00:00:02 Speaker 1: Bloomberg Audio Studios. Podcasts Radio News. 00:00:11 Speaker 2: This is the Bloomberg Surveillance Podcast. I'm Jonathan Farrow, along with Lisa Abramowitz and Anne-Marie Hordern. Join us each day for insight from the best in markets, economics and geopolitics. From our global headquarters in New York City, we are live on Bloomberg Television weekday mornings from 6 to 9 a.m. 00:00:27 Speaker 1: Eastern. 00:00:28 Speaker 2: Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business App. Here's a view on Wall Street this morning. Aaron Kennett of Clear Harbor Asset Management writing, expect AI and the extraordinary capital investment associated with the data center build out to increasingly enter the Fed's discussion. Aaron joins us now for more. Aaron, welcome to the program. Let's build on that. Is that a story the Fed strips out or has to bake in and begin to react to? 00:00:56 Speaker 1: We'll have to see, Jonathan. 00:00:57 Speaker 3: I mean, we're going to hear from Fed Chair Warsh on Friday, and maybe we'll be able to read some tea leaves on how they're thinking about the September meeting. But certainly, AI is a big part of their story and their contemplation, because in the short term, we're looking at inflationary pressures. that are impacting ultimately consumers or at least concerning consumers. And there's huge political consequence to that. In the long term, there's a hope that AI will generate significant productivity gains, but it could also disintermediate employment. So there's a challenge there for the Fed as they speak both to the market as well as to the American people at both the FOMC level as well as out in Jackson Hole. 00:01:40 Speaker 4: And look at the runway for demand right now. 00:01:42 Speaker 2: The call from Nvidia, they're telling you this is going to continue, even with memory costs going to the moon, through the roof. Aaron, with that, you've got a market at the moment. You've got a whole AI ecosystem that's arguably increasingly rate insensitive, not rate sensitive. What can this Federal Reserve do about any of that? 00:02:00 Speaker 3: Yeah, I think it's challenging, which is probably why they're going to continue to sort of focus perhaps in a more traditional manner on the inflationary data and perhaps look through the rearview mirror. But as Fed Chair Walsh has indicated, sort of current data is more important than trying. 00:02:21 Speaker 1: To predict future data. So it's going to be a challenge. 00:02:23 Speaker 3: I mean, the last couple of weeks, we've seen both disinflationary pressures from PPI and CPI. And then just earlier this week with PCE, we saw a little bit of reacceleration concern there. And then on the employment front, of course, the last print was a little weaker than the prior few prints. And so I think the Fed is sort of in a holding pattern here, which is probably why the market may be correct that they don't do anything in September and that they contemplate a move in December. So we'll have to see. Certainly, tomorrow will be quite interesting from that perspective. 00:02:57 Speaker 5: Well, things like the impact of productivity, Aaron, because of AI aren't immediately clear yet as to what impact that will have on the economy. What is clear now is is the enormous wealth that's being created from all of this. There are stories of hundreds of houses in San Francisco going for $ 1 million over asking prices. The cars at the Monterey Car Show doubling in price at auctions that they were a year ago. 00:03:20 Speaker 6: Aaron, what about the wealth effect? 00:03:23 Speaker 5: How should policymakers be thinking about this enormous amount that all of a sudden consumers have in terms of firepower? 00:03:31 Speaker 6: Yeah, I mean, it's the tale of two economies. 00:03:35 Speaker 3: And, you know, certainly if you do not own financial assets in the midst of this period of a great boom, both on AI, but just the broader equity market since 2022, you've been left out in the cold. You've experienced higher interest rates on your cars. If you have a variable mortgage, you've experienced higher interest rates on that. Most people in the lower quartile don't have a mortgage. And so it's been, I think, really challenging. Credit card defaults at the lower quartile have actually increased and their lines have have been cut in some cases. And of course, prime rates on credit cards have been elevated. So you have a real challenge, which is feeding into the November elections and the narrative around data centers, not in my backyard, inflation. ISM manufacturing data has actually been accelerating, but we're not seeing significant improvement on the employment side as it pertains to that growth. 00:04:35 Speaker 1: So what does that mean? 00:04:36 Speaker 3: Higher margins for corporations, and perhaps less of a benefit from an employment perspective going forward. At least that's the concern right now at a policy level. 00:04:46 Speaker 5: It's a hard one to address, the two-speed economy that you're talking about, Aaron. So what can they do to address it when moving interest rates is something of a sledgehammer to this entire economy? 