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Hello and welcome to What Goes Up? A Weekly Markets Podcast.
My name is Mike Regan. I'm a senior editor at Bloomberg.
And I'm Wildana Hirek, a cross-asset reporter with Bloomberg.
And this week on the show, well, what if we've all been bracing for a recession that never actually shows up?
That's a question that's floating around more and more these days as the economy just keeps hanging in there.
Despite the rapid rise in interest rates, a few bank failures and all the dire predictions that came along with both of those.
We'll get into it with a well-known economist at a major Wall Street bank.
But first, Wildana, I've got a very strange question for you.
I'm shocked.
Yeah. I've never asked you a strange question.
Have you ever daydreamed about being a princess or a queen?
No. A little royalty you haven't?
No.
Well, that's a healthy outlook.
Yeah. It's not real. And they didn't have bathrooms.
Well, there are real princesses.
Oh, that's true. Like modern day.
Do you think the current princesses and princes?
Prince Harry doesn't have a modern bathroom?
He definitely does. But like, are they beloved by their people?
You know? It comes with a lot of baggage.
All right. Well, that's a healthy attitude.
Why are you asking?
Well, it's my craziest thing this week has to do with...
There's actually a market for royal titles, if you believe it or not.
Wow.
So I'll get into it.
I would buy one.
You would. All right.
I would be the highest bidder.
Oh, good. We're going to find out how much you're willing to pay.
Okay. I don't want to keep our guests waiting because...
And I actually just told him this right before we started taping.
I'm a huge fan of his. I've been a fan for years.
I'm so excited to have him.
Like you got posters on the wall?
Yeah, kind of. Yeah.
No, not to that extreme.
It's Seth Carpenter. He's the global chief economist at Morgan Stanley.
Seth, thank you so much for joining us.
Well done. Thank you. Mike, thanks for having me.
I am glad that this is audio only because I would have blushed.
Give him one of your jokes.
Oh, I'm blushing. Don't worry.
He's also a former writer of the Princeton Dinky as well.
I know.
Yes.
He got his PhD at Princeton.
My weird hobby is I love the Princeton Dinky.
I don't know why, but I find it fascinating that there's
a one-car train that goes what?
A mile back and forth every day?
And you can have your tall guy on it.
Or what's a tall guy?
A tall boy.
A tall boy.
You couldn't even finish a tall boy in the time of the day.
Oh, you can't.
Okay, but Seth, you have a very decorated resume.
So I'm hoping we can just start out.
You can tell us about your background and then how you ended up at Morgan Stanley.
How did I get to where I am?
You started off noting that I have a PhD in economics,
and I'm happy to say that my primary advisor was Ben Bernanke,
who when I was at Princeton did not have a Nobel Prize,
and now he does.
So maybe I had something to do with that.
I would say so.
No, that was actually a fantastic opportunity.
And I actually thought I was going to be an academic.
My research was on monetary policy,
but I went to teach for a couple of years at the College of William and Mary,
and then the Fed called and said,
are you interested in coming up to give a, to do an interview?
And the answer was yes.
And they offered me a job and I took it.
And shocking news for anybody who's in their late 20s,
Washington, D.C. is a bit more interesting to live in than Williamsburg, Virginia.
So I ended up staying in Washington, D.C.
And I was at the Fed for 15 years.
By the time I left, I was the deputy director of the Division of Monetary Affairs.
I got to work through the financial crisis, which was a terrible point in economic history,
but now that it's an in-review mirror,
it sort of was fascinating part of my career to be at the Fed in the trenches,
trying to work on both strategy for policy and then the nitty gritty,
like all of the different lending programs the Fed did and thinking about the Fed balance sheet.
I was for a while the Fed's person in charge of the Fed's balance sheet, if you will.
So it was fascinating, but at some point I needed a break.
I went to the Treasury Department ostensibly for just a one-year visit,
but while I was there, I had the very good fortune of having President Obama
nominate me to be Assistant Secretary for Financial Markets.
So I resigned from the Fed and got to work at the Treasury Department,
and I have to say that was a fantastic job.
