#1002 - Are Higher Rates Here to Stay? | With Bob Elliott

Summary

Real Vision Podcast: Episode #1002 - "Are Higher Rates Here to Stay?" with Bob Elliott

Release Date: March 26, 2024

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Introduction to the Discussion

In episode #1002 of the Real Vision Podcast titled "Are Higher Rates Here to Stay?", host Maggie welcomes back Bob Elliott, Founder and CEO/CIO of Unlimited Funds. The primary focus of their conversation centers around the current trajectory of interest rates in the U.S. economy, the implications for inflation, the labor market, and the broader financial landscape.

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Current State of the U.S. Economy

Maggie opens the discussion by highlighting recent economic indicators:

• Stock Market Behavior: Despite expectations of a stock rebound, most indexes closed lower except the Russell, which showed resilience.
• Treasury Yields: Slight declines were observed.
• Economic Data: Stronger than anticipated durable goods orders contrasted with a dip in consumer confidence.
• Upcoming Indicators: Anticipation of the Personal Consumption Expenditures (PCE) reading.

Maggie remarks at [01:19]:
"Where do you think the US Economy is?"

Bob Elliott responds at [01:55]:
"The economy moves slower than expectations. We're seeing modest deceleration with some data softening, particularly after the strong second half of last year."

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Inflation Dynamics and Energy Prices

A significant portion of the discussion delves into the complexities of inflation:

• Energy Prices: Initially, gas prices dropping from $5 to $3 provided a disinflationary effect. However, recent rebounds in oil and gasoline prices are raising concerns about sustained inflation.

  Maggie shares a personal anecdote at [03:09]:
  "Inflation is real. The smallest cup of yogurt ever for $7 in New York City is shocking."

• Disinflation vs. Inflation: While durable goods saw a decline in prices due to resolved supply chain issues, the services sector remains sticky, maintaining elevated inflation levels.

  Bob Elliott elaborates at [03:59]:
  "Durable goods disinflation flipping to inflation, coupled with slow-moving services inflation, challenges the Fed's ability to bring inflation below 2%."

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Wage Growth and Its Impact on Inflation

The conversation shifts to wage dynamics:

• Wage Inflation: Elevated nominal wages, especially among lower to middle-income cohorts, contribute directly to inflation. The relationship between wages and productivity is crucial in understanding inflationary pressures.

  Bob Elliott states at [06:02]:
  "Nominal wages continue to grow, particularly in high propensity to spend income cohorts. The key is whether productivity growth can offset this wage growth."

• Productivity Concerns: While there has been a recent uptick in productivity, questions remain about its sustainability amidst rising input costs like gasoline prices.

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Federal Reserve's Monetary Policy and Interest Rates

A central theme is the Federal Reserve's (Fed) approach to managing interest rates:

• Rate Cuts Speculation: Initially, the market anticipated multiple rate cuts. However, current data suggests that fewer cuts, if any, are likely.

  Maggie queries at [08:20]:
  "Does the Fed's plan to cut rates three times seem doable against this backdrop?"

  Bob Elliott responds at [08:43]:
  "Market adjustments now price in 2-3 cuts, but given the data, fewer cuts or none are more probable."

• Neutral Interest Rate: Elliott discusses the concept of a neutral interest rate likely higher than the post-2008 Financial Crisis era, suggesting rates closer to 3.5-4% or even 5%.

  At [15:59], Bob Elliott explains:
  "The baseline level of interest rates is likely higher than 2.5%, possibly around 4-5%, due to factors like higher demand for capital and persistent inflation."

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Implications for Bond and Stock Markets

The potential shift to higher interest rates has profound effects on various financial assets:

• Bond Markets: A rise in long-term rates would negatively impact bondholders who are locked into lower rates, altering valuation models and potentially leading to decreased bond prices.

  Maggie observes at [16:38]:
  "Higher neutral rates are bad for bondholders and could upend valuations, affecting the entire financial system."

• Stock Markets: Increased discount rates could lead to declines in stock valuations. However, Elliott believes the real economy could withstand the pressure from higher rates without a significant derailment.

