00:00:02 Speaker 1: Bloomberg Audio Studios. 00:00:04 Speaker 2: Podcasts Radio News. 00:00:11 Speaker 3: This is the Bloomberg Surveillance Podcast. I'm Jonathan Farrow, along with Lisa Abramowitz and Anne-Marie Hordern. Join us each day for insight from the best in markets, economics and geopolitics. From our global headquarters in New York City, we are live on Bloomberg Television weekday mornings from 6 to 9 a.m. Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business App. We begin this hour with stocks and bonds finding their footing. Keith Leonard of Truist writing, the market is moving from a powerful earnings season to a more two-sided macro debate with interest rates taking center stage. Keith joins us now for more. Keith, welcome to the program. For the last six months or so, high yields have not been a problem for this equity market. Keith, the question of the week is whether you believe that's about to change. 00:00:59 Speaker 2: Yeah, well, first, great to be with you. I think it is already changing. 00:01:03 Speaker 4: I mean, the market, even really since June, the S & P, I don't think people realize it. We're up about 1%. And I think after this earnings season, it's all about the macro. The 10-year is kind of playing with all of us because it's staying around this 480 level, which is an important technical level. And if we started to move more abruptly forward, above there, then I think. 00:01:25 Speaker 2: That's a risk. I would say it's a two-sided risk. 00:01:27 Speaker 4: Because everyone's really braced now for higher rates and concerned about that. And the Fed funds futures is now pricing in more than a 60% chance of a rate hike. 00:01:37 Speaker 2: So If they decide to. 00:01:39 Speaker 4: Hold, I mean, that could potentially be some upside for the market, too. 00:01:42 Speaker 2: So I think it's a two-way risk. 00:01:43 Speaker 4: And it is all about rates in the short term, as opposed to this earnings season, which was really one-sided. And that's why, Jonathan, we just think that this September, even though it seems like it's a pretty consensus, just a choppier period. But I wouldn't lose sight that we still think the primary market trend. 00:01:57 Speaker 2: Is up and that earnings will ultimately support this market. But it's all about the macro over the next few weeks. 00:02:02 Speaker 3: Well, let's just take one side of the race story and talk about rates potentially going higher, Keith. I think it matters why rates might go higher. We were talking about this yesterday. Strong nominal GDP is bearish for bonds. It's bullish for stocks. If they're raising rates for the right reasons, that can be constructive for the outlook for the equity market. Are they going to be raising rates for the right reasons? 00:02:22 Speaker 2: Yeah, well, you know, in some ways it's a combination. 00:02:24 Speaker 4: It is strong economic growth, but it's also that inflation and obviously oil prices are having an impact as well. Of course, there's discussions about fiscal deficits. 00:02:33 Speaker 2: Term premium, what's happening in Japan. 00:02:35 Speaker 4: So, yeah, listen, I think our view is that they don't necessarily need to raise rates. But from the last meeting, there is this focus on inflation. And if you keep talking about your focus is on inflation, you You need to raise it. But Jonathan, I don't think a quarter point matters that much. After we get through this next period, I think what would be more problematic for the markets and what we saw in the late 90s when we had technology being leadership is that you had a series of rate hikes which is much more destructive for the overall market. 00:03:03 Speaker 2: We don't think that's most likely the case. 00:03:06 Speaker 4: And then to the other point is even though rates are moving higher here, credit spreads remain very firm. Even though we've seen tech credit spreads move up, the overall index spreads are completely very tight as well. 00:03:17 Speaker 2: So we're not seeing some disruptive there. 00:03:19 Speaker 4: So all in all, I think the market can handle another quarter point move. Again, if it's a series of hikes, I think that would be more problematic for the bull case. 00:03:28 Speaker 1: Keith, you said something really interesting, that if the Fed does not hike rates this month, that that could lead to an upside surprise. Do you really think that that's the case, or do you think that could be construed as potentially having political overlay or a lack of credibility in the Fed that leads to some further jitters in the bond market? In other words, is this not so much of a binary trade as it might seem? 00:03:50 Speaker 2: Yeah, I think it's a fair point. 00:03:51 Speaker 4: I mean, I've been kind of debating that in my own head recently, you know, is because the market's pricing and we're braced for this. Walsh has said many times that we're focused on inflation. 00:04:01 Speaker 2: And to your point, like, you know. 00:04:03 Speaker 4: On one side, the market may be relieved that we don't see that rate hike and there won't be that series of hikes. On the other side, you know, then it's about the credibility of the Fed. So I just think around that, we're going to probably see some really strong reactions on both sides. 