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 looking to snap a three-day losing streak. Kate Moore of City Wealth writing, we hold an underweight duration since we believe the likely path for interest rates across advanced economies, central banks, runs higher. We prefer to take risk in equities. Kate joins us now for more. Kate, good morning. 00:00:51 Speaker 4: Good morning. 00:00:52 Speaker 3: How was the hiking? What did I miss? 00:00:54 Speaker 4: The hiking is always amazing. 00:00:56 Speaker 3: Good time had by all? 00:00:57 Speaker 5: Yeah, it was a good time had by all, including the bears, which I know, Jonathan, you care about. 00:01:00 Speaker 3: I'm very, very scared of the bears and won't be attending any time soon for those hikes. 00:01:04 Speaker 6: Yeah, a grizzly actually walked toward us on our hike. 00:01:06 Speaker 3: Oh, you saw one? 00:01:07 Speaker 5: You should be more concerned about the moose than the bears, but that's another story. 00:01:10 Speaker 3: It's like the hippo, right? 00:01:11 Speaker 1: Yeah. 00:01:12 Speaker 3: The hippo. People seem to think hippos are like, you know. 00:01:14 Speaker 2: Dumb, blind, and mean. 00:01:15 Speaker 7: Right? 00:01:15 Speaker 1: Yeah. 00:01:16 Speaker 3: We're conditioned as children to think that hippos are cute. And fast. 00:01:18 Speaker 4: Surprisingly fast. 00:01:18 Speaker 3: And they're not cute. 00:01:19 Speaker 2: And the little ones are sort of cute. 00:01:20 Speaker 3: And loose aren't either. 00:01:21 Speaker 1: Yeah. 00:01:22 Speaker 4: And neither are bears because they're adorable. 00:01:24 Speaker 3: My producer always tells. 00:01:25 Speaker 1: Me we're live. 00:01:25 Speaker 4: Anyway, I'm not a bear. 00:01:26 Speaker 3: We're live. 00:01:26 Speaker 1: Okay. 00:01:27 Speaker 3: There we go. But you're bullish stocks. 00:01:29 Speaker 1: So let's talk about it. 00:01:30 Speaker 5: I am still bullish stocks. though I think we have to expect a bit of consolidation in September. That is the normal course of business at this time of year. There's a multitude of reasons, and then people make up reasons, of course, but we're in this kind of holding period before we get to third quarter earnings. We know that. We obviously, and you guys were just talking about this, have a critically important Fed meeting and a few very important data points that people are going to want to digest. And then very, very importantly, this is a time where companies are talking to lots of investors. There's you know, an enormous number of conferences over the next two to three weeks. And people are just not going to be taking a lot of risk ahead of hearing from those management teams. So there is that kind of like pause that is very natural at this time of year that wouldn't stop us from being overweight and constructive into year end. 00:02:13 Speaker 4: I just want to make that point. 00:02:15 Speaker 3: Got it. 00:02:15 Speaker 2: Yeah. 00:02:16 Speaker 3: Underweight bonds though. And the big question, you know what the big question is right now, it's whether that bond story becomes a problem for equities. It hasn't so far. Will it change? Yeah, I don't think it's going to. 00:02:25 Speaker 5: Look, we've been underweight bonds for a good period of time, for the duration of my time as CIO at Citi. And we have continued to say, like in all of our investment committee meetings, are we now at a point where we want to add duration back into the portfolio, where we want to get to a more neutral position? And we just can't make the case, frankly. In fact, we think the economic data remains very strong, that we're in a sustainable expansion. But combined with that, the fiscal deficit story is no joke. And I think investors are not wholly focused on it, but they're also aware of it. And our expectation is that even if the Fed starts the path of policy tightening, that we're going to stay at a rate of inflation that is above Fed target for a while. It's going to take time for that, any interest rate moves, the blunt tool to. 00:03:07 Speaker 4: Really work its way through the system. 00:03:09 Speaker 1: Yeah. 00:03:09 Speaker 6: Just to sort of build on that, people had expected the long end of the yield curve to come in if the Fed was hawkish. And if we heard from Fed Chair Kevin Warsh that he was prepared to hike rates, he delivered. 00:03:21 Speaker 4: But the bond market didn't respond the way people thought. 00:03:23 Speaker 2: Why? 00:03:24 Speaker 4: You know, it's a good question. 