WEBVTT - Bill Dudley Talks US Stocks

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news. Former New York Fed

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<v Speaker 1>President Bill Dudley, also a Bloomberg opinion columnist, is out

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<v Speaker 1>with the new column, and he's warning that the US

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<v Speaker 1>equity market is in bubble territory. Dudley writes in this

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<v Speaker 1>column the tilt toward even higher yields and the diminishing

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<v Speaker 1>impact of AI spending on the economy could mean that

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<v Speaker 1>the bubble, as he sees it, maybe set the pop

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<v Speaker 1>in twenty twenty seven.

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<v Speaker 2>Please just say that.

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<v Speaker 1>Bill Dudley joins us right now to talk a little

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<v Speaker 1>bit more about that. Bill, I want to start off

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<v Speaker 1>first with this idea of the bubble itself and sort

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<v Speaker 1>of what the metrics you're using to I guess make

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<v Speaker 1>that judgment call that this is indeed a bubble or

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<v Speaker 1>bubble territory.

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<v Speaker 3>Well, the first thing you see is just the equity

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<v Speaker 3>market valuations are really stretched. If you look at the

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<v Speaker 3>Schiller case ratio, it's at forty one all time HIOW

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<v Speaker 3>was forty four in December nineteen ninety nine. The average

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<v Speaker 3>over the last twenty five thirty years has been about seventeen.

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<v Speaker 3>You look at the real equity risk preming, the access

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<v Speaker 3>return you get for holding aquities compared to treasury inflation

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<v Speaker 3>protective securities one point one percent access expected return, less

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<v Speaker 3>than half day average we've seen since twenty ten. You

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<v Speaker 3>look at the Buffet indicator, which is just the US

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<v Speaker 3>market cap to GDP ratio, it's currently around two hundred

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<v Speaker 3>and forty percent. Buffett said that the stock market was

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<v Speaker 3>at a risky point when it was above one hundred, so

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<v Speaker 3>we're a two hundred and forty percent. So the first

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<v Speaker 3>thing is just you look at valuations and then you

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<v Speaker 3>think about what's actually happening in the cycle. There's a

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<v Speaker 3>huge investment boom going on in artificial intelligence, and this

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<v Speaker 3>year we're getting tremendous impetus to the economy from that.

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<v Speaker 3>But the impetus in twenty twenty seven is almost certainly

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<v Speaker 3>going to lessen because it's not the level of investment,

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<v Speaker 3>it's the change in investment that matters. And the change

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<v Speaker 3>investment also matters for earnings growth of the suppliers to

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<v Speaker 3>the AI hyperscalers. So I think that that's.

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<v Speaker 2>Another thing that's going to start to weigh in the market,

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<v Speaker 2>is that you're going to start.

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<v Speaker 3>To see slow down in the boom itself, and when

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<v Speaker 3>the boom slows, that means profit growth expectations are going

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<v Speaker 3>to come down, and there's many downward.

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<v Speaker 2>Pressure on profit margins.

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<v Speaker 3>So just like you had a really great story on

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<v Speaker 3>the way up, expanding profit margins, higher volume on the

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<v Speaker 3>way die, slowing volume growth and more constrained profit margins. Now,

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<v Speaker 3>the last problem you have for the AI is just

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<v Speaker 3>the fact that are the AI hyperscaler is going to

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<v Speaker 3>be able to generate the two trillion dollars of revenue

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<v Speaker 3>they need to justify their investment.

