Speaker 1: Hello, and welcome to another episode of the Odd Lots podcast.
Speaker 1: I'm Joe and I'm Tracy Alloy. Tracy, we know a
Speaker 1: couple of things about the economy right now. We know
Speaker 1: that inflation is high, it's way too hot for the
Speaker 1: FED and the general public, and that the FED as
Speaker 1: of the moment, plans to hike aggressively over the next
Speaker 1: several meetings in order to bring down inflation. I don't
Speaker 1: think we actually know much more than that. Yeah, I
Speaker 1: think there are a lot of open questions on what exactly,
Speaker 1: well a, what impact our hikes actually going to have
Speaker 1: on the economy, how to interest rate hikes actually work
Speaker 1: to slow down price levels, And of course there's this
Speaker 1: big open question about whether or not we should be
Speaker 1: targeting demand when supply seems to be more of an issue.
Speaker 1: But the other thing we don't really know is how
Speaker 1: does the FED react once the impact or the effects
Speaker 1: of those hikes start working their way through the economy.
Speaker 1: What level of inflation is acceptable? Does it have to
Speaker 1: go back to two percent? Is the FED willing to
Speaker 1: I don't know, accept slightly higher levels of inflation in
Speaker 1: order to preserve I guess functioning financial markets and things
Speaker 1: like yeah, like like the question of okay, if it
Speaker 1: would the FED be happy with three and a half
Speaker 1: inflation three and a half inflation if it means it
Speaker 1: doesn't push us into a research Yeah, it strikes me
Speaker 1: is like an interesting question. It feels like, and I
Speaker 1: know we've been saying this for two years now, but
Speaker 1: it feels like we are actually in a different type
Speaker 1: of economic cycle, and so there are a lot of
Speaker 1: open questions swirling around exactly what that looks like and
Speaker 1: how potentially it ends. Yes, so I think there's this
Speaker 1: view that Okay, maybe uh, the inflation is expected to
Speaker 1: come down significantly, but it's unlikely to get back down
Speaker 1: to target by the end of the year. And so
Speaker 1: then the question is like, well, how hard does the
Speaker 1: FED push for those last one or two percent or
Speaker 1: does it ease off a little bit. But then also again,
Speaker 1: and it's a question that never really comes up, which
Speaker 1: is can the Fed articulate how rate hikes help, how
Speaker 1: they how they tame inflation. We have this idea, you
Speaker 1: hike rates inflation and theory goes down. But I think
Speaker 1: the FED is getting a little bit more explicit about this.
Speaker 1: It's like, yeah, well, maybe there's gonna be some pain.
Speaker 1: Maybe unemployment is going to rise, but again, most parts
Speaker 1: of the economy aren't really rate sensitive. It's like housing
Speaker 1: is obviously the big one, maybe autos, and so the
Speaker 1: connection between rate hikes and actually getting inflation of target,
Speaker 1: at least to me, I think there's still some ambiguity. Yeah,
Speaker 1: and I think, I mean, I think most of the
Speaker 1: people at the FED would readily admit that, and they're
Speaker 1: still talk talking about it and trying to work their
Speaker 1: way through it as well. So it's a weird time.
Speaker 1: And I think that, you know, right, there's all these
Speaker 1: questions about what is the Fed's goal, how does it
Speaker 1: accomplish them, what's it, what's it really trying to achieve?
Speaker 1: What success look like. So we're going to talk about
Speaker 1: that today. We're going to be speaking to one of
Speaker 1: our colleagues at Bloomberg, one of the sharpest people here,
Speaker 1: one of the great writer and someone that we've been
Speaker 1: fans of for years before he even came to Bloomberg.
Speaker 1: So it's real treat and he's a colleague. We're gonna
Speaker 1: be speaking with Ed Harrison, he's a senior editor on
Speaker 1: the Markets team, and he will answer, he will tell
Speaker 1: us all the answers to these questions. He has the answers,
Speaker 1: he's gonna give us a edit. Thank you so much
Speaker 1: for coming on odd lots, well, thank you for having me,
Speaker 1: and I hope I have some of the our colleague
Speaker 1: now at Bloomberg coming up on the year. Actually next
Speaker 1: month it will be one year. I don't want to say,
Speaker 1: I don't want to like sidetrack because this is not
Speaker 1: the topic of the conversation of them. Maybe we could
Speaker 1: get into it, but you know, I've been reading your
Speaker 1: blog and your newsletter. Credit right now is for year.
Speaker 1: It's probably coming out a decade, and I was thinking,
Speaker 1: I was actually talked to someone about it the other day,
Speaker 1: and you know, you're there's sort of like indispensable source.
Speaker 1: During the euro crisis, Italian spreads are widening again, Like
Speaker 1: where's a little bit of tension in Europe again, isn't there? Yeah,
Speaker 1: I mean there are all sorts of weird externalities that happened.
Speaker 1: When I mean, because the way I remember the euro
Speaker 1: crisis anyway was Dubai World. Yeah, I remember Dubai. That
Speaker 1: was the event that kicked off people questioning UH sovereign
Speaker 1: debt and bizarrely then it moves straight to Europe. So
Speaker 1: Dubai degrees exactly. It's almost like a butterfly flat effect. Uh,
Speaker 1: this is bringing back euro crisis flashbacks. So I'm going
Speaker 1: to bring us back to firmly because we have a Yeah, yeah,
Speaker 1: we'll just talk about the e CP for for thirty minutes,
Speaker 1: and it speaks seven languages, so he's actually anyway, let's
Speaker 1: go back, We'll talk about the ECB in court Uguese
Speaker 1: and greet No, let's talk about inflation and the economy
Speaker 1: in the US and try to focus it a little bit.
