How High Will U.S. Rates Fly? w/ Joseph Wang aka 'The Fed Guy"

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2:08How high will U.S. rates go? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Joseph Wang, Principal, FedGuide.com. Hi, Joseph. It's great to see you again. Hey, Maggie. It's so great to see you again. It's great to be back. Yeah. On a week that, as we were discussing right before we came on, has been very busy for central bankers. We've heard from all of them, all of them on the same stage at one point. And we've got some really interesting economic data. And that really seemed like it was driving today here in the US. We had a little bit of mixed action on stocks, the Dow, S &P, and Russell all higher, Russell up by more than 1%.

2:46But Nasdaq, just about flat. Looks like it was trying to sort of come back and inch into positive territory. We had yields up on treasuries after U.S. GDP revised up. It seemed to catch everybody by surprise. What's going on with this U.S. economy? That's a great summary. So what I think is happening is that over the past few months, there have been a lot of people in the investment community who are thinking that the U.S. is going into a recession. And if you are going into a recession, I think the standard playbook over the past few years was to buy big tech, buy bonds, wait for the Fed to cut rates.

3:22And that's been the story for the past couple of years, actually. The market has always been basically fighting the Fed, thinking that the Fed will be cutting rates anytime soon. This recent data really, really turns that narrative upside down because the GDP data was very positive. So this is the third read of the quarter one GDP. The GDP data usually gets revised several times. And so this revision was very positive. It shows that GDP growth at 2 % annual rate the first quarter. Now, this is notable for a couple reasons. First, it shows that we're not in a recession and the economy seems to be accelerating.

4:04Okay, so that's the complete opposite of what many people expected. And the second point is that this is above the Fed's perceived long-term trend. So the Fed has been trying to slow the economy down, try to get inflation down. According to Fed's forecast, they think that the potential growth of the US economy is 1.8%. And Chair Powell has been telling everyone they want to get GDP to grow below trend. This is not below trend. This is above trend. And it shows that after doing 500 basis points of hikes, the Fed doesn't seem to have accomplished what they want to accomplish. That suggests more rate hikes.

4:42And it suggests, of course, higher yields and, in my view, ultimately lower risk asset prices as well. So and we'll dig into that a little bit in a moment. We've, by the way, got some great questions coming in already and we will get to them, everybody. But let's just sort of get Joseph's sort of macro thinking before we dive in. You know, it's interesting because they decided to pause. Right. And so he kind of has explained that many times is that they're still very hawkish, but it's just speed isn't as important right now. But it's interesting to see that even that GDP come up higher than expected.

5:17And it's not just that, right? We had weekly jobless claims fall the most since 2021. It seems on so many different levels that as you point out, it's not just resilient. That's the word we were using. It seems like it's regaining momentum in some areas. Is this just the policy lag is taking longer or is the tightening they've done to date just not enough? So I think it's because the policy they've tightened is just not enough. And with respect to lags, I actually think the lags have already passed. And that's why we're reaccelerating again. I think a really good area to look at is housing, for example.

5:57Housing, last year, mortgage rates went up, went around 7%. Housing slowed down a lot. You know, house prices came down a lot. And then at some point in quarter one, it seems like housing prices bottomed and housing is re-accelerating again. And by the way, at Chair Powell's recent press conference, he also said that as well. So that seems to be that the tightening happened and is over. And now we're working through that. And, you know, home builders are approaching all-time highs. Housing starts are increasing again. Housing prices are increasing again. And that's supposed to be one of the areas that is most impacted by interest rates.

6:34So I think the Fed has a lot more work to do. Yeah, it would appear to create a real dilemma for them. And that's super interesting, Joseph, if you think that lag's hit already, because I think that's what people have been holding out for when they're trying to game out the timing of the recession. You know, looking at this has been a very aggressive tightening, but I wish we should just have that chart on replay of the massive amount of stimulus that hit the economy post COVID when you try to think about the balancing act they're trying to do. You mentioned housing. Warren Pies was on with us a couple of weeks ago.

7:07For our regular viewers, you remember, we had a really, really interesting conversation about housing. He's really digging in deep there, looking at construction payrolls, very much on the same page with you, saying, hang on a second, this is not, we are not getting the kind of readings we would that consistent with recession. And he raised the idea that maybe the Fed needs to fine tune its inflation fighting efforts. Let's have a listen to what he said, and we'll talk on the other side. If it was me, I think what they could do is you're talking about the housing market, you're talking about borrowing channels, raising that front end.