00:04:17 Speaker 2: But I ultimately think as we. 00:04:18 Speaker 4: Move past September into October, that then the market will start focusing back on earnings. And I realize this next Fed meeting is really important. But again, I don't think it's going to lead to a series of of rate hikes. And I think, again, that's where it would be more problematic. So I'm trying to separate kind of the short-term noise versus the underlying trends for this market. And the other point I will say is I mentioned earlier that the S & P has been flat since June, but we reset valuations down to about a 19 multiple, not necessarily cheap from a historical standpoint, but a pretty good reset. Text multiples down from 33 last October to about 21. And earning trends even as we start looking into next year, are being revised higher. So I think that's the bigger, you know, I think ultimately the market will come back there, but. 00:05:04 Speaker 2: This next month, the focus is not there. 00:05:08 Speaker 1: Keith, is it still applicable to talk about the S & P 500 and averages, given just how much dispersion there's been under the hood, given the fact that it really has been a two-speed economy, as the Beige Book yesterday really highlighted? 00:05:22 Speaker 4: Yeah, one thing that we've been noting in our work recently, we track a measure of correlations within the S & P, so how stocks are acting together. And that measure of correlation is at the lowest level we've seen in about 30 years. 00:05:35 Speaker 2: So what does that mean? 00:05:36 Speaker 4: It really goes to your point, Lisa, that we're seeing more dispersion between winners and losers. And when we break that down, we're seeing that within tech, specifically for obvious reasons, and then consumer discretionary based on that two-speed economy. So Listen, it's always a, you know, it's always a stock picker's market per se. But I would also say historically, if you look back at some of the studies, you know, that have been done, you know, two or three percent of stocks in the market have driven the long-term outperformance. So, you know, the big cap stuff still does matter. And I think the S & P, even though it's really concentrated, you know, it. 00:06:08 Speaker 2: Still matters how these big cap stocks do. 00:06:11 Speaker 3: Stay with us. More Bloomberg Surveillance coming up after this. Jati Bhattacharya of TD Securities writing the following this morning. The risk of BOJ hikes are rising as that is the only sustainable way to stem currency weakness. Jati joins us now for more. Jati, good morning. 00:06:33 Speaker 5: Good morning. 00:06:34 Speaker 3: Can we just start the move for the last 24 hours? 00:06:36 Speaker 6: Yes. 00:06:36 Speaker 3: Because it was a pretty spicy move on Dolly Yen yesterday and then again today with some follow through. 00:06:42 Speaker 2: What is that? What's behind it? 00:06:44 Speaker 5: I mean, we've heard from Japanese officials overnight. They've not claimed it's an intervention. Also, the move is interesting because you saw the yen move higher one pip yesterday, but the bigger follow-through was today, with no other move in other asset classes particularly. It could be potentially people bracing for more aggressive signal from the BOJ. I think they have to hike in September. I think even Besant has cornered them into that move. But I think people are potentially expecting them to signal a more aggressive path for hiking interest rates. We know they've been in the cadence of once in six months. Maybe now it's once every three months. And that requires a systematic unwind of the yen shorts, which have been built substantially over the last year and a half. 00:07:26 Speaker 3: If you really wanted to succeed here, I can think of a couple of ways to do it. Kill the momentum with actual intervention one. They've done that a few times, but they haven't backed it up with bigger moves. The bigger moves would be ultimately some budget discipline. mixed with a bigger hike in the BOJ and a willingness to do even more, plus getting the government pension fund to shift its investment and bring some more capital back home. How close are we to those other things? 00:07:50 Speaker 5: I think all three incredible points, in fact, we published a note not too long ago, it was titled No Country for Strong Yen, and in which we mentioned exactly those three systemic things which need to change for the yen weakness to reverse its course. Unfortunately, the GPIF and the budget fiscal discipline are very political in nature. Now, the only option left after repeated interventions, joint intervention, Besson trying to draw up on markets along with Japan, the only thing left now is the BOJ rate hikes, and that's the low-hanging fruit now. And I think in anticipation of that is what's leading people to unwind their yen shorts. We do know we are in a carry environment. Oil prices are here to remain high. Central banks are pressured to hike interest rates. The global bond sell-off continues globally. So, carry trades will remain the flavor of the season. But if the BOJ signals a big, you know, big hiking cycle and a big carry-on wind, we actually think the next thing that will happen is a big carry rotation to different funders and, in fact, even different logs. 00:08:55 Speaker 1: How much does the Bank of Japan have to accelerate its rate hikes with the Federal Reserve hikes in September? 00:09:01 Speaker 5: Definitely December, I think of another full quarter basis point hike in December, and I think markets will be expecting them to follow through in the first half of next year as well. If the Fed hikes, we know it will not be once, it will be at least twice. Markets already pricing 60 basis points. Our base case is still not for a Fed hike, but if they were to hike, we think it will be twice. 00:09:21 Speaker 2: You could say an. 00:09:22 Speaker 5: Additional 10 to 15 basis points is the global risk premium around oil, but it's there even the Bank of Canada curve, which is where we think they're least likely to hike. But it's the risk premium there, but if they hike, it's twice, and that puts significant pressure on the interest rate differentials, and then Japan needs to go at least thrice in the next nine months. 