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Speaker 2: This is the Bloomberg Surveillance Podcast. I'm Lisa A.
Speaker 3: Bramwoids, along with Tom Keane and Jonathan Ferrow. Join us
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Speaker 4: National security experts debating whether the US has sufficient throughput
Speaker 4: capacity to bank Ukraine, Israel, and possibly Taiwan in a
Speaker 4: simultaneous and extended conflict scenario. The unanimous and emphatic answer
Speaker 4: from experts is no, which underscores the likelihood of a
Speaker 4: period of fiscal dominance in which deficits are mostly disregarded
Speaker 4: and interest rates must adjust to a higher equilibrium.
Speaker 5: The leaf Sinc.
Speaker 4: The chief global economist and Peach and fixed Income joins
Speaker 4: us right now wander for to catch up with you, sir,
Speaker 4: What a difficult time. Going to lean a little bit
Speaker 4: on your experience in the administration along the way In
Speaker 4: this conversation as well, Paul Tudor Jones caught up with
Speaker 4: a regional business news network called CNBC in the last
Speaker 4: twenty four hours. You might have heard of Paul. I'm
Speaker 4: not sure about the network deal. This is what he
Speaker 4: had to say. He said, he's never seen this kind
Speaker 4: of geopolitical tension in the last something like fifty years,
Speaker 4: with the deficit position, the budget position of the United
Speaker 4: States this week, deleep, How important is that.
Speaker 6: He's right? The backdrop is returned to the most intense
Speaker 6: period of great power competition in at least three decades.
Speaker 6: That's going to mean more demand on physcal spending to
Speaker 6: shore up our sources of competitive advantage. And you know,
Speaker 6: it's also it's also the reality that we're seeing a
Speaker 6: surge of yields driven by term premium because bond investors
Speaker 6: they don't know whether we're going to grow fast enough,
Speaker 6: whether tax revenues will be high enough to service a
Speaker 6: rise in cost of capital. They don't know whether other
Speaker 6: buyers are going to show up at auction, and they
Speaker 6: don't know whether Washington, DC can exert enough fiscal restraint
Speaker 6: if growth falters. And that's why you're seeing this repricing.
Speaker 6: It's a very challenging.
Speaker 3: Time, Delli. If you wrote this column that we found
Speaker 3: fascinating and we've cited quite a bit about the lack
Speaker 3: of price in sensitive buyers really questioning the ability for
Speaker 3: the US to borrow at some of the rates that
Speaker 3: they were accustomed to in the past. Can you just
Speaker 3: bring that forward to today's moment, with increasing calls for
Speaker 3: military aid. How much does that actually make you double
Speaker 3: down on this idea of borrowing regardless of where we are,
Speaker 3: in order to finance national security and other concerns.
Speaker 6: Well, Lisa, here's how I synthesize what's going on. There
Speaker 6: are three fundamental dynamics. What's the fed's near term reaction function,
Speaker 6: what's long run neutral, and what's the term premium? And
Speaker 6: then you have to overlay the impact of the attack
Speaker 6: on Israel on the Fed's reaction function. I think Lori
Speaker 6: Logan said it best, and we have a higher term premium.
Speaker 6: A higher term premium, all things equal, implies a softer
Speaker 6: economic outlook and greater likelihood that the policy rate has peaked. Okay,
Speaker 6: on long run neutral rates, I think what we're seeing
Speaker 6: with payrolls and lots of other evidence is it something
Speaker 6: really positive is happening on the supply side of the economy.
Speaker 6: That's how you can get above trend growth alongside disinflation.
Speaker 6: So long run neutral rates are going higher, then you
Speaker 6: have term premium. We just spoke about that. The balance
Speaker 6: of risks are still moving higher. If the house is
Speaker 6: in disarray, that means no durable physical consolidation is on
Speaker 6: the horizon, and therefore you have a durable risk of
Speaker 6: a supply demand in balance that is no longer showing
Speaker 6: up at every Treasury auction. Neither are large overseas buyers
Speaker 6: to the same degree, either because they're savings balances have
Speaker 6: fallen or because they want to diversify their holdings and
Speaker 6: now overlay the impulse of the attack on Israel. It's
Speaker 6: another injection of uncertainty. It's another potential supply side shock
Speaker 6: on energy prices. And the net of it for me
Speaker 6: is you do get a higher drift in long term
Speaker 6: yields with an anchored front end.
Speaker 3: So, based on what you're saying, Tahalif, do you think
Speaker 3: that the move that we've seen, barring the past couple
Speaker 3: of days in longer term yields makes sense or that
Speaker 3: it's not high enough, or that it's gone a little
Speaker 3: bit over the board.
Speaker 6: Well, I mean in the I mean Emory said it
Speaker 6: right right now. We're in the thickest fog of a
Speaker 6: hideous and tragic war, and so we're seeing a flight
Speaker 6: to quality on the back end of the curve. But
Speaker 6: I think over time, as market participants think through the
Speaker 6: second and third order effects, the forces that I mentioned
Speaker 6: going to cause a drift higher and the front end.
Speaker 6: I think think that's where I have the most conviction
Speaker 6: at this point. I think the FED has said now
Speaker 6: with a chorus of officials, we're going to let markets
Speaker 6: do the work for us, and if the data continue
Speaker 6: to moderate both on growth and inflation, we can watch
Speaker 6: and wait.