00:04:58 Speaker 3: I think in some important sense, particularly now that Secretary Besson has weighed in on the long end, just speaking about the importance of Fed independence, for Fed Chair Warsh to convey that there is a new sheriff in town, but there's an FOMC committee as a whole that's trying to work together, may not always agree, but is independent from the political noise of the moment, I think that's going to be critically important. And perhaps we're going to hear from Fed Chair Warsh on that point as well tomorrow. 00:05:26 Speaker 2: Aaron, slightly controversial. I brought up this point yesterday. They're losing patience. You can see that in some of the speeches we've seen more recently, losing patience after missing their target for so long, some five plus years. It also appears, Aaron, to some extent they're losing confidence in the person leading them. And I think you can point out several policymakers on that committee who said very little about missing this target for so long under Chairman Powell and are saying a lot more under Chairman Walsh. 00:05:51 Speaker 4: What do you make of that change? 00:05:53 Speaker 3: Yeah, I mean, I observe them all and I try to observe them all when they put posts out and sometimes their videos are on LinkedIn. You know, Beth Hammock, who I respect, but is sometimes, you know, pushing back on Fed chairs, worse reticence to perhaps raise rates, for example. And I don't know, I guess if there's a new leader at the Fed, there's also an element of signaling not just to the market, but to the Fed chair himself that, no. 00:06:25 Speaker 6: We are voting members. 00:06:27 Speaker 3: Yes, you're the sheriff, but ultimately, this is a committee and it requires multiple people to decide on where policy is going. 00:06:35 Speaker 1: And we want to let you know that we. 00:06:37 Speaker 6: Have strong views. 00:06:38 Speaker 3: I mean, to say that that they don't have trust in this Fed chair because inflation has been incrementally elevated above the target since he's been at the helm, but then not see them critique Fed Chair Powell for such a long period of time. I find that unfair to this current Fed chair. And I think there's probably a level of professionalism within the FOMC that will prevail. And this may be more of a narrative that we're worried about. 00:07:10 Speaker 4: Stay with us. 00:07:11 Speaker 2: More Bloomberg surveillance coming up after this. Let's talk about tech and meta. Meta down in the pre-market by four tenths of one percent. Meta agreeing to pay up to 18 billion dollars in a landmark settlement. 00:07:33 Speaker 3: This is a major breakthrough because when it comes to protecting our children's mental. 00:07:38 Speaker 1: Health, there is no time to lose. 00:07:41 Speaker 3: It has always been our goal to make sure that every platform protects children in the same way that Meta is going to be protecting children. 00:07:48 Speaker 2: The agreement requiring Meta to put new guardrails on its platforms, including time limits for younger users. A portion of the settlement is dependent on competitors like TikTok and YouTube agreeing to play by the same rules. Professor Stuart Benjamin of the Duke School of Law writing, this settlement is about Meta's bottom line and in particular, their competitive position. Miners use YouTube the most, followed by TikTok, so they have more to lose than Meta does. Stuart joins us now for more. Professor, welcome to the program. Why did they settle? And as you indicated, why didn't they settle earlier? 00:08:20 Speaker 1: I think that's the most interesting question. 00:08:23 Speaker 7: I don't think anything that happened in the trial was a surprise to them. In fact, as you may know, in pretrial discovery, they already turned over all of the information that was basically. 00:08:33 Speaker 1: Being used against them. So they knew what was coming. 00:08:36 Speaker 7: This was all could have been prefigured pretty accurately. My guess is what happened is that they saw they were getting into cigarette company land in terms of the public reaction to them. and that this motivated them to settle. If I might add, I think that having settled now, I'm guessing they wish they had settled two weeks ago, because all they've gotten out is a couple of weeks of bad publicity and really not much to show for it. 00:09:04 Speaker 2: Professor, what kind of litigation exposure still remains? There are some outstanding issues. And what kind of read would you gauge from their approach to this litigation for their approach to the other litigation? 00:09:15 Speaker 7: But these were the big cases because this was the equivalent of the cigarette litigation where you have the states going after you, being able to sue it essentially on behalf of all of the citizens of the states. So there are still going to be a bunch of other smaller lawsuits that will be brought, they'll have to deal with. But those are going to be in the millions, not the billions, and probably not the high billions. And a lot of the oomph, to use a technical term, in those later cases is going to be taken away now that meta has changed its practices. It doesn't actually change legally the harms that minors might have had in previous years. 