  At [18:54], Maggie summarizes:
  "The real economy can tolerate higher rates, but the financial economy, particularly assets sensitive to interest rates, cannot."

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Commercial Real Estate (CRE) and Banking Sector Resilience

The discussion touches upon the resilience of the commercial real estate sector and the banking industry's ability to manage potential stresses:

• Commercial Real Estate: Despite higher interest rates, banks have demonstrated adeptness in managing CRE exposures through loan restructuring and regulatory relief.

  Maggie notes at [28:34]:
  "Banks are experienced in dealing with bad loans, and CRE issues are being methodically managed without threatening the broader financial system."

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Global Central Banks and Comparative Monetary Policies

Bob Elliott provides insights into the actions of other central banks, particularly the European Central Bank (ECB):

• European Central Bank (ECB): The ECB appears more hawkish, yet recent wage data (3.1%) suggests they may act more aggressively than the Fed in managing inflation.

  At [33:19], Maggie explains:
  "The ECB might move faster in tightening due to softer growth and lower wage increases compared to the U.S."

• Bank of Japan (BOJ): Elliott speculates that the BOJ is likely to maintain its current easing stance for the foreseeable future.

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Investment Opportunities Amid Higher Rates

Concluding the discussion, Maggie asks Elliott about current investment opportunities in a rising rate environment:

• Yield Curve Steepener: Elliott suggests that positioning for a steepening yield curve could be advantageous, offering risk-reward benefits and tail risk protection.

  Bob Elliott advises at [34:25]:
  "A yield curve steepener is an attractive bet, providing protection against unexpected market shocks."

• U.S. Dollar: The dollar remains compelling due to the robust U.S. economy and comparatively dovish stances of other central banks.

  Elliott adds:
  "The dollar is strong, especially against currencies of regions where central banks are easing."

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Conclusion and Key Takeaways

• Higher Interest Rates: The consensus leans towards sustained higher interest rates, potentially around 4-5%, diverging from the previous 15-year norm of 2-2.5%.

• Inflation Management: Persistent inflation, especially in the services sector and wage growth, challenges the Fed's ability to lower rates, necessitating a reevaluation of monetary policy strategies.

• Financial Market Implications: Higher rates pose risks to bondholders and could recalibrate stock valuations, although the real economy may remain resilient.

• Global Dynamics: Other central banks, notably the ECB, may adopt more aggressive tightening measures based on their unique economic indicators.

• Investment Strategies: Emphasizing yield curve steepeners and leveraging a strong U.S. dollar present viable opportunities in the current financial climate.

Notable Quote:

At [36:52], Elliott underscores the importance of being a rate strategist:
"The bonds are also in the credit, and the bonds are in the loans, and the bonds are in everything. The bonds are in the houses. Everyone has to be a rate strategist because it matters so much."

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This episode provides a comprehensive analysis of the current economic indicators, the Federal Reserve's potential policy directions, and the broader implications for various asset classes. Bob Elliott offers a nuanced perspective on navigating the complexities of higher interest rates, emphasizing the importance of strategic positioning in an evolving financial landscape.

Transcript

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[Maggie]

Our higher rates Here to stay. Hi everyone. Welcome to the Real Vision Daily Briefing. With me today is Bob Elliott, co.

[Bob Elliott]

Founder and CEO CIO of Unlimited Funds.

[Maggie]

Hi Bob, it's great to have you back again.

Hey Maggie, great to see you.

So we thought we were going to get a little rebound in stocks today and they were most of the day, but they kind of faded into the close here and we ended up with losses. All except the Russell. The Russell looks like they're hanging on and we had treasury yields edged lower. It seems like it's going to be one of those weeks where we meander around. We had stronger than expected durable goods, but consumer confidence dipped a little. We know we've got a PCE reading at the end of the week, so it seems like a good place to just start off and kind of take a look at what you see happening in the economy since we are getting a little bit of mixed readings. Where do you think the US Economy is?

