1 00:00:00,130 --> 00:00:02,910 Speaker 1: Hey, Odd Lots listeners, the Odd Lots tour continues and 2 00:00:02,970 --> 00:00:04,330 Speaker 1: our next stop is in Chicago. 3 00:00:04,570 --> 00:00:04,930 Speaker 2: That's right. 4 00:00:04,990 --> 00:00:07,500 Speaker 3: Joe and I will be at the City Winery Chicago 5 00:00:07,620 --> 00:00:11,140 Speaker 3: on October 15th for a live Odd Lots recording. Tickets 6 00:00:11,300 --> 00:00:14,720 Speaker 3: are on sale now at Bloomberg.com forward slash Odd Lots. 7 00:00:15,020 --> 00:00:17,460 Speaker 1: And of course, a special thank you to Barclays for 8 00:00:17,520 --> 00:00:19,040 Speaker 1: supporting Odd Lots Live. 9 00:00:19,280 --> 00:00:23,000 Speaker 3: So that's October 15th at City Winery in Chicago. Get 10 00:00:23,060 --> 00:00:23,959 Speaker 3: your tickets now. 11 00:00:26,880 --> 00:00:29,730 Speaker 1: Bloomberg Audio Studios. Podcasts. 12 00:00:30,050 --> 00:00:31,410 Speaker 2: Radio. News. 13 00:00:42,680 --> 00:00:45,620 Speaker 3: Hello and welcome to another episode of the Oddbots Podcast. 14 00:00:45,680 --> 00:00:46,540 Speaker 3: I'm Tracy Alloway. 15 00:00:46,680 --> 00:00:47,860 Speaker 1: And I'm Joe Wiesenthal. 16 00:00:48,220 --> 00:00:51,260 Speaker 3: Joe, we're back in New York. Yeah. But the Jackson 17 00:00:51,300 --> 00:00:52,620 Speaker 3: Hole episodes continue. 18 00:00:53,820 --> 00:00:55,750 Speaker 1: That's true. You know what, by the way, oh my 19 00:00:57,690 --> 00:01:01,350 Speaker 1: The 30-year rate, by the way, it's just straight up 20 00:01:01,410 --> 00:01:04,890 Speaker 1: the last few weeks. But it's right around, as of 21 00:01:04,910 --> 00:01:08,780 Speaker 1: the time that we're recording this, it's at 5.592. It 22 00:01:09,220 --> 00:01:12,380 Speaker 1: has now hit the highest level since 2002. Wow. So 23 00:01:12,800 --> 00:01:14,420 Speaker 1: a few weeks ago, we were looking at the yield 24 00:01:14,480 --> 00:01:16,750 Speaker 1: curve and saying all these things. Oh, now highest level 25 00:01:16,790 --> 00:01:16,990 Speaker 1: since 2007. 26 00:01:16,970 --> 00:01:17,110 Speaker 3: Yeah. 27 00:01:18,940 --> 00:01:21,920 Speaker 1: And then it was 2004 was the other year, and 28 00:01:21,980 --> 00:01:25,000 Speaker 1: now we're getting higher since 2002. It really is both 29 00:01:25,080 --> 00:01:27,100 Speaker 1: extraordinary speed and scale. 30 00:01:27,380 --> 00:01:27,580 Speaker 2: Yeah. 31 00:01:27,670 --> 00:01:30,569 Speaker 3: And the other thing that happened since Jackson Hole is 32 00:01:30,690 --> 00:01:31,630 Speaker 3: we had a Fed rate hike. 33 00:01:31,650 --> 00:01:32,350 Speaker 1: We had a Fed rate. 34 00:01:33,590 --> 00:01:36,770 Speaker 3: And yet yields continue to soar. And so there's an 35 00:01:36,870 --> 00:01:39,550 Speaker 3: open question over whether or not that rate hike is 36 00:01:39,590 --> 00:01:43,000 Speaker 3: having its intended effect in terms of dampening down financial 37 00:01:43,040 --> 00:01:47,810 Speaker 3: conditions and things like that. Yeah. Another big thing in 38 00:01:47,830 --> 00:01:50,340 Speaker 3: the background, I feel like I have to list all 39 00:01:50,400 --> 00:01:54,600 Speaker 3: these mega trends, but the other big thing is there's 40 00:01:54,620 --> 00:01:59,760 Speaker 3: been this ongoing debate over Fed's communication style, the new 41 00:01:59,800 --> 00:02:03,920 Speaker 3: communication framework, what does credibility mean when a central bank 42 00:02:03,980 --> 00:02:07,510 Speaker 3: is in an inflation-fighting environment and things like that. We 43 00:02:07,530 --> 00:02:09,190 Speaker 3: have to talk about all of this. Yeah. 44 00:02:09,610 --> 00:02:14,440 Speaker 1: When you said another thing in the backdrop, I was like, 45 00:02:14,480 --> 00:02:16,560 Speaker 1: which of the many things are you going to choose here? 46 00:02:16,620 --> 00:02:19,579 Speaker 1: Because you could have said, oh, you know, this is 47 00:02:20,060 --> 00:02:23,780 Speaker 1: against the backdrop of large deficits, against the backdrop of 48 00:02:24,120 --> 00:02:28,170 Speaker 1: AI spending and the fact that big hyperscalers are spending 49 00:02:28,250 --> 00:02:30,970 Speaker 1: it and borrowing at rates that are like the size 50 00:02:31,010 --> 00:02:34,650 Speaker 1: of like pretty big nations, you could have said, in 51 00:02:34,669 --> 00:02:39,310 Speaker 1: the backdrop of longstanding questions about U.S. global hegemony and 52 00:02:39,330 --> 00:02:42,470 Speaker 1: the link between war and the dollar and so forth, 53 00:02:42,530 --> 00:02:45,710 Speaker 1: et cetera. And so there are many backdrops. There are 54 00:02:45,790 --> 00:02:46,330 Speaker 1: infinite backdrops. 55 00:02:46,350 --> 00:02:47,950 Speaker 3: I could have gone on for a while, but I 56 00:02:47,990 --> 00:02:49,870 Speaker 3: chose not to. No, there's so much going on at 57 00:02:49,889 --> 00:02:50,250 Speaker 3: the moment. 58 00:02:50,570 --> 00:02:51,950 Speaker 1: But it all relates to rates. 59 00:02:52,110 --> 00:02:54,350 Speaker 3: It all relates to rates. And we do, in fact, 60 00:02:54,490 --> 00:02:57,610 Speaker 3: have the perfect guest, someone who can opine and share 61 00:02:57,650 --> 00:03:00,620 Speaker 3: her research on many of these things. We're going to 62 00:03:00,639 --> 00:03:03,859 Speaker 3: be speaking with Carolyn Pfluger. She is an associate professor 63 00:03:04,020 --> 00:03:07,280 Speaker 3: at the University of Chicago Harris School of Public Policy, 64 00:03:07,400 --> 00:03:10,540 Speaker 3: as well as a visiting scholar over at the Chicago Fed. 65 00:03:11,020 --> 00:03:15,019 Speaker 3: And she presented a very famous paper at Jackson Hole 66 00:03:15,040 --> 00:03:17,520 Speaker 3: a couple years ago. We didn't get a chance to 67 00:03:17,560 --> 00:03:19,760 Speaker 3: talk to her when we were in Jackson Hole, but 68 00:03:19,800 --> 00:03:22,149 Speaker 3: we're going to make it up right now. So Carolyn, 69 00:03:22,250 --> 00:03:23,720 Speaker 3: thank you so much for coming on All Thoughts. 70 00:03:24,000 --> 00:03:25,810 Speaker 2: Thank you for having me. It's really great to be here. 71 00:03:26,450 --> 00:03:30,440 Speaker 3: Why don't you give us the sort of, 3,000-foot overview 72 00:03:30,620 --> 00:03:32,700 Speaker 3: of your research. What's your specialty here? 73 00:03:33,250 --> 00:03:38,330 Speaker 2: So most broadly, I'm interested in how the macroeconomy, monetary policy, 74 00:03:38,430 --> 00:03:42,290 Speaker 2: and inflation are reflected in bond markets and are in 75 00:03:42,350 --> 00:03:45,230 Speaker 2: turn shaped by them. I think that's a pretty interesting 76 00:03:45,270 --> 00:03:46,310 Speaker 2: topic because. 77 00:03:46,410 --> 00:03:46,910 Speaker 1: We do too. 78 00:03:48,110 --> 00:03:51,370 Speaker 2: You know, to me, the macroeconomy, inflation, unemployment, those are 79 00:03:51,430 --> 00:03:54,570 Speaker 2: the big questions. They're not easy to answer, but that 80 00:03:54,610 --> 00:03:57,330 Speaker 2: makes it all the more intriguing to me. And of course, 81 00:03:57,370 --> 00:04:01,270 Speaker 2: financial markets are unique in that they're sophisticated, they're forward-looking. 82 00:04:01,310 --> 00:04:03,050 Speaker 2: So a lot of these things get priced in, and 83 00:04:03,070 --> 00:04:04,430 Speaker 2: that's what I find very interesting. 84 00:04:04,730 --> 00:04:07,910 Speaker 1: You said that you think about the way various things 85 00:04:07,950 --> 00:04:11,340 Speaker 1: get reflected in the bond market, but then also how 86 00:04:11,400 --> 00:04:15,260 Speaker 1: the bond market then reflects back onto, quote, the real 87 00:04:15,320 --> 00:04:18,560 Speaker 1: economy or the real world or whatever. That part doesn't 88 00:04:18,600 --> 00:04:22,020 Speaker 1: get discussed as much, it seems like for the most part, people, 89 00:04:22,279 --> 00:04:24,520 Speaker 1: when they think about the link between the real economy 90 00:04:24,580 --> 00:04:27,380 Speaker 1: and the bond market, It seems like they mostly make, 91 00:04:27,600 --> 00:04:30,020 Speaker 1: you know, it goes in one direction. So it's interesting 92 00:04:30,040 --> 00:04:31,740 Speaker 1: to me that you said reflected back. 93 00:04:32,520 --> 00:04:32,760 Speaker 3: Yes. 94 00:04:32,900 --> 00:04:36,299 Speaker 2: So that brings me to my research on the policy 95 00:04:36,360 --> 00:04:40,520 Speaker 2: reaction function. Now, what is a policy reaction function? Just 96 00:04:40,600 --> 00:04:45,680 Speaker 2: as a quick definition. Most simply, that's what markets or 97 00:04:46,260 --> 00:04:49,610 Speaker 2: observers more broadly expect the Fed to do in response 98 00:04:49,640 --> 00:04:54,830 Speaker 2: to economic conditions. So as a numerical example, if forecasters 99 00:04:54,890 --> 00:04:59,090 Speaker 2: expect markets 2% inflation, they might forecast a 4% policy rate. 100 00:04:59,970 --> 00:05:05,640 Speaker 2: If they expect 4% inflation, they might expect a 6% 101 00:05:05,640 --> 00:05:09,000 Speaker 2: policy rate. So that would be a one-for-one adjustment, a 102 00:05:09,160 --> 00:05:16,180 Speaker 2: perceived policy reaction coefficient of one. And that matters. This 103 00:05:16,240 --> 00:05:21,220 Speaker 2: policy reaction function matters for at least two reasons. And 104 00:05:21,360 --> 00:05:24,260 Speaker 2: one of them comes back to your question, this reflection back. 105 00:05:24,810 --> 00:05:29,010 Speaker 2: which is that if the policy reaction function is well understood, 106 00:05:29,790 --> 00:05:33,390 Speaker 2: then that means that as data comes out, unemployment, inflation, 107 00:05:33,440 --> 00:05:36,020 Speaker 2: and so on, the policy rates will move in the 108 00:05:36,060 --> 00:05:39,260 Speaker 2: direction that the Fed intended and thereby help with monetary 109 00:05:39,300 --> 00:05:42,419 Speaker 2: policy transmission or maybe even speed it up before the 110 00:05:42,460 --> 00:05:43,640 Speaker 2: next FOMC meeting. 