00:09:56 Speaker 1: I just think it's going to have an impact on on juries. 00:10:00 Speaker 5: Professor, as you pointed out, the competitive landscape to this is really interesting. Of the 18 billion, only 12.7 billion they have to pay out. The rest is contingent on TikTok and YouTube adopting very similar measures. Why would it be structured this way? And why would both the states and Meta go along with having this kind of competitive clause in this decision, in this settlement? 00:10:23 Speaker 7: It's a great question. For Meta, it's easy, as you saw in the write-up that I had. Meta is the third most popular of these platforms. YouTube, far and away the most popular among minors. Then TikTok, then Meta. So from their standpoint, they love to be able to say, it's not just the other five billion. We will have a one-hour cap instead of a two-hour cap on limits only if our competitors have similar caps. Well, that hurts their competitors more than it hurts them. So then the interesting question is, why do the states agree to it? My guess is from the state's standpoint, this was icing on the cake. They were already getting more than $ 12 billion from Meta. If this puts pressure on TikTok and YouTube, all the better from the state's perspective. 00:11:09 Speaker 1: You're worried about protecting children? 00:11:13 Speaker 7: We are now aligned in Meta in having an interest in pushing Meta's competitors to have similar limits. 00:11:21 Speaker 6: Well, the way Meta. 00:11:22 Speaker 5: Has interpreted this is to say not that they got caught creating a product that was addictive for teens, but instead saying, look at us. We are now the standard bearer in terms of delivering a product for teens that is now safe. And our competitors, they should follow suit. Professor, you mentioned that they wish they had settled this two weeks ago for PR's sake. Do you think that the cleanup they're doing now is enough to help restore their public image? 00:11:46 Speaker 7: It's a great question because I do think that they've been getting just hammered in the press. 00:11:52 Speaker 1: And so I think this will probably help a lot. 00:11:55 Speaker 7: Again, I think if they could have been seen as doing this willingly before the drip drop in. 00:12:03 Speaker 1: The litigation, I frankly think they would have been in a stronger position. 00:12:07 Speaker 4: Stay with us. 00:12:08 Speaker 2: More Bloomberg surveillance coming up after this. under Cervantes this morning, setting the stage for Jackson Holt. 00:12:24 Speaker 1: All eyes are going to be on Walsh on Friday. 00:12:26 Speaker 7: Will Kevin Walsh say that we have a fiscal issue that's driving the inflation side? 00:12:32 Speaker 3: Forward expectations around inflation is ultimately the self-fulfilling prophecy. 00:12:37 Speaker 1: Broadening out the inflation view would be useful. 00:12:39 Speaker 4: So here's the latest this morning. 00:12:41 Speaker 2: Global Central Bank is arriving at Jackson Hole preparing for remarks from Fed Chair Kevin Walsh tomorrow. Sticky inflation, a rising U.S. deficit, adding pressure to those comments. Torsten Slocke of Apollo writing, the bottom line for investors is... that interest rates are going to stay higher for longer. Torsten joins us now for more. 00:12:57 Speaker 4: Torsten, good morning. Good to see you, buddy. What are you expecting tomorrow morning? 00:13:01 Speaker 8: Well, I think that he will have to deliver something that is clearer than what he did at the July press conference. And the most likely outcome is that I think that he will deliver. more clarity about his economic outlook. And I think that that will involve some framework guidance, not forward guidance, but some reaction function description that explains what do we think is. 00:13:19 Speaker 6: Going on with inflation? What do we think is going on with the labor market? 00:13:21 Speaker 8: And therefore, broad economic picture that the market then can begin to interpret as well. What does he put weight on when he thinks about where the economy is at the moment? 00:13:29 Speaker 4: Is that going to have a hawkish flavor? 00:13:31 Speaker 8: I do think that it will have a hawkish flavor because at the moment the risk is that if he does not give any framework guidance, the risk is that that will involve a much higher move in long rates because long rates need some more clarity around what are the reaction functions for the FOMC, what are the frameworks that they're using, are they going to tighten policy through rate hikes, through the balance sheet, through tighter financial conditions. Does he think the move on rates is enough to slow inflation down? giving some guidance about what do they think at the moment is the outlook for the economy. Not in terms of forward guidance, but what do they think is why, where we are with inflation and unemployment. That must be the answer to what could at least solve this problem. 