Wall Street Week - Full Show 7/22/2022
This week was all about heat. Record temperatures in Europe and United States concerns where the Europeans can heat their homes this winter and central banks trying to take the heat out of prices on both sides of the Atlantic. This is Bloomberg Wall Street Week. I'm David Westin this week special contributor Larry Summers of Harvard and the growing divergence among the economies of the United States Europe and China. They've got an aspect to their problem that we don't have in the United States.
This is pushing Europe in the right direction in a dangerous situation. And Brian Moynihan of Bank of America and how we can feel so bad when the economy appears to be doing so well. What they're saying they see versus what they're doing is kind of interesting. That's the Fed's toughest challenge. It may be summer but temperatures this week or ridiculous even for mid-July with records broken in London. I'm pretty pretty
desperate. I mean there is sweat running down everybody's backs. Wildfires in Spain have never been seen that condition. The fire never is completely new for us. And misery throughout much of the United States. This climate debate in a very hot America. Washington D.C. normal 100 102 here in a couple days. But it is a serious issue. And if this heat is coming in part from a warming planet. Congress told us this week it isn't going to do much about it leaving it to President Biden to take matters into his own hands. Climate change is in the coming weeks. I'm going to use the power I have as president
to turn these words in a formal official government action. While Europe is just as concerned about not having the natural gas it needs come winter because of a threatened Russia cut off. Russia is blackmailing us. Russia is using energy as a weapon. And therefore Europe needs to be ready. And while the commission was preparing for natural gas rationing the European Central Bank moved on a different kind of heat. The heat of inflation. We decided to raise the three key ECB interest rates by 50 basis points and approved the transmission protection instrument. And when it comes to the markets well they generated their own kind of heat this week with the S&P 500 up over two and a half percent. That's its best week in a month. And that was after it gave up almost 2 percent on Friday alone in part because of
disappointing reports from SNAP and Twitter. While the Nasdaq was up three and a third percent while investors liked bonds as well with the yield on the 10 year falling from two point nine percent down to two and three quarters percent today take Stuart. All we welcome now Bob Michael is J.P. Morgan Asset Management CEO and head of Fixed Income. And Aaron Brown portfolio manager at PIMCO. So Aaron let me start with you on equities and those earnings that we had as I say SNAP and Twitter certainly disappointed. Overall how are we doing with equities and earnings right now that the bar was low going into earnings season. But that said I think there are three main takeaways that we're hearing from the second quarter. The first is that we saw real market excel acceleration downward in terms of demand trends and a softening
really across the board in the second quarter. We saw you know not just the early consumer. Second calls disappointing to the downside which we heard in the first quarter. But we're now really starting to see that right now to the broader economy. You mentioned the disappointment in earnings that we saw from Snapchat on on Thursday but you also saw negative earnings revisions lower from some of the consumer cyclicals some of the industrials some of the metals and mining company. And really
what you're hearing a lot from corporates right now is that the consumer is is weakening. But you're also starting to see business confidence also weaken. And you've started to see some of those advertiser dollars starting to get shrunk on the back of the fact that the demand environment just doesn't support it. The other I think key takeaway that you'd started to see in the
second quarter earnings season is inflation remains persistent. But what's new is that you're starting to see higher financing costs also start to really bite in terms of corporate profitability and the interest rate increases that we've seen on the back of the Fed. Raising rates has really started to hurt corporates in terms of their earnings profitability because it costs more now finance. And the third I think key takeaway and this is a real change in trend is that the dollar's strength is also starting to really impact the corporate profitability. We've seen the dollar rally about six and a half percent in the second quarter. That shaves about one and a half to 2 percent off of earnings. And you heard from corporates like Procter and
Gamble Johnson and Johnson as well as IBM all to talk about you know lower profitability ahead because of the higher dollar. And this isn't something that we've heard about really talked about since 2016. So that's a new wrinkle in terms of the outlook for the second half. So Bob that was equal time for the equity side. What about on the bond side. Let me add one other softening number. We had PMI numbers that came in on Friday that were softer as well. I hear Aaron I understand everything she's
saying. We have a completely different take on corporate America and it starts with it's priced in. If you look at the start of the year investment grade corporate bonds yield at somewhere around two point four percent. They're now yielding four point six percent. You look at high yield it yielded under 5 percent at the start of the yield. It's now yielding over 8. Percent So there is an awful lot of the bad news that Aaron talked about priced into the market. We look at those yields and we say this is the time to buy particularly in high yield where you're being compensated for default rates that can go up to 6 percent. We look at where we think default rates are going to go.
