Is Everyone Wrong About U.S. Rates? With Harry Melandri

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

1:41Is everyone wrong about US rates? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Harry Malandri, advisor at MI2 Partners. Hi, Harry. It's great to see you. Hi, Maggie. It's always good to see you. How are you doing? I'm doing all right. I'm doing all right. So if we look across the markets today, a little bit mixed. We had the Dow up, but S &P and Nasdaq kind of drifting down, treasury yields creeping back up, as was the US dollar, but pretty muted overall. And I'm interested to get your thoughts because as we sort of have gone through the last weeks, you hear a lot of different perspectives.

2:20And our pro members know that you have the incredibly difficult job of moderating, some might say playing referee on our monthly macro insider show that Raoul and Julian do. And I know that three of you have been going back and forth about what's happening in the economy. And I want to play a clip from that and then break down your macro outlook on the other side. Let's have a listen. The risk is that you have actually a shrinking labor force, or at least not a growing one, in an environment where we're trying to reaccelerate, where nominal GDP is not shrinking much. It's come down a wee bit. But inflation has dropped a fair bit.

3:02And so you just play this mix between either higher inflation or higher real growth. And higher real growth is just not. We've never seen a real sustainable acceleration in higher real growth from 3.6 % unemployment. And I don't see that labor force increasing until either you, you know, we You have some bloody miracle. Or you smash equities to the point that all those retirees come back, right? And until AI kicks in, that could be two years, three years in real economic terms. And that's a lifetime. Raoul, what happens to your thesis if the Fed holds rates at current levels to 2024? Zero in terms of asset price performance generally.

3:55the issue where that would test my everything code thesis is the interest payments on the debt. If we don't see a balance sheet increase to deal with that, then something structurally has changed that allows for the payment of those debts. Now, could it be to do with Julian's idea about nominal growth? I think real growth is actually the underlying factor behind the interest payments, but maybe there's not. So that's what it will do is test that thesis about the liquidity thesis and the fact that interest payments get monetized. And that full episode is on our website. Raoul, Julian, and Harry put each other to the test once a month on our pro tier.

4:35You can check it out there. And Harry, Jordan, we obviously have a few viewers, lots of people happy to see you roll up on the daily briefing, as are we always. And Jordan said, we need a show filled with Harry's dad jokes. I agree with that. Because he was just doing it while the clip was running. You have ESP. I didn't even know there were dad jokes. That is a whack and a half. So as long as the glare from my forehead, expanding forehead, isn't blinding you, Maggie, I'm happy to talk about any of this macro stuff. All right. So let's pick up from that because you and early on, And we know Raoul and Julian have slightly different views.

5:18Sometimes it's just because their time frame is different. But I think that in that show, you've all been unearthing the fact that there are a couple different sort of narratives out there. They're often competing with each other, whether we look at growth, whether we look at inflation, whether we look at the direction of interest rates. Everybody can't be right. So how are you thinking about this? So first of all, I like the point that Raoul made. Of course, I work with Julian all the time. I love Julian's work, and it's core to what we do and everything. But I thought the point Raoul made there was quite central.

5:54And it's the same point we have when we play musical chairs with kids. The Fed tightens its balance sheet and raises rates. Monetary conditions are tightening up, and somebody somewhere is not going to have access to financing. And as that situation ratchets tighter, either they proactively ease or bad things happen to good people or perhaps financially less careful people. So I think a lot of that is where the difference between Julian and Raul's view. Raul believes the Fed will proactively ease and Julian is arguing that there's got to be a lot of pain before the Fed is convinced enough to loosen rates.

6:36So I would characterize the current situation as one where we have two stories that are competing in macro markets. Story number one, narrative number one, is this economy can't stand rates this high. And it's only a matter of time till the Fed kills the economy. And the other story which is out there is we're going to have a soft landing just like in 1994. And you should imagine Jake Powell as a figure skater and the Fed has just executed a perfect triple sell code. The inflation was entirely transient. It's now gone the way of all base effects. It's just disappeared into a puff of smoke. So you can safely buy stocks and you don't have to worry too much about bonds.

7:16They can leave rates where they are to create a little bit more slack in the economy. But there's policy space to cut rates as and when it really needs to because inflation won't get out of hand. You're far too spicy, Harry, for me to think that you're buying into that beautific scene that you just wanted. You know, I'm just a cynical man, and it's a problem for me. I miss out on some of the biggest rallies. I didn't have NVIDIA. My friend Oz had NVIDIA, but no, I'm an idiot. I didn't have NVIDIA. So I am dubious, and I'm dubious because, first of all, there aren't many of us who can imagine Jay Powell as a figure skater.