00:03:25 Speaker 5: I don't know that many people who are that focused on investing in that very long end, kind of the 30-year space, for example, besides those people who have to match their liabilities. 00:03:35 Speaker 4: This is what I will say, though. 00:03:37 Speaker 5: I think there is a question until we start actually moving, until we start actually hiking, until we get not just words but actual action about how sustained any commitment to getting to the 2% target will be. I feel like we've gotten to this point where, you know, Chair Warsh started talking about it several months ago. And we continue to get data that is above the target. And we're still waiting and waiting and waiting, I think, for that first policy move. 00:04:05 Speaker 6: So there's still a credibility gap that is affecting the long end of the yield curve for the U.S.? I think it's like neutral, right? 00:04:11 Speaker 5: But I do think it, yeah, kind of neutral on the credibility. But people want to feel very, very confident that what, you know, the Fed chair and the FOMC voters are saying is something that they will actually follow through on and that they won't just keep on kicking the can down the road. 00:04:24 Speaker 6: If long-term treasuries are no longer the ballast that they used to be, what's the haven asset? 00:04:28 Speaker 1: Yeah. 00:04:29 Speaker 4: This is a tough one, Lisa. 00:04:30 Speaker 5: I mean, we've just definitely been trying to explore this ourselves. And I think we've talked about this on this show. I added gold to the portfolio last year, a pretty considerable portion for most of the risk profiles. This was hard because, to be fair, I have not been a gold bug my whole life. In fact, many times I've argued against gold. But I was looking for an asset that I thought could outperform long duration and could be a And would provide something that I thought was less correlated to the equity risk I wanted to continue to hold and run with. And so that is part of our strategy right now. But I'd be lying if I said we knew all of the uncorrelated assets we could add that would provide that balance to the risk. Because I want to continue to lean into the equity story. 00:05:12 Speaker 3: It's funny because for years and years and years, with higher rates, people would say the opportunity cost was working against you to own gold. 00:05:18 Speaker 1: Totally. 00:05:18 Speaker 4: And I think I was one of those people saying that. 00:05:20 Speaker 3: So what's the shift? What's the shift? 00:05:22 Speaker 5: Well, I think there are a number of things. Number one, we are seeing more, you know, reserve diversification. That's a really important part. Central banks, sovereign wealth funds, pension funds, institutional allocators are now looking at it as an asset. So we always have to understand the positioning, the technicals, and the sentiment around an asset in order to make a decision around it. I think the second thing that's really important is that, you know, we have had these geopolitical tensions and realignments, not just of trade, but also, obviously, military realignments that are leading people to ask how much they want to hold in U.S. 00:05:51 Speaker 4: Dollar assets. 00:05:52 Speaker 5: Now, we haven't seen people back away from treasuries yet, but as long as that discussion is in the market, gold, I think, becomes a viable asset. 00:06:00 Speaker 4: Additional asset for a portfolio. 00:06:02 Speaker 3: Lisa asked a great question earlier. She asks great questions all the time, but this one stood out. 00:06:05 Speaker 4: Yeah, she's always great. 00:06:07 Speaker 3: How bonds behave in an economic downturn? Will treasuries rally if we get into some trouble? Are you confident they will? 00:06:14 Speaker 4: I'm not confident they will. 00:06:15 Speaker 3: That is such a massive switch. 00:06:17 Speaker 5: It is such a massive switch. And this is something we've been talking about with a lot of our clients. And, you know, even some pension funds and endowments and stuff I work with. Which is to say, there's this knee-jerk reaction that bonds are the safe haven asset. But in an environment where you think in an economic downturn, government spending actually increases, the fiscal deficit actually gets worse. 00:06:36 Speaker 4: Which seems to be the case. 00:06:38 Speaker 5: It's deficit up in expansions and deficit up in contractions. 00:06:42 Speaker 4: It makes it. 00:06:42 Speaker 5: Harder and harder to say that the yield that's being offered right now is appropriate for most investors. 