WEBVTT - At the Money: How To Know When The Fed Will Cut

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<v Speaker 1>Beautiful God.

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<v Speaker 2>Over the past few years, it seems as if markets

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<v Speaker 2>have been obsessed with Federal Reserve action, first the rate

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<v Speaker 2>hiking cycle and now quote unquote the inevitable rate cuts.

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<v Speaker 2>Investors might find it useful to know when is the

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<v Speaker 2>FED going to start a new cycle of cutting rates.

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<v Speaker 2>As it turns out, there's specific data you should be

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<v Speaker 2>looking at to know when that cycle might begin. I'm

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<v Speaker 2>Barry Ridhelts, and on today's edition of At the Money,

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<v Speaker 2>we're going to discuss how you can tell when the

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<v Speaker 2>Fed is going to start cutting rates. To help us

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<v Speaker 2>unpack all of this and what it means for your portfolio,

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<v Speaker 2>let's bring in Jim Bianco, chief strategist at Bianco Research.

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<v Speaker 2>His firm has been providing objective, an unconventional research and

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<v Speaker 2>commentary to portfolio managers since nineteen ninety and it's top

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<v Speaker 2>rated amongst institutional traders. So Jim, let's just start with

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<v Speaker 2>the basics. How significant are rate cuts or hikes to

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<v Speaker 2>the typical market cycle?

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<v Speaker 3>How much do they really matter?

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<v Speaker 1>Thanks for having me, Berry, and the answer is they

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<v Speaker 1>matter more now than they have, say, over the last

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<v Speaker 1>fifteen years, for a very simple reason. There is a

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<v Speaker 1>yield again in the bond market. And as my friend

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<v Speaker 1>Jim Grant likes to say, who writes the newsletter, Grant's

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<v Speaker 1>Interest Rate Observer, it's nice to have an interest rate

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<v Speaker 1>to observe again, And because of that, we've got a

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<v Speaker 1>whole different dynamic. Well, in twenty nineteen, when your average

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<v Speaker 1>money market fund was yielding zero and your average bond

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<v Speaker 1>fund was yielding two percent, we used to scream, Tina,

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<v Speaker 1>there is no alternative. You can't sit there in a

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<v Speaker 1>zero money market fund. You got to move up the

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<v Speaker 1>risk curve to stocks, and you've got to, you know,

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<v Speaker 1>try and get some kind of reward from it. Well,

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<v Speaker 1>in twenty twenty four, now a money market fund is

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<v Speaker 1>yielding five point three percent and a bond fund is

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<v Speaker 1>yielding around four point eight to five percent. Well, that's

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<v Speaker 1>two thirds of what you can expect out of the

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<v Speaker 1>stock market. And especially if we wanted to stick with

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<v Speaker 1>a money market fund and virtually no market risk, because

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<v Speaker 1>it has an neev of one dollar every day, and

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<v Speaker 1>there's a fair number of people will say seventy percent,

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<v Speaker 1>two thirds of the stock market without any risk at

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<v Speaker 1>all market risk, that is sign me up for that.

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<v Speaker 2>So let's talk about raising and lowering rates. I have

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<v Speaker 2>to go back to twenty twenty two when the Fed

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<v Speaker 2>began their rate hiking cycle. It seems like a lot

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<v Speaker 2>of investors were blindsided by what was arguably the most

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<v Speaker 2>aggressive tightening cycle since since Paul Volker five hundred and

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<v Speaker 2>twenty five basis points in about eighteen months. Why, given

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<v Speaker 2>what had happened with CPI inflation spiking, why were investors

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<v Speaker 2>so blindsided by that.

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<v Speaker 1>They had gone forty years without seeing inflation and they

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<v Speaker 1>couldn't believe that inflation was going to return. And the

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<v Speaker 1>typical economist actually was arguing that there is no more

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<v Speaker 1>inflation again. And I might add to this day, the

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<v Speaker 1>typical economist still argues that we don't have inflation.

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<v Speaker 3>Now.

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<v Speaker 1>I'm fond of saying that the term two things could

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<v Speaker 1>be true at once. And what you saw in twenty

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<v Speaker 1>twenty two, twenty twenty one, and twenty two two is

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<v Speaker 1>transitory inflation that got us to nine percent on CPI.

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<v Speaker 1>But once that transitory element of nine percent is settled out,

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<v Speaker 1>what I believe we're starting to see more and more

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<v Speaker 1>of is there is a new underlying higher inflation level.

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<v Speaker 1>It is not two percent, It is more like three

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<v Speaker 1>to four percent inflation, not as I like to say,

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<v Speaker 1>it's not eight ten or Zimbabwe. It's three to four percent.

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<v Speaker 1>And that three to four percent is what's got the

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<v Speaker 1>Fed slow in cutting rates. It's got people debating whether

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<v Speaker 1>or not interest rates should come down more or go

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<v Speaker 1>up more. So, yes, we had transitory inflation because of

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<v Speaker 1>the lockdowns and the supply train constraints, and that has

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<v Speaker 1>gone away, but left in its wake is a higher

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<v Speaker 1>level of inflation, and that is the debate that we're

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<v Speaker 1>having right now. And if we have a higher level

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<v Speaker 1>of inflation, that is going to weigh heavily on monetary policy.

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<v Speaker 3>He hadn't done them any good.

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<v Speaker 2>So in the mid nineties, where were rates? How high

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<v Speaker 2>had they gone up? And then how much lower had

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<v Speaker 2>the Fed taken them?

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<v Speaker 1>So they were at six percent at their peak in

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<v Speaker 1>late nineteen ninety four, and the Fed started to cut

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<v Speaker 1>rates and then they eventually wound up a cutting them

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<v Speaker 1>all the way down to three percent. At that point,

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<v Speaker 1>we thought that three percent was a microscopically low interest rate.

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<v Speaker 1>We know what we were in star Forth over the

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<v Speaker 1>next twenty years, So those rates were not very different

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<v Speaker 1>than the rates that we're seeing today with the FED

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<v Speaker 1>being a five to five and a quarter and with

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<v Speaker 1>the bond with the yield and the ten year Treasury

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<v Speaker 1>at around four fifteen to four twenty, so we're kind

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<v Speaker 1>of in the same range that we've seen that.

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<v Speaker 2>So if I'm an investor and I want to know

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<v Speaker 2>the best data series to track and the levels to

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<v Speaker 2>pay attention to, that are going to give me a

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<v Speaker 2>heads up that, hey, the FED is really going to

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<v Speaker 2>start cutting rates. Now what should I be looking at

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<v Speaker 2>and what are the levels that suggest? Okay, now the

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<v Speaker 2>FED is going to be comfortable, maybe not cutting them

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<v Speaker 2>in half the way they did in the mid nineties,

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<v Speaker 2>but certainly taking rates from five to five and a

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<v Speaker 2>quarter down to four to four and a quarter four

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<v Speaker 2>and a half something like that.

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<v Speaker 1>So one forward looking measure and one kind of backward

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<v Speaker 1>looking measure that matters for the FED. The forward looking

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<v Speaker 1>measure is going to be probably the labor market. What

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<v Speaker 1>the FED is most concerned about is higher interest rates.

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<v Speaker 1>Are they going to weigh on business borrowing costs and

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<v Speaker 1>reduce their propensity or willingness to continue to hire workers.

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<v Speaker 1>So let's look at the initial claims for unemployment insurance.

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<v Speaker 1>It's a number that's put out every Thursday for the

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<v Speaker 1>previous week initial claims. Everybody has unemployment insurance. It's a

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<v Speaker 1>state program BUERAFU label. Statistic just aggregates to fifty states

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<v Speaker 1>and puts out that number on a seasonally adjusted basis.

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<v Speaker 1>It's in the low two hundred thousands right now. That

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<v Speaker 1>is over the last fifty years, an extraordinarily low number,

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<v Speaker 1>you start to and so if it goes up to

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<v Speaker 1>two twenty five or two forty, it's still a low number.

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<v Speaker 1>I think if you start seeing it, you know, start

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<v Speaker 1>pushing two seventy five or above three hundred thousand, are

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<v Speaker 1>that means new recipients for unemployment insurance that week? Then

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<v Speaker 1>I start thinking that, you know, there is a real

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<v Speaker 1>problem starting to brew in the labor market. The Fed

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<v Speaker 1>will see that too, and the propensity for them to

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<v Speaker 1>cut will grow. And I want to emphasize here two

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<v Speaker 1>hundred thousand on Wall Street tends to kind of get

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<v Speaker 1>themselves myopic. Here, Oh, it went from two hundred thousand

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<v Speaker 1>to two hundred and twenty five, two hundred and thirty thousand.

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<v Speaker 3>The labor market is weakening.

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<v Speaker 1>No, that's all noise down near the lowest numbers that

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<v Speaker 1>we've ever seen in fifty years. It's got to do

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<v Speaker 1>something more significant than that.

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<v Speaker 2>What's the best inflation data to track that? You know,

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<v Speaker 2>Jerome Powell is paying attention to.

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<v Speaker 1>So Pow likes this obtuse number. He likes it because

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<v Speaker 1>he made it up called cores supercore. So it's it's

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<v Speaker 1>it's inflation less house excuse me, less food, less energy,

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<v Speaker 1>and less housing services. Now before you roll your eyes

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<v Speaker 1>and go, so you're talking about inflation provided I don't eat,

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<v Speaker 1>I don't drive, and I don't live anywhere. Inflation ex

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<v Speaker 1>inflation right right, what's left over is driven by wages.

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<v Speaker 1>And why he looks at that is he's trying to say,

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<v Speaker 1>are we seeing a wage spiral?