00:09:40 Speaker 1: Do you think that there's going to be a global repatriation of assets away from the U.S., partly because it is so expensive to hedge against the dollar at this point? So if you're going to go in to the U.S. to buy hyperscaler debt or hyperscaler assets, if you want to hedge, you have to buy assets in another currency. It's probably the most efficient way to do that. How much are you starting to see that? Do you expect that to really feed into dollar weakness? 00:10:05 Speaker 5: So we did go through a cycle of that, but it never stuck because then the AI trade came back and then people started pooling money back into the US. But what did stick is that people are still hedging their dollar exposure. In fact, interestingly, even people in Asia, particularly in China, they're willing to pay the cost of carry to hedge the dollar exposure. So people are still piling money into U.S. assets, but the hedge ratios have not completely gone back to where they were pre-Trump taking over as the U.S. president. In fact, that's what's keeping the dollar in still somewhat of a bearish regime. You can see that the dollar finds it easier to sell off than rally here. With so much going on in the U.S., you have the Fed almost ready to hike. 00:10:48 Speaker 2: U.S. 00:10:48 Speaker 5: Economy appears resilient. You have U.S. equity outperformance. The AI trade is booming in the U.S., Yet the dollar has behaved substantially weaker than it would have in its erstwhile safe haven prime era, which means that people are still hesitant to hold the dollar exposure. They're still buying U.S. assets in large amounts, but they're not willing to hold the dollar exposure. 00:11:08 Speaker 3: You said the carry trade was about to change and the funding currency would be different and the longs would be too. Can you explain that a little bit more? 00:11:16 Speaker 2: Yes. 00:11:17 Speaker 5: So if BOJ starts signaling an aggressive path to hiking interest rates, we do think that potentially that needs to have a bigger unwind in the yen short. We do know the yen shorts have been at a three-decade extreme high. So that unwind would need a reversal into other funders. We think the Canadian dollar could potentially be one funder, given that the Bank of Canada is the least likely to hike. You know, we do have the tariff uncertainty ongoing. Even if inflation is pressured to the upside, it's not significantly away from target. So we think that, you know, the CAD can start to be used as a funder again. The Swissy potentially as well, given that they are not going to be hiking interest rates aggressively or, you know, as much as the BOJ needs to. In terms of longs, the Brazilian real has been a favorite pick for so long. But we know that heading into elections, there's a lot of headline risk. Before every single election, two months into it is the worst time to be into the long real trade. I'd love to buy the currency irrespective of who wins the presidency. Even under Lula, who markets consider unfriendly for markets, we've had the best four years in the real. So I would love to buy the currency, but I would wait for the second round of elections to be done. The Mexican peso as well is extremely looking crowded now. So the South African rand is one which we've been flagging to clients for quite some time. I think there's still more room for the currency. It's very well commodity diversified. Benefits with gold prices sticking up. So that's definitely one place where we think there's more room for longs. 00:12:53 Speaker 3: Stay with us. More Bloomberg surveillance coming up after this. Let's talk about the story in the nation's capital that continues to build in the world of politics. Under surveillance this morning, the major data center debate down in Washington, D.C. 00:13:15 Speaker 6: If your community embraces data center, you're going to have great economics. You'll have more power will be built in the price of power in your community will go down and you'll have the economic power of their paying taxes. 00:13:30 Speaker 2: And they're making your community better. 00:13:32 Speaker 3: So here's the latest this morning. The Trump administration blaming misinformation and poor communication for the public backlash against data centers. The Treasury Secretary Scott Besson blasting hyperscalers, saying, quote, the industry has done a terrible job of explaining themselves. They've been tone deaf to communities. Adam Hodger, Bully Pulpit International, joins us now for more. 00:13:51 Speaker 2: Adam, good morning. 00:13:52 Speaker 3: Good to see you. 00:13:52 Speaker 2: Good to see you. 00:13:53 Speaker 3: How much daylight is there between what the administration is saying right now and what we've heard on the campaign trail going into the midterms? 00:14:01 Speaker 2: Huge daylight. 00:14:02 Speaker 7: What you heard from the president yesterday was that if you don't support data centers, we're going to be poor, and you're dumb if you don't get behind it. And that is just what people are hearing in their communities, that all these buildings are being built without any input from the community. without any sense of what it means for their day-to-day lives. People are getting jobs out of it. People are going to build it, and that has some impact. But I think whenever you're going into a local community, you should try to embrace and get their buy-in on the front end. And it feels like there's a whole lot of agency that's taken out of the hands of people. And that is true, I think, across the political spectrum. I think it's why you've seen some backlash to a range of issues. There's this general sense within the country that things are out of your control, whether it's prices, whether it's these things being built in your neighborhood. And that leads to more backlash against the leaders who are in office. And so I think that's why you're saying some of the backlash to the candidates who are embracing these data centers are all walking back from it across the spectrum, Pennsylvania, Texas, right? 