Odd Lots - This Is the Macro Picture Going Into 2021

Episode Date: December 14, 2020

It's obviously been an extraordinary year for markets and the economy for reasons that don't need stating at this point. But what does 2021 have in store? Can the current trends continue? We talked with two of the smartest macro thinkers we know: Jon Turek, the author of the Cheap Convexity Blog, and Naufal Sanaullah, the Chief Macro Strategist at EIA All Weather Alpha Partners, to discuss the big themes and what to watch for next year.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. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. Tracy, so obviously markets continuing to have an extraordinary year, at least risk assets for the most part, stocks continue to power to new all-time highs all around. the world, optimism breaking out. But I'd say like the nature of the stock market rally or the nature of the market rally in general is sort of taken on a different complexion lately. I think people have been nervous about valuations for some time and the idea that even though we've had the biggest pandemic in over 100 years, which is really eaten into economic activity, we still have stocks at a record. People sort of naturally feel a little bit nervous

about that. And then recently we had the sell-off in U.S. Treasuries as well and a little bit of a pickup in inflation expectations, which might be the beginning of, well, some people are talking about it being the beginning of a bigger change for the market. And this would be a good time actually to mention that we were recording this on Thursday, December 3rd, 9 a.m. The usual 2020 caveat. Yeah, that the whole world may have changed by the time anyone actually listens to this episode. But yeah, we have seen a little bit of an uptick in treasury yields, market-based measures of inflation, actually higher than they were pre-crisis, but some measures back to levels not seen since 2019. And also, if you look at some of the really hot stocks lately,

it's some of the real like sort of back-to-normal, unsexy stuff out there. So it's like airlines and physical retail, I think like shares of Macy's were up like 75% in November. U.S. steel, steel company, absolutely wild chart. If you take a look at that, so it is in the beginning of this rally and it, you know, thinking back to the spring, it was very much like tech of the stay-at-home trade. We're starting to see it broaden out. And so people like buying energy, another area, oil doing very well.

So these areas that did not participate in the first part of the recovery or for several months into this have been getting a lot of excitement lately or enthusiasm. Yeah, that's right. And of course, we have talked about, you know, another sort of great rotation coming up. Yeah, right. And of course, every time we talk about these rotations, there's the question is like, is this another head fake? Is there we just going to, is everyone just going to go back to buying Fang and Microsoft and, you know, of course, treasuries in a couple weeks? Or is this something new? So lots to think about as we close out 2020. from a macro perspective, all kinds of different moving parts going into 2021.

Yeah. And I think, you know, there's clearly a lot going on. But 2021 is going to be an interesting year, right? Like, if you just look at the market currently at all-time highs, you have that broadening of the rally. The big question is whether or not it's going to keep going. And then you have all these idiosyncratic events like what happens with the vaccine. And of course, how do central banks respond to that? that if we get a vaccine and the economy really starts to recover, then could you finally, finally get inflation, which could unsettle the market in one way or another. So I think you're right. Like there are these turning points that you can sort of see on the horizon, but the big question is whether or not, you know, we're just going to be talking about them or actually experiencing them,

whether or not it's another head fake, yes. Yeah. No, yeah, it's going to be a really interesting Hopefully it's not as interesting as 2020. But, you know, for our sakes, from a stuff to talk about standpoint, we hope it's at least somewhat interesting. Anyway, macro. So, yeah, to talk about the outlook, I thought we'd bring on two of the smartest people we know who discuss macro from both a pure econ perspective and a market's perspective, both have previously been on the show. I want to bring on Nolfo Sinala. He's a macro strategist and portfolio manager at EIA, All Weather Alpha Partners, and John Turrick. He's the author of the cheap convexity blog, which has been a must read all year for people in the know on macro and market, sort of tying together both the price action and the bigger economic themes of the year.

So, Nolfo and John, thank you so much for joining us. Thanks for having me. Yeah, thanks for having me. Absolutely. Thanks for coming back. So I sort of start off broad and either one of you could pick up. But sort of like, what's the number one thing on your mind right now in terms of the big questions or the big things to get right when you're thinking about the outlook for markets in 2021? I think we would probably both agree that the dollars, you know, kind of at the focal point of our analyses. You know, we are in a very new, interesting regime with the Fed. And if the Fed is to follow through on this, you know, new regime and framework,

then what that would suggest is that, you know, as we get positive outcomes in the macroeconomy, it should actually lead to feedback loops via a lower dollar. And so that's why we've been, you know, here at EIA, we've been really focused on expressing a lot of our bullish trades through short-bush. dollar expressions. So I think I think getting the dollar right, getting the Fed right, and then figuring out the similarities and differences between what is a vaccine type of reflation and what is a typical stimulus type of reflation. And John's written about all these things in a lot of detail and that's some great framework. So I'll let him jump in a little bit too. Yeah, no, I think as has been the

