Pause, Skip, or Hike? w/ Dr. Komal Sri-Kumar

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

1:34pause, skip, or hike. Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Sri Kumar, founder and president of Sri Kumar Global. Hi, Sri. It's nice to see you. Very good to be back with you, Maggie. How are you today? Well, we're all struggling a little bit on the East Coast, that's for sure. We were joking that everyone's talking about Canada, mostly because of that terrible air quality coming from the wildfires and some weather patterns, even shutting down all the airports here on the East Coast. So hopefully all our East Coast friends and viewers are taking care of themselves.

2:08Before we jump in, though, just a reminder to everyone, we have moved the extended daily briefings to Wednesday. So this isn't extended. If you want to stay past the half hour, you need to be a member. So just scan the QR code and you can join or hop on that trial. If you're in both chats, you're going to want to move over to the platform to continue with us. So please do that. which is a shout out to Emma who was asking at the start. Yeah, so Canada front and center, but I think overshadowed by the crazy air quality and pictures that are all over social media, the Bank of Canada, Sri, surprised investors by hiking interest rates today after being the first one to pause.

2:47And that struck me as very interesting, and it seemed to have raised even more questions about the Federal Reserve. How are you thinking about the Fed? We're in the blackout period now until the meeting next week. How are you thinking about this scenario? When you compare Canada with the United States, Maggie, the two economies have been very similar. Take a look. The Bank of Canada has a 2 % inflation target, the same as the Federal Reserve. We are having a tight labor market south of the border, and it's the same thing in Canada, which is also one factor that caused them to increase. politically to continue to increase interest rates as they had done in the past turned out to be untenable after a period of time.

3:31So Bank of Canada paused. But then they found out inflation continues to remain high. They also have a problem with core inflation remaining high. So it's not just food and energy. And so they decided to increase. So what is amazing to me also, Maggie, is that despite being a smaller economy and despite Canada sometimes being thought of as a follower of the United States, they are the leader in this case. And if June 14th, the Fed happens to pause when the Bank of Canada increased, it's not as if funds will flow from the United States and surge to Canada. That's not the risk. The risk is what is the bigger economy doing when the smaller economy is showing a better way to go?

4:21So what do you think the Fed will do next week? What will they do and what should they do? There might be two different answers. Yeah, there are two things. One, if I can get to June 14th, when the decision will be announced and Jerome Powell will speak at 2.30 p.m. Eastern, I would be better off talking about June 14th if I did not have to go through June 13th in order to get there. What happens June 13th, 8.30 a.m. East Coast, time, in the morning, we are going to get the consumer price inflation numbers. The expectation is it is going to remain very high, close to the previous high. Now, if we end up with the inflation actually accelerating from past levels, it's going to be very difficult for Jerome Powell to sing the pause tune when he speaks at the press conference.

5:15So what I think happens is that you're going to get a really high inflation rate on Tuesday. Then on Wednesday, if that happens, the Fed will use, they've now introduced a new word into the vocabulary, into the jargon. It is not just pause or hike. It is skip. As if this is a game where you skip, run, and then stop, and then keep doing it again. I think skip essentially means that you don't do it next month, but expect them to hike again in the month of July. The question is, is this a game? What are you going to achieve by not doing it in June and delaying it to July? Nothing at all. So I think my expectation is there will be no rate increase.

6:06It's not going to achieve very much for the Fed, unfortunately. So you think there will be no rate increase. It's interesting you point that out because they do want that intention. The intention of introducing Skip is to sort of say that they're being vigilant about inflation. But presumably, if they're pausing, they don't know what's happening, right? They can't see into the future to find out what's happening. So it is kind of ridiculous to introduce that into the market. And conditions are changing if they're data dependent. So why even do that? Exactly. The reason is that they do not have a long-term plan.

6:40They have openly come out and said that decision is going to be based on the latest data points. Remember, various Fed members have said it will depend on how the latest numbers are going to show. That's not the way it should be. You need to have a long-term program, which the Fed doesn't. I call it seat-of-the-pants decision-making, which is what I think we have today. I am a big fan of something to follow a rule, a structure. One of those is my Columbia University professor for my PhD dissertation, John Taylor, who is now at Stanford. And he has something called the Taylor Rule. It talks about how the interest rate should be done, set, based on where real economic growth is and where inflation is relative to where you want them to be.