It's a much higher quality high yield bond market. Six percent of it washed away in 2020. If you look at the amount and double BS it's the highest ever. Fifty three percent. We think default rates only get up to two point seven percent. The other thing we're noticing is that clients are returning to the bond market especially corporate bonds. And it's because they have renewed confidence in the central banks. It started with the Fed 75 basis point increase and it continued with the ECB as 50 basis point increase. So what I did see another bank who will go unnamed has a fund
managers report that came out this week and said that this is the time to go into bonds. Exactly what you just said. But. OK. So put that together with the Federal Reserve. We're going to hear for the FOMC this week. Is that saying we're thinking they've gone as far as you're going to go or they're not going to go as far as we're thinking at least. Well what it's telling us is the market is now fairly pricing in where they think the Fed should go and the Fed is in sync with that. So we're talking about a Fed funds rate somewhere around three and a half percent at year end. That's 200 basis points above where we are. Go back to the start of the year. People are saying maybe the Fed will do one or two 25 basis point hikes. That was fantasy world.
This is the real world. I think we know that. Sorry. Go ahead. No go ahead Aaron. Aaron go ahead. No I just want to go back to Bob's earlier point saying that it was priced in because when you look at constant census earnings estimates for the second half of the year they're still up about 10 percent year on year. And even if you look at twenty twenty three estimates they're up about 8 to 9 percent in terms of what market expectations are pricing in for next year. Now the market right now in terms of the equity land is trading at about 16 times forward earnings which is the average mark market multiple over the lifecycle of the S&P 500. So we're trading at average market multiples yet still pricing in pretty lofty earnings expectations for the
second half of the year and 2023 which tells me that the market actually isn't fully priced for a recession at all. Certain segments of the market have certainly repriced lower and are pricing in I think more comfortable levels to start to dip your toe back in. But broadly speaking I think the market is very mispriced for an oncoming recession remember. Typically in recessions we see the Dow or earnings earnings fall about 24. IBEX Jihye Lee slightly less than that. But but you know that
would imply that we would have negative earnings over the next year not positive earnings which is currently consensus expectations. So we're we're there. We're looking at the corporate bond market and we think that where credit spreads have gotten to where yields and corporate credit had gotten to it placed in about 75 percent probability of recession. The other thing that we're very mindful of is our job is not to predict the economy. Our job is to predict the markets. And we were looking at yields that had doubled in corporate credit and we were looking at a lot of cash on the sidelines. And you were looking at pension funds who were discounting their liabilities either side of 7
percent that could go into the top of the capital structure by buying high yield debt and getting over a percent. Those are the flows that we're seeing returning to the market. It's just begun. So Aaron BOVESPA a number of the table 75 percent chance of a recession within what pretty time but over the next 18 18 months. What's your number. Yeah I think that for a very mild
recession I think about 60 percent probability has been priced in for a garden variety recession. I think only about 40 percent probability is priced in. I think that's more like what we're looking at over the next 12 months. And so the market's pricing in basically stagnating growth. I think it's going to be negative growth which I think implies A that the market has fall further to reprice on top of that. I think that yes you know you have seen do you see yields emerge
in corporate credit right now. A lot of that has been just based on the fact that we've seen the cash free rate increase pretty significantly since the start of the year based on federal funds hikes. So we haven't really seen spread widening. When you look at that same measure of spread widening versus the historical
recessionary periods it would imply that you really haven't seen the market price in a full recession in terms of how far this far far spreads typically widen. Corporates I think is much more attractively valued. I think that there is a place you could start giving your telling but not with respect to high yield. Bob last word on this subject. High yield credit spreads started the year at three hundred. Basis points they got to six hundred basis points. That's a doubling. They're now five hundred basis
points over. That's 200 basis points. You look at the quality of the high yield market. It's difficult to even get to a 3 percent default rate in a moderate recession. Forget about a mild recession. A moderate recession. It's priced in a great discussion and two sides of the house. Aaron Brown and Bob Michael McKee staying with us. We're gonna turn and take a look around the world at investment opportunities in places like China and Europe. That's next. On Wall Street week on Bloomberg. The real reason why we're optimistic is the underlying economic momentum is so strong and I think that distinguishes Hong Kong and South China from almost anywhere else in the world at the present time. In your view then the Hong Kong is not going to
