Odd Lots - Lots More: Did the Fed Just Make a Policy Mistake?

Episode Date: August 2, 2024

This week, the Federal Reserve opted to keep interest rates unchanged while suggesting that it could cut as soon as September. But there's an ongoing discussion about whether or not the Fed is behind the curve, with some of the most recent data suggesting that the economy is already slowing. On Thursday, for instance, initial jobless claims rose to the highest level in almost a year while the ISM survey showed manufacturing activity shrinking by the most in eight months. So is the Fed making a massive policy error by keeping rates on hold? And does it matter? We bring back Macquarie strategist Viktor Shvets to discuss the recent central bank decision, the macro outlook, and the impact of geopolitical uncertainty. Read More: Fed on Course for September Rate Cut as Risks to Job Market Grow Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at  bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

A lot of short daily news podcasts focus on just one story. But right now, you probably need more. On Up First from NPR, we bring you three of the world's top headlines every day in under 15 minutes. Because no one's story can capture all that's happening in this big, crazy world of ours on any given morning. Listen now to the Up First podcast from NPR. Bloomberg Audio Studios. Podcasts, Radio, News. Hi, Tracy. How are you?

It's so nice to say you. Yeah, it's mutual. Thank you so much for doing this. Look, I'm going to share it. You're getting, you're getting worse. I'm getting worse. Yeah, then the last three months. Victor is referring to my beard.

Yes. And the rest of the dim in all of it. I'm letting myself go. No, no, but you obviously must be very relaxed. I'm not shaving until the fence starts cutting rates. Okay, that's coming. So that's good. I did a deadlift. One, two, three. Two, three.

Hedgemi. Okay, good. Okay. What's true? GEMany. Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S.

Where's the best squid impostom? These are the important questions. Is it robots taking over the world? No, I think that, like, in a couple of years, the AI will do a really good job of making the oddlots podcast. And people are saying, I don't really need to listen to Joe and Tracy anymore. We do have... Cha-ching. The perfect guest.

You're listening to Lots More, where we catch up with friends about what's going on right now. Because even when the odd lots is over, there's always lots more. And we really do have the perfect guest. It is kind of crazy. So the market is pricing in, what is it, a little over 70 basis points of cuts right now, which means like the Fed would need to cut every meeting through the end of this year. assuming it doesn't do a 50 basis point cut, which seems a little extreme. Yeah, I think it does. But remember, Federal Reserve has no visibility. They have no trust in their

models. That is why they're so data dependent. So when people say, well, we can rule out 50 bibs, why could you rule out? If you think of the governors, so the former governors, only two, three months ago, they were higher for longer. Suddenly they've changed their mind. It's no longer high for longer. So that's sort of volatility, almost inevitable outcome of highly volatile neutral rates. So prima facie, if you just look at it, 70 bibs looks high, but on the other hand, I don't think you can necessarily rule it out. And if you start looking slightly longer term, let's say look at December 2025, January 2026, the market is still looking at somewhere around four as a policy rates. Now, four of the policy rates to me is too high.

I think the numbers should be somewhere closer to three and a half, maybe even less than that. So to answer your question, it looks like it's high, but Fed has no confidence in their methodology, in their models, or a visibility of what happens, and therefore it is possible that you might end up with that. So we are speaking with Victor Schfetz, McCory strategist, and one of our repeat-oddots guests, it is, of course, the week that we have just seen a meeting from the Federal Reserve, where they opted to hold rates as expected, but they definitely telegraphed that that rate cut was coming, Joe. You know, when I, so I didn't watch the press conference because I was on a train and I had an appointment. I had to take the day off of work.

But it was nice because then I read the transcript this morning without the, you know, without the distraction of Twitter and all the commentary. And I hadn't read any of the various commentary from the strategist. But when I read the transcript, I thought of our last conversation with Victor. specifically, because it was so clear. To your point, they just want to see more numbers. The models that suggest, okay, unemployment is rising and the Fed is restrictive and therefore inflation should come down, etc. All of these theoretical ideas, I don't get the impression they have any confidence. They just want to see more numbers. That's it. That's absolutely right. And there is a reason for that. And the reason is that we live in the world of abundance. We have too much of everything. We have too much of capital. We