Speaker 4: Dealey, But I just want to finish on the potential
Speaker 4: policy response, and this I think involves your experience in
Speaker 4: the administration. What kind of sanctions response should we be
Speaker 4: looking out for as a team. For the investors listening
Speaker 4: to this program right now, what would you expect to
Speaker 4: see from the administration the White House in a coming
Speaker 4: weeks and months.
Speaker 6: Well, I mean, the leading edge of any response from
Speaker 6: the administration, if it proves necessary, will be in the
Speaker 6: military route. That's why you see two aircraft carriers moving
Speaker 6: to the Eastern med That's why you see all of
Speaker 6: these efforts to shore up Israel's Iron Dome. There will
Speaker 6: be a sanctions component because money is fungible to the
Speaker 6: extent that Iran is seen as directly directly involved in
Speaker 6: the planning and execution of the attack. I think you'd
Speaker 6: see the screws of screws of sanctions Titan. There'll be
Speaker 6: a global effort, but that's that's second order to the
Speaker 6: military response.
Speaker 4: Delim's just been said about the sanctions response and the
Speaker 4: fact that perhaps this administration turned a blind eye to
Speaker 4: Iranian crude production and perhaps Chinese's buying off that crude.
Speaker 4: What's your view on that.
Speaker 6: I disagree with the prebis. I mean, I know there's
Speaker 6: a lot of a lot of hype about the six
Speaker 6: billion dollars. The administration spoken pretty clearly not a dollar
Speaker 6: has been has been sent to Tehran. I would be
Speaker 6: shocked if a dollar ever moves to Tehran in the
Speaker 6: aftermath of this attack. And so you know that there
Speaker 6: is going to be I think less and less Iranian
Speaker 6: crudeill on the market. The question for the administration is
Speaker 6: can they get an offset from Saudi from other sources,
Speaker 6: from domestic producers. That's going to be the challenge.
Speaker 3: So dully, you just said that you think that refreezing
Speaker 3: that six billion dollars is pretty much a certainty at
Speaker 3: this point. Is there a potential ramification? Does this have
Speaker 3: any kind of play in to some of the accusations
Speaker 3: of using a dollar as a weapon or any of
Speaker 3: these talks that have really flared up a couple of
Speaker 3: years ago.
Speaker 6: I don't. I don't think so, Lisa. I mean, if
Speaker 6: we're talking about the barbaric invasion of Ukraine or this
Speaker 6: hideous attack on Israel, Uh, there have to be there
Speaker 6: have to be consequences. And when you stop short of
Speaker 6: deploying your military, economic tools are the are the second
Speaker 6: best resort. So that's that's what we're seeing I don't
Speaker 6: think it's a threat to dollarization. We're going to move
Speaker 6: with our allies, and we're doing so to uphold the
Speaker 6: principles that underpin peace and security across the world. That's
Speaker 6: that's good for the world, that's good for for financial markets,
Speaker 6: that's good for the economy. That's what these sanctions do.
Speaker 4: Deleeve, don't be a stranger. It's trite to catch up
Speaker 4: with you, SA. Hopefully we can do that again soon, Deleep.
Speaker 4: Think of page and fixed income. If you want to
Speaker 4: guess now, is Judy Norman the Center on US Politics
Speaker 4: Code Director Judy wonderful to hear from you, and let
Speaker 4: me do you offer you the challenge to answer that question?
Speaker 4: Is that a distinction without a difference?
Speaker 7: You know, I do think it's important to differentiate on this,
Speaker 7: and it's interesting to me that Israel in particular is
Speaker 7: being very cautious to pin blame directly on Iran. Again,
Speaker 7: Israel and the US have long known that Iran has
Speaker 7: funded Hamas, has provided much of their weaponry, et cetera.
Speaker 8: But this operation does look to be different.
Speaker 7: And again importantly, I think a direct pin on Iran
Speaker 7: would escalate the region very quickly. This wouldn't just be
Speaker 7: Israel and Iran as to states, it would also include
Speaker 7: all of Iran's proxy groups has Blah proxy groups in
Speaker 7: Iraq and elsewhere, and.
Speaker 8: So it could just blow up very quickly.
Speaker 7: And I think both the US and Israel are aware
Speaker 7: of that, and one of their goals in these coming
Speaker 7: days is going to be containment along with you know,
Speaker 7: retribution and deterrent. So that's on everyone's mind right now.
Speaker 7: It doesn't mean that Iran is not going to play
Speaker 7: into this, but I think for the short immediate future,
Speaker 7: coour heads are trying to figure out where exactly a
Speaker 7: place to blame and act accordingly.
Speaker 4: Did Judy walk us through the tension in that statement?
Speaker 4: The words that you just used almost a contradiction between
Speaker 4: retribution and containment. Are those two things compatible?
Speaker 7: Well, I think this is going to be a real
Speaker 7: challenge over the next few days, the next few weeks.
Speaker 7: On the one hand, of course, Israel wants retribution for
Speaker 7: these attacks. They want to deter a broader conflict, as
Speaker 7: does the US. But at the same time you're trying
Speaker 7: to contain again the conflict as we just spoke about,
Speaker 7: from spelling out whether it's in the West Bank and
Speaker 7: has Bolah or throughout the.
Speaker 8: Region or just over the long term.
