Jerome Powell And The Fed Are Creating Market Chaos

0:28Hello, everyone. with Joseph Wang.

0:42Before we get into this conversation with Joseph, I need your help. We currently are sitting at just over 39 ,000 subscribers on YouTube. My goal is to get to 1 million subscribers. Hit the subscribe button and let's get into this conversation. Joseph, I thought a great place to start this conversation is the Federal Reserve is obviously one of the most important players in the market. Right now, they seem to be at somewhat of a confusing point. Some of the people at the Fed are very bullish and they seem to think that we should be cutting rates and driving the market. Other people seem to be a little bit more worried.

1:13Maybe it's about the inflation story or they want to be a little bit more cautious. How do you evaluate what is the Fed's position today? You have different people saying different things out in the market. And so how do you sift through all of the different maybe talking points that you're hearing. Oh yeah, it's a really tough place for the Fed to be in. They're basically in very stark disagreement. Now, usually the market has a pretty good idea of what the Fed is going to do. But when you look at what the market is pricing, it's basically a coin flip for whether or not we get a December cut.

1:41Now, I'll give you the arguments of both the doves and the hawks right now. And maybe the audience can help, can make up their own mind. So basically, if you are a Fed policymaker, you're thinking about three things. You're thinking about the trajectory of inflation, the trajectory of unemployment, and you're thinking about just how restrictive policy is right now, right? So the Fed is a dual mandate central bank. It wants full employment and it wants price stability. And the way that it gets there is by adjusting interest rates. So if you look at the unemployment situation, well, we all know that looking at consumer surveys and looking at private data, the unemployment rate is, you know, trending higher and the labor market doesn't seem to be doing well.

2:22A lot of new graduates, a lot of people who lost their job are having a lot of trouble finding work. Now, if you are a hawk, you're looking at this and saying, yeah, sure, we hear all these people complaining about the labor market. We hear about companies firing people. But at the end of the day, the unemployment rate, it's trending higher. It's still about 4.3%. That's historically low. Yeah, we're not really creating any jobs. Maybe we've been creating zero jobs. But part of that is because we have this huge change in demographics. Our population was growing, let's say, 3 million a year, largely due to illegal immigration.

2:59But now that illegal immigration is ended under President Trump, well, we have a decline in the supply of labor. And so that's why jobs growth is slow. So we're going to focus more on the unemployment rate, which remains low. So they're not worried about that. Now, if you're a dove and you're worried about, and you want to cut rates, what you're saying is that, yeah, we do have these changes in demographics such that we have a lower supply of labor, but we also have a big decline in the demand for labor. And the way you tell a difference is price. Now, wages have been decelerating for the past several months.

3:34And when I talked, when these federal officials talk to businesses, they also get a pretty downbeat sense of the job market. And so the labor market, even though the unemployment rate is still quite low, it's moving in the wrong direction. And we got a cut as an insurance cut to get ahead of this, because we all know monetary policy works with a lag. So that's the labor side. And then you move on to the inflation side. So let's be clear now, the Fed's inflation mandate is 2%, and it's been above that for a really long time. If you are a hawk, you'll look at this and say, my gosh, inflation is 3%, we've been above target for many years, we really got to, we can't cut rates.

4:15We got to stay where we are because the people, they might think that maybe the Fed has shifted their inflation target and we want inflation expectations to be under control. Now, if you're a dove and you want to cut rates, what you would say is you're looking at inflation statistics and you're saying part of this is just because of tariffs. Now, inflation is 3 % according to PCE, But if I take out that tariff portion, according to my calculations, it's just 2.5%. And 2.5%, yeah, it's above 2%, but it's not that much above and it's trending lower. So I'm not too worried. I'm more worried about the labor market.

4:52Now, the last thing you look at if you're a Fed policymaker is now we're at 4 % interest rates. How much is that holding the economy back? If it's holding the economy back a lot, you know, maybe I want to adjust that a bit lower so that we're not super restrictive. If I think the interest rate at 4 % does not impact the economy that much, then maybe I don't want to further cut because then I might run the risk of actually stimulating the economy. And if you're a hawk, you'll think that I'm not really at 4%. It doesn't seem to be holding back the economy too much. So there's no reason to cut. And if you're a dove, you think that you look at interest rates and you look at housing, you look at auto loans and you'll say, you know, 4 % interest rates, it's really slowing the economy down.