111 00:05:43,660 --> 00:05:46,400 Speaker 3: So this is the market doing, quote, the Fed's work 112 00:05:46,520 --> 00:05:46,880 Speaker 3: for it. 113 00:05:47,060 --> 00:05:47,620 Speaker 1: Correct. 114 00:05:47,660 --> 00:05:47,860 Speaker 3: Yes. 115 00:05:47,880 --> 00:05:51,960 Speaker 1: But you say only if the reaction function is understood, right? 116 00:05:52,830 --> 00:05:56,789 Speaker 2: Correct. That's why the understanding is important, right? So if 117 00:05:56,830 --> 00:06:01,490 Speaker 2: there is, you know, whatever the intended policy reaction function is, 118 00:06:01,510 --> 00:06:05,770 Speaker 2: you know, if it's well understood, markets will adjust in 119 00:06:05,810 --> 00:06:09,839 Speaker 2: response to inflation news coming out and unemployment news coming 120 00:06:09,940 --> 00:06:10,660 Speaker 2: out and so on. 121 00:06:11,360 --> 00:06:15,420 Speaker 3: How are you actually measuring how the market incorporates its 122 00:06:15,500 --> 00:06:17,880 Speaker 3: future expectations of Fed policy? Because there are a number 123 00:06:17,920 --> 00:06:20,289 Speaker 3: of ways that you could do it, you know, some 124 00:06:20,380 --> 00:06:22,510 Speaker 3: obvious ones, but what are you looking at specifically? 125 00:06:22,870 --> 00:06:25,770 Speaker 2: Yes, that's a great question. I mean, I think the 126 00:06:25,790 --> 00:06:28,770 Speaker 2: main point is that a policy reaction function can and 127 00:06:28,810 --> 00:06:33,930 Speaker 2: should be measured. And what my co-authors and I have done, 128 00:06:33,950 --> 00:06:37,190 Speaker 2: I would think of is actually the most obvious way 129 00:06:37,250 --> 00:06:39,310 Speaker 2: of doing it, which is, I think, always a good 130 00:06:39,470 --> 00:06:43,040 Speaker 2: starting point. So this is joint work with my co-authors, 131 00:06:43,130 --> 00:06:45,880 Speaker 2: Michael Bauer at the San Francisco Fed and Adi Sundaram 132 00:06:46,010 --> 00:06:49,720 Speaker 2: at Harvard Business School. So we took two approaches. The 133 00:06:49,760 --> 00:06:55,060 Speaker 2: first one is based on forecasts. We didn't run our 134 00:06:55,120 --> 00:06:57,820 Speaker 2: own surveys because we wanted to know, you know, how 135 00:06:57,860 --> 00:07:02,849 Speaker 2: have these perceptions changed over time, historically, over decades. And, 136 00:07:03,110 --> 00:07:06,630 Speaker 2: you know, a policy reaction function is quite similar to 137 00:07:06,770 --> 00:07:11,050 Speaker 2: a 1993 type Taylor rule, but there are important differences. 138 00:07:11,870 --> 00:07:16,760 Speaker 2: The first difference is that it's forward-looking. So it's about expectations. 139 00:07:17,200 --> 00:07:21,000 Speaker 2: The second difference is that it's a little bit shorter run. 140 00:07:21,040 --> 00:07:23,680 Speaker 2: It's about the next couple of quarters, at most the 141 00:07:23,700 --> 00:07:29,220 Speaker 2: next couple of years. And traditional monetary policy rules are 142 00:07:29,600 --> 00:07:33,530 Speaker 2: used to describe historical data in a backward-looking manner. What 143 00:07:33,550 --> 00:07:37,530 Speaker 2: we said is, hang on, rather than using this historical data, 144 00:07:38,330 --> 00:07:44,210 Speaker 2: let's just use forecasts, survey data, interest rate forecasts. And 145 00:07:44,230 --> 00:07:47,130 Speaker 2: it turns out that every month, There is a lot 146 00:07:47,150 --> 00:07:49,970 Speaker 2: of richness in terms of the forecasts that are being 147 00:07:50,010 --> 00:07:53,560 Speaker 2: produced for the policy rate. And so we use this 148 00:07:53,680 --> 00:07:57,400 Speaker 2: data from the blue chip of financial forecasters, which asks, 149 00:07:58,000 --> 00:08:02,000 Speaker 2: what is your forecast for the Fed funds rate? And 150 00:08:02,060 --> 00:08:05,960 Speaker 2: what are the underlying assumptions that you used for inflation 151 00:08:06,430 --> 00:08:09,370 Speaker 2: and output to come up with this policy rate forecast? 152 00:08:10,250 --> 00:08:13,190 Speaker 2: So in a way, it's an ideal setup because it's asking, 153 00:08:13,290 --> 00:08:15,750 Speaker 2: what is the rule for the Fed that you're plugging in? 154 00:08:16,970 --> 00:08:22,630 Speaker 2: And so we just took this data that's forward-looking, you know, 155 00:08:22,630 --> 00:08:25,970 Speaker 2: 30 to 50 forecasters, a couple of forecast horizons, up 156 00:08:26,030 --> 00:08:28,970 Speaker 2: to six quarters out, and we ran the exact same 157 00:08:29,010 --> 00:08:33,550 Speaker 2: regression that you would run for a monetary policy rule, but, 158 00:08:33,770 --> 00:08:37,819 Speaker 2: you know, on this different data, forward-looking data. So, yeah, 159 00:08:37,860 --> 00:08:41,420 Speaker 2: if you basically treat this, we can't run experiments on 160 00:08:41,460 --> 00:08:44,660 Speaker 2: the macroeconomy, but if you treat this data as the 161 00:08:44,720 --> 00:08:49,760 Speaker 2: best approximation of, experiment on the macroeconomy, we ran a 162 00:08:49,800 --> 00:08:54,339 Speaker 2: regression of the forecasted Fed funds rate onto forecasted inflation 163 00:08:55,059 --> 00:09:00,700 Speaker 2: and forecasted output relative to potential. And so the coefficients 164 00:09:00,760 --> 00:09:04,750 Speaker 2: there on inflation would tell us when forecasters are forecasting 165 00:09:04,809 --> 00:09:08,410 Speaker 2: high inflation, how much higher is the expected Fed funds 166 00:09:08,450 --> 00:09:12,870 Speaker 2: rate and vice versa, for example. So that's the first methodology. 167 00:09:13,630 --> 00:09:16,980 Speaker 2: The second one is closer to what I said about 168 00:09:18,320 --> 00:09:24,740 Speaker 2: the macroeconomic announcement dates and rates moving in response. You 169 00:09:24,760 --> 00:09:28,000 Speaker 2: can use that also to obtain a market perceived rule, 170 00:09:28,410 --> 00:09:32,010 Speaker 2: just to say if inflation comes out higher or lower 171 00:09:32,050 --> 00:09:36,730 Speaker 2: than expected. Let's say inflation comes out higher than expected 172 00:09:36,890 --> 00:09:40,720 Speaker 2: and interest rates, say the two-year rate, goes up a lot. 173 00:09:41,790 --> 00:09:45,870 Speaker 2: then that is also a regression that we run. You 174 00:09:45,910 --> 00:09:48,790 Speaker 2: need a couple of observations, of course. It's a rolling window. 175 00:09:50,010 --> 00:09:52,170 Speaker 2: But you can run this regression of how much do 176 00:09:52,250 --> 00:09:56,510 Speaker 2: yields change onto what's the inflation news on that day. 177 00:09:57,030 --> 00:10:00,640 Speaker 2: And that gives another way of getting a perceived reaction. function. 178 00:10:01,440 --> 00:10:05,340 Speaker 2: It turns out that both of these methodologies often give 179 00:10:05,380 --> 00:10:08,239 Speaker 2: very similar answers. And I love that because it makes 180 00:10:08,300 --> 00:10:10,380 Speaker 2: me a lot more comfortable with either methodology. 181 00:10:11,270 --> 00:10:15,090 Speaker 1: So one thing I'm curious about is, okay, you know, 182 00:10:15,110 --> 00:10:17,929 Speaker 1: you look at market reactions and you get, there's one 183 00:10:17,990 --> 00:10:20,390 Speaker 1: number there, right? There's a lot of different views of 184 00:10:20,410 --> 00:10:22,609 Speaker 1: the market, but it's one number. Whereas if you're doing 185 00:10:22,650 --> 00:10:26,150 Speaker 1: a survey, you're going to get, you can average them together, 186 00:10:26,190 --> 00:10:29,080 Speaker 1: but you can see all the different views. Something I'm 187 00:10:29,240 --> 00:10:35,120 Speaker 1: curious about with the surveys or anything is whether we 188 00:10:35,220 --> 00:10:39,460 Speaker 1: see historical changes over time with respect to, I suppose, 189 00:10:39,970 --> 00:10:43,490 Speaker 1: the spread or the dispersion of views, are there times 190 00:10:43,610 --> 00:10:46,490 Speaker 1: where people in the market have, you know, there's a 191 00:10:46,610 --> 00:10:52,059 Speaker 1: clear consensus of what market participants or forecasters perceive the 192 00:10:52,220 --> 00:10:55,120 Speaker 1: reaction function to be? And are there times that we 193 00:10:55,160 --> 00:10:58,980 Speaker 1: can point to where there is a lot of ambiguity 194 00:10:59,040 --> 00:11:00,860 Speaker 1: on the part of market participants? 195 00:11:01,380 --> 00:11:07,870 Speaker 2: Yes, that's interesting. So we have focused on the variation 196 00:11:08,070 --> 00:11:11,870 Speaker 2: over time in the point estimate of the reaction function. 197 00:11:12,790 --> 00:11:17,330 Speaker 2: There clearly is a lot of heterogeneity across forecasters. We've 198 00:11:17,350 --> 00:11:19,429 Speaker 2: looked at that a little bit, but we've really focused 199 00:11:19,510 --> 00:11:23,240 Speaker 2: on how does it vary over time. But as one example, 200 00:11:23,280 --> 00:11:29,610 Speaker 2: when there was a lot of agreement after Late 2011 201 00:11:29,610 --> 00:11:31,860 Speaker 2: was when the Fed came out and gave very clear 202 00:11:31,929 --> 00:11:35,120 Speaker 2: date-based forward guidance. Interest rates will be at zero at 203 00:11:35,200 --> 00:11:39,140 Speaker 2: least until mid-2013. At that point, all the Fed funds 204 00:11:39,160 --> 00:11:43,880 Speaker 2: rate forecasts collapsed to zero and you'll see absolutely no dispersion. 