Odd Lots - 54: How Trump Did Something Yellen, Draghi Could Only Dream Of

Episode Date: November 11, 2016

There's a lot to process from last week's U.S. election. One surprising thing already is the market reaction. Equities surged following the vote, and interest rates are sharply higher. Market measures of inflation expectations and Fed hikes now suggest that people see more inflation and more rate hikes in the future. This is something our top central bankers have had a very difficult time in doing. How come? On this week's Odd Lots, we spoke with David Beckworth, a research fellow at the Mercatus Center, about Trump, fiscal policy, monetary policy and the changing market outlook for interest rates and inflation.See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a lot. It's a firm. It's a lot. It's a lot. It's a a commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com

slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing Corporation Distributor. Put knowledge to work and grow your business with CIT. From transportation to health care to manufacturing, CIT offers commercial lending, leasing, and treasury management services for small and middle market businesses. Learn more at cIT.com. Put knowledge to work. Hello and welcome to another edition of the Odd Lots podcast. I'm Joe Wisenthal, managing editor at Bloomberg Markets. And I'm Tracy Allaway, executive editor at Bloomberg Markets. Uh, well, Tracy, it's been quite a week. You could put it that way.

There was something about an election somewhere, right? Yeah, I remember that election. Quite and not only was the election extraordinary for all kinds of sort of political and historical reasons. It's also been an extraordinary aftermath we've seen in financial markets. and it's completely confounded basically everything anyone would have predicted going into the vote. That's right.

So we were told that if Donald Trump got elected, that was the ultimate sort of political tail risk. And it happened. And we got an initial market sell off, like right when the results started coming in. But at the time of us recording this, we've seen markets rebound quite strongly, right? Right. I guess we should say, you know, just in the full transparency, we're recording this on a Thursday after the election. The podcast, people won't be listening to it till a few days from now. So if the entire market changes again and there's some huge crash or something before you hear this. Just disregard. Disregard. You can stop listening. You can just disregard everything. Such is the world of podcasts where we have to, where we have to do this in advance. But one other thing, so we didn't get. the crash that people expected. In fact, markets have been surging. Perhaps more interestingly and

far more importantly from a financial markets perspective, we've also seen a pretty big increase in long-term interest rates. Yield on the 10-year U.S. Treasury is above 2% for the first time since January. Other market-based measures of future possible inflation have been going up. This is also, people have been waiting for a rise in some of these measures for quite some time. And in the immediate aftermath of Trump's victory, we actually appear to be seeing some of these moves. Right. So all it took for inflation expectations to come back was the complete political upheaval of the United States of America, right? Yeah, that's all it took. Just a completely stunning political outcome. and whereas Janet Yellen and Ben Bernanke and Corrota have been trying so hard to get inflation expectations up,

Donald Trump seems to have accomplished that in about 48 hours. And he's not even in office yet. Amazing. And he's not even in office yet. So on that note, I think we have the perfect guest for the week. His name is David Beckworth. He's a research fellow at the Mercatus Center. He writes a fantastic blog called Macro and Other Market. musings where he talks about monetary policy, inflation, the macroeconomy, and all that stuff.

And I think he's a perfect guest to help us break down some of these moves in financial markets that we've seen and what traders might be anticipating under a Donald Trump presidency. Let's bring in David. David, thank you for joining us. Well, thank you for having me on the show. So quite an extraordinary few days in financial markets, wouldn't you say? Absolutely. Yes, as you mentioned in the intro, Donald Trump has done more to make Treasury yields great again. Janet Yellen has tried and been Bernanke tried in years to do and couldn't accomplish.

But it also speaks a swing in risk premium. And maybe. So let's talk about this stuff because, you know, people like to talk about the Fed having an inflation target. And in the U.S., the central bank is supposed to target stable prices and full employment. They've aimed for this 2% inflation target for years and haven't really been able to hit it, except very briefly. They've done all kinds of stuff. They've tried QE. They've tried forward guidance.