00:14:12 Speaker 5: Is that enough or does he need to go to a step further and say, if core PCE remains elevated, then we will be hiking? Does he need to be that explicit? 00:14:20 Speaker 6: Well, I do not think it will come with numbers. 00:14:22 Speaker 8: The only number that he probably will say is 2% inflation because that is ultimately the goal. But I think what the market is looking for and what they will likely also deliver tomorrow is that there is some need for description of how do we get from 3.5% down to 2%. Do you expect that to happen in a few months? Do you expect that to happen over a few years? I mean, what is the path ahead of us, and what are the various forces in the economy that are arguing for why inflation is likely to come down? 00:14:47 Speaker 5: Torsten, though, does that to some degree betray what Kevin Warsh has clearly communicated as his ethos? That is, that the market doesn't need hand-holding. If he comes out and acts in a way that is seen to hold the market's hand, doesn't it counteract this narrative that he's trying to portray that is, I don't need to give explicit guidance. 00:15:04 Speaker 6: I don't need forward guidance. 00:15:05 Speaker 5: I don't need to hold your hand because there won't be issues with macroeconomic volatility. You can sort it out yourself, markets. 00:15:11 Speaker 8: Well, and the problem with that is that rates are higher for longer for reasons that have nothing to do with the business cycle and nothing to do with. 00:15:16 Speaker 6: What the Fed is doing. 00:15:18 Speaker 8: Number one, of course, the fiscal situation is not great. That's putting upward pressure on the term premium, on long-term interest rates. That means long rates are going to be higher for longer. In the front end, inflation is unfortunately not true. 00:15:28 Speaker 6: It's 3.5%. 00:15:29 Speaker 8: And given 3.5 is not 2, that means that he still needs to have a view on, well, what is the process of getting down from 3.5 to 2? And if we have inflation at this high level, we will also have rates higher for longer in the front end. And by the way, in the belly, because of hyperscaler issuance, we also have upward pressure on rates. So the whole yield curve is at risk of moving higher because we simply have some forces, in particular hyperscaler issuance and also the fiscal situation, that really is just not under the Fed's control. 00:15:55 Speaker 2: This has been such an unforgiving month. For the Fed chair, Kevin Walsh, the news conference was bad enough, but subsequent events have made it look even worse. So he's been reluctant to engage in communication about his reaction function and the like. And then the FT provides a view of how he thinks about the world that wasn't represented in the news conference. 00:16:14 Speaker 6: One, two. 00:16:15 Speaker 2: He wants to see an unfiltered message from markets. Then his Treasury Secretary steps in and provides a filter for financial markets. 00:16:23 Speaker 4: Can he take that approach anymore? 00:16:25 Speaker 8: Well, the challenge, of course, is that there are other things than what the Fed is doing that are driving rates, in particular in the belly and further out the curve. And those are the things that he can't really do anything about. So a recognition of that there are other things could be one way to say, well, rates have gone up and there's not much we can do about that. But broadly speaking, what he can control is, of course, the front end. So a description of the economic outlook of what's going on with inflation, what's going on with the unemployment rate, all that would be very critical for what could be happening to the front end of the curve. The last thing on this is also we might also hear something about AI because this becomes really important for rates. If we take this conversation into 2027, think about it the following way. If AI fails, if this is a bubble and it bursts, we will absolutely have rates much, much lower. And then the discussion about the fiscal situation and inflation is probably going to be more in the background relative to the AI story. So if AI fails, let's agree, next year rates will probably be a lot lower. But if AI succeeds, and we also have massive disinflationary forces because now the tech companies and everyone is making trillions of dollars and that improves productivity and therefore lowers inflation. 00:17:28 Speaker 6: You could also have a scenario where ai. 00:17:30 Speaker 8: Both if it fails and if it succeeds that ai could result in rates being lower sometime next year that's not where we are right now but that might be helping him so if he does talk about ai and saying what are the different consequences of different scenarios that could be helping both in terms of rates in the front end and in the. 00:17:45 Speaker 4: Long end gave us two scenarios there which way are you leaning So at. 00:17:48 Speaker 8: The moment, I still think the market is trying to figure out, apropos the Nvidia earnings, what exactly is the scenario we're on? 00:17:54 Speaker 6: Are we on the scenario where. 