205 00:11:43,920 --> 00:11:46,640 Speaker 2: So that would be an example where that collapsed. 206 00:11:47,120 --> 00:11:49,500 Speaker 3: So what moves the needle when it comes to the 207 00:11:50,020 --> 00:11:55,110 Speaker 3: market's policy reaction function? Is it the Fed actually doing 208 00:11:55,170 --> 00:11:59,610 Speaker 3: something and raising or lowering rates? Or is it forward guidance? 209 00:11:59,710 --> 00:12:02,890 Speaker 3: Is it having a press conference where they answer a 210 00:12:02,929 --> 00:12:06,589 Speaker 3: question particularly well or badly? What do you observe in 211 00:12:06,630 --> 00:12:08,310 Speaker 3: terms of what actually moves the needle? 212 00:12:08,809 --> 00:12:12,400 Speaker 2: Great question. And that's a question that my co-authors and 213 00:12:12,559 --> 00:12:15,700 Speaker 2: I thought a lot about. I think, you know, just 214 00:12:15,740 --> 00:12:20,160 Speaker 2: having measurement is extremely useful, whichever approach you choose, right? 215 00:12:20,220 --> 00:12:24,370 Speaker 2: So in order, picking a framework or picking a communication strategy, 216 00:12:24,380 --> 00:12:28,090 Speaker 2: evaluating it, I think is very important. So now what 217 00:12:28,110 --> 00:12:30,890 Speaker 2: we looked at in terms of what moves the needle 218 00:12:31,010 --> 00:12:34,810 Speaker 2: on the perceived reaction function, let me take you back 219 00:12:34,910 --> 00:12:37,410 Speaker 2: to 2020. It was not a good time for any 220 00:12:37,450 --> 00:12:41,410 Speaker 2: of us, but so that was the time of the pandemic. 221 00:12:41,490 --> 00:12:47,620 Speaker 2: Initially inflation was extremely low and in 2021 inflation then 222 00:12:47,679 --> 00:12:51,339 Speaker 2: picked up and there were some of these really big 223 00:12:51,580 --> 00:12:56,240 Speaker 2: positive inflation surprises. And that was also the time where 224 00:12:56,260 --> 00:13:00,040 Speaker 2: there was the discussion of, you know, is inflation permanent? 225 00:13:00,120 --> 00:13:02,460 Speaker 2: Is it transitory? The T word. 226 00:13:02,820 --> 00:13:04,320 Speaker 3: We need to get a transitory clock. 227 00:13:04,340 --> 00:13:05,350 Speaker 2: Yeah, yeah. Foreign. 228 00:13:05,370 --> 00:13:05,750 Speaker 3: Yeah. 229 00:13:06,590 --> 00:13:09,829 Speaker 2: The Fed initially just kept interest rates at zero. It 230 00:13:09,870 --> 00:13:13,290 Speaker 2: was also the time when there was this now old 231 00:13:13,309 --> 00:13:16,010 Speaker 2: new framework of average inflation targeting in 2021. 232 00:13:15,990 --> 00:13:16,150 Speaker 3: Yeah. 233 00:13:20,300 --> 00:13:23,959 Speaker 2: So the interest rates stayed at zero for quite a while, 234 00:13:24,040 --> 00:13:31,540 Speaker 2: even though inflation was running at 5%, 6%. And the 235 00:13:31,590 --> 00:13:35,190 Speaker 2: perceived reaction function that we saw at that time was 236 00:13:35,910 --> 00:13:41,370 Speaker 2: extremely flat. So there was a perception that the policy 237 00:13:41,429 --> 00:13:47,949 Speaker 2: rate would stay at zero pretty much irrespective of economic conditions. 238 00:13:48,110 --> 00:13:52,400 Speaker 2: And you saw that, for example... In May 2021, that 239 00:13:52,460 --> 00:13:57,030 Speaker 2: was a particularly positive inflation surprise. That was an inflation 240 00:13:57,090 --> 00:14:01,610 Speaker 2: surprise of almost half a percent. So annualized, the surprise 241 00:14:01,650 --> 00:14:06,890 Speaker 2: component was 6%. That's huge. And the two-year rate didn't move, 242 00:14:07,350 --> 00:14:10,470 Speaker 2: not at all. And you also saw that in the forecasts, 243 00:14:10,510 --> 00:14:13,750 Speaker 2: which were all very, very close to zero. And that 244 00:14:13,790 --> 00:14:17,089 Speaker 2: was true for the forecasters who had higher inflation expectations. 245 00:14:17,130 --> 00:14:20,010 Speaker 2: That was true for the ones who had lower inflation expectations. 246 00:14:20,440 --> 00:14:22,120 Speaker 2: So that's a little bit the nice thing about our 247 00:14:22,140 --> 00:14:25,080 Speaker 2: data set, because, of course, there was a very big 248 00:14:26,100 --> 00:14:29,160 Speaker 2: good ship transitory, as Powell called it at some point 249 00:14:29,240 --> 00:14:32,870 Speaker 2: at the time. A lot of people thought inflation was transitory, 250 00:14:33,650 --> 00:14:37,490 Speaker 2: but not everyone. And by looking at this set of 251 00:14:37,550 --> 00:14:40,770 Speaker 2: different forecasters, we can also see the ones who thought 252 00:14:40,790 --> 00:14:44,850 Speaker 2: that inflation would be higher. And all of them expected 253 00:14:44,890 --> 00:14:45,770 Speaker 2: zero interest rates. 254 00:14:46,050 --> 00:14:46,200 Speaker 3: Hmm. 255 00:14:46,680 --> 00:14:49,700 Speaker 2: And that I think is quite telling about, you know, 256 00:14:49,720 --> 00:14:54,240 Speaker 2: the response that was anticipated at the time. And so then, 257 00:14:54,280 --> 00:14:57,440 Speaker 2: you know, towards the end of 2021, the tone started 258 00:14:57,460 --> 00:15:01,180 Speaker 2: to change and March 2022 was liftoff. At first, just 259 00:15:01,180 --> 00:15:04,180 Speaker 2: 25 basis points. And then we saw these really, really 260 00:15:04,330 --> 00:15:08,690 Speaker 2: big interest rate hikes repeatedly. And so after the Fed 261 00:15:08,750 --> 00:15:11,870 Speaker 2: started to act, that's when in our data, we see 262 00:15:11,930 --> 00:15:16,850 Speaker 2: that the perceived inflation response really picks up. It basically 263 00:15:16,890 --> 00:15:23,670 Speaker 2: goes from zero to one between, say, early 2022 towards 264 00:15:23,740 --> 00:15:27,680 Speaker 2: the end of 2023. So there was a very big 265 00:15:27,820 --> 00:15:33,120 Speaker 2: increase in the perceived inflation response, but it occurred late 266 00:15:33,320 --> 00:15:35,580 Speaker 2: and only after the Fed had started to act. So 267 00:15:35,720 --> 00:15:37,760 Speaker 2: we call that the learning from actions channel. 268 00:15:54,270 --> 00:15:58,560 Speaker 1: In a dream country that actually executes perfect monetary policy 269 00:15:59,000 --> 00:16:03,360 Speaker 1: all the time, does it have a perfectly stable reaction 270 00:16:03,420 --> 00:16:04,560 Speaker 1: function in central bank? 271 00:16:05,640 --> 00:16:09,460 Speaker 2: That's a good question. And that goes back to, I think, 272 00:16:09,500 --> 00:16:13,370 Speaker 2: the difference between a monetary policy rule and a reaction function. 273 00:16:13,830 --> 00:16:17,750 Speaker 2: I don't think it has to be stable. It doesn't 274 00:16:17,790 --> 00:16:21,390 Speaker 2: have to be perfectly stable over time. It also goes 275 00:16:21,450 --> 00:16:26,580 Speaker 2: back to this much older discussion about rules versus discretion, right? 276 00:16:26,630 --> 00:16:30,500 Speaker 2: If it was just a mechanical rule, then, you know, 277 00:16:31,380 --> 00:16:35,460 Speaker 2: why are central banks needed at all? So there is, 278 00:16:35,660 --> 00:16:38,620 Speaker 2: you know, conditions change. I don't think it needs to 279 00:16:38,660 --> 00:16:42,800 Speaker 2: be stable. And, you know, the appropriate reaction may be 280 00:16:42,840 --> 00:16:46,460 Speaker 2: different at different points in time. Actually, what we see 281 00:16:46,500 --> 00:16:50,070 Speaker 2: in our data, we do a very simple exploration. We 282 00:16:50,110 --> 00:16:55,020 Speaker 2: have an earlier paper in the Quarterly Journal of Economics, 283 00:16:55,180 --> 00:16:59,230 Speaker 2: also with Michael and Adi, where we look at a 284 00:16:59,300 --> 00:17:04,609 Speaker 2: longer time series of the perceived reaction to output. And 285 00:17:04,670 --> 00:17:08,050 Speaker 2: we see that it varies over time and we try 286 00:17:08,109 --> 00:17:12,090 Speaker 2: to systematize a little bit. When is this perceived reaction 287 00:17:12,130 --> 00:17:15,570 Speaker 2: to output steep? When is it flat? And what we 288 00:17:15,710 --> 00:17:21,010 Speaker 2: find is that it tends to be steeper during tightening cycles. 289 00:17:21,210 --> 00:17:24,970 Speaker 2: So that's when Chairs Bernanke or Yellen would have said, 290 00:17:25,350 --> 00:17:27,970 Speaker 2: we're going to be quite data dependent. And you see 291 00:17:28,020 --> 00:17:30,800 Speaker 2: that in the data in that there is a stronger 292 00:17:30,859 --> 00:17:36,760 Speaker 2: perceived response to output, whereas easings are often sudden and 293 00:17:37,300 --> 00:17:40,010 Speaker 2: then not much else is expected. So that tends to 294 00:17:40,030 --> 00:17:44,310 Speaker 2: be a time when the perceived policy reaction becomes flatter. 295 00:17:45,130 --> 00:17:50,429 Speaker 3: So if the market's perceived reaction function moves the most 296 00:17:50,590 --> 00:17:54,370 Speaker 3: when a central bank is actually doing something, so they're 297 00:17:54,410 --> 00:17:57,889 Speaker 3: taking an action rather than perhaps just talking about it, 298 00:17:58,490 --> 00:18:01,510 Speaker 3: what happens if a central bank wants to be gradual 299 00:18:02,090 --> 00:18:04,810 Speaker 3: in terms of raising rates? Because we all remember 2022, 300 00:18:04,810 --> 00:18:09,510 Speaker 3: the big liftoff, that was a pretty painful time for markets. 