Apollo Chief Economist Torsten Slok Talks Energy Shock, Inflation

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We're pleased to welcome Torson Slock, he is chief economist at Apollo for this macro conversation.

And Torson, you heard what Mike was saying about inflation expectations,

and we see that in some measures.

What are you thinking about inflation expectations?

Because there's market-based measures, there's also survey-based measures.

It's not really time to worry until everything points in the same direction, right?

Well, the key issue is that, of course, head-line inflation is showing signs of higher inflation.

That makes total sense because head-line inflation also consists of food and, of course, importantly energy.

Core inflation expectations, we don't quite know yet what they are doing.

But what we do know is that when you look at various other sentiment indicators,

including today we've got consumer confidence, also starting to go down.

If you look at the daily indicators for consumer sentiment from morning consult,

it's also going down for low-income, middle-income, and high-income households.

But the key issue at this point is that if you look at the actual spending,

the daily data for how many people travel on airplanes are still good,

the weekly data for Red Book, same-store retail sales,

meaning what was sales in stores last week, relatively to the same week a year ago,

is actually also still very strong.

And what you're also seeing even hotel demand on a weekly basis from star,

is also very strong, both red pie strong, the daily ready strong, the occupancy ready strong.

So there's a very different divergence between what a consumer's saying,

relative to what are they actually doing.

So at this point, the duration of the shock has simply not been long enough

to actually create that demand destruction that we all worry so much about.

Right, and in fact, if you look at longer term inflation expectations,

and you see that within University of Michigan sentiment survey today,

those are well anchored.

Absolutely, so both on a market basis and a survey basis,

long term inflation expectations are very, very stable

and have not shown any signs of going up.

In fact, some of them have actually started to go down.

So exactly the fit would mainly worry about our markets getting worried about inflation becoming out of control.

Maybe yes, in the next year, we can call that transitory temporary,

whatever we want to call it, but it's very clear the market is saying,

this is absolutely something that's only here for a very limited time.

And then we will go back and have inflation expectations at the longer run,

more stable level.

Now, the one difference here between the Wall Street folks and Fed folks is perhaps

the inflation indicators they're looking at.

CPI has been going down, and it'll obviously on a headline basis go up.

A PCE, even without oil, has been rising.

And that's the index that they follow.

When you listen to Fed folks, they're not talking about rate increases yet.

But have they pretty much wiped out the idea of any rate cuts this year

because the Bloomberg survey today showed economists think we're going to see a rise in inflation

but we're still going to see two cuts before the end of the year.

Absolutely, and it was also very interesting the ECFC Gold Bloomberg survey

was that the probability of recession actually went up from 25% to 30%.

So we're almost looking at more bifurcated distribution

where either you worry a lot about inflation being higher,

and potentially above three now for a very extended period,

meaning at least the next several quarters.

Alternatively, people are beginning to worry about that.

Maybe there is a harder landing that is also potentially an outcome.

So that distribution tells you exactly what the problem is for the Fed,

namely they worry on the one hand about inflation being high,

but they also worry about the labor market begins to deteriorate,

including of course also if AI puts up a pressure on unemployment

and all those factors are of course the challenges for the Fed,

namely how much should they put up weight on inflation,

relative to how much weight should they put on the risk of the labor market,

might begin to deteriorate over the next several months.

Well, let's stay with the labor market

because the JavaScript claims numbers that we got this week ticked up slightly

but remain pretty much near historically low levels.

Is the low higher low-fire market still intact and at this point

not an immediate source of concern?

Absolutely, I think it was low higher low-fire

because of the trade war for most of last year,

and now I think it's low higher low-fire because of the energy shock.

So that's why companies are responding in probably the most rational way

by saying we don't really know exactly how long time the shock will last.

We don't know what all the prices will go to.

So for that reason, it makes sense that the labor market continues to show this

fairly cautious overall properties,

especially as you mentioned,

that jobless claims continue to be relatively low.

What will we need to see in the jobs data,

whether it's high-frequency data or the monthly reports to signal

some kind of Fed relief is on the way?

Well, the key issue, of course, is next Friday,

and particularly for fixed income more broadly,

that is the most important number across the board,

both for rates and for credit, namely,

is the economy still producing jobs?

Or as we saw last month, are we still losing jobs

the way that we did with the 92,000 decline that we saw in the previous months?

And the key issue, therefore, becomes the labor market data

is just taking a very, very prominent, more important role than usual

because inflation is telling us to hike,

but now we certainly have that the other side of the dual mandate,

namely the labor market, might begin to show some more cooling,

especially now that immigration restrictions and the labor supply

is also weighing down on the overall outlook for non-found payroll.