Yeah, I mean, I think it's always important to recognize that the economy moves way slower than all of our expectations and certainly anything that's on Twitter on a day to day basis. And so what we're seeing with the economy has been 7/4 of above add or above potential growth and we're kind of seeing the same thing play out. But we're seeing a little bit of deceleration, I'd say sort of through the quarter here with some of the later data a little softer than some of the earlier data and the strength that we saw in the second half of last year. So modest deceleration. And I think the real question is what's going on on that inflation side of things, which is starting to pick up, showing some signs of, at a minimum, not moving durably down to the 2% or below 2% threshold. And I think in particular starting to raise questions with the rebound in oil prices and gasoline prices starting to raise the question of, you know, is a, is a three handle on inflation kind of where we're going to be at for, you know, through the course of the year?

Yeah. And it, it, you know, energy was a big relief and it seems like whack a mole.

[Bob Elliott]

Right.

[Maggie]

I mean, I think everyone has anecdotal evidence. In fact, my, my husband just messaged me. He was in New York City today and just messaged me. Inflation, it's real. And it was like the smallest cup of YoGurt ever for $7. Like, that's not unusual for New York. But, but I mean, even that, I was like, wow, okay, like, you better go hungry. But I mean, it was, it was kind of shocking. But I feel like we all still have instances where sometimes we're like, okay, like I feel a little bit better about this, but a lot of the time we just feel that stickiness of, of certain things just don't seem to be going down. Or, you know, there's periodic food depending on what you're buying, get a break on eggs, something else jumps up. It doesn't feel like we're having this really rapid deceleration. So I mean, it still may happen though, right? Inflation lags, doesn't it?

Yeah, well, I think the complicated thing with inflation is that there's a bunch of different moving pieces that are sometimes moving counter to each other. So the initial bout of disinflation coming from the fact that gas prices went from five to three, which then flowed flows into all sorts of different places in the economy and then also a big shift downward in durable goods as the supply chain issues started to get resolved, started to see a drop in used auto prices in particular, but also imported durable goods. And so that created like a big disinflationary impulse on the economy and brought inflation down considerably. I think the key question, and at the same time, the services side of things, you know, you can look at a lot of different pieces of it, but it's certainly not moving rapidly down. It certainly remains relatively elevated. I think the challenge is, as we look ahead, some of those big disinflationary impulses that existed with oil prices and gas prices falling and having another leg down through the end of the year, but now reversing and up 60, 70 cents depending on exactly what you look at. And having those durable goods prices that were falling now starting, you know, starting to rise. I thought it was one of the more interesting pieces of the inflation report was goods, durable goods, disinflation started to flip to inflation. That's not a good sign at a time when those sort of, the services side of things just isn't moving down as fast as certainly the Fed would hope. That's not a great combination on a forward looking basis. And, and so I think that's when, when Chairman Powell talks about needing more evidence that that's what he means. It's not like no one's sitting here thinking, oh, inflation is going to go to 5% or 10% anytime soon. The question is are we stabilizing at 3 or are we stabilizing at 2 in a compelling way? And I think that's the question that he's got on his mind. And I think there's good evidence to suggest that maybe they shouldn't be confident that it is there, particularly on a forward looking basis.

Yeah. How do wages plug into this? Because, you know, there was a time back in the day, I always remember that being the scariest thing for the Fed because wage inflation is really something that never, or I shouldn't say never, but is, is typically hard to reverse. Right. You don't, once you get that wage, it's very hard to get to take it away without inflicting a lot of pain or layoffs and kind of resetting the whole situation. They get baked in for years at a time. Are we seeing that or is the labor market. The labor market's been tricky. Right. Because we don't know what's temporary or business cycle. We don't know what's structural. It seems like it's been kind of hard to figure that out. What are you thinking about in terms of wages?

