Did the Fed's Message Fall Short?

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1:24And now to the top analysis of today's markets.

1:34Did the Fed's message fall short? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Jeremy Schwartz, Global Chief Investment Officer at WisdomTree. Hi, Jeremy. It's great to see you. Thanks for having me, Maggie. Good to be with you. Yeah, and kind of an interesting day, right? We watched the Fed yesterday, pal and gang, do their best to characterize the decision as a hawkish skip, really emphasizing that fight on inflation, but it doesn't seem like the market's reading it that way. U.S. stocks all in rally mode up over 1%. Treasury yields are down. What do you make of this?

2:08There's something for everybody in that kind of statement. And actually, the data has been coming. And the market today is sort of like this Goldilocks market where it's not too hot, it's not too cold. Fed's just kind of right. Now, we think they are being too hawkish, actually. We actually don't think the economy is quite as strong and a sense of inflation we think is coming way down more than Powell is even saying. But he's made good comments. He's making comments about the cumulative tightening, that monetary policy takes time. Obviously, they skip. Now, he said skip. I shouldn't say skip. It was a funny quote when he tripped over his lines there.

2:52But But the dot plot reads out hawkish with two more anticipated hikes. They're anticipating better growth, actually still higher inflation, lower unemployment. That lower unemployment is sort of this Goldilocks scenario. They can pretend to be hawkish with this sort of two hikes in the dot plot, but they don't have to hike. And it could be a pause. I mean, we've been saying this is likely the last hike. And I definitely have other friends and economists who are saying, no, they're going to keep hiking. They're going to hike in July. They're going to hike later. Inflation is sticky. And I understand some of that.

3:30But we have our own measure of inflation. We call it sort of the alternative inflation that reflects what's going on, what we see more in the real world. And Powell is talking about housing coming down. Now, there's issues in all the way people calculate all sorts of things in the CPI. But, you know, the shelter inflation in BLS is annualizing at 8%. And that is a significant component of traditional CPI. Now, that shelter number has two components. It has an owner's equivalent rent, and it has rent. Rent is increasing. If you look at real-time rent from Zillow, it's 6 % year over year. But Case-Shiller housing is zero to negative year over year.

4:19I mean, so it's come way down. Seven of the last nine months, it's come down. So when we put in our calculation for shelter inflation, I have half of 1%. So I put out this chart right after inflation came out. And instead of 4.1 headline inflation, my numbers show 1.4. Well, that's a big difference. Big headline. It's like, hey, they've already achieved their goal. I was saying soon. My number might get to zero this summer. So wait, so walk us through again why. And it really reminds me of Jeff Gundlach yesterday saying, like, I think they're looking at the wrong things. There's this high-frequency data that's happening now in the economy, and he also sees a rapid deterioration, both in inflation and growth.

5:07I'm going to come to that. But why is your inflation read so different than the Fed's or to the standard model that we're on? What's so interesting is how important this housing number is. The only thing we're doing differently, we're using all of CPI, but we're substituting a different housing number. And so it shows you how important shelter inflation is in the number. Shelter inflation is 8 % in the CPI numbers that everybody's quoting. But in the real world, it's not 8%. I mean, rents, yes, 6%. But even rents are only a quarter of the shelter inflation that's in there. It's this owner's equivalent rent.

5:52And what is owner's equivalent rent is a whole other question. But it ultimately will track home prices to some degree. And this is where home prices are going at zero to negative the last 12 months, not 8%. So do you know why there's such a discrepancy in that data? And presumably, if you know it, hasn't anybody told the Fed? Well, they did, to their credit, a few months ago, they did start saying, this is why you started hearing them say core services at shelter. So you finally did hear them say this core services at shelter. But shelter is a huge part of it, particularly if it's declining and offsetting the inflation they have elsewhere.

6:32So they're starting to recognize that some of that inflation is coming down. Ours is coming so down that it offsets everything else and actually gives you this. In my view, my number is going to hit zero this summer. It's already below 2%. It's already below their target. He's saying it suggests easing on their targets. Which the market has backed out now. The market's taken all the easing out this year. I mean, Sewell does have a loud voice. He is on CNBC all the time. People are listening to him. But I don't know. So the market does not believe what they say. And generally, the market can be right.

7:10But if they stick with this overly hawkish narrative, that is the true issue. I mean, the market's not cheap. There are segments of the markets that are really not cheap. And so the more they keep pushing and try to tighten inflation that's not really there in our view, that's where you have an issue for the economy. So is it fair to say, if you're looking at this, that shelter explains the stickiness of inflation, at least in the traditional measures, and that it's not coming from wages? The Fed's kind of hinted at this. Are we past the point where we're concerned about wage inflation? That was another positive.