Speaker 1: So maybe just to begin with the really broad question
Speaker 1: that Joe was kind of hinting at in the intro,
Speaker 1: but what exactly our interest rate hikes supposed to do
Speaker 1: in the current situation. I think that they're basically supposed
Speaker 1: to from what I understand, the FED saying is bring
Speaker 1: supply demand into balance. And ultimately, when they say that,
Speaker 1: what they're saying essentially is is that if the supply
Speaker 1: is limited, then we're going to limit the demand. We're
Speaker 1: going to bring demand down to the limited level that
Speaker 1: supply is. So they're essentially creating the preconditions for a recession. Now,
Speaker 1: if they bring the demand down to a level to
Speaker 1: think of it in sort of like a Goldilocks or well,
Speaker 1: actually I think it's the one with the too hot
Speaker 1: too cold forwards. What was um that they're thinking, Okay,
Speaker 1: we'll bring it down, demand down, but not so far
Speaker 1: down that we have a recession. How All has started
Speaker 1: to dance around that issue, and I think he is
Speaker 1: mirroring something that I heard Loretta Master, who's the Cleveland
Speaker 1: FED president say. She mentioned to Mike McKee, one of
Speaker 1: our colleagues, that maybe we'll get another quarter or two
Speaker 1: of negative growth to go along with the Q one
Speaker 1: negative growth that we had. Mike McKee was like, that
Speaker 1: sounds kind of like a recession, and she was like, no, no,
Speaker 1: maybe not. And so now the new code word is softish,
Speaker 1: soft soft landing soft ish. So what does that mean?
Speaker 1: I think what it means to me is what the
Speaker 1: FED is effectively doing is they're telling you that a
Speaker 1: mild recession is not a problem. And to some extent,
Speaker 1: I mean, look, I don't think the FED wants a recession. Clearly,
Speaker 1: like all things being equal, it would clearly prefer growth
Speaker 1: to recession. But there is something about that sick knowing
Speaker 1: it seems like it's an expression of seriousness. When the
Speaker 1: FED is telling us that it might be willing to
Speaker 1: tolerate a recession if that's what it takes to bring
Speaker 1: down demand such to a level such that we're back
Speaker 1: and balanced and don't have this high inflation anymore. It's
Speaker 1: sort of indicating a a seriousness about the degree to
Speaker 1: which it will undertake its task definitely. And so I
Speaker 1: think then the question for us is are what are
Speaker 1: their hopes and dreams and what are their prognostications about
Speaker 1: what's likely to occur? You know, is the is the FED,
Speaker 1: unlike what Bill Dudley saying, actually pulling its punches. Is
Speaker 1: the FED not giving us the full story? Maybe the
Speaker 1: FED actually believes that soft dish is the base case.
Speaker 1: Why don't you go out and say that. But they're
Speaker 1: not saying that. What they're saying is is we're hoping
Speaker 1: that we can get this down and the economy keeps growing.
Speaker 1: But more and more of financial markets are pricing themselves
Speaker 1: as if that is more likely to be the case.
Speaker 1: So there's another thing that I think we take for
Speaker 1: granted at this point in time, and I think it
Speaker 1: should be discussed a lot more and that is the
Speaker 1: pace of the hiking cycle. So we just saw fifty
Speaker 1: basis points at the last decision, and I think the
Speaker 1: Fed's talking about doing fifty basis points at the next decision.
Speaker 1: And it seems like they are moving, and they've used
Speaker 1: the specific word, but they're moving quickly and expeditiously, and
Speaker 1: it feels like there's really a sense of urgency. But
Speaker 1: on the other hand, they will also openly talk about
Speaker 1: the economy is already slowing. We think that inflation is
Speaker 1: currently peaking. So I guess my question is, like, why
Speaker 1: that urgency? What exactly are they worried about here? Is
Speaker 1: it inflation expectations becoming unmoored, is it some sort of
Speaker 1: wage price spiral, or is it something really simple like
Speaker 1: credit city they have to come in and convince people
Speaker 1: that they are serious about prices. Yeah, I think it's
Speaker 1: all of that. Um And you know, there are three
Speaker 1: words that I've been listening to that I find very interesting,
Speaker 1: and the way that they talk about it expeditiously as
Speaker 1: one of the words. Cadence is another word, and then
Speaker 1: there's that softish word. I think that when you combine
Speaker 1: the three of them together, what it says is that
Speaker 1: they want to front load, meaning that they want to
Speaker 1: do it at a specific cadence fifty basis points, and
Speaker 1: then have the optionality after that to be able to
Speaker 1: do whatever they need. You know, Loretta Mester, who I
Speaker 1: mentioned before, I find her talking points very beneficial. They're
Speaker 1: very much on point in terms of, you know, what
Speaker 1: the FED is looking to do. And she talked about
Speaker 1: the optionality question, and so that's what frontloading is supposed
Speaker 1: to do. It's supposed to say, if we at the
Speaker 1: time that we start hiking hike more aggressively in the beginning,
Speaker 1: then we have the option to go zero, we have
Speaker 1: the option to go twenty five, we have the option
Speaker 1: to go fifth. We have more optionality that way. And
Speaker 1: given the fact that our policy acts with a lag,
Speaker 1: then that's beneficial because the stuff that we did three
Speaker 1: or four months ago, we'll start to see that filter
Speaker 1: into the system, and then we might even be able
Speaker 1: to completely miss a meeting. We might be able to
Speaker 1: go that meeting, we might be able to speed it up.
Speaker 1: But by front loading, by going at this specific cadence,
Speaker 1: this fifty basis points cadence, we're giving ourselves more optionality
Speaker 1: rather than less I want to actually go back to
Speaker 1: the first question because there's another component of it. When
Speaker 1: we talk about what is the FED trying to do?