Speaker 7: And you know, John, Israel is going to be if
Speaker 7: they do launch a ground offensive, it's going to be
Speaker 7: very difficult. Gaza is a very highly populated urban area.
Speaker 7: You would face mass casualties for Israeli military personnel, for
Speaker 7: Palestinian civilians, which we're already seeing, and of course that
Speaker 7: does of hostages that are being held in Gaza, So
Speaker 7: this would be very tricky. It's also very tricky to
Speaker 7: just OUs to mass as a group, and it's very
Speaker 7: tricky to know what would be.
Speaker 8: Next for Gaza.
Speaker 7: So I think the road ahead is going to be
Speaker 7: challenging for Israel. We've seen these, you know, I would
Speaker 7: say Israel Palestein has become almost emblematic of the term
Speaker 7: cycles of violence, with different kinds of acts of retribution
Speaker 7: that then lead to more acts and unfortunatably and casualties
Speaker 7: on both sides. So that's the reality of the situation,
Speaker 7: and it's a very tough needle to thread.
Speaker 3: Julie, Given all of that, what do you make of
Speaker 3: the discussion of John Kirby of the US talking yesterday
Speaker 3: about Cutter actively trying to negotiate some sort of hostage release,
Speaker 3: something that could maybe de escalate the way that you're
Speaker 3: talking about.
Speaker 7: Yeah, it'll be really interesting to see Cutter's role in this.
Speaker 7: We have heard these reports of some kind of negotiations
Speaker 7: around hostages, at least around women and children and elderly,
Speaker 7: some kind of a negotiation that might happen there. You know,
Speaker 7: Cutter has has been an important intermediary, I would say,
Speaker 7: between the US and Israel and groups that they can't
Speaker 7: or won't negotiate directly with. And I think we're going
Speaker 7: to see that playing an important role here. Again, this
Speaker 7: question of the hostages is very much in the forefront
Speaker 7: for Israel and how they coordinate any kind of operation.
Speaker 7: It's also very much, obviously in the minds of the
Speaker 7: US and other countries that have their citizens being held there.
Speaker 3: Right now, What are the red lines, Julie, do we
Speaker 3: have a sense of as Israel plans the incursion, the
Speaker 3: potential ground operation in Gaza, is there a sense of
Speaker 3: pressure being placed on Israel to show restraint in certain
Speaker 3: areas from the US, from other allies as well as
Speaker 3: from Middle Eastern partners like Saudi Arabia that had previously
Speaker 3: been discussing with Israel.
Speaker 8: Sure, absolutely.
Speaker 7: You know, I think we heard from Biden yesterday a
Speaker 7: very committed US response to Israel. You know, we're with
Speaker 7: Israel and really not setting any red lines at this point.
Speaker 8: We're hearing different messaging.
Speaker 7: From the EU, from European partners in AWA, and of
Speaker 7: course from within the region, you know, calling on Israel
Speaker 7: to stay within the bounds of international law, within the
Speaker 7: bounds of kind of rules of war and these kinds
Speaker 7: of things in terms of proportionality and targeting of civilians.
Speaker 7: So I think this will be an ongoing conversation. I
Speaker 7: think it's it's a very difficult one. I think many
Speaker 7: feel a lot of aversion to talking about both sides,
Speaker 7: whereas others feel it very necessary degree for the civilian
Speaker 7: loss of life on both sides of this border.
Speaker 4: Judy, when you hear numbers like more than one thousand civilians,
Speaker 4: and then we have conversations where we talk about a
Speaker 4: proportional response. What on earth is a proportional response to
Speaker 4: what took place over the weekend.
Speaker 8: Yeah, I think many in Israel be asking that.
Speaker 7: And again I think this has been again a situation that, unfortunately,
Speaker 7: time and time again has played out in the Middle East,
Speaker 7: and is this in this Israel Palestine conflict. You know,
Speaker 7: over the decades we have seen different kinds of atrocities
Speaker 7: that again are then met with a response that you
Speaker 7: also read aults and civilian casualties that then just escalate
Speaker 7: for many this kind of long term security challenge of
Speaker 7: then getting more people involved in resistance and whatnot. So
Speaker 7: it's a very challenging path, I would say morally as
Speaker 7: well strategically for Israel as they try and balance what
Speaker 7: might be short term necessities and responses with what might
Speaker 7: be real long term strategic thinking of what does this
Speaker 7: mean for the long run and what kind of future
Speaker 7: are we setting up if we respond in a way
Speaker 7: that just fuels this conflict even further.
Speaker 5: Judy, thank you, Thank you for your insight. Jully Norman. Then,
Speaker 5: if you see our center on US politics.
Speaker 3: Someone who's been tracking the sort of push pull between
Speaker 3: inflation and potential weakness around the edges is Torston Slock,
Speaker 3: chief economist Apollo Global Management, who puts out charts that
Speaker 3: we cite pretty much every single day. And Torston, I
Speaker 3: just want to thank you and your team because we
Speaker 3: always use them as talking points and hot topics.
Speaker 2: So we appreciate that, but I.
Speaker 3: Want to start with your impression of a reacceleration that
Speaker 3: we're starting to see on the margins in goods prices.
