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 out with stocks retreating as yields and crude climb. Bob Michael of J.P. Morgan Asset Management staying bullish on bonds, writing, we like the intermediate and long end with yields over 5%. The price action last week, unusual, suggesting a blow-off top in yields is forming. Bob joins us now for more. Bob, good morning. 00:00:52 Speaker 4: Happy to be here. 00:00:53 Speaker 3: What's going wrong in your fixed income this morning? 00:00:55 Speaker 4: Well, I think a couple things synced up last week. One is we got midway through the week and it was clear there wasn't going to be a peace accord yet. in the Middle East during UN week. So suddenly you've got oil going higher. You've got everyone concerned about the second round effects of that. Will that get passed through to finished goods and services? And then you had some Fed speakers come in, notably New York Fed President Williams talking about more may need to be done. And if you go back a week earlier, he was one we thought could be a dovish dissent. And I think those couple of things caught the market off guard probably there were a couple stops along the way, so we've had the backup. 00:01:37 Speaker 3: Is that enough to change your mind? And if not, why? 00:01:40 Speaker 4: It's not. One of the things that puzzled us is the move from 390 to over 5% was pretty orderly, and we were always looking for a blow off top. We never got it. We hit our nominal and real yield levels. We did some buying. For us, the bigger problem was when we got down to 493%. Do we chase it? So 523 is a much happier place for us in the bond market. We can go back in, buy with some yield. 00:02:09 Speaker 1: At this point, there's a question about whether we're going to see yield curve flattening or yield curve steepening. We had seen pretty steady yield curve flattening when people were expecting the Fed to do that much more. Now, as John was saying over the past couple of sessions after that PMI print, you've seen an expanding in the yield curve. Do you expect that to continue? 00:02:26 Speaker 4: I I don't. It feels to us the entire yield curve is oversold. The demons have set in. Everyone has PTSD going back to 2022. Does the Fed have to do 200 basis points or more? I think once we get PCE this week, once we see the labor market, things will start to settle down again. So you're backing up the truck? Backing up the truck is your term, not mine. 00:02:54 Speaker 1: Are you aggressively buying right now? 00:02:56 Speaker 4: If we see some stabilization here, we have our next buy level. We've got plenty of buying yet to do. 00:03:01 Speaker 3: We're starting to see some instability. Maybe that's not the right word, but starting to see some spread, widening and credit. Lisa went through the details. That's something we haven't seen for much of this year. seen some jitters beneath the surface, particularly in triple Cs, but now starting to migrate to the headline index level, spreads wider for the past few sessions. What do you think is happening with credit now? We've seen signs that maybe this Fed action might be biting elsewhere. 00:03:23 Speaker 4: For sure. One of the things we've talked about is, can the Fed actually do a total of six rate hikes, go from three and five-eighths to five and an eighth, because if they can't, then bond yields of over 5% are pretty much a gift to you, which is where we think we are. We have already seen that the rise in yields, the 110, 130 basis points back up in yields, is starting to slow the economy. We know that businesses are struggling more to finance themselves in the public markets. We know that if you're a corporate America floating rate borrower through the bank loan market, your costs are going to go up significantly. And of course, there's the housing market. I don't believe mortgage rates have dropped down to 4% again. 00:04:10 Speaker 3: Is it fair to say that it's slowing the economy, the parts of the economy that were already slow? 00:04:16 Speaker 4: I think that's fair. I think you also have to say we're all filling up our cars or trucks. We're buying gas. We're buying petrol, whatever it is. The cost of that has gone up a lot, and it's been with us now for about six months. So it does bite into discretionary income, and I think you're going to see some of that pass through the economy. All of that is telling us, sure, the economy looks okay. Corporate profitability looks fine. Earnings growth looks fantastic. But there are headwinds that have formed out there from higher yields, from more aggressive central banks, and from higher energy prices. 00:04:56 Speaker 1: Would you rather take corporate credit risk or sovereign risk of the U.S. 00:05:00 Speaker 5: Government? 00:05:03 Speaker 4: If I thought we were going to go into recession, sovereign risk of the U.S. government for sure. Because then I think you're looking at a 20% return. You're looking at yields dropping 200 basis points, the Fed stepping in, and you're getting 16% on the return plus another 5% in yield. So absolutely, we don't think that's going to happen. We think that's still very much a tail case. We still like the U.S. economy. There is a lot of money still sloshing around. So if we can pick up credit in the investment grade space, close to 100 basis points over government bonds, we'll buy that. Below investment grade, close to 300, we'll buy that. 00:05:47 Speaker 1: So in other words, you like both investment grade and high yields. Investment grade now almost 6%. High yield over 8% all-in yields. You think both of those are going to be good returns and you're not going to suffer from losses due to defaults? 