Submitted by Peter Tchir, Academy Securities — Macro Strategy
Warsh’s Mark Antony Moment
I really wanted to go with Warsh is “puttin’ on the foil” as the title for our Jackson Hole preview, but I’m told the Hanson Brothers might not be as iconic as I thought. In any case, of all my failings as a parent, getting my kids to finally watch Slapshot is one of the easier ones to correct. I felt the “vibe” of Warsh “puttin’ on the foil” in the green room as he gets ready to speak to the Jackson Hole crowd was good, but today we’ll go a little more “highbrow.”
Friends, economists, central bankers, lend me your ears;
I come to bury inflation, not to praise it.
As you know we have been on the side of No Cuts:
- We discussed this along with the danger of Cheap Chinese Compute on Thursday on CNBC.
- On Friday, we discussed Iran, ProSec, and the Fed on Bloomberg TV (starts at the 2:19:40 mark, with Lisa giving her best Seinfeld impersonation of No Hikes For You (last weekend’s T-Report)). The segment before discusses why the Fed is still going to hike 75 bps, so the combination of the two segments makes for some interesting viewing.
- The Path to a September Rate Cut (Despite AI Inflation). Restarting the conflict in Iran has not been good for this timeline, and the data task force is likely to take longer to come back with recommendations than I’d like, but the points, I believe, are still valid.
Arguing about what data the Fed uses and how they interpret the data is not new for the T-Report:
- A few “oldies but goodies”:
The role of a strategist is to determine what is likely to happen, not what one wants to happen. This report may skew a little to the “want” rather than “expect” side of the equation, but sometimes it is healthy to vent (and possibly influence policy).
The Warsh Reaction Function is Clear
Okay, that is probably an overstatement, but I think worrying about the reaction function is missing the main point. The main point is to figure out what data Warsh is going to react to. The “reaction function” consists of two parts:
- The data that feeds into the equation.
- The equation that processes the data to get an answer.
Why do so many people still think PCE or some other data point (that has likely led to bad policy decisions in the past) is what Warsh will use? I suspect his “reaction function” will be more or less “normal,” but what will be unusual is what data he uses to input into that function.
That is a key premise to my view on how he should attack his Jackson Hole Speech.
The Speech I Would Give
This is definitely a mix of what I’d say, what he may say, with a bit too much Shakespeare to keep the report aligned with the title. Mark Antony’s speech starts with one thing and ends with pretty much the exact opposite, which hopefully I’m able to replicate here (and I was tempted to put on the foil to help write this).
Friends, economists, central bankers, lend me your ears;
I come to bury inflation, not to praise it.
Inflation is Bad, But…
Step 1 — Argue inflation is bad, but it is at least a little unclear that this is always true, or if there is some scientific method to determine what level of inflation is bad.
Is inflation bad? Yes, some level of inflation, historically, has hurt a segment of the population. Do we know that exact level? No. Well, some say 2%, but why not 0%? Why not 4%? 2% seems like an awfully convenient round number. If we had rigorous scientific backing it would be one thing, but unlike “hard sciences” much of what we do in economics is conjecture. [Step 1a — inflation is bad, but how do we know 2% is the “right” target?]
Is inflation bad? Yes, but don’t we need to look at income growth as well? Inflation erodes purchasing power, but if wages are rising at or near the pace of inflation, should we be that concerned? If we had 4% wage growth, 1% real yields, and inflation running at 3%, should we try to stop it? Nominal is important but real numbers are important too. [Step 1b — inflation may be bad, but it needs to be thought of in an overall context.]
Is inflation bad? Yes, and Powell was an honorable man, but…
We’ve all agreed that inflation is bad, but yet, my honorable predecessor left rates unchanged even as inflation soared. Did this inflation in 2021 not seem bad? Surely the Fed must have been afraid of inflation above 4% using the auspices of the BLS data. While relying on the high priests to examine the entrails, could they have not looked for other signs that inflation was there? [Step 1c — hint at better ways to measure].
Then in 2024, just before an election, my predecessors were able to cut rates. Inflation must have been below 2%, no? No, inflation was above 3%, but we cut rates. Yes, I understand why everybody says inflation is bad, but did they act on it? [Step 1d — point out recent examples that don’t match the current angst on inflation].
Rate Hikes Quell Inflation, Except…
Step 2 — Argue that rate hikes are not always an effective tool against inflation.
Rate hikes will quell inflation. Yes, we have a conflict in the Middle East where the U.S., under the guidance of President Trump, is trying to make the world safe (I’m writing what he as an appointee might say). One offshoot of that conflict has been higher energy prices across the globe. The U.S. as a net exporter has weathered this better than other regions. Energy prices (including gasoline, jet fuel, and diesel) have risen, along with products reliant on oil and LNG as their feedstock. Will hiking rates cause oil prices to come down? Will people drive less because of a hike? How does raising the cost of funding help our great energy companies explore and produce more energy? Shouldn’t we be making it easier for companies to invest in energy production rather than the other way around? If we had a “natural” supply and demand imbalance, hiking rates might be effective. However, hiking rates due to a conflict, which could ultimately lead to lower energy prices, seems like the bigger mistake. [Step 2a — argue that hiking to offset inflation due to Iran is counterproductive].