7:41What we've seen is it kind of is it has this kind of perversely stimulative effect where it actually increases this interest income to a certain small segment of the population who already have a lot of money. And then it incentivizes economic activity through that channel. I think they need to really hit the borrowing channel. They want to slow the economy down and slow inflation down, slow down housing costs. And that would point to additional QT or more aggressive QT and balance sheet operations. I thought that was such a great observation. And I've been thinking a lot about it because we just haven't been talking about QT at all.

8:18So I think it speaks to this maybe two-zone economy where there are the halves or those with some wealth, especially wealth connected to investments, treasuries, the higher yield that are benefiting still from this and maybe have some of that, the gains in tech or the stimulus still in their savings. And then other parts of the economy and workers that are much more stretched, you know, and who are running up their credit cards and who are living paycheck to paycheck. And we still see that we anecdotally know it. Right. Many of us are those people. So what do you think? Is there a conversation at the Fed that maybe they've got to be more targeted and try to address the parts of the economy where there still is a lot of stimulus?

9:10So absolutely. I think Warren makes a really good point in that the Fed should be trying to, I guess, change the way that they are doing more strict monetary policy, but perhaps changing their QT to try to get longer-dated yields higher. After all, raising the overnight rate doesn't really pass through to the economy all that much. It's really the longer-dated yields, let's say the 10-year, that's much more economically sensitive, right? If you are getting a mortgage, then that's mostly keyed off of the 10-year yield. But the Fed actually has been pretty resolute when, as to not changing their QTA policy, from their perspective, it very much seems like it's on autopilot.

9:51However, right now, it's expected that the U.S. Treasury will continue to issue massive amounts of debt. I think the expectation right now is between$1.5 to$2 trillion a year, basically forever. So eventually, I would expect the 10-year yield to go higher. One thing though, is that I think the Fed has kind of made, kind of, is kind of creating a problem for themselves because over the past few years, they've basically taught the market that, you know, if anything bad happens, we're going to cut rates, we're going to cut rates. So now when they want to change their tune, the market doesn't really believe them.

10:28And so that's part of the reason why long-rider yields are stuck at such a low level simply because the investor class has been conditioned over the past few decades to always expect lower rates. And so that psychology has to change before I think we can actually get monetary policy to be more restrictive through higher, longer-divided yields. Now, Warren also makes a really good point that I like in that monetary policy raising the overnight rate has an uneven balance where it increases interest rate income for some people. So I took a look at this for the non-financial corporate sector, and this is really interesting.

11:04So in quarter one of 2023, the net interest rate payments made by the non-financial corporate sector in the U.S. actually declined compared to last quarter. Now, how does it make sense for interest rates to go to 500 basis points, and yet the net interest expense of the non-financial corporations declines? That's because a lot of their debt is longer dated at regular low interest rates, but they also have a lot of money market fund investments and deposits at commercial banks that are paying close to 5%. So, so far, it hasn't actually been constraining to the non-financial corporates. It's been marginally increasing their interest income.

11:46Hey, 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. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and 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.

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12:59That's so interesting. So that's stimulative. Yes, it is. You know, it's funny because we talked to Warren Mosler and I know MMT is controversial and people feel really tribal about it. But he was making this point that conversely, now I don't know that you can run the logic all the way out. I think if you start to do that, that's where we get some disagreement. But this idea that raising rates has a stimulative effect, some people really push back on that, but it appears that that is true for segments of the economy. Absolutely, for segments of the economy. And it also depends on your stock of public debt.

13:34So this stimulative impact wouldn't really happen for the private sector because in the private sector, let's say that I'm borrowing from you, Maggie. Well, if I pay interest payments to you, I have less income, you have more. It's a redistributive effect. There's no net increase in the amount of purchasing power in the public sphere. But when you're talking about public money, well, how does the government pay for its interest rates expense? It just prints more treasuries, right? So if you have a lot of public debt, then raising the interest rates increases the government's interest rate expense and forces the government to basically print more treasuries, which increases the purchasing power of the public, as Warren Mosler noted.

14:16So our debt to GDP is pretty high. I'm not sure that it's high enough for that impact to dominate all their impacts, but it's definitely something we need to keep in mind simply because we haven't actually been at this level of debt before. Well, actually, not since the wars anyway. And interest rates are very high. So I think that makes the Fed's job a lot more difficult going forward. Yeah, that's a great observation. And it's, I think, important for us to tease that out as we scratch our heads and wonder why we're seeing the economy continue to, you know, fire away as it has given in the face of those rate hikes.

14:51So one thing you hear, Joseph, and I don't know if it's just the other side of the coin of something you just said a moment ago, if you see difference. Some people, you just said something very interesting that the markets are kind of conditioned that when things go bad, the Fed's just going to come in and hike rates. So they're kind of looking out as they do and anticipating that that's what's going to happen. Is this the same as if we hear people say the feds, because they're working with basically the blunt instrument of the fed funds rate, they're going to hike until they break something. And what they're going to break is the economy and the labor market.

15:25And we will have a recession because the only way they're going to get inflation under control is to force us to have a recession. And at that point, depending how bad it gets, or if they break another part of the system, they're going to have to come to the rescue. Is that the same thing or do you see market psychology as something separate? Can the Fed change the psychology of the market but maybe not throw us into a deep recession? I think there's definitely some of that going on. I think if you ask me or I think most people a couple of years ago, what would happen if the Fed hiked rates to 5 percent?

16:02I think we would all be very bearish on the economy and the financial assets. But, you know, we're at 5 percent and things seem to be OK. We have the stock market basically going up every day for the past month. So I think the people who are betting on, let's say, the Fed is going to have to cut rates soon because something will break or we will go into a recession, have been wrong so far. and I think they'll continue to be wrong. And I think so for a couple of reasons. Now, if you're thinking that if you hike rates to five or even 6%, you're going to cause some kind of financial accident where we have some kind of financial crisis that forces the Fed to cut.

16:41I think that's not in line with how central banks operate today. Now, there's been a lot of discussion about this in the central banking community. And that is to say, how do we maintain restrictive monetary policy and financial stability. And the conclusion is that we can roll out these targeted facilities to address any financial instability that arises. And we've seen this in action recently, twice. Now, last quarter, the last two quarters ago last year, so the end of last year, the UK obviously had an accident in their gilt market. Gilt market imploded. Gilt yields shot to the moon. And what the Bank of England did was they rolled out targeted asset purchases.

17:25And after the situation calmed down, they went right back to hiking rates. So targeted facilities prevents implosion so we can keep hiking rates, no need to cut rates. Same thing happened in the US in March. So we had a bit of a panic in the banking sector. Fed rolls out new bank lending facility and then goes back to hiking rates. So if you're thinking that the Fed would eventually break something in the financial markets forcing them to cut rates. I just don't think that's how the world works anymore. Now, on the second point, let's say the Fed hikes a lot, we get into recession and the Fed cuts rates.

18:01Again, this strikes me as breaking the cardinal rule of investing. That is to say, don't fight the Fed, which has been the rule since the Great Financial Crises. Now, the Fed has been telling you very clearly that it wants to slow economic growth down. It wants the economy and unemployment to go higher because that's how it thinks that it gets inflation under control. So if we get a recession, if we get slower growth, that's exactly what the Fed wants. They were telling you they're going to keep rates higher for longer, and not just the Fed. Basically, all the developed markets, central banks, except the Bank of Japan, have been on this.

18:38Now, I would also note, though, that since I study the financial system, and that's kind of how I make my investment choices, the Fed has hiked rates to 5%, but if you look at common channels of monetary policy transmission, it's just not effective. And so that link between high interest, high Fed funds rates and weak economic growth doesn't seem to be there. And we can see the evidence of that clearly today as GDP continues to be revised higher. As Warren Pye notes, of course, you know, Housing market, still quite strong. If you look at financial assets, which is also a way that the Fed tries to tighten monetary policy, negative wealth effect, lower financial assets, people have less wealth to spend, less demand for goods and services.

19:25But if you look at financial assets, they're all doing quite well. So the channels of monetary policy transmission are not working as well as the Fed thought they would. And that's why they keep revising up their economic projections as well as their terminal rate. And I suspect they have more revisions upwards to go. Do you have a target for the terminal rate? How high do you think rates can go? Yeah. So, you know, if you look back for the past year, in the beginning, the Fed was telling everyone that we're going to be higher for longer. We're going to hike to maybe at 5%. And the market was fighting that, thinking the Fed first that they would not get there.

20:02Secondly, when they get there, they would cut rapidly. Now the market is becoming more and more on the same page as the Fed, thinking that maybe we might actually do have two more hikes this year to get to 5.5. I think 5.5, that's reasonable. But if I had to weigh the balance of risks, I think the risk is that we go even higher, even perhaps to 6%, maybe not by the end of this year, but maybe early next year, simply because what they're doing is not working. And what we see clearly is that the U.S. economy is doing well. Wow. OK, that's a big adjustment to get to. So let's cycle in a couple of questions here.

20:44Daniel asking, do you have any insights you can share about regional U.S. bank capitalization ratios at current? Just so if folks missed it, major banks and institutions passed the stress test today pretty easily by the signs of it. In fact, JPMorgan Wells, they were some of the biggest gainers, best performers today. What are you thinking about regional U.S. bank capitalization ratios, Joseph? So I think there's a—so right now, Vice Chair Barr of Supervision at the Fed, who's the guy in charge of setting regulations for banks, is in the process of proposing new bank capital regulations. And if you listen to the most recent testimony when Chair Powell went to Congress, you note that the congressmen were basically very, very interested in one thing, and that is bank capital requirements.

21:32They had, I don't know, over and over again, they were asking Chair Powell, you know, are you going to raise bank capital requirements? Is this a good thing? Don't you know that this will constrict lending and so forth? So on the one hand, you have the Fed and probably some politicians wanting higher capital requirements. And you have the second thing in status, the bank lobbying groups are in full court press to try to stop this. So at the end of the day, I suspect that we will see some kind of higher capital requirements for some of the large regional banks. Now, these aren't the small banks.

22:08In the U.S., you have about 4 ,500 banks. The vast majority of them are very small and will not be affected. But going forward, you could see, I think, not just the GSIBs, but the, let's say, the next year down, super regionals have slightly higher capital requirements. Now, at the moment, I think the capital that they have is totally adequate. Now, what happened in March was not a capital problem from my perspective. Capital is a liability of a bank. It's used to absorb credit losses. There have been very limited credit losses. What happened in March was a liquidity problem. So from my perspective, I don't think higher capital requirements is necessary.

22:46And so I also don't think that banks lack capital today. 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.

23:01So speaking of liquidity, I think it's Lasse. I'm sorry for pronouncing your name wrong. Thanks for the great shows. Oh, thank you. Question, could Mr. Wang comment on the global liquidity situation? Does he see it declining or growing? So liquidity is a kind of amorphous term. I think if you ask 10 people, we have 10 different definitions. What people commonly think of in the Twitter world, actually, when they think of liquidity, it's often referring to something like reserve levels of commercial banks. You see that actually staying about where it was right now. There is a lot of concern that after the debt ceiling was resolved that the TGA, so the federal government would try to refill its checking account at the Fed of the Treasury General account, and that would suck out liquidity out of the banking system.

23:55That was a very likely scenario at that time. But what happened was that the U.S. Treasury actually adjusted its debt issuance so that future buildup in the TGA would come more out of the money market funds rather than the banking sector. So what the U.S. Treasury did was that they concentrated their debt issuance in very short-dated Treasury bills, which are attractive to money market funds. So what we're seeing happening now is money market funds taking money out of the reverse repo facility and buying these short dated bills. And the money then goes to the Treasury General account. So I think that that risk is is off the table so far.

24:34Amazing. That's a fantastic point because we talked about that endlessly. Douglas asking, this is why when you know the financial plumbing as well as you do, Joseph, it's it's magical. Douglas asking, what happens in two months when a rate auction fails? How bad do things get? There's a presumption you're making, Douglas, that a rate auction will fail. So maybe let's start with that question. Do you see any concern about global markets absorbing all of this issuance that's coming from Treasury? So that's a really good point. There's a tremendous amount of issuance coming out. As I noted earlier, it's not going to stop.

25:11It's going to be$1.5 to$2 trillion forever. Now, I'm not worried about an auction fail. So the way that the U.S. government sells debt is that it sells debt through auction. So the auction is held by the New York Fed, and the participants are largely the primary dealers, which are regulated entities that have the special privilege of trading with the Fed. Other people can participate as well, but they have to apply for it. But it's mostly primary dealers. Now, if you're a primary dealer, you have an obligation to bid at the Treasury auctions. And this is to guarantee that auctions never fail. at the end of the day, someone will buy them.