Financial Conditions Remain Loose, How To Kill Inflation | Andy Constan
Summary
TLDRIn this episode of 'On the Margin,' the host is joined by Andy from Damspring Advisers to discuss the current state of the economy, inflation, and the role of the Federal Reserve. They delve into the recent CPI numbers, the potential for rate cuts, and the impact of financial conditions on the economy. Andy shares his insights on the banking sector, the importance of community banks, and the future of interest rates. The episode also highlights the partnership with Aura, an AI-powered application for online safety, and Mantra, a security-focused L1 blockchain project.
Takeaways
- π The importance of online safety is highlighted, with the mention of Aura, an AI-powered application, protecting against cybercrime and scams.
- π Discussion on the current economic climate, particularly focusing on the CPI print and signs of economic reheating.
- πΉ Insights from Andy, CEO of Damspring Advisers, on the plateauing of inflation and the Federal Reserve's potential actions.
- π¦ Commentary on the banking sector's resilience and the impact of small bank issues on the broader economy.
- π Analysis of the yield curve inversion and its historical implications for recessions.
- π¬ Andy's perspective on the upcoming FOMC meeting, including expectations for interest rate cuts and the potential shift in the long-term interest rate target.
- π€ The impact of AI on the market and the significant returns in the stock market being driven by a narrow set of companies.
- π Discussion on the growth of Bitcoin and cryptocurrencies, and their response to financial conditions.
- π’ Consideration of the role and challenges of community banks in the US economy, and the importance of maintaining a diverse banking system.
- π The script's mention of the recent troubles in the banking sector, including Silicon Valley Bank and New York Community Bank.
- π― The potential for a shift in the Federal Reserve's policy approach, with a focus on managing inflation and supporting full employment.
Q & A
What is the main concern regarding online safety mentioned in the transcript?
-The main concern is the prevalence of cybercrime and phishing attempts, which have become a significant issue for individuals and businesses operating online, especially in the cryptocurrency space.
How does the guest, Andy, view the current state of inflation?
-Andy views the current state of inflation as plateauing at an unacceptable level to the Federal Reserve, requiring more patience before rate cuts occur for inflation to stay durably at target.
What is the significance of the recent CPI print mentioned in the transcript?
-The recent CPI print indicates that there may be signs of the economy reheating, with inflation staying substantially above the target for a while, partly due to extremely easy financial conditions since late October.
What does Andy predict about the Federal Reserve's target rate?
-Andy predicts that the Federal Reserve won't prematurely raise the target rate until they have achieved it at 2% and then consider raising it further.
What is the role of community banks in the US financial system according to the transcript?
-Community banks play a crucial role in serving the needs of local businesses and individuals, providing a diverse and broad banking system that is favored by the populace and elected officials.
What is the current long-term interest rate target set by the Federal Reserve?
-The current long-term interest rate target set by the Federal Reserve is 2.5%.
What does Andy suggest about the impact of AI on the economy?
-Andy suggests that the boost of AI could lead to a higher neutral rate due to increased productivity, indicating a potential shift in the economic environment post-COVID.
What is the 'tailor rule' mentioned in the transcript?
-The 'tailor rule' is a method used by the Federal Reserve to determine the appropriate level of interest rates based on expectations for inflation, long-term neutral rate, and GDP.
What was the main topic of discussion in the podcast?
-The main topic of discussion in the podcast was the state of the economy, inflation, and the role of the Federal Reserve in managing interest rates and financial conditions.
What is the significance of the yield curve inversion mentioned in the transcript?
-The yield curve inversion is significant as it typically precedes a recession, indicating that long-term interest rates are lower than short-term rates, which can discourage investment and signal economic contraction.
What is the outlook for the upcoming FOMC meeting?
-The outlook for the upcoming FOMC meeting includes maintaining the same interest rate, potential changes to the interest rate projections for 2024, and discussions on quantitative tightening based on the current financial conditions and economic indicators.
Outlines
π Online Safety with Aura
The speaker introduces Aura, an all-in-one application powered by AI that protects online safety. They discuss the increasing risks of being a human on the internet, with constant scam phone calls and phishing attempts. The speaker emphasizes the high statistics of cybercrime, stating that one in four people fall victim to it, especially in the crypto world. The episode is sponsored by Aura and Mantra, a security-focused L1, which will be discussed later in the show.
π Economic Outlook and Inflation
The speaker and guest, Andy, CEO of Damspring Advisers, discuss the recent CPI print and the signs of a slightly reheating economy. They delve into the topic of inflation, agreeing that it has been transient but is now plateauing at an unacceptable level for the Fed. Andy shares his long-term view that inflation will stay in the 3-4% range until the Fed takes necessary actions to curb it. They also discuss the possibility of the Fed changing its target rate from 2% and the implications of such a move.