Speaker 1: It is you by raising rage and as you say that,
Speaker 1: it's trying to bring supply and demand into balance and
Speaker 1: a supply constrained environment, it means bring demand down. But
Speaker 1: there's another step, which is what is the transmission mechanism
Speaker 1: between higher rates and bringing demand down? How do you
Speaker 1: think it works or how does the FED thing that
Speaker 1: works mechanically? They had marks, they're like fifty and may
Speaker 1: probably gonna get another. How does the higher rates translate
Speaker 1: into lower demand? Yeah, I mean, and that is the
Speaker 1: tricky question. I mean, that's the dollar question because there
Speaker 1: are a lot of different thoughts about that. It's so
Speaker 1: wild that like this is the primary tool that we
Speaker 1: have in the developed world to manage inflation, which economists
Speaker 1: considered basically to be the top test, and that actually
Speaker 1: we don't really know or have like a clear sustinct
Speaker 1: answer from anyone, but how that works? But any what,
Speaker 1: what's what's the thinking generally on how this works? Well,
Speaker 1: let me throw a curveball into the conversation, because you know,
Speaker 1: every once in a while get a chance to talk
Speaker 1: to Warren Moser, the godfather of mm T. Yeah, and
Speaker 1: as controversial is some of the things he says are.
Speaker 1: The thing that I find the most interesting in the
Speaker 1: controversy is his concept that when the Fed hikes rates,
Speaker 1: they're actually adding interest income to the private sector. So literally,
Speaker 1: yesterday I was walking down the street and I got
Speaker 1: an email. It was from my savings account. The savings
Speaker 1: account said, your interest rate is going up. It's going
Speaker 1: up from like almost nail to a little bit more
Speaker 1: than nil. But that amount that it went up by
Speaker 1: a new team is uh. You know, that potentially could
Speaker 1: add to aggregate demand. So when we talk about interest
Speaker 1: rates going up only working against uh, the economy, it's
Speaker 1: not entirely true. When you look at the mechanisms offen
Speaker 1: what's sort of like the mainstream view of the transmission. Yeah,
Speaker 1: so I think the mainstream view of the transmission mechanism
Speaker 1: is mostly about financial conditions tightening. And you know, there
Speaker 1: are two things in particular that I would think of,
Speaker 1: one as mortgages and interest rates for businesses, and then
Speaker 1: the other is discount rates. So you think about stocks
Speaker 1: and bonds going down because interest rates are going up,
Speaker 1: that's financial conditions tightening. But also when you think about
Speaker 1: mortgage rates going up, when you think about bond yields
Speaker 1: going up, that's also financial conditions tightening. And the biggest
Speaker 1: tricky point for the FED is that the United States
Speaker 1: is an economy, especially in the household sector, that is
Speaker 1: leveraged to fixed rate mortgages. You know, in the UK,
Speaker 1: when you raise interest rates immediately, everyone's mortgages goes up
Speaker 1: relatively quickly. In the United States, there's been a massive
Speaker 1: refive boom that has been stopped out now and so
Speaker 1: there are a lot of people who are at very
Speaker 1: very low thirty year of mortgage rates and so increase
Speaker 1: seen interest rates just a little bit, you know, fifty
Speaker 1: basis points, a hundred basis points may not be enough
Speaker 1: to have a tightening of conditions in that market. That
Speaker 1: is interesting. Does that mean that they have to pull
Speaker 1: other levers or they have to wait for other components
Speaker 1: of financial conditions to start tightening, And you know, things
Speaker 1: like asset prices will feed into that, right right, So
Speaker 1: I mean they're looking at an aggregate picture, and so
Speaker 1: they have to if they want the feed through mechanism
Speaker 1: to work, then they might have to do more or
Speaker 1: get more from one of those other areas, and obviously
Speaker 1: the more that you get, the greater the chance for
Speaker 1: discontinuity where you get sort of liquidity problems, where you
Speaker 1: get crises and things of that nature. Yeah, So this
Speaker 1: is what I was sort of alluding to in the
Speaker 1: intro about market functioning. But it does feel like we
Speaker 1: are in this environment. You know, things are unclear at
Speaker 1: the best of times, and no one seems to know
Speaker 1: how inflation actually works or how interest rates actually worked
Speaker 1: to tame inflation. And then add in this unusual situation, uh,
Speaker 1: post COVID, where we have supply issues. Uh, we have
Speaker 1: things just being very different to how they were before.
Speaker 1: And it feels like that there's a potential here for
Speaker 1: something to go wrong, or for something to break, or
Speaker 1: for the FED to overdo it in some way. So
Speaker 1: how do you think they're thinking about and trying to
Speaker 1: manage that particular risk? You know, that is a very
Speaker 1: good question, because it's not clear that they have a
Speaker 1: specific strategy on that. Uh. The thing that I found
Speaker 1: most interesting from the FED recently is that some of
Speaker 1: the speakers, and I think actually most of the speakers
Speaker 1: that I've heard including the most hawkish speaker, mentioned the
Speaker 1: tightening of financial conditions. And I think that the terminology
Speaker 1: that Jim Bullard, who is the St. Louis FED President
Speaker 1: and who is uh one of the more openly hawkish members,
Speaker 1: the terminology use was quite a bit or you know,
Speaker 1: a lot, So to me, that's sort of a messaging
Speaker 1: that it sort of undercuts this whole thing that we're
Speaker 1: moving expeditious lee and will you know, we want to
Speaker 1: soft this potentially mild recession landing. But at the same time,
Speaker 1: it tells you that they're looking at financial conditions so
Speaker 1: they won't let things unravel. Uh, is I think what
Speaker 1: the messaging is that. I mean, that's the best they
Speaker 1: can do. So this is something Tracy and I were
Speaker 1: actually just talking about this at lunch, and you know,
Speaker 1: stock trading is really hard and I could never do
Speaker 1: it professionally, and I'm glad that's not my job. But
Speaker 1: you know, stocks are financial conditions or the you know,
Speaker 1: when stocks go up, that represents a loosening of financial
Speaker 1: conditions when they go down. In some sense, the FED
Speaker 1: basically said by saying that a we wanna defeat inflation
Speaker 1: by tightening policy and be our policy works through tightening
Speaker 1: financial conditions. In some sense, the FED sort of told
Speaker 1: you that they were going to make stocks go down, right,
Speaker 1: And you know, I think it's interesting because the number
Speaker 1: of former FED officials and people in the know who
Speaker 1: have been telling the FED, and Build Dudley in particular,
Speaker 1: that by the way, if stocks aren't going down, you're
Speaker 1: really not tightening plants of conditions. I think it's interesting
Speaker 1: because clearly they're listening to what Bill Dudley has to say. Well,
Speaker 1: and then the other follow on that striking is I
Speaker 1: think if you look at like corporate behavior, you can
Speaker 1: see a pretty clear link between a following stock market
Speaker 1: and hiring and decisions to hold back on hiring. And
Speaker 1: so we know that the most intense um selling in
Speaker 1: the stock market is a lot of these high flying
Speaker 1: tech stocks, and one after another, you're reading these memos
Speaker 1: like we're putting on a hiring freeze because investors want
Speaker 1: to see free cash flow. They don't want us to
Speaker 1: spend a lot. So to the extent that the goal
Speaker 1: of for the FED is to have the softish landing
Speaker 1: and to sap demand. And one way you sap demand
Speaker 1: is by weakening the labor market. Maybe increasing unemployment. You
Speaker 1: can draw a pretty straight line between they've tightened, they've
Speaker 1: hit stocks, and stocks the companies who stocks have fallen
Speaker 1: are slowing hiring, right, and so unemployment. I think Bill
Speaker 1: Dudley at one point during the last business cycle, when
Speaker 1: he was a FED official, you know, New York Fed president,
Speaker 1: he mentioned something about to load two low unemployment, low
Speaker 1: low unemployment, and I think he said too low unemployment.