They've, you know, hinted at other sort of extraordinary policies going forward. They have all these dots and press conferences, all these new innovations designed to keep prices stable and boost inflation. It's never worked. And we joke about Donald Trump having done more to accomplish this in 48 hours after being elected than the central bankers have done. But it's not really a joke. So what is it about his win that seems to have jolted financial markets? and what does it say? Well, I think it speaks to an understanding that I've actually developed over these past few years,

and that has Fed took once. So, you know, if it's to hit 2%. What if the Fed target as some politically controversial? Bernanke, if you recall in 2010, on the time of QE2, and he got rare. It was 1%. One thing I think that really we tend to overlook is the Fed is limited or is empowered as much as the public wants it to be. And if the public wants low inflation, you know, and it is a referendum by the public saying, okay, we can try a little bit more rapid aggregate demand growth.

Now, I do not say that explicitly, but by bringing him into office, some of his proposals for investment spending will be easier, will be a tolerance for higher inflation. And that's something the Fed couldn't do on its own. And that's, again, kind of one of the points I've come to appreciate is in theory the Fed can do whatever it wants, but in practice it can't because there's political constraints. But, David, if that's the case, then what do you think has driven the change in the general attitude towards inflation? Like, what's happened over the past four years or so to make people ready all of a sudden for prices to go up? It's a tough story to tell, no doubt.

But I think what has happened, going back to the crisis up until Trump, if you look at the history of inflation targeting, it hits the world around 1990, we really did need some. company tried money supply time as they've done that. They've gotten better at it. I think they've built up this is what we want. We go into the crisis. There's all this uncertainty. There's this disaster. And the last thing the public wants is in their target environment where low inflation was the expected norm. Then you have a crisis where people are concerned. After seven, eight years of slow people become behind economic angst. They want something different. So maybe people aren't explicitly articulating their minds. We want higher inflation. But by voting for Trump, they want something new. They want something different. And that's going to include, it's kind of maybe an

unconscious vote for higher inflation, higher aggregate demand growth. All right. So I get that. And I, you know, I get that politics changes and, you know, suddenly we have something new. But couldn't it also be as simple as fiscal policy really matters to inflation expectations? And on Donald Trump, when he had his victory speech, he made a very point. First of all, he said it a lot the campaign. He said tax cuts. He said double infrastructure spending than Hillary Clinton. He said repatriation of foreign cash. There's all just sort of raw money. And then in his victory speech, he talked about rebuilding bridges and hospitals and America's cities. And all this is a fiscal stimulus. And couldn't it suggest that maybe inflation is a, the fiscal side is a big determinant of

inflation and inflation expectations, and then it's just not really about the Fed as much as people thought. Absolutely. And I think what's neat about this is this is kind of a natural experiment. If you recall, Trump actually said something that sounded very much like the MMT School of Thought a while back during the campaign. He said, look, the government can, you know, he can print its own money. If the government runs up deficit, they can just eventually pay off the debt but pretty more money,

very much and we're going to have a great natural experiment on that. And I guess what you could say is absolutely. And again, going back to the point I mentioned earlier, I think it speaks the policy and monetary policy. Here's another way of thinking about this. Imagine the Federal Reserve. Imagine, for example, some of its assets had lost value, some of those mortgage-beck secure. They suddenly lost value of more liabilities, more monetary base of inflation because now the Fed could be based in in the future. What would happen in that case? What would happen is the U.S. trade ever become insolvent in the sense who couldn't control, inflation, the monetary base,

the Fed would give bonds to pull the monetary base. It speaks to, though, is ultimately, the Fed being able to control inflation depends on the Treasury being solved in itself. If the Treasury would have financial health, it would impair its ability to build a Fed out. There's a change in approach. Ultimately, going to shape expectations about inflation.

So, yes, Joe, I do think it speaks to the importance of fiscal policy for inflation. All right. We have to take a quick break for a commercial, but then when we come back, I want to dive more into this question. Put knowledge to work and grow your business with CIT. From transportation to health care to manufacturing, CIT offers commercial lending, leasing, and treasury management services for small and middle market businesses.