Speaker 9: I think what's most important reader here is it shows
Speaker 9: how difficult it is to get the horse back in
Speaker 9: the bond when it comes to inflation. You think about first,
Speaker 9: goods inflation went up when we were sitting at home
Speaker 9: ordering stuff online during the pandemic. Then goods inflation came
Speaker 9: down when the supply Chaine came back on steam. And now,
Speaker 9: as Mike was just pointing out, it looks like goods
Speaker 9: inflation is beginning to re accelerate because manufacturing is beginning
Speaker 9: to show more signs of life. And you have, broadly speaking, therefore,
Speaker 9: as separate cycle in goods inflation relative to the cycle
Speaker 9: in services inflation, where initially when we were sitting at home,
Speaker 9: there was no service inflation. Now we're all going to restaurants, hotels,
Speaker 9: basically flying consumer services, and that's why service inflation has
Speaker 9: been very high. What we that cycle difference has been
Speaker 9: a very important feature, and it shows in the data
Speaker 9: also today.
Speaker 3: What we did see though, during the immediate aftermath of
Speaker 3: the pandemic was that people weren't as sensitive to price
Speaker 3: increases because they accepted that inflation was happening and they
Speaker 3: had huge bundles of savings that were left over from
Speaker 3: the pandemic. Is now different? Are you seeing consumers push back,
Speaker 3: spend less.
Speaker 2: Not actually spent when they see prices going.
Speaker 8: Up that much?
Speaker 9: Well, if you look at what was the distribution of
Speaker 9: consumption on goods and services before the pandemic, we have
Speaker 9: not normalized back, so that level in terms of the
Speaker 9: shares spent on services reads as to the shares spends
Speaker 9: on goods. We still spend quote unquote too much on goods,
Speaker 9: So that means that services still has some more upside.
Speaker 9: So you're right, people have been willing to spend more
Speaker 9: money to go to Taylor, Swift, tickets, US Open and
Speaker 9: Queen's all these things that have been so expensive because
Speaker 9: there has still been savings around. But as we all
Speaker 9: know and as we talk about all the time, we
Speaker 9: of course have this issue that savings are running out,
Speaker 9: combined with student loan payments coming back, all that does
Speaker 9: point to still more weakness on the consumer in the
Speaker 9: coming quarters.
Speaker 3: When you put charts out, especially on that savings rate.
Speaker 3: How much pushback do you get from people because everyone
Speaker 3: is so discerning of the type of data and the
Speaker 3: way that it's being framed. That a story with data
Speaker 3: can be dissected in five different ways by five different people.
Speaker 9: That's right, and I think that's also why it's not
Speaker 9: only about savings running out. It's also about the very
Speaker 9: big picture that the FED is trying still to cool
Speaker 9: the economy down. We hear that also from Merry Daily
Speaker 9: here in the segment you just played, where we are
Speaker 9: seeing already in the data, consumers are seeing higher telanguage
Speaker 9: rates on credit cards and order loans. Corporates are seeing
Speaker 9: default rates go up on high yield and on loans.
Speaker 9: We're also seeing interest covers ratios starting to dip, both
Speaker 9: by investment grade and high yield, and also on the
Speaker 9: banking side, we're also seeing a slowing in loan growth
Speaker 9: in the weekly data from the FED, both for large
Speaker 9: banks and for small banks. So taking consumers, corporates, and
Speaker 9: banks combined, the FED is succeeding. This is exactly what
Speaker 9: the textbook would have predicted, that we are seeing a
Speaker 9: slow down on consumption on corporates and on banks, and
Speaker 9: that's why this also will result in more slowing over
Speaker 9: the coming quarters.
Speaker 3: More slowing and recession. More slowing is not the same, right,
Speaker 3: And there's a question of how much slowing is necessary
Speaker 3: to truly put the horse back in the bar. And
Speaker 3: as you say, to use your analogy, and this has
Speaker 3: been one of the conundrums that's been into the market.
Speaker 2: Do you have a sense of whether.
Speaker 3: It requires a greater slowing to get that horseback in
Speaker 3: the barn? Then people are currently using as a base case.
Speaker 3: And when I say people, I mean FED officials.
Speaker 9: I do think that we need more slowing because coll
Speaker 9: PC today is three point nine and the target for
Speaker 9: the FIT is that it should be two. So we
Speaker 9: are still running around after the horse out there and
Speaker 9: trying to get it back into the two percent range,
Speaker 9: and we're just not there yet. That's what literally every
Speaker 9: from C member is telling us. So with that backdrop,
Speaker 9: given what's happening to the delinquagy rates for consumers, given
Speaker 9: what's I mean, the fault rates for Hiyil are going
Speaker 9: up at the fastest rate in the last six months
Speaker 9: in years. So the result of that is that we
Speaker 9: are seeing the effects of the FED tightening. Every single day.
Speaker 9: There are companies that cannot get financing. There are consumers
Speaker 9: who cannot buy a new car, and at the moment
Speaker 9: who have a hard time buying a new home. So
Speaker 9: in that sense, tight up policy with the Fed funds
Speaker 9: rate at five and a half is way way above
Speaker 9: the two and a half percent where they're fed and
Speaker 9: the dot plot things we should be in the long run.
Speaker 9: So policy is working exactly as the textbook have predicted.
Speaker 9: Is just the savings making it take a little bit
Speaker 9: longer time. But we are moving towards, in my view,
Speaker 9: a faster slow down what the market is considered to
Speaker 9: six expecting we're going to.
