: are they pretty loud and clear here?
Speaker 4: No, I mean I think they're closer to loud and clear.
Speaker 4: I mean I think reason why we probably haven't seen
Speaker 4: as much of a descent or open aired sort of
Speaker 4: dialogue is because inflation is still well buff target. Yes,
Speaker 4: it has come down, you know, the more recent data
Speaker 4: is lower than what it was a year ago. But
Speaker 4: I think that that they're still off on their core mandate,
Speaker 4: which is why we're seeing still coalestion coalescing around the
Speaker 4: final decision. I think again, as we get closer to
Speaker 4: two percent, could be a ways off, but as closer
Speaker 4: we get a two percent inflation I think you could
Speaker 4: see more healthy debate, including on.
Speaker 1: The voting, you know, Joe, I think one of the
Speaker 1: remarks that caught some people by surprise was when Jerome
Speaker 1: Palce said he doesn't see the economy getting back to
Speaker 1: that two percent target until twenty twenty five, so you know,
Speaker 1: another year and change, you know, five quarters or so.
Speaker 1: Does that make sense? You know, we've seen such an
Speaker 1: aggressive drop from you know, what was the peak in
Speaker 1: headline CPI like nine to three in the last print.
Speaker 1: Does it make sense that it would take that much
Speaker 1: longer to get to two?
Speaker 3: You know?
Speaker 1: Is it a is it a story of base effects
Speaker 1: that you know, now we're comparing year over year to
Speaker 1: inflation that had already cooled off. How are you thinking
Speaker 1: about how long it'll take to get to that two percent?
Speaker 3: Well, I think it will take some time.
Speaker 4: I think that's you know, I think that was a
Speaker 4: subtle but a very important point is actually it's one
Speaker 4: of the most important comments I thought that was made today, Mike,
Speaker 4: and that you know, there's there's our own research and projections,
Speaker 4: the Federal reserves projections as well as academic analysis, including
Speaker 4: from former chairman Ben Bernanke all point to that to
Speaker 4: the same outcome, which is inflation and remaining elevated, meaning.
Speaker 3: Above two percent for some time.
Speaker 4: The primary reason for that is the tightness in the
Speaker 4: labor market, and so you know, I think that's where
Speaker 4: you know, and we have been of the view I've
Speaker 4: been have had strong conviction for some time that we
Speaker 4: were going to need to see some material cooling in
Speaker 4: the labor market to get to two percent in any
Speaker 4: near term horizon, because it is in the wage dynamics.
Speaker 4: And so I don't I think the market has slowly,
Speaker 4: the bond market has slowly come to grips with that
Speaker 4: starting to price out cuts. Right if recall at the
Speaker 4: beginning of the year there was you know, high conviction
Speaker 4: in the bond market there would be significant easy and
Speaker 4: almost at this point right now. And so I think
Speaker 4: even those comments today, I still think point to the
Speaker 4: fact that you know, it's going to take some labor
Speaker 4: market weakness to get to that last yard at as
Speaker 4: many call it, from three percent trend inflation down to two,
Speaker 4: which brings up another I think important debate that words
Speaker 4: matter with respect to this narrative around the soft landing.
Speaker 4: But perhaps you know, I'll say that for another question.
Speaker 2: Before we get there, and I do want to get there,
Speaker 2: I want to talk a little bit more about what
Speaker 2: you're saying about wages in the fact that we need
Speaker 2: to see some cooling in the labor market to get
Speaker 2: back to target. Is that because there's evidence of a
Speaker 2: wage price spiral at this point?
Speaker 4: Well, I think, kay, I think there was clearly that
Speaker 4: last year you had wage pressures that were significant six
Speaker 4: seven percent. You had labor market turnover that was as
Speaker 4: high as a generation. Again, we all knew some of
Speaker 4: that was somewhat temporary. But I think where I come out,
Speaker 4: there's not a wage price spiral. But the fact is
Speaker 4: the labor market is imbalanced, and we've grown. You know,
Speaker 4: there's measures that many point to the vacancy to unemployment rate.
Speaker 4: You know that ratio one is in balanced number of
Speaker 4: vacancies equal number of unemployed Americans. We've grown that data
Speaker 4: actually back to as far back as World War One,
Speaker 4: so one hundred years, which gave us early insight during
Speaker 4: the throes of COVID that we're going to have some
Speaker 4: wage based inflation pressures. That ratio now has come down,
Speaker 4: that's good news, but we're starting to enter the territory
Speaker 4: the ratio is right now, one point five vacancies to
Speaker 4: a unemployment of one, So one point five is above one.