5:40I want to cut it a little bit to be more balanced so that I could support the labor market, even as putting a little bit of downward pressure on inflation. So that's the debate right now. And what you hear is that the more important people, say Governor Waller, who was a Fed governor, and all the governors like Bowman and Moran, they will be more inclined towards a cut. But if you look into the Fed presidents, many of them who are new and not as important, they'll talk a lot about not cutting. So that's the debate. My guess is that what will happen is that we'll get more data in the coming weeks, and it will be really clear to the market whether or not we'll cut or not.

6:20My bet is that we will get a cut in December. Yeah, to me it seems like we will get the cut, but there's a lot of kind of soap opera between now and then we've got to work through. And maybe the data changes, right, and people will kind of change their mind. One of the things that you're highlighting here is I think that historically over the last four or five years, the Fed kept repeating that they were data dependent. And they just kept saying like, hey, we look at the data, we look at the data, we look at the data. At some point around the end of 24 into beginning of 2025, we then with the tariffs, they almost became less data dependent and more like inflation forecasters.

6:53And that might be too big of a generalization, but it does feel like there was some, you know, kind of leaving of data dependency and more so like, hey, we think these tariffs are going to be inflationary. We need to kind of, you know, hold back a little bit to make sure that we understand that. Is that a fair kind of analysis as to what's happened? Is there a kind of changing the way that they make decisions internally as well? That's a great point you caught on to. So let me give you just a little bit of history. So before the pandemic, the Fed would often sit monetary policy with a forward-looking view.

7:24So they'd have these models that kind of give them an idea of where the data is going. And they kind of have to do this, right? Because when you change interest rates, there's a lag between that change and how it impacts the real economy. So you definitely got to be forward-looking. And then we get into the pandemic. And according to the models at the time, inflation was going to be transitory. So the Fed should not be hiking interest rates. And we had a big discussion about that at the Fed. And that turned out to be not just wrong, but ridiculously wrong, right? Inflation went up a lot and it persisted.

7:55And so they realized that these models, these forward-looking things that they were doing, they weren't working. And so they became a lot more humble. they would switch to data dependency mode, which is that they don't really know what the future will look like. They'll just look at the data and make decisions then. But the problem with that is that if you're just looking at data, you're basically driving while looking at the rearview mirror. So you're not taking into account that monetary policy is going to act with a lag. Now, heading into today, I think what's happening is that you have a divide on the Fed where the more, I think, more hawkish people, they're still in data dependent mode.

8:34They're still driving, looking at the rear view mirror and they're still looking at, hey, you know, inflation is like 3%, we shouldn't do anything. But the more forward people, forward looking people are looking and saying, hey, you know, we got all these big policy changes. For example, because illegal immigration is down, we're going to have less demand for rent, for shelter, right? We're going to have fewer people looking for housing. So rents are going to come down. So that suggests that inflation is probably not going to be a big concern going forward as it was in the past. We got to be forward looking and we should cut interest rates right now.

9:09So there is kind of a divide in how they how they're acting, whether or not to be super data dependent or more forward looking on the Fed right now. Now, is it better for the Fed to all be in agreement and everyone be thinking the same way and kind of, you know, consensus is immediate? Or is it better for there to be like zero consensus, max disagreement, you know, almost contrarian takes and dissent all the time. Which one do we want to optimize for? How do we get better decisions at the Fed? A full agreement or actually this kind of dissent divide that you're describing? Honestly, I think it's better that we get both.

