Wall Street Week - 03/15/2022
The Fed inflation and war in Ukraine all coming together. This is Bloomberg Wall Street week. I'm David Westin. This week special contributor Larry Summers on the Fed playing a tough hand. I think they're recognizing that they're behind the curve. I think they've still got a long way to go. And Rick Reeder of BlackRock on a Federal Reserve dealing with multiple crises close to the zero bound. This week we had it all. A continuing war in Ukraine with Ukraine President Zelinsky addressing Congress and President
Biden and the president. By then you are the leader of the nation on this issue. I wish you lead a leader of the world. Being the leader of the world means to be the leader of peace. As President Biden plans a trip to Europe next week to consult with allies. The White House announcing President Biden is going to travel to Brussels next week to meet with NATO allies as Russia presses on with its invasion of Ukraine. With more Russian sanctions on the table we have to seriously consider which mean puts pressure on Putin and which mean could harm our have small oil shot up to over one hundred thirty dollars a barrel only to plunge below 100 dollars. If you have access to a chart intraday frank crude put it up right now. Ninety seven
ninety seven hand to unfriend then take it back a week or so. You've got a forty dollar plus swing gone crude on Brent Tom Keene a week one single week forty dollar swing all of which were important to investors but none as important as the Federal Reserve decision on Wednesday when it made it official. We are moving from monetary loosening the monetary tightening. Every meeting is a live meeting and we're going to be looking at evolving conditions. I think that the Fed has largely abandoned monetary orthodoxy. It's trying to be too cute in how it's managing this whether
cute or not. Markets took what the Fed had to say in stride with stocks rising again on Friday capping a risk on week for the S&P 500 up over 6 percent. That is the best week since November of 2020. And tech did even better with Nasdaq higher by 8 percent. While bond yields after shooting up briefly with the Fed's announcement on Wednesday settle back down to one two point one four on the 10 year by the end of the week up a bit but not that much in the meantime. Oil after all those fluctuations ended up with Brent around 1 0 7. Take us through this volatile week. Welcome now. Joanne Feeney she is portfolio manager at Advisors
Capital Management and Sonali Basak. She is chief investment officer at Franklin Templeton Fixed Income. So so now let me start with you because bonds were very much in the spotlight this week given what the Fed did and there actually bond market did what the feds say makes sense to you. Mixed. Say. So here's the thing. What the Fed did I think was a smart thing to do. It validated what the market was already pricing which was seven rate hikes this this year.
The reason I would say it's mixed is I look at the terminal rates that the Fed has which is around two point eight and it has inflation core PCI e dropping from the four handle this year down to two point six next year. So you've got rates barely positive. So that part to me. Not true. Not so sure it makes so much sense. The seven rate hikes. I mean it was almost I would say a no brainer. Given that the market had already priced this it would have been crazy for them to have missed that opportunity. I do think actually they've left the door open for more than seven rate hikes this year itself. And I'm very interested in that. And then I'm gonna stop. I'm very interested in the fact that the market really isn't pricing any rate hikes for all practical purposes after the Fed is done with this year and a little bit. So clearly the market is still not taking the
Fed very seriously on this. And what about from the equity side of it. Yeah. You know it was really interesting to see the dynamics this week with the Fed coming in as expected but not lowering their growth forecast for example and delivering that anticipated plan for seven rate hikes. You equities said OK that's what we expected. We've already built in these kinds of rate hikes. And moreover the Fed has just confirmed a slowing growth environment which you know equity investors I think we're expecting and what we saw interestingly as you pointed out David at the beginning was NASDAQ actually went up more than the S&P showing I think the beginnings of a return to more growth oriented tech oriented stocks because in a slowing growth environment broadly speaking where are investors going to find growth. You're going to have to find the names that have secular drivers. And a lot of those are technology companies. So now you're to refer to the projections for where rates are going to go. Given where inflation is.