00:15:03 Speaker 2: They're all walking. 00:15:04 Speaker 7: Away from these data centers because they feel like they missed the mark on where the actual public sentiment was. 00:15:10 Speaker 2: Yeah, but there are two aspects here. 00:15:12 Speaker 1: And I'm glad that you brought up Governor Abbott of Texas because he was kind of the poster child of welcoming in data centers. 00:15:17 Speaker 2: To that state. 00:15:18 Speaker 1: He's pushed back and said sort of what Secretary Besson said, which is they've done a terrible job reaching out to communities. How much is this a PR issue where they just haven't messaged this correctly? And how much is this a fundamental issue where communities are not seeing the benefits just yet and may never see the benefits, even if there is a productivity boom in. 00:15:35 Speaker 2: The overall country? I definitely think there's a lot to that, right? 00:15:40 Speaker 7: I mean, there is a feeling from the people like, this building is just built on the side of the highway, the side of the road, and I don't even know what goes on in there. There's no windows. 00:15:49 Speaker 2: It just kind of sits there. 00:15:49 Speaker 7: It's this ugly thing that makes a. 00:15:50 Speaker 3: Lot of noise. 00:15:51 Speaker 7: And so I think the people in their communities are like, well, what is that doing for me? They may not use AI on an everyday basis. And so the people who are showing up to town halls to protest it Aren't the ones who are using it fundamentally in every day of their life. And they're saying like, and that thing could take my job. It could lead to a robot that I can't control. It leads to fears and speculation that I think the companies have a hard time getting ahead of. 00:16:19 Speaker 1: One thing that President Trump was saying was not just that people are stupid if they don't like them, but that they are going to fall behind China or that we collectively are going to fall behind China because China doesn't have to follow the public relations kind of dance that the democratic government does. 00:16:35 Speaker 2: And this is the future, whether people like it or not. 00:16:38 Speaker 1: I mean, what's the messaging on both sides of the aisle to allow AI to develop and foster or while just improving some of the PR aspects and potentially outreaches to communities? 00:16:50 Speaker 7: Look, when I was at the National Security Council, that was often something that we wrestled with. How do you communicate the value of this product or this thing to the American people that they may not even touch in their day-to-day lives, but they think it's going to cost them real, real money? 00:17:05 Speaker 2: I think if you can get. 00:17:06 Speaker 7: The companies maybe to have a little bit more of the ownership of the cost on the front and acknowledge we're doing this We're spending the money on ourselves. We're going to pay for all the energy costs. It's not going to fall on you. And we want your input on what we then do with the investments into the community. That may be a way to get ahead of some of the political backlash. But I think there is a real risk. As you write, China does not have to worry about any of these concerns. They just build it and you're stuck with it. Obviously, I think there's upside in our system to having a bit more of that open debate. But look, that is a real risk that politicians and leaders will have to get ahead of. But if we're going to win, if we're going to get ahead, we have to figure out a way. There's no sort of losing the AI race, if you will. 00:17:54 Speaker 3: In one way, the president doesn't have to worry about it either. He doesn't have to run again. And in your opinion, what do you think this is going to do to the campaigns we might see into 28, not just for the Democrats, but Republicans as well? 00:18:07 Speaker 2: The ground is 100 percent shifted. 00:18:09 Speaker 7: I mean, just look at some of the candidates who, Josh Shapiro in Pennsylvania, was a clear key proponent of democracy. the investment in the state. 00:18:16 Speaker 2: Because it was making a difference in the bottom line. 00:18:19 Speaker 7: And look, a third of GDP right now is AI-related construction. That is a fundamental underpinning of our growth right now. And you don't want to poo-poo that growth in the future. But you have to get the politics right. Because I think you will see candidates. 00:18:36 Speaker 2: who. 00:18:36 Speaker 7: Figure out a way to thread that needle over the next few months. Because there's no question, this issue's not going away. People are going to have to find a way to talk about it. And that's where candidates on the trail, they prove if they got it, right? If they're the ones who are going to be the nominee, they're going to say like, okay, this is how we balance that issue. 00:18:54 Speaker 3: This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics, and geopolitics. You can watch the show live on Bloomberg TV, weekday mornings from 6 a.m. to 9 a.m. 00:19:05 Speaker 2: Eastern. 00:19:05 Speaker 3: Subscribe to the podcast on Apple, Spotify, or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business App.