π‘ Financial Conditions and Interest Rates
The conversation turns to the easy financial conditions since October and the impact on inflation. The speaker and Andy discuss the Fed's mission and the challenges in achieving their goals. They question the discussions about rate cuts by the end of the year and explore the idea that the persistent level of inflation might be higher than in the past. They also touch on the service economy's insensitivity to short-term interest rates and the importance of long-term interest rates in financial conditions.
π Mortgage Rates and Economic Impact
The discussion focuses on mortgage rates and their significant impact on the economy, contrasting the period of 8% rates in October to the sub-7% rates currently. The speaker highlights how financial conditions indexes support the view that the economy is as easy as it has been throughout the tightening phase. They also address the Fed's members' opinions on the restrictiveness of financial conditions and the market's reaction to the Fed's December meeting, which was interpreted as a pivot towards easing.
π‘οΈ Aura: Protection Against Cybercrime
The speaker reiterates the importance of online safety and promotes Aura, an AI-powered app that offers protection for identity, financial accounts, and devices. They emphasize Aura's benefits, including immediate notifications of hacking attempts and 24/7 support to resolve fraud issues. The speaker offers a special discount for listeners who sign up through a provided link.
π Mantra and the Future of Tokenization
The episode is also sponsored by Mantra, a security-first L1 that aims to onboard financial institutions into web 3. The speaker discusses the potential of tokenizing trillions of dollars of off-chain assets and the need for a compliant L1 like Mantra. They highlight Mantra's rapid growth and its features, such as IBC interoperability and smart contracts. The speaker also mentions the upcoming blockchain testnet launch and opportunities for developers.
π Market Analysis and Bitcoin's Role
The speaker and Andy analyze the market's performance, noting the narrow basis of the S&P's return on a few tech stocks, particularly NVIDIA. They discuss the role of AI in the market and Bitcoin's new all-time highs. The speaker expresses a cautious view on the broader market rally, acknowledging the potential for frothiness but also recognizing the changing financial conditions that favor such trends.
π Yield Curves and Recession Indicators
The conversation includes an analysis of yield curves and their inversion, which typically precedes a recession. The speaker questions the abnormal duration of the inversion without significant economic downturn and explores the reasons behind it. They discuss the Fed's actions, the resilience of financial institutions, and the unique aspects of the current economic environment that may lead to a different kind of recession cycle.
π¦ Banking Sector Challenges and Community Banks
The speaker and Andy discuss recent troubles in the banking sector, including issues with Silicon Valley Bank and New York Community Bank. They argue that while there will always be challenges for small banks, the overall banking system remains resilient. They emphasize the importance of community banks in the US and the regulatory support they receive to ensure their survival and competitiveness.
π§ Upcoming FOMC Meeting and Monetary Policy
The speaker asks Andy for a preview of the upcoming FOMC meeting. They discuss the expected outcomes, including the rate decision, the Statement, the SEP (Summary of Economic Projections), and the press conference. Andy focuses on the potential changes in the SEP, the implications of the recent economic data, and the Fed's long-term interest rate targets. They also touch on the possibility of further discussions on quantitative tightening.
π€ Final Thoughts and Resources
The speaker concludes the conversation with Andy, thanking him for his insights and discussing the importance of following their work. They provide resources for listeners to learn more about Damspring and Andy's collaboration with Nick, including their Twitter handles and websites.
Mindmap
Keywords
π‘Aura
π‘Cybercrime
π‘Inflation
π‘Federal Reserve (FED)
π‘Cryptocurrency
π‘Supply Chain Disruptions
π‘Quantitative Tightening
π‘Interest Rates
π‘Financial Conditions
π‘Taylor Rule
π‘Mantra
Highlights
The importance of online safety is emphasized, with the introduction of Aura, an AI-powered application designed to protect users from cybercrime.
The discussion highlights the prevalence of cybercrime and scams, with one in four people falling victim, especially in the cryptocurrency space.
The guest, Andy, shares his experience with a new plant and the engagement he received from his followers on social media, showcasing the impact of social media on personal life.
The conversation delves into the recent CPI print and the signs of a slight economic reheating, indicating a complex economic landscape.
Andy's long-term call on inflation suggests that the reopening period's supply constraints led to significant inflation, which was transitory.
The expectation is that inflation will plateau at an unacceptable level for the FED, requiring patience before rate cuts occur.
The discussion touches on the potential for the FED to raise the target rate from 2%, with the consensus being that they will not do so prematurely.
The narrative of the FED changing its target before declaring victory is seen as a sign of weakness and unlikely to happen.
