Is the U.S. Economy Too Hot to Handle? With Jim Bianco

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

1:41Is the U.S. economy too hot to handle? Hi, everyone. Welcome to this extended Real Vision Daily Briefing. With me today is Jim Bianco, president of Bianco Research. Hey, Jim, it's great to see you. Great to see you, too. An interesting day that I wound up coming on. Somebody thinks we designed it. They think I have ESP. I wish I had those powers, But it is an interesting day. So just before we jump into it, just a reminder to everyone, thank you for your patience. What is too hot to handle is the mad genius happening on Bianco's computer and just in general for Skype and Zoom and everything like that.

2:17All these systems are problematic. Slack, if you have it, everything's been having issues today. But we got them now. And it is an extended daily briefing. So if you want to remain with us for the second half and you are not already a member, scan the QR code, jump on a trial so you don't miss anything. So, Jim, lots of different news today. What jumped out at you? You tell me. What did you find interesting? Well, two things. Obviously, the big story this morning was the downgrade by Fitch of the US from AAA to AA +, and how everybody's been misreading that, and what that really means, and bottom line, it doesn't mean anything.

3:00And it doesn't mean anything. Let me stick with that for a second. And it doesn't mean anything because Fitch, Moody's, S &P, our national statistical rating organizations, NRSOs, they are not a party of elders or a council of elders that came out of the drum tower that decided that the U.S. is worth less than it was the day before. That's not what this is about. This is about that a lot of people have mandates and they have guidelines on what they can invest in and cannot invest in. In 2011, when S &P downgraded the US, some of those mandates that were written back as far as the 70s said that your mandate was that if you wanted to put margin up at the exchange, you can only use AAA-rated securities.

3:45Oh, man, now all of a sudden, Treasury bills won't qualify for margin, and that would create chaos in the financial markets. or collateral for a repo trade or some other type of organization, or that you are an investor and you can only invest in AAA. That was 2011. And that's why when S &P downgraded, we had a lot of chaos. In the 12 years since then, we have changed a lot of those rules to say AAA and or government debt. And now that the US got downgraded, there's still government debt. So it doesn't really matter as much. So what happened was a legal thing happened last night with Fitch downgrading to S &P.

4:28You have to scramble to, if you're somebody listening to this call and you trade options or you trade futures, all right, well, you're going to have to check with your broker to see if posting Treasury securities is still applicable for margin. Yes, because they will accept government securities. Maybe 15 years ago, the rules said AAA securities, but that's not been changed. And that's why this was largely a non-event for the market. It will remain a non-event for the market because all these rating agencies are legal movements. They're not economic movements. So that's a really important distinction.

5:05And I remember covering that downgrade, and it was much more serious that you felt that people were very concerned about the implications. So thank you for laying out exactly why it's not does not feel like that this time around, because we saw it screamed all over the headlines and the timing of it was a surprise. The fact that they downgraded it, they've been warning they had it on negative watch. The timing caught some people off guard. But ultimately, as you say, it doesn't matter if it doesn't have the same implications. So what about the economic data that you've been seeing? If the downgrade wasn't important, what about what about what's happening with the economy?

5:39Because we did, we have a big jobs number Friday, but we have been getting this sort of steady drumbeat of kind of interesting readings on the US economy. Yes. And the drumbeat that we've been getting has been good. The economy has been looking rather well. It looks like, you know, to put it in the parlance of soft landing, you know, with shout out to Torsten Slock for inventing the word, no landing is what we've got. The plane is just continuing on. It isn't even putting down its landing gear at all to even attempt it. And that is where, is that good that we're just continuing on? Maybe. And why would I say maybe?

6:22What would be wrong with the economy just continuing to grow? Inflation. That's really where I think the issue is coming in, is as we look at inflation and as we all convinced ourselves last week that inflation's done, the Fed just did their last rate hike, it's all over. We're not even a week later, and now all of a sudden we're starting to talk about maybe inflation is coming back. Maybe the economy is going to stay strong. Maybe the problem with the labor market is there is no problem with the labor market, and that's going to keep wages up. And that might open the door to that other rate hike that the Fed said that they would do in 2023.

6:58And I've been very vocal that there might even be another one after that. It may probably be 2024, but they might not be done at all. So yeah, the economy, the numbers are looking pretty good. And that in 2018, 2019 would have been great news. But in 2023, that might mean just more inflation. And that might mean more rate hikes. And that's really where I think the market's now starting to focus on and getting a little concerned. Yeah, because you're right. We had not only were you hearing soft landing, you were hearing the peak is in for rates, Treasury peak is in. We have the Fed themselves really messaged around that, saying they're data dependent, and inflation was looking encouraging.

7:47Do you think the Fed's going to be surprised by this, Jim? ED HARRISON Fed's always surprised by this stuff. I mean, that's nothing new. Quick word about the Fed. They are an organization of 1 ,000 PhDs, and they model public information, because there really isn't any non-public information when it comes to the economy. And so they know no more than the consensus knows. And that's why a lot of their forecasts are consensus forecasts. What the Fed does have that we don't have is internal bank data because they're banking regulators, but then all the banks go bust and we know how good that is for them as well.

8:24So as we look forward, I think that, yeah, the Fed has been signaling the same thing Wall Street's been signaling, right? They took off the table the idea that there'd be a recession later this year. They are also looking at the idea that maybe inflation is bottomed. So they're in that same camp. But now, if you look at what's been happening, especially in the energy market, especially with gasoline prices, up almost 6 % in a little over a week is what we've seen with gasoline prices. This is going to filter through more and more to inflation. Cleveland Fed does this thing called the nowcast for inflation.

9:04They make an estimate for July and August. And I know everybody comes back to me and says, yeah, well, it's not very good. True, but it's as good as the consensus or anybody's forecast. They've got year over year inflation back to nearly 4 % in two months. It's going to go from 3 % to 3.4 when the July number comes out, if their forecast of 0.4 for July is correct. They've got a forecast now for August of 0.65, almost 0.7. If that is correct, we'll be near 4 % on year-over-year inflation in the space of just two months. Now, that is a big base effect in there. Base effect, why? Because a year ago, gasoline prices collapsed.

9:51So you had zero for July of 2022 inflation. You had 0.2 for July of August of 2022 inflation. So yeah, you're going to get a big base effect. But what I've argued is, J-PAL is not going to look at a creep back to 4 % in year-over-year inflation and say, that's it, we're done, we're done, no more rate hikes. No, he's going to have to continue to at least maintain the charade that they are being tight because of higher inflation. And rate cuts, a quick word on rate cuts, the Fed only cuts rates, the last four rate cut cycles have only occurred under one scenario. The economy falls apart and the Fed panics, and they're trying to stop a recession and they can't.

10:39This idea that the Fed is going to declare victory and start cutting next year as part of a look at how good we are, we slayed inflation, they don't work that way. They will stop raising rates and maybe stop raising rates for seven years if they have to. But the day that a rate cut comes is usually, the rate cut is usually the worst day to own stocks because that is the confirmation everything is falling apart. February 2020, early March of 2020 was the last time they started cutting rates. Now, let me be clear here. We're not cutting rates now, and we're not talking about cutting rates right now.

11:18But this whole idea that the Fed's going to pivot next year and that's going to be really bullish, it usually is the opposite. It's usually the worst environment because the Fed does not want to feed the monster of a financial market bubble. So they will only cut rates when everything goes sideways. And at that point, you don't want to own anything when things start going sideways. Hey, 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.

11:51Yeah, that's a great point. And it's always you always sort of wonder when you see people, the market rallying because the Fed's going to ease. It's like, well, that's happening. we've got bigger problems, right? We've got very big problems. So we have a bunch of questions about treasuries, about rates. I'm going to get to as many as we can. We've got longer today. But you mentioned the stock market. Just to plug back into today's action, we saw US stocks retreat, right? I mean, they've been on a tear. It seemed like nothing could push them down. But not only did we see them selling off, we saw them sort of accelerating a little bit into the close.

12:25And you're going to see a lot of headlines that connect that Fitch downgrade to igniting the sell-off and everything. I think we need to put that aside based on what you just said. What do you make of this sell-off? Does it feel like just consolidation after this relentless march higher? Or is there something else going on, you think? Yeah, the Fitch downgrades US Treasuries, and they don't sell off, but stocks do. Please explain. But that's going to be on every headline, because that's how it goes. Of course, every headline is going to be that way. I think really what's going on is if you look at the, let's take the 30-year yield for one example.

13:00We hit 420 today intraday. Now, the high last October was 438. We're starting to get back in the shouting distance of the high of the entire hiking cycle, which was almost a year ago. So rates are starting to move higher. and the yield curve is starting to steepen, or in this case, get less inverted. What does that mean that the yield curve is starting to steepen? That means that long-term rates are moving up faster than short-term rates. Now, why would long-term rates start moving up faster? In this point of the cycle, if you're not diligent, you being the central bank, not diligent in addressing inflation, I don't want to own your long-term securities.

13:44And your long-term securities are selling off harder. Yes, there's also the issue of that the Treasury announced more supply. I tend to push back on that for two reasons. One, supply has always had a very loose relationship with interest rates. And two, it was largely known that this supply was going to come. And three, most of the supply, even though they increased to 10 and 30 years, most of the supply is still on the front end of the curve. It's not in the back end of the curve. So I think the better explanation of what's happening with interest rates is there is a creeping worry about inflation, not 9 % June of 22 worry about inflation, but 4%.

14:21And if we're going to stay at 4%, then let's do some math. Let's say that we creep back to 4%. And then let's say that the Fed and thinks that their long-term inflation goal is not 2%, it's 3%. Jay Powell's already told us that he thinks the neutral funds rate is half a percent above the long-term inflation rate. So if the long-term inflation rate is now 3 % instead of 2%, that means the neutral funds rate is 3.5%. Well, when the yield curve normalizes, it should be about 150 basis points above that, that means that the fair value for the 10-year is 5. It's at 403 right now. So the yield is way too low.

15:04That's why this inflation thing matters. Because if inflation is going to be a stickier problem, a 3 % problem, maybe 3.5%, not 2%, I'm not saying anything about 9%, then you're talking about that interest rates are too low, and they're going to have to start moving up. Now, that might not affect the Magnificent Seven on stocks, but it will affect the other 493 and the Russell 2000, that those stocks will start to feel the brunt of higher rates. In fact, they have. Those stocks have really underperformed when you start looking, especially when you get into the Russell 2000 or you get into what's called the Russell Microcap Index, which is the lower 1 ,000 stocks in the 2000.

15:47I mean, that stock index, the bottom 1 ,000 stocks of the Russell 2000, so that is the smaller of the small cap stocks, was still down on the year three weeks ago. So any rally that they've had has only come in the last three or four weeks. So those stocks have really been struggling. Why do I think they've been struggling? Because they've got to contend with higher interest rates, and they have to contend with a banking system that is not as healthy as we would like it to be. Big companies could go borrow in the corporate bond market. Small companies have to go to banks. And then if the banking system is not willing to hand out loans because of their problems, then it's going to be felt within the rest of the economy.

16:31So higher rates matters. And it's showing up. It may not matter to NVIDIA. It It may not matter to Apple. It may not matter to Microsoft. It may not matter to Tesla. But it does matter to pretty much everything else. I think that's a really, really important statement, Jim. And our regular viewers will remember when we had Ben Miller on talking about the real economy versus the financial economy. There is sensitivity. And even there are some companies, I'm imagining, Jim, that maybe had a capital cushion, but they're going to have to go to the market soon. They just don't have this mountain of cash like an apple to float themselves, right?

17:09These are smaller companies that, you know, they're in order to operate. They need cash flow and they need to borrow. They're going to get hit. Even if they didn't get hit now, they're going to get hit with a rate reset. So there is a lot of sensitivity that people seem to forget about because they're focused on the other part of the market, which has looked okay. So, Doug, I think that answered your question. Jim, is the 10-year yield signaling future inflation? You're saying it's certainly signaling that rates are too low. Does it mean that we're going to see higher inflation from here or just that it's sticky where it is and rates are not recognizing that appropriately or both?

17:48I think it's the second statement, that inflation is going to stay stickier in the three to three and a half range. And like I said, you do the math, then fair value is closer to five on the 10-year note. And the steepening yield curve, meaning the long-term rates rising faster than short-term rates, I mean, if I was to put it bluntly, Jay Powell, if you're not going to deal with the inflation problem, I don't want to own your 10-year note. And that's basically what you've started. That's what a steepening yield curve means, is that the Fed might be falling behind the curve. The yield curve, the two-year, 10-year curve, just to put this in perspective, was 104 basis points last week.

18:27and it's 81 basis points, at least it was about an hour ago, 81 basis points right now. That's a big move in a week for the yield curve to steep it out or get less inverted by 23 basis points in about six days, six trading days. Again, volatility in the bond market like we are not used to seeing though, right? Not only are we not used to seeing it, but I spend my day with a lot of bond people and it's like, oh, what's going on? Quiet day. 10-year only moved about 14 basis points. I'm like, man, I can remember when the 10-year move, 14 basis points, our jaws were on the floor. Now that's just Wednesday in the bond market right now.

19:04This is the opposite of what's happening in the stock market with a 13 VIX and nothing's going on over there. There is a lot of volatility and there is a lot of movement within the bond market. Yeah, which is something, again, that's really important to bring up. I want to get this question in from Carl. Can Jim make a sensible thesis as to why after the credit downgrade, gold is lower, Bitcoin is lower, et cetera, when in theory, they should be higher on devaluation? Is this obvious manipulation? Please advise. So you said on obvious devaluation, the implication in your question is the downgrade meant something.

19:49The downgrade meant something. And like I said, it's a legal thing, the downgrade. If you are a financial manager that can only invest in AAA or can only use certain securities for margin, and those securities now become ineligible because they got downgraded, that's a big deal. But that's not the case. So when you look at gold and you look at Bitcoin or other outside of the financial system type of areas, first of all, you have to say that the downgrade did not impact anything. So now those areas, like Bitcoin and stuff, they're going to start trading on their own issues. And crypto's got issues right now.

20:31I would, you know, without going down the rabbit hole here, I'll just say that between the terror ruling that the courts had about whether or not those were investment contracts and the Curve Finance hack that we saw over the weekend really going to a primitive in DeFi and showing that it is vulnerable, there are some real problems there in crypto, not problems they can't solve. But as I've often said, the killer in crypto is still going to be hacks. Anybody gets hacked that has got credibility like Curve, and it really just casts a pull over the entire space right now. And so that's where I think that the crypto space is really struggling with right now.

21:21Because I'll say this to any crypto devs that are following, this is not gaming. You cannot put out a buggy 1.0 and people just have a bad game experience and the game crashes. You put a buggy 1.0 DeFi, and people lose their life savings. You cannot ever, ever, ever have a hack. And what do crypto have all the time? Hacks. And that's why it's just never going to get ready for prime time if this continues. And now that you've had a hack, although minor, in one of the more important primitives in curve finance, it just really casts, I think, a big pall over the entire space. So that's my little diatribe about what's going on with crypto.

22:04Gold, I've been on here before, and I'll just say with gold, with all due respects to Peter Schiff, I love Peter Schiff, but man, you've got everything Peter's ever wanted with gold for the last year, and it just can't get out of its own way. I don't know what more is going to get gold to move at this point. We've had inflation. We've had recession fears. We've had volatility in the bond market. We've had banking failures. We've had all kinds of things that gold bugs say, this is going to get it to go. Now we just had a downgrade. The US is no longer AAA. It cannot move. Gold's got bigger issues than just the Fitch downgrade right now.

22:43We'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.

22:54Yeah, that's well said. One of the most frustrating things. We have loads of people that come on that also say, I've just given up. I understand the arguments. But a question about Bitcoin, is it still trading like a risk asset? The other issues aside, is it correlating still with risk assets? To some extent, it really isn't. It had a big run in January. A lot of the cryptos did, and then it's been struggling. So its correlation with the NASDAQ has been weakening some. So it really hasn't been. And I've argued that that's a good thing, because in the long run, it is not a risk asset. If your argument is Bitcoin is a risk asset, it has no place, because it's just part of the current TradFi system.

23:44It's just a levered version of the triple Qs. Well, I can go buy the Dexion 3X QQQ, and I don't need Bitcoin at that point. Bitcoin is supposed to be something else. So it's starting to show that. But what I think it's getting mired in is this regulatory morass of, is it a security? Isn't it a security? Now, Bitcoin might not be, but the rest of the world is. But the problem is, Bitcoin might not be a security, but every electronic wallet like MetaMask or something like that that you want to own Bitcoin in has to register. And so it is becoming a problem, this regulatory thing. I think ultimately, crypto is going to win that argument, but it hasn't been won just yet.

24:31And all legal arguments go backward and forward all the time before you finally get to that final resolution. So it's still got some issues. So we have so many good questions, and I will get to as many as possible. Before we have to flip over for members only, though, and I know I realize we started a couple minutes late, so I'm going to extend this just a few more minutes. I want to get your thoughts on oil. So we've been talking about inflation. How does energy fit into that picture? You mentioned gas prices, by the way, up 6%. That's a huge move. We always talk about gas prices as being like almost an immediate tax on the consumer.

25:05So we can talk about that. But what do you see happening with oil prices from here? Well, let me start with gas real quick. Up 6 % in nine days, that's the biggest move it's had since last November. It equals the move that it had in January. If that move holds, that 6 % in nine days holds, that adds two-tenths to the overall CPI number. Now, of course, oil prices, I mean, gasoline prices could retreat and take some of that back. But if it holds, it would add two-tenths. Now, what's been the driver of that? Since late June, crude oil prices are up over 21%. And what's been the driver of that, that the 21 % rally in crude oil prices, it's starting to get gasoline prices.

25:45OPEC has been very clear with Russia, the OPEC plus about voluntarily cutting production and continuing to cut production. And they have been very clear that their goal is to crush all of the short sellers in the crude oil market that, you know, the OPEC minister, OPEC energy minister said he wants to make them ouch. That was his exact phrase that he used about speculators in oil. They want to see the price of oil go through the roof. And I had been kind of critical of them because they've been saying it since like March. And from March to like June, they weren't getting any traction on that. And they kept cutting production and cutting production and it wasn't working.