Wall Street Week - Full Show (07/29/2022)

Wall Street Week - Full Show (07/29/2022)

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Lots of talk about the Fed about the economy about China about European natural gas but how much really changed. This is Bloomberg Wall Street week. I'm David Westin this week special contributor Larry Summers of Harvard on the Fed and getting the economy back on track. I think Jay Powell said things that to be blunt were analytically indefensible. And Ken Jacobs of Lazard

on how a changing Supreme Court could affect his business. You have an industry like insurance which has 50 different regulators in 50 different states. It was an extravaganza of talk and data this week with President Biden finally having that talk with China's President Xi. President Xi actually emphasizing to President Biden that they should coordinate on macroeconomic policies according to the Chinese foreign minister read out the EU energy commissioner laying out plans to deal with further natural gas cuts from Russia. Maybe start saving gas now and that we have a blueprint back together in a coordinated way. If the situation doesn't Congress move that chip's bill towards the president's desk. And to top it off Senator Schumer and Manchin tried to pull a rabbit

out of the hat with a surprise deal on climate and deficit reduction. This bill is far from perfect. It's a compromise but it's often how progress is made. And of course the big one the Fed setting a new funds rate and share power saying they'll keep tightening. We're strongly committed to returning inflation to our 2 percent objective as the stance of monetary policy

tightens further. It likely will become appropriate to slow the pace of increases. But we shouldn't expect a lot more of that forward guidance. We think it's time to just go to a meeting by meeting basis and not provide the kind of clear guidance that we had provided on the way to neutral.

And if the Fed thought it would have an easy time of it the numbers kept coming in this week making it more complicated with GDP down for a second straight quarter on Thursday and then on Friday. Personal consumption and employment cost index numbers coming in higher than expected showing that inflation is not close to done with us yet. And the markets well they pretty much took it all in stride with the S&P 500 up almost four point three percent for the week ending the month with its best performance since November of 2020. And the Nasdaq posted even higher weekly gains up some four point seven percent while bond yields remain subdued with the 10 year yield ending the week at two point six five giving up nearly 35 basis points. Help us sort through all of this. We welcome now Rebecca Patterson Bridgewater chief investment strategist and Sarah Kanter CEO of Causeway Capital. So welcome both of you. Back to Wall Street again. Rebecca let me start with you and what the Fed has in front of it. What is it trying to do. Well the Fed is trying to get Goldilocks. And

that means it wants to get inflation back down as fast as it can towards its 2 percent target without engineering a recession. And the market is giving it the benefit of the doubt. If you look at what's discounted into markets today it is basically two and a half percent inflation and in just over a year and only a moderate slowdown in growth. And I think it's going to be almost impossible for the Fed to get everything it wants here. The porridge is gonna be too hot or too cold either. Inflation will end up running much higher than the Fed's target and they risk losing their credibility. Or if they're serious about getting inflation down especially from the current high levels it's going to require more TARP more tightening which we think is going to engineer a deeper recession. And that's what we're focused on. We think that within six to nine months we're going

to be looking at U.S. GDP that's negative to negative 3 percent. So Sarah where are you on this. Because it felt like a tension this week between the markets the futures markets on the one hand saying exactly. Rebecca just said an economist on the other hand saying you know what. We've got a really jack up the rates a lot to get inflation under control. Which side are you on. The more skeptical side. I think that's how we are as valued. Managers always want to have it proven to us. But no we've had so much liquidity created four trillion dollars out of enlargement to the Fed's balance sheet since the beginning of the pandemic in early 2020. That's a lot of liquidity and it's still there. The Fed only just started to reduce go into it from

the quantitative easing to quantity tightening starting June 1 this year. And it's just beginning and it'll go from 30 billion a month and then bump that up 2 to 60 billion a month and letting those bonds roll off that again starts to compress bank reserves. This will take its cut and be quite lagged in its effect. So financial conditions will just tighten due to that reason alone. And we don't think markets anticipate that at all. And I think

just building Sarah on your point it's it's important to remember that the markets are really looking at the rates. They're not thinking as much about quantitative tightening or do the roll off of the Fed's balance sheet which is on autopilot. That's going to keep going. And so we don't have the Fed buying bonds. We don't have banks buying bonds anymore. And so we've seen bond yields come down in the last couple of weeks. But how much further can they come