The conversation explores the impact of easy financial conditions since late October on inflation and the economy.
The FED's reluctance to change the target before achieving it is discussed, reflecting their commitment to meeting their objectives.
The potential for the FED to let inflation drift higher after reaching its target is considered, indicating a strategic approach to monetary policy.
The discussion highlights the challenges in managing financial conditions due to the shift towards a service economy and the reduced sensitivity to short-term interest rates.
The impact of long-term interest rates on the economy, particularly mortgage rates, is discussed, showing the importance of these rates in influencing financial conditions.
The FED's approach to easing back and the considerations for when to start are explored, highlighting the complexity of economic policy decisions.
The conversation includes a detailed analysis of the FED's potential actions at the upcoming FOMC meeting, providing insights into the decision-making process.
The importance of community banks in the US and their role in serving small businesses is discussed, emphasizing the value of a diverse banking system.
The potential changes in the FED's long-term target rate and the implications for the post-COVID economy are considered, reflecting on the evolving economic landscape.
Transcripts
hey everyone this episode is brought to
you by Aura the all-in-one application
that protects your safety online powered
by AI honestly it is worse to just be a
human that exists on the internet from a
safety perspective than it ever has been
before I'm constantly getting weird scam
phone calls from everyone I'm sure you
guys do too there are lots of weird
fishing attempts that are made to
internal employees at blockworks and on
Twitter so I have to do these posts that
hey I'll never ask you for money it just
is terrible the actual statistics is
that one in four people now fall victim
to cyber crime and if you operate in
crypto it is even worse you are more at
risk that's why we're happy to partner
up with aura here and I'm going to be
telling you all about them later in the
show hey everyone this episode is
brought to you by Mantra the security
first compliance focused L1 which is
onboarding the next wave of financial
institutions you're going to be hearing
all about them later in the show but for
now Mantra thanks for making this
episode possible all right everyone
welcome back to another episode of on
the margin today I'm joined by repeat
guest Andy constant the CEO of dam
spring advisers Andy welcome back to the
show how are you sir good to see you I
was just saying I've got very little
reason to complain these days I'm doing
pretty well um longtime listeners of the
Pod will
know I got a new plant my old plant died
I got a lot of comments new plant so for
you I was wondering I you know as we
were as I was in the green room waiting
to be brought on I was like he has a
plant in the back corner of his room and
of was and I didn't notice it was new I
got some I had some very eagle IED uh
YouTube followers who who were telling
me for weeks that my plant didn't look
very healthy and I said this actually
looks totally fine to me and then one
day one stock kind of bent in half I was
like that's weird that's never happened
was like every single one I was no you
know and I've kept it alive for like a
year and a half so I was kind of bummed
to see it go but the people didn't come
here to talk about plants uh we came
here to talk about macro Andy just
starting off at a high level um maybe we
could start with this recent CPI print
it it has felt a little bit like to me
and not to editorialize that you know
we're starting to see slightly signs of
reheating a little bit in the economy um
you know we can go through the CPI
numbers but do you agree with that
General sentiment or what's your sort of
thought on yeah so my call long term has
been that uh the um inflation had this
large um
reopening during a period of very um
tight Supply constraints due to supply
disruption that caused significant
inflation and that in fact was
transitory and it turned out to be so um
and so this as the supply chain as that
impulse of of reopening ended and the
supply chain uh got rebuilt um we saw
inflation fall but it's always been my
view that we would have inflation um
that would Plateau at a level that was
unacceptable to the FED um and I think
we're you know we approached closer to
Target than I expected but I think we're
now at a point where it's going to be
require a bit more patience before rate
Cuts occur for inflation to um stay
durably at Target and um you know I
think the numbers are beginning to show
that um it's partly I think due to the
extremely easy financial conditions that
have developed since late
October um
and I suspect we're going to see you
know inflation stay a substantially
above Target for a while um but you know
that's not certain and policy makers can
act um and so it's not a prediction but
that's been my bias and still is but I
but but I would like to say one thing
I'm never I without Supply disruptions
and without a whole bunch more
you know significantly larger than
current fiscal spending um I don't
expect inflation to Roar back I just
expect it to stay in the three to four
range for until the FED actually does
what it needs to do to kill it okay
that's a really good I'm I'm in that
camp with you as well now there have
been murmur I've seen little Snippets
here and there about um you know it's
kind of been a narrative that maybe the
fed and and chair Powell uh might raise
their target rate from 2% what do you
think about that idea I think he they
won't until uh they've got it durably at
2% and then consider raising it but I
don't think they will uh prematurely
raise the target so that they can
declare Victory because I think the
markets would uh would destroy them if
