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Speaker 1: After a November to remember for stocks and just about

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Speaker 1: every investment asset rally, December has gotten off to a

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Speaker 1: bit of a rough start for long traders, dialing back

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Speaker 1: some of their bets that the Federal Reserve will cut

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Speaker 1: rates as aggressively as they might have thought just a

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Speaker 1: few weeks ago. Really seen some weakness in the latest

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Speaker 1: economic data, but Fed Chairman Jerome Powell is keeping up

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Speaker 1: his message that the central Bank needs to move carefully

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Speaker 1: on policy into next year. So let's talk more about

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Speaker 1: this economy and the policy path from here on out.

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Speaker 1: We are very pleased to be joined this morning by

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Speaker 1: Mohammad al Arian, the chief economic advisor at Alliance, the

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Speaker 1: president of Queen's College, Cambridge, and of course columnist for

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Speaker 1: Bloomberg Opinion. Muhammad, thank you so much for taking the

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Speaker 1: time this morning. I want to start by asking what

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Speaker 1: you made of the exuberance we saw over rate cuts

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Speaker 1: last month. Was it overdone?

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Speaker 2: First? Good morning, Nathan, Thanks for having me. Yes, I

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Speaker 2: believe it was overdone. I do believe that the Fed

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Speaker 2: is done raising weights, but I don't think they will

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Speaker 2: validate what's currently priced in by the markets in terms

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Speaker 2: of weightcuts next year.

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Speaker 1: Now, we have this debate going about how long the

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Speaker 1: FED will keep rates elevated, whether it's higher for longer,

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Speaker 1: high for longer. I mean, the market is pricing in

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Speaker 1: one hundred and twenty five basis points of rate cuts

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Speaker 1: next year. Does the Fed have room for that kind

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Speaker 1: of easing.

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Speaker 2: Not yet. There's a few things that we have to

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Speaker 2: keep in mind. One is inflation dynamic. While we've had

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Speaker 2: goods deflation, services remain while they're hot in terms of

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Speaker 2: the inflation rate, they're not disinflating fast enough, and at

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Speaker 2: some point the goods deflation will stop. So getting to

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Speaker 2: two percent inflation is the inflation target is far from automatic. Second,

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Speaker 2: and we'll get more evidence this week, the labor market

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Speaker 2: is still doing really well, and I suspect that the

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Speaker 2: Fed would like to see some weakening in the labor market. Thirdly,

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Speaker 2: the markets have already loosened financial conditions significantly. You know,

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Speaker 2: Nathan November going to the Goldman Sachs Index of financial

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Speaker 2: conditions was the biggest loosening of conditions in any month

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Speaker 2: since records. So there's been a tremendous loosening of financial conditions.

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Speaker 2: I think if you look at those three things, they

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Speaker 2: suggest the FED will be more careful in cutting weights

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Speaker 2: than what the markets expect.

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Speaker 1: Right now, well, let's take those three things in turn. Then,

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Speaker 1: starting with the stickiness of services inflation, why do you

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Speaker 1: see it sticking around as much as it has? Can

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Speaker 1: policy make an impact on the elevated services price pressures

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Speaker 1: that we're seeing in this economy.

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Speaker 2: Nathan, That's a key question, and a very good one.

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Speaker 2: The problem with falling behind on inflation, which is what

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Speaker 2: has what happened to FED, is that you allow the

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Speaker 2: inflation process to go from a few items in this

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Speaker 2: case it was energy and food to the good sector

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Speaker 2: as a whole, and then next thing you know, it

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Speaker 2: starts getting embedded in the service sector. Now why is

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Speaker 2: that a problem? Because the service sector is less sensitive

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Speaker 2: to interest rate hikes, So the minute it gets embedded

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Speaker 2: in the service sector, it's harder for the central bank

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Speaker 2: to get to that inflation. And that's why the stickiness

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Speaker 2: of the service component of inflation is something to keep

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Speaker 2: on the weight O skein. Hopefully it's not going to

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Speaker 2: last for a very long time, but don't forget the

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Speaker 2: outright deflation and goods is going to stop, so we

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Speaker 2: do need the service sector to disinflate further.

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Speaker 1: And that gets to the question about whether cracks in

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Speaker 1: the labor market are what it's going to take to

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Speaker 1: get inflation down to the target that the FED has

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Speaker 1: set out two percent because services are so tied to

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Speaker 1: the labor market. What is your expectation about the data

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Speaker 1: that we're going to see on the jobs market this week,

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Speaker 1: particularly the JOLTS data today and the all important Friday

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Speaker 1: jobs report.

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Speaker 2: So it's interesting that for the JOLT data today, Blommerk

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Speaker 2: Economics expects only a marginal decline and Bloomerk Economics expects

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Speaker 2: that the ratio of the unemployed two job vacancies will

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Speaker 2: stay above the historical averages. So to put it into context,

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Speaker 2: blom Mirk Economics expects that way shure to go from

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Speaker 2: one point five to one point four to four and

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Speaker 2: that's still above the average. Nathan, your question really comes

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Speaker 2: down to something that the FED doesn't want to talk about,

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Speaker 2: but increasingly others are talking about, which is two percent

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Speaker 2: the right inflation target. If our labor market is slightly

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Speaker 2: less flexible than what it used to be before, the

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Speaker 2: supply side as a whole is less flexible around the world,

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Speaker 2: which it is should we continue to insist on a

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Speaker 2: two percent inflation target or should the Fed be willing

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Speaker 2: to tolerate somewhere above that. Why would the Fed want

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Speaker 2: to tolerate somewhere above that? Not because it wants to

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Speaker 2: create inflation expectations that won't happen, but instead because it

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Speaker 2: doesn't want to unduly sacrifice the job market, unduly sacrifice growth,

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Speaker 2: and unduly sacrifice aspects that our key to the equality

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Speaker 2: of income and wealth. So that's going to ultimately be

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Speaker 2: the big question is does the FED insist on staying

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Speaker 2: at two percent and therefore with really weakening the labor market,

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Speaker 2: or is it willing to tolerate slightly higher inflation because

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Speaker 2: that's the reality of today's supply constrained global economy.

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Speaker 1: We're speaking with Muhammad al aarian Bloomberg opinion columnist and

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Speaker 1: the chief economic advisor at Alliance. That is a big question, Muhammad,

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Speaker 1: because this Fed has really hammered home the target of

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Speaker 1: two percent. They've really been laser focused on that. Do

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Speaker 1: you see room from some of the commentary that we're

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Speaker 1: hearing from this Federal Reserve that it could be open

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Speaker 1: to a higher inflation target And what would that mean

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Speaker 1: for the US economy.

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Speaker 2: So I don't think we'll ever hear this FED say

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Speaker 2: we are revising our inflation target from two to say

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Speaker 2: three percent. That's not gonna happen. They're not going to

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Speaker 2: explicitly revise up the inflation target because they've missed it

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Speaker 2: for so long and by so much that they will

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Speaker 2: feel that that will undermine the credibility. What they may

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Speaker 2: do is continue to promise us two percent in the future,

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Speaker 2: but but hollow weight. I don't get to two percent

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Speaker 2: very quickly. Now, what does that mean for the economy.

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Speaker 2: I think ultimately the choice facing the FED is the

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Speaker 2: following nason. Either they stick to two percent and with

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Speaker 2: tipping the economy into recession, or they tolerate slightly high inflation,

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Speaker 2: they don't push the economy into recession, and they find

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Speaker 2: out that that is stable, that it doesn't un anchor

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Speaker 2: inflation or expectations. My hope is that they will opt

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Speaker 2: for the second option, but we will have to wait

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Speaker 2: and see.

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Speaker 1: Well what could that mean though for market volatility. I mean,

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Speaker 1: we've seen a lot of questioning in this market about

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Speaker 1: whether the FED is serious about the message that it's

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Speaker 1: putting out there. If we do see the sort of

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Speaker 1: rhetorical focus on a two percent target, but maybe not

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Speaker 1: a realistic two percent target. What could that mean for

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Speaker 1: market volatility?

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Speaker 2: So, first, the sources of volatility we've seen in the

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Speaker 2: fixed income market was unthinkable not so long ago. Everyday

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Speaker 2: seven to ten basis points move is often on very little,

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Speaker 2: So that's something else going on in the fixing can market.

