Lots More: Did the Fed Just Make a Policy Mistake?

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1:17Bloomberg Audio Studios, podcasts, radio, news. Hi, Tracy, how are you? It's so nice to see you. Yeah, it's mutual. Thank you so much for doing Yeah. Looking forward to sharing. You're getting worse. I'm getting worse. Yeah, than the last three months. Victor is referring to my beard. Yes. And the rest of the dimming. And all of it. And all of it. I'm letting myself go. No, no, no. But you obviously must be very relaxed. I'm not shaving until the fence starts cutting red. Okay, that's coming. Yeah. So that's good. I did a deadlift. One, two, three. Egemonie. Egemonie. Okay, go. What to? Congemony.

2:00Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best squid ink pasta? These are the important questions. Is it robots taking over the world? No, I think that, like, in a couple of years, the AI will do a really good job of making the Odd Lots podcast. And people will say, I don't really need to listen to Joe and Tracy anymore. We do have... Cha-ching. The perfect guest. You're listening to Lots More, where we catch up with friends about what's going on right now.

2:33Because even when the odd lots is over, there's always lots more. And we really do have the perfect guest.

2:41It is kind of crazy. So the market is pricing in, what is it, a little over 70 basis points of cuts right now, which means like the Fed would need to cut every meeting through the end of this year, assuming it doesn't do a 50 basis point cut, which seems a little extreme. Yeah, I think it does. But remember, Federal Reserve has no visibility. They have no trust in their models. That is why they're so data dependent. So when people say, well, we can rule out 50 bips, why could you rule out? If you think of the governors, so the former governors, Only two, three months ago, they were higher for longer.

3:20Suddenly, they've changed their mind. It's no longer higher for longer. So that's sort of volatility, almost inevitable outcome of highly volatile neutral rates. So prima facie, if you just look at it, 70 bps looks high. But on the other hand, I don't think you can necessarily rule it out. And if you start looking slightly longer term, let's say look at December 2025, January 2026, the market is still looking at somewhere around four as a policy rates. Now, four of the policy rates to me is too high. I think the number should be somewhere closer to three and a half, maybe even less than that. So to answer your question, it looks like it's high, but Fed has no confidence in their methodology, in their models, or a visibility of what happens, and therefore it is possible that you might end up with that.

4:11So we are speaking with Victor Schwetz, McCrory strategist and one of our repeat odd lots guests. It is, of course, the week that we have just seen a meeting from the Federal Reserve where they opted to hold rates as expected. But they definitely telegraphed that that rate cut was coming, Joe. You know, when I so I didn't watch the press conference because I was on a train and I had an appointment. I had to take the day off of work. But it was nice because then I read the transcript this morning without the distraction of Twitter and all the commentary, and I hadn't read any of the various commentary from the strategist.

4:46But when I read the transcript, I thought of our last conversation with Victor specifically because it was so clear. To your point, they just want to see more numbers. The models that suggest, okay, unemployment is rising and the Fed is restrictive and therefore inflation should come down, etc. All of these theoretical ideas, I don't get the impression they have any confidence. They just want to see more numbers. That's it. That's absolutely right. And there is a reason for that. And the reason is that we live in a world of abundance. We have too much of everything. We have too much of capital.

5:21We have too much of most of the products. Technology keeps reducing marginal costs. there was a perception for a period of time that certain areas are in deficit or constrained, such as some of the metals or labor. But even that is proving to be not true. So if you live in a world of abundance rather than scarcity, economic models do not work because all economic models and investment model are predicated on constrained outcomes, that you're choosing the best possible outcome out of variety. If there is abundance, prices don't work, Prices don't signal the same impact. Neither do they have the same impact on underlying economy.

6:01Wait, so Powell is definitely, I feel like he's aware of the criticism that the Fed is maybe too data dependent at this point. And in fact, in the press conference, he was kind of at pains to emphasize that they're not data dependent. Or sorry, what was it? Data dependency doesn't mean data point dependency. Which is kind of funny, especially since we're recording this on Thursday and we have had some very interesting single data points, including initial jobless claims rising to the highest level in nearly a year. But what does it mean to be data dependent, but not data point dependent? It means I have no clue.

