#964 - What the Fed Means For Your Money | With Sven Henrich

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0:35What does the Fed mean for your money? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Sven Heinrich, founder of the Northman Trader. Hi, Sven. Welcome back. Hi, Maggie. Good to be with you. Thanks for having me. Welcome back to Real Vision. I think this might be your first time on the Daily Briefing. If not, it's been too long. So we're so excited to have you today, which is turning out to be quite a day. If we look across the action, it's looking like the Fed's not very good for your money if you were holding U.S. stocks today. Stocks fell across the board. In fact, we saw that sell-off seemed to accelerate into the close.

1:07We've got the NASDAQ down over 2%, about 2.25%, Russell down 2%, S &P down a little over 1.5%. We've got the VIX up. So in the 10-year, looks like down, retreating down below 4%. So investors digesting not only the latest Fed meeting, presser from J-PAL, also a lot of earnings. So a lot of this is feeding onto each other. But let's start with the Fed. Looks like March is off the table. What jumped out at you? What did you make of what we heard from Jay Powell? You know, I'm usually somewhat known to be critical of the Fed. And in particular, you know, over the years, there are various policy areas, if you will.

1:52But I have to give Powell credit a little bit because he actually stuck to his guns for once. Whether that's turning out to be sustainable, we shall see. Look, in December, we had, following the October lows, we already had a massive easing in financial conditions. And Powell in early December was talking about it's way too soon to talk about rate cuts. But then two weeks later, he said, we're talking about rate cuts. and that further eased financial conditions and has culminated with the most drastic easing in financial conditions on record at a time when the Fed on paper is still supposed to be in that tightening process.

2:37And the added complexity to all this is, you know, while the Fed is running QT in the background, we've actually seen a dramatic net increase in liquidity into the financial system from various type of sources including the ptfp bank rescue facility that was put in in march the drainage of the reverse repo through which the treasury has been cleverly funding its record deficit, record in the sense that we are in a record non-recessionary deficit spending environment, which we've never seen. And of course, the reversal in yields, which in September Powell said was doing the job for them, meaning higher yields.

3:25And then yields collapsed rather dramatically. And of course, all this has led to a, you know, just very powerful rally in equity markets at 20 on the S &P. And all of a sudden, you know, it's all soft lending, happy talk again. And so if you're concerned about all this easing in financial conditions, actually pushing back on the gains made on the inflation front, meaning you're too easy too soon, because All this easing in financial conditions, in effect, is equivalent to about three rate cuts already. The market already ran with this, right? And the Fed is not yet at its 2 % core inflation target.

4:16So if I were them, I would have said, okay, I want to push back against this a little bit. And that's what Powell did. So in this context, fair enough. Whether he actually means it, it's a completely different story. because we've seen Fed speakers say all kinds of things and then do something completely different. That's the problem. That has been the problem. But they will say that they're data dependent and that they're very reluctant to, I mean, they clearly course corrected from the fall, but they're reluctant to sort of get too far down the road because they want to see what happens. They're trying to sort of land that kind of perfect combination where they can slow things down without tipping it into recession, which we know is super hard.

5:02Going into this, there seemed to be a real mismatch between what the Fed was saying, even in its forecast, and what the market was saying. As you said, it ran ahead, right? It got way ahead of the Fed. Do you think... Go ahead. Go ahead. I just wonder if that gap has been closed or if there's still work to be done. Are they more in line now, or do you think that the market's still pricing in too much easing, too many rate cuts too soon? No, the gap is clearly still there. I mean, Powell pushed back against the expectation of a March rate cut today, and the market's dialing that back a little bit.

5:41But the gap still remains on a fundamental level. And this is where this journey on the macro side is now very interesting and unique because I referenced that deficit earlier. You know, we have a view that the economy is doing great and it seems to be doing well. The labor market is holding on and all that good stuff. But we all forget, and that's kind of missing in the larger debate. When you increase debt by$2.7 trillion in 12 months, and you're on a$2 trillion deficit, that is fiscal impulse. It means it actually goes into the economy. If we had a balanced budget, which we never do, obviously, but haven't had it in over 24 years, I believe, if you ran a balanced budget, you would not be running positive GDP growth right now.

6:40You wouldn't. For example, in the fourth quarter, GDP increased by a little over$300 billion, while the deficit increased by over$500 billion. dollars right the government is hiring and has been hiring half the jobs over the last few years have come from government hiring while the private sector labor market actually has somewhat peaked it seems and obviously now we're seeing a bunch of layoff notices coming in so i'm wondering if we'll all be all not having a look at the real economy but maybe a little bit over optimistically positive economy. And that leads perhaps to too much enthusiasm quite yet.

7:28I'm not saying there's not going to be a soft landing, but I think the body or the roads are littered with bodies and past cycles where you get that sense of optimism about a soft landing. And what we're coming out of, and this is really critical right now, and this is the reasons why companies are announcing layoffs. This period of high inflation gave benefits, just companies, great benefits for margin improvement, right? Because they were able to pass these prices on to consumers. But there's a flip side to that. Now that inflation is coming down, they don't, they're losing that cushion. So they are all of a sudden faced with shrinking profit margins.

8:11And in order to make up for those profit margins, they're going to have to cut fat, which is employees. It's called efficiency. To the extent you can do all this without any massive layoffs, then that's fine. And maybe you just get a slight tick up in the unemployment rate and that's that. But that's typically not what happens, right? The historic track record is a different one. You do not have much history at all to sit at 3.5 % unemployment, and you're going to remain there, even in the 4 % range. That's typically not what happens. But it may happen this time, obviously. We can't know until something breaks and nothing has broken at this stage.

8:55Yeah, it sounds like you're a little bit worried maybe that the economy is a little weaker underneath than maybe it seems. George just gave a really – we were just talking about how complex the macro environment is, and it remains that way. We talked about it last year. And George in the chat just brought up a really good point and said yields were down today as hawkish words flowed from the Fed. So we saw the reaction in the stock market to sort of Powell trying to sound hawkish, trying to sort of say, hey, hey, we're going to take our time. March seems very unlikely. We don't really know. We have to see the data.

9:33We don't want to blow this. I'm paraphrasing. But yields went down. They didn't seem to have the same reaction. Did that surprise you or are they sniffing out something that they think is coming regardless of what Jay Powell is saying? It's a very good question. And it's a particularly good question because what we've seen over the last couple of years is this really high correlation between where the yields are going and where the stock market are going. It's an inverse relationship. So you can even flip charts and just show this relationship. It's beautiful, actually, right? So that's why we had the big flips in market in October of 2022.

10:15And again, in October of 2023, it's when yields flipped the direction and they started coming down. And that was positive equities. And it may be worthwhile looking at a chart I brought of the one-year yield. And it goes back decades. And this chart, this was the point I made in early November, which basically said in any given cycle, when you have the peak of yields in a cycle, that leads to a market runway. It's relief, right? Because the peak tightening is over and you get the improvement in liquidity. And so what we've seen time and time again prior to a recession unfolding is you get this market runway that can last for months.

11:11It can even last for years. And I submit to you that's exactly, precisely what we've just seen off of the October lows. In this sense, the market has been behaving very rationally and very consistent with history. It is not until the relief from yields turns into terror, into yield terror, I call it, when actually the lag effects traditionally of rate hikes filter through the economy and then something breaks in the labor market. And that's typically when the Fed panic cuts rates and tries to re-stimulate everything. I mean, that's the typical cycle. And at least on that measure, what we've seen so far is consistent with that.

12:02Now, what we've seen today, you know, in past months, if you saw a drop in yields, you would have expected a positive reaction in equities. Now, is this today a warning sign that maybe we may have that type of relationship shift where this now turns into yield terror and there's an imminent recession? I can't say. I would need to see a lot more evidence of this as maybe a one-day wonder, so to speak. But yes, I would say that we all have to be respectable of the fact that given this massive deficit spending, that none of us have a sense of the real strength of the economy. and you know as and keep in mind though and we liquidity has trumped everything and the u.s government is showing no signs of slowing this incredible debt deluge jennie d 'ellen especially came out this week saying well maybe we're going to have less funding requirements in the second quarter in particular well we'll see about that right because last year they promised us of a deficit of minus a trillion and a half and they came in with one you know just about two trillion so they were completely off and so their their own visibility may be a tad limited right uh and and there's obviously the debt ceiling had been kicked into early 2025 so in principle they have an unlimited credit card to keep going the challenge is and janet yellen you know gotta love Janet Yellen.

13:40When every Fed speaker was out in the summer, in the fall, talking about higher for longer, higher for longer, she suddenly came out at the beginning of October and said, higher for longer may not necessarily be a given. And guess what? Soon after that, yields peaked and dropped hard. So I always urge people to pay close attention to Janet Yellen, Because she has, as head of treasury, she has an urgent need for lower rates. Because not only are interest payments on government debts skyrocketing, right? They're hitting over$1 trillion this year. But there is a lot more refunding requirements coming because of old debt maturities that were originally financed at much lower rates.

14:28And all of a sudden, they're going to have to contend with much higher rates. So this funding beast that is out there, it's only going to get worse. So she needs lower rates for sure. And so there's a gap between market expectations between the Fed and the market. But there's also a gap between what the Treasury needs. And there's a conflict there. So the longer the Fed holds on, the worse it's going to get for Treasury. 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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16:10Yeah, and we talk about that a lot here on Real Vision. Raoul talks about that a lot, that, listen, they can't afford to keep rates this high from that funding lens. So when you're looking at what has to go, it's hard to see. They can talk about inflation all they want. it's hard to see how that narrative doesn't bend to the need to be able to get those interest payments down. So I want to circle back. Certainly, it seems like for all those reasons, bond yields are headed lower. Do you have a sense that we're going to continue to see it move lower at a pretty rapid clip? Is it going to front run the Fed actually announcing those easings?

16:49or do you think it sort of just hovers around this range below four that we've seen it park at when it's trying to figure out what's happening? Well, this is what a liquidity equation comes in. There is some unknowables on this point because we're facing some real deadlines here coming into March. To the extent that Janet Yellen and her team were able to manage the you know the funding on the short end and thereby using reverse repo as kind of the funding mechanism and that adding liquidity into the system the reverse repo facility is going to be hitting zero at some point march april at at the earliest in that context actually surprised that wasn't addressed today by the fed um and and in that sense then you may end up with some more pressure on yields and of course you got you got all kinds of concerns geopolitically that we none of us can control i.e red sea and i am generally concerned obviously that financial conditions have eased so fast uh that that may and then you have the wealth effect from record highs in the main indices and you know and all this positivity and before you know it you know we're going to see pressure on spending again remember the traditional way to beat inflation is a recession right Because you bring the economy to a halt.

18:20And what they've done here is the economy is growing better than ever. Everything is great. So if they are able to continue to see lower inflation, which, by the way, if you look at the year-over-year effects, that will probably continue for a few months at least. but there's there's always risk that you know we're going the arthur burns route from the 70s which powell wanted to avoid but now these events have kind of overtaken the entire tightening process that we may see a surprise at some point uh later on but i i can't predict this um so we're gonna have to keep a close eye on this as well as on what's happening with the regional banks now that they've announced that they're going to end the bank funding program in March as well.

19:12And we got a little headshot in markets today about that as well, as one of the regional banks got clobbered pretty hard on this. We're all in the view, because we have record highs, that the lag effects from previous rate hikes no longer matter. But when I said earlier, maybe the economy is not as strong as it appears, I would encourage everyone to look at the underlying broader stock market. And I have a chart for that too. Yeah, let's bring up, because you have been looking under the hood at the rally we've seen and the nature of it. So walk us through what you're looking at for stocks. Yeah, so we came in from October.

19:55I was talking about that shift in yields being peak in the cycle and that would be really bullish stocks. And fair enough, that has so far worked out. And then there was a lot of talk about, okay, we're going to see a broadening of rally, small caps, everything else had been lagging. And we saw some of that into year end. And this chart that I brought with you is, it's called the Value Line Geometric Index. It's a particular measure of equal weight. There's different measures on this, but I've used this chart for years because it's It's been one of those really helpful charts in assessing potential topping and bottoming patterns in markets.

20:42And as you can see on the right side, basically, it's actually quite shocking how precise this has been over the last couple of years during this quote-unquote tightening cycle. and you have a very precisely defined range. And in October, it looked terrible, right? It had broken all down again. Small caps were not following. Everything was bad. But then there was a positive divergence, which I'm not showing here in this chart, just to keep it simple. But there was a positive divergence. That was a buy signal along with the view on yields. And we ripped higher. What was surprising is that it stopped dead in its tracks at the beginning of January.

21:26couldn't get above the resistance that we've seen over the last couple of years. Okay, that's a problem, right? Because if you want a true confirmation of the bull market, you want to see a crossing of that line. You want to see getting above resistance. XVG is a broad indicator of a lot of stocks, right? And then the really interesting part is at the beginning of January, we had a little pullback. Okay, fair enough. We were very overbought on a short-term basis. And then another rally to new highs just now in the last week, right? And XVG was not able to get to the January highs. It's made a lower high.

22:10That's a negative divergence. And ironically, we've seen this twice before in recent years. One was right in the lead up to the January 22 top, okay? The same type of situation, S &P makes snow high, XVG does not. We saw it in the lead up to the COVID crash. S &P makes snow high, XVG does not. So generally, I would say that's a warning sign. In terms of my earlier comment about the economy being perhaps weaker, if the economy was so strong and lag effects don't matter, why has XVG not been able to cross above that resistance line? While, and we've been talking about this generally in markets for years, about the thinning of the herd, the leadership by big cap tech, well, that leadership has now narrowed even more.

23:08I mean, the market cap expansions we've seen in the favor of very few stocks is absolutely staggering, right? I mean, Microsoft, from the October 22 loss to now, has basically doubled the market cap,$1.5 trillion. I'm not saying Microsoft's not a great company. They don't have a great story. They do. They're delivering. They have a great story. but all of a sudden we're looking at a few stocks that control 12 and a half trillion dollars in market cap nearly half of us gdp that's razor thin that's razor thin and in in general i would say you would want a broadening of a bull market you can't be reliant on just a few because then you get accidents i.e tesla this past week as well you don't want to lose lose the leadership so So, you know, while bears have probably been run over, I'd say bulls now have a lot to prove as well, because this this is not this is not a healthy picture in general.

24:10And it throws in some warning signs. 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.

24:22Yeah, I'm glad you brought that up because whenever we talk about stocks, we always have to think about how do we need to look at it when it has been so concentrated in those few names. And we have not, you're right, we have not seen that broadening out that a lot of people, we started to see it in November, but it didn't get any follow through. I want to pause the stock question for one second because we have one related to what you were talking about that I want to make sure I get in from Nick. It's a very good one. Sven, you mentioned deficit spending. A lot of the U.S. states and local municipalities are still flush with cash and have not yet spent the federal money yet.

24:57How and where do you see this affecting the market? Could that put a bid under equities? i'm not sure i mean i'm not an expert on state spending but i i would argue in general government spending has been a great contributor to growth i mentioned the deficit but you know you have major construction projects you have you know attempts to get manufacturing back to the u.s which is conducive for jobs and so forth i mean it's it's it's tremendous the amount of money that has gone into. So as far as saying, maybe this whole tightening cycle was a bit of an illusion, right? Because, okay, you're tightening on the monetary side, but you're really goosing the whole liquidity equation on the fiscal side.

25:44And this is the great experiment now because typically when you see a big deficit, you see it in context of a crisis that's unfolding. Oh my God, we have to stimulate. We need to support everything. Now we're doing it without a recession at all. And I have no place because we've never seen that before. And maybe you can argue, well, this is so powerful, it's going to brush over maybe these lag effects, and that's how you can get maybe to a soft landing. I hate to be so bland about it, but that would be kind of a unique government subsidy. In context of all the debt that's been accumulated in the last few years, I've got to be honest with you.

26:28When we went into this tightening cycle, remember the Fed had just printed money through the zoo and then were forced to panic rate hike because they had gotten the inflation equation so dramatically wrong. So my impression at the time was, well, if they're going to just coming out of 15 years of zero rates and now they go panic high into the highest debt construct ever, something's going to break. That's what a lot of people thought. A lot of people expected that. But then I got really suspicious. I got suspicious in the summer of 22 when, you know, remember we had the Ukraine, Russia invasion of Ukraine.

27:15We had consecutive lows in the S &P. We had wild rallies and the new sell-offs to new lows. Something happened there that didn't make sense to me. And that was the VEX. it kept making lower highs and lower highs and lower highs even at the October 22 lows. And that's why I came up with the term of this controlled bear market. A lot of people were out there saying, hey, the VIX has got to go to 45 foot proper bottom to be in. Absolutely correct in any historic sense, but that didn't happen. In fact, I came up with a new indicator and that was basically the yellow indicator because every time markets got in trouble, Yellen was out there and she was concerned about something like the UK Guild and liquidity in the treasury market in October 22.

28:05Then she was concerned about the banking crisis. And then all of a sudden in October, she talked about higher for longer, not a given. Every single one of these utterances, if you paid close attention to them, turned out to be key pivot bottoms in markets. Fact. You know, you can call it coincidental. It's the yell and put, sort of, isn't it? We talked about the Bernanke Fed put. It's the yell and put. It's the yell and put. And so in context, you have to wonder who's really in charge here, right? And so to see the VIX, then last year we saw this again, the VIX just got absolutely monkey hammered.

28:44There was a moment where actually he was trying to defend a long-term uptrend from the 2017 lows. It got a cut, crushed below, and now we've been sitting for three months in this 13, 14 range, which generally is also a bit concerning because extended periods of volatility comparisons lead to accidents, especially if you got massively extended charts. So now we're in this really weird situation where we got some stocks that are massively overbought, but we have a broader market that sends signals that it's actually oversold because it is so weak underneath. And I think this is going to make for a really interesting journey here in the next few months to negotiate.

29:26That's a great point. So as we close out, what's the pace car here? What sets the tone? Is it the Fed? Is it the economy and maybe consumer behavior? Is it bond rates? Because as you pointed out earlier, that bonds really seem to be dictating. Equities were responding to moves in yields, which whipped all over the place last year. So is that what's in the lead? What is going to determine what happens, particularly to the stock market? Because that's what people are most exposed to. Well, the key driver to everything, take the combined picture of everything we talked about, is liquidity. So we've got to keep a very close eye on how liquidity evolves.

30:09It's been tremendous expansion in the last three, four months. and if that speaker turns off for whatever reason watch out right in fact i have a chart of the s &p that may be of interest here because i've been tracking this since the very early part of october and you know we're technicians so we're paying very close to technicals and this cup and handle pointed out early october and it just said you know unless bears can break anything uh this is screaming much, much higher. And just as a side point, I want to point out, bears had a COVID global pandemic as an excuse. They had record inflation and they had a record tightening cycle as an excuse and nothing ever got broken.

30:53In fact, in October, we had that little dip below that trend line to the COVID lows and guess what? It got saved as well. I mean, absolutely nothing. It's really fast. That's why I come back to the notion of this controlled bear market, the hidden forces underneath because they always show up at the right time. And this cup and handle pattern has paid technically absolutely beautifully. And frankly, the full conclusion is 5 ,400. It's got a lot of room higher. Having said that, when you have breakouts like this, and especially very aggressive breakouts, you can make the case that there will be some sort of pulling back and maybe even backtesting.