301 00:18:10,310 --> 00:18:14,570 Speaker 3: Is there just an accepted trade-off here where maybe... you 302 00:18:14,609 --> 00:18:17,359 Speaker 3: have to show the market that you're serious about inflation 303 00:18:17,450 --> 00:18:21,230 Speaker 3: by actually doing something. And that helps the market change 304 00:18:21,600 --> 00:18:25,879 Speaker 3: its perceived market function or its perceived policy function. And 305 00:18:25,920 --> 00:18:30,160 Speaker 3: then that helps with actually fighting inflation. But the offset 306 00:18:30,240 --> 00:18:33,639 Speaker 3: or the trade-off is that, you know, stocks are going 307 00:18:33,660 --> 00:18:36,160 Speaker 3: to go down or there might be financial stability issues 308 00:18:36,200 --> 00:18:36,980 Speaker 3: or something like that. 309 00:18:38,220 --> 00:18:42,160 Speaker 2: Yes, that's very interesting. That gets me to a different 310 00:18:43,270 --> 00:18:47,610 Speaker 2: branch of my research, which is, um, which is about 311 00:18:48,590 --> 00:18:51,930 Speaker 2: the risks in treasury bond markets. You know, I have, 312 00:18:52,050 --> 00:18:54,930 Speaker 2: I've worked on that, uh, for a long time going 313 00:18:54,990 --> 00:19:00,240 Speaker 2: back and a fact that you may be aware of, 314 00:19:00,310 --> 00:19:03,430 Speaker 2: but many people aren't is that treasury bonds were not 315 00:19:03,490 --> 00:19:09,410 Speaker 2: always safe historically. So there were periods, especially during the seventies, 316 00:19:09,790 --> 00:19:14,800 Speaker 2: eighties and nineties when Treasury bonds were viewed as quite risky. 317 00:19:14,840 --> 00:19:17,859 Speaker 2: That was the period of bond market vigilantes, the inflation 318 00:19:17,900 --> 00:19:22,020 Speaker 2: risk premium. And the way I measure that in the 319 00:19:22,060 --> 00:19:30,270 Speaker 2: data is through the co-movement between bonds and stocks. So pre-2000, 320 00:19:30,430 --> 00:19:33,389 Speaker 2: treasury bonds were actually quite stock-like, if you will, in 321 00:19:33,410 --> 00:19:37,090 Speaker 2: their correlation with the bond market. And that's a recent 322 00:19:37,250 --> 00:19:42,580 Speaker 2: paper with John Campbell and Luis Becerra at Harvard. Now, post-2000, 323 00:19:42,640 --> 00:19:47,090 Speaker 2: treasury bonds were safe in the sense that they had 324 00:19:47,109 --> 00:19:50,850 Speaker 2: a negative correlation with the stock market. And then in 325 00:19:50,869 --> 00:19:54,010 Speaker 2: the most recent period, these types of bond risks have 326 00:19:54,050 --> 00:19:57,760 Speaker 2: gone up again. There are many ways, many reasons to 327 00:19:57,840 --> 00:20:01,639 Speaker 2: care about this type of bond risk. Most simply, if 328 00:20:01,660 --> 00:20:06,140 Speaker 2: you're holding a portfolio that contains bond and stocks, having 329 00:20:06,180 --> 00:20:10,060 Speaker 2: a positive correlation means that there is nowhere to hide. Right. 330 00:20:10,650 --> 00:20:12,990 Speaker 3: Another reason why 2022 was so painful. 331 00:20:13,369 --> 00:20:16,640 Speaker 2: That's right. And I think that is connected to monetary policy. 332 00:20:16,740 --> 00:20:20,540 Speaker 2: So in the research that I've done on that, you know, 333 00:20:20,560 --> 00:20:23,300 Speaker 2: I've asked what has changed in these bond risks? Is 334 00:20:23,359 --> 00:20:27,540 Speaker 2: it nominal? Is it real? Why has it changed? Can 335 00:20:27,580 --> 00:20:32,100 Speaker 2: we attribute it to deeper forces, the nature of shocks, 336 00:20:32,300 --> 00:20:36,169 Speaker 2: luck versus policy? And what does it mean for yields 337 00:20:36,210 --> 00:20:39,790 Speaker 2: going forward? Or not necessarily going forward, but just what 338 00:20:39,830 --> 00:20:43,630 Speaker 2: does it mean for yields? What I've found in this 339 00:20:43,690 --> 00:20:50,160 Speaker 2: research is that the inflation component in nominal bonds plays 340 00:20:50,200 --> 00:20:55,960 Speaker 2: an important role. That's a very natural decomposition. So the 341 00:20:56,180 --> 00:21:00,920 Speaker 2: US Treasury issues regular nominal bonds, which pay $ 100 10 342 00:21:00,920 --> 00:21:04,070 Speaker 2: years in the future. And then it also issues bonds 343 00:21:04,160 --> 00:21:09,670 Speaker 2: that pay $ 100 increased by the inflation index 10 years 344 00:21:09,710 --> 00:21:11,870 Speaker 2: in the future. And that means if you hold these 345 00:21:12,490 --> 00:21:15,750 Speaker 2: inflation index bonds or tips, you don't really need to 346 00:21:15,830 --> 00:21:19,320 Speaker 2: fear inflation. Whereas when you hold nominal bonds, that's of 347 00:21:19,380 --> 00:21:24,180 Speaker 2: course exposed. And so if you look over time, the 348 00:21:25,580 --> 00:21:30,540 Speaker 2: bond risks were so positive in the pre 2000 period. 349 00:21:30,640 --> 00:21:32,639 Speaker 2: And for that, actually, I need to go to UK 350 00:21:32,660 --> 00:21:35,440 Speaker 2: data because they've had inflation linked bonds for much longer. 351 00:21:36,520 --> 00:21:39,240 Speaker 2: But in this UK data, you see that a big 352 00:21:39,380 --> 00:21:42,800 Speaker 2: chunk of these bond risks were on the inflation side. 353 00:21:43,760 --> 00:21:48,140 Speaker 2: And then post 2000, the inflation component became much smaller 354 00:21:48,200 --> 00:21:51,679 Speaker 2: and both the nominal and the real treasury bond risks 355 00:21:52,160 --> 00:21:55,720 Speaker 2: were negative. And then most recently, actually, the increase in 356 00:21:55,770 --> 00:22:00,730 Speaker 2: bond risks has some similarities and some differences compared to 357 00:22:00,930 --> 00:22:04,470 Speaker 2: the 1980s. The similarity is that bonds and stocks have 358 00:22:04,520 --> 00:22:07,639 Speaker 2: moved together often when we see treasury bond yields going up, 359 00:22:07,780 --> 00:22:12,300 Speaker 2: the stock market tanks. But the difference is, A, it's 360 00:22:12,340 --> 00:22:15,100 Speaker 2: not as big. We're not back to the 1980s yet, 361 00:22:15,200 --> 00:22:18,720 Speaker 2: at least according to my data. The other difference is 362 00:22:18,880 --> 00:22:22,530 Speaker 2: that a good chunk of it most recently has been 363 00:22:23,250 --> 00:22:25,990 Speaker 2: in the index bonds. So it's not necessarily about the 364 00:22:26,030 --> 00:22:30,570 Speaker 2: inflation component in the same way. So I think to 365 00:22:30,630 --> 00:22:35,430 Speaker 2: understand the change from the pre-2000 to post-2000, an important 366 00:22:35,530 --> 00:22:41,290 Speaker 2: component is the inflation part. Why is that? Well, in 367 00:22:41,310 --> 00:22:45,700 Speaker 2: the 1980s, stagflation was the thing that everyone was talking about. 368 00:22:46,240 --> 00:22:48,720 Speaker 2: If you have a stagflation and you hold nominal bonds, 369 00:22:48,840 --> 00:22:52,619 Speaker 2: that's terrible because they become worth less. The recession is 370 00:22:52,660 --> 00:22:55,260 Speaker 2: terrible for stocks, so then they move together and bonds 371 00:22:55,320 --> 00:22:59,939 Speaker 2: are risky. Post-2000, recessions tended to be more of the 372 00:22:59,980 --> 00:23:04,609 Speaker 2: demand variety, which means also that recessions tended to be 373 00:23:04,660 --> 00:23:10,369 Speaker 2: lower inflation, and so nominal bonds benefit from low inflation. 374 00:23:11,530 --> 00:23:15,050 Speaker 2: And so then in some of my work with John 375 00:23:15,090 --> 00:23:18,490 Speaker 2: and Luis, we have shown that this can explain why 376 00:23:18,820 --> 00:23:23,340 Speaker 2: treasury bond risks changed around 2000. What the interesting question 377 00:23:23,380 --> 00:23:26,090 Speaker 2: is that still remains is, Is, of course, you know, 378 00:23:26,150 --> 00:23:27,959 Speaker 2: is it luck? You know, is this just if we 379 00:23:28,200 --> 00:23:30,699 Speaker 2: experience supply shocks, is everything going to go back to 380 00:23:30,720 --> 00:23:34,960 Speaker 2: the 1980s? Or is there also a degree of policy 381 00:23:35,020 --> 00:23:38,790 Speaker 2: to it? So I have then, you know, lots of 382 00:23:38,890 --> 00:23:42,270 Speaker 2: models and so on. But, you know, the punchline is 383 00:23:42,470 --> 00:23:47,290 Speaker 2: that it really requires a perfect storm to go back 384 00:23:47,410 --> 00:23:52,619 Speaker 2: to the 1980s risky bond markets. It requires the inflationary shocks. 385 00:23:53,060 --> 00:23:56,899 Speaker 2: Let's say supply shocks. The typical one would be oil 386 00:23:56,960 --> 00:24:01,290 Speaker 2: price shocks, or it could also be fiscal sort of 387 00:24:01,350 --> 00:24:06,490 Speaker 2: lack of credibility, inflation expectations that start moving. So you 388 00:24:06,530 --> 00:24:09,409 Speaker 2: need these type of inflationary shocks and you need a 389 00:24:09,450 --> 00:24:15,409 Speaker 2: Fed that's willing or forced to accept a recession when 390 00:24:15,450 --> 00:24:18,649 Speaker 2: these shocks happen. And I think that has been a 391 00:24:18,670 --> 00:24:23,590 Speaker 2: little bit different in the past five years, uh, from, 392 00:24:23,770 --> 00:24:26,970 Speaker 2: from the 1980s in the sense that, uh, the fed 393 00:24:27,030 --> 00:24:30,380 Speaker 2: has been able to move more gradually. So that's the big, 394 00:24:30,470 --> 00:24:33,180 Speaker 2: that's really, I think of it as two big differences 395 00:24:33,240 --> 00:24:37,840 Speaker 2: that happened around 2000. One is the supply shocks changed 396 00:24:37,900 --> 00:24:42,679 Speaker 2: to demand shocks, but of course, monetary policy also gained 397 00:24:42,740 --> 00:24:45,060 Speaker 2: a lot of credibility. And the way that shows up 398 00:24:45,220 --> 00:24:48,360 Speaker 2: in my data is as a more gradual inertial monetary 399 00:24:48,400 --> 00:24:52,949 Speaker 2: policy rule. And that has the advantage that when supply 400 00:24:52,990 --> 00:24:56,520 Speaker 2: shocks happen, a more gradual rule may be able to 401 00:24:57,230 --> 00:25:00,200 Speaker 2: stick a soft landing. And if that's getting priced in, 402 00:25:00,260 --> 00:25:02,780 Speaker 2: it means that stocks don't need to fall at the 403 00:25:02,820 --> 00:25:05,000 Speaker 2: same time as the bond market. 