BONUS EPISODE: Bloomberg Surveillance in Jackson Hole

0:00This is a special edition of Bloomberg Surveillance in your Odd Lots podcast feed. We're in Jackson Hole, Wyoming, along with Joe and Tracy, covering the Fed's annual symposium. Keep listening for conversations with Peterson Institute President Adam Posen and Philadelphia Fed President Patrick Harker. That's coming up on this special edition of Bloomberg Surveillance.

0:28This is the Bloomberg Surveillance Podcast. I'm Tom Keen, along with Jonathan Farrow and Lisa Abramowitz. Join us each day for insight from the best in economics, geopolitics, finance and investment. Subscribe to Bloomberg Surveillance on Demand on Apple, Spotify and anywhere you get your podcasts. And always on Bloomberg.com, the Bloomberg Terminal and the Bloomberg Business App. Perfect guest for reaction to this speech is Mohamed Al-Erin of Bloomberg Opinion and Queens College, Cambridge. Mohamed, thanks for being with us and being with us through that speech as well. What were your thoughts when you heard some of those words from Chairman Powell just moments ago?

1:06I had three takeaways, John. First, it's a speech that said very little that is new. He repeated what he has said in the past and he has retained maximum policy optionality. Second, he reminded us that with the exception of the inflation target, which he said is 2 % and will remain 2%, everything else is uncertain. and his reference to our star in particular was very interesting. And third, what I thought was also curious is how he ended the speech. He ended the speech talking about we will follow the stars in a cloudy sky. Everybody sees the cloudy sky, but what's interesting is that the rest of Jackson Hall will be about moving stars, all the structural changes that are going on domestically and internationally.

1:56And that just adds to the topic that the three of you have been talking, that it's a very complex world out there. And the Fed has to navigate a lot of moving pieces. Mohammed, one conversation you and I have had over the last several weeks, the last several months for that matter. People are having this discussion here as well. Are we, from your standpoint, in your opinion, sufficiently restrictive? John, this goes immediately to what is the right inflation target. If the right inflation target is 2 % and they want to get there in a credible period of time, then we are not sufficiently restrictive.

2:33If the right inflation target, as you've heard many people say, including Adam Pozen today, is above 2 % given all the structural changes, and the way we're going to get there is not by announcing the new target, but by following a shadow target. and then once we see it stable at adopting it, I think that's the most likely outcome, by the way, then we are sufficiently restrictive. Mohamed, does it concern you that we've heard a lot of people who sound pretty happy, actually, other than Jay Powell, who is taking sort of the adult tone of, we're not there yet, stop declaring victory, there's a lot more down the pike.

3:12Everybody else sounds like things are going really well and the Fed policy is achieving exactly what it sought to. So I don't think it's everybody else, but most people are, especially in the marketplace. Not so the economists. You have Larry Summers, for example, reminding us this morning that if you look at the 70s inflation cycle, this one looks very similar. He has two graphs up and he's sort of warning implicitly that we may see a pickup in inflation. So I think the marketplace is much more complacent than the economists are. The economists recognize that there are many moving pieces, whereas the marketplace thinks that we've gotten to a new equilibrium.

3:55And from here, it's going to be cut next year. That remains to be seen. Do you think, Mohamed, that it's important for the Fed to get ahead of a potential resurgence in inflation? Or do you think that Jay Powell's approach of watching the stars and seeing what they are will be sufficient to curtail some sort of more embedded inflation? It's hard, Lisa, because as you know, they have not, like past feds, opted for strategic view of inflation, nor do they have a functional monetary policy framework. So they've become highly data dependent, which means that they are using instruments with lags on backward looking data.

4:41So they are in a bit of a tough situation. They're going to remain data dependent. So I don't think he knows what they will do in September. He's going to wait to see what the drops report is. He's going to wait for the CPI numbers, and then they're going to decide what to do. But this is the irony. It's a highly dependent, data-dependent Fed using instruments that act with a lag. Plenty of feedback, Tom. This coming from Neil Dattu of RenMac, just published in, saying the following. I thought Powell delivered a neutral speech. The Fed sees its monetary policy stance as restrictive and will make a more tempered approach the future meetings.

5:15Proceed carefully. Risk management. These are all catchphrases for do nothing right now. The view from Neil Datter just moments ago. A lot more response coming in here. Mixed market, red and green on the screen. Dr. O 'Arian, I want to touch upon your iconic work in game theory and that the word that I'm hearing this morning is complexity. I heard it from you. I heard it from John Lipsky and others. The simplicity we're all begging for is T decisions. You are known for this. This is a Jackson Hole devoid of T decisions. How do our viewers and listeners handle the complexity now and to come? Tom, I think the most important thing to understand is that we have left the world of insufficient demand and we are now in a world of insufficient supply.

6:06And there's many reasons for that. It's a world that's not going to go away anytime soon. It's not pandemic issues that are fully reversible quickly. There are longer term issues going on, change globalization, supply change management, the functioning of the labor market and the list goes on. So we are now in a different world of supply side constraints. And that world will mean that countries will become more inwardly looking, which we've seen already. It also means that policy has to adjust to that. Now, put on top of that the layer of industrial policy as we embark more meaningfully on a green transition.

6:47And it's all about the supply side, Tom. And that's where monetary policy is really challenged. because it acts on the demand side. We're thrilled, Mohamed, to have Dr. Gorgieva with us and then you and Christine Lagarde with us later. And the heart of the matter is, are we beyond the supply shocks of this pandemic? Where are we on that continuum, Mohamed? Have we escaped COVID? I mean, we've escaped the worst of COVID, but we're dealing with the legacy of COVID. But we're also dealing with the legacy of the war. We're also dealing with many other legacies. You know, Tom, it's fascinating that you will have President Lagarde on, because if you think the U.S.

7:29is complicated, then in terms of degrees of complexity, Europe is even higher. The U.K. is even higher than that. So it's going to be really interesting to talk, as you will do, to President Lagarde, because even though she has a single mandate, her environment is significantly more complicated than the Fed's, which is already complicated. So, Mohamed, Xi is so much more exposed. Europe is much more exposed to what's developing in China at the moment. Mohamed, if you took the US out of the equation right now, and we'd be talking just about Europe and China, wouldn't we be talking about things like rate cuts and easing and stimulating the economy?

8:11If you take the US out of the equation, you would be talking about stagflation. And that's what everybody is afraid of. The U.S. is exceptional, and it's exceptional in its economic performance. And if you take the U.S. away, then you're taking away the only engine of growth for this global economy. But you're not taking away the supply side issues that are causing the inflationary pressures. So if you take the U.S. away, we would be talking about not just the risk of stagflation in Europe, but you would be talking about the risk of stagflation in the global economy. Mohamed, is that the risk or the reality in Europe right now?

8:49John, it's still the risk. You know, yes, Germany is struggling the most, and that is, if you like, the engine for Europe. But there's also good things happening in Europe away from Germany. It's a high risk. It's flashing red, not even yellow. It's flashing red. But it's not yet a done deal. The U.S. is much better off. China, ironically, is the one that's suffering the most. as you've been discussing all morning, there is no obvious policy response. And now these piecemeal responses are being rejected by the marketplace really quickly. The marketplace is no longer embracing the notion that China can get itself out of the mess it finds itself in.

9:37And that's perhaps the cause of the manufacturing recession that we see in Germany and parts of Europe. But the services side, we've been talking about how that's maybe more directly affected by the ECB's policies and where rates are and the more direct transmission mechanism than in the U.S. Jay Powell just said that there is evidence that the long and variable lags are coming to the fore and will actually reduce growth materially in the U.S. Is Europe a model where the U.S. is headed with respect to services in the next couple of months or in the next year? I hope not, Lisa. Our service sector has been stronger.

10:11and even though the PMI numbers this week were disappointing, at least there were over 50 for the service sector. We don't want PMIs south of 50. And also, ironically, the service sector is where Europe gets the stagflation as well. It's not the goods sector. It's the service sector that's the source of the inflation problem. So I hope we don't follow Europe because if we do, then we will be talking about a very different outlook for the U.S. We're still still talking about the potential for some sort of weakness down the pike. One thing that Jay Powell's speech did was seem to remove rate cuts in the near future, at least for the foreseeable future.

10:55And you can see that shifting upward in the rate expectations. Do you think that this economy can handle a 5 % Fed funds rate for the remainder of next year, even with all the strength that you're hearing about? Lisa, we don't know. And he did use the word agile. And that's absolutely correct. He's got to be agile. Look, there are all sorts of sectors that adjust with a lag. We haven't seen the full impact yet of the higher rates. You're starting to see it play out in various segments, but in a very small way. Remember, not everything gets refinanced immediately. This is very unlike the UK economy, where the effective duration is much shorter.

11:35So you get refinancing quickly, and the rate effects happen much quicker. So we don't know how well we can navigate the 5%. It seems that the big issues in the banking sector are behind us. But so far, and it's really important to stress this, we've dealt only with interest rate risk. We have not dealt with credit risk. We have not dealt with liquidity risk. And that's what people in the marketplace have to keep an eye on. Stuart Kaiser, a city, publishing just moments ago, give you a flavor of what's happening on the south side. Not a game changer for markets from Chair Powell, but reminders on upside risk to inflation that demand downside risk to growth.