become like the rest of China. The rest of China is going to become like Hong Kong. That's the way it looks at the moment. Yes. That was Luis Raka ISE you're talking with Robert Lloyd George. 30 years ago on Wall Street week since then Hong Kong has reverted to China. China has joined the WTO and the Chinese economy has grown from twenty seven billion dollars to just about seventeen point seven trillion dollars. But I have to say
I'm not sure it's because the rest of China has become more like Hong Kong. Still with us our Aaron Brown and PIMCO and Bob Michael of J.P. Morgan. So let's go around the world here a little bit starting with China if we could Bob. When you look at the credit market in China bond markets in China are they attractive too. Yes they are. And China continues to struggle with the zero Covid policy and the constant shutdowns. So it's going to take a lot off of GDP. And because of that we think that GDP will come in somewhere around 3 percent. You look at the 10 year trying to government bond. It's yielding about 2.8
percent. That looks to be pretty good value to us. I think for us one of the bigger discussions we're having is what is Euro Covid policy mean for recession and inflation. And unfortunately it means stagflation. It means that you're taking out a large area of consumption but you're still going to have the supply bottlenecks. That's not necessarily good for the rest of the economy. And one of us is trying to invest more. I know this is somewhere where Bob and I actually agree. You know I think that you know from a Chinese bond perspective I think Chinese bonds do offer value particularly in a global context stopped. That said I think the big question mark for China right now is what they're going to do with respect to their currency. You know I
believe that their currency is likely going to continue to weaken in a zero carbon policy where growth really is handicapped. And as a result of that I think that that likely means that it's going to really harbor poorly for the rest of the world. Remember you know historically it's been difficult for emerging market assets to do well in environments where China growth is very weak and particularly if China continues to weaken its currency or allow for its currency to gradually weaken. It also means that you won't likely see emerging market strength outside of China. What that ultimately means is that it's pretty poor for global growth. I think people have been expecting market. Investors have been expecting that you would likely see some type of recovery in China particularly this year and in the back half of this year. I don't think that we're going to get it which makes in my mind tiny China Chinese risk assets pretty on investable right now. This is where I'm going
to disagree with everything. We're back on track. We're looking at the rest of the emerging markets emerging market debt. And we think that could be the surprise of the second half of the year. Well upside surprise for the bond market lately. And if you look at the developed markets central banks really when you look at the ECB just starting to raise rates the Fed early on and the Bank of Japan starting in the emerging markets since the start of 20 21 30 central banks have raised rates a hundred and seventy times for a total of 15000 basis points. So those markets have anticipated inflation. They've priced it in. There are high real yields there. People are afraid to go in because of inflation because of the strong dollar. We think there's an opportunity there. You put together a basket of Brazil South Africa and Mexico. You've got a seven
and a quarter percent yield. All you need this for the dollar to remain stable and not keep going up all you need Aaron. All you need is your dollar. You may say it's able to. Bob took it. It's actually the ECB. What about Europe. Yeah well I just want to go back to Netflix really briefly. I mean Bob earlier you were saying you can get an 8 percent yield out of high yield. So why would you get a 7 percent yield out of emerging market assets if it's a lower quality asset with more ethics risk on it. I think
that in order to be bullish emerging market assets you need to fall. Do you need want to see a stabilization in global growth. And probably even much more importantly you need to see inflation stabilize in emerging markets unless and until you see them you know inflation stabilizing you're going to continue to see those central banks chasing and trying to get in control of inflation. And that just means that you know likely you're see you going to see higher rates in emerging markets. So I think it's too early right now to call for a buy in emerging market assets in emerging market bonds. With respect to Europe you know
I think that Europe is really challenged right now and that's largely as a result of the fact that they have much higher reliance on energy and gas from from Russia than the rest of the world and particularly versus the U.S.. And so I think that you're going to see a real impairment to European corporates in the second half of the year because of higher energy costs. And I also think that. See a forced curtailment of industrial energy usage which means that corporate profitability in Europe is going to be quite weak. I do think that you know based on some of the PMI data that we got over the last 48 hours out of Europe