Speaker 1: So you know, mentally, this whole Phillips curve thinking, which
Speaker 1: is what that's representative of. It says that you need
Speaker 1: to throw people out of work and uh, and that's
Speaker 1: going and that's ultimately how demand gets slowed down. So
Speaker 1: when we think about the transmission mechanism, ultimately it's about
Speaker 1: people losing their jobs, which is difficult just on a
Speaker 1: human level to think about. That's that's our transmission mechanism.
Speaker 1: So one thing I was reading just before I came
Speaker 1: in here, there's a big paper published by the Bank
Speaker 1: for International Settlements. Actually I think they called it a book,
Speaker 1: and it is very long, and it's all about inequality
Speaker 1: in recent years, the fact that inequality has been going
Speaker 1: up and what it means for central banks and the
Speaker 1: contention there is that inequality actually makes monetary policy less
Speaker 1: effective because you know a lot of people are sort
Speaker 1: of the wealthiest percentile or the wealthiest chunk of the
Speaker 1: population are insulated from things like mortgage rates going up
Speaker 1: to your point earlier. So I guess my question is, is
Speaker 1: is there a better way to try to bring supply
Speaker 1: and demand into balance than a pure blunt interest rate hike. Yeah,
Speaker 1: And it's to me that question automatically makes you think
Speaker 1: about fiscal and monetary policy and some of the debates
Speaker 1: that you might have about what you should do and
Speaker 1: where there is a quasi fiscal monetary policy where the
Speaker 1: line gets drawn, etcetera. And I think what we've seen
Speaker 1: is that the FED believes, and it's probably true that
Speaker 1: these other substitute policies like quantitative easy are squishy, They're
Speaker 1: not as easy to deal with, and there are externalities
Speaker 1: like we saw with the repot crisis in two thousand
Speaker 1: and nineteen, that they wish to avoid. So quantitative tightening
Speaker 1: is seen as an adjunct to the primary tools. I
Speaker 1: think there between a rock and a hard place in
Speaker 1: terms of coming up with other mechanisms regulatory certainly, but
Speaker 1: you know this hard blunt instrument really is what they have,
Speaker 1: and then you ask yourself what else can be done
Speaker 1: from a policy perspective, and that obviously begs the fiscal question. UH.
Speaker 1: I think what we're seeing, especially with the degree of
Speaker 1: in the United States at least wrangling discord ward that
Speaker 1: if you want things to get done because you're behind
Speaker 1: the curve or because inflation is moving quickly, it's very
Speaker 1: difficult to think that fiscal is a replacement for monetary policy.
Speaker 1: And I think that one of the reasons that we've
Speaker 1: been leaning on monetary policy, and these are unelected officials obviously,
Speaker 1: is because they can get it done very quickly. Well,
Speaker 1: and if if we sort of accept and I don't
Speaker 1: know that we necessarily should, but if we sort of
Speaker 1: accept this premise that people need to be thrown out
Speaker 1: of work in order to bring supply and demand into balance,
Speaker 1: I guess at some level politicians maybe like getting doubt
Speaker 1: source that to UH, unelected officials at the at the
Speaker 1: Federal Reserve, rather than having to make a policy decision
Speaker 1: that would have that effect. Yeah, I think that you know,
Speaker 1: we we would need a complete rework of our police,
Speaker 1: little cool policy making institutions, and not just in the
Speaker 1: United States, but I would say generally speaking in western
Speaker 1: or in industrialized economies. So where do you stand and
Speaker 1: what is history tell us about this prospect of either
Speaker 1: the soft or the soft dish landing, because there are
Speaker 1: some few of its like this is a fantasy. It
Speaker 1: never happens every time they go into one of these
Speaker 1: hiking cycles, especially with inflation as high as it is
Speaker 1: eight percent, so they have a lot of work to
Speaker 1: do to bring into the target. And so the argument is,
Speaker 1: there is no historical precedent for this much of an
Speaker 1: inflation collapse, without a recession, without a meaningful increase in
Speaker 1: the unemployment rate. To my mind, the only counter argument is, yeah,
Speaker 1: maybe there's no historical precedent for that. There's also no
Speaker 1: historical precedent really for a pandemic and this sort of
Speaker 1: extremely strange business cycle or this cycle that we've seen
Speaker 1: over the last two years. But in your reading of history,
Speaker 1: is the soft dish landing possible? I would say that's
Speaker 1: not my base case. I'll give you two things that
Speaker 1: I'm looking at, which some of the Fed officials point to,
Speaker 1: and the seventies. So with regard to ninety four, one
Speaker 1: of the reasons that we look at that is because
Speaker 1: that was a soft ish landing. Not just softish, it
Speaker 1: was soft in the sense that, you know, you had
Speaker 1: a fourteen percent correction in the NASDAC at that particular juncture,
Speaker 1: interest rates went up, people were thrown out of work.