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<v Speaker 1>Yeah, well absolutely, and we're going to get there in

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<v Speaker 1>a second. But I do want to go back to

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<v Speaker 1>the financing thing because and we know obviously these levels

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<v Speaker 1>can't sustain themselves. But then you talk to the CEOs

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<v Speaker 1>of these companies or the analysts who cover them, and

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<v Speaker 1>they all seem to think, at least for the next

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<v Speaker 1>two or three years, that we're going to continue to

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<v Speaker 1>kind of see this type of spending. And there was

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<v Speaker 1>a story that just crossed the wire before you came

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<v Speaker 1>on on a broadcom helping to range a financing deal

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<v Speaker 1>for sixty seventy billion dollars. It seems I know it's

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<v Speaker 1>not never ending, but when you hear okay, twenty twenty seven,

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<v Speaker 1>that's around the corner, you don't think that some of

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<v Speaker 1>these tens of billions, hundreds of billions of dollars that

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<v Speaker 1>have already been announced and the idea that they keep

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<v Speaker 1>raising their cap X numbers, you don't think that that

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<v Speaker 1>is going to continue much longer.

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<v Speaker 3>Well, I think cap X in twenty seven will be

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<v Speaker 3>higher than twenty six, but the increase in cap X

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<v Speaker 3>in twenty seven will be smaller than the increase in

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<v Speaker 3>twenty six.

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<v Speaker 2>Also, if you look at the financing, it's much less by.

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<v Speaker 3>The hyperscalers doing it out of their own cash flows

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<v Speaker 3>on their own balance sheets. So it's getting pretty incestuous

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<v Speaker 3>as the suppliers are lending to the hyperscalers, and private

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<v Speaker 3>equity is obviously private credits.

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<v Speaker 2>Doing their own piece.

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<v Speaker 3>So you're also getting greater opacity in terms of how

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<v Speaker 3>this is actually being funded. The way it comes to

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<v Speaker 3>an end, I think is pretty simple, profit margins. The

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<v Speaker 3>whole thing starts to slow. Profit margins start to be compressed,

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<v Speaker 3>and then expectations of future profits get diminished, and you know,

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<v Speaker 3>the stock markets, you know, the dis kind of present

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<v Speaker 3>value of future earnings that they startishing down earnings expectations

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<v Speaker 3>that flows back to the stock press at present, and

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<v Speaker 3>other issues that doesn't get a lot of attention. Is

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<v Speaker 3>also the supply of equities is going to increase. We've

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<v Speaker 3>had some really big IPOs this year, and the lockups

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<v Speaker 3>on those sipos are going to end, and so you're

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<v Speaker 3>also going to have a greater floating supply of equities

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<v Speaker 3>that has to be absorbed by the marketplace. Yeah.

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<v Speaker 1>And speaking of which, I mean we reported earlier today

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<v Speaker 1>the Anthropic, which is looking to come to market, is

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<v Speaker 1>now looking like it actually might actually be as big,

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<v Speaker 1>maybe not bigger than SpaceX. I do want to get

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<v Speaker 1>your thoughts specifically though, on this idea of the revenue

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<v Speaker 1>and profitability catch up to all of this CAPEX spend.

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<v Speaker 1>I mean, you can put the numbers on a piece

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<v Speaker 1>of paper and you can see how ambitious this spending

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<v Speaker 1>is and the idea that you do not have a

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<v Speaker 1>revenue stream at least right now that's commensurate with that spend.

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<v Speaker 1>Is this just kind of a redux of what we

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<v Speaker 1>saw with the dot com build out or the telecom

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<v Speaker 1>build out, or even the railroad build out.

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<v Speaker 3>Yeah, I mean I think it is because I think

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<v Speaker 3>every he wants to be first, because this is a

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<v Speaker 3>winner take all kind of game. So everyone's putting all

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<v Speaker 3>their chips into the table, and at the end of

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<v Speaker 3>the day was probably gonna happen. You're gonad up with overcapacity,

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<v Speaker 3>and we end up with overcapacity. You lose the ability

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<v Speaker 3>to have a lot of control over pricing, and so

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<v Speaker 3>your ability to charge what you want to charge and

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<v Speaker 3>justify your investment starts to become impaired. Look at the

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<v Speaker 3>railroads and the internet, telecom boom, all those things did

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<v Speaker 3>great things for the e commedy.

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<v Speaker 2>So two things can be true at the same time.