that we're likely in a recession in the third quarter in Europe at the start of a recession and you'll likely see that recession conditions ensue over the next few quarters. So I think that Europe is a real bleak spot in terms of the global growth trajectory. So some rebuttal. Yeah. DAX emerging. Well I knew you were I knew yours. I think there are three sovereigns who aren't going to be really happy that they just got compared to below investment grade U.S. corporate. So let's put that to the side. Europe. Yeah I hear. I agree with her and they've got a real
problem. It looks like inflation is going to remain structurally high. The ECB is going to do what they can to slow down consumption. Ultimately we like sovereign debt there. But but we like Germany. We're not necessarily sold on Italy. So we're sticking in the sovereign side. We think there's some normalization in policy to come from the ECB but they're not going to get anywhere near as high as in rates as as the Federal Reserve. So Aaron to put you on the spot what's the worst problem for Europe right now. The collapse of the government. Italy or the problem the ECB faces and particularly Russian
natural gas. I think energy is by far the number one problem that Europe is facing right now. You know frankly for Italy specifically certainly the collapse of the government is a challenge. But I think that a much larger looming risk out there is the curtailment in what's going to be in supply in you know into Europe for natural gas. And what that ultimately is going to mean for demand destruction. That's necessary to come from it. What does that say to you as a bond investor in Europe. Well
it says a couple of things. It tells us to be careful on corporate Europe because the input costs pressures aren't going to go away anytime soon. It tells us that the ECB can only raise rates so high maybe one and a half one and three quarters percent. That's about it. And it means that you're going to want that flight to quality. So as I said German government that is the place for us to be. So last question here Aaron. You heard Bob say providing we have a stable dollar. What do you expect the dollar to do from here on out. Will it continue to strengthen against other currencies.
Unfortunately I think we're still in a period of dollar exceptionalism which means that because of the somewhat relative better growth trajectory of the U.S. versus Europe because of the less reliance on Russia as a source of natural gas and energy and because of defensive properties of the dollar I do think that the dollar is likely to remain quite robust over the next couple of quarters. And so I think that the dollar is likely going to continue to strengthen. You're here with Aaron on that one Bob. No. The dollar has peaked. And even Aaron was talking about you know the downside to the U.S. economy. The dollar's gone as far as it can. It's really stretch versus all currencies. OK. The main thing I want to know is is there a
PIMCO versus J.P. Morgan softball game this summer. I would like to be there. To see what their respective positions you both play because it would be a feisty one. But there's been really great having you both on. We really need that kind of constructive disagreement. Thank you so much to Bob Michael of J.P. Morgan Asset Management Aaron PIMCO Pam Brown of PIMCO. Up
next we're going to look ahead to next week on Wall Street and that's on Wall Street week on Bloomberg. This is Wall Street week. I'm David Westin. It is time now for a peek ahead. Next week on global Wall Street. Starting with Juliette Saly in Singapore. Thanks David. A big week on the earnings front with Samsung Rio Tinto and Yum. China among those releasing numbers labor issues supply chains inflation and the energy crisis. Among some of the
major themes we'll be watching out for in the post earnings calls. Plus a report from China in the week ahead likely to show profit growth stalled at industrial companies in the first half of 2022. That's thanks to Covid lockdowns. Meanwhile Australia's headline inflation could hit a 21 year high of 6 per cent and inflation is likely to climb above 65 per cent in crisis hit Sri Lanka. Here in Europe we're looking ahead to the biggest week of the earnings season with the region's top banks automakers airlines and energy companies all reporting. Investors of course will be scrutinizing any commentary on inflation supply chains
labor costs anything executives say about their concerns around a recession. We will be bringing you executive interviews from the likes of Ryanair Deutsche Bank and Shell just to name a few. It is also a big week when it comes to the economic data. Are we expecting inflation prints out on Thursday and Friday and a GDP number out for the eurozone on Friday. It's a huge week for investors who have to pass the state of the economy through a slew of economic data on both sides of the Atlantic including inflation and GDP numbers plus a barrage of corporate earnings. Big tech is on debt from Apple to Microsoft. We know there's
plans to slow hiring but just how worried are the biggest and fastest growing companies in the S&P 500 about the consumer. We'll get that answer from another angle too. It's not just big tech household. Names like Coca-Cola McDonald's and even Chevron will shed light on just how much faith they have in spending ability around the world and just how dangerous the dollar is to their bottom line. But the big event will be on Wednesday with the Federal Reserve expected to hike interest rates by 75 basis points despite some Wall Street banks still calling for 100 as their base case. Is the market prepared. We'll find out next week. Thanks to Juliette Saly Tom Mackenzie and critic Gupta. Coming up if we're headed toward a recession why haven't U.S. consumers gotten the memo. We asked. Bank of America chairman