have too much of most of the products. Technology keeps reducing marginal cost. There was a perception for a period of time that certain areas are in deficit or constrained, such as some of the metals or labour, but even that is proving to be not true. So if you live in the world of abundance rather scarcity, economic models do not work, because all economic models and investment model are predicated on constrained outcomes, that you're choosing the best possible outcome out of variety. If there is abundance, prices don't work. Prices don't signal the same impact. Neither do they have the same impact on underlying economy. Wait, so Powell is definitely, I feel like he's aware of the criticism that the Fed is maybe too data dependent at this point. And in fact, in the press conference,

he was kind of at pains to emphasize that they're not data dependent. Or, sorry, what was it? Data dependency doesn't mean data point dependency, which is kind of funny, especially since we're recording this on Thursday, and we have had some very interesting single data points, including initial jobless claims rising to the highest level in nearly a year. But what does it mean to be data dependent, but not data point dependent? It means I have no clue. And essentially what it says is that, look, I don't know what I'm going to do. because I don't understand why financial conditions are not tightening more than they should have. I don't understand why unemployment is where it is. Yes, employment cost numbers, for example,

yesterday have come out. 0.9% was really the lowest for about three or almost four years. So there is no evidence there is a wage spiral. If you think of goods inflation, it's continued to disinflate. Service inflation is coming back. Even idiosyncratic numbers like imaginary, you know, or occupied rent or differences between insurance policies in the market and what CPI numbers have, or use car prices, all of those idiosyncrasies also going away. So you could argue a legitimate question, what are you waiting for? And the answer is they don't want to be Arthur Burns. They don't want to be in a position that they're revisiting sort of 1970s all over again.

And so he's basically saying anything is possible, anything is probable, and I cannot guide you in any meaningful way forward. The only say I can say is that it looks like we're going to cut. Beyond that, we're either data dependent or data point dependent, or maybe we're not data point dependent, but we're certainly not forward-looking the way we should be. So Tracy mentioned this, we're recording this August 1st. There's a non-farm payrolls report that will come out tomorrow, probably by the time people listen to this. But I just want to talk about some of the data that we've seen. Tracy mentioned it. Initial jobless claims around the highest in the year. The ISM manufacturing number came in

well below expectations. The employment sub-index of ISM outside of the COVID period, this is the worst since 2009, which Bloomberg's Cameron Christ pointed out, ADP, I don't know if anyone actually pays that close attention to it. It came in lower than expectations. Today we've got unit labor costs. They're expected to grow 1.7%. They only grew 0.9%. I guess the question is, okay, is there a risk of a policy mistake? Could things be slowing down more rapidly than the Fed things?

And even with the concerns that they have that actually this is the moment and maybe things are going to get rolling. There is. There is a possibility of that. And you can also add to that quit rates. Quit rates basically return to normality. So everything is pointing to the fact that labor market is going. getting noticed tight, everything points to the direction of less robust wage increases coming through. There is no wage spiral. Now, could you commit a policy error? Of course you could. But one of the

things I keep highlighting, policy errors are important when you got scarcity. If you have abundance, you can reverse that policy error in 30 seconds. In fact, even less than 30 seconds. One word potentially could reverse almost the entire impact of your policy error. So one of the same I've been highlighting is that there is a strong possibility of committing policy area if you're backward looking rather than if you're forward looking. But the fact that we have too much capital, the fact that we repricing sinks in a split second, the fact that central banks have unlimited toolkit that is growing on a daily basis, even if you commit a policy error, you probably cannot perpetuate it. So in other words, you will be able to reverse it quite quickly in my view.

I saw an interesting thing from Nikolas over at Datatrek this morning where he was talking about or asking if labor market normalization, which is how Powell couched it on Wednesday, whether or not normalization is the new transitory in the sense that they might be focusing on that and the market starts to focus on it too. And then it turns out that, well, it's not really normalizing. It's in a downturn and the Fed is making a mistake. But just on the idea of abundance. I mean, you say repricing can happen very quickly, but going back to the transitory idea, that's not what we saw when we saw prices begin to go up. That's because essentially what you had at the time is Federal Reserve insisting on transitory when it wasn't transitory. So in other words, if Federal Reserve wants to commit a policy error, they can. If they insist on perpetuating policy error, they can do that too. If they want to put the economy into recession, they're capable of doing it.