00:05:59 Speaker 4: I don't think so. I don't think we're going into recession. That's still pretty much a bottom line. I think you look at the market movement and you start getting worried about, is this going to overheat? Is it going to wind up in recession? We could just wind up somewhere in between, which looks like what we're headed for. That's great for corporate credit. 00:06:19 Speaker 3: Where does your confidence come from that they can achieve their inflation objectives, given everything you've just said? 00:06:25 Speaker 4: I don't think their inflation objective is 2%. I think the inflation objective is mid twos. I think what we learned from the pre-COVID era that a 2% target is too low, hence the flexible average inflation targeting regime that Powell wanted to put through. If you target 2%, you expose yourself to too many times to 1.6%, 1.7%, which for an economy the size and complexity of the U.S. is too low. It makes too great a part of the economy feel like they're left behind, left out. 00:07:01 Speaker 3: How big is that difference, 50 basis points, to you in this market? If anyone accidentally tuned in to watch financial news this morning and heard people arguing over 2 versus 2.5, they might wonder why that's a big deal. Is 50 basis points a big deal? 00:07:13 Speaker 4: So I wouldn't have thought so, but while I was waiting in the green room, I just emailed Kelsey. Two bad yields weren't down seven basis points this morning instead of up. And then that's a 14 basis point differential. Apply the same thing to inflation. It's not that big a deal unless it goes up 50 basis points, and then suddenly you're 100 basis points away from your target. Look, we're going to get a re-estimation of personal consumption expenditures. We expect that will take some steam out of core. It will compress closer to core CPI, which is in the mid twos. We're kind of there. We're not that far away. As we talked about, there are some headwinds in the economy that have formed from higher yields. We'll see what happens. 00:08:00 Speaker 3: Do you think Kevin Walsh is there with you? I've seen note after note compare him to Volcker. I just wonder whether you believe he's right there with you on this. 00:08:09 Speaker 4: I don't know because I don't know what the task forces will tell him. I don't know if he's going to listen to them. We don't know what his reaction function is. That's okay. We'll figure it out ourselves. I've been in this market for a long time, since 1981. I've invested through periods where inflation has stayed in the mid twos. The economy has done great. The bond market has performed well. 00:08:35 Speaker 6: It's okay. 00:08:36 Speaker 4: We can live with that. That's actually better for the U.S. economy. 00:08:40 Speaker 3: Bob, you went through a long list of reasons after the Fed decision to buy bonds. You had one caveat. You said, I hope we get the situation addressed in the Middle East. How difficult is it to be long fixed income at the moment, given that we haven't settled this dispute through the Strait of Formersen across the Middle East? 00:08:56 Speaker 4: It's a challenge for sure because we all know the price of energy leads to refined goods. So you're looking at gasoline, you're looking at petrol. You think about do businesses start to pass that along? Do workers demand higher wages? And do you get this sort of spiral effect? in inflation that would cause the central banks to go several hundred basis points higher for whatever reason we're not as concerned as we were in 2021 2022 because the supply demand imbalance in the economy and in markets just isn't there it feels as though a lot of this is already priced in It feels as though higher energy prices are less of an inflation threat and more of a headwind to the global economy. If we look at break-even yields in the market and try to get some estimate of inflation, they've remained relatively stable. What we've seen is that real yields have gone up a lot. So to us, that's a problem. 00:10:00 Speaker 5: Would it be more problematic to the inflationary environment if there is a diesel export ban? 00:10:08 Speaker 4: Probably near term. When I hear that, I think back to the Nixon price controls. They don't really work all that well. So I do get a little concerned that policy may be clumsy in here and the unintended consequences of it. 00:10:25 Speaker 5: Add on top of that what Jonathan brought up from the Wall Street Journal over the weekend, that potentially the administration's going to start the bombing campaign after the midterm elections. Where will yields be if we just have this low-turn, new normal for the remainder of the year into next year? 00:10:42 Speaker 4: It depends where the economy will be. If it causes the economy to roll over, then the Fed will have little choice but to pause on interest rates. They're not going to be able to control inflation. They're going to see from a much weaker economy that demand has dropped off on its own. That's where you get into, is there another rate hike or two as opposed to four, five, six more? 00:11:06 Speaker 1: Why didn't yields drop more when oil prices dropped? Why is that correlation broken down where only yields rise when oil prices go up and they don't seem to go down when oil prices go back down? 00:11:16 Speaker 4: Well, there was a lot that happened last week. And I think one of the reasons, of course, is that the Fed speakers came out. They were more hawkish. I think when you look at some of the PMI data, that was stronger. And let's not forget the Treasury. They put out there $ 6 billion in repurchases. They only did $ 4 billion. And the market looked at that and said, well, you know, we're not going to get that big support of the long end that the Treasury Secretary talks about. 