But I did that until 2016, and then I went to the private sector to financial markets,
worked for a year at a hedge fund, worked for four years at a different bank.
And now I'm happy to say I am the Global Chief Economist here at Morgan Stanley,
and I couldn't be happier.
I guess you did have to buy a new wardrobe when you moved to Washington, though, Seth.
He couldn't walk around in those colonial uniforms anymore.
Instripe suit with a tricorn or a hat.
To get back to what I was saying in the introduction, my impression is that you were
sort of leaning into the soft landing camp these days, thinking that perhaps fingers crossed,
knock on wood and all that, we actually might be able to avoid a recession.
Walk us through how you're thinking about that.
What's changed to make you a little bit less worried about recession?
Absolutely. We've actually been in the soft landing camp for a while.
There were definitely times when everyone in markets was throwing rocks and sticks at us
and saying that we're crazy because it was clear we'd get a recession,
and then the data for January and February came in that looked a lot better,
and people were telling us that we were crazy, that we were still calling for a big slowdown.
And now the world has shifted again.
What is our thinking?
The first thing is that it seems hard to avoid the fact that the US economy is going to slow down,
and part of the reason why that's hard to avoid is because that is absolutely categorically the
Fed's objective. The reason they will keep hiking interest rates at least a bit more is because
they want the economy to slow down a lot in order to have inflationary pressures abate.
So the slowdown part should be pretty easy to get on board with.
So what about the missing the recession part?
Well, partly because the slowdown is the Fed's choice, at least having a chance to avoid a
recession should also be the Fed's choice. And we think they're looking carefully at the data
and asking, do we have enough evidence that things are slowing down a lot, but not yet
crashing because that's what they're looking for in order to stop the hiking cycle?
So we think the last hike is in May when there'll be more evidence of more of a slowdown, but
not yet evidence that things have actually fallen off of a cliff.
And then I think the last part of our thesis is usually what takes in the US to get a recession is
some shock or something that causes the slowdown. So we've got that.
But you also need an amplification mechanism. So the economy slows down and businesses lay
off millions of workers and their lack of income causes a slump in spending, or you get a big
credit crunch and everything seizes up. Both of those are clearly possible, but we don't think
they are imminent. For the labor side of things, the job market still seems pretty healthy.
The unemployment rate is very low. And if you kind of look at how much employment do we have
relative to the level of GDP, you come away with the conclusion that, boy, businesses are still
a little short-handed. But what that means is the economy can slow down and businesses don't have
to do the same wave of firing that they've had to do in previous slowdown. So that makes us feel
a little bit better. And even though there's clearly tighter funding conditions for banks and banks
are pulling back on their lending, especially given what's happened in the wake of all of the
banking turmoil, we got to remember that things were already slowing down. Low growth was already
slowing before we got these new sensational headlines about the banking sector turmoil.
And because we were sure the economy was going to be slowing down anyway, the demand for that
borrowing is going to be following. And so we don't think any pullback by banks and
they're willing this to lend is going to be the thing that tips us over to recession.
So not a super rosy outlook. We are looking for growth that's below half a percent in real
terms, so very, very close to zero. But importantly, we are not looking for a full-blown recession
where we have several months in a row of contraction. Okay, so Seth, you mentioned tighter funding
conditions. And I'm wondering where else you are looking to see signs of that now that we've
obviously we've had the bank turmoil in a month since that happened. I know I was reading some
notes from some of the big banks and a couple of them actually mentioned Fastenall, some of the
warnings from that company and that company being such a bellwether. So where else are you looking
maybe for signs of tighter funding conditions? So we're trying to look as broadly and as deeply
as we possibly can. You can look at things like delinquency rates and deterioration of credit
quality on credit cards and that kind of lending to customers. But I close to home for a big chunk
of my career. The Federal Reserve has their senior loan officer opinion survey. They have a survey
in terms of business lending. And there they ask lots of banks what's going on with your
lending. And I think that's another really key source of information about willing this to
lend by creditors. Yes, I wonder everybody was kind of bracing for, if not a credit crunch,
definitely some kind of credit slowdown after Silicon Valley Bank and Signature Bank failed.