7:30You feed them into an equation. It comes out with an interest rate and everybody can see what it's going to be. There is no uncertainty. The problem is, yes, it is very efficient, but you don't need all those voting members of the Federal Reserve. They can all go home. We can save some salaries in the process. And bureaucracy being what it is, they will not agree to it. Janet Yellen was a member of the Federal Reserve Board of Governors in the 1990s. And she actually wrote a note saying the Taylor rule is a good rule. She hopes the Fed will adopt it soon. Well, that was 30 years ago. It's still not there.

8:11That is part of the problem. It adds to the uncertainty for the market. And Maggie, you and I keep talking about what happened June 14th. If we had a rule in place, we would both know exactly what the Fed is going to do. No uncertainty. The market can go on with long-term expectations rather than fluctuate on a day-to-day basis. 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.

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9:46You know, Sri, you bring up an interesting point when you say the real economy. So what is happening in the real economy? I've heard so many really experienced macro analysts, investors say this is one of the hardest markets they've been in. We look at some data looks really weak. Some things look like they're rolling over, but we saw ISM services. It's going down, but it's still hovering around 50. Jobs grew by over 300 ,000. What's happening with the underlying economy? To what extent have we seen the impact of the rate hikes the Fed's already put in place? Have they started to hit? Are they still coming at us?

10:25Where are we in this arc? I have a lot of sympathy, Maggie, with those people who say this is a very complex economy. What is it that has happened? We have had not only the traditional Fed liking for monetary easing and supporting the markets, which they have done again from economic cycle to economic cycle, but we have two other developments which are not present in past economic crises or past recessions. One, COVID. We are having it for the first time since the Spanish flu in 1918, so more than 100 years ago. Second, we had the U.S. Treasury and the Federal Reserve, both of which went absolutely wild.

11:10I would call it berserk, irresponsible policy in 2020 and 2021 in terms of expansion, in terms of the stimulus provided. So we have so much cash floating around, which explains why the labor market is so tight. On the other hand, when you have weakness in services developed, when weakness in Institute of Supply Management figures, that's because the liquidity cannot go to every direction. It helps the labor market. So the labor market remains strong. But on the other hand, inflation also remains high and economic growth has continued. So we are going to have this variety of features within the economy which were not present in the past.

11:57That's why it makes it a lot more difficult to forecast. And again, I know you're going to touch upon equities versus fixed income later. So I will leave that to later. But I will just mention one sentence. I believe more in the bond market, what the treasury markets are saying. And I hope we'll get a chance to talk about that in some detail. Oh, we absolutely will. The problem is people have gotten smoked in bonds, right? It's been bond volatility has been unprecedented in some respects. So it's been really hard, I think, for some people to get the signal out of that. Just want to bring up a comment from YouTube from Passport Bros Business Class.

12:42I love these names. Interest rates are already so high that raising it won't make much of a difference. Is it kind of like pushing on a string here? I mean, if they're so high already, is another hike going to make that much difference? Or do they have to really continue to be aggressive here in order to finally kill inflation? I would say in answer to that person's question, what is it that you want the Fed to achieve out of the rate increase? If you think that one more rate increase is going to kill inflation, the person asking the question is absolutely correct. It will not do it. Inflation will not get killed because interest rate goes from five to five and a quarter to five and a quarter to five and a half.

13:24will not make a change. But it will make a difference in one other area, namely the cumulative 10 increases we have had over the last 15 months is at some point you're going to see a situation saying one more rate increase, that's the straw which broke the camel's back. Go back to March. We didn't expect a regional banking crisis. We didn't see that happening. However, the Fed's irresponsible policy of thinking that inflation was going to be transitory gave bank management such as Silicon Valley Bank the idea that yields are going to remain low. How can you blame Silicon Valley Bank where the exalted chairman of the Federal Reserve told you that inflation and interest rates are going to be low?

14:13So the problem we have now is that there are various other things that have come in, which the investors have to take into account. And if there is one more rate increase, you're going to have some new credit event. I have my favorites to talk about whenever we have the opportunity to raise that issue. Fantastic. And Bo pointing out they need to raise for sentiment as well. When you said the 10 rate hikes, we've gone from almost zero to where we are now. That is a very aggressive. I mean, we were coming from such a low point, but those are a lot of rate hikes to work through the system. When do you think it's finally, I know you sort of explained that it's countering all the stimulus out there, which was also extreme.