00:11:44 Speaker 3: Stay with us. More Bloomberg surveillance coming up after this. Lindsay Piazza of Stifel expecting, quote, a relatively neutral slew of data offering justification for the September rate hike, but not necessarily fueling the argument for additional action right away. Lindsay joins us now for more. Lindsay, did that hot PMI change things at all? 00:12:13 Speaker 2: No, I don't think it did. I think it was another indication that the U.S. economy is still on relatively positive footing. So again, justifying the fact that the Fed does have some room to further firm monetary policy going forward and really shift the focus to tackling elevated inflation, and eventually get us back to that 2% target. Now, we've heard some relatively hawkish commentary from Fed officials, but this is coming years after elevated prices have become ingrained in the economy. So I'm still not overly convinced that this is a Fed willing to do what it takes to get us back to that 2% target. 00:12:53 Speaker 1: That said, Lindsay, if there is strong jobs growth, then that could potentially give them more space to potentially raise much more than certain people are expecting currently. How are you looking at the Friday non-farm payrolls report to gauge just how much space this Federal Reserve has? 00:13:10 Speaker 2: Well, I think the employment picture is going to give the Fed enough space to do the bare minimum of what they've already priced in as we look at the summary of economic projections. Remember, the majority of officials are still anticipating very minimal upside action, just one additional rate increase by the end of the year and a potential additional increase at the start of next year. So we're not talking about a potentially aggressive move higher in the federal funds rate. So a still stable, still positive employment picture allows them to do that, but it doesn't necessarily open up the gates, the floodgates, for a material move higher in monetary policy, or at least that's not what we're seeing as a proposed move. pathway from policy officials at this point. 00:13:57 Speaker 1: That said, Lindsay, a lot of people who have come on the show this morning and over the past couple of weeks have said ultimately this is a much less interest. 00:14:03 Speaker 3: Rate sensitive economy. 00:14:04 Speaker 1: It would take substantially higher yields to truly bring inflation down to 2%. It doesn't seem like that would necessarily be warranted given that a lot of the inflation is out of the Fed's control. 00:14:15 Speaker 3: What's your response to that? 00:14:15 Speaker 1: I mean, is it futile to raise rates at all or even substantially if ultimately the drivers are coming from elsewhere? 00:14:22 Speaker 6: Yeah. 00:14:23 Speaker 2: Well, I do think it's going to be more difficult because part of the problem is the Fed is fighting inflation that they left to become ingrained into the economy the first time around. Post-pandemic, the Fed clearly stopped short of a sufficiently restrictive level to get us back to a point of price stability. And so those earlier price pressures are still The Fed is still contending, I should say, with those earlier price pressures. Now you layer on additional price pressures as a result of this increased investment in the technology space, this energy price shock. Yes, some of that is out of the Fed's control, but that doesn't mean that monetary policy officials throw up their hands. That simply means that they focus on more intense policy moves that in order to reinstate price stability. That is their job. That is part of their dual mandate. And whether or not it's difficult, they need to keep their eye on the ball to get us back to that point of price stability. 00:15:17 Speaker 3: Do you think it requires a higher unemployment rate? 00:15:21 Speaker 2: I do think the Fed is going to have to slow the economy in order to get inflation under control. And part of the consequence of that is a slightly higher unemployment rate, or maybe even a notably higher unemployment rate from where we are. Right now, at near 4% unemployment, it's very clear that the Fed does have additional room to raise rates to a firmer point of policy and still keep us not only in that full employment range, but in order to break through that upper bound to slow growth, slow consumption, and get us back to a slower point of price growth. 00:15:59 Speaker 3: Stay with us. More Bloomberg Surveillance coming up after this. So here's the latest this morning. The president, Tanig Axios, the U.S. and Iran are heading back to the negotiating table later this week following Washington's rejection of Tehran's latest deal to reopen the strait. To build on this conversation, joining us now for more, Henrietta Trace of Vader Partners. Henrietta, welcome to the program. You saw the news from Saudi Arabia. That's some good news, some good news for this energy market. Is there any other good news out there heading into the midterms on the energy front? 00:16:37 Speaker 6: You know, I thought that there was going to be a chance. There was some optimism circling around the White House last week. 00:16:42 Speaker 2: Going into the U.N. 00:16:43 Speaker 6: That there might be some real meaty talks to at least get another MOU or a ceasefire. It's just not in the works. And the core holdup is, to my mind, Article 5 of the MOU that the president agreed to this summer, which gives Iran control of the Strait of Hormuz to negotiate a working arrangement between on tax policy with Oman to have an understanding that there is a way to get ships through the strait that they are in part involved with. As long as Iran is involved with ships getting through, you have tankers, insurers, farmers, banks that have to coordinate with a designated entity, the Islamic Revolutionary Guard. And that is untenable for a Western democracy and a Western economy as we're seeing play out in our elections in real time right now. 00:17:30 Speaker 5: It's also untenable for Arab partners. They don't want to see this either. Henrietta, when it comes to domestic politics, are we closer to an embargo on diesel? 