down without retail investors institutional investors moving out of equities into bonds. I think what we've seen historically is when stocks go down bonds rally and you get that diversification. We've had that for the last few weeks. We didn't have it for the first half of the year. I don't think we can. Count on that as we get Kuti continuing quantitative tightening continuing. Bond yields may come down but it's going to be a lot harder for them to do that. In this environment

where the Fed's created a liquidity hole it's taking liquidity out and it's not as clear today who's going to fill that who's going to supply the demand to keep bond yields going further down. So let me pursue that liquidity issue a little bit Sarah because you mentioned that the lack of liquidity that really makes the markets as I said much more volatile. And so what does it do to an investor. How do you know. Do you have a G.P.S. at this point given where we are. The key is to have a low entry price because you've got to have that margin of safety. And what this will mean if if massive increases in liquidity. And again this wasn't just the Fed. Central banks globally were all RTX the European Central Bank the Bank of Japan. And as they take

all in unison take liquidity out of the system. What pushed up market multiples. What made valuations expand. What made investors indifferent to valuation. It'll be just the opposite. And we've already seen that start because some of the hardest hit stocks globally including in the U.S. market and they had the most bloated valuations so that we can expect more of that in the future where those stocks which had valuations unjustifiable based on the kind of cash they can generate are likely to see a rerating downward. And the thing that we're watching really as we go forward is what happens to growth and

therefore earnings. We expect that there is still a shoe to drop here with a reduction in earnings expectations. We're seeing early days consumer confidence that outlook expectations component this week lowest level since 2013. Confidence leads activity. Activity is going to flow into earnings of someone. Spending goes down that affects someone else's income. And so we

think that even those stocks in the United States have fallen quite a lot. Year to date that's almost exclusively reflecting higher discount rates and higher risk premium. We haven't seen lower earnings baked into equities yet and we think that's still ahead of us. It's a really good point because margins in general across all industries are near peak levels in the U.S.. That's not usually a sign of a continued bull market. And furthermore look at just some of those basic indicators like market cap to GDP. Take the U.S. market. It is another high level similar to where it was in prior to past

or at past peaks say the top of the global financial crisis and also the TMT bubble in the late 90s early 2000s. So none of those bode well for a market that supposedly is going to keep marching forward at the same time. Rebecca we've got data going into different directions because GDP is down. Consumer confidence as you say is down. Su Keenan personal spending is up and there's still a lot of money on the balance sheets household balance sheets as well as a lot of corporate balance sheets.

Yeah. So what we've seen is initially as we were coming out of the pandemic if we can say that even I'm not sure people are spending down the excess savings the stimulus they received as a result of the pandemic that is back down savings rate is back close to 5 percent and the spending is being prolonged through credit. So people are now tapping into their credit cards to keep that spending going. But as interest rates continue to rise the cost of servicing that credit continues to rise. We think that's going to be another inflection point lower and an important marker to watch to see when does consumption start taking a bigger step lower. So Rebecca I'm sorry Sara. When does the other shoe drop on credit. Because if interest rates are going up as Rebecca says sooner or later you got to pay the piper. Well what will really spur a blow up further in spreads and therefore that's going to have ramifications across the U.S.

economy in fact globally will be as inflation gets beyond again to our point what the Fed is anticipating and we may see some of that centered in housing. Well the momentum we're seeing in rents looks unstoppable. And that is a very big impact on CPI. I think that's a great point. You know a lot of people are looking at the housing activity which has really slowed quickly as mortgage rates have gone up and said oh well housing inflation will be gone in a blink. But really as people can't afford homes then they rent and rents are still resetting higher. So we have rent inflation that is still marching higher and housing inflation given the very very constrained supplies and now rising household formation helping demand at the margin.

We think we're in a position where housing inflation partly due to rents is going to be sticky. Wages might start to to moderate but there are going to be relatively sticky. Both of these things are a big reason why we think inflation is not likely to get back down towards the Fed's target as quickly as the market's price especially CAC because people still have jobs.

And if anything wages are going up. They are they're going up here. And the labor scarcity just anecdotally everywhere you go you see signs help wanted. And it just seems as if the portion of the labor force just vanished. And it's not again specific to the U.S. We see this in Europe as well. They're crying need for more labor. And whether immigration can fill that gap is very debatable. OK. Sara Carter and Rebecca Patterson will stay with us as we take a look at earnings. It was a big earnings week as well for Wall Street. And that's coming up next on Wall Street week on Bloomberg.

