Bloomberg Surveillance TV: October 8, 2024

Published Oct 8, 2024, 4:00 PM

- Ben Snider, Goldman Sachs Sr. Strategist
- Mohamed El-Erian, Queens' College Cambridge BBO & President
- Mark Cabana, BofA Global Research Head of US Rates Strategy

Ben Snider of Goldman Sachs believes there is a lot of potential earnings upside ahead. Mohamed El-Erian of Queens' Colleg e Cambridge says, "the economy is fundamentally sound, so it can absorb shocks." Mark Cabana of BofA thinks the Fed will cut by 25bps until March of next year.

Bloomberg Audio Studios, Podcasts, radio News.

This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and Amrie Hordern. Join us each day for insight from the best in markets, economics, and geopolitics from our global headquarters in New York City. We are live on Bloomberg Television weekday mornings from six to nine am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen, and as always on the Bloomberg Terminal and the Bloomberg Business App. Mohammed l erna Queen's College, Cambridge, expecting more data surprises, saying quote, last Friday's data surprise relative to consensus expectations will not be the last one unless economists resist the temptation to look through the shock. What is needed in today's economy is to be more open minded about why such surprises keep occurring and how best to frame the accompanying policy regimes. Muhammedan pleased to say join us again, Mohammed, Welcome back to the program sir.

Let's get into that.

Why was it the volatility between reports that stood out for you and not just the strength in isolation.

Thanks for having me, John. Look, this volatility, or what you've called ping pong narrative, has been with us for a while, and there's a clash. There's a clash between the mindset of most analysts that tend to think that the economy is in a structural equilibrium and the reality that we are going through major transition, both economic and policy wise. So if you're thinking one way about the economy but it's operating in another paradigm, you will get these surprises.

So the obvious question with Bee Mohammad when you write things like how best to frame the accompanying policy regimes, what the Federal Reserve should be doing with this incoming information.

So, first of all, understand that were going through structural changes. Luckily for us, these changes are favorable, unlike what you're seeing in Europe, unlike what you're seeing in China. That's the first thing. The second, it's not just about monetary policy. Yes, the FED was the only game in talent, but that's no longer the case. Fiscal policy is having an impact, Structure reforms are having an impact, So think beyond the FED. So what does it mean for the FED continue? In what I sense, and I hope I'm right. I sense is two evolution in how they are approaching policy, and you see this a little bit in John Williams's interview in the Financial Times. The first one is to be less excessively data dependent and have a more balanced backward looking forward looking approach. And the second one is to get away from this notion that you can target a specific outcome and have much more of an insurance mindset. And I think that if these two evolutions are correct and continue, it's good for the FED and would be good for the economy.

Mohammed Just to that point, Adriana Kugler spoke yesterday too, and so that she's monitoring both Hurricane Helene and geopolitical events, but then goes on to say that the fear is is that they could have an impact on American employment, that risks escalate, uncertainty escalates, and that means that the FED might have to move more towards neutral more quickly. When you look at these exogenous shocks, is it still a FED put is it a FED that's going to come in and not cut And maybe isn't as concerns about the inflationary risks of for example, targeting oil capabilities by Iran Danny.

The hardest thing is when the external shock, whether it's coming from oil crisis, whether it's coming from a supply disruption in the port, or whether it's coming from this awful hurricane down south. The hard thing is when it's stagflationary, when it lowers, grows, and increases price pressure. That is when the FED gets into a really difficult situation. Let's hope that none of these potential external shocks. One of them is resolved, but the other two are not. Let's hope that they don't because it will make it very hard for the FED to decide what to do. I think, and I believe for a long time, that the economy is fundamentally sound, so it can absorb shocks. What it cannot absorb is a policy mistake, Muhammad.

When it comes to these potential policies and these exogged shocks that Danny's talking about, the big unknown is obviously the composition of Washington next year.

How should the.

FED be thinking about twenty twenty five when we might have very different policies coming out of the White House in Congress.

I think they have no choice but to do what they said they do, which is, we will wait. We will see what happens in the presidential election, we will see what happens to Congress. We will see to what happens to actual as opposed to stated policy approaches, and then we will include this in our assessment. And Marie, is very difficult to move earlier. If you were forced to move, you'd be more cautious on the inflation side for both candidates.

Is that why potentially we got this clear guidance today from President Williams in the Financial Times basically saying follow the dot plots, don't read into the fifty basis point cut. That was the exception, not the rule, because on November seven, they may be meeting without knowing the results of the election.