Speaker 1: You know what we've the financial condition adjustment that we've
Speaker 1: seen thus far is commensurate with that particular period. It
Speaker 1: would be nice if that were the analog. There there
Speaker 1: are multiple problems with that analog. However, one of the
Speaker 1: problems that you mentioned is that inflation is much higher now.
Speaker 1: Second problem is because inflation is much higher, we have
Speaker 1: to be more aggressive, or at least the FED believes
Speaker 1: that it has to be more aggressive. In there was
Speaker 1: never any back to back rate hikes of more than
Speaker 1: issues points. Uh. The last time that there were back
Speaker 1: to back rate hikes greater than basis points and those
Speaker 1: are the last two before recession. And now the Feds
Speaker 1: talking about back to back to back fifty basis point
Speaker 1: rate hikes plus the potential for more after that. So
Speaker 1: that's a differential in terms of the adjustment process, which
Speaker 1: is much greater than and then the last thing, going
Speaker 1: back to the inflation question, when you look at the
Speaker 1: FED funds rate and the real rate of inflation that
Speaker 1: people experience. So when you think about real rates rather
Speaker 1: than you know, Treasury inflation protected securities, tips look at
Speaker 1: FED funds minus CPR and what you find is is
Speaker 1: is that in order to break the back of inflation,
Speaker 1: you had FED funds above cp I materially for a
Speaker 1: continuous period of time in the early eighties, and and
Speaker 1: we're nowhere close to that. So that would be like, right,
Speaker 1: I can't even imagine exactly, And you know, I'm actually
Speaker 1: I was writing a piece right before this about the
Speaker 1: seventies in that regard. You know, if you look at
Speaker 1: the seventies early seventies, before the oil shock, we had
Speaker 1: FED funds above cp I as inflation was going up.
Speaker 1: But then the oil shock hit and the Fed relented.
Speaker 1: They allowed the Fed funds to fall below the cp
Speaker 1: I and then inflation kept on going down, but it
Speaker 1: dipped only to five point nine percent before it started
Speaker 1: going up again. And then that's when Boker came in
Speaker 1: and really went to town. Can I say something weird?
Speaker 1: You know, people talk about low interest rates and easy money,
Speaker 1: but when I hear like ten percent Fed funds, right,
Speaker 1: and I think, like I just put money in a
Speaker 1: bank account and get ten percent back, Like that seems
Speaker 1: like the really easy money to me. But I guess
Speaker 1: obviously you'd be losing a lot on inflation, and that's
Speaker 1: the whole point of having higher interest rates, and you
Speaker 1: might not have an income in an environment. Setting that aside,
Speaker 1: temperacent sounds great, okay um. On a serious note, so
Speaker 1: I feel like to the recession point, one of the
Speaker 1: things that has happened most recently is we've also seen
Speaker 1: some questions swirling around the health of the U. S. Consumer.
Speaker 1: And this was supposed to be the thing that was
Speaker 1: really underpinning the expansion. Consumers were resilient. Now we've seen
Speaker 1: consumer sentiment readings for the past few months that have
Speaker 1: come in quite poorly, and then more recently we've seen
Speaker 1: some major major retailers start to warn on the profit forecast.
Speaker 1: So Target and Walmart were the big names most recently.
Speaker 1: We're recording this on May nineteen. I should add, what
Speaker 1: is going on there and does is that an early
Speaker 1: sign of the economy slowing or an early sign that
Speaker 1: perhaps we've misinterpreted and inventory build as underlying economic strength
Speaker 1: and maybe we're hiking too fast. Yeah. My view on
Speaker 1: that is that the markets are looking forward, and they're
Speaker 1: looking forward to concerns about the consumer, and those concerns
Speaker 1: are in the future, and that the data that we've
Speaker 1: seen thus far do not show the consumer melting at
Speaker 1: this point in time. So, first, on consumer sentiment, I
Speaker 1: think that in the last two recessions, what we saw
Speaker 1: is there's no correlation between consumer sentiment and actual consumer spending.
Speaker 1: That the concept that because sentiment has been low for
Speaker 1: a while, but spending we just got April data is fantasic,
Speaker 1: is great. I don't know what economists use consumer sentiment
Speaker 1: for in order from a predictive tool, but I'm very
Speaker 1: skeptical about that tool as a you know, foreshadowing of
Speaker 1: ekening consumer demand. Then the second thing when you look
Speaker 1: at Target and Walmart in particular, I was looking at
Speaker 1: Target just the other day when it came out comparable
Speaker 1: store sales were up three percent versus expectations for like
Speaker 1: zero points something percent, zero point three or zero point five.
Speaker 1: I think it was so they beat on the top
Speaker 1: line basis. Their problem was that the margins were cut
Speaker 1: in half. And obviously, since your stock is based upon
Speaker 1: your net income, you know, the free cash flow. That's
Speaker 1: a problem for the stock, but it's not a problem
Speaker 1: for consumer spending. It was really interesting reading the Target
Speaker 1: earning this call because it was strange. I mean, so
Speaker 1: Target came out of their quarterlier part and they then
Speaker 1: the stock proceeded to plunge, had a worst day since.
Speaker 1: But as you say, the top line was okay, and
Speaker 1: they actually said, like, demand is fine and people keep
Speaker 1: coming to the storage and Travis, it was basically their
Speaker 1: costs are going up, and they really misread apparently the
Speaker 1: ship aft in consumption, which we all knew was coming,
Speaker 1: and so everyone's been talking for like probably at least
Speaker 1: a year and a half it's like at some point
Speaker 1: we're gonna switch back from household durable goods to services,
Speaker 1: and they really misread the timing and now they have
Speaker 1: this huge inventory pile. But it was interesting how they
Speaker 1: kind of said, like, but actually help the consumers, okay, right,
Speaker 1: And so in the context of correction and the worst
Speaker 1: day since n it tells you that, you know, it
Speaker 1: tells you something about the sentiment of the markets and
Speaker 1: the jitteriness. It doesn't tell you anything about actual consumer demand.