About today that could be little argument. Corporations reported their worst profit decline in 29 years. Revised Commerce Department figures for the first quarter showed that both the economy's downturn and the pressures of inflation were worse than previously reported. And international speculators began dumping dollars and acquiring gold with a fervor not seen for quite some time. That was the way things look the Lewis Brookhiser on Wall Street week back in nineteen seventy five. We were coming out of a recession. Today we may have inflation but we haven't really seen a downturn in corporate profits at least yet. Much less a weaker dollar. We've seen just the reverse effect. Rebecca

Patterson of Bridgewater and Sarah co-editor of Causeway Capital have stayed with us. So Sarah let me go to you on the equities question. We had a lot of earnings out this week. It went both ways. But I think sort of overall earnings came in pretty well so far. They have and I think both Rebecca and I have commented on. And what's happened in the past is initially reflective of the future. In other words there are so many challenges ahead in a persistent inflationary environment for companies in terms of cost increases not to mention a consumer that's deliberately being reined in. And this just may be a really tough next several quarters of reporting. How tough. Hard to say but unlikely to be buoyant. And that's to the point that and we've seen multiple derailing

now we may very well see earnings fall too. And that's typically what happens in market pullbacks both multiples and earnings fall. And that again is a phenomena that likely occur globally. So Rebecca you have a little bit of money at Bridgewater that you have to put to work every once in a while. What about the question particularly of debt versus equity. You mentioned before the question of when stocks are attractive. We had that Bank of America fund managers were coming out saying look you're better off right now going into bonds. And we don't see bonds as attractive at this point in the US but also in places like Europe with you know with the Fed still tightening with the Fed demand for bonds now gone it's going the other way. Banks were

huge buyers of bonds last year. They're gone. We think there's going to be a greater challenge for demand to meet supply there. But there was there was another great point just made when we were referencing nineteen seventy five there which was this fall in the dollar and this move into gold. And and it's so interesting to compare what was happening then versus now. And and back then we saw the dollar fall in part because people thought that inflation expectations were on anchored and high inflation was going to undermine the value of currency. And as you just said it's the opposite. Right now we've seen a strong dollar as the U.S. has looked like the nicest house in a bad neighborhood. What I would say though as we think about earnings

and equities and bonds and people's portfolios is that we're in a world that's so different from the last decade when it comes to currency markets. Volatility is picking up. And as we have inflation surprises monetary policy surprises and a huge cone of uncertainty we should expect that affects volatility to continue and it flows through to companies. I think two big ways. One just if the companies themselves are hedging that risk or not. So we are seeing multinationals underperforming more domestic

companies by wide margins just year to date. We think that is likely to continue as these kind of relatively wild moves continue in currencies. And then more broadly if you're thinking about your portfolio what currency are you denominated and what currency risk are you taking. And it can make a very big difference to your performance. I mean just year to date if you think about if you hedged a foreign currency equity or didn't hedge it could be the difference in 10 percentage points in performance for those stocks. And we think that's going to continue and possibly escalate. So I would just say as we think about equities we think about bonds and earnings. I would also make sure not to ignore currencies as part of that equation for

your total return. So Sarah take all and put it together. I think Sony has real look at that particular kind of value investor. You look for good value in terms of low valuations buying at the bottom moving up with it. What's attractive to you right now. They go where the currencies have been the weakest where there's potential for a a return to some sort of more normal currency valuation. And the euro might be a good place to start. The euro is off about twelve percent versus the dollar year to date and maybe 15 of the last 12 months. So yes it's on sale. And

it has been painful having stocks denominated in euro less. They were dollar earners. But this does present an opportunity because likely the eurozone will go into some sort of pullback as energy becomes scarce particularly this winter natural gas in particular. But out of that is the recovery especially given the amount of spending that the eurozone has in mind in order to revitalize their economies and work for the U.S. is likely to work for the eurozone. So there are stocks that companies now buying back large portions of their outstanding market cap. That's really interesting. You can if they're that confident the