they were to do such a thing um and you
know that that would backfire so I think
that's unlik likely um at the same time
they do reg five every five years they
do re review their framework and you
know that starts in end of 2024 and
they'll announce something end of 2025
and sure they could have a different
Target yeah and that makes a lot of
sense to me actually basically the idea
would be that it's sort of a sign of
weakness from the FED if they were to
change their target before declaring
victory yeah I mean I think so um
certainly not showing a willingness to
um take pain in order to achieve your
target if you just raise your Target and
avoid to to avoid the pain okay so your
framework you know if I could sum it up
is that uh there the maybe the
persistent or almost like the the
standing level of inflation is going to
be a little higher than it's been in the
past the fed's still going to do
everything they can to get it down to 2%
but then maybe they'll let it drift
higher a little bit after that is that
about right yeah I you know I I don't
know that they will do everything they
can to get it to 2% I think they will uh
but that'll potentially put at in
Jeopardy their um you know their full
employment mandate uh right now it
doesn't seem like much risk to to as um
as Governor Waller said what's the rush
um it doesn't seem like there's a rush
to ease but um
we'll have to see um you know this is
where it gets difficult it has been easy
up till now this is where it gets
difficult can you say a little bit more
about the easy financial conditions that
we've had since October and just the you
know if we're if we're talking the FED
hasn't accomplished their mission I know
they've got a way that headline
inflation against unemployment but you
know if they they haven't even
accomplished their mission so far and
maybe they're starting to suspect that
inflation is going to be a little bit
more persistent ultimately like why are
we talking about rate cuts at all by the
end of the year right and and the answer
to that is you have to
project um they've said they are going
to start cutting before it gets to
Target and that makes sense because if
you don't do that the the economy has a
certain set of a bit of momentum and if
you uh wait till 2% you're going to see
it go past your Target on the downside
so I get that idea and that's a sensible
idea that you know it's like we know we
need to stop a mile away but we're going
30 knots in a battleship you take your
foot off the gas before you get to you
know you put your foot on the brake
before you get to a mile you know half a
mile out and you can't stop um so I get
that um but the and so there's this
economic momentum idea um so then the
question is is it time to to start
easing back
and what I think about um the economy
and why I think the FED pulls on the
short-term rate lever is because um
nobody at least in this economy and
certainly in most of the economies that
we've been aware of for most of our
Lives
um we're in more of a service economy
than ever before we don't consume
big heavy things that if you drop on
your foot it'll hurt we consume services
and so big things big Capital things
require financing um and we have less
financing than we've had in additional
additionally um most of the financing
that was done when people did borrow
borrow to consume uh on capital goods
was done at um a longer term fixed rate
and housing still is like that and so
that economy just isn't that sensitive
to short-term interest rates Banks
typically are very sensitive to
short-term interest rates because when
short-term interest rates are increased
they need to pay their depositors more
money if they need to pay their
depositors more money they need to
charge more on their loans those loans
are floating rate and so they go up but
the problem is that bank loans are just
not being financed floating anymore it's
mostly most of their assets are
long-term treasuries which they bought
and mortgages which are fixed rate um
and so you just don't have um that lever
just doesn't do much to um the borrowing
rate that affects the economy and so
when I talk about financial conditions I
talk about I'm talking about the rates
that matter to people who borrow um to
to consume and those rates are long-term
interest rates and so just looking at
mortgages for instance mortgages uh
interest rates in July were at around 7%
they climbed to about 8% on a 30-year
fixed and you know things looked pretty
damn tight in um October and then for a
variety of reasons I can go into the
market um decided that uh there wasn't
ample supply of bonds from the treasury
and has been rallying ever since and now
mortgage rates are sub
7% and so that has an impact
on the economy much more than during
that whole period of time they never
changed the short-term rate the
short-term rate was the same for that
whole period of time and yet Financial
conditions have very different response
when mortgages are 8% than when they're
at 7% so I consider most of the uh
Financial conditions indexes would
support that view the Goldman for
Goldman for instance has a pretty good
one um and it shows that we're as easy
as we've been pretty much the whole
tightening phase what is your thought on
whether or not the FED thinks that
they're at the appropriate uh
restriction in terms of financial
conditions right every single one of the
fed's members um when they're on um
uh primarily focus on the uh short-term
interest rate and whether that's
restrictive and they use a tailor Rule
and the tailor rule says there's a
certain expectation for inflation for
the long-term neutral rate and for GDP
and uh
if any of those things fall like if GDP
comes down or um inflation expectations
come down uh in order to keep the same
level of tightness you you have to uh
cut nominal interest rates and that's
been the narrative from the fed and in
the Dot Plot for over two years but it
really came to a head in December when