How is inflation going to come up. So come down so dramatically if we don't get to positive real rates and real yields as a practical matter. Don't you have to have the rates above where inflation is projected to be. And is the Fed really planning for that. You know I would just say one thing. Hope it's not a strategy. And I think the Fed's forecasts. All right. That projections and I think Joanne and I talked about this earlier. But you know it depends on a very rapid resumption of supply chains to some form of normalcy. Because I don't think that monetary policy at this
point is going to be successful in bringing core. E let alone headline BCE down in the timeframe the Fed is envisaging with its style of rate hikes. The Fed is planning and yes there is a growth slowdown. It's not it is a slowdown but it is not a recession. So I think that is a part of what is going on over here that you know it will not. I think the Fed is trying to tread that line are not freaking the market out. And it probably six clearly very successfully did that. But I do wonder whether in June when we get the next set of as a P and dot plots we're going to see something
different. And it's going to depend critically on what we see on inflation over the next two three months. Yeah. What's an all points out there David is is that the wide variety of projections by the FOMC members. If you look at those top slots unfortunately we can't teach them apart and look at one person's projections separate from the others. But you see this incredible range for example you know some folks saying they expect the Fed funds rates to end the year at 3 percent. Others one point five percent. And that tells you there are a lot of different assumptions and understandings of what the dynamics
are this year that are going to drive inflation growth and rates. You know for example a lot of folks are still thinking that the base effect is going to play through the lower inflation in the second half of the year. That is we saw last year in the spring those big price increases and we got a lot of those that's going to take some of the wind out of the sails of inflation. Some people must be modeling it that way and others are recognizing that really unusual IBEX right now for the Fed job openings are enormous. Firms out there are really trying harder. So the Fed is raising rates into a pretty strong economy
and it's unlikely that firms are going to turn around and say oh no the Fed is raising rates are going higher. They see that there's still an awful lot of consumer demand out there. And the consumer remains fundamentally strong with very very strong balance sheets. And even the fiscal support is running out for consumers. And even if some of them are really suffering from a high food and gas prices that are out there enough of them are more comfortable sitting on those balance sheets to sustain consumer demand. So it's a really tough spot for the Fed. They need to raise rates. But on the other hand the economy is still very strong. And so we are likely to see supply come back. And so that's why I think there's such a disparity of
projections that are coming out of the FOMC as to how this is actually going to play out. And trust me that is to say hey we're going to be watching the data. We're going to update it as we need to. As the year goes by I couldn't agree more. So the issue of that dispersion is very real but they always talk about the central tendency as well. And so they are right or wrongly giving some form of forward guidance via the ACP and the dot plot. I totally accept that because I think that in particular
that strong labor market. We are in a very different place. You know consumers and it's not just a strong labor market. Consumers are coming into this sitting on over two trillion in savings. So even if we have that fiscal control consumers still have savings to allow them to validate these price pressures to some extent. So yes we expect some slowdown but they can run down the stock of savings certainly through the end of this year. And ironically indeed the higher inflation is probably
going to bring back some more of those people who are out of the labor force back into the labor force. So I wouldn't be surprised if we saw in the months going forward the participation rate going up but the inflation but the unemployment rate also going up because of that participation rate change. So it isn't a sign of weakness. So Joy that's exactly what I want to ask you about because both you and so now have talked about the strong labor market. And we heard Jay Powell the chairman of the Fed say it's actually unhealthy. It's so strong. At the same time if you look at those economic projections it says basically inflation is going to be higher rates are going to be higher growth is gonna be less and we will not have any increased unemployment. How can that be right. Just as a matter of basic economic theory can those numbers all
be. Well again as I said I also pointed out that dispersion is reduced. Those projections right. They're looking at the central tendency is looking at the median. But within those projections you can have wildly different individual forecasts that have for example inflation going up growth going down you know with higher rates. The average happens to show unemployment not changing. But if we just step back from that how can we imagine
that somebody put on my economist for a second. How can we imagine that happening where rates are going up inflation is still high and yet unemployment doesn't go up. And I think that that's where the situation is really different. With the vast amount of job openings still out there well above that the number of unemployed people firms are really starting to hire. And it's an all pointed out we could very well see a higher labor participation may not necessarily see a higher unemployment rate even in this rising rate and high inflation environment just that there's such a shortage. Firms are desperately trying to fill chairs. And so we could continue to see that kind of strength. That's why I think the Fed is really facing a really unusual challenge. OK so now decide of Franklin Templeton and Joanne Feeney of