future and then a whole lot more about it than we do in terms of their own companies. There are a number of European banks. UniCredit in Italy is one example. Now are they buying back 40 percent of their stock. They have a 6 percent dividend yield. That's like 20 percent payout. You know that's fantastic on on 40 percent of tangible book value. You may think that funds terrify. Who wants to be in Italy right now. There's the political uncertainty. But that's exactly when you want to buy because the next stage is to get back to 60 or 70 percent of tangible book and you've doubled your money. And I guess I would contrast that. You might be seeing great opportunities in specific companies. But when we look at Europe overall from our

perspective we are still bearish. Now there might be a timing element Sarah between what you're saying and I'm saying but I agree that they're doing some fiscal stimulus. I think with the potential for them to lose more energy supply in the winter it will be important to see if the governments take those losses off the companies and onto the government balance sheets just like we saw the U.S. do for some U.S. companies during Covid. Will Europe do that as well. That would certainly be a positive for European equities if that move happens in the absence of that. I do think you have to reckon with the ECB tightening and what is an incredibly challenging environment. So the European Central Bank slowing growth even worse than what we're seeing in the United States so far and very high multi decade high inflation. So they're stuck between a rock and a hard place. And

you mentioned Italy. You know look Italy tends to go through governments roughly every 18 months going back to World War 2. So this is not that unusual however. Italy right now desperately needs these fiscal transfers from the European Union. And if this this government which isn't as cohesive today is unable to pass reforms the fiscal tap gets turned off. And if the fiscal tap gets turned off while the ECB is tightening I think European equities are really going to struggle. So at the risk of being hurt here at a whole nother level of complexity China you're talking about somebody who's going through a bit of a rough patch right now in terms of growth. Covid 19 Covid zero policy. Is that other any attractive potentials actually over there. So China is very complicated at the moment to your point. It has been a draconian lockdowns down and back to Europe. I mean so

many European multinationals have business in China. Do you have some sort of trade arrangement. So it's been tough for them. There are all kinds of these supply side shock problems. Central banks don't really do anything about that. They're all about the demand side. So that's one of the reasons why Europe's likely recover because they don't need to engage in massive tightening to offset inflation. Good part of that is supply related. And some of it's coming from China. And how long the Chinese

government intends to strangle their economy is the big debate because they can't go too far because the fact is we rule with an autocratic arm and you have prosperity. They take away that if the government takes away prosperity the autocracy may be in danger. And that's what makes China so fascinating potentially combustible at the moment. And just adding to that you know I think one of the things we got out of the Politburo meeting this week was we're going to stay focused on infrastructure stimulus and China. We're not going to increase the focus on consumption. And so when we think about how the different levers of Chinese growth flow through to multinational companies it's important to understand that nuance. If it's infrastructure led that's going to have a different spillover effect to other companies around the world commodity related companies companies that are servicing that infrastructure versus the consumer. But you know to the fragility of China today if you go to the youth unemployment rate in China I'm sure you've reported this as a big deal. Unemployment almost double what we have in the United

States close to 20 percent. That's something China can't tolerate. And so I would expect over the coming months we're going to see more and more steps for them to try to make sure these young adults have jobs whether they're with the state owned enterprises through some of these. Infrastructure projects cetera but I am concerned that growth in China isn't going to recover that quickly in the second half of the year which again folds into this bigger global growth picture. Europe slowing China slowing the US is slowing. How do we see stocks rallying. Sustainably in that environment. At the same time President Xi does have a party plenum coming up sometime October or November. He might want to make sure that he gets re-elected for yet a third term. Thank you so very much Rebecca Patterson of Bridgewater and Sarah Carter of Causeway Capital. Up next what's

happening next week on global Wall Street. That's next on Wall Street. Week on Bloomberg. This is Wall Street week. I'm David Westin. It's time now to take a look ahead at next week starting with Juliette Saly in Singapore. Thanks David. We'll be looking at China PMI ISE as mortgage boycotts take more pressure on distressed developers and intensify the housing slump. A rise in Covid-19 cases may have

also hurt sentiment in the services sector. Meanwhile central bank meetings in India and Australia will also be significant for investors in this region. Australia's central bank likely to lift its inflation forecast. Hike rates by 50 basis points and flagged more tightening ahead as it races to restrain consumer price gain. Here in Europe we're looking ahead to the OPEC plus meeting next week to see if that charm offensive by President Joe Biden with his Saudi counterpart has paid off. We'll see if the Saudis pump any more oil to alleviate prices at the pump. And here in the U.K. switching focus. The summer of strikes.