Speaker 4: It's imbalance demand exceed supply. We're starting to enter the
Speaker 4: territory where any further drop in vacancies starts to be
Speaker 4: associated with a modest increase in unemployment. That's important because
Speaker 4: that suggests that and there hasn't been an exception to
Speaker 4: that for one hundred years. So if we're right, we
Speaker 4: should see some further weakness in the labor market. If
Speaker 4: we do not, then that opens up a different door,
Speaker 4: which means inflation may be stickier than we think, and
Speaker 4: that would be a surprise to the market.
Speaker 2: I did want to wrap in this conversation we're having
Speaker 2: on the labor market to current events that we're seeing
Speaker 2: in the economy, especially when we're seeing all these labor negotiations.
Speaker 2: We saw a big win for labor un unions this
Speaker 2: week with the Teamsters versus UPS, and actually the Teamsters
Speaker 2: chief was on Bloomberg Television after that saying that now
Speaker 2: they're taking the name at Amazon, and I'm wondering how
Speaker 2: you're viewing that, whether those are one off scenarios where
Speaker 2: you know, maybe that segment that was involved, that union
Speaker 2: that was involved gets a price hike. How that is
Speaker 2: fitting into your overall view on the labor market right now?
Speaker 4: Well, you know, I think you know, if you talk
Speaker 4: to friends and colleagues, as even a Boston as an employer,
Speaker 4: you know, you can feel the tightness in the labor
Speaker 4: market when you're looking for applicants. It's in the data,
Speaker 4: it's in common experience. It's not as tight as a
Speaker 4: year ago. Last year seemed like a really a frenzy
Speaker 4: where demand just was was was drassicala ecceede supply. Labor
Speaker 4: turnovers come down. We know, job you know wage increases
Speaker 4: are double the rate when you leave a company for
Speaker 4: a new job then when you stay at the existing ones,
Speaker 4: So is labor turnovers come down. The wage growth is cooled,
Speaker 4: and again this is good news for consumers. But the
Speaker 4: fact is we still have an imbalanced labor market. Now
Speaker 4: that's why the biggest reason why the Fed took rates
Speaker 4: from zero to five percent, right, It's just that there
Speaker 4: was that debate a year ago, your member, between Waller
Speaker 4: and Summers and others and some calling that immaculate disinflation,
Speaker 4: meaning you could have that ratio which at one point
Speaker 4: was two vacancies to one unemployed. You could fall most
Speaker 4: magically to one. I'm just saying that that's that's historically unprecedented.
Speaker 4: You can drop from two to about one point five
Speaker 4: maybe one point three, which we're we're tracking along that pace.
Speaker 4: At that point, it becomes that that sort of that
Speaker 4: line becomes a little kinked, and so any further drop
Speaker 4: in vacancies to get a better balance in labor market,
Speaker 4: which gets to the wage pressures being a little bit less,
Speaker 4: you know, intense, you start to see a rise in unemployment,
Speaker 4: and so there's no getting around that trade off at
Speaker 4: some point. And that I think the soft that the
Speaker 4: soft landing crowd has to come as to grips with
Speaker 4: is that is it theoretically possible, Sure, but it would
Speaker 4: actually require decent good luck and further labor supply coming
Speaker 4: out of the woodwork for us to magically balance the
Speaker 4: labor market.
Speaker 3: Over the next six months.
Speaker 1: Well, Joe, let's talk about that soft landing notion. I mean,
Speaker 1: it seems like it's getting a bigger and bigger sort
Speaker 1: of constituency among economists. One of the interesting things Pal
Speaker 1: said today was that the FED staff is no longer
Speaker 1: forecasting a recession. The IMF this week raised its its
Speaker 1: growth forecast for next year. And at Bloomberg, you know,
Speaker 1: obviously we do a lot of surveys of economists. They've
Speaker 1: boosted their GDP estimates for the second and third quarters.
Speaker 1: According to that survey, consensus is there's about a sixty
Speaker 1: percent chance of a recession within the next twelve months.
Speaker 1: I'm curious what how you're handicapping it, you know, is
Speaker 1: that sixty percent sound high to you? Load to you?
Speaker 1: Is it? Is it more of a sure thing than that?
Speaker 1: How are you thinking about?
Speaker 4: So I'll give you my answer. I also give you
Speaker 4: which it's semantics, but it's actually a very important one
Speaker 4: and that is actually many of the forecasts out there,
Speaker 4: although they seem dramatically bipolar, either if there's a recession
Speaker 4: camp or there's a soft landing camp, right, they're actually
Speaker 4: the forecasts, including the FED, including vanguards you know, are
Speaker 4: forecast and many from you know, many many economist firms.