Yeah, I mean wages are critical. If you just think about very simple level inflation in the economy can be seen as how much are people earning relative to what their productivity is? And the difference between those two things essentially has to be prices because what they earn, they spend and what they produce gets bought. You know, it's a little more complicated that than that in reality, but that kind of gives you a good benchmark of how to think about wages. And so nominal wages continue to be, you know, moderately elevated. They've come down a little bit, but still, particularly when you, when you look at the wages of high propensity to spend income cohorts. So say your 60th percentile and below or your 80th percentile and below. Those wages continue to grow pretty rapidly on a nominal basis. A couple, let's say 2% above where they were pre Covid. The interesting question, the key question is how much productivity are you getting out of those workers? We have seen a pickup in productivity and measured productivity over the course of the last couple of quarters back to sort of the longer term trend line. If that continues, then we can live with 5% wage growth and 3% productivity. That's an okay outcome. I think the real question is is that really durable over time and do we get that nominal wage growth derailed by input costs like gasoline prices going up, you know, 20, 25%? That, that's a big deal. You know, if you're, if you're in the lower income cohorts with, with the high propensity to spend, that shift in gas prices from the low threes to the high threes matters where you, in the day to day basis.

Yeah, it does. We used to always think about it as an immediate tax, right. I mean it's something that hits a pocketbook instantaneously. You really feel it. It's got a really like sort of gut, gut visceral response because you got to open up your wallet every, you know how, depending how often you drive it. Americans drive a lot. So against that backdrop, does the Fed's plan to cut rates three times seem doable against this backdrop?

Well, I think it's a good question and certainly when you look at that situation, certainly from the market pricing, a lot of the easy money has been made. We came into the year it was six or seven cuts. The economy was growing above potential and there were inflationary pressures that had yet to be resolved. And the idea that the Fed was going to cut six to seven times was not reasonable. Despite the real rater type comments that were going on, we've adjusted Significantly now to 2 to 3 cuts priced into the market. From my perspective, I look at that and I say, is that what I do? Probably not on the margin, will the Fed probably do less than that given the data, you know, the data that's likely to come out, probably. But when you're talking, when you're, when you're talking about, you know, the difference between are they going to cut once or twice? You know, you're kind of like splitting hairs there at that point. Certainly from a trading markets perspective. Yeah, in a way that I don't, you know, it's, it's within the cone of plausible it's also very plausible that zero happen over the course of the year. But we're in the ballpark of not too much easing is likely to occur given the momentum that exists both in inflation and in the economy.

Yeah. Which is, as you say, very different from where we came into the year, what we came in thinking. So Jack Burnett gets the gold star today because I think he's asking the question certainly that we're all thinking about and that you've been tweeting about and if the long term rate is closer to three and a half to 4% instead of 2%. First of all, let's start with is, is that a likely scenario that we need to adjust to? And then I'll ask part two of his question. Hey everyone, we're going to take a.

[Bob Elliott]

Quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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[Bob Elliott]

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[Maggie]

Yeah, I think it's, it's a, it is a critical question to, to start to, to be wrestling with. You know, I remember in this cycle when the short rate was at 2 1/2% and Chairman Powell said it was highly, you know, it was restricted at 2 1/2 percent. And you looked at, you're like, I don't think so, man. Yeah, and he tried, you know, he was trying to, to, to back away at that. And even at rates at five and a half and in the high fours and through to the mid fives, over the course of basically a year plus, growth has continued to be at or a bit above potential. And so you look at that picture and you say the overall sensitivity of the economy to the short rate, to the existing long rate structure, even with interest rates between four and four and a half percent, things are okay in the economy. And so what that highlights, I'd say on a tactical cyclical basis, that really raises a question of whether there's enough tightening that exists on the short end to really slow things down meaningfully or quickly. I think the question on the longer term, which is what does that longer term neutral interest rate look like? I think part of it is, first of all, a lot of uncertainty. And there'll be seven academics in a room and you get seven opinions about it and seven highly quantitative models describing what's going, going on. So, you know, we have to accept the ambiguity of it. But I would say, look, there's a lot of people who talked about a two or two and a half percent rate back during the post GFC era where we had huge debt overhangs and in the private sector and depressed spending and incomes. That sort of story is not really pertinent, that pertinent to today. A lot of the healing has happened in the private sector in terms of the balance sheets. If anything, we're moving to an era where we're starting to get likely a lot more investment, part of it supported by the government and part of it private sector driven as a part of the deglobalization dynamic. So that's a draw for credit. And at the same time, the global savings glut has really stopped in a way that had existed right after the gfc, where you had global central banks basically recycling liquidity into US Treasuries and into US dollars. Places like China are more concerned with their currency going down than going up these days. And so you basically have this situation where probably the demand for capital on a forward looking basis is meaningfully higher than where it was back in the post GFC period. The supply of capital is probably lower. And we've got this inflation issue which we at least have to acknowledge is, is more of an issue today than it was 10 years ago when people were more concerned about deflation. You put that all together and probably the sort of baseline level of interest rates that you're seeing is probably going to be higher certainly than two and a half, which is where we were for the last 15 years, which is.