Yeah, I know. I think they want to pivot away from the fifty because I think that if they knew then what they know now, they wouldn't have done fifty. They would have done twenty five, as many people proposed. So they're trying to pivot away from the fifty and get the conversation forward looking. And I think you see that in commentary over and over again coming out.

Of the FED.

Muhammad still every FED speaker that talked yesterday back fifty. No one tried to walk away from it. I mean, of course they probably wouldn't make a mistake, But what does that tell you about Chair Powell still hold on this committee and to direct monetary policy.

Danny looked that.

They have no choice but to defend the fifty because there was only one descending vote, so of course they had to defend the fifty, saying what we knew then okay led us to fifty. I think it's John who called it a drugy moment, the first time we've really had a drugy moment by chef, by Chair Powell. It was an important moment that he got done, and he was willing to tolerate one important descent. I don't think he's going to play that card over and over.

Again, Mohammed. I love your thoughts.

A little bit deeper on what we saw from Kolby Smith and John Williams in the Financial Times. I'll share the quote with you, the direct quote. If inflation fools even faster than expected, that would quote call for policy to normalize a little bit more quickly. If inflation still, that would call for interest rates to come down more slowly. There's a bias there, Muhammad, is to reduce interest rates, and it's a bias to reduce interest rates based on what happens with inflation, not what happens with payrolls.

And I'd love your thoughts on that.

Because last week before we spoke to you, before we had that data, we had some guest points out that the inflation data.

Didn't matter anymore.

Do you think it's the inflation data will set the tone for the pace of interest rate reductions over the next three quarters, and maybe not so much payrolls.

So I think it's both, John, It's going to be the inflation data and the employment numbers. I think the bias you're sensing comes from where the neutral rate is. The midpoint the range is really large, really large. But if you look at where the midpoint is, it leads to this narrative that we are very restrictive. That's where that bias comes from. Now, as you know, my neutral rate is higher than the average. People will differ on where the neutral rate is. But that bias comes because people just compare where neutral is and say, wow, we're still very far away from that.

We we've made the argument that things have changed and I think a lot of people on the FMC are yet to be convinced. Could you lay up that argument, now, what has changed over the last five years that's led to a high neutral rate in and what are those conditions while we in that regime for a long time to come.

And you've heard it from others like Larry Summers, and there's also a hint of it in the Williams interview that we mentioned earlier. First of all, it has to happen what's happened between investment and savings, and that gap actually is getting bigger between investment and saving. The second thing is, let's not ignore what's happening on the fiscal side. And then the third thing is the fragmenting global system. The system of global system is structurally becoming more sensitive and more vulnerable to adverse shocks. So you put these three things together and it suggests that the neutral weight has migrated up, and not just by a bit, but by a notable amount.

Martin, The language does continue to be gradual reductions. Do you think that there's a sense on the FED that they realized that this might be the case. In gradualism is necessary to end at the right point.

That's the great point. But gradualism means different things to different people. Gradualism, I think, to most of us, means take small steps. You're still in the dark, the image that chair Pal shed with us a few years ago. You're still feeling around in the dark. You're not quite sure why everything is, so take it easy. That's one bit of gradualism, and that's the bit that I That's why I think I thought twenty five basis points starting in July was the right thing. Let's not do anything big bold, because what ends up doing is it changes expectations.

Look.

Then there's a much bigger point, which is markets are all over the place. In the last what fifteen days, the probability of a fifty basis point cut in November has gone from over sixty percent to zero. Think about that, November is next month. That is how much uncertainty there has been in this market. This market lacks anchors when it comes to how it sees the interestate part. The whole profile of raight cuts has moved up, meaning fewer cuts by fifty basis points. You know, these are massive moves based on data points, and until we restore some sort of anchor you're going to have this volatility that, as you know, I worry that at some point you may expose a structural weakness somewhere in the system.

Well, when it comes to these anchors, how difficult it is to understand what the FED views as neutral. You mentioned Williams again, and he hinted that that in the Financial Times article he said, we'll quote way above it. What does way above it mean?

That's exactly it. They have to be careful with their words, That's exactly it.

I mean.

I think that that there's going to be a lot written on what went wrong with FED communications starting in twenty twenty one, and why is it that now FED communication amplifies volatility, which is not what it's supposed to do. The whole point of forward policy guidance is to lower the overall volatility of the path and what we are living in this strange regime where FED communication enhances volatility, and that is something that I expect a lot of work is going to be done on as to how not to repeat this mistake going forward.