00:06:49 Speaker 6: If you take a step back and you don't see long-term bonds as being a haven in and longer or higher yields aren't really offering competition to equities. At what point does that lead to just lower returns overall for a longer period of time? Because ultimately, it has to constrain the multiples on equities if people are looking for more returns, if they're looking for higher dividends, if they're looking for more payouts, and if they're expecting more in terms of growth at a time where you already potentially have had peak growth. 00:07:17 Speaker 5: You know, I'm not so worried about the multiples being like an obstacle for the equity market, because look what's happened so far in 2026, right? Earnings have been the primary driver of the market, not multiple expansion. And I think if we're right, that we are going to continue to have a broadening out in terms of earnings, that the CapEx and investment cycle is going to benefit many different industries, and that... I'm an optimist that AI is going to lead to productivity gains across a variety. 00:07:41 Speaker 4: Of different industries. 00:07:42 Speaker 5: If we're right on that, then even if you have a pointer to a multiple contraction that may be somewhat contributed to from the bond side, that you can still have a very healthy total return. 00:07:53 Speaker 4: But people are uncomfortable. They think of equities as risk. 00:07:56 Speaker 5: And I think that, you know, sustained earnings growth and free cash flow is less risky than what you can get in the bond market right now. 00:08:03 Speaker 3: Stay with us. More Bloomberg Surveillance coming up after this. High crude prices again this morning, then 90 on WTI, Brent crude at 95. That's keeping the bond market very much under pressure. Torsten Slocke of Apollo seeing a bigger problem in bonds abroad, writing the U.S. term premium currently sits below the term premium in both Japan and Germany, pushing back on the idea that the U.S. fiscal situation is having a uniquely large impact. on long-term rates. Torsten joins us now for more. Torsten, good morning. 00:08:39 Speaker 2: Good to see you. 00:08:40 Speaker 3: This is an important conversation. What is driving yields and not just stateside, but worldwide? 00:08:45 Speaker 7: Yeah, because the key issue is you can basically drop the yield into two different components. Long rates are driven by Fed expectations and they're driven by the term premium, which basically means everything else than Fed expectations. And it's very clear that Fed expectations, we went into this year expecting rate cuts. The dot plot was saying several cuts are coming. Now we're sitting here having conversations with Jackson Hole that, well, maybe now wars will be hiking at the next meeting. So it's not surprising that when Fed expectations go from very significantly expecting cuts to now expecting hikes, that you also have a move higher in long rates. And this debate about the term premium is really important because the term premium is not only about the sustainability. 00:09:23 Speaker 2: Of fiscal policy. 00:09:24 Speaker 7: It's also about the credibility of monetary policy. Let's say that the Fed tomorrow were to say our inflation target is no longer due. 00:09:31 Speaker 2: Now it's fall. 00:09:33 Speaker 7: If that's the case, well, both Fed expectations would, of. 00:09:35 Speaker 1: Course, move. 00:09:36 Speaker 7: But the term premium would also move because that would create more uncertainty about whether the Fed is hitting the target or not. And if you take this globally, the point of this is that, well, we would have expected when you just hear the conversation in U.S. financial markets that this is all about inflation. US fiscal unsustainability, Fed credibility. But if you look at this over the last 12 months, the term premium has literally done nothing. 00:09:56 Speaker 2: It's moved sideways. And in fact, the term premium for the U.S. 00:09:59 Speaker 7: Is lower than where it is for Japan and Germany, telling you that there's actually fewer worries about U.S. policymaking in the U.S. than there is in Japan and in Germany. 00:10:09 Speaker 3: That's how the market is pricing the story. Can I get your judgment on it? Do you think that's the right way of pricing the story? 00:10:14 Speaker 7: Well, what I think just is very noteworthy is that all the reasons for why long rates are going up have everything to do that we have a strong economy and we have some inflation. 00:10:24 Speaker 2: And at the same time, of course, we have a shock in the Middle East. 00:10:26 Speaker 7: So there's a huge confusion around, well, this is all about fiscal Well, there's actually also some other very, very important things that are putting upward pressure on rates. So let's not forget that when we think hard about what are the drivers of why rates are going up, it actually, if you just look at the term premium loan, has very little to do with the fiscal situation and has much more to do with what's going on in the Middle East. And of course, also what's going on with the late effects of tariffs and other things that are putting upward pressure on inflation. 00:10:51 Speaker 6: So why did Treasury Secretary Scott Besson come out with a plan to try to curtail the long end of the yield curve, to potentially stave off some of the selling coming from Japan, if this is all a logical consequence of the fundamental backdrop? 00:11:03 Speaker 7: Because the problem also politically is the following, namely that rates are restrictive for the housing market, but rates are not restrictive. 00:11:10 Speaker 2: When it comes to AI. 00:11:12 Speaker 7: So that's why this discussion among A4MC members about is our star higher or lower, Is monetary policy restrictive at this level? Well, it's restrictive for the housing market and for the auto sector, but it's actually not restrictive for the AI sector. And that begins to matter because, as we all know, in the pandemic, we had that mortgage rates were like 2.7, and now they're like 6.7. So there's a huge, huge difference when it comes to the impact of the housing market, which, of course, is very also important politically. 00:11:38 Speaker 6: How high would yields have to go before they become restrictive for the AI component of the economy? 00:11:42 Speaker 7: Yes, so this becomes very important because the expected returns from the hyperscalers, from the labs, from everyone in the AI are way, way above the Fed funds rate. So in simple economics, if the costs of borrowing the Fed funds rate, which is a little less than 4%, is dramatically lower than the 10, 20% that people expect to get in AI, that means that we still have plenty of room for rates to rise. And that's probably a very important reason why the economic data continues to hold up namely that we have a shock in the Middle East. We now also have that AI is still powering ahead. We can discuss separately whether that's about to slow down sometime in the next several quarters. 00:12:15 Speaker 2: But at this point, AI is still powering ahead. 00:12:17 Speaker 7: And all that is, of course, arguing that if growth is still strong, we have a supply shock in the Middle East. Well, for those reasons, of course, yields should be heading higher. 00:12:25 Speaker 3: Does the Fed have a role to play? 00:12:27 Speaker 7: Well, the challenge for the Fed is that they, of course, only control the front end. And here, the long end is really what's most critical. 00:12:32 Speaker 2: From a transmission mechanism perspective. 00:12:34 Speaker 7: Maybe the housing market is really not doing well because long rates are higher. 00:12:37 Speaker 3: We've noticed the debate change a little bit in the last few weeks. People have tried to attribute blame. Many conversations on this program, attributing blame to the Fed share, contributing to that move at the long end. How much influence does he have over the long end of the curve? 00:12:51 Speaker 7: Well, ultimately, of course, the term premium is driven by Fed credibility and fiscal policy credibility. 00:12:56 Speaker 2: In other words, if the Fed. 00:12:57 Speaker 7: Were to dramatically change their tone in terms of whether their target was 2%, whether they were thinking about some other objectives, then you would begin to see the term premium go up. But the fact that the term premium has done literally nothing in the last 12 months, it tells you something very, very important, namely that both Fed credibility is literally where it was 12 months ago, and also fiscal policy sustainability and credibility is also where it was 12 months ago. So in that sense, the Fed could undermine the term premium and push it higher. But at this point, there's just nothing suggesting that that's what's happening. 00:13:27 Speaker 6: It's notable that the U.S. is not where, say, Germany and the U.K. are with yields at the highest levels going back more than a decade. How much does the rest of the world potentially have a fiscal doom loop if the US hikes rates, potentially 75 basis points, taking back what we saw last year at the same time that growth holds up? 00:13:47 Speaker 7: Yeah, this is really important because just purely looking at debt-to-GDP, Japan is basically double of what we have in the U.S. So that means that Japan has a much bigger fiscal problem than we have in the U.S. 00:13:58 Speaker 2: That's not to say that we don't have a fiscal problem in the U.S. 00:14:01 Speaker 7: It's just saying in relative terms to your good question, Lisa, the Japanese just have a bigger problem. So if the Fed does start to hike, then the debt servicing. 