Waller focused everyone on it and the
immediate reaction to markets was this
was the pivot and uh the FED um saw that
despite putting an SCP which had 75
basis points of cuts in the December
fomc the Market put uh priced in almost
seven Cuts almost 175 basis points of
cuts and that was again an extreme
easing fueled asset price rallies as it
looked like a pivot um and it isn't the
rate particularly it's the pivot that
was the trigger and
so it really did the FED a disservice
and they've been walking that back ever
since but that's the idea and there's
still fed officials every day that come
on and say that the uh that the
um um Financial conditions are
restrictive um I don't see any evidence
of that at all except for the tayor
rule um there are a handful of fed
officials that do talk about and were
talking about in October how uh the
higher long-term interest rates like
that mortgage rate I was quoting you had
been doing some of the fed's work for
them um they really they've stopped
saying that and actually took it out of
the January um statement that Financial
conditions were tight um because on at
that on that particular aspect um
long-term interest rates were no longer
doing the feds work for them but they
really haven't done anything about that
they haven't they they have limited
ability to do it and they're also very
nervous about uh quantitative tightening
and the potential that um as the reverse
repo program goes toward zero that
there's going to be an accident in the
banking system that will cause them to
have to end QT
prematurely and so that was something
that was discussed in December and the
and then spoken about in the minutes in
January and then once again in January
and in This Time Pal got a bunch of
questions and um and both Williams and
Waller had to uh make speeches about it
um and Logan wrote a speech about it
each of these Governors talking about
their their desire to extend
quantitative tightening till they've
taking reserves down to where they think
they should be but potentially pausing
or slowing or tapering quantitative
tightening because of the potential risk
to the financial system and all that
created easy easier conditions as well
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them out hey everyone this episode is
brought to you by Mantra the security
first compliance focused L1 which is
onboarding the next wave of financial
institutions into web 3 so you guys have
heard me talk about Larry fin talking
about tokenization you've seen the clips
on CNBC you know that Larry and black
rock are very very excited about this
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opportunities for you and I highly
recommend you click the link at the
bottom of the show notes that'll know
that I sent you uh thanks very much
again mantra for making this possible
and again guys click the link at the
bottom of the show notes one of the
other things that the last time you and
I were chatting was and you you have
this great piece on I think you called
it script the only way to kill inflation
and I actually have you you organized
that as a five act play which I can
actually here if you give me a second I
can share my screen here uh so you can
see it but um yeah there are there are
these these five acts and act one is
higher for longer Island so hikes
continue and they don't achieve the goal
act two long end yield rise uh long end
yields rise to new highs which requires
a supply Catalyst act three is multiple
compression higher yields take the legs
out of the equity rally act four
earnings contractions the tightening of
act two and act three hit demand and
then finally you have Act five which is
recession Island Equity sell off
companies fire workers unemployment goes
down Etc uh it looked for a little while
uh like we were moving into um act three
of that play but it sort of looks like
that's been delayed uh can can you give
us your 100% so this script was written
in July of last year the supply Catalyst
came when the treasury decided to issue
a sign a significantly increased the
amount of long duration coupon bonds
that they um were going to issue and um
all of a sudden longer end yields began
to Rise um they peaked at around a
little over 5% on tens and
30s and sometime middle of September the
equity Market started following yields
um bond prices lower and that created
both an increase in yields and an
increase uh a decrease in multiples and
so we were solidly in act three until
Halloween and Janny Ellen decided to not
and by the way totally reasonable bond
yields when she decided to issue all
this coupon Bonds on July 31st had gone
up by 115 basis points sharply and so
she decided okay we'll take a break
we're not going to increase coupons
quite so much we're not going to
increase them at
all
um and the market just said gosh we can
absorb that Supply easily you should
have given us more and of course that
meant interest rates fell Equity prices
rallied and here we are back in Act
One um and I said literally that day um
you know Janet has rewound the script to
act one um
and I think we're actually given the way
bonds are trading they're not quite as
low in yield as they were last July
there are a lot of bonds slashing around
as a supply Catalyst like the
accumulation of what is now about 500
billion of coupon new money coupon
issuance per quarter is
Supply
overhang and yields are starting to rise
they're just they're well off where they
they're well higher than where they were
when this was announced in febru on
January 31st so I think we're in act too
but the multiple compression is nowhere
yet to be seen it has probably surprised
a lot of the commentators I think that
um frankly equities have done so well
within the last uh couple months right
um it sort of at least when I was
looking at 2023 it made sense to me
there's some amount of reversion to the
mean um after the horrendous year that
2022 was um but then at least I was sort
of looking at it and questioning is this
rally gonna extend and we've sort of
broken into new all-time highs and the
market does seem to be shrugging off
even these signs that you and I were
talking about at the beginning of the
podcast about well maybe inflation is
heating back up a little bit just sort
of feels like everyone wants to wants to
go what's your what's your take on that
yeah so I mean I think clearly equities
have been doing great and it's become a
little bit more Broad and you know that
is a a significant change but I think
it's also important to um look back at
what actually has happened and you know
most of the return in equities for the
last two months and the last 14 months
has been um
very narrow very very narrow um the and
that is
um for instance um this year and I wrote
ran this a couple of days ago this year
of the S&P
return
um
32% of the return is
NVIDIA and 11% of it is in meta and 7%
of it is in
Microsoft and that's really it you know
there are a handful of other stocks and
if you look at those returns for the
last two
years uh not last 14 months 18% of the
S&P Total return of I think it's around
30% for the the um 14 months 18% of that
is NVIDIA so there's definitely
some thing to the idea that this is all
about uh
Ai and so okay so what does that mean
well it means a lot of things um you
know without determining whether you
know AI is realistic or the stocks are
realistic it's just a fact that the
market has um largely been up in a in a
very very historically narrow way
yeah well I mean one other data point to
add to the AI story is obviously Bitcoin
and crypto is back to the highs right
Bitcoin has been making new all-time
highs as well U now I would put myself
in the camp of a I'm probably in this
True Believer camp that I'm I'm a big
supporter of that but I also am a
realist and I understand how the rest of
the market views that and I'm deep
enough in the ecosystems know a lot of
the stuff that is going up right now
doesn't make an enormous amount of sense
so you know when you pair those two data
points together
maybe it does Point towards slightly
brothier rally
than yeah I mean it would I'm I I don't
know anything about Bitcoin really you
know I'm just a amateur on that but when
I look at it and think um you know when
I was trading around 30,000 and sort of
just really sort of solidly not much
volatility not much
anything I was thinking you know it
really has become responsive to
financial conditions like a digital gold
and I thought that was great I thought
it was great for Bitcoin and for
whatever reason um both gold and Bitcoin
and silver and other precious metal the
precious metals
broadly have all gone up a lot in the
last um few months um the specifics on
bitcoin you know the flows on bitcoin
it's the ETFs all that sort of stuff are
super exciting for people that know but
not for me it does seem like that um
uh there is a bit more froth than it
being digital gold
again yeah that may be welld deserved
but it's um it's significantly
outperforming what I consider the its
base value which is the value of it as
money and so why I I think it's
consistent with Easy Financial
conditions it certainly looks like that
I was looking you know I mean you are
much more of a student of of markets
than me and I was just trying to get a
sense of how long I mean you know last
time you and I were together we were
talking about term Premia compressing
and if you look at the the yield curve
has been inverted the twos and the 10
have been inverted now since you know
for coming up on two years and I I guess
I'm just curious you know with the full
span of of history I mean how I I sort
of had 18 months in my in my rattling
around my brain as typically you know
post a a yield curve inversion that's
when we get a recession um is it
abnormal for the yield curve to be
inverted for this long without any like
much negative economic activity what do
you think that takes me back to the our
the thing we started with which is um
long-term interest rates just are not
restrictive yeah so the the reason why
yield curves get
inverted and then the economy goes into
a recession is because the
inversion makes it very unattractive to
own long-term
treasuries and so their yields rise so
the the way the dis inversion occurs is
through what's called a bare steepener
where the long-term yields rise while
the short-term yields stay
fixed that's typ typically what
literally the FED is trying to do when
they raise short-term interest rates is
make long-term interest rates go up and
they failed to and I describe that as
being a supply problem that has been
undermined by the form of QT that they
decided to
use um and the treasury's decision to
use bills tap the RRP and all those
things and so my view and this is where
the script comes in my view is you don't
get a
recession until you raise long-term
interest rates and that's the goal of
the uh rise in short-term interest rates
now most people will say well you know
what usually happens is not a bare
steepener what usually happens is the
Fed breaks something and is forced to
cut rates and you get a bull steepener
and that's what causes a recession
it's the
breaking and that's true mostly and all
cycles in which you raise interest rates
short-term interest rates enough so that
Banks become in trouble and credit
becomes in trouble because they can't
afford to pay off their loans that's
when you have the financial system break
and it's
happened 2007 was obviously the big case
but 2001 in
1994 in 1989 in
1987 well back to the beginning of my
career financial markets break before
the before the long-term interest rates
rise this is just not that kind of
environment there's nothing to break
banks have had some duration exposure
which a few of them um broke but not
much
but the major Banks the major financial
institutions and the major corporates
even the less major corporates financed