Speaker 4: They're actually more similar than different. There's just there's this
Speaker 4: there's been this bipolar sort of oh we're in the
Speaker 4: recession camp or not?
Speaker 3: Why say that?
Speaker 4: Is almost everyone has a rise in the unemployment rate
Speaker 4: of at least thirty or forty basis points, so going
Speaker 4: above four percent over the next year.
Speaker 3: Right.
Speaker 4: Well, historically that that that has been one hundred percent
Speaker 4: associated with a recession, now not necessarily deep in magnitude,
Speaker 4: but a recession that, by the way, is the Federal
Speaker 4: Reserves forecast. So the Federal Reserve, I mean semantically, they
Speaker 4: they're on record saying no, no recession, but by that metric,
Speaker 4: it actually it would it is a recession because you
Speaker 4: have very modest job losses. Now GDP could be you know,
Speaker 4: zero point five percent, one percent next year. That's closer
Speaker 4: to our projections one percent. You know, here's the quiz
Speaker 4: in two thousand and one, which has been our central
Speaker 4: tendency of what's the most closest reference point for a
Speaker 4: very mild recession, which is our baseline two thousand and one,
Speaker 4: GDP never fell on an annual basis Really, yeah, we
Speaker 4: had unemployment rise.
Speaker 1: Yeah.
Speaker 4: No. In fact, many recessions do not have GDP fall
Speaker 4: in the calendar year with which they occur. Again, except
Speaker 4: GFC and nineteen eighty two and all those deep ones
Speaker 4: clearly fall. So again, we haven't changed our view on
Speaker 4: that the data has been a little bit stronger than expected.
Speaker 4: But ultimately our view has been you can't have your cake,
Speaker 4: you need it too, which means to get inflation down
Speaker 4: to that last yard of two percent, you have to
Speaker 4: see a modest weakening in the labor market, which means,
Speaker 4: on pointing rate's going to rise, although hopefully not Drasticgo
Speaker 4: let's say let's say four and a half percent over
Speaker 4: the next year. Well, that's one hundred basis point rise, right,
Speaker 4: So by definition, that is a recession. Now, anyone who
Speaker 4: thinks that that's a soft landing is spitting in the
Speaker 4: face of one hundred and fifty years of history. I'm
Speaker 4: just saying that that's categorically wrong. Now, I think what
Speaker 4: the soft landing camp really is is there's actually no
Speaker 4: landing at all, meaning there's no rise in unemployment. Now
Speaker 4: I would assign the probability of that of roughly fifteen percent.
Speaker 4: I mean, that would be both good luck on the
Speaker 4: supply side. We still have an increase in labor force
Speaker 4: participation rate for example. Right, we got better news there,
Speaker 4: and you would have the federal reserve really calibrated just
Speaker 4: the right way. The five and a half percent fed
Speaker 4: funds with core coming down, it's enough to have non
Speaker 4: farm payrolls over the next year come in I don't know,
Speaker 4: let's say one hundred thousand, just enough to have a
Speaker 4: rise on point rate, but you don't have job losses
Speaker 4: where you start to really you know, start to see
Speaker 4: set am weaken further. Effectively, that's an environment where businesses
Speaker 4: do not really have job cuts, they effectively they just
Speaker 4: pause on hiring.
Speaker 3: That is that, in my mind, is what the soft
Speaker 3: landing really is.
Speaker 4: And and so that's where I think, you know, from
Speaker 4: an economists perspective, that may sound a little bit like
Speaker 4: you know, splitting hairs, but it's actually important. So our view,
Speaker 4: we say that is a low probability, so the odds
Speaker 4: of recession are higher than sixty percent, but we're not calling,
Speaker 4: you know, like for a deep recession. It's been it's
Speaker 4: fairly mild and closest examples two thousand and one, so
Speaker 4: hopefully that's helpful. I just see this disconnect between those
Speaker 4: saying we're going to avoid recession, yet they have an
Speaker 4: unemployment rate rise in of one hundred basis points. It's
Speaker 4: just I just don't think that's possible to have those
Speaker 4: two outcomes at the same time.
Speaker 2: Joe, there's a lot to dig into there, But I
Speaker 2: want to return to a point you made that to
Speaker 2: get to the last yard, to get back to two percent,
Speaker 2: sort of The plain question I have is whether or
Speaker 2: not that's worth it. Is it worth it to get
Speaker 2: to two percent and tip the economy into a recession
Speaker 2: versus accepting, you know, maybe a higher inflation rate of
Speaker 2: two and a half percent.
Speaker 4: Again, it's a fair question, Katie. I've heard that dialogue.