Was the emergency term lending facility that was introduced and the discount window at the Fed
opened wide? Was that enough to basically prevent that type of contagion from that type of nervousness
among banks to rein in lending? Do you think or is it something else?
So that's a great question and it's really hard to know what the counterfactual would have been.
But then when you start to look into the details, there wasn't, at least in the first week, that
much that went through that new term lending facility, about $12 billion or so. A huge amount
went to the FDIC's bridge banks. There's also a fair amount based on first republics and public
disclosures that went directly there. And so my initial reading, perhaps through some slightly
rose colored glasses, was that the situation based on that borrowing was more idiosyncratic
than systemic. Now, there's still a lot of borrowing from many banks and the amount going
through that term facility has actually edged up a bit over time. It has not fallen. So
we don't want to be complacent. But my initial read was that it was more idiosyncratic than
systemic. And so as a result, yeah, I suspect that the lending was there, took care of some of
the institutions that critically needed others, as we know, or have been resolved or are being
resolved. And so my take really though is that we had a largely idiosyncratic problem against
a backdrop of the whole system facing higher funding costs. But that was very much the intent
of the Fed by raising the federal funds rate 500 basis points. I do think there was mostly an
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You know, the other issue that's coming up with banks a lot these days, Seth, and
admittedly, I'm kind of talking my book here a little bit. I've got a story in our Business Week
magazine about this this week, but it's basically the notion of deposit beta. When the Fed
funds rate goes up to 5%, how quickly do banks jack up their rates that they pay on savings deposits,
demand deposits, especially in reflection to how much the Fed funds rate has gone up.
Because it's a really fascinating, I think, almost a historical whiplash that we've seen. You saw
bank deposits just swell tremendously during the pandemic, something like 20% in 2020, I believe
it was, and then another 10% in 2021. Now they're starting to shrink, albeit not by a ton. I think
it was like a percent and a half last year. But on an aggregate basis, bank deposits are shrinking.
There's more competition, possibly for deposits. A lot of banks are now paying above 4% on their
savings rates, their deposit rates. To me, that creates a lot of questions, I think, about the
financial system. And warning here, I'm about to give you about a 10-part question.
Stand by. But A, does that sort of deposit competition, that worry-ness about stickiness of
deposits, have any effect on the supply credit, do you think? And secondly, does it have any macro
follow-up for the markets themselves? I'm thinking, if I can get 4%, 4.5% on my savings account at a
bank, am I going to be less willing to take risk in the stock market? That sort of thing. So,
I'm curious how you see that whole situation playing out, both from the credit side
and any other potential macro impact it might have.
Absolutely. So, fascinating topic, one that is absolutely critical. So, let me take a step back
and think about it in a historical sense. Every time we have an interest rate cycle,
business cycle, and then the Fed's moving short-term rates up and down, you see an interesting and
fairly familiar pattern when the Fed cuts rates and market rates fall, deposits fall along with them,
and then the Fed starts to raise interest rates and deposits kind of lag. And then over time,
that deposit beta, as you noted, starts to pick up. A big plug to my colleague, Betsy Grace, who
runs equity research at Morgan Stanley for financial institutions. She's been saying,
since the beginning of this hiking cycle, that the deposit beta increase this time would be
more dramatic than it has been in the past cycles, and that's been borne out, as you've said.
I think there are a few things that are a little bit different this time
than previous cycles, at least recent cycles. One is the speed with which the Fed
increased interest rates. We had 475 basis point rate increases this time,
compared to the previous couple of hiking cycles. That's a really big departure in terms of speed,
and banks are having to follow up on it. Historically, though, what do you see? You see the growth rate
of deposits fall, or even an outright decline in deposits, because as market rates start to go up,
and people can invest in treasury bills, deposits start to look a little less attractive,
you see that same pattern. Qualitatively, we're seeing the same thing.