My point is none of it is necessary because even if you commit a policy error and you quickly realize you have, you can unwind it incredibly fast. Whereas if you look at Paul Walker, if you look at Greenspan, they had nowhere near the same capability of achieving that outcome. So there is a risk of an error, there is a risk of a recession, but your view is that the rate tool is powerful enough such that even if we were to go into a downturn, that that one lever for what various reasons is powerful enough to reverse it fairly quickly. Well, not so much raids, but rather communication strategy. So the essence of Federal Reserve

or any central bank these days is really a communication strategy coupled with macro and microcruential controls and coupled with specific policies designed to tailor circumstances that beyond your control that suddenly arises, whether it's Silicon Valley Bank, or something else. That's the essence, not so much rates. Because in the world of abundance, price doesn't work as well, because there is no scarcity. So all Federal Reserve needs to do is to change communication strategy, to change some of the liquidity positions. And that could be enough. Now, ultimately, if you start looking really longer term, there is no doubt that rates at some point in time do work. And that's what I'm saying, that if Federal Reserve wants to

commit a policy error, wants to perpetuate policy era, and place a U.S. economy or any other economy in the recession, they're capable of doing it. Just there is no reason for that. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Ruffini. We'll bring you the latest headlines, in-depth analysis, and big interviews, all the stories that hit home on your days off. And I'm Lisa Mateo. Watch and listen to Bloomberg this weekend for thoughtful, enlightening conversations about business, lifestyle, people, and culture. On Saturday mornings, we put the past week's events into context, examining what happened in the markets and the world.

That on Sundays we speak with journalists, columnists, and key political figures to prepare you for the week ahead. Join us as soon as you wake up and bring us with you wherever your weekend plans take you. Watch us on Bloomberg Television. Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg television, radio, and wherever you get your podcasts. Victor, do you remember two years ago? I think it was also in the summertime when the Fed said they basically like ruled out the possibility of a 75 basis point hike. And then

they went ahead and did it. And they sort of abandoned forward guidance, which had been the this principle that they had been using post-2008 financial crisis to guide the markets and dampen bond market volatility. I don't know. I've been thinking about that moment for a while now. It feels like we're sort of having a repeat on the data dependency thing. Like it's another shift in the emphasis of the central bank's communication policy. Yeah, it is. It is. And again, if you go back, If you go back to those times, the reason we shifted is because Jay Powell, quite correctly, was saying that neutral rates are becoming very unstable. You know, I can't see the stars.

He kept highlighting, he'd been highlighting it for years now. And what he basically is, I don't know where neutral rate is. In a nominal terms, is it more like 3.3.5% that people currently expect, or is it closer to 4.4.5? And if it is 4.4.5, is it possible that in the next 6 to 12 months is going to dropped to two and a half, three percent. And so he has no visibility exactly where neutral rate is. He doesn't know where it's going up or coming down. He's not even sure what forces actually are driving it so quickly up and down. I mean, we can talk about a number of forces, one of them

election and electoral cycles, we can talk about geopolitics, we can talk about climate, we can talk about health care. There is a number of things that outside the economic system that drives you. So in the past, mostly what you had is economic cycles and capital market cycle we're driving everything. Today, it's the forces outside the system. Now, what is the ability of Federal Reserve to estimate and anticipate any of these things outside macroeconomic system? The answer is zero. The ability to predict, the ability to anticipate, the ability to price is zero. But these are the factors that are capable of swinging neutral rates quite considerably.

You mentioned one thing just then, which is political uncertainty, and this is something I wanted to ask you, which is, okay, markets are pricing in roughly a little over 70 basis points worth of cuts at the moment for the rest of the year. How much of that pricing is due to uncertainty stemming from the political situation right now? How much of it is basically risk off getting priced into that market? None. I don't believe anybody can price political outcomes, either. with the Trump or Harris wins or the Republicans sweep and control their House and Senate and the presidency with a Democrat sweep and to have a full trifactor what's going to happen at state election levels because remember 44 states also have elections, 16 governors or something running for elections on top of that. I don't think anybody can predict, including investors. So right now, I don't think anything is reflected. People are trying to do Trump trades and they have Harris trades. To me, it's not relevant. First of all, it's not clear what the trades are. Because one of the

things, it's been very clear in European elections, and increasingly US as well, that if you on extreme right want to take control and govern, people will force you to abandon your most extreme views. This is what happened to brothers of Italy. That's what happened to RNN. That's what happened to RN. In some ways, that's even happening to AFD in Germany on top of that. The same happening with Republicans. They no longer want to cut welfare payments. They've abandoned Project 2025. If you say with Kamala Harris, she's now saying fracking is going to go forward.

So the good thing I sing right now globally is that electorate is not mad enough, is not angry enough to go to the extreme. So if you want to have an opportunity to govern, you must abundant your most extreme views and extreme policies. And if you do abandon them, then really how much of a real difference is there between the Harris trade or, I don't know, Trump trade or any other trade? So right now, to answer your question, I don't think anything is embedded. I think people are trying to trade and anticipate certain things. But at the end of the day, it's pretty useless because there is no way you will know that. And we might not even know that until January, because more than likely, there is going to be quite a lot of litigation after November election.

It's always striking to me how badly various political electoral themed baskets or trade ideas do. You know, the Mexican peso was a Trump trade in 2016 and was getting hammered every time he did well in the polls. Turned out to be one of the best performing currencies during his years of presidency. Do you remember, Joe, in 2016, after Trump won, every single cell side piece of research that came out was like Trump will make whatever great again. And it was everything from like energy stocks to the most esoteric like acid-backed securities. It was amazing. Yeah, people including cryptocurrency. They're so other than the one in our in the studio right now, many lazy titlers of a sell side notes with the exception of the person we're talking to.

But you know, the energy is a good example because energy did really badly under Trump. And then it did really well under Biden, even though the Biden baskets in 2020 would have said to all buy solar stocks, which have all done. extremely mediocre. Actually, you also mentioned geopolitics, and I get that you can't really put together a compelling electoral trade. Would you see any fingerprints of either the geopolitical situation or the election on either the economy or markets right now? Is it showing up anywhere? No, none. I would argue even Europe, where we've gone through quite a number of cycles, because quite a few countries had elections and European Union and parliament had elections. You don't actually see a great deal of fingerprints at all, either on an economy or ECB policies or the market, whether it's

equity or fixed income or any other market. So to me, and again, I think part of the reason is I keep coming back to that, people are not yet mad enough. They're not yet angry enough. And so the extremes do not have the same pool as they otherwise would have. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Mosk. here to tell you about our new on-demand news report delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories. Episodes are published throughout the day with the latest information and data to keep you informed. Yes, there are other products like this from a variety of news organizations,

but they usually rerun their radio newscasts throughout the day. That's not what we do. We create customized episodes that can only be heard on Bloomberg. News Now. And we don't wait an hour to publish breaking news. When news breaks, we'll have an episode up in your podcast feed within minutes. So you're always getting the latest stories and developments. Get the reporting and the context from Bloomberg's 3,000 journalists and analysts we're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. Can we just go back to, I'd just like to go back to the U.S. and the Fed

specifically again. So setting aside, you know, one of the concerns. about a policy mistake or waiting too long? Is this notion, and this is sort of the implied insight of the SOM rule, for example, is that unemployment feeds on itself. I lose my job, I spend less, I spend less at your business, you lay off workers, your workers lose income, they spend less, et cetera. That intuitively makes a lot of sense to me, that unemployment contained its own momentum that builds on itself. But your view seems to be that it can be short-circuited, in a fairly short period of time. Can you reconcile that for me and why you have this belief that, okay, maybe it is a mistake to wait to September or maybe the Fed should signal more

forcefully that a rate cut cycle that begins in September will be aggressive? But can you sort of reconcile this for me why you believe that they can reverse a policy error fairly quickly? And I'm saying, Claudia, some, actually pulling back from your own rule. And for a very good reason, for a very good reason. First of all, we had a massive dislocation of demand and supply curves for goods and services and labor over the last three to four years. Secondly, we're getting very tremendous changes in the structure of the labor market itself. So increasingly, Bureau of Labor Statistics is not really capturing the labor market and what the labor market does. Whether it's a gig jobs, whether it's a multiple jobs, there are many studies that were done over the last five,

six years, which basically shows that methodology that Bureau of Labor Statistics employs understate labor participation by at least two percentage points, which means all of this low labor participation is not actually true. They also significantly, therefore, are understating the hours work and overstating wages per hour. So it's a structural shift that is occurring right now in a labor market combined with a gradual volatility of demand and supply curves that we have experienced that really blunts that rule. It doesn't really allow that rule to function. But beyond that, and that's something I'm saying, Claudia, it doesn't address, beyond that is sort of my pet idea of abundance rather than scarcity. But just on this,

