#1039 - Will Dollar Weakness Bring Rate Cuts? With Dr. Komal Sri-Kumar and Dale Pinkert

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0:59Hi, Warriors. I'm Dale Pinkert. And today, I'm happy to have the opportunity to speak to one of the more thoughtful and experienced voices in the business. Shree, welcome back to Real Vision. Dale, thank you very much. Very good to be with you. Yeah, I've watched you on financial media for many years. It's a pleasure to meet you and to be able to talk to you. Why don't we start by dialing it back a little bit to the Fed meeting? a week ago. And one of the big issues was QT. And I went through your Twitter stream, and I saw that you noticed what I was paying attention to, that they cut back on the selling of the treasuries for QT and did not cut back on the selling of MBSs.

1:53And you had a comment that Perhaps Powell has some concerns, and that's why they're cutting QT on treasuries. I want to ask you the fact that they're not cutting QT on MBSs. Do you think the Fed sees risk in what those mortgages, back securities, what the assets standing behind them are, and they don't want to take real estate risk and feel like it's more important for them to take a stand in treasuries? Great questions, Dale. I think there are several motivations involved here. Since you began with mortgage-backed securities, let's begin there. If they had reduced the extent of mortgage-backed securities that they are going to put into the market, that, again, would have influenced the housing market.

2:48And I think that is something the chairman and the rest of his colleagues at the Federal Open Market Committee did not want to be part of. I see. On the other hand, treasuries, by reducing the amount of QT, which is another way of saying they're going to put only$25 billion worth of bonds into the market every month, not$60 billion as was the previous ceiling. they are giving help to Janet Yellen. They are giving help to President Joe Biden in trying to keep Treasury yields lower to that extent. Keep in mind that the deficit of the Treasury is extremely high. And when I began my career, and I hate to tell you how long ago, Dale, but it was some 40 plus years ago, So I learned that a country needed to have its debt GDP ratio less than 50 percent.

3:48Right. Today, the United States is at 122 percent. Not only that, we have the deficit increasing as the economic growth is strong, which is the opposite of what you would anticipate. So Powell is doing his bit to help his colleague and the previous Fed chair, Janet Yellen, in this process. Okay, so I understand that they're trying to help by dumping less supply on the market. I looked at what happened here this week, and thank God they cut back QT, because even with real bullish news, the long end of the market, TLT is the ETF that I track, really didn't have that great of a week. But before we get to that, other Fed watchers, you know, I won't name them, but someone who wrote the book Fed Up seemed to believe that during the presser that we had after the Fed announcement that Powell pivoted.

4:50Did you hear any language in there that made you think the same thing? I think Powell has been pivoting so frequently from time to time. It is hard to keep track of it. You need to be just as much a ballet dancer, I think, to keep up with him, Dale. But look at where the events came from. May 1st, where he gave the presser, he essentially was trying to tell us that he was not, that interest rate increases were unlikely. and he still held out the hope for interest rate increases, interest rate cuts to take place. But then we had some really bad CPI numbers. And when we had the difficult numbers, then he had to once again pivot.

5:39But he said in Amsterdam earlier this week, where he was speaking at a press conference, that still interest rate increases are unlikely. Irresponsible, he said. Right. And I think when you do not know where inflation is headed and with the amount of errors that the Fed has had in predicting inflation going all the way back to 2021, he should have a bit more of humility in his forecast, which are missing. So my point to you would be, yes, there was one more pivot. And he's trying desperately to tell you, please, please believe me, we are not going to increase interest rates. And somehow we are going to find a way to cut rates during the months to come.

6:28Well, you know, let me push back against Paul. I know I'm just a trader. I didn't go to Harvard. But when I look at things like this, gold, and I look at things like copper, and I see things like GameStop, the memes becoming Lazarus, to me, it's irresponsible that he's not hiking and that he hasn't quelled what he started to quell a couple years ago. and you even had a comment that even though the CPI was a little better, that we've seen this before and that inflation, you think, in your view, will re-accelerate and the numbers may not be as good going forward later on this year. What is behind your belief that inflation is embedded?