Advisors Capital Management will both be staying with us as we turn from what the Fed did this week to what investors should do in response. That's next on Wall Street week on Bloomberg. This is Wall Street we come David Westin Sonali Basak of Franklin Templeton Fixing Income and Joanne Feeney of Advisors Capital Management stayed with us so we can talk about what investors should do with the information that they got this week. Joyless started the equity side this time. What does an equity investor take away from this. What stocks you want to buy. Maybe not so much given what we saw this week. Yeah. You know David it really depends what sort of equity investor you are. What are you looking for. You retired and you want to be conservative. Are you younger or have reason to be more aggressive. You're really very different strategies here. So if we look at sort of the more conservative media income oriented I think you really have to think about having some defensive position some insurance in the portfolios because global risks are elevated and they're going to stay elevated. And it isn't just Russia and the Ukraine. It's Covid
potentially. It's always you know other things. And so what's maybe new now is to have some insurance positions that go beyond sort of the energy the banks the real estate protection against inflation towards you know some of those things that we'll do. Well if this Russia Ukraine situation really lasts a long time. What is it hitting commodity prices. So you can know not necessarily the commodities but companies that are going to do well because of those higher prices that are going to persist for a while. For example Caterpillar Reindeer which is going to see a big increase in the demand as as more mining happens. Right. As more countries go toward demanding food self-sufficiency for example. So there are a lot of interesting
ways to build insurance portfolios in this kind of environment. But one shouldn't forget the reopening is still happen and there are some reopening trades one can play if you're careful about the inflation exposure in a growth portfolio. For example we just added match as people go out and date more in person. We think that's a good one for folks to to to be involved with. And then there's the tech side. As we saw some of the rebound has begun and we think that's going to continue. But again some of that is a little bit more on the aggressive side. So it really depends a sort of portfolio. We've all of these things a lot of
them for a very long time. We find it's very important to ride out the volatility in this kind of a market that you want to make sure you're comfortable doing so. So now not to put too fine a point on it but on the fixed income side why do I want to invest in bonds right now given the fact I know rates are going up and if I do which are the bonds I want to buy. So I'd say that for one thing there's always a place for bonds and portfolios and certainly this is not the most attractive time to be heavily invested in long duration assets. Because I certainly believe that we are going to see a steepening of the yield curve. I know that markets are anticipating the yield curve actually inverting which would be positive for long
duration bonds eventually. But I would just note that that seems to be presuming that the Fed is going to come in swoop in and bail the bond market out again the way it has. Every single time in the last 14 years since the global financial crisis when the market has wobbled. So I do think that long duration assets there will be some interesting plays there because spreads have widened. They may widen a little more. But I. But towards the end of this cycle certainly a lot of those long duration assets
become very interesting again. But right now I look at floating rate instruments. So I look at the bank loan space within high yield. We have seen spreads blow out. And certainly that allows us to go back in and find specific areas and sectors. And here I would actually say that a lot of what Joanne said and from a sector perspective applies to fixed income as well the reopening trades looking at energy plays etc.. And the last thing I would say is when you do see commodity prices taking off the way they have one has remember that within the emerging markets face every country is not a loser. There are countries which actually do well when commodity prices go up and others that do badly. And so even in that area I would say that there are places where
I would say that you can hide otherwise stepping slightly outside my round house so to speak I would say definitely it's worth looking at alternatives. And from the perspective of real estate and the classics like Stagflation Trades which would be commodities real estate places like gold for example and certainly I think that you could you could probably do with some inflation protection. And anyway you can find it at this point. Joanne what about recession protection. Because we just heard and I'll refer to the flattening yield curve some people think he's going to invert often an indication depending on which part of the curve you look at what possible recession as you do is invent an equity veteran need to be taking into account the possibility of recession in your investments. Yeah. You want to give it some some probability weights. You don't want to necessarily put it in that direction. We think it's a bit early. We're just seeing such good signs of strength in the US economy. The big concern obviously is the war and how it might really affect Europe if it goes on for a long time. But
building the portfolio what we've done for a long time is own stocks that continue to do well even in a recession. There are some consumer staples for example real estate holds up very well. And so you really do have to build that kind of insurance into portfolios as well. So it does it does depend on your time horizon and your goals. And you know for example in the growth portfolio know you're still going to be pretty long duration as all but you're going to still own these assets that are going to have a longer time to play through. And so in a recession environment or just a slowing aggregate growth environment it's