We've had rail strikes. We've had two strikes. Those are set to continue on Monday with walkouts from barristers and workers at telecom giant. The Bank of England meanwhile expected to hike rates for the sixth consecutive time as the economy here in the UK continues to slow. Members of the Conservative Party. Well they'll be receiving their ballot papers and we'll be able to

cast their votes for the two leading contenders now to take over from Boris Johnson as leader of the conservative government and prime minister of the UK. Stateside the tech earnings continue PayPal Pinterest Air B and B in Advanced Micro Devices all report next week. That's alongside Uber and Lyft. What are they going to tell us about the gay economy and fuel prices. And it doesn't stop there. Starbucks and Under Armour are also on deck. We've also got plenty of Fed speak coming up. The presence of the St. Louis Chicago and Cleveland Fed are all due to speak on what comes DAX for the central bank. And then payrolls Friday. The jobs report is in the spotlight. Anything under 100000 is likely to ring alarm bells at the Federal Reserve. An extremely tight labor market that used to be a point of pride will now be the Achilles heel of the US economy. Does that change. Next week

we're going to find out. Thanks to Juliette Saly Tom Mackenzie and critic Gupta. Coming up we have a Supreme Court taking a different direction on a wide range of issues. But what could it mean for the markets and for that matter deals. We ask Ken Jacobs of Lazard Prayer. That's next on Wall Street week on Bloomberg. The Supreme Court is rocking the boat for us all in an historic term the court managed to turn the heat up on just about everything it touched from its overturning Roe vs. Wade. The health and life of women in this nation are now at risk. What will save the lives of millions of children. And it will give families hope to its permitting concealed weapons. Unquestionably the biggest Second Amendment ruling in more than a decade from this court to its telling the EPA to back off on regulating power plants. The U.S. Supreme Court has restricted the Environmental Protection Agency's authority to curb

greenhouse gases from power plants. The debate continues on the wisdom of all these decisions but taken together they raise important questions for business and the markets. Questions about how the rule of law that underpins our entire system will work under this new court with some like Senator Portman of Ohio saying it's just an appropriate reminder of the power ultimately remains with the Congress not the regulators. And that's what the Supreme Court was was essentially saying is that wait a minute. We've got to be sure that the Congress which is representative of the people you know has it has the final say. While critics like Larry Tribe say the court has abandoned principle in favor of personality strikes me as profoundly unprincipled because the Supreme Court has long said that decisions of great durability should not be overruled in the absence of some extraordinary change other than the mere personnel of the court.

And to tell us whether there might really be a connection between what the Supreme Court is doing the one hand and the business world on the other. We have a true leader in the business world. He is the chairman and CEO of Lazard for he is Ken Jacobs. Ken great to have you back. Thank you. DAX really good to be here. So we tend to think of things like abortion and social issues the Supreme Court and even some of the regulatory issues as more in the zone of politics or even political philosophy. Can they affect the business world as well. Yes. So when you step back and you think about the United States U.S. has a handful of really true competitive advantages. One is rule of law. Second is demographics. And a third is one market. And

buy one market where we're a market of 300 350 million people with essentially one set of rules. So when a company goes to do business in the United States by and large it's one set of rules for the whole country. And what the Supreme Court is doing is essentially saying look the administrative state has become unwieldy. It's taken on too much responsibility. Congress really should do a better job of writing laws more specifically. And we're going to start to

whittle back some of the things that the administrative is doing. Well on paper that sounds great. And then perhaps will be less regulation. Maybe the laws will be clearer better written. But the reality is Congress is rife with polarization. It's difficult to get anything done without a supermajority. So the reality is that there's a vacuum. And so we're going from a from a from a place where we have a clear sense. We may not like all the regulation but we have a clear sense of the rules to a place

where the rules are uncertain. And increasingly the states are stepping in and making decisions on many of these rules. And what's ending up happening is is an end up with multiple rules with multiple states. And candidly probably written by and by groups or people that aren't as competent as exists in Congress. And that's worrisome. Take us into your business specifically. You've got a very large advisory business. You've also got a big asset management business. How did those challenges was perhaps a very diffuse set of rules and regulations laws. How could it potentially affect your ability to take asset management as an example. That's probably the easier one of the two to to see the impact. So you have a state that essentially says look we don't