6:41And essentially what it says is that, look, I don't know what I'm going to do because I don't understand why financial conditions are not tightening more than they should have. I don't understand why unemployment is where it is. Yes, employment cost numbers, for example, yesterday have come out. 0.9 % was really the lowest for about three or almost four years. So there is no evidence there is a wage spiral. If you think of goods inflation, it's continued to disinflate. Service inflation is coming back. Even idiosyncratic numbers like imaginary owner-occupied rent or differences between insurance policies in the market and what CPI numbers have or used car prices.

7:25All of those idiosyncrasies are also going away. So you could argue a legitimate question, what are you waiting for? And the answer is they don't want to be Arthur Burns. They don't want to be in a position that they're revisiting sort of 1970s all over again. And so he's basically saying anything is possible, anything is probable, and I cannot guide you in any meaningful way forward. The only thing I can say is that it looks like we're going to cut. Beyond that, we're either data dependent or data point dependent, or maybe we're not data point dependent, but we're certainly not forward looking the way we should be.

8:03So Tracy mentioned this recording this August 1st. There's a non-farm payrolls report that'll come out tomorrow, probably by the time people listen to this. But I just want to talk about some of the data that we've seen. Tracy mentioned it. Initial jobless claims around the highest in the year. The ISM manufacturing number came in well below expectations. The employment sub-index of ISM outside of the COVID period. This is the worst since 2009, which Bloomberg's Cameron Christ pointed out. ADP, I don't know if anyone actually pays that close attention to it. It came in lower than expectations.

8:41Today, we've got unit labor costs. They're expected to grow 1.7%. They only grew 0.9%. I guess the question is, okay, is there a risk of a policy mistake? Could things be slowing down more rapidly than the Fed things, and even with the concerns that they have that actually this is the moment and maybe things are going to get rolling. There is. There is a possibility of that. And you can also add to that quit rates. Quit rates basically return to normality. So everything is pointing to the fact that labor market is getting noticed tight. Everything points to the direction of less robust wage increases coming through.

9:18There is no wage spiral. Now, could you commit a policy error? Of course you could. But one of the things I keep highlighting, policy errors are important when you've got scarcity. If you have abundance, you can reverse that policy error in 30 seconds. In fact, even less than 30 seconds. One word potentially could reverse almost the entire impact of your policy error. So one of the things I've been highlighting is that there is a strong possibility of committing policy error if you're backward looking rather than if you're forward looking. But the fact that we have too much capital, the fact that we're repricing things in a split second, the fact that central banks have unlimited toolkit that is growing on a daily basis, even if you commit a policy error, you probably cannot perpetuate it.

10:06So in other words, you will be able to reverse it quite quickly, in my view. I saw an interesting thing from Nick Colas over at DataTrek this morning where he was talking about or asking if labor market normalization, which is how Powell couched it on Wednesday, whether or not normalization is the new transitory in the sense that they might be focusing on that and the market starts to focus on it too. And then it turns out that, well, it's not really normalizing. It's in a downturn and the Fed is making a mistake. But just on the idea of abundance, I mean, you say repricing can happen very quickly, but going back to the transitory idea.

10:45That's not what we saw when we saw prices begin to go up. That's because essentially what you had at the time is Federal Reserve insisting on transitory when it wasn't transitory. So in other words, if Federal Reserve wants to commit a policy error, they can. If they insist on perpetuating policy error, they can do that too. If they want to put the economy into recession, they're capable of doing it. My point is none of it is necessary because even if you commit a policy error and you quickly realize you have, you can unwind it incredibly fast. Whereas if you look at Paul Walker, if you look at Greenspan, they had nowhere near the same capability of achieving that outcome.

11:27So there is a risk of an error. There is a risk of a recession. But your view is that the rate tool is powerful enough such that even if we were to go into a downturn, that that one lever for what various reasons is powerful enough to reverse it fairly quickly? Well, not so much raids, but rather communication strategy. So the essence of Federal Reserve or any central bank these days is really communication strategy coupled with macro and micro prudential controls and coupled with specific policies designed to tailor circumstances that beyond your control that suddenly arises, whether it's Silicon Valley Bank or something else.

12:10That's the essence, not so much rates. Because in a world of abundance, price doesn't work as well because there is no scarcity. So all Federal Reserve needs to do is to change communication strategy, to change some of the liquidity positions, and that could be enough. Now, ultimately, if you start looking really longer term, there is no doubt that rates at some point in time do work. And that's what I'm saying, that if Federal Reserve wants to commit a policy error, wants to perpetuate policy error, and place a U.S. economy or any other economy into recession, they're capable of doing it. Just there is no reason for that.