important for investors both a long enough horizon to say well where can I find growth. What's going to continue to grow even if there's a recession. You look at cloud computing look at data center expansion. This is still continuing and likely to do so through a recession. Look at software that is used for information technology infrastructure and firms that those are the sort of companies by the way that are welcome take from the wage inflation that may very well bedevil profits in more labor intensive industries. And so that's a way to build in that kind of protection portfolio as well. You know if I could just say one thing that you know to go back and I don't want to beat this to death but you know that inverted yield curve. We need to keep. We need to keep in mind the Fed owns a quarter of this market. So you know it owns a
quarter of this market. The yield curve is really not seeing as much as perhaps we think it's saying. So that's one thing that I would I would note when we look to the yield curve for signs there is so it is so distorted at this price at this stage that you know I would not look at the yield curve. Yeah. And sonars as we were talking about earlier you know the nominal refuel or if you look at the two 10 or whichever that's getting very flat may very well invert which kind of makes sense. We have high
near-term inflation and much lower projections for inflation 10 years from now. So interest rates near term should be a lot higher than interest rates on return. But if you if you pull out inflation with a real interest rate yield curve is actually pretty healthy. And it's a real interest rate yield curve that should be telling us more about real growth projections. And so there isn't as negative a signal coming from there. And I think that's that's what we're seeing in the strength of consumer firms hiring. GDP growth expected still to be well above long term trends this year in that.
And I would just add to that. If you look at really alcoves as well if I look at inflation linked that's not a market the Fed owns again a quarter of that market. So I tend to be a little bit more skeptical about the inflation signals the duration of inflation and inflation expectations. I would just note that as
we come to fall if what we anticipate happens and people have seen seven to eight percent inflation for an extended protracted period of time the ideal or the risks of a wage price spiral become far more serious. And that means that inflation might hold on for longer than the Fed would like or indeed any of us would like in the market because that's not a healthy environment for any stocks or bonds. So yeah we've made it the end of this discussion without a lot of discussion about the war. So Joanne I'm going to give you the hardest job. Just briefly at the end the market seems to be looking past Ukraine right now. Are they premature or are they on to something. Well you know when we look back at the markets and various force and disruptions recessions pandemics you know we do see that investors tend to recognize that wars tend to be temporary disruptions. They think there may be reason to believe that the risk associated with this situation are more elevated but they're in Townsville. And so I think investors are recognizing that the disruption even if bad is likely to be mostly focused
on Europe. Know I've been here in the US. Well done Joanne. You landed at that hard assignment. Thanks so much. Just another sign of Franklin Templeton fixed income and also Joanne Feeney of Advisors Capital Management. Coming up we'll take a look at the week ahead. Around the world. That's next on Wall Street week on Bloomberg.
This is Wall Street week. I'm David Westin. We look ahead now to what's coming up next week. A global Wall Street starting with Juliette Saly in Singapore. Well thanks David. China's economy remains in focus for investors as Covid lockdowns and risks from the Russia. Ukraine will put further pressure on the need for further stimulus. However China's loan prime rates for March will likely remain unchanged for a second straight month after banks lowered their quotes in January. Elsewhere we get key earnings across sectors from tech to autos
to banks. Investors will be waiting for Beijing to follow up on its vow to stabilize China's markets with tangible actions. Now over to Dani Burger in London. Danny. Thanks Juliette. The war in Ukraine continues to be the focus for Europe in the coming week and he talks between Ukraine and Russia will be closely watched as well as the continued shelling of Ukrainian cities. Now looking at refugee numbers of people who have left Ukraine surpassing three million people. The international response will also be closely watched with the US pledging new weaponry and at the same time European countries stepping up their defense spending now over Romaine Bostick in New York. Thanks Danny. After the Federal Reserve lifted interest rates and signalled hikes at all remaining meetings this year we're going to hear again from Sherrod's Ron Paul. Next week he speaks at the 30th
Annual Policy Conference of the National Association for Business Economics on Monday. Economic data next week include new home sales. University of Michigan sentiment data and durable goods orders. Durable goods which have increased in 19 of the past 21 months. They're expected to have fallen in February for the first time since September and a small handful of earnings to watch next week including Adobe Carnival General Mills Darden and Nike. Nike may be of keen importance to the broader market as equity investors have shifted focus from supply chain concerns to weather. Strengthening consumer spending can sustain the economy in the face of higher interest rates. David.