wanna hire an asset manager that is worried about climate. And so they will restrict the ability of a state pension fund to invest in that manager. Another state may say you know what. We will only invest in managers that take into account climate. Now if it's a small state with very little population and very little assets under management in their state pension funds maybe it doesn't matter that much. When we start having big states doodling on this it's a real problem. Well we're starting to see it like this in places like Texas and Florida and California and New York just to pick for and seem to have different attitudes toward these things. Are you seeing it affect your business so far or is this more on the horizon. It's I would say it's on the horizon but it's worrisome. And you sort of think about it. You

have an industry like insurance which has 50 different regulators in 50 different states. That's a complex industry but that's a real exception in the U.S. economy. Most of the U.S. economy is dominated by companies or are driven by companies that are able to operate in all 50 states without a concern. And this is something that I think really runs the risk of upsetting one of the true competitive advantages of the United States. Is there another factor here with the Supreme Court which we sell so there's less term where they're changing their mind they're overturning precedent. That's been on the books for a long time.

And there's a reason for what we call a little bit starry decisis. Right. So there's a predictability for business. OK. So go back to what I thought were the three or four competitive advantages of U.S. unified big unified market demographics. And the third one is rule of law and rule of law when you really think it through is really about predictability certainty conservatism. In that sense the idea that you can predict what's going to happen you have an idea of what the rules are. This is kind of upsetting the apple cart when you go back and you you shift. And what does that do to the competitors of the United States over against Europe on the one hand or China on the other. I mean China certainly has had issues with

some of that unpredictability in recent days. Yeah. So look this is not overnight going gonna upset the competitiveness of the U.S. versus Europe and China but it's headed in the wrong direction. China the advantage China has compared to almost any other market is it's a billion two billion three of people with one market. And in many respects that is the advantage that a lot of major Chinese companies have is a very big unified market. And so that's that's the risk. Talk about your business

right now because we've got a very strong dollar as I understand that may have affected your business to some extent. We also have a slowdown. We've seen just this week we saw the GDP. How is it affecting your business. So on one end of the spectrum it's it's highly resilient. The advisory business had strong first half and the outlook for the second half seems seems pretty strong to us right now. The question for the advisory business is going to be what

happens in 2023. What's the build like a backlog build of assignments and such into the latter part of this year. And that largely depends on what happens in the credit markets over the course of the next couple of months or so. The asset management business is obviously been subject to the turbulence of markets globally. But performance has really improved dramatically as we would hope it would in an environment where quality and value should be performing. The challenge in our business just compared to many of our peers

is we are global. We're an international business with the asset management business a high exposure non dollar assets and in the advisory business a very significant significant business outside the United States. So the impact of the move of the euro and the impact you can see it on the Bloomberg dollar index and move the dollar against virtually every currency in the world has has negatively affected us. But. But at this point it looks like there's been a 30 percent move

in the dollar against Bloomberg in DAX and against the euro over the course of the last couple of years. I would guess that there's probably another not another 30 percent to go. So maybe the worst is over. I'm not sure I'm calling a recovery yet and a weakening of the dollar. But I think probably the worst is over. Come back to the

uncertainty we were talking about. We were talking with the Supreme Court but there's all sorts of uncertainties of uncertainty the marketplace right now. I don't know exactly where the economy's going. We don't know where a lot of geopolitics are going. Things like that. Is that causing people to sit on their money essentially. Particularly the advisory business. Do you have CEOs saying you know what I think it's not right to move right now. I think it's everywhere because what's happened is we've gone from just taking the economy as an example. You know three months ago everybody was focused on

highly focused on inflation as they should be. Today inflation is in the rearview mirror at least with regard to the bond market. And now everybody is focused on recession. And so the question now is where's where's inflation. And it's clearly going to come down from where it was 9 or 10 percent as it level out at 4 or 5 or 2 or 3. There's a big debate about that. But in addition to that we now have the question of recession. How deep how long. And until there is a what I'd say a new consensus a new set of convictions people are going to be cautious about putting money to work. People have to be cautious about making

big decisions. And I think that's going to unfold over the course of the fall. Ken finally on the inflation front you take a long term view for your business. Are there some structural factors that suggest we're going to have a higher level inflation. We have the past whether it's demographics whether it's not a D globalization but something of a pulling back from some of the globalization some of the frictions between the U.S. and China for example. Well the one friction that is clear is we all got spoiled by Justin. Justin time economy where everything was minutes away or pretty predictable. Supply chains have been interrupted. Logistics have been interrupted. Part of it is Covid. Part of it is a shift in

wages. China's become a more expensive place to do business as the supply chains shift as well to places that are perhaps less reliable. And as a result of that we're not in just a time economy anymore. And there's there's probably more friction than there used to be. And that probably is something we're gonna have to live with. Ken thank you so much for being here. Really appreciate it. Ken Jacobs he is the chairman and CEO of Lazard for our.