7:53I say if you go back to the positives that came from this press conference, for a while it sounded like Powell was really anti-labor, really anti-American worker who has not kept up with inflation. Like, so wages have not, the last two to three years, it's not, there's been declining real wage growth. And, you know, you say the worker, you create, and if you really want to point at the thing, you say, hey, you created all this inflation. You let the money supply expand 40 % from March of 2020 to March of 2022. And now you're telling people you can't catch up with inflation. What are you telling the worker?

8:29Why are you telling them they can't catch up with the inflation you created? So, and now you're getting to election season is do you want everybody hammering the Fed is that, you know, you really shouldn't be so anti-labor, anti-worker, let them, you know, yes, we need to address inflation, address inflation is a real issue. Prices are high. But it's coming down. The growth rate's naturally coming down. And you should let the worker catch up. They deserve to catch up. Yeah. And if there's no sign that it's a wage spiral, then they can. If it becomes clear that it's the sort of backward looking shelter component, then again, I think you're stringing together why we see the market looking through the hawkish rhetoric and saying, OK, if it's a lag in shelter and that's coming down, maybe some measures that the sort of more real time measures that the Fed's not tracking are coming down.

9:26Inflation less of a problem. The Fed doesn't have to kill the job market. We don't have to see skyrocketing unemployment for them to finally pause or hold them here. But that will support the economy. So are we back to, dare I say, are we back to a soft landing scenario? Or is that just crazy talk? Well, I mean, the markets are saying this is Goldilocks. I mean, that is definitely what it's saying. Same thing, right? Bullish thing. I'd say your point on the wage price spiral, very important and spot on, is that if wage growth was going way above inflation, that's what goes for the spiral is that, hey, wages are outpacing inflation.

10:08Now they start raising prices to keep up with the pressure they're trying to put in wages. But wages are not keeping up with inflation. So the negative real wage growth is why there's no real spiral in our view. The higher wage growth in the system is slow moving. It's sort of, it'll catch up over time. You know, people renegotiate contracts every year, but, you know, and there's a question of slack and will unemployment rise. And hey, the Fed's forecast the unemployment to rise to 4.1 and four and a half next year. So they are expecting a softness. Now, before they actually, they were projecting a recession because they were saying we're going to have, based on the good Q1 GDP, and then they're basically where their outlook for the full year GDP was, they were projecting negative GDP growth for the last three quarters.

11:03They're no longer projecting a recession in that sense. But it's still pretty sluggish growth and not an overly strong environment there. We still have hired a lot of workers, and there's this question of productivity, like what are all these workers doing? It's been a very perplexing, we hear about AI and how AI is going to transform the economy and make us so much more productive. You haven't seen that in the official data yet. And the question will be, this was one of the things we thought could help save the economy this year. We might actually, we thought we'd go into this year and have negative employment growth and positive GDP because productivity would rebound from dismal, dismal levels.

11:44productivity still seems dismal, dismal levels because we're still hiring a lot of people and we still, you know, and the economy is not growing at some gangbusters pace. So productivity is still negative and not a useful contributor. So that's an interesting. It's one to watch though, isn't it? Because I feel like we've been doing a festival of learning here for the last two weeks. And I feel like, which if you missed it, if you're a member, You can, of course, rewatch it on the platform. I feel like a lot of the, I'm going to call them bridges to all of us, right? Like there was all this development of it, but then it landed on our computers and chat GBT.

12:23So the sort of bridges out to the general population, to companies to really sort of use this, they're there, but it's still so early and it's moving so rapidly. So we don't know yet, right? We could still see that productivity. It may just be a little bit further down the pipeline. Why does that matter? Why do you pay so much such close attention to productivity for people who may not sort of understand how that plugs into the equation? Well, it's important. There's economic productivity and then there's company profit margins, which is another way of expressing it. You know, like the economic wide is pretty straightforward that you have real GDP is how many people are working and how productive are those people?

13:04Like the output per hour worked, Which is another point on economic growth was you heard at the last jobs report, people were like, oh, it was a decent jobs report. But hours worked ticked down a tenth. And when you have a tenth of an hour worked less, when you have something like 34 kind of hour work weeks and you have a tenth, that's three tenths of an hour worked less. There's 150 million people. And so you just multiply three-tenths times 150 million people working, that's like 450 ,000 jobs less. So we had a 360 ,000 job number last month. They worked less. So it wasn't that great of a jobs number.

13:47There were people sharing last job number. It wasn't quite so good because that hours worked often gets ignored by a number of commentators. But how many hours worked and how productive are you in those hours are the key variables. Now, for profit margins, if you could do more with less, that's like the ultimate definition of productivity. We're always being sweated. Can you sweat a little harder? Can you work harder? Can you do a little bit more with either less resources, less people? And technology can do that if you potentially are able to do more with less, if technology solves that issue.

14:25And so profit margins could be supported. I mean, that's what you see with Meta. The classic year of efficiency is their, what is it, 25 to 30 percent of their workforce? They're not being any less productive. The profits are actually doing well. You see they're way overhired. Now they're scaling back. Can they do more with less people? That's the classic definition of productivity. 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.

15:00Yeah. Can they do more with less people? And then the next question, as we think out further out down the AI line, and this is where we don't know, but a lot of really interesting speculation about this, does that free up those people to do brand new things that we don't know? Or does it just result in us having to kind of completely redefine what people are doing? That's going to be, but that's a much bigger further out. So very interesting. And we talked to Jim Bianco yesterday, He had some thoughts about the change nature of work, sparked a lot of comments on the platform, which was great to see.

15:31And we'll revisit that, everyone. But we were also talking about, so on the issue of profitability, so this kind of brings us to the stock rally that we're seeing. I want to ask you about the banking sector because so we've got this Goldilocks sort of moment. The market's taking off. Risk appetite is back. But no, not too long ago, we were worried about the situation with the banking sector. We spoke to Jim about it yesterday. And even with a pause, he's less worried about sort of wave of failures, but is really paying attention to the profitability part of the banking sector. Let's have a listen to what he said, and we'll talk on the other side.

16:13Right. And what's going to happen is a lot of the banks that are, you know, the ones that pack Wests in the Western Alliances, you know, Pack West is in Beverly Hills, Western Alliances in Phoenix. These are big regional banks that have been under stress. There's been huge borrowings by the Federal Home Loan Bank. Remember that before you get to the Fed in the Fed discount window, the joke about the Federal Home Loan Banks, it's structured very similar to the Fed, is it's the lender of next to last resort, and the Fed is the lender of last resort. And they have extended over a trillion dollars of credit to a lot of these regional banks.

16:48Now, that means that the regional banks are liquid. They have no liquidity problems, but that money is expensive. What is good for them and good for their profitability is you leave your money in the bank getting half a percent because they could take the money, pay you half a percent, lend it out at 6%, keep the rest for themselves. But if you take your money out of the bank, they lose that deposit. And, of course, you put it in a money market fund. That's not a bank deposit getting 5%. They have to replace your lost money. They can go borrow from the Federal Home Loan Bank, but it costs them 5 % to do that.

17:22So now all of a sudden, their cost of funding is just skyrocketing because of this. So you're right. The Fed will look at this and go, banks have profitability problem, not my concern, raise rates. And if there is a problem with the profitability, call Michael Barr, the head of supervision, tell him to send some bank examiners to talk to them. That's the way that they're going to look at it. That was part of the extended daily briefing we did yesterday. We do it each Wednesday now. We've shifted it so it's midweek so that we can have time to talk about it and put some things into practice. If you want to be able to participate in that part of the discussion, scan the QR code, join our community so you can be an RV member.

18:01So, Jeremy, you know, interesting to bring that up because it's like, oh, that's in everyone's rearview mirror, too. How are you thinking about the banking sector? What's your outlook? You know, Jim and one of my colleagues, Jeff Winninger, have been extensively using the term bank walk to describe some of the dynamics with the bank, which is, hey, we're not worried about bank failures. But the fact that you can earn 5 % risk free and basically treasury security, I mean, we have an ETF called the floating rate treasury ETF, USFR. It's got one week duration. So there's the volatility from price of interest rate movements.

18:39If you look at the, it's been in the markets in 2014 when the government first issued these securities. The NAV is very stable like that because it just collects the interest and it resets every week. And you're in the 530s, 540s, and you don't have any people talk about FDIC insurance or the bank deposits safe. Well, the banks are passing along what you could earn in these treasuries, which are now over 5%. And so that trend is going to continue. Now, what's really interesting, we've seen our ETF, and even today it's traded another$500 million. So there's still a lot of people interested in this fund.

19:16It's a$16.5 billion fund. One of the interesting things we're launching in the next few weeks is called Wisdom Tree Prime. And what's very tricky for the banks, we're going to have things where you could keep your money in treasuries, digital treasuries, but then essentially links spending to that on top of it, which is sort of a form of modern banking, in my view, and that you could actually spend off treasuries. I think the banks are challenged in the sense of they're not paying, to his point on profitability, they're not paying the 5 % that everybody should be earning. And so we think this bank walk continues.

19:53We think there's other people doing stuff like what we're building. So you guys are basically innovating as the banks are handcuffed by this. You guys are stepping on it because you can. Wisdom Tree Prime wait list is there in the next few weeks. That's really, and if other people are doing it, that's going to be, so this is not just like a hiccup moment. This is now trends which will be in place, which are going to really challenge the bank business model. And you even heard Powell say it's early to say all the fallout. Like he was close to say, we don't know what's going to happen. And yet, you're sort of saying as long as it's profitability and it's not systemic, you know, inherent sort of failure of a large institution, they don't care.

20:38That's not their problem. Talk to somebody else. Talk to bank supervision. Talk to shareholders. Feds are not going to do anything about that. Is that right? So, you know, you heard Yellen basically testify at one point saying small banks, not my problem. It's the large banks. And if you and if you have a large bank, we care about you. If it's a small bank, you're on your own. And I do think the mentality is from the Fed, this is their problem. You know, if the banks want deposits, pay the appropriate interest rate. Right. Like don't let people go to things like our floating rate treasury or money market funds.

21:11Pay the five percent that they can be due. So I do think the bank, the Fed is not overly concerned about that issue. You know, they're saying they're happy if the small banks collapse and go to not collapse generally, but just they consolidate. Yeah, it collapse in smaller, like less in the market. I know you need to consolidate, get concentrated in the big and the big banks that might have other sources of profitability and less concerns. But it is a strange thing for even like the largest bank among the largest banks, Bank of America challenged on this exact question. Why are you not paying your people the appropriate 5 % interest rates?

21:50And part of it is because they have so much checking, how much they don't want to sacrifice that profitability, which is, okay, smart in the short run, not smart in the long run. You know, there are these other options that the way technology is going that will provide more competition for them. More competition, of course. I'm sure there are going to be a lot of people weighing in on consumer protections around all of that, insurance, blah, blah, blah, all that stuff. But you're right. And forget what you add in fintech and everything else. G. Blackburn says deposit flight, higher Fed funds, real estate, corporate credit issues, all risks for bank.

22:27What is the upside? Is there an upside? Is there any buying opportunity in this sector if you go up the food chain to the larger? Well, the thing that's my point on buying treasuries is you remove all that question about the FDIC insurance and the safety. It's you have one-for-one backing. Your collateral is the Treasury. So that safety concern is so different, you know, versus, hey, you're just an unsecured depositor. You do have to worry about the bank health. If you have Treasuries, you're in good shape. I mean, there'll always be these debt ceiling limits, but the government's pretty good at paying back.

23:04Well, if that's the worry, yeah, we've got bigger fidgety, right?

23:10I am still caught. I agree with this sort of Bianco and my colleague Winninger kind of view on this bank walk scenario that I think there's a longer term problem. And so I'm not rushing into the banks. I mean, there are definitely people who want to say, hey, these are really cheap. If there's a big if, if people do not care about earning the 5 % interest, then OK, they're fine, they're cheap. But I think people care about the 5 % interest and over time will want that. Yeah. Can the broader market do well without the banking sector? Or can we see it broaden out to everything else but the banking sector?

23:48Because right now there's a lot of concerns about how narrow it is. around. There's no question this year has been the revenge of tech. You know, big tech is dominating. AI, anything AI related is dominating. And then everything else is sort of sluggish. Brett did improve recently and sort of small caps have been catching up the last very last few weeks. But I think, you know, small caps are more heavy with these banks. So that's the main conundrum is I like the valuations on solar small caps, but the issue is that you get so much of the banks that I prefer going up in quality. I mean, I think if I'm going for value, things I probably talked about with you before, I like Japan, which is sub 10 PEs on some of our Japan value things.

24:34International has very reasonable values, half the PEs of the S &P. But US small and the banks, I do think still have some issues. 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.

24:56So we have an interesting, if we're looking international, we have an interesting setup because you have divergence, right? We just saw the ECB raise rates today, citing inflation. They had paused. We saw Canada, same, raise. And we've got a policy decision for Japan, but now people, it sounds like maybe thinking that they're going to sort of hold on to that negative interest rate policy through the remainder of this year, when it looked like it was more on the table earlier with the change in. How are you seeing that sort of interest rate differential? That's one of the most interesting things about Japan is there's now this 5 % carry trade.