and CEO Brian Moynihan. That's next on Wall Street week on Bloomberg. Recession. It's what we fear and what some tell us is either inevitable. Unfortunately I think our recession is going to be inevitable or much more likely than not if we're all talking ourselves into recession and being very pessimistic. The odds
are that we you know we lose faith and we go into a recession. And we certainly have some of the elements in negative growth for the first quarter and growth that is at best subdued for the second. There's probably close to a 50 50 chance. Maybe it's a bit less than that that we've had two negative quarters in a row. But then again we have employment that we've rarely seen. We simply have a very strong unemployment situation a very strong labor market that's continuing to fuel consumer spending keeping the economy moving forward and twice as many job openings as there are people looking for work. Right now the labor market is extremely tight and I would say unsustainably hot and a strong retail sales. The main measure of consumer goods. People were actually buying fewer weren't goods over the past few months. And the major banks telling us the consumer is
strong. They're going out. They're traveling they're doing things are getting dressed up. They're going to weddings. They're going back to the office they're going out to dinner more. So how can it be that we're heading for a recession when so much of the U.S. economy is still bathed in sunlight. Bank of America has one of the best possible vantage points on the economy overall and on the US consumer in particular. So we took the question of how to reconcile all the conflicting data points to the man at the top chair and CEO Brian Moynihan. Starting with what he sees in the state of the consumer. I just saw the data for the first few weeks of July and the end of day in the first couple weeks of July. The consumers in the aggregate spend across debit cards credit cards checks written Zell Bunny
RBA cash at the MS cash from tellers all the different ways to spend it. They spent about 9 9 percent plus more than they spent the first two weeks of July of 21. The transaction borrowing grew at 6 or 7 percent 6 percent plus. That means people are doing more things and so the consumer spending is strong. The second thing is the customers have in their accounts more money mid month of July than they did in June. And so they continue to build their account balances especially in the lower wage earning populations. We have in our customer base we serve all these customers. So to give you a sense the customer that pre pandemic would have had one to two thousand of average balances in our accounts had an average of 14 now has seven thousand plus in that account. That same customer two and a half years later the customer had between two
and five averaged thirty five hundred come forward two. A half years later they have thirteen thousand. So there's money in accounts. And by the way they're not going down. They went up a little round tax refunds that came down when they spent some tax refunds. And that was April May. And then you saw them start to grow in June. And you're seeing a continuing to ISE there. They
have money in accounts. The third thing is are they borrowing. And the answer is we're seeing some growth in our credit cards. Some go through our home equity balances stabilization or mortgage balances. But the end of day they have plenty capacity and home equity to borrow. There were 30 billion pre pandemic loans around the low 20s. So there's that capacity. Credit cards are 95 billion pandemic. They're now 80 mid 80s moving up. That is at capacity. Plus there's other lines. So there's capacity bar. The home values are still strong. So that's good. So as you look across all that data you say the consumer strong. Now when
you do a survey of what consumers feel like they say your consumer sentiment is down. And that's because they read about inflation they hear about inflation. So the answer is what they're saying they see versus what they're doing is kind of interesting. And if you look at the unemployment levels and wage growth and it's strong. So that's the conundrum. That's the Fed's toughest challenge. You have a strong consumer and they need us slow down the economy. And that's that's a that's a lot of work. And so we see everything constructive on a consumer side in our database. And by the way the wealthy customers are same thing except for frankly they had to pay more taxes in the second quarter 50 percent more by estimates than last year. So
therefore their balances went down and now the recovery. So Brian I think you just put your finger on one of the questions. Certainly that's perplexing to me that a lot of the data indicate the consumer is really strong but the consumer sentiment is really really weak. How could it be that good. Well we feel that bad about it. And I guess the follow on question is can we talk ourselves into a downturn. How much of this is sentiment and how much of this is behavior. But a couple of things. So my experience with consumers across the year especially on the investment side which you know I ran for the