Speaker 4: I've been in research meetings with Federal Reserve officials. That
Speaker 4: conversation has been had. I hear that argument. I just
Speaker 4: think it's risky. Could it work?
Speaker 3: Yes?
Speaker 4: I mean, why die on the hill for two point
Speaker 4: seven percent core inflection?
Speaker 3: Right?
Speaker 4: The only risk to that is what happened in nineteen
Speaker 4: sixty seven, And that's actually the.
Speaker 3: One year where the yield curve inverted, yet we didn't
Speaker 3: have a recession.
Speaker 4: People call it a soft landing, But as I've written
Speaker 4: to our own clients and Vanguard, what happened two years
Speaker 4: later was actually a deeper recession and inflation came back.
Speaker 4: Now that's not our baseline, But why I bring up
Speaker 4: nineteen sixty seven is comes back to that indicator I
Speaker 4: mentioned before, the vacancy's unemployment ratio. In nineteen six, conditions
Speaker 4: were very similar as now. The Federal Reserve cut rakes
Speaker 4: because of some a little bit of credit pressures in
Speaker 4: the banking sector. Now again, the Federal Reserve is not
Speaker 4: cutting rates today. Within a year, though, that vacancy on
Speaker 4: appointment ratio it cooled down but always remained well above one.
Speaker 4: It started to rise again closer back to two, which
Speaker 4: is where we were at the beginning of the year,
Speaker 4: And so the Federal Reserve had to switch course dramatically
Speaker 4: and actually had to take rates. They were at five
Speaker 4: and a half, They took them down to three. By
Speaker 4: the end of sixty nine are up to nine percent,
Speaker 4: and a deep recession followed. Why so, like you could
Speaker 4: let inflation kind of hover at two and a half
Speaker 4: two point seven, I would be looking at that point
Speaker 4: if that was the decision, where's that vacancy the unappointment.
Speaker 3: Ratio is it? Is it good?
Speaker 4: It is it around one, which is like the true
Speaker 4: sooft landing, or is it going back up closer to
Speaker 4: the two ratio than we had to beginning of the year.
Speaker 4: If that is the case, then I would be screaming
Speaker 4: for higher rates because we have seen that play out before.
Speaker 4: So I would put a caveat, like, if you're going
Speaker 4: to pursue that policy and let inflation hover around three percent,
Speaker 4: really keep a close eye on the imbalance or balance
Speaker 4: in the labor market, because that was a mistake that
Speaker 4: I think many would take back that mistake in nineteen
Speaker 4: sixty seven.
Speaker 1: Hey, Joe, if I could ask you to switch hats
Speaker 1: for a minute here, As I said at the top,
Speaker 1: you are the global chief economist at Vanguard, but you're
Speaker 1: also head of the investment strategy group and on the
Speaker 1: portfolio management team in fixed income. So I'm curious how
Speaker 1: you were thinking about the bond market. You know, it
Speaker 1: seems like yields have sort of settled into this range
Speaker 1: last few months, call it four point eight four point
Speaker 1: nine on the two year and about three point eight
Speaker 1: three point nine on the ten year. We did have
Speaker 1: the ten year spike above four a few weeks ago,
Speaker 1: but it seems like it's settled back into that three
Speaker 1: point eight three point nine, you know, at least on
Speaker 1: a nominal basis. Obviously, real yields are another story there.
Speaker 1: As inflation comes down but are we just kind of
Speaker 1: locked into this range phenomenal yields. Do you think if
Speaker 1: we if the FED is sort of going into plateau
Speaker 1: rates for the rest of this year and next year.
Speaker 3: I think so.
Speaker 4: I mean, I think, you know, first of all, from
Speaker 4: an investment perspective, our theme has been for a year
Speaker 4: that you know, bonds would come back because you have
Speaker 4: some rich real yields that you mentioned Mike, right, You
Speaker 4: have real yields positive across most of the term structure.
Speaker 4: It's something that you know that I've called the beginning
Speaker 4: of the year, that return to sound money, right, And
Speaker 4: I think it's been the best positive single development in
Speaker 4: the financial markets in the last twenty years bar none.
Speaker 3: Because we have less of a subsidization by.
Speaker 4: Savers to those have had debt, you know, because you
Speaker 4: had you had negative interest real interest rates.
Speaker 3: So that is a theme for us.
Speaker 4: I think within the fixed income market. To have a
Speaker 4: higher long end of the curve, to have a higher
Speaker 4: ten year treasury, you're going to need to make an
Speaker 4: argument that either inflation is going to cyclically come back,
Speaker 4: which I would say more as a tail risk, although
Speaker 4: certainly possible.