7:56But secondly, I don't really believe scenario number one either, that the economy can't stand rates as high. After all, how is that consistent with earnings results like caterpillars today? And there's just way too much macro data, which is surprising to the upside. The S &P Global Macro Manufacturing PMI was surprisingly strong. It showed people with no significant firing intentions. It's a good economy. So the question is, why is it such a good economy, right? I mean, monetary policy always has winners and losers, but there seems to be more winners and fewer losers out there. And I feel for the losers.

8:40I really do. Students are going to start paying their student loans again in October. They don't own real estate. They don't own stocks. They do have debts, and those debts are resetting at much higher rates. Not a lot of fun. So how can we explain the surprisingly consistent strength in the economy in the face of 525 weeks of rate hikes? I think it's got something to do with the 8.5 % of GDP federal deficit. Can we put that chart up? I think we've got it up, haven't we? Yeah. Which one? I think we have two. Which one do you want to look at? That one you've got. That's exactly the right one. So I think it's kind of hard to have a recession when the government is force-feeding money into the real economy and via the real economy into the financial markets on this scale.

9:26um if you think about it um i mean what did i learn from covid i learned uh during covid that fiscal policy is really effective really effective um and can do amazing things um so much more so in many ways in monetary policy because you do have losers from monetary policy as well as winners and so on winners as well as losers so before covid eight and a half percent fiscal eight and percent of GDP as a fiscal stimulus was about double the normal level of the deficit. Of course, COVID screwed up all the charts. Everything was literally off the charts when COVID happened, but we had 18%. But where we are, it's about twice the normal level of fiscal stimulus.

10:11So perhaps we shouldn't be so shocked that the economy is strong. And then you've interviewed Warren Mosler. I'm careful with that interview because he's a tricky guy. He's clever and easily irritated. People feel really strongly. We've talked about this. It's very tribal. This is modern monetary theory. For those of you who want to see it, we did the full interview. It was fascinating stuff. Harry and I talked before the interview as well about it, but it's worth listening to. So you don't have to believe in MMT. You can dismiss MMT completely and still take some of the observations that Mosler has.

10:54And the key one where he persuaded me was when he pointed out what we were saying back in the 90s about Italy. Do you remember when Italy had a debt to GDP of like 100 % and everyone thought that debt might explode away to infinity? Well, for some reason, we have a debt to GDP of 100 % and nobody worries about it. But, you know, with a debt to GDP of 100%, if you go from zero to 5 % interest rates, you've injected 5 % interest payments into the economy. It's a big effect. So we shouldn't be so surprised that the economy is strong. Hey, everyone, we're going to take a quick break right now to hear a word from our partners.

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12:44So this is, this is, I think this is really important. And, and, you know, our regular viewers will know that we were, we've been talking about this and, and get some guests have been pointing it out. Um, some of them a little bit more specifically and, and some of them looking at some of the sort of, you know, companies or investments they have in the real world, talking about that fiscal spending. We, we passed the infrastructure act, right? They're all of these things. And we've been talking all last week about how we're all seeing that effect. So why? It doesn't seem like people are that focused on that, though.

13:17You don't hear people talking about that that much. Why not? Is it just because it's so obvious in front of us? We've been trained to focus on the Fed, to look at that particular wizard behind the curtain, magician behind the curtain, and not at what's going on in Congress. But I think that's a mistake. And I think it's much easier to understand how markets are trading and how the economy is outperforming forecasts if you don't look at the apparently tight monetary. And we can argue about how tight monetary is and the incredibly loose fiscal. So, you know, I just did some reading for Jules and I did a lot of reading on the Inflation Reduction Act.

14:00I had no idea how stimulative it was. It's an enormous bill handing out huge amounts of money, ideally, if you're a chemical company, you know about this because you're making an awful lot of money out of it. These handouts are big and they impact things. And you're seeing it in things like manufacturing construction, which is a near term high. And capital. I mean, look at capital today, up 8%. I also think there may be a little bit of the fact that people are so used to Washington tying themselves into knots and being unable to do anything that we're shocked that this is actually feeding directly into the economy.

14:42You could argue whether that was a good idea or a bad idea, but it doesn't change the fact that that has already happened. I think for long periods of time, we didn't have a lot of action in fiscal policy. We didn't. It's been on the shoulders of monetary policy. Yeah. And we pretend that the Fed's independent. Well, it's Fed's independent right up until the point the Fed does something central government doesn't want them to do, and then it won't be quite as independent anymore. And I think there's a key issue there, because if I were trying to come to a conclusion about when the economy might soften, the prerequisite would be when fiscal policy was less stimulant, when monetary policy became more aggressive.

15:30The Fed just told us that it kind of thinks it's done for the time being. But I have serious doubts in the run-up to the next presidential election that we're going to do anything about fiscal policy until much later in 2024. Nobody campaigns on tightening their belt. It doesn't help. A friend of mine refers to the first iron rule of politics. My reelection matters more than anything else. And it's absolutely true. You can't pass a law unless you're in office. So it's hard for me to believe we're going to see any significant reduction in the amount of fiscal stimulus. And in that case, I start asking myself, oh, dear, the Fed thinks it's almost done and bond markets can see relatively strong growth.

16:24Have you seen the Atlanta Fed's latest GDP Now estimate? No. What is it? Tell us. Because Harry is in the weeds on all of this stuff. I don't know if I call these the weeds, but I do hang around in some really boring places. It's true. It's true. So the last print was 100 beeps higher than the previous one. It's like three and a half. It's way above the blue chip consensus with a range of 10 economic forecasts. So the GDP now is telling you the growth is surprising to the upside. And again, that's happening while the Fed is telling us that the Fed's base case is no longer a recession. So either we have a soft landing or perhaps we're going to have no landing at all.

17:12So this is, I think, really important, Harry. And we just had someone join both Joe and I think it was Ralph. What did I miss? What you missed is Harry laying out why maybe everyone might be wrong on this or at least lots of people. Because again, if we just sort of summarize that, Harry, as you point out, there are people who think that the Fed's going to stay aggressive and push us into recession, break something. And those who think they're going to achieve a soft landing, that camp, by the way, has really been picking up that narrative lately. You're talking about a third option that not many are, which is no landing at all, just a robust economy.

17:59Now, what does that do to inflation? I'm going to guess it's not, to have a soft landing, you need moderating inflation. So we've all gotten very happy about the declining core inflation. It has come down an awful long way, and it's now about 3%. Sorry, headline inflation. Core inflation, not so much. And there are excellent reasons out there to think core inflation will come down. But some of them I just don't buy. And an example of that would be the optimism about shelter inflation. People seem to me to be confusing the first and second derivatives of shelter inflation. Now, I only wish this was my idea.

18:42It wasn't my observation. I got it from Jim Bianco. But Jim Bianco, I was in a call with Jim Bianco, and he made this observation. And it's immediately obvious, if you know anything about real estate, you know the adjustment you see in rents tends to follow through because most people's rent doesn't move very much. Most people's rent doesn't reset. You don't get rid of good tenants and high rates on them and residential unless they move out. When they move out, then you reset rents. So, the increase in rents we've already seen, the upward pressure we have is likely to persist, even if the acceleration impulse is gone.

19:22We're still going to see higher than expected shelter inflation, if you ask me. And that's one bit I'm really happy to take. Make another observation as well, because you could think of this as like a situation where there's people who need to rent and they're in trouble, but the people who don't need to rent, they're great, they're golden. It's not true. we've got an awful lot of older people who would, if they could, choose to move to Florida. God knows why. No offence, Florida. But they want to move to Florida, and they'd like to sell their big place and buy a smaller place down there, free up some cash.

19:57But with mortgage rates as they are, unless their current place is so much bigger than the place they intend to move to, it doesn't make any sense. So you have people living in bigger houses than they need because they've got a cheap mortgage and there's no point moving. Yeah, they're trapped in their house. Right. And that means they're trapped with their property taxes too, but there you go. By the way, Jim is going to be with us folks tomorrow. So we will bring this up with him, Harry. So another Jim in our chat has a question. I think it's a good one. I want to insert it here. Is there a message when a good portion of the growth in GDP is derived from government spending?

20:35Does the makeup of the growth matter? Yeah. I mean, I don't want to get political. I definitely want to avoid politics. But the classic concept is crowding out. And we argue that high-quality growth is seldom government-inspired growth because do you really want the government allocating resources for the economy? And if you do, you get a Soviet-style economy and you lose efficiency. You have deadweight losses. Now, the counter argument to that is when I look at some of the spending program the government is trying to catalyze with its policies, I agree they're important. So the IRA, for example, has a bugger all to do with reducing inflation, but it does have a lot to do with stimulating renewable energy.

21:29And there are huge subsidies for renewable energy investment. And, you know, if you keep these in place for any length of time, lots of people are going to go and reach out for that 30 % tax credit. And we're going to find very cheap renewable energy at some point. That's just going to happen because you've incentivized it and you've privileged it. And the problem is when you pick winners, you implicitly pick some losers too. And, you know, let's see what happens when the losers find out they've lost and are unhappy about it. So yeah, there's crowding out effects and the impact of those. We're going to take another quick break to hear a word from our partners.

22:09We'll be right back with more of the day's top analysis on the Real Vision daily briefing.

22:17So what is the implication? So now we have a third scenario in here where there's no landing. The economy's kind of going gangbusters. Does that mean that the Fed holds at this level or is inflation going to be problematic enough that we could actually see them moving rates higher? What's the outlook for U.S. rates? So if you sat through that entire incredibly tedious presser with Jay Powell, and Lord alone knows that was a moment when I wish he was figure skating, actually. If you sat through it, you could tell that they moved to data dependence, which means that they pre-programmed these rate hikes.

23:05The ones we've had are obviously already set in stone. That's what data dependent now means. But OK, so now they don't intend to move rates. The impression I got was they really didn't want to move them anymore. And if they're forced, that's because they don't believe they have to. They don't believe they. It seems to me they'll be very uncomfortable. There's a higher hurdle than there has been to move rates. Now, I suspect if I say that to their face, they'll say I'm completely wrong and it's not true. But I just got the sense that they don't want to do more in rates. that said they will be deeply embarrassed if inflation ticks up.

23:45I think inflation will tick up from here. And it's an MI2 view, I think. And one of the reasons why inflation will tick up is because there's a lot of stim in there. There's a lot of fiscal stim. The US economy is tight. There's not much loosening the tightness up. It's terrible if you need to borrow money. But if you don't need to borrow money, you're receiving rates. You're making money off of higher rates and you're spending it wherever you spend it. So if you look at commodity markets, they look like they may have bottomed. The base effects will have dropped out from the start of the Ukraine-Russia war.

24:25And so we've gained all of the kind of improvements due to lower energy prices. And right on cue, energy markets have decided to rally again. So if anything, the next impulse seems to be higher commodity prices, a tighter real economy. None of this makes me feel particularly optimistic that inflation is vanquished. And I don't know if you did you see the Gita? Yeah, this is where I prove that I belong in kitchens at parties. But did you see the Gita Gopinath IMF speech at Sintra? Shockingly, I did not, Harry. It's funny. You're obviously hanging around different places. But I thought she hit the nail on the head.

25:07She argued that the inflation genie is still there. It's reduced. The problem has gone down. But most G10 economies are running too hot and have excessive fiscal policy going on simultaneously. And they need to tighten up a little bit. RAOUL PAL Well, it's interesting because the headline that everyone reported out of that, which is why you have to listen and read the details like Harry does, is that global growth is better. I think they upgraded global growth. And that was the main headline that most traditional media ran with. But the knock-on effect of that is, well, it's stronger, but maybe policy is not adequate for that.

25:47Yeah, inflation is not vanquished. They need to be tighter for longer. They need to do something about fiscal policy. And there are problems here that need to be addressed. And I think if this is correct, the smaller open economies have a serious problem coming to them. And places like the U.S. are a little privileged, but they also have a similar, they've got the same problem. It's just that they have, they don't depend as much on the kindness of strangers. What's the problem? The mix of monetary and fiscal policy is not sufficiently tight. So they're not generating their own domestic savings, which means they're dependent on international capital market flows, which means at some point down the line, the last 20 years or 30 years, we relied on Japan and China, who were saving huge amounts of their GDP, which meant that we could consume a bit more of ours.

26:42If there is any reason why, going forward, Japanese savings decline and Chinese savings were to decline, where are the capital, the flows that will absorb or will finance the Western economy's consumption? I know it's no use for policymakers, but you can see there's a problem because the global aggregate savings, there may not be sufficient savings to go around given the objectives that governments have. What does the pain look like from that? Where does that manifest? How does that manifest? In small open economies, you get balance of payments crises. That's what you'll see. Sovereign debt crisis?