Is Goldilocks Just A Fairy Tale?

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0:53Is Goldilocks a fairy tale? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Dr. Sree Kumar, president of Sree Kumar Global Strategies. Hi, Sree. How are you? Very well, and good to be with you again, Maggie. It's always good to see you. And what a week we have to talk about. The economy, U.S. economy humming along. We had decent economic data, no nasty surprises on inflation. Then, of course, the Fed comes out and says it's happy with the progress it's seeing and puts rate cuts into the forecast next year if inflation keeps moving lower. Markets rocket off the back of that.

1:30The Dow hit an all-time high. The Nasdaq looks to be closing in record territory, the yield on the 10-year closing at its lowest level since July. I mean, this has been a really big market move. In fact, before we dive in, let's just have a listen to the guests on all week who've been kind of describing the momentum that they see behind this market reaction. Let's have a listen. The way this bond market works right now is just like we saw in late October. When it gets ready to go, oh, it's 4.24, it's 4.26, it's 4.8. What just happened? That's the way it moves. Or if it wants to go in the other way, it's 4.21, it's 4.2.

2:09You think it's going to go down? It's 3.75. And that's the way that it seems to work over and over again. So when it gets ready to move, it will move. The Fed is not going to cut rates unless there's an accident or a crash or a meaningful rollover in the economy. And I disagree. I think the Fed's going to cut 100 basis points regardless because they've over-tightened. They've over-tightened, and real interest rates are over 3%. And they're going to take back some of that tightening. So that's the base case. But I think that there are people in line to get into this market because they feel like they missed that pivot into, you know, from tightening to easing because it wasn't really clear there.

2:49A lot of folks, instead of being long cash, they've been getting squeezed or they've been getting blown up in bonds up until about the beginning of November 1st of this year. So it's telling you that, you know, there's a big asset allocation tree. If we soft land as the economy, which I'm saying the probability has risen, although I'm not certain that's actually going to happen, but it doesn't have to happen. It just needs to stay, remain the modal outcome for market participants for more units of time for the market to rise and those funds to flow. That's all that needs to happen. It's a technical process, not a fundamental process.

3:19There's a massive amount of positive flows in this market and it is squeezing the shorts. But Powell is just piling on. We're at three standard deviations over the 20-day right now. You see that so rarely. RSIs are stretched more than they've been in the last two years. But again, that's what happens when you get everything aligning together. The flows themselves are already super positive, and then you got this little Powell bit on top of that. When everybody gets bullish and everything just seems like coast is clear, it's exactly when you need to start looking the other way.

3:59Really great to hear all of that. And, you know, a shout out for Tony, who, again, has really had his finger on the pulse of sentiment. But I really appreciated also Darius and Jim really laying out some of the dynamics that are happening underneath the hood. As we all focus on fundamentals, there's a lot of sort of seasonality and flow that's driving this. So it's really helpful to wrap our head around that. So Sri, you listen to Jay Powell and he says he's not taking a victory lap, but it certainly sounds like this Goldilocks scenario and all the markets are rallying right into Christmas. I mean, what could possibly go wrong, right?

4:35But as Jim said, that should maybe make all of us nervous. I don't know. How are you feeling? Do you think this is like a sort of sign that they are managing this or are you worried? Maggie, I share Jim's worry. And clearly, at a time at which the markets were rallying so sharply, even before the Fed decision Wednesday and before the Powell press conference, he had a job laid out in front of him, which is to restrain market enthusiasm and to make sure that the Fed can still continue with its inflation mitigation objective. and not let the rally go up and beyond. On the other hand, he essentially poured gasoline into the fire, and the fire is burning even more broadly, even bigger than before his speech.

5:34And that is what is the big surprise to me. It is shocking that the Fed chairman, who begins every press conference by saying he feels for the low and middle income groups and the high cost of living that they are experiencing. And he did that Wednesday as well. The rest of the press conference had very little to do with his initial objective. And I think we are going to pay a price for this. I do not think the interest rates are going to come down as sharply as he has suggested, nor inflation come down in the same basis all the way down. Typically over history, inflation comes up, goes down, and then it goes up again.

6:17And that's, I think, the big risk that we all run. So what will drive that inflation higher? If you see a resurgence in inflation, first of all, are you talking about a spike up in inflation or you just think inflation is going to be sticky and hang above target here? At the very least, it is going to be sticky with the core inflation rate still in the 3.5 % area, headline being somewhere below it, perhaps about 3%. So we are still talking about the inflation remaining at close to two times the Fed target. Now, the Fed does not have the option of declaring victory and walking away because they once made a mistake about inflation being transitory, and now they really have to conquer it.