Speaker 3: The other one is is that our star that's so
Speaker 3: called neutral rate is higher.
Speaker 4: And as you know, our listeners may know, you know,
Speaker 4: or we've published research, we've put it on external websites
Speaker 4: to say that our star is actually is higher, which
Speaker 4: is one of our thesis going into the year that
Speaker 4: FED wasn't as restrictive as people think. So I think
Speaker 4: from a fixed income perspective, you know, but again, bonds
Speaker 4: are back, They're providing income across various investment strategies. On
Speaker 4: the corporate sector, I mean, you see the total nominal
Speaker 4: yield and on a real, real perspective of pretty compelling
Speaker 4: on the municipal space, similar case. So I think it's
Speaker 4: been a great development. We viewed this as view really
Speaker 4: as a positive outcome for investors. My biggest concern five
Speaker 4: years ago, Mike, is that we had negative interest rates
Speaker 4: or remember the concerns around secular stagnation and low interest
Speaker 4: rates forever. I think this is, you know, the power
Speaker 4: of compounding find an investment perspective is pretty powerful.
Speaker 2: So just to draw that point out a little bit,
Speaker 2: maybe this is an oversimplification, but if our star is higher,
Speaker 2: do treasury yields across the curve need to be structurally
Speaker 2: higher as well?
Speaker 4: Yeah, it's an esoteric terms, okaitis you know, but it's
Speaker 4: effectively a way saying, what is the neutral cache rate? Right,
Speaker 4: which is the bise asset for any security in the world, equities,
Speaker 4: fixed income, private equity, So the risk free rate? What's
Speaker 4: that neutral risk free rate? No one can see it.
Speaker 4: It's like something in the heavenly bodies. You know, it's
Speaker 4: out there if you can't actually feel it with your hands.
Speaker 4: But our research that we've updated, actually it's fed O
Speaker 4: Reserve's own research, we can show that it's one hundred
Speaker 4: basis points higher than whatever that neutral rate was before COVID,
Speaker 4: and it was starting to rise actually before COVID, and
Speaker 4: it doesn't move on a dime. So if we're right,
Speaker 4: that means the neutral nominal rate is roughly three and
Speaker 4: a half, maybe perhaps this high as four percent, say
Speaker 4: a cash rate a treasury T bill, and then you
Speaker 4: would price out the yield curve from that, which would
Speaker 4: get out of fair value potentially for the tenure treasury
Speaker 4: over time. So with the you know, a modestyness in
Speaker 4: the yield curve, you can get a fair value five
Speaker 4: or ten years from now on a tenure that's a
Speaker 4: little bit higher than where we are today, and that's
Speaker 4: really debate in the market. The market was very bomb market,
Speaker 4: as you know, was very skeptical that we were ever
Speaker 4: going to leave that secular stagnation camp. We were anticipating
Speaker 4: high odds that we would. We just did not know
Speaker 4: the timing of it. But we think this is more
Speaker 4: there's more permanence to the recent rise in interest rates. Yeah,
Speaker 4: the Federal Reserve may cut rates in the next two years
Speaker 4: with some economic weakness, but I think neutral rate is
Speaker 4: clearly nominal rate is clearly in the three percent, you know,
Speaker 4: three to four percent range. We can debate within that
Speaker 4: range and as if it's slightly over that. But again,
Speaker 4: that's a dramatic shift from where we were pre.
Speaker 2: COVID and Joe, You'll have to forgive me, but I'm
Speaker 2: a journalist. I think in headlines so unforgivable listening to
Speaker 2: what you're saying. I mean, ten year yields right now
Speaker 2: we're at three point eighty six percent. If the cash
Speaker 2: rate is you know, three and a half, I have
Speaker 2: to assume that has to rise. Is this the end
Speaker 2: of the bond bull market?
Speaker 4: Then I would characterize it differently. So my headline would
Speaker 4: be there's more permanence to this, and then this is
Speaker 4: really a good news. So I think those that have
Speaker 4: been betting that we're going to we're well above normal
Speaker 4: ranges and betting on a significant drop in interest rates.
Speaker 4: I just think it's off base now this fair value range.
Speaker 4: You know, the ten year traders are three point eight.
Speaker 4: But there's a probability of recession in the next twelve months,
Speaker 4: and so the market is trying to have assign a
Speaker 4: certain probability to that over the next several years, which
Speaker 4: can drop us below the numbers I just gave you, right,
Speaker 4: So it doesn't surprise me that we're a little bit
Speaker 4: below the four percent for four and a half percent
Speaker 4: range on the tenure because it's also trying to discount
Speaker 4: economic weakness in the next two years.