7:26Is it because you and I lived through the 70s, Sri? And we saw that they had to do it not once, but three times that you had to embark on a tightening campaign to win the war after thinking you did by winning a battle? These are, again, very timely questions, Dale. Let me begin with the 1970s and then very quickly let us move over to the more recent past. 1970s, we had Arthur Burns, the chairman of the Federal Reserve, who was repeatedly bullied by President Richard Nixon to follow an interest rate and monetary policy that were helpful to the 1972 election to Nixon being reelected. Now, going back to it, and I have checked the money supply numbers, the M1 money supply definition, and from 1970 to 1972, there was a significant pickup in the rate of increase in the M1.

8:29The only way to justify it is that they needed all the paper printed dollars to pay for the cost of the Vietnam War, and that is where the cash was being spent. Now, that in turn gave rise to the inflation of the 1970s, but they were made worse by the fact that Arthur Burns kept increasing interest rates, cutting back and frequently changing, shifting policy one way or the other. We gave it a name. We call it the stop and go policies of the 1970s. Now, coming to the more recent past, Jerome Powell appears to be following along the Arthur Burns path. Exactly. What he's doing, Dale, is to essentially tell us when the inflation is above the Fed's target, he tells us that interest rate increases are unlikely.

9:25That kind of a comment is unwarranted. What does he hope to get out of that? And the only thing I can think of is that somehow, for some reason of his own, he's cheerleading the equity market. And as you said, they are being reflected in the price of copper. They are being reflected in the price of gold, all increasing sharply. And that is where the effect is taking place in the Fed's, what I call, irresponsible policy at the moment. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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11:07Yes, they watch gold, right? They watch everything on the trading desk at the Fed. So they have to be aware of new historical highs and what's happening. I know that you also made a comment about the dollar in your notes, that there's an expectation of lower rates. I actually think when you look at things like, perhaps let me pull up the 10-year, the 10-year seems to be responding more to what's happening here. We tried to bounce back. We're bouncing back off major support here, Sri. But it looks like this is a failing rally. And if we start taking out 430, we could be beneath 4 % in fairly short order.

11:55So it looks like the market, regardless of what Paul was saying, and that's a question I have for you, does Paul lead the market or does he follow what bond and no traders, the old bond vigilantes are doing in the market? Does he really lead the market or does he follow the market? The bond vigilantes right now are either absent or if not absent, they are dormant. They are not very active at the moment. If you did have an active bond market and vigilantism were to be present, you should be seeing the 10-year yield well over 5 % currently, which is what something Larry Summers said at his interview a few weeks ago.

12:45But then I disagreed with the former Treasury Secretary. I said the 10-year yield is not going to go there. It will go there only if the bond vigilantes are very active and working. But right now, what you have is a situation where there is immense amount of uncertainty overall in the rest of the market. The U.S. Treasury is the only safe haven you have among securities, other than going into gold or copper in terms of securities, and you do not have the euro market, the Japanese market, or the Chinese market as alternatives for safe haven purposes. That is what is helping the treasuries. One last point, just to show where Powell is being led by the market rather than he leading them.

13:37If you have something break in the system, and I have repeatedly said that I have two favorite candidates, a deterioration of the U.S. banking situation with a crisis worse than March of 2023, or secondly, while we are pretending that the commercial real estate problems don't exist and everything will resolve themselves by them on their own, that you have suddenly a big volume of these bad debts which come on the markets. You have some institution which goes billy up, whether it is on the banking side or the real estate development side. And that in turn causes the Fed to come in, cut interest rates by 75 basis points, 1 % at one go.