404 00:25:05,840 --> 00:25:09,700 Speaker 1: Let's talk about, because you mentioned perfect storm, you mentioned 405 00:25:09,920 --> 00:25:13,360 Speaker 1: oil price shocks. People look, we said at the beginning, 406 00:25:13,680 --> 00:25:17,679 Speaker 1: there are so many backdrops to this conversation. When you 407 00:25:17,700 --> 00:25:21,410 Speaker 1: look at the interest rates, uh, where the 30 year 408 00:25:21,430 --> 00:25:25,550 Speaker 1: is right now. What do you, like, how do you decompose, um, 409 00:25:25,910 --> 00:25:29,310 Speaker 1: the factors just driving, uh, either in the last few 410 00:25:29,330 --> 00:25:31,889 Speaker 1: years or even on the last few months or even weeks? 411 00:25:32,790 --> 00:25:35,520 Speaker 2: Great. Um, so let me, let me take a slightly 412 00:25:35,560 --> 00:25:40,300 Speaker 2: bigger perspective because as academics, we have the, we have 413 00:25:40,340 --> 00:25:43,200 Speaker 2: the luxury of, uh, looking at longer data, but hopefully 414 00:25:43,240 --> 00:25:46,310 Speaker 2: this is useful. So if I look at the past 415 00:25:46,400 --> 00:25:51,230 Speaker 2: five years, um, what has changed, I think is that 416 00:25:51,330 --> 00:25:55,050 Speaker 2: treasury bonds have become a lot riskier. That's the bond 417 00:25:55,090 --> 00:25:57,470 Speaker 2: stock movement that I just talked about that has gone 418 00:25:57,530 --> 00:26:02,330 Speaker 2: up a lot. And if you think about any sort 419 00:26:02,369 --> 00:26:07,830 Speaker 2: of basic investment logic, if an asset is risky, investors 420 00:26:07,869 --> 00:26:09,970 Speaker 2: should not be willing to pay as much for it 421 00:26:10,350 --> 00:26:15,070 Speaker 2: or said differently. Investors should require a higher return to 422 00:26:15,130 --> 00:26:19,290 Speaker 2: compensate for holding this risk. And so because these risks 423 00:26:19,330 --> 00:26:22,330 Speaker 2: have gone up so much, that should really drive up 424 00:26:22,930 --> 00:26:25,990 Speaker 2: the yield or drive down the price on bonds because 425 00:26:26,030 --> 00:26:30,190 Speaker 2: they move inversely. And so that's something that I have 426 00:26:30,230 --> 00:26:35,770 Speaker 2: been working on with. from Boston College and Adi Sundaram 427 00:26:35,810 --> 00:26:40,470 Speaker 2: from HBS, we have asked, are these changing bond risks? 428 00:26:40,670 --> 00:26:44,190 Speaker 2: Are they priced in? Can they help us explain some 429 00:26:44,230 --> 00:26:47,840 Speaker 2: of these big trends in bond yields? The 10-year yield 430 00:26:47,859 --> 00:26:51,380 Speaker 2: was at 11.5% in the 80s. Hard to imagine, no? 431 00:26:52,160 --> 00:26:55,639 Speaker 2: And it came down a lot towards the 2010s. And 432 00:26:55,660 --> 00:27:00,600 Speaker 2: then we've seen this very substantial reversal recently. And what 433 00:27:00,640 --> 00:27:06,810 Speaker 2: we find is that the expected return that's priced in 434 00:27:07,250 --> 00:27:12,130 Speaker 2: bond markets actually moves quite closely with bond stock cool 435 00:27:12,150 --> 00:27:16,670 Speaker 2: movements in the data. Now you might think that's really simple, 436 00:27:16,710 --> 00:27:19,280 Speaker 2: you know, why wouldn't we know that already? And the 437 00:27:19,340 --> 00:27:22,700 Speaker 2: tricky thing is that at the same time, of course, 438 00:27:23,340 --> 00:27:25,420 Speaker 2: a lot of other things changed in the bond market. 439 00:27:25,460 --> 00:27:30,619 Speaker 2: Inflation came down. And when studying bond markets, really, we 440 00:27:30,680 --> 00:27:34,889 Speaker 2: don't have that many not as much of a cross section. 441 00:27:34,930 --> 00:27:38,910 Speaker 2: We don't have as many different assets as if we're, say, asking, 442 00:27:38,930 --> 00:27:42,930 Speaker 2: you know, how is one stock price versus another? So 443 00:27:43,020 --> 00:27:45,740 Speaker 2: that in this kind of these big time trends can 444 00:27:45,800 --> 00:27:49,960 Speaker 2: lead to forecast errors and surprises. So that realized returns 445 00:27:50,400 --> 00:27:55,080 Speaker 2: can sometimes look very different from expected returns. Anyway, so 446 00:27:55,480 --> 00:28:00,880 Speaker 2: if we take advantage of similar forecast data to what 447 00:28:00,940 --> 00:28:04,380 Speaker 2: I talked about earlier, And we just say, well, what's 448 00:28:04,420 --> 00:28:07,730 Speaker 2: the return that you would expect on, say, a 10-year 449 00:28:07,750 --> 00:28:11,429 Speaker 2: treasury bond if the yield next year turns out to 450 00:28:11,450 --> 00:28:16,340 Speaker 2: hit exactly what informed forecasters were expecting it to be? 451 00:28:17,369 --> 00:28:19,270 Speaker 2: And once you do that, so you take out some 452 00:28:19,310 --> 00:28:23,389 Speaker 2: of this forecast error component, the relationship with bond stock 453 00:28:23,410 --> 00:28:26,840 Speaker 2: movements is really striking. It's there for the U.S. It's 454 00:28:26,880 --> 00:28:30,520 Speaker 2: across bond maturities. You can even see it across different 455 00:28:30,660 --> 00:28:37,010 Speaker 2: developed markets, which had pretty different experiences sometimes. So there's 456 00:28:37,130 --> 00:28:41,270 Speaker 2: pretty clear evidence that markets require a higher return when 457 00:28:41,310 --> 00:28:43,610 Speaker 2: bonds are risky. And so we. 458 00:28:45,230 --> 00:28:48,270 Speaker 2: Once we quantify that a little bit, and I'll call 459 00:28:48,310 --> 00:28:52,110 Speaker 2: it a back of the envelope calculation, what we find 460 00:28:52,150 --> 00:28:56,650 Speaker 2: is that roughly maybe a quarter of the decline between 461 00:28:56,690 --> 00:29:01,490 Speaker 2: the mid-80s and 2010s in the 10-year yield was due 462 00:29:01,580 --> 00:29:05,080 Speaker 2: to treasury bonds becoming better hedges. The other part being, 463 00:29:05,760 --> 00:29:09,680 Speaker 2: among other things, inflation expectations went down. But over the 464 00:29:09,740 --> 00:29:14,320 Speaker 2: past five years, or let's call it 2020 through 2025, 465 00:29:15,260 --> 00:29:19,820 Speaker 2: The increase in the 10-year yield was really, the majority was, 466 00:29:21,040 --> 00:29:27,459 Speaker 2: you can explain with changes in bonds becoming more stock-like. And, 467 00:29:27,580 --> 00:29:32,110 Speaker 2: you know, of course, inflation expectations over the past five, six, 468 00:29:32,150 --> 00:29:37,210 Speaker 2: seven years have been quite stable. We experienced high inflation, 469 00:29:37,310 --> 00:29:41,540 Speaker 2: but if you look at long-term inflation expectations, they're quite stable. 470 00:29:41,600 --> 00:29:43,890 Speaker 2: And I think that's the other side of the coin, 471 00:29:43,950 --> 00:29:49,090 Speaker 2: that bond yields going up then reflect increasing risks and 472 00:29:49,150 --> 00:29:51,780 Speaker 2: increasing required compensation for risks. 473 00:30:08,300 --> 00:30:12,520 Speaker 3: How do we make bonds more bond-like again? Because if 474 00:30:12,580 --> 00:30:16,820 Speaker 3: you think that what's driving yields is just investors asking 475 00:30:16,840 --> 00:30:19,900 Speaker 3: for more compensation because the debt is perceived to be 476 00:30:20,000 --> 00:30:23,540 Speaker 3: riskier than it has been previously, it feels like we 477 00:30:23,580 --> 00:30:26,800 Speaker 3: need to return to a state where bonds could serve 478 00:30:27,160 --> 00:30:30,920 Speaker 3: that hedging role or at least not be perceived to 479 00:30:30,980 --> 00:30:34,720 Speaker 3: be as volatile or stock-like as you described. 480 00:30:35,120 --> 00:30:40,510 Speaker 2: I'd like to decompose that into... luck versus policy. If 481 00:30:40,530 --> 00:30:43,890 Speaker 2: you remember in the 1990s, during the great moderation, people 482 00:30:43,950 --> 00:30:48,200 Speaker 2: were discussing, economists were discussing, was this luck or was 483 00:30:48,240 --> 00:30:50,960 Speaker 2: this policy? And I think one can similarly think about 484 00:30:50,980 --> 00:30:55,680 Speaker 2: that here. There is certainly an element of luck here. 485 00:30:56,380 --> 00:31:00,610 Speaker 2: The nature of the shocks hitting the economy, you know, 486 00:31:00,630 --> 00:31:06,410 Speaker 2: that changes. And then there is the element of monetary policy, 487 00:31:06,470 --> 00:31:10,450 Speaker 2: which As I mentioned before, having a more gradual approach 488 00:31:10,790 --> 00:31:17,360 Speaker 2: to monetary policy priced in helps in keeping the bonds bond-like. Now, 489 00:31:17,820 --> 00:31:20,780 Speaker 2: what is needed in the background for this gradual approach 490 00:31:20,940 --> 00:31:24,560 Speaker 2: is probably something that one would call central bank credibility. 491 00:31:25,850 --> 00:31:30,350 Speaker 2: If the trust is there that eventually the central bank 492 00:31:30,390 --> 00:31:33,590 Speaker 2: will do what is needed, then that's something that would, 493 00:31:34,390 --> 00:31:36,430 Speaker 2: you know, in my models is something that can keep 494 00:31:36,470 --> 00:31:37,310 Speaker 2: the bonds bond-like. 495 00:31:37,750 --> 00:31:44,180 Speaker 1: So that's interesting because you mentioned at least market-based measures 496 00:31:44,300 --> 00:31:49,700 Speaker 1: of inflation expectations or break-evens. They have been pretty stable. 