00:14:08 Speaker 2: Costs everywhere will begin to move higher. 00:14:10 Speaker 7: Of course, the Treasury has been moving more debt from the long end to the front end, so there is now more sensitivity to what the Fed is doing. 00:14:17 Speaker 2: But globally, it really is a. 00:14:18 Speaker 7: Problem that taxpayers are just feeling the bill here, that we have rates going up everywhere, and of course, therefore, the debt servicing costs are going up everywhere. 00:14:25 Speaker 3: Torsten, everybody likes to quote the debt GDP ratio out of Japan because it's a massive number. Does it make a difference that the BOJ owns half the JGB market? 00:14:32 Speaker 7: Yeah, it also makes a big difference that 95% of JGBs are held domestically. So this also means that it's not the case like it is in the U.S., where we have that's more like 20% and 25% over the last several years, where we have much more sensitivity to what foreigners are thinking. So in that sense, for the U.S., we have indeed seen a more significant move towards interest rate-sensitive holders of U.S. 00:14:53 Speaker 2: Debt. 00:14:54 Speaker 7: Where official holdings, central banks, the Fed, foreign central banks have seen their share go down. And at the same time, the private sector holdings, both domestically and. 00:15:02 Speaker 2: Abroad, their holdings have gone up. 00:15:03 Speaker 7: So we have much more sensitivity to interest rates among the holders of U.S. 00:15:07 Speaker 2: Treasuries. 00:15:07 Speaker 7: And that's, of course, a challenge for the Treasury, namely that they have become more vulnerable to what the level of rates are. 00:15:12 Speaker 3: Does that introduce more volatility into the Treasury market? 00:15:15 Speaker 7: Absolutely, because you also have another statistic, namely a little bit less than 10% of treasuries are held in the basis trade. So when you see prime brokerage balances go up, you see repo go up, the financial system has become more vulnerable to the basis trade unwinding because that has just played a bigger and bigger role. That may have dampened a little bit more recently, but the bottom line is the same, namely the last several. 00:15:35 Speaker 2: Years, the holders of treasuries. 00:15:37 Speaker 7: Has truly shifted away from someone who really didn't care about what the level of yields was because they were basically doing it for FX reasons and the Fed was doing it for other reasons. 00:15:45 Speaker 2: Whereas private sector was doing it for rates reasons. 00:15:47 Speaker 3: When you frame it this way, does it make more sense that the Treasury Secretary stepped in and talked about killing the momentum of what was becoming a one-way trade? 00:15:53 Speaker 2: Yeah, so he's just looking at the level of yields. 00:15:55 Speaker 7: And we can then debate for a long time what is the reason why rates are higher. But for him, it ultimately is, of course, the issue that yields are just very, very high. And that's a challenge, especially for the parts of the economy that are yield sensitive. So that's especially housing. But it's also the auto sector. The auto sector is also not doing very well. because the auto sector is also very sensitive to the levels of yields that we're seeing at the moment. 00:16:16 Speaker 3: Stay with us. More Bloomberg surveillance coming up after this. Stephen Shulker, The Shaw Group, writing the following. Washington is treating Venezuela's enormous reserves as though they are immediately available barrels. They are not. Stephen joins us now for more. Stephen, do you remember that song? What is it good for? Absolutely nothing. 00:16:41 Speaker 1: Absolutely nothing. Absolutely. So some of the Pollyannish takes on the Venezuelan oil there as if we just stumbled upon 65 billion barrels of oil sitting at a tank, at a dock, with a loading arm, ready to get into a empty tanker. That's not going to happen. What we have here is a situation of decades of the Bolivarian revolution introduced by Hugo Chavez. in the early 2000s that has absolutely decimated the Venezuelan oil industry by, as you New Yorkers like to say, the warmth of collectivism. So it took 25 years to destroy a once vibrant industry in Venezuela. It is going to take more than just a couple of years to get it stable and to get it to be a significant player on the global market. We're talking at a minimum five years, if not 10 years, before Venezuelan oil makes a significant impact on the global oil markets. 