7:06And instead of doing that, they just have declared victory, I think, very prematurely in my view. That's the first point. Second, your question as to where the pickup in inflation can come from, it can be because of a widening of the Middle East conflict. It could be because of some oil production facilities being destroyed in the war. Anything like that could cause a 20 % to 25 % oil price increase within a couple of days. And that is going to be reflected in the headline inflation rate. So the Powell forecast, if anything, assuming it is based on economic theory, is assuming perfection everywhere.

7:49And that's simply not what happens. That's the reason, Maggie, why I feel that this is not the scenario that is actually going to play out.

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9:12So it's interesting. presumably, we saw Williams, one of the Fed officials, try to tamp down some of that enthusiasm, but they had to know coming out with those rate forecasts that this was going to happen. Did they just simply miscalculate how quickly things would move? Or do you think they see something that's making them nervous? Do you think, like Jared suggested, that they have over-tightened? Maybe they're worried that they've over-tightened. Great questions. I'm going to give you three points in response. One, in terms of something worrying them in the background, clearly you see that the number of bank assets which are underwater because of interest rates remaining much higher than the banks expected, those losses are huge.

10:00According to the Federal Reserve Bank of Kansas study, through the end of October,$550 billion of loans, or you're talking about 30 % of the regulatory capital is underwater. My guess is that number is going to be increasing. If that's the figure for the banking sector as a whole, some of the banks are likely to have 50, 60 % of the regulatory capital being used up to back up these losses. That's one reason. Second, go back to Wednesday morning and you see that Powell gave an interview on CNBC and before, I'm sorry, you had Janet Yellen give a presentation to CNBC before the Powell conference.

10:50And essentially, she said in a not so subtle hint that as inflation has been coming down, interest rates ought to come down also. So this is from the former chair of the Federal Reserve, the present Treasury Secretary, and a lady who repeatedly mentioned that they don't interfere in Federal Reserve policy. And Powell clearly heard it. And this was a few hours before his own press conference. And that may have influenced it as well. And finally, I like to point out that the Federal Reserve is in fact a political animal, even though they keep repeating that they are free of politics, they don't look at politics.

11:31They almost, there is an expression, you protested too much. Why do you go ahead and keep protesting that you're independent? And the reason is that you are not independent. And we are one year away from elections. The new president, whoever that may be, gets to either re-nominate Powell beginning in early 2026, or the new president will decide to replace him. And that also must be influencing the decisions in terms of what is being done right now. I have recommended, Maggie, publicly that the Federal Reserve chairman ought to serve just a one six-year term, not four years like now. You get six years, you will not be renominated, and therefore we are going to reduce the political influence on your decisions.

12:23That's not happening. That was the third reason why I think we are seeing what we saw with the Powell press conference. Interesting. Interesting. One thing that comes up a lot, Therese, so interesting that you know the election's going to put, some argue that maybe that's the reason to pull rate cuts forward, by the way, is that they don't want to be cutting into the election to be seeming political. But a lot of people also asking about this idea of having to bring down. So you mentioned the banks struggling. So maybe looking for a reason to bring rates down to take pressure off the banks, even though they're not saying that.

13:03Some people also worry about the interest payments on the U.S. government debt and saying, you know, they've got to bring those down because it's just unsustainable. So as soon as inflation gives them the cover to do that, that's a driving force. What do you think about that? I think all of those are operative. In fact, look at what happened with net interest payments in the month of November. For about the first time in 20 years, it exceeded defense spending of the United States. So in other words, interest payments take up more resources. And even if interest rates come down, Maggie, there is going to be a lag between the reduction in the interest rate and the reduction in the interest payments total.

13:47And that also means that they are going to have to operate very quickly. In terms of bringing the interest rate reduction forward in order not to seem very political, I don't think that is going to be lost on the electorate. You do need a few months before the lower interest rates to have a positive income on consumer spending. Perhaps it will delay the reduction in the unemployment rate, but it is also going to push up the inflation rate either in the next two to three months or a bit later. Here is the quandary this administration runs. In the past, you could play political games like this. You could cut the interest rate.

14:29You could provide stimulus before the elections, and then you can suffer the consequences after the elections once you have been reelected or elected. Now, we are coming down from a situation of extremely high interest rates, so the choice is also being removed from the government because they cannot afford to make the political mistake again in terms of allowing inflation to go up, and that's the risk they are running. They certainly are. Sri, when we are looking at the U.S. economy, are you surprised at the strength you're seeing? Or are you expecting, do you think that it's going to continue to do that?

15:11Are you expecting a recession? I mean, retail sales still look pretty good, even though people always worry about the consumer. The numbers have been decent. What do you see happening to the U.S. economy? The U.S. economy, I think there are two things that history tells you. One is, The economy continues to do very well until such a time that it just falls off a cliff. And that's what happened in 2007. We saw October, November unemployment rate remaining relatively low. And in the first half of 2008, unemployment started to increase quite sharply. So that's one note of warning from history. The second is the amount of stimulus that is in the system today, both in the form of fiscal spending as well as monetary easing, is unprecedented.

16:00And we have so much stimulus there that that is also causing a delay in the recession. The question is, can you buy off eternal prosperity by doing that? My answer is, no, you cannot. You can postpone the recession, but you can't completely ban it. So I do still see the recession for the first half of 2024. So we had, you know, if that's the case and we have a recession, are we back to a situation where the Fed has to make a choice? Because this is what I think has led people to factor in and price in all the easing, is the anticipation that we will eventually go into recession. So if you see recession, but you see sticky inflation, what does that mean for the Fed?

16:50What it means for the Fed, if it is sticky at between 3 % and 4 % inflation rate, Maggie, and you have a recession, the Fed just pauses and says, we haven't given up our fight on inflation, but we have a twin mandate. It is not only inflation, but we also have to worry about employment. We are now focusing on employment without taking our eyes away from inflation, and we will come back to it very soon. So that's the excuse you provide. Political excuse, it's not an economically rational one. We should point out the Fed has put the forecast in, but they haven't eased, and presumably if that data starts to turn, they'll be data dependent.

17:36They've always said that. But the problem is that by simply suggesting it's in the forecast now, the markets run far ahead of them. Talk to me about rates because we had, with this expectation now, you certainly have a camp of people who are going back and ratcheting down their forecast for 2024 when it comes to where interest rates will be. But I will say that two of the analysts in that piece that we just ran, while they're talking in the short term about the powerful forces that could extend this market reaction that we've seen, this rally in stocks and bonds, longer term, a couple of them are worried.

18:17They disagree. They're not all on the same page. But Jim Bianco and Jim Carso both think that the 10-year is going back above 5. Jim thinks it's possible we hit 5.5. Now, we talked to him before the Fed meeting, so I don't want to ever hold anybody when they're in market developments. But they see a risk that we're going to see another ricochet in bond markets. It's like we've seen seven and they've been so painful. How do you see this scenario now playing out in the Treasury market based on your forecast? First of all, let's start with the Federal Reserve and then we'll go to the long-dated Treasuries.

18:56Federal Reserve, I don't think they are going to cut as much as some of these analysts are anticipating. You're not going to have five, six cuts in interest rates during calendar year 2024. If anything, they do a couple of them, and they find by then inflation remains very sticky, and they pause on rate declines rather than keep on cutting. So that's the first point I would make. Now let's go to the long-dated treasuries. I disagree, and I have said that repeatedly over the last year to two years, that anywhere around 4%, the 10-year treasury is very attractive. If it goes up any higher, it's not going to stay there.

19:41We hit a high of 5.02 in October. But then anywhere around there, if you bought it and you're going to be a holder for two to three years at least, you're going to do very well in terms of not only cash income, but on top of that, a capital gain. Why is that? One, I don't think we are back to 9 % inflation rate anytime soon, like we had in the middle of 2022. Unless economic policy goes haywire, we don't believe that. We don't expect that. So I'm looking for it to be sticky at 3 % to 4 % rather than rush up much higher. That would argue for 10-year and 30-year treasuries not going up significantly in terms of yield, but indeed going down further.

20:31Second, it's been said that with the fiscal spending being such a big issue for the United States, deficit getting out of control, at some point, the US Treasury is going to have difficulty financing its deficits. I do not subscribe to that. I don't like the fiscal deficit. I do not condone the fiscal profligacy. But I don't think it is going to cause the yield to go up on the bond side. Why is that? If you had the story of five or 10 years ago, the Chinese renminbi becoming the dominant currency in the world, and all capital rushing into China as a competitor to the U.S. Treasury, you may have had that situation today.

21:17But what has happened is that the United States stands alone as the sole beacon, as a safe haven for investors to go to. And we have the advantage of being almost the only good house in the neighborhood, even though this house is not good enough. It's like the dirty shirt, the dirtiest shirt, the cleanest shirt and dirty laundry, rather. Exactly, exactly. So that's the situation we are in. And it is lucky for the United States. It's lucky for all of us who live here that that is what is happening. And therefore, I believe that the 10-year treasury yields are not going up just because of the fiscal deficit.

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22:49Visit superai.com for 20 % off tickets with the code REALVISION. Look for the link in the description. We have Ralph asking, given your view, what do you expect about the U.S. dollar? Do you see it strengthening or weakening from here? Before I came on the show, I looked at the U.S. dollar. It has weakened again. The DXY, the dollar index, is trading at about 102 and change. Over the past month, we have come from about 104, 105. And it's fallen off a cliff after the Powell speech on Wednesday. But then I don't see the dollar losing much altitude hereafter, Maggie. And the reason is the other countries, other major currencies are also going to be easing.

23:41the European Central Bank and the Bank of England, while they are holding on and they gave tougher messages on Thursday compared with what we heard from Powell on Wednesday, they are eventually, they are also going to have to ease, but their economies are in, especially the Eurozone economy is in worse shape than the United States. and they are going to have more of an easing of monetary policy. So I'm looking, if you were to look at the euro, for instance, for the dollar to be somewhere between 1.05 and 1.1 dollars per euro. So$1.05 to$1.10. So it is just going to be on that range. Right now, it's about$1.09 today.

24:32And if the ECB eases, then I think it's going to go to about 104, 105. But then we are going to be trading in that range. The big question mark for the dollar is going to be what happens to the Japanese yen. The Bank of Japan has repeatedly given indication they are going to give up on yield curve control. They have partially given up, but they have not fully done so yet. So once they do, instead of being at 141, 142 yen per dollar, we are probably going to see the yen move closer toward the 120 mark or even the 100 mark. And that in turn, the stronger yen is probably one way in which the weaker dollar gets reflected in global markets.

25:20So the only currency that I see that has a significant potential for appreciation versus the dollar is probably going to be the Japanese yen. So I wanted to ask you about China, because we were, you know, if you look at commodities, they've been down. It's been quite a decline. You know, you mentioned oil before, but across the board, commodities have been down. Some people suggesting that that signals recession. earlier this week, Jim said, yeah, it signals economic weakness, but in China. How important is China when we look at this global economic puzzle? And are you concerned that they are running out of policy options to try to revive that economy?

26:06You have two questions there. First of all, how important is China? China is much less important today than it was even three years ago. And the reason is, if you look at the Chinese trade statistics, their export-import statistics are all much reduced compared with where they were before. So in other words, China is becoming a more isolated economy from an economic point of view, not political, not geopolitical. But I'm talking economically, it has become more self-contained. They are forced to look more at domestic consumption for their stimulus rather than from exports. You're going to have a few countries which are very dependent on China as a market.

26:53Three of them come to mind. In Europe, it is Germany, which is a big export power, and China is a particularly important market. Australia, for which China is by far the important destination. And thirdly, in Latin America, it is Brazil, which is dependent on Chinese exports to China. So if you set those three countries aside, I think the impact on the rest of the world is going to be relatively minor. Interesting. So we heard when we first ran the compilation of the different voices that we had on this week, at the end, Jim was talking about when everything's moving this way is exactly when you should sort of worry.

27:39And we had an in-depth conversation yesterday about where he sees some concern. We have everyone now talking about getting back into bonds. We have everyone talking about maybe the rally is going to broaden and the beat up areas of the stock market are going to do well. Small caps, bank stocks. If you're worried, where do you think the concern is? What are you worried about happening? I think the concern should be for the trader. And again, as we always mention, I don't look at it from a trading perspective, but look at it from a top-down macro perspective. So if you say that you have a two - to three-year time horizon, and you're essentially going to close your eyes, you're not going to read or look at financial news for the next couple of years, you're going to be in 10-year and 30-year treasuries, you're going to do very well at the end of two to three years.

28:38But with all of these people jumping in to long-dated paper in the last three or four days, and then if that move turned out to be in excess, you might well have a correction take place in the short term with yields moving up and people losing money in it. But if you were to stick with it, as I suggested sticking with it, even when the 10-year went up to 502, I said it is not going to go up much higher. We had some famous names in the markets who talked about 6%, 7 % yield on the 10-year. I said it's simply not going to get there because the US dollar is too unique. The treasuries are so precious in the global scene that the funds will rush into it.