case, you know, in the last few weeks, I think the dollar will probably continue. to be like the fulcrum instrument for kind of how the market digests and prices going forward this recovery. I think what's kind of interesting is, and as Naafool is suggesting with the new Fed reaction function, is that the Fed has moved from like their primary objective of being able to cut off left tails, right, to suggest that, okay, something's bads happened. How do we respond, either through, you know, financial markets or whatever? And now, as they, as they, there's a train in motion, the Fed's best move in terms of kind of accommodating this recovery will basically be pushing whatever the train is and giving it another nudge. So in the end of Q3,

we thought this train was probably going to be fiscal. And in August, we were kind of pricing this more MMT-type world. And then fiscal negotiations kind of fell apart. We had an election where we're likely going to have a divided government. So the market scope for fiscal kind of came down. And now, post the vaccine news, we kind of begin to entertain a market that goes from a fiscal led recovery to a private sector led recovery. And that may change the channel, but it still gets the train in motion. And now the Fed can jump on and say, okay, like there was, you know, an awful pandemic last year. And now we're in 2021 with a vaccine. And that doesn't really change anything for policy. And that's a really powerful, I think, macro tool for them to basically push forward

this recovery. Now, you mentioned the idea of a weaker dollar and feedback loops. Could you maybe go into some more detail about how exactly you see that working? Yeah. So with respect to the dollar more structurally, you know, if you think about the regime from, say, the financial crisis until COVID. You know, the dollar was like the only game in town in terms of collecting yield and having positive growth prospects in the major economies and the major accessible markets. COVID's really changed that dynamic as, you know, the feds kind of caught down to like Europe and Japan interest rates wise, as well as has changed its reaction function to be far

more doveish and far more accommodative to positive outcomes. at the same time, China has kind of taken the rule of, you know, the yield premium. And they've made some changes to their markets, you know, since, especially since 2015, when they, when they had their FX policy shift. And, you know, the Chinese government bond market has really turned into this, you know, I think the way John put it once is just, you know, it's like one big sucking sound of capital, just really big one-way flows. And so what that, what that kind of means to me is that, you know, there's a structural, the structural headwinds to the U.S. dollar, and those will not only be reflecting positive outcomes and reflationary outcomes,

but will also likely be driving them in a feedback loop as well through a variety of channels, both through, you know, what that means to current accounts, as well as, you know, just general credit creation. I'm curious about this idea and John, you've talked about a lot, both of you, but the idea of there being a meaningful difference between a fiscal stimulus led reflation and a vaccine-led reflation. So it's funny because, you know, as you discussed, John, it's like going into Q3, beginning to give Q4, the thought was like, okay, maybe we're going to get a fiscal deal, or maybe Biden is going to win with it and get a Democratic Senate. and then they're going to pass a massive bill next year.

But then that didn't happen. We didn't get the unified government. There's no fiscal deal as of yet. And yet, like a couple of days after the election, we got the really good news from Pfizer about their vaccine. And suddenly people realize that a vaccine is likely coming and it's going to be effective. And the renormalization of economic activity might truly begin in earnest sometime in the beginning of 2021. So from a sort of market standpoint, what are the meaningful distinctions between that recovery led

by a vaccine and a return to normal versus recovery led by a sort of CARES Act 2.0? Right. I think it's such a key point, honestly, and it has been a big theme for the last few weeks. I think it works through two channels. I think one is the fundamental economic channel, which is to say that a fiscal deal that has a very heavy composition towards transfer payments has a much more immediate nominal impact, right? Because it goes into people's pockets. People can spend. There's a consumption element. And it's much more nominal because it's not followed by there's no new productivity. There's no new investment, et cetera. It's very consumption focus. And that kind of, that is, you know, trickles out through the trade deficit. It's a weaker dollar, but it's, you know,

it's consumption led. So it has a much more nominal impact. The that, vaccine on the other hand is different in the sense that it's much more on the corporate side, in the sense that it gives businesses kind of more clarity in terms of CAP-X, inventory, restocking, more business-related decisions. And that has more of a real impact in terms of, you know, leading to potentially like higher levels of real growth in the coming year. And I think basically what the market kind of did with this transition from a fiscal regime to a Vax regime, is it traded scope for certainty, right? The potential of like more of an MMT type fiscal approach was kind of like,

oh, we could have like high levels of nominal GDP and that could be pretty cool. But what the vaccine regime brings is like we kind of know what the world's going to look like end of Q2 on next year. and that has a massive reduction in risk premium, and the market can levitate off that. And if I could add a little bit to that as well, you know, and, you know, you definitely have seen this, what John's mentioning, you've definitely seen it in the markets, whether it's, you know, some of the beaten down cyclicals, whether it's, you know, the trade sensitive places like, you know, the NECA has been one of our longs to play this vaccine trade.