00:17:39 Speaker 3: Oh, no question. 00:17:40 Speaker 6: I don't think it'll be a full scale embargo. What we're looking at is restrictions on different kinds of products. The White House is scrambling now to find out what they can do on anything else anywhere down the line with diesel and gasoline, diesel being the primary focus. But you can see what's happened is that the oil men are against the farmers and they're really battling it out to see where they can get prices down as the leadership and the majority party struggles with being underwater in states like Kansas, Iowa, Alaska, Michigan, Ohio, states that they just can't afford to lose that have been hammered by the one, two, three punch of immigration policy tariffs and now the war. So this is where we are and they really need to find some ways to get prices down so they don't get shellacked at the polls. 00:18:30 Speaker 5: Well, how is this going to basically reflect on the Republican Party? It basically puts Iowa, as you sort of alluded to, versus Texas. 00:18:38 Speaker 6: That's exactly what it is, Emery. I mean, it is amazing to see the most senior Republican in the United States Senate, the guy third in line to the presidency, come out and say, hey, oil men, you're killing us, when they're from the same party dealing with the same issues. And as you had Clayton point out earlier in the day, what helps with the diesel ban around the South and the Gulf is not gonna help the farmers on the East Coast, states like Pennsylvania or even New Jersey that also have massive farming contingents. Maine, this is not where that heating oil, that diesel is gonna go. So that's really the core issue. And to see it fracture the Republican Party is just a massive pressure and pain point, which brings me back to Iran cannot control the Strait of Hormuz in any capacity if there are free and fair elections in the United States and not in Iran. 00:19:26 Speaker 3: It's incompatible. 00:19:27 Speaker 1: Henrietta, speaking of the fractures in the Republican Party, there were 17 incumbent congressional Republicans who called for the end of the war in Iran over the past couple of days as they tried to win their different seats. How big of an influence is this going to be for the president, given the rising swell of incumbents who are really struggling to get reelected? 00:19:50 Speaker 6: Well, the call is really, does the president capitulate and result in Iranian regulatory power over the strait, which we just discussed is not tenable? Or does it lead the president to escalate the war? My expectation throughout since the first MOU has been that we need more military escalation because I'm obviously not smart enough to find a third alternative. 00:20:11 Speaker 4: To get us through this. 00:20:13 Speaker 6: And the pain points that the Republicans are telling the president are very, very real. It's not real enough for them to vote against it in the United States Senate. Obviously, Democrats are in a position as the minority party in a privileged motion to bring a war powers vote up. for the umpteenth time. And you did not lose a number of Republicans who have come out in opposition to the war. They did not vote against the president. That's for obvious political reasons. You don't wanna vote against the president during wartime. That's a very bad look. So the party is going to stay together. And I think most Obviously, or most openly, that's true of the senators who are not going to run against. Senators Cassidy, Senators Cornyn, they're gonna stick with their man. That makes sense from a presidential perspective, from a United States Senate perspective. But as we go forward, the president is gonna face some tough choices. He's got two more years of this. I know it's insane, but you got a position for 2028. This war needs to be wrapped up. God knows where diesel prices would be by then. Hopefully, we'll have a solution where the hormones is totally irrelevant to the conversation, but that's a 2030 story. 00:21:16 Speaker 1: We got some poll results over the weekend showing that the approval rating for the president is around 37 percent, which is the lowest for any president heading into a midterm election in modern history. How much credence do you give some of this polling? How much predictive factor do you give it, given that in the past, specifically in the Trump era, they have been less reflective of the actual results? 00:21:40 Speaker 6: What concerns me for any optimism around Democrats is the voters are not coming around and being like, hey, I support the Democratic Party. That's not what's happening here. This is, as you rightly point out, solely a story about President Trump. That's why Republicans are trying to distance themselves from the president right now. In some cases, scrubbing the president's commentary from their entire websites. not showing up with JD Vance when he comes into town to campaign, as was the case with Ashley Hinson in Iowa last week. What you're seeing is the party trying to position for 2028. Who's gonna be the next front runner? Who's gonna steer this party that's been under control of President Trump for the last decade? They need to find their next man. So I think that fight is really gonna play out and be fascinating for the next two years. 00:22:28 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 App.