company before I CEO for a bunch years you could see the stock market trading volume of retail customers you know correlate with sentiment. So you know when people don't feel good they don't put as much money in the equity market. You've seen a kickback and a little bit now but you know that went down a lot. And so there's you know these things do play off each other. So the sentiment out there plays off of stock market levels house price belief whether the debate about whether I'm going to have a job all those things play off. But the actual behavior plays off of really one straightforward thing. Do I have a job and am I getting paid. And if I have a job am I getting paid. I pay my bills. I can drive my family I can take my vacations I can buy
the new car and all those things you know in that that right now you know unemployment in the three mid 3s is a very low unemployment rate. And so that's why the consumers are spending even though they may not feel good because they're being told worry about a European war worry about an energy crisis or worry about a food crisis. And by the way there is inflation and really worry about that and inflation. You know there's been many quotes about inflation that people have died down but it's
insidious and it gets on people's minds and causes behavior change. It just hasn't changed it yet. And that's the key point. That hasn't changed yet. And if they get it right it start feeling better and then maybe it won't have the changes. As much as you say employment is the single biggest indicator of where we're headed in the economy. Overall employment is extremely strong right now. But does that suggest that if in fact we're to have a recession which many people including Bank of America
reject that we have to get a lot more unemployment pretty quickly. Well that's that's kind of the interesting thing. If you look at the blue chip economist and you look at our economist and you look at the street economists a subset of blue chip economists I just come looking through it. And so that you know 10 or 11 large investment banks have economists. I think we add one other one have a a negative part in 22 or 23. The rest of you are very slow growth. So you want to a 5 percent growth rate to have maybe a 2 percent growth. Or even less down to you know really no growth. Have you seen this thing slow down. The thing is all of us still have unemployment. You take the blue chip and look at it the highest. It's like 5 percent which doesn't seem consistent with the recession
level people are predicting because remember we were five percent unemployment moving down to 17 and things like that. So it's a little hard to figure out how people can predict the economy slowing that much unemployment staying strong. Is it because the averages are in the low fours and that that's something I think that people just one side. The other side if you listen to the Fed chair he'll they'll talk about they need to have labor markets is not so tight and it's very tight now to job openings for every job. But that is that is kind of the conundrum that when I look down all those stats I sort of say
wait a second how can you have that kind of slow economic growth. But that kind of strong employment in the absolute sense coexist. And the answer is one's got to give and we'll see one more data point. Brian if I may you also have access into a lot of American business and not just the really big ones but small and medium sized enterprises as well right across the country. What are they mainly worried about as you talk to them. Number one the activity in our small business 5 million under revenue companies that core small business were one of the largest if not the largest player in it by far as I said earlier the origination activity new loans originated was up about 10 percent year over year to two point nine billion versus two point sixty two point seven. So that's good. That means they're still demanding credit. Okay. And then we looked at the small
business again five main under open cut companies. They're used to their small business credit cards. That's growing in double digits. Plus that means are using these the business cards using it to buy things and do things. So that's that's strong. What they were worried about in our surveys that we do inflation for them. That's input costs going up wage getting people on how
much they have to pay them can even find him if I want to pay them and then can I fill the orders I have. And so if you talk to the manufacturing people who say my problem is the supply chain still moping around and I've got stuff that I could I've got orders out there. You go out through your year and next year no problem at all. I just got to get the stuff in to all the component parts to complete the thing and then sell it. I've got 60 percent 70 percent 80 percent and I need to get the labor to do it. And at that you know it's a very difficult time to manage that sort of mechanism. But the good news is they've
got committed contracts to take the stuff when it's done. And so this supply chain is pushed out the demand cycle a little bit because they're just a lot of stuff that still has to be manufactured and sold you know in various industries in that 50 million and under revenue company itself. They all worry about all the things you read about the paper because they read the same papers and think about them and actually see them day to day execution supply chain labor tightness input prices. But on