Speaker 1: The thing that they said that worried me the most
Speaker 1: was the point that you said they used to be
Speaker 1: very good at reading consumer demand, but the pandemic and
Speaker 1: supply chain shortages has wrought havoc on their ability to forecast.
Speaker 1: And I think that this is the hidden problem from
Speaker 1: an inflationary perspective, because when you have one of the
Speaker 1: best companies in terms of being able to do that
Speaker 1: having those problems, then the question becomes a how long
Speaker 1: does that last? And be why are they having those problems.
Speaker 1: I think one of the reasons that they're having the
Speaker 1: problems is because we're in a new era. That era
Speaker 1: is not the previous era, which was a just in
Speaker 1: time inventory era. We're in an era where supply chains
Speaker 1: are less just in time inventory builds, and then by
Speaker 1: the time you realize that you've not gotten it right,
Speaker 1: then suddenly you have to purge those inventors and demand
Speaker 1: is moved to somewhere else. That's much more akin to
Speaker 1: the period that we had pre China integration into the
Speaker 1: global this system. That's more like, you know, the nineteen
Speaker 1: seventies and nineteen eighties and nine nineties, and now we're
Speaker 1: going back to that. So if we go back to
Speaker 1: the soft landing question. You pointed out like history is
Speaker 1: not very encouraging on this front, but I guess they
Speaker 1: you know, to me, I can think of like a
Speaker 1: few counter reasons, and one is, look, we've we're in
Speaker 1: We're not in a business cycle classically. The recession that
Speaker 1: we saw in spring of is not like a true
Speaker 1: It was an exogenous shock. It we bounced back very quickly.
Speaker 1: The recovery was not a normal expansion. It was um so.
Speaker 1: And I think if you listen to feed officials, even Powell,
Speaker 1: there's if the you know, eight plus eight point five
Speaker 1: percent inflation that we see today, there's some chunk of
Speaker 1: it that would still be characterized as transitory factors, right,
Speaker 1: things related supply chain pressure is like the sort of
Speaker 1: things we used to talk about on this podcast a
Speaker 1: year ago, you know, cars and chips and all that.
Speaker 1: And then there's something I was like, some sort of
Speaker 1: like underlying pressure. And I guess the sort of like
Speaker 1: the optimistic arguments is that a big chunk of that
Speaker 1: eight and a half percent is still things that we
Speaker 1: would call it transitory event will normalize when all the
Speaker 1: effects of the pandemic are gone. How do you think
Speaker 1: about that? Coursure, like, how do you wait, why do
Speaker 1: you think we have eight and a half percent inflation
Speaker 1: right now? Like, how do you sort of like wait
Speaker 1: the different drivers of it? Yeah, and I think it's
Speaker 1: a great question, but I don't know any more than
Speaker 1: anyone else obviously. But that's the that's another you know,
Speaker 1: sixt or four thousand other question in terms of should
Speaker 1: we wait? Where where's our terminal rate? In terms of
Speaker 1: how we think about this, because let's say let's disaggregate
Speaker 1: the eight point three percent and say that four percent
Speaker 1: of that is temporary, four point three percent of that
Speaker 1: is remaining. We're going to bring demand down to the
Speaker 1: supply level, and so that four point three percent will
Speaker 1: fall to two percent over time. That's one way to
Speaker 1: look at it. What does that mean in terms of
Speaker 1: the terminal rate? It means three rate hikes up to
Speaker 1: two percent and then say, uh, basis point hikes until
Speaker 1: you get to say three point five percent. By the
Speaker 1: time you get to three point five percent, actually the
Speaker 1: Fed Funds rate is above or about the same as
Speaker 1: the c p I. So that's a scenario, and that's
Speaker 1: a very benign scenario. A less benign scenario is one
Speaker 1: in which only say two percent of that is actually
Speaker 1: supply chain related, and that you bring demand down. You
Speaker 1: bring it down to say where the CPI is at
Speaker 1: five and a half percent, and then you said that
Speaker 1: your terminal rate is three and a half percent, You
Speaker 1: cause a recession with inflation still at five and it
Speaker 1: takes down to say three and a half percent, but
Speaker 1: then it starts to go up again because at that
Speaker 1: point the economy is re accelerating. So you've miscalculated. I
Speaker 1: would say that that's what happened in the seventies, is that, uh,
Speaker 1: they miscalculated how much in seventy seventy five they needed
Speaker 1: to deal with the inflation problem. So what's your estimate
Speaker 1: for how long it could take to get to a
Speaker 1: point where the Fed would have to reassess what it's doing,
Speaker 1: Like what is the sort of make or break time frame?
Speaker 1: I think you're looking at the beginning of two thousand
Speaker 1: twenty three, when they will be able to see what
Speaker 1: the discrepancy sort of in the March time frame. By
Speaker 1: that time you can get to they're the FED funds
Speaker 1: forward terminal rate of three fifty, So Fed funds forwards
Speaker 1: say the FED will get to three fifty by March
Speaker 1: of two three. If you're at that level and the
Speaker 1: c p I is five, then you have a question
Speaker 1: as to do you want to stop there, do you
Speaker 1: want to continue to go higher? What are financial conditions
Speaker 1: and what's the state of the economy at that particular juncture,
Speaker 1: Because those are the three variables that you're playing with,
Speaker 1: and you know that leaves the FED less room obviously
Speaker 1: to to operate if two of those things are problematic
Speaker 1: as opposed to one. So the other thing that I
Speaker 1: think is worth thinking about as we discuss the timing
Speaker 1: of all of this and the pace or of the
Speaker 1: cadence um as the FED has put it, is political considerations.