00:17:55 Speaker 8: Things are about to turn south in terms of companies not seeing the payoff from AI? Or is there really a true scenario where we're going to see a dramatic increase in productivity? 00:18:04 Speaker 6: We've not seen that yet. 00:18:05 Speaker 8: Or dramatic increase in particular in profit margins in the S & P 493, meaning outside of the tech sector, because we haven't seen that yet either. So the model through scenario, which is the one we're in at the moment, while we're trying to figure out is AI widely successful or is AI a failure, that's the scenario where you still have weight put on the fiscal situation and the inflation situation. 00:18:25 Speaker 2: He's given a hint of that, but let's say he leans really hard into the production boom scenario, the productivity boom scenario. This market is just going to think he's super dovish. 00:18:33 Speaker 8: Yeah, because that's like going to the casino and putting everything on red. 00:18:36 Speaker 1: Right. 00:18:37 Speaker 6: And we do not know if it will be red. It could also be black. 00:18:40 Speaker 8: And that's, of course, why this risk is that if the Fed leans too heavily into one scenario and say, well, AI is going to raise productivity, that will solve all the inflation problems. By the way, that will also solve all fiscal problems. Well, if you do that, then if that does not happen, then we will, of course, have some serious problems, particularly in 2027. 00:18:57 Speaker 5: Is there also the same, a similar risk, not to the same magnitude, but a similar risk if he also leans on his committees, saying that we can't fully give his outlook because he's still waiting for results to see what they come back with? 00:19:08 Speaker 6: Absolutely. 00:19:08 Speaker 8: The task forces, of course, that now will come later this year, of course, are very, very critical for the whole discussion of what is the Fed framework. So that's also why the tiptoeing from him tomorrow must also be taken into account that the task forces have not said anything yet. And now he needs to say something about framework guidance, and we will only get the task forces later this year. Surely, he's already pointed to what actually most people agree. He's absolutely right that forward guidance is not a good idea. But what most people also agree is that framework guidance is a good idea. And now we need to get some framework guidance from him tomorrow, probably through the economic outlook. But we also will get much more framework guidance when the task forces come out later this year. 00:19:46 Speaker 6: Does that mean any. 00:19:46 Speaker 5: Framework guidance he gives now we should be viewing as very short-term and will change once we get the task force results later this year? 00:19:53 Speaker 8: Well, this is why tomorrow may be more helicopter framework guidance rather than the details that we are probably. 00:19:58 Speaker 6: Going to get from the task forces. 00:20:00 Speaker 2: Can I ask you a delicate question to wrap things up? Are you seeing signs that the committee is losing faith in their leader? 00:20:06 Speaker 8: Well, at the last meeting we had three dissents, but remember also under Powell in April we also had three dissents and in December we also had three dissents. So it's actually not unusual, in particular more recently, to have three dissents. But it's of course very clear and it's very important to remember that there are 12 voting members on the FOMC. The chair's most prominent and important role is to call the other members and try to figure out before the meeting What are you going to do? 00:20:27 Speaker 6: What are you going to do? And what should we be saying? How do you think about this? 00:20:31 Speaker 8: And try to balance the consensus and figure out how do we come to some compromise. So he both has to clarify his own views, but the challenge is he also has to clarify the views of the others. And that's, of course, why this becomes very important from a committee perspective, namely what do they as a group think is the best response to where the economy is. 00:20:48 Speaker 2: At the moment. 00:20:48 Speaker 4: Do you think the others are becoming more powerful? 00:20:51 Speaker 8: Well, if he decides to say very little tomorrow and if he does not give any guidance on where he thinks inflation and unemployment is today, of course, the risk is that other FOMC members will begin to get more, meaning risk, meaning the consideration he must take into account is that others will begin to get some more attention. So the toothpaste will come out one way or the other that people have used on all kinds of things. And suddenly the market will be paying a lot of attention also to what the Fed presidents are saying regionally. And of course, the other FOMC members on the board. 00:21:19 Speaker 2: This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics and geopolitics. You can watch the show live on Bloomberg TV, weekday mornings from 6am to 9am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business Hour.