497 00:31:50,320 --> 00:31:53,280 Speaker 1: So two things that call us to mind. First of all, 498 00:31:53,360 --> 00:31:55,180 Speaker 1: I'm curious if you have a theory for why. Because 499 00:31:55,220 --> 00:31:57,640 Speaker 1: if you have a central bank that's now missed its 500 00:31:58,000 --> 00:32:01,790 Speaker 1: inflation target for five years, more or less, at this point, 501 00:32:02,420 --> 00:32:08,610 Speaker 1: is it surprising that... that the market has not said, 502 00:32:08,650 --> 00:32:10,850 Speaker 1: you know what, over the next 10 years, I do 503 00:32:10,930 --> 00:32:13,520 Speaker 1: not feel as confident that the Fed will hit its 504 00:32:13,580 --> 00:32:16,700 Speaker 1: inflation target as I used to, because I've already seen 505 00:32:16,720 --> 00:32:19,400 Speaker 1: that you could go five years and it's not there. 506 00:32:19,880 --> 00:32:23,860 Speaker 1: And then B, to my mind, if it is, doesn't 507 00:32:23,900 --> 00:32:27,750 Speaker 1: that imply that actually the Fed is still seen as 508 00:32:27,830 --> 00:32:31,490 Speaker 1: quite credible for all of their misses? If already the 509 00:32:31,530 --> 00:32:35,710 Speaker 1: market is pricing in stable inflation, not very high above target, 510 00:32:36,230 --> 00:32:39,730 Speaker 1: then why shouldn't we just surmise that, okay, the Fed 511 00:32:39,770 --> 00:32:41,150 Speaker 1: is perceived as quite credible? 512 00:32:42,470 --> 00:32:46,130 Speaker 2: Yes, that's interesting. So I'm not an expert on how 513 00:32:46,190 --> 00:32:51,800 Speaker 2: inflation expectations are formed. My colleague at Chicago, Stefan Nagel, 514 00:32:51,820 --> 00:32:55,520 Speaker 2: has some really interesting work on that. He has really 515 00:32:55,540 --> 00:33:01,020 Speaker 2: interesting things, work on that. Now, what I think we 516 00:33:01,060 --> 00:33:04,660 Speaker 2: do see is that the point estimate, the level of 517 00:33:04,740 --> 00:33:10,170 Speaker 2: the long-term inflation expectations has remained relatively stable. But at 518 00:33:10,190 --> 00:33:14,550 Speaker 2: the same time, we have seen more volatility and we 519 00:33:14,590 --> 00:33:19,310 Speaker 2: have seen a de-linking between the nominal and the real bonds. 520 00:33:19,550 --> 00:33:24,120 Speaker 2: So before 2000, if you were looking at nominal 10-year 521 00:33:24,160 --> 00:33:30,380 Speaker 2: treasuries versus the inflation index bonds, the correlation was very 522 00:33:30,460 --> 00:33:34,290 Speaker 2: high because no one was really thinking about inflation, but 523 00:33:34,330 --> 00:33:39,690 Speaker 2: that correlation has changed. So even though on average, I 524 00:33:39,750 --> 00:33:44,940 Speaker 2: think the inflation, the average long-term inflation that's priced in 525 00:33:44,980 --> 00:33:48,380 Speaker 2: looks very stable, you know, we have seen changes that 526 00:33:48,460 --> 00:33:53,780 Speaker 2: are probably related to more uncertainty. And that's something that 527 00:33:53,820 --> 00:33:56,640 Speaker 2: also in my 1980s paper, for example, I asked, you know, 528 00:33:56,680 --> 00:34:01,990 Speaker 2: what's the counterfactual that explains best the bond market's the 529 00:34:02,030 --> 00:34:06,810 Speaker 2: bond risks in 2021, 2022. And the answer was a 530 00:34:06,970 --> 00:34:14,210 Speaker 2: combination of 1980s supply style shocks combined with a more 531 00:34:14,270 --> 00:34:18,690 Speaker 2: inertial monetary policy like in the 2000s. And so that's 532 00:34:18,750 --> 00:34:24,489 Speaker 2: something that generates more inflationary shocks, but the response of 533 00:34:24,800 --> 00:34:29,000 Speaker 2: real rates and nominal rates is different because the monetary 534 00:34:29,040 --> 00:34:31,220 Speaker 2: policy that's priced in is a little more inertial. 535 00:34:31,600 --> 00:34:34,660 Speaker 3: I don't know if you've done any specific research on 536 00:34:34,719 --> 00:34:39,010 Speaker 3: this per se, but we started out talking about various megatrends, 537 00:34:39,140 --> 00:34:41,609 Speaker 3: of which there are many. And maybe one of them 538 00:34:41,650 --> 00:34:45,090 Speaker 3: we didn't mention is that the holders of U.S. debt 539 00:34:45,310 --> 00:34:49,010 Speaker 3: has changed very dramatically in recent years. So, for instance, 540 00:34:49,050 --> 00:34:52,010 Speaker 3: you have a lot more hedge funds present in the market. 541 00:34:52,410 --> 00:34:55,860 Speaker 3: Do you notice anything or do you think about the changing, 542 00:34:55,940 --> 00:34:58,560 Speaker 3: I guess, buyer base for U.S. treasuries at all and 543 00:34:58,739 --> 00:35:00,859 Speaker 3: how it might relate to some of your work? 544 00:35:01,950 --> 00:35:06,330 Speaker 2: So the buyer base is certainly interesting. It's not really 545 00:35:06,370 --> 00:35:11,560 Speaker 2: what my research is about. What I can say is 546 00:35:11,620 --> 00:35:15,500 Speaker 2: that if you think about changing bond yields, right, so 547 00:35:15,860 --> 00:35:18,379 Speaker 2: there has been, there was for a long time, there 548 00:35:18,420 --> 00:35:23,020 Speaker 2: was a discussion. Is it a decline in the natural rate, 549 00:35:23,100 --> 00:35:27,150 Speaker 2: which would be productive growth? Is it a change in 550 00:35:27,830 --> 00:35:32,009 Speaker 2: the demand for scarce safe assets, or is it a 551 00:35:32,070 --> 00:35:36,950 Speaker 2: change in the safety of treasuries themselves? What I can 552 00:35:37,010 --> 00:35:41,090 Speaker 2: say is that the change in the safety of treasuries 553 00:35:41,150 --> 00:35:44,759 Speaker 2: themselves is a substantial component. That doesn't mean that the 554 00:35:44,840 --> 00:35:50,160 Speaker 2: other aspects don't matter, but there's certainly something to the 555 00:35:50,200 --> 00:35:52,200 Speaker 2: changing riskiness of treasury bonds. 556 00:35:53,070 --> 00:35:56,230 Speaker 1: So one of the things that people talk about a 557 00:35:56,310 --> 00:36:00,569 Speaker 1: lot is just like, okay, let's say we perceive the 558 00:36:00,650 --> 00:36:05,180 Speaker 1: central bank to be still fairly still credible. inflation is 559 00:36:05,219 --> 00:36:07,660 Speaker 1: going to come back down at some point, maybe a 560 00:36:08,160 --> 00:36:11,890 Speaker 1: little more volatile than we look. There are many aspects 561 00:36:12,050 --> 00:36:16,670 Speaker 1: of the U.S. policymaking apparatus that I would say we 562 00:36:16,710 --> 00:36:21,810 Speaker 1: could neutrally describe as volatile, right? So we obviously have 563 00:36:22,130 --> 00:36:25,469 Speaker 1: a very volatile tariff schedule that has changed a lot 564 00:36:25,890 --> 00:36:28,489 Speaker 1: over the last year and a half. There are two 565 00:36:28,550 --> 00:36:32,750 Speaker 1: wars going on, and particularly the war in Iran specifically. 566 00:36:34,469 --> 00:36:37,379 Speaker 1: There's at least a few different, there's all the spending 567 00:36:37,410 --> 00:36:40,140 Speaker 1: associated with it. There's the shock to the price of oil. 568 00:36:40,480 --> 00:36:43,239 Speaker 1: And then there's the question of whether the U S 569 00:36:43,300 --> 00:36:46,940 Speaker 1: is even, uh, has a powerful enough military to win 570 00:36:46,960 --> 00:36:50,620 Speaker 1: a war if it wanted and actually recapture the straight. 571 00:36:50,980 --> 00:36:53,779 Speaker 1: And so then you start talking about like, well, you know, 572 00:36:53,840 --> 00:36:57,620 Speaker 1: dollar hegemony and the U S is the superpower. And 573 00:36:57,680 --> 00:37:00,110 Speaker 1: that has the effect. And it's like, wait, is the 574 00:37:00,200 --> 00:37:02,770 Speaker 1: U S the superpower that we thought it was? Does 575 00:37:02,810 --> 00:37:06,410 Speaker 1: this say anything? Is it all of these questions, whether 576 00:37:06,450 --> 00:37:11,379 Speaker 1: the physical strength of the U.S. as a power and 577 00:37:11,430 --> 00:37:14,719 Speaker 1: the domestic policy volatility, how much is that part of 578 00:37:14,760 --> 00:37:16,419 Speaker 1: the story here? 579 00:37:16,560 --> 00:37:19,940 Speaker 2: Great question. Yes. So, yeah, I have done a little 580 00:37:19,960 --> 00:37:25,180 Speaker 2: bit of work thinking about the interlink between geopolitics and 581 00:37:26,100 --> 00:37:29,180 Speaker 2: the safety in bond markets. I'll say that, you know, 582 00:37:29,200 --> 00:37:32,670 Speaker 2: I find that is even a little bit broader and 583 00:37:32,690 --> 00:37:36,529 Speaker 2: a longer horizon than what I usually study. But if 584 00:37:36,550 --> 00:37:39,850 Speaker 2: you go back very far to the development of bond markets, 585 00:37:39,950 --> 00:37:44,219 Speaker 2: they were pretty closely linked to winning wars and financing wars. 586 00:37:44,410 --> 00:37:45,489 Speaker 1: Yeah. 587 00:37:46,480 --> 00:37:51,979 Speaker 2: Hamilton recognized this in his address about the public debt 588 00:37:52,040 --> 00:37:56,080 Speaker 2: in 1790, where he said, look, most countries that are 589 00:37:56,120 --> 00:37:59,240 Speaker 2: involved in a war need bond markets and the US 590 00:37:59,580 --> 00:38:02,660 Speaker 2: credit is, and I'll quote here, is the price of 591 00:38:02,900 --> 00:38:05,489 Speaker 2: our liberty. So he was very aware of that. A 592 00:38:06,670 --> 00:38:11,549 Speaker 2: famous example, or maybe the most famous example of this 593 00:38:11,590 --> 00:38:15,330 Speaker 2: would also be the UK. The UK had a functioning, 594 00:38:15,430 --> 00:38:19,009 Speaker 2: deep bond market with low borrowing rates prior to the 595 00:38:19,050 --> 00:38:22,730 Speaker 2: Napoleonic Wars, and that helped it a lot. And then 596 00:38:22,770 --> 00:38:27,660 Speaker 2: in turn, winning these wars made it the undisputed military 597 00:38:27,920 --> 00:38:31,950 Speaker 2: and financial power for several decades to come. So you 598 00:38:32,010 --> 00:38:37,169 Speaker 2: see that during this time, UK government borrowing rates were 599 00:38:37,570 --> 00:38:40,930 Speaker 2: really low and stable. And then of course, the US 600 00:38:41,160 --> 00:38:45,000 Speaker 2: in the second half of the 20th century has held 601 00:38:45,060 --> 00:38:48,900 Speaker 2: a similar position with being the militarily strongest country, having 602 00:38:48,960 --> 00:38:53,140 Speaker 2: low borrowing rates, and so on. So there's reason to 603 00:38:53,200 --> 00:38:58,040 Speaker 2: think that these two advantages, military and financial, they're interlinked. 