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13:45You've got your core holdings, some recurring crypto buys, maybe even a few strategic option plays on the side. The point is you're engaged with your investments and Public gets that. That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry-leading 3.6 % APY, high-yield cash account. Switch to the platform built for those who take investing seriously. Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio.

14:19That's public.com slash market. Paid for by public investing. All investing involves the risk of loss, including loss of principle. Brokered services for U.S. listed registered securities, options and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA and SIPC. Crypto trading provided by ZeroHash. Complete disclosures available at public.com slash disclosures. Victor, do you remember two years ago, I think it was also in the summertime when the Fed said they basically like ruled out the possibility of a 75 basis point hike, and then they went ahead and did it.

14:54And they sort of abandoned forward guidance, which had been this principle that they had been using post-2008 financial crisis to guide the markets and dampen bond market volatility. I don't know. I've been thinking about that moment for a while now. It feels like we're sort of having a repeat on the data dependency thing. It's another shift in the emphasis of the central bank's communication policy. Yeah, it is. It is. And again, if you go back to those times, the reason we shifted is because Jay Powell quite correctly was saying that neutral rates are becoming very unstable. You know, I can't see the stars.

15:31He kept highlighting. He'd been highlighting it for years now. And what he basically saying, I don't know where neutral rate is. In a nominal terms, is it more like three, three and a half percent that people currently expect? Or is it closer to four, four and a half? And if it is four, four and a half, is it possible that in the next six to 12 months is going to drop to two and a half, three percent. And so he has no visibility exactly where neutral rate is. He doesn't know where it's going up or coming down. He's not even sure what forces actually are driving it so quickly up and down. I mean, we can talk about a number of forces, one of them election and electoral cycles.

16:09We can talk about geopolitics. We can talk about climate. We can talk about health care. There is a number of things that outside the economic system that drives you. So in the past, mostly what you had is economic cycles and capital market cycle were driving everything. Today, it's the forces outside the system. Now, what is the ability of Federal Reserve to estimate and anticipate any of these things outside macroeconomic system? The answer is zero. The ability to predict, the ability to anticipate, the ability to price is zero. But these are the factors that are capable of swinging neutral rates quite considerably.

16:49You mentioned one thing just then, which is political uncertainty. And this is something I wanted to ask you, which is, okay, markets are pricing in roughly a little over 70 basis points worth of cuts at the moment for the rest of the year. How much of that pricing is due to uncertainty stemming from the political situation right now? How much of it is basically risk off getting priced into that market? None. I don't believe anybody can price political outcomes, either with a Trump or Harris wins or whether Republicans sweep and control the House and Senate and the presidency, with a Democrat sweep and to have a full trifecta, what's going to happen at state election levels, because remember, 44 states also have elections, 16 governors or something running for elections on top of that.

17:37I don't think anybody can predict, including investors. So right now, I don't think anything is reflected. People are trying to do Trump trades and they have Harris trades. To me, it's not relevant. First of all, it's not clear what the trades are. Because one of the things it's been very clear in European elections, and increasingly US as well, that if you on extreme right want to take control and govern, people will force you to abandon your most extreme views. This is what happened to Brothers of Italy. That's what happened to RNN. That's what happened to RN. In some ways, that's even happening to AFD in Germany on top of that.

18:16The same happening with Republicans. They no longer want to cut welfare payments. They've abandoned Project 2025. If you say with Kamala Harris, she's now saying fracking is going to go forward. So the good thing I think right now globally is that electorate is not mad enough, is not angry enough to go to the extreme. So if you want to have an opportunity to govern, you must abandon your most extreme views and extreme policies. And if you do abandon them, then really how much of a real difference is there between the Harris trade or, I don't know, Trump trade or any other trade? So right now to answer your question, I don't think anything is embedded.

18:58I think people are trying to trade and anticipate certain things. But at the end of the day, it's pretty useless because there is no way you will know that. And we might not even know that until January, because more than likely, there is going to be quite a lot of litigation after November election. It's always striking to me how badly various political electoral themed baskets or trade ideas do. You know, the Mexican peso was a Trump trade in 2016 and was getting hammered every time he did well in the polls. Turned out to be one of the best performing currencies during his years of presidency.