Coming up we wrap up the week with our special contributor Larry Summers of Harvard. That's next on Wall Street week on Bloomberg. This is Walter Reed. I'm David Westin. Welcome once again our very special contributor Larry Summers of Harvard. So Larry a lot happened this week. But let's start at the end of the week with what you told us last week was the most important indicator that we should be looking at the economy. And that is the employment cost index. It came in it came in above survey. David

we we weren't sure what was going to be happening with wage inflation. We hoped that the indications in some of the monthly surveys that earnings growth was slowing and that that might slow the whole inflation process would materialize. That didn't happen. Looks like inflation is running at a pretty stable rate. It's still two and a half points at least above where it was

before this whole episode started. Depends on just how you look at the figures. But really no evidence of a significant decline. If you look at the private sector and you take out benefits then it's going up a bit. If you look at the 12 month figure it's going up a bit. Those may be the wrong things to do. So it may be better to look at the overall figure. But I think it's showing what I've been saying for quite some time now which is that we are an ingrained moderate to high inflation economy. Nothing like 9 percent inflation is built in but inflation above 4 looks to be pretty securely built in. And if productivity

growth doesn't accelerate it could be worse than that quite easily. So I'm pretty uncomfortable with the current situation and I think it just points to the difficulties that the Fed is facing going forward and confirms the broad diagnosis that we have an overheated economy that's not going to fix itself and therefore we're not likely to get out of this excess inflation situation without having a recession. So there you have been steadfast on this program and elsewhere on your views about inflation. And yet there's something of a debate going on right now between on the one hand the markets and on the other hand economists with the markets sort of saying OK the Fed will hike for a while. They'll start backing off next year and actually

we'll have some reductions in 2023. But they economists say boy the economy doesn't look that way. We're gonna have to keep going and keep it pretty high. What do you do when you have that kind of debate. We'll see what judgment the Fed's make. It makes the challenge they're going to have. And it's a agonizing challenge. And it's why would be better if we weren't in the

kind of configuration we were in and would be better if we had not overstimulated the economy last year. Is that on the one hand I think you are likely to see a significant slowdown in growth. You are likely to see recessionary forces develop over the next year. And on the other hand it's going to take a lot to get the inflation out of the system. The danger David is that they don't persevere strongly enough in restrictive policy. And that's what gets you a stagflation situation where growth slows

and you don't beat the inflation out of the system. It's like if you don't complete your course of antibiotics and then your illness comes back and the drugs or bacteria resisted. On the other hand I don't think we can deny that if they do what's necessary to contain inflation then it's not going to be a happy economic situation over some over some interval. Secretary Yellen said yesterday that she held out the prospect of getting out of this without unemployment going above 5. I've got enormous respect for her as an economist but I have to say that statement greatly surprised me. It didn't surprise me as much as the Fed saying we were going to get out of this with four point one percent

unemployment. But I don't see any basis for thinking that either of those statements is a reasonable prediction given what we know. My own research with Olivier Blanchard looking carefully at. Statistics looking carefully at quit statistics would suggest that just to get to a neutral posture with respect to inflation we're going to have to take unemployment up towards 5. And in order to bring down inflation we're going to have to be restrictive which means an unemployment rate above 5. So Lara

you mentioned some of the questions about the neutral unemployment rate we heard about from Secretary Young. We also heard about where we were with a neutral rate on interest rates from Jay Powell. What do you economists do when you put together these neutral rates. Look I think Jay Powell said things that to be blunt were analytically indefensible. He claimed twice in his press conference that the Fed was now at the neutral interest rate calling it two and a half. It's elementary that the level