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Speaker 2: What is more wearisome is the issue you raised, which

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Speaker 2: is that the FED says things and the market totally

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Speaker 2: ignored it. Last Friday was a perfect example of that.

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Speaker 2: Chair Pal was very clear, he said it would be

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Speaker 2: premature to talk about any interest rate cuts, and he

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Speaker 2: left the door open for interest rate hikes. And yet

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Speaker 2: a market that had already rallied by forty basis points

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Speaker 2: in the front and on the second year, the second year,

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Speaker 2: the two year yield had come down by forty basis

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Speaker 2: points rallied another ten basis points, and that, you know,

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Speaker 2: started a whole conversation yesterday about whether chair Pal was

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Speaker 2: steamrolled by the market, whether the Fed pal was stiff

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Speaker 2: armed by the market. The fact is that FED communication

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Speaker 2: is not as impactful as it used.

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Speaker 1: To be, which gets to a question I've been wanting

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Speaker 1: to ask you all morning long. I mean, you've been

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Speaker 1: very critical of FED messaging FED policy in the past.

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Speaker 1: You've said that the FED waited too long to tackle inflation.

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Speaker 1: How would you grade the Fed's performance now?

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Speaker 2: So, I think they've played major catchup, which they needed

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Speaker 2: to do. So if you look at analysis and action

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Speaker 2: where they had failed earlier, they have corrected that. They've

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Speaker 2: also paid much more attention to the supervisory role, so

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Speaker 2: that is good. Communications remains poor, and again we had

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Speaker 2: examples of that over the last few weeks. So they

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Speaker 2: still have a significant communication problem, and they still have

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Speaker 2: a credibility problem. You know, the whole point of forward

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Speaker 2: guidance is for the markets to listen to you and

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Speaker 2: for the markets to do the heavy lifting for you.

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Speaker 2: What we're seeing now is forward guidance, as we saw

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Speaker 2: last Friday, completely ignored by the market. And it is

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Speaker 2: really interesting to me, Nathan, that the market is taking

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Speaker 2: on the FED on a variable that the FED controls completely.

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Speaker 2: I mean, think about that. The market is basically telling

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Speaker 2: the FED, I don't care what you think about an

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Speaker 2: indust rate that you set, I think you're going to

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Speaker 2: do something completely different. That's quite a statement. From the

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Speaker 2: market to the FED.

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Speaker 1: So in our last minute, Muhammad, what would it take

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Speaker 1: for the market and for you to get that credibility

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Speaker 1: back from the Federal Reserve? What does the FED need

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Speaker 1: to do to regain its credibility in your view?

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Speaker 2: So first, let me just say that in terms of

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Speaker 2: the outlook for twenty twenty four, I think the market

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Speaker 2: should be listening more to the FED. That's why I

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Speaker 2: don't think the FED is going to end up validating

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Speaker 2: what the market is pricing in for cuts. In terms

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Speaker 2: of what it takes, takes a couple of things. One

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Speaker 2: is something that if recent G thirty report on central

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Speaker 2: bank stresses, is for central banks to be more humble,

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Speaker 2: to recognize that we live in a different world and

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Speaker 2: they've got to have a much border mindset and much

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Speaker 2: greater cognitive diversity. And the second thing will take is

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Speaker 2: better accountability. The FED is not as accountable as it

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Speaker 2: should be, and therefore, even when it makes mistakes, repeated mistakes,

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Speaker 2: and they've made five different mistakes in the last few years,

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Speaker 2: even when it makes repeated mistakes, it doesn't own those mistakes,

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Speaker 2: and therefore it raises doubt among lots of people as

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Speaker 2: to whether it's learning from those mistakes. So the two

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Speaker 2: things it really would take is being more open minded,

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Speaker 2: having greater cognitive diversity, and secondly better accountability.

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Speaker 1: Thank you, Mohammed, Really good to get your thoughts this morning.

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Speaker 1: Muhammad al Arian, Bloomberg Opinion columnist and chief economic advisor

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Speaker 1: at Alian's