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<v Speaker 3>Now? Why is a wage spiral important?

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<v Speaker 1>No one is against anybody getting a raise, But the

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<v Speaker 1>fact is, if everybody is getting a four percent raise,

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<v Speaker 1>you can afford three to four percent inflation. If everybody's

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<v Speaker 1>getting a five percent raise, you can afford four percent inflation.

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<v Speaker 1>And that's what they're most concerned about, is getting that

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<v Speaker 1>inflation spiral going with a wage spiral. So they look

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<v Speaker 1>at the super core number as a way to say, yes,

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<v Speaker 1>we understand that there's housing. We understand that there's driving,

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<v Speaker 1>we understand that there's eating, and there's inflation in those three.

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<v Speaker 1>But we also understand that there's way inflation in wages.

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<v Speaker 1>And that's what they're trying to do is look at wages,

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<v Speaker 1>and so that's probably the best measure to look at.

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<v Speaker 2>So I know what a data wonk and a market

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<v Speaker 2>historian you are, but I suspect a lot of investors,

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<v Speaker 2>a lot of listeners, may not know what happens to

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<v Speaker 2>the bond market and the equity market once the Fed

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<v Speaker 2>finally begins cutting rates.

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<v Speaker 1>It depends on why, because there's two scenarios in there.

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<v Speaker 1>If the Fed starts cutting rates like it did in

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<v Speaker 1>twenty twenty, or like it did in two thousand and eight,

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<v Speaker 1>or like it did even in two thousand and one,

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<v Speaker 1>and it's a panic, Oh my god, the economy is

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<v Speaker 1>falling apart. People are losing their jobs. We've got to

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<v Speaker 1>start to stimulate the economy. We have to stop a recession.

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<v Speaker 1>If they're cutting rates because of a panic, it doesn't work.

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<v Speaker 1>We had recessions every time they started doing that, last

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<v Speaker 1>one being twenty twenty when they saw what was happening

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<v Speaker 1>with COVID, and because it is projecting a recession, which

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<v Speaker 1>means less economic activity, lower earnings. It's usually a difficult

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<v Speaker 1>period for risk markets like the stock market or real

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<v Speaker 1>estate prices and the like. If the Fed is cutting

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<v Speaker 1>rates like they did in nineteen ninety five or like

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<v Speaker 1>they did in twenty nineteen, it's kind of a victory lap.

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<v Speaker 3>We did it.

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<v Speaker 1>We stopped the bad stuff from happening, our magic tool

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<v Speaker 1>of interest rates, accomplished everything that we need. Now we

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<v Speaker 1>don't need a restrictive rate anymore, and they back off

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<v Speaker 1>of that restrictive rate. Well ninety five and twenty nineteen,

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<v Speaker 1>risk markets took off. Now twenty nineteen was short lived

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<v Speaker 1>because then COVID gotten away, and that was an exogenous

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<v Speaker 1>event that was not financially related. But they were going

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<v Speaker 1>right up until the moment that COVID hit. So why

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<v Speaker 1>is the Fed cutting rates? It really matters more than

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<v Speaker 1>when will they cut rates? And right now what everybody's

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<v Speaker 1>hoping for is the why will be a victory lap.

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<v Speaker 1>We did it, We stopped that bad old inflation. It's

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<v Speaker 1>gotten back to our two percent target. We could go

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<v Speaker 1>back to the way we were pre pandemic. And then

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<v Speaker 1>once we're there. We could now start to back off

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<v Speaker 1>of this restrictive rate and everybody will celebrate that. Yay,

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<v Speaker 1>we're getting into straight relief without it being a signal

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<v Speaker 1>that the economy is falling.

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<v Speaker 2>So to wrap up, investors hoping for rate cuts should

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<v Speaker 2>be aware that sometimes there's a positive response when it's

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<v Speaker 2>a victory lap. Sometimes when it's revealing the economy is

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<v Speaker 2>softening or a recession is coming, tends not to be

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<v Speaker 2>good for stocks. Volatility tends to increase. It's a classic

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<v Speaker 2>case of be careful what you wish for. But if

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<v Speaker 2>you want to know what the Fed is going to do,

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<v Speaker 2>you should keep track of initial unemployment claims. When they

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<v Speaker 2>get up towards three hundred thousand per week, that's a

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<v Speaker 2>warning sign. And follow Chairman Pal's super core Inflation, where

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<v Speaker 2>he's looking at the rate of wage increases to determine

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<v Speaker 2>when the Fed begins its newest rate cutting cycle. I'm

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<v Speaker 2>Barry Retults and you've been listening to Bloomberg's at the Money, got.

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<v Speaker 3>Head. I know the first kind is the gems.

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<v Speaker 1>And it counts up bigger lucky, She's goose.

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<v Speaker 3>Then it comes laughing, she's worse.