of the neutral interest rate depends upon the inflation rate. We've got on the most quoted measure a nine point one percent inflation measure. He extrapolated off core or something. It's four or five percent inflation. There is no conceivable way that a two and a half percent interest rate in an economy inflating like this is anywhere near neutral. And if you think it is neutral you are misjudging the posture of policy in a fundamental way. So I was very sorry to hear him say that and frankly surprised. He said back in 2018 that the neutral interest rate that the Fed was approaching the neutral interest

rate at a time when the inflation rate was one point nine percent how he could be saying the same thing today when the inflation rate is where it is is inexplicable to me. And it's the same kind of. To be blunt wishful thinking that got us into the problems we have now with the use of the term transitory. So I hope the rigor of the economic analysis at the Federal Reserve is going to step up. So Larry in the meantime we have some legislation coming out of Capitol Hill something perhaps we didn't even expect. We had the CHIPS Act but now we have this proposed inflation reduction act. Last week on this program you sent a powerful message to people who are saying increasing taxes actually might be inflationary. So that's really not true

at all. I suspect one of the people you're communicating with may have been Joe mentioned through Wall Street week. I don't want to ask you about what you've said specifically Joe Manchin but give us your reaction to what the proposal is now that's come up with respect to increasing taxes. Yes paying for it but also addressing climate. I was glad to see the bill. I think it's going to reduce the rate of inflation because it's going to reduce deficits and demand over time because it's going to use the federal government's power to negotiate lower prices for pharmaceuticals. And because it's going to increase supply of energy. So demand supply pricing power all working to reduce inflation. I think it's going to help the environment because of the climate change measures. I think it's going to help fairness in our country because of the expansions in health care availability. I think it's going to help fairness in our country by closing some very important tax loopholes that allow very

profitable companies to avoid paying any any taxes. Could the bill be improved. Of course. I was really sorry to see that the very important enabling legislation for the international tax agreements that Secretary Yellen has negotiated didn't get included in this. And while I was glad to see progress in reducing the carried interest loophole frankly there's still some loopholes in the solution. I think we should be saying that all carried interest when realized is taxed as ordinary income when the investor takes it out. And this bill is still well short of that in a variety of respect. Well that really is a ringing endorsement. Thank you so much. That's our special material Larry Summers here on Wall Street Week. Of course he's from Harvard University. Coming up the one place in the world where the supply chain has

worked all too well. This is Wall Street week on Bloomberg. Finally one more thought. It's the economy stupid but which economy. There is no end of worrying and complaining about the US economy these days from too much inflation. We certainly see peak inflation coming sometime in the second half to two higher risk of recession. I think there are many reasons why we're going to have a severe recession and a severe financial crisis

to supply chains that just won't cooperate. Fix the supply chain. These are all things that will be beneficial to the country writ large. But through it all the one thing that ISE states does not seem to lack is jobs. Just about twice as many jobs would be of people to fill them. You are still seeing jobs despite substantial peaks and that robust demand for labor may just be the one thing that keeps the wolf of recession from our collective door. You got some up and you got some down. You got the job market very strong and yet at the same time you've got GDP growth stalling out. And so the Fed's got to figure out how hard to step on the brake. So as we

all continue to worry and complain about the U.S. economy and as the markets continue to be buffeted by all that worrying and complaining you've got so many different crosscurrents that are going on in so many different forces acting on the market that you have these little mini moments. Take a moment to consider the plight of China right now. Yes China. That economic miracle now facing slowing growth and a deeply troubled property market. Unfortunately the private sector with what's collapsing far as the eye can see that China is going to take a while to recover and Covid shutdowns that have wreaked havoc with companies like Philips needing inputs for overseas markets. The second quarter was impacted by a lot of headwinds. China looked down supply issues and rising inflation. And Elon Musk's Tesla not getting what it needs for the China market. YouTube was a unique call for Tesla due to a prolonged

shutdown of our struggling factory. The past few years have been quite a few measures turned green. But from a supply chain though for several years now you can add to China's woes an oversupply of young college graduates. It has ten times the number of college graduates that it had only ten years ago. And way too many of them cannot find jobs. With almost 20 percent of

young people unemployed twice the rate in the United States. So as those of us in the United States complain about too few workers our Chinese counterparts complain about too many. But in the end whichever version of labor issues you have it does come back to James Carville 30 years ago. It's the economy stupid that does it for this episode of Wall Street Week. I'm David Westin. This is Bloomberg. See you next week.

2022-08-03 19:21

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