604 00:38:59,160 --> 00:38:59,660 Speaker 2: And so. 605 00:39:01,530 --> 00:39:04,689 Speaker 2: What I've thought about with my co-author Pierre Red from 606 00:39:04,870 --> 00:39:09,410 Speaker 2: Columbia is in a model where financial markets can become 607 00:39:09,510 --> 00:39:14,940 Speaker 2: deeper and the capacity to borrow can take different levels. 608 00:39:15,060 --> 00:39:19,540 Speaker 2: How does this shape this interaction between financial markets and 609 00:39:20,719 --> 00:39:24,840 Speaker 2: the military equilibrium? And so the basic idea is that 610 00:39:26,280 --> 00:39:31,930 Speaker 2: if bond markets are really minuscule, they don't matter, right? 611 00:39:31,950 --> 00:39:35,110 Speaker 2: Whoever has an exogenous advantage, if it's a natural moat 612 00:39:35,290 --> 00:39:39,969 Speaker 2: or a mountaintop or whatever it is, that country is 613 00:39:39,989 --> 00:39:42,739 Speaker 2: going to be the safest. It's going to be able 614 00:39:42,800 --> 00:39:50,770 Speaker 2: to borrow at the capacity is a little bit higher, 615 00:39:51,989 --> 00:39:55,750 Speaker 2: something different can happen. The country that maybe starts with 616 00:39:55,790 --> 00:39:58,750 Speaker 2: an exogenous advantage may be able to save its way 617 00:39:58,810 --> 00:40:03,630 Speaker 2: little by little into having a financial and military advantage. 618 00:40:04,930 --> 00:40:09,870 Speaker 2: And in our model, there's something like a tipping point. 619 00:40:10,170 --> 00:40:12,870 Speaker 2: If the system starts out on the one side, one 620 00:40:12,910 --> 00:40:16,450 Speaker 2: hegemon keeps getting stronger and stronger. If the system starts 621 00:40:16,510 --> 00:40:19,920 Speaker 2: out on the other side, you get convergence to the 622 00:40:19,980 --> 00:40:24,860 Speaker 2: other hegemon. And then if borrowing capacity is very high, 623 00:40:25,200 --> 00:40:31,330 Speaker 2: debt-to-GDP ratios are very high, the causality, if you will, 624 00:40:31,630 --> 00:40:35,070 Speaker 2: can flow in the other direction with financial market expectations 625 00:40:36,090 --> 00:40:41,320 Speaker 2: becoming self-fulfilling. So financial markets expect that one country is safer, 626 00:40:41,500 --> 00:40:44,879 Speaker 2: they offer lower financing rates, and that allows for this 627 00:40:45,200 --> 00:40:51,400 Speaker 2: investment to happen and which makes the expectations justified. Now, 628 00:40:51,460 --> 00:40:54,540 Speaker 2: this last case we think of more as, my co-author 629 00:40:54,580 --> 00:40:57,299 Speaker 2: and I think more of as a hypothetical. It's not 630 00:40:57,360 --> 00:41:00,960 Speaker 2: necessarily what has happened, but it's kind of an interesting 631 00:41:01,000 --> 00:41:04,140 Speaker 2: thing to think about that there could be a hegemonic 632 00:41:04,180 --> 00:41:08,040 Speaker 2: transition that doesn't even involve war. It's just financial markets 633 00:41:08,680 --> 00:41:11,980 Speaker 2: deciding and pricing in their expectations. 634 00:41:12,180 --> 00:41:13,640 Speaker 3: Who is the best AI agent? 635 00:41:15,850 --> 00:41:19,890 Speaker 1: Have you seen the yield on, what do you think, 636 00:41:20,150 --> 00:41:23,200 Speaker 1: what do you think the yield on the Chinese, actually, 637 00:41:23,390 --> 00:41:25,560 Speaker 1: the Chinese 30-year bond is? 638 00:41:25,620 --> 00:41:25,900 Speaker 3: Tell me. 639 00:41:25,900 --> 00:41:26,500 Speaker 2: 2%. 640 00:41:26,500 --> 00:41:31,200 Speaker 1: Wow. So, again, you know, I'm not putting words in 641 00:41:31,219 --> 00:41:33,960 Speaker 1: the guest's mouth, but, you know, you're like talking about 642 00:41:34,540 --> 00:41:38,440 Speaker 1: people are talking about a hegemonic transformation without a war. 643 00:41:38,520 --> 00:41:41,410 Speaker 1: So we're at like 5.6. By the way, we're recording 644 00:41:41,430 --> 00:41:44,170 Speaker 1: this September 29th. Who knows what it's going to be 645 00:41:44,210 --> 00:41:46,480 Speaker 1: by the time we're listening. But yeah, the yield of 646 00:41:46,520 --> 00:41:49,419 Speaker 1: the Chinese 30-year bond, 2% right now. 647 00:41:50,110 --> 00:41:50,740 Speaker 3: That's crazy. 648 00:41:50,930 --> 00:41:51,310 Speaker 2: Yeah. 649 00:41:51,330 --> 00:41:53,229 Speaker 3: I remember there was a moment a few years ago 650 00:41:53,290 --> 00:41:55,910 Speaker 3: where a bunch of people got really into Chinese bonds, 651 00:41:55,950 --> 00:41:58,170 Speaker 3: I guess because they were added to the index. So 652 00:41:58,230 --> 00:42:01,410 Speaker 3: that would be an obvious catalyst. I wanted to go 653 00:42:01,450 --> 00:42:06,700 Speaker 3: back to the perceived policy reaction function for a second 654 00:42:06,900 --> 00:42:09,239 Speaker 3: and maybe talk about some of the recent things that 655 00:42:09,260 --> 00:42:13,920 Speaker 3: Kevin Warsh has said. So he talked about wanting markets 656 00:42:14,040 --> 00:42:17,860 Speaker 3: to be the ball, I guess. But he has also 657 00:42:18,760 --> 00:42:25,060 Speaker 3: emphasized financial conditions, which are market-driven. And there seems to 658 00:42:25,100 --> 00:42:28,980 Speaker 3: be a little bit of circularity there, I guess, where 659 00:42:29,239 --> 00:42:34,500 Speaker 3: the Fed maybe is reacting to market-driven financial conditions, but 660 00:42:34,540 --> 00:42:38,020 Speaker 3: then markets are reacting still to what they think the 661 00:42:38,080 --> 00:42:43,250 Speaker 3: Fed will do. Is there any way of disaggregating those two? 662 00:42:43,330 --> 00:42:45,670 Speaker 3: How do you get away from that reflexivity? 663 00:42:47,370 --> 00:42:52,210 Speaker 2: I can't really talk about what Warsh would say. You'd 664 00:42:52,550 --> 00:42:56,220 Speaker 2: really need to ask him yourselves. What we did try 665 00:42:56,340 --> 00:43:03,560 Speaker 2: in our estimation of the perceived reaction functions is we 666 00:43:03,640 --> 00:43:09,129 Speaker 2: tried to include something about financial conditions. We included forecasts 667 00:43:09,370 --> 00:43:13,880 Speaker 2: of the BAA, AAA spread, which get reported in the 668 00:43:13,900 --> 00:43:17,420 Speaker 2: same data set. If I remember correctly, there was a 669 00:43:17,440 --> 00:43:19,700 Speaker 2: little bit of a coefficient on that, but it didn't 670 00:43:19,719 --> 00:43:22,940 Speaker 2: really change any of the other responses. So yeah, it's 671 00:43:22,960 --> 00:43:27,280 Speaker 2: certainly a discussion whether the Fed responds to financial conditions 672 00:43:27,320 --> 00:43:30,760 Speaker 2: because they reflect the macroeconomy or whether there's something separate. 673 00:43:31,800 --> 00:43:33,950 Speaker 2: But we found that kind of in terms of the 674 00:43:34,050 --> 00:43:38,190 Speaker 2: response to the macroeconomy, it didn't really change that all 675 00:43:38,210 --> 00:43:38,529 Speaker 2: that much. 676 00:43:39,360 --> 00:43:45,339 Speaker 1: What's your view on supply as a factor in bond yields? 677 00:43:45,380 --> 00:43:47,700 Speaker 1: This is a big question. People are like, well, bond 678 00:43:47,739 --> 00:43:50,890 Speaker 1: yields are going up straightforwardly because they're issuing so many 679 00:43:50,910 --> 00:43:53,010 Speaker 1: of them. How does supply fit into your framework? 680 00:43:53,290 --> 00:43:57,229 Speaker 2: Yeah, supply is interesting. And my framework supply is very 681 00:43:57,290 --> 00:44:00,410 Speaker 2: simple in the sense that, you know, in the end, 682 00:44:00,510 --> 00:44:04,239 Speaker 2: the exposure, we're all taxpayers. And to the extent that 683 00:44:04,280 --> 00:44:07,480 Speaker 2: we're also holding bonds, it's just, you know, going from 684 00:44:07,580 --> 00:44:11,239 Speaker 2: one pocket to the other. Now, of course, the real 685 00:44:11,280 --> 00:44:13,500 Speaker 2: world is a lot more complicated. There are people who 686 00:44:13,540 --> 00:44:15,520 Speaker 2: are long bonds. There are people who are short bonds. 