Learn more at CIT.com. Put knowledge to work. And we're back with David Beckworth. He's a researcher at the Mercatus Center. And we've been talking about the role. of fiscal policy in driving inflation and inflation expectations. And I want to keep hitting this question. I want to drill down further into this question because there has been a view out there that fiscal policy is essentially impudent on anything having to do with total demand

and inflation. They talk about Ricardian equivalence and that if the government drives up deficits, then that'll make people think that there will be higher taxes in the future, and so they'll spend less, and ultimately, that will counteract any stimulative effects of that spending. And generally, I think it's sort of mainstream economic view that the fiscal side of the ledger of economic management is not where inflation comes from, and that it's the, you know, inflation is essentially controlled by the Fed. But it at least seems to be. You know, like a possibility that if we do get, you know, one of the things that's interesting about Trump's spending plans is that they're not countercyclical in the sense that we're at 4.9% unemployment.

There is not obvious that there's a huge sort of output gap here. It does seem like, you know, as we've been talking about, there could be a real natural test here where maybe the fiscal side is really the main driver and the Fed just isn't as important. as we thought on this front. Do you think that's possible that some of these assumptions that we had about the significance of the Fed in controlling or targeting inflation was overstated? Careful, though, and how we say this, kind of what you're referring to, I think, is what we've called the monetary policy offset, right, in the past. So if fiscal policy, you know, had tried, and I think you could, you could, you could, Obama's fiscal stimulus,

make this concrete, large spending plan, but, you know, we didn't see a huge spike in aggregate demand, a huge spike in inflation. You could have argued it put a floor into the economy and that didn't have run up against inflation goes up. Right. I think behind both of those, really, maybe another way of saying, behind fiscal policy and behind monetary policy is lurking maybe this, again, this public acceptance. What will the public tolerate?

And so maybe by electing Trump, the public has stated with the norm. We were tired with this tinkering on the margins by fiscal policy, monetary policy. We want to open up the, and the, you know, and the. start the engine, let's get, keep in mind, fiscal policy will affect spending and inflation by affecting the velocity. So you think of money times velocity in the economy. Fiscal policy generally is going to work through velocity. Monetary story ultimately, but fiscal policy and monetary policy are interacting, and I think it's reflecting the public's tolerance level for it.

So on that interaction point, you suggested early on in the conversation that the Fed may have been hamstrung a little bit by a general reluctance or political reluctance to do more in terms of boosting inflation and Trump potentially changes that. How do you see that relationship between the Fed and Trump actually developing? Because there's also been the opposite suggestion, which is that if inflation runs too hot, then the Fed might step in or even we saw Citigroup's Matt King suggest that maybe Janet Yellen just kind of wants to seek revenge on Trump in some way. And so maybe she'll be a reluctant partner in his, or an obstacle in his quest to boost inflation. So how will that actually play out? Well, that'll be interesting. Again, I think it may, you know, tighten what the Fed can do. He may appoint

the economy going. But yeah, he seems to be very support policy. So one way to look at it is he may rain in, the feds are hitting the gas pedal on the fiscal policy side. And, you know, so they'll work into this outcome. You know, someone who's probably, she has written some columns for the monetary policy. And initially enough, she takes a very hard money view, sympathetic to the gold standard. So it is a little bit with the more aggressive. It's almost, it's almost as if we don't totally know what Trump has got planned. You could almost say, He's a bit of a mystery on some of these things. So maybe I'm being naively optimistic here.

No, I mean, we all have very few clues to go on with this stuff. And that's why I think the decisive financial market reaction is so interesting. Because whereas, you know, anyone could sort of pull together some Donald Trump quotes and try to come up with some theory about what he's going to do economically, no one is totally sure, but there really is quite a startling riot. reaction in financial markets. I want to ask another question about inflation. And tell me if I'm just completely off base here, and if this is nonsense or if there might be something to this. It seems to me that inflation is lower in really stable economies. So some of the most stable countries,

and I mean politically, Singapore has negative CPI growth. Switzerland is in, has virtually no inflation. Japan, one of the most stable countries politically, in a sense, hasn't had inflation in forever. And then if you look at the countries with a lot of inflation, you tend to see much more volatile emerging markets with weaker political stability, South Africa, Brazil, Turkey. Zimbabwe would be the most famous. Zimbabwe being the most extraordinary one. Is there a connection in your view between sort of political stability? and inflation, and is there anything that we can derive from that, given the apparent decline in the U.S.? I think there's two stories behind that. The first one, I think, is less important,