Quantitatively, the speed of the increase was much bigger. The key difference here is that the Fed
has this reverse repo facility, where they take in cash from investors and primarily
money market mutual funds, and they're using that tool to help keep all market interest rates
higher. That tool existed in the last hiking cycle, but that was a much more gradual hiking
cycle. It did not exist in any other previous hiking cycle. When you can see, our investors who
might have otherwise had their cash into posited banks, they now have their cash shifted over to
a money market mutual fund. That money market mutual fund can put that cash at the Fed,
and it's facilitating that very historical pattern of higher interest rates leading to
slower deposit growth or even negative deposit growth. It's helping that process move along,
but it's doing it even more effectively than historically and again, against the backdrop of a
much faster hiking cycle. The first part of the question is, absolutely yes, this shift in deposit
matters. It's part of a normal hiking cycle, but it's just happening much more quickly and perhaps
much more effectively than it has historically. What does it mean for other asset prices?
Again, usually when people talk about portfolio construction, they think about what can you get
on a risk-free asset and then any other risky asset has to outperform in an expected value.
Deposits are paying more this time around, money funds are paying more than before, T-bills
are doing more than paying more than before. My colleagues in interest rate strategy here at
Morgan Stanley had put out a piece as their outlook for 2023 that was called the year of yield.
Cash, once again, is an actual asset class. It's not just where you have your wealth because you
can't make up your mind yet. It's a legitimate asset class because T-bills are paying 5%.
The second part of your question, I'll also answer yes too. I think this is absolutely an
important development. It matters at a macro level, it matters at a financial market level,
but it is ultimately at the end of the day, just part of how monetary policy works.
But boy, the details are a little bit different this time around.
Seth, I'm also wondering if maybe there's a disinflationary aspect to this in that if I'm somebody
who puts a bunch of money in a money market fund, I'd be less inclined to actually go out and then
spend it. I wouldn't have it at the ready if I wanted to buy a brand new TV, for instance.
I think that is possible. I think there's definitely the possibility that easier savings means less
spending. That makes a lot of sense. There's not always a lot of evidence in the empirical
research, and it all comes down to how to household's way spending versus savings.
But one thing that it clearly does is for anybody who is going to be borrowing in order to spend
the cost of funding is just going up. We see this clearly in banks, their cost of funding is going
up, making it harder for them to lend households that might want to borrow in order to buy a new car.
Their cost of borrowing is going up because anyone who's borrowing at this point is going up.
That for me is the traditionally stronger channel for monetary policy, but it could work
through the savings mechanism the way you said it as well.
Seth, you had mentioned those flashbacks to your days in Washington when the debt ceiling first
sort of reared its ugly head and became an issue. I guess we're in the extraordinary measures
phase of the debt ceiling right now. As we get closer and closer to the drop-dead date,
there's this assumption that its brinkmanship, that some deal will be cut at the 11th hour.
But I got to say, politics is way more bare knuckles than I think it's ever been in my life.
And I wonder if that is the wrong way to think about it this time. You think there is a bigger
risk this time of some actual default and some serious financial risks to the whole system because
of that this time? Absolutely. I do think that the risks are bigger this time. And I think there
are a few things that figure into that calculus. At the end of the day, this is a standoff game
theoretic setting between two sides in a negotiation. And that's for me part of how I think about it
as an economist. But the things that are different now relative to say 2011 and 2013. And let's not
forget both of those episodes came basically down to the wire and were a little bit, for me at
least nerve-wracking. But now you've got different leadership in the House of Representatives where
there were lots of rounds of voting to come up with the speakership. And I think that probably
changes a little bit how the calculation goes on that side. I think the other point that's very
different now relative to 2011 or 2013 is that in the public domain, on the Feds public website
are the transcripts of two different conference calls, one in 2013, one in 2011, where the FOMC
discussed what would happen if we got to the point where the Treasury ran out of cash.
And if you read that, you might conclude, I think wrongly from my personal perspective,
but it would be easy to conclude that the Feds got a plan and there's a way to finesse
not defaulting on Treasury securities while avoiding paying on other government obligations.