00:17:34 Speaker 6: Stephen, it's one thing for Chevron to get a deal, as we saw this morning, for developing oil fields in Venezuela. Do you understand this deal that President Trump struck with Venezuela to take ownership as a nation of some of the oil fields in Venezuela to potentially help plug the SPR? Do you understand any of the logistics behind that? 00:17:57 Speaker 1: Well, the notion that we are going to use Venezuelan oil to plug the SPR is pure fantasy. From a technological standpoint, from an engineering standpoint, can it happen? Yes. Realistically, is it going to happen? Absolutely not. Venezuelan oil is the highest viscous. heaviest, densest oil in the world. The SPR logistically cannot handle that oil. So what you would have to do is what they do. They cut the oil, the men's oil with a dilute to make it viscous, to get it to be able to move actually through a pipe, and then they upgrade it. The SPR is a storage facility. They don't have the hydro treaters. They don't have any of the equipment to upgrade the Venezuelan oil. So first, they would have to go to a refinery. They would have to upgrade it. Then they would have to go into the SPR. Again, logistically, is it possible? Yes. Realistically, economically, will it happen? Absolutely not. So the notion that we're going to use Venezuelan oil to replenish the SPR is pure fantasy. It will not happen. 00:19:00 Speaker 6: Steven, how much more time do we have before the SPR is actually completely emptied, at least the viable oil that we can extract? 00:19:09 Speaker 1: Yeah, absolutely. So at the current rate, the analyzed rate, which will fall by and I'm using the midterms November as a benchmark, will be down to about 245 million barrels, which is a fraction of the 700 million barrels of its capacity. Now, of course, the previous administration drew down barrels and now this administration has accelerated that. So at our current rate, at some point in the new year, we're going to be at a level that, look, we're already at a level that we only have about 14 weeks worth of import cover left in the SPR. At the start of the war, we had 30 weeks. So we've halved our import. cover of the SPR since March. So, by certainly by the second quarter of next year, when demand kicks in going into the summer, we are going to be at significantly dangerous levels with the remaining barrels sitting left in the SPR. 00:20:03 Speaker 3: Stephen, just how vulnerable are we going into hurricane season on the refining side? 00:20:07 Speaker 1: Now, the refining side, and that's the crux of it. So we're talking about the SBR. These are government-owned. We all own the SBR, our balance. The commercial stocks of crude oil and unites are actually in good shape. What is not in good shape are diesel, gasoline, jet fuel inventories. Those are at lows. And the concern, the overarching concern in the market right now is the situation in distillate. And this all stems from the war, but not the war you're thinking about. This is the war between Ukraine and Russia that has decimated Russian refinery capacity and has decimated the European distillate market. So the United States refiners who are doing everything they can at max capacity to get oil, jet fuel, gasoline onto the market. They are now the marginal supplier of distillate fuels going into Europe at this point. Now, we're in the summer. Demand for distillate is at its weakest, and inventories should be building. They're not. Inventories, in fact, right now in the United States, are at the lowest point for the season And we're at the weakest demand part. So as we go into fall and as intermodal demand picks up, as agricultural demand picks up, as heating demand picks up for distillates, we're looking at an extremely dangerous situation. Distillate prices are now at the third highest level in the futures that they've ever been. They were higher twice during in 2022 when inflation was running rampant. But certainly we are on a course where inventories are extremely low at a point of the season where demand is at its weakness. Now, you just move that along along the number line here at a couple of months when demand begins to pick up. Inventories are at a very dire situation for us here in the United States and especially for our European trading partners. 00:21:49 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 6am to 9am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business Hour.