So that's why next week is becoming very critical for thinking about

what is the Fed going to do because so far it's been easy for them in the ACP

this week to just say, oh, we rise up inflation

and they also revised up GDP,

but if the legal market begins to show softness,

then that would, of course, become more challenging for them.

I have to ask you, when I was studying economics,

they taught us a couple of rules.

One was, it's never different this time.

And another was, you can make a point forecast or a time forecast,

but never this two at the same time.

But in your chart this week,

and this has gotten a lot of play in social media,

you say we're going to have a very short term disturbance in the bond market

and 50 years of security in the Middle East that will keep down oil prices.

That's quite a time forecast.

That's true.

But I think the logic really here for investors is quite simple.

We should all be stepping back and looking at this with a much more long term perspective.

Let's agree that the situation we have today, it's not sustainable.

We cannot have this, we can discuss for a long time,

but we cannot have this for several years, definitely not,

and we cannot perhaps even have it for several months.

And if that's the case, we should expect to have some resolution.

It makes sense that it's complicated for everyone to figure out

what is the military strategy, what's going to response on both sides.

But the conclusion must be that from a market perspective,

we get closer to the midterm election in eight months from that perspective.

There's probably also some political considerations both in Iran and in the US

that comes to the conclusion.

50 years.

But I do think that at the end of this, we will probably have a situation

that is quite different in the sense that we will probably have,

at least from the GCC side in the Middle East,

probably more connection with the US, probably more connection with Europe,

and therefore probably also more stability, more broadly relative to where we were just a few months ago.

We have to get through the fog of the current next few months in order to get to that point.

You did bring along a chart with you this time that shows that there's a lot of supply

going to market investment-grade supply.

It combined $14 trillion worth of supply.

How did you get to $14 trillion?

Yes, so the chart you look at here, it shows shoes from the Treasury.

They put out data for what is the total amount of US Treasury debt

that needs to be refinanced in the next 12 months.

And as you can see in the yellow line, it is about $10 trillion that needs to be refinanced.

In other words, US government debt that rolls over.

So this is bills, this is coupons, this is across the whole curve.

If you now add to that, two other things.

On top of that line, we also have two trillion in government budget deficit.

So that brings us to 12 trillion.

And finally, we also have about two trillion in net gross issuance

from the hyperscalers and the banks in IG.

So that means that the total supply of investment-grade bonds that are coming to the market

is about 12 trillion from the government and two trillion from corporates.

That brings you to a number that is roughly given US GDP is 30 trillion.

Roughly 50% of GDP that needs to be absorbed by financial markets.

That's a very, very, the highest number we've seen in history.

That's a very substantial amount of bonds of investment-grade credit

and investment-grade bonds that are coming to the market.

So the short answer is, if we already were about inflation going up

because of Mike's chart with inflation expectations going up,

we have tariffs, putting up with pressure,

all the prices putting up with pressure.

We have a fairly strong economy also putting up with pressure.

And now we also have significant supply coming to the market.

That does bring the risk that there is some upside pressure on rates

within the front and the long end.

And there's also on top of that because of the significant increase in IG debt

also upward pressure on credit spreads.

That means that both spreads and credit are under upward pressure

for these technical reasons.

And also the level of yields in rates is also under upward pressure

because of this supply being so significant.

So very quickly, how are you thinking about the demand dynamics then?

Because we already know what the supply is going to be.

There's going to be a ton of it.

Well, that's why a lot of the people who spoke just before we started here discussing

are exactly saying that this is actually an interesting time to look at the level of yields,

especially if there is now an environment where all the prices might eventually come down.

And especially if people begin to worry about that the economy might also begin to slow up it down.

If that's the case, you both have a level of base rates that's higher temporarily at the moment.

But you also have spreads in credit that's also temporarily higher.

And that's just given all in yields in credit.

Both in investment grade but also some parts of high yield that actually looks quite juicy.

Software has its own problems.

Sure.

But the rest of the high yield market is actually generally also looking at yield levels

that are at more interesting levels at the moment.

All right, Torson Slack.

Thank you as always for coming in.

Torson Slack of Apollo that Chief Economist at the firm.

The thing about AI for business, it may not automatically fit the way your business works.

At IBM, we've seen this firsthand.

But by embedding AI across HR, IT, and procurement processes,

we've reduced cost by millions, slash repetitive tasks, and freed thousands of hours for strategic work.

Now we're helping companies get smarter by putting AI where it actually pays off.

Deep in the work that moves the business.

Let's create smart to business.

IBM.

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