Is It Different This Time? A New Take on Fed Policies and Inflation

In this episode, I explore whether rising interest rates truly curb inflation or inadvertently widen the economic divide between the haves and have-nots. Some are starting to challenge traditional economic theories and ask, "Is it different this time?" The above explores a new concept that is sweeping credit and equity desks. Hope you can tune in. Comments welcome. Thanks for watching. 
David Nelson, CFA - Host of the Money Runner

Transcript

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There's a battle brewing on Wall Street and it's starting to impact Main Street, forcing many market professionals to question traditional thinking on monetary policy and with it, how to position risk assets. We all know the phrase The Fed keeps on hiking until something breaks. The theory being that after you break a few things the economy starts to slow, employment softens, and the shock to you drive consumer finally falls into the abyss. Lack of demand. Forces, prices lower and the cycle starts all over again. But today, we're starting to hear voices push back on that theory, saying, wait for it. It's different this time. Welcome to the Money Runner. I'm David Nelson It's ambiguous at best whether a higher interest rate helps bring down inflation versus actually contributes to it. That's from Rick Rieder, head of the Global Allocation team at BlackRock. In a Bloomberg interview. He suggests that interest expenses for consumers are growing and for those with lower incomes, a much higher percentage of their net worth is debt. Rick argues that at a certain level, higher rates actually contribute to inflation. Not only do small companies get hurt and those with lower incomes get hurt and of course, small banks get hurt, but in some ways it actually helps divide up both the corporate and private sector between the haves and the have nots. You've heard me say it on this podcast before. If you're at the top of the income pyramid, you're doing just fine. Asset inflation has its advantages, especially if you are long real estate and stocks. Trading down at the supermarket and even avoiding fast food restaurants. What many Americans at the bottom of the income ladder are forced to live with each and every day. Small companies don't have the fortress like balance sheets that Apple or Microsoft have, but they still have to fund working capital. Mega-Cap companies are sitting on a ton of cash and much of their debt was funded at much lower rates. The top ten companies in the S&P 500, as of their last filing, have over 400 billion in cash, likely earning at least 5% interest. That's serious money. The list goes on. This is from Jack Manley at J.P. Morgan. We're not going to see a meaningful downward pressure on inflation until we see downward pressure on shelter costs. And you're not going to see meaningful downward pressure on shelter costs until the Fed lowers rates. Mortgages come down to a more reasonable level and supply comes back online. In other words, no one can sell their home and give up that low mortgage rate. Buying a new home is unaffordable with rates this high. Both Rick and Jack believe that even with a modest reduction in rates, supply would come back online, forcing prices lower, provide some relief to shelter inflation, government spending and with it, the share of economic output influenced by government outlays is on the rise. Higher rates are doing nothing to slow down that spending. Trust me, there's no one in the administration looking at elevated rates and saying, Hey, we should pull back because the cost of debt is too high. This is from the Congressional Budget Office. Federal outlays in 2024 total 6.5 trillion, which amounts to 23.1% of GDP. We all know which direction that number is going. The calls for the Fed to cut rates to lower inflation continues to spread. Starwood Capital CEO Barry Stearn late Wednesday on CNBC said Fed rate hikes aren't impacting the job market. He says we've added a million jobs in construction and we've added them even though we increased rates 500 basis points. Why? Data centers, the transportation bill, the Chips Act, etc.. In other words, Barry doesn't believe the Fed has the right tools and the playbook is not working. We'll see if Barry's right when we get a look at the May jobs report. The comments above beg. The question is what? We are witnessing a frustration from the investment community that so desperately wants rate cuts and are willing to buy into any theory that supports that view or does it make sense at this point in the cycle to think outside the box? The Fed believes, at least if we take them at their word, that they need to hold rates in restrictive territory until they break the back of inflation. If history is any guide, they will get that wrong. The lag effect in monetary policy is so big that the timing of interest rate changes is as much art as it is science. Economist Milton Friedman and Anna Schwartz, in their book, A Program for Monetary Stability, wrote There is much evidence that monetary changes have their effect only after a considerable lag and over a long period. And that lag is rather variable. If the above is true, then waiting for inflation to hit 2% target or even waiting for it to approach that target might be a bridge too far. The soft landing they hoped to engineer could prove elusive. Markets react to all sorts of stimulus, and the above could be feeding the bullish narrative. Wednesday's better than expected ISM Services number helped spark a rally in risk assets. In addition, the softer than expected ADP payroll numbers gave hope to bond bulls that the employment picture is starting to ease. Whatever the reason, risk assets are starting to sniff it out. Wednesday's massive surge in tech up better than 2% and the Nasdaq 100 at another all time high is in part being driven by Fed funds bets. In the space of just 48 hours, market sentiment has shifted from higher for longer to we just might get two cuts before the end of the year. The phrase it's different this time is frightening for many, especially those of us who uttered those same words during the dot com boom that went bust. From the ashes of that fire. sale we said we'll never make that mistake again. Well, like most things in life, the truth rarely lives on the extreme. And perhaps there is a more solid middle ground we can explore. Contrary to Fed thinking, I don't believe one or two cuts would be the end of life as we know it. A couple of modest 25 basis point cuts to take the edge off the mortgage market will quickly bear fruit or won't. Putting the car into neutral. Is it the same as stepping on the accelerator? The Fed funds real rate is in restrictive territory and more than 100 basis points above the average for the last half century. Throwing in with Rick, Barry and Jack, the Fed should cut rates at least two times before the year's out. Even better, they should cut right now. There I’ve said it. Sometimes it is different. Thanks for sharing your time today. We know you have choices and I hope you'll come back for more. Don't forget to visit our Substack site. DCNELSON123@SUBSTACK.COM I'm David Nelson. And this is the Money Runner.