Rate hikes will quell inflation. Yes, we have one of the largest capital investments this nation has ever seen! We are building data centers and AI processing power across the country! It is a “revolution” that is “transforming” the country. There are strong arguments that over time, this build out will increase productivity, thereby dampening inflation. Assuming that we think it is good policy to dampen future productivity gains (over today’s concerns), would it even work? Will a single “compute” project be put on hold because we raise rates by 50 bps? Given the profit potential being priced into the market, a 50 bp hike would be a mere blip for these companies regarding their willingness to proceed with projects. Yet every other part of the economy would be hurt. [Step 2b — argue that hiking to slow the “compute” spend is bad public policy and would not work anyways].
We will hike rates when inflation is too high (if we believe that hiking rates will not only act to lower inflation, but also serve the longer-term interests of the nation). The key sources of inflation that we are experiencing will not be impacted by hikes and it would be bad public policy, at the national level, to slow the “compute build.”
Task Forces Are Ambitious, Or Just Common Sense?
Step 3 — Changing the Fed is “ambitious” but necessary.
Is a Balance Sheet Policy Task Force ambitious? Yes, but how did something that was once considered “extraordinary” become a basic part of the tool kit? The most recent Quantitative Easing ended in March 2022. We continued to buy bonds up until the day we first hiked? It is unclear why we waited so long to hike with inflation spiking, but to still be buying bonds right up until that moment in time seems wrong. If QE is “extraordinary,” that makes no sense. The 10-year Treasury was 1.5% in December 2021, with inflation soaring, and the Fed kept buying bonds?
Going back to COVID, we saw “near panic” in corporate bond markets. The need to raise money was overwhelming the ability to support prices. The “carnage” in ETFs attracted the Fed’s attention. A short-dated corporate bond ETF was trading at an extremely large discount relative to NAV, which was causing the ETF Spiral™ to play out (according to the T-Report at Academy Securities (wishful thinking plug on my part)). On a Sunday night, in conjunction with Treasury, the Federal Reserve announced programs to not only purchase corporate debt in the secondary market and to buy corporate debt new issues, but also to buy corporate bond ETFs. The result was instantaneous and markets recovered before the announced programs ever bought a single corporate bond or ETF. It in fact took weeks, or longer, to develop the protocols and piping to execute the plan, but we went ahead with the purchases, even though the announcement had done the heavy lifting. [Step 3a — is it ambitious to question how we use the balance sheet? Yes, but it seems like an extremely useful exercise].
Is having an Inflation Frameworks Task Force ambitious? Yes. Why weren’t we hiking earlier? Why were we cutting when inflation was well above target? Why would we hike (or cut) when many entities (including every person and corporation locking in long-term low yields during ZIRP) would not respond to that simple decision?
Is having a Data Sources Task Force ambitious? Actually, no, it is not ambitious, it is common sense! It has been a long time since anyone at the Fed used a slide rule, so why would we not reassess what data we look at? Businesses have been built around processing, analyzing, and procuring data in a timely fashion. These businesses only survive if they are useful. The Fed itself publishes a swathe of data that seems to be largely ignored by the Fed (at least at FOMC meetings — Cleveland Fed Tenant Repeat Rent). Let’s examine what we already have at the Fed and BLS that can be used. Let’s examine other outside sources. Let’s create a “best of breed” dashboard. I cannot even fathom why some view this as “ambitious” instead of standard operating procedure!
Bottom Line
If I were Warsh, I’d take the gloves off and come out swinging!
Hammer home the point that while “inflation is bad,” the exact level that is “bad” is difficult to determine. There have been inconsistencies in the application of interest rate policy with inflation readings. Get people to question the status quo on what data is useful or not.
Argue that not all sources of inflation would be impacted by raising rates. That understanding the drivers of inflation is key to effective policy — not a “knee jerk” reaction to a number.
Highlight how we have an opportunity to rethink much of the Fed policy making process from the ground up with these task forces, and that these task forces should be the “norm” and should have been in existence already.
I wouldn’t weigh in on jobs (recent data supports the cuts, but this is already getting too long).
I wouldn’t weigh in on the neutral rate — far too wonky and will let Miran or someone else champion that part of the argument on why policy is too restrictive.
Probably far too aggressive on my take (and use of Mark Antony), but I expect that by the end of Jackson Hole, we will see rate hike expectations continue to drop.
I’m not as bullish on rates out the curve, as global sovereign bond issuance (to support defense spending and infrastructure spending) and ongoing corporate debt issuance are likely to keep pressure on the longer end of the yield curve. It doesn’t help, at least for now, that traditional buyers like Japan and the Middle East are likely not buying as much of our debt as they once did (for different reasons).
Rising bond yields and a “hawkish” Fed are something that should not be a concern for equity markets!
Cowards die many times before their deaths; the valiant never taste of death but once.
That seems like a good quote from Shakespeare’s Julius Caesar as it is the approach I’d like to see Warsh take (he will emerge victorious, if this is done well).
Have a great weekend, and at least now I won’t have to write about Jackson Hole next weekend.
