Is the Fed Still Fighting? With Dr. Sri-Kumar

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

1:41Is the Fed's fight not over? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Dr. Srikumar, president and founder of Srikumar Global Strategies. Hi there. How are you? Good to be back with you, Maggie. How are you? Oh, well, we're so happy to have you back. There's so much going on in the world of central banks and macroeconomics right now, and a lot of market action. So we're just closing the US session. We saw mixed action with stocks, but really all of the activity and movement is in the bond market. We saw a big move up in yields. I think I saw a headline that it's the worst week for bonds this year.

2:20We had some economic data out, services IMS still expanding, albeit at a slower pace. We have a big jobs number tomorrow. What do you make when you look across what we're seeing in the markets in the macro landscape, Sri? I think starting with the macro part, clearly the economy is a lot stronger than had been anticipated for this time of the cycle, Maggie. But I just don't believe the statement that there is going to be no recession. And I'm not a person who believes in immaculate disinflation as if it happens without any pain at all. After we have had so much of an expansion of monetary and fiscal measures, we have to pay the price.

3:06And I think that is going to get done. Where is the signal coming from? I believe the bond market. I'm a big believer in treasuries. the fact that the yield curve has been inverted for such a long period of time, it's an important signal for me. By comparison with that, go back. Look at the Great Recession, which began in December of 2007, two months prior. In October of 2007, the S &P 500 reached a record high. It just shows that the bond market is a better predictor than the equity market, and it is still screaming recession in my view, Maggie. Interesting. I think that Andreas shares some concern watching what's happening in the bond market again.

3:56We've been talking to him. He's been doing some academy sessions on our platform. But he also, in Steno signals, really sort of zeroed in on those signals. Let's play a clip from that and then we'll talk on the other side. the true signal is the uninversion of the yield curve, the steepening of the yield curve again. And we see very, very early signs of that re-steepening. Here we have the history of the spread between 10 and two-year bonds in the US, and all of the light blue bars represent historical recessions. And as you can see, the spread between 10 and two years tends to pick up amidst the recession or even just prior to a recession, as for example in 2007.

4:45So we need to watch that signal now, because this whole discussion of a rebound relative to a recession will likely be showcased or defined by this trend in the yield curve early in the discussion. And we've seen clear tendencies towards a steeper yield curve over the past week. So these are early days, but this is the signal I'm watching now. I have my eyes glued on this spread because if this re-steepening of the yield curve continues, I think it's a really bad sign. It's another great episode of Send-O Signals. And Andres always delivers actionables and how he's thinking about putting his macro into action, which we love about that show.

5:30If you want to see the whole program, it's on the platform. If you're not a member, scan the QR code. So, Sri, it's interesting. I want to bring this point up. You just said it a moment ago, but it might be worth expanding on. Joe, in the chat, just said bond markets still behaving differently from equities. We're not that far from all-time highs on the S &P. And in fact, we saw a downdraft yesterday. I was a little surprised to see the stock market kind of trying to make a comeback. NASDAQ, I think, was almost positive a minute ago. Now, It did close lower in the red. But down to 10, this is by no means panic selling in the stock market.

6:10What do you make? How do you address the fact that we have such different sort of vibes between bonds and stocks? They're behaving so differently. I think what has happened is there has been so much of liquidity created in the early part of the cycle, 2021, 2022. and the fiscal stimulus that came from the Biden program at the beginning of his administration. Some of that, according to Federal Reserve calculations, those excess savings are still in the hands of consumers. That is clearly helping on the equity side. Second, the economy remains strong because of the fact that the equity market is putting some money into the pockets of investors.

6:56and that spending remains quite vibrant. And then on the employment side, once again, going back to the fiscal stimulus, the amount of it which went to the employees essentially made it so that they didn't have to go look for a job elsewhere. The quit rate has remained very high. All of this says to me that in terms of being a labor market, it is very different from what we had had in the past. All of these explain the fact that even after a year, 16 months of monetary tightening, you still have a very strong equity market. But the Treasury market typically goes beyond that. And when it sees a recession, it projects it with an inversion.

7:42And recall that the inversion began in the 2 to 10 year in July of 2022 at the beginning of the month. So we are more than one year into the inversion. And so that's what I think is giving you a signal which is very different from the equity side of it, Maggie. Yeah. And we also, we've had earnings. Some people were worried ahead of time. But some of them have been good, certainly company by company. But we have Amazon just reporting numbers after the bell. The stock's up 5%, 5.8 % in after-hour trade right now. Now, you have to wait for the conference call. And sometimes the comparisons, the estimate seems way off.

8:21So I'm not really sure what happened there. We'll have to dig into that. But some of the earnings have been coming out and supporting this. So it's been hard for stock investors to know what to do, even though people feel like it's getting overextended. You've missed some rallies if you sat out. Exactly. Yeah, you missed some rallies. So you're staying in it. But now that bond yields have risen and you've had yields are up right across the curve, equities are feeling the pain because you don't have to be in equities to get a decent return. You don't have to be in it to get a decent after inflation return.

8:57So I think fixed income market is now increasingly competing with the equity market, and that's not good for equities. That's a great point. What do you expect from the jobs number tomorrow? I'm looking for it. I don't differ from consensus there. I'm still looking for about 190 ,000 to 200 ,000 jobs. That would be very close to the 209 ,000 that we created the month before. We have to see if that figure is going to get revised or not. But the more important thing for me is what happens to average hourly earnings. I'm still expecting that figure will come out at more than 4 % year on year, maybe 4.1%, 4.2 % increase.

9:44And that, Maggie, is just inconsistent with getting to a 2 % inflation rate, which is why I think going back to the title that you gave to the presentation, the Fed has a lot more work to do. Yeah. Before we get into the Fed dilemma, productivity was strong today. A lot of economists like that were pointing that out. Does that help when you're looking at the strength of the economy and the potential inflationary impulses? Productivity increase, provided it is sustained, can be helpful because productivity is the obverse of the labor cost. So when productivity increases, you can afford to give your workers more wages because they are producing more widgets per hour.

10:35And therefore, they deserve the higher wage without leading to inflation. But look at what has happened. Yes, one quarter on an annualized basis, the quarter to quarter figure was very high. But we had five quarters of declines in productivity. And the latest quarter, the second quarter, was up only 1.3 % compared with a year earlier. So when you put it all together, it looks to me so far more like a dead cat bounce rather than say that you are having a genuine pickup in productivity. I'd like to see some more before saying that productivity has really turned around, given the fact that you have five quarters negative on the productivity side quarter after quarter.

11:22Hey, 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.

11:34Yeah, that's a great point. You need to see a trend, right? One month does not make a trend. That's what they always like to say. So Colin, by the way, in the chat, thank you, Colin, giving us updates. And Amazon's giving strong future guidance for Q3, which is going to help. So Sri, Jim Bianco yesterday made the point that higher rates are going to be tough for stocks, maybe if you X out like the Magnificent Seven, which Amazon would seem to be defying that right now. But those really big mega caps, the NVIDIAs, the Amazons, the Apples, but for the rest of the stock market, higher rates are going to be a problem.

12:14Do you agree with that, that we need to look at the broader market, maybe the broader S &P 500, even the Russell, to look at the impact of higher rates? You should look at the broader market, and you're spot on. I think the broader market is more susceptible to higher interest rates than a few companies which may have special advantages and where investors don't care what the interest rate is. That's one. Second is, do you borrow money in order to make the investment? Are you investing in equities on margin because you think equities can go only one way and that is up? And if that turns and there are margin calls, it is going to accelerate the decline in equities if that follows.

13:00So those are the two concerns you must have on the broader equity market compared with the magnificent seven. Yeah, great point. Has the Fed lost control of the situation? The Fed, I think, lost control of the situation three years ago, and they've been trying desperately to crawl their way back. They lost it when they doubled the balance sheet from 2020, early 2020 to early 2022, a balance sheet which was then at$4.5 trillion, and they raised it to almost$9 trillion two years later, I don't see any reason, COVID or no COVID, for them to have done that. They kept the interest rate so low. That's when they lost the market.

13:48Since then, they have increased the interest rate substantially by five and a quarter percentage points. And some clients say to me, don't you think that is a very tough central bank? I say, no, it isn't. When you take into account not over the last 16 months, when you look at the last three years, it is not a tough central bank at all. They are just atoning for extreme laxity before. That's why I think you have messages from Jerome Powell which are contradictory one meeting to the other. He said one thing at the June 14 conference after the Federal Open Markets Committee decision to pause. and about two weeks later, he was in Europe talking at the European Central Bank Forum, and he turned out very hawkish in the company of Christine Lagarde and Andrew Bailey, the ECB and Bank of England heads, because they were very hawkish.

14:48So Fed has also lost it because it does not have a consistent message. At one point, of course, mandatorily, every meeting, the chairman begins by talking about how he feels for the problems of middle and lower class people. I call it the mandatory years with which you have to start every meeting. Then you can do whatever you want. That's where I think there is the real concern that the Fed has lost its mandate, and therefore it has lost its way. We're going to get to the global implications in a moment, but if the strength from the economy is coming from the fiscal side, which you mentioned, and our very observant guests have been talking about since last week, since the market actually had the realization itself, we've had analysts and strategists after strategists come on and start to warn about being worried about that, a no landing, if you will.

15:51If it's coming from that side, does the Fed have the tools to rein it in? Can they do anything if it's the fiscal stimulus that's driving, not monetary? The fiscal and monetary are, again, both are two arms working together. And if you have excess fiscal stimulus, again, go back to early 2021, the Biden administration had just come into office and they introduced a very large fiscal program. When that happened, if you have a repeat of that situation, the monetary policy has to be tighter. Instead, that was also lax. So today, and especially as you go into the election season, fiscal policy is going to get more lax.

16:41The president seems to be determined to allow the students to delay repaying loan payments. And he's going to find a way that he can do it despite the decision by courts not to allow that. So when you put that together with where we are, the monetary policy has to be more careful. But that's not what you see. You saw a pause in June and very likely we are going to a pause on September 20th at the next decision. So it seems to me that the monetary policy is acting on its own. And recall what happens when journalists ask Powell the question every time, what do you think about fiscal policy? And the answer he gives is, I deal with monetary policy.

17:31I cannot comment on fiscal policy. That makes no sense to me. There you have to take into account fiscal policy. And if you are independent, as they supposedly say about the Federal Reserve mandate, you should feel independent enough to criticize the fiscal policy when it interferes with your monetary policy making. If fiscal policy is also helping determine interest rates, then monetary policy should not only adjust to it, but should also criticize the problems that he has. And that's, I think, lacking in the monetary policy as it's being implemented today. So where do you think it's very interesting?

18:15And Christopher, your message made me laugh. But Christopher pointing out that Bill Ackman went public that he's shorting bonds. Warren Buffett says he's still buying them. Granted, they probably have very different timeframes that they're operating on. What do you think happens to the 10-year? How high could 10-year treasuries go, given the fact that the Fed is still behind the curve, the economy looks stronger than anyone expected, inflation remains a risk? What are we looking at for a 10-year treasury? Look at a little bit of past history. October of last year, the 10-year reached a peak of 3.23%, 323%.

18:53And then, I'm sorry, 423, just over 4%. And I had been saying repeatedly the neighborhood of 4 % is going to be the ceiling. And so when I was asked about 423, I said, well, we have gone a bit over, but that's not going to be sustained. And sure enough, we came down to about the 350 range. I still feel the same way. Today, we are at 318, 418, 419 on the 10-year. You could hit 425, but I don't think there is enough strength in order to push the yield further. Why? Because I don't think the economy is strong enough to push the yield up. Inflation has been coming down, even though it's above Fed target.

19:41That does not argue for higher 10-year Treasury yield either. When you put it all together, I would expect we are close to the peak of the 10-year yield. Let's look at one other factor, and that is with the Fed having increased interest rates by five and a quarter percent and at the same time having resumed quantitative tightening. Quantitative tightening was set aside in March and April as a result of the regional banking crisis. The assets of the Federal Reserve shot up in March, but they have since started to go down again. They are tightening again. When you do that, all of that is going to cause something to break in the system.

20:26And whether it is another banking crisis, whether it's a commercial real estate issue that really blows up, or there is a credit crunch, I see something happening by the end of the year. If that happens, Maggie, you're talking about the 10-year yield plummeting after that. it doesn't stay so high as it is today, which is why I'm still very bullish on the high-grade fixed-income market. 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.

21:02So it's because you think the Fed is going to break something. It's not. That is the difference between, I'm guessing that view aligns a little bit with what Raoul has been thinking, although we're going to have to get an update from him on that. So let's talk about what's happening abroad. We had the BOE hiking rates again today too. What is the outlook there? There have been some pretty, things look resilient here, which is putting the Fed in a bit of a pickle. But in the UK, we've seen some, I mean, a housing figure, a third of UK homes' prices are falling. You've seen some pretty weak data there.

21:41What's the situation in the UK? You said it right. The UK situation is much more dire than what you have in the United States. They have significant amount of food inflation, much more so than we have here. They have energy inflation. Wage costs are, again, substantially rising at a very fast rate. All of that explains the fact that UK inflation rate is still beyond control in contrast to what is happening on the other side of the English Channel that you have in continental Europe, you have inflation rate which has come down quite sharply. And they are dealing more with the likelihood of a recession, whereas the UK is dealing with extremely high inflation rate.

22:28One other reason, which is hardly ever mentioned in terms of looking at the UK, is the Brexit decision. The decision to get out of a common market exchange and freely flowing goods and services across. And once you don't have that and you isolate yourself for political reasons, which is what I think the previous Prime Minister Boris Johnson got achieved, you're going to pay the price in terms of higher inflation. So it's going to be a very difficult situation. Current Prime Minister Rishi Sunak is going to face elections coming up at the end of next year, beginning of 2025. And he's going to go into elections with probably very high inflation rate.

23:17And here is one other thing about housing that you referred to, Maggie. because of, again, the big problem that they had last September, October, with the mortgage rates exploding, with a short-term policy, incomprehensible policy of short-term Prime Minister Liz Truss. You had the bond yields rise, and they haven't come back to the pre-crisis level yet. And if you are a homeowner and you're going to be renegotiating your mortgage, you're going to find that the interest rate you have to pay is substantially higher than where it was, let's say, last summer. That's also going to be an inflation problem.

24:03It's going to be also a problem on the political side. And those are the things which are still yet to be taken into account. So UK, I think, is in it for the long haul. If I were prime minister or if I had the ability to do anything about it, I would say, I made a big mistake. We shouldn't have got out of Brexit. And we need to get into the common relationship again. But of course, politically, that's impossible. It's not going to happen. Yeah. And one can only imagine the reaction of the Europeans after all this. So we've got really tough sledding in the UK. recessionary outlook for the ECB.

24:47What about the Bank of Japan? We can't forget about that because they've tweaked their yield curve control, but been intervening to try to manage the move. How do you see that going? Again, we have had two stages so far. Before the previous governor of the Bank of Japan left his office, after being in office for 10 years, he tweaked it instead of allowing it by just going to plus or minus 25 basis points so that the 10-year bond yield would vary between minus 25 and plus 25, he said the range was going to be 50 basis points. And of course, promptly, the 10-year yield went to plus 50 basis points as a result of the move.

25:34So, and thereafter, when it became clear that the new governor, Mr. Uveda, was not going to take any step to give up on yield curve control, as it is known, the yield actually went down to about 30, 35 basis points. But every time they do that, Maggie, they are spending a huge amount of money supporting the bond yield or the bond price. and that's the reason why it's an unviable policy. It was even discussed in the case of the United States as to whether yield curve control could be practiced as a way of getting the U.S. economy to grow more rapidly, meaning you fix the yield at a certain level and you buy and sell bonds to fix it there.

26:23We tried it in the United States in the 1940s and it was dropped in 1952 at the start of the Korea during the Korean War. Yes, the fiscal deficit went out of control. The interest rates were very high and the U.S. Treasury and the Federal Reserve came to an agreement. They could not support it anymore. They gave up and that 10-year yield just shot up after that. Now, Japan is in a similar situation. Their inflation has come back. even the core inflation rate is well over 3%. That is not consistent with having a 10-year yield of plus half percent. So what are they going to do? I think they are going to give up very gradually.

27:10And my guess is if I were to put a time on it, end of this year by the time at which the 10-year yield goes to 1%. But that ought to be of concern to US and European investors because US and European investors are big purchasers of JGBs or Japan government bonds, and Japan is the largest creditor nation in the whole world. So if that happens, I have made my own back of the envelope calculations that we can have the 10-year yield rise by 25 basis points if and when the Bank of Japan completely gives up on yield curve control. So this is an outlook here where we have the potential for upward pressure coming from different directions on US rates.

28:01And Artemis and Christopher are both asking, with long rates now above their March highs, won't the regional banking crisis return in some form? Do you think this will trigger more regional bank failures that then trigger rate cuts, Aramis, not Artemis, Aramis, excuse me. The answer to Aramis is I would agree. What Aramis is saying is exactly what I have been saying for a while. Before the banking crisis, I said there is going to be a credit event of some kind. I didn't know it was going to be the banking crisis, but it turned out to be. Now that that has happened, the same factors that existed then, namely that they have$500 billion of assets underwater, according to the FDIC at the end of March.

28:52And whether they keep it in the trading portfolio or the long-term portfolio, a loss is a loss. To me, it doesn't matter what the accounting rule tells you. So when they have$500 billion underwater, and if the 10-year yield increases further, and recall that in 2021, they believe Jerome Powell, believing that inflation was going to be transitory. That means a 10-year yield will come down. So if I buy 10-year bonds at 1.5%, it's going to come down to 1%. And I'm going to make a lot of money with the capital gain. That was the expectation. Of course, Mr. Powell was wrong. But he walked away from the problem.