the other hand what they also see is good demand for their products and services which gives them optimism. That was Brian Moynihan chair and CEO of Bank of America. Coming up we wrap up the week once again with our special contributor Larry Summers of Harvard. That's next. On Wall Street week on Bloomberg. This is Wall Street week time David Westin we are joined once again by our very special contributor Larry Summers of Harvard. So Larry one of the big developments of this week was the European Central Bank which made an historic move 50 basis points also implemented a new emergency policy. What did you make of what they did. Look I think they had to do it. Europe's got a serious inflation problem. Yes a lot of it's coming from the supply side. But if you don't respond it becomes entrenched
and not much more expensive to eradicate. They've got an aspect to their problem that we don't have in the United States coming out of the fact that they're a monetary union rather than just a monetary system. And so if you're going to have to administer substantial shocks to contain inflation you're going to have to insulate the European economy and the weaker credits in the European economy from that. And that's what they had to do. I think all things considered they took the right kind of steps. And this is pushing Europe in the right direction in a dangerous situation. I was very sorry to see the political developments in
Italy which are yet another example of one of the great challenges of our times which is populist leadership and populist politics. Unsettling the prospects for rational policymaking and creating greater challenges in the long run. I strongly suspect that Italy will regret that Mario Draghi did not have a longer run as prime minister and head of government. Well I'll take those two and put them together Larry. Actually the politics of Italy on the one hand and the monetary policy the ECB the ECB try to address some of that with their new policy. It was unclear exactly how it gets implemented. Try to keep the spreads on the bonds for example between Italy and Germany in check. I mean
here's the ECB problem David. It's you know to use a phrase from the security area it's double deterrence. They want on the one hand to deter the speculators from speculating against Italy and other periphery countries. That requires a confidence sense that that the ECB is going to stand behind them. On the other hand they don't want to finance unlimited spending and so they want to put pressure on countries to manage their affairs responsibly so that points towards an element of conditionality. But the more the conditionality is credible to the countries the more it's unsettling to the markets the more confidence you give the markets the more the countries feel that they don't need to do their part in terms of making painful policy adjustments. So it's a very difficult balance to strike. And I think this was a reasonable move
forward in striking that balance. But it's not going to be easy going forward. One of the other things that we heard from Madam Legarde is something you and I talked about and cannot in connection with the Fed which is forward guidance. It sounds to me like essentially ECB saying we're out of the business of foreign got forward guidance. We'll take it meeting by meeting
David except for some quite particular quite unusual circumstances. I think forward guidance is generally a mistake for central banks. Forward guidance tends to run into the problem that the market doesn't believe it very much so. It's not very impactful. And the central bank takes its own credibility seriously and it's constrained down the road by the forward guidance that it gave in the past. So except for very extreme deflationary situations I think forward guidance is a
tool that is better off kept in the closet back in United States. We've got a number of important events coming up next week. We've got a meeting of the FOMC. We also have really important potentially data coming out particularly P.C. corporate sea and otherwise and also the ECI numbers. What are you going to be looking at. Look I think the most interesting and informative number is going to be the ECI number David. The wage picture is mixed. The average hourly earnings data that come out in each employment report have been relatively favorable and benign for the last several months. On the other
hand the last Atlanta Fed report which looks at the wage changes for particular individuals and therefore controls for composition issues was really quite alarming. And so there's a divergence between those two reports that is not well understood. And I think we'll get greater clarity on that when we see what happens with the employment cost index. If wage inflation is continuing to accelerate which is what you would tend to think given how high vacancies are relative to unemployment. That's going to be a very concerning sign if somehow despite everything. Wage growth is slowing. That's gotta
be reassuring to the Fed in terms of the risks of entrenched inflation. So I think that's going to be very revealing and informative. No when it comes. I think at this point most people kind of have a 75 basis point increase locked in for the Fed. And I don't think they expect the Fed to make dramatic news with any policy announcements. I think the P.C. number can be previewed pretty well on the basis of what happened in the CPI. It's likely to look a bit better but we've still got us very serious slog of inflation ahead of us for the medium term. A huge amount is