Why this is a big deal. When I saw that tweet, I was like, when we're changing from basically assumptions that we've held for 15 years, that sounds like a big deal. So the other part of Jack's question, I split it into two, but his question is, are there areas of the market that will adjust higher? That's such a great neutral way to put it, Jack, because I'm wondering when I hear that, okay, is that, is the fact that the neutral rate may be closer to between 4, maybe 4 and a half, 5% even, is that in it of itself a bad thing? And then I think his question is, what is that adjustment? If there are areas that have to adjust, what does that look like?

Well, it's a bad, I mean, it's a bad thing. If you're a bondholder and you've locked in low interest rates for an extended period of time, those people who came to the year buying in the, you know, at 375, if the neutral rate is, you know, closer to 4 to 5 and on top of it, you have a circumstance where the term premium is pretty depressed right now as well. You could, you know that that's not a good, good picture for bondholders. And I would emphasize like this, this, this assumption that the Fed is going to bring interest rates back to 2 and a half or 3% in this cycle is like, is baked in all of these different models. Like, you know, I'm sure you every once in a while bump into a few, a few interviews on Bloomberg and you listen to the bond people and basically every single bond person says, well, you know, the long term rate is two and a half or the Fed will bring interest rates down to 3. Like imagine those folks and that's causing them to buy, to be clear, that's causing them to buy yield at 425. At 425, if your long term rate is 2 and a half, it actually looks like a pretty good deal over a cycle time frame. When those folks start to say, I'm not so sure, maybe I need a pencil and a higher number. And we're actually seeing that in terms of surveys of professional economists and, and dealers, we're starting to see that long term rate expectation creep up. When that shifts, that totally changes the valuation picture on bonds. And so bonds, particularly risk free bonds, treasury bonds, serve as the backbone of the whole economy. We already saw last summer, it doesn't take that big a rise to start to upend the apple cart and create some risk to stocks due to the rising discount rate if those yields rise. So that's, you know, a lot of, a lot of the rest of the financial system is really dependent upon this continued expectation that interest rates are going to be low for a long time.

Yeah. So the argument when you hear that is that even if the Fed will go back to that rate, even if they have to inflict pain to get there, but you're suggesting maybe they don't go back to that.

Right? Well, I think, I think that's part of, the, part of the question is if the economy is structurally running hotter with higher productivity, higher demand for capital, lower savings rates, et cetera, you can have an economy that continues and higher inflation, you can have an economy that continues to be fine. Right. You can have your unemployment rate at, let's say five, which to be clear, the average unemployment rate is five. Not, you know, not three, not, you know, not three and a half, not four. It's five. The idea that you could have an unemployment rate, just in terms of thinking through things, let's say we had, you know, long end yield move to 5 and we had an unemployment rate of 5. That seems like a perfectly plausible solution to the macro economy. And that could, you know, and would that be, that would be undesirable tactically for the Fed. But in a strategic sense, a 5% unemployment rate would be fine. Would be a fine.

This is why I asked, is it in itself a bad thing? It sounds like it's just settling where the economy can handle it. Right. And as opposed to everyone hating zero interest rates and some of the repercussions that come from that and being worried about deflation, you're in a different regime. The problem in the rub is that the system is built on expectations of it being at two or two and a half, right?