Speaker 3: But I again, I.
Speaker 4: Think we're within a normal range. I think the big
Speaker 4: headline I would be putting is bonds will stay back.
Speaker 4: You know, the headline beginning the years was bonds are back.
Speaker 4: I think that they'll they'll stay high in their perch
Speaker 4: for the foreseeable future.
Speaker 1: Chairman Palell duly noted at the press conference the long
Speaker 1: and variable lags of monetary policy and how signal they're
Speaker 1: still kind of waiting for perhaps some other shoes to drop.
Speaker 1: You know, we saw the issues with regional banks in
Speaker 1: the spring. These days, there's this sort of slow trickle
Speaker 1: of alarming news in the commercial real estate sector. You know,
Speaker 1: there's a lot of debt coming up for refinance in
Speaker 1: the next few years at much higher rates, with much
Speaker 1: lower occupancy rates on top of it. I'm just curious
Speaker 1: where how you're thinking about that long and variable lag
Speaker 1: and where maybe we should be looking for the effects
Speaker 1: to perhaps surprise people. I mean, is it commercial real estate?
Speaker 1: Is the regional banking issue not something that's completely solved
Speaker 1: at the moment, Where perhaps would you worry about effects
Speaker 1: from this aggressive interest rate campaign that we haven't really
Speaker 1: seen yet.
Speaker 3: Yeah, well, I think it'd be too Mike. I mean,
Speaker 3: clearly commercial real estate.
Speaker 4: Has gotten the most attention, and not to say that's
Speaker 4: that that's misplaced. Myself and my team are looking at
Speaker 4: two other areas in addition, and one is if we're
Speaker 4: going to have a recession at all, or that's called it,
Speaker 4: you know, just a significant slowdup. We had it in housing,
Speaker 4: but there has to be weakness in the in the
Speaker 4: construction in the employment.
Speaker 3: Side we are now.
Speaker 4: Housis would suggest that the pen up demand which was
Speaker 4: which is still significant from the COVID type period, that
Speaker 4: starts to wean its way through the system by November,
Speaker 4: and so after that point, if there's not renewed demand,
Speaker 4: then we're going to start to see modest layoffs. That's
Speaker 4: the break even. So it puts you into early twenty
Speaker 4: twenty four. And then the other one is what you
Speaker 4: said in terms of terms out in terms of you know,
Speaker 4: refinancing or new debt costs.
Speaker 3: Again, because a lot of a lot of.
Speaker 4: The locking in of low interest rates during COVID, I
Speaker 4: think there is some truth to the fact that the
Speaker 4: lives could be somewhat longer this cycle because of the
Speaker 4: lock up. Exactly, the interest rates sensitivity for the economy
Speaker 4: right now is lower than what it would be on average,
Speaker 4: right And so both of them put you into not
Speaker 4: that interest rates don't have an impact on the economy,
Speaker 4: it just puts you in the downturn. The flowdown being
Speaker 4: later into twenty twenty four. That would corroborate with another
Speaker 4: piece Avage was had nothing to do with the lags,
Speaker 4: and that's just what the fact is only now that
Speaker 4: have we had the real, the real Fed funds rate,
Speaker 4: so that you know where the Fed is five and
Speaker 4: a half percent today minus the rate of trend inflation,
Speaker 4: which you know is own recently gone. That those lines
Speaker 4: have only recently crossed, and so you know, we've really
Speaker 4: never had a recession without the Fed funds rateing at
Speaker 4: least two percentage points above the rate of core inflation.
Speaker 3: So if you put cord four and a.
Speaker 4: Half roughly, let's say in three months we're down to
Speaker 4: three and a half only, then you start really ticking
Speaker 4: the clock between those long and variable lags impacting the
Speaker 4: economy from a from a growth perspective. So housing is
Speaker 4: still I think you know something I would I would
Speaker 4: focus on. It's tough for me to square having a
Speaker 4: slowdown in the labor market and not having some modest
Speaker 4: job losses on the construction side.
Speaker 2: Yeah, and it's been really interesting to watch the home
Speaker 2: builder stocks in particular really crush it this year because
Speaker 2: people just don't want to sell out of that three
Speaker 2: percent mortgage. The supply of existing homes has been very tight.
Speaker 2: So definitely an area that we've been watching at Bloomberg.