Speaker 3: Put the horse back in the pasture and leave that
Speaker 3: alone for the remainder of our time. But I do
Speaker 3: want to know why we are seeing upside surprises to
Speaker 3: the economic data in such a significant way if there
Speaker 3: is this material slowing, I mean, this has been one
Speaker 3: of the conundrums for so many people who are expecting
Speaker 3: and seeing anecdotally all of the slowing and yet each
Speaker 3: economic print coming in stronger, stronger, stronger.
Speaker 9: There are some exceptions to that. I know, the label
Speaker 9: market obviously surprise to the upside on the headline, but
Speaker 9: if you look under the hood. You see that in
Speaker 9: particular in terms of job openings peaked literally in March
Speaker 9: of twenty twenty two when the Fed started raising rates.
Speaker 9: That's been coming down. You're also seeing the work week
Speaker 9: coming down. You're also seeing wages for jobs switches coming down.
Speaker 9: You've also seen an increase in percentage of permanent job losses.
Speaker 9: So a number of the label market indicators under the
Speaker 9: hood are showing more signs of weakness, and we are
Speaker 9: definitely moving towards that. We will also maybe get that
Speaker 9: increase in the unemployment rate that Jay Powell has talked about.
Speaker 3: Given the unrust in the Middle East, there's a lot
Speaker 3: of focus on oil prices and what would happen if
Speaker 3: oil prices do have a sustained rise. How do you
Speaker 3: factor that in to your concept of harder landing than
Speaker 3: people are certainly except.
Speaker 9: I know that is certainly a very important point. I mean,
Speaker 9: oil prices now they first went up and now they've
Speaker 9: gone down a bit. But it's certainly the case that
Speaker 9: the moving oil prices is very critical also in particular
Speaker 9: of course for headline inflation. So from that perspective, the
Speaker 9: second round effects are likely going to be more limited,
Speaker 9: at least historically, they have become more and more limited
Speaker 9: over time because the economy is less sensitive to oil prices,
Speaker 9: is less energy intensive. But the short answer to your
Speaker 9: question is for headline inflation and therefore also for the fit,
Speaker 9: it does become important what oil prices are.
Speaker 2: Doing when we shake out. Where are you?
Speaker 3: Where is your thinking in terms of the long term
Speaker 3: neutral rate and how much shifted upward given some of
Speaker 3: the paradigm shifts.
Speaker 9: I think that there are some very important arguments for
Speaker 9: why the long run rate is going to be higher.
Speaker 9: We first of all have more deglobalization, more segmentation globally.
Speaker 9: That's putting more upward pressure because of unsharing or reshowing
Speaker 9: and friends showing increasing cost of production. We also generally
Speaker 9: speaking have that energy transition is going to be costly.
Speaker 9: That also is going to put upward pressure on the
Speaker 9: production of energy, and therefore if people pay more for energy,
Speaker 9: including the adjustment costs, then that will also be putting
Speaker 9: upward pressure on inflation. And finally, we likely also have globally
Speaker 9: less immigration, and if that's the case, that also means
Speaker 9: that we'd like you to going to see higher cost
Speaker 9: of production, not only in the US, but also in
Speaker 9: Europe and a broad So the conclusion is both the
Speaker 9: globalization and also energy transition and also what might be
Speaker 9: happening with immigration, all argues for that the long run
Speaker 9: rate neutral rate is likely going to be high. The
Speaker 9: FED says that in the long run will be two
Speaker 9: and a half, but we could be up closer to three,
Speaker 9: maybe even three and a half. And that's very important
Speaker 9: for anyone planning with a long horizon, because that's telling
Speaker 9: you that on page one in the finance textbook, if
Speaker 9: the risk free rate is going up, we all in
Speaker 9: financial markets need to pay attention.
Speaker 3: Tourist and slack of Apollo. Always wonderful to get your thoughts.
Speaker 3: Thank you so much for being here with us.
Speaker 5: It's a bit a supermanent.
Speaker 4: Second quotative strategy has a job at BANKCAW.
Speaker 5: Good to see it.
Speaker 4: Nice to see to see a constructive and I read
Speaker 4: your note from the other week that this can work.
Speaker 4: We can see equity returns in a higher rate environment.
Speaker 4: So the lower rates her to sort help us us
Speaker 4: out which one is it.
Speaker 10: So I think that lower rates are I mean, I
Speaker 10: think there's too much focus on the short end of
Speaker 10: the curve. I think the long end of the curve
Speaker 10: probably matters more for stocks. And then when I think about,
Speaker 10: you know, why the long end is moving higher, one
Speaker 10: of the reasons is supplied demand. You know, there's less
Speaker 10: demand from the FED and China, boja, et cetera. But
Speaker 10: there's also this growth story that you could argue for,
Speaker 10: which is the idea that companies are now focused on,
Speaker 10: you know, what they should be focused on. So so
Speaker 10: we're in an environment where I think a lot of
Speaker 10: the levers for margin improvement from kind of lower quality
Speaker 10: sources like globalization or cheap finance and saying are behind us.