and even, you know, these dislocations between gold prices and real yields, I think all three of those things reflect exactly what John's saying with respect to the reduction of risk premium. But in addition as well, I think one other distinction between the two types of, you know, two types of reflation are that the consumption basket mixed should likely shift towards services as, you know, we get this normalization type of dynamic. And that should be really interesting to me because for two reasons. One, one tailwind to the short dollar and long remand-B type of dynamic has been, so far, has been how much, you know, the consumption basket mix has flattered, you know, the goods exporters like China. And so it's, you know, we may see some hiccups, you know, or some retracements or this or that sometime, you know, early next year. But especially if, you know, the trend's able to persist and, you know, ultimately get. through those, you know, those types of transitions, that would really reinforce the case that this is a structural shift and has, you know, a lot of legs to go. And the second point with

respect to this, you know, the consumption basket mix shift to services is one thing I'm really interested on and to see is if there's been, if COVID ends up being a permanent downward shock to the labor intensity of services output, as in, you know, the services output, you know, the services output and services demand rebounds, but does the employment side of it underperform the output side of it? And that would be really interesting, you know, the idea being, you know, what the WTO and the Chinese entrance of WTO, what it was to goods and the labor intensity of goods, we could see a smaller version of that materialized in services. I don't have a strong view yet about this. I think it's really going to be just something to keep in the back of our

minds and see how it unfolds in real time. But if that were to materialize, that would just give that much more of a tailwind for the Fed to remain accommodated because, you know, the employment would not be, the employment picture wouldn't be recovering, you know, necessarily as swiftly as expected on the services side. So just on that note, I mean, we are starting to see some commentators, including some former Athot's guests, but, you know, people like Tim Dewey at the, the, the University of Oregon talking about the potential to have a supercharged economy next year where, you know, everything looks pretty good. You got a vaccination.

People go back to spending. Unemployment rebounds and isn't actually, you know, as bad as maybe the Fed was expecting. And perhaps it sparks a little bit of inflation that puts the Fed in an awkward position. Is that a risk that you see for now? next year or do you think the structural changes that you just described are going to be enough to avoid that scenario? I, yeah, me personally, I think the Fed will likely remain accommodative. What should be interesting is, you know, to the extent that we see these dynamics start to emerge

in the conversations, it's likely to be reflected in internal divisions within the FOMC. And so what I'll be really interested to see is how Chair Powell kind of navigates those decisions and, you know, kind of put on a bit, like look at some of the statements to do more of a political lens along those lines. But yeah, I think that there's a, there's a pretty high chance that we have a very strong economy next year. You know, some of these south side forecasts may actually be, you know, a little bit lower than, you know, what I would expect. And, you know, we'll know more, you know, later this month, but especially around the March FMC meeting. But the sign so far suggest to me that, you know, this is a new regime shift and we're not really going to,

they're not really going to get ahead of it. And just to be clear, with respect to what I was mentioning with the labor intensity of output of services, that would be more of a question about on the back end, like not necessarily in the next few months, but more so about, you know, what's the long-term run rate of, you know, employment growth and the services aside. And what does that mean for, you know, Fed forecasts? Where are they likely to have to mark up and down, you know, the longer term forecast? But I know this is another question that I'm sure John has some great thoughts about too. So I'll let him jump in. Yeah, no, I think it's really interesting in the sense that the recovery next year is going to look very different than

ones of at least the most recent past in terms of output shocks in the sense that balance sheets are in a much better position, as people like Tim Dewe have said that there's, you know, there's this element of excess savings. And that's kind of come from this combination of the CARES Act, kind of having this huge multiplier, but also having the, you know, with the virus having these constraints in terms of people's ability to spend it. And I think the other thing is we actually went into the crisis with, you know, household balance sheets in relatively good shape. So coming out of it, it's not that usually in a recession, you kind of have this lethargic hysteresis kind of as people have to repair balance sheets. And that's why it takes time for recoveries to get off the

ground. And I think that could be very different this time, given that it's just, we had a, we had a recession where disposable income went up. So it could, you know, very much change the scope of the recovery. And as it relates to the Fed, I think, and I think this is something I'm fairly confident, and people are underestimating is I don't think the Fed reaction function or response so far is cyclical. I think it's structural. And what I mean by that is I think the Fed is kind of, is not saying like this was the right reaction to a COVID shock in the sense of their forward guidance, balance sheet policy, and, et cetera, I think what they're saying is, is like, we got things wrong a few years ago, and that's not going to happen again. And the manifestation of that will be

that, yes, things are going to be, quote, unquote, back to normal in the middle of next year, but the Fed won't, because it's not a cyclical response. It's a structural response. So I think the Fed will be much more doveish than I think a lot of people think. the recalibration of their approach, especially with respect to the Phillips curve, predates COVID, right? So what John's saying makes a lot of sense to me and conversations with John have actually kind of influenced my view here. One last point I'd like to add there is, you know, I think that one of the biggest things that, you know, I had to adapt to in real time and kind of change my mind on is exactly that Tim Dewey hypothesis of excess savings. And, you know, John and I have talked a little bit about, you know, what would be cool ways to maybe think about the distributional aspects of this and if the data, you know, exists for that. And that could be a key question to really gauge how far it can take us through next year.

But it is really interesting, you know, the initial conditions really do matter in terms of macroeconomic thinking. And the initial conditions, the balance sheet wise on the household side especially, don't really suggest that we have to have very elevated savings. rates for a long time as balance sheets have to get repaired. And to the extent that we would need elevated the savings rates in response to the virus uncertainty, it's kind of similar to what John was saying with respect to the risk premium compression on the back of the vaccine news. You trade scope for certainty and that certainty ends up being a pretty big headwind to, you know, how high personal savings rates, you know, end up being next year. The news doesn't stop on the weekends. context changes constantly.

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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. So one of the questions, and I think Nolfal, I've asked you this before, but it's something I've been curious about a lot. Like, all right, we talk about regime shift and the Fed's regime shift is fairly clear and you believe it and they're going to be a much less aggressive they claim in hiking rates. They're not going to be trying to get ahead of inflation in the same way. And so that's potentially quite significant. Obviously, the post-COVID economy could look different than the pre-COVID economy in ways, and maybe we'll talk

about that more. But what does that mean for then sort of like normalized markets? And obviously, right now, as we said in the intro, we're in this era or this, not an era, we're in this like moment where people are buying like Macy's and airlines and steel companies, companies that were not sexy at all pre-crisis, suddenly getting some sort of back to normal appeal. But as we normalize and maybe in just sort of like Q3 of next year, things start to look genuinely normal. Do people just go back to buying Microsoft and Netflix and Tesla as their leaders? Or does something fundamentally change where like new winners can emerge on a more sustainable basis? That's a great question.

I wish I had a great answer to that. you know, one thing that should be interesting along these lines is the results of the Georgia elections will likely give some signal with respect to what we can expect on the fiscal front until the next batch of midterms in 2022. And that should be kind of interesting to keep in the back of our minds. But yeah, you know, I think that at some point next year, I wouldn't be surprised if, you know, we kind of pivot back to, you know, people are long long. the long end of the bond market and long, you know, NASDAQ and China tech. And it's interesting

actually seeing how we've already kind of, we, despite the fact that we've had this huge cyclicals rally, you know, the NASDAQ actually did kind of catch, catch up a little bit in, in recent sessions. So I think there's still going to likely be a structural demand for that type of stuff. And, you know, I would say, though, that like I'm actually more interested. interested in, like in terms of normalization trades that have durability, I'm more interested in looking at things in emerging markets and looking at stuff that's sensitive to global trade growth like the NECA, as opposed to, you know, just buying, you know, U.S. energy stocks and, you know, retail operators.

I think, I think he's, I think it's 100% right. And I think one may be of the more interesting transitions to come. in, you know, 2021, 2022 could be in terms of like these narratives of like a fiscal reflation to a Vax reflation is that the Vax reflation kind of morphs into this broadening of a risk premium compression. And I think like one of the, I think a lot of market action post the vaccine kind of felt like like the market was exhaling a little bit, right? Like it had all this built up risk premiums and like all these cyclicals. had no idea. And you saw it like across asset classes in terms of like trade sensitive currencies,

et cetera, EM bond markets where there's just this very high level of risk premium. And I think this kind of really dates back a while. And why I think this could be maybe a bigger theme is that it's it could be another one of these regime shifts because what we had in 2010 to 2020 was basically post-financial crisis was basically exogenous shock after exogenous shock. And we went from the Euro crisis to China deval concerns, to Brexit, to trade war, and finally the mother of all shocks in terms of COVID. And unfortunately, he passed away this year, but Emmanuel Farhi at Harvard, actually did a lot of work on kind of why the market price so much risk premium when discount rates were so low. And I think it has something to do with this, and it led to things like, you know, we'd have,

like, the, you know, Swiss currency on a effective exchange rate evaluation metric, be it, like, you know, just going a straight line from 2010 to 2020, when things that were, like, cyclically driven, like the Swedish Krona or the Aussie dollar, things like that, would kind of just be in a decline lower. It was basically the market just saying, I want safety at all costs, and I don't want to I don't want anything to do with cyclicals. I don't need that. There's this embedded risk premium, and I think it's right for it to be there. And I wonder if kind of the vaccine and the combination of all these left-tail measures

we've taken, with fiscal filling in for deflation, with the European deal, and things like that, I wonder if the combination of left-tail changes and this catalyst to reduce risk premium kind of, you know, can have a higher trajectory than people think. You know, I'm looking right down on the Bloomberg terminal of the ME-MXEF, the emerging market index and on a long-term scale. And so interesting because, you know, we haven't gone anywhere since 2007. You know, it's just been a bunch of zigs and zags along the way. So, you know, a lot of volatility along the way. but we're basically, you know, haven't made any upward progress. I think this is before carry, I'll be it.

But, you know, if the framing that John and I are presenting, especially with respect to the dollar, if those end up being right, then I wouldn't be surprised if, you know, some of these emerging markets are really kind of coiled and could be a really interesting and more durable trade. And as we kind of hand off like John said, from just a pure vaccine exhalation to a broader-based, you know, reduction to risk premium. And I would expect, you know, the emerging markets trade to probably have more durability

along those lines than just, you know, the U.S. cyclicals in U.S. small value. So this was actually going to beat into my next question. But we started this whole conversation talking about how the dollar is going to be really important to 2021. And the more you talk about sort of your specific ideas, I can see why you're so focused on the dollar. So clearly, if you're long emerging markets, that matters quite a lot. Do you think, well, first of all, what would it take to get a higher dollar in this environment? And secondly, is the suggestion here that the Federal Reserve has sort of become comfortable with this idea that it's the world central bank and that it's actively looking at financial conditions

and actively caring about a stronger U.S. dollar and what it does to the rest of the world economy. With respect to what it would take for a higher dollar, I mean, one thing that would obviously do that is if the Fed ended up being less dupish or less, you know, authentic in its reaction function shift than we might be thinking in this conversation. And more, more tactically in terms of like shorter term trading, I think that like I mentioned earlier, you know, the combination of the consumption basket makes shifting toward services at the same time as potential for, you know, maybe a little bit of compression of the yield spread between U.S. and China, that could give some hiccups along the way, although I think they would be opportunities

to add or enter into these types of trades. And with respect to the Fed, I do think that, you know, they've become more comfortable with this notion of being the World Central Bank. You know, Brainerd's been really influential along the lines of how the international conditions kind of, you know, are part of the analysis the FOMC has to make. But I think more generally, you know, and even before COVID, it was just this notion that why were we hiking in the first place? Why were we short-circuiting these recoveries when, you know, our Philips curve, kind of based models never really showed like, never materialized. The inflation never came. And, you know, what are the cost, benefit, tradeoffs? And I think they have come to the conclusion that it's time to let it rip. But again, you know, I think John's a little bit more confident than I

am about this, although, you know, I wouldn't be surprised if I kind of converge to his views. But, you know, the question there, I think, is going to be about how does Chair Powell navigate what are likely to be kind of emerging internal divisions, even if they're not super strong, you know, as as members of the FOMC start thinking about the back end of this recovery more so than just the here and now, that should probably become more in play as a debate. And, you know, it should be interesting to see how we navigate that. And I'll let John hop in about both questions as well. Yeah, I mean, I think on the Fed, on the Fed part, I think it's, I think the Fed really nailed, and there's a brain art speech in July that kind of really crystallized this when she

talked about kind of stabilization to accommodation. And, and I think that the Fed is, is very now comfortable in the idea that a lot of their policy effects kind of happen in the second derivative. And it's not like the traditional Michael Woodford, oh, we do QE real interest rates, all term premium compresses, and aggregate demand goes bonkers. It's not like that anymore. It's how do we, through financial markets, through financial conditions, kind of create these feedback loops that basically allows our policy posture to expand for us. And it's actually much more durable because they, because their feedback loops, they play off each other, right? So the Fed can say that, okay, things are going well, that changes nothing for us. That has an effect on the dollar,

which has an effect on real yields, which has an effect on the dollar. So kind of setting these things in motion, I think will add power to the Fed's very pro-cyclical ability to ease. And in terms of the dollar in the sense of what could possibly be potential positive catalyst, I mean, I think number one is, I think, probably positioning as like we kind of get into January and it becomes a very consensus view. There's always these Q1 shakeouts, it seems, in terms of the popular trades. But I think what may be actually kind of may be able to offset that is that a lot of people, I think, want to play these trades in a catch-up sense, right? So you see these things like, oh, copper gold ratio has gone vertical and Russell versus S&P, et cetera, and the 10-year bond yield

has done pretty much. I mean, it's, you know, marginally higher, but it's not really done anything. And I think a lot of macro is still kind of looking at like, okay, how do I pay rates to play this catch-up or how do I do? And I think that's really missing the point because the reason these things can go vertical is because they keep looking over there. Russell S&P ratio keeps looking over its shoulder at the bomb market and seeing nothing. So that's what allows it to go nuts. And same with a lot of the cyclical data. And so I think that a lot of these things, yes, there will be probably hiccups in terms of the recovery, in terms of the vaccine rollout, etc. But in bigger picture terms, I think the trades that are working now are still

the bigger trades going forward. I'm Francine Lacqua, an award-winning journalist. And I've got a new podcast, leaders with Francine Laquois. 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. I want to actually like really have you spell out that last point because it sounds pretty important. People look at the rebound in small caps, value, commodities, copper, which is a commodity.

And they're like, all right, but when are yields going to catch up? But it's not like that. There's no inherent with this new Fed regime, there's no inherent reason for yields to catch up. And if anything, it's this ongoing compression of the long end of the curve that further accelerates the gap between the two. Just sort of explain that. Or if I'm, if I'm, if I'm some.

your view correctly and how much longer that dynamic could potentially run. Yeah, I know. I think you actually summed it up perfectly. I think that it can run further in the sense that there will be these times when people are like, oh, maybe we can like price in hikes in 2023. And you've seen this recently a little bit on the backs, on the back of the backs reflation narrative where within the bond market, if you look at like a butterfly, you'll see that the belly is kind of cheapening at the same rate that the long end is. And that's kind of saying like, okay, like maybe they'll be, you know, because usually when the belly leads, like the belly led the bond market lower.

So that's like five, sevens, tens. And when that happens, you kind of say like, okay, this could be a policy change is coming. But I think bigger picture is that all this stuff is kind of there used to be these cut off mechanisms to these moves, right? As in cyclicals would get off the mat, the dollar would start going lower. and then we'd say, oh, this means in two years that the Fed can remove accommodation. And now we're saying that in two years, the Fed's accommodation level is going to look eerily similar to what it is now. And I think that's a very powerful point going forward.

You know, before we wrap up novel, I'd love to go back to your point about could the COVID-19 crisis be to services productivity as China's entry into the WTO in 2000 was to goods productivity and the sort of deflation or disinflation that we saw for the next couple of decades in goods. Walk through your thinking there. What do you see happening out in the real world, out in the economy that you think could cause this, where we return to services pre-crisis levels of services consumption, but not pre-crisis levels of services employment and sort of, A, why do you think that's a possibility? And what do you see as some of the knock-on effects of that? Well, the, you know, first of all, this is very speculative of a view. It's something that I'm just kind of, you know, I just want to see how it materializes more of a question than a view. But this was a huge shock and it was very, very concentrated in the services sector. And so there's, there's always this kind of, you know, necessity is the mother of invention type of thing,

type of dynamic. So that's one thing I think that, you know, service, services oriented. into businesses have been likely focused a lot on the technological side in terms of how they kind of restart their businesses. And secondly, you know, the COVID shock kind of just digitized everything and pulled forward a lot of this kind of technological, you know, implementation of a lot of things. And so, you know, I wouldn't be surprised if that's how it materialized. What it would look like in terms of like on the ground in the real economy, it's a good question. I don't know if I have a great answer, but in terms of knock on effects, what it would mean is that we would have another kind of wave of, you know, positive output

shocks that the Fed doesn't necessarily need to short circuit because it's not seeing the same impulse on employment and inflation. And, you know, that's likely, you know, if that were to materialize, that would likely be, you know, another inequality widening dynamic. And, you know, it would lead to kind of like a Goldilocks type of environment for the markets. So, you know, that's one thing I'm interested to see as we restart the services sectors. What are we seeing in terms of the output versus employment picture, especially like later in the year, once we're kind of, because, you know, on the front end of reopening and normalization, you know, we should see a very robust hiring response in response to, you know, a rebound in demand.

But I'm interested to see if that kind of tapers off a little bit relative to output. And if that does happen, that that probably has some implications for longer-term bond yields unless and until we do see some sort of more structural fiscal policy shift, because I think that that's going to be necessary to offset some of these inequality widening forces. And that's kind of when you start looking at the 2022 midterm. and stuff like that. To an extent, the Georgia elections too, but even with the Georgia elections, you know, even if both seats go Democrat, it's 50-50 with a Vice President Harris tiebreaker, the folks with the most leverage in that environment would be the centrist Democrats.

You know, you need Joe Bansion on board for a lot of stuff. It's very different than, you know, if you have like 50, 354 seats in the Senate and, you know, the progressives would have a lot more leverage. So that's kind of a messy way of me trying to lay out how I'm thinking about this. So I'm thinking back to the beginning of this year 2020. And when I think about all the crazy things that happened, I mean, just in January, we had the beginning of the COVID outbreak in earnest in Wuhan. We had, you know, the U.S. and Iran getting pretty close to an all-out war. Lots of things happening. I mean, Kobe Bryant dying in a helicopter crash. That was a big deal as well. I mean, I'm thinking about how to phrase this question. But like, what is your tail risk that you're watching out for in, in 2021?

But not the obvious ones. Like, we don't get a vaccine that works. What's your sort of out there? What's your left field tail risk for 2021? on. Yeah, the unknown unknown. I think that I'll, I won't try and predict that, but I'll go with, I think that it will be very interesting in a policy sense, not only like kind of gauging new reaction functions in fiscal and central banks around the world, but kind of gauging when will, when will the rate of change matter in terms of of policy easing, right? And it's like, will the end of 2021 be kind of these rolling cliffs of either central bank accommodation ending and fiscal accommodation ending? Because we like to forget that even though that, you know, the U.S. has had a messy kind of fiscal picture, even though the CARES Act was obviously such a success, the rest of the world is actually kind of doing it a lot more effectively. I mean, Europe has its issues with disbursements of the, you know, the supernational project, but Germany and France both acted when mitigation measures went back

into effect. Canada is, you know, promising more fiscal next year. Australia, New Zealand, the same. Even Korea, surplus Korea has an expansionary budget for next year. Japan's on their third or fourth supplementary budget. So a lot of these, you know, these changes in what was previously pretty dogmatic behavior from a lot of fiscal actors has happened. And the question is, I guess, kind of looking at it for more of a tail risk scenario is what if a lot of this goes off, kind of cliffs off at the same time. And then the market kind of becomes uncomfortable with this fiscal transition, you know, into the private sector because for the last 10 years, the private sector hasn't exactly achieved escape velocity on its own or doesn't have a good track record of it.

So I think in terms of risks, I guess that would be my, my 2021 risk. I think that makes a lot of sense, too, you know, as Johns mentioned a lot about how there's kind of a pro-cyclicality element and dynamic with respect to this Fed regime. So if we do see some rolling cliffs in terms of greater change of policy accommodation, at the same time as kind of the big normalization boost kind of starts to taper off, that could be kind of a nasty cocktail, especially because, you know, this is a question I'm really I'm really interested to see in the back half of next year, you know, what is what is the run rate that we kind of converge back to? Like, you know, has nothing really changed in the underlying picture? You know, once we're past, you know, the COVID shock and then the real normalization upward shock, you know, are we in the same kind of nominal growth environment as before? Because if so, you know, tapering off to that to that kind of run rate at the same time as, you know, if if we do see some sort of close. cliffs on the policy front, it'll be pro-suitable on the way down as well, the same way it's been

really effective on the way up. And I guess the other thing I would mention would be, you know, just the typical classic macro punter geopolitics, right? Anything can happen with respect to geopolitics. I think it'll be interesting to see the approach that President-elect Biden takes with respect to China. I understand the, you know, it's nice to have a lot of the uncertainty removed. But, you know, as I mentioned a couple of times on Bloomberg with you, Joe, during the trade war, I always kind of looked at it as it was a lot more bark than bite. And ultimately, you know, the trade deal, quote or quote was, you know, it didn't really change anything structurally. And actually, it cemented financial entanglements between the U.S. and China. President-elect Biden's approach may kind of depart from that.