Thanks to Juliette Saly Dani Burger and Romaine Bostick. Coming up inflation fed tightening and a war in Ukraine. They've roiled the markets. So what's a central bank to do. We hear from Rick Reeder of BlackRock. That's next on Wall Street week on Bloomberg. February 24 marked the invasion of Ukraine by Russia. Putin started a war with Ukraine with the democratic world. Changing the lives of millions of Ukrainians civilian targets have been hit again. Last night the emergency services in the capital city
in Kiev have also been reporting hit on residential buildings and resonating through economies around the world as the United States and its allies move decisively to impose a wide range of economic sanctions. We are enforcing the most significant package of economic sanctions in history and it's causing significant damage to Russia's economy. But the world was already changing before Russian troops came across the border with Ukraine with concerns over inflation higher than they've been in 40 years. We're not going to let high inflation become entrenched. The costs of that would be too high and ongoing problems with the supply chain triggered by a pandemic that touched every corner of the global economy. It's just another
headwind and a ripple through supply chains that are already very stressed. We had seen some recent signs of improvement in supply chains but you had seen that year end and going into early this year. But I think all of this really gets reversed because of the war all of which poses a unique set of challenges for central banks like the Fed that have to respond to multiple crises when they are very close to the zero bound with their interest rates. We are starting this Fed episode at the Lower
Balonne. As you mentioned the last time inflation was like this was actually July of 1978. It was just under 8 percent. Short rates at that point were 8 percent. My tenure was just above 8 percent. To take us through what the Fed is confronting we welcome back. Now Rick Rieder BlackRock CIO Global Fixed Income and head of the Global Allocation Investment Team. Rick great to have you back with us on Wall Street week. So as we just said the Fed had
a hard job before the war came up. There are a lot of problems there. Now they've got the war on top of it in a nutshell. It's a favorite game. How they doing. You know what I mean. Listen I think you're Powell alluded to the fact that they should have moved earlier. I mean we're in it. You know the Fed is behind the curve significantly behind the curve. You know now I think what's really tricky is how do you move. How do you move to the other side quickly and not disrupt the system so aggressively. So I think they're in a tough spot. In fact I think this is the toughest spot I've seen a Fed in maybe in my career. And so I and so this I think it I think it's going to be a challenge. I think you've got an
economy that you'd always say this high prices are the cure for high prices. You actually see an economy that's starting to moderate in a number of places. And I think that I think the Fed has to try and be careful about not letting the economy slip into a recession while they're well they're trying to deal with inflation. Looks at much of this. Inflation is supply shock driven. You know when you go through some of these you know we talk about energy a lot. You know the global wheat production 34 percent comes from Russia Ukraine pretty incredible numbers. You're going to see that flow through of food prices. So it's a challenging dynamic that's going to impact the economy for sure. And the Fed's got a got to run a struggle a very fine line. So
as you say record high prices are said to be the solution for high prices. I would put up a chart here for our television audience will describe it for those of us joining us on radio that basically illustrates that point in terms of real consumption not now a consumption but real consumption. The extent to which really inflation at this point is outpacing the growth in consumption. It's pretty incredible David. I mean we went through this period with this explosive set of real growth quantities real growth of goods demand that as you as you emerge from the pandemic you were buying cars and furniture et cetera and across the board electronics computers et cetera then now you get this spike higher in prices. And what you're seeing is a pretty extraordinary dynamic that now real real consumption is starting to come off i.e. the cure for high prices high prices people start to pull back on demand. You're seeing this in the inventory builds. Retailers are growing interview. You're seeing
inventories start to build. That will bring that will bring prices down. But it's definitely something to pay attention to. I think I one other chart that shows the dynamic that where we are today in consumer sentiment consumer sentiment is the lowest it's been in 10 years. You know desire a good time to buy a car a house. Durables are really falling precipitously. So you know this is part of that dynamic that the Fed has got to straddle this line and the consumers are going to are going to pull back. I mean look at these numbers. It's pretty staggering. I think what you're talking about these numbers falling off a cliff when
the consumer is arguably in the best shape I've ever seen them in history. Savings rate is up. Wages are up. Hiring is up. And yet they're going to pull back and they're going to wait because these prices are eye popping high and in a good way for a for a better period of time particularly when we need. When you look at the consumption basket for lower middle income fuel and food shelter where you're seeing the biggest price hikes makes it really tough for consumption to stay up. I want to come back to the lower middle income. But before that just interpret that conditions chart for me just a little bit. Rick is that death
and destruction worth RTS. That's exactly right. I mean it's literally the dynamic by the way you've seen us corporate earnings. Interesting. You see a lot of companies now and the reporting the revenues are still decent. But then when you actually dissect their revenues and you get a dynamic where while they're not getting it from quantity anymore they're getting it from price. There's a limit to how much you can get. And this is part of why earnings can can start to come off over
the next couple of years because you can't keep getting it through price. You've got to get it through through quantity as well. By the way when you look at what the Fed did in terms of their projections this week they dramatically brought down real GDP. They dropped dramatically brought up inflation. Listen. That is something that will boost the economy. The U.S. economy particularly is most flexible self calibrating economy in the world. And I think you're going to see that you're starting to see that transmission through the economy today. And yet as you point out there may be some good news in here that some of the middle and lower income people are gaining the most right now. So I mean this this is you know I think it's a very easy answer.
And quite frankly I don't think it's a complete answer when people say gosh the Fed just got to keep raising rates and do it quickly. You've got to be really careful if you think about what's happened the last few years. Wages are moving up. You're bringing more people into the labor force. By the way there's two million or so less people in the labor force today than pre coded. You'd need to keep cultivating that. And this is where I think when you look at this chart I mean look at how well lower and middle income is doing now. You're seeing exclusive wage growth and people coming into the workforce. That is something
the Fed wants to keep going. And particularly think the income burden in this country or the Detroit should set the debt burden in this country. And we're going to have to fund an awful lot of debt over the coming year. It's going to be really careful. If you lift interest rates too much that debt burden is going to be too high. And B you want to keep lower and middle income wages up and keep bringing people into the labor force. So I just don't think it's as easy as. People say it's like like she's
getting a great weight rates up. We got to get him up quickly. We got to reduce the balance quickly. I think listen we're far from neutral but needs to move away from easy policy which is I mean think about think about the irony. QE was happening last week and now now we're going the other side. They've got to move quickly away from that. But I just think projecting out where we're gonna be through six months hence on the economy. I just don't think that that's as easy as people suggest it is. A Rick
you're responsible for investing an awful lot of money there at BlackRock. I have to ask you how are you taking into account if at all the war in Ukraine. Because it looked to me this week like the market's almost dead. We're going to react for a while but we're over it. We're back to saying words business as usual. Virtual IBEX is the most extraordinary weeks in markets I've ever seen. I mean so by the way the news now is the Ukrainian news. You had a more hawkish fed and then the markets just in particular the equity market just went right through it. Now some of it is rate stabilized. That was a big deal. Part of his people sitting on the sideline. The losses have been significant this year both in bonds and stocks. So people were on the
sidelines are sitting on a lot of cash. And then you know you started OK maybe I can start to put some money to work. And I said that started to build on itself. And there was one significant piece of news this week that should not be underestimated. China is watching how China is going to align with Russia or not. And there were some significant statements both on the regulatory side on the growth side but also somewhat clearly appears to be some detaching between China and Russia. And that was one of things the markets were super concerned about because that creates a framework that's really hard to deal with. Bless your brother for raising because the other question I had was China because some people think that maybe President Xi capitulated when it comes to. So the regulation of big tech and some of the issues with really
seeking investors from outside of China. Yeah I mean listen it was a pretty strong set of statements. I mean I was actually blown away by how aggressive these statements were. I think there's a couple of things to talk about your point. Chinese economy has been slow right hand and you have the lockdown in some of the citizens and et cetera. That is that has created some concern. And then you know a lot of pressure and immense pressure on some of the markets there. So listen I thought it was a pretty strong statement. And I think that's part of what the markets latched onto this week. Yeah well when Rick Wagoner says it's one of most extraordinary weeks in markets you have to listen to Rick. It's always so
great to have you on Wall Street. There's Rick Reader of course of BlackRock. Thanks David. Coming up special contributor Larry Summers wraps up the week for us. This is Wall Street. I'm David Westin. Welcome back. Once again our very special contributor Larry Summers of Harvard to help us
wrap up this week. So Larry you've been calling for quite some time on this program and elsewhere for the Fed to really wake up smell the coffee and realize we need to be focusing on inflation. We need to increase interest rates. They took a big step in that direction this week. Was it enough. They did and I was glad to say it. I think they're recognizing that they're behind the curve. I think they've still got a long way to go. They've got a long way to go in forecasting realistically. I just don't believe that it is plausible that we're going to have three years of three and a half percent unemployment while inflation falls precipitously. Nor do I believe that inflation is likely to fall precipitously on a path
where the nominal interest rate never gets within 2 percentage points of where the inflation rate is right now. Not at any point in the next three years. I also think that the Fed needs to recognize that its 2020 framework was perhaps a good idea in the deflationary context of that moment though I'm not sure it was but it is surely not. Got anything connected with our
current kinds of challenges. So perhaps institutions adjust with some gradualism. So perhaps we're moving in the right direction. But I think there's a long way to go and I don't think the Fed has really done all that will be necessary to preserve its credibility in the face of the substantial inflation that I think is likely to come to us in recent months. You know I just had a chance to review what is the best data on wages. The data from the Atlanta Fed. And depending on which of the indices you use how you weight the data and so forth on some measures is wage inflation is now getting close to 7 percent. And that is just not consistent with the kind of places that we want to go in terms of inflation. So Laurie to focus very specifically inflation which you've been asking us to do now as I say for over a year. If you take a
reasonable projection of inflation out over the next year or two years what kind of Fed funds rate do we need to get it down. Clearly we need to get into a positive real yield. No. And what do you need to get the rates to be in order to really have the rates be higher than the inflation rate. Here's the problem with Fed think David. They assume 2 percent long term inflation and then they say that the neutral rate is two point four and then they say look we're going to raise rates to two point seven so we're going to be above the neutral rate. So aren't we great. But the problem is that that whole calculation is based on the assumption that we're going to get inflation down to 2 and they don't provide a basis for believing that. A simpler and more direct way to think about it is to say that when inflation goes up. If you just raise interest rates as much as inflation went up then you're not changing real interest rates at all.
If you want to tighten policy you have to raise interest rates by more than inflation went up. We used to be a 2 percent inflation country. Now we're almost certainly a 6 percent inflation country and on some measures where an 8 percent inflation country and so we've got to raise interest rates by more than 4 percentage points.
We've got to raise them by 4 percent to stay neutral and we probably have to raise them more than that. So I think ultimately we're going to need a four or five 5 percent interest rates levels. They're not even thinking of as conceivable. Now the reason for this is that they believe as do many to be fair to them in the markets that the main problem with team transitory was the marketing not the reality. So they think inflation is going to come way down without any action on their part to bring it down. Maybe I see rental inflation which is 40 percent to the core CPI is likely to rise substantially this year. I see more bottlenecks coming as China gets into very substantial lock down. I read a story this morning about airline
prices really taking off as people start to travel again. Their numbers suggesting low medical care inflation prices. But every hospital in the country is desperately short on nurses and other medical personnel. So I don't think we can count on the transitory inflation view and I don't think we can count on the restraint they're providing because by the standard measures they're not meeting the test of providing any restraint on their path. And that's why I think we have a long way to go. One of the things that certainly people at the pump are feeling as the price of
gas. And we had the president this week weigh in and it's weak actually really saying wait a second the price of oil at that point was down to ninety six dollars a barrel. Last time I was there it was only like three dollars and thirty cents at the pump. Now it's 440. It must be that the oil comes are padding their profits. How about that economic analysis. You know I wish the president got more help from his economic advisers. Those spreads between gasoline prices and refine or
refine and prices very substantially on a range of factors. There's lags between the price of oil and the price of gasoline when natural gas is in short supply with diesel is in desperately short supply. It affects the mix of products that refiners provide in ways to change that spread. Maybe there is a basis for thinking that profits are being padded but there's nothing that would support that in the president's tweet. And I haven't seen any analysis coming out of the administration or any place else that provided serious support for that. Look at a time when we have a war to fight at a time when energy security
is a central issue for us at a time when over time we're going to have to cooperate with our energy companies on the necessary transition away from fossil fuels. I think we should be very careful about accusing them of bad behavior unless we've got clear evidence. Now the administration may have clear evidence and if so I'll be the first to admit that and to want to look at evaluate the evidence. But this kind of comparison that was contained in the president's tweet I'm afraid does not represent that kind of clear evidence there. Let me pick up on your reference to the war because this week certainly we did not see
a conclusion to that war. Quite the opposite in many respects. At the same time we're trying to bring in China at least keep them neutral or maybe come in on the United States side to discourage Russia. If you can't take a look forward when this war ends it will at some point. What does the world look like in that world. Some people I've heard say look we're moving from a world of globalization and cooperation into the rivalry of great powers like the late 19th century.
I don't know the answer to that. I'm not sure anybody does. It demands very large amounts of very hard and I think it will often be painful thought. What I would hope that we would recognize is that we would bring a kind of tragic realism to this and we may be well be right about all that is evil and wrong. Yet China and Saudi Arabia in Arad in Russia in other countries. On the other hand we need to make our way in the world. And I'm not sure a posture of outrage towards all the other countries in the world that have substantial leverage or even towards a large fraction of those countries is going to be a viable strategy for us. From my perspective the central challenge as we go forward
in the world is finding a way for the United States and China to mutually accommodate each other not necessarily to be friends but to have respect for each other. That's what I believe. Ultimately our success depends on. Ultimately the stability of the world depends on it. And I think as we carry on all of our other relationships we need to maintain a strong awareness of that central reality. That's so terribly helpful. Thank you very much. That's Larry Summers our special contributor here at Wall Street. He of course of Harvard University. Coming up when a single sign can cut through the fog of war. This is Wall Street week on Bloomberg.
Finally one more thought. Cutting through the fog of war the Prussian military strategist Clausewitz wrote of war being the realm of uncertainty where three quarters of the bases for actions were wrapped in a fog of uncertainty. And the war in Ukraine is certainly no exception to that with Russia claiming the United States has secret chemical weapons in Ukraine something NATO Secretary-General Jens Stoltenberg terms absurd. They are making absurd claims about biological labs and chemical
weapons in Ukraine. This is just an old ally and we get wildly differing accounts of the losses being suffered. There still are some really really severe images of people being killed off shelling of residential areas getting bombed. And how much do you see that fear in the Eastern European nations that feel incredibly Vonnie Quinn. They continue destroying the cities killing our children civilians. And it speaks for one fact only that even if we continue talking with Russia then does not have an impact on the behavior of the Russian army on the ground. If the venue knew the accusation about the shelling of the infamous maternity hospital in Mary Ubel and the shelling of the Mariupol theatre and the fact that Russia is not allowing refugees to leave Ukraine all these things have been refuted many times. At one point Russian Foreign Minister Lavrov even denied that Russia had invaded Ukraine in the first place.
He used to run on that but are not planning to attack countries. We did not have Ukraine. And it certainly doesn't help that Russia has made any so-called fake war report a crime driving Western journalists from the country. The media from outside of Russia has a difficult time penetrating audiences and getting in. But even in the fog of war sometimes a ray of sunshine makes it through. And that's what happened this week on live Russian TV. When a news producer named Marina Oxiana Clover
burst onto the set in the middle of an evening newscast on one of the state controlled broadcasts holding up a sign condemning the war and saying simply Potosi this volume of route they are lying to you. She was promptly arrested interrogated charged and find the equivalent of two hundred and eighty dollars. At least so far. So at least sometimes in some places it appears that the truth can conquer even the fog of war. That does it for this episode of Wall Street Week. I'm David Westin. This is Bloomberg. See you next week.
2022-03-21 23:52