going to depend on what happens with commodity prices. The agreement reached this morning that suggests that Ukrainian wheat may at long last flow to the rest of the world. That was certainly an encouraging sign but there are huge overhangs of uncertainty surrounding the oil market. And while it's not what's currently priced into the forward market I think we have to recognize that there are real risks of substantial oil spikes that we're all focused on. The Fed is the
front line of defense as it were against inflation. At the same time is it only the Fed. Are there things we can do in fiscal policy at this point that can address the inflation issue. Look fiscal policy makes a big difference. This is. The time for stimulative fiscal policies like continuing moratoriums on student debt relief. This is not the time for anything that's going to be a big new spending program. In fact it's the time for short term deficit reduction. That's why I'm so disappointed that the IDF seems to be gaining currency that you shouldn't raise taxes when there's inflation. I actually think that just the right thing to do is to raise taxes right now to take some of the demand out of the economy. We can raise substantial
revenue by cutting corporate tax loopholes. In fact if we don't do it we're likely to lose what I think was a huge accomplishment for the Biden administration. The global tax cooperation agreement that Secretary Yellen concluded we can generate significant revenues simply by enforcing the tax law and taking some of the spend taking some of the money out of high income tax evaders who then go and spend the money and that'll contribute to reduced inflation as well. So I sure wish we could get past this basically ludicrous economic idea that tax increases are inflationary. It's just not right. One quick one here at the end Larry we had a lot of earnings out of tech particularly SNAP and also Twitter. They didn't do so well this week. Is that tell us they telling us anything broader. Look I think what you're
seeing in tech is what you kind of always see which is just when governments getting aroused that something is a source of monopoly power and earning excess profits. That tends to be when it peaks in the marketplace. That's how it was with IBM many years ago. That's how it was with Microsoft. I think we're seeing some elements of that with this advertising supported tech businesses right now. OK. Larry always such a pleasure to have you with us. And a privilege really. That's Larry Summers of Harvard our very special contributor here on Wall Street Week. Coming up what aren't our leaders telling us and why not. That's next on Wall Street week on Bloomberg.
Finally one more thought. Stranger things. Sure it's a hit series that came to Netflix's rescue and earnings this week. It's risky as hell. But it's also a fair description of a lot of what we're all seeing these days. Everything from record heat in Europe the scorching heat wave tormenting Europe is pushing power systems to the edge to a slowing economy while consumers keep spending a lot of uncertainty. You guys have been talking about it all day. Higher recession ISE slower growth to supply
chain problems that just won't go away. Now we see that weak weak links in the supply chain. But sometimes it seems as though our leaders hope that if they don't tell us the bad news it will simply take care of itself. Remember back after 9/11 when President George W. Bush told us all we could help in the war on terror by doing more shopping. We cannot let the terrorists achieve the objective. Of frightening our nation to the point where we don't we don't conduct business. Where people don't shop. That's that's their intention. Or Fed Chair Jay Powell telling us more recently that inflation was only transitory. Long past the point when we knew otherwise. But
we don't expect it. Those that upward pressure will produce substantially higher prices or that the effects will be persistent. We expect that will be transitory or temporary. And it doesn't look like we've learned our lesson. We all know that gas prices are way too high even if they have come down a bit. But when President Biden talks about the problem he pulls out every trick in the book except the one that's most obvious just asking us to buy less gas. Dear I'm calling on Congress to
suspend the federal gas tax calling on states to either suspend the state gas tax as well. I'm calling on the industry to refine more oil into gasoline. Or what about coming up with a plan for that. Be a five sub variant that could wreak havoc on yet another winter. Clearly it needs to be taken seriously because to be a five variant has what we call a transmission advantage
over the price variance. And maybe the biggest one of them all really doing something about climate rather than just talking about it. No president in the future would walk into the White House and undo what is going on around the world. This is bigger than the United States. But this week maybe we saw the pattern broken when Europe finally admitted the obvious that if Russia cuts the natural gas supply everyone is going to have to cut way back. We have to reduce our gas consumption. I know this is a big ask for the whole of the European Union but it is necessary to to protect us. Every member state should
reduce the use of gas. And our second objective is we provide a safety net for all member states. Maybe other leaders can take a page from the European book so that the rest of us don't have to resort to a superpower teenager to save the day like the kids of Hawkins in stranger things. Kansas a success or 20 to 1. Never tell me the odds. That does it for this episode of Wall Street Week. I'm David Westin. This is Bloomberg. See you next week.
2022-08-01 11:03