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<v Speaker 3>The technological innovation can be really transformative, but at the

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<v Speaker 3>same time you can have an investment boom and bus.

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<v Speaker 3>And in fact, if you look at history, it tells

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<v Speaker 3>you that that's usually the case. So the question here

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<v Speaker 3>is really it just really not whether it's going to

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<v Speaker 3>be a turn from a boom to a bus. It's

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<v Speaker 3>really a question of timing and magnitude.

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<v Speaker 1>Well, the hyperscalers, I mean, they would make the argument,

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<v Speaker 1>they have made the argument publicly that even if there

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<v Speaker 1>is sort of some excess capacity from this data center

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<v Speaker 1>build out the ideas that meaning excess capacity for the

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<v Speaker 1>AI specific stuff that the idea is that they're still

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<v Speaker 1>enough sort of computing and cloud computing business on AI

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<v Speaker 1>stuff that all of this equipment and these and these

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<v Speaker 1>facilities can handle. Is that just kind of a little

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<v Speaker 1>bit of a red herring in your view?

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<v Speaker 3>Well, well, I just think the magnitude of the investment

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<v Speaker 3>is so great relative to what we've seen historically that

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<v Speaker 3>it's hard for me to imagine that you're just sort

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<v Speaker 3>of cloud computing It by itself could take up all

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<v Speaker 3>this capacity. You know, we're talking about an extraordinarily large

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<v Speaker 3>increase in into orders of magnitude increase in compute capacity. Now,

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<v Speaker 3>it's fine, I mean that could be that can turn

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<v Speaker 3>out to be very useful, But at the end of

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<v Speaker 3>the day, is it all going to be needed?

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<v Speaker 2>And two are people going to be able price for that?

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<v Speaker 1>With regards with regards to the economic impact, do you

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<v Speaker 1>not buy into this idea of the productivity improvements and

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<v Speaker 1>enhancements that AI will bring or may bring, or maybe

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<v Speaker 1>has already brought for some companies, Well, I.

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<v Speaker 3>Think there's going to be significant protinty enhancements, but it's

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<v Speaker 3>not clear that the protinty enhancements necessarily all go to

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<v Speaker 3>the AI providers. You know. Historically, you know, you look

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<v Speaker 3>at a lot of the innovations, a lot of the

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<v Speaker 3>access returns get competed away, and then why shouldn't they

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<v Speaker 3>be competed away? In this case, It's not like we

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<v Speaker 3>have one AI innovator. We have like seven or eight

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<v Speaker 3>different firms that are going all into this space. We're

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<v Speaker 3>probably gonna end up with, you know, two or three

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<v Speaker 3>that are really turned out to be you know, viable

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<v Speaker 3>in the long run. But getting from the seven or

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<v Speaker 3>eight to the two or three, I think it's gonna

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<v Speaker 3>be pretty painful.

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<v Speaker 1>What about the cost of capital that's gone up. We've

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<v Speaker 1>actually seen some issuers that had borrowed at one rate

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<v Speaker 1>maybe a few months ago, coming back to market and

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<v Speaker 1>pay you know several you know, tens of basiness points

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<v Speaker 1>more than what they had. And of course you have

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<v Speaker 1>this huge move that we've seen in long term treasury

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<v Speaker 1>yields just over the past couple of months. To be honest,

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<v Speaker 1>with a thirty year old year year yield at five

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<v Speaker 1>point three percent, does that factor in to this maybe

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<v Speaker 1>AI boom slowing down?

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<v Speaker 2>Well, it weighs on valuation, right.

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<v Speaker 3>I mean, obviously, if we have higher interest rates, that's

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<v Speaker 3>that's a competition of bonds for the equi market. But

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<v Speaker 3>you know, the riseingels, even though it's getting a lot

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<v Speaker 3>of attention because it's very different than what we've been

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<v Speaker 3>in in for the last twenty years or so, the

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<v Speaker 3>rising yields really isn't that large at this point.

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<v Speaker 2>Now.