Speaker 2: But I do want to ask about you know, we're
Speaker 2: talking about all these scary things, and I want to
Speaker 2: talk about what is the haven asset in this environment,
Speaker 2: because you would think it's treasuries, But then you take
Speaker 2: a look at treasury volatility. It's come in a little bit,
Speaker 2: but it's still pretty elevated relative to history. And then
Speaker 2: you take a look at some of the big tech
Speaker 2: stocks that are just absolutely crushing it this year, and
Speaker 2: it feels like the there's no volatility to speak of.
Speaker 2: And I haven't even mentioned the vics here, and Joe,
Speaker 2: I guess this is a long way of asking, why
Speaker 2: is it that text stocks have pretty much supplanted treasuries
Speaker 2: as the safety trade this year? And do you think that,
Speaker 2: you know, maybe that holds water, that maybe that's not
Speaker 2: the worst dynamic in the world.
Speaker 3: Well, you know, we looked at that.
Speaker 4: You know, ca'se a good question even over a year ago,
Speaker 4: and we're back to where we were a year ago,
Speaker 4: right where we had gross stocks. It's just you know,
Speaker 4: fantastic valuation levels at least relative to say the other
Speaker 4: half of the un verse, more value based companies. And
Speaker 4: I think there's two things going on. One is legitimate
Speaker 4: and one more of a narrative which you start to
Speaker 4: get concerned with with overvaluations, and the narrative is today
Speaker 4: it's AI, but before it was platform effects, network effects,
Speaker 4: winner take all dynamics. Again, there's some truth to it,
Speaker 4: but it's one of the reasons why you can get overvaluations.
Speaker 4: It's the extent of the of the multiple that's priced in,
Speaker 4: and the other one is just a discount rate. I mean,
Speaker 4: I still think, you know, you can justify some of
Speaker 4: the growth stock the tech stocks valuations only if you
Speaker 4: think that we live in the old world and that
Speaker 4: rates are going to are well above where they should be,
Speaker 4: and that we're going to ultimately go back to the
Speaker 4: very low interest rate environment. So I don't think, you know,
Speaker 4: tech stocks are certainly not immune to gravity. So if
Speaker 4: you ask your question, where is there a haven, I'd
Speaker 4: be more I would want to stay fully investigate. I mean,
Speaker 4: I think the natural response would be cash, but over
Speaker 4: a long period of time, I'm not going to get
Speaker 4: really a strong risk premium for that. So you know,
Speaker 4: for me, person, oh yeah, I'm looking at areas that
Speaker 4: haven't been his love for the past year, and that's
Speaker 4: like the value part of the market. You're still participating
Speaker 4: in the equity market, but you know, he doesn't have
Speaker 4: that major run up like you have on the tech side.
Speaker 4: And I don't need value stocks to grow at the
Speaker 4: same path as gross stocks to win, because that has
Speaker 4: not been the case historically, So I would put the
Speaker 4: value of risk premium. It's been a headwind the past
Speaker 4: six months, but I think over long periods of history
Speaker 4: it's been a tailwind. So that's where I'd be kind
Speaker 4: of rebalancing into because the market is pretty unbalanced within
Speaker 4: the equity market.
Speaker 1: Well, you're listening to Joe Davis. He's the global chief
Speaker 1: Economists and head of Investment Strategy Group at Vanguard. Katie
Speaker 1: at Larry Steaks in West Philly. The name of the sandwich,
Speaker 1: the famous sandwich is the belly filler. That's you're just disgusted.
Speaker 1: I was gonna say, I think Joe filled our belly
Speaker 1: there with a lot of good information there is that
Speaker 1: Is that too weird? The belly filler? Joe, the belly filler.
Speaker 1: Thanks man, the belly filler. I always love that one. Anyway, Joe,
Speaker 1: we can't let you go just yet. We do have
Speaker 1: attrition on the podcast where we have to reveal the
Speaker 1: craziest things we've seen in markets, or in your case,
Speaker 1: I'll take in economic data. Whatever you got for the week, Katie,
Speaker 1: how about you go first.
Speaker 2: I think this is pretty good. Take a look at
Speaker 2: the Dow Jones Industrial Average. On Wednesday, it closed it's
Speaker 2: thirteenth straight up day in a row, a wind streak
Speaker 2: of thirteen days. That is the longest wind streak for
Speaker 2: the Dow since January nineteen eighty seven.
Speaker 1: Since eighty seven. Oh boy, well, that's anomenous here to
Speaker 1: bring out. I don't know about that, that connection to
Speaker 1: nineteen eighty seven. I guess we got ten months till
Speaker 1: everything hits the fan. That is pretty amazing. Thirteen days. Yeah, wow,
Speaker 1: that's a good one. That is crazy. Yeah, you did well.
Speaker 2: All right?
Speaker 1: How about you, Joe, you got anything crazy for Yeah?