but it's a part of this so often many of those countries you think will be in terms of infatobinomics. I'm like nothing else, and yet inflation is much lower than they wanted. And in my view, politically, they can't do this. Their population is shrinking. It's getting older, and that's a powerful voting block and high inflation that eats away at their fixed. It is a demographic issue, which also speaks to another reason rates might be low around the world in advanced economies. I think a second issue, though, is the difference between something of these advanced economies and the emerging markets is the advanced economies, again, as I mentioned earlier, have had inflation targeting for a longer time. And it's just targeting everyone comes to expect low inflation, and anything outside of that.

How can you possibly go above 2% inflation? Even if it's needed, even if it's a temporary departure, I think we've gotten to the point where the body politic and a lot of advanced economies will not tolerate a deviation. So in my writings, I've called this the inflation targeting straight jackets. They've been so good that they've worked themselves into a corner and they can't get out. They don't have the flexibility they need during deep recessions. So I think that's probably the biggest part of the story in advanced economies is made them less able. And again, Donald Trump, what Donald Trump has done, if I can see my inflation, he's unbuttoned that straight and grow policy, fiscal policy, more degrees of freedom to work. All right. David Beckworth, research fellow at the Mercatus Center.

I think this is a great conversation to sort of introduce people to what I think is going to be a really hot economic debate over the coming years and sort of a real-time economic laboratory experiment, particularly on. on the economy. Well, I really appreciate you coming on, David Beckworth. You should check out his blog, Macro, and Other Market Musings. And David also has his own podcast. Do you want to tell us about that real quickly? Yeah, it's called Macro Musings, and we look at macroeconomist and writers, journalists of the day. Well, I think everyone should check that out if they're interested in these topics. And I suspect, again, that as some of these debates unfold, that will continue to be a must-listen. So really appreciate you coming on today. Thank you for having me on.

Well, Tracy, I think that was like the perfectly time guest for what we've seen in the markets so far in the Trump era. And I am very interested in seeing like if a sort of economic regime change has sort of shock to the system fiscally will actually change the trajectory of interest rates and inflation, which as you know as well as, anyone has been falling nonstop for years. Yeah, it's going to be really interesting to watch. My only sort of one thought on this is I wonder if we're ascribing too much meaning to what we've seen in markets so far in terms of these inflation expectations. No one, you mentioned this, but no one really knows what Trump's exact policies are going to be on this front. And I just wonder if investors at this point are sort of projecting the, their hopes and their dreams onto Trump, right? They want they want inflation to come back. They

want infrastructure spending. They want tax cuts. They want business-friendly environment. And who knows if that's really going to happen? No, I think that's obviously this, there's a lot of hopeful trading it looks like going on based on just sort of minimal evidence to piece together. And the fact that we still don't really know how Republicans in Congress who have been opposed to any sort of extra deficit spending under the Obama years, whether they're ready to turn on a dime the way, uh, I mean, you could, they could because, uh, politicians, you know, politicians are politicians. So it's certainly, you know, and anyone, we don't really know what anyone really believes, uh, on these things because everything is situational with this stuff. Um, but we don't

really know how much they're willing to, uh, go back on everything that they've been saying. But definitely, I think we're going to be talking about this for a, while to come for sure. Yeah. And I think, you know, it's interesting looking at the financial market reaction because beyond stocks, beyond bonds, one of the things that we've been seeing is a really big surge in industrial metals prices. So copper, iron ore, again, on this belief that we're going to be building thousands of bridges and skyscrapers and new hospitals and schools, which is going to need all this stuff. And if, you know, if we actually get something like that, and I don't know if we will, but if we actually do watching the economic ramifications of this is really going to be perhaps one of the most important economic stories of the next few years.

All right. Well, this has been another episode of the Odd Lots podcast. Thank you, everyone, for listening. I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. And I'm Tracy Alloway. I'm on Twitter at Tracy Alloway. And you can follow David Beckworth on Twitter at David Beckworth. Thanks for listening. Put knowledge to work and grow your business with CIT. From transportation to health care to manufacturing, CIT offers commercial lending, leasing, and treasury management services

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