I'm not sure creating that potentially false sense of comfort is a good thing to get a quick
and easy resolution to these sorts of things. So I do think the water has got more money because
of the political circumstances, because of the extra information in the public domain.
I worry. Maybe it's just because I'm always a congenital worrier, but we really do, in my opinion,
need to see hopefully a timely resolution one way or the other.
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Seth, I also want to take us abroad because you're bullish on China growth and I'm wondering,
first of all, what you're projecting in terms of China's economic growth and then how that
actually is helping hold up global growth numbers, which maybe would be looking a little bit more
anemic without some of the numbers that China's been posting recently. Sure. A great topic. We are
here at Morgan Stanley, very bullish on economic growth for Asia in general and China in particular.
We've written down 5.7% growth for China this year, which is above the official growth target
from Beijing of about 5%. The data that are coming in now in terms of the rebound,
first we got readings on things like Mobility Index is now more the data are coming in.
My take is they're coming in in line with that very bullish outlook for what's going on with China.
And so we are sticking with our view, 5.7% growth for this year, maybe even some risk to the
upside. It will however require that as the year progresses, as spending continues to recover,
that we get more and more people brought back into the labor force, more employment gains,
especially in my young people. But we think that's likely to happen. And in lots of ways,
that's the thesis for our outlook is first reopening coming off of a really weak level.
And then as economic activity continues, it has the standard virtuous cycle, if you will, of
pulling people back to work. Now, the spillover to the rest of the world, though, I think is very
interesting this time. People are used to looking at past cycles where China
accelerated and it helped pull the whole global economy along. This time, well, it's going to be
good, presumably for the rest of Asia, especially the parts of Asia that will benefit from Chinese
tourism. But we've got some research out there that suggests that the normal spillovers from
Chinese economic growth to the rest of the world, if you were to say, okay, this year, close to 3%
point acceleration, can we multiply that 3% point acceleration by the same coefficient we would
normally use in past cycles? And the answer I think is no, it's probably only about half as much.
And that includes the spillovers to commodities. And the reason for that is most of the growth
that we're seeing in China this year is likely to be domestic spending, as opposed to a lot of the
growth being fueled by exports. So that's one difference. And second, a lot of it is going to be skewed
towards services instead of towards physical goods. Now, to be clear, the housing market that
had been imploding is not only stabilized, it's actually starting to recover. So there's,
it's not as though this is a binary 1, 0 kind of outcome. So we are getting a recovery in housing.
We do think part of the fiscal policy stimulus will be through infrastructure. But boy,
relative to historical patterns, a heavy skew towards spending on services. And that just means
you're going to get less of a poll into China from the rest of the world than you would have
in previous cycles. So we are bullish China. We're bullish Asia more generally. We think Asia
outperforms. But we don't think that China is going to end up being the engine of growth for
the global economy. We're looking at weak growth in the US and in Europe this year.
Well, Seth Carpenter, global chief economist at Morgan Stanley, what a absolute pleasure to
pick your brain like that. We really appreciate it. Can't let you go quite yet, though. We do have
a tradition here on what goes up where we have to go over all the craziest things we've seen.
Where we torture our guests. We torture where the torture let the torture commence. Yes.
Yes. All right. I'm going to start for once. I'm going to start.
As I said, Valdana, I think you should buy a royal title from the nation of sea land. Have
you ever heard of sea land? This is great. So this is courtesy of a story in the athletic,
which is actually a sports website. But one of the best stories doesn't sound like it.
How do you ever figure one of the best future stories I've read about the while. It's about
the sovereign nation of sea land, which sits six nautical miles off the coast of Suffolk,
England. And basically what it was in World War II, the Brits built a ocean fort. Basically,
it looks like a big oil platform. It was called H.M. Fort Roughs. And the idea was to have sort of
defenses out in the sea to fight off the German warplanes as they came over. Some guy in 1967,
a ham radio operator of all people named Patty Roy Bates, decided he was going to take over
the fort and make it the sovereign nation of sea land. And he pretty much got away with it.
He's out in the international waters. There's not much Britain can do to get it back from him.