Speaker 10: But ahead of us is this very exciting new theme
Speaker 10: which we haven't you know, talked about for a long time,
Speaker 10: which is efficiency, productivity, replacing labor with you know, more
Speaker 10: efficient procedures, be it AI or automation, et cetera. So
Speaker 10: I think that those are the drivers that could move
Speaker 10: the market higher from here. Now what's interesting is that
Speaker 10: so far this whole AI theme has only been rewarding tech,
Speaker 10: and I think that the story is so much broader
Speaker 10: than that. So, you know, based on our quant work,
Speaker 10: we've found that if the S and P five hundred
Speaker 10: has the opportunity to become even labor lighter than it
Speaker 10: is today. That translates into stable margins and a bump
Speaker 10: up in the multiple because investors are willing to pay
Speaker 10: more for efficiency gains than just low quality you know,
Speaker 10: fed money plus.
Speaker 8: A little bit of globalization.
Speaker 3: Are you saying that the AI boom has maybe been
Speaker 3: priced in accurately for tech companies but inaccurately priced for
Speaker 3: the rest of the comple that will benefit in just
Speaker 3: a significant a way.
Speaker 10: That is a much more eloquent way of saying what
Speaker 10: I just said with many less words. But I do
Speaker 10: think that that's the idea is you know, we're so
Speaker 10: far we're in this environment where it's like old economy
Speaker 10: is terrible, don't buy anything that's not tech. We're going
Speaker 10: to get money from this AI theme. I think the
Speaker 10: idea here is that old economy companies that are labor
Speaker 10: intensive have more tools to get labor light. And what
Speaker 10: we found, you know, in our quantitative work, is that
Speaker 10: companies that become labor light always outperform companies that don't.
Speaker 10: And it's kind of an obvious point, but it plays
Speaker 10: out in the data.
Speaker 3: Part of being able to get there and to survive
Speaker 3: long enough to get there to be able to make investments,
Speaker 3: which requires money that potentially you have to borrow. So
Speaker 3: it raises a fundamental question about at what point the
Speaker 3: rate structure makes this prohibitive for some of these old
Speaker 3: economy companies to come up to the new world. What's
Speaker 3: the tipping point for yields where it starts matter really
Speaker 3: significantly to you?
Speaker 10: For Yeah, for the S and P five hundred, I
Speaker 10: think we can see higher yields, and I guess the
Speaker 10: good news is a lot of these problematic companies with
Speaker 10: floating rate risk and that are unable to handle current
Speaker 10: rates or higher rates have dropped out of the S
Speaker 10: and P five hundred. So there's been this sort of
Speaker 10: natural attrition out of the SMP into the Russell two thousand.
Speaker 10: What I think is really interesting is that twice as
Speaker 10: many companies have fallen from the SMP to the Russell
Speaker 10: than have risen from the Russell to the SMP compared
Speaker 10: to an average year. So that is telling us that
Speaker 10: it's basically a story of the losers dropping out of
Speaker 10: the index into other indices. I don't love the Russell
Speaker 10: two thousand right now. I think it's riddled with small
Speaker 10: cap zombie companies like healthcare tech companies that can't handle
Speaker 10: this rates environment. But I think the S and P
Speaker 10: five hundred has seen a lot of those problem stories
Speaker 10: drop out, and it looks pretty healthy, right right. I
Speaker 10: love the equal weighted S and P five hundred.
Speaker 5: That's my well.
Speaker 10: I just think that the you know, as you pointed out,
Speaker 10: probably a lot of this good news has been priced
Speaker 10: into the mega cap tech cohort, maybe even overpriced into
Speaker 10: the megacap tech cohort. Everybody owns these companies, so there's
Speaker 10: not a lot of buying pressure if you think about
Speaker 10: who's next to load up on the Magnificent seven. But
Speaker 10: there is a broader array of companies that actually look
Speaker 10: pretty healthy. And if we don't go into this you
Speaker 10: know hotly forecast recession that we're all preparing for, embracing
Speaker 10: ourselves for. I think that the market could rip from here.
Speaker 10: The equal weighted SMP could.
Speaker 5: Rip, could rip. What kind of upside is rip?
Speaker 10: So yeah, it's all relative, right, So you know, I
Speaker 10: think that what we're forecasting through your end is forty
Speaker 10: six hundred for the SMP. I think the equal weighted
Speaker 10: SMP could do double those gains. So from here it's
Speaker 10: not that demonstrable. But I think over the next ten years,
Speaker 10: buying the equal weighted S and P five hundred today
Speaker 10: on a valuation basis suggests that you could get more
Speaker 10: than ten percent price returns per year from the equal
Speaker 10: weighted S and P. This is not an environment where
Speaker 10: a lot of other asset classes promised ten percent returns
Speaker 10: plus additional dividend yields.
Speaker 4: What I'm doing technically, though, I was stripping out the
Speaker 4: muscle of big tech. Yeah, and relatively speaking, giving say
Speaker 4: financial is a bigger presence.
Speaker 5: Do I want to do that right now?
Speaker 10: So financials is a tricky one. I like financials. I
Speaker 10: like large cap financials because A the banks have already
Speaker 10: been regulated. B A lot of the bad news is
Speaker 10: behind us.
Speaker 2: See, there's got.
Speaker 10: To be a shape of the yield curve that helps
Speaker 10: the banks. And what's interesting is that every phase of
Speaker 10: the yield curve has been cast as bad four banks.
Speaker 10: I think we're actually moving into an environment where, you know,
Speaker 10: if the FED is closer to being done on the
Speaker 10: short end and the long end is potentially higher for longer,
Speaker 10: that's historically been a good environment for lending. I think
Speaker 10: the banks also have the opportunity and old financial companies
Speaker 10: have the opportunity to get less labor intensive, which is
Speaker 10: bad for me, but it's good for margins of financial companies.