9:43And what I mean is that within closed doors, you want to have a rigorous debate, a ferocious debate. You want people to, so that everyone gets the full amount of perspectives, all the data. And then at the end of the day, after you make a decision, everyone should close ranks and put on the United Fund. I think that's you do in corporations as well right the ceo makes a decision you don't want the vice president or someone to go out public and say that the ceo is an idiot why would we listen to him so but we want to have the big furious debate within uh to have uh to have to arrive at the best uh solution to hear all the perspectives now what's happening now historically speaking the fed is a very consensus-driven organization so my sense is that there usually isn't much of a ferocious debate inside everyone just kind of you know agrees with each other and you end up with a with a decision today though there is definitely a lot more dissent this year we've had two governors dissent and i think in december no matter which way we go we're also going to get more dissents as well so i think that shows one is it's that there there is a good debate happening so that makes it more likely for there to be a good decision but having all that all these descents i think it does confuse the market a little bit.

10:56And it's part of the reason why the market is not sure how to price the path of interest rates. Now, one of the things I've been talking about probably for five or six years is the quality of the economic data that they're looking at. And we should be clear that the Fed usually is not the one collecting the data. They are just analyzing data that whether it's the BLS or somebody else is giving to them. In that data, some of the things that we've had a field day critiquing is this idea of calling homeowners and saying, what do you think you could rent your home for or sending people physically into a grocery store with a tablet and hoping that they find the right product and manually input it correctly.

11:31I do think that people generally are starting to become weary of some of this data, even the CPI metric. I think it's like 40 % of all of the inputs are now being estimated instead of actual data that they have. And so do you think that the Fed also internally is like, hey, we know the data we're getting is as good as we have, but it may not be the best data or may have inaccuracies. How do they deal with that? And do they recognize that there might be some kind of bad data going in could lead to bad decisions coming out? Yeah, for sure. And not right now, due to the government shutdown, we don't even have official data.

12:06So I think he raised a really good point. And what Fed speakers have been saying over the past week is like, we have no official data, but no problem. Why? Because we got all this other data. Now, part of it is private sector data. We have, for example, the ADP and Paychex. Now, these are large payroll processors in the U.S. And so they have a very big sample. So if you have a company, you oftentimes hire one of them to do your payroll processing. So they have a good idea of whether or not we have job growth or not. If you are looking at things like inflation, you also have private sector data like Truflation and so forth.

12:42And also, I think it's worth noting that the Fed is also a very big data collector. So they have reserve banks all throughout the country. And what these reserve banks do is that they go out and they talk to people. They talk to people. They try to figure out, hey, how's your business doing? What are you thinking about prices? What are you thinking about the job market? What are you thinking about demand? And these reports are published in the Beige book, which the Fed also makes public in a summarized fashion. So they do have a wide range of data sources. How much they rely on each, I'm not sure.

13:13I think it's probably going to be up to the individual decision maker. But one thing to keep in mind is a couple of things, actually. So these private data people, they've been with us for some time. I remember after the great financial crises, when we were doing quantitative, the Fed was doing quantitative easing. There was tremendous fear about inflation and you'd have these private data vendors like ShadowSats or so forth try to tell you that inflation is going up a bazillion percent, gold going to the moon. But at the end of the day, that just wasn't true. We had a great recession and pretty low inflation for a decade afterwards.

13:49So we do have to be wary about the quality of data of these private providers. But I think they've improved a lot. and the Fed employs a few hundred PhD economists, which I don't really think economics is that useful in understanding the world, but these guys are very sharp when it comes to statistics. So I think they will do appropriate vetting of the data and appropriate weighing, not just relying on one source to arrive at a decision. So I'd say the data quality, because of it, so much of it is available now. I think it's getting better and it's improving their decision-making. You know, what's interesting to me is we talk all the time about something like a truflation, right?

14:27Kind of real-time alternative metrics. And it now feels like you're getting positive and negative inputs to using the internet, right? So I'll give you two examples. Truflation can go and say, hey, there's all these prices that are out there. We don't have to call a homeowner and say, well, could you rent your home for? We can just simply go poll and see what our home's actually renting for. And then we can use that input. Great. The Michigan sentiment survey, the consumer sentiment survey, Tom Lee recently showed that because they have moved online, along with probably unintentional, but it is happening, a slide to surveying more Democrats versus Republicans about 65-35 now, you now are starting to see sentiment actually show up worse than if you were to survey just 50-50, inflation expectations, all these things start to skew based on a political line.