So he and his family have been living there ever since. They have a soccer team, believe it or not.
The whole sovereign nation of sea land is actually half the size of a soccer pitch.
But the fascinating part is you can buy a royal title from sea land, barren, barrenness,
sir, game, count, count us. Can I put it on my resume if I buy it?
You took Duchess, absolutely. You bought and paid for it. So the question is,
the lowest priced title, royal title mind you from the island of sea land is Lord or Lady.
So you could be Lady Vildana Hirek of sea land for a certain price. Now the question is,
what do you think it costs to be Lady Vildana of sea land?
I'm going to buy this. And then the next week's episode, I'm going to introduce myself as Lady
Vildana Hirek. Okay, I'm only bidding a thousand bucks on this.
A thousand bucks. So it's in British pounds. So that would be out of what 900 probably British
pounds. Yeah, 980 or something. Seth, you're now contested on the game show. We like to call
the prices precise. What do you think the going rate for a title of Lady of sea land is?
Sorry, the thousand and one pound.
Thousand ones, you're going on the over, huh? Oh my gosh.
You guys, the King of sea land is going to be reaching out to both of you guys, I think.
Because he's willing to sell one for the low, low price of 24 pounds, 99 pounds.
Oh, shoot.
So you guys are over paying. I was just cursed. I overpaid and I thought I was.
But guess what? I beat Seth Carpenter in this game.
Whoa, whoa. That's huge.
She's never going to let you hear the end of that.
I don't need to be a lady anymore.
The highest price is Dooker Duchess. So for a thousand pounds, you guys could be Duke and Duchess.
Duke Duchess Lady. 499 pounds.
Wow.
99 pence.
That's pretty good. I wish you hadn't gone first because I actually can't compete.
Mine is actually from my sister, who I mentioned last week, has been sending me tons of crazy
things now that she's a fan of the podcast. So again, a shout out to Maralla. And she sent
me this article. It's about Apple having a savings account now. And the interest rate is 4.15%.
It's amazing, right? Yeah. That's made its way to my business week story,
along with their partner with Goldman Sachs. Goldman, yeah.
And it sits on the wallet on your phone, which makes, I don't know if I want my
entire savings sitting in my phone wallet. Yeah, because this subway machine might
steal it from you when you swipe in. Yeah, or something or something.
Because that's how it works, right? What do you think, Seth?
You will not have your entire savings in your Apple wallet on your phone?
I am not precisely because of my fear of what the subway turned above my business.
They're known for stealing money. The good news is you get to ride for free for the rest of your life.
The bad news is you're broke. But it, you know, Seth, it does go to speak to this competition for
deposits really heating up. I think it's, you know, so many of us had sort of written off savings
accounts for so long as just, you know, a piggyback, not really a place to earn a yield. And the times
really have changed. It's pretty fascinating to watch.
It is a huge change now relative to where things have been for a while. But I like to tell some
of the younger folks in the bank that I'm old enough to remember that there were even
recessions when the federal funds rate didn't go down to zero. So it hasn't always been the case
that savings accounts were useless until we're going back to normal as far as I can tell.
Yeah, yeah. Fair point. Fair point.
Well, how about you, Seth? Do you see anything crazy these days?
You remember I'm the global chief economist. So I look around the world and it looks like
every corner of the world had something just a little bit crazy going on. So I don't think I can
narrow it down. Fair enough. It's a crazy world all around. It's a mad, mad, mad, mad world.
Which you don't get that reference. I do. It's a song. Is it a song?
It might be, but it's a movie. A movie. Great movie, by the way.
Well, Seth Carpenter, such a really an honor to talk to you and hear your thoughts about
everything. I hope we can do it again someday soon. Oh my gosh, this was great. Thank you for
having me. I appreciate it. Thank you so much for joining us.
What goes up will be back next week. Until then, you can find us on the Bloomberg terminal,
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podcasts at podcasts. What goes up is produced by Stacey Wong and our head of podcasts is Sage
Boudman. Thanks for listening and we'll see you next week.
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