Speaker 10: So lots of levers that I think are underappreciated, as
Speaker 10: well as the fact that if financials, if regulated banks
Speaker 10: are regulated utilities, now, why don't they have the multiple
Speaker 10: of a regulated utilities company.
Speaker 2: Is your view.
Speaker 3: Predicated on the idea that we're really not going to
Speaker 3: get much.
Speaker 2: Of a recession.
Speaker 3: Is this basically predicated on the Fed's view of the world.
Speaker 10: It's well, this is predicated on the idea that the
Speaker 10: reason it's taking longer for the FED to control this
Speaker 10: economy is that a lot of that leverage risk has
Speaker 10: been taken out of consumers and corporates and moved to
Speaker 10: public the public sector, the government balance sheet, and the
Speaker 10: fed's own asset base. And while that all sounds in
Speaker 10: nerm racking and terrifying that we're sitting on, you know,
Speaker 10: levels of debt to GDP that are similar to emerging economies,
Speaker 10: what we found is that high levels of government leverage
Speaker 10: are not anathema for stocks. So this is interesting because
Speaker 10: I've always been like kind of worried, like in the
Speaker 10: back about this looming debt to GDP for the US
Speaker 10: and what's it going to.
Speaker 8: Do to us?
Speaker 10: It seems really awful, leverages evil. The truth is the
Speaker 10: market actually outperforms or does better during periods of a
Speaker 10: higher leverage ratio in the public sector than lower. So
Speaker 10: leverage in the public sector isn't necessarily what we need
Speaker 10: to worry about. Maybe it makes our bonds that much
Speaker 10: more less attractive, which you know, I think US treasuries
Speaker 10: might be the riskiest assecline.
Speaker 5: We can have this conversation for a long time.
Speaker 4: I wonder if yes, that's associated with coming down of
Speaker 4: bottoms in the economy, and that's.
Speaker 10: When the exactly and we grow our way out exactly.
Speaker 5: You see as always so bit of superminding. The of
Speaker 5: Bank of.
Speaker 3: America joining US now, I'm so pleased to say, to
Speaker 3: give us a lot more light than I certainly can
Speaker 3: Shatt Bloomberg's Alex Steel and Julian Lee joining us. Alex,
Speaker 3: I want to start with you, why is this deal
Speaker 3: so important?
Speaker 8: So?
Speaker 11: First of all, fifty nine point five billion dollars is
Speaker 11: nothing to sneeze. Ad in eighteen percent premium for a Pioneer.
Speaker 11: This is an enormous deal, and the broader context is
Speaker 11: that this could potentially unlock shale what people are calling
Speaker 11: shale three point zero, which would be a huge wave
Speaker 11: of m and a big deals, big spending in the
Speaker 11: permium and really long laterals, which is the basically the
Speaker 11: technique that you use to get a lot of oil
Speaker 11: out of shale, and that would be a very different
Speaker 11: place than we were in just a few years ago,
Speaker 11: where it was very much reducing capital spend. Interestingly enough,
Speaker 11: many analysts say that buying Pioneer is being capex sensitive
Speaker 11: because it actually longer term will cost less than having
Speaker 11: to increase capex to keep production.
Speaker 8: Even level, much less growing.
Speaker 3: Funnily enough, there's a question about whether part of the
Speaker 3: reason why now this deal is happening is because regulators
Speaker 3: will be more okay with it, that actually this is
Speaker 3: going to be more amenable to both investors and to
Speaker 3: regulators because of this emphasis on energy and appending this
Speaker 3: idea of just generally focusing a bit more on the
Speaker 3: need for fossil fuels rather than the move away.
Speaker 11: Yeah, you know, I see it twofold. I think one
Speaker 11: it is going to have some many trust issues. I
Speaker 11: think this gives a lot of fodder to the Greens
Speaker 11: in DC to say you're spending sixty billion dollars on
Speaker 11: fossil fuels, you're spending seventeen billion dollars in the next
Speaker 11: few years on carbon solutions and low carbon solutions. So
Speaker 11: there's that part. But in terms of kind of why now,
Speaker 11: I wonder, and I'll ask the CEOs this in the
Speaker 11: next hour, is this actually a Scott Sheffield thing? So
Speaker 11: pinor Natural Resources is like the holy grail of the permium.
Speaker 11: Scott retired once, then he came back because they didn't
Speaker 11: like the CEO at the time.
Speaker 8: And he's retiring at the end of the year.
Speaker 11: There's also been some productivity questions for Pioneer over the
Speaker 11: last two quarters. It just basically means you've gotten all
Speaker 11: the good stuff.
Speaker 8: Out of the rock.
Speaker 11: There's more there, but the really juicy stuff has been
Speaker 11: drilled and can you really get more out? Many say
Speaker 11: that that problem has been solved, but still a productivity question.
Speaker 11: There was underperformance over the last few months a Pioneer
Speaker 11: versus its peers, and I wonder if I wonder, and
Speaker 11: I'll ask it if that played more of a role.
Speaker 3: I'm wondering, Julian, from your standpoint, where the US plays
Speaker 3: in the global oil sphere and how much deals like
Speaker 3: this and just generally looking for more efficiency and frankly
Speaker 3: record production this year plays on the global stage at
Speaker 3: a time or Saudi Arabia is trying to control supply
Speaker 3: that much more.