all their
debt when interest rates were very low
and built Capital principally due to the
GFC um built Capital ratios up in the
banking system um and so are very
resilient and just aren't going to break
and so um I think this cycle ends when
you get the bare
steepener and that causes the economy to
slow through the script that I describe
but you know we we we don't know we may
get a magical disinflation and we may
get a soft landing and that's really the
expectation now that somehow this little
blip up in inflation won't persist and
we'll go back to zero uh to two to
Target and we will do it with no job LW
and if that
happens you're going to have
a Fed that cuts doesn't cut a lot but
Cuts enough to basically make the yield
curve go
flat Andy what do you think about you
know you're mentioning and and this the
whole idea of the FED breaking things I
think I know what your response is going
to be here but you know some people
would point to the troubles in the
banking sector over the course of the
last I don't know 15 months uh since I
think March of last year with Silicon
Valley Bank we just recently had uh New
York City Bank Corp um over here had to
get a bailout by I think it's it's Steve
nin's firm uh Liberty libertus Capital
uh1 billion dollar injection um I guess
I guess it maybe even answer where I
think you're going to go with this it
feels like sort of non-issues even if
you I'm for those of you who are
following Along on on video uh you know
you can see deposits at small
domestically chartered commercial Banks
you it's basically back to what it was
um even post the
Panic so it feels kind of like I'm guess
I'm answering my own question here but
it feels like the banking system's
actually fine what do you think so the
banking system has what it always has
which is recession exposure to uh the
weakest credits which in this
environment everyone knows is Office
Buildings and
um there are going to be credit losses
on Office Buildings um New York's New
York Community Bank was appears to me to
be a um you know a real failure to
manage their portfol to know what they
actually own in their portfolio and to
have it marked appropriately it was a
couple of loans associated with um rent
controlled housing in the in the New
York area those those those buildings
are full of people it's not it's not
like it's an office building that has no
they just marked the loan wrong um and
had to take a huge hit on that and it
lost confidence in management because
their controls weren't good so you're
gonna always have things like that and
I'm sure that we're going to have many
small banks that are going to struggle
in a
recession with their loan book because
they always do um but first you need the
recession you're not going to get the
break until people can't
pay yeah really well said Andy I've got
I've got one more question for you on
this and I want to actually have you
dust off your your old crystal ball we
got the fomc coming up this week and I'm
curious to get a preview from your
standpoint of what we should expect um
maybe there's a pedantic or sort of
silly question but it feels like I mean
if you look at just the history of
banking and um sort of small we used to
have even going all the way back to the
50s and 60s like many many sort of small
community oriented Banks and like up to
somewhere around like 50 60,000
something like that and you can look at
this chart of the amount of banks here
in the US and it's just a one-way trip
down and various uh
Financial uh you know disasters have led
to smaller Banks uh being absorbed with
by larger banks with bigger balance
sheets um and there's some amount of
that just makes a lot of sense right you
could view that for a very capitalist
lens creative destruction uh this is
just the way that it should go on the
other hand and um honestly just from my
experience with block works as a you
know we were a bootstrap for the first
five years of our existence um you know
getting credit as a small business has
never been particularly easy and it's
not getting easier with uh only having
these large Banks and you know covid was
another sort of eye opener for me when
there was all that stimulus that was
going out and I just assumed I just kind
of assumed that Corporate America big
businesses employed most people but I
had it wrong actually it's two-thirds of
people in the US are Ed by small
business and it seems to me there's this
sort of problem where if you have a big
Bank they're not bad people they're not
evil uh it's just they're customers it
makes sense for them to serve Amazon of
the Amazon of the world or the Walmarts
of the world uh and so it does feel like
there's a little bit of a mismatch in
terms of the job providers here in the
US and who has access to credit does
that make sense I don't know if that
what do you think about that view well I
mean I think the first thing that you
have to do is put the US Bank banking
system in context with most of the
developed world and in most of the
developed World there are you know four
banks in your
country um you might have some credit
unions you might have some people that
can extend credit but basically the US
has a unique and diverse and Broad
banking system that has gotten less
broad but still has last I looked has
6,000 banking it's institutions that are
federally
chartered um and that's a that
uh you know people don't understand why
we don't tax gas more people in Europe
see their gas is very very expensive and
tax very high and all
that and people just don't have a sense
of the scale of the country it's really
big and really far apart and people live
very far apart and Community Banks are
are an important aspect of the way
Americans businesses and people live and
so I think there's and I would say there
is a very strong and it was a lot a lot
of the discussion in the um um pal
testimonies uh last week last week um
were about this very topic uh there is