14:24And then the 10-year treasuries overnight would be below 4%. So those are my expectations. Okay, so should people feel comfortable, Sri, keeping deposits in the bank even though they're insured up to$250 ,000? Do you feel comfortable? Do you do research to find a safe bank? Or do you feel okay with the ones that are on kind of the watch list because of their positions and their debt and their books? Up to the$250 ,000 maximum for the FDIC, I would feel comfortable with any banking institution. But beyond that, you're on your own. It is as if you are buying a security which is risky, and you have to evaluate whether the higher interest rate that that bank provides you for putting, let's say, a million dollars is worth it compared with putting it in four different institutions of$250 ,000 each and enjoying a lower interest rate rather than the high interest rate offered by the bank, which is on the watch list.

15:39So that is where I would go for. I feel secure about the FDIC insurance. And why is that the case? Because the combination of the Treasury and the Federal Reserve can always pay your single dollar that you deposited back, 100 cents on the dollar you put in. The problem you're going to have is with inflation. The day you get cheated in terms of the real value of the deposit you put in, not in the case of the nominal value, your nominal valuation is safe. Your real value is not. Okay. And especially if we're embarking on a bear market in the dollar, do you think a bear market would be helpful for the Fed and also in paying off the debt with cheaper dollars?

16:28All of those would be helpful. Yes, indeed. If you have the dollar weakened, both in terms of prices, there are two ways to weaken the dollar. One is the inflation goes up, which means your dollar is worth less. Right. Right. Your dollar is also worth less if it weakens with respect to the euro, with respect to the yen and the pound sterling. So either case or both cases are going to be good for the Treasury to be able to pay off the debt at much lower valuations. But here is again the problem. You cannot have the dollar weakened substantially with respect to the other currencies, because no other currency is ready to take its place on the global scale.

17:13So what are you doing? Instead, you're going into gold and you're going into copper. Those turn out to be your alternatives. Maybe to some extent, some parts of real estate you may still go into as an inflation hedge because the securities-wise, you don't have a good substitute for the dollar. It would also exacerbate any inflationary pressure for the Fed because just in nominal terms, things like grains and other things besides metals, natural gas. It looks to me like we're in a lot of embryonic bull markets, even things that were depressed have a heartbeat in the last month or so. So they'd have to fight that battle too.

18:04if they weaken the dollar. But it could be their sacrificial lamb in the jam that they're in. Is that what you think may happen? Rather than call them sacrificial lambs, which means that you're making a conscious decision to actually sacrifice those commodities or let prices go up or the dollar weaken, it is going to happen without anything that the Fed or the Treasury can do about it. The problem is when the debt is so high and the deficit is so substantial, the Treasury is not going to be able to do anything to correct the situation. So in order to be able to correct the situation, they need to have some room to maneuver.

18:52But the high level of deficit and the debt to GDP ratio has removed that freedom, the flexibility of the U.S. Treasury. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

19:13Okay, because technically we had a failure up here, and I actually have targets if you look at something long term. And tell me if I'm being too aggressive, but could you picture the dollar falling back to par, even breaking it and trading in the 90s? Because that's what I think might happen down the road. You are obviously talking about with respect to the euro, right? The dollar index is heavily weighted in euro. So yeah, euro, that would probably translate into something like$1.20 in the euro. So you are talking about a much more expensive euro and a much weaker dollar because you need$1.20 compared with today's$1.09 to pay a euro.

20:11I don't know that that will necessarily be the case, Dale. And here is my reasoning for it. That the exchange rate, we say, and from my days of my PhD thesis, it takes me back, that the exchange rate is what we call a relative price. It is the price of one currency with respect to the other currency. So in order for the dollar to weaken so sharply, the euro has to agree to strengthen just as sharply. And I think the Europeans who are having a very weak economic recovery, and this is particularly shown in terms of what is happening to Germany, for example, cannot afford to have the euro being valued at$1.20.

20:59Okay. My expectation is that the dollar-euro exchange rate is going to be fluctuating between 105 and 110. And right now, we are at about 109. Right. It has been pretty range-bound. Really, you look at it since 2022, it's been in the range you just defined. But every once in a while, ranges don't last forever. And sometimes they break out of ranges. And that's what's happening in a lot of commodities. And I think it could happen in the dollar. I want to talk to you about gold. Because this last rally in gold, Sri, despite the dollar being in rally mode, yields were climbing. All right. They got up to 478, 474 on the 10-year.

21:54And it had no impact on the gold price. It kept rising when normally, I've seen times where the dollar and gold could go up, but really not with yields going up at the same time. Is there a new regime change happening here that the Chinese started with their vast accumulation of gold? That gold is the next reserve currency because there isn't one to replace the dollar. that gold is where people are going because they don't trust any other fiat. And that's including central banks, not even trusting their own currency. That is very well put, Dale. I couldn't have said it better. So I think what the Chinese are doing with respect to buying immense amount of gold is I think also happening with the private sector.

22:49The global private citizens have increased their holdings of gold at the same time as the official holdings have increased. And that reflects the fact, again, going back to saying that the exchange rate is only a relative price. You have a situation when the dollar is weakening somewhat with respect to the euro recently, but it cannot weaken very much because the Europeans would not allow it to weaken very much. So what has to happen is that it is all getting reflected in commodities, in the price of copper, in the price of gold. And that is the way in which it is going to get shown because the currencies are not going to fully reflect it.

23:33So, yes, the Chinese purchase of gold is contributing to it. But the other factors are simply the immense amount of monetary creation by the Federal Reserve. and just look at the balance sheet of the Fed. Yes. Compare it with September 2008 at the Lehman failure to now we have gone from 800 billion today to 7.3 trillion. So we are almost 10 times and the GDP has not increased as much. Yes. Problem we have, and that is why commodity prices are increasing so sharply that if you do not have an alternative to the dollar in terms of other currencies, you're going to find other alternatives in commodities or any other space that you can.

24:26And that is what is being reflected now in terms of what the investors are doing. And for Jerome Powell and his colleagues to pretend that inflation is transitory, that it is all due to a supply shock in the commodities, it either shows that they are totally ignorant of the situation, or they must think that the investors are pretty foolish and they will take anything from the Federal Reserve. I haven't concluded which is the case actually in terms of what is happening today. Okay, well, people also view risk and the stock market as a place that gives them some relief and pretty good relief over the years from any kind of dollar deterioration or getting 0 % on your money and even doing well when you're getting 5 % on your money because the interest you earn, you could just put back into the stock market.

25:25And you brought up that the market believes that there's still a Fed put out there. And I'm assuming that you don't think there is. And you never know how far a rubber band can stretch. Do you think that there's a problem with assuming too much risk now that people should be more focused on the return of capital rather than the return on capital? It depends. The answer to you, it is a multifaceted issue, Dale. And let me try to answer at least a few different ways. First of all, in terms of what the public is faced with, is that they have to decide how much of risk to take. Clearly, the equity valuations are very high.

26:20And why is it that just this week, we had the Dow Jones Industrial Average hit the 4 ,000 mark. We had the S &P 500 continue to rally. We have had a very good four, three and a half, four and a half months so far. Why is that happening? I think people are going into it because even if the rubber band breaks, by that I mean you have a catastrophe like it happened in 2008. And let's think about what would have happened if you check your portfolio in 2007, say, or the beginning of 2008, and you check your portfolio again 10 years later, what you lost in September of 2008 was more than made up by the Fed.

27:11Yes. Okay. So that's ingrained. And it's not even recency biased because it's been decades of this going on. Okay, so as far as it being overvalued, is it possible that it becomes even more extremely overvalued? Because the stock market is not the economy. So what is not good for the economy can actually be booster rockets for risk with the yields falling and the dollar falling and the market was doing okay without those two tailwinds. And now they have the tailwind. So as the U.S. economy begins to show soft spots, that actually is negative for the economy leading towards recession. But during that interim, it could be very bullish for the stock market because it's actually those two things are accelerators for the financialized economy, which is our stock market.