Speaker 12: Yeah, I mean, you know, the US is certainly playing
Speaker 12: an important role, and growth in output in the Permian
Speaker 12: and other shale basins is going to be important. I
Speaker 12: don't think this deal sort of changes the outlook for
Speaker 12: oil prices in the short term, but potentially over the
Speaker 12: longer term it may do it. Certainly. I think brings
Speaker 12: together contiguous acreage, you know, acreage next to each other
Speaker 12: under a single owner that allows for longer horizontal wells
Speaker 12: to be drilled, greater economies of scale in terms of
Speaker 12: that investment in you drilling. That could boost the prospects
Speaker 12: for Permian production and US production in total, but that's
Speaker 12: probably two or three years away at least in the
Speaker 12: short term. I think it doesn't change anything. But what
Speaker 12: it does do is mean that the shale basins of
Speaker 12: the US are going to be important contributors not just
Speaker 12: to production but to potential production growth in the four
Speaker 12: to five years ahead.
Speaker 3: Julian, from your vantage point, how much are deals like
Speaker 3: this made possible based on oil prices being higher and
Speaker 3: if you have the feeling that they are going to
Speaker 3: remain so in the longer term.
Speaker 12: Well, I think, you know, there are many things I
Speaker 12: think that have factored into this deal and why now,
Speaker 12: And I think, as Alex said that, you know, the
Speaker 12: Scott Sheffield question is certainly potentially one of those. As
Speaker 12: to oil prices, I mean, at the moment, they are
Speaker 12: very much being dictated I think by Saudi Arabia's oil policy.
Speaker 12: They want oil prices somewhere closer to one hundred dollars
Speaker 12: a barrel than seventy, for example, and they are prepared
Speaker 12: to make the production sacrifices at the moment to ensure
Speaker 12: that happens. The big question is going to be over
Speaker 12: the longer term whether they can continue to do that
Speaker 12: if demand growth starts to ease off as people are
Speaker 12: expecting next year, and we get additional supplies coming on
Speaker 12: from places like the US, Guyana, Brazil, and so that's
Speaker 12: going to be a challenge for Saudi Arabia, perhaps over
Speaker 12: the next twelve to twenty four months. The immediate question
Speaker 12: is how this terrible attack by Hamas on Israel is
Speaker 12: going to play out. We saw a jump in prices,
Speaker 12: followed over the last couple of days by something of
Speaker 12: a retreat. Very much is going to depend on whether
Speaker 12: this conflict spreads and starts to suck in oil producers
Speaker 12: in the Middle East, Iran being the big question.
Speaker 3: Mark Alex, your idea just in terms of the pricing
Speaker 3: and how that factors in.
Speaker 11: Yeah, so one analysts said that Pioneer has sixty three
Speaker 11: hundred net locations of high quality inventory. That's like top
Speaker 11: tier acreage where you get a ten percent return at
Speaker 11: WTI price is fifty or lower. So like the last
Speaker 11: barrel produce may increase, like you might need eighty dollars
Speaker 11: a barrel for that kind of floor, but you're buying
Speaker 11: stuff that you can make money and have a nice
Speaker 11: return sub fifty.
Speaker 3: Which is the reason why I thank people are doing this, Alex.
Speaker 3: What are you hearing in terms of other deals coming
Speaker 3: down the pike to either compete with this or just
Speaker 3: that have been in the work since suddenly people are
Speaker 3: finding the reason to get it done.
Speaker 11: So it's going to have to happen because if you're
Speaker 11: a mid tier player, you will not be able to
Speaker 11: compete with this. So the Oxes of the world, you
Speaker 11: have Chevron like, they're going to be just fine even
Speaker 11: though they're dwarfed a bit by this deal. But the
Speaker 11: smaller guy, I don't know how you're going to do it.
Speaker 11: And there's a lot of small, mom and pop private
Speaker 11: companies as well that have are been kind of pulling
Speaker 11: back on some of their drilling, and the theory is
Speaker 11: they're doing that so then they can clean themselves up
Speaker 11: a little bit to them be bought. So we'll see
Speaker 11: how quickly it takes for that to happen.
Speaker 3: And just real quick here, Julian, and not to pivot
Speaker 3: too much, but I would like to get a final
Speaker 3: word from you on what you're hearing out of Iran
Speaker 3: and how much further crackdown of sanctions would really influence
Speaker 3: the price.
Speaker 12: Well, I mean we're hearing relatively little out of Iran.
Speaker 12: I mean there's been you know, political support voice for
Speaker 12: Hamas as they're very often generally is from Tehran. We're
Speaker 12: not hearing anything yet about action against Iran or any
Speaker 12: action to try to restrict their own oil exports. We've
Speaker 12: seen a fairly substantial increase in estimates of production and
Speaker 12: exports over recent months. That's been an important factor in
Speaker 12: holding oil prices lower than they would otherwise have been.
Speaker 12: And there is a challenge here that if you start
Speaker 12: going after Iran's oil exports, that is going to have
Speaker 12: an impact on the oil price, and nobody wants higher
Speaker 12: oil prices in the consuming countries.
Speaker 3: Julian Lee, Bloomberg's Alex Steel, Thank you so much for
Speaker 3: being with us. Subscribe to the Bloomberg Surveillance podcast on Apple, Spotify,
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Speaker 12: Rest.
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