Is The Fed Done?

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1:09Is the Fed finally done? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Joseph Wang, principal at thefedguy.com. Hi, Joseph. It's great to have you back on. Hey, Maggie. It's a pleasure to be back. So it has been quite a week. We had the Fed's decision to hold rates steady, a softer than expected payroll number this morning, a flood of earnings out, and the market has reacted. A huge swing in bond yields, a 10-year, which was sitting at 5 % at times last week, all the way down to 4.57. Stocks, meanwhile, surged higher. The Nasdaq over 1 % again today. The S &P very close to that.

1:47The Dow up over 0.5%. The Russell even participating up almost 3 % today. And that rounds out what has been a string of very nice looking gains for stocks. I think it's going to end up being the best week for stocks this year. Before we dive into your thoughts about all of this, I just wanted to give a shout out to all of the guests who were on the daily briefing this week who really telegraphed the possibility of this market reaction. Pay close attention. We're going to look at the highlights. Pay close attention to the date stamp on the videos, and let's have a listen. sitting in the mid 80s for Brent in particular is kind of the sweet spot for both sides and I think absent any geopolitical risk I think both the Saudis and the you know OPEC plus in general would be happy with a low volatile oil price range bound between 70 and 90.

2:42In those price regimes producers can make good money governments can fund their fiscal obligations the economy is not really thrown into much strain. Stocks are vulnerable on the upside in the extremely short term. Like we said, with everybody short, we've reached some really serious support levels where, you know, grazing through the Nasdaq's 200-day moving average, the same in the S &P. If we bounce from here from an oversold condition, just before we figure out what the next move is, it wouldn't be shocking at all to me. The 10-year and 30-year yields, I think, are a steal. If you can put your cash away, you're going to see capital gains, I think, coming from being in it for a long period of time.

3:22So I think that's where you're going to be, whether you are looking for where you can get a high return or protect yourself in case of a storm, the storm being something happening to US equities. This has been a very thin, narrow market in terms of participation. The percentage of stocks in the Nasdaq that were trading above their long-term moving averages, even while the Nasdaq was still well above its 200 was like 30%. That means that two thirds of the Nasdaq was in a bear market while one third was dragging all the dead weight higher with it. Like I want to see that dynamic completely reverse.

4:06That was pretty good stuff. All of those were ahead of the event actually happening. So I thought they all deserved a little bit of a humble brag. But I think it's a case of really looking at the fundamentals, understanding policy, but also some of the market positioning and what's happening kind of underneath the hood, I think is really what enabled them to see some of what was coming. Just great stuff. And that is the kind of content that is across the platform. So if you are listening on YouTube or audio and you are not a full member, come on over and join us at realvision.com. So Joseph, the question at this point with that great setup is, is all this enthusiasm justified?

4:42Is the Fed done hiking? So in my view, of course, I think the Fed is done. And in fact, I think that rate hikes are probably going to occur faster than the market is expecting. At the moment, the market is thinking maybe sometime in the middle of next year. Now, to be perfectly clear - Wait, you mean cuts? Fed cuts or Fed hikes? Yes. Fed cuts are coming. Okay. Wow. So to be perfectly clear, when we listened to Chair Powell at his most recent meeting, he was not going to tell you that he was going to be done. He was definitely keeping open the possibility of future hikes. His theme in that press conference over and over again was that he believed that monetary policy is restrictive, but he doesn't know if it's sufficiently restrictive.

5:27So he's still holding out some possibility of a further hike. But I think that's becoming less and less likely going forward. And you can see that reflected in market pricing as well. I think there's a couple of reasons for that. One is that, as Chair Powell noted, to some extent, higher yields, higher longer-yielded yields can substitute for rate hikes. Now, over the past few weeks, we've seen the 10-year soar, right? It's traded above 5 % for a little bit. It's retreated notably. But it's still a lot higher than it was just a few weeks ago. Now, I expect that the 10-year yield to hold around this range for the coming months.

6:09And if that's the case, then I think that's enough to substitute for the last rate hike that the Fed had penciled in during their September dot plot. And the second thing is, it does seem like the data seems to be agreeing with the Fed in a sense that inflation definitely is trending in the right direction. So we have, I guess, month over month basis. Inflation has definitely trended towards, not there yet, trended towards 2%. We do see some very gradual softening in the labor market, like today's print, for example, which was actually OK. But across metrics, let's say headline, let's say unemployment rate, let's say labor participation rate, wage growth, all very, very slightly softer than expected.

6:52So that's heading in the right direction. And globally, of course, if you look around the world, in the Eurozone, in China, in the UK, it seems like we're heading into a global slowdown, and that should affect economic conditions in the US as well. Yeah, so that's a pretty compelling case. And it's what the Fed's really been waiting for, right, is some evidence they can do this. I'm curious if you think the reaction was expected. Did the Fed expect this kind of reaction when they announced they leave rates unchanged? And does it present a problem? Because even though the Treasury market was doing the work for the Fed, we've seen a really rapid turnaround now.

7:33And that's a big move for Treasury yields to drop that much from last week. Does this sort of immediate knee-jerk reaction sort of undo what they'd hoped for? I think this reaction is what Sherpao had in mind when he was saying that, yeah, longer-dilled rising could, to some extent, tighten financial conditions, but only if they're persistent, because he acknowledges that there's a lot of volatility in the markets. As you noted, Maggie, the 10-year yield has been going up and down like a penny stock almost. So I actually think what's happening in the treasury market is not so much a reaction to the Fed, although that plays a role, But I think the bigger driver is its reaction to the Treasury quarterly refunding announcement that was also made the same day.

8:21Now, in that announcement, again, there's a couple of things that I think were very supportive of the Treasury market. The first, of course, is that the U.S. Treasury said that they would probably only increase coupon sizes for one more quarter. Now, that's less than expected. Last August, they were telegraphing an increase over a few quarters. So, again, going forward, that suggests that coupon supply, so the supply of longer-dated treasuries, is lower than the market expected. Now, the second thing, though, which I think is a much bigger deal, is that the Treasury seems to be suggesting that they're going to issue a lot more Treasury bills.

8:58So, shorter-dated Treasuries rather than longer-dated Treasury coupons going forward. The Treasury itself, they have a policy of issuing, let's say, between 50 % to 20 % of their overall outstanding debt in Treasury bills. Last August, they said that they would go slightly above that and go issue bills to, let's say, 22.4 % of overall marketable outstanding. Now, this past statement, they seem to strongly suggest they're even willing to go above that. Now, what they're doing then is that they're issuing fewer, longer-dated Treasuries, so there's less supply. They're at the long end, let's say 10-year, 30-year, and that's supportive of Treasury yields, basic supply and demand.

9:43And instead, they're going to issue more Treasury bills. And there's tremendous demand for Treasury bills right now for money market funds. So it does make sense as a policy to do that. It's not something that will help forever because eventually you're going to get too much issuance in the front end as well. But I think that's a few months away, maybe after November or something like that. That's so interesting. And the mechanics of the auctions and what's happening with supply is really important right now. So do you think this is just a really sort of savvy way of being a market participant, understanding that they can do this?

10:20Does it carry any risk? There's a couple of ways to think about this. So first of all, Treasury has a tradition of being a principled actor. They don't want to time the market. They have a principle of being regular and predictable, and also a principle of issuing 15 % to 20 % of their total issuance in bills. So this is a departure from what they've been doing over the past several years, and I think it was a surprise to some people. So if you're the government, you want to move slowly and predictably, and you don't want to surprise people. So I think from that perspective, this wasn't a good move.

10:56But from a market participant's perspective, it is actually quite clever because right now we have tremendous demand for Treasury bills, but obviously not a lot of demand for longer-dated Treasuries, which is why Treasury yields have gone up so much over the past few weeks. So this maneuver here is going to give more stability to the markets. I think it's a major contributor in the big rally we see in the 10-year. And of course, if we have stability in the treasury market, that's positive for equities. And I think that contributes to the equity rally we've seen this week as well. Hey, everyone, we're going to take a quick break right now to hear a word from our partners.

11:33We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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12:42So have we seen now the peak in Treasury yields? So for the year, I think so for the year. But my own perspective is that we are in a paradigm shift where the future will not look like the past. So if you think back over the past few decades, we've had a tremendous, tremendous bull market in Treasuries. So the yields basically just went steadily downwards since the 1980s. I think that all reverses. It's really easy to see how that could be the case if you just look at Treasury supply, which at the moment is projected to be, let's say, 1.5 to 2 trillion a year forever. Now, that's based on current law.

13:24And as we all know, current law can change. It usually only changes to one direction, though. That is to say, even more government spending. So it's likely we'll have even more issuance. And if you add quantitative tightening on top of that, the private sector is going to have to absorb over$2 trillion in Treasuries next year, actually closer to$2.5 trillion next year, depending on how long QT goes. That's a tremendous amount of supply. And I don't think the financial system is flexible enough to absorb that at current rates. So I expect that even though we got some temporary reprive from maybe a little bit slower data from the Treasury's announcement and from a Fed that was interpreted to be dovish, I think in a few months, maybe sometime in the middle of next year, these problems are going to resurface again.

14:15They're not going away. The only way they can go away is if Congress spends less money, and I don't see that happening. So Treasury yields have only one way to go in the medium term. In my perspective, that is up. Unless, of course, the Fed wants to step in and do something about it, but we're not there yet. Which would be yield curve control. Something like that. Somehow to put a cap on. So you say it very calmly, but the massive implications, if we have treasury yields that are going to trend higher and just maybe get these little, I think somebody referred to it as pushing a beach ball down, a little reprieve where you get yields to go down, but they're going to pop back higher because you have this mountain of issuance and debt that we just can't get around.

15:00What are the implications of that for the economy?

15:06So actually, I would actually think that it's probably not going to be as bad as expected. And because the reason that yields are going higher is because of tremendous supply. And the reason that you have tremendous supply is because you have tremendous deficit spending. Now, deficit spending is stimulative, is supportive of the economy. It does depend on how the money is being spent. But on the one hand, the government continues to add money into the system that is supportive of cash flows. And that means people can continue to service their debt, even though interest rates are going higher. Now, there's going to be some fine tuning to this, of course, because how high yields go is in part due to market liquidity.

15:50So you could have yields go much higher than even the increased deficit spending being supportive of the economy can help. And if that were the case, I would expect the Fed to try to either do some sort of purchasing operation to support the market or maybe some sort of yield curve control. Again, that's something that is in the medium term. We're not there yet. We probably have to go through a normal slowdown cycle, however slight it will be first. Yeah. So if we think about that, it's a great point about the fact that it'll stimulate the economy. I guess when we talk about the impact, it depends who you are, right?

16:32So if you're in the economy, if you're somebody who's benefiting from the stimulus, if you're a manufacturer who's getting funds or you're building a road and there's government spending for that, defense, wherever that money goes, that'll be a benefit. If you're somebody who owes, though, who needs to borrow, that's really problematic. And presumably, that's what Jamie Dimon was alluding to when he said the world cannot operate at this level of sort of structurally higher rates. It's not set up for that from a credit perspective. Is that being overly gloomy or is it a problem? Because we see commercial real estate.

17:09We know a lot of people are locked in 30-year mortgages with low rates, but eventually these rates reset, right? we're sort of seeing a little bit of a strain. Is that a problem for credit markets? So I think you're targeting exactly the right thing. There's some distributive effect of this, right? Let's say that you are someone who doesn't have, let's say, floating rate debt, then you're probably not going to be affected by this. But if you have floating rate debt, you're going to probably have to renew at high rates and that's going to squeeze your cash flow. But I would also take a step back and think about this over the past two years.

17:46Over the past two years, people have been saying that the system cannot handle higher rates. This is not acceptable. Something's going to break and so forth. And fast forward to today, well, last quarter we had real GDP growth of 4.9%. So I'm thinking that that mental model, maybe there's something changing that that mental model is not accounting for. And I think what it's not accounting for is that when you have tremendous deficit spending, you're injecting equity. and to the financial system. And so even though you have higher interest rate expenses, you can also afford it. There will be pockets of stress for sure.

18:23And we see that, for example, in commercial real estate, although I suspect that has more to do with a revenue problem where you have a lot of people working from home. And so a lot of the restaurants and so forth cannot operate. So I don't feel that's purely a rate problem. Now, let's say that everyone went back to work. Well, if you have significant deficit spending, then you have more revenues, more cash flows. It is modestly inflationary as well, depending on supply constraints and so forth. So they would be able to afford higher rent, which in turn means that they can afford higher mortgages on their real estate.

19:00So I would just point out that things still seem to be going OK, but their interest rates have risen significantly. That's such an interesting point, and it's a good way to flip it around because we're all sort of waiting for. Some people have suggested that the fact that we're all waiting for something to break and waiting for this catastrophe, maybe there's some recency bias in there because of what happened with the great financial crisis. And it's the recession that everyone's sort of been looking for, dying to get to in a way. So if we think about that with that government spending, do we see a recession?

19:35Do we see a credit event? Could it be, could it, it's possible that neither happened? So we will definitely have a recession. Recession is, it's a business cycle. It's part of a human nature almost, right? So you think the good times last forever. You will overextend yourself. Good times don't materialize, or at least not to the extent that you expect it. And so you retrench a bit. But I think it's really hard for me to see a serious recession going forward. One, of course, is because there remains tremendous amounts of spending by the government, deficit spending about 7 % right now that's supportive.

20:11But more importantly, so I think what the policymakers have learned in 2020 is that if there's anything bad happens, you can always just spend more money and it will go away. So if you think back 20 years ago around the great financial crisis, there was a lot of reluctance to engage in tremendous amounts of government spending. There was talk of stuff like moral hazard and things like that. That stuff is all gone now. Everyone is on board. The magic solution to any economic problem is to just spend more money. The side effect of that is inflation, but I think that they are able to stomach that.

20:51So if we ever have a serious recession, I would expect them to open up that same playbook. And so the recession would be very, very deep. Of course, this also suggests that going forward, inflation should be higher than it was in the past 10 years. Yeah, so potentially structurally higher inflation, structurally higher interest rates, that sort of environment. Doug, I think that answered the question you asked about the slowdown resulting in a recession, but Joseph thinking maybe not a severe one. Jake has a great question. Does the declining reverse repo balance increase overall money supply and ultimately inflation?

21:34Can the RRP running dry be the nail on the coffin for inflation and possibly overshoot? So there's a couple of points in that question. One is that the relationship between the RRP declining and money supply, and the second is between the money supply and inflation. So as the RRP runs down, yes, it will increase money supply. What's happening is that the money market funds are taking money out of the reverse repo facility, lending it to the government, and the government then spends it into the private sector. And when the government spends, it ends up in someone's bank account. So it will increase M2 money supply.

22:15But I would be cautious about the link between money supply and inflation. So in the 1980s, there were many people who thought this. At the Fed, they invented M2, M3, M4, M5. Everyone tried to track that, and it turned out to not be very useful. I will also note that more recently, there are some important people making some more research, suggesting that, yeah, maybe there is sometimes some link. I don't know, but I don't think it will be a big impact on inflation. are just looking narrowly at between M2 and economic activity. I think of the rise of an M2, in my view, is more linked to financial assets because when people have money, they don't really necessarily spend it on goods and services.

23:01In fact, they tend to spend it on assets since it tends to be the wealthy people who have most of the money. 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.

23:20On that point, Philip asking, increasing credit card debt, especially with the bottom half of consumers, sort of the worry is that there'll be lower spending coming. Do you see that and will that impact company profits? So on social media, I do see people post that image of soaring credit card balances. I think it's over a trillion dollars now. But I don't think that's the right comparison because you have to notice that credit card balances is nominal. And over the past few years, we've had an inflationary period. Prices of everything have gone up. When you normalize that by disposable income, you get a very, very different picture.

24:02So when you normalize credit card balances by total disposable income, you'll note that it's actually trending. It's actually historically quite low. So that's what you want to keep in mind. So, yes, credit card debt has gone up, but still have incomes as well. So I don't worry about that. I love that. It's so important. And thank you for that answer, Joseph, because I think that you can throw anything on social media and create a lot of, you know, this is the thing with sort of charts and statistics. You know, if you have no context around it, they can suggest a narrative that, you know, there may be other information points, data points that are needed for that.

24:43So, Philip, I hope that answered your question. I think that was great to jot down in your notes, people. If you're on the platform, tag that and put it in your notes, because that's going to be something that you need to remember in the future. We also had some movements on the Bank of Japan, Joseph, that I wanted to ask you about, because, of course, the Fed's not the only central bank in the world. And we have been in this situation where everyone's been trying to get inflation under control. A lot of questions both about the ECB and BOE as well. But Bank of Japan sort of signaled that they'd be making a big change over the last holdout with yield curve control, and they indicated that they would be at least tweaking it and being a little bit more flexible on that.

25:29Do you think that's possible? Because once you signal you're not going to hold a firm line, the market tends to test you. So how do you see that happening? And what is the impact for the rest of the world? I think that they're breaking out champagne that we had a big rally in Treasury, so that it didn't have to be tested this week. That's right.