15:15And so I do think that there's this very interesting thing where they perfected the surveying or the calculation and methodology for a certain type of data set. But now as they move online, you know, careful what we wish for, right? Because they kind of have to go and they need a couple of years probably to perfect it. And so, you know, we can hope that it's good right out of the gate, but the truth is it will get better over time. And so some of these anomalies in the data are important to understand, even as they move towards more real time or more online surveys, right? Totally agree with that.

15:44A lot of that stuff online is, you know, you got to clean it, You got to be careful. And like you suggested, you could have bias in sampling. So it's really careful to check those, how that's collected. So you got to be trained in this. And so I think it's something that I hope that the Fed and PhD economists are able to do well. But yeah, it is definitely dangerous that it can be misleading. So it has to be handled carefully. Let's talk about kind of from an investment standpoint. So you've got a very good understanding of the Fed and I think kind of how they operate, how they make decisions, what data they're using.

16:15Where are you excited about in kind of the macro world of you could invest in pretty much anything. You can invest in, you know, public equities, bonds, precious metals, real estate, anything that you want. Where are you putting money in the portfolio? What are you excited about right now? Yeah, I think the big macro trend of our age is just this fiscal deficit. It's not just in the U.S. It's in all countries. And it's basically unstoppable because the way that our governments are set up, we're democratically elected, right? And nobody wants to have pain. the pain tolerance is basically zero. It's been degrading over time.

16:49And so from my understanding of the financial system, the way you want to look at fiscal deficits, it's basically money printing. So what is that? Why do I say that? So let's say that I gave you a billion dollars in treasury securities. Now that's a billion dollars asset, right? You can't go and take that and say buy pizza at your local Papa John's or anything like that. But you can take that billion dollar treasury, You can sell it easily because it's a liquid market and there's no credit risk and you can get bank deposits in exchange for that and spend it. And so when you are issuing treasuries, you are basically printing money.

17:27Treasuries, not just treasuries, but any sovereign debt is just money that pays interest. And that's happening at a tremendous, tremendous rate. and if that is the trend for the developed world, then I would think that assets like gold are going to continue to shine and my observation is that people are usually under allocated to gold. It's kind of a new thing but it's been doing very well this year and if you have this big trend of just massive, massive fiscal deficits, that's what's going to shine in the coming years and on top of that, of course, you also have these geopolitical risks whereas you have a potential bifurcation of the world and people who are not part of the western bloc they might want to hedge their dollar exposure and we see for example many many entities in china continuing to accumulate gold so this is i think this is going to be the big secular bull market in the coming years now when you see you know countries like china or maybe other countries outside the united states that are buying gold is the thought process that they're just going to use it as some sort of central bank reserve?

18:32Do you think that they'll try to like peg their currency back or back it by gold and return to a gold standard? Like what is kind of their end game with buying the gold today? Is it just get away from the dollar? How do you think about that? And maybe the impact on gold's price? So I think about it this way. So let's say that you're China, you have a literally a trillion dollar trade surplus every year. What does that mean? Every year you're selling a bunch of goods and services and you're making a trillion dollars. So you have all this trillion dollar cash. Now that sounds like a good problem to have, except that where are you going to place it?

19:03Nobody can handle it. You can't put it in the bank, right? Then you have huge bank credit risk. You used to buy treasuries, but then, you know, maybe one day the United States is not your friend anymore and they maybe they just freeze your assets. We saw that happen with Russia. You can go and you can lend it to countries in Africa, to other Eastern Europe and so forth. And there's a limit where you can do that. And at the end of the day, these countries might not pay you back. So one of the common ways that you could put this trillion dollar trade surplus is to buy gold. And after all, it's something that has historically, through a very long period of time, been considered an asset, at least, if not a store of wealth.

19:46And so I don't think it's going to be used to, say, have a gold-backed currency. Having a gold-backed currency has pluses and minuses. From the government's perspective, though, it's all negative because then you lose power. If you have a fiat-based currency, the government can basically just print and spend as much as it likes. once you tie your currency to gold, you have a real world anchor that limits your power, limits how much you can just print and spend. And I don't think anyone, any government wants to do that. It might be good for the public because it constrains the government and maybe has less inflationary impact going forward.