15:00So we're sort of pushing against this extraordinary situation. Do you feel like we're going to, how's the Fed calculating this? Do we have an idea about the lag of those rate hikes? Have they hit or not yet? at? Let me answer you in two parts. First of all, I agree with you fully, Maggie. Even though you've had 10 rate hikes, the 10 rate hikes were in fact to counter what they were doing in 2020-21. Keep in mind that from the beginning of 2020 to March of 2022, when the tightening began, 13-14 months, the balance sheet of the Federal Reserve doubled. It went from an already bloated$4 trillion at the beginning of 2020 at the start of COVID to almost$9 trillion at the beginning of 2022.

15:54That's how much of excess we had. I couldn't tell you whether Jerome Powell wanted to be re-nominated by the president, whether at the beginning of 2021 he wanted to show himself as a team player but there was no economic rationale for the expansion to take place at that pace and also keeping interest rates very low for a long period of time. The fundamental principle we learned in macroeconomic theory 101 when we start graduate school is that the Fed controls short-term interest rates not the long-term bonds. So for the Fed to have said we are controlling low interest rates and therefore inflation and bond yields are going to remain under control is simply not backed by theory.

16:44And those are the reasons why he was trying to make the change very quickly. The second part of answering is what are they going to be doing in the future and have they done it too fast? Yes, they had. But on the other hand, what alternative did he have? The mistake was not made in the last 15 months of hiking too sharply. The error was already done in 2021 by misjudging how much inflation would pick up. So once you make a serious error, there is no amount of penance you can do in order to counter the fact that you've had a serious error in your background. Got to clean up that mess. Colin asking, do you think the market is misjudging the strength of core inflation?

17:36No, the market, I think, has a good idea of core inflation, which is the reason why the bond yields are still remaining high. And core inflation is, again, keep in mind, let's repeat what core inflation means. It's the overall inflation rate, like the consumer price index, out of which you have removed food and you have removed energy. The two components are thought to be very volatile, fluctuating. So the rest of it is looking at goods and services, which are expected to be more stable. And the core inflation has continued to remain high, even in the Fed's favorite inflation measure, which is called the personal consumption expenditure core index.

18:20And that is still running at well over 4 % or twice the Fed target. So the market, I don't think, is misjudging it, Colin. I would say the market got it right ahead of the Fed. And the Fed is the one which is falling behind or it's behind the curve. 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.

18:50Yeah. And there's another dynamic, which we've been talking about a lot. In fact, we're doing an entire festival of learning this week around the subject of AI. So we see the bond market and stock market acting very differently. As you've been mentioning, and we're going to talk about in a moment, the yield curve is inverted. And yet we're watching this small group, granted, but tech names soar on the back of this very powerful AI narrative. And, you know, there are a lot of influential people coming out and saying, you know, yes, there's been a lot of movement, but this feels real. This feels like it's transformative.

19:25We did see the Nasdaq give up some gains today. But even bulls like Beth Kindig, who was on and did the NVIDIA call at the beginning of January that we've been talking about, she came back on our show Three Ideas and recently. And even though this is such a transformative moment in technology, she's also getting a little bit concerned about valuations. Let's listen to a clip of that, and then we'll talk on the other side. And I would say that AI is at risk of becoming a buzzword for many companies, but not NVIDIA. They're the leader in parallel processing. The GPUs are required for every workload, AI workload.

20:04And so they're really the hub of this transformational trend. However, the valuation, as you know, is very high. And I have held NVIDIA for a long time. It was a 15 % allocation going into that earnings call. I'm not buying right now. And I think that having a 15 % allocation going into that earnings call means that I really understand this company. I understand the timing. And to put my best foot forward, I just want to be really clear that I'm not buying right now. I do believe there will be better entries in the future. And this can get rocked a few ways. First of all, Semi will always have a China risk.

20:43Secondly, AMD is bringing the heat. They're starting to come out with MI300 GPU. And that full interview, including Beth's analysis of AMD and her other trade ideas, is on our platform. You can scan the QR code to get access to that. So Sri, how are you thinking about the divergence between stocks and bonds? You mentioned that you like to look at the bond market. Walk us through why. The reason is, first of all, look at the equity market surge. It is not a generalized increase in equity market as eared, particularly last week. when it was concentrated in just not even a handful, less than a handful of stocks, which caused most of the increase.

21:25So that is one indication. It is much more security specific, Maggie, rather than even the equity asset class by itself. Having said that, it is history that I depend on in terms of looking at why the bond market is a better predictor than equities. I happened in fact I have a report in my archives written in September October of 2007 when I said the US economy was at the verge of recession and when I wrote that I was called a fear monger I was told that I did not have a basis for that I had a basis throughout 2006 one year triad we had the two to ten year yield curve for the treasuries inverted.

22:14And typically, I have learned from experience that not just an inversion, which is one or two days old, but is sustained over several months typically leads to a recession after about between nine and 15 months after the inversion has begun. So that's essentially what I used to talk about it. And it turned out to be correct. I said in October that we are at the verge of a recession. December 2007, the grand recession began. What were the equity markets saying at that time? October 9, 2007, the S &P 500 index hit an all-time record. Equity holders were all excited. They said equities are suggesting a strong economy.

23:02What did the commodities market say? commodity market commodity prices were increasing first half of 2008 global oil prices were surging by may of 2008 oil prices were at about 150 dollars a barrel somewhere which we have not even got we are not even at half that level today and then the european central bank in july of 2008 decided that the global economy was booming and they increased interest rates and two months later, the whole world crashed. So much for trusting commodities, so much for trusting equities. But when you look at the Treasury market, after having been inverted through 2006, through the end of 2007, believe it or not, the yield curve started to steepen and became positive.

23:55What was it saying? It was looking beyond the recession that it had predicted. and it was looking forward to the recovery taking place, which began in early 2009. So we have a good record, both from the treasuries as well as a bad record from equities. So I would be very skeptical buying the equity story today. That's so interesting. Ralph asking, can we see his 2007 report from the archives? We'll work on that, Ralph. Maybe we can get Sri to share it with us and we'll post it on the platform. Yeah, it was with the previous employer. So I have to figure out whether I can get it out. All right.

24:39Well, we'll work. Yeah. When our digital stuff belongs to us one day. You know, Sri, you just raised something very interesting, and I'm going to pull it out of my archive brain. A long time ago, I was talking to a portfolio manager. I don't think it was in the 2007-2008 period. I think it was something after that. But we were at a juncture like this. And he said to me, the problem is the bonds are great at flagging bad news, but they're terrible at – they're kind of always bearish. Bond people are always bearish. They're great at flagging the bad news, but they're terrible at calling the swing and sort of recognizing the good news, where he felt like sometimes equities had to jump on that.

25:24Is that false thinking? Can treasuries also flag that upturn or do equities tend to lead on that? Well, we just spoke about it. If you look at the treasuries, I talked about how the treasury yield curve had started to steepen in 2008, 2007, 2008. So when we realized finally that Lehman Brothers had gone bankrupt and we were in the midst of a crisis in the summer fall of 2008, the treasury market was actually rallying. Okay. So they already, like they're sort of, you know, sell the news, buy the rumor, sell the news, that kind of thing. Exactly. They had gone past the Great Recession and they are looking for the recovery.

26:11And so I'm saying, here is an instance of the bond market telling you something positive that is taking place also. So I would not put that aside. But here is my concern. The equity market is generally almost always euphoric. So what do I learn from it? Even a broken clock is going to give you the correct time twice a day, and that is no way to judge the accuracy of time from a clock. So that's my problem with equity. Yeah, fair enough. Fair enough. And we have seen that. So I'm conscious of time. We're not quite there yet. But whenever we sort of start to dive in, it's hard to find a point here.

26:52So I'm going to, instead of it being right at the bottom of the hour, I'm going to just do it here where we're going to transition. If you want to continue, you know the drill. If you're not a member, you've got to scan the QR code to join our community, jump on a trial. For those who have to jump, and I've got to get these programming notes in. There's no other way to do it. The daily briefing, remember, is moving to summer Fridays. Summer Fridays, people, so we can match up with all of you because I know that many of you have summer Fridays if you're in the office, even if you're not, and have important fun places to be.

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