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<v Speaker 3>The thing that could obviously cause this all to come

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<v Speaker 3>together much more quickly is if people start to give

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<v Speaker 3>up on the US in terms of the fiscal sustainability.

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<v Speaker 2>The US has a very large budget deficit.

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<v Speaker 3>I think that's weighing on the bond market, and if

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<v Speaker 3>fact were to come together more quickly, you could see

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<v Speaker 3>a higher spike and yields, and then that obviously could

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<v Speaker 3>be the precipitating event. I mean, it's hard to know

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<v Speaker 3>exactly what's going to be the driver of the end,

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<v Speaker 3>but there's so many risk factors out there presently, it's

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<v Speaker 3>hard to believe that we're going to skatee through this.

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<v Speaker 1>Unscathed well with regards to those risk factors, particularly when

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<v Speaker 1>it comes to the obviously the forty trillion on debt

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<v Speaker 1>and then obviously the deficit. Why ning six percent of

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<v Speaker 1>GDP now and some of the measures that Scott Besson

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<v Speaker 1>has made with these buyback announcements to try to I guess,

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<v Speaker 1>keep a cap if you will on rates. Is that

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<v Speaker 1>going to be enough? I mean, even in a short

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<v Speaker 1>term to address this issue. Absent any sort of move

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<v Speaker 1>by Congress or anyone else, any other policy makers in

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<v Speaker 1>Washington to get the deficit and debt situation under control.

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<v Speaker 3>Well, what Bess is doing is going to help it

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<v Speaker 3>very much at the margin. But you know, reducing the

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<v Speaker 3>amount of long term treasure debt outstanding, you know it's

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<v Speaker 3>worth you know, basis points, not percentage points in terms

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<v Speaker 3>of the level of interest rates. So it's really tactical

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<v Speaker 3>rather than strategic. I mean, really, at the end of

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<v Speaker 3>the day, you have to fundamentally attack the budget problem,

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<v Speaker 3>the fiscal problem, and that requires a lot of heavy lifting.

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<v Speaker 3>And we have political paralysis in the United States where

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<v Speaker 3>the Democrats wanted to do it one way, the Republicans

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<v Speaker 3>wanted to do it a totally different way, and as

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<v Speaker 3>a result, nothing gets done. I mean, just look at

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<v Speaker 3>Social Security. It's not that many years now to where

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<v Speaker 3>solid security is going to be fully insolvent and the

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<v Speaker 3>fact that we're not even fully strongly debating that and

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<v Speaker 3>taking that up in Congress to decide how to fix

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<v Speaker 3>social security quite unnerving.

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<v Speaker 1>Frankly, Well, I mean, obviously this is a problem for

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<v Speaker 1>the Treasury Department right now? Does this become a problem

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<v Speaker 1>for the Fed? Bill, particularly against the backdrop of a

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<v Speaker 1>new chair Jackson Hole about a week from today, I

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<v Speaker 1>believe where you know, investors are going to want to

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<v Speaker 1>hear something. I'm not sure we're going to get it,

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<v Speaker 1>but they're certainly going to want to hear from warshing

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<v Speaker 1>the others as to exactly what the game plan is.

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<v Speaker 3>Well, the FED has to take the world as it is,

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<v Speaker 3>and if the US is pursuing an unsustainable fiscal path,

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<v Speaker 3>that just makes the job on the FED a lot

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<v Speaker 3>more difficult. So if you start to have fiscal consolidation,

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<v Speaker 3>that would obviously slow down economic growth, and the FED

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<v Speaker 3>could respond by lowering interest rates. But at the end

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<v Speaker 3>of the day, the Fed is just stuck with the

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<v Speaker 3>world is it is not the world that it wants

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<v Speaker 3>to be.

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<v Speaker 1>All Right, Bill always appreciated great column today, Bill Dudley.

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<v Speaker 1>He's a Bloomberg opinion columnist, and more importantly, former president

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<v Speaker 1>of the New York Fed,