20:28But for the government, who of course makes this decision, I don't think they want to give up their power. So at the moment, I think of it as solving a big asset management problem that countries, China and countries like China have. That is to say, you're making a lot of money. A lot of it is dominated in dollars. You want to have a little bit of a – you want to have a place to put it and a hedge against geopolitical risk. Let's talk about artificial intelligence. To me, it's really interesting. Like there's the AI trade in public equities that has obviously brought immense amount of capital into the market.

21:02It's been a huge driver of not only the indexes, but many single name stocks. There's been some cracks in the AI narrative, I think, over the last week or two. And people are now questioning like, hey, where's the money going to come from? What are the physical limitations to building this stuff out? How many of these companies can continue to grow at the rate that they're growing? So AI, in a way, has been a big driver, but now maybe introducing questions in public equities. At the same time, AI has also been a huge driver of questions in the labor market. So people see the jobs, you know, number going down like, oh, artificial intelligence is replacing these people.

21:34That's why the labor market is weakening. How do you evaluate AI? How do you kind of stay on top of maybe where it's creating opportunities, but also where it is creating, you know, kind of obstacles for either the Fed or for a portfolio? So I think that AI is definitely in a bit of a bubble. So you have tremendous interest in it. And I think it is a revolutionary technology. But I'm not sure it'll actually make all these tech companies a lot of money. Because at the end of the day, it looks like it's going to be a commodity, right? You have all these AI models. They perform similarly. And in addition to that, you also have these open source models from China, which continue to improve.

22:13So it's hard to see how this commoditized product can be profitable. And on top of that, it takes a lot of money, a lot of capex to have these data centers. So I think this was always from a fundamental perspective, quite a weak narrative. But, you know, that doesn't always stop the market. Recently, what it seems to be the market seems to be concerned about is, well, you have some AI companies seeing their credit spreads blow out. So that's the bond market being a little bit concerned about the profitability of these AI companies. And you also had, of course, Michael Burry, a very famous investor, questioning the profitability of this.

22:50So I think that's impact sentiment. I'm not sure it's the end of the AI bubble. There's a lot of momentum behind this. You have the Fed probably cutting rates. And these things probably, my best guess, it's probably just a pullback at the moment. Now, I think this has unlocked tremendous opportunity, not so much for the AI companies, but for basically everyone else in office work type jobs. Like, for example, if you are, let's say, in media, you could have AI maybe help you do editing. If you are an analyst like what I do, AI has been tremendously helpful in organizing data, scraping websites and so forth.

23:27So there's definitely a lot of opportunity for people, I think for knowledge workers to be able to become even more productive. And I think it's going to create a lot of businesses that can take advantage of the tools that they develop. It's going to have a big impact on the labor market for sure. Are there jobs that are going to be replaced? Absolutely. But that's the same with every technology change, right? We used to have all these people basically, for example, typing. Now, we don't do that. We have printers. We have computers. We used to have people who made shoes for horses. We don't do that anymore.

24:03We have auto mechanics instead. So it's going to be a time of turmoil for some people, for knowledge workers. I think it's actually going to be better because they can take advantage of it. And it's going to be good for manual workers as well. But I think the middle layer, people who are not maybe super knowledge workers, but maybe just maybe more back office stuff, I think that's going to be a problem. And they're probably going to have to find new jobs. Yeah, I mean, look, it's pretty interesting how it seems like AI is driving efficiency, it's driving productivity, it's driving profits. And so in a weird way, the worse the labor market gets, at least the generalized narrative is the more profitable the companies become, which means the more value that they are driving, which kind of drives that K-shaped economy.

24:50So it's very, very weird time, I think, in financial markets as we navigate this. Absolutely. And it's very exciting, too. So I actually, I like this. I would be bored if every day was like the day before. I agree. Joseph, where can we send people to find you on the internet or find some of the work that you're writing and putting out there? Sure. So if you guys are interested, I can be found on YouTube. I have a channel called Joseph Wayne. I'm on Twitter, FedGuy12. And if you're interested in my work, I have a bestselling book here on central banking. It's in its category on amazon.com. Amazing.