We're lucky to speak to one of the authors of those books yet to be written. Mohammed is going to catch out with you this morning. Thank you, sir, I appreciate it. Muhammad al Aaron of Queen's College, Cambridge, winnis around the table logged into the Bloomberg terminal.

Mark Havanner of Bank for America. Mark is going to see you.

Likewise, thanks for joining to guess what's changed from you and your cause for the Federal Reserve based on what happened on Friday.

Sure, we were in the fifty basiness point cut camp for November. The data dictates that that is no longer necessary. So we now think that they'll go twenty five, and that they'll deliver a string of twenty five basis point rate cuts until they get to March of next so around four percent, and then they'll slow down to a quarterly pace of cuts until they get to a trough of three to three in a quarter.

At least that's the base case.

Now, I'll tell you that amongst our clients, there's a lot of uncertainty out there right now.

The data has surprised.

It doesn't seem like the data is giving us a particularly clear narrative on what's going to happen. And we sense that investors are really shifting probabilities of what the most likely economic outcome is there was a lot of belief that we were headed to a soft landing with elevated risks of a recession, or at least increasing risks of a recession. Now soft landing is still the base case, it seems, but the market is putting a little bit more weight on the possibility that maybe there's a quote unquote no landing type scenario, or maybe the Fed doesn't need to cut much below four percent at all. And so the market right now, we think, given that uncertainty, is just trying to be a bit defensive rates Clients don't want to extend too far out the curve right now, especially given that we're just about a month away from the election, and as a result of that, they're keeping things nimble and light and kind of waiting for data to try and guide a bit more.

We saw money pile into money market funds as well ahead of that economic data. And I've asked this a few times, what do you think is behind that move? What's driving that.

Rates are still high?

And just because the Fed is cutting doesn't necessarily change your behavior as a depositor. Ask yourself, what does your retail bank deposit pay you, if it pays you something close to T bill yield, you should tell me where you bank, because I'd be interested in knowing that. But for most retail depositors, they're offered something close to zero, and so T bill rates are still well above that. And so we do think that there's going to continue to be a lot of inflows into money market mutual funds even if the FED is cutting, because it's not about whether rates are rising or falling, it's about the overall level of interest rates. And work that we have done says that you shouldn't expect to see really large outflows from money funds unless the FED cuts to something that is at or below two percent, and that seems very unlikely based upon the data that we have at hand and what the market is thinking about the FED cutting cycle.

Market's also a tenure that's been going higher. Yields have been going higher even since before the FED cut by fifty basis points, and it's just continued on.

How much of that is just.

A factor of what you first started talking about, that unknowingness, that vulnerability, and that volatility just adding a premium to this bond market, Well, I.

Think it's a couple of things. Number one, I think it's that rates investors do believe that a more proactive FED today means a better economy tomorrow.

And think about on the day when.

We set, when we saw the FED cut fifty, you actually saw long end yields rise because there was a sense that the FED was going to be decisive at quickly do what it takes to support the economy, and then that should allow for better growth in the future. That we think is arguably the biggest part of why the back end has been moving up a bit. But there's also supply demand concerns, and the election is a big wild card. Certainly, it doesn't seem like fiscal policy is going to be tightened in a big way after the election, and so we can debate, well, how easy will fiscal policy get based upon the election outcome. But I think investors are just a little bit reluctant to extend out the curve, knowing that you can get political outcomes that would result in much easier fiscal policy and more treasury supply.

As you're saying this, though, I'm thinking in my head, who is the candidate for less fiscal spending?

So I don't want to get into the politics too much.

But it's a good response.

Thanks, I've been trained well, but via media people. But investors right now do not expect that there's really any party or any candidate that supports meaningful fiscal austerity, and so therefore it's just a question of whether or not the fiscal outlook gets a lot worse or a little worse, and investors, knowing that the election is very tight, and knowing that investors don't want to take a strong call on that right now, are deciding to just stay a little bit shorter duration. So some of the flows work that members of my team do sees that they're very sizeable inflows into fixed income funds, not too different from the money market mutual fund inflows John that you referred to earlier. But when those flows come in, they're generally staying short on the curve, and that is due to investors who just don't have a lot of confidence in what the political or macro backdrop looks like in a month or so. And as a result of that, these positions are kind of de facto and steepeners. And when you get really strong data like we had on Friday, then that does create a bit of attension for investors who have moved further in on the curve.

Jonathan and I were just talking about the fact that if we might not have a decision days or even weeks out, this could also drag on for months. This could be contested. What are flows on the short end look like then.

So it's a great question. I guess I would just respond by saying that over recent weeks and months, we have certainly seen that treasuries have regained their flight to quality attributes. When inflation was high, let's say, rewind a year ago or so, I think we could have debated how much treasuries actually retained that flight to quality benefit. But if there is acute uncertainty, whether it's due to US politics or whether it's due to geopolitics, we do think that treasuries will still retain that flight to quality attribute, and we should expect to see cash move into treasury securities, probably mostly at the front or belly of the curve in those types of scenarios, but certainly for the asset class overall, we do think that it will retain those kind of risk off or flight to quality benefits that we have historically.

So a lot about the front end.

You've talked about how that money and money market funds could be quite sticky and less FED funds. Comes down to something like to can we talk about the long end and just finish that?

Sure?

What are you looking for the long end to curve what kind of numbers? We had a guest from pagim Yes THATDA saying we're in the buy zone four percent for twenty five lock it in, get a second by second opportunity, take it.

What's your advice?

Yeah, So we wrote yesterday that we do think at least using the tenure as a proxy between four to four and a quarter is a reasonable place to begin scaling in. We're already there, obviously, But here's the framework that we have used, and a number of folks on our team have wrote recently written about this in slightly different ways, but we called it two three four type framework.

The FED is.

Almost certainly going to cut to four percent, almost regardless of the data.

Don't believe me.

Look at their dots in twenty twenty five, all dots except the one or below four percent, So that seems to be the recalibration zone. And that's maybe consistent with quote unquote no landing, and so if the economy performs really well, then four percent is probably where the they'll end up. In a soft landing scenario. Using the fed's own baseline, they'll probably end up closer to three percent. That's the b of a house view. That's our economist's view as well. And if there's a recession or some type of sharp slowdown, then you can envision a two percent or lower type of outcome. So then the question is really how do you assign probabilities to those various outcomes. And again, our base case is the soft landing.

That's all well and good, But if you.

Just look at ten year ois, let's say that's around three sixty at the moment. If that gets up to three seventy five or even higher, then clearly the market is overweighting that four percent outcome. That's so called no landing outcome, and investors can decide for themselves whether or not they think that's reasonable. We think that's very optimistic, and the world's a very uncertain place. The rest of the world is maybe not as robust as the US is, and so to think that we could slip into a soft landing or a potentially harder landing is not unreasonable. And again US rates and fixed income provide a hedge again to those outcomes.

And therefore we do.

Think that if ten year OIS gets to three seventy five, again be thinking the ten year close to for fifteen, for twenty five. At that point, we do think that it's a very reasonable opportunity to begin to scale in and trust that it should perform at some point or at least that your downside is very limited if you're investing around those levels.

Mark appreciate it. Good having Thank you, sir, Mark A. Banave of Bank of America. So here's the latest Goldman Sachs upgrading the S and P five hundred target, predicting the index will hit six k by year end as six three hundred and twelve months time the team of Goldman writing. The primary driver of the upward revision to our twenty twenty five EPs estimate is greater margin expansion. The macro backdrop remains conducive to modest margin expansion, with prices charged outpacing input cost growth. Ben Sneyder Golmmet Sachs responsible for some of these co joints just around the table.

Thank good to see you welcome to the program. Good to be here.

Let's get to the margin expansion, the pricing power. Where does that pricing power come from?

Right now? Who's got it?

I heard you just mentioned it this morning's results from PEPSI. And basically the way we think about margins is price inflation minus input cost inflation. And we've all been so focused on price inflation and it has slowed, but input cost inflation has slowed even more so. For example, if you look at unit labor cost growth in the US, which is wages adjusted for productivity, that grew at basically zero percent last quarter.

Economists have been trying to figure out if layoffs come next as they start to present margins just a little bit more. How do you think about that as an actuality strategist to the layoffs coming.

It's great you raise it in the context because I view profit margins as a really useful leading indicator for layoffs, and I think it's very intuitive. If you run a business and your margins are contracting, that would probably lead you to higher fewer employees, or maybe even lay some off. But the good news is today margins are expanding, and I think that really confirms the strong labor market data we saw last week, And you.

Also write though by twenty twenty which, first of all, hats off for having any idea.

What twenty twenty six looks like.

But by that time you start to have a limited ability to expand margins. What's happening to corporate America over the next few years where that can't continue?

Well, like everyone else, like the market, we're trying to be forward looking. We could get surprised, but at the moment, our view is that growth by then will be close to trend and the labor market will have tightened a little bit as opposed to the loosening we've seen over the last couple of years. In that kind of environment, growth can still be very solid, but typically it's harder for companies to really expand margins.

So how uneven is that going to be? Because I know you're talking about it on a headline level, but again, John and I were just talking about PEPSI needing to cut costs, feeling some volume difficulty. How even will the ability to expand margins next year be?

It actually looks to us like the ability of companies to expand margins is improving, not not getting more narrow. One of the characteristics of the market over the last couple of years is I'm sure most of our viewers know, is that it's been a pretty narrow breath market. Technology stocks have been able to grow more margins. Everyone else's kind of struggled. But now with the economy in such good shape, it really looks like more and more parts of the equity market are able to raise profits as well.

Ben, Let's talk about the corporate tax right for next year, we can have twenty eight percent or fifteen percent. The Democrats took your recent note by you and the team and really ran away with it because what it would mean for growth, but ignored what it actually mean for corporation's bottom line. What could we see with a twenty eight percent corporate tax rate.

We've put those proposals through our models, and we estimate that those could have, of course, a substantial impact on earnings, just as we saw in twenty seventeen and eighteen under the TCJA tax cuts.

But I think it's.

Important to note you mentioned fifteen percent twenty eight percent. Those aren't the only options. It's always possible that tax policy falls somewhere in the middle or just remains where it is with the federal rate of twenty one percent, and then of course there are a whole number of other factors to think about as well. There's a fiscal expansion, there's tariff policy, and then of course there's the primary driver of earnings, which is GDP growth, and so ultimately there could be a change to the earnings outlook post election, but from our perspective, the much more important driver is the strength of the economy, the margin story we were talking about earlier, and so net net, we feel very comfortable about the path going forward.

If there is a twenty eight percent though corporate tax plan for the policy you say that can cut S and P five hundred earnings by five percent, what would that do to your twenty twenty five or to Danny's point, if you can look into the future twenty twenty six price targets.

Yeah, So keep in mind it's a one time shift to earnings. And right now we're forecasting eleven percent earnings growth next year, so if we were to subtract five percent from that, we get about six percent earnings growth, which coincidentally is where our forecast was last week before we raised our estimates.

Habersis proposal is clean, at least compared to Trump's Propiesal can we talk about that fifteen percent with a condition, a manufacturing condition here in the unated snakes? How are you and the say you considering that? How do you put that through any kind of model?

It's difficult to do.

Fifteen percent is relatively straightforward, and we run those numbers and then I think the question is uncertainty, And actually that is the key dynamic that we've seen historically around elections. You know, there's been a lot of discussion about tariffs and tax but ultimately, if you look at every single presidential election year, uncertainty is really the most important thing for stocks. And it's this period the weeks before the election when uncertainty tends to be highest. That leads to higher implied volatility, a little bit of market weakness. But of course the flip side of that is after the election that uncertainty moves lower and stocks usually rise higher. And as you mentioned earlier, we expect the SMP to repeat that pattern this year.

What do you make also on impact, say to a company like deer, the former president is talking about tariffs on deer. If they move some labor and production to say, Mexico, how do you envision all of us coming into plane twenty twenty five if the former president is in the White House.

Yeah.

I think basically my read from all of this policy discussion is that it's much more going to be a story of rotation within the equity market than a dynamic that affects the level of the S and P and aggrogate. And you can see this if you look at correlations with prediction markets over the last few months. For example, small caps tend to have perform better as you've seen Republican odds rise in prediction markets. And so ultimately, depending on the policies that are actually laid out by whoever the next administration is, I think that will change where we think within the market investors should invest. But in aggregate, I don't think it's really going to change our view.

Let's get to sect the code then, Fankfoot place debate within the equity market at the moment, where is it.

I think the key change that is happening right now, no surprise, is the actual FED cuts and the market is forward looking. We've seen the long end of yield curve decline well in advance.

Of those cuts, but the actual cuts.

Themselves do seem to be having some impact on economic activity. So, for example, mortgage applications have risen in the last couple weeks. We've seen very very little housing turnover over the last couple of years. I think you can imagine that as the FED cuts, we'll see more housing turnover. And that means if you're a broker, if you sell furniture, there's a lot of potential earnings upside ahead.

Ben appreciate it. It's going to say it.

What did against say Ben Snyder, Thattic Golment sank some of the election means for your equity market. This is the Bloomberg Seventans podcast, bringing you the best in market, economics, angio politics. You can watch the show live on Bloomberg TV weekday mornings from six am to nine am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen, and as always on the Bloomberg Terminal and the Bloomberg Business app.

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