regardless of whether the rule holds firm. And I get that because no rule is going to be ironclad and, you know, that's what. Pal talked about it in the presser yesterday. He was like, this is something that has happened throughout history, but it doesn't mean it's always going to in the future. It's absolutely not an iron law at all. And, you know, there are other... It's not a law of nature. It's not a law. Neither is the curve inversion, a law of incoming recession, as we've seen over the last couple of years. Nonetheless, just the insight, just the core intuition of negative momentum building on itself. Does that concern it? Yes. Yeah, it is. Because ultimately, people do need to consume. Ultimately, people do need to spend. We have a problem measuring exactly where we are. But

the intuitive reaction, what you've just said, Joe, is absolutely correct. So that's why I kept saying, can we have committed policy error? Yes. Okay. Can we wait too long? Yes. Could there be a price that will be exacted from the economists and the market because we waited too long? The answer is yes. Can you quantify it right now? The answer is no. Okay. And the only twist I have, that we have a capability of reversing it faster than what we did 15 years ago, 20, 30 years ago. Joe wanted to go back to the Fed. I want to go back to politics because I opened up one of your recent research notes, and I had a minor heart attack because one of the things in it, it asks the question, what links us to the 1930s and the 1970s? So the idea here is that in 1968, investors, as you say, did not know they were going to face a devastating

decade where basically they wouldn't make back their losses on stocks until like the 1980s or the 1990s. As an elder millennial who has only just started building wealth in the stock market, I came to it kind of late. This is a very frightening prospect to me. What was your conclusion? Yeah, absolutely. Anybody who was investing in 1928, 29 would have spent until 1950s getting at least real value of the investment. Everybody in 1968 would have waited until early. in 1990s again to get the real value. The conclusion was that this time around there are some differences compared to 2030s or late 6070s. One of the key differences is that at this stage, volatility of economic and inflationary outcomes are much less pronounced than what we had in those

periods. The other difference is that the policymakers have a much wider set of tools that they are available to them or to offset any extreme volatile. that is likely to emerge. And I guess the third area is 1930s have their nifty 50s, you know, 1970s have they own nifty 50s. But those were fairly conventional companies that just happened to have the right positioning at the time. And they provided some degree of stability. Today, the equivalent of the old nifty 50s is actually driven by incredibly strong, structural and circular drivers, mostly technology, but not just technology. productivity driven, which we really didn't have in 1930s, and we really didn't have in 1970s.

This were relatively technologically benign areas compared to what we have today. So theoretically, our equivalent of nifty-50, and by the way, composition could change. It doesn't have to be a magnificent 7 or Magnificent 4 or, you know, Fang or granola. The composition will change. What constitute that basket will change. But the basic principle, that we now have companies capable of growing and growing productivity, almost irrespective of the environment that they're facing. That's quite different compared to what we had in 1970s. So my conclusion was, yes, there is a lot of similarities between the two political, geopolitical, lack of consistent, commonly agreed business, economic, social political model on a global basis.

That's why other people propagating other models. So there is a lot of commonalities, but there are differences which should result in a better outcomes, if you're a millennial just investing, should result in a better outcome than those generations experience. I guess on the plus side, even if I experienced like three decades of no wealth building, I guess I'll be doing odd lots for the next 30 years. There's literally what I was going to say.

Literally you took it out of my, if neither of us accumulate enough savings to retire, and it means we're doing odd lots until our 80s, Tracy, I'm happy to keep doing it. I'm happy to be here in the year, 264 still recording podcasts with you. I commit to that now. I won't be here, but you can carry on.

Lots more is produced by Carmen Rodriguez and Dashel Bennett with help from Moses Ondom and Kale Brooks. Our sound engineer is Blake Maples. Sage Baumann is the head of Bloomberg podcasts. Please rate, review, and subscribe to Odd Lots and Lots More on your favorite podcast. platforms. And remember that Bloomberg subscribers can listen to all of our podcasts, add free by connecting through Apple Podcasts. Thanks for listening. Make refining great again. Make M&A great again. Make

Eurofinancial P&L great again. Like really random. It's so funny. I'm Francine Lacquhar, an award-winning journalist, and I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment, but I've always been curious who are these people as leaders. I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts.