Robert David Kaplan: The fourth quarter is going to be weak

CNBC Exclusive: CNBC Transcript: Dallas Fed President Robert David Kaplan Speaks with CNBC’s Steve Liesman Today

Robert David Kaplan

Image source: CNBC Video Screenshot

WHEN: Today, Tuesday, November 26, 2019

WHERE: CNBC’s “Squawk Box

The following is the unofficial transcript of a CNBC EXCLUSIVE interview with Dallas Fed President Robert David Kaplan and CNBC’s Steve Liesman on CNBC’s “Squawk Box” (M-F 6AM – 9AM) today, Tuesday, November 26th. The following is a link to video of the interview on CNBC.com:

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STEVE LIESMAN: Good morning, Andrew. I am here in the Englewood Cliffs headquarters studios with Robert David Kaplan, the President of the Dallas Federal Reserve Bank. Mr. Kaplan— President Kaplan, let’s start off with the outlook for growth.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: And I want to talk about short-term and a sort of longer-term.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: Our CNBC Rapid Update running at 1.5% for the fourth quarter. That’s the median of tracking forecast. Does this seem like the low to you in the growth slowdown? Is it up from here?

ROBERT DAVID KAPLAN: Yeah. We think fourth quarter is going to be weak—we at the Dallas Fed. And we think we have a good chance to grow at 2% next year. One of the reasons the fourth quarter is going to be weak, we believe, is probably a significant inventory adjustment, which might be as much as half a percent or more of GDP growth. That happens.

STEVE LIESMAN: Where does that come from, that inventory adjustment? Why does—

ROBERT DAVID KAPLAN: Just means people have been destocking. And probably the reason they were destocking is there was a lot of pessimism over the last number of months about, you know, future growth prospects. So, businesses destocked. We’ll see that show up in the fourth quarter. But we think things will stabilize. We’ve got a good chance to grow at 2% next year.

STEVE LIESMAN: So, let’s go to the long-term part of it. Is 2% the runway? We can’t get out of it. And we can’t – we’re not going to go below it. We can’t get above it. A lot of folks wanted us to grow. Everybody wants us go—

ROBERT DAVID KAPLAN: I’d like to grow more. Here’s the issue: we’ve got some structural issues that are not going away. Aging demographics, aging workforce which means slowing workforce growth. And our productivity has been sluggish. Mainly, we think at the Dallas Fed because of lack of investment in skills training and education and also, this sluggish CapEx that we’re seeing, probably due primarily to de-globalization is reducing productivity. And so, GDP growth is made up of growth in the workforce and growth in productivity. So, we think at the Dallas Fed potential GDP growth in the United Statesis 1.75% to 2%. But, it gets worse if we don’t make policy changes. We think over the next five to ten years, it will slowly decline.

STEVE LIESMAN: Even less than that?

ROBERT DAVID KAPLAN: It will. Yes.

STEVE LIESMAN: What if we were to, for example, to stop this de-globalization which I think is a euphemism for the trade war—

ROBERT DAVID KAPLAN: It’s a—

STEVE LIESMAN: Or maybe the trade war is a euphemism for de-globalization. Anyway—

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: Isn’t that somehow subtracting from growth right now?

ROBERT DAVID KAPLAN: Yeah. I think weak manufacturing, weak global growth, weak business investment all relate to uncertainty regarding trade. And if that got stabilized, I think we’d have a chance to see those measures improve.

STEVE LIESMAN: How fast could the economy grow if we put the trade war behind us?

ROBERT DAVID KAPLAN: I’m still of the view and we’re of the view potential in the U.S. is around 2%. And for people who are disappointed in that, I’m disappointed in that. And we should be because we’re very highly leveraged as a country, particularly at the government level, but if you want to grow faster, we need policies away from monetary policy. Monetary policy is not going to address this. If you need -- you need infrastructure spending, you need immigration reform, you need policies that improve education, skills training.

STEVE LIESMAN: Let’s talk about monetary policy. Is the mid cycle adjustment over?

ROBERT DAVID KAPLAN: For me, yes. It is for the time being. I think policy is in the right place right now.

STEVE LIESMAN: And how do you come to that conclusion?

ROBERT DAVID KAPLAN: It was my view back in June that we needed some adjustment. And one of the tells of that for me was the shape of the yield curve. And a lot of people say, ‘The yield curve doesn’t mean what it used to.’ I don’t actually agree with that. I think when you have the Fed funds rate above every rate along the curve, it was a signal to me it has to be adjusted. We now have a more normally shaped yield curve. And that, to me, is reinforcing the fact that I think 1.5 to 1.75% on the fed funds rate is about right. And I’d need to see some material change in the outlook to cause me to want to adjust that rate.

STEVE LIESMAN: Let’s talk about the risks. The Fed was raising rates in 2018.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: And then it cut them.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: Sort of two steps forward, one step backward or one step forward two steps backward.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: In any event, is it okay to run the economy at a funds rate of 1.5 to 1.75? Are there risks that are being created, for example, in debt?

ROBERT DAVID KAPLAN: Well, yeah. When we run rates that are historically low, yeah, you tend to create excesses in balances. And that’s a nice way of saying financial market -- stock market PEs get higher, cap rates on real estate get lower. You worry about consumers leveraging up and buying more goods and services with leverage. And so, I’m watching all of that. But on the other hand, we have to accept if potential growth is 1.75 to 2, Fed fund’s rate is going to be historically lower than we’re accustomed. And we’re seeing along the -- look at the 10-year treasury. Over the last year it went from 3.25 to 1.75. I think the markets are telling us that if prospects for growth are this sluggish, you’re just going to have lower rates than we’ve had historically.

STEVE LIESMAN: So, this is one of the cool things about "Squawk Box.” We’ve got Leader Cantor on the desk at the Nasdaq. He’s going to ask President Kaplan a question. Go for it, Eric.

ERIC CANTOR: President, it’s good to see you—

ROBERT DAVID KAPLAN: Good to see you, too, Eric.

ERIC CANTOR: --this morning. You know, there’s been a lot of coverage lately on the increasing indebtedness on the part of corporate America.

ROBERT DAVID KAPLAN: Yeah.

ERIC CANTOR: There’s been some scrutiny on the CLO markets. And just wanted to understand what you think systemically that that poses, whether there is some risk. I mean, there’s folks out there who have a analogized to ’08 and our MBS market. And how do you think all of that fits into what you’ve been talking about in a slow growth environment and the potential for rates to either go up, or what happens if they do with all of this indebtedness?

ROBERT DAVID KAPLAN: So, to your point, we’ve got a record level of corporate debt. And to be specific, triple-B debt has tripled over the last few years. Leveraged loans, as well as double-D and single-d debt has grown dramatically. It’s not like ’08-’09 because the problem with ’08, ’09, is the lenders were overleveraged.

Right now, we have an issue where the borrowers are highly leveraged. And my concern is if you have a downturn, where we grow more slowly, it means that this amount of debt could be an amplifier. And what I mean by amplifier, a higher percentage of cash flows are being spent on servicing debt. I don’t think the CLO market will be the place the problem occurs because I think the CLO structure -- for your viewers, that was the traunching of bank loans.

That actually fared pretty well in ’08 and ’09. And I’ve taken a hard look at it. I think it will fare reasonably well in the future. The thing I am worried about is if you get two or three triple-B downgrades to double-B or single-B. That could lead to a rapid widening in credit spreads, which could then lead to a rapid tightening in financial conditions. We’re more vulnerable to that now with this amount of corporate debt.

STEVE LIESMAN: We need to just provide the background. You spent a little bit of time at Goldman Sachs, so, this sort of area is not something you’re unfamiliar with.

ROBERT DAVID KAPLAN: Right. 23 years. Yeah.

STEVE LIESMAN: Let me go to this issue here of worker shortages. And you have a sort of different idea about the capital spending decline, and you’ve heard from some of your folks in the Dallas district.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: Which is not a small district.

ROBERT DAVID KAPLAN: Yeah.

STEVE LIESMAN: That one reason companies aren’t investing is because they can’t find the workers for it.

ROBERT DAVID KAPLAN: So, it’s probably the secondary reason. So, the first reason I hear not only in Texas but nationwide is uncertainty -- policy uncertainty generally. It’s not just the trade dispute with China. It’s trade uncertainties globally. The threat against Mexico that happened 2 1/2 months ago, even though it didn’t occur.

Logistics in supply chain arrangements. Auto tariffs being threatened against Europe. It creates enough uncertainty that most businesses have said, ‘We’re just going to put CapEx on hold.’ Now, the second reason, which you mentioned, I hear from people, is that they can’t find workers, they can’t find engineers, they can’t find service oriented workers.

And, when I ask them, ‘What are you doing about it?’ They’re saying, ‘We’re just delaying CapEx. We’re slowing CapEx. We’re not sure if we can staff some of these projects.’ So, I think it’s a secondary reason. But, I think it’s worth noting we are very tight in the labor force. We’re getting underrepresented groups in. I hope that continues. But we should recognize, we’ve got a historically tight labor force.

STEVE LIESMAN: Robert David Kaplan, Dallas Fed Chairman. Thank you for joining us this morning.

ROBERT DAVID KAPLAN: Good to talk to you, Steve.



About the Author

Jacob Wolinsky
Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Prior to ValueWalk, Jacob was VP of Business Development at SumZero. Prior to SumZero, Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver