#998 - Can the Fed Nail the Soft Landing? | With Darius Dale

0:00Hi, on the 5th and 6th of June 2024, I'll be speaking at the largest AI event in Asia, Super AI in Singapore at the iconic Marina Bay Sands. Alongside brilliant minds like Edward Snowden, Benedict Devon and Balaji Srinivasan, I'll be on a stage exploring the extraordinary potential of AI and the profound change it represents, not just for financial markets, but also for the world as we know it. With over 5 ,000 attendees and over 150 side events, Singapore will become a vibrant hub for a full week from the 3rd and 9th of June. visit superai.com to register and join me with 20 % off tickets using the code real vision use the link in the description and i'll see you there it's going to be incredible

0:57and the fed nailed the soft landing hi everyone welcome to the real vision daily briefing with me today is Darius Dale, founder of 42 Macro. Hey, Darius. Hey, Maggie. It's great to be back. How are you doing? Great to have you. So Fed Chair Powell spoke and the market seemed to like what they heard. What did you make of the decision, the dots, the press conference, everything? One word, very dovish. Oh, no, that's two words.

1:25One big meeting, though. Exactly. So it's incredibly dovish, obviously. The markets are appropriate to respond with both rates rallying as well as stocks and then broader risk assets rallying. This is a Fed that does not want to push back against financial conditions at all, really. It's certainly a Fed that it looks like it's going to continue to get us, continue getting us paid in financial markets. So as the old adage goes, don't fight the Fed, especially when they're trying to put money into your pockets. Yeah. And you know, it's funny because we, I think a lot of people were sort of wondering if they were going to make a change, because we saw the last time we heard from them, the data was kind of falling in line with their narrative.

2:08This time around, we know that some of the data points and the inflation readings have been coming in stronger than expected. Not everything. You can find your data point and certainly you can see some pockets of weakness or things cooling. But generally, it seemed a little hotter. And then people were, And in fact, the Fed themselves, there was no change in policy, but they did raise their growth forecast. But at the same time said they're sticking by their plans to still ease three times. Does it seem doable what they're talking about? Well, it's all doable. If they want to be as easy as they want, they can.

2:41Right. So let's throw up chart one to kind of get a quick rundown, quick rundown of what actually happened with respect to their summary of the projection. So the key takeaway, in our opinion, is the Fed now agrees with our no landing call. I recall that, you know, you and I have been talking about the resilient U.S. economy theme that we authored back in the summer of 2022 and how that's likely to contribute to inflation kind of landing at a level that's palatable from the perspective of Fed's price stability target. But that's not that's not an outcome that we expect today. That's an outcome we expect in a few quarters.

3:10So getting back into the summary of economic projections, what we saw is that they took up their real GDP forecast for 2024 by 70 basis points. They took it up 2025 by 20 basis points, and then they took their 2026 real GDP forecast up by 10 basis points. They did this while lowering the unemployment rate projections for 2024 and 2026. They increased their headline PCE inflation projection up 10 basis points in 2025. They increased it by 20 basis points for 2024. And they did all this, as you said, without changing their median Fed funds rate projection. It's still three cuts here for 2024. They did have a slight lift to their 2025 projections in terms of the Fed funds rate.

3:56So effectively one rate hike in 2025 and 2026. and there was a modest 10-12 basis point uptick in the longer run projection, which is effectively the market's expectation of where the Fed thinks neutral is. So this is the first move we've seen in the neutral rate projections. It's going back to, I want to say, 2020. And in our opinion, it's sort of getting the Fed incrementally more in line with where markets participants are. So if you go to slide two, Brian, the Fed and money market petitions are now in line. If you look at their year-end 2024 and year-end 2025 policy rate projections. If you look at the December 2024 Fed funds rate relative to the Fed's dot plot, it's essentially the same.

4:37And 2025 is now the same as the Fed's 2025 dot plot as well. Where there is divergence is when you look at the December 2026 Fed funds rate projection relative to the Fed funds futures market, which is 50 basis points, a full two rate hikes above where the Fed is projecting. And then if you look at the longer run estimate relative to the 2027 Fed funds rate price, then you see that the market is 135 basis points north of where the Fed is. So the market agrees with our no-landing scenario, if you think about this from the perspective of the policy rate. The Fed has not gotten there yet, and the Fed has been reluctant to acknowledge the fundamental changes in the economy that you and I have been talking about for the better part of two years now that are contributing to higher nominal GDP and really just a higher nominal GDP environment that we've been dealing with for much of the past four years.

5:30So it's interesting. If they're doing this, are they letting inflation go? Is there a worry that inflation rears back up if they are going to stay on their rate cut path? Or is that rate cut path subject to change based on what we're seeing? So that rate cut path is always subject to change, right? The dot plot is not an outline of where policy will be. It's an outline of where they think policy will be based on everything they know today, which could obviously change between now and then. Jay Powell has consistently reiterated in recent months that the Fed has a lot of confidence that they're going to continue to see more good data on the inflation front.

6:07Now, they have to receive it in order to actually begin implementing the rate cuts. But they have a lot of confidence that, you know, some of the things like the lagged impact of housing price and rental price disinflation are going to flow through a CBI PC deflator statistics on a lag over the next couple of quarters to really accelerate the disinflation process. In our opinion, that'll be the last leg of this inflation we see. We'll start to reaccelerate from a level that will not allow us to have a mean or an average of 2 % inflation when you look at it across the full cycle. In our opinion, that's something the market's going to have to deal with most likely in the second half of the year.

6:42But again, right now, it's time to continue making tons of money on financial markets. And one of the reasons I say that is the Fed, with respect to its balance sheet policy, got incrementally dovish today. So, Brian, if you go to slide three, where we show the Fed is, Jay Powell communicated today that the Fed is thinking about, or they have already having discussions about slowing the pace of balance sheet runoff. And again, this is balance sheet runoff, and Jay Powell has actually adopted the phrase that we've been trying to condition investors to adopt. Because, again, they're not doing QT.

7:14They're not selling bonds to the market. They're just allowing zero data expiry treasury securities to roll off, and they're not reinvesting those proceeds back into the treasury market. And so Jay Powell said that he gave us an incremental nugget here in terms of the Fed is sinking Apple reserve balances rather than abundant reserve balances. And so in my opinion, that's sort of a change that suggests that the Fed is not looking to get reserve bank reserves anywhere near the level they were in 2019 as a share of GDP basis, as a share of commercial bank assets. That's the second panel on this chart.

7:48As a share of commercial bank liabilities and as a share of commercial bank deposits. You know, we're at 12%, 15%, 17%, and 20 % respectively. And, you know, we're well off the levels that we saw where the Fed had to do an about-face pivot back in 2019. You know, at 12%, you know, we were basically double where we were if you look at reserve balances relative to nominal GDP. For one instance, you know, we were at 15 % reserve balances divided by bank assets, and that number got all the way down to 8 % back in the middle, in the 2019 policy pivot. So it's our expectation that the Fed, having learned from that lesson, is very concerned about any disruption in the liquidity and the plumbing of the financial system, so much so that they're now going to slow balance sheet runoff with inflation still considerably above target.

8:39And in our opinion, that is an incremental risk on signal from the perspective of asset markets. That's really, really important to point that out, Darius, and that's not going to make it into the first batch of headlines. And for all of those of you who are listening yesterday, you heard Peter Bookvar say how much he was really listening to what they said about the balance sheet. So that's a fantastic flag. So are we right now, if we look at the economy, first of all, is the picture the Fed painted aligned with what your models are telling you about the economy? And it seems like the labor market is really important now.

9:17Yeah, absolutely. So just going back to what we discussed in slide one, we've been of the view that the U.S. economy has been and will likely continue to be more resilient than about 99.9 % of investors for the past almost two years. And both the Fed and general market census has caught up to the 42 macro research view, which we continue to maintain. On inflation, the Fed is now starting to get incrementally closer to our expectation that inflation is probably going to be a little bit more sticky, albeit the trend is lower. The trend is still lower over the short to medium term. However, when you think about this from the medium to longer term perspective, it is unlikely we break down through the long-term trend in inflation in a way that allows us to create a mean of 2 % inflation over a full cycle.

10:02And so in our opinion, we think that because of that outcome, we're going to continue to see the Fed increase its longer-run interest rate, Fed funds rate projections higher and higher as we go over the next few quarters and into the next couple of years to catch up with where markets already are from a money market standpoint, which is higher for longer. Yeah. So that leads me to ask about the bond market because we did see, as we mentioned, we saw stocks rallying, but we did see bonds in the bond market. We did see yields fall, but only a little bit. So would you expect yields to fall further from here?

10:38or are we kind of pinned with the 10-year above 4 %? Is the Fed news kind of already priced in and we're kind of stuck at this level now? 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.

11:08and unlimited demo. See a trading opportunity? You'll be able to trade it in just two clicks. Feel ready? You can move to real money with as little as$100 once your account is approved. And the great thing is that in addition to crypto, Plus500 gives you access to a wide range of instruments. S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus 500. With over 20 years of experience, Plus 500 is your gateway to the markets.

11:43Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus.

11:57Good news and bad news. First, the bad news. Mint is shutting down. The good news? There's an even better alternative. Many Mint users are turning to Monarch money and loving it. Monarch is the top rated all-in-one personal finance app. It gives you a comprehensive view of all of your accounts, investments, transactions, cash flow, net worth, and more. Plus, create custom budgets, track progress toward financial goals, and collaborate with your partner. And now listeners of this show will get an extended 30-day free trial when you go to monarchmoney.com forward slash vision. Monarch has a tool that allows you to easily import your data from Mint and keep all of your tags and categories.

12:43It's the most customizable budgeting app. Change the layout of your dashboard, toggle between light and dark mode, create custom budgets and notifications, set up automatic rules for transactions and notifications, and more. Monarch is obsessed with constantly improving the product. They release updates every two weeks and allow customers to submit suggestions, vote on requested features, and view the product roadmap. After reading the reviews, I can see why it's the top-rated personal finance app. And right now, listeners of this show will get an extended 30-day free trial when you go to monarchmoney.com slash vision.

13:24That's M-O-N-A-R-C-H-M-O-N-E-Y dot com slash vision for your extended 30-day free trial. Go to monarchmoney.com slash vision. Yeah, no, that's a great question. So the incremental news on the balance sheet well off was the key catalyst to cause yields to reverse their course. trying to pick up slide four, where we show the indexed performance of the Treasury two-year, 10-year, and 30-year Treasury yield on a one-day basis. So as you can see, we had a nice spike in the initial phases of the S &P release and Fed's press conference, but that initial spike actually was followed by some sharp declines.

14:07Two-year Treasury yields finished the day on change. The 30-year Treasury yield finished the day down three basis points. Sorry, the 30-year Treasury yield finished the day on change. The 10-year Treasury yield finished the day down three basis points, and the two-year Treasury yield finished today down eight basis points. And so that, in our opinion, was a signal that asset markets need to be incrementally less concerned about the confluence of above target, or not above target, just bloated fiscal Treasury net issuance and relative to a Fed that was not reinvesting the proceeds of its bonds back into the Treasury market.

14:38And so that, in our opinion, is actually quite positive for asset markets. Now, again, we think the trend in Treasury yields is probably higher from here because, again, we have this longer term structural dynamic whereby the Fed has to recognize that the neutral policy rate of the economy has likely gravitated higher, which is something you and I, Maggie, talked about back as early as I want to say August of 2022. And we're now just now starting to see, you know, a few basis points of the Fed acknowledging that here in the first quarter of 2024. You know, we believe the Fed has been forced, increasingly being forced into fiscal dominance by this sort of policy pivot with respect to its balance sheet policy.

15:15If you go to slide five, Brian, where we show some of the key metrics of the U.S. fiscal impulse, specifically the fiscal year-to-date, the year-over-year growth rate of the fiscal year-to-date Treasury receipts. That's the green bars in the top panel. Treasury outlays or expenditures in the red. Those are the red bars in the second panel. And then the budget balance itself in the blue bars in the bottom panel there. We see Treasury receipts are up 7 % on a year-over-year, fiscal year-to-date basis, but that's actually lagging this growth rate of outlays, which is up 9%, and the confluence of that renders the budget balance or the budget deficit itself is actually up 15 % on a fiscal year, year-over-year basis.

15:56So in our opinion, this is, you know, this is the incremental fiscal impulse that we continue to see out of the Biden administration, which in our opinion continues to confirm that he's going all in on winning the election, which was shown on slide six there. In our opinion, we think that incremental fiscal dominance is essentially forcing the Fed to take this sort of laissez-faire, very easy relative to their own projections kind of monetary policy stance. In this chart here on slide six, we show our fiscal policy monitor, which we update every month when the budget statement comes out for our clients.

16:30And what kind of the key takeaways, the key highlight I'd show you in this chart is the, if you look into the year-over-year percentage change column, where we show the growth rate of federal expenditures, they were up 19 % on a calendar year-to-date basis, on a year-over-year calendar year-to-date basis in 2023. And they're up 6 % on top of that here in 2024. And so this is we continue to see very clear and obvious evidence of the Biden administration going all in on winning the election. And as we show on slide seven, it's actually working. So the predicted odds, you know, where we show the predicted odds for Biden and Trump, Biden being the blue and Trump being the red.

17:09Biden is now back ahead of Trump after being after falling behind Trump for much of the past kind of four to five months. And so I don't believe that's going to be sustainable. But again, for now, we continue to see this move that we're seeing higher in Biden's, I wouldn't say approving, but the odds of Biden capturing the 2024 presidential election. Those are rising as he's stepping his foot on the gas from the perspective of the fiscal impulse. And that's something we expect to continue. It's something we expect to continue contributing to U.S. economic resiliency. And at some point in the second half of the year, most likely by the end of Q3, we'll see that start to contribute to unsatisfactory inflation outcomes.

17:48Yeah, it's a tricky one, balancing the benefit from fiscal with the inflation side, which we know has been a hot topic in the election, not just here, but everywhere. You know, people very sensitive to those prices. So that's a tricky one to balance from a political point of view. And speaking of that fiscal dominance, which, by the way, came up so much in week one in terms of the kind of new regime we're in where fiscal dominance is front and center. It's so different from what we were used to previously. And everyone trying to grapple with that was one of the big challenges that came up from our series in week one.

18:26And there's a headline today. I'm sure many of you saw it. Intel awarded$8.5 billion from CHIPS Act grant. Now, remember, the CHIPS Act was passed in 2022. So that legislation is older, but we're seeing some of this stuff come through the pipeline. Could also receive up to$11 billion in loans tied to those legislation. So there's so much of it right now, and it's got to impact so much of the economy, Darius, in a way that really we all have to. I mean, I know you're modeling it like crazy because this is so different from the monetary policy, which was dominant for so long, especially in that zero interest rate environment.

19:02Yeah, no, it's really quite remarkable, quite frankly. I mean, we are in a historic era. This has been a very unique business cycle. This is one of the most, in my opinion, just from someone who's studied business cycles at a very high level for the past 15 years, this is the most unique business cycle we've ever seen. We've never seen such uncorrelation between the various sectors of the economy throughout the business cycle. We've never really entered a business cycle with such high levels of liquidity on household and corporate balance sheets. What else is different? The handoff from monetary dominance to fiscal dominance in this particular business cycle has been unique as well.

19:41We've had immaculate disinflation, which is something that has historically never happened. You typically need to go through a recession to actually have significantly positive inflation outcomes. We've also had immaculate slackening in the labor market, i.e. we've had slack created in the labor market primarily through the guise of reduction in job openings from the perspective of labor demand rather than the perspective of the total employment. And so there's a lot of weird, funky things going on. And if you're relying, like you and I've talked about this before for months and quarters, if you're relying on old models, particularly on the DSGE or autoregressive side of things, those models are not trained, cannot be trained for what we are experiencing here.

20:19So you need someone to piece the puzzle together, 100 % of all the different puts and takes on how the economy actually functions and performs. And if you don't understand that, we highly suggest you partner with someone that does. Yeah, no, absolutely. And it feels like we've been rolling out of zero interest rates was an experiment. This is an experiment. I mean, we're just in that period right now. Speaking of chips, by the way, gosh, if they're not at the center of every conversation we seem to be having, because in addition to all of this, of course, regime of fiscal dominance, we're layering on what is the beginning of what many believe is an enormous tech revolution around AI.

20:57We're trying to figure out what that means, what that might mean down the road, and what role chips are going to play. Jordi Visser and Beth Kendig sat down today and had a fascinating conversation about tech. If you didn't get a chance to see it, it's on the platform. I highly recommend you do. Of course, everyone wanted to know about valuations, about what's happening, about the winners, the potential winners in the AI space. Let's have a listen to a clip from that, and then we'll talk on the other side. Yeah. So I guess I would preface all this and just say get comfortable semiconductors. They are 50 % of the AI market.

21:37That's up from 20 % to 30 % of the mobile market. And they will be, for us, the right way to participate in AI in the near term. We had like 45 % allocation going into 2023 to AI, I want to say 40 % of that was semiconductors. And the other thing that I guess if there's anything to get out of this conversation today, it's that the semiconductors are going to become the AI software players. Already, NVIDIA, the biggest announcements this past week, in my opinion, are the Omniverse Cloud APIs. Apple is now partnering with NVIDIA on Omniverse for Vision Pro headsets. Like, since when does Apple partner with somebody on software to attract developers?

22:26We'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. Few investments make a better long-term hedge against inflation, depression, and economic downturns than precious metals like gold and silver. Plan for the inevitable and protect your environment savings with a gold-backed IRA from Noble Gold Investments. Noble Gold Investments is the gold IRA company that Americans trust. The founders of Noble Gold have more than 20 years of combined experience in buying gold and silver. They have secured more than$1 billion in precious metals for their clients.

23:06Gold remains steady when inflation is on the rise and the dollar is in turmoil. Its value doesn't just hold, it increases during inflationary periods. And unlike money, gold can't be printed. It's your shield in times of economic uncertainty. Invest in something you can hold. Go to noblegoldinvestments.com slash vision to get started. Don't wait. That's noblegoldinvestments.com slash vision. Whenever Beth says, if you take one thing away from this interview, we're all like, mic drop, what? Underline, exclamation point, bookmark that on the platform. Go watch the whole interview. It's fantastic.

23:46And Beth is part of our RV marketplace. So you can go check out her outstanding work there and get a discount in the process. So Darius, how are you plugging this other sort of new era we're in into how you're thinking about things? And I know there's been so much sort of angst about these valuations and the momentum we've seen and the narrow nature of the market. But then you have the kind of these fundamental argument that you also have to plug in. And a lot of people just are not sure what to do with the tech space. And they're leaning again today. Oh, yeah, absolutely. So there's sort of, you know, in our opinion, so there's two things I'll say on this.

24:25In terms of how to think about this as an investor from the perspective of modeling the economy, in our opinion, obviously, AI is going to contribute to faster than what we've experienced in terms of productivity growth. Now, how much, we don't know. So we don't really know what the terminal destination is for that either. But we know that it's more relative to the recent trend, particularly the recent trend of almost two years of negative productivity growth. So AI is one of those contributing factors. We also have sort of declining labor turnover and turnover in the labor market. The crits rate and the hires rate are now back to at or below trend levels.

24:59So that is contributing to higher productivity in the labor market in terms of that reduction turnover. And then we also have improved supply chain conditions. And one of the things we track are the supplier delivery time components of the ISM manufacturing services reports. And those numbers are at or below levels that are below cycle lows from previous cycles. And so we know that if we have slower supplier delivery times, i.e., better supply chain conditions, you can create more widgets or more units of a service in the same amount of time. So we're having this productivity renaissance here in the United States of America.