Those expectations, you know, I like to joke the fact that the bonds are in the stocks, right. But the bonds are also in the credit, and the bonds are in the loans, and the bonds are, you know, bonds are in everything. The bonds are in the houses. You know, that's, that's kind of the challenge from an asset holder's perspective is, is the fact that we're moving to a, to a structurally higher rate may not be so bad for the real economy, but it isn't great for asset holders. Now, the question is, does that yield move so fast that it then creates enough of a hit to asset prices to then flow through to the real economy as spending slows and creates that sort of downward dynamic? We saw just a taste of that last summer, although, you know, even with rates at 5, like, look, big picture, like, stocks were down 10%, 10, 15%. You know, stocks go down 10 or 15% over the course of three or six months. It's like, not that big a deal. And the economy actually accelerated. It didn't actually deteriorate. And there are other things going on. I wouldn't necessarily draw that linkage to it. But the idea of saying, like, could the real economy tolerate, you know, an environment of 5 moving back to 5% interest rates, given all the things that are going on? Yeah, absolutely. Absolutely.

Could the asset. The financial economy cannot, though.

Well, the financial economy, you know, has high sensitivity to that sort of dynamic. And, and obviously it depends, because it depends on the, essentially the duration sensitivity. You know, there's a lot of assets that are out there that are not that duration sensitive, but, you know, there are certainly many assets that are duration sensitive. And what would have, you know, I think the question that you sort of have to pencil through is what would, you know, stock, if interest rates go to 5% from where they are today, that's 75, let's say 75 basis point rise at, I don't know, 15 years of duration, that would get you, again, another 10 to 15% hit in stocks. Is that enough to derail the recovery, or is that just simply annoying for equity holders that we're hoping for yolo, NASDAQ to go through the roof and never stop going down? My guess is it's more of that ladder, which is that you can have the real economy persist kind of. Okay, you'll persist, okay, and have a Hit to a moderate hit to asset prices as the interest rates reset. It's really a question of does that then beget more concern about interest rates? Does that create bond vigilantes? Does that start to spook investors who so far are, you know, when the yield rises, they come in and buy. Just look at the flows into the TLT like it is, you know, typically the way it works is for stocks. When stock prices go up, people buy. And when stock prices go down, they sell for tlt. As that yield rose, people were pouring into tlt. Buying the yield, buying the yield, buying the yield. As long as that persists in the.

Anticipation that it would drop later in.

The anticipation that would drop or just like they were looking at and they said a five year old yield is not a bad yield, all things considered. And so as long as that dynamic persists, then probably the yields don't rise too much. Certainly they don't rise to whatever that crazy thing that was said back in October, Yields are going to rise to 17% or something. That's probably not going to happen. The real question is do they rise to 5 in this sort of environment as things reset, or do they rise closer to 6? And the difference between stocks getting, you know, a drag of 10 to 15% versus, you know, 20 to 30%, that's a big difference in terms of what the second order consequences are in the real economy.

Yeah, it's a fascinating problem to work through because it doesn't seem like anyone's positioned for that. We're going to take another quick break.

[Bob Elliott]

To hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily briefing.

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[Bob Elliott]

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[Maggie]

