Financial Conditions Remain Loose, How To Kill Inflation | Andy Constan

Summary

In 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

• 🌐 The importance of online safety is highlighted, with the mention of Aura, an AI-powered application, protecting against cybercrime and scams.
• 📈 Discussion on the current economic climate, particularly focusing on the CPI print and signs of economic reheating.
• 💹 Insights from Andy, CEO of Damspring Advisers, on the plateauing of inflation and the Federal Reserve's potential actions.
• 🏦 Commentary on the banking sector's resilience and the impact of small bank issues on the broader economy.
• 📊 Analysis of the yield curve inversion and its historical implications for recessions.
• 💬 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.
• 🤖 The impact of AI on the market and the significant returns in the stock market being driven by a narrow set of companies.
• 🚀 Discussion on the growth of Bitcoin and cryptocurrencies, and their response to financial conditions.
• 🏢 Consideration of the role and challenges of community banks in the US economy, and the importance of maintaining a diverse banking system.
• 📉 The script's mention of the recent troubles in the banking sector, including Silicon Valley Bank and New York Community Bank.
• 🎯 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

00:00

🌐 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.

05:02

📈 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.

10:05

💡 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.

15:06

🏠 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.

20:08

🛡️ 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.

25:08

🚀 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.

30:10

📊 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.

35:11

📈 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.

40:11

🏦 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.

🎧 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.

🎤 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.

Keywords

💡Aura

Aura is an all-in-one application mentioned in the transcript that focuses on protecting online safety through AI technology. It is designed to alert users when someone attempts to hack into their bank accounts or social media, offering 24/7 support to resolve any fraudulent issues. In the context of the video, Aura is a sponsor that provides a solution to the prevalent problem of cybercrime and phishing scams, which have become a significant concern for internet users, especially those operating in the crypto space.

💡Cybercrime

Cybercrime refers to criminal activities conducted via the internet, such as scam phone calls, phishing attempts, and other forms of online fraud. In the transcript, the speaker discusses the increasing prevalence of cybercrime and the challenges it poses to internet safety, emphasizing that it has become worse than ever before from a safety perspective.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. In the transcript, the discussion revolves around the recent CPI (Consumer Price Index) print and the speaker's views on the plateau of inflation at an unacceptable level to the Federal Reserve. The conversation touches on the transitory nature of inflation due to supply chain disruptions and the potential for inflation to remain higher than in the past.

💡Federal Reserve (FED)

The Federal Reserve, often referred to as the FED, is the central banking system of the United States, responsible for implementing monetary policy. In the transcript, the FED's role in managing inflation and its potential actions, such as rate cuts, are discussed. The speaker speculates on the FED's approach to maintaining inflation targets and the impact of its decisions on the broader economy.

💡Cryptocurrency

Cryptocurrency is a digital or virtual currency that uses cryptography for security. It is decentralized and operates on technology called blockchain, which is a distributed ledger enforced by a network of computers. In the transcript, the speaker mentions that those operating in the crypto space are at a higher risk of cybercrime, indicating the significant financial value and the target nature of cryptocurrency users.

💡Supply Chain Disruptions

Supply chain disruptions refer to interruptions or bottlenecks in the flow of goods and services from the point of origin to the point of consumption. In the context of the transcript, these disruptions are mentioned as a contributing factor to the significant inflation experienced during the reopening of the economy post-pandemic.

💡Quantitative Tightening

Quantitative tightening is the process by which a central bank reduces the size of its balance sheet by selling assets or allowing securities to mature without reinvesting. This is the opposite of quantitative easing, which involves increasing the money supply by buying assets. In the transcript, the speaker mentions the FED's concerns about quantitative tightening and its potential impact on the financial system.

💡Interest Rates

Interest rates are the cost of borrowing money or the return on investment for savings. Central banks, like the Federal Reserve, adjust interest rates to control inflation and stabilize the economy. In the transcript, the speaker discusses the FED's decisions on interest rates and their implications for the economy, including the possibility of rate cuts in the future.

💡Financial Conditions

Financial conditions refer to the cost and availability of credit and other financial resources in the economy. They are influenced by factors such as interest rates, credit spreads, and asset prices. In the transcript, the speaker talks about the ease of financial conditions since October and how they impact the economy more than short-term interest rates.

💡Taylor Rule

The Taylor Rule is an economic principle that suggests a way to adjust interest rates in response to changes in inflation and output gap (the difference between actual and potential output). It is used as a guideline by central banks, including the Federal Reserve, to maintain price stability and full employment. In the transcript, the speaker discusses the Taylor Rule in the context of the FED's decision-making process regarding interest rates.

💡Mantra

Mantra, as mentioned in the transcript, is a security-first compliance-focused Layer 1 (L1) blockchain project that aims to onboard the next wave of financial institutions into web 3. It is built using the Cosmos SDK and features interoperability and smart contracts, positioning it as a key player in the tokenization space.

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

hey everyone we partnered with aura for

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about it at the top of this episod

episode but cyber crime and fishing

scams have basically become the bane of

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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

idea and the reason for that is they're

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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

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