28:19Absolutely. All of the above. And let me throw in one more element to it. If indeed you have a recession taking place, that in turn, from a stock market point of view, will lead the Fed to cut interest rates several times. and that is going to boost the equity market despite the recession that you have. And having looked at the past behavior of the Federal Reserve over the last 10 to 15 years, it is fair to conclude on the part of investors that any loss over the next three to six months will be more than made up over the next two years with the liquidity that is being provided. The only ones who are going to lose out are going to be the ones who depend on bank interest income and wage income.

29:11Think about what happened after 2008. Yes. Ben Bernanke did not see the crisis coming. And he said in July of 2007, he told the U.S. Congress the subprime mortgage is a mere $50 to$100 billion problem. Contained. Contained. It wasn't. And then, of course, he poured liquidity in and we had zero interest rates for a long time. The stock market was thrilled. The S &P 500 from a bottom of 666 in early March got up substantially after that. Who lost out? If you were a low-income earner who could not put your money into the equity market, you left it in bank deposits, then you got no income out of it.

30:03Your wages were in bad shape. And we look at something called a Gini coefficient, which measures the income inequality in the United States that worsened significantly from 2008 in the decade that followed. So what happens? If you were Ben Bernanke, he ended up, he got the Nobel Prize in economics. So I sometimes think maybe that's what Jerome Powell is trying to do. If there is a crash and if it is a deterioration, he may get a Nobel Prize five years from now. Well, many people have surprised me that have won that prize. How about the prize and the potential impact of what might be the most unstable, unpredictable presidential election that neither side will accept the results?

31:02That is going to cause immense instability, if that is what it is. So far, we are assuming that November 5th, the day of the elections, if not that same day, a day later, we will know who Victor is. But that may not be the case. And under those circumstances, I think you have further uncertainty. And again, the Fed is going to be at the center of that uncertainty because you have President Joe Biden, who has said twice in recent times, including at a press conference he was at with the Japanese prime minister, he forecast that the interest rate will be cut by the Fed by the end of this year. And this is by an administration which says it doesn't interfere in monetary policy.

31:50On the other hand, Donald Trump has also indicated that if elected president, he will not renominate Jerome Powell as the chairman. So we have the Fed playing a very important role here. And an indeterminate result in November is going to just worsen problems for all of us. OK, here's my sister, Sri. And tell me it could be this pet. She says, oh, Dale, I'm just going to get out of the market in October and then get back in after the election. How could that possibly work? It's too simple. What do you think? I think it is too, in a sense, it is on the simple side, Dale, and I would tell your sister, based on what she said, if she is concerned about her portfolio over the three or four months after October, she's probably doing the right thing.

32:52However, if she has a longer term horizon, eventually the politics are going to get resolved with one or the other candidate succeeding for the next four years. And you're going to have, we are off merrily to the races as far as financial markets are concerned. And she and all of us don't want to miss out on that rally either. Okay, well, you know, as far as I'm concerned, you have given us hope. And what a lot of people have a lot of fear about what's going to happen, how things are between citizens of our country being adversarial, Hollywood putting out a movie called Civil War. so there's a lot of fear out there very refreshing to have hope that this too shall pass absolutely Sri, I could talk to you for days and I really enjoyed having the chance to talk to you and meet you and I think we've given people today a real vision of what's happening excellent, Dale, it was great to chat with you and I think you came up with some terrific questions so it made for a very good discussion.

34:09Well, you know, when you survive an interview with me, you become my brother. You're definitely my brother now and like it or not, and really, I think that people learned a lot listening to what you had to say today, Sri. It's been a pleasure. So everyone, hope you enjoyed it. It will be on video. So check Sri out at his website at shrikomarglobalstrategies.com and his thoughts and perspectives on Substack. And that's a wrap for us. We hope you enjoyed this episode. At Real Vision, we arm you with the expert knowledge, time-efficient tools, and a powerful network to help you succeed on your financial journey.