Yeah. Not many people are positioned for shift to meaningfully higher rates. And I mean it makes sense why that is, which is that in general asset managers are invested, they're investors and they are invested. And so in a lot of ways it's functionally hard for many asset managers to be positioned for that. And what really matters is what the marginal, the marginal buying pressure is. And, and I mean we know that obviously there's a lot of marginal buying and selling pressure. And from that perspective, I think we know that there's obviously a lot of treasury supply here. As we step into quarter two, the net supply of duration is going to be about twice what it was in the first quarter. And that's up from, you know, last summer where essentially, you know, it was very, very, very low given the, the various tga, you know, the debt ceiling and the TGA refill, et cetera. And so I think that's a really interesting question. We're gonna, we're gonna get a good sense of the sensitivities because it's gonna basically ask the question, it's gonna give us a good insight into how much do yields need to rise or do they need to, to rise in order to swallow that duration supply at the current price levels. My guess is we probably will need to see higher interest rates to get those rate sensitive buyers to come into the market. I should say they're rate sensitive and yield curve sensitive. So if you're, as a simple example, like you know, Japanese buyers are typically buying, they're typically buying in a currency hedged way. You know that currency hedge way is essentially a bet on the yield curve. What about households, you know, they're buying tlt. How high do yields need to go in order for them to look good about it? We sort of achieved balance at 5%, which I wrote at the time. Actually, at the time I was like, yeah, 5%. I sort of add up all the buyers and it kind of looks, you know, close to imbalance. It looks reasonable. The question is, as we go to this next round where maybe the disinflationary forces aren't quite so present, there's some concern on the upside and where we've extended growth and the level of equity prices, are people going to need something higher than 5 to come in and swallow that higher total duration supply.

Yeah. Which, gosh, could make for a real summer of discontent. So to. To follow on and stick with Jack's excellent question for a moment. Two areas that seem like. Because he's sort of saying basically, where's the pain? Right. Where the market adjusts higher. When you're talking about treasury yields, what about commercial real estate? This sounds like this would be the last thing that the commercial real estate market would need.

Yeah, I mean, commercial real estate. I think the challenge with commercial real estate is that it's not all that viable at 4% yields or 5% yields or 6% yields. And so I think maybe it doesn't.

Matter as much because the question is.

Sort of the marginal impact. I think probably there is not all that big. You know, I don't want to. It matters whether the yields are 4 versus 6. But, you know, the big problem is that no one's going to the office.

As evidenced by, like, the idea of extending and pretending. If you get those rates down, you know, if they were going to go back down to 2%, yes. You still have a problem. You still have the distressed guys that have to come in and you have a liquidation that could probably take, like, savings and loans. Someone refers to it, you know, decades to unwind or repurpose. But now the idea that you're in a different rate regime can only make that, you know, I think that situation more difficult.

Yeah, that's right. I think the main thing. The main thing with the CRE world is that it is almost entirely on balance sheet loans.

Yeah.

And the one thing that the banking system is really, really good at is extending, pretending, modifying, you know, terminating, structuring, restructuring. Like that whole world, like, if there's one thing bankers are good at, it's not necessarily making loans, but they're darn good at dealing with bad loans.

And a lot of experience.

They have a lot of experience dealing with that. And I think there's a lot of regulatory relief.

Yeah.

That exists for them to, you know, not necessarily resolve those things immediately. I put out something a couple of weeks ago, you know, since CRE blew up, let's say everyone started to talk about it, like, early last year. You know, the banking system has earned about $60 billion in NIM from CRE and they've lost $600 million. So that gives you a sense as, you know, $60 billion of NIM, $600 million of losses. Charge offs that have occurred. I give you a sense like this is like Washington paint dry. It is not, you know, people who relate this to the financial crisis. Not at all the financial crisis, the.

Financial crisis that was the wheels coming off the entire global system. This is, this is, this is a problem that they know how it's painful and painstaking, but they have done this before in many different areas.

Exactly, exactly. And banks can. The whole cleverness of a bank is that they earn the income today and they take the losses over extremely long period of time. And that allows them, if, if the losses are big enough to out earn through their NIM on other assets on other loans which to clear are resetting. We have to remember that like those things are resetting. NIMs are actually fine. You know, they're staying in the two and a half, three percent range, you know, three and a half for some of the smaller cohorts. Those are decent NIMs. They can absorb a lot of losses with NIMs like that for an extended period of time. And so it doesn't mean that like, you know, are banks going to be making money hand over fist? Probably not. Are the ones that are concentrating these assets going to, you know, are their stocks going to be fantastic? Probably not. A great stock pick depends on what's priced in. But you know, you could easily see the stocks kind of being, you know, bad performers for an extended period of time. But that's very different from this is the thing that's going to bring down the economy.