Speaker 4: I would say, well, and it probably matches Katie's chart.
Speaker 4: That would be you know, the number of web searches
Speaker 4: for the phrase soft landing. It used to be high,
Speaker 4: than it dropped to zero. Now it's back at record highs.
Speaker 4: And so I think those two charts would be very
Speaker 4: highly correlated. May maybe they stick for the rest of
Speaker 4: the year. I'm skeptical, but hey, here's the wishing.
Speaker 1: All right, good stuff to both you. I'll give you
Speaker 1: mine now, all right. This is courtesy of cbsnews dot Com. Joe,
Speaker 1: I prefer the alternative asset classes for my crazy things,
Speaker 1: and this is about as alternative as it gets. It's
Speaker 1: a gold, ruby and diamond ring worn by rapped legend
Speaker 1: Tupac Shakur during his last public appearance. Wow, he were, yeah,
Speaker 1: how about that? And it's pretty cool look and it's
Speaker 1: got a crown on it, and with the crown is
Speaker 1: made of rubies and diamonds and gold. He apparently was
Speaker 1: a big reader of Machavelli and like the medieval kings
Speaker 1: and medieval lure of Europe. Anyway, Yeah, yeah, who knew
Speaker 1: about Tupac? What up production at Sotheby's. So it's time
Speaker 1: to play that game. The price is precise. I regret
Speaker 1: to inform both of you. You are contestants. Katie, what's
Speaker 1: your price or the winning bid for rap legend Tupac
Speaker 1: Shakur's gold, ruby and diamond ring.
Speaker 2: Can I tell you something horrible? I actually just googled
Speaker 2: it because it sounded so it sounded very pretty, and
Speaker 2: I wanted.
Speaker 1: To see no, no, googling.
Speaker 2: I'm sorry, I'm sorry. I removed myself.
Speaker 1: You forfeit, You forfeit. Well, Joe, I gotta tell you
Speaker 1: you're automatically the winner. But I still want to hear
Speaker 1: what your bid is.
Speaker 3: Oh, I know I heard. I was just going to
Speaker 3: throw it a million. I have no idea.
Speaker 1: Are you googling too? Joe? You hit it exactly on
Speaker 1: the nose. That's impressive.
Speaker 3: How big was the diamonds and rubies?
Speaker 1: Katie does it?
Speaker 5: Say?
Speaker 1: I don't know, but it's not it.
Speaker 2: Yeah, I mean the diamonds are accents. I'm on people
Speaker 2: dot com right now. It's more about the crown. Is
Speaker 2: really the centerpiece of in the crowd.
Speaker 1: Yeah, yeah, Well.
Speaker 4: That makes more sense to me though than you know,
Speaker 4: you know, things like sneakers and stuff.
Speaker 3: At least there's intrinsic.
Speaker 4: Guys who knows, well, at least you're gonna do if
Speaker 4: you're gonna diversify and alternative assets. You got that, You
Speaker 4: got gold, diamonds and ruby, so you got multiple You
Speaker 4: got it.
Speaker 1: All covered right South of Beys had only estimated two
Speaker 1: hundred to three hundred thousand, so way off base. They said, wow,
Speaker 1: this makes it the most valuable hip hop artifact ever sold,
Speaker 1: I don't know.
Speaker 4: Artifact sounds well, you could tell, you could tell that
Speaker 4: the Federal Reserve that perhaps financial conditions are not that restrictive.
Speaker 3: When you have things going on.
Speaker 1: We're gonna add Tupac's jewelry to the financial conditions index.
Speaker 1: But and rest in peace to uh to mister Shaker.
Speaker 1: My old college buddy Jeff Peerlman is actually right in
Speaker 1: a biography of them, so little shout out to them. Yeah, Joe,
Speaker 1: pleasure to hear your thoughts. We really appreciate it. Oh
Speaker 1: and you never didn't give us your favorite cheeseteak. Join
Speaker 1: it's not Larry's.
Speaker 4: Oh I go Pats Downtown. Yeah all right, yeah, but
Speaker 4: they're all good, you know, classic. And you know, Katie,
Speaker 4: you should try the chicken cheese steak. You know, It's
Speaker 4: just it's a nice diversifier too.
Speaker 1: I'm gonna I'm gonna buy you one next time I'm
Speaker 1: in the Okay together, Katie.
Speaker 2: I appreciate that, but I'll just have a burger.
Speaker 1: Yeah, man man oh man. Anyway, Joe, David Niche so
Speaker 1: much for your time. We really appreciate it.
Speaker 3: Thank you both for having me.
Speaker 2: What Goes Up.
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