Speaker 1: And of course the Federal Reserve is supposed to be
Speaker 1: an independent body. They're not supposed to care about politics,
Speaker 1: but in practice I suspect that it may play some
Speaker 1: sort of role, or it would at least be at
Speaker 1: the back of their minds that later this year we're
Speaker 1: going to have an election. Yeah, and you know you
Speaker 1: asked at the top of the show about considerations that
Speaker 1: you didn't mention the politics and the time, but I didn't.
Speaker 1: I suspect that that could play a role. I mean,
Speaker 1: is it. Here's a question, is it preferable to hike
Speaker 1: fifty and then ease into other rate hikes well before
Speaker 1: a midterm a contentious, contentious mid term election, or would
Speaker 1: you rather be going, you know, fifty basis points at
Speaker 1: a time in a November and December f o m C.
Speaker 1: And I think that, you know, it's preferable to do
Speaker 1: the first as opposed to the ladder. I look at
Speaker 1: the speech that Jerome Powell gave at the beginning of
Speaker 1: the last fom C meeting as highly unusual and a
Speaker 1: representation of the level of political pressure that he must
Speaker 1: be under. Because when you speak to the American people,
Speaker 1: I want to speak directly to the American people. He
Speaker 1: said to me. That's a sign that he feels political
Speaker 1: pressure to speak to the American people. And so, as
Speaker 1: a political is AFT would like to be. The reality
Speaker 1: is is that they are a creature of Washington, and
Speaker 1: they're in Washington, and they work at the behest of Congress.
Speaker 1: You know. My my senses is that by the time
Speaker 1: September comes around, Yeah, and that's when people are gonna
Speaker 1: be on the campaign course, the economy will have decelerated,
Speaker 1: meaning that right now we're not seeing full on deceleration.
Speaker 1: The consumers still holding up, but by September we will
Speaker 1: see some deceleration. And then the calculus from a political
Speaker 1: perspective is do we want you to go on inflation
Speaker 1: and do we want you to go on growth? Yeah,
Speaker 1: we're sort of and then we're back to UH to
Speaker 1: having these discussions again about unemployment versus UH price stability.
Speaker 1: Because you know, when the jobless claims that came out today,
Speaker 1: I'm up, Yes, I thought that. I mean, that number
Speaker 1: is historically no low number, but so it seems like
Speaker 1: the bull case just on like on labor is So
Speaker 1: since the middle of March weekly initial job was claimed,
Speaker 1: it's clearly been ticking up. There's clearly um, there's clearly
Speaker 1: an uptrend, but the absolute levels are low. So I
Speaker 1: feel like there is this hope and maybe it sort
Speaker 1: of relates to the soft dish landing again. You know,
Speaker 1: I remember, like the early two thousands of people used
Speaker 1: to talk about the jobless recovery. Right, So we had
Speaker 1: the recession after the dot com crash and after nine eleven,
Speaker 1: and then the economy started growing again, but it was
Speaker 1: not producing a ton of jobs. And I feel like
Speaker 1: the hope is that we have sort of like the
Speaker 1: the unemployment list recession whatever, the opposite of a jobless
Speaker 1: recovery is that basically there is some way to slow
Speaker 1: down the economy, but that we're starting in such a
Speaker 1: good position and that there's so much labor demand and
Speaker 1: that there's so much like room to slow that we
Speaker 1: can actually have a slow down without a meaningful rise
Speaker 1: in the unemployment rate. Because like that feels like like
Speaker 1: that's the bull scenario, and you hear people talking about that.
Speaker 1: I don't know if it's possible that it does sound
Speaker 1: like people are talking about that, and I think that
Speaker 1: the missing pieces um the participation rate that they're saying
Speaker 1: essentially that the pandemic is still having a residual effect
Speaker 1: on the participation rate. And uh, even if we get
Speaker 1: an uptick in jobless claims and things of that nature,
Speaker 1: there's still lots of people who are on the sidelines.
Speaker 1: And as long as we get the softest landing, as
Speaker 1: soon as we start to re accelerate, those people will
Speaker 1: come back into the workforce and all will be well.
Speaker 1: I'm not gonna comment on that, but I will say
Speaker 1: that the political situation is going to be quite different.
Speaker 1: If that doesn't come to pass. If between now you know,
Speaker 1: May and say September, when the FED is going to
Speaker 1: have to decide are they going to go for the
Speaker 1: fourth fifty, you have a considerable uptick in either unemployment
Speaker 1: or slow down in the economy, then the political calculus
Speaker 1: chan is tremendously before we go. There's one other question
Speaker 1: that I want to ask about, which is this year
Speaker 1: of course, and you know everyone talks about it is
Speaker 1: the two sort of unexpected again fresh exogenous shocks. There's
Speaker 1: the core. There's of course Russia's invasion of Ukraine, which
Speaker 1: has various destabilizing effects. It has effects on energy and
Speaker 1: so forth. And then the extremely hard lockdowns in China,
Speaker 1: which are creating new supply chain stress. How does the
Speaker 1: FED incorporate you know, they're gonna be tempted the effects
Speaker 1: of them. They're not you know, they don't reflect underlying conditions,
Speaker 1: but they're real. And uh, they've pushed gasoline prices up
Speaker 1: and again we heard Cisco earnings, they said that they're
Speaker 1: having real supply chain issues out of China. Again, how
Speaker 1: do these sort of outside shocks that are outside of
Speaker 1: like the cycle effect the Fed's thinking at this point,
Speaker 1: I would think that it gives them more impetus to
Speaker 1: front load in order to have greater optionality on the
Speaker 1: back side, you know, the quicker they can get these
Speaker 1: hikes in there. The quicker they can come to say
Speaker 1: that we're at the neutral rate, We've gotten to a
Speaker 1: level that we feel is justifiable over the long term,
Speaker 1: and then whatever shock hits the economy, they can then
Speaker 1: deal with that shock at that time without having to
Speaker 1: worry about, you know, being at a level that's lower
Speaker 1: than the neutral rate. I mean, the worst thing for
Speaker 1: them would be that the shock happens when interest rates
Speaker 1: are at one percent. Then their hands are tied. Then
Speaker 1: you have to start thinking about reversing, quantitative tightening, all
Speaker 1: these kinds of things. That's gonna be a very difficult situation. Uh,
Speaker 1: Ed Harrison, so great to have you on finally, and
Speaker 1: uh there's a great chat, and I genuinely feel I
Speaker 1: have a better understanding of like how the FED and
Speaker 1: how we should be thinking about the FEDS challenge for
Speaker 1: the rest of the year after that. So thanks for
Speaker 1: coming on. And you're writing a new newsletter at Bloomberg.