And so we could see some geopolitical hiccups along the way, especially because China's becoming a little bit more aggressive with respect to what it considers its clients. I'm sure that, you know, we're going to see alliance building start to emerge or alliance rebuilding start to emerge. But, you know, the transition has the potential to be a little bit messy. And in fact, I think that, you know, the personnel decisions that the transition team is making is interesting because the undersecretary for the U.S. one of them, he actually was the lead negotiator for TPP. I think it signals that President-elect Biden wants to take a relatively active stance with respect to China. So, you know, that's always, that's always kind of in the cards and it's probably a little bit less top of mind than it was under the Trump administration. So that could be something that

catches us by surprise. Well, John and Norfolk, so great to talk to both of your real treat. Tons to think about into 2021. Maybe we'll do like a mid-year. update like next June or July and sort of take stock of how things are going. I think that'd be good. Yeah, absolutely. All right. Well, looking forward to it and I appreciate both of you and all the work you've done this year and helping us understand this. Thanks for coming on outlaw. Thank you. Yeah, thank you. Look forward to next time. Take care, guys. That was great. I really think just in terms of understanding this year, I mean, throughout following both of them on Twitter, following their writings, et cetera. I don't think there's any two people that I think have had.

a clearer sense of the moving parts of the macro picture than those two. So it's great to talk to them about what they see happening next year. Yeah, it was a really nice framing of the big macro trends for 2021. I got to say you mentioned this idea of coming back and doing a mid-year update. I really hope that January 2021 is relatively boring and that it's not a repeat of what happened in January 2020 and that we don't have to have them come back on in February or something because the world is falling apart. I really hope that's the case. I know. It's like I wanted to be like I said, it said the beginning, a little less interesting, but you know, I don't want a boring year, but a little more boring. Well, I think even if even if we get a vaccine and even if we get a global economic

recovery, which might normally be considered boring for financial journalists, I think it's still going to end up being an interesting year, as John and Knopf were saying, because of the policy implications and this handoff or the interaction between fiscal inflation and vaccine inflation. Like, even if everything goes, as they were describing, there's still a big question mark over how the Fed reacts to that combination. You know, the point that John made and both of them about the pro-cyclicality of the feedback loops of the current Fed posture. I just think, like, cannot be sort of understated.

This idea of that, like, okay, the Fed has, let's say the Fed holds rates at zero. And so, you know, earlier in the year, we had unemployment at over 10%. So zero rates, unemployment over 10%, you know, we have this accommodative level. If the Fed is still holding rates at zero with no intention of hiking anytime soon, when the unemployment rate is below 7%, then that is implicitly more accommodative because the level of the economy has improved, but we haven't got any corresponding tightening. So implicitly, we've been having this ongoing easing ever since the economy started rebounding in late March and early April.

And I think that really helps explain some of the extremity of these moves. That's like if you're sort of easing further implicitly as the economy recovers, you know, you can see how, you know, there's the feedback loop that's sort of like, I think I remember someone put it as like rocket fuel for the market. Yeah. I think Knopf actually said that. No, that's exactly right. It's it. And I think they mentioned that brain nerd speech about going from stabilization to accommodation. Like, there's a policy shift that is taking place. And so when you when you look at it through that framework, then U.S. stocks at an all-time record, like it doesn't seem as. is divorced from economic reality as it would be otherwise. I do think like the big question mark, however, is still like in the post-crisis landscape, whenever we can declare we're post-crisis, which is probably at some point when everyone, a lot of people have had the vaccine and it's just not a big issue anymore and everything's

totally reopened. Do we just go back to the pre-crisis environment of people buying 10-year bonds in Microsoft and calling it a day? or is there a new leadership? And like, I'm kind of skeptical that anything meaningfully macro changes. And I'm thinking back to like our conversation with Paul McCulley. It's like in theory, we want to see some new like fiscal led permanent change to how we do macro management. And that could produce a shift. But in fact, like we can't even like get a minor extension to the Karazak.

And if you look at Biden's nominees, you know, like a lot of them sort of like progressive new things. but also a lot of like, you know, pretty mainstream conventional ideas, which means like it's still really hard to see like where the big long term macro shift comes from from sort of yeah. And then would we get, how do you get a big market shift without a big macro policy shift? Hard to see much changing. Yeah. I think that's fair. That's fair. I mean, people are so focused on how to get from the current situation from right now to this sort of. of end point in 2021 when things go back to normal that I think a lot of people like we're so focused on the journey that we're not necessarily considering the destination of what that end

point actually looks like. And I think you have a strong argument that maybe it just looks like, you know, what the earlier years actually look like. Yeah, absolutely. Well, going to be an interesting year and plenty of talk about and we'll have them back. either way. And that's that. Should we leave it there? Not too interesting, hopefully, as you mentioned. All right, let's leave it there. This has been another episode of the Odd Lots podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. Follow our guests on Twitter, Nafel Sonala. He's locked, but maybe he'll let you follow him.

At Nauphel Sonala. Follow our other guest, John Turich. He's at J. Turrick 18. Follow our producer Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca today. And check out all of our podcasts at Bloomberg under the handle at podcast. Thanks for listening. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow 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. 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,

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