12:14Mohamed O 'Leary is still with us. Mohamed, I just want to finish on that with you. The downside risk to growth to counter the upside risk to inflation. Is that something we all need to be cautious of going into year-end and beyond? Yes, and that's why Chair Powell had a speech full of optionality. You know, I go back to what Mike McKee correctly said. It's not that the content was new. It wasn't. There was nothing in that speech that we didn't know before, whether it was explaining what has been behind inflation or whether it was explaining the range of policy possibilities and the risks and the need for risk management.

12:51All that has been said before. What was notable this time is that it was packaged, slightly more hawkish than dovish. And that's what people are picking up on. But ultimately, John, if we step back, the only thing he said is that what we know for sure is his belief is that 2 % is the right inflation target and will remain the right inflation target. That issue is going to be hotly discussed in the next quarters as we get more and more data. Yeah, Mohamed, I don't think that debate is going away anytime soon, even if Chairman Powell tries to put it to bed. Mohamed, thanks for being with us today.

13:31Appreciate it, as always. It's Mohammed Al-Aryan.

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15:24It will be analysis and interpretation. Owning the high ground on that is Joseph Wiesenthal and Tracy Alloway. They host a podcast, Odd Lots. Alloway had to redo her fireplace mantle because the awards have come in. Oh, right. So large. Yeah, they're piling up. I mean, Wiesenthal already had a mantle that could hold 300 pounds. In New York City. Joining us, Tracy Alloway from Odd Lots. Weisenthal would not get out of bed this early this morning. What I love about your work back at the FT and years ago is you own a perspective of London and New York and synthesizing the Western world. China and an exceptional Japan with Ueda in attendance here in this YCC disaster just had to listen to his hawkish one.

16:14How does Asia interpret what we heard this morning? Well, I'm kind of confused at some of the bond market action that we've seen. So two-year yields going above 5 percent hawkish interpretation. But I'm on the Neil Dutta side here, which is this was a very dovish speech, actually. Powell sort of gave a nod to the R-star debate, the idea about whether or not the neutral rate of interest is structurally higher in the current world. But then in the next sentence, he basically goes, but we have no idea what R-star is anyway. So it's completely irrelevant. And they're talking about being at restricted.

16:48That's not a small matter, John. Yeah, that's not a small matter. This has come up a couple of times today. The guy from New York City, you know, the private equity guy, whatever Powell is, he's not too big on the plug-ins of our start. But Tracy, something you've discussed, this probably shouldn't come as a surprise, should it? I don't think so. To me, it very much resembles what we saw last month from Powell. It's very much a data-dependent speech, which makes sense because you have two major data points coming up before the next Fed decision. Why would Powell stick his neck out at this particular moment in time?

17:21And of course, there is a lot of uncertainty about those long and variable lags, as you were talking about, Lisa. And this is a problem right now for Jay Powell because he wants to bring things down, but he doesn't want to curtail dynamism too much. Do you think that it seems fair to view his speech as saying that rate cuts are not in the cards for a longer period of time next year? because that's maybe what he wanted to say in the implicit sort of tone, but not what he actually said. I think he'd have to see a real deterioration in the underlying data to justify a rate cut. And that's just not happening.

17:54We have a lot of sort of anecdotal data points about maybe consumer spending is starting to weaken, but we haven't seen any of that in the unemployment rate, right? Now, that said, I know the tone of this particular Jackson Hole is very different to last year, where Powell was talking about how we'd have to assume more pain in order to bring down inflation. But that said, it's still a really uncomfortable moment for central bankers because inflation is coming down in a way that they didn't necessarily expect, right? The Phillips curve says that if inflation is coming down, the unemployment rate should be going up, but that hasn't been what's happening.

18:31So there's still a ton of uncertainty here. This is essentially, while it is global central bankers coming together. It's also essentially an academic conference. You're here with Adlaz to speak to some of the academic research. What are you hoping to illuminate in this whole shifting global structure that was sort of the theme? Yeah, that's exactly right. So I know that the focus is always going to be on the sort of short term outlook for interest rates, but really Jackson Hole is about the long term framework of monetary policy. And one of the big themes that is starting to emerge is this idea of higher public debt.

19:07And we've seen that borne out in the Fitch rating cut recently, bond yields higher because of some concerns over the outlook for U.S. fiscal health. And again, the unusual thing about this moment in time is that we are seeing massive fiscal spending at a time of low unemployment. That hasn't really happened before. And so I think there are a lot of people at this conference who are wrestling with that idea and that dynamic. You and Joe Weisd have rockstar hours. You just sort of wander in and you do your podcast and you do it by piecing together conversations where Bloomberg surveillance is complete and total chaos 24 seven.

19:40What's the conversation here you're most looking for into your next podcast? Well, thank you for assuming that all thoughts isn't constant chaos as well, Tom. Well, we're having you on later today. That doesn't count. That was just, well, please. What's the conversation you want right now at Jackson Hole? Okay. The big picture goes back to that bond outlook. What does a world of structurally higher debt look like? Does it necessitate higher interest rates? And what new financial risks does it introduce into the system? So we basically moved from a system that was very much reliant on bank lending to one that is far more bond based.

20:17And how do you square a world where bonds really, really matter with central bank mandates to bring down inflation? There's a tension there. You can't build the financial system on bonds and assume that they're going to be very low volatility and then try to bring down inflation and have higher rates. Tracy, this was great. It's good to have you here. Thank you. Thank you for having me. Thank you very much. Tracy Alloway, the host, the co-host of the Odd Lots podcast.

20:45Joining us is Patrick Harker, the Philadelphia Fed president. Patrick, good morning. Good morning. Let's start right here. Not what Chairman Powell said, but what your colleague over at the Boston Fed said in the last 24 hours, that this resilience of this economy suggests maybe we might have to do more. You take a different view. Why? So, look, we have to get inflation down to 2%. We all agree on that. I mean, everybody is, we're all committed to that. The question is how to get there. We are at a restrictive stance, in my view, and we're putting pressure on the economy to slow inflation. The question is whether we need to increase the pressure or just keep pushing, pushing, pushing.

21:22And I'm in the camp right now. Just keep the pressure going. Let this work through. Again, the data may dictate that we change course or I change course. But for right now, what I'm seeing and what I'm hearing, particularly soft data, what I'm hearing, I've been around my district all summer talking to people, is that the plea I hear is you've done a lot very quickly. You've taken a lot of pressure quickly. Now let us work through that. Let the banking system work through it. Let the corporations work through that. So that I agree with that. I think we just keep the pressure on and see how things turn out.

21:58Jay Powell didn't really say anything new, but he did sort of cast it in a hawkish light. And he talked about how the economy is perhaps growing faster than anticipated. And that could increase inflationary pressures. So what would it take to get you to change your view and think we need to raise rates more? If we saw that the decreases in inflation were stalling, right, that we weren't making that progress that we need to make. But how would that manifest itself? Because people who calculate CPI, the analysts, suggest we're going to see it go back up just essentially for mechanical reasons. On the headline side, yeah, for sure.

22:36But we're going to see shelter inflation come down, right? It's coming down now. You see this with real-time rents. So if service inflation in particular, or core service inflation, whatever you want to call it, super core, if that continues to stall, then I'd say we have to do more. But again, I really want to emphasize, we are doing something right now. It's not as though keeping rates where they are is doing nothing. We're actually continuing to put pressure on the economy. You said, and Jay Powell just said, that it was important to get inflation back down to 2%. That was unequivocal. Does it matter when?

23:10I mean, right now, I can see in the dots that it's not until after 2025. If it takes till 2030, does it matter? Oh, yeah. 2030 is a long way off. 2026, 2027. We're going to get under four this year, under three next year, and then get to two in 2025. So, yeah, it's going to take some time. But what really matters, what I hear all the time is not just a headline, not just super core, but think about the essentials of life, the things that people really need, shelter, food, transportation, energy. As long as they're moving in the right direction, Americans are better off. And we need to be committed to that.

23:43You clearly think we're sufficiently restrictive. Other people think we don't. So let's go through that point. Unemployment is still 3.5 percent. Growth this quarter could come in at about 3 percent. Yep. What is the evidence that we're sufficiently restrictive? What can you actually point to beyond the soft data? Let's talk about the real hard data. So inflation is starting to soften. We are hearing story after story. I'm hearing of... And you think that's connected to where interest rates are right now? Yeah. What's the channel for that? Labor markets are definitely easing up. We're hearing this over and over again.

24:13It's easier to get employees. And the retail numbers I'm a little suspicious of. Because what we're hearing, for example, from a major supplier to the back-to-school market is sales are not what they expected. So we are starting to see these early signs, but they're early. And so I don't think we need to react either way right now. Just let this ride a little bit. Let's just keep putting the pressure on. Well, if you keep the pressure on, but even don't raise rates, how long do you need to keep the pressure on? When would you see moving away from the peak? Clearly not until next year at the earliest.