19:32Do you remember, Joe, in 2016, after Trump won, every single sell side piece of research that came out was like Trump will make whatever great again. And it was everything from like energy stocks to the most esoteric, like acid backed securities. It was amazing. Yeah, people. Including cryptocurrency. Other than the one in the studio right now, many lazy titlers of sell side notes with the exception of the person we're talking to. But, you know, the energy is a good example because energy did really badly under Trump and then it did really well under Biden, even though the Biden baskets in 2020 would have said to all buy solar stocks, which have all done extremely mediocre.

20:14Actually, you also mentioned geopolitics. And I get that you can't really put together a compelling electoral trade. Would you see any fingerprints of either the geopolitical situation or the election on either the economy or markets right now? Is it showing up anywhere? No, none. I would argue even Europe, where we've gone through quite a number of cycles, because quite a few countries had elections and European Union Parliament had elections, you don't actually see a great deal of fingerprints at all, either on an economy or ECB policies or the market, whether it's equity or fixed income or any other market.

20:48So to me, and again, I think part of the reason is, I keep coming back to that, people are not yet mad enough. They're not yet angry enough. And so the extremes do not have the same pool as they otherwise would have.

21:16support for the show comes from public.com you're thoughtful about where your money goes you've got your core holdings some recurring crypto buys maybe even a few strategic option plays on the side the point is you're engaged with your investments and public gets that That's why they built an investing platform for those who take it seriously. On Public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry-leading 3.6 % APY, high-yield cash account. Switch to the platform built for those who take investing seriously. Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio.

21:56That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokerage services for U.S.-listed registered securities, options, and bonds and a self-directed account are offered by Public Investing, Inc., member FINRA, and SIPC. Crypto trading provided by XeroHash. Complete disclosures available at public.com slash disclosures. Introducing the all-new Adobe Acrobat Studio, now with AI-powered PDF spaces. Do more with PDFs than you ever thought possible. Need AI to turn 100 pages of market research into five insights with a click?

22:29Do that with Acrobat. Need templates for a sales proposal that'll close that deal? Do that with Acrobat. Need an AI specialist to tailor the tone of your market report to sound real smart in real time? Do that with the all-new Adobe Acrobat Studio. Learn more at adobe.com slash do that with Acrobat. Can we just go back to, I'd just like to go back to the U.S. and the Fed specifically again. So setting aside, you know, one of the concerns about a policy mistake or waiting too long is this notion, and this is sort of the implied insight of the SOM rule, for example, is that unemployment feeds on itself.

23:06I lose my job. I spend less. I spend less at your business. You lay off workers. Your workers lose income. They spend less, et cetera. That intuitively makes a lot of sense to me, that unemployment contains its own momentum that builds on itself. But your view seems to be that it can be short-circuited in a fairly short period of time. Can you reconcile that for me and why you have this belief that, okay, maybe it is a mistake to wait to September or maybe the Fed should signal more forcefully that a rate cut cycle that begins in September will be aggressive? But can you sort of reconcile this for me, why you believe that they can reverse a policy error fairly quickly?

23:45And I think Claudia some. She has. actually pulling back from your own rule. And for a very good reason, for a very good reason. First of all, we had a massive dislocation of demand and supply curves for goods and services and labor over the last three to four years. Secondly, we're getting very tremendous changes in the structure of the labor market itself. So increasingly, Bureau of Labor Statistics is not really capturing the labor market and what the labor market does. Whether it's a gig jobs, whether it's a multiple jobs, There are many studies that were done over the last five, six years, which basically shows that methodology that Bureau of Labor Statistics employs understate labor participation by at least two percentage points, which means all of this low labor participation is not actually true.

24:32They also significantly, therefore, are understating the hours worked and overstating wages per hour. So it's a structural shift that is occurring right now in the labor market combined with a gradual volatility of demand and supply curves that we have experienced that really blunts that rule. It doesn't really allow that rule to function. But beyond that, and that's something I think Claudia doesn't address, beyond that is sort of my pet idea of abundance rather than scarcity. But just on this, regardless of whether the rule holds firm, and I get that because no rule is going to be ironclad and, you know, that applies.

25:11Well, Powell talked about it in the presser yesterday. He was like, this is something that has happened throughout history, but it doesn't mean it's always going to in the future. It's absolutely not an iron law at all. It's not a law of nature. It's not a law. Neither is the curve inversion a law of incoming recession, as we've seen over the last couple of years. Nonetheless, just the core intuition of negative momentum building on itself, does that concern you? Yes. Yeah, it is. Because ultimately, people do need to consume. Ultimately, people do need to spend. We have a problem measuring exactly where we are.