687 00:44:16,160 --> 00:44:19,600 Speaker 2: In the paper where we look at how are bond 688 00:44:19,640 --> 00:44:24,360 Speaker 2: stock co-movements priced, I think that's the closest that I 689 00:44:24,400 --> 00:44:28,580 Speaker 2: can come to saying how this is priced. So you 690 00:44:28,620 --> 00:44:32,279 Speaker 2: might have the idea that, well, bond markets are totally 691 00:44:32,340 --> 00:44:37,719 Speaker 2: separate from the stock market. It's all about... type of 692 00:44:37,800 --> 00:44:41,820 Speaker 2: investor who's holding too many bonds and thereby, if bonds 693 00:44:41,860 --> 00:44:44,879 Speaker 2: become more volatile or this investor has to hold even 694 00:44:44,920 --> 00:44:49,540 Speaker 2: more bonds, that's when they're not going to be willing 695 00:44:49,580 --> 00:44:51,560 Speaker 2: to pay as much for bonds. That's when the prices 696 00:44:52,080 --> 00:44:56,340 Speaker 2: fall and the yields go up. What is interesting, I think, 697 00:44:56,800 --> 00:45:00,200 Speaker 2: what we find is that there is actually something about 698 00:45:00,239 --> 00:45:03,560 Speaker 2: the co-movement with the stock market, which would suggest that 699 00:45:03,600 --> 00:45:08,669 Speaker 2: these bond risks are at least to a first order 700 00:45:09,030 --> 00:45:14,420 Speaker 2: priced against the stock market. That doesn't mean that additional 701 00:45:15,160 --> 00:45:19,580 Speaker 2: specific bond market exposure for these investors doesn't matter. It's 702 00:45:19,680 --> 00:45:24,620 Speaker 2: probably there also. But I think it's just kind of 703 00:45:24,739 --> 00:45:27,980 Speaker 2: interesting that there is exposure to the stock market that 704 00:45:28,040 --> 00:45:33,549 Speaker 2: matters for whether investors end up holding too much risk 705 00:45:33,610 --> 00:45:33,850 Speaker 2: or not. 706 00:45:34,580 --> 00:45:38,020 Speaker 1: I remember during the first Trump administration when he passed 707 00:45:38,040 --> 00:45:39,900 Speaker 1: the tax cuts and they knew it was going to 708 00:45:39,980 --> 00:45:42,640 Speaker 1: widen the deficit and people were like, oh, where's the 709 00:45:42,690 --> 00:45:44,830 Speaker 1: money going to come from? And that whole time I 710 00:45:44,850 --> 00:45:47,850 Speaker 1: was just thinking, well, he just passed a tax cut. 711 00:45:47,890 --> 00:45:49,230 Speaker 1: We know where the money is going to come from. 712 00:45:49,570 --> 00:45:53,270 Speaker 1: A bunch more people have dollars in their account and 713 00:45:53,310 --> 00:45:55,170 Speaker 1: maybe they're not going to go out and buy treasuries 714 00:45:55,230 --> 00:45:57,489 Speaker 1: necessary with it. But maybe they'll go out and buy 715 00:45:57,530 --> 00:45:59,660 Speaker 1: a boat and then the boat owner will buy some 716 00:45:59,700 --> 00:46:03,840 Speaker 1: stock and then the stockholder will buy some treasuries. It 717 00:46:04,120 --> 00:46:08,980 Speaker 1: does seem as though when you see these fiscal events, 718 00:46:09,340 --> 00:46:12,280 Speaker 1: they're often corresponding with some other part of the ledger 719 00:46:12,600 --> 00:46:13,560 Speaker 1: having more cash. 720 00:46:13,340 --> 00:46:16,840 Speaker 2: In the pocket. That's right. Yeah. So that's in economics, 721 00:46:17,160 --> 00:46:21,569 Speaker 2: that's called recording equivalence. I think it's just a powerful argument, right? 722 00:46:21,590 --> 00:46:24,390 Speaker 2: You always need to think about where does the money 723 00:46:24,430 --> 00:46:27,370 Speaker 2: come from? Where does it go? And Of course, in reality, 724 00:46:27,430 --> 00:46:30,370 Speaker 2: all of this is violated, but as a first approximation, 725 00:46:30,410 --> 00:46:32,290 Speaker 2: I think it's still useful to think about. 726 00:46:32,700 --> 00:46:35,719 Speaker 1: It doesn't work in reality, but it works in theory 727 00:46:36,140 --> 00:46:40,120 Speaker 1: and it has robust explanatory power. No, I've always found 728 00:46:40,140 --> 00:46:41,160 Speaker 1: that to be very compelling. 729 00:46:41,420 --> 00:46:45,180 Speaker 3: Perfect for podcasts and posting online. All right, Carolyn, thank 730 00:46:45,200 --> 00:46:48,290 Speaker 3: you so much for coming on OddLots. Really appreciate it. 731 00:46:49,090 --> 00:46:50,220 Speaker 2: Thank you. My pleasure. Thank you. 732 00:47:03,040 --> 00:47:04,340 Speaker 3: So, Joe, that was fascinating. 733 00:47:04,400 --> 00:47:04,840 Speaker 1: Yeah, yeah. 734 00:47:04,860 --> 00:47:07,980 Speaker 3: Truly the perfect guest for this particular moment in time. 735 00:47:08,320 --> 00:47:10,640 Speaker 3: My big takeaway, Bond's got to be more Bond-like. 736 00:47:11,140 --> 00:47:13,160 Speaker 1: Bond's got to be more Bond-like. By the way, I 737 00:47:13,219 --> 00:47:16,000 Speaker 1: think maybe I'll make this a chart of the day 738 00:47:16,060 --> 00:47:19,020 Speaker 1: or something in the newsletter. You should just look at 739 00:47:19,060 --> 00:47:23,600 Speaker 1: the spread of between the generic Chinese tenure and the U.S. 740 00:47:23,640 --> 00:47:23,969 Speaker 2: Tenure. 741 00:47:24,050 --> 00:47:29,569 Speaker 1: Because not only is it dramatic, I mean, it just 742 00:47:29,590 --> 00:47:31,550 Speaker 1: flipped during COVID. 743 00:47:31,850 --> 00:47:32,810 Speaker 3: The U.S. 744 00:47:33,170 --> 00:47:37,340 Speaker 1: Was yielding much less than U.S. tenure yields were yielding 745 00:47:37,440 --> 00:47:42,060 Speaker 1: much less than their Chinese counterparts up until late 2020. 746 00:47:42,060 --> 00:47:46,220 Speaker 1: And since then, it's been a rocket. And now there's 747 00:47:46,239 --> 00:47:50,259 Speaker 1: over 350 basis points spread between the two of them. 748 00:47:50,360 --> 00:47:51,040 Speaker 1: It's pretty striking. 749 00:47:51,100 --> 00:47:53,259 Speaker 3: That's on the spread. I would just argue that the 750 00:47:53,300 --> 00:47:57,420 Speaker 3: longer term downward trend in Chinese bonds looks like it 751 00:47:57,480 --> 00:48:02,209 Speaker 3: started in like late 2018, 2019 when they were added 752 00:48:02,270 --> 00:48:04,990 Speaker 3: to the indices. So there's an argument to be made 753 00:48:05,070 --> 00:48:09,469 Speaker 3: that the benchmark index providers are the future shapers of 754 00:48:09,530 --> 00:48:10,529 Speaker 3: global hegemonies. 755 00:48:11,230 --> 00:48:14,230 Speaker 1: Either way, I like the idea of, I mean, it's 756 00:48:14,330 --> 00:48:17,290 Speaker 1: a really powerful idea that it's like, Can you have 757 00:48:17,370 --> 00:48:22,969 Speaker 1: like a handing off of the hegemon? Can you have 758 00:48:23,010 --> 00:48:26,370 Speaker 1: a handoff from the hegemon in the financial markets alone? 759 00:48:27,050 --> 00:48:30,379 Speaker 1: But it's really interesting thinking about the way this compounds, right? 760 00:48:30,410 --> 00:48:33,279 Speaker 1: Because if you have the financial advantage, if you could 761 00:48:33,360 --> 00:48:37,300 Speaker 1: borrow money more cheaply, then you can reinvest that money 762 00:48:37,500 --> 00:48:42,120 Speaker 1: into economic productivity, military, and so forth. And then you 763 00:48:42,140 --> 00:48:46,520 Speaker 1: can see how these things compound together. and snowball over decades. 764 00:48:47,520 --> 00:48:50,380 Speaker 1: And okay, so the US now wants to embark on 765 00:48:50,420 --> 00:48:54,160 Speaker 1: this big effort of industrialization. We had that conversation with 766 00:48:54,219 --> 00:48:57,100 Speaker 1: Chris Power of Hadrian in LA, talking about the ship 767 00:48:57,140 --> 00:49:00,299 Speaker 1: gap and the robotics gap, etc. Well, we might do that, 768 00:49:00,400 --> 00:49:02,200 Speaker 1: we might, but like, it's going to cost us a 769 00:49:02,219 --> 00:49:05,609 Speaker 1: lot more to just from a sort of dollar standpoint, 770 00:49:06,010 --> 00:49:08,350 Speaker 1: or resource standpoint, than it would have been, say, 10 771 00:49:08,350 --> 00:49:10,620 Speaker 1: or 15 years ago. You can meme invest. 772 00:49:10,180 --> 00:49:13,480 Speaker 3: Your way to military superiority. You just have to come 773 00:49:13,480 --> 00:49:16,640 Speaker 3: up with a better story than the other guy. That's right. 774 00:49:16,640 --> 00:49:17,540 Speaker 3: And convince investors. 775 00:49:17,560 --> 00:49:19,420 Speaker 2: That's right. All right. Shall we leave it there? 776 00:49:19,500 --> 00:49:20,020 Speaker 1: Let's leave it there. 777 00:49:20,400 --> 00:49:22,890 Speaker 3: This has been another episode of the All Thoughts Podcast. 778 00:49:22,910 --> 00:49:25,590 Speaker 3: I'm Traci Allaway. You can follow me at Traci Allaway. 779 00:49:25,810 --> 00:49:28,830 Speaker 1: And I'm Joe Weisenthal. You can follow me at The Stalwart. 780 00:49:29,140 --> 00:49:33,120 Speaker 1: Follow our producers, Carmen Rodriguez at CarmenArmond, Dashiell Bennett at Dashbot, 781 00:49:33,200 --> 00:49:36,180 Speaker 1: Kale Brooks at Kale Brooks, and Kevin Lozano at Kevin 782 00:49:36,219 --> 00:49:39,820 Speaker 1: Lloyd Lozano. And for more OddLots content, go to Bloomberg.com 783 00:49:39,860 --> 00:49:43,109 Speaker 1: slash OddLots or the daily newsletter in all of our episodes. 784 00:49:43,450 --> 00:49:45,210 Speaker 1: And you can chat about all of these topics 24-7 785 00:49:45,770 --> 00:49:48,930 Speaker 1: in our Discord, Discord.gg slash OddLots. 786 00:49:49,250 --> 00:49:51,549 Speaker 3: And if you enjoyed this conversation, if you like it 787 00:49:51,610 --> 00:49:53,469 Speaker 3: when we talk about the bond market, then please leave 788 00:49:53,530 --> 00:49:56,950 Speaker 3: us a positive review on your favorite podcast platform. And remember, 789 00:49:57,050 --> 00:49:59,350 Speaker 3: if you are a Bloomberg subscriber, you can listen to 790 00:49:59,550 --> 00:50:02,390 Speaker 3: all of our episodes absolutely ad free. All you need 791 00:50:02,410 --> 00:50:05,070 Speaker 3: to do is find the Bloomberg channel on Apple Podcasts 792 00:50:05,150 --> 00:50:18,230 Speaker 3: and follow the instructions there. Thanks for listening. Thank you.