That's a great observation because we get a lot of questions that people worried about commercial real estate and I think that that's a really, really sort of accurate description of banking. NIM is net interest margin, everyone, by the way, the amount of money bank makes on earning in, on its interest in loans. This is another great question because I know you're looking at Europe, you're looking at Japan. Two different people are asking in two different versions, both Mark and Ralph, any chance other central banks go before or instead of the Fed? And importantly, does it matter? Another great question.

Yeah, well, it matters. The beautiful thing about trading markets is you can bet on the other markets and the money doesn't care whether you're betting on the ECB or the Fed. So that's always something to keep in mind when you're thinking about how do you build diversification. When I look at, I think probably the place that looks most interesting to me is, is what's going on with the ECB who has talked very hawkish, but under the Hood, what you see is there's a pretty big difference in terms of the inflationary picture in the US and in Europe. And I think it was overshadowed by the Fed situation last week. The ECB, the quarterly wage numbers came out about 3.1, down considerably from where they've been running 5 to 6%. And if you watch the Lagarde press conferences, which, you know, I recommend at triple speed, if you're gonna, if you're gonna, if you're gonna waste your time.

With that, every Fed conference, every central banker.

That's right. That's right, exactly. Speed that stuff up. It was kind of the primary sticking point. If you go back to the last couple of meetings where they were like, we're not so sure. Wages are a bit of a concern. We wanna see them come down. And in order for us to feel comfortable, we need to see them come down. 3% is a bit, a bit higher than what it was prior to Covid, but it's not. 3% is fine. They can deal with 3% wage growth in the economy. And that's going to, combined with the fact that we're likely to get soft enough readings on inflation that my guess is the ECB is going to be faster moving than what we see with the Fed in terms of responding to the real economy dynamics. The growth is also a little softer there and things like other elements like that that are not literally in their mandate but certainly influence what they're thinking.

So I always like to end it with you, Bob, about where you see opportunity right now. Sounds like it's not US Treasuries.

It's not US Treasuries, that's for sure.

What do you like?

Or maybe I should say that is an opportunity. Right. You don't have to be long only. Right. You know. You know, I think, I think when I, when I look at the market a lot, we came into the year and basically people were underpricing the durability of the economy and the need to not cut nearly as much. And so positions like long stocks versus bonds and, you know, short, short rates both look pretty attractive coming into the year. Most of the money in those trades have been made. I think at this point, you like, look on the margin do I think the probability probabilities are probably a little too high of cuts in the summer months, given what we're seeing in the data. So maybe that's a fade a little bit. I think the real question is what's going on with the long end and are we going to have an environment Here where there starts to get pressure in the long end, that's a place maybe a yield curve steepener I think is an interesting bet from a risk reward perspective. You also get a little bit of tail risk protection in the event of a one off unexpected shock into the market. I like steepness in this environment. The dollar is also pretty compelling in this environment from the perspective of the US economy continuing to run hot and other central banks being a little more dovish than what many people are expecting. And so the dollar across several developed crosses looks compelling as well, particularly in places like the UK and Europe are likely to shift to easing given their economic circumstance. And honestly, the BOJ is likely to stay easy. The real question is when is the BOJ going to run tight monetary policy? The break even right now is the day I retire. I don't know.

And since we know you have new additions, that's a long way off for all.

And that's a long way.

Exactly. Exactly. Bob, great stuff. It's not something people are talking about. We've all kind of just listened to that press conference from Powell and thought, oh, they're dovish and everyone's just chugging along on that assumption. But I heard someone the other day have the greatest line, which is that doesn't matter what part of the market you watch, everyone has to be a rate strategist because it matters so much. So to get a perspective on that, super important for our audience. So thank you so much.

Yeah, thanks for having me. It's always great to catch up.

Great stuff and congrats again on the little one. Thank you World for you. Hopefully you get a lot of sleep. Hopefully. He's a sleeper. You're laughing. I know the early days are rough, but wonderful. All right, thanks Bob. We'll see you again soon. Thanks to all of you. We'll be back same time tomorrow. Take care and good luck out there everybody.

[Bob Elliott]

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