Speaker 1: Oh yeah, that's right, good Tracy. You are very good.
Speaker 1: I have to everything risk and if I could give
Speaker 1: it a plus, what I would say is is that
Speaker 1: it's about the concept that we are now post a
Speaker 1: great financial crisis, living in a world in which there
Speaker 1: are risks that are embedded in the system in ways
Speaker 1: that we can't understand. And I think that we're seeing
Speaker 1: that this whole discussion was a manifestation of a risk
Speaker 1: that I, as a you know, hardcore deflationists, would have
Speaker 1: told you what didn't exist two years ago, and yet
Speaker 1: here it is. Yeah, no, absolutely, And I think, like,
Speaker 1: you know, we're all sort of like figuring out is
Speaker 1: this is this a true? What I'll say is this
Speaker 1: the twenty tens are starting to feel like a long
Speaker 1: time ago. You know, It's one point it was like oh,
Speaker 1: I kind of it's like, oh, we just normalize. It's
Speaker 1: also back to like that, but that is starting to
Speaker 1: feel like a lot that that economy that we had
Speaker 1: in feels like a long time ago. But it's also
Speaker 1: just kind of crazy that we spent like a decade
Speaker 1: worried about why inflation was under target and and doing
Speaker 1: a lot of stuff to try to get it up,
Speaker 1: and then suddenly it's like, oh, inflations up, Oops, a
Speaker 1: little bit too much? Yeah. Who whatever thought that we
Speaker 1: wanted to go back to the days of secular stechniques. Yeah, exactly,
Speaker 1: this makes secular stagnation look good nineteen. And the big
Speaker 1: issues where are we going to teach coal miners to code?
Speaker 1: And what are we going to do about truck drivers
Speaker 1: when AI robots put you know, the big those were
Speaker 1: like the big products back then. This is like, anyway,
Speaker 1: thank you so much for coming out. I have to say,
Speaker 1: Tracy hearing Ed talk about this sort of history is
Speaker 1: the poor prospects of a soft landing, at least based
Speaker 1: on history, we're not encouraging. Like I sort of got
Speaker 1: a little bit more pessimistic of that part. Yeah, I mean,
Speaker 1: I think the overarching thing that comes through on that
Speaker 1: conversation is just how difficult it is to balance everything
Speaker 1: that's going on. And as we discussed, you know, it's
Speaker 1: interest rate hikes aren't necessarily the best tool for an
Speaker 1: environment where supply is more of the issue than demand.
Speaker 1: And then the other thing that I was thinking, and
Speaker 1: I'm going to repeat it again, but it seems like
Speaker 1: so many of our problems at the moment stem from
Speaker 1: the unusual nous of the situation and the fact that
Speaker 1: we don't really have I know, we reach for historical
Speaker 1: analogies and parallels like the seventies, but actually there isn't
Speaker 1: a really good example of this happening. Maybe like post
Speaker 1: nineteen eighteen Spanish flu kind of thing, but the and
Speaker 1: and honestly, that actually to me is like the optimistic thing,
Speaker 1: which is like, Okay, in the past, we had to
Speaker 1: get FED funds up above inflation in order to bring
Speaker 1: it down, which means that you know, we're no work
Speaker 1: close to enough the optimistic cases, yes, but this is
Speaker 1: not like any of those scenarios. There is still a
Speaker 1: large residual transitory effect. I'm still sort of I'm pretty
Speaker 1: sympathetic to that view and that for natural reasons things
Speaker 1: will roll over. But we have no idea. And you
Speaker 1: know what else, we have no idea. You know, I'm
Speaker 1: thinking back to some of the episodes we did in
Speaker 1: summer of even before inflation started picking out right in
Speaker 1: the middle of It's like we would like ask people,
Speaker 1: ask central banks, central bankers, like what causes inflation? And
Speaker 1: we get like no idea, Like no one had any
Speaker 1: good answers back then, Like we don't really know what
Speaker 1: caused inflation. For being honest, and now we have inflation,
Speaker 1: but it's still not obvious to me that even now
Speaker 1: with that, that we actually know why. I would like
Speaker 1: to see this is slightly off topic, but I would
Speaker 1: like to see anthropological look at inflation, or like a
Speaker 1: social sociology social theology look at inflation, Like look at
Speaker 1: it from the perspective of the people who are making
Speaker 1: the decisions to raise prices and why they're doing. Yeah,
Speaker 1: let's get let's get a manager from like Procter and
Speaker 1: gamble on and talk to how they and then the
Speaker 1: people just forget, forget the central bankers. They'll just blame
Speaker 1: the person they're buying the commodities from. Some then we
Speaker 1: got to talk to the commodity person and so on.
Speaker 1: But okay, well, let's do a series on that, all right. Yeah,
Speaker 1: we just got an idea for you know, an in
Speaker 1: number of episodes. Okay, shall we leave it there. Let's
Speaker 1: leave it there. This has been another episode of the
Speaker 1: All Thoughts podcast. I'm Tracy Alloway. You can follow me
Speaker 1: on Twitter at Tracy Alloway and I'm Joe Why Isn't All?
Speaker 1: You can follow me on Twitter at The Stalwart. Follow
Speaker 1: our guest Ed Harrison, He's at Edward and h. Follow
Speaker 1: our producer Carmen Rodriguez at Carmen Rman. Follow the Bloomberg
Speaker 1: ahead of podcast Francesca leaving at Francisco Today, and check
Speaker 1: out all of our podcasts under the handle at podcasts.
Speaker 1: Thanks for listening to