favoritism played by our country and its
regulators to ensure that the community
banking system has uh competitive
advantages so that it can survive
because it's it's wanted by our populace
and our and our elected officials to
remain now on the margin is it a good
idea or a bad idea I think it's like you
know the other things that make us a
unique country is uh it's sort of
necessary you just can't have Chase
Manhattan service the entire country it
just is Not
Practical yeah that's a really good
point I agree with that um you know that
I was gonna say you know those like Leo
DiCaprio memes where he's pointing and
he said on the margin anyway Tree for Me
Right Andy uh we've got an fomc coming
up this next week um what can listeners
expect what do you think well you know
there's no surprise about the rate the
rate's going to be kept at the same um
and so there's three uh things to look
at and um those are the uh at 2:00 we'll
get the statement
which won't have much to
it and then we'll get the uh
SCP um which uh I'll get to and then
lastly we'll have the press conference
and
so um coming to the SCP that's what I'll
I'll be focused on and and
um the message that the FED gives will
be encoded in that document um as of um
the last
quarterly report which was in December
the FED projected that they were going
to cut interest rates by 75 basis
points in
2024 and so that's the that's the
important headline do they change that
um the next thing that people will focus
on if they don't change it even if they
do but is why they have acted on that
rate either by not changing it or really
the only potential outcome is they
change it to two cuts versus three there
isn't a likely outcome for four Cuts uh
just so let me just step back and say
that document takes 19 votes and calcul
the
median
expectation and so that means the 10th
vote if 10 are on three Cuts or less it
prints three Cuts if 10 are on two cuts
or more or sorry three Cuts or more it
prints three if they're two cuts or less
it prints two and six of the governors
are at three cuts and four are at two
cuts based on September December's SCP
and then there are some extreme guys and
the the extreme guys don't affect the
medium they're all probably going to
head toward the middle though I think
the bias is to in Broad Strokes is less
cuts um they're all going to head they
may all head to the middle but it'll
really depend on whether two
guys men or women go from six Cuts three
cuts to two cuts or not if two go
we see two cuts priced uh um in the
SCP now does that matter well in a
voting institution the median really
matters but that assumes that they're
actually going to not have a they're
going to allow a vote that is not
unanimous which is very unusual so they
do it it's an important data point we'll
see how it plays out the other things
are that are interesting that are that
drive that decision by this
so-called tailor rule are um whether the
U inflation expectation for 20124
changes which it most likely won't it'll
most likely stay where it is which was
already pretty low at around I believe
it was
2.4 um and then the other question is
what the GDP print will be and it was at
1.2 which is very low and so it's
possible that rate could go up to to 1.5
or something like that um and that might
be enough to get somebody to flip two
people to flip from three cuts to two
cuts um we don't know um and then the
last thing which you're hearing um again
with the fed you hear lots of different
opinions
um is the long-term interest rate and
that'll be seen in the in the in the
what they talk about is their long-term
Target um it has been two and a half
for I think four full years now um and
so the question is is the postco
environment one in which uh the economy
is going
to um require higher real interest rates
higher neutral rate than before um and I
think the answer to that is without a
doubt and if you ask on the productivity
that boost of AI to some future it's
without a doubt it's higher but the FED
has been very unwilling to move so it'll
be interesting to see if any of them
move um that rate higher so the way I
look at it is um the SCP is either going
to be really not much change or slightly
more
hawkish um and I think the press
conference will just follow that
outcome um pal has a very very difficult
time being hawkish but at the same time
Financial conditions have ex become
extremely easy and so may want to do a
Jackson Hole like mic drop on financial
conditions but you know
that's who knows
um and I guess the last thing will be
any details on quantitative tightening
they're they're they're destined um to
have another conversation about the me
mecs of when based on what will they
taper and um while I don't expect that
to be in the in the um in the statement
pal will get a question on that my guess
is he'll kick it down the road because
with the RRP now at 500 billion plus
there's no reason to
rush but we'll see and so that's a full
outlook for the fomc and what to look
for that's a great Outlook Andy I really
appreciate you Dustin off that old
crystal ball for us and um I'm sure we
could keep going for hours here but we
got a we got a wind down um I really
appreciate the time as always and I want
to give a shout out to uh you and your
fellow gry beard Nick who we didn't have
on today but uh I always enjoy your guys
content and um if folks want to find out
either more about damp spring or the
work that you do with Nick um what's the
best way for people to find out well the
best way is to follow me at damp spring
or Nick and I at two gray beards or to
go in our websites which are are those
Twitter handles.com
awesome all right guys um you've heard
Andy on the show before highly recommend
that you definitely go follow him and uh
yeah check out his work so Andy as
always a pleasure to talk thank you so
much for hopping on today thanks
[Music]
m
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